Item 1. Business
General
Klamath First Bancorp, Inc. ("Company"), an Oregon corporation, was organized on June 16, 1995 for the purpose of becoming the holding company for Klamath First Federal Savings and Loan Association ("Association") upon the Association's conversion from a federal mutual to a federal stock savings and loan association ("Conversion"). The Conversion was completed on October 4, 1995. At September 30, 2002, the Company had total assets of $1.5 billion, total deposits of $1.1 billion and shareholders' equity of $119.9 million. All references to the Company herein include the Association where applicable.
The Association was organized in 1934. The Association is regulated by the Office of Thrift Supervision ("OTS") and its deposits are insured up to applicable limits under the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Association also is a member of the Federal Home Loan Bank ("FHLB") System through the FHLB of Seattle.
In July 1997, the Association acquired 25 former First Interstate Bank branches from Wells Fargo Bank, N.A. The branches are located in rural communities throughout Oregon and expanded and complemented the then existing network of the Association's branches. The acquisition was accounted for as a purchase and resulted in the addition of approximately $241.3 million in deposits on the acquisition date of July 18, 1997.
In September 2001, the Association acquired 13 branches from Washington Mutual Bank ("WAMU"), 11 of which are located on the northern and southern Oregon coast and two of which are located in northeastern Oregon. These locations enhance the Association's geographic coverage on the coast and in northeastern Oregon. The acquisition was accounted for as a purchase and resulted in the addition of approximately $179.3 million in loans, assumption of $423.5 million in deposits, and addition of 124 experienced branch personnel on the acquisition date of September 7, 2001. As part of the purchase, the Company also recorded $15.0 million of core deposit intangible and $24.1 million of other intangible assets. See Note 2 of the Notes to Consolidated Financial Statements contained in the 2002 Annual Report to Shareholders ("Annual Report"), included as Exhibit 13 to this Form 10-K.
The Association is a progressive, community-oriented financial institution that focuses on serving customers within its primary market area. Accordingly, the Association is primarily engaged in attracting deposits from the general public through its offices and using those and other available sources of funds to originate permanent residential one- to four-family real estate loans within its market area, as well as commercial real estate and multi-family residential loans, loans to consumers, and loans for commercial purposes. At September 30, 2002, permanent residential one- to four-family real estate loans totaled $339.4 million, or 54.53% of total loans. While the Association has historically emphasized fixed rate mortgage lending, it has been diversifying its loan portfolio by focusing on increasing the number of originations of commercial real estate loans, multi-family residential loans, residential construction loans, small business loans and consumer loans. Significant progress was made toward increasing the commercial and consumer loans in the portfolio with the purchase of the branches from WAMU. These newer loan products generally carry adjustable rates, higher yields, or shorter terms than the traditional fixed rate mortgages. This lending strategy is designed to enhance earnings, reduce interest rate risk, and provide a more complete range of financial services to customers and the local communities served by the Association. At September 30, 2002, the Association's total loan portfolio consisted of 66.43% fixed rate and 33.57% adjustable rate loans, after deducting loans in process and non-performing loans.
Market Area
The Association continues to expand its market area in Oregon and Washington. Upon the acquisition of 13 branches from WAMU in September 2001, the Association had a presence in 26 of Oregon's 36 counties and had one
in-store branch in the state of Washington. In fiscal 2002, new in-store branches were opened in Hermiston, Eugene and Springfield, Oregon and Richland, Washington. Also during fiscal 2002, a second branch was opened in Medford, Oregon, expanding service to that community. The Association's primary market area, which encompasses the State of Oregon and some adjacent areas of California, Idaho, and Washington, can be characterized as a predominantly rural area containing a number of communities that are experiencing moderate to rapid population growth. The population growth in the market area, particularly in Southern Oregon, has been supported in large part by the agreeable climate, and by favorable real estate values. The economy of the market area is still based primarily on agriculture and lumber and wood products, but is experiencing diversification into light manufacturing, health care and other services and sectors. Tourism is a significant industry in many regions of the market area, including Central Oregon and the Oregon coast. The addition of branches in the Eugene-Springfield metropolitan area provides access to this major population center.
Yields Earned and Rates Paid
The following table sets forth, for the periods and at the date indicated, the weighted average yields earned on interest-earning assets, the weighted average interest rates paid on interest-bearing liabilities, and the interest rate spread between the weighted average yields earned and rates paid.
Average Balances, Net Interest Income and Yields Earned and Rates Paid
Reference is made to the section entitled "Average Balances, Net Interest Income and Yields Earned and Rates Paid" on page 13 of the Annual Report, which section is incorporated herein by reference.
Interest Sensitivity Gap Analysis
Reference is made to the section entitled "Interest Sensitivity Gap Analysis" on page 10 of the Annual Report, which section is incorporated herein by reference.
Rate/Volume Analysis
Reference is made to the section entitled "Rate/Volume Analysis" on page 14 of the Annual Report, which section is incorporated herein by reference.
Lending Activities
General. As a federally chartered savings and loan association, the Association has authority to originate and purchase loans secured by real estate located throughout the United States. With the expanded market area provided by the branch acquisitions in 1997 and 2001, the Association's mortgage lending has diversified throughout the state of Oregon. It is management's intention, subject to market conditions, that the Association will continue to originate long-term mortgage loans for the purchase, construction or refinance of one- to four-family residential real estate to meet the needs of customers in our market area. However, to enhance interest income and reduce interest rate risk, the Association is placing increased emphasis on the origination or purchase of adjustable rate loans secured by one- to four- family residential, multi-family residential and commercial real estate, the majority of which are located outside Klamath, Jackson, and Deschutes counties. Subject to market conditions, the Association sells loans to Fannie Mae (formerly the Federal National Mortgage Association) and other agents.
Permanent residential one- to four-family mortgage loans amounted to $339.4 million, or 54.53%, of the Association's total loan portfolio before net items at September 30, 2002. The Association originates other loans secured by multi-family residential and commercial real estate, construction and land loans. Those loans amounted to $137.6 million, or 22.11%, of the total loan portfolio before net items at September 30, 2002. Approximately 23.36%, or $145.4 million, of the Association's total loan portfolio before net items, as of September 30, 2002, consisted of non-real estate loans. Commercial real estate and non-real estate loans increased significantly as a result of the WAMU branch acquisition in September 2001. The acquisition included $179.3 million in loans, of which $118.8 million were commercial real estate and commercial business loans and $50.7 million were consumer loans. Fiscal 2002 showed continued growth in non-real estate loans.
Permissible loans-to-one borrower by the Association are generally limited to 15% of unimpaired capital and surplus. The Association's loan-to-one borrower limitation was $15.4 million at September 30, 2002. At September 30, 2002, the Association had 54 borrowing relationships with outstanding balances in excess of $1.0 million, the largest of which amounted to $7.2 million and consisted of eight loans, five of which were secured by commercial and single family real estate and three of which were unsecured.
The Association has emphasized the origination or purchase of adjustable rate loans in order to increase the interest rate sensitivity of its loan portfolio. The Association has been successful in expanding the production of adjustable rate consumer loans and has purchased adjustable rate single family, multi-family residential and non- residential real estate loans. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Market Risk and Asset/Liability Management" and "INTEREST SENSITIVITY GAP ANALYSIS" in the Annual Report. At September 30, 2002, $207.5 million, or 33.57%, of loans in the
Association's total loan portfolio after loans in process and non-performing loans, consisted of adjustable rate loans. At September 30, 2001, $203.7 million, or 29.43%, of the Association's loans carried adjustable rates.
Loan Portfolio Analysis. The following table sets forth the composition of the loan portfolio by type of loan at the dates indicated.
The following table sets forth the amount of fixed-rate and adjustable rate loans, net of loans in process and non-performing loans, included in the total loan portfolio at the dates indicated.
Permanent Residential One- to Four-Family Mortgage Loans. The primary lending activity of the Association has been the origination of permanent residential one- to four-family mortgage loans. Management believes that this policy of focusing on single-family residential mortgage loans has been successful in contributing to interest income while keeping delinquencies and losses to a minimum. At September 30, 2002, $339.4 million, or 54.53%, of the Association's total loan portfolio, before net items, consisted of permanent residential one- to four-family mortgage loans, down from $421.5 million at September 30, 2001. At September 30, 2002, the average balance of the Association's permanent residential one- to four-family mortgage loans was $78,397.
