UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
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þ
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Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
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For the Quarterly Period Ended March 31, 2008
or
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o
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Transition Report Pursuant to Section 13 or 15(D) Of The Securities Exchange Act Of 1934
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For the transition period from
to
Commission file number: 001-33188
WSB Financial Group, Inc.
(Exact name of registrant as specified in its charter)
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Washington
(State or other jurisdiction of incorporation or organization)
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20-3153598
(I.R.S. Employer Identification No.)
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607 Pacific Avenue
Bremerton, Washington
(Address of principal executive offices)
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98337
(Zip Code)
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(360) 405-1200
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
þ
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Smaller reporting company
o
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
o
No
þ
Indicate the number of shares outstanding on each of the registrants classes of common stock, as of the latest practical
date.
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Class
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Outstanding as of May 8, 2008
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Common Stock, $1.00 par value
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5,574,853
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WSB FINANCIAL GROUP, INC.
FORM 10-Q
MARCH 31, 2008
INDEX
i
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
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March 31,
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December 31,
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2008
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2007
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Unaudited
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ASSETS
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Cash and cash equivalents
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Cash and due from banks
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$
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10,390,216
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$
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10,026,460
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Federal funds sold
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102,500,000
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56,900,000
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Total cash and cash equivalents
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112,890,216
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66,926,460
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Investment securities available for sale, at fair value
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7,691,217
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8,832,146
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Federal Home Loan Bank stock, at cost
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318,900
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318,900
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Loans
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385,678,867
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412,949,947
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Less allowance for loan losses
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(26,291,809
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)
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(19,513,765
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)
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Total loans, net
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359,387,058
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393,436,182
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Premises and equipment, net
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8,689,041
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8,759,750
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Accrued interest receivable
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2,175,619
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2,540,554
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Other real estate owned
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1,883,411
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983,411
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Deferred tax asset
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9,073,733
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6,496,106
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Other assets
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1,424,668
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1,039,655
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Total assets
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$
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503,533,863
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$
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489,333,164
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LIABILITIES AND STOCKHOLDERS EQUITY
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Deposits
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Non-interest-bearing
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$
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23,043,276
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$
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24,711,246
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Interest-bearing
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418,503,500
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396,733,599
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Total deposits
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441,546,776
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421,444,845
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Accrued interest payable
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2,231,937
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1,955,434
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Other liabilities
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527,081
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964,870
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Junior subordinated debentures
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8,248,000
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8,248,000
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Total liabilities
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452,553,794
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432,613,149
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Stockholders equity
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Common stock, $1 par value; 15,357,250 shares
authorized; 5,574,853 and 5,574,853 shares issued and
outstanding at March 31, 2008 and December 31, 2007,
respectively
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5,574,853
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5,574,853
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Additional paid-in capital
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48,230,291
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48,223,669
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Retained earnings (accumulated deficit)
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(2,964,584
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)
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2,853,756
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Accumulated other comprehensive income
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139,509
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67,737
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Total stockholders equity
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50,980,069
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56,720,015
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Total liabilities and stockholders equity
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$
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503,533,863
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$
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489,333,164
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See accompanying notes to unaudited consolidated financial statements
1
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
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Three Months Ended
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March 31
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2008
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2007
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(Unaudited)
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(Unaudited)
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INTEREST INCOME
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Interest and fees on loans
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$
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6,336,236
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$
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8,343,410
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Interest on investments
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Taxable
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79,468
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73,055
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Tax-exempt
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18,800
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18,885
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Interest on federal funds sold
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554,744
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155,497
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Other interest income
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25,175
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50,149
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Total interest income
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7,014,423
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8,640,996
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INTEREST EXPENSE
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Deposits
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4,835,320
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3,661,370
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Other borrowings
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1,092
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Junior subordinated debentures
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144,000
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146,196
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Total interest expense
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4,979,320
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3,808,658
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NET INTEREST INCOME
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2,035,103
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4,832,338
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PROVISION FOR LOAN LOSSES
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7,690,000
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491,400
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Net interest (expense) income after provision for loan losses
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(5,654,897
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)
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4,340,938
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NONINTEREST INCOME
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Service charges on deposit accounts
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78,458
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84,027
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Other customer fees
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92,764
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245,875
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Net gain on sale of loans
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979,168
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Other income
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64,329
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36,403
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Total noninterest income
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235,551
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1,345,473
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NONINTEREST EXPENSE
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Salaries and employee benefits
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1,525,578
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2,666,624
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Premises lease
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77,326
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90,286
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Depreciation and amortization expense
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201,995
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193,087
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Occupancy and equipment
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158,658
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168,180
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Data and item processing
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183,750
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151,364
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Advertising expense
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41,564
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53,849
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Printing, stationery and supplies
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41,831
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59,629
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Telephone expense
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22,502
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29,004
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Postage and courier
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35,195
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39,020
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Legal fees
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306,123
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38,469
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Director fees
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108,850
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57,400
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Business and occupation taxes
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57,388
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72,622
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Accounting and audit fees
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157,687
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49,249
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Consultant fees
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136,316
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12,702
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OREO losses and expense, net
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26,465
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7,799
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Provision (benefit) for unfunded credit losses
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(320,000
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)
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Other expenses
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632,236
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369,972
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Total noninterest expense
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3,393,464
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4,059,256
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INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
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(8,812,810
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)
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1,627,155
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PROVISION (BENEFIT) FOR INCOME TAXES
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(2,994,470
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)
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545,000
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NET INCOME (LOSS)
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$
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(5,818,340
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)
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$
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1,082,155
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EARNINGS (LOSS) PER SHARE
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Basic
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$
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(1.04
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)
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$
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0.20
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Diluted
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$
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(1.04
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)
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$
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0.18
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Weighted-average number of common shares outstanding
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5,574,853
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5,548,283
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Weighted-average number of dilutive shares outstanding
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5,574,853
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6,109,233
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See accompanying notes to unaudited consolidated financial statements
2
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND
COMPREHENSIVE INCOME (LOSS)
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Retained
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Accumulated
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Common Stock
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Additional
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Earnings
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Other
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Number
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Paid-In
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(Accumulated
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Comprehensive
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Shares
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Amount
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Capital
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Deficit)
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(Loss) Income
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Total
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Balance, December 31, 2006
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|
5,545,673
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$
|
5,545,673
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$
|
48,089,861
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$
|
8,053,915
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|
$
|
(32,321
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)
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$
|
61,657,128
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Net income
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|
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|
|
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1,082,155
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1,082,155
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|
|
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|
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|
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Other comprehensive loss, net
of tax of ($874)
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|
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(1,696
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)
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|
(1,696
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)
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|
|
|
|
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|
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Total comprehensive income
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|
|
|
|
|
|
|
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|
|
|
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|
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|
|
|
|
|
|
1,080,459
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|
|
|
|
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|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock based compensation expense
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|
|
|
|
|
|
|
|
|
4,608
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|
|
|
|
|
|
|
|
|
|
|
4,608
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|
Stock options exercised
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|
|
10,748
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|
|
|
10,748
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|
|
|
45,740
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|
|
|
|
|
|
|
|
|
|
|
56,488
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2007 (unaudited)
|
|
|
5,556,421
|
|
|
$
|
5,556,421
|
|
|
$
|
48,140,209
|
|
|
$
|
9,136,070
|
|
|
$
|
(34,017
|
)
|
|
$
|
62,798,683
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
|
5,574,853
|
|
|
$
|
5,574,853
|
|
|
$
|
48,223,669
|
|
|
$
|
2,853,756
|
|
|
$
|
67,737
|
|
|
$
|
56,720,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,818,340
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)
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|
|
|
|
|
|
(5,818,340
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income, net
of tax of $36,973
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71,772
|
|
|
|
71,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,746,568
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
6,622
|
|
|
|
|
|
|
|
|
|
|
|
6,622
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2008 (unaudited)
|
|
|
5,574,853
|
|
|
$
|
5,574,853
|
|
|
$
|
48,230,291
|
|
|
$
|
(2,964,584
|
)
|
|
$
|
139,509
|
|
|
$
|
50,980,069
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited consolidated financial statements
3
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(5,818,340
|
)
|
|
$
|
1,082,155
|
|
Adjustments to reconcile net income (loss) to net cash from
operating activities
|
|
|
|
|
|
|
|
|
Provision for loan losses
|
|
|
7,690,000
|
|
|
|
491,400
|
|
Provision for unfunded credit losses
|
|
|
(320,000
|
)
|
|
|
|
|
Depreciation and amortization
|
|
|
201,995
|
|
|
|
193,087
|
|
Amortization (accretion) of premiums/discounts
|
|
|
(3,860
|
)
|
|
|
1,742
|
|
Stock based compensation
|
|
|
6,622
|
|
|
|
4,608
|
|
Net loss (gain) on sale of OREO
|
|
|
10,903
|
|
|
|
(2,176
|
)
|
Origination of loans held for sale
|
|
|
|
|
|
|
(33,684,973
|
)
|
Proceeds from sale of loans held for sale
|
|
|
|
|
|
|
39,874,252
|
|
Net gain on sale of loans
|
|
|
|
|
|
|
(979,168
|
)
|
Deferred income tax benefit
|
|
|
(2,614,600
|
)
|
|
|
(565,543
|
)
|
Net change in
|
|
|
|
|
|
|
|
|
Accrued interest receivable
|
|
|
364,935
|
|
|
|
(57,381
|
)
|
Other assets
|
|
|
(385,013
|
)
|
|
|
321,671
|
|
Accrued interest payable
|
|
|
276,503
|
|
|
|
343,619
|
|
Other liabilities
|
|
|
(117,789
|
)
|
|
|
727,337
|
|
|
|
|
|
|
|
|
Net cash from operating activities
|
|
|
(708,644
|
)
|
|
|
7,750,630
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net change in loans
|
|
|
25,359,124
|
|
|
|
(44,066,685
|
)
|
Purchases of investments available-for-sale
|
|
|
|
|
|
|
(1,991,600
|
)
|
Proceeds from calls and maturities of investments available-for-sale
|
|
|
1,250,000
|
|
|
|
2,300,000
|
|
Principal repayments of mortgage-backed securities
|
|
|
3,534
|
|
|
|
2,720
|
|
Proceeds from sale of OREO
|
|
|
89,097
|
|
|
|
182,176
|
|
Purchases of premises and equipment
|
|
|
(131,286
|
)
|
|
|
(1,149,812
|
)
|
|
|
|
|
|
|
|
Net cash from investing activities
|
|
|
26,570,469
|
|
|
|
(44,723,201
|
)
|
|
|
|
|
|
|
|
CASH FLOW FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net change in non-interest-bearing deposits
|
|
|
(1,667,970
|
)
|
|
|
649,838
|
|
Net change in interest-bearing deposits
|
|
|
21,769,901
|
|
|
|
46,015,117
|
|
Proceeds from exercise of stock options
|
|
|
|
|
|
|
56,488
|
|
|
|
|
|
|
|
|
Net cash from financing activities
|
|
|
20,101,931
|
|
|
|
46,721,443
|
|
|
|
|
|
|
|
|
NET INCREASE IN CASH AND CASH EQUIVALENTS
|
|
|
45,963,756
|
|
|
|
9,748,872
|
|
CASH AND CASH EQUIVALENTS, beginning of period
|
|
|
66,926,460
|
|
|
|
26,198,104
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period
|
|
$
|
112,890,216
|
|
|
$
|
35,946,976
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
4,702,817
|
|
|
$
|
3,465,039
|
|
|
|
|
|
|
|
|
Income taxes paid
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
NON-CASH INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Real estate acquired through foreclosure in settlement of loans
|
|
$
|
1,000,000
|
|
|
$
|
1,489,776
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited consolidated financial statements
4
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Summary of Significant Accounting Policies
Nature of operations and basis of consolidation On March 12, 1999, Westsound Bank (the
Bank) was granted a state charter as a commercial bank whose principal activity is to engage in
general commercial banking business in the Bremerton area of Kitsap County, Washington. The Bank
generates commercial, mortgage and consumer loans and receives deposits from customers located
primarily in Bremerton, Washington. As a Washington State chartered financial institution, the Bank
is subject to regulations by the Washington State Banking Department of Financial Institutions and
the Federal Deposit Insurance Corporation. Westsound Bank has branch offices in Bremerton,
Silverdale, Port Angeles, Port Orchard, Sequim, Gig Harbor, Poulsbo, Federal Way, and Port
Townsend, Washington.
The Bank is located in an area that has a significant U.S. Department of Defense presence.
Closure or downsizing of one of the two large bases could affect operating results adversely. No
such indication of closure or downsizing has been made in Department of Defense plans as indicated
in budgets.
In July, 2005, WSB Financial Group, Inc. (the Company), a bank holding company, was issued a
certificate of incorporation as a Washington Profit Corporation. During 2005, the Federal Reserve
Bank of San Francisco granted authority to WSB Financial Group, Inc. to become a bank holding
company through a reorganization of the ownership interests of Westsound Bank.
WSB Financial Group Trust I (Trust), a subsidiary of WSB Financial Group, Inc., was formed in
July 2005 for the exclusive purpose of issuing Trust Preferred Securities and common securities and
using the $8 million in proceeds from the issuance to acquire junior subordinated debentures issued
by WSB Financial Group, Inc. In accordance with Interpretation No. 46, Consolidation of Variable
Interest Entities, the Trust is not consolidated in the Companys financial statements.
The consolidated financial statements include the accounts of WSB Financial Group, Inc. and
its wholly owned subsidiaries, excluding the Trust, after eliminating all intercompany
transactions.
Unaudited Interim Financial Information
The accompanying interim consolidated financial
statements as of March 31, 2008 and for the three month periods ended March 31, 2008 and 2007 are
unaudited. The unaudited interim financial statements have been prepared on the same basis as the
annual financial statements and, in the opinion of management, reflect all adjustments, which
include only normal recurring adjustments, necessary to present fairly the Companys financial
position as of March 31, 2008, its results of operations for the three month periods ended March
31, 2008 and 2007, and its cash flows for the three months ended March 31, 2008 and 2007. The
results of operations for the interim periods are not necessarily indicative of the results for the
full year. Certain information and footnote disclosures included in the Companys financial
statements for the year ended December 31, 2007 have been condensed or omitted from this report.
Accordingly, the statements should be read with the financial statements and notes thereto included
in the Companys December 31, 2007 financial statements.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reporting amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant change relate to the
determination of the allowance for loan losses and deferred tax asset/liability.
Cash and cash equivalents
For purposes of reporting cash flows, cash and cash equivalents
are cash on hand, amounts due from banks, and federal funds sold, and have maturities of three
months or less. The Bank places its cash with high credit quality institutions. The amounts on
deposit fluctuate and, at times, exceed the insured limit by the U.S. Federal Deposit Insurance
Corporation, which potentially subjects the Bank to credit risk. Generally, federal funds are
purchased and sold for one-day periods.
Investment securities
Investment securities are classified into one of three categories: (1)
held-to-maturity, (2) available-for-sale, or (3) trading. Investment securities are categorized as
held-to-maturity when the Bank has the
5
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
positive intent and ability to hold those securities to maturity. Securities which are
held-to-maturity are stated at cost and adjusted for amortization of premiums and accretion of
discounts, which are recognized as
adjustments to interest income. The Bank had no securities classified as held-to-maturity as
of March 31, 2008 and December 31, 2007. The Bank had no trading securities as of March 31, 2008
and December 31, 2007.
Investment securities categorized as available-for-sale are generally held for investment
purposes (to maturity), although unanticipated future events may result in the sale of some
securities. Available-for-sale securities are recorded at estimated fair value, with the net
unrealized gain or loss included in comprehensive income, net of the related tax effect. Realized
gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of
securities sold, using the specific identification method.
Declines in the fair value of individual held-to-maturity, and available-for-sale securities
below their cost that are other than temporary are recognized by write-downs of the individual
securities to their fair value. Such write-downs would be included in earnings as realized losses.
In estimating other-than-temporary impairment losses, management considers (1) the length of time
and the extent to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its
investment in the issuer for a period of time sufficient to allow for any anticipated recovery in
fair value. Gains and losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.
Premiums and discounts are recognized in interest income using the interest method over the
period to maturity.
Federal Home Loan Bank stock
The Banks investment in Federal Home Loan Bank (the FHLB)
stock is carried at par value ($100 per share), which reasonably approximates its fair value. As a
member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB
stock based on specified percentages of its outstanding FHLB advances. The Bank may request
redemption at par value of any stock in excess of the amount the Bank is required to hold. Stock
redemptions are at the discretion of the FHLB.
Loans held for sale
Loans originated and intended for sale in the secondary market are
carried at the lower of aggregate cost or fair value, as determined by aggregate outstanding
commitments from investors or current investor yield requirements. Net unrealized losses are
recognized through a valuation allowance by charges to income.
Mortgage loans held for sale are generally sold with the mortgage servicing rights released by
the Bank. Gains or losses on sales of mortgage loans are recognized based on the difference between
the selling price and the carrying value of the related mortgage loans sold.
Accounting for derivatives
The Company has engaged in the production of loans for sale to
buyers and investors in the secondary mortgage market. These loan production activities expose the
Company to risk that a loans market value may decline between the date the Company enters into an
interest rate lock commitment with a borrower to fund a loan, or with a seller to purchase a loan,
and the loans ultimate sale into the secondary market. The Company reduces its exposure to this
risk by entering into contracts to sell loans to buyers at specified prices to hedge against the
economic risk of market value declines. The Company considers its commitments to extend secondary
market qualifying loans (the pipeline) with interest rate lock commitments to be derivatives, as
well as its firm commitments to deliver loans, all of which are recognized at their estimated fair
values. The Company had no interest rate lock commitment derivatives at March 31, 2008 and December
31, 2007.
Loans and allowances for loan losses
Loans that management has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are reported at their outstanding
principal adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs
on originated loans and unamortized premiums or discounts on purchased loans. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination
costs, are deferred and recognized as an adjustment of the related loan yield using the interest
method.
6
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
The Bank considers loans impaired when it is probable the Bank will be unable to collect all
amounts as scheduled under the loan agreement. Impaired loans are measured based on the present
value of expected future cash flows discounted at the loans effective interest rate, or, as a
practical expedient, at the loans observable market
price or the fair value of the collateral, if the loan is collateral dependent. Changes in
these values will be reflected in income and as adjustments to the allowance for loan losses.
The accrual of interest on impaired loans is generally discontinued at the time the loan is 90
days past due or when, in managements opinion, the borrower may be unable to meet payments as they
become due. Factors considered by management in determining impairment include payment status,
collateral value and the probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding
the loan and the borrower, including the length of the delay, the reasons for the delay, the
borrowers prior payment record and the amount of the shortfall in relation to the principal and
interest owed. When interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are received, or
payment is considered certain. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future payments are reasonably assured.
The allowance is based on a continuing review of loans which includes consideration of actual
loss experience, changes in the size and character of the portfolio, identification of individual
problem situations which may affect the borrowers ability to repay, and evaluations of the
prevailing and anticipated economic conditions. This evaluation is inherently subjective, as it
requires estimates that are susceptible to significant revision, as more information becomes
available.
The allowance for loan losses is increased by charges to income and decreased by charge-offs
(net of recoveries). While management uses available information to recognize losses on loans,
changes in economic conditions may necessitate revision of the estimate in future years. In
addition, various regulatory agencies, as an integral part of their examination processes,
periodically review the Banks allowance for loan losses. Such agencies may require the Bank to
recognize additional losses based on their judgment using information available to them at the time
of their examination.
The allowance is allocated based on general, classified, specific and conditions components of
the loan portfolio. The classified component relates to loans that are risk rated as either
doubtful, substandard or special mention. For such loans that are also classified as impaired, a
specific allowance is established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan are lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss experience adjusted for
qualitative factors. A conditions component is maintained to cover uncertainties that could affect
managements estimate of probable losses. This conditions component of the allowance reflects
internal and external factors that may impact the loan portfolio performance in future periods.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.
Accordingly, the Bank does not separately identify individual consumer and residential loans for
impairment disclosures, unless such loans are the subject of a restructuring agreement.
Stock option plans
The Company accounts for all share-based payments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 123(R),
Share-Based Payment,
which is a
revision of SFAS No. 123,
Accounting for Stock-Based Compensation.
SFAS 123(R) supersedes
Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees,
and amends
SFAS No. 95,
Statement of Cash Flows.
Generally, the approach in SFAS 123(R) is similar to the
approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values.
Earnings (loss) per common share
Basic earnings per share represents income available to
common stockholders divided by the weighted-average number of common shares outstanding during the
period. Diluted
7
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
earnings per share reflects additional common shares that would have been
outstanding if dilutive potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common shares that may be issued by
the Company relate solely to outstanding stock options, and are determined using the treasury stock
method. For the 2008 fiscal year, all outstanding stock options were excluded from the computation
of the loss per share due to the net loss recorded during the period.
