-----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, BTH2r1fHmqZLOzRZ0PV0RieryApamM9FyN41yXmeBggcKv1kGZQJXfbqQXWL49OR svGFjaLat3e3lh+m3DZreg== 0000946924-02-000010.txt : 20021227 0000946924-02-000010.hdr.sgml : 20021227 20021227162429 ACCESSION NUMBER: 0000946924-02-000010 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021227 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KLAMATH FIRST BANCORP INC CENTRAL INDEX KEY: 0000946924 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 931180440 STATE OF INCORPORATION: OR FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-26556 FILM NUMBER: 02870466 BUSINESS ADDRESS: STREET 1: 540 MAIN ST CITY: KLAMATH FALLS STATE: OR ZIP: 97601 BUSINESS PHONE: 5418823444 MAIL ADDRESS: STREET 2: 540 MAIN STREET CITY: KLAMATH STATE: OR ZIP: 97601 10-K 1 k10_0902.txt 10K FOR YEAR ENDED 9/30/02 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 September 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-26556 KLAMATH FIRST BANCORP, INC. (Exact name of registrant as specified in its charter) Oregon 93-1180440 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) I.D. Number) 540 Main Street, Klamath Falls, Oregon 97601 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (541) 882-3444 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) 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 whether 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 the Registrant's knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. YES NO X Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES X NO As of November 29, 2002, there were issued and outstanding 6,746,481 shares of the Registrant's common stock. The Registrant's voting stock is traded over-the-counter and is listed on the Nasdaq National Market under the symbol "KFBI." The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based on the closing sales price of the Registrant's common stock as quoted on the Nasdaq National Market on November 29, 2002 of $15.15, was $85,830,492. For purposes of this calculation, common stock of the Registrant held by officers and directors of the Registrant and the Klamath First Federal Savings and Loan Association Employee Stock Ownership Plan are considered affiliates. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of Registrant's Annual Report to Shareholders for the Fiscal Year Ended September 30, 2002 ("Annual Report") (Parts I and II). 2. Portions of Registrant's Definitive Proxy Statement for the 2003 Annual Meeting of Shareholders (Part III). PART I Item 1. Business General Klamath First Bancorp, Inc. ("Company"), an Oregon corporation, was organized on June 16, 1995 for the purpose of becoming the holding company for Klamath First Federal Savings and Loan Association ("Association") upon the Association's conversion from a federal mutual to a federal stock savings and loan association ("Conversion"). The Conversion was completed on October 4, 1995. At September 30, 2002, the Company had total assets of $1.5 billion, total deposits of $1.1 billion and shareholders' equity of $119.9 million. All references to the Company herein include the Association where applicable. The Association was organized in 1934. The Association is regulated by the Office of Thrift Supervision ("OTS") and its deposits are insured up to applicable limits under the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Association also is a member of the Federal Home Loan Bank ("FHLB") System through the FHLB of Seattle. In July 1997, the Association acquired 25 former First Interstate Bank branches from Wells Fargo Bank, N.A. The branches are located in rural communities throughout Oregon and expanded and complemented the then existing network of the Association's branches. The acquisition was accounted for as a purchase and resulted in the addition of approximately $241.3 million in deposits on the acquisition date of July 18, 1997. In September 2001, the Association acquired 13 branches from Washington Mutual Bank ("WAMU"), 11 of which are located on the northern and southern Oregon coast and two of which are located in northeastern Oregon. These locations enhance the Association's geographic coverage on the coast and in northeastern Oregon. The acquisition was accounted for as a purchase and resulted in the addition of approximately $179.3 million in loans, assumption of $423.5 million in deposits, and addition of 124 experienced branch personnel on the acquisition date of September 7, 2001. As part of the purchase, the Company also recorded $15.0 million of core deposit intangible and $24.1 million of other intangible assets. See Note 2 of the Notes to Consolidated Financial Statements contained in the 2002 Annual Report to Shareholders ("Annual Report"), included as Exhibit 13 to this Form 10-K. The Association is a progressive, community-oriented financial institution that focuses on serving customers within its primary market area. Accordingly, the Association is primarily engaged in attracting deposits from the general public through its offices and using those and other available sources of funds to originate permanent residential one- to four-family real estate loans within its market area, as well as commercial real estate and multi-family residential loans, loans to consumers, and loans for commercial purposes. At September 30, 2002, permanent residential one- to four-family real estate loans totaled $339.4 million, or 54.53% of total loans. While the Association has historically emphasized fixed rate mortgage lending, it has been diversifying its loan portfolio by focusing on increasing the number of originations of commercial real estate loans, multi-family residential loans, residential construction loans, small business loans and consumer loans. Significant progress was made toward increasing the commercial and consumer loans in the portfolio with the purchase of the branches from WAMU. These newer loan products generally carry adjustable rates, higher yields, or shorter terms than the traditional fixed rate mortgages. This lending strategy is designed to enhance earnings, reduce interest rate risk, and provide a more complete range of financial services to customers and the local communities served by the Association. At September 30, 2002, the Association's total loan portfolio consisted of 66.43% fixed rate and 33.57% adjustable rate loans, after deducting loans in process and non-performing loans. Market Area The Association continues to expand its market area in Oregon and Washington. Upon the acquisition of 13 branches from WAMU in September 2001, the Association had a presence in 26 of Oregon's 36 counties and had one 1 in-store branch in the state of Washington. In fiscal 2002, new in-store branches were opened in Hermiston, Eugene and Springfield, Oregon and Richland, Washington. Also during fiscal 2002, a second branch was opened in Medford, Oregon, expanding service to that community. The Association's primary market area, which encompasses the State of Oregon and some adjacent areas of California, Idaho, and Washington, can be characterized as a predominantly rural area containing a number of communities that are experiencing moderate to rapid population growth. The population growth in the market area, particularly in Southern Oregon, has been supported in large part by the agreeable climate, and by favorable real estate values. The economy of the market area is still based primarily on agriculture and lumber and wood products, but is experiencing diversification into light manufacturing, health care and other services and sectors. Tourism is a significant industry in many regions of the market area, including Central Oregon and the Oregon coast. The addition of branches in the Eugene-Springfield metropolitan area provides access to this major population center. Yields Earned and Rates Paid The following table sets forth, for the periods and at the date indicated, the weighted average yields earned on interest-earning assets, the weighted average interest rates paid on interest-bearing liabilities, and the interest rate spread between the weighted average yields earned and rates paid.