The Association presently originates both fixed-rate mortgage loans and adjustable rate mortgages ("ARMs") secured by one- to four-family properties with terms of 15 to 30 years. Historically, most of the loans originated by the Association have been fixed rate loans secured by one- to four-family properties. At September 30, 2002, $311.4 million, or 50.40%, of the total loans after loans in process and non-performing loans were fixed rate one- to four-family loans and $28.4 million, or 4.59%, were ARM loans. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment. In order to improve interest rate risk, the Association sells the majority of its conforming fixed rate one- to four-family mortgage production, while ARM loans are retained in the portfolio.
The loan fees charged, interest rates and other provisions of the Association's ARM loans are determined by the Association on the basis of its own pricing criteria and competitive market conditions. At September 30, 2002, the Association charged origination fees ranging from 1.00% to 1.75% on its ARM loans.
In an attempt to increase adjustable rate mortgages in the loan portfolio, the Association offers several loan products which are competitive with other institutions originating mortgages in the Association's primary market area. The Association has introduced variable rate loan products that bear fixed rates for the first three or five years and then reprice annually thereafter. The loans which bear fixed rates for five years are indexed to the One-Year Constant Maturity Treasury Bill Index and have a maximum rate increase of 5.00% over the life of the loan. The loans which bear fixed rates for the first three years are indexed to the FHLB of Seattle 12-Month Short Term Advance Rate and have a maximum increase of 6.00% over the life of the loan. All ARM loan products have a maximum increase or decrease of 2.00% in any one year. As a supplement to origination of ARM loans, the Association purchases ARMs from other institutions when suitable loans can be found which meet its underwriting criteria.
The Association qualifies an ARM loan borrower based on the borrower's ability to repay the loan using the fully indexed rate. As a result, the Association believes that the potential for delinquencies and defaults on ARM loans when rates adjust upwards is lessened.
The retention of ARM loans in the Association's loan portfolio helps reduce the Association's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased costs
due to changed rates to be paid by the customer. It is possible that, during periods of rising interest rates, the risk of default on ARM loans may increase as a result of repricing with increased costs to the borrower. The ARM loans originated by the Association generally provide, as a marketing incentive, for initial rates of interest below the rates which would apply were the adjustment index used for pricing initially (discounting). Increased risks of default or delinquency could occur because of discounting the rate. Another consideration is that although ARM loans allow the Association to increase the sensitivity of its asset base to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Because of these considerations, the Association has no assurance that yields on ARM loans will be sufficient to offset increases in the Association's cost of funds.
The loan-to-value ratio, maturity and other provisions of the loans made by the Association generally have reflected the policy of making loans in accordance with sound lending practices, market conditions and underwriting standards established by the Association. The Association's lending policies on permanent residential one- to four-family mortgage loans generally limit the maximum loan-to-value ratio to 97% of the lesser of the appraised value or purchase price of the property. All permanent residential one- to four-family mortgage loans in excess of an 80% loan-to-value ratio require private mortgage insurance.
The Association also has a limited amount of non-owner-occupied permanent residential one- to four-family mortgage loans in its portfolio. These loans are underwritten using generally the same criteria as owner-occupied permanent residential one- to four-family mortgage loans, except that the maximum loan-to-value ratio is generally 80% of the lesser of the appraised value or purchase price of the property and such loans are generally provided at an interest rate higher than owner-occupied loans.
The Association offers fixed-rate, permanent residential one- to four-family mortgage loans with terms of 15 to 30 years. Substantially all permanent one- to four-family loans have original contractual terms to maturity of 30 years. Such loans are amortized on a monthly basis with principal and interest due each month and customarily include "due-on-sale" clauses. The Association enforces due-on-sale clauses to the extent permitted under applicable laws. Substantially all of the Association's mortgage loan portfolio consists of conventional loans.
Commercial and Multi-Family Real Estate Loans. The Association originates loans secured by multi-family and commercial real estate and also purchases participations in loans secured by multi-family and commercial real estate when suitable investments can be found. See "-- Loan Originations, Purchases, and Sales." At September 30, 2002, $21.6 million, or 3.47%, of the Association's total loan portfolio before net items consisted of loans secured by existing multi-family residential real estate and $91.7 million, or 14.73%, of the Association's total loan portfolio before net items consisted of loans secured by existing commercial real estate. The Association's commercial and multi-family real estate loans primarily include loans secured by office buildings, small shopping centers, churches, mini-storage warehouses and apartment buildings. Substantially all of the Association's commercial and multi-family real estate loans are secured by properties located in the Association's primary market area. The average outstanding balance of commercial and multi-family real estate loans was $248,667 at September 30, 2002, the largest of which was a $3.5 million commercial real estate loan secured by a motel. Originations of commercial real estate and multi-family residential real estate amounted to 11.2%, 16.46% and 11.09% of the Association's total loan originations in the fiscal years ended September 30, 2002, 2001, and 2000, respectively. As part of the WAMU acquisition in September 2001, the Association purchased $9.1 million in multi-family residential loans and $54.6 million in commercial real estate loans. During the year ended September 30, 2002 the Association purchased $1.7 million in commercial real estate participations. The properties securing these loans were located within the Association's market area.
The Association's commercial and multi-family loans generally have terms which range up to 25 years and loan-to-value ratios of up to 75%. The Association currently originates fixed and adjustable rate commercial and multi-family real estate loans. Commercial real estate and multi-family adjustable rate loans are priced to be competitive with other commercial lenders in the Association's market area. A variety of terms are available to meet specific commercial and multi-family residential financing needs. As of September 30, 2002, $105.6 million, or 17.07%, after
loans in process and non-performing loans of other mortgage loans, including commercial and multi-family residential real estate loans, had adjustable rates of interest.
Multi-family residential and commercial real estate lending is generally considered to involve a higher degree of risk than permanent residential one- to four-family lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. The Association generally attempts to mitigate the risks associated with multi-family residential and commercial real estate lending by, among other things, lending on collateral located in its market area and following strict underwriting standards. Loans considered for purchase are subjected to the same underwriting standards as those originated in-house.
Construction Loans. The Association makes construction loans to individuals for the construction of their single-family residences. The Association also makes loans to builders for the construction of single-family residences which are not presold at the time of origination ("speculative loans") and for construction of commercial properties. Speculative loans are scheduled to pay off in 12 to 18 months. At September 30, 2002, construction loans amounted to $15.2 million (including $4.6 million of speculative loans), or 2.45%, of the Association's total loan portfolio before net items. The Association purchased $1.7 million in commercial construction loans from WAMU as part of the branch purchase. During the construction phase, the borrower pays only interest on the disbursed loan proceeds until maturity, when the total amount is due. The Association's construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. The Association periodically reviews the progress of the underlying construction project through physical inspections.
Construction financing is generally considered to involve a higher degree of risk of loss than financing on improved, owner-occupied real estate because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates and, in the case of speculative loans, the need to obtain a purchaser. The Association has sought to minimize the risks associated with construction lending by limiting construction loans to qualified owner-occupied borrowers with construction performed by qualified state licensed builders located primarily in the Association's market area. The Association's underwriting criteria are designed to evaluate and minimize the risks of each construction loan.
Loan proceeds are disbursed only as construction progresses and inspections warrant. These loans are underwritten to the same standards and to the same terms and requirements as one- to four-family purchase mortgage loans, except the loans provide for disbursement of funds during a construction period of up to one year. During this period, the borrower is required to make monthly payments of accrued interest on the outstanding loan balance. Disbursements during the construction period are limited to no more than the percent of completion. Up to 97% loan-to-value upon completion of construction may be disbursed if private mortgage insurance above 80% loan-to-value is in place.
Land Loans. The Association makes loans to individuals for the purpose of acquiring land upon which to build their permanent residence. These loans generally have 20 year amortization periods, with a balloon payment due in five years, and maximum loan-to-value ratios of 80%. As of September 30, 2002, $4.2 million, or 0.67%, of the Association's total loan portfolio consisted of land loans.
Commercial Business Lending. The purchase of the branches from WAMU in September 2001 included significant commercial business loans as well as the lending expertise needed for commercial lending activities. As a result, commercial business lending has increased due to both loans purchased from WAMU and new originations during fiscal 2002. The Association's commercial business lending activities focus primarily on small to medium size businesses owned by individuals well known to the Association and who reside in the Association's primary market area. At September 30, 2002, commercial business loans amounted to $62.1 million, or 9.98% of the total loan portfolio and
42.72% of total non-real estate loans. Included in these loans are $14.2 million of agricultural loans. See "-- Agricultural Lending."