Earnings (loss) per common share have been computed based on the following:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Numerator
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(5,818,340
|
)
|
|
$
|
1,082,155
|
|
Denominator
|
|
|
|
|
|
|
|
|
Weighted-average number of common shares outstanding
|
|
|
5,574,853
|
|
|
|
5,548,283
|
|
Incremental shares assumed for stock options(1)
|
|
|
|
|
|
|
560,950
|
|
|
|
|
|
|
|
|
Weighted-average number of dilutive shares outstanding
|
|
|
5,574,853
|
|
|
|
6,109,233
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per common share
|
|
$
|
(1.04
|
)
|
|
$
|
0.20
|
|
Diluted earnings (loss) per common share(2)
|
|
$
|
(1.04
|
)
|
|
$
|
0.18
|
|
|
|
|
(1)
|
|
There were no anti-dilutive options at March 31, 2007.
|
|
(2)
|
|
Excludes all stock options as anti-dilutive in periods with net losses.
|
Recent accounting pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair
Value Measurements
(SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures about fair value
measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair
value measurements. Accordingly, SFAS 157 does not require any new fair value measurements. SFAS
157 is effective for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. SFAS 157 did not have a material impact on our
consolidated financial statements. (See Note 13.)
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits
entities to choose to measure many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the opportunity to mitigate
volatility in reporting earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the
beginning of an entitys first fiscal year that begins after November 15, 2007. The Company elected
not to report using the Fair Value Option under SFAS 159 as of January 1, 2008.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (SFAS 160). SFAS 160 applies to all entities
that prepare consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in one or more
subsidiaries or that deconsolidate a subsidiary. The objective is to improve relevance,
comparability, and transparency of the financial information that a reporting entity provides in
its consolidated financial statements by establishing accounting and reporting standards. SFAS 160
is effective for
8
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
annual periods after December 15, 2008. SFAS 160 is not expected to have a
material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities an amendment of FASB Statement No. 133 (SFAS 161). SFAS requires enhanced
disclosures about an entitys derivative and hedging activities and improves financial reporting.
This statement is effective for financial statements issued for the fiscal years and interim
periods beginning after November 15, 2008, with early application encouraged. SFAS 161 is not
expected to have a material impact on our consolidated financial statements.
In December 2007, the FASB revised SFAS No. 141,
Business Combinations
(SFAS 141(R)). SFAS
141(R) improves the completeness of the information reported about a business combination by
changing the requirements for recognizing assets acquired and liabilities assumed arising from
contingencies. This statement requires an acquirer to recognize assets acquired and liabilities
assumed arising from contractual contingencies as of the acquisition date, measured at their fair
value. SFAS 141R applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or after December 15,
2008, and is not expected to have a material impact on our consolidated financial statements.
Reclassifications
Certain amounts in the prior period financial statements have been
reclassified to conform to the current years presentation and do not affect previously reported
net income, equity, or earnings per share.
Note 2 Regulatory Actions
FDIC Order:
On March 10, 2008, Westsound Bank (the Bank) entered into a Stipulation and
Consent to the Issuance of an Order to Cease and Desist (the FDIC order) with the Federal Deposit
Insurance Corporation, or FDIC, and the Washington Department of Financial Institutions, Division
of Banks, or DFI.
The regulators determined the Bank had engaged in unsafe or unsound banking practices, by
engaging in unsatisfactory lending and collection practices, operating with inadequate management
and board supervision, with less than satisfactory capital in relation to its large volume of poor
quality loans and with an inadequate loan valuation reserve, and with inadequate provisions for
liquidity, inadequate internal routine and control policies, and in violation of various banking
laws and regulations relating to internal audits and controls, real estate appraisal and lending
guidelines, and responsibilities of bank directors and officers.
Under the terms of the FDIC order, the Bank cannot declare dividends without the prior written
approval of the FDIC and the DFI. Other material provisions of the order require the Bank to: (i)
review the compensation and effectiveness of Westsound Banks current executive officers and
directors, and the structure of the board and its committees, (ii) strengthen the Banks board of
directors oversight of management and operations of the Bank, (iii) improve the Banks internal
controls, internal audit function, lending and collection policies and procedures, particularly
with respect to the origination and monitoring of construction loans, (iv) maintain specified
capital and liquidity ratios, and (v) prepare and submit progress reports to the FDIC and the DFI.
The FDIC order will remain in effect until modified or terminated by the FDIC and the DFI.
The order does not restrict the Bank from transacting its normal banking business. The Bank
will serve its customers in all areas including making loans, establishing lines of credit,
accepting deposits and processing banking transactions. All customer deposits remain fully insured
to the highest limits set by FDIC. The FDIC and DFI did not impose any monetary penalties.
FRB Notice:
On February 14, 2008, the Federal Reserve Bank of San Francisco, or FRB, notified
WSB Financial Group, Inc. (the Company) and the Bank that it had designated the Company and
Westsound Bank to be in a troubled condition for purposes of Section 914 of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989. As a result of that designation neither
the Company nor the Bank may appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers without notifying the FRB. In addition,
neither the Company nor the Bank may make indemnification and severance payments without complying
with certain statutory restrictions including prior written approval of the FRB and
9
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
concurrence from the FDIC. Further, the Company is generally prohibited from making any payments to any entity,
including dividends and interest payments (including dividends on its trust preferred securities,
and interest at the holding company level), director fees, consulting expenses and other operating
expenses, without notifying the FRB for prior approval of such payments.
Capital:
Although the Company and the Bank were well capitalized at March 31, 2008 based on
their financial statements prepared in accordance with generally accepted accounting principles in
the United States and the general percentages in the regulatory guidelines, the Company and the
Bank understand that they are no longer regarded as well capitalized for federal regulatory
purposes, as a result of the deficiencies cited in the FDIC order.
Westsound Bank believes it has been reclassified from well capitalized to adequately
capitalized. As a result of this reclassification, the Banks borrowing costs and terms from the
FRB, the FHLB and other financial institutions, as well as the Banks premiums to the Deposit
Insurance Fund administered by the FDIC to insure bank and savings association deposits (generally
up to $100,000 per customer), are expected to increase.
Compliance Efforts:
The Company and the Bank are actively engaged in responding to the
concerns raised in the FDIC order, and believe that they have already addressed many of the
regulators requirements. The Company is also complying with the terms of the FRB notice, and has
exercised its option to start deferring payments of quarterly interest on its trust preferred
securities on March 15, 2008 and June 15, 2008, as permitted by the indenture agreement.
Westsound Bank has begun working with these regulatory agencies and has acted promptly on
directions it has received from these agencies in the past several months, including the following
actions:
|
|
|
Retained a new president and chief executive officer, Terry A. Peterson, on
April 15, 2008;
|
|
|
|
|
Conducting a comprehensive review of the qualifications of management and
existing staff and consideration of potential changes that may be required;
|
|
|
|
|
Retained an independent third party consultant to review and evaluate the loan
portfolio and began implementing many of his recommendations to improve the Banks
loan approval and loan servicing processes;
|
|
|
|
|
Added $13.9 million to total provisions for loan losses, including $348,000 in
unfunded commitments in the third quarter of 2007, increased fourth quarter 2007
reserves by $1.7 million and increased first quarter 2008 reserves by $7.7 million;
|
|
|
|
|
Strengthened collections and loss recovery teams to accelerate resolution of
problem loans, including retaining two experienced loan administration and workout
specialists as consultants.
|
|
|
|
|
Began developing a capital management plan to maintain strong capital ratios;
|
|
|
|
|
Began implementing new procedures to strengthen the monitoring of lending
activities with particular emphasis on monitoring individual lender/borrower
relationships;
|
|
|
|
|
Initiated a review of loan documentation policy and is correcting documentation
deficiencies;
|
|
|
|
|
Developed a liquidity and funds management plan to address anticipated funding
needs;
|
|
|
|
|
Increasing internal controls over loan portfolio review;
|
|
|
|
|
Establishing a communications procedure for reporting progress in all areas to
the FDIC and DFI.
|
10
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
A number of these initiatives are complete and a number of policies and procedures have been
implemented. As a result, the Bank has already acted upon several items addressed by the FDIC
order.
Note 3 Loans and Allowance for Loan Losses
Loans are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Real estate loans
|
|
$
|
353,595,168
|
|
|
$
|
378,820,821
|
|
Commercial and industrial loans
|
|
|
29,338,310
|
|
|
|
31,376,932
|
|
Individual loans for household and other personal expenditures
|
|
|
2,328,856
|
|
|
|
2,612,883
|
|
Other loans
|
|
|
1,052,672
|
|
|
|
1,105,922
|
|
Deferred fees
|
|
|
(637,139
|
)
|
|
|
(966,611
|
)
|
|
|
|
|
|
|
|
|
|
$
|
385,678,867
|
|
|
$
|
412,949,947
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Allowance for loan losses
|
|
|
|
|
|
|
|
|
Balances, beginning of period
|
|
$
|
19,513,765
|
|
|
$
|
3,971,789
|
|
Provision for losses
|
|
|
7,690,000
|
|
|
|
491,400
|
|
Recoveries
|
|
|
3,783
|
|
|
|
54
|
|
Loans charged off
|
|
|
(915,739
|
)
|
|
|
(49,927
|
)
|
Reclassification of allowance for unfunded credit
commitments to other liabilities
|
|
|
|
|
|
|
(6,400
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, end of period
|
|
$
|
26,291,809
|
|
|
$
|
4,406,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31,
2008
|
|
|
March
31,
2007
|
|
|
|
|
|
|
|
|
|
|
Total non-accrual loans
|
|
$
|
70,313,000
|
|
|
$
|
209,000
|
|
|
|
|
|
|
|
|
Total loans 90 days or more past due and still accruing
|
|
$
|
|
|
|
$
|
343,000
|
|
|
|
|
|
|
|
|
Impaired loans are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Impaired Loans
|
|
|
|
|
|
|
|
|
Balance at end of period (1)
|
|
$
|
18,962,139
|
|
|
$
|
612,278
|
|
|
|
|
|
|
|
|
Total related allowance for losses
|
|
$
|
4,178,695
|
|
|
$
|
127,048
|
|
|
|
|
|
|
|
|
Average investment in impaired loans
|
|
$
|
23,818,786
|
|
|
$
|
153,070
|
|
|
|
|
|
|
|
|
Interest income recognized on impaired loans
|
|
$
|
104,127
|
|
|
$
|
6,631
|
|
|
|
|
|
|
|
|
Cash-basis interest income received on impaired loans
|
|
$
|
90,192
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes $12.9 million non-accrual loans at March 31, 2008 and $209,000 at March 31, 2007.
|
11
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
As of March 31, 2008, we added $7.7 million, or $5.1 million after tax, to our provision for
loan losses, based on managements quarterly review, the maturing of our construction loans and
continued uncertainty in the local housing market. This resulted in an after-tax impact of $0.91
per diluted share in the first quarter 2008 results. In the previous two quarters ended December
31, 2007 and September 30, 2007, we recorded provisions for loan losses of $1.7 million and $13.4
million, respectively.
Although the Company believes it is using the best information available to make
determinations with respect to the allowance for loan losses and its current allowance for loan
losses is adequate for such purposes, management reviews the loan portfolio each quarter and
adjustments may be necessary in future periods if the assumptions used in making our initial
determinations prove to be incorrect.
Note 4 Deposits
Deposit account balances are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Non-interest-bearing
|
|
$
|
23,043,276
|
|
|
$
|
24,711,246
|
|
Interest-bearing demand
|
|
|
9,619,347
|
|
|
|
12,350,558
|
|
Money market accounts
|
|
|
69,898,881
|
|
|
|
79,218,421
|
|
Savings deposits
|
|
|
12,959,515
|
|
|
|
10,338,768
|
|
Certificates of deposit exceeding $100,000
|
|
|
160,094,476
|
|
|
|
149,198,911
|
|
Certificates of deposit less than $100,000
|
|
|
165,931,281
|
|
|
|
145,626,941
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
441,546,776
|
|
|
$
|
421,444,845
|
|
|
|
|
|
|
|
|
Scheduled maturities of certificates are as follows for the years ending as of March 31:
|
|
|
|
|
2008
|
|
$
|
169,416,658
|
|
2009
|
|
|
120,084,954
|
|
2010
|
|
|
17,474,694
|
|
2011
|
|
|
6,443,154
|
|
2012
|
|
|
12,438,360
|
|
2013
|
|
|
167,937
|
|
|
|
|
|
|
|
$
|
326,025,757
|
|
|
|
|
|
Note 5 Advances and Junior Subordinated Debentures Payable
At March 31, 2008, one committed line of credit arrangement totaling $10,000,000 was available
to the Bank from unaffiliated banks with maturities dated June 30, 2008. This line provides for
interest at the then existing federal funds rate. There were no borrowings outstanding under this
credit arrangement at March 31, 2008.
The Bank is a member of the FHLB of Seattle. Our credit line of $16.0 million with FHLB has
been placed on hold until FHLB completes its credit analysis of the Bank and will probably be
collateral dependent. These borrowings must be secured by pledging qualified loans. Borrowings
generally provide for interest at the then current published rates. There were no borrowings
outstanding under this credit line at March 31, 2008.
In order to manage the capital position more efficiently, the Company formed the Trust, a
Delaware statutory trust formed with capital of $248,000, for the sole purpose of issuing trust
preferred securities. During the third quarter of 2005, the Trust issued 8,000 Capital Securities,
or the trust preferred securities, with liquidation value of $1,000 per security, for gross
proceeds of $8.0 million. The entire proceeds of the issuance were invested by the Trust in $8.248
million of Junior Subordinated Deferrable Interest Debentures, or the junior subordinated
debentures payable, issued by the Company, with identical maturity, repricing and payment terms as
the trust preferred securities. The subordinated debentures
represent the sole assets of the Trust.
The subordinated debentures
12
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
mature on September 15, 2035, and bear an interest rate at March 31,
2008 of 6.72% (based on 3-month LIBOR plus 1.73%), with repricing occurring and interest payments
due quarterly. The Company injected $7.9 million of the net proceeds from the sale of the
subordinated debentures into the Bank and retained the remaining proceeds.
The subordinated debentures are redeemable by the Company, subject to receipt of prior
approval from the Federal Reserve Bank of San Francisco, on any March 15, June 15, September 15 or
December 15 on or after September 15, 2010.
The redemption price is par plus accrued and unpaid interest, except in the case of redemption
under a special event which is defined in the debenture occurring prior to September 15, 2010. The
trust preferred securities are subject to mandatory redemption to the extent of any early
redemption of the subordinated debentures and upon maturity of the subordinated debentures on
September 15, 2035.
Holders of the trust preferred securities are entitled to a cumulative cash distribution on
the liquidation amount of $1,000 per security at an interest rate at March 31, 2008 of 6.72%. For
each successive period beginning on March 15 of each year, the rate will be adjusted to equal the
3-month LIBOR plus 1.73%. The Trust has the option to defer payment of the distributions for a
period of up to five years, as long as we are not in default on the payment of interest on the
subordinated debentures. The Company has guaranteed, on a subordinated basis, distributions and
other payments due on the trust preferred securities. For financial reporting purposes, the Trust
is accounted for under the equity method and is included in other assets on the accompanying
consolidated statement of financial condition. The subordinated debentures issued and guaranteed by
the Company and held by the Trust are reflected on the consolidated statement of financial
condition in accordance with provisions of Interpretation No. 46 issued by the Financial Accounting
Standards Board, or FASB, No. 46, Consolidation of Variable Interest Entities. Under applicable
regulatory guidelines, all of the trust preferred securities currently qualify as Tier 1 capital,
although this classification may be subject to future change.
On February 25, 2008 and May 1, 2008, the Company elected to defer payment of interest on the
Junior Subordinated Debt Securities for the interest payments due March 15, 2008 and June 15, 2008,
respectively, as allowed under the indenture agreement. This election was the result of the
notification by the Federal Reserve Bank of San Francisco, or FRB that WSB Financial Group, Inc.
(the Company) and the Bank had been designated to be in a troubled condition for purposes of
Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. As a result
of that designation, the Company is generally prohibited from making any payments to any entity,
including dividends and interest payments (including dividends on its trust preferred securities,
and interest at the holding company level) without notifying the FRB for prior approval of such
payments.
Note 6 Loan Commitments and Contingent Liabilities
Loan Commitments.
Many of our lending relationships contain funded and unfunded elements. The
funded portion is reflected on our balance sheet. For lending relationships carried at historical
cost, the unfunded component of these commitments is not recorded on our balance sheet until a draw
is made under the credit facility; however, a reserve is established for probable losses. At March
31, 2008 we had a reserve balance of $145,000 for allowance for unfunded credit losses and $465,000
at December 31, 2007 .
The following table summarizes the total unfunded, or off-balance sheet, credit extension
commitment amounts by expiration date.
13
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2008
|
|
|
|
Amount of Commitment Expiration Per Period
|
|
|
|
Total Amounts
|
|
|
|
|
|
|
|
|
|
|
|
After 5
|
|
|
|
Committed
|
|
|
Less Than 1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
Years
|
|
|
|
(In thousands)
|
|
Other Commitments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to extend credit
|
|
$
|
50,306
|
|
|
$
|
45,537
|
|
|
$
|
4,769
|
|
|
$
|
|
|
|
$
|
|
|
Credit cards
|
|
|
2,265
|
|
|
|
|
|
|
|
2,265
|
|
|
|
|
|
|
|
|
|
Standby letters of credit
|
|
|
701
|
|
|
|
701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
53,272
|
|
|
$
|
46,238
|
|
|
$
|
7,034
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Legally binding commitments to extend credit generally have specified rates and maturities.
Certain of these commitments have adverse change clauses that help to protect us against
deterioration in the borrowers ability to pay.
Contingent Liabilities for Sold Loans.
In the ordinary course of business, the Bank sells
loans without recourse that may have to be subsequently repurchased due to defects that occurred
during the origination of the
loan. The defects are categorized as documentation errors, underwriting errors, early payment
defaults, breach of representation or warranty, delinquencies and fraud. When a loan sold to an
investor without recourse fails to perform according to its contractual terms, the investor will
typically review the loan file to determine whether defects in the origination process occurred. If
a defect is identified, the Bank may be required to either repurchase the loan or indemnify the
investor for losses sustained. If there are no such defects, the Bank has no commitment to
repurchase the loan. The Bank has recorded no reserve to cover loss exposure related to these
guarantees. The Company has repurchased two real estate loans totaling $715,590 in the first
quarter 2008 and one real estate loan totaling $750,000 in the fourth quarter 2007.
Note 7 Stockholders Equity and Regulatory Matters
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to meet the minimum regulatory
capital requirements can initiate certain mandatory and possible additional discretionary actions
by regulators that if undertaken, could have a direct material effect on the Companys and Banks
financial statements. Under the regulatory capital adequacy guidelines and regulatory framework for
prompt corrective action, the Company and the Bank must meet specific capital guidelines involving
quantitative measures of their assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and classification under the
prompt corrective action guidelines are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company
and the Bank to maintain minimum amounts and ratios of total risk-based capital and Tier 1 capital
to risk-weighted assets (as defined in the regulations), and Tier 1 capital to adjusted total
assets (as defined). To be categorized as well capitalized, an institution must maintain minimum
total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as disclosed in the table below.
14
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
The Companys and the Banks actual and required capital amounts and ratios are as follows
(dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
To Be Well Capitalized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Under the Prompt
|
|
|
|
|
|
|
|
|
|
|
For Capital Adequacy
|
|
Corrective Action
|
|
|
Actual
|
|
Purposes
|
|
Provisions
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
As of March 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Risk-Based Capital
(to Risk-Weighted Assets)
Consolidated
|
|
$
|
64,377
|
|
|
|
16.0
|
%
|
|
$
|
32,168
|
|
|
|
³
8.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
62,904
|
|
|
|
15.7
|
%
|
|
$
|
32,155
|
|
|
|
³
8.0
|
%
|
|
$
|
40,194
|
|
|
|
³
10.0
|
%
|
|
Tier 1 Capital
(to Risk-Weighted Assets)
Consolidated
|
|
$
|
59,088
|
|
|
|
14.7
|
%
|
|
$
|
32,157
|
|
|
|
³
4.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
57,615
|
|
|
|
14.3
|
%
|
|
$
|
16,082
|
|
|
|
³
4.0
|
%
|
|
$
|
24,124
|
|
|
|
³
6.0
|
%
|
|
Tier 1 Capital
(to Average Assets)
Consolidated
|
|
$
|
59,088
|
|
|
|
11.8
|
%
|
|
$
|
40,196
|
|
|
|
³
4.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
57,615
|
|
|
|
11.5
|
%
|
|
$
|
20,092
|
|
|
|
³
4.0
|
%
|
|
$
|
25,116
|
|
|
|
³
5.0
|
%
|
|
As of December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Risk-Based Capital
(to Risk-Weighted Assets)
Consolidated
|
|
$
|
70,364
|
|
|
|
16.7
|
%
|
|
$
|
33,809
|
|
|
|
³
8.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
68,761
|
|
|
|
16.3
|
%
|
|
$
|
33,810
|
|
|
|
³
8.0
|
%
|
|
$
|
42,262
|
|
|
|
³
10.0
|
%
|
|
Tier 1 Capital
(to Risk-Weighted Assets)
Consolidated
|
|
$
|
64,900
|
|
|
|
15.4
|
%
|
|
$
|
33,802
|
|
|
|
³
4.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
63,297
|
|
|
|
15.0
|
%
|
|
$
|
16,902
|
|
|
|
³
4.0
|
%
|
|
$
|
25,353
|
|
|
|
³
6.0
|
%
|
|
Tier 1 Capital
(to Average Assets)
Consolidated
|
|
$
|
64,900
|
|
|
|
13.9
|
%
|
|
$
|
37,299
|
|
|
|
³
4.0
|
%
|
|
NA
|
|
NA
|
Westsound Bank
|
|
$
|
63,297
|
|
|
|
13.6
|
%
|
|
$
|
18,589
|
|
|
|
³
4.0
|
%
|
|
$
|
23,237
|
|
|
|
³
5.0
|
%
|
Although the ratios presented above show that the Company and the Bank were well capitalized
at March 31, 2008 and December 31, 2007 based on their financial statements prepared in accordance
with generally accepted accounting principles in the United States and the general percentages in
regulatory guidelines, the Company and the Bank understand that they are no longer regarded as
well capitalized for federal regulatory purposes, as a result of the deficiencies cited in the
FDIC order. (See Note 2.) There are no conditions or events since the FDIC order that management
believes have changed the Banks category.
