First Mutual Bancshares, Inc., (Nasdaq: FMSB) the holding company
for First Mutual Bank, today reported that solid loan growth and
continued margin expansion contributed to record profits in both
the fourth quarter and full year 2005. For the quarter ended
December 31, 2005, the net interest margin increased 15 basis
points from the preceding quarter to 4.18%. Net income was $2.5
million, up 10% from $2.3 million in the fourth quarter last year.
Earnings per diluted share grew 13% in the fourth quarter to $0.45,
compared to $0.40 per share a year ago, reflecting the November
2005 stock buyback that retired 2.7% of shares outstanding. In
2005, the net interest margin was up 7 basis points from 2004 to
4.08%, contributing to 11% growth in both profits and earnings per
share. Net income increased to $10.3 million, or $1.86 per diluted
share in the year, compared to $9.3 million, or $1.68 per diluted
share in 2004. -0- *T Financial highlights for 2005, compared to a
year ago include: 1. Loan originations increased 12% to $526
million. 2. Net loans grew 9% and deposits 13%. 3. Credit quality
remains excellent, with non-performing assets equaling just 0.08%
of total assets at year-end. 4. Net interest margin expanded in
each of the last three quarters. 5. Noninterest income increased
26% despite a decline in gains on asset sales. 6. Return on average
equity was 16.6%. *T Management will host an analyst conference
call tomorrow morning, January 25, at 7:00 am PST (10:00 am EST) to
discuss the results. Investment professionals are invited to dial
303-262-2140 to participate in the live call. All current and
prospective shareholders are welcome to listen to the live call or
the replay through a webcast posted on the bank's website,
www.firstmutual.com. Shortly after the call concludes, a telephone
replay will be available for a month at 303-590-3000, using
passcode 11049602#. "We have maintained our credit quality and
generated solid returns by continuing to focus on our consumer loan
products," stated John Valaas, President and CEO. "This approach
has lessened our dependence on the sectors that are overly crowded
with competition, primarily commercial real estate, and more
cyclical businesses like mortgage refinancings. While income
property lending remains an important business line, we have had
very good credit experience in our niche consumer products, which
are less impacted by interest rate changes and generate superior
yields." First Mutual's net interest margin improved to 4.18%,
compared to 4.03% in the preceding quarter and 3.99% in the fourth
quarter of 2004. For the year, the net interest margin expanded to
4.08%, from 4.01% in 2004. The yield on earning assets improved to
6.95% in the most recent quarter, from 6.69% in the third quarter
of 2005 and 5.98% in the year-ago quarter. For the full year, the
yield on earnings assets improved to 6.55%, compared to 5.89% in
2004. Reflecting the rising interest rate environment, the cost of
interest-bearing liabilities followed a similar trend, reaching
3.09% in the fourth quarter of 2005, from 2.87% in the third
quarter and 2.13% in the final quarter last year. For 2005, the
cost of interest-bearing liabilities grew to 2.74%, compared to
1.78% in the previous year. "In sales finance, we originate loans
through a national network of home improvement contractors," Valaas
said. "Our proprietary software makes credit decisions almost
instantly and helps the contractor close the sale. Although these
fixed-rate loans have a relatively short life, the margins are far
superior to more traditional business lines. We also get solid
yields from our non-conforming residential loans, which do not meet
the typical requirements of the secondary market and are kept in
our portfolio, as well as custom residential construction." At the
end of 2005, income property loans had dropped to 34% of total
loans, compared to 40% a year earlier. Non-conforming home loans
had grown to 25% of First Mutual's loan portfolio, compared to 22%
a year earlier. Consumer loans, primarily sales finance, increased
to 13% of total loans, from 12% at the end of 2004. Single family
custom construction loans grew to 10% of total loans at year-end
2005, versus 8% a year earlier. Business banking, commercial
construction, and speculative single-family construction loans
remained unchanged from year-end 2004 at 13%, 3%, and 2% of total
loans, respectively. New loan originations increased 12% to $526
million in 2005, compared to $470 million in the previous year. In
the fourth quarter, loan originations were $120 million, versus
$122 million in the same quarter last year. Net portfolio loans
increased by 9% to $868 million, compared to $799 million at the
end of 2004. Total assets also grew by 8% to $1.09 billion, from
$1.00 billion at the end of last year. Non-performing assets (NPAs)
were $897,000 at year-end, compared to $1.0 million at the end of
2004. NPAs were 0.08% of total assets at December 31, 2005, down
from 0.10% of total assets at the end of last year. The provision
for loan losses was $1.5 million in 2005, more than double net
charge-offs, building the loan loss reserve to $10.1 million. The
allowance for loan losses represented 1.13% of gross loans at
year-end. Total deposits increased 13% to $761 million at year-end,
compared to $675 million at the end of December 2004. Core deposits
grew by 3% to $271 million, from $263 million a year ago, while
time deposits increased by 19% to $489 million, versus $412 million
at the end of last year. "The market for core deposits has been
very competitive," Valaas said. "However, we have thus far kept the
yields on interest-bearing accounts at favorable levels while still
supporting our loan growth. We also increased both business and
consumer checking accounts and balances in 2005, momentum that we
anticipate will carry over into 2006." The number of business
checking accounts increased by 15% to 2,262 as of December 31,
2005, with associated balances rising 47% from year-end 2004.
Consumer checking accounts increased 10% to 7,429 accounts at the
end of 2005, with total balances up 5%. In the quarter ended
December 31, 2005, total revenues increased 11% to $11.8 million,
from $10.7 million in the fourth quarter last year, primarily due
to increased net interest income, which was up 12% to $10.5 million
in the most recent quarter, from $9.4 million in the fourth quarter
last year. Reflecting the containment of funding costs in a rising
interest rate environment, interest income grew by $3.9 million in
the fourth quarter, while interest expense was up $2.8 million over
the final quarter of 2004. Noninterest income grew 5% to $1.3
million, versus $1.2 million a year ago, and noninterest expense
increased 12% to $7.7 million, from $6.8 million in the December
2004 quarter. "In the second quarter of 2005, we made a strategic
decision to keep more sales finance loans in our portfolio," Valaas
said. "Since we had been servicing the loans that we sold, it was
assumed that gain on sale of loans and servicing fees would decline
as interest income grew. Mitigating that somewhat has been the sale
of more participations in commercial loans." In 2005, total
revenues were $45.6 million, up 13% from $40.3 million in the
previous year, largely due to increased net interest income. Net
interest income grew 12% to $40.2 million, compared to $36.0
million last year, with interest income growing by $12.2 million
and interest expense by $8.1 million over 2004 levels. Noninterest