Commercial business loans may be unsecured loans, but generally are secured by various types of business collateral other than real estate (such as, inventory, equipment, etc.). In many instances, however, such loans are often also secured by junior liens on real estate. Lines of credit are generally renewable and made for a one-year term and are generally variable rate indexed to the prime rate. Term loans are generally originated with three to five year maturities, with a maximum of seven years, on a fully amortizing basis. As with commercial real estate loans, the Association generally requires annual financial statements from its commercial business borrowers and, if the borrower is a corporation, personal guarantees from the principals.
Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential, commercial and multi-family real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan primarily depends on cash flow and profitability of the business, and creditworthiness of the borrower (and guarantors) and requires successful operation and management of the business entity while liquidation of the collateral is a secondary and sometimes insufficient source of repayment. Consequently, repayment of such loans may be affected by adverse business or economic conditions.
As part of its commercial business lending activities, the Association issues standby letters of credit or performance bonds as an accommodation to its borrowers. See "-- Loan Commitments and Letters of Credit."
Agricultural Lending. The Association did not offer loans on agricultural properties or for agricultural production until the WAMU branch acquisition, even though agriculture is a major industry in the Association's market area. As part of the WAMU branch acquisition, the Association purchased $4.2 million of agricultural real estate loans and $11.9 million of agricultural production loans, as well as obtaining lending personnel with expertise in originating and monitoring agricultural loans. At September 30, 2002, agricultural loans amounted to $19.1 million, or 3.07%, of the total loan portfolio; $4.9 million of these loans were secured by real estate.
In underwriting agricultural operating loans, the Association considers the cash flow of the borrower based upon the expected income stream as well as the value of collateral used to secure the loan. Collateral generally consists of livestock or cash crops produced by the farm, such as grains, corn, and alfalfa. In addition to considering cash flow and obtaining a blanket security interest in the farm's cash crop, the Association may also collateralize an operating loan with the equipment, breeding stock, real estate, and federal agricultural program payments to the borrower. Payments on agricultural operating loans depend on the successful operation of the farm, which may be adversely affected by weather conditions that limit crop yields, fluctuations in market prices for agricultural products and livestock, and changes in government regulations and subsidies.
Agricultural real estate loans primarily are secured by first liens on farmland and improvements thereon located in the Association's market area to service the needs of the Association's existing customers.
Among the greater and more common risks to agricultural lending can be weather conditions and disease. These risks can be mitigated through multi-peril crop insurance. Uncertain supplies of water in some market areas has the potential to decrease yields and increase energy costs for the Association's borrowers. However, very few of the Association's agricultural loans are secured by real estate or operations in the Klamath Basin, which was affected by
curtailment of irrigation water during the summer of 2001, and those being financed have liquid secondary sources of repayment. Commodity prices also present a risk which may be reduced by the use of set price contracts.
Federal savings and loan associations are authorized to make loans secured by business or agricultural real estate in amounts up to 400% of capital and to make additional loans to businesses and farms (which may, but need not be secured by real estate) in amounts up to 20% of assets provided that all loans in excess of the 10% of assets must be made to small businesses and farms that qualify as small businesses. Effective January 1, 2002 the OTS increased the dollar amount limit in the definition of small business loans from $1 million to $2 million and farm loans from $500,000 to $2 million. As of September 30, 2002, the Association was well within the regulatory limits for such business loans.
Consumer and Other Lending. The Association originates a variety of consumer loans. Such loans generally have shorter terms to maturity and higher interest rates than mortgage loans. At September 30, 2002, the Association's consumer loans totaled $83.3 million, or 13.38%, of the Association's total loans. A total of $50.6 million in consumer loans were added to the portfolio as part of the WAMU branch acquisition in September 2001. The Association's consumer loans consist primarily of home improvement and equity loans, automobile loans, boat and recreational vehicle loans, unsecured loans, and deposit account loans.
The Association has placed increasing emphasis on the origination of consumer loans due to their shorter terms and higher yields than residential mortgage loans. The Association anticipates that it will continue to be an active originator of these loans. Factors that may affect the ability of the Association to increase its originations in this area include the demand for such loans, interest rates and the state of the local and national economy.
The Association offers consumer lines of credit on either a secured or unsecured basis. Secured lines of credit are generally secured by a second mortgage on the borrower's primary residence. Secured and unsecured lines of credit have interest rates that vary above the prime lending rate based on the credit risk of the borrower, collateral, and loan amount. In both cases, the rate adjusts monthly. The Association requires minimum payment of interest only, and depending on the loan product, may require at least 2% of the unpaid principal balance monthly. At September 30, 2002, $29.4 million was outstanding on approved lines of credit.
The Association offers home equity and home improvement loans that are made on the security of primary residences. Loans normally have terms of up to 15 years requiring monthly payments of principal and interest. At September 30, 2002, home equity loans and home improvement loans amounted to $65.1 million, or 78.16% of consumer loans, and 10.46% of total loans.
At September 30, 2002, the Association's automobile loan portfolio amounted to $7.7 million, or 9.19%, of consumer loans and 1.23% of total loans at that date. The maximum term for the Association's automobile loans is 72 months with the amount financed based upon a percentage of purchase price. The Association generally requires all borrowers to maintain the automobile insurance, including collision, fire and theft, with a maximum allowable deductible and with the Association listed as loss payee.
At September 30, 2002, unsecured consumer loans amounted to $5.1 million, or less than 1%, of total loans. These loans are made for a maximum of 48 months or less with fixed rates of interest and are offered primarily to existing customers of the Association.
Consumer loans potentially have a greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles and other vehicles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At September 30, 2002, the Association had $248,000 in consumer loans accounted for on a nonaccrual basis.
Loan Maturity and Repricing. The following table sets forth certain information at September 30, 2002 regarding the dollar amount of total loans, after loans in process and non-performing loans, maturing in the Association's portfolio, based on the contractual terms to maturity or repricing date. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.
Scheduled contractual amortization of loans does not reflect the actual term of the Association's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which gives the Association the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.
The dollar amount of all loans, net of loans in process and non-performing loans, due one year after September 30, 2002, which have fixed interest rates and have adjustable rates, was $405.4 million and $90.8 million, respectively.
Loan Commitments. The Association issues commitments for fixed and adjustable rate loans conditioned upon the occurrence of certain events. Such commitments are made on specified terms and conditions and are honored for up to 60 days from commitment. The Association had outstanding loan commitments of approximately $33.0 million at September 30, 2002 consisting of $12.9 million of variable rate loans and $20.1 million of fixed rate loans. See Note 14 of the Notes to Consolidated Financial Statements contained in the Annual Report.
Loan Solicitation and Processing. The Association originates real estate and other loans at each of its offices. Loan originations are obtained by a variety of sources, including developers, builders, existing customers, newspapers, radio, periodical advertising and walk-in customers, although referrals from local realtors have been the primary source. Loan applications are taken by lending personnel, and the loan processing department obtains credit reports, appraisals and other documentation involved with a loan. All of the Association's lending is subject to its written nondiscriminatory underwriting standards, loan origination procedures and lending policies prescribed by the Association's Board of Directors. Property valuations are required on all real estate loans and are prepared by employees experienced in the field of real estate or by independent appraisers approved by the Association's Board of Directors. Additionally, all appraisals on loans in excess of $250,000 must meet applicable regulatory standards.
The Association's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan, the adequacy of the value of the property that will secure the loan, and, in the case of commercial and multi-family real estate loans, the cash flow of the project and the quality of management involved with the project. The Association generally requires title insurance on all loans and also that borrowers provide evidence of fire and extended casualty insurance in amounts and through insurers that are acceptable to the Association. A loan application file is first reviewed by a loan officer of the Association, then is submitted to a credit officer with appropriate underwriting authority for approval. Certain large loans, where the borrower has aggregate debt with the Association of $1 million or more, are reviewed by the board of directors. For those relationships in which the aggregate debt with the Association is $3 million or greater, board approval is required prior to funding of the loan. The Association can generally make loan commitments, subject to property valuation and possible other conditions of approval, in three to five days if income and credit data of the borrower are readily available.
Loan Originations, Purchases and Sales. The Association has originated a majority of the loans in its portfolio. During the year ended September 30, 2002, the Association originated $281.7 million in total loans, compared to $136.5 million during the same period of 2001. The higher level of loan originations was attributable to decreasing interest rates and the expansion of the branch network. The Association has a program to sell loans to Fannie Mae and other lenders. Through this program, $68.7 million in fixed rate loans were sold during the year ended September 30, 2002, all of which were one- to four-family mortgages. Servicing was retained on the loans sold to Fannie Mae and was released on loans sold to other brokers. During the year ended September 30, 2001, the Company securitized $190.3 million of fixed rate single family mortgages through Fannie Mae. Servicing was retained on these loans.
