-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C/tL7XvXhF0mUnF1SlnPUQz+9/mUTssDA3qjV9+HM99H7BjRsoruePOgBnG70hb1 gzzmPlW6tUOIOoyhdI8AEA== 0001193125-06-051018.txt : 20060310 0001193125-06-051018.hdr.sgml : 20060310 20060310160633 ACCESSION NUMBER: 0001193125-06-051018 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060310 DATE AS OF CHANGE: 20060310 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MOUNTAIN BANK HOLDING CO CENTRAL INDEX KEY: 0000898018 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 911602736 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-28394 FILM NUMBER: 06679468 BUSINESS ADDRESS: STREET 1: 501 ROOSEVELT AVE EAST STREET 2: PO BOX 98 CITY: ENUMCLAW STATE: WA ZIP: 98022 BUSINESS PHONE: 2068250100 MAIL ADDRESS: STREET 1: 501 ROOSEVELE AVENUE CITY: ENUMCLAW STATE: WA ZIP: 98022 10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

 


 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2005.

 

¨ Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)

Commission File Number:    0 - 28394

 


MOUNTAIN BANK HOLDING COMPANY

(exact name of registrant as specified in its charter)

 


 

WASHINGTON   91-1602736

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

identification Number)

501 Roosevelt Avenue, PO Box 98, Enumclaw, WA 98022
            (address of principal executive offices)                      (zip code)

Registrant’s telephone number:    (360) 825-0100

 


Securities registered pursuant to Section 12(b) of the Act:    None

Securities registered pursuant to Section 12(g) of the Act:    Common Stock, no par value

                                                                                                                                   (title of class)

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated file, or a non-accelerated filer.

 

Large accelerated filer  ¨   Accelerated filer  ¨   Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  ¨    No  x

As of June 30, 2005, the aggregate market value of the 1,862,210 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes the 435,281 shares held by all directors and executive officers of the Registrant as a group, was $31,657,570. This figure is based on the closing sale price of $17.00 per share of the Registrant’s Common Stock on June 30, 2005.

Number of shares of common stock outstanding as of February 28, 2006: 2,302,741

DOCUMENTS INCORPORATED BY REFERENCE

The Proxy Statement for the 2006 Annual Meeting of Shareholders to be held on April 25, 2006 is incorporated by reference into Part III of this Annual Report on Form 10-K.

 



Table of Contents

TABLE OF CONTENTS

 

          Page #
Part I

ITEM 1.

  

Business

   1
  

General

   1
  

Mt. Rainier Bank

   1
  

History

   2
  

Business

   2
  

Service Area

   2
  

Employees

   3
  

Competition

   3
  

Products and Services

   3
  

Marketing

   3
  

Forward Looking Statement Disclosure

   4
  

Statistical Information About Mountain Bank Holding

   4
  

Distribution of Average Assets, Liabilities and Shareholders’ Equity & Interest Yields

   5
  

Rate Volume Analysis

   6
  

Investment Portfolio

   6
  

Lending Activities

   8
  

Risk Elements—Non-Accrual, Past Due and Restructured Loans

   12
  

Credit Risk Management and Allowance for Credit Losses

   13
  

Allocation of the Allowance for Credit Losses By Loan Classification

   15
  

Deposits

   17
  

Return on Equity and Assets

   19
  

Supervision and Regulation

   19
  

Significant Changes in Banking Laws and Regulations

  
  

Mountain Bank Holding Company

   19
  

Bank Holding Company Regulation

   20
  

Transactions with Affiliates

   20
  

Tie-In Arrangements

   20
  

State Law Restrictions

   21
  

Mt. Rainier National Bank

   21
  

Interstate Banking and Branching

   21
  

Deposit Insurance

   22
  

Dividends

   22
  

Capital Adequacy

   22
  

Effects of Government Monetary Policy

   24

ITEM 1A

  

Risk Factors

   24

ITEM 1B

  

Unresolved Staff Comments

   26

ITEM 2.

  

Properties

   26

ITEM 3.

  

Legal Proceedings

   27

ITEM 4.

  

Submission of Matters to a Vote of Security Holders

   27
Part II

ITEM 5.

  

Market for Registrant’s Common Equity and Related Stockholder Matters

   28
  

Market Information

   28
  

Number of Equity Holders

   28

 

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          Page #
  

Stock Dividends

   28
  

Payment of Dividends

   29
  

Equity Compensation Plan Information

   29

ITEM 6.

  

Selected Financial Data

   30

ITEM 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   31

ITEM 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   43

ITEM 8.

  

Consolidated Financial Statements and Supplementary Data

   44

ITEM 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   44

ITEM 9A.

  

Controls and Procedures

   44

ITEM 9B.

  

Other Information

   44
Part III

ITEM 10.

  

Directors and Executive Officers of the Registrant

   45

ITEM 11.

  

Executive Compensation

   45

ITEM 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   45

ITEM 13.

  

Certain Relationships and Related Transactions

   45

ITEM 14.

  

Principal Accountant Fees and Services

   45
Part IV

ITEM 15.

  

Exhibits and Financial Statement Schedules

   46
Signatures

 

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FORM 10-K

Available Information

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, and beneficial ownership reports on Forms 3, 4, and 5 as soon as practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission can be found on the SEC’s Edgar database at www.sec.gov, free of charge.

PART I

(ITEMS 1-4)

ITEM 1. BUSINESS

General

Mountain Bank Holding Company (“Mountain Bank Holding”) is a Washington corporation formed in 1993 primarily to hold all of the Common Stock of Mt. Rainier National Bank (“Mt. Rainier Bank”), a National Banking Association organized under the laws of the United States. Mt. Rainier Bank provides personal and commercial banking and related financial services at its main office located in Enumclaw, Washington, and from five branch offices located in Buckley, Black Diamond, Auburn, Maple Valley, and Sumner Washington. Mt. Rainier Bank also provides loan services at a loan production office located in Federal Way, Washington. Mountain Bank Holding is regulated by the Federal Reserve Board (the “FRB”) under the Bank Holding Company Act of 1956, as amended. A bank holding company is generally defined as a company that has direct or indirect control of a bank. Mountain Bank Holding qualifies as a bank holding company because it owns one hundred percent (100%) of the outstanding securities of Mt. Rainier National Bank (Mt. Rainier Bank). At December 31, 2005, Mountain Bank Holding reported on a consolidated basis total assets of $194,524,000, total deposits of $171,813,000, and shareholders’ equity of $20,299,000.

Mountain Bank Holding’s strategy is to capitalize on its investment in Mt. Rainier Bank through continued growth in Mt. Rainier Bank’s assets, deposits and earnings, and creation of long-term value for Company shareholders by pursuing the following:

 

    Monitoring carefully the credit quality of Mt. Rainier Bank’s existing asset base;

 

    Concentrating on expense control, interest spread maximization and marketing of fee-based products, as well as maintaining adequate liquidity and capital levels;

 

    Emphasizing close working relationships between Mt. Rainier Bank’s senior management, directors, loan officers and commercial customers; and

 

    Focusing on training programs to ensure that management and staff has knowledge necessary to serve customers and remain in compliance with all legal and regulatory obligations.

There can be no assurance that Mt. Rainier Bank will achieve these objectives.

DESCRIPTION OF MT. RAINIER NATIONAL BANK

Mt. Rainier Bank

Mt. Rainier National Bank is a wholly owned subsidiary of Mountain Bank Holding. While Mountain Bank Holding and Mt. Rainier Bank are distinctly different entities regulated by different regulatory bodies, the cash flow of Mountain Bank Holding presently is entirely derived from dividends upstreamed from Mt. Rainier Bank to Mountain Bank Holding. Therefore, the value of the securities of Mountain Bank Holding is, to a large extent, dependent upon the success of Mt. Rainier Bank.

 

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History

Mt. Rainier Bank opened on July 2, 1990, in Enumclaw, Washington, and has been operating since that date.

Business

Mt. Rainier Bank, through its main office, five branches and one loan production office, offers a full line of commercial banking services.

The principal sources of Mt. Rainier Bank’s revenues are: (i) interest and fees on loans; (ii) deposit service charges; (iii) interest on deposits in other banks (generally on an overnight basis); (iv) gains on mortgages originated and sold to the secondary market; (v) interest on investments, and (vi) fees from sales of non-deposit investment products. Loans include short-to-medium-term commercial and consumer loans, including real estate loans, operating loans and lines, equipment loans, automobile loans, recreational vehicle and truck loans, personal loans and lines of credit, home improvement and rehabilitation loans, VISA national credit cards, and residential mortgage lending. Mt. Rainier Bank also offers safe deposit boxes, direct deposit of payroll and social security checks, automated teller machine access, debit cards, automatic drafts for various accounts, telephone banking, Internet banking and bill payment services. Mt. Rainier Bank has a night depository and an ATM, as well as drive-up services, at each of its branch offices.

Mt. Rainier Bank’s core deposit base generally has been enhanced through advertising and deposit promotions, and focusing on securing the entire banking relationship of each of its customers. Deposit products include checking accounts, savings programs, NOW accounts and certificates of deposit. Mt. Rainier Bank has not used brokered deposits as a source of funds.

Mt. Rainier Bank’s commercial banking activities target high net worth individuals and their businesses with an emphasis on small to medium size businesses. Mt. Rainier Bank’s operating strategy is to offer personal service, flexibility and timely responsiveness to the needs of its customers. Senior management of Mt. Rainier Bank and Mountain Bank Holding maintain close personal contact and close working relationships with Mt. Rainier Bank’s commercial customers and their businesses, and Mt. Rainier Bank’s and the Company’s Boards of Directors primarily include local business people from Mt. Rainier Bank’s primary service area. Most of Mt. Rainier Bank’s new commercial banking business consists of referrals from existing customers. Mountain Bank Holding believes that Mt. Rainier Bank’s loan portfolio is appropriately diversified. All floating rate loans are priced at prime or higher.

Mountain Bank Holding believes that the growth in loans and profitability achieved by Mt. Rainier Bank also is attributable in large measure to its strategy of targeting smaller and medium size businesses in the manner described above and to the business and personal relationships and experience of Mt. Rainier Bank’s and Mountain Bank Holding’s management and Directors, rather than the result of greater risk-taking or price concessions. In addition, there have been numerous acquisitions and mergers of banks in Mt. Rainier Bank’s primary service area, which have made the larger institutions in the market even larger. This has resulted in Mt. Rainier Bank focusing primarily on the needs of the smaller and medium size commercial customers.

Service Area

Mt. Rainier Bank’s primary service area is South King County and East Pierce County, including Enumclaw, Buckley, Black Diamond, Auburn, Maple Valley, Sumner, and Federal Way and surrounding communities. Enumclaw’s population is 11,190, having experienced 47% growth since 1990. Enumclaw is primarily considered a residential community, with most growth in single-family residences. The local economy is dependent upon the forest products industry, farming, and tourism. Buckley has experienced less growth with a population of 4,515. Buckley is a residential community with very little business growth in the past few years. Black Diamond has a current population of 4,080, up from 1,760 in 1990. Auburn is a larger community with a population of 47,470, up from 35,230 in 1990. In the last few years the number of households grew 5.6% with

 

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forecasts showing another 3,400 homes will be built by 2008. Auburn leads south King County in job creation. Maple Valley has current population of 17,175, up from 10,500 in 1997 when it became a city. Sumner’s population has increased approximately 42% to 8,900. Federal Way has a growing population of approximately 85,800 people within the city limits. The city is home to world-class companies, as well as small businesses of all kinds, with the city boasting the second highest number of businesses in South King County.

Employees

As of December 31, 2005, Mountain Bank Holding employed a full-time President and CEO and a half-time Chief Financial Officer. As of the same date, Mt. Rainier Bank had 71 full-time-equivalent employees, including three Executive Officers. None of Mt. Rainier Bank’s employees is presently represented by a union or covered by a collective bargaining agreement. Mt. Rainier Bank considers its relationships with its employees to be good.

Competition

The banking business in Mt. Rainier Bank’s primary service area is highly competitive with respect to both loans and deposits. All the major out-of-state commercial banks that operate in Washington (including Bank of America, Key Bank, Wells Fargo and U.S. Bank) have a branch or branches within Mt. Rainier Bank’s primary service area. Among the advantages such major banks have are their ability to finance wide-ranging advertising campaigns and to allocate their investment assets to geographic regions of higher yield and demand. Such banks offer certain services which are not offered directly by Mt. Rainier Bank (but are offered indirectly through correspondent institutions); and, by virtue of their greater total capitalization (legal lending limits to an individual customer are based upon a percentage of a bank’s shareholder equity accounts) such banks have substantially higher lending limits than Mt. Rainier Bank.

Mt. Rainier Bank also competes with a number of non-bank competitors such as insurance companies, small loan companies, finance companies, mortgage companies, credit unions, brokerage houses, and other financial institutions. Many of Mountain Bank Holding’s non-bank competitors are not subject to the extensive federal and state regulations which govern Mountain Bank Holding and, as a result, have a competitive advantage over Mountain Bank Holding in providing certain services.

Mt. Rainier Bank believes its competitive position has been strengthened by the consolidation in the banking industry, which has resulted in a focus by the larger banks on their larger accounts, with less direct contact between the officers and their customers. Mt. Rainier Bank’s strategy, by contrast, is to remain a middle market lender, which maintains close, long-term contact with its customers.

Products and Services

In conjunction with the growth of its asset base, Mt. Rainier Bank has introduced new products and services to position it to better compete in its highly competitive market. Mt. Rainier Bank’s customers demand not only a wide range of financial products but also efficient and convenient service. In response to these demands, Mt. Rainier Bank has developed a mix of products and services utilizing technology available to the banking industry such as telephone banking, internet banking, bill payment services and automated teller machines. Additionally, Mt. Rainier Bank offers a wide range of commercial and retail banking products and services to its customers. Deposit accounts include certificates of deposit, individual retirement accounts and other time deposits, checking and other demand deposit accounts, interest-bearing checking accounts, savings accounts and money market accounts. Loans include residential real estate, commercial, real estate construction and development, installment and consumer loans. Other products and services include: credit related insurance, ATMs, safe deposit boxes and non-deposit investment products.

Marketing

Mt. Rainier Bank uses, to the fullest extent possible the flexibility accorded by its independent status to improve its market share. This includes an emphasis on specialized services, local promotional activity, and

 

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personal contacts by Mt. Rainier Bank’s officers, directors and employees. Mt. Rainier Bank also seeks to provide special services and programs for individuals in its primary service area who are employed in the business and professional fields. In the event there are customers whose loan demands exceed Mt. Rainier Bank’s lending limits, Mt. Rainier Bank arranges for such loans on a participation basis with other financial institutions.

Forward Looking Statement Disclosure

In addition to historical information, this report may contain certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA). This statement is included for the express purpose of availing Mountain Bank Holding of the protections of the safe harbor provisions of the PSLRA. The forward-looking statements contained in this report are subject to factors, risks, and uncertainties that may cause actual results to differ materially from those projected. Important factors that might cause such a material difference include, but are not limited to, those discussed in this report. Such items that could cause actual results to differ materially from the forward looking statements in this report are: general economic conditions, world and national events that could impact the economy and interest rates, including their impact on capital expenditures; business conditions in the banking industry; the regulatory environment; new legislation; vendor quality and efficiency; employee retention factors; rapidly changing technology and evolving banking industry standards; competitive standards; competitive factors, including increased competition with community, regional, and national financial institutions; fluctuating interest rate environments; and similar matters. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of the statement. Mountain Bank Holding undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in this and other documents we file from time to time with the Securities and Exchange Commission.

Statistical Information about Mountain Bank Holding

The following statistical information should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere herein.

 

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DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY

AND INTEREST YIELDS

The following table sets forth the average balance sheets of Mountain Bank Holding for the past three years along with an analysis of interest income and expenses for each major category of interest earning assets and interest bearing liabilities, the average rate paid in each category, and net yield on earning assets. Average non-accrual loans were $24,000 in 2005, $62,000 in 2004 and $155,000 in 2003 and are included in average total loans. Loan fees of $728,000 in 2005, $894,000 in 2004 and $922,000 in 2003 are included in interest income.

 

    Year ended Dec. 31,  
    2005     2004     2003  
    Average
Balance
   

Int Earned/

Expense

 

Annualized
Yield/

Rate

    Average
Balance
   

Int Earned/

Expense

 

Annualized
Yield/

Rate

    Average
Balance
   

Int Earned/

Expense

 

Annualized
Yield/

Rate

 
    (dollars in thousands)  

Assets

                 

Interest and dividend earning assets:

                 

Loans*

  $ 122,251     $ 9,309   7.6 %   $ 109,439     $ 8,139   7.4 %   $ 91,351     $ 7,275   8.0 %

Taxable Investments

    36,683       1,238   3.4 %     36,323       1,130   3.1 %     30,209       989   3.3 %

Non-taxable investments

    1,248       41   3.3 %     235       8   3.4 %     473       16   3.4 %

Federal funds sold

    1,841       91   4.9 %     —         —     0.0 %     —         —     0.0 %

Deposits in banks

    9,613       199   2.1 %     11,465       127   1.1 %     16,247       177   1.1 %
                                               

Total interest earning assets

    171,636       10,878   6.3 %     157,462       9,404   6.0 %     138,280       8,457   6.1 %
                             

Non-interest earning assets:

                 

Cash and due from banks

    3,428           1,842           1,370      

Premises and equipment

    6,797           5,712           5,237      

Other assets

    5,163           4,831           4,580      

Reserve for possible loan losses

    (1,476 )         (1,234 )         (949 )    
                                   

Total assets

  $ 185,548         $ 168,613         $ 148,518      
                                   

Liabilities and shareholders’ equity

                 

Interest bearing liabilities:

                 

Interest bearing demand deposits

  $ 57,753       658   1.1 %   $ 53,980       568   1.1 %   $ 48,613       547   1.1 %

Savings

    18,235       136   0.7 %     16,724       125   0.7 %     14,529       119   0.8 %

Certificates of deposit

    33,285       929   2.8 %     32,159       701   2.2 %     30,918       775   2.5 %

Certificates of deposit over $100,000

    22,492       735   3.3 %     20,848       535   2.6 %     16,460       477   2.9 %
                                               

Total interest bearing deposits

    131,765       2,458   1.9 %     123,711       1,929   1.6 %     110,520       1,918   1.7 %
                                   

Federal funds purchased

    2       —     0.0 %     —         —         —         —    

Other borrowings

    416       7   1.7 %     33       3   8.0 %     35       3   8.6 %
                                               

Total interest bearing liabilities

    132,183       2,465   1.9 %     123,744       1,932   1.6 %     110,555       1,921   1.7 %
                             

Non-interest bearing liabilities:

                 

Demand deposits

    32,480           26,200           20,890      

Other liabilities

    1,538           1,173           1,134      

Shareholders’ equity

    19,347           17,518           15,939      
                                   
  $ 185,548         $ 168,635         $ 148,518      
                                   

Net interest income

    $ 8,413       $ 7,472       $ 6,536  
                             

Net interest margin

      4.90 %       4.75 %       4.73 %

* Non-accrual loan interest is not included.

 

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RATE/VOLUME ANALYSIS

The table below sets forth certain information regarding changes in interest income and interest expense of Mountain Bank Holding for the years indicated. For each category of interest-earning assets and interest-bearing liability, information is provided on changes attributable to: (1) changes in volume (changes in volume multiplied by old rate) and (2) changes in rate (changes in rate multiplied by old average volume). The change in interest income and interest expense attributable to changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate.

 

     Year ended December 31,  
    

2005

Increase(Decrease) Due to

   

2004

Increase(Decrease) Due to

 
     Total    Volume     Yield     Total     Volume     Yield  
     (in thousands)     (in thousands)  

Interest and dividend income:

             

Loan portfolio

   $ 1,170    $ 981     $ 189     $ 864     $ 1,369     $ (505 )

Taxable Investments

     108    $ 11     $ 97       141       193       (60 )

Non-taxable investments

     33    $ 33     $ (0 )     (8 )     (8 )     —    

Federal funds sold

     91    $ 91     $ —         —         —         —    

Deposits in banks

     72    $ (23 )   $ 95       (50 )     (53 )     3  

All interest-earning assets

   $ 1,474    $ 1,093     $ 381     $ 947     $ 1,501     $ (562 )
                                               

Interest expense:

             

Interest bearing demand

     90      22       68       21       58       (37 )

Savings

     11      11       (0 )     6       17       (11 )

Certificates of deposit under $100,000

     228      24       204       (74 )     30       (104 )

Certificates of deposit over $100,000

     200      38       162       58       117       (59 )

Total deposit accounts

   $ 529    $ 94     $ 435     $ 11     $ 222     $ (211 )
                                               

Other borrowings

     4      8       (4 )     —         —         —    

Total interest bearing liabilities

   $ 533    $ 102     $ 431     $ 11     $ 222     $ (211 )
                                               

Change in net interest income

   $ 941    $ 991     $ (51 )   $ 936     $ 1,279     $ (351 )

Investment Portfolio

The investment policy of Mt. Rainier Bank is an integral part of the overall asset/liability management of Mt. Rainier Bank. Mt. Rainier Bank’s investment policy is to establish a portfolio, which will provide liquidity necessary to facilitate making loans and to cover deposit fluctuations while at the same time achieving a satisfactory investment return on the funds invested. The investment policy is reviewed annually by Mt. Rainier Bank’s Board of Directors. Mt. Rainier Bank stresses the following attributes for its investments: capital protection, liquidity, yield, risk management and pledge ability. Under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, Mt. Rainier Bank is required to classify its portfolio into three categories: Held to Maturity, Trading Securities, and Available for Sale.

Held to Maturity securities include debt securities that Mt. Rainier Bank has positive intent and ability to hold to maturity; these securities are reported at amortized cost. As of December 31, 2005, Mt. Rainier Bank held no securities as Held to Maturity.

Trading Securities include debt and equity securities that are purchased and held solely for the purpose of selling them in the short-term future for trading profits. Trading Securities are reported at fair market value with unrealized gains and losses included in earnings. As of December 31, 2005, Mt. Rainier Bank held no securities as Trading Securities.

 

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Available for Sale securities include those that may be sold to implement Mt. Rainier Bank’s asset/liability management strategies, including responses to changes in interest rates, prepayment rates and similar factors. These securities are reported at fair market value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity. All of Mt. Rainier Bank’s investment securities at December 31, 2005 were classified as Available for Sale.