The Company and Westsound Bank believe they remain adequately-capitalized under regulatory
guidelines, as of March 31, 2008, following the additional provisions for loan losses, and
management believes that the Company has sufficient capital resources and liquidity to be able to
continue its normal business operations.
Federal Reserve Board Regulations require maintenance of certain minimum reserve balances on
deposit with the Federal Reserve Bank. The minimum reserve requirement at March 31, 2008 and
December 31, 2007 was $539,000 and $594,000, respectively. Also, under Washington State law,
approval from the state banking regulators is required prior to declaring cash dividends.
Note 8 Restrictions on Dividends, Loans and Advances
Federal and state banking regulations place certain restrictions on dividends paid and loans
or advances made by the Bank to the holding company. The total amount of dividends which may be
paid at any date is
15
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
generally limited to the retained earnings of the Bank, and loans or advances are limited to
10 percent of the Banks capital stock and surplus on a secured basis.
The Banks retained earnings available for the payment of dividends was $0 at March 31, 2008
and $3,444,000 at December 31, 2007. Accordingly, $59,735,000 of the Companys equity in the net
assets of the Bank was restricted at March 31, 2008 and $59,921,000 at December 31, 2007. Funds
available for loans or advances by the Bank to the holding company amounted to $11,947,000 at March
31, 2008, compared to $12,673,000 at December 31, 2007.
In addition, dividends paid by the Bank to the holding company would be prohibited if the
effect thereof would cause the Banks capital to be reduced below applicable minimum capital
requirements.
See Note 2 for further restrictions.
Note 9 Incentive Stock Option Plan
The Companys stockholders approved an Incentive Stock Option Plan on May 19, 1999. The
purpose of the plan is to increase ownership interest in the Company by employees and directors of
the Company, and to provide an incentive to serve as an employee and/or director of the Company.
The stockholders originally approved 184,287 shares of common stock to the Plan. The stockholders
approved additional allocations of 614,290 in 2005, 614,290 in 2004 and 184,287 shares in 2002. The
maximum term of a stock option granted under the plan is ten years. Incentive stock options
generally vest over a five year period while non-qualified stock options generally vest
immediately.
The following table summarizes the stock option activity for the three months ended March 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise Price
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Per Share
|
|
|
Term (in years)
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding as of December 31, 2007
|
|
|
887,080
|
|
|
$
|
7.99
|
|
|
|
|
|
|
|
|
|
Authorized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(5,837
|
)
|
|
|
6.32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding as of March 31, 2008
|
|
|
881,243
|
|
|
$
|
8.00
|
|
|
|
5.95
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable as of March 31, 2008
|
|
|
771,436
|
|
|
$
|
7.63
|
|
|
|
6.05
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The intrinsic value for stock options is calculated based on the exercise price of the
underlying awards and the market price of our common stock as of the reporting date.
There were no stock options exercised during the three months ended March 31, 2008.
The Company did not grant any options during the quarter ended March 31, 2008. There was
$116,000 in unrecognized compensation cost related to stock options issued in 2007 as of March 31,
2008 that is expected to be recognized as expense using a graded vesting over a five year period.
Compensation expense related to these options was approximately $7,000 for the three months ending
March 31, 2008.
Note 10 Income Taxes
The Bank believes, based upon available information, that the net deferred tax asset will be
realized in the normal course of operations.
16
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
The Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty
in Income Taxes
, on January 1, 2007. The Company had not recognized tax benefits which would
require an adjustment to the January 1, 2007 beginning balance of retained earnings. The Company
had no unrecognized tax benefits at January 1, 2007, December 31, 2007 or at March 31, 2008.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in
tax expense. During the years ended December 31, 2007 and 2006 the Company recognized no interest
and penalties.
The Company and its subsidiary file consolidated income tax returns in the U.S. Federal income
jurisdiction. With few exceptions, the Company is no longer subject to U.S. Federal or state/local
income tax examinations by tax authorities for years before 2004.
Note 11 Loan Concentrations
As of March 31, 2008, in managements judgment, a concentration of loans existed in real
estate-related loans. At that date, real estate-related loans comprised 91.5% of total loans, of
which approximately 67.3%, 18.9% and 13.8% were construction and land development, commercial real
estate and residential real estate, respectively.
Additionally, as of March 31, 2008, in managements judgment, a concentration of loans existed
in interest-only loans, primarily construction and development loans secured by real estate. The
Companys construction portfolio reflects some borrower concentration risk, and also carries the
enhanced risks encountered with construction loans generally. The Company also finances
contractors, including a number of small builders and individuals, on a speculative basis.
Construction loans are generally more risky than permanent mortgage loans because they are
dependent upon the borrowers ability to complete the project within budget, the borrowers ability
to generate cash to service the loan (by selling or leasing the project), and the value of the
collateral depends on project completion when market conditions may have changed. At March 31,
2008, interest-only loans comprised 62.0% of total loans, of which approximately 87.0% were
construction and land development, 6.7% were residential, 2.5% were commercial real estate, 3.6%
were commercial and industrial, and 0.2% were consumer. As of December 31, 2007, interest only
loans comprised 64.4% of total loans.
The Bank also had a high concentration of loans with loans to value in excess of supervisory
limits. The original maximum credit on these loans was $34,204,000 at March 31, 2008 and
$64,755,000 at December 31, 2007.
Our loan portfolio is also concentrated in real estate and a substantial majority of our loans
and operations are in west Puget Sound, and therefore our business is particularly vulnerable to a
downturn in the local real estate market.
A substantial decline in the performance of the economy, in general, or a decline in real
estate values in our primary market areas, in particular, could have an adverse impact on
collectibility, increase the level of real estate-related non-performing loans, or have other
adverse effects which alone or in the aggregate could have a material adverse effect on the
Companys business, financial condition, results of operations and cash flows. Interest-only loans
also carry greater risk than principal and interest loans do, to the extent that no principal is
paid prior to maturity, particularly during a period of rising interest rates and declining real
estate values.
Note 12 Pending Litigation
In October 2007, a purported securities fraud class action lawsuit was commenced in the United
States District Court for the Western District of Washington against the Company and certain of its
directors and current and former officers alleging violations of Sections 11 and 15 of the
Securities Act of 1933 and seeking an unspecified amount of compensatory damages and other relief
in connection with the Companys initial public offering. Since then four additional, similar
actions have been filed in the U.S. District Court in the Western District of Washington. As is
typical in these cases, all the actions have been consolidated into a single action, In RE: WSB
Financial Group Securities Litigation, Master File No. CO7-1747 RAJ.
As of May 8, 2008, the Company had commenced collection activities on approximately 168 real
estate loans by sending notices of default to the borrowers. Some or all of these loans may result
in foreclosure actions.
17
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
The Company is unable to predict the outcome of these matters. The Companys cash
expenditures, including legal fees, associated with the pending litigation and the regulatory
proceedings described in Note 2 above, cannot be reasonably predicted at this time. Litigation and
any potential regulatory actions or proceedings can be time-consuming and expensive and could
divert management time and attention from the Companys business, which could have a material
adverse effect on its revenues and results of operations. The adverse resolution of any specific
lawsuit or potential regulatory action or proceeding could have a material adverse effect on the
Companys business, results of operations, and financial condition.
Note 13 Fair Value Measurements
On January 1, 2008 the Company adopted SFAS No. 157,
Fair Market Measurements
(SFAS 157).
SFAS 157 establishes a framework for measuring the fair value of assets and liabilities using a
hierarchy system consisting of three levels, based on the markets in which the assets and
liabilities are traded and the reliability of the assumptions used to determine fair value. These
levels are:
Level 1
Valuation based on quoted prices in active markets for identical assets or
liabilities.
Level 2
Valuation based on quoted prices for similar assets or liabilities in active
markets, quoted prices for identical or similar instruments in markets that are not active and
model-based valuation techniques for which significant assumptions are observable in the market.
Level 3
Valuation generated from unobservable inputs that are supported by little or no
market activity. Valuation techniques include use of pricing models, cash flow methodologies or
similar techniques, as well as instruments for which the determination of fair value requires
significant management judgment of estimation.
The following table summarizes the assets of the Company for which fair values are determined
on a recurring basis as of March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value measurements using
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant Other
|
|
|
Significant
|
|
|
|
|
|
|
|
Markets for
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Identical Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
3/31/2008
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Description
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available for sale
|
|
$
|
7,691
|
|
|
$
|
0
|
|
|
$
|
7,691
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
7,691
|
|
|
$
|
0
|
|
|
$
|
7,691
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the assets of the Company for which fair values are determined
on a nonrecurring basis as of March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value measurements using
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant Other
|
|
|
Significant
|
|
|
|
|
|
|
|
Markets for
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Identical Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
3/31/2008
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Description
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired loans
|
|
$
|
14,300
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
14,300
|
|
Other real estate owned
|
|
|
1,883
|
|
|
|
0
|
|
|
|
0
|
|
|
|
1,883
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
16,183
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
16,183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
WSB FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Continued)
The following is a description of the valuation methodologies used to measure and disclose
fair value of financial assets and liabilities:
Securities available for sale: Securities are recorded at fair value on a recurring basis.
Fair value is based on quoted market prices, if available. If quoted market prices are not
available, the fair market value is based on a matrix pricing model provided by an outside
independent source.
Impaired loans: We do not record impaired loans at fair value on a recurring basis. However
from time to time, nonrecurring fair value adjustments to collateral dependent loans are recorded
to reflect partial write-downs based on observable market price or current appraised value of
collateral.
Other Real Estate Owned (OREO): We do not record other real estate owned at fair value on a
recurring basis. All OREO properties are recorded by us at amounts which are equal to or less than
the fair market value of the properties based on current independent appraisals reduced by
estimated selling costs upon transfer of the loans to OREO. From time to time nonrecurring fair
value adjustments to other real estate owed is recorded to reflect partial write downs based on
observable market price or current appraised value of collateral.
(Remainder of page intentionally blank)
19
ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Notice About Forward-Looking Statements
This quarterly report on
Form 10-Q
includes forward-looking statements. These statements may
be identified by the use of forward-looking terminology such as anticipate, believe,
continue, could, estimate, expect, intend, may, might, plan, potential,
predict, should or will or the negative thereof or other variations thereon or comparable
terminology. We have based these forward-looking statements on our current expectations,
assumptions, estimates and projections. While we believe these expectations, assumptions, estimates
and projections are reasonable, such forward-looking statements are only predictions and involve
known and unknown risks and uncertainties, many of which are beyond our control. These and other
important factors, including those discussed in this report under the headings Risk Factors,
Managements Discussion and Analysis of Financial Condition and Results of Operations and
Business may cause our actual results, performance or achievements to differ materially from any
future results, performance or achievements expressed or implied by these forward-looking
statements. Some of the key factors that could cause actual results to differ from our expectations
are:
|
|
|
changes in general economic conditions, either nationally or locally in the west
Puget Sound and Seattle Metropolitan Statistical Area;
|
|
|
|
|
inflation, interest rate, market and monetary fluctuations;
|
|
|
|
|
legislative or regulatory changes or changes in accounting principles, policies
or guidelines;
|
|
|
|
|
the adequacy of our credit risk management and the allowance for loan losses,
Westsound Banks asset quality, and our ability to collect on delinquent loans,
including our construction and land development loans;
|
|
|
|
|
the availability of and costs associated with sources of liquidity;
|
|
|
|
|
changes in real estate values generally, within the markets in which we generate
loans, which could adversely affect the demand for loans and may adversely affect
collateral held on outstanding loans;
|
|
|
|
|
our ability to successfully defend against claims asserted against us in
lawsuits arising out of, or related to, our lending operations or any regulatory
action taken against us, as well as any unanticipated litigation, regulatory, or
other judicial proceedings;
|
|
|
|
|
our ability to successfully operate under the terms of the FDIC order;
|
|
|
|
|
the success of the Company at managing the risks involved in the foregoing; and
|
|
|
|
|
other risks which may be described in our future filings with the SEC under the
Securities Exchange Act of 1934.
|
Given these risks and uncertainties, you are cautioned not to place undue reliance on such
forward-looking statements. The forward-looking statements included or incorporated by reference
into this report are made only as of the date hereof. We do not undertake and specifically decline
any obligation to update any such statements or to publicly announce the results of any revisions
to any such statements to reflect future events or developments.
Overview
We are a bank holding company headquartered in Bremerton, Washington. We emphasize a
service-oriented culture with a sales-based delivery model focused primarily on real estate lending
products and supplemented by commercial banking products and services. We deliver these products
through nine full service
20
branches that are located primarily in the west Puget Sound area. As of
March 31, 2008 we have, on a consolidated basis, $503.5 million in total assets, net loans of
$359.4 million, total deposits of $441.5 million, and stockholders equity of $50.9 million.
At March 31, 2008, gross loans increased 3% year-over year to $386 million from $376 million
at March 31, 2007, and decreased 7% from $413 million at December 31, 2007. Deposits grew 22% to
$442 million at March 31, 2008, from $362 million a year ago, with growth in time deposits
accounting for most of the increase. However, with the significant challenges continuing in our
real estate loan portfolio, particularly our construction and development loans, the pending
litigation and regulatory matters, our financial performance in the first quarter of 2008 suffered,
and we will continue to face these issues in future periods. See Recent Developments. The
Companys provision for loan losses, levels of non-performing loans and OREO property, allowance
for loan losses, levels of impaired loans and non-accrual loans increased significantly in the
quarter ended March 31, 2008. The weakness in the local housing market is expected to continue in
the near term, and the situation could deteriorate further before the market stabilizes.
We generate most of our revenue from interest on loans and investments, loan fees, and service
charges. As of March 31, 2008, 81.1% of our revenue was interest on loans, 6.3% loan fees, 3.3%
service charges, and other non-interest income and 9.3% interest on investments. We offer a variety
of loans to our customers, including commercial and residential real estate loans, construction and
land development loans, commercial and industrial loans, and to a lesser extent, consumer loans. As
of March 31, 2008, approximately 91.5% of our loans related to the construction or development,
purchase, improvement or refinancing of commercial and residential real estate, approximately 7.6%
were C&I loans and 0.9% were consumer loans. Approximately 78.6% of our revenue is derived from
real estate, of which approximately 16.3% is derived from residential real estate. Including our
originations of residential real estate loans, approximately 97.7% of our actual lending activities
are related to real estate. Of this amount, 37.2% is residential real estate, 60.5% is construction
and land development
We offer a wide range of real estate and other loan products to meet the demands of our
customers. We have also recently increased our emphasis on C&I lending, although the portion of the
loan portfolio invested in C&I loans is still relatively small. While continuing our commitment to
commercial real estate lending, we expect C&I lending to become increasingly important for us over
time.
We are experiencing significant difficulties in our loan portfolio, particularly our
construction and land development loans, which have resulted in a $7.7 million increase in our
provision for loan losses in the first quarter of 2008. These matters are discussed below in
Recent Developments. An adverse change in the economy affecting values of real estate
generally, or in west Puget Sound, could, because of our high concentration of loans secured by
real estate, materially and adversely affect our profitability, growth and financial condition.
Further, because approximately 62.0% of our loans are interest-only (primarily real estate
construction and development) and 38.4% are variable rate, significant increases in interest rates
could also result in increased loan delinquencies, defaults and foreclosures.
Nonperforming assets (NPAs) at March 31, 2008 totaled $72.2 million which includes $70.3
million of loans on non-accrual status and $1.9 million in other real estate owned, or OREO. The
allowance for loan losses was $26.3 million, or 6.82% of gross loans at March 31, 2008. During the
first quarter of 2008, net charge-offs totaled $912,000, or 0.23% of average loans at March 31,
2008. Of the non-accrual loans, 37% were in Kitsap County, 31% were in King County, 17% were in
Pierce County, and a remaining 15% were in other parts of western Washington.
The increase in non-accrual loans also impacted net interest income, as $1.6 million in
interest income was reversed in the first quarter. In addition, we are maintaining a high level of
liquidity using higher cost wholesale funding sources and have more than half of our deposits in
time certificates. As we collect our construction loans and development loans, we expect to be able
to deleverage the balance sheet over the next few quarters. As we do this our yields and cost of
funds should gradually return to more normal levels.
These factors, combined with the significant reduction in fee income from new loan
originations, contributed to significant margin compression in the first quarter 2008. Net interest
margin in the first quarter dropped to 1.65% from 3.62% in the fourth quarter of 2007 and 5.06% in
the first quarter a year ago. Net interest income, before the loan loss provision, was $2.0 million
in the first quarter, compared to $4.8 million in the same
21
quarter last year. Following the
provision for loan losses of $7.7 million, the first quarter net interest income was negative $5.7
million compared to $4.3 million a year ago.
Primarily because of closing our wholesale mortgage operation last Fall, the Companys
noninterest income declined to $236,000 in the first quarter, compared to $1.3 million in the first
quarter a year ago. The decline was offset somewhat by the drop in noninterest expense, which fell
to $3.4 million in the quarter from $4.1 million in the first quarter of 2007.
Deposits are our primary source of funding. Our largest expenses are interest on these
deposits and salaries and employee benefits. We measure our performance by calculating our net
interest margin, return on average assets, and return on average equity. Net interest margin is
calculated by dividing net interest income, which is the difference between interest income on
interest-earning assets (such as loans and securities) and interest expense on interest-bearing
liabilities (such as customer deposits and other borrowings which are used to fund those assets),
by total average earning assets. Net interest income is our largest source of revenue. Interest
rate fluctuations, as well as changes in the amount and type of earning assets and liabilities,
combine to affect net interest income. We also measure our performance by our efficiency ratio,
which is calculated by dividing non-interest expense less amortization of core deposit intangibles
by the sum of net interest income on a tax equivalent basis and non-interest income.
Market interest rates decreased in first quarter 2008 as a result of the Federal Reserves
monetary policies. Our net interest margin decreased to 1.65% compared to 5.06% for the same period
2007 due to the increase in non-accruing loans. In addition, a substantial percentage of our loan
portfolio (38.4% of our total loans as of March 31, 2008) has been comprised of variable rate loans
that reprice as interest rates rise or fall. The Federal Reserve began reducing interest rates in
September 2007. As interest rates decline, our margins could also decrease until we can adjust the
mix of our assets and liabilities to compensate for the changed interest rate environment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Key Financial Matters
|
|
|
Three Months Ended
|
|
Year Ended
|
|
|
March 31,
|
|
December 31,
|
|
|
2008
|
|
2007
|
|
2007
|
|
|
(Dollars in thousands, except per share data)
|
Net income (loss)
|
|
$
|
(5,818
|
)
|
|
$
|
1,082
|
|
|
$
|
(5,200
|
)
|
Basic earnings (loss) per share
|
|
|
(1.04
|
)
|
|
|
0.20
|
|
|
|
(0.93
|
)
|
Diluted earnings (loss) per share
|
|
|
(1.04
|
)
|
|
|
0.18
|
|
|
|
(0.93
|
)
|
Total assets
|
|
|
503,534
|
|
|
|
435,632
|
|
|
|
489,333
|
|
Net loans(1)
|
|
|
359,387
|
|
|
|
377,084
|
|
|
|
393,436
|
|
Total deposits
|
|
|
441,547
|
|
|
|
361,687
|
|
|
|
421,445
|
|
Net interest margin
|
|
|
1.65
|
%
|
|
|
5.06
|
%
|
|
|
4.62
|
%
|
Efficiency ratio
|
|
|
149.4
|
%
|
|
|
65.7
|
%
|
|
|
67.6
|
%
|
Return on average assets
|
|
|
(4.66
|
)%
|
|
|
1.10
|
%
|
|
|
(1.17
|
)%
|
Return on average equity
|
|
|
(41.3
|
)%
|
|
|
7.0
|
%
|
|
|
(8.4
|
)%
|
|
|
|
(1)
|
|
Includes loans held for sale.
|
Recent Developments.
Changes in Management.
We retained a new president and chief executive officer, Terry A.
Peterson, on April 15, 2008, and Donald F. Cox, Jr., who is our audit committee financial expert,
was elected by the board to serve as its new chairman. Mr. Peterson was granted options for 100,000
shares under our Incentive Stock Option Plan and the right to purchase up to $1,000,000 of the
Companys common stock at market prices pursuant to his employment agreement.
Increased Reserves for Loan Losses.