Year Ended At September 30, September 30, -------------------------------------- 2002 2002 2001 2000 ------ ------ ------ ------ Weighted average yield: Loans receivable ............................ 7.36% 7.90% 7.86% 7.64% Mortgage-backed and related securities ...... 5.54 5.18 6.02 5.86 Investment securities ....................... 4.80 4.72 5.64 6.00 Federal funds sold .......................... 1.70 2.09 4.13 5.59 Interest-earning deposits ................... 1.79 1.75 4.06 5.63 FHLB stock .................................. 6.05 6.25 6.75 6.69 Combined weighted average yield on interest-bearing assets ....................... 6.28 6.35 6.99 7.22 ---- ---- ---- ---- Weighted average rate paid on: Tax and insurance reserve ................... 1.29 2.85 3.85 2.02 Passbook and statement savings .............. 0.75 1.13 2.26 1.78 Interest-bearing checking ................... 0.44 0.74 1.08 1.12 Money market ................................ 1.44 2.00 3.85 4.17 Certificates of deposit ..................... 4.00 4.35 5.76 5.40 FHLB advances/Short term borrowings ......... 5.07 5.69 5.95 5.90 Combined weighted average rate on interest-bearing liabilities .................. 3.19 3.31 4.81 4.72 ---- ---- ---- ---- Interest rate spread ........................... 3.09% 3.04% 2.18% 2.50% ==== ==== ==== ----
2 Average Balances, Net Interest Income and Yields Earned and Rates Paid Reference is made to the section entitled "Average Balances, Net Interest Income and Yields Earned and Rates Paid" on page 13 of the Annual Report, which section is incorporated herein by reference. Interest Sensitivity Gap Analysis Reference is made to the section entitled "Interest Sensitivity Gap Analysis" on page 10 of the Annual Report, which section is incorporated herein by reference. Rate/Volume Analysis Reference is made to the section entitled "Rate/Volume Analysis" on page 14 of the Annual Report, which section is incorporated herein by reference. Lending Activities General. As a federally chartered savings and loan association, the Association has authority to originate and purchase loans secured by real estate located throughout the United States. With the expanded market area provided by the branch acquisitions in 1997 and 2001, the Association's mortgage lending has diversified throughout the state of Oregon. It is management's intention, subject to market conditions, that the Association will continue to originate long-term mortgage loans for the purchase, construction or refinance of one- to four-family residential real estate to meet the needs of customers in our market area. However, to enhance interest income and reduce interest rate risk, the Association is placing increased emphasis on the origination or purchase of adjustable rate loans secured by one- to four- family residential, multi-family residential and commercial real estate, the majority of which are located outside Klamath, Jackson, and Deschutes counties. Subject to market conditions, the Association sells loans to Fannie Mae (formerly the Federal National Mortgage Association) and other agents. Permanent residential one- to four-family mortgage loans amounted to $339.4 million, or 54.53%, of the Association's total loan portfolio before net items at September 30, 2002. The Association originates other loans secured by multi-family residential and commercial real estate, construction and land loans. Those loans amounted to $137.6 million, or 22.11%, of the total loan portfolio before net items at September 30, 2002. Approximately 23.36%, or $145.4 million, of the Association's total loan portfolio before net items, as of September 30, 2002, consisted of non-real estate loans. Commercial real estate and non-real estate loans increased significantly as a result of the WAMU branch acquisition in September 2001. The acquisition included $179.3 million in loans, of which $118.8 million were commercial real estate and commercial business loans and $50.7 million were consumer loans. Fiscal 2002 showed continued growth in non-real estate loans. Permissible loans-to-one borrower by the Association are generally limited to 15% of unimpaired capital and surplus. The Association's loan-to-one borrower limitation was $15.4 million at September 30, 2002. At September 30, 2002, the Association had 54 borrowing relationships with outstanding balances in excess of $1.0 million, the largest of which amounted to $7.2 million and consisted of eight loans, five of which were secured by commercial and single family real estate and three of which were unsecured. The Association has emphasized the origination or purchase of adjustable rate loans in order to increase the interest rate sensitivity of its loan portfolio. The Association has been successful in expanding the production of adjustable rate consumer loans and has purchased adjustable rate single family, multi-family residential and non- residential real estate loans. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Market Risk and Asset/Liability Management" and "INTEREST SENSITIVITY GAP ANALYSIS" in the Annual Report. At September 30, 2002, $207.5 million, or 33.57%, of loans in the 3 Association's total loan portfolio after loans in process and non-performing loans, consisted of adjustable rate loans. At September 30, 2001, $203.7 million, or 29.43%, of the Association's loans carried adjustable rates. 4 Loan Portfolio Analysis. The following table sets forth the composition of the loan portfolio by type of loan at the dates indicated.
At September 30, -------------------------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ----------------- ----------------- ----------------- ---------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- ------- ------- ------- -------- (Dollars in thousands) Real estate loans: Permanent residential one- to four-family ...... $339,404 54.53% $421,499 60.12% $639,165 85.12% $647,130 83.56% $577,471 81.95% Multi-family residential ... 21,595 3.47 23,257 3.32 19,015 2.53 18,412 2.38 19,230 2.73 Construction ............... 15,224 2.45 21,674 3.09 25,289 3.37 53,219 6.87 64,289 9.12 Agricultural ............... 4,889 0.79 4,218 0.60 -- -- -- -- -- -- Commercial ................. 91,703 14.73 99,318 14.17 42,277 5.63 37,079 4.79 29,457 4.18 Land ....................... 4,164 0.67 3,697 0.53 3,394 0.45 2,064 0.27 2,185 0.31 -------- ------- -------- ------- -------- ------- ------- ------- ------- -------- Total real estate loans ...... 476,979 76.64 573,663 81.83 729,140 97.10 757,904 97.87 692,632 98.29 -------- ------- -------- ------- -------- ------- ------- ------- ------- -------- Non-real estate loans: Savings accounts ........... 1,262 0.20 2,091 0.30 1,957 0.26 1,800 0.23 1,991 0.28 Home improvement and home equity loans ............. 65,092 10.46 50,464 7.20 8,338 1.11 6,726 0.87 5,750 0.82 Other consumer ............. 16,926 2.72 18,697 2.67 6,888 0.92 4,568 0.59 2,287 0.32 Commercial ................. 62,102 9.98 56,098 8.00 4,586 0.61 3,443 0.44 2,043 0.29 -------- ------- -------- ------- -------- ------- ------- ------- ------- -------- Total non-real estate loans .. 145,382 23.36 127,350 18.17 21,769 2.90 16,537 2.13 12,071 1.71 -------- ------- -------- ------- -------- ------- ------- ------- ------- -------- Total loans ................. 622,361 100.00% 701,013 100.00% 750,909 100.00% 774,441 100.00% 704,703 100.00% ======= ======= ======= ======= ======= Less: Undisbursed portion of loans . 3,609 8,473 10,350 24,176 26,987 Deferred loan fees ........... 3,911 4,599 7,440 7,988 7,620 Allowance for loan losses .... 7,376 7,951 4,082 2,484 1,950 -------- -------- -------- -------- -------- Net loans .................... $607,465 $679,990 $729,037 $739,793 $668,146 ======== ======== ======== ======== ========
5 The following table sets forth the amount of fixed-rate and adjustable rate loans, net of loans in process and non-performing loans, included in the total loan portfolio at the dates indicated.
At September 30, ---------------------------------------------------------------- 2002 2001 -------------------------- -------------------------- Amount Percent Amount Percent --------- ------- --------- ------- (Dollars in thousands) Fixed rate... . . . . . $410,499 66.43% $488,559 70.57% Adjustable-rate......... 207,458 33.57 203,719 29.43 -------- ------ -------- ------ Total.............. $617,957 100.00% $692,278 100.00% ======== ====== ======== ======
Permanent Residential One- to Four-Family Mortgage Loans. The primary lending activity of the Association has been the origination of permanent residential one- to four-family mortgage loans. Management believes that this policy of focusing on single-family residential mortgage loans has been successful in contributing to interest income while keeping delinquencies and losses to a minimum. At September 30, 2002, $339.4 million, or 54.53%, of the Association's total loan portfolio, before net items, consisted of permanent residential one- to four-family mortgage loans, down from $421.5 million at September 30, 2001. At September 30, 2002, the average balance of the Association's permanent residential one- to four-family mortgage loans was $78,397. The Association presently originates both fixed-rate mortgage loans and adjustable rate mortgages ("ARMs") secured by one- to four-family properties with terms of 15 to 30 years. Historically, most of the loans originated by the Association have been fixed rate loans secured by one- to four-family properties. At September 30, 2002, $311.4 million, or 50.40%, of the total loans after loans in process and non-performing loans were fixed rate one- to four-family loans and $28.4 million, or 4.59%, were ARM loans. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment. In order to improve interest rate risk, the Association sells the majority of its conforming fixed rate one- to four-family mortgage production, while ARM loans are retained in the portfolio. The loan fees charged, interest rates and other provisions of the Association's ARM loans are determined by the Association on the basis of its own pricing criteria and competitive market conditions. At September 30, 2002, the Association charged origination fees ranging from 1.00% to 1.75% on its ARM loans. In an attempt to increase adjustable rate mortgages in the loan portfolio, the Association offers several loan products which are competitive with other institutions originating mortgages in the Association's primary market area. The Association has introduced variable rate loan products that bear fixed rates for the first three or five years and then reprice annually thereafter. The loans which bear fixed rates for five years are indexed to the One-Year Constant Maturity Treasury Bill Index and have a maximum rate increase of 5.00% over the life of the loan. The loans which bear fixed rates for the first three years are indexed to the FHLB of Seattle 12-Month Short Term Advance Rate and have a maximum increase of 6.00% over the life of the loan. All ARM loan products have a maximum increase or decrease of 2.00% in any one year. As a supplement to origination of ARM loans, the Association purchases ARMs from other institutions when suitable loans can be found which meet its underwriting criteria. The Association qualifies an ARM loan borrower based on the borrower's ability to repay the loan using the fully indexed rate. As a result, the Association believes that the potential for delinquencies and defaults on ARM loans when rates adjust upwards is lessened. The retention of ARM loans in the Association's loan portfolio helps reduce the Association's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased costs 6 due to changed rates to be paid by the customer. It is possible that, during periods of rising interest rates, the risk of default on ARM loans may increase as a result of repricing with increased costs to the borrower. The ARM loans originated by the Association generally provide, as a marketing incentive, for initial rates of interest below the rates which would apply were the adjustment index used for pricing initially (discounting). Increased risks of default or delinquency could occur