As a national bank and member of the Federal Reserve System, Mt. Rainier Bank is required to have $310,000 invested in Federal Reserve Bank Stock. As a requirement of being a member of the Federal Home Loan Bank of Seattle, Mt. Rainier Bank is required to keep $425,000 in stock. This portion of Mt. Rainier Bank’s investment portfolio is not liquid.

The following table sets forth the composition of the Mountain Bank Holding’s investment portfolio as of December 31 for the years indicated.

 

     2005    2004    2003
     Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
     (in thousands)

US Treasury securities

   $ 4,005    $ 3,976    $ 3,094    $ 3,087    $ 3,654    $ 3,624

US Government and agency securities

     25,809      25,480      16,835      16,742      11,501      11,628

Mortgage Backed Securities

     14,533      14,237      15,106      15,029      11,793      11,813

Municipal bonds

     2,647      2,635      295      297      217      221

Corporate Bonds

     186      185      2,268      2,287      4,838      4,944

Equity securities

     60      60      60      60      60      60
                                         

Total

   $ 47,240    $ 46,573    $ 37,658    $ 37,502    $ 32,063    $ 32,290
                                         

The investment portfolio at December 31, 2005, excluding equity securities was categorized by maturity as follows:

 

    (in thousands)  
    December 31, 2005  
    One Year or Less     One to Five Years     Five to Ten Years     Over Ten Years  
    Carrying
Value
  Annualized
Weighted
Average
Yield
    Carrying
Value
  Annualized
Weighted
Average
Yield
    Carrying
Value
  Annualized
Weighted
Average
Yield
    Carrying
Value
  Annualized
Weighted
Average
Yield
 
    (Dollars in Thousands)  

Investment securities:

 

U.S. Treasury Securities

  $ 991   2.00 %   $ 2,985   4.48 %   $ —       $ —    

US Government and agency securities

    6,409   2.88 %     19,071   3.67 %     —         —    

Mortgage-backed securities

    156   5.92 %     12,849   4.55 %     1,232   3.63 %     —    

Municipal bonds*

    —         742   3.88 %     1,770   3.50 %     123   2.85 %

Corporate Bonds

    185   6.88 %     —     0.00 %        
  $ 7,741   2.92 %   $ 35,647   4.05 %   $ 3,002   4.12 %   $ 123   2.85 %

* tax equivalent yield

Mortgage-Backed Securities. Mountain Bank Holding’s mortgage-backed securities portfolio consists of securities issued under government-sponsored agency programs, including those of Fannie Mae and Freddie Mac. These certificates are modified pass-through mortgage-backed securities that represent undivided interests in underlying pools of fixed-rate, predominately single-family and, to a lesser extent, multi-family residential

 

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mortgages issued by these government-sponsored entities. Fannie Mae and Freddie Mac generally provide the certificate holder a guarantee of timely payments of interest, whether or not collected.

Mortgage-backed securities generally increase the quality of Mountain Bank Holding’s assets by virtue of the insurance or guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of Mountain Bank Holding. At December 31, 2005, there were no mortgage-backed securities pledged to secure obligations of Mountain Bank Holding.

While mortgage-backed securities carry a reduced credit risk as compared to whole loans, such securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of such mortgage loans and so affect both the prepayment speed, and value, of such securities. The prepayment risk associated with mortgage-backed securities is monitored periodically, and prepayment rate assumptions adjusted as appropriate to update Mountain Bank Holding’s mortgage-backed securities accounting and asset/liability reports. Classification of Mountain Bank Holding’s mortgage-backed securities portfolio as available for sale is designed to minimize that risk.

Lending Activities

The two main areas in which Mt. Rainier Bank has directed its lendable funds are real estate and commercial loans. At December 31, 2005, these categories accounted for approximately 77% and 20%, respectively, of Mt. Rainier Bank’s total loan portfolio. Mt. Rainier Bank’s major source of income is interest and fees charged on loans. Accordingly Mt. Rainier Bank has a significant concentration in real estate loans and is subject to any potential downturn in the real estate market.

In general, Mt. Rainier Bank is permitted by law to make loans to single borrowers in aggregate amounts of up to fifteen percent (15%) of Mt. Rainier Bank’s unimpaired capital and unimpaired surplus. Mt. Rainier Bank, on occasion, sells participations in loans when necessary to stay within lending limits or to otherwise limit Mt. Rainier Bank’s exposure. Mt. Rainier Bank’s goal is to reduce the risk of undue concentrations of loans to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2005, no such concentration exceeded 10% of Mt. Rainier Bank’s loan portfolio. Mt. Rainier Bank has no loans to customers in foreign countries. Its policy generally is to lend within Washington State, however Mt. Rainier Bank does have some loans to out-of-state borrowers.

In the normal course of business there are various commitments outstanding and commitments to extend credit, which are not reflected in the financial statements. These commitments generally require the customers to maintain certain credit standards and have fixed expiration dates or other termination clauses. Mt. Rainier Bank uses the same credit policies in making commitments as it does for loans. Management does not expect that all such commitments will be fully utilized.

Lending activities are conducted pursuant to a written Loan Policy, which has been adopted by the Board of Directors of Mt. Rainier Bank. Each loan officer has a defined lending authority. Regardless of lending authority, aggregate loans over $1,000,000 are approved by Mt. Rainier Bank’s Loan Committee, made up of the President and Credit Administrator of Mt. Rainier Bank and three directors and aggregate loans over $350,000 are reviewed by that committee.

The bank’s secondary mortgage activity consists of originating residential loans wherein the closing of each loan is preceded by its negotiated sale. Primarily, these loans are funded by the bank and promptly sold. The bank also makes residential construction loans wherein a “take-out” is negotiated on the secondary market. Bank guidelines for loan-to-value ratios are closely adhered to.

 

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The following table sets forth the composition of the Company’s gross loan portfolio, including loans held for sale, by loan type, as of December 31 for the years indicated.

 

    2005     2004     2003     2002     2001  
    Amounts     Percent     Amounts   Percent     Amounts   Percent     Amounts   Percent     Amounts   Percent  
    (In thousands)  

Commercial and Agricultural

  $ 24,025     19.32 %   $ 26,918   22.26 %   $ 21,526   21.80 %   $ 20,510   24.93 %   $ 18,483   26.83 %

Real Estate:

                   

Residential 1-4 family

    12,024     9.67 %     9,833   8.13 %     12,243   12.40 %     13,516   16.43 %     13,790   20.02 %

Commercial

    71,264     57.31 %     67,077   55.47 %     48,266   48.88 %     36,875   44.83 %     25,793   37.44 %

Construction and land development

    12,671     10.18 %     11,696   9.67 %     10,833   10.97 %     5,602   6.81 %     5,506   7.99 %

Consumer

    4,375     3.52 %     5,408   4.47 %     5,876   5.95 %     5,758   7.00 %     5,315   7.72 %

Total gross loans

  $ 124,359     100.00 %   $ 120,932   100.00 %   $ 98,744   100.00 %   $ 82,261   100.00 %   $ 68,887   100.00 %

Net deferred loan fees

  $ (134 )     $ —       $ —       $ —       $ —    
                                         

Total net loans

  $ 124,225       $ 120,932     $ 98,744     $ 82,261     $ 68,887  
                                         

The following table summarizes the scheduled contractual gross loan maturities for the Company’s total loan portfolio due for the periods indicated as of December 31, 2005. Adjustable rate loans are shown in the period in which loan principal payments are contractually due.

 

    Total   Less than one year   One to five years   Over 5 years
      Fixed   Variable   Fixed   Variable   Fixed   Variable
    (in thousands)

Commercial and Agricultural

  $ 24,025   $ 1,346   $ 8,026   $ 12,796   $ —     $ 1,857   $ —  

Real Estate:

             

Residential 1-4 family

    12,024     159     2,703     2,176     385     6,601     —  

Commercial

    71,264     1,040     12,444     13,988     36,617     7,175     —  

Construction and land development

    12,671     2,716     7,879     64     1,422     590     —  

Consumer

    4,375     494     285     3,075     —       521     —  
                                         

Total loans

  $ 124,359   $ 5,755   $ 31,337   $ 32,099   $ 38,424   $ 16,744   $ —  
                                         

One- to Four-Family Residential Mortgage Lending. One- to four-family residential mortgage loan originations are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals from real estate agents and builders. At December 31, 2005, the Company’s one- to four-family residential mortgage loan portfolio totaled $12 million, or 9.67% of the Company’s total gross loan portfolio.

The Company originates one- to four-family residential mortgage loans with terms up to a maximum of 5-years, with the exception of the home equity program, which has a maximum maturity of 15-years, and with loan-to-value ratios up to 80% of the appraised value of the secured property. Residential loans generally do not include prepayment penalties.

In underwriting one- to four-family residential real estate loans, the Company evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan. Independent fee appraisers approved by the Board of Directors appraise most properties securing real estate loans made by the Company. The Company generally requires borrowers to obtain title insurance, and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan.

Commercial and Multi-Family Real Estate Lending. The Company engages in commercial and multi-family real estate lending in its primary market area and surrounding areas. At December 31, 2005, the Company’s commercial and multi-family real estate loan portfolio totaled $71.3 million, or 57.3% of the Company’s total gross loan portfolio. The loans are generally secured by properties located in the Company’s primary market area and surrounding areas.

 

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Primarily apartment buildings, warehouse buildings, assisted living/retirement facilities; and office buildings secure the Company’s commercial and multi-family real estate loan portfolio. Commercial and multi-family real estate loans generally have terms that do not exceed 25 years, with 5 year call dates, have loan-to-value ratios of up to 80% of the appraised value of the secured property, and are typically secured by personal guarantees of the borrowers. The Company has a variety of rate adjustment features and other terms in its commercial and multi-family real estate loan portfolio. Commercial and multi-family real estate loans provide for a margin over a number of different indices. In underwriting these loans, the Company currently analyzes the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. Independent appraisers perform appraisals on properties securing commercial real estate loans originated by the Company.

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Construction, Land, and Land Development Lending. The Company makes construction, land and land development loans to individuals for the construction of their residences as well as to builders for the construction of one- to four-family residences and commercial and multi-family real estate. At December 31, 2005, the Company’s construction, land and land development loan portfolio totaled $12.7 million, or 10.2% of the Company’s total gross loan portfolio. Of the $12.7 million, approximately $3.3 million consists of land loans that may or may not be in development stages.

Construction loans to individuals for one to four family residences are structured to be converted to permanent loans at the end of the construction phase, which typically runs up to twelve months. These construction loans have rates and terms, which generally match the one- to four-family loan rates then offered by the Company, except that during the construction phase the borrower pays interest only. Generally, the maximum loan-to-value ratio of owner occupied single-family construction loans is 80% of the appraised value. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.

Generally, construction loans to builders of one- to four-family residences require the payment of interest only for up to 12 months and have terms of up to 12 months. These loans may provide for the payment of interest and loan fees from loan proceeds and carry adjustable rates of interest. Loan fees charged in connection with the origination of such loans are generally 1%.

Construction loans on commercial and multi-family real estate projects may be secured by apartments, agricultural facilities, small office buildings, medical facilities, assisted living facilities, or other property, and are generally structured to be converted to permanent loans at the end of the construction phase, which generally runs up to 18 months. During the construction phase the borrower pays interest only. These loans generally provide for the payment of interest and loan fees from loan proceeds. All of these loans were performing in accordance with their terms at December 31, 2005.

Construction loans are obtained principally through continued business from builders who have previously borrowed from the Company and from existing customers who are building new facilities. The application process includes a submission to the Company of accurate plans, specifications, costs of the project to be constructed and projected revenues from the project. These items are also used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of the appraised value of the property or the cost of construction (land plus building).

 

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Construction loans to borrowers other than owner-occupants involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans. Also, the funding of loan fees and interest during the construction phase makes the monitoring of the progress of the project particularly important, as customary early warning signals of project difficulties may not be present.

Commercial and Agricultural Lending. The Company also originates commercial business loans and agricultural loans. Most of the Company’s commercial business loans have been extended to finance local and regional businesses and include short-term loans to finance machinery and equipment purchases, inventory and accounts receivable. Commercial loans also involve the extension of revolving credit for a combination of equipment acquisitions and working capital in expanding companies. The Company also originates loans to finance the purchase of farmland, livestock, farm machinery and equipment, other farm related products and farm production loans. At December 31, 2005, $24 million, or 19.3% of the Company’s total gross loan portfolio was comprised of commercial business and agricultural loans.

The maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Generally, the maximum term on non-mortgage lines of credit is one year. The loan-to-value ratio on such loans and lines of credit generally may not exceed 80% of the value of the collateral securing the loan. The Company’s commercial business lending policy includes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of the Company’s current credit analysis. Nonetheless, such loans are believed to carry higher credit risk than more traditional investments.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is likely to be dependent upon the general economic environment). Business assets and personal guarantees usually, but not always, secure the Company’s commercial business loans. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At December 31, 2005, none of the Company’s commercial business loan portfolio was non-performing.

Consumer Lending. The Company offers a variety of secured consumer loans, including home equity, home improvement, automobile, boat and loans secured by savings deposits. In addition, the Company offers other secured and unsecured consumer loans. The Company currently originates substantially all of its consumer loans in its primary market area and surrounding areas. At December 31, 2005, the Company’s consumer loan portfolio totaled $4.4 million, or 3.5% of its total gross loan portfolio.

The largest component of the Company’s consumer loan portfolio consists of home equity loans and lines of credit. The Company offers fixed-rate equity loans and adjustable rate home equity lines of credit. Substantially all of the Company’s home equity loans and lines of credit are secured by second mortgages on principal residences. The Company will lend amounts, which, together with all prior liens, may be up to 80% of the appraised value of the property securing the loan. Home equity loans and lines of credit generally have maximum terms of fifteen years.

The Company primarily originates automobile loans on a direct basis. Direct loans are loans made when the Company extends credit directly to the borrower, as opposed to indirect loans, which are made when the Company purchases loan contracts, often at a discount, from automobile dealers, which have extended credit to their customers. The Company’s automobile loans typically are originated at fixed interest rates with terms up to 60 months for new and used vehicles. Loans secured by automobiles are generally originated for up to 80% of the N.A.D.A. book value of the automobile securing the loan.

 

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Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards employed by the Company for consumer loans include an application, a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans, which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount, which can be recovered on such loans.

RISK ELEMENTS—NON-ACCRUAL, PAST DUE AND RESTRUCTURED LOANS

The following table sets forth information regarding non-performing loans of Mt. Rainier Bank on the dates indicated. Accrual of interest is discontinued when there is reasonable doubt as to the full, timely collection of interest or principal. When a loan becomes contractually past due 90 days with respect to interest or principal, it is reviewed and a determination is made as to whether it should be placed on non-accrual status. When a loan is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to principal and interest and when, in the judgment of management, the loans are estimated to be fully collectible as to principal and interest. At December 31, 2005, the Mt. Rainier Bank had $20,000 in loans on non-accrual status.

At December 31, 2005, the company had $580,000 of loans that were internally classified as substandard for one or more reasons. Two of these loans were past due over 30 days at December 31, 2005, totaling $20,000. If these loans were deemed non-performing, the Company’s ratio of non-performing assets and restructured loans as a percent of total assets would have been .31% at December 31, 2005.

 

       2005         2004         2003         2002         2001    
     (Dollars in thousands)  

Restructured loans

   $ —       $ —       $ —       $ —       $ —    

Nonaccrual loans:

          

Commercial

   $ —       $ —       $ 88     $ 88     $ —    

Consumer

   $ 20     $ —       $ 16     $ —       $ —    

Total nonaccrual loans

   $ 20     $ —       $ 104     $ 88     $ —    

Total foreclosed real estate loans(1)

   $ —       $ —       $ 140     $ 151     $ —    

Accruing loans 90 days or more past due

   $ —       $ 8     $ —       $ —       $ —    

Total nonperforming assets and restructured loans

   $ 20     $ 8     $ 244     $ 239     $ —    

Total nonperforming assets and restructured loans as a percent of total assets

     0.01 %     0.00 %     0.16 %     0.17 %     0.00 %

 

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The following table sets forth the Company’s loan delinquencies by type, before the allowance for credit losses, by amount and by percentage of type at December 31, 2005.

 

     Loans Delinquent For:  
     30-59 days     60-89 days    90 days and over  
    

Amount

  

Percent of

Category

   

Amount

  

Percent

  

Amount

  

Percent

 
                
     (Dollars in thousands)  

Commercial and agriculture

   $ 12    0.05 %   $ —         $ —     

Real Estate:

                

Residential 1-4 family

   $ —        $ —         $ —     

Commercial

   $ —        $ —         $ —     

Construction and land development

   $ —        $ —         $ —     

Consumer

   $ —        $ —         $ 20    0.46 %

Interest income on loans is recognized based on principal amounts outstanding, at applicable interest rates. Accrual of interest on impaired loans is discontinued when reasonable doubt exists as to the full, and timely collection of interest or principal or when payment of principal or interest is contractually past due 90 days, unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and when the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought current with respect to principal and interest and when, in the opinion of management, the loans are estimated to be fully collectible as to both principal and interest.

CREDIT RISK MANAGEMENT AND ALLOWANCE FOR CREDIT LOSSES

Credit risk and exposure to loss are inherent parts of the banking business. Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of Mt. Rainier Bank’s operations. The loan review procedures are designed to monitor adherence to established criteria and to ensure that on a continuing basis such standards are enforced and maintained.

Management’s objective in establishing lending and investment standards is to manage the risk of loss and provide for income generation through pricing policies. To effectuate this policy, we have established specific terms and maturity schedules for each loan type, such as commercial, real estate, consumer, etc.

Applicable regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, regulatory examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectable and of such little value that continuance as an asset of the institution is not warranted. When an insured institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. These allowances represent loss allowances, which have been established to recognize the inherent risk associated with lending activities and the risks associated with particular problem assets. When Mountain Bank Holding classifies problem assets as loss, it charges off the balance of the asset against the allowance for credit losses. Assets, which do not currently expose the bank to sufficient risk to warrant classification in one of the aforementioned categories but possess

 

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weaknesses, are required to be designated as special mention. Mountain Bank Holding’s determination as to the classification of its assets is subject to review by the OCC during periodic examinations.

The loan portfolio is regularly reviewed and management determines the amount of loans to be charged off. In addition, such factors as Mt. Rainier Bank’s previous loan loss experience, prevailing economic conditions, industry concentrations and the overall quality of the loan portfolio are considered. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in economic conditions. In addition, the OCC, as part of its examination process, periodically reviews the allowances for credit losses and foreclosed real estate. The OCC may require Mt. Rainier Bank to recognize additions to the allowance based on its judgments about information available at the time of examination. In addition, any loan or portion of a loan that is classified as a ‘loss’ by regulatory examiners is charged-off.

The allowance for credit losses is maintained at a level management considers adequate to provide for probable losses based on evaluating known and inherent risks in the loan portfolio. The allowance is reduced by loans charged off and increased by provisions charged to earnings and recoveries on loans previously charged off. The allowance is based on management’s periodic evaluation of factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

When information confirms that specific loans or portions of loans are uncollectible, these amounts are charged off against the allowance for credit losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent to bring the loan current; Mt. Rainier Bank has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; the estimated fair value of the collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement.

Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value. If fair value at the date of foreclosure is lower than the balance of the related loan, the difference will be charged-off to the allowance for loan losses at the time of transfer. Management periodically updates valuations and if the value declines, a specific provision for losses on such property is established by a charge to operations. Mt. Rainier Bank had no foreclosed real estate at December 31, 2005.

 

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The allowance for credit losses is estimated by management based on historical loss experience and known changes within the loan portfolio at the measurement date. The provision that is charged to income is the amount needed to maintain an adequate allowance for credit losses. The allowance for credit losses at December 31, 2005 was $1,569,000 or 1.28% of loans outstanding. The allowance for credit losses at year-end 2004 was $1,376,000 or 1.14% of loans outstanding. The following table presents data related to Mt. Rainier Bank’s allowance for credit losses as of December 31 for the years indicated.

 

     2005     2004     2003     2002     2001  
     (Dollars in thousands)  

Allowance for loan losses

          

(beginning of period)

   $ 1,376     $ 1,101     $ 852     $ 753     $ 700  

Loans charged off:

          

Commercial and agricultural

     —         9       101       10       13  

Real estate construction

     —         —         —         —         —    

Real estate mortgage

     —         —         —         221       —    

Consumer

     6       10       41       47       25  
                                        

Total

     6       19       142       278       38  
                                        

Recoveries of loans previously charged off:

          

Commercial and agricultural

     0       16       3       10       0  

Real estate construction

     0       0       0       0       0  

Real estate mortgage

     0       0       0       0       0  

Consumer

     0       2       3       7       6  
                                        

Total

     0       18       6       17       6  
                                        

Net loans charged off

     6       1       136       261       32  

Provision for possible loan losses

     199       276       385       360       85  

Allowance for possible loan losses

     —         —         —         —         —    
                                        

(end of period)

   $ 1,569     $ 1,376     $ 1,101     $ 852     $ 753  
                                        

Loans outstanding:

          

Average

   $ 122,251     $ 109,439     $ 91,351     $ 74,940     $ 67,875  

End of period

     122,435       120,403       98,744       82,261       68,887  

Ratio of allowance for loan loss to total loans outstanding

          

Average

     1.28 %     1.26 %     1.21 %     1.14 %     1.11 %

End of period

     1.28 %     1.14 %     1.12 %     1.04 %     1.09 %

Ratio of net charge-offs to average loans outstanding

     0.00 %     0.00 %     0.15 %     0.35 %     0.05 %

Allocation of Loan Loss By Loan Classification

 

    12/31/2005     12/31/2004     12/31/2003     12/31/2002     12/31/2001  
    Amount   Percent of
loans in
each
category to
total loans
    Amount   Percent of
loans in
each
category to
total loans
    Amount   Percent of
loans in
each
category to
total loans
    Amount   Percent of
loans in
each
category to
total loans
    Amount   Percent of
loans in
each
category to
total loans
 

Commercial and agricultural

  $ 367   19.32 %   $ 370   22.26 %   $ 294   21.80 %   $ 246   24.93 %   $ 231   26.83 %

Real estate construction

    94   10.18 %     80   9.67 %     74   10.97 %     30   6.81 %     33   7.99 %

Real estate mortgage

    1,003   66.98 %     816   63.60 %     622   61.28 %     459   61.26 %     348   57.46 %

Consumer

    105   3.52 %     110   4.47 %     111   5.95 %     117   7.00 %     139   7.72 %

Unallocated

    —     0.00 %     —     0.00 %     —     0.00 %     0   0.00 %     1   0.00 %
                                                           

Total loans

  $ 1,569   100.00 %   $ 1,376   100.00 %   $ 1,101   100.00 %   $ 852   100.00 %   $ 753   100.00 %
                                                           

 

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The foregoing conditions and adjustments reflect management’s best estimate of items recognized when adjusting the loss percentage for each pool of loans, and adjustments to historical experience. These factors affect our assessment of low and high estimates of losses in our portfolio. The determination of the amounts of the provisions for credit losses is based on management’s current judgment and the quality of the loan portfolio, and considers all known, relevant internal and external factors that affect loan collectibility. These include regional economic indicators such as employment; retail sales; real estate trends and specific areas of concentration for our market including the forest and dairy/agricultural industries.