For the quarter ending March 31, 2008, we added $7.7
million to our provision for loan losses, based on managements quarterly review, continued
uncertainty in the local housing market, increases in our non-accrual loans and OREO property,
which primarily relate to the maturing of our
22
construction and land development loans, and our
determination of specific impaired loans under generally accepted accounting principles. In the
previous two quarters ended December 31, 2007 and September 30, 2007, we recorded provisions for
loan losses of $1.7 million and $13.4 million, respectively.
Although the Company believes it is using the best information available to make
determinations with respect to the allowance for loan losses and its current allowance for loan
losses is adequate for such purposes, management reviews the loan portfolio each quarter and
adjustments may be necessary in future periods if the assumptions used in making our initial
determinations prove to be incorrect.
Construction and Development Loans.
We continue to work through the issues with the
construction loans in Westsound Banks loan portfolio. The Bank has scaled back its construction
loan originations in the past few months and is concentrating on working with its borrowers to
complete existing projects in a timely manner and to bring past-due loans current.
During the first quarter of 2008, however, non-accrual loans increased significantly, from
$24.9 to $70.3 million, as a result of maturing construction and land development loans that we are
choosing not to renew in order to keep all of our legal remedy options available. Many of these
loans, which were typically for 12 to 18 month terms, originated in 2006 or 2007 and as a result
are reaching their contractual maturities. At 90 days past due, these loans are placed into a
non-accrual status while we work with our borrowers to maximize our recovery. The majority of our
remaining construction and land development loans mature in the next two quarters of 2008.
Therefore, the contraction or expansion of our non-accrual loan portfolio in future periods will
depend upon our ongoing collection efforts. In the first quarter we had $37 million in total loan
payoffs and acquired four completed homes by deeds in lieu of foreclosure. The outstanding
principal balance of our loans with respect to these OREO properties is $1,883,411. We have listed
these properties for sale with local real estate brokers, who are actively marketing the properties
for sale. One of these homes was sold on May 5, 2008 for $80,980, at a loss of $9,020.
The real estate collateral evaluations supporting our construction and land development loan
portfolios have suffered along with the recent decline in the local housing market. While the
overall economy remains relatively good in our west Puget Sound market, the housing market is slow,
with weaker demand for housing, higher inventory levels and longer marketing times. The Seattle
Times recently reported that according to a national index home prices declined in the Seattle MSA
over the past year by 2.7%, compared to the national average decrease of 12.7%. The Bank is rapidly
updating its real estate appraisals to better understand its total exposure to these loans. All of
these loans are secured by deeds of trust on the land and improvements and were typically
underwritten at 75% to 80% loan to value ratios. However, a loan made in 2006 that was within our
policy guidelines may have a loan to value today that exceeds those guidelines, and the projects
are in various stages of completion.
Our cash expenditures, including legal and accounting fees, associated with the collection of
the loans determined to be impaired or downgraded and added to our watch list cannot be reasonably
predicted, and the actual amount of such expenditures will depend upon the manner in which our
collection efforts are structured and conducted. However, these efforts can be time consuming and
expensive and could divert management time and attention from our business, which could have a
material effect on our revenues and results of operations.
Regulatory Proceedings.
Westsound Bank has signed an agreement with the Federal Deposit
Insurance Corporation (FDIC) and the Washington Department of Financial Institutions, Division of
Banks (DFI) to enter into a cease and desist order which primarily addresses the Banks lending
practices and the Company is implementing a comprehensive plan to achieve full compliance.
Although Westsound Bank has agreed to the order, it has not admitted or denied any allegations
of unsafe or unsound banking practices, or any legal or regulatory violations. The order is a
formal action by the FDIC and DFI requiring the Bank to take corrective measures in a number of
areas. No monetary penalties were assessed by the FDIC in connection with the order.
FDIC Order:
On March 10, 2008, Westsound Bank (the Bank) entered into a Stipulation and
Consent to the Issuance of an Order to Cease and Desist (the FDIC order) with the Federal Deposit
Insurance Corporation, or FDIC, and the Washington Department of Financial Institutions, Division
of Banks, or DFI.
23
The regulators determined the Bank had engaged in unsafe or unsound banking practices, by
engaging in unsatisfactory lending and collection practices, operating with inadequate management
and board supervision, with less than satisfactory capital in relation to its large volume of poor
quality loans and with an inadequate loan valuation reserve, and with inadequate provisions for
liquidity, inadequate internal routine and control policies, and in violation of various banking
laws and regulations relating to internal audits and controls, real estate appraisal and lending
guidelines, and responsibilities of bank directors and officers.
Under the terms of the FDIC order, the Bank cannot declare dividends without the prior written
approval of the FDIC and the DFI. Other material provisions of the order require the Bank to: (i)
review the compensation and effectiveness of Westsound Banks current executive officers and
directors, and the structure of the board and its committees, (ii) strengthen the Banks board of
directors oversight of management and operations of the Bank, (iii) improve the Banks internal
controls, internal audit function, lending and collection policies and procedures, particularly
with respect to the origination and monitoring of construction loans, (iv) maintain specified
capital and liquidity ratios, and (v) prepare and submit progress reports to the FDIC and the DFI.
The FDIC order will remain in effect until modified or terminated by the FDIC and the DFI.
The order does not restrict the Bank from transacting its normal banking business. The Bank
will serve its customers in all areas including making loans, establishing lines of credit,
accepting deposits and processing banking transactions. All customer deposits remain fully insured
to the highest limits set by FDIC. The FDIC and DFI did not impose any monetary penalties.
FRB Notice:
On February 14, 2008, the Federal Reserve Bank of San Francisco, or FRB, notified
WSB Financial Group, Inc. (the Company) and the Bank that it had designated the Company and
Westsound Bank to be in a troubled condition for purposes of Section 914 of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989. As a result of that designation neither
the Company nor the Bank may appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers without notifying the FRB. In addition,
neither the Company nor the Bank may make indemnification and severance payments without complying
with certain statutory restrictions including prior written approval of the FRB and concurrence
from the FDIC. Further, the Company is generally prohibited from making any payments to any entity,
including dividends and interest payments (including dividends on its trust preferred securities,
and interest at the holding company level), director fees, consulting expenses and other operating
expenses, without notifying the FRB for prior approval of such payments.
Capital:
Although the Company and the Bank were well capitalized at March 31, 2008 based on
their financial statements prepared in accordance with generally accepted accounting principles in
the United States and the general percentages in the regulatory guidelines, we understand that the
Company and the Bank are no longer regarded as well capitalized for federal regulatory purposes,
as a result of the deficiencies cited in the FDIC order.
We believe Westsound Bank has been reclassified from well capitalized to adequately
capitalized. As a result of this reclassification, the Banks borrowing costs and terms from the
FRB, the FHLB and other financial institutions, as well as the Banks premiums to the Deposit
Insurance Fund administered by the FDIC to insure bank and savings association deposits (generally
up to $100,000 per customer), are expected to increase.
Compliance Efforts:
The Company and the Bank are actively engaged in responding to the
concerns raised in the FDIC order, and believe that they have already addressed many of the
regulators requirements. See Part I, Item 4: Controls and Procedures. The Company is also
complying with the terms of the FRB notice, and has exercised its option to start deferring
payments of quarterly interest on its trust preferred securities on March 15, 2008 and June 30,
2008, as permitted by the indenture agreement.
Westsound Bank has begun working with these regulatory agencies and has acted promptly on
directions it has received from these agencies in the past several months, including the following
actions:
|
|
|
Retained a new president and chief executive officer, Terry A. Peterson, on
April 15, 2008;
|
|
|
|
|
Conducting a comprehensive review of the qualifications of management and
existing staff and consideration of potential changes that may be required;
|
24
|
|
|
Retained an independent third party consultant to review and evaluate the loan
portfolio and began implementing many of his recommendations to improve the Banks
loan approval and loan servicing processes;
|
|
|
|
|
Added $13.9 million to total provisions for loan losses, including $548,000 in
unfunded commitments in the third quarter of 2007, increased fourth quarter 2007
reserves by $1.7 million and increased first quarter 2008 reserves by $7.7 million;
|
|
|
|
|
Strengthened collections and loss recovery teams to accelerate resolution of
problem loans, including retaining two experienced loan administration and workout
specialists as consultants.
|
|
|
|
|
Began developing a capital management plan to maintain strong capital ratios;
|
|
|
|
|
Began implementing new procedures to strengthen the monitoring of lending
activities with particular emphasis on monitoring individual lender/borrower
relationships;
|
|
|
|
|
Initiated a review of loan documentation policy and is correcting documentation
deficiencies;
|
|
|
|
|
Developed a liquidity and funds management plan to address anticipated funding
needs;
|
|
|
|
|
Increasing internal controls over loan portfolio review;
|
|
|
|
|
Establishing a communications procedure for reporting progress in all areas to
the FDIC and DFI.
|
A number of these initiatives are complete and a number of policies and procedures have been
implemented. As a result, the Bank has already acted upon several items addressed by the order.
Our cash expenditures, including legal and accounting fees, associated with the regulatory
proceedings and the pending litigation described below (see Part II, Item 1: Legal Proceedings)
cannot be reasonably predicted at this time. Litigation and any potential regulatory actions or
proceedings can be time-consuming and expensive and could divert management time and attention from
our business, which could have a material adverse effect on our revenues and results of operations.
The adverse resolution of any specific lawsuit or potential regulatory action or proceeding could
have a material adverse effect on our business, results of operations, and financial condition.
Deposits.
As of March 31, 2008 and December 31, 2007, we had $114.8 million and $117.4
million, respectively, of deposits from wholesale sources, including brokered deposits and Internet
certificates of deposit. See Note 4 to the Companys unaudited consolidated financial statements
for more information on the Companys deposits. Management has developed and is implementing
strategic advertising campaigns and promotions to attract and maintain core deposits and reduce its
recent reliance on wholesale funding sources which are generally more rate-sensitive and considered
a less stable funding source than local retail deposit relationships, or so-called core deposits.
As described above (see Capital Resources), as a result of the FDIC order the Bank is subject
to regulatory limitations with respect to its wholesale sourcing of deposits.
Under the Federal Deposit Insurance Corporation Improvement Act, or FDICIA, banks may be
restricted in their ability to accept brokered deposits, depending on their capital classification.
Well-capitalized banks are permitted to accept brokered deposits, but all banks that are not
well-capitalized are not permitted to accept such deposits. The FDIC may, on a case-by-case basis,
permit banks that are adequately capitalized to accept brokered deposits if the FDIC determines
that acceptance of such deposits would not constitute an unsafe or unsound banking practice with
respect to the bank. As of March 31, 2008 and December 31, 2007, we had $57.5 million and $65.0
million, respectively, of brokered deposits. As a result of the FDIC order described below in
Recent Developments, the Bank is subject to limitations with respect to its brokered deposits.
The FDIC order prohibits Westsound Bank from increasing the amount of broker deposits above the
amount outstanding on the effective date of the FDIC order, or soliciting, retaining or rolling
over broker deposits except as approved by FDIC.
The Company and Westsound Bank remain adequately capitalized under regulatory guidelines, as
of March 31, 2008, following the provisions for loan losses described above, and management
believes the Company has
25
sufficient capital resources and liquidity to be able to continue its
normal business operations. See Capital Resources and Liquidity below.
Key Factors in Evaluating Financial Condition and Results of Operations
As a bank holding company, we focus on a number of key factors in evaluating our financial
condition and results of operations including:
|
|
|
Return on Average Equity;
|
|
|
|
|
Return on Average Assets;
|
|
|
|
|
Asset Quality;
|
|
|
|
|
Asset Growth;
|
|
|
|
|
Capital and Liquidity;
|
|
|
|
|
Net Interest Margin; and
|
|
|
|
|
Operating Efficiency.
|
Return on Average Equity.
Our return to our stockholders is measured in the form of return on
average equity, or ROE. We had a net loss of $5.8 million for the three months ended March 31, 2008
compared to net income of $1.1 million for the three months ended March 31, 2007. The net loss was
due to the significant increase in the provision for loan losses. Basic earnings (loss) per share,
or EPS, decreased to $(1.04) for the three months ended March 31, 2008 compared to earnings per
share of $0.20 for the three months ended March 31, 2007. Similarly, diluted EPS decreased to
$(1.04) for the three months ended March 31, 2008 compared to earnings per share of $0.18 for the
three months ended March 31, 2007. Our ROE decreased to (41.3)% for the three months ended March
31, 2008 compared to 7.0% for the three months ended March 31, 2007.
Return on Average Assets.
Our return on average assets, or ROA, for the three months ended
March 31, 2008 was (4.66)% compared to 1.10% for the three months ended March 31, 2007.
Asset Quality.
For all banks and bank holding companies, asset quality has a significant
impact on the overall financial condition and results of operations. Asset quality is measured in
terms of nonperforming loans and assets as a percentage of total loans and total assets, and net
charge-offs as a percentage of average loans. These measures are key elements in estimating the
future earnings of a financial institution. We had $70,313,000 in non-performing loans as of March
31, 2008 compared to $25,322,000 at December 31, 2007. Non-performing loans as a percentage of
total loans were 18.20% as of March 31, 2008 compared to 6.12% at December 31, 2007. For the three
months ended March 31, 2008 net charge-offs to average loans were 0.23%, as compared to 0.01% for
the year ended December 31, 2007.
Asset Growth.
Because revenues from both net interest income and non-interest income are a
function of asset size, growth in assets has a direct impact on net income and EPS. The majority of
our assets are loans, and the majority of our liabilities are deposits, and therefore the ability
to generate loans and deposits are fundamental to our asset growth. Total assets increased 2.9%
during the first three months of 2008 from $489.3 million as of December 31, 2007 to $503.5 million
as of March 31, 2008. Total deposits increased 4.8% to $441.5 million as of March 31, 2008 compared
to $421.4 million as of December 31, 2007. Net loans decreased 8.7% to $359.4 million as of March
31, 2008 compared to $393.4 million as of December 31, 2007.
Capital and Liquidity.
Maintaining adequate capital levels in light of our rapid growth has
been one of our primary areas of focus. Our actual equity to assets decreased to 11.6% at December
31, 2007, as a result of our net loss, and our average equity to average assets at March 31, 2008
was 11.3%. We monitor liquidity levels to ensure we have adequate sources available to fund our
loan growth. The key measure we use to monitor liquidity is the net loan to deposit ratio. At March
31, 2008 the net loan to deposit ratio had decreased to 81.4%, down from 93.4% at December 31,
2007.
Net Interest Margin.
Our net interest margin decreased to 1.65% for the first quarter of 2008
compared to 5.06% for first quarter of 2007, primarily as a result of on the increase in
non-accruing loans. Our net interest margin for the year ended December 31, 2007 was 4.62%
26
Operating Efficiency.
Operating efficiency is the measure of how efficiently earnings before
taxes are generated as a percentage of revenue. Our efficiency ratio (operating expenses divided by
net interest income plus non-interest income) deteriorated increasing to 149.4% for the first
quarter of 2008 compared to 65.7% for first quarter of 2007, as a result of decreases in net
interest income and the increased non-interest expense associated with operating as a public
company and the review and collection of loans. Our efficiency ratio for the year ended December
31, 2007 was 67.6%.
Critical Accounting Policies
Our accounting policies are integral to understanding our financial results. Our most complex
accounting policies require managements judgment to ascertain the valuation of assets,
liabilities, commitments and contingencies. We have established detailed policies and control
procedures that are intended to ensure valuation methods are well controlled and applied
consistently from period to period. In addition, the policies and procedures are intended to ensure
that the process for changing methodologies occurs in an appropriate manner. The following is a
brief description of our current accounting policies involving significant management valuation
judgments.
Allowance for Loan Losses.
The allowance for loan losses represents our best estimate of the
probable losses inherent in the existing loan portfolio. The allowance for loan losses is increased
by the provision for loan losses charged to expense and reduced by loans charged off, net of
recoveries.
We evaluate our allowance for loan losses monthly. We believe that the allowance for loan
losses, or ALLL, is a critical accounting estimate because it is based upon managements
assessment of various factors affecting the collectibility of the loans, including current economic
conditions, past credit experience, delinquency status, the value of the underlying collateral, if
any, and a continuing review of the portfolio of loans. For a discussion of the allowance and our
methodology, see Financial Condition Allowance for Loan Losses.
We maintain an ALLL based on a number of quantitative and qualitative factors, including
levels and trends of past due and non-accrual loans, asset classifications, loan grades, change in
volume and mix of loans, collateral value, historical loss experience, size and complexity of
individual credits, and economic conditions. Provisions for loan losses are provided on both a
specific and general basis. Specific allowances are provided for impaired credits for which the
expected/anticipated loss is measurable. General valuation allowances are based on a portfolio
segmentation based on risk grading, with a further evaluation of various quantitative and
qualitative factors noted above.
We periodically review the assumptions and formulae by which additions are made to the
specific and general valuation allowances for losses in an effort to refine such allowances in
light of the current status of the factors described above.
Although we believe the level of the allowance as of March 31, 2008 was adequate to absorb
probable losses in the loan portfolio, a decline in local economic, or other factors, could result
in increasing losses that cannot be reasonably predicted at this time.
Available for Sale Securities.
Statement of Financial Accounting Standards No. 115,
Accounting
for Certain Investments in Debt and Equity Securities,
requires that available-for-sale securities
be carried at fair value. We believe this is a critical accounting estimate in that the fair
value of a security is based on quoted market prices or if quoted market prices are not available,
fair values are extrapolated from the quoted prices of similar investments. Management utilizes the
services of a reputable third-party vendor to assist with the determination of estimated fair
values. Adjustments to the available-for-sale securities fair value impact the consolidated
financial statements by increasing or decreasing assets and stockholders equity.
Income Taxes.
We use the liability method in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined based upon the difference between the values of
the assets and liabilities as reflected in the financial statements and their related tax basis
using enacted tax rates in effect for the year in which the differences are expected to be
recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. Any estimated tax exposure items
identified would be considered in a tax contingency reserve. Changes in any tax contingency reserve
would be based on specific developments, events, or transactions.
27
Stock Options.
Prior to 2006, we elected to follow Accounting Principles Board Option No. 25,
Accounting for Stock Issued to Employees, or APB 25, and related interpretations in accounting for
employee stock options using the fair value method, and provided the required pro forma disclosures
of SFAS No. 123, or SFAS 123, Accounting for Stock-Based Compensation. Under APB 25, because the
exercise price of the options equals the estimated market price of the stock on the issuance date,
no compensation expense is recorded. As required, on January 1, 2006 we adopted SFAS No. 123R, or
SFAS 123R, Share-Based Payment (Revised 2004) which establishes standards for the accounting for
transactions in which an entity (i) exchanges its equity instruments for goods and services, or
(ii) incurs liabilities in exchange for goods and services that are based on the fair value of the
entitys equity instruments or that may be settled by the issuance of the equity instruments. SFAS
123R eliminates the ability to account for stock-based compensation using APB 25 and requires that
such transactions be recognized over the service period, which is usually the same as the vesting
period, as compensation cost in the income statement based on their fair values on the measurement
date, which is generally the date of the grant.
We adopted SFAS 123R using a modified prospective approach. Under the modified prospective
approach, prior periods are not revised for comparative purposes. The valuation provisions of SFAS
123R apply to new awards and to awards that are outstanding on the effective date and subsequently
modified or cancelled. Compensation expense, net of estimated forfeitures, for awards outstanding
at the effective date is recognized over the remaining service period using the compensation cost
calculated in prior periods.
We have granted nonqualified and qualified stock options under our Stock Option Plan prior to
2006. We granted 24,000 shares in options in 2007 and none in the first quarter 2008. However, as
previously reported on Form 8-K, we granted stock options for 100,000 shares to our new president
and chief executive officer, Terry A. Peterson, on April 18, 2008. See Recent Developments
Changes in Management. Our stock options for employees include a service condition that relates
only to vesting. The stock options generally vest over five years at the rate of 20% per year.
Compensation expense is amortized on a straight-line basis over the vesting period of the award.
The determination of the fair value of stock options using an option-pricing model is affected
by our stock price as well as assumptions regarding a number of complex and subjective variables.
The volatility assumption is based on a combination of the historical volatility of our common
stock over a period of time equal to the expected term of the stock options. The expected term of
employee stock options represents the weighted-average period the stock options are expected to
remain outstanding. The expected term assumption is estimated based primarily on the options
vesting terms and remaining contractual life and employees expected exercise and post-vesting
employment termination behavior. The risk-free interest rate assumption is based upon observed
interest rates on the grant date appropriate for the term of the employee stock options. The
dividend yield assumption is based on the expectation of no future dividend payouts by us.
As share-based compensation expense under SFAS 123R is based on awards ultimately expected to
vest, it is reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at
the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ
from those estimates.
Results of Operations
Our results of operations depend primarily on net interest income, which is the difference
between interest income and interest expense. Interest income is the earnings we receive on our
interest earning assets, such as loans and investments, and interest expense is the expense we
incur on our interest bearing liabilities, such as interest bearing deposits and other borrowings.
Factors that determine the level of net income include the volume of earning assets and interest
bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of
non-performing loans and other non-earning assets, and the amount of non-interest bearing
liabilities supporting earning assets. Non-interest income includes service charges and other
deposit related fees, and non-interest expense consists primarily of employee compensation and
benefits, occupancy, equipment and depreciation expense, and other operating expenses.