because of discounting the rate. Another consideration is that although ARM loans allow the Association to increase the sensitivity of its asset base to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Because of these considerations, the Association has no assurance that yields on ARM loans will be sufficient to offset increases in the Association's cost of funds. The loan-to-value ratio, maturity and other provisions of the loans made by the Association generally have reflected the policy of making loans in accordance with sound lending practices, market conditions and underwriting standards established by the Association. The Association's lending policies on permanent residential one- to four-family mortgage loans generally limit the maximum loan-to-value ratio to 97% of the lesser of the appraised value or purchase price of the property. All permanent residential one- to four-family mortgage loans in excess of an 80% loan-to-value ratio require private mortgage insurance. The Association also has a limited amount of non-owner-occupied permanent residential one- to four-family mortgage loans in its portfolio. These loans are underwritten using generally the same criteria as owner-occupied permanent residential one- to four-family mortgage loans, except that the maximum loan-to-value ratio is generally 80% of the lesser of the appraised value or purchase price of the property and such loans are generally provided at an interest rate higher than owner-occupied loans. The Association offers fixed-rate, permanent residential one- to four-family mortgage loans with terms of 15 to 30 years. Substantially all permanent one- to four-family loans have original contractual terms to maturity of 30 years. Such loans are amortized on a monthly basis with principal and interest due each month and customarily include "due-on-sale" clauses. The Association enforces due-on-sale clauses to the extent permitted under applicable laws. Substantially all of the Association's mortgage loan portfolio consists of conventional loans. Commercial and Multi-Family Real Estate Loans. The Association originates loans secured by multi-family and commercial real estate and also purchases participations in loans secured by multi-family and commercial real estate when suitable investments can be found. See "-- Loan Originations, Purchases, and Sales." At September 30, 2002, $21.6 million, or 3.47%, of the Association's total loan portfolio before net items consisted of loans secured by existing multi-family residential real estate and $91.7 million, or 14.73%, of the Association's total loan portfolio before net items consisted of loans secured by existing commercial real estate. The Association's commercial and multi-family real estate loans primarily include loans secured by office buildings, small shopping centers, churches, mini-storage warehouses and apartment buildings. Substantially all of the Association's commercial and multi-family real estate loans are secured by properties located in the Association's primary market area. The average outstanding balance of commercial and multi-family real estate loans was $248,667 at September 30, 2002, the largest of which was a $3.5 million commercial real estate loan secured by a motel. Originations of commercial real estate and multi-family residential real estate amounted to 11.2%, 16.46% and 11.09% of the Association's total loan originations in the fiscal years ended September 30, 2002, 2001, and 2000, respectively. As part of the WAMU acquisition in September 2001, the Association purchased $9.1 million in multi-family residential loans and $54.6 million in commercial real estate loans. During the year ended September 30, 2002 the Association purchased $1.7 million in commercial real estate participations. The properties securing these loans were located within the Association's market area. The Association's commercial and multi-family loans generally have terms which range up to 25 years and loan-to-value ratios of up to 75%. The Association currently originates fixed and adjustable rate commercial and multi-family real estate loans. Commercial real estate and multi-family adjustable rate loans are priced to be competitive with other commercial lenders in the Association's market area. A variety of terms are available to meet specific commercial and multi-family residential financing needs. As of September 30, 2002, $105.6 million, or 17.07%, after 7 loans in process and non-performing loans of other mortgage loans, including commercial and multi-family residential real estate loans, had adjustable rates of interest. Multi-family residential and commercial real estate lending is generally considered to involve a higher degree of risk than permanent residential one- to four-family lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. The Association generally attempts to mitigate the risks associated with multi-family residential and commercial real estate lending by, among other things, lending on collateral located in its market area and following strict underwriting standards. Loans considered for purchase are subjected to the same underwriting standards as those originated in-house. Construction Loans. The Association makes construction loans to individuals for the construction of their single-family residences. The Association also makes loans to builders for the construction of single-family residences which are not presold at the time of origination ("speculative loans") and for construction of commercial properties. Speculative loans are scheduled to pay off in 12 to 18 months. At September 30, 2002, construction loans amounted to $15.2 million (including $4.6 million of speculative loans), or 2.45%, of the Association's total loan portfolio before net items. The Association purchased $1.7 million in commercial construction loans from WAMU as part of the branch purchase. During the construction phase, the borrower pays only interest on the disbursed loan proceeds until maturity, when the total amount is due. The Association's construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. The Association periodically reviews the progress of the underlying construction project through physical inspections. Construction financing is generally considered to involve a higher degree of risk of loss than financing on improved, owner-occupied real estate because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates and, in the case of speculative loans, the need to obtain a purchaser. The Association has sought to minimize the risks associated with construction lending by limiting construction loans to qualified owner-occupied borrowers with construction performed by qualified state licensed builders located primarily in the Association's market area. The Association's underwriting criteria are designed to evaluate and minimize the risks of each construction loan. Loan proceeds are disbursed only as construction progresses and inspections warrant. These loans are underwritten to the same standards and to the same terms and requirements as one- to four-family purchase mortgage loans, except the loans provide for disbursement of funds during a construction period of up to one year. During this period, the borrower is required to make monthly payments of accrued interest on the outstanding loan balance. Disbursements during the construction period are limited to no more than the percent of completion. Up to 97% loan-to-value upon completion of construction may be disbursed if private mortgage insurance above 80% loan-to-value is in place. Land Loans. The Association makes loans to individuals for the purpose of acquiring land upon which to build their permanent residence. These loans generally have 20 year amortization periods, with a balloon payment due in five years, and maximum loan-to-value ratios of 80%. As of September 30, 2002, $4.2 million, or 0.67%, of the Association's total loan portfolio consisted of land loans. Commercial Business Lending. The purchase of the branches from WAMU in September 2001 included significant commercial business loans as well as the lending expertise needed for commercial lending activities. As a result, commercial business lending has increased due to both loans purchased from WAMU and new originations during fiscal 2002. The Association's commercial business lending activities focus primarily on small to medium size businesses owned by individuals well known to the Association and who reside in the Association's primary market area. At September 30, 2002, commercial business loans amounted to $62.1 million, or 9.98% of the total loan portfolio and 8 42.72% of total non-real estate loans. Included in these loans are $14.2 million of agricultural loans. See "-- Agricultural Lending." Commercial business loans may be unsecured loans, but generally are secured by various types of business collateral other than real estate (such as, inventory, equipment, etc.). In many instances, however, such loans are often also secured by junior liens on real estate. Lines of credit are generally renewable and made for a one-year term and are generally variable rate indexed to the prime rate. Term loans are generally originated with three to five year maturities, with a maximum of seven years, on a fully amortizing basis. As with commercial real estate loans, the Association generally requires annual financial statements from its commercial business borrowers and, if the borrower is a corporation, personal guarantees from the principals. Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential, commercial and multi-family real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan primarily depends on cash flow and profitability of the business, and creditworthiness of the borrower (and guarantors) and requires successful operation and management of the business entity while liquidation of the collateral is a secondary and sometimes insufficient source of repayment. Consequently, repayment of such loans may be affected by adverse business or economic conditions. As part of its commercial business lending activities, the Association issues standby letters of credit or performance bonds as an accommodation to its borrowers. See "-- Loan Commitments and Letters of Credit." Agricultural Lending. The Association did not offer loans on agricultural properties or for agricultural production until the WAMU branch acquisition, even though agriculture is a major industry in the Association's market area. As part of the WAMU branch acquisition, the Association purchased $4.2 million of agricultural real estate loans and $11.9 million of agricultural production loans, as well as obtaining lending personnel with expertise in originating and monitoring agricultural loans. At September 30, 2002, agricultural loans amounted to $19.1 million, or 3.07%, of the total loan portfolio; $4.9 million of these loans were secured by real estate. In underwriting agricultural operating loans, the Association considers the cash flow of the borrower based upon the expected income stream as well as the value of collateral used to secure the loan. Collateral generally consists of livestock or cash crops produced by the farm, such as grains, corn, and alfalfa. In addition to considering cash flow and obtaining a blanket security interest in the farm's cash crop, the Association may also collateralize an operating loan with the equipment, breeding stock, real estate, and federal agricultural program payments to the borrower. Payments on agricultural operating loans depend on the successful operation of the farm, which may be adversely affected by weather conditions that limit crop yields, fluctuations in market prices for agricultural products and livestock, and changes in government regulations and subsidies. Agricultural real estate loans primarily are secured by first liens on farmland and improvements thereon located in the Association's market area to service the needs of the Association's existing customers. Among the greater and more common risks to agricultural lending can be weather conditions and disease. These risks can be mitigated through multi-peril crop