During 2005, the loan loss allocations by category were adjusted to reflect the overall changes as they affect percentages in each pool of loans categorized by the bank’s Loan Loss Reserve Analysis. By this method, the allowance for consumer loans, as a percentage of overall loans decreased from 8.00% to 6.69% and the allowance for commercial and agriculture loans decreased from 26.89% to 23.39% as of December 31, 2005. During this same period, the allowance for real estate secured loans increased from 65.12% to 69.92% of the bank portfolio. The fundamental process for calculating the bank’s loan loss allocation requirements remained unchanged during this accounting period.

Mountain Bank Holding utilizes an internal asset classification system as a means of reporting problem and potential problem assets. At each scheduled Bank Board of Directors meeting, a watch list is presented, showing significant loan relationships listed as Special Mention, Substandard, and Doubtful. Set forth below is a discussion of each of these classifications.

Special Mention: A special mention extension of credit is defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the credit or the institution’s credit position. Special mention credits are not considered as part of the classified extensions of credit category and do not expose an institution to sufficient risk to warrant classification. They are currently protected but are potentially weak. They constitute an undue and unwarranted credit risk.

Loans in this category have some identifiable problem, most notably slowness in payments, but, in management’s opinion, offer no immediate risk of loss. An extension of credit that is not delinquent also may be identified as special mention. These loans are classified due to Mt. Rainer Bank’s management’s actions or the servicing of the loan. The lending officer may be unable to properly supervise the credit because of an inadequate loan or credit agreement. There may be questions regarding the condition of and/or control over collateral. Economic or market conditions may unfavorably affect the obligor in the future. A declining trend in the obligor’s operations or an imbalanced position in the balance sheet may exist, although it is not to the point that repayment is jeopardized. Another example of a special mention credit is one that has other deviations from prudent lending practices.

If Mt. Rainier Bank may have to consider relying on a secondary or alternative source of repayment, then collection may not yet be in jeopardy, but the loan may be considered special mention. Other trends that indicate that the loan may deteriorate further include such “red flags” as continuous overdrafts, negative trends on a financial statement, such as a deficit net worth, a delay in the receipt of financial statements, accounts receivable aging, etc. These loans on a regular basis can be 30 days or more past due. Judgments, tax liens, delinquent real estate taxes, cancellation of insurance policies and exceptions to bank policies are other “red flags”.

Substandard: A substandard extension of credit is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Extensions of credit so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that Mt. Rainier Bank will sustain some loss if the deficiencies are not corrected. In other words, there is more than normal risk of loss. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist in individual extensions of credit classified substandard.

The likelihood that a substandard loan will be paid from the primary source of repayment is uncertain. Financial deterioration is underway and very close attention is warranted to insure that the loan is collected

 

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without a loss. Mt. Rainier Bank may be relying on a secondary source of repayment, such as liquidating collateral, or collecting on guarantees. The borrower cannot keep up with either the interest or principal payments. If Mt. Rainier Bank is forced into a subordinated or unsecured position due to flaws in documentation, the loan may be substandard. If the loan must be restructured, or interest rate concessions made, it should be classified as such. If Mt. Rainier Bank is contemplating foreclosure or legal action, the credit is likely substandard.

Doubtful: An extension of credit classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage of and strengthen the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceedings, capital injection, perfecting liens on additional collateral, or refinancing plans.

If the primary source of repayment is gone, and there is doubt as to the quality of the secondary source, then the loan will be considered doubtful. If a court suit is pending, and is the only means of collection, a loan is generally doubtful. As stated above, the loss amount in this category is often undeterminable, and the loan is classified doubtful until said loss can be determined.

Potential problem loans are loans included on the watch list presented to the Board of Directors but where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms. At December 31, 2005, 2004, 2003, 2002 and 2001, special mention, substandard, and doubtful classifications were as follows:

 

     2005    2004    2003    2002    2001
     (in thousands)

Special mention

   $ 1,162    $ 2,000    $ 978    $ 763    $ 269

Substandard

     580      923      759      532      1,699

Doubtful

     —        —        —        —        —  
                                  

Total Classified

   $ 1,742    $ 2,923    $ 1,737    $ 1,295    $ 1,968
                                  

Total classifications include those loans that have been adversely classified by bank regulators and the Company’s internal loan review department. These amounts include non-accrual and impaired loans. Mountain Bank Holding continues to monitor its loan portfolio for adverse changes in specific types of loans and overall.

Mountain Bank Holding’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Mt. Rainier Bank’s primary regulators in the course of its regulatory examinations, which can order the establishment of additional general or specific loss allowances. There can be no assurance that regulators, in reviewing Mt. Rainier Bank’s loan portfolio, will not request the bank to materially increase its allowance for loan losses. Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary.

DEPOSITS

Mt. Rainier Bank’s primary sources of funds are deposits, borrowings, amortization and repayment of loan principal, interest earned on or maturation of investment securities and short-term investments, and funds provided from operations.

 

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The following tables set forth the average amounts of and average rates paid on Mt. Rainier Bank’s deposit accounts for December 31 of the years indicated, as well as the actual amounts and percentage of total deposits as of December 31 of the years indicated.

 

     2005     2004     2003  
    

Average

Amount

  

Average

Rate Paid

   

Average

Amount

  

Average

Rate Paid

   

Average

Amount

  

Average

Rate Paid

 
               
     (Dollars in thousands)  

Non-interest bearing demand deposits

   $ 32,480    0 %   $ 26,200    0 %   $ 20,890    0 %

Interest-bearing demand deposits

     57,753    1.1 %     53,980    1.1 %     48,613    1.1 %

Savings deposits

     18,235    0.7 %     16,724    0.7 %     14,529    0.8 %

Time deposits under $100,000

     33,285    2.8 %     32,159    2.2 %     30,918    2.5 %

Time deposits over $100,000

     22,492    3.3 %     20,848    2.6 %     16,460    2.9 %
                                       

Total

   $ 164,245    1.9 %   $ 149,911    1.6 %   $ 131,410    1.7 %
                                       
     2005     2004     2003  
    

Actual

Amounts

  

Percentage

Total Deposits

   

Actual

Amounts

  

Percentage

Total Deposits

   

Actual

Amounts

  

Percentage

Total Deposits

 
               
     (Dollars in thousands)  

Non-interest bearing demand deposits

   $ 33,298    19.38 %   $ 28,984    18.39 %   $ 23,756    17.12 %

Interest-bearing demand deposits

     57,866    33.68 %     58,059    36.84 %     51,041    36.78 %

Savings deposits

     19,654    11.44 %     16,241    10.31 %     15,679    11.30 %

Time deposits under $100,000

     35,244    20.51 %     30,830    19.56 %     31,258    22.52 %

Time deposits over $100,000

     25,751    14.99 %     23,486    14.90 %     17,041    12.28 %
                                       

Total

   $ 171,813    100.00 %   $ 157,600    100.00 %   $ 138,775    100.00 %
                                       

At December 31, the scheduled maturities of certificates of deposits were:

 

    

$100,000 or

more

   Less than
$100,000

Three months or less

   $ 3,730    $ 6,096

Three months through six months

     2,471      6,155

Six months though twelve months

     8,793      12,933

Over twelve months

     10,757      10,060
             

Total

   $ 25,751    $ 35,244
             

Deposits. The Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company’s deposits consist of regular savings accounts, money market savings accounts, NOW and regular checking accounts, and certificate accounts currently ranging in terms from seven days to 60 months. The Company only solicits deposits from its primary market area and does not currently use brokers to obtain deposits. The Company relies primarily on competitive pricing policies, advertising and high-quality customer service to attract and retain these deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition.

The variety of deposit accounts offered by the Company has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Company endeavors to manage the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience,

 

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the Company believes that its regular savings, money market savings accounts, NOW and regular checking accounts are relatively stable sources of deposits. However, the ability of the Company to attract and maintain certificates of deposit and the rates paid on these deposits has been and will continue to be significantly affected by market conditions.

Borrowings. Although deposits are the Company’s primary source of funds, the Company’s policy has been to utilize borrowings when they are a less costly source of funds, can be invested at a positive interest rate spread, or when the Company desires additional capacity to fund loan demand.

RETURN ON EQUITY AND ASSETS

The following table sets forth certain ratios related to the Company for the periods indicated.

 

     Year ended December 31  
           2005                 2004           2003  
                 (As Restated)  

Return on assets (1)

   1.12 %   0.84 %   0.82 %

Return on equity (2)

   10.79 %   8.09 %   7.67 %

Dividend payout ratio (3)

   16.48 %   14.49 %   0.00 %

Average equity to average assets

   10.43 %   10.63 %   10.89 %

(1) Net income divided by average total assets
(2) Net income divided by average equity
(3) Dividends declared per share divided by net income per share

The following table represents short term borrowings for the years ended,

 

     2005     2004     2003  
     Amount
Outstanding
   Maximum
Amounts
    Amount
Outstanding
   Maximum
Amounts
    Amount
Outstanding
   Maximum
Amounts
 
     (Dollars in thousands)  

Repurchase agreements

   $ 470    $ 1,086     $ —      $ —       $ —      $ —    
     2005     2004     2003  
     Average
Outstanding
   Weighted
Rate
    Average
Outstanding
   Weighted
Rate
    Average
Outstanding
   Weighted
Rate
 
     (Dollars in thousands)  

Repurchase agreements

   $ 386      1.05 %   $ —        0 %   $ —        0 %

SUPERVISION AND REGULATION

The following discussion is only intended to provide brief summaries of significant statutes and regulations that affect the banking industry and therefore is not complete. Changes in applicable laws or regulations and in the policies of regulators may have a material effect on our business and prospects. We cannot accurately predict the nature or extent of the effects on our business and earnings that fiscal or monetary policies, or new federal or state laws, may have in the future.

Mountain Bank Holding

General

As a bank holding company, we are subject to the Bank Holding Company Act of 1956, which places us under the supervision of the Board of Governors of the Federal Reserve. We must file annual reports with the Federal Reserve and must provide it with such additional information as it may require. In addition, the Federal Reserve periodically examines us and Mt. Rainier Bank.

 

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Bank Holding Company Regulation

In general, the Bank Holding Company Act limits bank holding company business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the Federal Reserve Board’s approval before they:

 

    acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5% of the voting shares of such bank;

 

    merge or consolidate with another bank holding company; or

 

    acquire substantially all of the assets of any additional banks.

Subject to certain state laws, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state and out-of-state banks. Under the Gramm-Leach-Bliley Act, a bank holding company meeting certain qualifications may apply to the Federal Reserve Board to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain activities deemed financial in nature, such as securities brokerage and insurance underwriting.

Control of Nonbanks. With certain exceptions, the Bank Holding Company Act prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve Board determines such activities are incidental or closely related to the business of banking.

Control Transactions. The Change in Bank Control Act of 1978 requires a person (or group of persons acting in concert) acquiring “control” of a bank holding company to provide the Federal Reserve Board with 60 days’ prior written notice of the proposed acquisition. Following receipt of this notice, the Federal Reserve Board has 60 days (or up to 90 days if extended) within which to issue a notice disapproving the proposed acquisition. In addition, any “company” must obtain the Federal Reserve Board’s approval before acquiring 25% (5% if the “company” is a bank holding company) or more of the outstanding shares or otherwise obtaining control over Mountain Bank Holding.

Transactions with Affiliates

Mountain Bank Holding and Mt. Rainier Bank are deemed affiliates within the meaning of the Federal Reserve Act, and transactions between affiliates are subject to certain restrictions. Generally, the Federal Reserve Act limits the extent to which a financial institution or its subsidiaries may engage in “covered transactions” with an affiliate. It also requires all transactions with an affiliate, whether or not “covered transactions,” to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.

Tie-In Arrangements

Mountain Bank Holding and Mt. Rainier Bank cannot engage in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither we nor Mt. Rainier Bank may condition an extension of credit on either a requirement that the customer obtain additional services provided by either of us, or an agreement by the customer to refrain from obtaining other services from a competitor.

The Federal Reserve Board has adopted exceptions to its anti-tying rules that allow banks greater flexibility to package products with their affiliates. These exceptions were designed to enhance competition in banking and non-banking products and to allow banks and their affiliates to provide more efficient, lower cost service to their customers.

 

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State Law Restrictions

As a Washington business corporation, we may be subject to certain limitations and restrictions under applicable Washington corporate law. In addition, although Mt. Rainier Bank is a national bank and therefore primarily regulated by the Office of the Comptroller of the Currency, Washington law may affect certain activities of Mt. Rainier Bank.

Mt. Rainier National Bank

General

Mt. Rainier Bank, as a national banking association, is subject to regulation and examination by the OCC. The federal laws that apply to Mt. Rainier Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for loans. The laws and regulations governing Mt. Rainier Bank generally have been promulgated to protect depositors, not stockholders.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their jurisdiction, the Office of the Comptroller of the Currency evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility.

Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders, or any related interests of such persons. Extensions of credit must be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not covered above. Also, such extensions of credit must not involve more than the normal risk of repayment or present other unfavorable features.

Federal Deposit Insurance Corporation Improvement Act. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 each federal banking agency has prescribed, by regulation, noncapital safety and soundness standards for institutions under its authority. These standards cover internal controls, information systems, and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. We believe that Mt. Rainier Bank meets all such standards and do not believe that these regulatory standards materially affect our business operations.

Interstate Banking and Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit such purchases. Additionally, banks are permitted to merge with banks in other states as long as the home state of neither merging bank has “opted out.” The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

The Federal Deposit Insurance Corporation prohibits banks from using their interstate branches primarily for deposit production. The Federal Deposit Insurance Corporation has accordingly implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.

Washington has “opted in” to the Interstate Act and allows in-state banks to merge with out-of-state banks subject to certain aging requirements. Washington law generally authorizes the acquisition of an in-state bank by

 

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an out-of-state bank by merger with a Washington financial institution that has been in existence for at least 5 years prior to the acquisition. With regard to interstate bank branching, until recently, out-of-state banks that did not already operate a branch in Washington could not establish de novo branches in Washington or establish and operate a branch by acquiring a branch in Washington. In 2005, however, Washington interstate branching laws were amended so that an out-of-state bank may, subject to the Director’s approval, open de novo branches in Washington or acquire an in-state branch so long as the home state of the out-of-state bank has reciprocal laws with respect to de novo branching or branch acquisitions.

Deposit Insurance

The deposits of Mt. Rainier Bank are currently insured to a maximum of $100,000 per depositor (in some instances up to $100,000 per deposit account, depending on the ownership category of the account) through the Bank Insurance Fund administered by the Federal Deposit Insurance Corporation. Under the Federal Deposit Insurance Reform Act of 2005, the Bank Insurance Fund will be merged with the Savings Association Insurance Fund into a new Deposit Insurance Fund, and the maximum deposit insurance amounts will be subject to inflation adjustments every five years, commencing April, 2010. All insured banks are required to pay semi-annual deposit insurance premium assessments to the Federal Deposit Insurance Corporation.

Dividends

The principal source of Mountain Bank Holding’s cash revenues is dividends received from Mt. Rainier Bank. The payment of dividends is subject to certain restrictions. For example, a national bank generally can pay dividends out of its undivided profits. However, a national bank cannot pay dividends unless the bank’s capital surplus equals or exceeds its capital stock. There are two exceptions to that restriction. First, a national bank can pay an annual dividend if the bank first transfers ten percent of its net income for the preceding four quarters to capital surplus. Second, a national bank can declare quarterly or semiannual dividends if the bank transfers ten percent or more of its net income for the preceding two quarters to capital surplus. Overlaying these restrictions is an additional restriction that limits the payment of dividends during any calendar year to the extent of the bank’s retained net income for the previous two years, unless approved by the Office of the Comptroller of the Currency. Federal legislation that would simplify dividend calculations for national banks is currently pending. Other than the laws and regulations noted above, which apply to all national banks and bank holding companies, neither we nor Mt. Rainier Bank are currently subject to any regulatory restrictions on our dividends.

Capital Adequacy

Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. If capital falls below minimum guideline levels, the holding company or bank may be denied approval to acquire or establish additional banks or nonbank businesses or to open new facilities.

The Federal Deposit Insurance Corporation and Federal Reserve use risk-based capital guidelines for banks and bank holding companies. These are designed to make such capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the Federal Reserve has noted that bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimum. The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier I capital. Tier I capital for bank holding companies includes common shareholders’ equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less intangibles except as described above.

The Federal Reserve also employs a leverage ratio, which is Tier I capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to

 

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constrain the maximum degree to which a bank holding company may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 3%. However, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, the Federal Reserve expects an additional cushion of at least 1% to 2%.

The Federal Deposit Insurance Corporation Improvement Act created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the Federal Deposit Insurance Corporation, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are deemed to be “undercapitalized” depending on the category to which they are assigned are subject to certain mandatory supervisory corrective actions. We do not believe that these regulations have any material effect on our operations.

Other Significant Federal Laws and Regulations

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the “Act”) addresses corporate and accounting fraud. The Act establishes an accounting oversight board that enforces auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, it also (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission (the “SEC”); (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”

The Act requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings. To deter wrongdoing, the Act; (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.

As a publicly reporting company, we are subject to the requirements of the Act and related rules and regulations issued by the SEC. At the present time, we anticipate that we will incur additional expense as a result of the Act, including ongoing compliance with Section 404, but we do not expect that such compliance will have a material impact on our business.

USA Patriot Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) is intended to combat terrorism. Among other things, the USA Patriot Act (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money-laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports. The USA Patriot Act also increases governmental powers to investigate terrorism, including expanded government access to account records. The Department of the Treasury is empowered to administer and make rules to implement the USA Patriot Act. While we believe the USA Patriot Act may, to some degree, affect our record keeping and reporting expenses, we do not believe that it will have a material adverse effect on our business and operations.

Financial Services Modernization. The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act of 1999, brought about significant changes to the laws affecting banks and bank holding companies. Generally, the act (i) repealed the historical restrictions on preventing banks from affiliating with securities firms, (ii) provided a uniform framework for the activities of banks, savings institutions and their

 

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holding companies, (iii) broadened the activities that may be conducted by national banks and banking subsidiaries of bank holding companies, (iv) provided an enhanced framework for protecting the privacy of consumers’ information and (v) addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.

Bank holding companies may now engage in a wider variety of financial activities than permitted under previous law, particularly insurance and securities activities. In addition, in a change from previous law, a bank holding company may be owned, controlled or acquired by any company engaged in financially related activities, so long as such company meets certain regulatory requirements. The act also permits national banks (and certain state banks), either directly or through operating subsidiaries, to engage in certain non-banking financial activities.

We do not believe that the act has or will negatively affect our operations. However, to the extent the act permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This consolidation could result in a growing number of larger financial institutions that offer a wider variety of financial services than we currently offer and that can aggressively compete in the markets we currently serve.

Effects of Government Monetary Policy

Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. We cannot predict with certainty the nature and impact of future changes in monetary policies and their impact on Mountain Bank Holding and Mt. Rainier Bank.

ITEM 1A. RISK FACTORS

Fluctuating interest rates can adversely affect our profitability

Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect our interest rate spread, and, in turn, our profitability. We cannot assure you that we can minimize our interest rate risk. In addition, interest rates also affect the amount of money we can lend. When interest rates rise, the cost of borrowing also increases. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume, business and prospects. Most recently, rising rates have increased the interest rate margins for many financial institutions as interest rates have risen. In a falling rate environment, interest rate margins will decrease and competition for loans and deposits will increase. Mt. Rainier Bank will continue to be affected by changes in interest rates and other economic factors beyond its control. We are asset sensitive, meaning that our assets reprice more quickly than our liabilities. This has an adverse effect in the short term on our interest margins, in a falling interest rate environment.

Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings

We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in the portfolio. While we strive to carefully monitor credit quality and to identify loans that may

 

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become nonperforming, at any time there are loans included in the portfolio that will result in losses, but that have not been identified as nonperforming or potential problem loans. We cannot be sure that we will be able to identify deteriorating loans before they become nonperforming assets, or that we will be able to limit losses on those loans that are identified. As a result, future additions to the allowance may be necessary. Additionally, future additions to the allowance may be required based on changes in the loans comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions, or as a result of incorrect assumptions by management in determining the allowance. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses could have a negative effect on our financial condition and results of operation.

Some of our loan concentrations present a business risk if segments of the economy suffer a downturn

Our loan portfolio contains a high percentage of commercial and commercial real estate loans in relation to our total loans and total assets. Commercial and commercial real estate loans generally are viewed as having more risk of default than residential real estate loans or certain other types of loans or investments. These types of loans also typically are larger than residential real estate loans and other commercial loans. Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming loans. An increase in nonperforming loans could result in: a loss of earnings from these loans; an increase in the provision for loan losses; or an increase in loan charge-offs, which could have an adverse impact on our results of operations and financial condition. Dairy and agriculture loans could present additional risk if continued pressure concerning environmental issues results in increased costs and lower margins for farmers.