28
Financial Overview for the Three Months Ended March 31, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
Increase
|
|
|
|
2008
|
|
|
2007
|
|
|
(Decrease)
|
|
|
|
(Dollars in thousands, except per share data)
|
|
Consolidated Statement of Earnings Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
7,014
|
|
|
$
|
8,641
|
|
|
$
|
(1,627
|
)
|
Interest expense
|
|
|
4,979
|
|
|
|
3,809
|
|
|
|
1,170
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
2,035
|
|
|
|
4,832
|
|
|
|
(2,797
|
)
|
Provision for loan losses
|
|
|
7,690
|
|
|
|
491
|
|
|
|
7,199
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income (expense) after provision for loan
losses
|
|
|
(5,655
|
)
|
|
|
4,341
|
|
|
|
(9,996
|
)
|
Non-interest income
|
|
|
236
|
|
|
|
1,345
|
|
|
|
(1,109
|
)
|
Non-interest expense
|
|
|
3,393
|
|
|
|
4,059
|
|
|
|
(666
|
)
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before provision (benefit)for income taxes
|
|
|
(8,812
|
)
|
|
|
1,627
|
|
|
|
(10,439
|
)
|
Provision (benefit) for income taxes
|
|
|
(2,994
|
)
|
|
|
545
|
|
|
|
(3,539
|
)
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(5,818
|
)
|
|
$
|
1,082
|
|
|
$
|
(6,900
|
)
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share basic
|
|
$
|
(1.04
|
)
|
|
$
|
0.20
|
|
|
$
|
(1.24
|
)
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share diluted
|
|
$
|
(1.04
|
)
|
|
$
|
0.18
|
|
|
$
|
(1.22
|
)
|
|
|
|
|
|
|
|
|
|
|
The Company reported a net loss of $5.8 million or $1.04 loss per diluted share for the
quarter ended March 31, 2008 as compared to net income of $1.1 million or $0.18 diluted earnings
per share for the quarter ended March 31, 2007. The loss is attributable to a $7.7 million
provision for loan losses during the quarter ended March 31, 2008, compared to a $0.5 million
provision during the quarter ended March 31, 2007. Our return on average equity was (41.3)% and our
return on average assets was (4.66)% for the three months ended March 31, 2008, compared to 7.0%
and 1.10%, respectively for the three months ended March 31, 2007.
Net Interest Income and Net Interest Margin.
The $2.8 million, 57.9% decrease in net interest
income for the three month period ended March 31, 2008 was due to (i) a decrease in interest income
of $1.6 million, reflecting the effect of a $108.6 million increase in average interest-earning
assets offset by (ii) an increase in interest expense of $1.2 million. Average interest-earning
assets increased $108.6 million with interest income decreasing $1.7 million and interest expense
increasing $1.2 million. Average interest earning assets included average non-accrual loans of
$36.8 million and $238,000 at March 31, 2008 and March 31, 2007, respectively.
The average yield on our interest-earning assets was 5.69% for the three months ended March
31, 2008 period compared to 9.05% for the same period of 2007, a decrease of 3.36%. The decrease in
average yield on loans was due to the increase in non-accruing loans and interest reversals. The
decrease in the average yield on our interest-earning assets resulted from a decrease in market
rates, repricing on our adjustable rate loans, and new loans originated with lower interest rates
because of the decreasing interest rate environment in the first quarter 2008 and late 2007 and
reversal of non-accrual interest.
The cost of our average interest-bearing liabilities decreased to 4.77% for the three months
ended March 31, 2008 from 4.99% for the same period of 2007. In addition to broad decreases in the
average rates paid by Westsound Bank on deposit balances, the decrease was the result of the
lowering of deposit rates and change in the mix of deposits toward time deposits. Our average rate
on our interest-bearing deposits decreased 0.20% from 4.93% during the three months ended March 31,
2008 to 4.73% for the same period of 2007, reflecting the lowering of deposit rates. Our average
rate on total deposits (including non-interest bearing deposits) decreased to 4.47% for the three
months ended March 31, 2008 from 4.57% for the year ended December 31, 2007.
The 341 basis point decrease in our net interest margin, which decreased to 1.65% for the
three months ended March 31, 2008 from 5.06% for the three months ended March 31, 2007, was due to
the decrease in earning assets yield.
29
The following table sets forth a summary of average balances with corresponding interest
income and interest expense as well as average yield and cost information for the periods
presented. Average balances are derived from daily balances, and non-accrual loans are included as
interest earning assets for purposes of this table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
Yield
|
|
|
|
Average
|
|
|
|
|
|
|
or
|
|
|
Average
|
|
|
|
|
|
|
or
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Cost(6)
|
|
|
Balance
|
|
|
Interest
|
|
|
Cost(6)
|
|
|
|
(Dollars in thousands)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans(1)(2)(3)
|
|
$
|
404,498
|
|
|
$
|
6,336
|
|
|
|
6.30
|
%
|
|
$
|
363,296
|
|
|
$
|
8,343
|
|
|
|
9.31
|
%
|
Investment securities taxable
|
|
|
6,023
|
|
|
|
79
|
|
|
|
5.28
|
%
|
|
|
6,502
|
|
|
|
73
|
|
|
|
4.55
|
%
|
Investment securities non-taxable(3)
|
|
|
1,809
|
|
|
|
19
|
|
|
|
4.22
|
%
|
|
|
1,818
|
|
|
|
19
|
|
|
|
4.24
|
%
|
Federal funds sold
|
|
|
80,651
|
|
|
|
555
|
|
|
|
2.77
|
%
|
|
|
11,867
|
|
|
|
156
|
|
|
|
5.33
|
%
|
Other investments(4)
|
|
|
3,025
|
|
|
|
25
|
|
|
|
3.32
|
%
|
|
|
3,946
|
|
|
|
50
|
|
|
|
5.14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
496,006
|
|
|
|
7,014
|
|
|
|
5.69
|
%
|
|
|
387,429
|
|
|
|
8,641
|
|
|
|
9.05
|
%
|
Non-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
6,030
|
|
|
|
|
|
|
|
|
|
|
|
5,130
|
|
|
|
|
|
|
|
|
|
Unearned loan fees
|
|
|
(790
|
)
|
|
|
|
|
|
|
|
|
|
|
(818
|
)
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
|
(19,498
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,117
|
)
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
20,946
|
|
|
|
|
|
|
|
|
|
|
|
12,703
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
502,694
|
|
|
|
|
|
|
|
|
|
|
$
|
400,327
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand
|
|
$
|
7,171
|
|
|
$
|
17
|
|
|
|
0.95
|
%
|
|
$
|
7,635
|
|
|
$
|
19
|
|
|
|
1.01
|
%
|
Money market
|
|
|
76,667
|
|
|
|
733
|
|
|
|
3.85
|
%
|
|
|
104,745
|
|
|
|
1,174
|
|
|
|
4.55
|
%
|
Savings
|
|
|
11,377
|
|
|
|
93
|
|
|
|
3.29
|
%
|
|
|
4,634
|
|
|
|
42
|
|
|
|
3.68
|
%
|
Time certificates of deposit
|
|
|
316,190
|
|
|
|
3,992
|
|
|
|
5.08
|
%
|
|
|
183,961
|
|
|
|
2,427
|
|
|
|
5.35
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-bearing deposits
|
|
|
411,405
|
|
|
|
4,835
|
|
|
|
4.73
|
%
|
|
|
300,975
|
|
|
|
3,662
|
|
|
|
4.93
|
%
|
Short-term borrowings
|
|
|
0
|
|
|
|
0
|
|
|
|
0.00
|
%
|
|
|
85
|
|
|
|
1
|
|
|
|
4.77
|
%
|
Junior subordinated debt
|
|
|
8,248
|
|
|
|
144
|
|
|
|
7.02
|
%
|
|
|
8,248
|
|
|
|
146
|
|
|
|
7.18
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-bearing liabilities
|
|
|
419,653
|
|
|
|
4,979
|
|
|
|
4.77
|
%
|
|
|
309,308
|
|
|
|
3,809
|
|
|
|
4.99
|
%
|
Non-interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
23,191
|
|
|
|
|
|
|
|
|
|
|
|
26,969
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
3,146
|
|
|
|
|
|
|
|
|
|
|
|
1,754
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
445,990
|
|
|
|
|
|
|
|
|
|
|
|
338,031
|
|
|
|
|
|
|
|
|
|
Stockholders equity
|
|
|
56,704
|
|
|
|
|
|
|
|
|
|
|
|
62,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
502,694
|
|
|
|
|
|
|
|
|
|
|
$
|
400,327
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
2,035
|
|
|
|
|
|
|
|
|
|
|
$
|
4,832
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest spread(5)
|
|
|
|
|
|
|
|
|
|
|
0.92
|
%
|
|
|
|
|
|
|
|
|
|
|
4.05
|
%
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
1.65
|
%
|
|
|
|
|
|
|
|
|
|
|
5.06
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes average non-accrual loans of $36,785,000 at March 31, 2008 and $238,000 at March 31,
2007.
|
|
(2)
|
|
Loan fees of $0.5 million and $1.1 million are included in the yield computations for March
31, 2008 and 2007, respectively.
|
|
(3)
|
|
Yields on loans and securities have not been adjusted to a tax-equivalent basis.
|
|
(4)
|
|
Includes interest-bearing deposits with correspondent banks.
|
30
|
|
|
(5)
|
|
Net interest spread represents the average yield earned on interest earning assets less the
average rate paid on interest bearing liabilities.
|
|
(6)
|
|
Annualized.
|
The following table shows the change in interest income and interest expense and the amount of
change attributable to variances in volume, rates and the combination of volume and rates based on
the relative changes of volume and rates.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2008
|
|
|
|
Compared to Three Months
|
|
|
|
Ended March 31, 2007
|
|
|
|
Net Change
|
|
|
Rate
|
|
|
Volume
|
|
|
Mix
|
|
|
|
(In thousands)
|
|
Loans
|
|
$
|
(2,007
|
)
|
|
$
|
(10,948
|
)
|
|
$
|
3,837
|
|
|
$
|
5,104
|
|
Investment securities taxable
|
|
|
6
|
|
|
|
47
|
|
|
|
(22
|
)
|
|
|
(19
|
)
|
Investment securities non-taxable
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Federal funds sold
|
|
|
399
|
|
|
|
(304
|
)
|
|
|
3,667
|
|
|
|
(2,964
|
)
|
Other investments
|
|
|
(25
|
)
|
|
|
(72
|
)
|
|
|
(47
|
)
|
|
|
94
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
|
(1,627
|
)
|
|
|
(11,277
|
)
|
|
|
7,435
|
|
|
|
2,215
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand
|
|
|
(2
|
)
|
|
|
(4
|
)
|
|
|
(5
|
)
|
|
|
7
|
|
Money market
|
|
|
(441
|
)
|
|
|
(733
|
)
|
|
|
(1,276
|
)
|
|
|
1,568
|
|
Savings
|
|
|
51
|
|
|
|
(18
|
)
|
|
|
248
|
|
|
|
(179
|
)
|
Time certificates of deposit
|
|
|
1,565
|
|
|
|
(502
|
)
|
|
|
7,075
|
|
|
|
(5,008
|
)
|
Short-term borrowings
|
|
|
(1
|
)
|
|
|
(4
|
)
|
|
|
(4
|
)
|
|
|
7
|
|
Junior subordinated debt
|
|
|
(2
|
)
|
|
|
(13
|
)
|
|
|
0
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
|
1,170
|
|
|
|
(1,274
|
)
|
|
|
6,038
|
|
|
|
(3,594
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
$
|
(2,797
|
)
|
|
$
|
(10,003
|
)
|
|
$
|
1,397
|
|
|
$
|
5,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Loan Losses.
The provision for loan losses in each period is a charge against
earnings in that period. The provision is that amount required to maintain the allowance for loan
losses at a level that, in managements judgment, is adequate to absorb probable loan losses
inherent in the loan portfolio.
The provision for loan losses for the three months ended March 31, 2008 was $7,690,000
compared to $491,400 for the three months ended March 31, 2007. The provision increased
significantly in the quarter ended March 31, 2008, primarily as a result of the reassessment of our
construction and land development loan portfolio in light of recent deterioration in the local
housing market and the issues identified with respect to certain residential construction loans.
See Recent Developments above. Total net loans decreased by $34.0 million for the first three
months of 2008 compared to an increase of $36.9 million for the same period of 2007. We experienced
$912,000 of net loan charge-offs in the first three months 2008 compared to $50,000 of net loan
charge-offs in the same period of 2007.
For non-performing loans and any other loan where the borrower defaults on his loan agreement,
Westsound Bank intends to pursue any or all remedies available pursuant to the loan documents and
applicable federal and state laws, including foreclosure and pursuit of deficiencies.
Non-Interest Income.
The following table presents, for the periods indicated, the major
categories of non-interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
Increase
|
|
|
|
2008
|
|
|
2007
|
|
|
(Decrease)
|
|
|
|
(In thousands)
|
|
Service charges and other income
|
|
$
|
236
|
|
|
$
|
366
|
|
|
$
|
(130
|
)
|
Net gain on sale of loans
|
|
|
0
|
|
|
|
979
|
|
|
|
(979
|
)
|
|
|
|
|
|
|
|
|
|
|
Total non-interest income
|
|
$
|
236
|
|
|
$
|
1,345
|
|
|
$
|
(1,109
|
)
|
|
|
|
|
|
|
|
|
|
|
31
The $1,109,000 or 82.45% decrease in total non-interest income during the three months ended
March 31, 2008 was primarily influenced by the decrease in net gain on sale of loans and other loan
fee income.
Non-Interest Expense.
The following tables present, for the periods indicated, the major
categories of non-interest expense, which represent a re-classification of certain categories as
presented in our consolidated financial statements and related notes appearing elsewhere in this
report:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
|
|
|
|
Ended March 31,
|
|
|
Increase
|
|
|
|
2008
|
|
|
2007
|
|
|
(Decrease)
|
|
|
|
(In thousands)
|
|
Salaries, wages and employee benefits
|
|
$
|
1,526
|
|
|
$
|
2,667
|
|
|
$
|
(1,141
|
)
|
Occupancy, equipment and depreciation
|
|
|
438
|
|
|
|
451
|
|
|
|
(13
|
)
|
Data and item processing
|
|
|
184
|
|
|
|
151
|
|
|
|
33
|
|
Advertising expense
|
|
|
42
|
|
|
|
54
|
|
|
|
(12
|
)
|
Printing, stationery and supplies
|
|
|
42
|
|
|
|
60
|
|
|
|
(18
|
)
|
Telephone expense
|
|
|
23
|
|
|
|
29
|
|
|
|
(6
|
)
|
Postage and courier
|
|
|
35
|
|
|
|
39
|
|
|
|
(4
|
)
|
Legal fees
|
|
|
306
|
|
|
|
38
|
|
|
|
268
|
|
Director fees
|
|
|
109
|
|
|
|
57
|
|
|
|
52
|
|
Business & occupation taxes
|
|
|
57
|
|
|
|
73
|
|
|
|
(16
|
)
|
Accounting and audit fees
|
|
|
158
|
|
|
|
49
|
|
|
|
109
|
|
Consultant fees
|
|
|
136
|
|
|
|
13
|
|
|
|
123
|
|
OREO losses and expense, net
|
|
|
26
|
|
|
|
8
|
|
|
|
18
|
|
Provision (benefit) for unfunded credit losses
|
|
|
(320
|
)
|
|
|
0
|
|
|
|
(320
|
)
|
Other
|
|
|
631
|
|
|
|
370
|
|
|
|
261
|
|
|
|
|
|
|
|
|
|
|
|
Total non-interest expense
|
|
$
|
3,393
|
|
|
$
|
4,059
|
|
|
$
|
(666
|
)
|
|
|
|
|
|
|
|
|
|
|
The $0.7 million or 16.4% decrease in non-interest expense for the three months ended March
31, 2008 is primarily attributable to the salary, occupancy, other costs associated with downsizing
of our mortgage division and the decrease in allowance for unfunded credit losses. We reversed
$320,000 for credit losses for the period due to the decrease in undisbursed commitments. These
commitments were either funded or the loans were paid off.
Provision (Benefit) for Income Taxes.
We recorded tax benefit of $2,994,470 for the three
months ended March 31, 2008 compared to a tax provision of $545,000 for the same period in the
prior year. Our effective tax rate was approximately 34.0% for three months ended March 31, 2008
and 33.5% for the three months ended March 31, 2007. Differences from the statutory rates in either
period were largely due to the non-taxable nature of income from municipal securities. We increased
our deferred tax asset to $9.1 million from $6.5 million due to the increase in our provision for
loan losses. The Company believes the deferred tax asset will be recognized as deductible amounts
in future years and no valuation allowance was recorded.
Financial Condition
Our total assets at March 31, 2008 and December 31, 2007 were $503.5 million and $489.3
million, respectively. Our average earning assets for the three months ended March 31, 2008 and the
fiscal year ended December 31, 2007 were $496.0 million and $430.7 million, respectively, including
average non-accrual loans at $36.8 million and $1.5 million. Total deposits at March 31, 2008 and
December 31, 2007 were $441.5 million and $421.4 million, respectively.
Loans
Our net loans at March 31, 2008 and December 31, 2007 were $359.4 million and $393.4 million,
respectively, a decrease of 8.7% over the prior period. While we will continue to focus on our real
estate lending portfolio, we intend to diversify our lending portfolio in future periods including
more C&I loans. With the problems recently identified in our loan portfolio though and the decline
in demand for real estate loans, which we and other community banks have focused on for growth the
past several years, our rate of loan growth can be expected to decline, particularly in the near
term.
32
The following table shows the amounts (dollars in thousands) of loans outstanding at the end
of each of the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At March 31, 2008
|
|
|
At December 31, 2007
|
|
|
$ Increase
|
|
|
% Increase
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction & land development
|
|
$
|
237,888
|
|
|
|
61.6
|
%
|
|
$
|
253,188
|
|
|
|
61.2
|
%
|
|
$
|
(15,300
|
)
|
|
|
(6.0
|
)%
|
Commercial real estate
|
|
|
66,927
|
|
|
|
17.3
|
%
|
|
|
72,435
|
|
|
|
17.5
|
%
|
|
|
(5,508
|
)
|
|
|
(7.6
|
)%
|
Residential real estate
|
|
|
48,780
|
|
|
|
12.6
|
%
|
|
|
53,198
|
|
|
|
12.9
|
%
|
|
|
(4,418
|
)
|
|
|
(8.3
|
)%
|
Commercial & industrial loans
|
|
|
29,338
|
|
|
|
7.6
|
%
|
|
|
31,377
|
|
|
|
7.6
|
%
|
|
|
(2,039
|
)
|
|
|
(6.5
|
)%
|
Consumer loans
|
|
|
3,382
|
|
|
|
0.9
|
%
|
|
|
3,719
|
|
|
|
0.9
|
%
|
|
|
(337
|
)
|
|
|
(9.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loans
|
|
|
386,315
|
|
|
|
100.0
|
%
|
|
|
413,917
|
|
|
|
100.0
|
%
|
|
|
(27,602
|
)
|
|
|
(6.7
|
)%
|
Allowance for loan losses
|
|
|
26,292
|
|
|
|
|
|
|
|
19,514
|
|
|
|
|
|
|
|
3,778
|
|
|
|
34.7
|
%
|
Deferred loan fees, net
|
|
|
636
|
|
|
|
|
|
|
|
967
|
|
|
|
|
|
|
|
(331
|
)
|
|
|
(34.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loans
|
|
$
|
359,387
|
|
|
|
|
|
|
$
|
393,436
|
|
|
|
|
|
|
$
|
(31,049
|
)
|
|
|
(8.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Concentrations.
As of March 31, 2008, in managements judgment, a concentration of loans
existed in real estate-related loans. At that date, real estate-related loans comprised 91.5% of
total loans. At December 31, 2007, real estate-related loans comprised 91.5% of total loans, of
which approximately 66.8%, 19.1% and 14.1% were construction and land development, commercial real
estate and residential real estate, respectively.
Additionally, as of March 31, 2008, in managements judgment, a concentration of loans existed
in interest-only loans, primarily construction and development loans secured by real estate. At
that date, interest-only loans comprised 62.0% of total loans, of which approximately 87.0% were
construction and land development, 6.7% were residential, 2.5% were commercial real estate, 3.6%
were commercial and industrial, and 0.2% were consumer. As of December 31, 2007, interest only
loans comprised 64.4% of total loans.
Our loan portfolio is also concentrated in real estate and a substantial majority of our loans
and operations are in west Puget Sound, and therefore our business is particularly vulnerable to a
downturn in the local real estate market.
A substantial decline in the performance of the economy, in general, or a decline in real
estate values in our primary market areas, in particular, could have an adverse impact on
collectibility, increase the level of real estate-related non-performing loans, or have other
adverse effects which alone or in the aggregate could have a material adverse effect on our
business, financial condition, results of operations and cash flows. Interest-only loans also carry
greater risk than principal and interest loans do, to the extent that no principal is paid prior to
maturity, particularly during a period of rising interest rates and declining real estate values.
Non-Performing Assets.