insurance. Uncertain supplies of water in some market areas has the potential to decrease yields and increase energy costs for the Association's borrowers. However, very few of the Association's agricultural loans are secured by real estate or operations in the Klamath Basin, which was affected by 9 curtailment of irrigation water during the summer of 2001, and those being financed have liquid secondary sources of repayment. Commodity prices also present a risk which may be reduced by the use of set price contracts. Federal savings and loan associations are authorized to make loans secured by business or agricultural real estate in amounts up to 400% of capital and to make additional loans to businesses and farms (which may, but need not be secured by real estate) in amounts up to 20% of assets provided that all loans in excess of the 10% of assets must be made to small businesses and farms that qualify as small businesses. Effective January 1, 2002 the OTS increased the dollar amount limit in the definition of small business loans from $1 million to $2 million and farm loans from $500,000 to $2 million. As of September 30, 2002, the Association was well within the regulatory limits for such business loans. Consumer and Other Lending. The Association originates a variety of consumer loans. Such loans generally have shorter terms to maturity and higher interest rates than mortgage loans. At September 30, 2002, the Association's consumer loans totaled $83.3 million, or 13.38%, of the Association's total loans. A total of $50.6 million in consumer loans were added to the portfolio as part of the WAMU branch acquisition in September 2001. The Association's consumer loans consist primarily of home improvement and equity loans, automobile loans, boat and recreational vehicle loans, unsecured loans, and deposit account loans. The Association has placed increasing emphasis on the origination of consumer loans due to their shorter terms and higher yields than residential mortgage loans. The Association anticipates that it will continue to be an active originator of these loans. Factors that may affect the ability of the Association to increase its originations in this area include the demand for such loans, interest rates and the state of the local and national economy. The Association offers consumer lines of credit on either a secured or unsecured basis. Secured lines of credit are generally secured by a second mortgage on the borrower's primary residence. Secured and unsecured lines of credit have interest rates that vary above the prime lending rate based on the credit risk of the borrower, collateral, and loan amount. In both cases, the rate adjusts monthly. The Association requires minimum payment of interest only, and depending on the loan product, may require at least 2% of the unpaid principal balance monthly. At September 30, 2002, $29.4 million was outstanding on approved lines of credit. The Association offers home equity and home improvement loans that are made on the security of primary residences. Loans normally have terms of up to 15 years requiring monthly payments of principal and interest. At September 30, 2002, home equity loans and home improvement loans amounted to $65.1 million, or 78.16% of consumer loans, and 10.46% of total loans. At September 30, 2002, the Association's automobile loan portfolio amounted to $7.7 million, or 9.19%, of consumer loans and 1.23% of total loans at that date. The maximum term for the Association's automobile loans is 72 months with the amount financed based upon a percentage of purchase price. The Association generally requires all borrowers to maintain the automobile insurance, including collision, fire and theft, with a maximum allowable deductible and with the Association listed as loss payee. At September 30, 2002, unsecured consumer loans amounted to $5.1 million, or less than 1%, of total loans. These loans are made for a maximum of 48 months or less with fixed rates of interest and are offered primarily to existing customers of the Association. Consumer loans potentially have a greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles and other vehicles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the 10 application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At September 30, 2002, the Association had $248,000 in consumer loans accounted for on a nonaccrual basis. Loan Maturity and Repricing. The following table sets forth certain information at September 30, 2002 regarding the dollar amount of total loans, after loans in process and non-performing loans, maturing in the Association's portfolio, based on the contractual terms to maturity or repricing date. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.
After One Year Within One Year Through 5 Years After 5 Years Total --------------- --------------- ------------- --------- (In thousands) Permanent residential one- to four-family: Adjustable rate................... $ 19,116 $ 9,256 $ -- $ 28,372 Fixed rate........................ 853 1,626 308,948 311,427 Other mortgage loans: Adjustable rate................... 32,996 72,276 237 105,509 Fixed rate........................ 609 4,516 22,385 27,510 Non-real estate loans: Adjustable rate................... 64,557 8,951 69 73,577 Fixed rate........................ 3,616 19,244 48,702 71,562 -------- -------- -------- -------- Total loans..................... $121,747 $115,869 $380,341 $617,957 ======== ======== ======== ========
Scheduled contractual amortization of loans does not reflect the actual term of the Association's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which gives the Association the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The dollar amount of all loans, net of loans in process and non-performing loans, due one year after September 30, 2002, which have fixed interest rates and have adjustable rates, was $405.4 million and $90.8 million, respectively. Loan Commitments. The Association issues commitments for fixed and adjustable rate loans conditioned upon the occurrence of certain events. Such commitments are made on specified terms and conditions and are honored for up to 60 days from commitment. The Association had outstanding loan commitments of approximately $33.0 million at September 30, 2002 consisting of $12.9 million of variable rate loans and $20.1 million of fixed rate loans. See Note 14 of the Notes to Consolidated Financial Statements contained in the Annual Report. Loan Solicitation and Processing. The Association originates real estate and other loans at each of its offices. Loan originations are obtained by a variety of sources, including developers, builders, existing customers, newspapers, radio, periodical advertising and walk-in customers, although referrals from local realtors have been the primary source. Loan applications are taken by lending personnel, and the loan processing department obtains credit reports, appraisals and other documentation involved with a loan. All of the Association's lending is subject to its written nondiscriminatory underwriting standards, loan origination procedures and lending policies prescribed by the Association's Board of Directors. Property valuations are required on all real estate loans and are prepared by employees experienced in the field of real estate or by independent appraisers approved by the Association's Board of Directors. Additionally, all appraisals on loans in excess of $250,000 must meet applicable regulatory standards. 11 The Association's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan, the adequacy of the value of the property that will secure the loan, and, in the case of commercial and multi-family real estate loans, the cash flow of the project and the quality of management involved with the project. The Association generally requires title insurance on all loans and also that borrowers provide evidence of fire and extended casualty insurance in amounts and through insurers that are acceptable to the Association. A loan application file is first reviewed by a loan officer of the Association, then is submitted to a credit officer with appropriate underwriting authority for approval. Certain large loans, where the borrower has aggregate debt with the Association of $1 million or more, are reviewed by the board of directors. For those relationships in which the aggregate debt with the Association is $3 million or greater, board approval is required prior to funding of the loan. The Association can generally make loan commitments, subject to property valuation and possible other conditions of approval, in three to five days if income and credit data of the borrower are readily available. Loan Originations, Purchases and Sales. The Association has originated a majority of the loans in its portfolio. During the year ended September 30, 2002, the Association originated $281.7 million in total loans, compared to $136.5 million during the same period of 2001. The higher level of loan originations was attributable to decreasing interest rates and the expansion of the branch network. The Association has a program to sell loans to Fannie Mae and other lenders. Through this program, $68.7 million in fixed rate loans were sold during the year ended September 30, 2002, all of which were one- to four-family mortgages. Servicing was retained on the loans sold to Fannie Mae and was released on loans sold to other brokers. During the year ended September 30, 2001, the Company securitized $190.3 million of fixed rate single family mortgages through Fannie Mae. Servicing was retained on these loans. As noted previously, the Association purchased $179.3 million in loans from WAMU as part of the branch acquisition. The Association has also purchased permanent residential one- to four-family mortgage loans on detached residences from various localities throughout the western United States, primarily Oregon, Washington, and California. These loans were underwritten on the same basis as permanent residential one- to four-family real estate loans originated by the Association. At September 30, 2002, the balance of such loans was $4.4 million. The Association also purchases multi-family and commercial real estate mortgage loans secured by properties within the Association's primary market area. At September 30, 2002, the balance of such purchased loans was $9.5 million. These loans were underwritten on the same basis as similar loans originated by the Association. 12 The following table shows total loans originated, purchased and sold, loan reductions and the net increase in the Association's loans during the periods indicated.
Year Ended September 30, ---------------------------------------------- 2002 2001 2000 --------- ---------- -------- (In thousands) Total net loans at beginning of period...................... $679,990 $729,037 $739,793 -------- -------- -------- Loans originated and purchased: Real estate loans originated (1)........................... 161,278 93,907 81,671 Real estate loans purchased................................ 1,683 83,192 508 Non-real estate loans originated........................... 120,388 42,586 15,575 Non-real estate loans purchased............................ -- 99,720 -- -------- -------- -------- Total loans originated and purchased..................... 283,349 319,405 97,754 -------- -------- -------- Loan reductions: Principal paydowns......................................... (287,526) (145,544) (98,853) Loans sold................................................. (68,661) (30,709) (6,315) Loans securitized.......................................... -- (190,300) -- Other reductions (2)....................................... 313 (1,899) (3,342) -------- -------- -------- Total loan reductions................................... (355,874) (368,452) (108,510) -------- -------- -------- Total net loans at end of period............................ $607,465 $679,990 $729,037 ======== ======== ======== (1) Includes decreases/increases from loans-in-process. (2) Includes net reductions due to deferred loans fees, discounts net of amortization, provision for loan loss and transfers to real estate owned.