As noted previously, the Association purchased $179.3 million in loans from WAMU as part of the branch acquisition. The Association has also purchased permanent residential one- to four-family mortgage loans on detached residences from various localities throughout the western United States, primarily Oregon, Washington, and California. These loans were underwritten on the same basis as permanent residential one- to four-family real estate loans originated by the Association. At September 30, 2002, the balance of such loans was $4.4 million.
The Association also purchases multi-family and commercial real estate mortgage loans secured by properties within the Association's primary market area. At September 30, 2002, the balance of such purchased loans was $9.5 million. These loans were underwritten on the same basis as similar loans originated by the Association.
The following table shows total loans originated, purchased and sold, loan reductions and the net increase in the Association's loans during the periods indicated.
Loan Origination and Other Fees. In addition to interest earned on loans, the Association receives loan origination fees or "points" for originating loans. Loan points are a percentage of the principal amount of the real estate loan and are charged to the borrower in connection with the origination of the loan. The amount of points charged by the Association varies, though it generally is 1.00% on permanent loans and 1.75% on construction loans.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 91, which deals with the accounting for non-refundable fees and costs associated with originating or acquiring loans, the Association's loan origination fees and certain related direct loan origination costs are offset, and the resulting net amount is deferred and amortized as income over the contractual life of the related loans as an adjustment to the yield of such loans, or until the loan is paid in full. At September 30, 2002, the Association had $3.9 million of net loan fees which had been deferred and are being recognized as income over the contractual maturities of the related loans.
Asset Quality
Delinquent Loans. The following table sets forth information concerning delinquent loans at September 30, 2002, in dollar amount and as a percentage of the Association's total loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Association attempts to cure the delinquency by contacting the borrower. In the case of loans past due, appropriate late notices are generated on the seventh and fifteenth days after the due date. If the delinquency is not cured, the borrower is contacted by telephone the twenty-fifth day after the payment is due.
For real estate loans, in the event a loan is past due for 30 days or more, the Association will attempt to arrange an in-person interview with the borrower to determine the nature of the delinquency; based upon the results of the interview and its review of the loan status, the Association may negotiate a repayment program with the borrower. If a loan remains past due at 60 days, the Association performs an in-depth review of the loan status, the condition of the property and the circumstances of the borrower. If appropriate, an alternative payment plan is established. At 90 days past due, a letter prepared by the Association is sent to the borrower describing the steps to be taken to collect the loan, including acceptance of a voluntary deed-in-lieu of foreclosure, and of the initiation of foreclosure proceedings. A decision as to whether and when to initiate foreclosure proceedings is made by senior management, with the assistance of legal counsel, and reviewed by the Board of Directors.
For commercial loans, the borrowers are assigned to a commercial lender who is responsible for monitoring the relationship including collecting on delinquencies. When necessary, repossession, foreclosure, or other action may be taken including use of outside counsel.
For consumer loans, at 60 days past due a letter demanding payment is sent to the borrower. If the delinquency is not cured prior to becoming 90 days past due, repossession procedures are implemented for collateralized loans. At 90 days past due, consumer loans are generally charged off and sent to an outside collection agency.
Nonaccrual, Past Due and Restructured Loans. The Association's non-performing assets consist of nonaccrual loans, accruing loans greater than 90 days delinquent, real estate owned and other repossessed assets. All loans are reviewed on a regular basis and are placed on a nonaccrual status when, in the opinion of management, the collection of additional interest is deemed insufficient to warrant further accrual. Generally, the Association places all loans more than 90 days past due on nonaccrual status. Uncollectible interest on loans is charged-off or an allowance for losses is established by a charge to earnings equal to all interest previously accrued and interest is subsequently recognized only to the extent cash payments are received until delinquent interest is paid in full and, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal in which case the loan is returned to accrual status.
Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold. See Note 1 of the Notes to Consolidated Financial Statements contained in the Annual Report. When such property is acquired, it is recorded at the lower of the balance of the loan on the property at the date of acquisition (not to exceed the net realizable value) or the estimated fair value. Costs, excluding interest, relating to holding the property are expensed as incurred. Valuations are periodically performed by management and an allowance for losses is established by a charge to operations if the carrying value of the property exceeds its estimated net realizable value. From time to time, the
Association also acquires personal property which is classified as other repossessed assets and is carried on the books at estimated fair market value and disposed of as soon as commercially reasonable.
As of September 30, 2002, the Association's total nonaccrual loans amounted to $1.1 million, or 0.18% of total loans, before net items, compared with $270,000, or 0.04% of total loans, before net items, at September 30, 2001. Nonaccrual loans at September 30, 2002 by type are detailed in the table below. The increase in nonaccrual loans is primarily attributable to increases in nonaccrual commercial and consumer loans. The balance of these types of loans increased considerably with the WAMU branch acquisition in 2001 and so it is not unexpected that there is an increase in nonaccrual loans of these types.
At September 30, 2002, the Association had $188,000 in restructured loans.
Real estate owned increased from the prior year primarily as a result of the foreclosure on a commercial property during the year ended September 30, 2002. Properties held as real estate owned at September 30, 2001 were all subsequently sold.
The following table sets forth the amounts and categories of the Association's non-performing assets at the dates indicated.
The allowance for loan losses as a percentage of both total non-performing assets and total non-performing loans has decreased significantly at September 30, 2002. These decreases are the result of increases in non-performing loans and non-performing assets at September 30, 2002. At September 30, 2001, the allowance balance was greatly increased due to the loans purchased from WAMU. Because the majority of the loans purchased from WAMU were commercial and consumer loans with higher associated risks, the allowance increased, yet, because the loans were added in September 2001 there had not been an impact causing the level of non-performing loans and assets to increase by September 30, 2001. At present, the performance of the purchased loans has exceeded expectations and the Association believes that current reserves are adequate to cover the risk in the portfolio based on current levels of delinquency and non-performing assets.
For the year ended September 30, 2002, the amount of gross income that would have been recorded in the period then ended if non-accrual loans and troubled debt restructurings had been current according to their original terms, and the amount of interest income on such loans that was included in net income for each of such periods, were, in both cases, less than 1% of total interest income.
Classified Assets. Federal regulations require that each insured savings association classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are four categories used to classify problem assets: "special mention," "substandard," "doubtful," and "loss." Special mention assets are not considered classified assets, but are assets of questionable quality that have potential or past weaknesses that deserve management's close attention and monitoring. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount. General loss allowances established to cover probable losses related to special mention assets and assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital. Federal examiners may disagree with an insured institution's classifications and the amounts reserved.
As of September 30, 2002, total classified assets amounted to 0.30% of total assets, an increase from 0.16% at September 30, 2001. Assets classified substandard at September 30, 2002 totaled $4.4 million and included $353,781 in one- to four-family residential loans, a $843,144 land development loan, $2.1million in commercial real estate and $758,663 in foreclosed real estate consisting of five single family residences, a commercial property, and a boat. Assets classified substandard at September 30, 2001 totaled $2.7 million and included $270,393 in one- to four-family construction loans, a $2.0 million land development loan and $445,855 in foreclosed real estate consisting of single family residences. These problem assets were not concentrated in any one market area.
Impaired Loans. Management generally identifies loans to be evaluated for impairment when such loans are on nonaccrual status or have been restructured. However, not all nonaccrual loans are impaired. In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, loans are considered impaired when it is probable that the Association will be unable to collect all amounts contractually due, including scheduled interest payments. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of underlying collateral, and current economic conditions.
Allowance for Loan Losses. The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses based on management's assessment of various factors affecting the loan portfolio, including a review of all loans for which full collectibility may not be reasonably assured, an overall evaluation of the quality of the underlying collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss allowance. The level of allowance for loan losses is determined based on stratifying the loan portfolio in to classes based on risk. For example, loans are stratified based on type of interest rate (fixed or adjustable), age of the loan (less seasoned loans are assigned a higher percentage), geographic location, and type of loan. Each stratum is assigned an appropriate level of allowance percentage based on historical loss experience and risk level assigned to the type of loans. While management believes it uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. At September 30, 2002, the Association had an allowance for loan losses of $7.4 million, which was equal to 398.70% of non-performing assets and 1.19% of total loans.
Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management. Management considers historical loan loss experience, the volume and type of lending conducted by the Association, industry standards, the amount of non-performing assets, general economic conditions (particularly as they relate to the Association's market area), and other factors related to the collectibility of the Association's loan portfolio in their determination of the adequacy of the allowance and the provision. The provisions for loan losses charged against income for the years ended September 30, 2002, 2001 and 2000 were $156,000, $387,000, and $1.8 million respectively. Management believes that the amount maintained in the allowance will be adequate to absorb probable losses in the portfolio.
The year ended September 30, 2001 included two transactions that affected the allowance and provision for loan losses. The sale and securitization of $190.3 million in fixed rate single family loans to Fannie Mae reduced the required allowance on mortgage loans. In conjunction with the sale, $231,000 of allowance was reclassified as part of the basis of the resulting mortgage-backed securities. The reduction in the loan portfolio reduced the need for additional allowance and thus the provision for loan losses was much lower this year than the previous year. The WAMU acquisition added $179.3 million of loans to the portfolio, a significant proportion of which were commercial and consumer loans. These loans by nature have higher credit risk. As part of the acquisition, an allowance for loan losses was established related to the acquired loans based on the types of loans and the best information available regarding the factors which may affect their collectibility. The higher balance of the allowance for loan losses reflects these changes whereby a block of low risk single family mortgage loans were sold and were replaced by a block of higher risk loans from the acquired branches.
The following table sets forth for the periods indicated information regarding changes in the Association's allowance for loan losses. All information is before net items.
The following tables set forth the breakdown of the allowance for loan losses by loan category and summarizes the percentage of total loans, before net items, in each category to total loans, before net items, at the dates indicated.
Although the Association believes that it has established its allowance for loan losses in accordance with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Association's loan portfolio, will not request the Association to significantly increase its allowance for loan losses, thereby reducing the Association's net worth and earnings. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance may adversely affect the Association's financial condition and results of operation.
Investment Activities
Federally chartered savings institutions have the authority to invest in securities of various federal agencies, certain insured certificates of deposit of banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. OTS regulations restrict investments in corporate debt securities of any one issuer in excess of 15% of the Association's unimpaired capital and unimpaired surplus, as defined by federal regulations, which totaled $102.8 million at September 30, 2002, plus an additional 10% if the investments are fully secured by readily marketable collateral. See "REGULATION OF THE ASSOCIATION-- Federal Regulation of Savings Associations -- Loans to One Borrower" for a discussion of additional restrictions on the Association's investment activities.
The investment securities portfolio is managed in accordance with a written investment policy adopted by the Board of Directors and administered by the Investment Committee, which consists of the President and four Board members. Generally, the investment policy is to invest funds among various categories of investments and maturities based upon the need for liquidity, to achieve the proper balance between its desire to minimize risk and maximize yield, and to fulfill the asset/liability management policy. The President and the Chief Financial Officer may independently invest up to 1.0% of total assets of the Company within the parameters set forth in the Investment Policy, to be subsequently reviewed with the Investment Committee or Board of Directors at its next scheduled meeting. Transactions or investments in any one security determined by type, maturity and coupon in excess of $10.0 million or 1.0% of assets are not permitted.
Investment securities held to maturity are carried at cost and adjusted for amortization of premiums and accretion of discounts. As of September 30, 2002, the Company had no held to maturity securities. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. Securities available for sale include securities that management intends to use as part of its asset/liability management strategy that may be sold in response to changes in interest rates or significant prepayment risks or both. As of September 30, 2002, the portfolio of securities available for sale consisted of $42.0 million in tax exempt securities issued by states and municipalities, $18.1 million in federal agency preferred stock, and $59.4 million in investment grade corporate investments.
During the years ended September 30, 2002, 2001, and 2000, neither the Company nor the Association held any off-balance sheet derivative financial instruments in their investment portfolios to which the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, would apply.
The following tables set forth certain information relating to the investment securities portfolio held to maturity and securities available for sale at the dates indicated.
The following table sets forth the maturities and weighted average yields of the debt securities in the investment portfolio at September 30, 2002.
At September 30, 2002 the Company did not hold any securities from a single issuer, other than the U.S. Government, whose aggregate book value was in excess of 10% of the Company's shareholders' equity, or $12.0 million.
Mortgage-Backed and Related Securities
At September 30, 2002, the Company's net mortgage-backed and related securities, all designated available-for-sale, totaled $650.8 million at fair value ($640.3 million at amortized cost) and had a weighted average yield of 5.54%. At September 30, 2002, 24.50% of the mortgage-backed and related securities were adjustable rate securities.
Mortgage-backed and related securities ("MBS") can be divided into two main groups. The first group, called mortgage participation certificates or pass-through certificates, typically represents a participation interest in a pool of single-family or multi-family mortgages. The principal and interest payments on these mortgages are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and resell the participation interests in the form of securities, to investors such as the Company. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the Federal Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae, the Government National Mortgage Association ("GNMA") and the U.S. Small Business Administration ("SBA").
The second group, called collateralized mortgage obligations ("CMOs"), consists of securities created from and secured by the securities in the first group described above. CMOs are an example of a security called a derivative, because they are derived from mortgage pass-through securities. Underwriters of CMOs create these securities by dividing up the interest and principal cash flows from the pools of mortgages and selling these different slices of cash flows as a new and different class of individual securities or "tranches." At September 30, 2002, the Company held $438.6 million of CMOs, comprised primarily of three classes, planned amortization class tranches ("PACs"), Sequentials, and Floaters. The least volatile CMOs are PACs. With PACs, the yields, average lives, and lockout periods when no payments are received are designed to be more stable and predictable than the actual performance of the underlying MBS. PACs are available in a variety of short term maturities, usually two, three, five, or seven years. CMO floaters are similar to adjustable rate mortgages; they carry an interest rate that changes in a fixed relationship to an interest rate index, typically the London Interbank Offer Rate ("LIBOR"). Sequentials, as the name implies, pay principal and interest sequentially. For example, the "A" tranche receives payments of principal and interest first, while the "B" and "C" tranches only receive interest until the "A" tranche principal par value is completely paid. Then the "B" tranche begins receiving principal and interest until all of its principal is paid, and so on. Sequential pay CMOs are created to obtain a more predictable cash flow than the underlying simple pass-through securities. However, the cash flow risk from the underlying pool remains the same. Floaters usually have caps that determine the highest interest that can be paid by the securities. Except for caps on Floaters, PACs and Floaters may help to manage interest rate risk by reducing asset duration. They also may help manage price volatility since they typically have short maturities or coupons that reset monthly or quarterly to reflect changes in the index rate.
MBS typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that fall within a specific range and have varying maturities. MBS generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. In addition, MBS are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of the Company. These types of securities also permit the Association to optimize its regulatory capital because they have low risk weighting.
Expected maturities of MBS will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Prepayments that are faster than anticipated may shorten the life of the security and may result in a loss of any premiums paid and thereby reduce the net yield on such securities. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, generally the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Company may be
subject to reinvestment risk because, to the extent that the Company's MBS amortize or prepay faster than anticipated, the Company may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate.
During the year ended September 30, 2002, MBS with a fair value of $376,335 were transferred from the held-to-maturity category to the available-for-sale portfolio. The Company does not have plans to purchase or classify securities as held-to-maturity in the foreseeable future.
The following tables set forth certain information relating to the mortgage-backed and related securities portfolio held to maturity and available for sale at the dates indicated.
Other Interest-Earning Assets
The Company had an other interest-earning asset of $457,000 earning 8.07% and maturing in May 2112.
Interest-Earning Deposits
The Company had interest-earning deposits in the FHLB of Seattle amounting to $5.9 million and $4.9 million at September 30, 2002 and 2001, respectively.
Deposit Activities and Other Sources of Funds
General. Deposits are the primary source of the Association's funds for lending and other investment purposes. In addition to deposits, the Association derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer term basis for general business purposes.
Deposits. The Association's deposits are attracted principally from within the Association's primary market area through the offering of a broad selection of deposit instruments, including checking accounts, negotiable order of withdrawal ("NOW") accounts, money market deposit accounts, passbook and statement savings accounts, and individual retirement account ("IRA") certificates and certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the time period the funds must remain on deposit and the interest rate.
The Association occasionally accepts deposits from outside its primary market area through both private placements and brokered deposits if the terms of the deposits fit the Association's specific needs and are at a rate lower than the rates on similar maturity borrowings through the FHLB of Seattle. At September 30, 2002, these deposits totaled $2.3 million, or 0.20% of total deposits.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established and reviewed on a periodic basis by the Association. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals and federal regulations.