Generally, loans are placed on non-accrual status when they become 90
days or more past due or at such earlier time as management determines timely recognition of
interest to be in doubt. Accrual of interest is discontinued on a loan when management believes,
after considering economic and business conditions and collection efforts that the borrowers
financial condition is such that collection of interest is doubtful. The following table summarizes
the loans for which the accrual of interest has been discontinued and loans more than 90 days past
due and still accruing interest, including those loans that have been restructured, and other real
estate owned, which we refer to as OREO:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands)
|
|
Non-accrual loans
|
|
$
|
70,313
|
|
|
$
|
24,923
|
|
Accruing loans past due 90 days or more
|
|
|
|
|
|
|
399
|
|
|
|
|
|
|
|
|
Total non-performing loans (NPLs)
|
|
|
70,313
|
|
|
|
25,322
|
|
Other real estate owned
|
|
|
1,883
|
|
|
|
983
|
|
|
|
|
|
|
|
|
Total non-performing assets (NPAs)
|
|
$
|
72,196
|
|
|
$
|
26,305
|
|
|
|
|
|
|
|
|
Selected ratios
|
|
|
|
|
|
|
|
|
NPLs to total loans
|
|
|
18.20
|
%
|
|
|
6.12
|
%
|
NPAs to total assets
|
|
|
14.34
|
%
|
|
|
5.38
|
%
|
33
Our levels of non-performing loans and OREO property increased significantly in the quarter
ended March 31, 2008, primarily as a result of the reassessment of our real estate loan portfolio
in light of recent deterioration in the local housing market and the issues identified with respect
to certain residential construction loans. See Recent Developments above.
The following table provides a break-down (dollars in thousands) by location of the Companys
loan portfolio at March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
Kitsap
|
|
|
% of
|
|
|
King
|
|
|
% of
|
|
|
Pierce
|
|
|
% of
|
|
|
Other
|
|
|
% of
|
|
|
|
Loans
|
|
|
County
|
|
|
Loans
|
|
|
County
|
|
|
Loans
|
|
|
County
|
|
|
Loans
|
|
|
Counties
|
|
|
Loans
|
|
Real estate loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spec construction
|
|
$
|
66,836
|
|
|
$
|
29,191
|
|
|
|
8
|
%
|
|
$
|
10,649
|
|
|
|
3
|
%
|
|
$
|
15,906
|
|
|
|
4
|
%
|
|
$
|
11,091
|
|
|
|
3
|
%
|
Custom construction
|
|
|
116,271
|
|
|
|
28,085
|
|
|
|
7
|
%
|
|
|
54,739
|
|
|
|
14
|
%
|
|
|
21,505
|
|
|
|
6
|
%
|
|
|
11,942
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total construction
|
|
|
183,107
|
|
|
|
57,276
|
|
|
|
15
|
%
|
|
|
65,388
|
|
|
|
17
|
%
|
|
|
37,410
|
|
|
|
10
|
%
|
|
|
23,033
|
|
|
|
6
|
%
|
Vacant land &
land development
|
|
|
54,781
|
|
|
|
30,095
|
|
|
|
8
|
%
|
|
|
5,215
|
|
|
|
1
|
%
|
|
|
6,001
|
|
|
|
2
|
%
|
|
|
13,470
|
|
|
|
3
|
%
|
1-4 family mortgage
|
|
|
35,554
|
|
|
|
15,874
|
|
|
|
4
|
%
|
|
|
3,469
|
|
|
|
1
|
%
|
|
|
6,771
|
|
|
|
2
|
%
|
|
|
9,440
|
|
|
|
2
|
%
|
Multifamily mortgage
|
|
|
13,226
|
|
|
|
6,139
|
|
|
|
2
|
%
|
|
|
|
|
|
|
0
|
%
|
|
|
3,271
|
|
|
|
1
|
%
|
|
|
3,816
|
|
|
|
1
|
%
|
Commercial real estate
|
|
|
66,927
|
|
|
|
44,452
|
|
|
|
11
|
%
|
|
|
4,194
|
|
|
|
1
|
%
|
|
|
3,919
|
|
|
|
1
|
%
|
|
|
14,362
|
|
|
|
4
|
%
|
Commercial & industrial
loans
|
|
|
29,338
|
|
|
|
24,296
|
|
|
|
6
|
%
|
|
|
79
|
|
|
|
0
|
%
|
|
|
3,071
|
|
|
|
1
|
%
|
|
|
1,892
|
|
|
|
1
|
%
|
Consumer loans
|
|
|
3,382
|
|
|
|
3,128
|
|
|
|
1
|
%
|
|
|
25
|
|
|
|
0
|
%
|
|
|
17
|
|
|
|
0
|
%
|
|
|
212
|
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loans
|
|
$
|
386,315
|
|
|
$
|
181,260
|
|
|
|
47
|
%
|
|
$
|
78,370
|
|
|
|
20
|
%
|
|
$
|
60,460
|
|
|
|
16
|
%
|
|
$
|
66,225
|
|
|
|
17
|
%
|
The following table provides a break-down (dollars in thousands) by non-accrual status of the
Companys loan portfolio at March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Non-
|
|
|
|
Loans
|
|
|
% of Loans
|
|
|
Non-Accruals
|
|
|
Accruals
|
|
Real estate loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spec construction
|
|
$
|
66,836
|
|
|
|
18
|
%
|
|
$
|
15,724
|
|
|
|
22
|
%
|
Custom construction
|
|
|
116,271
|
|
|
|
30
|
%
|
|
|
37,300
|
|
|
|
53
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total construction
|
|
|
183,107
|
|
|
|
48
|
%
|
|
|
52,724
|
|
|
|
75
|
%
|
Vacant land & land development
|
|
|
54,781
|
|
|
|
14
|
%
|
|
|
10,949
|
|
|
|
15
|
%
|
1-4 family mortgage
|
|
|
35,554
|
|
|
|
9
|
%
|
|
|
4,781
|
|
|
|
7
|
%
|
Multifamily mortgage
|
|
|
13,226
|
|
|
|
3
|
%
|
|
|
|
|
|
|
0
|
%
|
Commercial real estate
|
|
|
66,927
|
|
|
|
17
|
%
|
|
|
1,125
|
|
|
|
2
|
%
|
Commercial & industrial loans
|
|
|
29,338
|
|
|
|
8
|
%
|
|
|
710
|
|
|
|
1
|
%
|
Consumer loans
|
|
|
3,382
|
|
|
|
1
|
%
|
|
|
24
|
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loans
|
|
$
|
386,315
|
|
|
|
100
|
%
|
|
|
70,313
|
|
|
|
100
|
%
|
OREO Properties.
At March 31, 2008 we had $1.9 million in OREO property and $1.0 million at
December 31, 2007.
All OREO properties are recorded by us at amounts which are equal to or less than the fair
market value of the properties based on current independent appraisals reduced by estimated selling
costs.
Impaired Loans.
Impaired loans are loans for which it is probable that we will not be able
to collect all amounts due according to the original contractual terms of the loan agreement. The
category of impaired loans is not coextensive with the category of non-accrual loans, although
the two categories overlap. Non-accrual loans include impaired loans, which are not reviewed on a
collective basis for impairment, and are those loans on which the accrual of interest is
discontinued when collectibility of principal and interest is uncertain or payments of principal or
interest have become contractually past due 90 days. Management may choose to place a loan on
non-accrual status due to payment delinquency or uncertain collectibility, while not classifying
the loan as impaired if it is probable that we will collect all amounts due in accordance with the
original contractual terms of the loan or the loan is not a commercial, commercial real estate or
an individually significant mortgage or consumer loan.
In determining whether or not a loan is impaired, we apply our normal loan review procedures
on a case-by-case basis taking into consideration the circumstances surrounding the loan and
borrower, including the collateral
34
value, the reasons for the delay, the borrowers prior payment record, the amount of the
shortfall in relation to the principal and interest owed and the length of the delay. We measure
impairment on a loan-by-loan basis using either the present value of expected future cash flows
discounted at the loans effective interest rate or at the fair value of the collateral if the loan
is collateral dependent, less estimated selling costs. Loans for which an insignificant shortfall
in amount of payments is anticipated, but where we expect to collect all amounts due, are not
considered impaired. The following table summarizes our impaired loans.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Impaired Loans
|
|
|
|
|
|
|
|
|
Balance at end of period (1)
|
|
$
|
18,962,139
|
|
|
$
|
612,278
|
|
|
|
|
|
|
|
|
Total related allowance for losses
|
|
$
|
4,178,695
|
|
|
$
|
127,048
|
|
|
|
|
|
|
|
|
Average investment in impaired loans
|
|
$
|
23,818,786
|
|
|
$
|
153,070
|
|
|
|
|
|
|
|
|
Interest income recognized on impaired loans
|
|
$
|
104,127
|
|
|
$
|
6,631
|
|
|
|
|
|
|
|
|
Cash-basis interest income received on impaired loans
|
|
$
|
90,192
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes $12.9 million non-accrual loans at March 31, 2008 and $209,000 at March 31, 2007.
|
As a separate categorization, any troubled debt restructurings are defined as loans that we
have agreed to modify by accepting below-market terms, either by granting interest rate concessions
or by deferring principal and/or interest payments.
Our allowance for loan losses increased significantly in the quarter ended March 31, 2008,
primarily as a result of the reassessment of our real estate loan portfolio in light of recent
deterioration in the local housing market and the issues identified with respect to certain
residential construction loans. See Recent Developments above.
Loan Commitments.
Many of our lending relationships contain funded and unfunded elements. The
funded portion is reflected on our balance sheet. For lending relationships carried at historical
cost, the unfunded component of these commitments is not recorded on our balance sheet until a draw
is made under the credit facility; however, a reserve is established for probable losses. At March
31, 2008 we had a reserve balance of $145,000 for allowance for unfunded credit losses and $465,000
at December 31, 2007.
Legally binding commitments to extend credit generally have specified rates and maturities.
Certain of these commitments have adverse change clauses that help to protect us against
deterioration in the borrowers ability to pay.
As of March 31, 2008 and December 31, 2007, our unfunded commitments totaled $53,272,000 and
$81,610,000 respectively.
Contingent Liabilities for Sold Loans.
In the ordinary course of business, the Bank sells
loans without recourse that may have to be subsequently repurchased due to defects that occurred
during the origination of the loan. The defects are categorized as documentation errors,
underwriting errors, early payment defaults, breach of representation or warranty, delinquencies
and fraud. When a loan sold to an investor without recourse fails to perform according to its
contractual terms, the investor will typically review the loan file to determine whether defects in
the origination process occurred. If a defect is identified, the Bank may be required to either
repurchase the loan or indemnify the investor for losses sustained. If there are no such defects,
the Bank has no commitment to repurchase the loan. The Bank has recorded no reserve to cover loss
exposure related to these guarantees. The Company has repurchased two real estate loans totaling
$715,590 in the first quarter 2008 and one real estate loan totaling $750,000 in the fourth quarter
2007.
Allowance for Loan Losses
We must maintain an adequate allowance for loan losses, or ALLL, based on a comprehensive
methodology that assesses the probable losses inherent in the loan portfolio. We maintain an ALLL
based on a number of quantitative and qualitative factors, including levels and trends of past due
and non-accrual loans, asset classifications, loan grades, change in volume and mix of loans,
collateral value, historical loss experience, size and
35
complexity of individual credits and economic conditions. Provisions for loan losses are
provided on both a specific and general basis. Specific allowances are provided for impaired
credits for which the expected/anticipated loss is measurable. General valuation allowances are
based on a portfolio segmentation based on risk grading with a further evaluation of various
quantitative and qualitative factors noted above.
We periodically review the assumptions and formulae by which additions are made to the
specific and general valuation allowances for losses in an effort to refine such allowances in
light of the current status of the factors described above. The methodology is presented to and
approved by the board of directors.
Our provision for loan losses and levels of impaired loans and non-accrual loans increased
significantly in the quarter ended March 31, 2008, primarily as a result of the reassessment of our
construction and land development loan portfolio in light of recent deterioration in the local
housing market and the issues identified with respect to certain residential construction loans.
See Recent Developments above.
Specific Allocations.
All classified loans are carefully evaluated for loss portions or
potential loss exposure. The evaluation occurs at the time the loan is classified and on a regular
basis thereafter (at least quarterly). This evaluation is documented in a problem asset status
report relating to a specific loan or relationship. Specific allocation of reserves considers the
value of the collateral, the financial condition of the borrower, and industry and current economic
trends. We review the collateral value, cash flow, and tertiary support on each classified credit.
Any deficiency outlined by a real estate collateral evaluation liquidation analysis, or cash flow
shortfall is accounted for through a specific allocation reserve calculation for the loan.
General Allowances.
We perform a portfolio segmentation based on risk grading. Credits are
rated into different categories (Grades 1-7), with a percentage of the portfolio, based on grade,
allocated to the allowance. The loss factors for each risk grade are determined by management based
on managements overall assessment of the overall credit quality at month end taking into account
various quantitative and qualitative factors such as trends of past due and non-accrual loans,
asset classifications, loan grades, collateral value, historical loss experience and economic
conditions. The first three grades, grade three of which is divided into four subcategories, are
considered satisfactory or Pass, except 3-d for Watch loans requiring special monitoring. The
other four grades range from a Special Mention category to a Loss category. For a discussion of
these four grades, see Business Credit Policies in the Companys Annual Report on Form 10-K
filed with the Securities and Exchange Commission for the fiscal year ended December 31, 2007.
The following table sets forth the activity in our allowance for loan losses for the periods
indicated:
|
|
|
|
|
|
|
|
|
|
|
As of and For The
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands)
|
|
Allowance for loan losses:
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
19,514
|
|
|
$
|
3,972
|
|
Loans charged off
|
|
|
|
|
|
|
|
|
Real estate loans:
|
|
|
|
|
|
|
|
|
Construction
|
|
|
408
|
|
|
|
|
|
Commercial real estate
|
|
|
|
|
|
|
|
|
Residential real estate
|
|
|
507
|
|
|
|
47
|
|
Commercial & industrial loans
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
|
1
|
|
|
|
3
|
|
|
|
|
|
|
|
|
Total
|
|
|
916
|
|
|
|
50
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
Real estate loans:
|
|
|
|
|
|
|
|
|
Construction
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
|
|
|
|
|
|
|
Residential real estate
|
|
|
|
|
|
|
|
|
Commercial & industrial loans
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4
|
|
|
|
0
|
|
Net loan charge-off
|
|
|
912
|
|
|
|
50
|
|
36
|
|
|
|
|
|
|
|
|
|
|
As of and For The
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Reclassification of unfunded credit commitments to
other liabilities
|
|
|
|
|
|
|
(6
|
)
|
Provision for loan losses
|
|
|
7,690
|
|
|
|
491
|
|
|
|
|
|
|
|
|
Ending balance
|
|
$
|
26,292
|
|
|
$
|
4,407
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
386,315
|
|
|
$
|
382,582
|
|
Average loans
|
|
|
404,498
|
|
|
|
363,296
|
|
Non-performing loans
|
|
|
70,313
|
|
|
|
552
|
|
Selected ratios:
|
|
|
|
|
|
|
|
|
Net charge-offs to average loans
|
|
|
0.23
|
%
|
|
|
0.01
|
%
|
Provision for loan losses to average loans
|
|
|
1.90
|
%
|
|
|
0.14
|
%
|
Allowance for loan losses to loans outstanding at
end of period
|
|
|
6.82
|
%
|
|
|
1.15
|
%
|
Allowance for loan losses to non-performing loans
|
|
|
37.4
|
%
|
|
|
798.4
|
%
|
Our construction portfolio reflects some borrower concentration risk, and also carries the
enhanced risks encountered with construction loans generally. We also finance contractors,
including a number of small builders and individuals, on a speculative basis. Construction loans
are generally more risky than permanent mortgage loans because they are dependent upon the
borrowers ability to complete the project within budget, the borrowers ability to generate cash
to service the loan (by selling or leasing the project), and the value of the collateral depends on
project completion when market conditions may have changed. For these reasons, a higher allocation
is justified in this loan category.
Our commercial real estate loans are a mixture of new and seasoned properties, retail, office,
warehouse, and some industrial properties. Loans on properties are generally underwritten at a loan
to value ratio of less than 80% with a minimum debt coverage ratio of 1.2 times. Our grading system
allows our loan portfolio, including real estate, to be ranked across three pass risk grades.
Generally, the real estate loan portfolio is risk rated 3 Pass, except a number of the
residential construction loans which have been downgraded to 3-d, Watch, 4-Special Mention,
5-Substandard or for several loans, 6-Doubtful. The risk rated reserve factor increases with each
grade increase, and the general real estate portfolio grade of 3 is more reflective of the
various risks inherent in the real estate portfolio, such as large size and complexity of
individual credits, and overall concentration of credit risk. Accordingly, a greater allowance
allocation is provided on commercial real estate loans.
The principal sources of guidance on accounting for allowances in a loan portfolio under GAAP
are SFAS 5 and SFAS 114. In addition guidance given in SFAS 118 and Staff Accounting Bulletin No.
102 will be utilized and implemented as applicable.
Because there are additional risks of losses that cannot be quantified precisely or attributed
to particular loans or types of loans, including general economic, other conditions and trends, we
have established a portion of the allowance for loan losses based on our evaluation of these risks.
This portion of our allowance is determined based on various factors including, but not limited to,
general economic conditions of our market area, the growth, composition and diversification of our
loan portfolio, the experience level of our lending officers and staff, and the quality of our
credit risk management. At March 31, 2008, 79.8% of our total loan portfolio consisted of loans
booked in the last two years, including loan renewals. As of March 31, 2008, this risk portion of
the allowance for loan losses was $1,583,000 or 6.0% of the total allowance, compared with
$3,175,000 or 16.3% of the total allowance as of December 31, 2007. The decrease in this risk
portion of the allowance in the first quarter of 2008 was due to the reassessment of loans and
reclassifying them to specific allocations.
Investments
The carrying value of our investment securities totaled $7.7 million at March 31, 2008 and
$8.8 million at December 31, 2007. Our portfolio of investment securities during 2008 and 2007
consisted primarily of federal and state government securities.
37
The carrying values of our portfolio of investment securities at March 31, 2008 and December
31, 2007 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying Value at
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
$ Increase
|
|
|
% Increase
|
|
|
|
2008
|
|
|
2007
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
U.S. government agencies
|
|
$
|
5,836
|
|
|
$
|
6,980
|
|
|
$
|
(1,144
|
)
|
|
|
(16.4
|
)%
|
Obligations of states and political subdivisions
|
|
|
1,819
|
|
|
|
1,813
|
|
|
|
6
|
|
|
|
0.3
|
%
|
Mortgage-backed securities
|
|
|
36
|
|
|
|
39
|
|
|
|
(3
|
)
|
|
|
(7.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment securities
|
|
$
|
7,691
|
|
|
$
|
8,832
|
|
|
$
|
(1,141
|
)
|
|
|
(12.9
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
Total deposits were $441.5 million at March 31, 2008 compared to $421.4 million at December
31, 2007. The 4.8% increase in total deposits is attributed primarily to our current market growth
and entering into new markets. Non-interest-bearing demand deposits decreased to $23.0 million or
5.2% of total deposits from $24.7 million, or 5.9% of total deposits, at December 31, 2007.
Interest-bearing deposits are comprised of interest-bearing demand, money market accounts, regular
savings accounts, time deposits of under $100,000 and time deposits of $100,000 or more.
The following table shows the average amount and average rate paid on the categories of
deposits for each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Year Ended
|
|
|
|
March 31, 2008
|
|
|
December 31, 2007
|
|
|
|
Average
|
|
|
Average
|
|
|
Average
|
|
|
Average
|
|
|
|
Balance
|
|
|
Rate
|
|
|
Balance
|
|
|
Rate
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
Interest-bearing demand
|
|
$
|
7,171
|
|
|
|
0.95
|
%
|
|
$
|
7,542
|
|
|
|
1.02
|
%
|
Money market
|
|
|
76,667
|
|
|
|
3.85
|
%
|
|
|
99,941
|
|
|
|
4.49
|
%
|
Savings
|
|
|
11,377
|
|
|
|
3.29
|
%
|
|
|
7,802
|
|
|
|
3.78
|
%
|
Time certificates of deposit
|
|
|
316,190
|
|
|
|
5.08
|
%
|
|
|
226,050
|
|
|
|
5.33
|
%
|
Non-interest bearing deposits
|
|
|
23,191
|
|
|
|
0.00
|
%
|
|
|
28,426
|
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
434,596
|
|
|
|
4.47
|
%
|
|
$
|
369,761
|
|
|
|
4.57
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits are gathered from individuals, partnerships and corporations in our market areas. Our
policy also permits the acceptance of brokered deposits subject to regulatory approval. The
interest rates paid are competitively priced for each particular deposit product and structured to
meet our funding requirements. We will continue to manage interest expense through deposit pricing.
The 10 basis point decrease in interest rates paid during the three months ended March 31, 2008 is
reflective of the decrease in offering rates.
Stockholders Equity
Initial Public Offering.
We priced our initial public offering of 2,300,000 shares of our
common stock at $16.50 per share. We received net proceeds of approximately $40.2 million from our
sale of shares after deducting sales commissions and expenses. The underwriter of the Companys
initial public offering exercised and completed its option to purchase an additional 345,000 shares
of common stock to cover over-allotments effective Tuesday, December 19, 2006.
March 31, 2008 Overview.