An economic downturn in the market area we serve may cause us to have lower earnings and could increase our credit risk associated with our loan portfolio

The inability of borrowers to repay loans can erode our earnings. Substantially all of our loans are to businesses and individuals in south King and East Pierce counties, and any decline in the economy of this market area could impact us adversely. As a lender, we are exposed to the risk that our customers will be unable to repay their loans in accordance with their terms, and that any collateral securing the payment of their loans may not be sufficient to assure repayment.

Competition in our market area may limit our future success

Commercial banking is a highly competitive business. We compete with other commercial banks, savings and loan associations, credit unions and finance companies operating in our market area. We are subject to substantial competition for loans and deposits from other financial institutions. Some of our competitors are not subject to the same degree of regulation and restriction as we are. Some of our competitors have greater financial resources than we do. We compete for funds with other financial institutions that, in most cases, are significantly larger and able to provide a greater variety of services than we do and thus may obtain deposits at lower rates of interest. If we are unable to effectively compete in our market area, our business and results of operations could be adversely affected.

There is little trading activity in our outstanding shares

There is no active market for our outstanding shares, and it is unlikely that an established market for our shares will develop in the near future. We presently do not intend to seek listing of the shares on any securities exchange, or quotation on the Nasdaq interdealer quotation system. It is not known whether significant trading activity will take place for several years, if at all. Accordingly, our shares should be considered as a long-term investment.

 

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Our business could be harmed if we lost the services of our senior management team

We believe that our success to date and our prospects for success in the future are substantially dependent on our senior management team, which includes Roy T. Brooks, Chairman of the Board and CEO of Mountain Bank Holding, Steve W. Moergeli. President and CEO of Mt. Rainier Bank, Sheila M. Brumley, Chief Financial officer of Mountain Bank Holding and Senior Vice President and Cashier of Mt. Rainier Bank, and the experienced management team they have assembled. The loss of the services of any of these persons, could have an adverse effect on our business. In light of the relatively small number of persons involved in the south King and east Pierce area banking industry, we could have difficulty replacing any of our senior management team with equally competent persons who are also familiar with our market area.

There are restrictions on changes in control of the Company that could decrease our shareholders’ chance to realize a premium on their shares

As a Washington corporation, we are subject to various provisions of the Washington Business Corporation Act that impose restrictions on certain takeover offers and business combinations, such as combinations with interested shareholders and share repurchases from certain shareholders. Provisions in our Articles of Incorporation [requiring a staggered Board and/or containing fairness provisions] could have the effect of hindering, delaying or preventing a takeover bid. These provisions may inhibit takeover bids and could decrease the chance of shareholders realizing a premium over market price for their shares as a result of the takeover bid.

Government Regulation and Monetary Policy

The Company and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Company conducts its banking business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit holders of the Company’s securities. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Company. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, and any unfavorable change in these conditions could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. See “Supervision and Regulation” above.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Mountain Bank Holding has no unresolved staff comments.

ITEM 2. DESCRIPTION OF PROPERTY

Mt. Rainier Bank’s main office is in Enumclaw, Washington, at 501 Roosevelt Avenue, in an office building owned by Mt. Rainier Bank. The facility has 10,275 square feet.

On February 6, 1995, Mt. Rainier Bank opened its Buckley Branch located at 29290 Highway 410, Buckley, Washington. The facility has 3,100 square feet.

On January 26, 1998, Mt. Rainier Bank opened its Black Diamond Branch located at 31329 Third Avenue, Black Diamond, Washington. The facility has 3,100 square feet.

On November 16, 1998, Mt. Rainier Bank opened its Auburn Branch located at 1436 Auburn Way So, Auburn, Washington. This branch was relocated on September 17, 2005 to 2041 Auburn Way No, Auburn, Washington. The facility has approximately 4,850 square feet. The Company has received an earnest money agreement for the purchase of the former location at 1436 Auburn Way So.

 

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On April 5, 2002, Mt. Rainier Bank opened its Maple Valley Branch located at 23924 225th Way SE in Maple Valley, Washington. The facility has approximately 3,287 square feet.

On March 26, 2003, Mt. Rainier Bank opened its Sumner Branch located at 15104 E. Main St. in Sumner, Washington. The facility has approximately 3,768 square feet.

On March 15, 2004, Mt. Rainier Bank opened a loan production office in Federal Way, Washington. The office is a leased facility with approximately 1,000 square feet. On July 6, 2005, Mt. Rainier Bank purchased property at 33515 9th Avenue South in Federal Way, Washington. The property is approximately 40,000 square feet. The Company is in the process of obtaining permits and bids to construct a full service facility and intend to close the loan production office and relocate the staff to the full service branch upon completion.

Mt. Rainier Bank owns all of the facilities described above. Management believes that the facilities are of sound construction, in good operating condition, are appropriately insured and are adequately equipped for carrying on the business of the Company.

On March 27, 2003, Mountain Bank Holding purchased a vacant lot located at 1409 3rd Street along with a building located at 1445 3rd Street, Enumclaw, Washington. The building is approximately 2,880 square feet. The mortgage department of Mt. Rainier Bank is currently leasing approximately 1,440 square feet of the building with the remainder being used as a storage facility. The vacant lot will be used for future expansion.

ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings to which we or Mt. Rainier Bank are a party or of which any of our properties are subject; nor are there material proceedings known to us to be contemplated by any governmental authority; nor are there material proceedings known to us, pending or contemplated, in which any director, officer or affiliate or any principal security holder, or any associate of any of the foregoing, is a party or has an interest adverse to us or Mt. Rainier Bank.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of the year ended December 31, 2005, no matters were submitted to the security holders through the solicitation of proxies or otherwise.

 

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PART II

(Items 5-9)

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

No broker makes a market in Mountain Bank Holding’s common stock, and trading has not been extensive. Trades that have occurred cannot be characterized as amounting to an active market. The stock is traded by individuals on a personal basis and is not listed on any exchange or traded on the over-the-counter market. Due to the limited information available, the following price information may not accurately reflect the actual market value of the shares. The following data includes trades between individual investors. It does not include new issuances of stock, the exercise of stock options or shares issued under the Employee Stock Purchase Plan.

 

Period

   # of Shares Traded    Price Range

2005

     

1st Quarter

   6,170    $15.50 to $16.50

2nd Quarter

   8,993    $15.00 to $17.00

3rd Quarter

   15,276    $16.50 to $18.00

4th Quarter

   7,196    $17.50 to $19.00

2004

     

1st Quarter

   18,814    $14.25 to $15.00

2nd Quarter

   22,317    $15.00

3rd Quarter

   9,082    $15.00 to $15.50

4th Quarter

   4,171    $15.50 to $16.50

2003

     

1st Quarter

   13,533    $13.50 to $14.00

2nd Quarter

   2,895    $14.00

3rd Quarter

   20,264    $14.00 to $14.50

4th Quarter

   12,724    $14.25 to $15.00

The price information was obtained from Mt. Rainier Bank acting as transfer agent for Mountain Bank Holding.

On April 1, 2004, Mountain Bank Holding offered for sale 60,000 shares of no par value common stock at a subscription price of $15.00 per share. The offering was successfully completed on April 8, 2004.

As of December 31, 2005, there were 2,302,741 shares of Mountain Bank Holding Company common stock issued and outstanding.

At December 31, 2005, stock options for 153,775 shares of Mountain Bank Holding Company common stock were outstanding. See Note 11 of the audited financial statements for additional information.

Number of Equity Holders

As of January 31, 2006, there were 1,178 shareholders of record of Mountain Bank Holding’s common stock.

Stock Dividends

Dividends, when and if paid, will be subject to determination and declaration by the Board of Directors, which will take into account the financial condition of Mt. Rainier Bank and Mountain Bank Holding, results of

 

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operations, tax considerations, industry standards, economic conditions and other relevant factors. The ability of Mountain Bank Holding to pay dividends in the future will depend primarily upon the earnings of Mt. Rainier Bank and its ability to pay dividends to Mountain Bank Holding.

Payment of Dividends

The principal source of Mountain Bank Holding’s cash revenues is dividends received from Mt. Rainier Bank. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. In addition, a bank has certain restrictions on the payment of dividends and also may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. See “SUPERVISION AND REGULATION—MT. RAINIER NATIONAL BANK” contained elsewhere in this Annual Report. Other than the laws and regulations noted above, which apply to all banks and bank holding companies, neither Mt. Rainier Bank nor we are currently subject to any regulatory restrictions on our dividends.

On February 20, 2004, the Company paid a cash dividend in the amount of $.10 per share to shareholders of record as of February 20, 2004.

On March 15, 2005, the Company paid a cash dividend in the amount of $.15 per share to be paid to shareholders of record as of March 15, 2005.

On January 17, 2006, the Board of Directors approved a cash dividend in the amount of $.18 per share to be paid to shareholders of record as of February 1, 2006.

EQUITY COMPENSATION PLAN INFORMATION

 

     Year Ended December 31, 2005

Plan Category

   Number of Shares to
be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights
   Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
   Number of Shares
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (excluding shares
reflected in Column (a))
     (a)    (b)    (c) (1)

Equity compensation plans approved by security holders

   153,775    $ 10.26    42,170

Equity compensation plans not approved by security holders

   -0-    $ 0    -0-
                

Total

   153,775    $ 10.26    42,170
                

1) Includes 20,545 shares available for issuance under the company’s employee stock purchase plan as of December 31, 2005.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

     Year Ended December 31  
     2005     2004     2003     2002     2001  
     (Dollars in thousands)  

Income Statement Data

          

Interest income

   $ 10,878     $ 9,404     $ 8,457     $ 8,169     $ 8,261  

Interest expense

   $ 2,465     $ 1,932     $ 1,921     $ 2,563     $ 3,528  

Net interest income

   $ 8,413     $ 7,472     $ 6,536     $ 5,606     $ 4,733  

Provision for credit losses

   $ 199     $ 276     $ 385     $ 360     $ 85  

Net interest income after provision

   $ 8,214     $ 7,196     $ 6,151     $ 5,246     $ 4,648  

Non-interest income

   $ 1,559     $ 1,245     $ 1,615     $ 1,351     $ 1,147  

Non-interest expense

   $ 6,705     $ 6,398     $ 6,000     $ 5,156     $ 4,377  

Income before income taxes

   $ 3,068     $ 2,043     $ 1,766     $ 1,441     $ 1,418  

Income taxes

   $ 981     $ 625     $ 544     $ 426     $ 478  

Net income

   $ 2,087     $ 1,418     $ 1,222     $ 1,015     $ 940  

Per Share Data

          

Net income—basic

   $ 0.91     $ 0.64     $ 0.57     $ 0.48     $ 0.46  

Net income—diluted

   $ 0.88     $ 0.62     $ 0.55     $ 0.46     $ 0.44  

Cash dividends declared

   $ 0.15     $ 0.10     $ 0.00     $ 0.00     $ 0.00  

Book value per share

   $ 8.82     $ 8.21     $ 7.63     $ 7.18     $ 6.43  

Balance Sheet Data

          

Assets

   $ 194,524     $ 177,645     $ 156,425     $ 143,174     $ 125,881  

Loans, net

   $ 120,866     $ 119,027     $ 97,643     $ 81,409     $ 68,134  

Securities

   $ 46,573     $ 37,502     $ 32,290     $ 29,562     $ 31,612  

Deposits

   $ 171,813     $ 157,600     $ 138,775     $ 127,011     $ 112,111  

Shareholders’ equity

   $ 20,299     $ 18,568     $ 16,604     $ 15,404     $ 13,303  

Shares outstanding

     2,302,741       2,260,968       2,176,677       2,146,813       2,067,401  

Performance Ratios

          

Return on average assets

     1.12 %     0.84 %     0.82 %     0.78 %     0.83 %

Return on average equity

     10.79 %     8.09 %     7.67 %     7.14 %     7.40 %

Equity to assets

     10.44 %     10.45 %     10.61 %     10.76 %     10.57 %

Net interest margin

     4.90 %     4.75 %     4.70 %     4.60 %     4.50 %

Efficiency ratio

     67.10 %     73.48 %     73.54 %     74.32 %     74.73 %

Allowance for credit losses to loans

     1.28 %     1.14 %     1.12 %     1.04 %     1.09 %

Asset Quality Ratios

          

Net charge-offs to average loans outstanding

     0.00 %     0.00 %     0.15 %     0.35 %     0.05 %

Non-performing loans to period-end loans

     0.02 %     0.00 %     0.11 %     0.11 %     0.00 %

Non-performing assets to total assets

     0.01 %     0.00 %     0.16 %     0.17 %     0.00 %

Capital and Liquidity Ratios

          

Risk-based:

          

Tier 1 capital

     14.70 %     13.70 %     14.08 %     12.97 %     13.39 %

Total capital

     15.81 %     14.71 %     15.02 %     13.70 %     14.15 %

Average loans to average deposits

     74.43 %     73.01 %     69.52 %     64.61 %     68.21 %

Average shares outstanding:

          

Basic

     2,288,320       2,229,061       2,155,914       2,111,819       2,061,662  

Dilution

     2,338,440       2,298,897       2,240,437       2,195,058       2,137,480  
     2005     % of Change     2004     % of Change     2003  

Total Assets

   $ 194,524       9.50 %   $ 177,645       13.57 %   $ 156,425  

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Mountain Bank Holding Company (“Mountain Bank Holding”) is a Washington corporation formed in 1993 primarily to hold all of the Common Stock of Mt. Rainier National Bank (“Mt. Rainier Bank”), a National Banking Association organized under the laws of the United States.

Mountain Bank Holding focuses on establishing and maintaining long-term relationships with customers, and is committed to serving the financial service needs of the communities in its market area. The Company’s primary market area includes Pierce and South King counties. The Company attracts retail deposits from the general public and uses those deposits, together with other borrowed funds, to originate and purchase residential and commercial mortgage loans, to make consumer loans, and to provide financing for agricultural and other commercial business purposes.

Mountain Bank Holding’s basic mission is to maintain and enhance core earnings while serving its primary market area. As such, the Board of Directors has adopted a business strategy designed to (i) maintain Mountain Bank Holding’s tangible capital in excess of regulatory requirements, (ii) maintain the quality of Mountain Bank Holding’s assets, (iii) control operating expenses, (iv) maintain and, as possible, increase Mountain Bank Holding’s interest rate spread, and (v) manage Mountain Bank Holding’s exposure to changes in interest rates.

Financial Information Regarding Segment Reporting

We currently operate our business in three reportable segments, Community Banking, Mt. Rainier Mortgage and Other. Please refer to Note 23 of our consolidated financial statement for financial information.

Corporate Developments in Fiscal 2005

On March 15, 2005, Mountain Bank Holding paid a cash dividend of $.15 per share to shareholders of record on March 15, 2005. The total amount of the dividend was $341,000.

On July 6, 2005, Mt. Rainier Bank purchased property at 33515 9th Avenue South in Federal Way, Washington for a purchase price of $360,000 with the intent of building a full service facility and relocating the Federal Way Loan Production office.

On September 17, 2005, Mt. Rainier Bank relocated the Auburn facility at 1436 Auburn Way South to 2041 Auburn Way North.

The purpose of this discussion and analysis is to provide the reader with a concise description of the financial condition and changes therein and results of operations for Mountain Bank Holding and Mt. Rainier Bank for the years ended December 31, 2005, 2004 and 2003.

This discussion and analysis is intended to complement the audited consolidated financial statements and footnotes and the supplemental financial data and charts appearing elsewhere in this report, and should be read in conjunction with them. This discussion and analysis will focus on the following major areas: Financial Condition, Operating Results, Capital Requirements, Liquidity Resources, Asset Liability Management and Asset Quality.

Forward Looking Statement Disclosure

In addition to historical information, this report contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA). This statement is included for the express purpose of availing the Company of the protections of the safe harbor provisions of the PSLRA. The forward-looking statements contained in this report are subject to factors, risks, and uncertainties that may cause

 

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actual results to differ materially from those projected. Important factors that might cause such a material difference include, but are not limited to, those discussed in this section of the report. In addition, the following items are among the factors that could cause actual results to differ materially from the forward looking statements in this report: general economic conditions, including their impact on capital expenditures; business conditions in the banking industry; the regulatory environment; new legislation; vendor quality and efficiency; employee retention factors; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with community, regional, and national financial institutions; fluctuating interest rate environments; and similar matters. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of the statement. Mountain Bank Holding undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in this and other documents we file from time to time with the Securities and Exchange Commission.

Critical Accounting Policy

Mountain Bank Holding maintains a reserve to absorb probable loan losses inherent in the portfolio. The reserve is maintained at a level Mountain Bank Holding considers to be adequate and is based on ongoing quarterly assessments and evaluations of the collectibility and historical loss experience of loans. Credit losses are charged and recoveries are credited to the reserve. Provisions for credit losses are based on Mountain Bank Holding’s review of the historical credit loss experience and such factors that, in management’s judgment, deserve consideration under existing economic conditions in estimating probable credit losses. In determining the appropriate level of reserves, Mountain Bank Holding estimates losses using a range derived from “low” and “high” estimates. Mountain Bank Holding’s methodology for assessing the appropriate reserve level consists of several key elements. Mountain Bank Holding’s strategy for credit risk management includes a combination of conservative exposure limits significantly below legal lending limits and conservative underwriting, documentation and collections standards. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.

Loans subject to individual evaluation generally consist of commercial, commercial real estate and agricultural loans mainly because of their size and complexity. These loans are analyzed and assigned to risk categories according to Mountain Bank Holding’s internal risk rating system. Loans with a greater risk of loss are identified and placed on the “watch list” for regular management review. Those loans judged to reflect the highest risk profiles are evaluated individually for the impairment of repayment potential and collateral adequacy, and in conjunction with current economic conditions and loss experience, allowances are estimated. The review of individual loans includes those loans that are impaired as provided in SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” Any reserves for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral.

Other loans identified on Mountain Bank Holding’s “watch list” but not judged to be individually impaired from a repayment or collateral adequacy perspective are aggregated and reserves are recorded using models that track historical loan losses by loan type. In the case of other more homogeneous loan portfolios, including auto loans, residential mortgages, home equity loans and credit card loans, the determination of the allocated reserve is computed on a pooled basis. For these loan pools, historical loss ratios by loan type, current loss and past due experience, and management’s judgment of recent and forecasted economic effects on portfolio performance are factors utilized to determine the appropriate reserve amounts. Also, examination results from bank regulatory agencies and Mountain Bank Holding’s internal credit examinations are considered.

An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Reserves on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.

 

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Mountain Bank Holding’s primary market areas for lending are south King County and Pierce County. When evaluating the adequacy of reserves, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Company’s customers.

Mountain Bank Holding has not substantively changed any aspect to its overall approach in the determination of the reserve for loan and lease losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period reserve for loan losses.

Comparison of Financial Condition at December 31, 2005, 2004 and 2003

 

    December 31,  
    2005     Amount of
Change
    Percent of
Change
    2004     Amount of
Change
    Percent of
Change
    2003  
    (Dollars in thousands)  

Cash and deposits in other banks

  $ 7,374     $ (1,175 )   -13.74 %   $ 8,549     $ (7,012 )   -45.06 %   $ 15,561  

Fed funds sold

    3,647       3,647     100.00 %     —         —       0.00 %     —    

Investments:

             

US Treasury

    3,976       889     28.80 %     3,087       (537 )   -14.82 %     3,624  

U.S. Government and agency securities

    25,480       8,738     52.19 %     16,742       5,114     43.98 %     11,628  

Mortgage backed securities

    14,237       (792 )   -5.27 %     15,029       3,216     27.22 %     11,813  

Corporate, municipal and equity securities

    2,880       236     8.93 %     2,644       (2,581 )   -49.40 %     5,225  

Loans:

             

Loans held for sale

    1,790       1,261     238.37 %     529       529     0.00 %     —    

Commercial and agriculture

    24,025       (2,893 )   -10.75 %     26,918       5,392     25.05 %     21,526  

Real estate

    94,169       6,092     6.92 %     88,077       16,735     23.46 %     71,342  

Consumer

    4,375       (1,033 )   -19.10 %     5,408       (468 )   -7.96 %     5,876  

Net deferred loan fees

    (134 )     (134 )   100.00 %     —         —       0.00 %     —    

Provision for credit losses

    (1,569 )     (193 )   14.03 %     (1,376 )     (275 )   24.98 %     (1,101 )

Premises and equipment

    7,575       1,381     22.30 %     6,194       608     10.88 %     5,586  

Other assets

    6,699       855     14.63 %     5,844       499     9.34 %     5,345  
                                                   

Total Assets

  $ 194,524     $ 16,879     9.50 %   $ 177,645     $ 21,220     13.57 %   $ 156,425  
                                                   

Deposits:

             

Non-interest bearing deposits

  $ 33,298     $ 4,314     14.88 %   $ 28,984     $ 5,228     22.01 %   $ 23,756  

Interest bearing deposits

    138,515       9,899     7.70 %     128,616       13,597     11.82 %     115,019  

Other liabilities

    2,412       936     63.41 %     1,476       430     41.11 %     1,046  

Shareholders Equity

    20,299       1,730     9.32 %     18,569       1,965     11.83 %     16,604  
                                                   

Total liabilities and shareholders equity

  $ 194,524     $ 16,879     9.50 %   $ 177,645     $ 21,220     13.57 %   $ 156,425  
                                                   

Total Assets: The increase in total assets in 2005 was due primarily to an increase in securities available for sale of $9,071,000, an increase in cash, deposits in banks and federal funds sold of $2,472,000 and an increase in net loans receivable of $3,100,000, which was funded primarily by an increase in total deposits of $14,213,000 from current and new banking customers. The increase in total assets during 2004 was also due primarily to an increase in net loans receivable of $21,384,000 which was funded primarily by an increase in deposits of $18,825,000 from current and new banking customers and cash and deposits in banks.

 

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Cash and deposits in other banks: The increase in 2005 of $2,472,000 was funded by an increase in total deposits. The decrease in cash from 2003 to 2004 was primarily in overnight investments, which were also rolled into our investment portfolio to obtain a higher yield and used to fund a portion of the loan growth.

Investment Portfolio: In 2005 securities available for sale increased by $9,071,000. $8,738,000 of the increase was invested in US government sponsored agencies. Corporate maturities were redeployed into municipal securities. In 2004 the corporate and municipal maturities were redeployed into US government sponsored agencies as well as mortgage backed securities. Additional securities were purchased in these two categories with excess overnight funds to produce a higher yield.