For the year ended September 30, 2002, the Association experienced a net decrease in deposits (before interest credited) of $38.2 million. The majority of the decrease relates to declining balances in certificates of deposit. Early in the year the Association made a conscious effort to reduce interest expense on higher-priced certificate accounts resulting in a decrease of $87.1 million for certificates as they matured and were not renewed. Checking, savings, and money market accounts increased $76.3 million during the year.
At September 30, 2002, certificate accounts maturing during the year ending September 30, 2003 totaled $275.7 million. Based on historical experience, the Association expects that a significant amount will be renewed with the Association at maturity. In the event a significant amount of such accounts are not renewed at maturity, the Association would not expect a resultant adverse impact on operations and liquidity because of the Association's borrowing capacity. See "-- Borrowings."
In the unlikely event the Association is liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the Company, which is the sole shareholder of the Association. The majority of the Association's depositors are residents of the State of Oregon.
The following table indicates the amount of certificate accounts with balances of $100,000 or greater by time remaining until maturity as of September 30, 2002.
The following table sets forth the deposit balances in the various types of deposit accounts offered by the Association at the dates indicated.
The following table sets forth the deposit activities of the Association for the periods indicated.
Borrowings. Deposit liabilities are the primary source of funds for the Association's lending and investment activities and for its general business purposes. The Association may rely upon advances from the FHLB of Seattle, reverse repurchase agreements and bank lines of credit to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Seattle serves as the Association's primary borrowing source after deposits.
The FHLB of Seattle functions as a central reserve bank, providing credit for savings and loan associations and certain other member financial institutions. As a member, the Association is required to own capital stock in the FHLB of Seattle and is authorized to apply for advances on the security of certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. As a member of the FHLB, the Association maintains a credit line that is a percentage of its regulatory assets, subject to collateral requirements. At September 30, 2002, the credit line was 30% of total assets of the Association. Advances are collateralized in aggregate, as provided for in the Advances, Security and Deposit Agreements with the FHLB, by certain mortgages or deeds of trust and securities of the U.S. Government and agencies thereof.
The Company has established credit lines at two commercial banks. These credit lines represent aggregate borrowing capacity of $16.7 million. At September 30, 2002, borrowings under these lines of credit totaled $1.7 million.
The following table sets forth certain information regarding borrowings by the Company and Association at the end of and during the periods indicated:
Subsidiaries. The Association established an operating subsidiary, Pacific Cascades Financial, Inc., effective July 14, 2000. Pacific Cascades Financial, Inc. is an Oregon chartered corporation, of which the Association owns 100% of its capital stock. Pacific Cascades Financial serves as the Association's trustee on deeds of trust and as trustee, handles normal reconveyance transactions on paid-off Association loans and non-judicial foreclosures.
The Association also owns 100% of the capital stock of Klamath First Financial Services, Inc. Klamath First Financial serves as an investment subsidiary, providing investment and brokerage services to customers.
The Company established a subsidiary, Klamath First Capital Trust I, in July 2001 for the purpose of issuing mandatorily redeemable preferred securities. The Company also established Klamath First Capital Trust II in April 2002 for the purpose of issuing additional mandatorily redeemable preferred securities. See Note 13 of the Notes to Consolidated Financial Statements contained in the Annual Report.
REGULATION OF THE ASSOCIATION
General
The Association is subject to extensive regulation, examination and supervision by the OTS, as its chartering agency, and the FDIC, as the insurer of its deposits. The activities of federal savings institutions are governed by the Home Owners Loan Act ("HOLA") and, in certain respects, the Federal Deposit Insurance Act, and the regulations issued by the OTS and the FDIC to implement these statutes. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. Lending activities and other investments must comply with various statutory and regulatory capital requirements. In addition, the Association's relationship with its depositors and borrowers is also regulated to a great extent, especially in such matters as the ownership of deposit accounts and the form and content of the Association's mortgage documents. The Association is required to file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to review the Association's compliance with various regulatory requirements. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Company, the Association and their operations.
Federal Regulation of Savings Associations
Office of Thrift Supervision. The OTS is an office in the Department of the Treasury subject to the general oversight of the Secretary of the Treasury. The OTS has extensive authority over the operations of savings associations. Among other functions, the OTS issues and enforces regulations affecting federally insured savings associations and regularly examines these institutions.
All savings associations are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings association's total assets, including consolidated subsidiaries. The Association's OTS assessment for the fiscal year ended September 30, 2002 was $258,994.
Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated duties of the FHFB are to supervise the FHLBs, to ensure that the FHLBs carry out their housing finance mission, to ensure that the FHLBs remain adequately capitalized and able to raise funds in the capital markets, and to ensure that the FHLBs operate in a safe and sound manner.
The Association, as a member of the FHLB of Seattle, is required to acquire and hold shares of capital stock in the FHLB of Seattle in an amount equal to the greater of (i) 1.0% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or (ii) 1/20 of its advances (i.e., borrowings) from the FHLB of Seattle. The Association is in compliance with this requirement with an investment in FHLB of Seattle stock of $13.5 million at September 30, 2002.
Among other benefits, the FHLB provides a central credit facility for member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB of Seattle.
Federal Deposit Insurance Corporation. The FDIC is an independent federal agency established originally to insure the deposits, up to prescribed statutory limits, of federally insured banks and to preserve the safety and
soundness of the banking industry. The FDIC maintains two separate insurance funds: the Bank Insurance Fund ("BIF") and the SAIF. The Association's deposit accounts are insured by the FDIC under the SAIF to the maximum extent permitted by law. As insurer of the Association's deposits, the FDIC has examination, supervisory and enforcement authority over the Association.
As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1, or core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
The premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis points. However, SAIF insured institutions and BIF insured institutions are required to pay a Financing Corporation assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. This amount is currently equal to about 1.70 points for each $100 in domestic deposits for SAIF and BIF insured institutions. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in 2017 through 2019.
Under the Federal Deposit Insurance Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. Management of the Association does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Liquidity Requirements. Under OTS regulations, each savings institution is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 4%, but may be changed from time to time by the OTS to any amount within the range of 4% to 10%. Monetary penalties may be imposed for failure to meet liquidity requirements. The Association has never been subject to monetary penalties for failure to meet its liquidity requirements.
Prompt Corrective Action. The OTS is required to take certain supervisory actions against undercapitalized savings associations, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk- weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be
"significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OTS regulations also require that a capital restoration plan be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the institution's assets or the amount which would bring the institution into compliance with all capital standards. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At September 30, 2002, the Association was categorized as "well capitalized" under the prompt corrective action regulations of the OTS.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits ("Guidelines"). The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that the Association fails to meet any standard prescribed by the Guidelines, it may require the Association to submit to the agency an acceptable plan to achieve compliance with the standard. Management is aware of no conditions relating to these safety and soundness standards which would require submission of a plan of compliance.
Qualified Thrift Lender Test. All savings associations, including the Association, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments. At September 30, 2002, the Association met the qualified thrift investment test and its QTL percentage was 79.63%.
Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "-- Regulation of the Company."
Capital Requirements. Federally insured savings associations, such as the Association, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations.
The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). At September 30, 2002, the Association had tangible capital of $95.5 million, or 6.6% of adjusted total assets, which is approximately $73.6 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. At September 30, 2002, the Association had $40.3 million of intangible assets consisting of core deposit intangible and other intangible assets related to the Wells Fargo branch acquisition in 1997 and the WAMU branch acquisition in 2001.
The capital standards also require core capital equal to at least 3% to 4% of adjusted total assets, depending on an institution's supervisory rating. Core capital generally consists of tangible capital. At September 30, 2002, the Association had core capital equal to $95.5 million, or 6.6% of adjusted total assets, which is $37.2 million above the minimum leverage ratio requirement of 4% as in effect on that date.
The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital.
In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, are multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to- four family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by Fannie Mae or FHLMC.
On September 30, 2002, the Association had total risk-based capital of approximately $102.8 million, including $95.5 million in core capital and $7.3 million in qualifying supplementary capital, and risk-weighted assets of $733.7 million, or total capital of 14.0% of risk-weighted assets. This amount was $44.1 million above the 8% requirement in effect on that date.
The OTS is authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against savings associations that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations.
The OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Company or the Association may have a substantial adverse effect on their operations and profitability.
Limitations on Capital Distributions. The OTS imposes various restrictions on savings associations with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. The OTS also prohibits a savings association from declaring or paying any dividends or from repurchasing any of its stock if, as a result of such action, the regulatory
capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with the association's mutual to stock conversion.