Loan Origination and Other Fees. In addition to interest earned on loans, the Association receives loan origination fees or "points" for originating loans. Loan points are a percentage of the principal amount of the real estate loan and are charged to the borrower in connection with the origination of the loan. The amount of points charged by the Association varies, though it generally is 1.00% on permanent loans and 1.75% on construction loans. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 91, which deals with the accounting for non-refundable fees and costs associated with originating or acquiring loans, the Association's loan origination fees and certain related direct loan origination costs are offset, and the resulting net amount is deferred and amortized as income over the contractual life of the related loans as an adjustment to the yield of such loans, or until the loan is paid in full. At September 30, 2002, the Association had $3.9 million of net loan fees which had been deferred and are being recognized as income over the contractual maturities of the related loans. 13 Asset Quality Delinquent Loans. The following table sets forth information concerning delinquent loans at September 30, 2002, in dollar amount and as a percentage of the Association's total loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
Permanent residential Commercial Commercial 1-4 family Real Estate Non-Real Estate Consumer Total Amount Percentage Amount Percentage Amount Percentage Amount Percentage Amount Percentage (Dollars in thousands) Loans delinquent for 90 days and more..... $444 0.07% $ 353 0.06% $47 0.01% $247 0.04% $1,091 0.18%
Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Association attempts to cure the delinquency by contacting the borrower. In the case of loans past due, appropriate late notices are generated on the seventh and fifteenth days after the due date. If the delinquency is not cured, the borrower is contacted by telephone the twenty-fifth day after the payment is due. For real estate loans, in the event a loan is past due for 30 days or more, the Association will attempt to arrange an in-person interview with the borrower to determine the nature of the delinquency; based upon the results of the interview and its review of the loan status, the Association may negotiate a repayment program with the borrower. If a loan remains past due at 60 days, the Association performs an in-depth review of the loan status, the condition of the property and the circumstances of the borrower. If appropriate, an alternative payment plan is established. At 90 days past due, a letter prepared by the Association is sent to the borrower describing the steps to be taken to collect the loan, including acceptance of a voluntary deed-in-lieu of foreclosure, and of the initiation of foreclosure proceedings. A decision as to whether and when to initiate foreclosure proceedings is made by senior management, with the assistance of legal counsel, and reviewed by the Board of Directors. For commercial loans, the borrowers are assigned to a commercial lender who is responsible for monitoring the relationship including collecting on delinquencies. When necessary, repossession, foreclosure, or other action may be taken including use of outside counsel. For consumer loans, at 60 days past due a letter demanding payment is sent to the borrower. If the delinquency is not cured prior to becoming 90 days past due, repossession procedures are implemented for collateralized loans. At 90 days past due, consumer loans are generally charged off and sent to an outside collection agency. Nonaccrual, Past Due and Restructured Loans. The Association's non-performing assets consist of nonaccrual loans, accruing loans greater than 90 days delinquent, real estate owned and other repossessed assets. All loans are reviewed on a regular basis and are placed on a nonaccrual status when, in the opinion of management, the collection of additional interest is deemed insufficient to warrant further accrual. Generally, the Association places all loans more than 90 days past due on nonaccrual status. Uncollectible interest on loans is charged-off or an allowance for losses is established by a charge to earnings equal to all interest previously accrued and interest is subsequently recognized only to the extent cash payments are received until delinquent interest is paid in full and, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal in which case the loan is returned to accrual status. Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold. See Note 1 of the Notes to Consolidated Financial Statements contained in the Annual Report. When such property is acquired, it is recorded at the lower of the balance of the loan on the property at the date of acquisition (not to exceed the net realizable value) or the estimated fair value. Costs, excluding interest, relating to holding the property are expensed as incurred. Valuations are periodically performed by management and an allowance for losses is established by a charge to operations if the carrying value of the property exceeds its estimated net realizable value. From time to time, the 14 Association also acquires personal property which is classified as other repossessed assets and is carried on the books at estimated fair market value and disposed of as soon as commercially reasonable. As of September 30, 2002, the Association's total nonaccrual loans amounted to $1.1 million, or 0.18% of total loans, before net items, compared with $270,000, or 0.04% of total loans, before net items, at September 30, 2001. Nonaccrual loans at September 30, 2002 by type are detailed in the table below. The increase in nonaccrual loans is primarily attributable to increases in nonaccrual commercial and consumer loans. The balance of these types of loans increased considerably with the WAMU branch acquisition in 2001 and so it is not unexpected that there is an increase in nonaccrual loans of these types. At September 30, 2002, the Association had $188,000 in restructured loans. Real estate owned increased from the prior year primarily as a result of the foreclosure on a commercial property during the year ended September 30, 2002. Properties held as real estate owned at September 30, 2001 were all subsequently sold. The following table sets forth the amounts and categories of the Association's non-performing assets at the dates indicated.
At September 30, 2002 2001 2000 1999 1998 (Dollars in thousands) Non-accruing loans: One- to four-family real estate ..................... $444 $270 $715 $915 $513 Commercial real estate............................... 353 -- -- 2,400 -- Commercial non-real estate........................... 47 -- -- -- -- Consumer............................................. 247 -- 95 -- 11 Accruing loans greater than 90 days delinquent........................................ -- -- -- -- -- ------ ----- ------ ------ ---- Total non-performing loans........................... 1,091 270 810 3,315 524 ------ ----- ------ ------ ---- Real estate owned........................................ 717 446 788 1,495 -- Other repossessed assets................................. 42 -- -- -- -- ------ ----- ------ ------ ---- Total repossessed assets............................. 759 446 788 1,495 -- ------ ----- ------ ------ ---- Total non-performing assets.......................... $1,850 $ 716 $1,598 $4,810 $524 ====== ===== ====== ====== ==== Total non-performing assets as a percentage of total assets............................. 0.12% 0.05% 0.16% 0.46% 0.05% Total non-performing loans as a percentage of total loans, before net items....................................... 0.18% 0.04% 0.21% 0.62% 0.07% Allowance for loan losses as a percentage of total non-performing assets................................................. 398.70% 1110.47% 255.44% 51.64% 372.14% Allowance for loan losses as a percentage of total non-performing loans.......................... 676.08% 2944.81% 503.95% 74.93% 372.14%
15 The allowance for loan losses as a percentage of both total non-performing assets and total non-performing loans has decreased significantly at September 30, 2002. These decreases are the result of increases in non-performing loans and non-performing assets at September 30, 2002. At September 30, 2001, the allowance balance was greatly increased due to the loans purchased from WAMU. Because the majority of the loans purchased from WAMU were commercial and consumer loans with higher associated risks, the allowance increased, yet, because the loans were added in September 2001 there had not been an impact causing the level of non-performing loans and assets to increase by September 30, 2001. At present, the performance of the purchased loans has exceeded expectations and the Association believes that current reserves are adequate to cover the risk in the portfolio based on current levels of delinquency and non-performing assets. For the year ended September 30, 2002, the amount of gross income that would have been recorded in the period then ended if non-accrual loans and troubled debt restructurings had been current according to their original terms, and the amount of interest income on such loans that was included in net income for each of such periods, were, in both cases, less than 1% of total interest income. Classified Assets. Federal regulations require that each insured savings association classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are four categories used to classify problem assets: "special mention," "substandard," "doubtful," and "loss." Special mention assets are not considered classified assets, but are assets of questionable quality that have potential or past weaknesses that deserve management's close attention and monitoring. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount. General loss allowances established to cover probable losses related to special mention assets and assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital. Federal examiners may disagree with an insured institution's classifications and the amounts reserved. As of September 30, 2002, total classified assets amounted to 0.30% of total assets, an increase from 0.16% at September 30, 2001. Assets classified substandard at September 30, 2002 totaled $4.4 million and included $353,781 in one- to four-family residential loans, a $843,144 land development loan, $2.1million in commercial real estate and $758,663 in foreclosed real estate consisting of five single family residences, a commercial property, and a boat. Assets classified substandard at September 30, 2001 totaled $2.7 million and included $270,393 in one- to four-family construction loans, a $2.0 million land development loan and $445,855 in foreclosed real estate consisting of single family residences. These problem assets were not concentrated in any one market area. Impaired Loans. Management generally identifies loans to be evaluated for impairment when such loans are on nonaccrual status or have been restructured. However, not all nonaccrual loans are impaired. In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, loans are considered impaired when it is probable that the Association will be unable to collect all amounts contractually due, including scheduled interest payments. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of underlying collateral, and current economic conditions. Allowance for Loan Losses. The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses based on management's assessment of various factors affecting the loan portfolio, including a review of all loans for which full collectibility may not be reasonably assured, an overall evaluation of the quality of the underlying collateral, economic conditions, historical loan loss experience and other 16 factors that warrant recognition in providing for an adequate loan loss allowance. The level of allowance for loan losses is determined based on stratifying the loan portfolio in to classes based on risk. For example, loans are stratified based on type of interest rate (fixed or adjustable), age of the loan (less seasoned loans are assigned a higher percentage), geographic location, and type of loan. Each stratum is assigned an appropriate level of allowance percentage based on historical loss experience and risk level assigned to the type of loans. While management believes it uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. At September 30, 2002, the Association had an allowance for loan losses of $7.4 million, which was equal to 398.70% of non-performing assets and 1.19% of total loans. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management. Management considers historical loan loss experience, the volume and type of lending conducted by the Association, industry standards, the amount of non-performing assets, general economic conditions (particularly as they relate to the Association's market area), and other factors related to the collectibility of the Association's loan portfolio in their determination of the adequacy of the allowance and the provision. The provisions for loan losses charged against income for the years ended September 30, 2002, 2001 and 2000 were $156,000, $387,000, and $1.8 million respectively. Management believes that the amount maintained in the allowance will be adequate to absorb probable losses in the portfolio. The year ended September 30, 2001 included two transactions that affected the allowance and provision for loan losses. The sale and securitization of $190.3 million in fixed rate single family loans to Fannie Mae reduced the required allowance on mortgage loans. In conjunction with the sale, $231,000 of allowance was reclassified as part of the basis of the resulting mortgage-backed securities. The reduction in the loan portfolio reduced the need for additional allowance and thus the provision for loan losses was much lower this year than the previous year. The WAMU acquisition added $179.3 million of loans to the portfolio, a significant proportion of which were commercial and consumer loans. These loans by nature have higher credit risk. As part of the acquisition, an allowance for loan losses was established related to the acquired loans based on the types of loans and the best information available regarding the factors which may affect their collectibility. The higher balance of the allowance for loan losses reflects these changes whereby a block of low risk single family mortgage loans were sold and were replaced by a block of higher risk loans from the acquired branches. 17 The following table sets forth for the periods indicated information regarding changes in the Association's allowance for loan losses. All information is before net items.