Loans Receivable and Loans Held For Sale, net of allowance for credit losses: In 2005, loans increased by $3,427,000. The increase in loans was primarily due to growth in residential, construction and land development and commercial loans. The Bank’s Maple Valley, Sumner, Federal Way and Buckley branches contributed the largest increases. Commercial real estate loans and residential construction loans dominated growth. Overall, loan volume diminished in 2005 as demand for refinancing and purchasing of commercial income properties declined. In 2004, the increase in loans was primarily in commercial and agriculture and real estate loans. The Bank’s two new branches (Sumner and Federal Way), together, contributed $8,627,000 of the increase. Both branches were opened with seasoned, experienced loan officers. Commercial real estate loans continue to dominate portfolio growth. Motivated by excellent interest rates, borrowers are refinancing and purchasing commercial income properties.

Deposits: As illustrated in the above table, interest bearing deposits increased $9,899,000 and non-interest bearing increased $4,314,000. Likewise, interest-bearing deposits accounted for a larger percentage of the overall deposit growth in 2004. In 2005, the Buckley location increased deposits by $3,000,000 and the Black Diamond branch increased by approximately $5,800,000. Approximately $4,554,000 of the increase for 2004 was attributed to the new Sumner branch. The Bank opened over 3,000 accounts each year, from existing and new customers, which contributed to the deposit growth.

Shareholders’ Equity: In 2005, total shareholders equity increased by $1,730,000 to a total of $20,299,000. The increase reflected net income of $2,087,000 and the exercise of stock options, offset by the payment of dividends and a decrease in other comprehensive income. Total shareholders’ equity increased by $1,965,000 to a total of $18,569,000 at December 31, 2004. The net proceeds from the April 1, 2004 offering of $846,000, the exercise of stock options, net income of $1,418,000 and payment of dividends affected the components of shareholders’ equity.

 

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Comparison of Operating Results for Years Ended December 31, 2005, 2004 and 2003

 

     December 31,
     2005    Amount of
Change
    Percent of
Change
    2004    Amount of
Change
    Percent of
Change
    2003
     (Dollars in thousands)

Net interest income

   $ 8,413    $ 941     12.59 %   $ 7,472    $ 936     14.32 %   $ 6,536

Provision for credit losses

     199      (77 )   -27.90 %     276      (109 )   -28.31 %     385

Net interest income after provision for credit losses

     8,214      1,018     14.15 %     7,196      1,045     16.99 %     6,151

Non-interest income:

                

Service charges

     562      (19 )   -3.27 %     581      9     1.57 %     572

Gains on mortgage loans sold

     485      234     93.23 %     251      (363 )   -59.12 %     614

Gains on sales of securities available for sale, net

     —        (14 )   -100.00 %     14      14     0.00 %     —  

Income on bank owned life insurance

     151      (2 )   -1.31 %     153      —       0.00 %     153

Other

     361      115     46.75 %     246      (30 )   -10.87 %     276

Non-interest expense:

                

Salaries and employee benefits

     4,152      122     3.03 %     4,030      402     11.08 %     3,628

Occupancy and equipment expense

     897      (4 )   -0.44 %     901      36     4.16 %     865

Other expense

     1,656      189     12.88 %     1,467      (40 )   -2.65 %     1,507

Income before taxes

     3,068      1,025     50.17 %     2,043      277     15.69 %     1,766

Income taxes

     981      356     56.96 %     625      81     14.89 %     544

Net income

   $ 2,087    $ 669     47.18 %   $ 1,418    $ 196     16.04 %   $ 1,222

Net Income: Net income for 2005 was $2,087,000 or $.88 per diluted share ($.91 per basic share) compared to $1,418,000 or $.62 per diluted share ($.64 per basic share) in 2004. This reflected an increase of $47.2% over 2004. The higher income was attributed to the increase in the bank’s net interest margin from 4.8% in 2004 and 2003 to 4.9% in 2005, and an increase in gains on mortgage loans sold.

Net income for 2004 was $1,418,000 or $.62 per diluted share ($.64 per basic share) compared to $1,222,000 or $.57 per diluted share ($.55 per basic share). The higher earnings for 2004 were primarily a result of increased net interest income. Net interest income was higher due to a higher percentage of our earning assets being in loans, which earns more than securities and interest bearing deposits. The increase in net interest income was offset by a decrease in gains on mortgage loans sold and an increase in non-interest expense.

Net Interest Income: In 2005 average-earning assets increased to $171,636,000 from $157,462,000, which represented a 9.00% increase and the yield on average earning assets increased from 6.0% to 6.3% or 30 basis points. Based on the bank’s asset liability model, we are asset sensitive, which means that our assets re-price faster than our liabilities. In periods of rising interest rates, such as we have experienced in 2005 our net interest margin increases until we re-price our liabilities. Average interest bearing liabilities increased only $8,054,000 or 6.51% with the yield on interest bearing liabilities increasing from 1.6% to 1.9%. Mt. Rainier Bank’s net interest margin increased from 4.8% in 2004 and 2003 to 4.9% in 2005.

Provision for Credit Losses: For the years ended December 31, 2005, 2004 and 2003, net charge-offs were $6,000, $1,000 and $136,000 respectively. The provision for credit losses is determined by management based on the factors and processes described above under “BUSINESS—Credit Risk Management and Allowance for Credit Losses.” The total allowance for credit losses increased $193,000 to $1,569,000 at December 31, 2005 from $1,376,000 at December 31, 2004. The increased level of allowance for credit losses was primarily due to the growth in the loan portfolio and changes in the local economic expectations.

 

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Non-Interest Income: Non-interest income for 2005 increased by $314,000 to $1,559,000 from $1,245,000. The gain on mortgage loans sold accounted for $234,000 of the increase. In 2005, Mt. Rainier Bank sold the credit card portfolio for a gain of $66,000 that also accounted for a portion of the increase. Mountain Bank Holding’s non-interest income for 2004 decreased due primarily to a large decrease in gains on mortgage loans sold. Income from these gains decreased $363,000 to $251,000 in 2004 from $614,000 in 2003. The stabilization of interest rates has decreased the amount of mortgage refinance applications substantially.

Non-Interest Expense: In 2005, salary and benefit increases were primarily due to the addition of three full time equivalent staff positions, an increase in commissions on mortgage loans and an increase in employee benefit costs, offset by the deferral of compensation expense with regards to Fasb91. In 2004, salary and employee benefit increases were primarily due to the addition of three full time equivalent staff positions, $57,000 increase in incentive bonuses, $44,000 increase in employment benefit expense and $19,000 in employment taxes. Executive retirement compensation expense was $373,000 in 2004 compared to $322,000 in 2003. Non-interest expense as a percent of average assets decreased slightly at 3.61% in 2005 compared to 3.79% in 2004 as evidenced in the following table.

 

     2005     2004     2003  
     Amount   

% of Average

Assets

    Amount   

% of Average

Assets

    Amount   

% of Average

Assets

 

Salaries and employee benefits

   $ 4,152    2.24 %   $ 4,030    2.39 %   $ 3,628    2.44 %

Occupancy expenses

     414    0.22 %     373    0.22 %     330    0.22 %

Furniture and equipment

     483    0.26 %     528    0.31 %     535    0.36 %

Advertising

     55    0.03 %     42    0.02 %     46    0.03 %

Professional fees

     118    0.06 %     35    0.02 %     106    0.07 %

Business and occupation taxes

     147    0.08 %     122    0.07 %     121    0.08 %

Customer check expense

     32    0.02 %     37    0.02 %     48    0.03 %

Data processing expense

     434    0.23 %     416    0.25 %     387    0.26 %

Director fees

     125    0.07 %     119    0.07 %     130    0.09 %

FDIC assessment

     21    0.01 %     21    0.01 %     20    0.01 %

OCC assessment

     64    0.03 %     58    0.03 %     54    0.04 %

Office and stationary expense

     110    0.06 %     90    0.05 %     114    0.08 %

Postage

     41    0.02 %     46    0.03 %     47    0.03 %

Telephone

     101    0.05 %     92    0.05 %     83    0.06 %

Other

     408    0.22 %     389    0.23 %     351    0.24 %
                                       

Total

   $ 6,705    3.61 %   $ 6,398    3.79 %   $ 6,000    4.04 %
                                       

Provision for Income Taxes: The provision for income taxes increased in 2005 from 2004, primarily as a result of increased taxable income. The effective tax rate was 31.98% for 2005, compared to 30.59% in 2004 and 30.80% in 2003. Income from the Company’s life insurance policies is the primary reason the effective tax rate is lower than the statutory rate.

Capital Adequacy

Capital adequacy refers to the level of capital required to sustain asset growth over time and to absorb losses. Our objective is to maintain a level of capitalization that is sufficient to take advantage of profitable growth opportunities while meeting regulatory requirements. This is achieved by improving profitability through effectively allocating resources to more profitable businesses, improving asset quality, strengthening service quality, and streamlining costs. The primary measures used by management to monitor the results of these efforts are the ratios of average equity to average assets, average tangible equity to average tangible assets, and average equity to net loans.

The Federal Reserve Board has adopted capital guidelines governing the activities of bank holding companies. These guidelines require the maintenance of an amount of capital based on risk-adjusted assets so

 

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that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments.

The capital guidelines classify capital into two tiers, referred to as Tier I and Tier II. Under risk-based capital requirements, total capital consists of Tier I capital which is generally common shareholders’ equity less goodwill and Tier II capital which is primarily a portion of the allowance for credit losses and certain qualifying debt instruments. In determining risk-based capital requirements, assets are assigned risk-weights of 0% to 100%, depending primarily on the regulatory assigned levels of credit risk associated with such assets. Off-balance sheet items are considered in the calculation of risk-adjusted assets through conversion factors established by the regulators. The framework for calculating risk-based capital requires banks and bank holding companies to meet the regulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990 regulators added a leveraged computation to the capital requirements, comparing Tier I capital to total average assets less goodwill.

At December 31, 2005, Mt. Rainier Bank exceeded the regulatory minimums and qualified as a well-capitalized institution under the regulations.

The Federal Deposit Insurance Corporation Improvement Act of 1992 established five capital categories for banks and bank holding companies. The bank regulators adopted regulations defining these five capital categories in September 1992. Under these new regulations each bank is classified into one of the five categories based on its level of risk-based capital as measured by Tier I capital, total risk-based capital, and Tier I leverage ratios and its supervisory ratings.

Mountain Bank Holding’s equity capital was $20,299,000 at year-end 2005 compared to $18,568,000 at year-end 2004. The increase of $1,731,000 was attributed to the exercise of stock options, net income of $2,087,000, less the payment of cash dividends in the amount of $341,000 and a decrease in other comprehensive income. Mountain Bank Holding’s equity capital was $18,568,000 at year-end 2004 compared to $16,604,000 at year-end 2003. The increase of $1,964,000 was attributed to the sale of 60,000 shares of common stock at a price of $15.00 per share netting proceeds of $846,000, the exercise of stock options, net income of $1,418,000, less the payment of cash dividends in the amount of $219,000.

At December 31, 2005, Mountain Bank Holding’s Tier 1 Capital to Average Assets was 10.71%, Tier 1 Capital to Risk Weighted Assets was 14.70% and Total Capital to Risk Weighted Assets was 15.81%. Mountain Bank Holding would be considered “well capitalized” within applicable Federal banking regulatory guidelines at December 31, 2005. See Note 15 to Mountain Bank Holding’s Consolidated Financial Statements contained in this document for a table that shows the requirements for being considered “well capitalized” under such guidelines.

At December 31, 2004, Mountain Bank Holding’s Tier 1 Capital to Average Assets was 10.47%, Tier 1 Capital to Risk Weighted Assets was 13.70% and Total Capital to Risk Weighted Assets was 14.71%. Mountain Bank Holding would be considered “well capitalized” within applicable Federal banking regulatory guidelines at December 31, 2004. See Note 15 to Mountain Bank Holding’s Consolidated Financial Statements contained in this document for a table that shows the requirements for being considered “well capitalized” under such guidelines.

It has been the practice of Mountain Bank Holding to fund our growth and expansion through periodic stock offerings. Since its inception in 1993, we have had seven stock offerings. The most recent offering commenced in April 2004, pursuant to a prospectus dated April 1, 2004, in which we offered and sold 60,000 shares at $15.00 per share.

 

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Liquidity Resources

Liquidity. The ability to have readily available funds sufficient to repay fully maturing liabilities is of primary importance to depositors, creditors and regulators. Mt. Rainier Bank’s liquidity, represented by cash and cash due from banks, federal funds sold and interest-bearing deposits in other banks, is a result of its operating, investing and financing activities. In order to ensure funds are available at all times, Mt. Rainier Bank devotes resources to projecting on a monthly basis the amount of funds that will be required and maintains 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 that are generally matched to correspond to the maturity of liabilities. Mt Rainier Bank has borrowing lines at three correspondent banks in the aggregate amount of $15,000,000 and a borrowing line at Federal Home Loan Bank of Seattle in the approximate amount of $19,400,000 for a total available of $34,400,000 for short term funding.

Although Mt. Rainier Bank has no formal liquidity policy, in the opinion of management, its liquidity levels are considered adequate. Neither Mountain Bank Holding nor Mt. Rainier Bank is subject to any specific liquidity requirements imposed by regulatory orders. Mt. Rainier Bank is subject to general FDIC guidelines that do not require a minimum level of liquidity. Management believes its liquidity ratios meet or exceed these guidelines. Management does not know of any trends or demands that are reasonably likely to result in liquidity increasing or decreasing in any material manner.

The Bank’s primary investing activity is the origination of real estate, commercial and consumer loans. During the years ended December 31, 2005, 2004 and 2003, the Bank originated $88 million, $104.9 million and $81.4 million in loans, respectively. At December 31, 2005 the Bank had outstanding loan commitments of $21.3 million and outstanding letters of credit of $264 thousand. The Bank anticipates that it will have sufficient funds available to meet current loan commitments.

The volume of mortgage loans sold also impacts the Bank’s liquidity. During the years ended December 31, 2005, 2004 and 2003, the Bank sold $44.4 million, $22.4 million, and $42.9 million of residential mortgage loans. The fluctuation in loan sales is due in large part to the fluctuation of mortgage interest rates.

The Bank’s liquidity has been impacted by increases in deposit levels. During the years ended December 31, 2005, 2004 and 2003 deposits increased by $14.2 million, $18.8 million and $11.8 million.

Investment securities and interest bearing deposits increased to $53.8 million at December 31, 2005 from $44.4 million at December 31, 2004.

Impact of Inflation and Changing Prices

The consolidated financial statements and related consolidated financial data presented in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time and due to inflation. The impact of inflation on operations of Mountain Bank Holding is reflected in increased operating costs. Unlike most industrial companies, virtually all of Mountain Bank Holding’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services.

Asset and Liability Management

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or re-price within that

 

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time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap, as we have recently experienced, would tend to adversely affect net interest income, at least in the short term.

The asset/liability committee, which consists of Mt. Rainier Bank’s Chief Executive Officer, the Senior Vice President/Cashier, the Credit Administrator and other officers, is charged with monitoring the liquidity and funds position of Mt. Rainier Bank. The Committee regularly reviews:

 

    Information on current economic conditions and the outlook for interest rates;

 

    The asset/liability position of Mt. Rainier Bank;

 

    Mt. Rainier Bank’s current and projected liquidity position;

 

    Maturity/average life of the portfolio as a whole;

 

    Composition of the portfolio; and

 

    The tax position of the institution

Mt. Rainier Bank uses the “ALX” asset liability management model, a proprietary system. At December 31, 2005, we had a negative cumulative re-pricing gap within one year of approximately $66,262,000, or approximately 38.61% of total average earning assets. This negative re-pricing gap indicates that our future earnings may be materially adversely impacted by a rise in market interest rates, and such impact would primarily be felt in the twelve-month period after such a rise in rates.

The following table represents interest sensitivity profiles for Mt. Rainier Bank as of December 31, 2005. The table represents a static point in time and does not consider other variables, such as changing spread relationships or interest rate levels. “Interest sensitive gap” is the difference between total earning assets and total interest-bearing liabilities re-pricing in any given period.

 

     Total Within
One Year
    One Year To
Five Years
    Over
Five Years
 
     (Dollars in thousands)  

Rate Sensitive Assets:

      

Loans

   $ 37,455     $ 73,404     $ 13,480  

Investments (amortized cost)

     7,829       36,204       3,147  

Interest Bearing Deposits and Federal Funds Sold

     6,152       291       —    
                        

TOTAL

   $ 51,436     $ 109,899     $ 16,627  

Rate Sensitive Liabilities:

      

Savings, Now and Interest Checking

     77,520      

Time Deposits

     40,178       20,817       —    
                        

TOTAL

   $ 117,698     $ 20,817     $ 0  

Interest Sensitive Gap

   $ (66,262 )   $ 89,082     $ 16,627  
                        

Cumulative Gap

   $ (66,262 )   $ 22,820     $ 39,447  

Cumulative Gap as a % of Average Earning Assets

     -38.61 %     13.30 %     22.98 %

Currently, Mt. Rainier Bank’s interest sensitivity gap is negative within one year. Assuming that general market interest rate changes affected the re-pricing of assets and liabilities in equal magnitudes, this indicates that

 

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the effect of rising interest rates on Mountain Bank Holding would be a decrease in the net interest margin, whereas falling interest rates would cause a corresponding increase in margin. The bank’s asset liability model assumes assets and liabilities re-price at different times, therefore the net interest margin change could vary from these scenarios as evidenced in the chart below.

Based on the “ALX” asset liability model as of December 31, 2005, Mt. Rainier Bank’s sensitivity to gains or losses in future earnings due to hypothetical increases or decreases in the Fed Funds rate are as follows:

 

Increase in

Interest Rates

 

Net Interest

Margin Change

 

Decrease in

Interest Rates

 

Net Interest

Margin Change

+1.00%

  +$118,000   -1.00%   -$151,000

+2.00%

  +$236,000   -2.00%   -$302,000

Rate increases will generally increase the Company’s equity, while rate decreases will generally reduce equity.

Asset Quality

Non-performing assets include accruing loans past due ninety days or more, non-accrual loans, loans which have been restructured to provide a reduction or deferral of interest or principal for reasons related to the debtors financial difficulties, potential problem loans and loan concentrations, and foreclosed real estate.

Generally the accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when they are past due 90 days as to either principal or interest, unless they are well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against current income. If management determines that the ultimate collectibility of principal is in doubt, cash receipts on non-accrual loans are applied to reduce the principal balance on a cash-basis method, until the loans qualify for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following table summarizes the Bank’s non-accrual, past due, foreclosed real estate and restructured assets for the years ended December 31:

 

       2005        2004  
     (in thousands)

Loans accounted for on a Non-accrual basis

     

Commercial

     -0-      -0-

Consumer

   $ 20      -0-

Accruing loans which are past due 90 days or more

     

Commercial

     -0-      -0-

Real Estate

     -0-      -0-

Consumer

     -0-    $ 8

Foreclosed real estate

     -0-      -0-

Non-accrual loans as a percentage of net loans before the allowance for credit losses was .2% at year-end 2005 and 0% at year end 2004. Non performing loans as a percentage of the allowance for credit losses was 1.3% at year-end 2005 and .58% at year-end 2004, which is a measure of Mt. Rainier Bank’s ability to cover problem assets with existing reserves.

Mountain Bank Holding had no material restructured loans in 2005 or 2004. The asset quality of Mountain Bank Holding continues to be good, which is a result of good underwriting standards coupled with aggressive collection efforts and a stable local economy.

 

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There are certain amounts of interest that have not been accrued and certain amounts that have been collected on the above loans and included in income, which are indicated in the table below:

 

       2005        2004        2003  
     (in thousands)

Total interest income which would have been recorded during the period under original terms of loans on non-accrual

   $ 2    $ 1    $ 1

Interest income included in net income for the period

   $ 0    $ 1    $ 7

There were no commitments for additional funds related to loans above.

The provision for losses on loans was $199,000 for 2005, which is a decrease of $77,000 over the provision of $276,000 for 2004. The provision for credit losses is based on ongoing, quarterly analyses of the loan portfolio as well as general economic conditions, historic loan loss experience and loan mix.

IMPACT OF NEW ACCOUNTING STANDARDS

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS No. 123. SFAS 123R will require the Company to, among other things, measure all employee stock-based compensation awards using a fair value method and record such expense in the Company’s consolidated financial statements. The provisions of SFAS 123R are effective no later than the beginning of the next fiscal year that begins after December 31, 2005; the Company will adopt the new requirements in its first quarter of fiscal 2006 using the modified prospective transition method. The adoption of SFAS 123R will increase the Company’s future compensation expense for unvested awards outstanding as of December 31, 2005 by the following estimated amounts:

 

Year Ended December 31,

   Estimated additional
compensation expense
     (dollars in thousands)

2006

   $ 60

2007

   $ 38

2008

   $ 20

2009

   $ 7

2010

   $ 2

In addition, additional compensation costs in 2006 and beyond will be further impacted by various factors; among them being our future compensation strategy.

At its November 12-13, 2003 meeting, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company adopted the disclosure requirements in fiscal year 2003. At the March 17-18, 2004 meeting, the EITF reached a consensus, which approved an impairment model for debt and equity securities. In FASB Staff Position (“FSP”) 03-01-01, issued in September 2004, the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of Issue 03-01 was delayed.

On November 3, 2005, FSP FAS Nos. 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” was issued. This FSP nullifies certain requirements of Issue 03-1 and supersedes EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” This FSP nullified the requirements of paragraphs 10-18 of Issue 03-1, carried forward the requirements of paragraph 8 and 9 of Issue 03-1 with respect

 

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to cost-method investments and carries forward the disclosure requirements included in paragraphs 21 and 22 of Issue 03-1 and related examples. The guidance in this FSP shall be applied to reporting periods beginning after December 15, 2005. The Company believes the adoption of this FSP in 2006 will not materially impact our results of operations, financial condition, or related disclosures.

In May 2005, FASB issued SFAS No. 154, Accounting Changes for Error Corrections (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It established, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transaction requirements specific to the newly adopted accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on the Company’s consolidated financial statements.

Mortgage Banking Activities

Mortgage loans originated and intended for sale in the secondary market are reported as loans held for sale and are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized in a valuation allowance by charges to income.