The Association may make a capital distribution without OTS approval provided that the Association notifies the OTS 30 days before it declares the capital distribution and that the following requirements are met: (i) the Association has a regulatory rating in one of the two top examination categories, (ii) the Association is not of supervisory concern, and will remain adequately or well capitalized, as defined in the OTS prompt corrective action regulations, following the proposed distribution, and (iii) the distribution does not exceed the Association's net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid). If the Association does not meet these stated requirements, it must obtain the prior approval of the OTS before declaring any proposed distributions.
In the event the Association's capital falls below its regulatory requirements or the OTS notifies it that it is in need of more than normal supervision, the Association's ability to make capital distributions will be restricted. In addition, no distribution will be made if the Association is notified by the OTS that a proposed capital distribution would constitute an unsafe and unsound practice, which would otherwise be permitted by the regulation.
Loans to One Borrower. Federal law provides that savings institutions are generally subject to the national bank limit on loans to one borrower. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. At September 30, 2002, the Association's limit on loans to one borrower was $15.9 million. At September 30, 2002, the Association's largest aggregate amount of loans to one borrower was $7.2 million, all of which were performing according to their original terms.
Activities of Associations and Their Subsidiaries. When a savings association establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings association must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings associations also must conduct the activities of subsidiaries in accordance with existing regulations and orders.
The OTS may determine that the continuation by a savings association of its ownership or control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings association to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly.
Transactions with Affiliates. Savings associations must comply with Sections 23A and 23B of the Federal Reserve Act relative to transactions with affiliates in the same manner and to the same extent as if the savings association were a Federal Reserve member association. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association's capital. Affiliates of the Association include the Company and any company which is under common control with the Association. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a savings association holding company or acquire the securities of most affiliates. The OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals.
Community Reinvestment Act. Under the federal Community Reinvestment Act ("CRA"), all federally- insured financial institutions have a continuing and affirmative obligation consistent with safe and sound operations to help meet all the credit needs of its delineated community. The CRA does not establish specific lending requirements or programs nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to meet all the credit needs of its delineated community. The CRA requires the federal banking agencies, in connection with regulatory examinations, to assess an institution's record of meeting the credit needs of its delineated community and to take such record into account in evaluating regulatory applications to establish a new branch office that will accept deposits, relocate an existing office, or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, among others. The CRA requires public disclosure of an institution's CRA rating. The Association received a "satisfactory" rating as a result of its latest evaluation.
Regulatory and Criminal Enforcement Provisions. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $27,500 per day, or $1.1 million per day in especially egregious cases. Under the FDIA, the FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
REGULATION OF THE COMPANY
General
The Company is a unitary savings and loan holding company within the meaning of the HOLA. As such, it is registered with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. The Company is also subject to the information, proxy solicitation, insider trading restrictions, and other requirements of the Securities Exchange Act of 1934, as amended.
Company Acquisitions
The HOLA and OTS regulations issued thereunder generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring more than 5% of the voting stock of any other savings association or savings and loan holding company or controlling the assets thereof. They also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS.
Holding Company Activities
As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. If the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company. There generally are more restrictions on the activities of a multiple savings and loan holding company than a unitary savings and loan holding company. Specifically, if either federally insured subsidiary savings association fails to meet the QTL test, the activities of the Company and any of its subsidiaries (other than the Company or other federally insured subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not an insured association shall commence or continue for more than two years after becoming a multiple savings and loan association holding company or subsidiary thereof, any business activity other than: (i) furnishing or performing management services for a subsidiary insured institution, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary insured institution, (iv) holding or managing properties used or occupied by a subsidiary insured institution, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987 to be engaged in by multiple holding companies or (vii) those activities authorized by the Federal Reserve Board as permissible for bank holding companies, unless the OTS by regulation, prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above also must be approved by the OTS prior to being engaged in by a multiple holding company.
New Federal Legislation
Gramm-Leach-Bliley Financial Services Modernization Act of 1999. On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this legislation is to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Generally, the GLBA:
a. repealed the historical restrictions and eliminates many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers;
b. provided a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies;
c. broadened the activities that may be conducted by national banks, banking subsidiaries of bank holding companies and their financial subsidiaries;
d. provided an enhanced framework for protecting the privacy of consumer information;
e. adopted a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the FHLB system;
f. modified the laws governing the implementation of the CRA; and
g. addressed a variety of other legal and regulatory issues affecting day-to-day operations and long-term activities of financial institutions.
The GLBA also imposes certain obligations on financial institutions to develop privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer's request, and establish procedures and practices to protect and secure customer data. These privacy provisions were implemented by regulations that were effective on November 12, 2000. Compliance with the privacy provisions was required by July 1, 2001.
The USA Patriot Act. In response to the terrorist events of September 11th, 2001, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:
- Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti- money laundering program. - Section 326 of the Act authorizes the Secretary of the Department of Treasury, in conjunction with other bank regulators, to issue regulations by October 26, 2002 that provide for minimum standards with respect to customer identification at the time new accounts are opened.
- Section 312 of the Act requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering.
- Effective December 25, 2001, financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.
- Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.
To date, it has not been possible to predict the impact the USA PATRIOT Act and its implementing regulations may have on the Company and the Association.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law by President Bush on July 30, 2002 in response to public concerns regarding corporate accountability in connection with the recent
accounting scandals at Enron and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation enacted in some time. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission ("SEC"), under the Securities Exchange Act of 1934 ("Exchange Act").
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. The Sarbanes- Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters:
- audit committees;
- certification of financial statements by the chief executive officer and the chief financial officer;
- the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
- a prohibition on insider trading during pension plan black out periods;
- disclosure of off-balance sheet transactions;
- a prohibition on personal loans to directors and officers;
- expedited filing requirements for Form 4s;
- disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
- "real time" filing of periodic reports
- the formation of a public accounting oversight board;
- auditor independence; and
- various increased criminal penalties for violations of securities laws.
The Sarbanes-Oxley Act contains provisions which became effective upon enactment on July 30, 2002 and provisions which will become effective from within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various of the provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.
Affiliate Restrictions
The affiliate restrictions contained in Sections 23A and 23B of the Federal Reserve Act apply to all federally insured savings associations and any such "affiliate." A savings and loan holding company, its subsidiaries and any other company under common control are considered affiliates of the subsidiary savings association under the HOLA. Generally, Sections 23A and 23B: (i) limit the extent to which the insured association or its subsidiaries may engage in certain covered transactions with an affiliate to an amount equal to 10% of such institution's capital and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions. Also, a savings association may not make any loan to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies. Only the Federal Reserve may grant exemptions from the restrictions of Sections 23A and 23B. The OTS, however, may impose more stringent restrictions on savings associations for reasons of safety and soundness.
Qualified Thrift Lender Test
The HOLA requires any savings and loan holding company that controls a savings association that fails the QTL test, as explained under "-- Qualified Thrift Lender Test," to, within one year after the date on which the association ceases to be a QTL, register as and be deemed a bank holding company subject to all applicable laws and regulations.
TAXATION
Federal Taxation
General. The Company and the Association report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations, with some exceptions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Association.
Bad Debt Reserve. Historically, savings institutions such as the Association which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrift") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Association's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Association's actual taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non- qualifying reserve. Each year, the Association selected the most favorable way to calculate the deduction attributable to an addition to the tax bad debt reserve.
The provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Association has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Association's bad debt deduction will be determined on the basis of net charge-offs during the taxable year. The new rules allow an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996 adjusted for inflation. For this purpose, only
home purchase or home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year (fiscal year ending September 30, 1999 for the Company). The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders.
Distributions. To the extent that the Association makes "nondividend distributions" to the Company, such distributions will be considered to result in distributions from the balance of its bad debt reserves as of December 31, 1987 (or a lesser amount if the Association's loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans ("Excess Distributions"), and an amount based on the Excess Distributions will be included in the Association's taxable income. Nondividend distributions include distributions in excess of the Association's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Association"s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Association's bad debt reserve. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. The Association does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (" Code"), imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Association's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Association, whether or not an Alternative Minimum Tax ("AMT") is paid.
Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Association as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Association will not file a consolidated tax return, except that if the Company or the Association owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted.
Other Federal Tax Matters. There have not been any Internal Revenue Service audits of the Company's or the Association's federal income tax returns during the past five years. Subsequent to September 30, 2002, the Company was notified by the IRS of its intention to perform an audit of the tax year 1999 (year ended September 30, 2000).
State Taxation
The Company and the Association are subject to an Oregon corporate excise tax at a statutory rate of 6.6% of income. Neither the Company's nor the Association's Oregon state income tax returns have been audited during the past five years. The Association is subject to Washington state Business and Organization tax at the rate of 1.5% of gross receipts for the operations in that state. There have not been any audits of the Company's Washington state tax returns during the past five years.