income grew 26% to $5.4 million, from $4.3 million in 2004,
primarily due to the increase in loan servicing fees. Noninterest
expense was $28.3 million in 2005, up 15% from $24.6 million in the
previous year. First Mutual generated a 15.7% return on average
equity (ROE) in the final quarter of 2005, compared to 15.4% a year
earlier. For the full year, ROE was 16.6% compared to 16.8% in
2004. Return on average assets improved slightly for both the
quarter and year, to 0.93% and 0.99%, respectively. First Mutual's
consistent performance has garnered attention from a number of
sources. Keefe, Bruyette & Woods named First Mutual to its
Honor Roll in 2005 and 2004 for the company's 10-year earnings per
share growth rate. In August 2005, U.S. Banker magazine ranked
First Mutual #34 in the Top 100 Publicly Traded Mid-Tier Banks,
which includes those with less than $10 billion in assets, based on
its three-year return on equity. First Mutual Bancshares, Inc. is
the holding company for its wholly owned subsidiary, First Mutual
Bank, an independent, community-based bank that operates 12
full-service banking centers in the Puget Sound area and a sales
finance office in Jacksonville, Florida. www.firstmutual.com This
press release contains forward-looking statements including, among
others, statements about our anticipated increased business and
consumer checking accounts and our margins on sales finance and
residential loans, that are forward-looking statements for the
purposes of the safe harbor provisions under the Private Securities
Litigation Reform Act of 1995. These and other forward-looking
statements involve certain risks and uncertainties. Factors that
may cause actual results or earnings to differ materially from such
forward-looking statements include, among others, our continuing
experience with, and development of, the sales finance program and
related insurance matters, various factors affecting general
interest rates and the fiscal and monetary policies of the
government, economic and competitive environment, loan portfolio
growth, asset quality, and loan delinquency rates. We disclaim any
obligation to update or publicly announce future events or
developments that might affect the forward-looking statements
herein or to conform these statements to actual results or to
changes in our expectations. For further information regarding
First Mutual Bancshares and the issues regarding forward looking
information, please read company reports filed with the SEC and
available at www.sec.gov. -0- *T INCOME STATEMENT ----------------
(Unaudited) (Dollars in Fourth Quarter Ended Quarterly Thousands,
Except Per Share December 31, Percentage Data) 2005 2004 Change
---------- ---------- ---------- INTEREST INCOME Loans Receivable $
17,109 $ 13,270 Interest on AFS Securities 1,202 1,158 Interest on
HTM Securities 98 99 Interest Other 104 48 ---------- ----------
Total Interest Income 18,513 14,575 27% INTEREST EXPENSE Deposits
5,453 3,326 FHLB Advances and Other 2,520 1,821 ----------
---------- Total Interest Expense 7,973 5,147 55% Net Interest
Income 10,540 9,428 Provision for Loan Losses 325 350 ----------
---------- Net Interest Income After Loan Loss Provision 10,215
9,078 13% NONINTEREST INCOME Gain on Sales of Loans 323 562
Servicing Fees, Net of Amortization 287 111 Gain on Sales of
Investments - - Fees on Deposits 158 133 Other 535 431 ----------
---------- Total Noninterest Income 1,303 1,237 5% NONINTEREST
EXPENSE Salaries and Employee Benefits 4,183 4,053 Occupancy 1,029
767 Other 2,486 2,025 ---------- ---------- Total Noninterest
Expense 7,698 6,845 12% Income Before Federal Income Tax 3,820
3,470 Federal Income Tax 1,331 1,209 ---------- ---------- NET
INCOME $ 2,489 $ 2,261 10% ========== ========== EARNINGS PER
COMMON SHARE (EPS) DATA Basic EPS $ 0.47 $ 0.42 12% ==========
========== EPS, Assuming Dilution $ 0.45 $ 0.40 13% ==========
========== Weighted Average Shares Outstanding 5,287,234 5,286,517
Weighted Average Shares Outstanding Including Dilutive Effect of
Stock Options 5,490,516 5,536,908 INCOME STATEMENT ----------------
(Unaudited) (Dollars in Year Ended Annual Thousands, Except Per
Share December 31, Percentage Data) 2005 2004 Change ----------
---------- ---------- INTEREST INCOME Loans Receivable $61,623
$50,195 Interest on AFS Securities 4,950 4,030 Interest on HTM
Securities 392 419 Interest Other 397 483 ---------- ----------
Total Interest Income 67,362 55,127 22% INTEREST EXPENSE Deposits
18,191 12,292 FHLB Advances and Other 8,988 6,801 ----------
---------- Total Interest Expense 27,179 19,093 42% Net Interest
Income 40,183 36,034 Provision for Loan Losses 1,500 1,565
---------- ---------- Net Interest Income After Loan Loss Provision
38,683 34,469 12% NONINTEREST INCOME Gain on Sales of Loans 1,441
1,757 Servicing Fees, Net of Amortization 1,300 314 Gain on Sales
of Investments - 71 Fees on Deposits 630 571 Other 1,985 1,539
---------- ---------- Total Noninterest Income 5,356 4,252 26%
NONINTEREST EXPENSE Salaries and Employee Benefits 16,200 14,261
Occupancy 3,513 2,787 Other 8,625 7,566 ---------- ---------- Total
Noninterest Expense 28,338 24,614 15% Income Before Federal Income
Tax 15,701 14,107 Federal Income Tax 5,382 4,819 ----------
---------- NET INCOME $10,319 $9,288 11% ========== ==========
EARNINGS PER COMMON SHARE (EPS) DATA Basic EPS $1.94 $1.76 10%
========== ========== EPS, Assuming Dilution $1.86 $1.68 11%
========== ========== Weighted Average Shares Outstanding 5,314,616
5,264,412 Weighted Average Shares Outstanding Including Dilutive
Effect of Stock Options 5,542,779 5,513,658 BALANCE SHEET
------------- (Unaudited) (Dollars in Thousands) December 31,
September 30, December 31, Annual 2005 2005 2004 Change ----------
---------- ---------- ------ ASSETS: Interest-Earning Deposits $
1,229 $ 2,394 $ 309 Noninterest-Earning Demand Deposits and Cash on
Hand 24,552 20,184 13,536 ---------- ---------- ---------- Total
Cash and Cash Equivalents 25,781 22,578 13,845 86% Mortgage-Backed
and Other Securities, Available For Sale 114,450 114,738 124,225
Loans Receivable, Held For Sale 14,684 21,330 10,064
Mortgage-Backed and Other Securities, Held To Maturity 6,966 7,347
7,720 (Fair Value of $6,971, $7,399, and $7,827, respectively)
Loans Receivable 878,066 851,935 808,643 Reserve For Loan Losses
(10,069) (9,861) (9,301) ---------- ---------- ---------- Loans
Receivable, Net 867,997 842,074 799,342 9% Accrued Interest
Receivable 5,351 5,062 4,300 Land, Buildings and Equipment, Net
33,484 32,707 27,994 Federal Home Loan Bank (FHLB) Stock, at Cost
13,122 13,122 12,919 Servicing Assets 1,866 1,972 1,525 Other
Assets 2,464 2,078 1,849 ---------- ---------- ---------- TOTAL
ASSETS $1,086,165 $1,063,008 $1,003,783 8% ========== ==========
========== LIABILITIES AND STOCKHOLDERS' EQUITY: LIABILITIES:
Deposits: Money Market Deposit and Checking Accounts $ 263,445 $
250,532 $ 254,436 Savings 8,054 8,043 8,434 Time Deposits 489,222
468,928 412,499 ---------- ---------- ---------- Total Deposits
760,721 727,503 675,369 13% Drafts Payable 734 982 378 Accounts
Payable and Other Liabilities 15,707 10,490 14,106 Advance Payments
by Borrowers for Taxes and Insurance 1,671 3,249 1,676 FHLB
Advances 225,705 235,756 234,207 Other Advances 4,600 1,600 1,600
Long Term Debentures Payable 17,000 17,000 17,000 ----------
---------- ---------- Total Liabilities 1,026,138 996,580 944,336
9% STOCKHOLDERS' EQUITY: Common Stock $1 Par Value- Authorized,