As of March 31, 2008, our stockholders equity totaled $51.0 million,
and our equity to asset ratio was 10.1%, compared to 11.6% as of December 31, 2007. This decrease
is primarily the result of our asset growth and the net loss for the period that resulted from the
additions to the allowance for loan losses.
38
2007 Overview.
As of December 31, 2007, our stockholders equity totaled $56.7 million, and
our equity to asset ratio was 11.6%, compared to 15.9% as of December 31, 2006. This decrease is
primarily the results of our net loss for the period that resulted from the additions to the
allowance for loan losses.
Capital Resources
Current risk-based regulatory capital standards generally require banks and bank holding
companies to maintain a minimum ratio of core or Tier I capital (consisting principally of
common equity) to risk-weighted assets of at least 4%, a ratio of Tier I capital to adjusted total
assets (leverage ratio) of at least 4% and a ratio of total capital (which includes Tier I capital
plus certain forms of subordinated debt, a portion of the allowance for loan losses and preferred
stock) to risk-weighted assets of at least 8%. Risk-weighted assets are calculated by multiplying
the balance in each category of assets by a risk factor, which ranges from zero for cash assets and
certain government obligations to 100% for some types of loans, and adding the products together.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulatory Requirements
|
|
|
|
|
(Greater than or equal to
|
|
Actual at March 31, 2008
|
|
|
stated percentage)
|
|
|
|
|
|
WSB Financial
|
|
|
Adequately Capitalized
|
|
Well Capitalized
|
|
Westsound Bank
|
|
Group, Inc.
|
Tier 1 leverage capital ratio
|
|
|
4.0
|
%
|
|
|
5.0
|
%
|
|
|
11.5
|
%
|
|
|
11.8
|
%
|
Tier 1 risk-based capital
|
|
|
4.0
|
%
|
|
|
6.0
|
%
|
|
|
14.3
|
%
|
|
|
14.7
|
%
|
Total risk-based capital
|
|
|
8.0
|
%
|
|
|
10.0
|
%
|
|
|
15.7
|
%
|
|
|
16.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulatory Requirements
|
|
|
|
|
(Greater than or equal to
|
|
Actual at December 31, 2007
|
|
|
stated percentage)
|
|
|
|
|
|
WSB Financial
|
|
|
Adequately Capitalized
|
|
Well Capitalized
|
|
Westsound Bank
|
|
Group, Inc.
|
Tier 1 leverage capital ratio
|
|
|
4.0
|
%
|
|
|
5.0
|
%
|
|
|
13.6
|
%
|
|
|
13.9
|
%
|
Tier 1 risk-based capital
|
|
|
4.0
|
%
|
|
|
6.0
|
%
|
|
|
15.0
|
%
|
|
|
15.4
|
%
|
Total risk-based capital
|
|
|
8.0
|
%
|
|
|
10.0
|
%
|
|
|
16.3
|
%
|
|
|
16.7
|
%
|
Although the ratios presented above show that the Company and the Bank were well capitalized
at March 31, 2008 and December 31, 2007 based on their financial statements prepared in accordance
with generally accepted accounting principles in the United States and the general percentages in
regulatory guidelines, the Company and the Bank are no longer regarded as well capitalized for
federal regulatory purposes, as a result of the deficiencies cited in the FDIC order. See Note 2.
There are no conditions or events since the FDIC order that management believes have changed the
Banks category.
The Company and Westsound Bank believe they remain adequately-capitalized under regulatory
guidelines, as of March 31, 2008, following the additional provisions for loan losses, and
management believes that the Company has sufficient capital resources and liquidity to be able to
continue its normal business operations.
In order to manage our capital position more efficiently, we formed WSB Financial Group Trust
I, a Delaware statutory trust formed with capital of $248,000, for the sole purpose of issuing
trust preferred securities. During the third quarter of 2005, WSB Financial Group Trust I issued
8,000 Capital Securities, or the trust preferred securities, with liquidation value of $1,000 per
security, for gross proceeds of $8.0 million. The entire proceeds of the issuance were invested by
WSB Financial Group Trust I in $8.248 million of Junior Subordinated Deferrable Interest
Debentures, or the subordinated debentures, issued by Westsound Bank, with identical maturity,
repricing and payment terms as the trust preferred securities. The subordinated debentures
represent the sole assets of WSB Financial Group Trust I. The subordinated debentures mature on
September 15, 2035, and bear an interest rate at March 31, 2008 of 6.72% (based on 3-month LIBOR
plus 1.73%), with repricing occurring and interest payments due quarterly. We injected $7.9 million
of the net proceeds from the sale of the subordinated debentures into Westsound Bank and retained
the remaining proceeds for the needs of WSB Financial Group, Inc.
The subordinated debentures are redeemable by us, subject to our receipt of prior approval
from the Federal Reserve Bank of San Francisco, on any March 15, June 15, September 15 or December
15 on or after September 15, 2010.
The redemption price is par plus accrued and unpaid interest, except in the case of redemption
under a special event which is defined in the debenture occurring prior to September 15, 2010. The
trust preferred securities
39
are subject to mandatory redemption to the extent of any early redemption of the subordinated
debentures and upon maturity of the subordinated debentures on September 15, 2035.
Holders of the trust preferred securities are entitled to a cumulative cash distribution on
the liquidation amount of $1,000 per security at an interest rate at March 31, 2008 of 6.72%. For
each successive period beginning on March 15 of each year, the rate will be adjusted to equal the
3-month LIBOR plus 1.73%. WSB Financial Group Trust I has the option to defer payment of the
distributions for a period of up to five years, as long as we are not in default on the payment of
interest on the subordinated debentures. We have guaranteed, on a subordinated basis, distributions
and other payments due on the trust preferred securities. For financial reporting purposes, our
investment in the trust is accounted for under the equity method and is included in other assets on
the accompanying consolidated balance sheet. The subordinated debentures issued and guaranteed by
us and held by the trust are reflected on our consolidated balance sheet in accordance with
provisions of Interpretation No. 46 issued by the Financial Accounting Standards Board, or FASB,
No. 46, Consolidation of Variable Interest Entities. Under applicable regulatory guidelines, all of
the trust preferred securities currently qualify as Tier 1 capital, although this classification
may be subject to future change.
On February 25, 2008 and May 1, 2008, the Company elected to defer payment of interest on the
Junior Subordinated Debt Securities for the interest payment due March 15, 2008 and June 15, 2008,
respectively, as permitted by the indenture agreement. This election was the result of the
notification by the Federal Reserve Bank of San Francisco, or FRB that the Company and the Bank had
been designated to be in a troubled condition for purposes of Section 914 of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989. As a result of that designation, the
Company is generally prohibited from making any payments to any entity, including dividends and
interest payments (including dividends on its trust preferred securities, and interest at the hold
company level) without notifying the FRB for prior approval of such payments.
The Company may incur liabilities under certain contractual agreements contingent upon the
occurrence of certain events. A discussion of these contractual arrangements under which the
Company may be held liable is included above under Financial Condition Loans, Contingent
Liabilities for Sold Loans.
Liquidity
The ability to have readily available funds sufficient to repay fully maturing liabilities is
of primary importance to depositors, creditors and regulators. Our liquidity, represented by cash
and due from banks, federal funds sold and available-for-sale securities, is a result of its
operating, investing and financing activities and related cash flows. In order to ensure funds are
available at all times, we devote resources to projecting on a monthly basis the amount of funds
that will be required and maintain relationships with a diversified customer base so funds are
accessible. Liquidity requirements can also be met through short-term borrowings or the disposition
of short-term assets. We have a borrowing line with a correspondent bank totaling $10.0 million.
Our borrowing line with FHLB has been placed on hold until FHLB completes its credit analysis of
the Bank and will probably be collateral dependent. As of March 31, 2008 we had $6.0 million in
securities available to be sold or pledged to the FHLB.
We have a formal liquidity policy, and in the opinion of management, our liquid assets are
considered adequate to meet our cash flow needs for loan funding and deposit cash withdrawal for
the next 60 to 90 days. At March 31, 2008, we had approximately $120.6 million in liquid assets
comprised of $112.9 million in cash and cash equivalents (including fed funds sold of $102.5
million), and $7.7 million in available-for-sale securities.
On a long term basis, our liquidity will be met by changing the relative distribution of its
asset portfolios, i.e., reducing investment or loan volumes, or selling or encumbering assets.
Further, we will increase our liquidity by soliciting higher levels of deposit accounts through
promotional activities and/or borrowing from our correspondent banks as well as Federal Home Loan
Bank. At the current time, our long-term liquidity needs primarily relate to funds required to
support loan originations and commitments and deposit withdrawals. All of these needs can currently
be met by cash flows from investment payments and maturities, and investment sales if the need
arises. Our liquidity is comprised of three primary classifications: cash flows from or used in
operating activities; cash flows from or used in investing activities; and cash flows provided by
or used in financing activities.
40
Net cash provided by or used in operating activities has consisted primarily of net income
adjusted for certain non-cash income and expense items such as the loan loss provision, investment
and other amortization and depreciation.
Our primary investing activities are the origination of real estate, commercial and consumer
loans and purchase and sale of securities. We also invest in Federal Funds sold which increased by
$45.6 million at March 31, 2008 from December 31, 2007. Our net loans decreased for the three
months ended March 31, 2008 by $34.0 million. Investment securities decreased to $7.7 million at
March 31, 2008 from $8.8 million at December 31, 2007. At March 31, 2008 we had outstanding loan
commitments of $52.6 million and outstanding letters of credit of $701,000. We anticipate that we
will have sufficient funds available to meet current loan commitments.
Net cash provided by financing activities has been impacted significantly by increases in
deposit levels. During the three months ended March 31, 2008 and the year ended December 31, 2007,
deposits increased by $20.1 million and $106.4 million, respectively. During the year ended
December 31, 2006, net proceeds from our initial public offering provided an additional $40.2
million cash.
Recent Accounting Pronouncements
See Note 1 of the Consolidated Financial Statements for a discussion of recently issued or
proposed accounting pronouncements.
41
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in
market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our
market risk arises primarily from interest rate risk inherent in our lending and deposit taking
activities. To that end, management actively monitors and manages our interest rate risk exposure.
We do not have any market risk sensitive instruments entered into for trading purposes. We manage
our interest rate sensitivity by matching the re-pricing opportunities on our earning assets to
those on our funding liabilities.
Management uses various asset/liability strategies to manage the re-pricing characteristics of
our assets and liabilities designed to ensure that exposure to interest rate fluctuations is
limited within our guidelines of acceptable levels of risk-taking. Hedging strategies, including
the terms and pricing of loans and deposits, and managing the deployment of our securities, are
used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their
funding sources.
Interest rate risk is addressed by our Asset Liability Management Committee, or the ALCO,
which is comprised of the chief executive officer, chief financial officer and chief risk officer.
The ALCO monitors interest rate risk by analyzing the potential impact on the net portfolio of
equity value and net interest income from potential changes in interest rates, and considers the
impact of alternative strategies or changes in balance sheet structure. The ALCO manages our
balance sheet in part to maintain the potential impact on net portfolio value and net interest
income within acceptable ranges despite changes in interest rates.
Our exposure to interest rate risk is reviewed on at least a quarterly basis by the ALCO and
our Board of Directors. Interest rate risk exposure is measured using interest rate sensitivity
analysis to determine our change in net portfolio value in the event of hypothetical changes in
interest rates. If potential changes to net portfolio value and net interest income resulting from
hypothetical interest rate changes are not within the limits established by our Board of Directors,
the Board of Directors may direct management to adjust the asset and liability mix to bring
interest rate risk within board-approved limits.
Market Value of Portfolio Equity.
We measure the impact of market interest rate changes on the
net present value of estimated cash flows from our assets, liabilities and off-balance sheet items,
defined as market value of portfolio equity, using a simulation model. This simulation model
assesses the changes in the market value of interest rate sensitive financial instruments that
would occur in response to an instantaneous and sustained increase or decrease (shock) in market
interest rates of 100 and 200 basis points.
At March 31, 2008, our market value of portfolio equity exposure related to these hypothetical
changes in market interest rates was within the current guidelines established by us. The following
table shows our projected change in market value of portfolio equity for this set of rate shocks as
of March 31, 2008.
Market Value of Portfolio Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of
|
|
|
|
|
|
|
Percentage Change
|
|
Percentage of
|
|
Portfolio Equity
|
Interest Rate Scenario
|
|
Market Value
|
|
from Base
|
|
Total Assets
|
|
Book Value
|
|
|
(Dollars in thousands)
|
Up 200 basis points
|
|
$
|
50,788
|
|
|
|
2.4
|
%
|
|
|
10.1
|
%
|
|
|
99.62
|
%
|
Up 100 basis points
|
|
|
51,016
|
|
|
|
2.8
|
%
|
|
|
10.1
|
%
|
|
|
100.07
|
%
|
BASE
|
|
|
49,620
|
|
|
|
|
|
|
|
9.9
|
%
|
|
|
97.33
|
%
|
Down 100 basis points
|
|
|
48,869
|
|
|
|
(1.5
|
)%
|
|
|
9.7
|
%
|
|
|
95.86
|
%
|
Down 200 basis points
|
|
|
48,841
|
|
|
|
(1.6
|
)%
|
|
|
9.7
|
%
|
|
|
95.80
|
%
|
The computation of prospective effects of hypothetical interest rate changes are based on
numerous assumptions, including relative levels of market interest rates, asset prepayments and
deposit decay, and should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions we may undertake in response to changes in interest
rates. Actual amounts may differ from the projections set forth above should market conditions vary
from the underlying assumptions.
Net Interest Income Simulation.
In order to measure interest rate risk at March 31, 2008, we
used a simulation model to project changes in net interest income that result from forecasted
changes in interest rates. This
42
analysis calculates the difference between net interest income forecasted using a rising and a
falling interest rate scenario and a net interest income forecast using a base market interest rate
derived from the current treasury yield curve. The income simulation model includes various
assumptions regarding the re-pricing relationships for each of our products. Many of our assets are
floating rate loans, which are assumed to re-price immediately, and to the same extent as the
change in market rates according to their contracted index. Some loans and investment vehicles
include the opportunity of prepayment (embedded options), and accordingly the simulation model uses
national indexes to estimate these prepayments and reinvest their proceeds at current yields. Our
non-term deposit products re-price more slowly, usually changing less than the change in market
rates and at our discretion.
This analysis indicates the impact of changes in net interest income for the given set of rate
changes and assumptions. It assumes the balance sheet grows modestly, but that its structure will
remain similar to the structure at year-end. It does not account for all factors that impact this
analysis, including changes by management to mitigate the impact of interest rate changes or
secondary impacts such as changes to our credit risk profile as interest rates change.
Furthermore, loan prepayment rate estimates and spread relationships change regularly.
Interest rate changes create changes in actual loan prepayment rates that will differ from the
market estimates incorporated in this analysis. Changes that vary significantly from the
assumptions may have significant effects on our net interest income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was
increased or decreased, on an instantaneous and sustained basis, by 100 and 200 basis points. At
March 31, 2008, our net interest margin exposure related to these hypothetical changes in market
interest rates was within the current guidelines established by us.
Sensitivity of Net Interest Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Margin Change
|
|
|
Adjusted Net
|
|
Percentage Change
|
|
Net Interest
|
|
(in basis
|
Interest Rate Scenario
|
|
Interest Income(1)
|
|
from Base
|
|
Margin Percent(1)
|
|
points)
|
|
|
(Dollars in thousands)
|
Up 200 basis points
|
|
$
|
9,279
|
|
|
|
11.0
|
%
|
|
|
2.16
|
%
|
|
|
21
|
|
Up 100 basis points
|
|
|
8,726
|
|
|
|
4.4
|
%
|
|
|
2.03
|
%
|
|
|
8
|
|
BASE
|
|
|
8,358
|
|
|
|
|
|
|
|
1.95
|
%
|
|
|
|
|
Down 100 basis points
|
|
|
7,971
|
|
|
|
(4.6
|
)%
|
|
|
1.86
|
%
|
|
|
(9
|
)
|
Down 200 basis points
|
|
|
7,561
|
|
|
|
(9.5
|
)%
|
|
|
1.76
|
%
|
|
|
(19
|
)
|
|
|
|
(1)
|
|
These percentages are not comparable to other information discussing the percent of net
interest margin since the income simulation does not take into account loan fees.
|
Gap Analysis.
Another way to measure the impact that future changes in interest rates will
have on net interest income is through a cumulative gap measure. The gap represents the net
position of assets and liabilities subject to re-pricing in specified time periods.
The following table sets forth the distribution of re-pricing opportunities of our
interest-earning assets and interest-bearing liabilities, the interest rate sensitivity gap (that
is, interest rate sensitive assets less interest rate sensitive liabilities), cumulative
interest-earning assets and interest-bearing liabilities, the cumulative interest rate sensitivity
gap, the ratio of cumulative interest-earning assets to cumulative interest-bearing liabilities and
the cumulative gap as a percentage of total assets and total interest-earning assets as of March
31, 2008. The table also sets forth the time periods during which interest-earning assets and
interest-bearing liabilities will mature or may re-price in accordance with their contractual
terms. The interest rate relationships between the re-priceable assets and re-priceable liabilities
are not necessarily constant and may be affected by many factors, including the behavior of
customers in response to changes in interest rates. This table should, therefore, be used only as a
guide as to the possible effect changes in interest rates might have on our net interest margins.
43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2008
|
|
|
|
Amounts Maturing or Re-pricing in
|
|
|
|
|
|
|
|
Over
|
|
|
Over
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
Months
|
|
|
Year
|
|
|
|
|
|
|
|
|
|
|
|
|
Months
|
|
|
to
|
|
|
to
|
|
|
Over
|
|
|
|
|
|
|
|
|
|
or
|
|
|
12
|
|
|
5
|
|
|
5
|
|
|
Non-
|
|
|
|
|
|
|
Less
|
|
|
Months
|
|
|
Years
|
|
|
Years
|
|
|
Sensitive(1)
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
$
|
2,507
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7,883
|
|
|
$
|
10,390
|
|
Federal funds sold
|
|
|
102,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
102,500
|
|
Investment securities
|
|
|
799
|
|
|
|
1,656
|
|
|
|
4,241
|
|
|
|
784
|
|
|
|
211
|
|
|
|
7,691
|
|
Loans
|
|
|
146,325
|
|
|
|
84,054
|
|
|
|
72,388
|
|
|
|
13,215
|
|
|
|
69,697
|
|
|
|
385,679
|
|
Other assets(2)
|
|
|
567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,293
|
)
|
|
|
(2,726
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
252,698
|
|
|
$
|
85,710
|
|
|
$
|
76,629
|
|
|
$
|
13,999
|
|
|
$
|
74,498
|
|
|
$
|
503,534
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest-bearing demand
deposits
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
23,043
|
|
|
$
|
23,043
|
|
Interest-bearing demand, money
market and savings
|
|
|
10,311
|
|
|
|
30,933
|
|
|
|
47,047
|
|
|
|
4,187
|
|
|
|
|
|
|
|
92,478
|
|
Time certificates of deposit
|
|
|
66,608
|
|
|
|
156,405
|
|
|
|
93,383
|
|
|
|
9,690
|
|
|
|
(60
|
)
|
|
|
326,026
|
|
Short-term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
|
8,248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,248
|
|
Other liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,759
|
|
|
|
2,759
|
|
Stockholders equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50,980
|
|
|
|
50,980
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders equity
|
|
$
|
85,167
|
|
|
$
|
187,338
|
|
|
$
|
140,430
|
|
|
$
|
13,877
|
|
|
$
|
76,722
|
|
|
$
|
503,534
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period gap
|
|
|
167,531
|
|
|
|
(101,628
|
)
|
|
|
(63,801
|
)
|
|
|
122
|
|
|
|
(2,224
|
)
|
|
|
|
|
Cumulative interest-earning
assets
|
|
|
252,698
|
|
|
|
338,408
|
|
|
|
415,037
|
|
|
|
429,036
|
|
|
|
|
|
|
|
|
|
Cumulative interest-bearing
liabilities
|
|
|
85,167
|
|
|
|
272,505
|
|
|
|
412,935
|
|
|
|
426,812
|
|
|
|
|
|
|
|
|
|
Cumulative gap
|
|
|
167,531
|
|
|
|
65,903
|
|
|
|
2,102
|
|
|
|
2,224
|
|
|
|
|
|
|
|
|
|
Cumulative interest-earning
assets to cumulative
interest-bearing liabilities
|
|
|
2.97
|
|
|
|
1.24
|
|
|
|
1.01
|
|
|
|
1.01
|
|
|
|
|
|
|
|
|
|
Cumulative gap as a percent of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
33.1
|
%
|
|
|
13.0
|
%
|
|
|
0.4
|
%
|
|
|
0.4
|
%
|
|
|
|
|
|
|
|
|
Interest-earning assets
|
|
|
66.3
|
%
|
|
|
19.5
|
%
|
|
|
0.5
|
%
|
|
|
0.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Assets or liabilities and equity which are not interest rate-sensitive.
|
|
(2)
|
|
Allowance for loan losses of $26.3 million as of March 31, 2008 is included in other assets.
|
At March 31, 2008, we had $338.4 million in assets and $272.5 million in liabilities
re-pricing within one year. This means that $65.9 million more of our interest rate sensitive
assets than our interest rate sensitive liabilities will change to the then current rate (changes
occur due to the instruments being at a variable rate or because the maturity of the instrument
requires its replacement at the then current rate). The ratio of interest-earning assets to
interest-bearing liabilities maturing or re-pricing within one year at March 31, 2008 is 1.24. This
analysis indicates that at March 31, 2008, if interest rates were to increase, the gap would result
in a higher net interest margin. However, changes in the mix of earning assets or supporting
liabilities can either increase or decrease the net interest margin without affecting interest rate
sensitivity. In addition, the interest rate spread between an asset and its supporting liability
can vary significantly while the timing of re-pricing of both the asset and its supporting
liability can remain the same, thus impacting net interest income. This characteristic is referred
to as basis risk, and generally relates to the re-pricing characteristics of short-term funding
sources such as certificates of deposit.