Competition
The Association originates most of its loans to and accepts most of its deposits from residents of its market area. The Association is the oldest financial institution headquartered in Klamath Falls. The Association believes that it is a major competitor in the markets in which it operates. Nonetheless, the Association faces competition in attracting deposits and making real estate loans from various financial institutions, including banks, savings associations and mortgage brokers. In addition, the Association has faced additional significant competition for investors' funds from short-term money market securities and other corporate and government securities. The financial institution industry in the Association's market area is characterized by a mix of local independent financial institutions and offices of larger out-of-state financial institutions, including several multi-national bank holding companies. The ability of the Association to attract and retain savings deposits depends on its ability to generally provide a rate of return and liquidity risk comparable to that offered by competing investment opportunities. The Association competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Competition may increase as restrictions on the interstate operations of financial institutions continue to be reduced.
Personnel
As of September 30, 2002, the Association had 429 full-time and 103 part-time employees. The employees are not represented by a collective bargaining unit. The Association believes its relationship with its employees is good.
Executive Officers. The following table sets forth certain information regarding the executive officers of the Company.
Kermit K. Houser has served as President and Chief Executive Officer of the Company and the Association since November 2000. Mr. Houser was previously employed in various capacities by the Bank of America from 1983 to November 2000, as senior vice president and manager for commercial banking, executive vice president and senior credit officer, and most recently, as senior vice president and market executive for Bank of America's South Valley commercial banking, in Fresno, California. Mr. Houser has 31 years of experience in banking, and has been an active member of numerous civic and community organizations.
Marshall J. Alexander has 27 years of banking experience, including 16 years with the Association. He has served as Vice President and Chief Financial Officer since August 1994 and was named an Executive Vice President in December 2000.
Ben A. Gay joined Klamath First in September 2001 after a 30-year career in commercial banking and finance, on both the East and West coasts. Mr. Gay has served in a variety of managerial positions in lending, credit risk and loan management and has most recently served as a western regional executive for credit risk management for Bank of America.
Frank X. Hernandez has been employed by the Association since 1992. He served as Human Resources Officer until July 1998 when he was appointed Senior Vice President and Chief Operating Officer. He has 21 years experience in banking operations.
Craig M. Moore has a banking career of more than 25 years, with five of those years at Klamath First. He is an attorney, a Certified Internal Auditor and a Certified Financial Services Auditor.
M. Isabel Castellanos has 21 years experience in banking with extensive experience in management, sales, and training.
Walter F. Dodrill has served as Senior Vice President and Manager of the Business Banking Group of the Company since January 2002. Mr. Dodrill was previously employed by Western Bank from February 1974 to December 2001. Western Bank became a division of Washington Mutual in January 1996. Mr. Dodrill served as Senior Vice President - Regional Credit Administrator and Senior Vice President - Regional Manager for Western Bank. Mr. Dodrill has 29 years of experience in banking and has been active in civic and community organizations.
James E. Essany is a native of Gary, Indiana and a graduate of Indiana University with a Bachelor's of Science in Marketing. He began his banking career in 1979 and worked with three financial institutions in Indiana before joining Klamath First in May of 2000.
Nina G. Drake joined Klamath First in June 2002 as Vice President-Human Resources. She has an extensive background in human resource management in financial institutions and related industries. She earned her Master of Business Administration in May 2002 and holds a lifetime certification as a Senior Professional in Human Resource Management (SPHR).
Item 2.
Item 2. Properties
The following table sets forth the location of the Association's offices and other facilities used in operations as well as certain additional information relating to these offices and facilities as of September 30, 2002.
Item 3.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Company, mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Association holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Association's business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.
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 September 30, 2002.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters
The information contained under the section captioned "Common Stock Information" on page 16 of the Annual Report is incorporated herein by reference.
Item 6.
Item 6. Selected Financial Data
The information contained under the section captioned "Selected Consolidated Financial Data" on pages 5 and 6 of 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 in the section captioned "Management Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 7 of 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 Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk and Asset/Liability Management" beginning on page 7 of the Annual Report is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
(a) Financial Statements Independent Auditors' Report* Consolidated Balance Sheets as of September 30, 2002 and 2001* Consolidated Statements of Earnings for the Years Ended September 30, 2002, 2001 and 2000* Consolidated Statements of Shareholders' Equity for the Years Ended September 30, 2002, 2001 and 2000* Consolidated Statements of Cash Flows for the Years Ended September 30, 2002, 2001 and 2000* Notes to the Consolidated Financial Statements*
* Included in the Annual Report attached as Exhibit 13 hereto and incorporated herein by reference. All schedules have been omitted as the required information is either inapplicable or included in the Consolidated Financial Statements or related Notes contained in the Annual Report.
(b) Supplementary Data
The information entitled "Consolidated Supplemental Data - Selected Quarterly Financial Data" on page 35 of the Annual Report is incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no changes in or disagreements with Accountants on accounting and financial disclosure during the year ended September 30, 2002.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information contained under the section captioned "Proposal I - Election of Directors" contained in the Company's Proxy Statement, and "Part I - -- Business -- Personnel -- Executive Officers" of this report, 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.
Item 11.
Item 11. Executive Compensation
The information contained under the sections captioned "Executive Compensation" and "Directors' Compensation" under "Proposal I - Election of Directors" in the Proxy Statement is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement.
Equity Compensation Plan Information. The following table summarizes share and exercise price information about the Corporations' equity compensation plans as of September 30,2002.
(b) Security Ownership of Management
The information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement.
(c) Changes in Control
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
The information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information set forth under the section captioned "Proposal I - Election of Directors - Certain Transactions with the Association" in the Proxy Statement is incorporated herein by reference.
Item 14.
Item 14. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management within the 90-day period preceding the filing date of this annual report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in enduring that the information required to be disclosed by the Company in reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
(b) Changes in Internal Controls: In the year ended September 30, 2002, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3(a) Articles of Incorporation of the Registrant* 3(b) Bylaws of the Registrant* 10(a) Employment Agreement with Kermit K. Houser*** 10(b) Employment Agreement with Marshall J. Alexander*** 10(c) Employment Agreement with Frank X. Hernandez*** 10(d) Employment Agreement with Craig M. Moore*** 10(e) Employment Agreement with Ben A. Gay*** 10(f) 1996 Stock Option Plan** 10(g) 1996 Management Recognition and Development Plan** 13 Annual Report to Shareholders 21 Subsidiaries of the Registrant 23 Consent of Deloitte & Touche LLP with respect to financial statements of the Registrant 99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act ___________________
* Incorporated by reference to the Registrant's Registration Statement on Form S-1, filed on June 19, 1995. ** Incorporated reference to the Registrant's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. *** Incorporated by reference to the Registrant's Form 10-K for the year ended September 30, 2001, filed on December 29, 2001.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed during the quarter ended September 30, 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KLAMATH FIRST BANCORP, INC.
Date: December 27, 2002 By: /s/ Kermit K. Houser Kermit K. Houser President and Chief Executive Officer
Pursuant to 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.
SIGNATURES TITLE DATE
/s/ Kermit K. Houser President, Chief December 27, 2002 Kermit K. Houser Executive Officer and Director (Principal Executive Officer)
/s/ Marshall J. Alexander Executive Vice President and December 27, 2002 Marshall J. Alexander Chief Financial Officer (Principal Financial and Accounting Officer)
/s/ Rodney N. Murray Chairman of the Board December 27, 2002 Rodney N. Murray of Directors
/s/ Bernard Z. Agrons Director December 27, 2002 Bernard Z. Agrons
/s/ Timothy A. Bailey Director December 27, 2002 Timothy A. Bailey
/s/ James D. Bocchi Director December 27, 2002 James D. Bocchi
/s/ William C. Dalton Director December 27, 2002 William C. Dalton
/s/ Dianne E. Spires Director December 27, 2002 Dianne E. Spires
/s/ Donald N. Bauhofer Director December 27, 2002 Donald N. Bauhofer
Certification Required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Kermit K. Houser, certify that:
(1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp, Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
(3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
(6) The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: December 27, 2002
/s/ Kermit K. Houser ---------------------- Kermit K. Houser President and Chief Executive Officer
Certification Required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Marshall J. Alexander, certify that:
(1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp, Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
(3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
(6) The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: December 27, 2002
/s/ Marshall J. Alexander -------------------------- Marshall J. Alexander Executive Vice President and Chief Financial Officer