30,000,000 Shares Issued and Outstanding, 5,296,810, 5,355,542 and
5,288,489 Shares, Respectively 5,297 5,356 5,288 Additional Paid-in
Capital 45,289 46,530 45,595 Retained Earnings 10,877 15,558 9,220
Accumulated Other Comprehensive Income (Loss): Unrealized (Loss) on
Securities Available for Sale and Interest Rate Swap, Net of
Federal Income Tax (1,436) (1,016) (656) ---------- ----------
---------- Total Stockholders' Equity 60,027 66,428 59,447 1%
---------- ---------- ---------- TOTAL LIABILITIES AND EQUITY
$1,086,165 $1,063,008 $1,003,783 8% ========== ==========
========== FINANCIAL RATIOS Fourth Quarter Ended Year Ended
---------------- December 31, December 31, (Unaudited) 2005 2004
2005 2004 --------- -------- -------- -------- Return on Average
Assets 0.93% 0.91% 0.99% 0.98% Return on Average Equity 15.74%
15.40% 16.56% 16.76% Efficiency Ratio 65.01% 64.18% 62.23% 61.10%
Annualized Operating Expense/Average Assets 2.87% 2.76% 2.71% 2.64%
Yield on Earning Assets 6.95% 5.98% 6.55% 5.89% Cost of
Interest-Bearing Liabilities 3.09% 2.13% 2.74% 1.78% Net Interest
Spread 3.86% 3.85% 3.81% 4.11% Net Interest Margin 4.18% 3.99%
4.08% 4.01% Tier 1 Capital Ratio 7.11% 7.27% Risk Adjusted Capital
11.21% 11.88% Book Value Per Share $11.33 $11.24 AVERAGE BALANCES
---------------- (Unaudited) (Dollars in Fourth Quarter Ended Year
Ended Thousands) December 31, December 31, 2005 2004 2005 2004
---------- -------- ---------- -------- Average Assets $1,074,586
$993,474 $1,044,066 $932,314 Average Equity $ 63,227 $ 58,717 $
62,295 $ 55,137 Average Net Loans (includes LHFS) $ 873,042
$801,235 $ 846,043 $767,427 Average Deposits $ 744,112 $666,835 $
718,045 $629,630 Average Earning Assets $1,009,727 $945,684 $
986,513 $889,217 LOAN DATA --------- Fourth Quarter Ended Year
Ended (Unaudited) (Dollars in December 31, December 31, Thousands)
2005 2004 2005 2004 ------- ------- -------- -------- Net Loans
(Including Loans Held for Sale) $882,681 $809,406
Non-Performing/Non-Accrual Loans (90+ Delinquent) $ 897 $ 1,004 as
a Percentage of Gross Loans 0.10% 0.12% Real Estate Owned Loans and
Repossessed Assets $ - $ 3 Total Non-Performing Assets $ 897 $
1,007 as a Percentage of Total Assets 0.08% 0.10% Loan Loss
Reserves $ 10,069 $ 9,301 as a Percentage of Gross Loans 1.13%
1.14% Loan Loss Provision $ 325 $ 350 $ 1,500 $ 1,565 Net
Charge-Offs From Reserves $ 117 $ 206 $ 732 $ 670 *T FINANCIAL
DETAILS For the three months and full year ended December 31, 2005,
our net interest income increased 12% from the relative periods
last year, to $10.5 million and $40.2 million, respectively. For
both periods, the improvement in net interest income was
attributable to both growth in earning assets as well as the net
effects of asset and liability repricing, with asset growth
accounting for the majority of the improvement. The following table
illustrates the impact to our net interest income from balance
sheet growth and rate changes on our assets and liabilities, with
the results attributable to the level of earning assets classified
as "volume" and the effect of asset and liability repricing labeled
"rate." -0- *T Rate/Volume Quarter Ended Twelve Months Ended
Analysis Dec. 31, 2005 vs. Dec. 31, 2005 vs. Dec. 31, 2004 Dec. 31,
2004 Increase/(Decrease) Increase/(Decrease) due to due to Volume
Rate Total Volume Rate Total ------- ------- ------- -------
------- -------- (Dollars in thousands) Interest Income Total
Investments $(40) $138 $98 $666 $141 $807 Total Loans 1,288 2,551
3,839 4,509 6,921 11,430 ------- ------- ------- ------- -------
-------- Total Interest Income $1,248 $2,689 $3,937 $5,175 $7,062
$12,237 ------- ------- ------- ------- ------- -------- Interest
Expense Total Deposits $448 $1,679 $2,127 $1,590 $4,311 $5,901 FHLB
and Other (21) 720 699 202 1,985 2,187 ------- ------- -------
------- ------- -------- Total Interest Expense $427 $2,399 $2,826
$1,792 $6,296 $8,088 ------- ------- ------- ------- -------
-------- Net Interest Income $821 $290 $1,111 $3,383 $766 $4,149
======= ======= ======= ======= ======= ======== *T Earning Asset
Growth (Volume) For the quarter ended December 31, 2005, the growth
in our earning assets contributed an additional $1.2 million in
interest income relative to the same quarter last year. Partially
offsetting this improvement was an additional $427,000 in interest
expense incurred from the funding sources used to accommodate the
asset growth. Consequently, the net impact of asset growth was an
improvement in net interest income of $821,000, or 74% of the total
increase in net interest income compared to the fourth quarter of
2004. For the year, asset growth resulted in nearly $5.2 million in
additional interest income, which was again partially offset by an
increase in interest expense, in this case an additional $1.8
million, for the corresponding funding sources. As a result, the
improvement in net interest income attributable to asset growth
totaled nearly $3.4 million, which represented approximately 82% of
the year's overall improvement in net interest income. -0- *T
Average Earning Average Net Average Quarter Ended Assets Loans
Deposits ------------------ --------------- --------------
--------------- (Dollars in thousands) December 31, 2004 $945,684
$801,235 $666,835 March 31, 2005 $962,613 $816,127 $683,521 June
30, 2005 $979,981 $834,064 $705,680 September 30, 2005 $995,159
$854,343 $723,595 December 31, 2005 $1,009,727 $873,042 $744,112 *T
Our earning assets averaged just over $1.0 billion during the
fourth quarter of 2005, an increase of nearly $64 million, or 7%
over the same quarter in 2004. The growth over the prior year was
attributable to additional balances in our loan portfolio, as our
securities portfolio contracted in size relative to its level as of
December 2004. Throughout most of 2005, we found the yields
available on investment securities to be significantly less
attractive than those on loans, particularly when the funding costs
to support the additional assets were taken into account.
Consequently, as the securities in our portfolio amortized or
matured during 2005, we generally did not replace the paid off
securities, and instead redirected those cash flows to support loan
growth. In the event that market conditions should become more
conducive to holding investment securities, we would consider
increasing the size of our securities portfolio at that time.
Currently, however, we do not have any expectation of significantly
increasing the size of our investment portfolio. We generally rely
on growth in our deposit balances, including certificates issued in
institutional markets through deposit brokerage services, to
support our asset growth. During times when our deposit growth is
not sufficient to fully support our asset growth, we also utilize
advances from the Federal Home Loan Bank of Seattle (FHLB) as an
alternative funding source. For the final quarter of 2005, our
deposits averaged $744 million, representing growth of $77 million
over the average level of the same quarter in the prior year. As of
2005 year-end, total deposits were up $85 million from the end of
the prior year, with checking and money market balances accounting
for $9 million, or approximately 11% of the growth. Although
checking and money market deposits exhibited growth over their
year-ago levels, these balances showed declines in the first and
third quarters of this year. In those two quarters we aggressively
promoted, through attractive interest rates, our time deposits.