Gap analysis has certain limitations. Measuring the volume of re-pricing or maturing assets
and liabilities does not always measure the full impact on the portfolio value of equity or net
interest income. Gap analysis does not account for rate caps on products; dynamic changes such as
increasing prepayment speeds as interest rates
44
decrease, basis risk, embedded options or the benefit of no-rate funding sources. The relation
between product rate re-pricing and market rate changes (basis risk) is not the same for all
products. The majority of interest-earning assets generally re-price along with a movement in
market rates, while non-term deposit rates in general move more slowly and usually incorporate only
a fraction of the change in market rates. Products categorized as non-rate sensitive, such as our
non-interest-bearing demand deposits, in the gap analysis behave like long term fixed rate funding
sources. Management uses income simulation, net interest income rate shocks and market value of
portfolio equity as its primary interest rate risk management tools.
45
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures
Regulations under the Securities Exchange Act of 1934 require public companies to maintain
disclosure controls and procedures, which are defined to mean a companys controls and other
procedures that are designed to ensure that information required to be disclosed in the reports
that it files or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in the Commissions rules and forms. Our
chief executive officer and our chief financial officer, with the assistance of our principal
accounting officer, based on their evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures as of the end of the period covered by this report concluded
that, as disclosed below with respect to material weakness and changes in our internal control over
financial reporting, the Companys disclosure controls and procedures were not effective as of
March 31, 2008.
Management is also responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rule 13a-15(f) of the Securities Act of 1934. The Companys
internal control framework and processes are designed to provide reasonable assurance to management
and the board of directors regarding the reliability of financial reporting and the preparation of
the Companys consolidated financial statements in accordance with the accounting principles
generally accepted in the United States of America. In Managements Report on Internal Control
over Financial Reporting in our Form 10-K for the year ended December 31, 2007, management
assessed the effectiveness of our internal control over financial reporting as of December 31, 2007
based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission
in Internal ControlIntegrated Framework. As a result of that assessment, management concluded
that, as of December 31, 2007, our internal control over financial reporting was not effective.
Managements conclusion was based upon their review of the FDIC order (described below and in
Managements Discussion and Analysis of Financial Condition and Results of Operations Recent
Developments) and their findings of control deficiencies that constituted a material weakness in
connection with a lack of or sufficient or adequate policies, procedures, and controls with respect
to the underwriting, documentation and monitoring of loans, the detection of risks related to the
concentration and other risks associated with the residential construction and other loans, and the
determination of our provision for loan losses and related allowance for loan losses.
Our internal control over financial reporting includes policies and procedures that pertain to
the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions
and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded
as necessary to permit preparation of financial statements in accordance with accounting principles
generally accepted in the United States; (2) receipts and expenditures are being made only in
accordance with authorizations of management and the directors of the Company; and (3) unauthorized
acquisition, use or disposition of the Companys assets that could have a material effect on the
Companys financial statements are prevented or timely detected.
Limitations on Controls
Management does not expect that our disclosure controls and procedures or our internal control
over financial reporting will prevent or detect all error and fraud. Any control system, no matter
how well designed and operated, is based upon certain assumptions and can provide only reasonable,
not absolute, assurance that its objectives will be met. Further, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not occur or that all
control issues and instances of fraud, if any, within the Company have been detected. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Changes in Internal Control Over Financial Reporting.
The FDIC determined the Bank had engaged in unsafe or unsound banking practices, by engaging
in unsatisfactory lending and collection practices, operating with inadequate management and board
supervision, with less than satisfactory capital in relation to its large volume of poor quality
loans and with an inadequate loan valuation reserve, and with inadequate provisions for liquidity,
inadequate internal routine and control policies, and
46
in violation of various banking laws and regulations relating to internal audits and controls,
real estate appraisal and lending guidelines, and responsibilities of bank directors and officers.
We have made or are in the process of implementing the following managerial and operational
changes to correct these deficiencies and to improve our internal controls over financial
reporting, including:
|
|
|
the audit committee has engaged the services of Young and Associates to perform
a compensation analysis to include a peer analysis for the board of directors,
senior management and department heads.
|
|
|
|
|
the Bank retained an experienced credit manager that had recently been hired
from outside the Bank as a regional manager, as chief lending officer in June, 2007
to manage its loan origination and approval process, credit administration and
controls, timely identification of risk and problem loans and emerging risks in the
loan portfolio in compliance with company policies and procedures and banking laws
and regulations. Credit administration now validates loan grades through an
internal loan approval process developed by the chief lending officer. The chief
lending officer reports to the Banks chief executive officer.
|
|
|
|
|
in November, 2007 the Bank established a new special assets department managed
by a new vice president and manager of special assets recruited from outside the
Bank. The Special Assets Department is responsible for construction, commercial
real estate and commercial loan collections, reporting to the chief lending officer
and the board. The Bank recently retained an experienced workout specialist as a
consultant.
|
|
|
|
|
the Company retained a new independent loan consulting firm in the fourth
quarter of 2007 to perform external reviews of the Companys loan portfolio.
|
|
|
|
|
the chief lending officer is revising lending policies and developing a series
of new or improved reports for credit administration to better monitor credit risks
internally and provide more detail about loans and credits to senior management,
the Board and its loan committee, including but not limited to, concentrations,
exceptions to loan policies, special assets and OREO reports, and monthly
delinquent, non-accrual, classified loans and exposure. The Bank recently retained
an experienced loan administrator as a consultant.
|
|
|
|
|
a comprehensive risk assessment of the Bank was performed by Audit One, an
independent auditor, in first quarter 2008. As a result of this assessment, the
preliminary audit plan has been adopted by the audit committee, focusing on the
lending area.
|
|
|
|
|
the audit committee and the Board have made changes to the internal audit
function. Rather than add staff to our internal audit department and take the time
to train, we chose to engage third party firms that are strong, reputable companies
that will provide an independent and timely audit, including Audit One and Young
and Associates. All third party firms will report directly to the audit committee.
|
|
|
|
|
the audit committee has or will engage several companies, such as accounting,
audit, compliance and information technology consultants to conduct extensive
internal audits in the operational and lending area. The scope of the audit will be
identified and approved by the audit committee and will include loan process
review, procedural review, compliance with consumer regulations, privacy, loan
documentation, information reporting, reserve for loan and lease loss methodology
and calculations, enterprise risk assessment, holding company activities,
administrative activities, liquidity, central operations, compliance with the Bank
Secrecy Act. Internal audit results are reported regularly to the audit committee
on a continual basis using a modified tracking system. The department head is
responsible for providing a management response to the audit committee if there are
weaknesses noted in their area. Tracking of the audits will be performed by the
Companys chief risk officer.
|
47
|
|
|
establishing a communications procedure for reporting progress in all areas to
the FDIC and DFI.
|
We believe that these corrective actions, taken as a whole, will mitigate the control
deficiencies identified above but we still need to test the effectiveness of these actions. We plan
to continue an on-going review and evaluation of our internal control over financial reporting, and
we may make other changes as appropriate based on the results of managements reviews and
evaluations.
Except as described above, through the filing date of this report on Form 10-Q, there were no
changes in our internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
(Remainder of page intentionally blank)
48
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
As previously reported, a purported securities fraud class action lawsuit was commenced in the
United States District Court for the Western District of Washington against the Company and certain
of its directors and current and former officers alleging violations of Sections 11 and 15 of the
Securities Act of 1933 and seeking an unspecified amount of compensatory damages and other relief
in connection with the Companys initial public offering. Since then four additional, similar
actions have been filed in the U.S. District Court in the Western District of Washington. As is
typical in these types of cases, all the actions have been consolidated into a single action, In
Re: WSB Financial Group Securities Litigation, Master File No. CO7-1747 RAJ.
The Company received a letter dated December 13, 2007, from the San Francisco Regional Office
of the Securities and Exchange Commission (SEC) requesting that the Company produce certain
documents concerning various issues that have been the subject of recent public disclosure by the
Company. The SECs letter notes that the request should not be construed as any indication by the
SEC or its staff that any violation of law has occurred, or as an adverse reflection upon any
person, entity or security. The Company provided documents in response to the SECs request. The
Company intends to cooperate with the SEC staff.
As of May 8, 2008, the Company had commenced collection proceedings on approximately 168 real
estate loans by sending notices of default to the borrowers. Some or all of these loans could
result in foreclosure actions.
The Company is unable to predict the outcome of these matters. Our cash expenditures,
including legal and other fees, associated with the pending litigation and the regulatory
proceedings described above (see Managements Discussion and Analysis of Finalized Condition and
Results of Operations) cannot be reasonably predicted at this time. Litigation and any potential
regulatory actions or proceedings can be time-consuming and expensive and could divert management
time and attention from our business, which could have a material adverse effect on our revenues
and results of operations. The adverse resolution of any specific lawsuit or potential regulatory
action or proceeding could have a material adverse effect on our business, results of operations,
and financial condition.
In addition to the above, the Company and Westsound Bank are periodically a party to or
otherwise involved in legal proceedings arising in the normal and ordinary course of business, such
as claims to enforce liens, foreclose on loan defaults, and other issues incident to our business.
Other than the legal and regulatory proceedings described or referenced above and the anticipated
institution of additional lawsuits or claims arising out of or related to the impaired loans,
management does not believe that there is any proceeding threatened or pending against the Company
or the Bank which, if determined adversely, would have a material effect on the business, results
of operations, cash flows, or financial position of the Company or the Bank.
ITEM 1A: RISK FACTORS
We are updating the following risk factors in our Annual Report on Form 10-K for the year
ended December 31, 2007, which could materially affect our business, financial condition or future
results. Any of the following risk factors as well as those described in the Form 10-K could
materially and adversely affect our business, financial condition and results of operations after
December 31, 2007, and these are not the only risks that we may face. Many of these factors are
beyond our control, and in addition to the following risk factors you should read carefully the
factors described in Risk Factors in the Companys Form 10-K filed with the Securities and
Exchange Commission for a description of some, but not all, risks, uncertainties and contingencies.
Additional risks and uncertainties not currently known to us may also materially and adversely
affect our business, financial condition or results of operations.
Restrictions imposed by regulatory actions could have an adverse effect on us and failure to comply
with any of their provisions could result in further regulatory action or restrictions.
The Company and its subsidiary, Westsound Bank, are subject to regulatory actions, including
an FDIC order, with respect to their operations, described in Managements Discussion and Analysis
of Financial Condition and Results of Operations Recent Developments.
49
The FDIC order identified deficiencies within credit administration in connection with a lack
of sufficient or adequate policies, procedures, and control with respect to the underwriting,
documentation and monitoring of loans, the detection of risks related to the concentration and
other risks associated with our residential construction and land development and other loans, the
determination of our provision for loan losses and possible violations or contraventions of law.
These regulatory actions may limit our growth and adversely affect our earnings.
We are experiencing significant difficulties in our loan portfolio, particularly in our residential
construction, land development and mortgage loans. Over 91% of our loans are real estate related.
Approximately 91.5% of our loan portfolio as of March 31, 2008 was comprised of loans secured
by real estate, including construction and development, commercial and residential real estate
loans. We are experiencing significant difficulties in our loan portfolio, particularly our
residential construction, land development and mortgage loans. Many of these loans are maturing and
classified as non-performing assets while we work with the borrowers to maximize our recovery. In
the first quarter of 2008 our non-accrual loans increased significantly, from $24.9 to $70.3
million, primarily as a result of maturing construction and land development loans that we are
choosing not to renew in order to keep all of its legal remedy options available. The majority of
our remaining construction and land development loans mature in the next two quarters of 2008.
Therefore, the contraction or expansion of our non-accrual loan portfolio and OREO properties in
future periods will depend upon our ongoing collection efforts. See Managements Discussion and
Analysis of Financial Condition and Results of Operations.
The recent downturn in the local real estate market could cause collateral for loans made by us to
decline in value, and loan delinquencies and non-performing assets to increase.
The recent downturn in the local real estate market could increase loan delinquencies,
defaults and foreclosures, and significantly impair the value of our collateral and our ability to
sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate
source of repayment in the event of default by the borrower and may deteriorate in value during the
time the credit is extended. If real estate values decline further, it is also more likely that we
would be required to increase our allowance for loan losses. If during a period of reduced real
estate values we are required to liquidate the property collateralizing a loan to satisfy the debt
or to increase our allowance for loan losses, it could materially reduce our profitability and
adversely affect our financial condition.
Our allowance for loan losses may not be adequate to cover actual losses.
A significant source of risk arises from the possibility that we could sustain losses due to
loan defaults and non-performance on loans. We maintain an allowance for loan losses in accordance
with accounting principles generally accepted in the United States to provide for such defaults and
other non-performance. As of March 31, 2008, our allowance for loan losses as a percentage of loans
was 6.82%. The determination of the appropriate level of loan loss allowance is an inherently
difficult process and is based on numerous assumptions. The amount of future losses is susceptible
to changes in economic, operating and other conditions, including changes in interest rates, that
may be beyond our control. In addition, our underwriting policies, adherence to credit monitoring
processes, and risk management systems and controls may not prevent unexpected losses. Our
allowance for loan losses may not be adequate to cover actual loan losses. Moreover, any increase
in our allowance for loan losses will adversely affect our earnings.
Our future earnings will be significantly affected by the securities class action lawsuits pending
against us, and the collection and potential foreclosure actions that we are pursuing with respect
to our non-accrual loans.
The Company and Westsound Bank have been sued or named in the securities class action lawsuits
identified in Part II, Item 1 of this Form 10-Q, which, if adversely determined, could have a
material adverse effect on our consolidated financial position, results of operations, or cash
flows. Further, Westsound Bank is also involved in the collection and potential foreclosure actions
described in Part II, Item 1 of this Form 10-Q. Because we are unable to predict the impact or
resolution of these outstanding litigation matters or to reasonably estimate the potential loss, if
any, no reserves have yet been established therefor.
50
In this regard, we may determine in the future that it is necessary to establish such reserves
and, if so established, such reserves could have a material adverse impact on our financial
condition. Accordingly, our ability to successfully defend against claims asserted against us in
various lawsuits arising out of the circumstances surrounding the loans, may have a substantial
impact on the profitability of the Company.
Our future liquidity depends in part on our ability to attract and retain deposits, which could be
adversely affected by adverse publicity in our market area related to the legal and regulatory
actions in which we are or may be involved.
Our liquidity could be adversely affected by unexpected deposit outflows, excessive interest
rates by competitors, adverse publicity relating to regulatory and legal actions in which we are or
may be involved and similar matters. See Managements Discussion and Analysis of Financial
Condition and Results of OperationsLiquidity.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a)
Recent Sales of Unregistered Securities.
The following sets forth information regarding
all unregistered securities sold by the registrant in the three month period ended March 31, 2008:
(1)
Securities Issued Upon Exercise of Stock Options.
There were no shares of common stock
issued by registrant in the fiscal quarter ended March 31, 2008 pursuant to the exercise of stock
options under the 1999 Incentive Stock Option Plan (the Plan).
Such shares of common stock are issued pursuant to a written compensatory benefit plan under
circumstances that comply with the requirements of Rule 701 promulgated under the Securities Act,
and are thus exempted from the registration requirements of the Securities Act by virtue of Rule
701.
(b)
Initial Public Offering
. On December 19, 2006, the Company completed its initial public
offering. The net proceeds of the offering, including the exercise of the underwriters
over-allotment option, to the Company (after deducting expenses) were $40.2 million. The net
proceeds are being held as available cash in our banking subsidiary, Westsound Bank, which in turn
allows the bank to use these funds for its normal day to day funding needs. There has been no
material change in the planned use of proceeds from this initial public offering as described in
the Companys final prospectus filed with the SEC.
(c)
Dividends.
We have not paid, and currently have no plans to pay, cash dividends to our
stockholders. The payment of dividends is within the discretion of our board of directors and will
depend upon our earnings, capital requirements and operating and financial position, among other
factors.
Additionally, our junior subordinated debt agreement prohibits us from paying dividends if we
have deferred payment of interest on outstanding trust preferred securities. See Item 2:
Managements Discussion and Analysis of Financial Condition and Results of Operations Capital
Resources. We are deferring interest on our trust preferred securities. See Note 5 of the Notes to
Consolidated Financial Statements.
We are a legal entity separate and distinct from Westsound Bank. Because we are a holding
company with no significant assets other than Westsound Bank, we will be dependent upon dividends
from Westsound Bank for cash with which to pay dividends when, and if, our dividend policy changes.
For a discussion of the regulatory limitations on Westsound Banks ability to pay dividends, see
Supervision and Regulation Federal and State Regulation of Westsound Bank Dividends in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
51
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS
See Exhibit Index on pages 54 55.
52
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized
|
|
|
|
|
|
WSB FINANCIAL GROUP, INC
.
(Registrant)
|
|
Date: May 15, 2008
|
/s/ Terry A. Peterson
|
|
|
Terry A. Peterson, Chief Executive Officer
|
|
|
|
|
Date: May 15, 2008
|
/s/ Mark D. Freeman
|
|
|
Mark D. Freeman, Chief Financial Officer
|
|
|
|
|
53
|
|
|
Exhibit
|
|
|
Number
|
|
Exhibit Index
|
|
|
|
3.1+
|
|
Articles of Incorporation of WSB Financial Group, Inc.
|
|
|
|
3.2+
|
|
Articles of Amendment
|
|
|
|
3.3+
|
|
Bylaws of WSB Financial Group, Inc.
|
|
|
|
3.4+
|
|
Amendment to Bylaws
|
|
|
|
10.1*+
|
|
1999 Stock Option Plan
|
|
|
|
10.2*+
|
|
Forms of 1999 Incentive Stock Option Plan Agreements
|
|
|
|
(a)+
|
|
Directors
|
|
|
|
(b)+
|
|
Employees
|
|
|
|
10.3+
|
|
Lease for Port Orchard branch, dated May 28, 2001
|
|
|
|
10.4+
|
|
Lease for Silverdale branch, dated October 1, 2001 and October 1, 2003
|
|
|
|
10.5+
|
|
Lease for Gig Harbor branch, dated March 2, 2004
|
|
|
|
10.6+
|
|
Lease for Federal Way branch, dated March 30, 2005
|
|
|
|
10.7+
|
|
Lease for Port Townsend LPO, dated August 18, 2006
|
|
|
|
10.8+
|
|
Agreement between Westsound Bank and Fiserv Solutions Inc. dated August 11, 2006
|
|
|
|
10.9*+
|
|
Westsound Bank 401(k) Profit Sharing Plan
|
|
|
|
10.10+
|
|
Placement Agreement among the registrant, WSB Financial Group Trust I and Cohen
Bros. & Company dated July 25, 2005
|
|
|
|
10.11+
|
|
Indenture by and between the registrant and JPMorgan Chase Bank, National
Association, dated July 27, 2005
|
|
|
|
10.12+
|
|
Guarantee Agreement by and between the registrant and JPMorgan Chase Bank,
National Association, dated July 27, 2005
|
|
|
|
10.13*
|
|
Employment Agreement with Terry A. Peterson
|
|
|
|
10.14*+
|
|
Employment Agreement with Mark D. Freeman
|
|
|
|
10.15*+
|
|
Form of Employment Agreement with other executive officers
|
|
|
|
10.16+
|
|
Form of Indemnification Agreement with directors
|
|
|
|
10.17+
|
|
Audit Committee Charter
|
|
|
|
10.18+
|
|
Compensation Committee Charter
|
54
|
|
|
Exhibit
|
|
|
Number
|
|
Exhibit Index
|
|
|
|
10.19+
|
|
Corporate Governance/Nominating Committee Charter
|
|
|
|
10.20++
|
|
Separation Agreement with David K. Johnson (previously filed with the
Securities and Exchange Commission on Form 8-K on February 4, 2008)
|
|
|
|
31.1
|
|
Certification of Chief Executive Officer.
|
|
|
|
31.2
|
|
Certification of Chief Financial Officer.
|
|
|
|
32.1
|
|
Certification (of Terry A. Peterson) pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
32.2
|
|
Certification (of Mark D. Freeman) pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
*
|
|
Compensatory plan or arrangement
|
|
|
|
Confidential treatment has been requested with respect to certain
portions of this exhibit. Omitted portions have been filed separately
with the Securities and Exchange Commission.
|
|
+
|
|
Previously filed with the Companys Amendment No. 5 to the S-1
registration statement filed with the Securities and Exchange
Commission on December 8, 2006, file no. 333-137058.
|
|
++
|
|
Previously filed with the Companys Annual Report on Form 10-K for the
year ended December 31, 2007, filed with the Securities and Exchange
Commission on March 31, 2008.
|
55
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