At or for the Year Ended September 30, 2002 2001 2000 1999 1998 (Dollars in thousands) Total loans outstanding ....................... $ 622,361 $ 701,013 $ 750,909 $ 774,441 $ 704,703 Average loans outstanding ..................... $ 660,246 $ 611,095 $ 747,842 $ 721,658 $ 614,457 Allowance at beginning of period .............. $ 7,951 $ 4,082 $ 2,484 $ 1,950 $ 1,296 --------- --------- --------- --------- --------- Loans charged off: One- to four-family ...................... -- (3) -- -- -- Construction ............................. -- (19) (32) -- -- Commercial real estate ................... (323) -- (559) (392) -- Commercial business ...................... (134) (12) -- -- (17) Consumer ................................. (290) (56) (16) (6) (3) --------- --------- --------- --------- --------- Total charge offs ................... (747) (90) (607) (398) (20) --------- --------- --------- --------- --------- Recoveries of loans previously charged off: Commercial real estate ................... -- 34 440 -- -- Consumer ................................. 16 8 1 -- -- --------- --------- --------- --------- --------- Total recoveries .................... 16 42 441 -- -- --------- --------- --------- --------- --------- Provision for loans losses .................... 156 387 1,764 932 674 Acquisitions .................................. -- 3,761 -- -- -- Allowance reclassified with loan securitization -- (231) -- -- -- --------- --------- --------- --------- --------- Allowance at end of period .................... $ 7,376 $ 7,951 $ 4,082 $ 2,484 $ 1,950 ========= ========= ========= ========= ========= Allowance for loan losses as a percentage of total loans outstanding ................... 1.19% 1.13% 0.54% 0.32% 0.28% Ratio of net charge-offs to average loans outstanding during the period ................ 0.11% 0.01% 0.02% 0.06% --%
18 The following tables set forth the breakdown of the allowance for loan losses by loan category and summarizes the percentage of total loans, before net items, in each category to total loans, before net items, at the dates indicated.
At September 30, 2002 2001 2000 Percent of Percent of Percent of Amount Allowance in Percent of Amount Allowance in Percent of Amount Allowance in Percent of of Category to Total Loans of Category to Total Loans of Category to Total Loans Allowance Total Loan by Category Allowance Total Loans by Category Allowance Total Loans by Category (Dollars in thousands) Permanent residential 1-4 family......... $1,191 0.19% 54.53% $1,292 0.19% 60.12% $1,449 0.19% 85.12% Multi-family residential.... 528 0.09 3.47 540 0.08 3.32 365 0.05 2.53 Construction..... 422 0.07 2.45 12 0.01 3.09 420 0.05 3.37 Agriculture...... 169 0.03 0.79 158 0.02 0.60 -- -- -- Commercial real estate......... 2,611 0.42 14.73 3,611 0.52 14.17 1,403 0.19 5.63 Land............. 77 0.01 0.67 324 0.02 0.53 168 0.02 0.45 Commercial and industrial..... 1,560 0.25 9.98 1,325 0.19 8.00 86 0.01 0.61 Consumer......... 818 0.13 13.38 689 0.10 10.17 191 0.03 2.29 ------ ------ ------ ------ ------ ------ Total......... $7,376 1.19% 100.00% $7,951 1.13% 100.00% $4,082 0.54% 100.00% ====== ====== ====== ====== ====== ======
At September 30, 2000 1999 Percent of Percent of Amount Allowance in Percent of Amount Allowance in Percent of of Category to Total Loans of Category to Total Loans Allowance Total Loans by Category Allowance Total Loans by Category (Dollars in thousands) Permanent residential 1-4 family.................... $1,103 0.14% 83.56% $1,141 0.16% 81.95% Multi-family residential........ 267 0.03 2.38 124 0.02 2.73 Construction.................... 221 0.03 6.87 116 0.02 9.12 Agriculture..................... -- -- -- -- -- -- Commercial real estate.......... 730 0.09 4.79 444 0.07 4.18 Land............................ 28 -- 0.27 29 -- 0.31 Commercial and industrial....... 23 -- 0.44 14 -- 0.29 Consumer........................ 112 0.02 1.69 82 0.01 1.42 ------ ------ ------ ------ Total........................ $2,484 0.31% 100.00% $1,950 0.28% 100.00% ====== ====== ====== ======
19 Although the Association believes that it has established its allowance for loan losses in accordance with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Association's loan portfolio, will not request the Association to significantly increase its allowance for loan losses, thereby reducing the Association's net worth and earnings. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance may adversely affect the Association's financial condition and results of operation. Investment Activities Federally chartered savings institutions have the authority to invest in securities of various federal agencies, certain insured certificates of deposit of banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. OTS regulations restrict investments in corporate debt securities of any one issuer in excess of 15% of the Association's unimpaired capital and unimpaired surplus, as defined by federal regulations, which totaled $102.8 million at September 30, 2002, plus an additional 10% if the investments are fully secured by readily marketable collateral. See "REGULATION OF THE ASSOCIATION-- Federal Regulation of Savings Associations -- Loans to One Borrower" for a discussion of additional restrictions on the Association's investment activities. The investment securities portfolio is managed in accordance with a written investment policy adopted by the Board of Directors and administered by the Investment Committee, which consists of the President and four Board members. Generally, the investment policy is to invest funds among various categories of investments and maturities based upon the need for liquidity, to achieve the proper balance between its desire to minimize risk and maximize yield, and to fulfill the asset/liability management policy. The President and the Chief Financial Officer may independently invest up to 1.0% of total assets of the Company within the parameters set forth in the Investment Policy, to be subsequently reviewed with the Investment Committee or Board of Directors at its next scheduled meeting. Transactions or investments in any one security determined by type, maturity and coupon in excess of $10.0 million or 1.0% of assets are not permitted. Investment securities held to maturity are carried at cost and adjusted for amortization of premiums and accretion of discounts. As of September 30, 2002, the Company had no held to maturity securities. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. Securities available for sale include securities that management intends to use as part of its asset/liability management strategy that may be sold in response to changes in interest rates or significant prepayment risks or both. As of September 30, 2002, the portfolio of securities available for sale consisted of $42.0 million in tax exempt securities issued by states and municipalities, $18.1 million in federal agency preferred stock, and $59.4 million in investment grade corporate investments. During the years ended September 30, 2002, 2001, and 2000, neither the Company nor the Association held any off-balance sheet derivative financial instruments in their investment portfolios to which the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, would apply. 20 The following tables set forth certain information relating to the investment securities portfolio held to maturity and securities available for sale at the dates indicated.