Asset Yields and Funding Costs (Rate) For the fourth quarter of
2005, the net effects of our assets and liabilities repricing
boosted net interest income by $290,000 relative to the same period
in 2004. For the entire year, repricing contributed an additional
$766,000 to our net interest income, or approximately 18% of the
total increase. For the quarter and year ended December 31, 2005,
the effects of interest rate movements and repricing on our loan
portfolio accounted for $2.6 million and $6.9 million in additional
interest income, respectively. With adjustable-rate loans
accounting for the vast majority of our loan portfolio, and new
loan production being originated at higher interest rates, all
major loan types benefited from rising interest rate indexes. By
comparison, the effects of interest rate movements and repricing on
our securities portfolio were fairly modest, resulting in an
improvement of only $138,000 to interest income in the fourth
quarter. For the year, repricing resulted in only $141,000 in
additional income relative to 2004, due in large part to our
holdings of stock in the Federal Home Loan Bank of Seattle. As a
member of the FHLB, and to utilize FHLB advances as a funding
source for our lending and investment activities, we maintain a
position in FHLB stock. Our position in this stock, which totaled
approximately $13 million at December 31, 2005, has historically
paid dividends on a quarterly basis. Based on events at the FHLB,
however, the dividend rate for the first quarter of 2005 was well
below the rate paid in the first quarter of last year, and no
dividend was received in the second, third, or fourth quarters. At
this time, we do not anticipate receiving any dividend income on
our FHLB stock in the foreseeable future. Excluding the FHLB stock,
the impact of repricing in our securities portfolio was relatively
modest due to the percentage of the portfolio invested in
fixed-rate and hybrid ARM securities, which have not yet benefited
from rising rate indices. On the liability side of the balance
sheet, repricing increased our interest expense on both deposits
and FHLB advances for both the quarter and year ended December 31,
2005. The interest rate increases that drove loan and wholesale
funding rates higher beginning in mid-2004 began to influence the
deposit rates offered by our competitors in our local market in
early 2005, resulting in rate-related increases in interest expense
on both our non-maturity and time deposit accounts. -0- *T Net
Interest Margin Quarter Ended Net Interest Margin
------------------------- ----------------------------- December
31, 2004 3.99% March 31, 2005 4.08% June 30, 2005 4.01% September
30, 2005 4.03% December 31, 2005 4.18% *T Our net interest margin
totaled 4.18% for the fourth quarter of 2005, a 15 basis point
improvement from the third quarter level and well in excess of the
4.00% - 4.05% range we had forecast in our third-quarter press
release. The improvement in our margin for the fourth quarter can
be attributed to a combination of the yield earned on our loan
portfolio continuing to increase in response to rising market
interest rates, along with containing the increase in our funding
costs. Adjustable-rate loans, which reprice according to terms
specified in our loan agreements with the borrowers, accounted for
approximately 87% of our loan portfolio as of the 2005 year-end.
For the majority of these loans, repricing occurs on an annual
basis. A notable exception to this would be those loans tied to the
prime rate, about 18.4% of the portfolio, which typically reprice
within one or two days of any increase in the Federal Funds target
rate by the Federal Reserve. Consequently, most of the loans in our
portfolio benefited from continued increases in short-term market
interest rate indices. By comparison, rates on our retail deposits
are managed internally and not typically subject to any sort of
systematic adjustments based on market rate indices. In the third
quarter of 2005, in response to aggressive deposit rates offered by
some of our competitors, we utilized promotional time deposit rates
and significantly increased the rates paid on some of our
non-maturity deposits. Largely as a result of these rate increases,
the improvement in our net interest margin for the third quarter
fell below our expectations. In the fourth quarter of 2005, we were
less aggressive with our deposit pricing, and any promotional time
deposit rates were offered only for new deposits. Additionally,
following rate increases in the third quarter, we were able to
avoid making any substantial increases in the rates paid on our
non-maturity deposit products. This contributed significantly to
the improvement in our net interest margin, as rate movements on
non-maturity deposit products result in an immediate impact on the
margin as the rates paid on tens, or even hundreds of millions of
dollars in balances are immediately affected. We would note that
movements of retail deposit rates tend to lag major interest rate
indices, remaining static as the market indices begin moving, and
then continuing to move for some time after the market rates
stabilize or plateau at a given level. As a result, if short-term
rates were to stabilize, we could potentially see compression in
our net interest margin in subsequent quarters as the effects of
systematic loan repricing would diminish, while deposit rates could
continue to trend upward for some time afterwards based on the
lagging nature of retail deposit rate movements. However, given
that intense competition has already driven deposit rates higher
than what seems to be the historical norm, it is also possible that
these rates may not continue to trend upwards for as long or as far
as in previous rate cycles. Gap Report Based on our November 30,
2005, model, our one-year gap position totaled negative 5.6%,
implying liability sensitivity, with more liabilities than assets
expected to mature, reprice, or prepay over the following 12
months. Net Interest Income Simulation The results of our income
simulation model constructed using data as of November 30, 2005,
indicate that relative to a "base case" scenario described below,
our net interest income over the next 12 months would be expected
to improve by 0.41% in an environment where interest rates
gradually increase by 200 bps over the subject timeframe, and
decline 1.64% in a scenario in which rates fall 200 bps. The
magnitudes of these changes suggest that there is little
sensitivity in net interest income from the "base case" level over
the 12-month horizon, with relatively consistent net interest
income in all three scenarios. The changes indicated by the
simulation model represent variances from a "base case" scenario,
which is our forecast of net interest income assuming interest
rates remain unchanged from their levels as of the model date and
that no balance sheet growth or contraction occurs over the
forecasted period regardless of interest rate movements. The base
model does, however, illustrate the future effects of rate changes
that have already occurred but have not yet flowed through to all
the assets and liabilities on our balance sheet. These changes can
either increase or decrease net interest income, depending on the
timing and magnitudes of those changes. NONINTEREST INCOME For the
quarter, our noninterest income increased by $65,000, or 5%,
compared to the fourth quarter of last year, as additional service
fee income and higher loan prepayment fees offset significant
reductions in loan sales and gains thereon. For the year, our
noninterest income exceeded the 2004 level by $1.1 million, or 26%,
again primarily attributable to increases in service fee income and
loan prepayment fees compared to 2004. -0- *T Gain on Sales of
Loans Gains/(Losses) on Loan Sales 4Q 2005 4Q 2004 YTD 2005 YTD
2004 ---------------- ------------ ------------ ------------
------------- Consumer Loan Sale Gains $ - $ 461,000 $ 820,000 $
1,436,000 Residential Loan Sale Gains 230,000 34,000 350,000
147,000 Commercial Loan Sale Gains 93,000 67,000 271,000 174,000
----------- ----------- ----------- ------------ Total Gains on
Loan Sales $ 323,000 $ 562,000 $ 1,441,000 $ 1,757,000 Loans Sold
---------------- Consumer Loans Sold $ - $ 9,279,000 $17,883,000 $
35,572,000 Residential Loans Sold 16,489,000 10,824,000 38,019,000
35,787,000 Commercial Loans Sold 5,410,000 10,240,000 11,310,000
32,606,000 ----------- ----------- ----------- ------------ Total
Loans Sold $21,899,000 $30,343,000 $67,212,000 $103,965,000 *T For
the fourth quarter of 2005, the volume of loans sold declined
significantly relative to the prior year, with no consumer loan
sales occurring in the quarter. The reduction in sales resulted in
a 43% decline in gains on loan sales for the quarter. In our
second-quarter 2005 press release we noted a significant change in
our strategy regarding sales of consumer loans. Prior to that time,
our plan had been to sell approximately $6 - $8 million in sales
finance loans each quarter, though actual sales in a given quarter
could fall above or below this range depending on loan production,
market conditions, and other factors. In the second quarter of
2005, we elected to change this strategy and substantially reduce
our sales of these loans, selling only sufficient volumes to ensure
the continuity of the market. Accordingly, our third quarter loan
sales were well below those for the same period last year and no
sales occurred in the fourth quarter. While the reduction in gains
on sales negatively impacted our noninterest income in the third
and fourth quarters, we retained a greater volume of these
higher-yielding assets within our portfolio. At the present time,
we are experiencing an increased level of interest in, and
favorable opportunities to market, our consumer loans to other
institutional investors. Consequently, our expectation is that
sales of these loans will likely increase in 2006. In the first
quarter we anticipate selling $9 - 10 million of consumer loans,
and $7 - 9 million in the second quarter. However, given the
unpredictability of the level of interest among potential
investors, we do not know if the higher sales volumes are likely to
extend beyond the second quarter. Gains on residential loan sales
in the fourth quarter rose significantly, increasing $196,000
relative to the prior year due largely to a fourth quarter sale of
approximately $5.4 million in "interest only" (IO) residential
mortgages. Please refer to the "Portfolio Information - Residential
Lending" section for additional information regarding this sale as
well as an expected sale of low-documentation (low-doc) residential
loans in the first quarter of 2006. As we consider these IO and
low-doc sales to be unique transactions rather than indicative of
any future trend in loan sales, it is our expectation that gains on
residential loan sales will return to historical levels in future
quarters. In our second quarter press release, we also noted that
we had experienced increased interest in, and opportunities for,
sales of participations in our commercial real estate loans.