Servicing rights are recognized as assets for purchased rights and for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment charge or recovery is reported in a valuation allowance by charges or credits to income.

Loans Receivable

Loans receivable 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 balances adjusted for any charge-offs, the allowance for credit losses, and any deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method.

Because some loans may not be repaid in full, an allowance for credit losses is recorded. An allowance for credit losses is a valuation allowance for probable incurred credit losses. The allowance for credit losses is increased by a provision for credit losses charged to expense and decreased by charge-offs (net of recoveries). The allowance is based on ongoing, quarterly assessments of the probable and estimable losses inherent in the loan portfolio. The Company’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances.

The formula portion of the general credit loss allowance is established by applying a loss percentage factor to the different loan types. The allowances are provided based on Management’s continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, geographic concentrations, seasoning of the loan portfolio, specific industry conditions, and the duration of the current business cycle. The recovery of the carrying value of loans is susceptible to future market conditions beyond the Company’s control, which may result in losses or recoveries differing from those provided.

Specific allowances are established in cases where Management has identified significant conditions or circumstances related to a loan that Management believes indicate the probability that a loss has been incurred. Impaired loans consist of loans receivable that are not expected to be repaid in accordance with their contractual terms and are measured using the fair value of the collateral. Smaller balance loans are excluded from this analysis.

 

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Interest income on loans is accrued over the term of the loans based upon the principal outstanding. The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent that cash payments are received until, in management’s judgment, the borrower has the ability to make contractual interest and principal payments, in which case the loan is returned to accrual status.

Derivative Instruments

The Company regularly enters into commitments to originate and sell loans held for sale. Such commitments are considered derivative instruments under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138. These statements require the Bank to recognize all derivative instruments as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value. As of December 31, 2005 and 2004, the fair value of loan related commitments were equal to the stated value.

Interest Rate Lock Commitments

Commitments to originate loans (interest rate lock commitments), which primarily consist of commitments to originate fixed-rate residential mortgage loans, are recorded at fair value. Changes in the fair value of interest rate lock commitments are recognized in non-interest income on a quarterly basis. At December 31, 2005 and 2004, the fair value of the interest rate lock commitments were equal to the stated value.

Contractual Obligations

The following table presents, as of December 31, 2005, the Company’s significant fixed and determinable contractual obligations, within the categories described below, by payment date or contractual maturity. These contractual obligations are included in the Consolidated Balance Sheets.

 

Contractual Obligations

   Total    Less than
1 Year
   1 to 5
Years
   Over 5
Years

Long-term Debt Obligations

           

Note Payable

   $ 29          $ 29

Executive Retirement

     1,381            1,381

Deferred Compensation

     63            63

Total Long-term Obligation

     1,473      —        —        1,473

Short Term Debt Obligations

           

Securities sold with agreements to repurchase

     470      470      

Total Contractual Obligations

   $ 1,943    $ 470    $ —      $ 1,473

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to interest rate risk through our lending and deposit gathering activities. For a discussion of how this exposure is managed, see “Asset and Liability Management” under Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Neither the Company nor the Bank maintains a trading account for any class of financial instrument, nor do we engage in hedging activities or purchase high-risk derivative instruments. Moreover, neither the Company nor the Bank is subject to foreign currency exchange rate risk or commodity price risk.

 

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The table below provides information about our financial instruments that are sensitive to changes in interest rates as of December 31, 2005. The table presents principal cash flows and related weighted average interest rates by expected maturity dates. The data in this table may not be consistent with the amounts in the “Gap Analysis” table, which represents amounts by the re-pricing date or maturity date (whichever occurs sooner).

 

     By Expected Maturity
     Year Ended December 31,
     2006     2007     2008     2009     2010     After 2010     Total     Fair Value
     (Dollars in thousands)

Investment Securities

                

Amounts maturing:

                

Fixed rate

   $ 7,834     $ 16,830     $ 8,923     $ 3,737     $ 6,208     $ 3,148     $ 46,680     $ 46,022

Weighted average interest rate

     3.04 %     3.84 %     4.72 %     3.79 %     3.71 %     3.82 %     3.85 %  

Adjustable rate

       $ 500           $ 500     $ 491

Weighted average interest rate

         3.30 %           2.75 %  

Totals

   $ 7,834     $ 16,830     $ 9,423     $ 3,737     $ 6,208     $ 3,148     $ 47,180     $ 46,513

Loans

                

Amounts maturing:

                

Fixed rate

   $ 9,675     $ 8,123     $ 10,121     $ 6,616     $ 7,464     $ 4,724     $ 46,723     $ 49,246

Weighted average interest rate

     7.07 %     7.19 %     7.15 %     7.18 %     7.42 %     6.79 %     6.41 %  

Adjustable rate

   $ 35,842     $ 10,606     $ 8,235     $ 11,276     $ 9,831     $ 56     $ 75,846     $ 73,040

Weighted average interest rate

     7.85 %     6.68 %     6.70 %     6.94 %     7.43 %     7.75 %     0.00 %  

Totals

   $ 45,517     $ 18,729     $ 18,356     $ 17,892     $ 17,295     $ 4,780     $ 122,569     $ 122,286

Certificates of Deposit

                

Amounts maturing:

                

Fixed rate

   $ 40,178     $ 9,840     $ 3,473     $ 4,355     $ 3,141     $ 8     $ 60,995     $ 61,003

Weighted average interest rate

     3.36 %     3.84 %     3.52 %     3.87 %     4.40 %     6.58 %     3.54 %  

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required herein is incorporated by reference to Financial Statements following page 44 of this Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There were no changes or disagreements with accountants in 2005.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Section 13(a)-15(e) and 15d-15(e)) of the Securities Exchange Act of 1934 was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this annual report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (1) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (2) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Changes in Internal Controls: There were no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the evaluation date, nor any significant deficiencies or material weaknesses in such controls requiring corrective actions. As a result, no corrective actions were taken.

ITEM 9B. OTHER INFORMATION

None

 

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PART III

(Items 10-14)

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding “Directors and Executive Officers” of Mountain Bank Holding is incorporated by reference from Mountain Bank Holding’s 2006 Annual Proxy Statement (“Proxy Statement”) under the captions “BUSINESS OF THE MEETING-Election of Directors,” “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.”

Information regarding our code of ethics applicable to our principal executive officer and our principal financial officer appears under “INFORMATION REGARDING THE BOARD OF DIRECTORS AND ITS COMMITTEES-Corporate Governance” section of our Proxy Statement and is incorporated by reference. Our Code of Ethics is also filed as an Exhibit to our Report. Information regarding Mountain Bank Holding’s audit committee financial expert appears under the “INFORMATION REGARDING THE BOARD OF DIRECTORS AND ITS COMMITTEES-Certain Committees of the Board of Directors-Audit Committee” section of our Proxy Statement and is incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information regarding “Executive Compensation” of Mountain Bank Holding is incorporated by reference from Mountain Bank Holding’s Proxy Statement under the captions “INFORMATION REGARDING THE BOARD OF DIRECTORS AND ITS COMMITTEES—Compensation of Directors” and “EXECUTIVE COMPENSATION.”

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information regarding “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of Mountain Bank Holding is incorporated by reference from Mountain Bank Holding’s Proxy Statement under the caption “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.”

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding “Certain Relationships and Related Transactions” of Mountain Bank Holding is incorporated by reference from Mountain Bank Holding’s Proxy Statement under the caption “TRANSACTIONS WITH MANAGEMENT.”

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information regarding “Principal Accountant Fees and Services” is incorporated by reference from Mountain Bank Holding’s Proxy Statement under the caption “AUDITORS-FEES PAID TO INDEPENDENT AUDITORS”

 

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PART IV

(Item 15)

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)(1) The following documents are filed as part of this report:

 

     Audited Financial Statements

 

(a)(2) Schedules: None

 

(a)(3) Exhibits:

 

Exhibit No.   

Description

3.1    Amended and Restated Articles of Incorporation of the Registrant (1)
3.2    Amended and Restated By-laws of the Registrant (2)
10.1    Mt. Rainier National Bank 1990 Employee Stock Option Plan (3)
10.2    Mt. Rainier National Bank 1990 Director Stock Option Plan (4)
10.3    Mountain Bank Holding Company 1995 Employee Stock Purchase Plan (3)
10.4    Mountain Bank Holding Company 1999 Employee Stock Option Plan (3)
10.5    Form of 1999 Employee Stock Option Agreements (5)
10.6    Form of Mountain Bank Holding Company 1999 Director Stock Option Plan (5)
10.7    Form of 1999 Director Stock Option Agreement (5)
10.8    Form of 2002 Executive Supplemental Compensation Agreements dated January 1, 2002, as amended on March 3, 2005 for Messrs. Moergeli and Franks and Ms. Brumley (6)
10.9    Split Dollar Life Insurance Agreements for Messrs. Moergeli and Franks and Ms. Brumley (6)
10.10    Form of Change in Control Severance Agreement for Steve Moergeli and Sheila Brumley (6)
10.11    Salary Continuation Agreement for Sterlin Franks (6)
10.12    Form of Participant Long Term Care Agreement for directors and Sterlin Franks and Sheila Brumley (6)
10.13    Form of Amendment to the Supplemental Compensation Agreements for Messrs. Moergeli and Franks and Ms. Brumley (7)
14.    Code of Ethics (8)
23    Consent of McGladrey & Pullen LLP
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32    Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

(1) Incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10Q-SB for the quarter ended June 30, 2000.
(2) Incorporated by reference to exhibit 3.2 of the Registrant’s Annual Report on Form 10K-SB for the fiscal year ended December 31, 2000.
(3) Incorporated by reference to exhibits 99.1, 99.2 and 99.3, respectively, included in the Registrant’s Registration Statement on Form S-8, Registration No. 333-61782
(4) Incorporated by reference to exhibits included in the Registrant’s Registration Statement on Form 10-SB, Registration No. 000-28394
(5) Incorporated by reference to exhibits 6.5, 6.6, 6.7 and 6.8, respectively, of the Registrant’s Annual Report on Form 10KSB for the fiscal year ended December 31, 1999.
(6) Incorporated by reference to exhibits 6.8, 6.9, 6.10, 6.11 and 6.12, respectively, of the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002.
(7) Incorporated by reference to the Form 8-K filed by the registrant on March 8, 2005
(8) Incorporated by reference to Exhibit 12.2 of the Registrants annual report on Form 10KSB for the fiscal year-end December 31, 2003.

 

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Contents

 

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Financial Statements

  

Consolidated Balance Sheets

   F-3

Consolidated Statements of Income

   F-4

Consolidated Statements of Shareholders’ Equity

   F-5

Consolidated Statements of Cash Flows

   F-6

Notes to Consolidated Financial Statements

   F-7-28

 

F-1


Table of Contents

LOGO

Report of Independent Registered Public Accounting Firm

To the Board of Directors

Mountain Bank Holding Company

Enumclaw, Washington

We have audited the consolidated balance sheets of Mountain Bank Holding Company and Subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mountain Bank Holding Company and Subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

LOGO

Seattle, Washington

February 27, 2006

McGladrey & Pullen, LLP is a member firm of RSM International—

an affiliation of separate and independent legal entities.

 

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Table of Contents

Mountain Bank Holding Company and Subsidiary

Consolidated Financial Statements

Consolidated Balance Sheets

December 31, 2005 and 2004

(Dollars in Thousands)

 

     2005     2004  

Assets

    

Cash and due from banks

   $ 4,578     $ 2,364  

Interest bearing deposits at other financial institutions

     2,796       6,185  

Federal funds sold

     3,647       0  

Total cash and cash equivalents

     11,021       8,549  

Securities available for sale

     46,573       37,502  

Federal Home Loan Bank and Federal Reserve Bank stock, at cost

     735       734  

Loans held for sale

     1,790       529  

Loans

     122,435       120,403  

Allowance for credit losses

     1,569       1,376  

Net loans

     120,866       119,027  

Premises and equipment

     7,058       6,194  

Land held for sale

     517       0  

Accrued interest receivable

     863       681  

Bank owned life insurance

     3,922       3,771  

Other assets

     1,179       658  

Total assets

   $ 194,524     $ 177,645  

Liabilities

    

Deposits:

    

Demand, non-interest bearing

   $ 33,298     $ 28,984  

Savings and interest bearing demand

     77,520       74,300  

Time

     60,995       54,316  

Total deposits

     171,813       157,600  

Securities sold with agreements to repurchase

     470       0  

Accrued interest payable

     265       180  

Note payable

     29       32  

Executive retirement

     1,381       981  

Deferred compensation

     63       57  

Other liabilities

     204       226  

Total liabilities

     174,225       159,076  

Commitments and Contingencies

     0       0  

Shareholders’ Equity

    

Common stock (no par value); authorized 10,500,000 shares; issued and outstanding: 2005—2,302,741; 2004—2,260,968

     1,151       1,130  

Additional paid-in capital

     10,933       10,632  

Retained earnings

     8,656       6,910  

Accumulated other comprehensive loss

     (441 )     (103 )

Total shareholders’ equity

     20,299       18,569  

Total liabilities and shareholders’ equity

   $ 194,524     $ 177,645  

See notes to consolidated financial statements.

 

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Mountain Bank Holding Company and Subsidiary

Consolidated Statements of Income

Years Ended December 31, 2005, 2004 and 2003

(Dollars in Thousands, Except Per Share Amounts)

 

     2005    2004    2003

Interest and Dividend Income

        

Loans

   $ 9,309    $ 8,139    $ 7,275

Deposits in banks and federal funds sold

     290      127      177

Investment income:

        

Taxable

     1,225      1,096      940

Tax-exempt

     41      8      16

Dividends on stock

     13      34      49

Total interest and dividend income

     10,878      9,404      8,457

Interest Expense

        

Deposits

     2,458      1,929      1,918

Note payable

     3      3      3

Repurchase agreements

     4      —        —  

Total interest expense

     2,465      1,932      1,921

Net interest income

     8,413      7,472      6,536

Provision for Credit Losses

     199      276      385

Net interest income after provision for credit losses

     8,214      7,196      6,151

Non-Interest Income

        

Service charges and other fees on deposit accounts

     562      581      572

Gains on mortgage loans sold

     485      251      614

Gains on sales of securities available for sale—net

     —        14      —  

Bank owned life insurance income

     151      153      153

Other

     361      246      276

Total non-interest income

     1,559      1,245      1,615

Non-Interest Expenses

        

Salaries and employee benefits

     4,152      4,030      3,628

Occupancy

     414      373      330

Equipment

     483      528      535

Other

     1,656      1,467      1,507

Total non-interest expenses

     6,705      6,398      6,000

Income before income taxes

     3,068      2,043      1,766

Income Taxes

     981      625      544

Net income

   $ 2,087    $ 1,418    $ 1,222

Earnings Per Share

        

Basic

   $ 0.91    $ 0.64    $ 0.57

Diluted

   $ 0.88    $ 0.62    $ 0.55

Average Shares

        

Basic

     2,288,320      2,229,061      2,155,914

Diluted

     2,338,440      2,298,897      2,240,437

See notes to consolidated financial statements.

 

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Mountain Bank Holding Company and Subsidiary

Consolidated Statements of Shareholders’ Equity

Years Ended December 31, 2005, 2004 and 2003

(Dollars in Thousands)

 

    Shares of
Common
Stock
  Common
Stock
  Additional
Paid-in
Capital
  Retained
Earnings
    Accumulated
Other
Comprehensive
Income(Loss)
    Total  

Balance at December 31, 2002

  2,146,813   $ 1,073   $ 9,472   $ 4,489     $ 370     $ 15,404  

Comprehensive income:

           

Net income

          1,222         1,222  

Other comprehensive income, net of tax

           

Change in fair value of securities available for sale

            (220 )     (220 )

Comprehensive income

              1,002  

Sale of common stock under employee stock purchase plan

  1,464     1     17         18  

Exercise of stock options

  28,400     14     66         80  

Tax benefit from exercise of stock options

        100         100  

Balance at December 31, 2003

  2,176,677     1,088     9,655     5,711       150       16,604  

Comprehensive income:

           

Net income

          1,418         1,418  

Other comprehensive income, net of tax

           

Change in fair value of securities available for sale

            (253 )     (253 )

Comprehensive income

              1,165  

Payment of cash dividend ($.10 per share)

          (219 )       (219 )

Sale of common stock

  60,000     30     816         846  

Sale of common stock under employee stock purchase plan

  1,641     1     22         23  

Exercise of stock options

  22,650     11     61         72  

Tax benefit from exercise of stock options

        78         78  

Balance at December 31, 2004

  2,260,968   $ 1,130   $ 10,632   $ 6,910     $ (103 )   $ 18,569  

Comprehensive income:

           

Net income

          2,087         2,087  

Other comprehensive income, net of tax

           

Change in fair value of securities available for sale

            (338 )     (338 )

Comprehensive income

              1,749  

Payment of cash dividend ($.15 per share)

          (341 )       (341 )

Sale of common stock under employee stock purchase plan

  1,673     1     24         25  

Exercise of stock options

  40,100     20     116         136  

Tax benefit from exercise of stock options

        161         161  

Balance at December 31, 2005

  2,302,741   $ 1,151   $ 10,933   $ 8,656     $ (441 )   $ 20,299  

See notes to consolidated financial statements.

 

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Table of Contents

Mountain Bank Holding Company and Subsidiary

Consolidated Statements of Cash Flows

Years Ended December 31, 2005, 2004 and 2003

(Dollars in Thousands)

 

    2005     2004     2003  

Cash Flows from Operating Activities

     

Net Income

  $ 2,087     $ 1,418     $ 1,222  

Adjustments to reconcile net income to net cash provided by operating activities

     

Provision for credit losses

    199       276       385  

Depreciation and amortization

    427       534       526  

Deferred federal income tax expense(benefit)

    (183 )     (182 )     (51 )

Net amortization and accretion of bond premiums and discounts

    178       355       443  

Gains on sales of securities available for sale

    —         (14 )     —    

Stock dividends received

    (2 )     (15 )     (23 )

Gains on loans sold

    (551 )     (251 )     (614 )

Originations of loans held for sale

    (45,179 )     (23,143 )     (40,072 )

Proceeds from sales of loans

    44,918       22,685       43,557  

Deferred loan fee origination fees

    134       —         —    

Gain on sale of foreclosed real estate

    —         (18 )     —    

Bank owned life insurance income

    (151 )     (153 )     (153 )

Executive retirement and deferred compensation

    406       379       327  

(Increase) decrease in accrued interest receivable

    (182 )     (25 )     (55 )

(Increase) decrease is accrued interest payable

    85       21       (46 )

Other—net

    (160 )     483       191  

Net cash provided by operating activities

    2,026       2,350       5,637  

Cash Flows from Investing Activities

     

Activity in securities available for sale and Federal Reserve Bank and FHLB stock

     

Purchases

    (21,199 )     (23,486 )     (20,502 )

Maturities, prepayments and calls

    11,440       16,523       6,521  

Sales

    —         1,000       10,478  

Increase in loans made to customers, net of principal collections

    (2,487 )     (21,660 )     (16,619 )

Additions to premises and equipment

    (1,808 )     (1,142 )     (1,222 )

Proceeds from sale of other real estate owned

    —         158       —    

Purchase of bank owned life insurance

    —         (300 )     —    

Net cash used in investing activities

    (14,054 )     (28,907 )     (21,344 )

Cash Flows from financing Activities

     

Net increase in deposits

    14,213       18,825       11,764  

Net proceeds from issuance of stock

    161       941       98  

Repayment of note payable

    (3 )     (2 )     (2 )

Increase in securities sold with agreements to repurchase

    470       —         —    

Payment of dividends

    (341 )     (219 )     —    

Net cash provided by financing activities

    14,500       19,545       11,860  

Net change in cash and cash equivalents

    2,472       (7,012 )     (3,847 )

Cash and Cash Equivalents

     

Beginning of year

    8,549       15,561       19,408  

End of year

  $ 11,021     $ 8,549     $ 15,561  

Supplemental Disclosures of Cash Flow Information

     

Interest paid

  $ 2,380     $ 1,908     $ 1,967  

Income taxes paid

    1,095       625       544  

Supplemental Disclosures of Non-Cash Investing and Financing Activities

     

Unrealized loss on securities available for sale, net of tax

  $ (338 )   $ (253 )   $ (220 )

See notes to consolidated financial statements.

 

F-6


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003

Note 1—Summary of Significant Accounting Policies

Basis of Consolidation and Operations

The consolidated financial statements include the accounts of Mountain Bank Holding Company (the Company) and its wholly owned subsidiary, Mt. Rainier National Bank (the Bank). All significant inter company transactions and balances have been eliminated. The Company is a holding company, which operates primarily through its major subsidiary, the Bank.

The Bank operates a main office and five branches, and has a customer base centered in and around southeastern King County and northeastern Pierce County, Washington. The Bank provides loan and deposit services to customers, who are predominantly small- and middle-market businesses and middle-income individuals in Western Washington. Its primary funding source is deposits from businesses and individuals in its market area.

Consolidated Financial Statement Presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry. The preparation of consolidated 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 reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, as of the date of the consolidated balance sheet, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for credit losses.

Certain prior year amounts have been reclassified to conform to the 2005 presentation with no change to previously reported net income or shareholders’ equity. All dollar amounts, except per share information, are stated in thousands.

Securities Available for Sale

Securities available for sale consist of debt securities that the Bank intends to hold for an indefinite period, but not necessarily to maturity, and certain equity securities. Such securities may be sold to implement the Bank’s asset/liability management strategies and in response to changes in interest rates and similar factors, and certain equity securities. Securities available for sale are reported at fair value. Unrealized gains and losses, net of the related deferred tax effect, are reported as a net amount in a separate component of shareholder’s equity titled “accumulated other comprehensive income (loss).” Realized gains and losses on securities available for sale, determined using the specific identification method, are included in earnings. Accretion of discounts is recognized in interest income over the period to maturity. Amortization of premiums is recognized in interest income over the period to the call date.

Management evaluates debt and equity securities for other than temporary impairment on a quarterly basis based on the securities’ current credit quality, interest rates, term to maturity, and management’s intent and ability to hold the securities until the net book value is recovered. Any other than temporary declines in value are recognized on the statements of income as loss from securities.