At September 30, 2002 2001 2000 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value (In thousands) Held to maturity: State and municipal obligations $ -- $ -- $ 135 $ 137 $ 267 $ 270 Available for sale: U.S. Government obligations ... -- -- 40,120 40,852 49,190 48,786 State and municipal obligations 39,578 42,026 32,951 33,640 25,600 24,943 Corporate obligations ......... 61,648 59,423 65,404 64,718 43,899 42,899 FHLMC preferred stock ......... 18,715 18,093 15,716 15,466 -- -- -------- -------- -------- -------- -------- -------- Total ....................... $119,941 $119,542 $154,326 $154,813 $118,956 $116,898 ======== ======== ======== ======== ======== ========
At September 30, 2002 2001 2000 Amortized Percent of Amortized Percent of Amortized Percent of Cost Portfolio Cost Portfolio Cost Portfolio (Dollars in thousands) Held to maturity: State and municipal obligations......................... $ -- --% $ 135 0.09% $ 267 0.23% Available for sale: U.S. Government obligations............................. -- -- 40,120 26.00 49,190 41.35 State and municipal obligations......................... 39,578 33.00 32,951 21.35 25,600 21.52 Corporate obligations................................... 61,648 51.40 65,404 42.38 43,899 36.90 FHLMC preferred stock................................... 18,715 15.60 15,716 10.18 -- -- -------- ------ -------- ------ -------- ------ Total................................................. $119,941 100.00% $154,326 100.00% $118,956 100.00% ======== ====== ======== ====== ======== ======
The following table sets forth the maturities and weighted average yields of the debt securities in the investment portfolio at September 30, 2002.
One Year After One Through After Five Through After Ten or Less Five Years Ten Years Years Amount Yield Amount Yield Amount Yield Amount Yield (Dollars in thousands) Available for sale: State and municipal obligations (1) $100 4.45% $485 4.13% $790 4.42% $38,203 5.14% Corporate obligations 17,890 3.42% 23,923 4.98% -- -- 19,835 2.46% FHLMC preferred stock -- -- -- -- -- -- 18,715 3.10% _______ _______ ____ _______ Total $17,990 $24,408 $790 $76,753 ======= ======= ==== ======= (1) Interest on state and municipal obligations is tax-exempt for federal income tax purposes. The yields reported have not been calculated on a tax-equivalent basis.
21 At September 30, 2002 the Company did not hold any securities from a single issuer, other than the U.S. Government, whose aggregate book value was in excess of 10% of the Company's shareholders' equity, or $12.0 million. Mortgage-Backed and Related Securities At September 30, 2002, the Company's net mortgage-backed and related securities, all designated available-for-sale, totaled $650.8 million at fair value ($640.3 million at amortized cost) and had a weighted average yield of 5.54%. At September 30, 2002, 24.50% of the mortgage-backed and related securities were adjustable rate securities. Mortgage-backed and related securities ("MBS") can be divided into two main groups. The first group, called mortgage participation certificates or pass-through certificates, typically represents a participation interest in a pool of single-family or multi-family mortgages. The principal and interest payments on these mortgages are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and resell the participation interests in the form of securities, to investors such as the Company. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the Federal Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae, the Government National Mortgage Association ("GNMA") and the U.S. Small Business Administration ("SBA"). The second group, called collateralized mortgage obligations ("CMOs"), consists of securities created from and secured by the securities in the first group described above. CMOs are an example of a security called a derivative, because they are derived from mortgage pass-through securities. Underwriters of CMOs create these securities by dividing up the interest and principal cash flows from the pools of mortgages and selling these different slices of cash flows as a new and different class of individual securities or "tranches." At September 30, 2002, the Company held $438.6 million of CMOs, comprised primarily of three classes, planned amortization class tranches ("PACs"), Sequentials, and Floaters. The least volatile CMOs are PACs. With PACs, the yields, average lives, and lockout periods when no payments are received are designed to be more stable and predictable than the actual performance of the underlying MBS. PACs are available in a variety of short term maturities, usually two, three, five, or seven years. CMO floaters are similar to adjustable rate mortgages; they carry an interest rate that changes in a fixed relationship to an interest rate index, typically the London Interbank Offer Rate ("LIBOR"). Sequentials, as the name implies, pay principal and interest sequentially. For example, the "A" tranche receives payments of principal and interest first, while the "B" and "C" tranches only receive interest until the "A" tranche principal par value is completely paid. Then the "B" tranche begins receiving principal and interest until all of its principal is paid, and so on. Sequential pay CMOs are created to obtain a more predictable cash flow than the underlying simple pass-through securities. However, the cash flow risk from the underlying pool remains the same. Floaters usually have caps that determine the highest interest that can be paid by the securities. Except for caps on Floaters, PACs and Floaters may help to manage interest rate risk by reducing asset duration. They also may help manage price volatility since they typically have short maturities or coupons that reset monthly or quarterly to reflect changes in the index rate. MBS typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that fall within a specific range and have varying maturities. MBS generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. In addition, MBS are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of the Company. These types of securities also permit the Association to optimize its regulatory capital because they have low risk weighting. Expected maturities of MBS will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Prepayments that are faster than anticipated may shorten the life of the security and may result in a loss of any premiums paid and thereby reduce the net yield on such securities. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, generally the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Company may be 22 subject to reinvestment risk because, to the extent that the Company's MBS amortize or prepay faster than anticipated, the Company may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. During the year ended September 30, 2002, MBS with a fair value of $376,335 were transferred from the held-to-maturity category to the available-for-sale portfolio. The Company does not have plans to purchase or classify securities as held-to-maturity in the foreseeable future. The following tables set forth certain information relating to the mortgage-backed and related securities portfolio held to maturity and available for sale at the dates indicated.
At September 30, 2002 2001 2000 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value (In thousands) Held to maturity: GNMA.................. $ -- $ -- $ 1,621 $ 1,642 $ 2,160 $ 2,146 Available for sale: Fannie Mae .............. 128,867 130,233 56,833 57,194 13,498 13,598 FHLMC ................... 56,605 57,348 19,538 19,797 32,902 33,282 GNMA .................... 24,346 24,593 6,816 6,977 10,728 10,681 CMOs .................... 430,487 438,622 336,452 337,670 18,355 17,770 ---------- ---------- ---------- ---------- ---------- ---------- Total ................. $ 640,305 $ 650,796 $ 421,260 $ 423,280 $ 77,643 $ 77,477 ========== ========== ========== ========== ========== ==========
At September 30, 2002 2001 2000 Amortized Percent of Amortized Percent of Amortized Percent of Cost Portfolio Cost Portfolio Cost Portfolio (Dollars in thousands) Held to maturity: GNMA........ $ -- -- $ 1,621 0.38% $ 2,160 2.78% Available for sale: Fannie Mae.... 128,867 20.13 56,833 13.49 13,498 17.38 FHLMC ........ 56,605 8.84 19,538 4.64 32,902 42.38 GNMA ......... 24,346 3.80 6,816 1.62 10,728 13.82 CMOs ......... 430,487 67.23 336,452 79.87 18,355 23.64 -------- ------ -------- ------ ------- ------ Total ...... $640,305 100.00% $421,260 100.00% $77,643 100.00% ======== ====== ======== ====== ======= ======
Other Interest-Earning Assets The Company had an other interest-earning asset of $457,000 earning 8.07% and maturing in May 2112. Interest-Earning Deposits The Company had interest-earning deposits in the FHLB of Seattle amounting to $5.9 million and $4.9 million at September 30, 2002 and 2001, respectively. Deposit Activities and Other Sources of Funds 23 General. Deposits are the primary source of the Association's funds for lending and other investment purposes. In addition to deposits, the Association derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer term basis for general business purposes. Deposits. The Association's deposits are attracted principally from within the Association's primary market area through the offering of a broad selection of deposit instruments, including checking accounts, negotiable order of withdrawal ("NOW") accounts, money market deposit accounts, passbook and statement savings accounts, and individual retirement account ("IRA") certificates and certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the time period the funds must remain on deposit and the interest rate. The Association occasionally accepts deposits from outside its primary market area through both private placements and brokered deposits if the terms of the deposits fit the Association's specific needs and are at a rate lower than the rates on similar maturity borrowings through the FHLB of Seattle. At September 30, 2002, these deposits totaled $2.3 million, or 0.20% of total deposits. Interest rates paid, maturity terms, service fees and withdrawal penalties are established and reviewed on a periodic basis by the Association. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals and federal regulations. For the year ended September 30, 2002, the Association experienced a net decrease in deposits (before interest credited) of $38.2 million. The majority of the decrease relates to declining balances in certificates of deposit. Early in the year the Association made a conscious effort to reduce interest expense on higher-priced certificate accounts resulting in a decrease of $87.1 million for certificates as they matured and were not renewed. Checking, savings, and money market accounts increased $76.3 million during the year. At September 30, 2002, certificate accounts maturing during the year ending September 30, 2003 totaled $275.7 million. Based on historical experience, the Association expects that a significant amount will be renewed with the Association at maturity. In the event a significant amount of such accounts are not renewed at maturity, the Association would not expect a resultant adverse impact on operations and liquidity because of the Association's borrowing capacity. See "-- Borrowings." In the unlikely event the Association is liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the Company, which is the sole shareholder of the Association. The majority of the Association's depositors are residents of the State of Oregon. 24 The following table indicates the amount of certificate accounts with balances of $100,000 or greater by time remaining until maturity as of September 30, 2002.