Consequently, we added that we were considering the merits of
expanding our commercial real estate loan sales and potentially
originating credits with the intent to sell, rather than retain the
loans in our portfolio. While the volume of commercial real-estate
loans sold in the third quarter was modest and fourth-quarter sales
were down considerably relative to the same period last year, we
would note that these volumes do not reflect a decision against
expanding our commercial real-estate loan sales. Instead, we still
regard an increase in such sales as likely in 2006. Commercial
real-estate loan transactions, particularly those that are
candidates for sales of participations to other institutions, tend
to be larger-dollar credits and unpredictable in their timing and
frequency of occurrence. As a result, the volumes of commercial
real-estate loans sold, and gains thereon, can be expected to vary
considerably from one quarter to the next depending on the timing
of the loan and sales transactions. -0- *T Service Fee Income 4Q
2005 4Q 2004 YTD 2005 YTD 2004 --------- --------- -----------
--------- Consumer Loan Service Fees $273,000 $ 93,000 $1,228,000
$250,000 Commercial Loan Service Fees 10,000 18,000 69,000 65,000
Residential Loan Service Fees 4,000 - 3,000 (1,000) --------
-------- ---------- -------- Service Fee Income $287,000 $111,000
$1,300,000 $314,000 ======== ======== ========== ======== *T For
the three months and full year ended December 31, 2005, our total
servicing fee income rose 157% and 314% over the levels earned in
the same periods last year, due to substantial increases in fees
earned on consumer loans sold to and serviced for other
institutions. The growth in consumer loan service fees was largely
attributable to a change in the amortization period assumed for the
underlying servicing asset made in the first quarter of 2005.
Additional loan sales, particularly the larger sales in late 2004
and the first quarter of 2005, as well as corresponding growth in
our portfolio of consumer loans serviced for others, contributed to
the increase in servicing income. Servicing assets are recorded
when we sell loans to other investors and continue to service those
loans following the sale. To determine the fair value of the
servicing assets, we utilize a valuation model that calculates the
present value of future cash flows for the loans sold, based on
assumptions including market discount rates, anticipated prepayment
speeds, estimated servicing cost per loan, and other relevant
factors. These factors are subject to significant fluctuations, and
the estimates used in the models are subject to review and revision
based on actual experience and changes in expectations for the
future. The calculated value of the servicing rights is then
capitalized and amortized in proportion to, and over the period of,
estimated future net servicing income. Based on a review of our
assumptions in the first quarter of 2005, we determined that the
amortization period for the servicing rights on our consumer loan
servicing portfolio was significantly shorter than the term over
which these loans would be expected to provide net servicing
income. Consequently, we revised the amortization period such that
the average life of the amortization schedule would correspond with
the average life we were observing for the underlying loan
portfolio. This resulted in a significant increase in our net
servicing income. Note that any projection of servicing asset
amortization in future periods is limited by the conditions that
exist at the time the calculations are performed, and may not be
indicative of actual amortization expense that will be recorded in
future periods. The income received for servicing consumer loans
has also grown as a result of our sales finance loan sales,
particularly the larger sales last year and in the first quarter of
this year, and the corresponding growth in our portfolio of
consumer loans serviced for others. Based on our anticipated
consumer loan sales in 2006, we do not expect continued rapid
growth in service fee income. Fee income earned on our commercial
loans serviced for others was not a major contributor to the growth
in our total service fee income. In the event we expand our sales
of commercial real estate loans in 2006, however, we would expect
this income to grow and potentially become a significant percentage
of total service fee income. In contrast, residential loans are
typically sold servicing released, which means we no longer service
those loans once they are sold. Consequently, we do not view these
loans as a significant source of servicing fee income. -0- *T Other
Noninterest Income 4Q 2005 4Q 2004 YTD 2005 YTD 2004 ---------
--------- ----------- ----------- Rental Income $156,000 $152,000 $
627,000 $ 627,000 Loan Fees 178,000 117,000 647,000 384,000
ATM/Wires/Safe Deposit 70,000 50,000 258,000 190,000 Late Charges
61,000 49,000 207,000 167,000 Miscellaneous 70,000 63,000 246,000
171,000 -------- -------- ---------- ---------- Total Other
Noninterest Income $535,000 $431,000 $1,985,000 $1,539,000 ========
======== ========== ========== *T For the fourth quarter of 2005,
our noninterest income from sources other than those described
earlier rose by $104,000, or 24% over the same quarter last year,
and $446,000, or 29% for the year. The majority of this growth can
be attributed to loan fees, and more specifically prepayment fees,
which totaled $150,000 for the quarter, an increase of $91,000
relative to the fourth quarter of 2004. For the year, prepayment
fees increased by $238,000. We believe that a flattening of the
yield curve, which resulted from rising short-term interest rates
and relatively static longer-term interest rates, and increased
competition from other lenders contributed to the higher level of
loan payoffs and prepayment fees in 2005. The flattening of the
yield curve reduced the rate differential between short- and
long-term financing costs and provided a financial incentive for
borrowers with short-term or adjustable-rate loans to refinance
with long-term fixed rates. Increased competition among lenders in
our local market further accelerated loan payoffs, as this
competition frequently resulted in lenders offering borrowers the
opportunity to refinance at unusually low margins. Given the
uncertainties regarding interest rates and the behaviors of
borrowers and other lenders in the marketplace, we don't believe we
can predict the level of prepayment fees in future quarters with
any reasonable degree of accuracy. Significant growth was also
observed in our Visa/ATM fee income, which totaled nearly $54,000
for the fourth quarter, an increase of $18,000 over the fourth
quarter of 2004, and rose to $194,000 for the year, an increase of
almost $61,000 over the prior year level. We expect this source of
income to continue rising as checking accounts become a greater
piece of our overall deposit mix. Additionally, revenues received
from late charges on our loan portfolio increased 23% for the
quarter and 24% for the year relative to the same periods in 2004.