Federal Home Loan Bank and Federal Reserve Bank Stocks

The Bank, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. The recorded amount of FHLB stock equals its fair value because the shares can only be redeemed by the FHLB at the $100 per share par value.

 

F-7


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

As a national bank, the Bank is required to own stock in the Federal Reserve Bank (FRB) in an amount based on its capital. The recorded amount of the FRB stock equals its fair value because the shares can only be redeemed by the FRB at their par value.

Loans Held for Sale

Mortgage loans originated for sale in the foreseeable future in the secondary market are carried at the lower of aggregate cost or estimated market value. Gains and losses on sales of loans are recognized at settlement date and are determined by the difference between the sales proceeds and the carrying value of the loans. All sales are made without recourse. Net unrealized losses are recognized through a valuation allowance established by charges to income. All such loans are sold on a servicing released basis.

The Bank issues various representations and warranties associated with the sale of loans. The Bank has not experienced any significant losses during the years ended December 31, 2005, 2004 and 2003 regarding these representations and warranties.

Premises and Equipment

Premises and equipment are stated at cost less depreciation, which is computed on the straight-line method over the estimated useful lives of the assets, which range from two to five years for furniture and equipment, and thirty years for buildings and improvements. Gains or losses on dispositions are reflected in earnings. These assets are reviewed for impairment when events indicate their carrying value may not be recoverable. If management determines an impairment exists, the asset is reduced with an offsetting charge to expense.

Foreclosed Real Estate

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are initially recorded at the lower of cost or fair value of the properties less estimated costs of disposal. Any write-down to fair value at the time of transfer to foreclosed real estate is charged to the allowance for credit losses. Properties are evaluated regularly to ensure that the recorded amounts are supported by their current fair values. Any subsequent reductions in carrying values and revenue and expense from the operations of properties are charged to non-interest income. There is no foreclosed real estate as of December 31, 2005 and 2004.

Income Taxes

Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and the tax bases of assets and liabilities, and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. The deferred tax provision represents the difference between the net deferred tax asset/liability at the beginning and end of the year. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

The Bank provides for income taxes on a separate return basis and remits to the Company amounts currently payable.

Cash and Cash Equivalents

For purposes of presentation on the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption Cash and due from banks, Interest bearing deposits at other financial institutions and Federal funds sold. The Bank maintains its cash in depository institution accounts which, at times, may exceed federally insured limits. The Bank has not experienced any losses in such accounts.

 

F-8


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Stock-Based Compensation

Expense for employee compensation under stock option and employee stock purchase plans is based on Accounting Principles Board (APB) Opinion 25, with expense reported only if options are granted below market price at grant date.

SFAS No. 123, Accounting for Stock-Based Compensation, requires pro forma disclosures for companies that do not adopt its fair value accounting method of stock-based employee compensation awards granted. Accordingly, the following pro forma information presents net income and earnings per share had the fair value method been used to measure compensation cost for stock option and employee stock purchase plans. The exercise price of options granted is equivalent to the market value of underlying stock at the grant date. Accordingly, no compensation cost was actually recognized for stock options during 2005, 2004 and 2003.

 

     2005     2004     2003  

Net income, as reported

   $ 2,087     $ 1,418     $ 1,222  

Less total stock-based compensation expense determined under fair value method for all qualifying awards, net of related tax effects

     (81 )     (97 )     (125 )

Pro forma net income

   $ 2,006     $ 1,321     $ 1,097  

Earnings per share

      

Basic:

      

As reported

   $ 0.91     $ 0.64     $ 0.57  

Pro forma

     0.88       0.59       0.51  

Diluted:

      

As reported

     0.89       0.62       0.55  

Pro forma

     0.86       0.58       0.49  

The fair value of stock options granted were estimated at the date of grant using the Black-Scholes option pricing model. The Black Scholes option pricing model was originally developed for use in estimating the fair value of traded options, which have different characteristics from the Company’s employee stock options. The model is also sensitive to changes in assumptions, which can materially affect the fair value estimate. The following weighted-average assumptions were used to determine the fair value:

 

     For the Calendar Year  
       2005         2004         2003    

Risk free interest rate

   4.02 %   4.51 %   3.46 %

Expected dividend yield

   0.22     0.17     0  

Expected volatility

   17.01     23.40     24.00  

Expected option life (in years)

   6     9     9  

Weighted-average grant date fair value of options

   4.68     6.25     5.52  

Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating the fair values of financial instruments disclosed in these financial statements.

Cash and Cash Equivalents

The carrying amounts of cash and due from banks, interest bearing deposits at other financial institutions, and federal funds sold approximate their fair value.

 

F-9


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Securities Available for Sale

Fair value for securities is based on quoted market prices.

Federal Home Loan Bank and Federal Reserve Bank Stock

The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates their fair values.

Loans

For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of loans held for sale are based on their estimated market prices. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Deposit Liabilities

The fair value of deposits with no stated maturity date is included at the amount payable on demand. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation based on interest rates currently offered on similar certificates.

Note Payable

The fair value of the note payable is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest

The carrying amounts of accrued interest approximate their fair values.

Off-Balance-Sheet Instruments

The fair value of commitments to extend credit and standby letters of credit was estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the customers. Since the majority of the Bank’s off-balance-sheet instruments consist of non-fee producing, variable-rate commitments, the Bank has determined they do not have a distinguishable fair value.

Earnings Per Share

Basic earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if common shares were issued pursuant to the exercise of options under the Company’s stock option plans.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income(loss). Other comprehensive income(loss) includes the net change in net unrealized gains and losses on securities available for sale, net of reclassification adjustment and tax effects, and is also recognized as a separate component of shareholders’ equity.

 

F-10


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS No. 123. SFAS 123R will require the Company to, among other things, measure all employee stock-based compensation awards using a fair value method and record such expense in the Company’s consolidated financial statements. The provisions of SFAS 123R are effective no later than the beginning of the next fiscal year that begins after December 31, 2005; the Company will adopt the new requirements in its first quarter of fiscal 2006 using the modified prospective transition method. The adoption of SFAS 123R will increase the Company’s future compensation expense for unvested awards outstanding as of December 31, 2005 by the following estimated amounts:

 

Year ended December 31,

   Estimated additional
compensation expense
     (in thousands)

2006

   $ 60

2007

     38

2008

     20

2009

     7

2010

     2

In addition, additional compensation costs in 2006 and beyond will be further impacted by various factors; among them being our future compensation strategy.

At its November 12-13, 2003 meeting, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company adopted the disclosure requirements in fiscal year 2003. At the March 17-18, 2004 meeting, the EITF reached a consensus, which approved an impairment model for debt and equity securities. In FASB Staff Position (“FSP”) 03-01-01, issued in September 2004, the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of Issue 03-01 was delayed.

On November 3, 2005, FSP FAS Nos. 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” was issued. This FSP nullifies certain requirements of Issue 03-1 and supersedes EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” This FSP nullified the requirements of paragraphs 10-18 of Issue 03-1, carried forward the requirements of paragraph 8 and 9 of Issue 03-1 with respect to cost-method investments and carries forward the disclosure requirements included in paragraphs 21 and 22 of Issue 03-1 and related examples. The guidance in this FSP shall be applied to reporting periods beginning after December 15, 2005. The Company believes the adoption of this FSP in 2006 will not materially impact our results of operations, financial condition, or related disclosures.

In May 2005, FASB issued SFAS No. 154, Accounting Changes for Error Corrections (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It established, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transaction requirements specific to the newly adopted accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on the Company’s consolidated financial statements.

 

F-11


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Loans Receivable

Loans receivable 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 balances adjusted for any charge-offs, the allowance for credit losses, and any deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method.

Generally the accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when they are past due 90 days as to either principal or interest, unless they are well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against current income. If management determines that the ultimate collectibility of principal is in doubt, cash receipts on non-accrual loans are applied to reduce the principal balance on a cash-basis method, until the loans qualify for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Because some loans may not be repaid in full, an allowance for credit losses is recorded. An allowance for credit losses is a valuation allowance for probable incurred credit losses. The allowance for credit losses is increased by a provision for credit losses charged to expense and decreased by charge-offs (net of recoveries). The allowance is based on ongoing, quarterly assessments of the probable and estimable losses inherent in the loan portfolio. The Company’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances.

The formula portion of the general credit loss allowance is established by applying a loss percentage factor to the different loan types. The allowances are provided based on Management’s continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, geographic concentrations, seasoning of the loan portfolio, specific industry conditions, and the duration of the current business cycle. The recovery of the carrying value of loans is susceptible to future market conditions beyond the Company’s control, which may result in losses or recoveries differing from those provided.

Specific allowances are established in cases where Management has identified significant conditions or circumstances related to a loan that Management believes indicate the probability that a loss has been incurred. Impaired loans consist of loans receivable that are not expected to be repaid in accordance with their contractual terms and are generally measured using the fair value of the collateral. Smaller balance loans are excluded from this analysis.

Interest income on loans is accrued over the term of the loans based upon the principal outstanding. The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent that cash payments are received until, in management’s judgment, the borrower has the ability to make contractual interest and principal payments, in which case the loan is returned to accrual status.

Derivative Instruments

The Bank regularly enters into commitments to originate and sell loans held for sale. Such commitments are considered derivative instruments under Statement of Financial Accounting Standards (“SFAS”) No. 133,

 

F-12


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

“Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138. These statements require the Bank to recognize all derivative instruments as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value.

Commitments to originate loans (interest rate lock commitments), which primarily consist of commitments to originate fixed-rate residential mortgage loans, are recorded at fair value. Changes in the fair value of interest rate lock commitments are recognized in non-interest income on a quarterly basis.

As of December 31, 2005 and 2004 the fair values of the derivatives have been determined to be insignificant.

Note 2—Restricted Assets

Federal Reserve Board regulations require maintenance of minimum reserve balances either in cash on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The amounts of such balances for the years ended December 31, 2005 and 2004 were $1,316 and $854, respectively.

Note 3—Securities Available for Sale

Debt and equity securities have been classified according to management’s intent.

The carrying amounts of securities and their approximated fair values are as follows:

 

     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value

Securities Available for Sale

           

December 31, 2005

           

U.S. Treasury securities

   $ 4,005    $ —      $ 29    $ 3,976

U.S. Government and agency securities

     25,809      —        329      25,480

Mortgage-backed securities

     14,533      1      297      14,237

Obligations of states and political subdivisions

     2,647      —        12      2,635

Corporate securities

     186      —        1      185

Equity securities

     60      —        —        60
   $ 47,240    $ 1    $ 668    $ 46,573

December 31, 2004

           

U.S. Treasury securities

   $ 3,094    $ 7    $ 14    $ 3,087

U.S. Government and agency securities

     16,835      22      115      16,742

Mortgage-backed securities

     15,106      53      130      15,029

Obligations of states and political subdivisions

     295      2      —        297

Corporate securities

     2,268      20      1      2,287

Equity securities

     60      —        —        60
   $ 37,658    $ 104    $ 260    $ 37,502

There were no gross gains or losses on the sales of securities in 2005 and 2003. Gross gains on the sales of securities were $14 in 2004. There were no gross losses on the sales of securities in 2004.

 

F-13


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

The carrying amount and approximate market value of debt securities at December 31, 2005 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have a right to call or prepay obligations, with or without call or prepayment penalties.

 

     Amortized
Cost
   Fair
Value

Due in one year or less

   $ 7,834    $ 7,741

Due in one to five years

     36,198      35,647

Due in five years or more

     3,148      3,125
   $ 47,180    $ 46,513

Securities with a carrying value of $2,310 and $1,893 at December 31, 2005 and 2004, respectively, were assigned or pledged to secure public deposits, and for other purposes as required by law.

The following table shows the unrealized gross losses and fair value of securities in the available for sale portfolio at December 31, 2005, by the length of time that individual securities in each category have been in a continuous loss position:

 

     Less Than 12 Months    More Than 12 Months    Total
     Unrealized
Gross Loss
    Fair Value    Unrealized
Gross Loss
    Fair Value    Unrealized
Gross Loss
    Fair Value

U.S. Treasury securities

   $ (1 )   $ 979    $ (28 )   $ 2,011    $ (29 )     2,990

U.S. Government and agency securities

     (74 )     12,390      (255 )     13,090      (329 )     25,480

Mortgage-backed securities

     (79 )     5,350      (218 )     7,939      (297 )     13,289

Obligations of states and political subdivisions

     (12 )     899      —         —        (12 )     899

Corporate securities

   $ (1 )   $ 185           (1 )     185
   $ (167 )   $ 19,803    $ (501 )   $ 23,040    $ (668 )   $ 42,843

The Company has evaluated these securities and has determined that the decline in the value is temporary. This assessment was based on the following factors: i) the length of time and the extent to which the market value has been less than cost; ii) the financial condition and near-term prospects of the issuer; iii) the intent and the ability of the Company to retain its investment in a security for a period of time sufficient to allow for any anticipated recovery in market value; and iv) general market conditions which reflect prospects for the economy as a whole, including interest rates and sector credit spreads.

Note 4—Loans

Loans at December 31 consist of the following:

 

     2005     2004

Commercial and agricultural

   $ 24,025     $ 26,918

Real estate:

    

Residential 1-4 family

     10,234       9,304

Commercial

     71,264       67,077

Construction

     12,671       11,696

Consumer

     4,375       5,408

Gross loans

     122,569       120,403

Net deferred fees

     (134 )     —  

Total net loans

   $ 122,435     $ 120,403

 

F-14


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Changes in the allowance for credit losses for the years ended December 31 are as follows:

 

     2005     2004     2003  

Balance at beginning of year

   $ 1,376     $ 1,101     $ 852  

Provision for credit losses

     199       276       385  

Charge-offs

     (6 )     (19 )     (142 )

Recoveries

     0       18       6  

Net charge-offs

     (6 )     (1 )     (136 )

Balance at end of year

   $ 1,569     $ 1,376     $ 1,101  

Following is a summary of information pertaining to impaired loans:

 

       2005        2004        2003  

December 31

        

Impaired loans without a valuation allowance

   $ —      $ —      $ —  

Impaired loans with a valuation allowance

     20      —        104

Total impaired loans

   $ 20    $ —      $ 104

Valuation allowance related to impaired loans

   $ 2    $ —      $ 15

Years Ended December 31

        

Average investment in impaired loans

   $ 24    $ 62    $ 155

Interest income recognized on a cash basis on impaired loans

     —        —        7

At December 31, 2005, there were no commitments to lend additional funds to borrowers whose loans have been modified. There were no loans past due over 90 days and still accruing at December 31, 2005 and one loan in the amount of $8 past due over 90 days and still accruing interest at December 31, 2004.

At December 31, 2005 and 2004, certain officers and directors, or companies in which they have a 10% or more beneficial interest, were indebted to the Bank in the aggregate amount of $1,666 and $2,354, respectively. During 2005 advances of $480 were made, and repayments totaled $1,168.

Note 5—Premises and Equipment

The components of premises and equipment at December 31 are as follows:

 

     2005    2004

Land

   $ 2,590    $ 2,459

Buildings

     4,745      4,201

Equipment, furniture and fixtures

     3,208      2,803

Construction in process

     133      19
     10,676      9,482

Less accumulated depreciation

     3,618      3,288

Total premises and equipment

   $ 7,058    $ 6,194

 

F-15


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 6—Deposits

The composition of deposits at December 31 is as follows:

 

     2005    2004

Demand deposits, non-interest bearing

   $ 33,298    $ 28,984

NOW and money market accounts

     57,866      58,059

Savings deposits

     19,654      16,241

Time certificates, $100 or more

     25,751      23,486

Other time certificates

     35,244      30,830

Total

   $ 171,813    $ 157,600

Scheduled maturities of certificates of deposit for future years ending December 31 are as follows:

 

2006

   $ 40,178

2007

     9,840

2008

     3,473

2009

     4,355

2010

     3,141

2011

     8
   $ 60,995

Note 7—Note Payable

The note payable is secured by land, and is payable in monthly installments, including interest of 8%. Future principal maturities are $3 annually through 2009, and $17 thereafter.

Note 8—Income Taxes

The components of the provision for income taxes are as follows at December 31:

 

     2005     2004     2003  

Current

   $ 1,164     $ 807     $ 595  

Deferred expense (benefit)

     (183 )     (182 )     (51 )

Income taxes

   $ 981     $ 625     $ 544  

The effect of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31 follows:

 

     2005    2004

Deferred Tax Assets

     

Allowance for credit losses

   $ 499    $ 432

Deferred compensation

     491      306

Accumulated depreciation

     24      —  

Other

     11      3

Unrealized loss on securities available for sale

     226      53

Total deferred tax assets

     1,251      794

Deferred Tax Liabilities

     

Accumulated depreciation

     —        6

Deferred income

     501      394

Unrealized gain on securities available for sale

     —        —  

Total deferred tax liabilities

     501      400

Net deferred tax assets

   $ 750    $ 394

 

F-16


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

The following is a reconciliation between statutory and effective federal income tax rates for the years ended December 31:

 

     2005     2004     2003  
     Amount     Percent of
Pre-tax
Income
    Amount     Percent of
Pre-tax
Income
    Amount     Percent of
Pre-tax
Income
 

Income tax at statutory rate

   $ 1,074     35 %   $ 715     35 %   $ 618     35 %

Increase (decrease) resulting from:

            

Tax-exempt income

     (14 )   (0.5 )     (3 )   (0.2 )     (5 )   (0.3 )

Bank-owned life insurance

     (53 )   (1.7 )     (52 )   (2.5 )     (54 )   (3.1 )

Other

     (26 )   (0.8 )     (35 )   (1.7 )     (15 )   (0.8 )

Total income tax expense

   $ 981     32.0 %   $ 625     30.6 %   $ 544     30.8 %

Note 9—Commitments and Contingencies

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. The financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. A summary of the Bank’s commitments is as follows:

 

     2005    2004

Commercial and agriculture

   $ 12,158    $ 13,935

Real estate

     9,111      4,852

Credit cards

     —        3,506
   $ 21,269    $ 22,293

Outstanding commitments under letters of credit totaled $264 and $286 at December 31, 2005 and 2004, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank’s experience has been that approximately 75% of loan commitments are drawn upon by customers. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies as specified above, and is required in instances where the Bank deems necessary.

 

F-17


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

The Bank has agreements with commercial banks for lines of credit totaling approximately $15,000, and a credit line with the Federal Home Loan Bank of Seattle totaling 10% of assets. The Bank has entered into a blanket pledge agreement with the Federal Home Loan Bank to secure this credit line. These lines were not drawn upon at December 31, 2005 or 2004.

Note 10—Concentration of Credit Risk

The Bank has credit risk exposure, including off-balance-sheet credit risk exposure, as disclosed in Notes 4 and 9. The ultimate collectibility of a substandard portion of the loan portfolio is susceptible to changes in economic and market conditions in the region. The Bank generally requires collateral on all real estate loans and typically maintains loan-to-value ratios of no greater than 75% to 80%. Loans are generally limited, by federal and state banking regulations, to 15% of the Bank’s shareholder’s equity, excluding accumulated other comprehensive income (loss). The Bank, as a matter of practice, generally does not extend credit to any single borrower or group of related borrowers in excess of $3,000.

The contractual amounts of credit related financial instruments such as commitments to extend credit, credit card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults, and the value of any existing collateral becomes worthless. Investments in obligations of states and political subdivisions involve governmental entities within the Bank’s market area. Letters of credit were granted primarily to commercial borrowers.

Note 11—Stock Option Plans

Director Plans

The 1990 Director Stock Option Plan grants a director an option to purchase 3,000 shares of common stock upon initial election to the Board of Directors at an exercise price equal to the fair market value of the common stock at the date of grant. Options are exercisable on a cumulative basis in annual installments of one-third each on the third, fourth and fifth anniversary of the date of grant. A total of 126,000 shares of the Company’s common stock were reserved for option under this plan, of which options for 113,400 shares at $2.38 per share were granted on June 13, 1990, all of which were exercised prior to expiration on June 13, 2005 and options for 3,150 shares at $10.48 per share were granted on April 24, 2001 to expire April 24, 2016. Options granted in 1990 are fully vested. Of the options granted in 2001, 2,100 are vested at December 31, 2005. Options for 33,850 and 17,400 were exercised in 2005 and 2004, respectively, under this director plan. Options for 9,450 shares remain available under this plan.

The 1999 Director Stock Option Plan grants a director an option to purchase shares of common stock at an exercise price which must be no less than the greater of the fair market value of the common stock or the net book value of the common stock at the time of grant. A total of 42,000 shares of the Company’s common stock were reserved for option under this plan, of which 33,600 shares at $10.48 per share (fair market value) were granted on November 21, 2000, expiring on November 21, 2015. Options for 4,450 were granted on April 20, 2004 at $15.00 per share (fair market value), expiring on April 20, 2019. Options for 3,950 were granted on June 15, 2004 at $15.00 per share (fair market value), expiring on June 15, 2019. At December 31, 2005, options for 42,000 were outstanding under the 1999 plan; 33,600 shares were vested at December 31, 2005.

Employee Plans

In 1990 and 1999, the Company adopted plans providing for granting certain key employees options to purchase common stock. Under the terms of the plans, options are incentive stock options (as defined in the

 

F-18


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Internal Revenue Code). The option price will be fair market value at the date of grant or a price determined by the Board of Directors, but not less than fair value. Options are exercisable on a cumulative basis in annual installments of one-third each on the third, fourth and fifth anniversary of the date of grant. Pursuant to these plans, 210,000 shares are reserved for option as of December 31, 2005, of which 197,825 shares (after forfeitures) have been granted, A total of 12,175 shares remain available for future grant under the 1999 plan at December 31, 2005. No shares remain available for grant under the 1990 plan. In 2005 and 2004, options for 6,250 shares and 5,250 shares, respectively, were exercised under the employee plans.