The growth of sales finance loans, both in our portfolio and those
serviced for other investor institutions, accounted for the
majority of the increase for the year, but increased late fees
collected on our portfolio of residential loans also contributed to
the improvement, particularly in the fourth quarter. NONINTEREST
EXPENSE In the fourth quarter of 2005, total noninterest expenses
increased by $853,000, or 12%, over the same quarter of 2004. For
the full year, total operating expenses grew by $3.7 million, or
15%, compared to 2004. Salaries and Employee Benefits Expense The
increase in total compensation costs was a modest 3%, or $130,000
for the quarter, compared to the last quarter of 2004, and 14%, or
$1.9 million, for the year. -0- *T 4Q 2005 4Q 2004 YTD 2005 YTD
2004 ----------- ----------- ------------ ------------ Salaries
$2,734,000 $2,475,000 $10,407,000 $ 9,191,000 Commissions &
Incentive Bonuses 652,000 855,000 2,525,000 2,170,000 Employment
Taxes & Insurance 198,000 196,000 949,000 873,000 Temporary
Office Help 70,000 37,000 277,000 188,000 Benefits 529,000 490,000
2,042,000 1,839,000 ---------- ---------- ----------- -----------
Total Salary & Benefit Expenses $4,183,000 $4,053,000
$16,200,000 $14,261,000 ========== ========== ===========
=========== *T Our salary expense in the fourth quarter rose
$259,000, or approximately 10%, from 2004 to 2005. The growth in
salary costs was primarily due to the annual merit increases for
existing employees, which were awarded in April 2005, and a net
increase of six full-time-equivalent (FTE) employees over the
fourth quarter of 2004. The business areas that saw the most staff
growth included our consumer loan administration and residential
lending groups, reflecting an increase in residential loan volume,
as well as the need for supporting the servicing of the existing
loan portfolio. -0- *T Commissions & FTE at Incentive Quarter
Ended Quarter End Salaries Bonuses ----------------------
-------------- --------------- ------------- December 31, 2004 220
$ 2,475,000 $ 855,000 March 31, 2005 219 $ 2,621,000 $ 511,000 June
30, 2005 218 $ 2,526,000 $ 927,000 September 30, 2005 221 $
2,527,000 $ 434,000 December 31, 2005 226 $ 2,734,000 $ 652,000 *T
Salary expense was also up significantly on a sequential quarter
basis, rising $207,000 from the third quarter of 2005. In addition
to new positions and FTE, turnover in existing positions also
contributed to this increase, as employees hired in the third and
fourth quarters were frequently brought in at salary levels higher
than those they replaced. Included among these employees were
replacements for some higher paying positions, including a pair of
department managers and two vacated commercial lending positions.
As these positions were vacant prior to being filled in the
late-third or fourth quarter, the third-quarter salary figure
largely reflects the absence of some of these personnel, while the
fourth quarter includes the related salary expense. A reduction in
commissions and incentive bonuses largely offset the increase in
salaries for the fourth quarter, resulting in the low
quarter-to-quarter increase in overall salaries and employee
benefits. Most of the overall decrease in commission and incentive
bonus expense was attributable to a reduction in the
non-commissioned employee staff bonus pool relative to the prior
year. For those personnel not participating in a specified
commission or incentive compensation plan, we maintain a separate
bonus pool, with accruals made to the pool at the end of each
quarter based on our year-to-date performance. The large
discrepancy between the incentive bonus amounts for the fourth
quarter of 2005 and the prior year was due to the timing of
contributions in each year. In 2004, the majority of the funding
for the bonus pool was contributed during the fourth quarter, while
the bulk of the 2005 bonus pool contributions were made in the
second quarter of the year. Occupancy Expense Occupancy expense
showed the largest percentage increase among the subcategories for
total noninterest expense. In the fourth quarter of 2005, occupancy
costs increased 34% from the last quarter of 2004, growing by
$261,000 to slightly over $1.0 million. Occupancy expense for the
total year increased 26%, up $726,000 to $3.5 million in 2005. -0-
*T 4Q 2005 4Q 2004 YTD 2005 YTD 2004 ----------- ---------
----------- ----------- Rent Expense $ 80,000 $ 77,000 $ 322,000 $
314,000 Utilities & Maintenance 202,000 191,000 685,000 639,000
Depreciation Expense 508,000 347,000 1,651,000 1,321,000 Other
Occupancy Costs 239,000 152,000 855,000 513,000 ---------- --------
---------- ---------- Total Occupancy Expense $1,029,000 $767,000
$3,513,000 $2,787,000 ========== ======== ========== ========== *T
A primary factor in the escalation of occupancy expense was the
increase in depreciation cost, which rose $160,000 in the fourth
quarter and $330,000 for the year, compared to the same periods in
2004. The dramatic increase in depreciation expense was largely
attributed to the remodeling projects undertaken this year in
several banking centers and the corporate headquarters, First
Mutual Center. The fourth quarter of 2005 saw the completion of
these remodeling projects and a jump of 46%, as compared to the
like quarter of last year, in depreciation expense. Our other
occupancy expenses grew by $86,000 for the fourth quarter and
$342,000 for 2005, largely due to the increase in software
licensing fees, and the purchase of non-capitalized assets and
equipment, principally related to the remodeled offices. Our
licensing fees increased by $107,000 for the year with the adoption
of a new licensing agreement with Microsoft, as well as the
purchase of new banking-specific software programs. The purchases
of non-capitalized assets and peripheral equipment accounted for
$31,000 of the increase in other occupancy expenses for the fourth
quarter and $107,000 for the year. Other Noninterest Expense Other
noninterest expenses increased by $461,000, or 23%, on a
quarter-to-quarter basis and $1.1 million or, 14%, on a
year-to-year comparison. -0- *T 4Q 2005 4Q 2004 YTD 2005 YTD 2004
----------- ----------- ----------- ----------- Marketing &
Public Relations $ 333,000 $ 358,000 $1,389,000 $1,243,000 Credit
Insurance 463,000 319,000 1,506,000 1,102,000 Outside Services
249,000 138,000 763,000 600,000 Taxes 127,000 128,000 490,000
483,000 Information Systems 226,000 241,000 931,000 1,001,000 Legal
Fees 236,000 80,000 501,000 421,000 Other 852,000 761,000 3,045,000
2,716,000 ---------- ---------- ---------- ---------- Total Other
Noninterest Expenses $2,486,000 $2,025,000 $8,625,000 $7,566,000
========== ========== ========== ========== *T One of the more
significant increases in other noninterest expenses was the growth
in credit insurance premiums on our loan portfolio, a trend that
continued over the course of the year. Our credit insurance
premiums for the quarter increased by $144,000, or 45%, relative to
the fourth quarter of 2004, and $404,000, or 37%, on an annual
basis. Contributing significantly to the increase for the quarter
was the supplemental insurance provided by our new insurer on a
seasoned pool of loans that were also covered by our previous
insurer. Please refer to the "Portfolio Information - Sales Finance
(Home Improvement) Loans" section for additional details. While
most of the increase in the cost of credit insurance premiums was
attributable to the growth of insured balances in our sales finance
loan portfolio, a small percentage of the insurance expense
resulted from coverage on other consumer and real estate loans,
which we insure depending on various financial or non-financial
factors relating to the loans and/or borrowers. The fourth quarter
saw notable growth in expenditures for outside services, which
increased $111,000, or 80%, from the fourth quarter of 2004 to the
fourth quarter of 2005. The year-over-year increase in outside
services was a more moderate $163,000, or 27% over 2004. About
$36,000 of the quarterly increase in expense resulted from the
hiring of outside labor to assist in the internal moves associated
with the remodel of our banking centers and First Mutual Center. In
addition, we spent approximately $76,000 on outside consulting
services in the fourth quarter of this year, approximately half of
which was allocated to a project for testing internal data
processing controls related to the Sarbanes/Oxley Act. Loan
processing costs also experienced significant growth in expenses in
both the fourth quarter and the year, growing $69,000 over the
fourth quarter of last year and $183,000 over 2004. In accordance
with current accounting standards, certain expenses tied to loan
origination, including some of these loan processing costs, are
deferred and amortized over the life of each loan originated,
rather than expensed in the current period. Expenses are then
reported in the financial statements net of these deferrals. The
amount of expense subject to deferral and amortization can vary
from one period to the next based upon the number of loans
originated, the mix of loan types, and year-to-year changes in
"standard loan costs." The increase in processing costs observed in
2005 is largely the result of the reduction in deferred costs
compared to 2004. The amount of processing expense eligible for
deferral for several loan types, particularly custom construction
loans, declined compared to last year. An additional item of note
is the increase in fourth quarter legal fees, which rose $156,000
compared to the same period last year. For the year, the escalation
of legal fees was more moderate, showing an increase of $80,000 or
19%. The increase in this category for the fourth quarter was
largely attributable to legal fees on non-performing assets. We
don't anticipate that level of legal expenses in future periods.
Non-Performing Assets Our exposure to non-performing loans and
repossessed assets as of December 31, 2005 was: -0- *T Ninety-five
consumer loans. Full recovery anticipated from insurance claims.
$412,000 Two single-family residential loans in Western WA. No
anticipated loss. 294,000 Seventeen consumer loans. Possible loss
of $96,000. 96,000 Nine consumer loans. No anticipated loss. 66,000
One land loan in Eastern WA. No anticipated loss. 29,000 ---------
TOTAL NON-PERFORMING ASSETS $897,000 ========= *T PORTFOLIO
INFORMATION Commercial Real Estate Loans The average loan size
(excluding construction loans) in the Commercial Real Estate
portfolio was $715,000 as of December 31, 2005, with an average
loan-to-value ratio of 64%. At quarter-end, none of these
commercial loans were delinquent for 30 days or more. Small
individual investors or their limited liability companies and
business owners typically own the properties securing these loans.
At quarter-end, the portfolio was 45% residential (multi-family or
mobile home parks) and 55% commercial. The loans in our commercial
real estate portfolio are well diversified, secured by small retail
shopping centers, office buildings, warehouses, mini-storage
facilities, restaurants and gas stations, as well as other
properties classified as general commercial use. To diversify our
risk and to continue serving our customers, we sell participation
interests in some loans to other financial institutions. About 11%
of commercial real estate loan balances originated by the Bank have
been sold in this manner. We continue to service the customer's
loan and are paid a servicing fee by the participant. Likewise, we
occasionally buy an interest in loans originated by other lenders.
About $15 million of the portfolio, or 4%, has been purchased in
this manner. Sales Finance (Home Improvement) Loans The Sales
Finance loan portfolio balance increased by $6 million to $87
million. The Bank manages that portfolio by segregating the
portfolio into its uninsured and insured balances. The uninsured
balance totaled $52 million at year-end 2005, while the insured
balance amounted to $35 million. The decision to insure a loan is
principally determined by the borrower's credit score. Uninsured
loans have an average credit score of 740 while the insured loans
have an average score of 671. With the uninsured loans the bank is
responsible for loan losses, and as illustrated in the following
table the charge-offs for that portion of the portfolio have ranged
from a low of $93,000 in the most recent quarter to a high of
$147,000 in the second quarter of 2005. -0- *T UNINSURED PORTFOLIO
- BANK BALANCES
---------------------------------------------------------------------
Delinquent Charge-offs Loans Net Charge- (% of Bank (% of Bank Bank
Balance Offs portfolio) Portfolio) ------------------- ------------
----------- ----------- ------------ December 31, 2004 $41 million
$100,000 0.24% 0.66% March 31, 2005 $40 million $141,000 0.35%
0.62% June 30, 2005 $44 million $147,000 0.33% 0.77% September 30,
2005 $48 million $ 98,000 0.21% 1.20% December 31, 2005 $52 million
$ 93,000 0.18% 1.18% *T Losses that the Bank sustains in the
insured portfolio are reimbursed by an insurance carrier. As shown
in the following table, the claims to the insurance carrier have
varied in the last five quarters from a low of $359,000 to as much
as $1,023,000 in the fourth quarter of this year. The substantial
increase in claims paid during the fourth quarter is largely
attributable to bankruptcy filings that occurred just prior to the
change in bankruptcy laws on October 17, 2005. The potential
problem with coverage on our losses for this portion of the
portfolio is that the carrier has an upper limit on claims coverage
of 10% of the original pool of loans for any given year. The pool
of current concern is the policy year 2002/2003, which has a
current loan balance of $9.4 million with a remaining loss coverage
of $224,000. We have addressed that potential concern by utilizing
a second insurance carrier for that pool of loans. -0- *T INSURED
PORTFOLIO - BANK AND INVESTOR LOANS
---------------------------------------------------------------------
Delinquent Claims (% of Loans Insured (% of Bank Claims Paid
Balance) Portfolio) ------------------- ------------ --------------
--------------- December 31, 2004 $ 492,000 1.06% 2.58% March 31,
2005 $ 516,000 1.05% 2.75% June 30, 2005 $ 359,000 0.70% 3.23%
September 30, 2005 $ 483,000 0.89% 3.64% December 31, 2005
$1,023,000 1.87% 3.60% *T Until recently, the Bank maintained a
relationship with a single credit insurance company (Insurer #1).
Insurer #1 provided credit insurance on Sales Finance loans as well
as insurance on a small number of home equity products. In August
2005, we entered into an agreement with another credit insurance
company (Insurer #2) to provide similar insurance products with
very similar underwriting and pricing terms. With two insurers in
place, we split the Sales Finance loans requiring insurance between
the two insurers (see table below). In October of 2005, the Bank
and Insurer #1 were unable to reach an agreement on the pricing of
insurance for loans originated after October 1, 2005. Therefore,
effective on that date, all newly insured loans have been insured
by Insurer #2. This decision does not affect the pricing or
coverage in place on loans currently insured with Insurer #1, and
we continue to have a relationship with Insurer #1 for home equity
loan products. As was noted earlier, we have also purchased back-up
insurance from Insurer #2 on loans that are currently also insured
by Insurer #1 for the 2002/2003 policy year. The back-up insurance
has added $1.07 million in additional coverage to that pool year.
The cost of this additional insurance is competitive with the
premiums that we are paying to Insurer #1. Our contract with both
insurers provides them with a maximum exposure limit of 10% of the
loan balances insured in each policy year. In the event that
Insurer #1's maximum exposure limit on the 2002/2003 policy year is
exhausted, Insurer #2 will provide credit insurance coverage on the
remaining loans in that pool subject to policy limitations (see
table below). In addition to increasing our insurance coverage on
the pool year 2002/2003 we have tightened our underwriting approval
criteria. The performance of the loans in the 2003/2004 and
2004/2005 policy years appear to positively reflect these changes.
-0- *T Insurer #1 Current Policy Loans Loan Year(A) Insured Balance
---------- ------------- ------------- 2002/2003 $21,442,000
$9,436,000 2003/2004 $35,242,000 $20,058,000 2004/2005 $23,964,000
$18,704,000 Remaining Limit as Original Remaining % of Current
Policy Loss Claims Loss Current Delinquency Year(A) Limit Paid
Limit Balance Rate ---------- ------------ ----------- -----------
--------- ----------- 2002/2003 $2,144,000 $1,920,000 $224,000
2.37% 6.32% 2003/2004 $3,524,000 $1,746,000 $1,778,000 8.86% 6.09%
2004/2005 $2,396,000 $278,000 $2,118,000 11.32% 3.08% (A) Policy
years close on 9/30 of each year Insurer #2 Current Policy Loans
Loan Year Insured Balance ------------- ------------ --------------
2002/2003(B) $10,768,000 $9,436,000 ------------- ------------
-------------- 2005/2006(C) $10,088,000 $6,390,000 Remaining
Original Remaining Limit as % Current Policy Loss Claims Loss of
Current Delinquency Year Limit Paid Limit Balance Rate
------------- ------------ ------ ------------ -----------
---------- 2002/2003(B) $1,077,000 $0 $1,077,000 11.41% 6.32%
------------- ------------ ------ ------------ -----------
---------- Not Not Not 2005/2006(C) Applicable(C) $0 Applicable(C)
Applicable 0.40% (B) Loans in this policy year are the same loans
insured with Insurer #1 during the same time period. (C) Policy
year closes on 7/31 of each year. This pool period has not closed
and therefore the original loss limit cannot be calculated. The
loss limit will be 10% of the total loans insured in the pool. *T
The prepayment speeds for the entire portfolio continue to remain
in a range of between 30% and 40%. During the fourth quarter of
2005, the average new loan amount was $10,700. The average loan
balance in the entire portfolio is $9,200, and the yield on this
portfolio is 10.56%. Loans with credit insurance in place represent
40% of the Bank's portfolio balance, and 33% (by balance) of the
loans originated in the fourth quarter were insured. Residential
Lending The residential lending portfolio (including loans held for
sale) totaled $307 million on December 31, 2005. This represents an
increase of $10 million from the end of the third quarter. The
breakdown of that portfolio at year-end was: -0- *T Bank Balance %
of Portfolio -------------- ------------ Adjustable rate permanent
loans $ 167 million 54% Fixed rate permanent loans $ 6 million 2%
Residential building lots $ 38 million 12% Disbursed balances on
custom construction loans $ 91 million 30% Loans held-for-sale $ 5
million 2% -------------- ------------ Total $ 307 million 100%
============== ============ *T The portfolio has performed in an
exceptional manner, and currently only three loans, or 0.16% of
loan balances, are delinquent more than one payment. The average
loan balance in the permanent-loan portfolio is $195,000, and the
average balance in the building-lot portfolio is $113,000.