A summary of the status of the Company’s stock option plans as of December 31, 2005, 2004 and 2003, and changes during the years ended on those dates, is presented below:

 

     2005    2004    2003
     Shares     Weighted
Average
Exercise
Price
   Shares     Weighted
Average
Exercise
Price
   Shares     Weighted
Average
Exercise
Price

Outstanding at beginning of year

   191,075     $ 8.60    201,325     $ 7.58    207,825     $ 6.17

Granted

   9,000       17.17    13,800       15.00    24,000       14.00

Exercised

   (40,100 )     3.38    (22,650 )     3.21    (28,400 )     2.80

Forfeited

   (6,200 )     13.92    (1,400 )     10.48    (2,100 )     8.33

Outstanding at end of year

   153,775     $ 10.26    191,075     $ 8.60    201,325     $ 7.58

Options exercisable at year-end

   107,724     $ 8.43    130,473     $ 6.61    126,850     $ 5.36

The following information summarizes information about stock options outstanding and exercisable at December 31, 2005:

 

Range of exercise prices

   Number
Outstanding
   Weighted
Average
Remaining
Contractual
Life (Years)
   Weighted
Average
Exercise
Price
   Number
Exercisable
   Weighted
Average
Exercise
Price

$5.95 - $6.19

   35,700    1.8    5.97    35,700    5.97

$8.33 - $11.00

   76,775    4.5    9.72    72,024    9.64

$14.00 - $17.50

   41,300    8.4    14.98    —      —  

Note 12—Profit Sharing Plan

The Bank’s defined contribution profit sharing plan covers substantially all employees who have completed one year or more of service. Employees are eligible to defer up to 25% of their gross salary, with employer contributions to the Plan made at the discretion of the Board of Directors. The Bank’s contributions for the years ended December 31, 2005, 2004 and 2003 totaled $63, $57 and $53, respectively.

Note 13—Deferred and Executive Compensation Plans

In 1993 the Bank established a deferred compensation agreement with a director under which the director will defer a portion of his director fees. At retirement he will receive a benefit of $1.250 per month for 120 months. The accrued liability related to this agreement totaled $63, $57 and $52 at December 31, 2005, 2004 and 2003. Expenses associated with this plan were $5 annually in 2005, 2004 and 2003. The Bank has also purchased a whole-life insurance policy on the director, with values of $48, $44 and $40 at December 31, 2005, 2004 and 2003, which may be used to fund benefits under the deferred compensation plan.

 

F-19


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

The Company has three executive supplemental retirement agreements with certain members of management of the Company. The agreements provide for a defined cash benefit payable monthly upon reaching normal retirement as defined in the agreements (or upon early retirement as defined in the agreements with reduced benefit). Upon retirement of three executives, benefits will be payable in monthly installments, increasing 2.5% per year, for the life of the executive. The estimated liability under the executive supplemental retirement agreements is charged to compensation expense over the period to early retirement. The liability at December 31, 2005 and 2004 was $1,381 and $981, and amounts charged to compensation expense were $400, $373 and $322 in 2005, 2004 and 2003.

The agreements are unfunded; however, the Company has purchased life insurance (Bank owned life insurance) on the lives of four officers and expects to use the income generated from the life insurance to fund the benefits. In conjunction with purchasing the life insurance, the Company executed “Endorsement Split-Dollar Life Insurance Agreements” with each of its three Executive Officers and one non-executive officer. Pursuant to the agreements, the Company paid the premium on the policy on each officer’s life. The Company is the sole owner of the policy and its net cash surrender value, and in the event of the officer’s death while serving as a full-time employee of the Company, the Company will be entitled to receive at a minimum, that amount of the death proceeds equal to the cash surrender value. A portion of the death proceeds will be paid to the officer’s designated beneficiaries in lieu of the executive supplemental retirement benefit.

In 2002, the Company entered into severance agreements with Mr. Steve Moergeli and Ms. Sheila Brumley. The Severance Agreements provide for payments in the event of a change in the ownership or effective control of a substantial portion of the assets of the Company or the Bank. If Mr. Moergeli and/or Ms. Brumley remain employed with the Company and the Bank through the closing of a change in control, he and/or she, as the case may be, will receive a single cash payment equal to two times his or her highest W-2 income received from the Company and/or the Bank over the three years preceeding the closing. Subject to certain limitations imposed by the “parachute payment” provisions (Section 280G) of the Internal Revenue Code, assuming that severance occurred within the scope of the Severance Agreements effective January 1, 2006, the amounts that would be payable to Mr. Moergeli and Ms. Brumley would be $353 and $252, respectively.

Also in 2002, the Company purchased long-term care insurance on certain board members and management personnel. Benefits under this plan vest over five years from the date of the plan. Expenses related to this plan were $48 in 2005, 2004 and 2003.

Note 14—Employee Stock Purchase Plan

Effective July 1, 1995, the Company adopted an employee stock purchase plan whereby eligible employees can purchase common stock at the lesser of the stock’s fair market value at the beginning or the end of the plan year. The aggregate number of shares reserved under this plan is 42,000. At December 31, 2005, 20,545 remain available for purchase under this plan. No employee can purchase more than 420 shares of common stock in any given plan year; 1,673, 1,641 and 1,464 shares were purchased at a price of $15.00, $14.00 and $12.00 per share for the year’s ended December 31, 2005, 2004 and 2003, respectively.

Note 15—Regulatory Matters

The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can cause certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital adequacy guidelines that

 

F-20


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier 1 and total capital (as defined) to risk-weighted assets (as defined).

As of December 31, 2005, the most recent notification from the Bank’s regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution’s category.

The Company’s and the Bank’s actual capital amounts and ratios are also presented in the table.

 

                Capital
Adequacy
        

To be Well Capitalized

Under Prompt

Corrective Action

 
    

Actual

Amount

   Ratio     Purposes
Amount
   Ratio    

Provisions

Amount

   Ratio  

December 31, 2005

               

Tier 1 Capital (to average assets):

               

Consolidated

   $ 20,740    10.71 %   $ 7,747    4.00 %     N/A    N/A  

Bank

     20,123    10.41       7,730    4.00     $ 9,662    5.00 %

Tier 1 Capital (to risk-weighted assets):

               

Consolidated

     20,740    14.70       5,645    4.00       N/A    N/A  

Bank

     20,123    14.29       5,632    4.00       8,448    6.00  

Total Capital (to risk-weighted assets):

               

Consolidated

     22,310    15.81       11,290    8.00       N/A    N/A  

Bank

     21,692    15.41       11,265    8.00       14,081    10.00  

December 31, 2004

               

Tier 1 Capital (to average assets):

               

Consolidated

   $ 18,671    10.47 %   $ 7,132    4.00 %     N/A    N/A  

Bank

     18,253    10.25       7,121    4.00     $ 8,902    5.00 %

Tier 1 Capital (to risk-weighted assets):

               

Consolidated

     18,671    13.70       5,451    4.00       N/A    N/A  

Bank

     18,253    13.40       5,449    4.00       8,174    6.00  

Total capital (to risk-weighted assets):

               

Consolidated

     20,047    14.71       10,901    8.00       N/A    N/A  

Bank

     19,629    14.41       10,898    8.00       13,623    10.00  

Management believes, as of December 31, 2005, that the Company and the Bank meet all capital requirements to which they are subject.

Restrictions on Retained Earnings

National banks can initiate dividend payments in a given year, without prior regulatory approval, equal to net profits, as defined, for that year plus retained net profits for the preceding two years. The Bank can distribute as dividends to the parent company approximately $4,507 as of December 31, 2005 without regulatory approval.

 

F-21


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 16—Condensed Financial Information—Parent Company Only

Condensed Balance Sheets—December 31

 

     2005    2004

Assets

     

Cash

   $ 299    $ 163

Investment in the Bank

     19,682      18,150

Premises and equipment

     297      302

Other assets

     157      1

Total assets

   $ 20,435    $ 18,616

Liabilities

     

Dividend checks payable

   $ 3    $ —  

Income taxes payable

     —        18

Due to Bank

     133      29

Total liabilities

   $ 136    $ 47

Shareholders’ Equity

   $ 20,299    $ 18,569

Total liabilities and shareholders’ equity

   $ 20,435    $ 18,616

Condensed Statements of Income—Years Ended December 31

 

     2005     2004     2003  

Operating Income

      

Dividend income from the Bank

   $ 350     $ 100     $ 310  

Other income

     3       3       2  

Total operating income

     353       103       312  

Operating Expenses

     (202 )     (182 )     (184 )

Income (loss) before income taxes and equity in undistributed income of the Bank

     151       (79 )     128  

Income Tax Expense

     68       61       63  

Income (loss) before income taxes and equity in undistributed income of the Bank

     219       (18 )     191  

Equity in Undistributed Income of the Bank

     1,868       1,436       1,031  

Net income

   $ 2,087     $ 1,418     $ 1,222  

 

F-22


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Condensed Statements of Cash Flows—Years Ended December 31

 

     2005     2004     2003  

Cash Flows from Operating Activities

      

Net income

   $ 2,087     $ 1,418     $ 1,222  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

      

Equity in undistributed income of subsidiary

     (1,868 )     (1,436 )     (1,031 )

Depreciation

     5       4       3  

(Increase) Decrease in other assets

     (156 )     1       —    

(Decrease) Increase in other liabilities

     143       18       —    

Payable to bank

     104       29       —    

Other

     1       (20 )     (1 )

Net cash provided by operating activities

     316       14       193  

Cash Flows from Investing Activities

      

Investment in subsidiary

     —         (750 )     —    

Additions to premises and equipment

     —         —         (311 )

Net cash used in investing activities

     —         (750 )     (311 )

Cash Flows from Financing Activities

      

Proceeds from issuance of common stock

     161       941       198  

Payment for cash dividend

     (341 )     (219 )     —    

Net cash provided by (used in) financing activities

     (180 )     722       198  

Net change in cash

     136       (14 )     80  

Cash

      

Beginning of year

     163       177       97  

End of year

   $ 299     $ 163     $ 177  

Note 17—Other Expenses

Other expenses include the following amounts which are in excess of 1% of the total of interest income and non-interest income for the years ended December 31:

 

       2005        2004        2003  

Professional fees

   $ 118    $ 35    $ 106

Data processing

     434      416      387

Office supplies and expenses

     110      90      114

State taxes

     147      122      121

Director fees

     125      119      130

 

F-23


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 18—Earnings Per Share Disclosures

Following is information regarding the calculation of basic and diluted earnings per share for the years indicated:

 

     Net Income
(Numerator)
   Shares
(Denominator)
   Per Share
Amount
 

Year Ended December 31, 2005

        

Basic earnings per share:

        

Net Income

   $ 2,087    2,288,320    $ 0.91  

Effect of dilutive securities:

        

Options and stock purchase plan

     0    50,120      (0.03 )

Diluted earnings per share:

        

Net income

   $ 2,087    2,338,440    $ 0.88  

Year Ended December 31, 2004

        

Basic earnings per share:

        

Net Income

   $ 1,418    2,229,061    $ 0.64  

Effect of dilutive securities:

        

Options and stock purchase plan

     0    69,836      (0.02 )

Diluted earnings per share:

        

Net income

   $ 1,418    2,298,897    $ 0.62  

Year Ended December 31, 2003

        

Basic earnings per share:

        

Net Income

   $ 1,222    2,155,914    $ 0.57  

Effect of dilutive securities:

        

Options and stock purchase plan

     0    84,523      (0.02 )

Diluted earnings per share:

        

Net income

   $ 1,222    2,240,437    $ 0.55  

Note 19—Comprehensive Income

The following table represents net unrealized gains and losses, less reclassification adjustments for the years ended,

 

     Before Tax
Amount
    Tax Benefit
(Expense)
   Net of Tax
Amount
 

2005

       

Unrealized holding losses arising during the year

   $ (511 )   $ 173    $ (338 )

Reclassification adjustments for gains realized in net income

     —         —        —    

Net unrealized (losses)

   $ (511 )   $ 173    $ (338 )

2004

       

Unrealized holding losses arising during the year

   $ (369 )   $ 125    $ (244 )

Reclassification adjustments for gains realized in net income

     (14 )     5    $ (9 )

Net unrealized (losses)

   $ (383 )   $ 130    $ (253 )

2003

       

Unrealized holding losses arising during the year

   $ (333 )   $ 113    $ (220 )

Reclassification adjustments for gains realized in net income

     —         —        —    

Net unrealized (losses)

   $ (333 )   $ 113    $ (220 )

 

F-24


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 20—Fair Values of Financial Instruments

The estimated fair values of the Bank’s financial instruments at December 31 were as follows:

 

     2005    2004
     Carrying
Amount
   Fair Value    Carrying
Amount
   Fair Value

Financial Assets

           

Cash and cash equivalents

   $ 11,021    $ 11,021    $ 8,549    $ 8,549

Securities available for sale

     46,573      46,573      37,502      37,502

Federal Home Loan Bank and Federal Reserve Bank stocks

     735      735      734      734

Loans held for sale

     1,790      1,821      529      536

Loans

     120,866      119,014      119,027      118,745

Accrued interest receivable

     863      863      681      681

Financial Liabilities

           

Deposits

   $ 171,813    $ 171,802    $ 157,600    $ 157,763

Securities sold with agreements to repurchase

     470      470      —        —  

Note payable

     29      29      32      32

Accrued interest payable

     265      265      180      180

The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Bank’s financial instruments will change when interest rate levels change and that change may either be favorable or unfavorable to the Bank. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to do so in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.

Management monitors rates and maturities of assets and liabilities, and attempts to minimize interest rate risk by adjusting terms of new loans, and deposits and by investing in securities with terms that mitigate the Bank’s overall interest rate risk.

Note 21—Subsequent Event

On January 17, 2006, the Board of Directors approved a dividend in the amount of $.18 per share to be paid on or about March 3, 2006 to shareholders of record as of February 1, 2006.

 

F-25


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 22—Quarterly Data (Unaudited)

 

     First
Quarter
   Second
Quarter
   Third
Quarter
   Fourth
Quarter

Year Ended December 31, 2005

           

Interest income

   $ 2,412    $ 2,595    $ 2,883    $ 2,988

Interest expense

     521      554      660      730

Net interest income

     1,891      2,041      2,223      2,258

Provision for credit losses

     54      54      46      45

Non-interest income

     338      399      471      351

Non-interest expense

     1,562      1,616      1,727      1,800

Income before income taxes

     613      770      921      764

Income taxes

     192      251      290      248

Net income

   $ 421    $ 519    $ 631    $ 516

Earnings per common share:

           

Basic

   $ 0.19    $ 0.23    $ 0.27    $ 0.22

Diluted

     0.18      0.22      0.27      0.22

Year Ended December 31, 2004

           

Interest income

   $ 2,134    $ 2,315    $ 2,433    $ 2,522

Interest expense

     452      468      493      519

Net interest income

     1,682      1,847      1,940      2,003

Provision for credit losses

     69      69      69      69

Non-interest income

     304      345      333      263

Non-interest expense

     1,601      1,561      1,600      1,636

Income before income taxes

     316      562      604      561

Income taxes

     93      181      189      162

Net income

   $ 223    $ 381    $ 415    $ 399

Earnings per common share:

           

Basic

   $ 0.10    $ 0.17    $ 0.19    $ 0.18

Diluted

     0.10      0.16      0.18      0.18

Year Ended December 31, 2003

           

Interest income

   $ 2,043    $ 2,104    $ 2,160    $ 2,150

Interest expense

     517      476      475      453

Net interest income

     1,526      1,628      1,685      1,697

Provision for credit losses

     58      124      109      94

Non-interest income

     385      464      466      300

Non-interest expense

     1,488      1,491      1,597      1,424

Income before income taxes

     365      477      445      479

Income taxes

     107      151      136      150

Net income

   $ 258    $ 326    $ 309    $ 329

Earnings per common share:

           

Basic

   $ 0.12    $ 0.15    $ 0.15    $ 0.15

Diluted

     0.12      0.14      0.14      0.15

 

F-26


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

Note 23—Operating Segments

Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information, requires public enterprises to report certain information about their operating segments in the financial statements. The basis for determining the Company’s operating segments is the way in which management operates the businesses. Mountain Bank Holding has identified three business segments, Community Banking under the name of Mt. Rainier National Bank, mortgage lending transactions under the name of Mt. Rainier Mortgage, and other which includes non-deposit financial product sales under the name of DFC Financial Services. The non-deposit financial product sales do not meet the quantitative thresholds to be considered reportable segments under FAS 131 even when combined. Community Banking includes the branch banking network which have been aggregated into one reportable segment due to their similar economic characteristics. Mt. Rainier Mortgage originates first and second lien mortgages for sale in the secondary market.

Summarized financial information concerning Mountain Bank Holding’s reportable segments is shown in the following table. The “Other” column includes non-deposit financial product sales.

 

     As of and for the year ended
December 31, 2005
     Community
Banking
   Mt. Rainier
Mortgage
   Other     Consolidated
     (dollars in thousands)

Interest income

   $ 10,453    $ 425    $ —       $ 10,878

Interest expense

     2,444      21      —         2,465

Net interest income

     8,009      404      —         8,413

Provision for credit losses

     199      —        —         199

Noninterest income

     936      567      56       1,559

Noninterest expense

     6,018      620      67       6,705

Income(loss) before income taxes

     2,728      351      (11 )     3,068

Provision for income taxes

     861      120      —         981

Net income

     1,867      231      (11 )     2,087

Depreciation and amortization

     419      8      —         427

Assets

     194,291      244      (11 )     194,524

Loans, net*

     120,866      1,790      —         122,656

Deposits

     171,813      —        —         171,813

Equity

     20,079      231      (11 )     20,299

 

F-27


Table of Contents

Mountain Bank Holding Company and Subsidiary

Notes to Consolidated Financial Statements—(Continued)

December 31, 2005, 2004 and 2003

 

     As of and for the year ended
December 31, 2004
     Community
Banking
   Mt. Rainier
Mortgage
   Other     Consolidated
     (dollars in thousands)

Interest income

   $ 9,182    $ 222    $ —       $ 9,404

Interest expense

     1,923      9      —         1,932

Net interest income

     7,259      213      —         7,472

Provision for credit losses

     276      —        —         276

Noninterest income

     921      292      32       1,245

Noninterest expense

     5,963      369      66       6,398

Income(loss) before income taxes

     2,077      136      (34 )     2,043

Provision for income taxes

     578      47      —         625

Net income

     1,363      89      (34 )     1,418

Depreciation and amortization

     529      5      —         534

Assets

     177,588      91      (34 )     177,645

Loans, net*

     119,037      529      —         119,566

Deposits

     157,600      —        —         157,600

Equity

     18,514      89      (34 )     18,569
    

As of and for the year ended

December 31, 2003

     Community
Banking
   Mt. Rainier
Mortgage
   Other     Consolidated
     (dollars in thousands)

Interest income

   $ 8,145    $ 312    $ —       $ 8,457

Interest expense

     1,892      29      —         1,921

Net interest income

     6,253      283      —         6,536

Provision for credit losses

     385      —        —         385

Noninterest income

     868      709      38       1,615

Noninterest expense

     5,401      536      63       6,000

Income (loss) before income taxes

     1,335      456      (25 )     1,766

Provision for income taxes

     392      152      —         544

Net income

     943      304      (25 )     1,222

Depreciation and amortization

     520      6      —         526

Assets

     156,139      311      (25 )     156,425

Loans, net*

     97,643      —        —         97,643

Deposits

     138,775      —        —         138,775

Equity

     16,325      304      (25 )     16,604

* Includes loans held for sale

 

F-28


Table of Contents

Signatures

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized on March 10, 2006.

Mountain Bank Holding Company

 

By:

 

/s/    ROY T. BROOKS        

  Roy T. Brooks, Chairman of the Board & CEO

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 10th day of March 2006.

 

By:

 

/s/    ROY T. BROOKS        

     
 

Roy T. Brooks, Chairman of the Board & CEO

(Principal Executive Officer)

     

By:

 

/s/    SHEILA M. BRUMLEY        

     
 

Sheila M. Brumley, CFO & Secretary to the Board

(Principal Accounting Officer)

     

By:

 

/s/    SUSAN K. BOWEN-HAHTO        

   

By:

 

/s/    BRIAN W. GALLAGHER        

  Susan K. Bowen-Hahto, Director       Brian W. Gallagher, Director

By:

 

/s/    MICHAEL K. JONES        

   

By:

 

/s/    BARRY C. KOMBOL        

  Michael K. Jones, Director       Barry C. Kombol, Director

By:

 

/s/    STEVE W. MOERGELI        

   

By:

 

/s/    JOHN W. RAEDER        

  Steve W. Moergeli, Director       John W. Raeder, Director

By:

 

/s/    GARRETT S. VAN BEEK        

   

By:

 

/s/    HANS R. ZURCHER        

  Garrett S. Van Beek, Director       Hans R. Zurcher, Director

By:

 

/s/    J.B. RUPERT        

     
  J.B. Rupert, Director      
EX-23 2 dex23.htm CONSENT OF MCGLADREY & PULLEN LLP Consent of McGladrey & Pullen LLP

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement No. 33-61782 of Mountain Bank Holding Company on Form S-8 of our report, dated February 27, 2006, relating to the consolidated financial statements of Mountain Bank Holding Company which appear in this Form 10-K for the year ended December 31, 2005.

 

/s/    MCGLADREY & PULLEN, LLP

Tacoma, Washington

March 10, 2006

EX-31.1 3 dex311.htm CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 Certification of Chief Executive Officer Pursuant to Section 302

Exhibit 31.1

CERTIFICATION

I, Roy T. Brooks, President and CEO, certify that:

(1) I have reviewed this annual report on Form 10-K of Mountain Bank Holding Company.

(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

(3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: March 10, 2006

   

/s/    ROY T. BROOKS        

    Roy T. Brooks, President & CEO
EX-31.2 4 dex312.htm CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 Certification of Chief Financial Officer Pursuant to Section 302

Exhibit 31.2

CERTIFICATION

I, Sheila M. Brumley, SVP and CFO, certify that:

(1) I have reviewed this annual report on Form 10-K of Mountain Bank Holding Company.

(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

(3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: March 10, 2006

   

/s/    SHEILA M. BRUMLEY        

    Sheila M. Brumley, SVP & CFO
EX-32 5 dex32.htm CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER Certifications of Chief Executive Officer and Chief Financial Officer

Exhibit 32

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Mountain Bank Holding Company (the “Company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Roy T. Brooks, Chief Executive Officer and Sheila M. Brumley, Chief Financial Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of the operations of the Company.

 

/s/    ROY T. BROOKS        

   

/s/    SHEILA M. BRUMLEY        

Roy T. Brooks, Chief Executive Officer     Sheila M. Brumley, Chief Financial Officer

Date: March 10, 2006

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