Owner-occupied properties, excluding building lots, constitute 78%
of the loan balances. Our portfolio program underwriting is
typically described as non-conforming. The portfolio generally
consists of loans that, for a variety of reasons, are not readily
salable in the secondary market at the time of origination. The
yield earned on the portfolio is generally much higher than the
yield earned on a more typical "conforming underwriting" portfolio.
We underwrite the portfolio permanent loans by focusing primarily
on the borrower's good or excellent credit and our overall exposure
on the loan. We manually underwrite all loans and review the loans
for compensating factors to offset the non-conforming elements of
those loans. At year-end 2005, we had $4 million of loans in the
portfolio that had "interest only" payment plans until their first
interest rate change date, at which time the loan converts to
normal amortizing payments. This represents about 2% of the
permanent residential lending portfolio and less than half of 1% of
total loans. The loans with the interest-only feature were
underwritten using a payment of full principal and interest in the
calculation of monthly debts. This insures that loans were not made
to borrowers that only qualify due to the interest-only payment
feature on the loan. We no longer originate loans with
interest-only payment plans nor do we originate an "Option ARM"
product, where borrowers are given a variety of monthly payment
options that allow for the possibility of negative amortization. As
of December 31, 2005, we held about $2.8 million of
low-documentation permanent residential loans on our books. We also
held about $13.9 million in disbursed balances, and another $14
million in additional commitments on low-documentation custom
construction loans. These loans allow lower levels of documentation
to verify a borrower's income or assets. Through a combination of
the borrower's equity in the property and the purchase of mortgage
insurance on each individual loan, all low-documentation loans have
a loan-to-value of no more than 70% exposure to the Bank. Until
such time as we have an established track record with the
performance of low-documentation residential mortgages, we have set
an internal limit of 1% of the Bank's loan portfolio (approximately
$9 million). Due to unexpected demand for this product during the
third quarter, that limit was exceeded. We have since ceased
offering low-documentation custom construction loans and have begun
to explore the sale of low-documentation loans to other investors.
We believe that the successful implementation of these measures
over time will bring the portfolio balances of low-documentation
loans below the internal limit. PORTFOLIO DISTRIBUTION The loan
portfolio distribution at the end of the fourth quarter was as
follows: -0- *T Single Family (including loans held-for-sale) 25%
Income Property 34% Business Banking 13% Commercial Construction 3%
Single Family Construction: Spec 2% Custom 10% Consumer 13% *T
Adjustable-rate loans accounted for 87% of our total portfolio.
DEPOSIT INFORMATION The number of business checking accounts
increased by 15%, from 1,968 at December 31, 2004, to 2,262 as of
December 31, 2005, a gain of 294 accounts. The deposit balances for
those accounts grew 47%. Consumer checking accounts also increased,
from 6,763 at year-end 2004 to 7,429 this year, an increase of 666
accounts, or 10%. Our total balances for consumer checking accounts
rose 5%. The following table shows the distribution of our
deposits. -0- *T Money Market Time Deposits Checking Accounts
Savings ------------------- -------------- -----------
------------- ------- December 31, 2004 61% 14% 24% 1% March 31,
2005 64% 13% 22% 1% June 30, 2005 64% 14% 21% 1% September 30, 2005
65% 14% 20% 1% December 31, 2005 64% 14% 21% 1% *T OUTLOOK FOR
FIRST QUARTER 2006 Net Interest Margin Our forecast for the fourth
quarter was a range of 4.00% - 4.05%; the margin for the quarter
exceeded that forecast at 4.18%. Our margin was better than
anticipated because of a lower than expected increase in deposit
rates. The repricing of loans in the rising interest-rate
environment proceeded as anticipated, while the slower repricing of
deposits was a pleasant surprise. Our current expectation is that
the margin in the first quarter will decline slightly on a
sequential quarter basis to a range of 4.10% - 4.15%. We anticipate
that there will be some catch up in the repricing of deposits that
will put pressure on the margin. Loan Portfolio Growth The loan
portfolio, excluding loans held-for-sale, grew by $26 million,
exceeding our forecast of $10 - $15 million. We had anticipated
commercial loan sales to be far stronger than the $5.4 million that
was sold during the quarter. Our outlook for first quarter is loan
growth in the $12 - $17 million range. We expect consumer loan
sales in the $8 - $10 million range, as compared to no sales in the
fourth quarter. Noninterest Income Our estimate for the fourth
quarter was a range of $1.4 - $1.6 million. The actual result for
the quarter fell short of that forecast at $1.3 million. Our
expectation of increased commercial loan sales failed to
materialize, and although gains on loan sales were higher than
third quarter ,they were less than what we had anticipated. For the
first quarter, we again expect fee income to fall within a range of
$1.4 - $1.6 million, reflecting a sizeable increase in gain on
consumer loan sales relative to the fourth quarter. Noninterest
Expense Noninterest expense increased by 12% on a
quarter-to-quarter comparison, which was significantly greater than
our forecast of 6%. The unfavorable results were largely
attributable to increased legal costs related to non-performing
assets, and depreciation expense associated with the recently
completed remodeling of our banking centers and the corporate
headquarters. Our forecast for the first quarter of 2006 is $7.3
million, which is a growth of 6% in operating costs over the first
quarter of 2005 and a decrease of 5% on a sequential quarter basis
from the fourth quarter. This press release contains
forward-looking statements, including, among others, statements
about our anticipated increased business and consumer checking
accounts and our margins on sales finance and residential loans,
statements about our gap and net interest income simulation models,
our potential sales of consumer, sales finance, commercial real
estate, and "low-documentation" residential mortgage loans and the
servicing of those loans, the level of our legal fees for
non-performing assets, our handling of insurance and other credit
issues with respect to our sales finance program and other matters
that are forward-looking statements for the purposes of the safe
harbor provisions under the Private Securities Litigation Reform
Act of 1995. Although we believe that the expectations expressed in
these forward-looking statements are based on reasonable
assumptions within the bounds of our knowledge of our business,
operations, and prospects, these forward-looking statements are
subject to numerous uncertainties and risks, and actual events,
results, and developments will ultimately differ from the
expectations and may differ materially from those expressed or
implied in such forward-looking statements. Factors that could
affect actual results include the various factors affecting our
acquisition and sales of various loan products, general interest
rate and net interest changes and the fiscal and monetary policies
of the government, economic conditions in our market area and the
nation as a whole; our ability to continue to develop new deposits
and loans; our ability to control our expenses while increasing our
services, our facilities and the quality of our operations; the
impact of competitive products, services, and pricing; and our
credit risk management. There are other risks and uncertainties
that could affect us which are discussed from time to time in our
filings with the Securities and Exchange Commission. These risks
and uncertainties should be considered in evaluating the
forward-looking statements, and undue reliance should not be placed
on such statements. We are not responsible for updating any such
forward-looking statements.
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