Certificate Maturity Period Accounts (In thousands) Three months or less................................... $11,930 Over three through six months.......................... 20,209 Over six through twelve months......................... 26,181 Over twelve months..................................... 50,440 -------- Total.............................................. $108,760 ========
The following table sets forth the deposit balances in the various types of deposit accounts offered by the Association at the dates indicated.
At September 30, 2002 2001 2000 Percent Percent Percent of Increase of Increase of Amount Total (Decrease) Amount Total (Decrease) Amount Total (Dollars in thousands) Certificates of deposit ........ $ 456,719 39.99% ($87,161) $ 543,880 47.17% $171,132 $ 372,748 53.60% ---------- ------ -------- ---------- ------ -------- ---------- ------ Transaction accounts: Non-interest checking .......... 142,773 12.50 12,124 130,649 11.33 76,309 54,340 7.81 Interest-bearing checking ...... 125,867 11.02 9,111 116,756 10.13 44,570 72,186 10.38 Passbook and statement savings . 86,001 7.53 8,355 77,646 6.74 29,699 47,947 6.90 Money market deposits .......... 330,646 28.96 46,753 283,893 24.63 135,733 148,160 21.31 ---------- ------ -------- ---------- ------ -------- ---------- ------ Total transaction accounts ..... 685,287 60.01 76,343 608,944 52.83 286,311 322,633 46.40 ---------- ------ -------- ---------- ------ -------- ---------- ------ Total deposits ................. $1,142,006 100.00% ($10,818) $1,152,824 100.00% $457,443 $ 695,381 100.00% ========== ====== ======== ========== ====== ======== ========== ====== The majority of the increases noted for the year ended September 30, 2001 relate to the WAMU branch acquisition.
The following table sets forth the deposit activities of the Association for the periods indicated.
Year Ended September 30, 2002 2001 2000 (Dollars in thousands) Beginning balance....................................... $1,152,824 $695,381 $720,401 ---------- ---------- -------- Increase due to acquired deposits....................... -- 423,457 -- Net inflow (outflow) of deposits before interest credited...................................... (38,002) 6,902 (49,728) Interest credited....................................... 27,184 27,084 24,708 ---------- ---------- -------- Net increase (decrease) in deposits..................... (10,818) 457,443 (25,020) ---------- ---------- -------- Ending balance.......................................... $1,142,006 $1,152,824 $695,381 ========== ========== ========
25 Borrowings. Deposit liabilities are the primary source of funds for the Association's lending and investment activities and for its general business purposes. The Association may rely upon advances from the FHLB of Seattle, reverse repurchase agreements and bank lines of credit to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Seattle serves as the Association's primary borrowing source after deposits. The FHLB of Seattle functions as a central reserve bank, providing credit for savings and loan associations and certain other member financial institutions. As a member, the Association is required to own capital stock in the FHLB of Seattle and is authorized to apply for advances on the security of certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. As a member of the FHLB, the Association maintains a credit line that is a percentage of its regulatory assets, subject to collateral requirements. At September 30, 2002, the credit line was 30% of total assets of the Association. Advances are collateralized in aggregate, as provided for in the Advances, Security and Deposit Agreements with the FHLB, by certain mortgages or deeds of trust and securities of the U.S. Government and agencies thereof. The Company has established credit lines at two commercial banks. These credit lines represent aggregate borrowing capacity of $16.7 million. At September 30, 2002, borrowings under these lines of credit totaled $1.7 million. The following table sets forth certain information regarding borrowings by the Company and Association at the end of and during the periods indicated:
At September 30, 2002 2001 2000 Weighted average rate paid on: FHLB advances................................................ 5.07% 5.73% 5.90% Short term borrowings........................................ 4.75% 5.58% 9.01%
Year Ended September 30, 2002 2001 2000 (Dollars in thousands) Maximum amount outstanding at any month end: FHLB advances................................................ $205,250 $173,000 $230,000 Short term borrowings........................................ 1,700 6,400 3,000 Approximate average balance: FHLB advances................................................ 168,333 170,521 207,218 Short term borrowings........................................ 1,705 3,265 1,290 Approximate weighted average rate paid on: FHLB advances................................................ 5.71% 5.90% 5.88% Short term borrowings........................................ 4.32% 8.22% 9.34%
Subsidiaries. The Association established an operating subsidiary, Pacific Cascades Financial, Inc., effective July 14, 2000. Pacific Cascades Financial, Inc. is an Oregon chartered corporation, of which the Association owns 100% of its capital stock. Pacific Cascades Financial serves as the Association's trustee on deeds of trust and as trustee, handles normal reconveyance transactions on paid-off Association loans and non-judicial foreclosures. 26 The Association also owns 100% of the capital stock of Klamath First Financial Services, Inc. Klamath First Financial serves as an investment subsidiary, providing investment and brokerage services to customers. The Company established a subsidiary, Klamath First Capital Trust I, in July 2001 for the purpose of issuing mandatorily redeemable preferred securities. The Company also established Klamath First Capital Trust II in April 2002 for the purpose of issuing additional mandatorily redeemable preferred securities. See Note 13 of the Notes to Consolidated Financial Statements contained in the Annual Report. 27 REGULATION OF THE ASSOCIATION General The Association is subject to extensive regulation, examination and supervision by the OTS, as its chartering agency, and the FDIC, as the insurer of its deposits. The activities of federal savings institutions are governed by the Home Owners Loan Act ("HOLA") and, in certain respects, the Federal Deposit Insurance Act, and the regulations issued by the OTS and the FDIC to implement these statutes. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. Lending activities and other investments must comply with various statutory and regulatory capital requirements. In addition, the Association's relationship with its depositors and borrowers is also regulated to a great extent, especially in such matters as the ownership of deposit accounts and the form and content of the Association's mortgage documents. The Association is required to file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to review the Association's compliance with various regulatory requirements. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Company, the Association and their operations. Federal Regulation of Savings Associations Office of Thrift Supervision. The OTS is an office in the Department of the Treasury subject to the general oversight of the Secretary of the Treasury. The OTS has extensive authority over the operations of savings associations. Among other functions, the OTS issues and enforces regulations affecting federally insured savings associations and regularly examines these institutions. All savings associations are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings association's total assets, including consolidated subsidiaries. The Association's OTS assessment for the fiscal year ended September 30, 2002 was $258,994. Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated duties of the FHFB are to supervise the FHLBs, to ensure that the FHLBs carry out their housing finance mission, to ensure that the FHLBs remain adequately capitalized and able to raise funds in the capital markets, and to ensure that the FHLBs operate in a safe and sound manner. The Association, as a member of the FHLB of Seattle, is required to acquire and hold shares of capital stock in the FHLB of Seattle in an amount equal to the greater of (i) 1.0% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or (ii) 1/20 of its advances (i.e., borrowings) from the FHLB of Seattle. The Association is in compliance with this requirement with an investment in FHLB of Seattle stock of $13.5 million at September 30, 2002. Among other benefits, the FHLB provides a central credit facility for member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB of Seattle. Federal Deposit Insurance Corporation. The FDIC is an independent federal agency established originally to insure the deposits, up to prescribed statutory limits, of federally insured banks and to preserve the safety and 28 soundness of the banking industry. The FDIC maintains two separate insurance funds: the Bank Insurance Fund ("BIF") and the SAIF. The Association's deposit accounts are insured by the FDIC under the SAIF to the maximum extent permitted by law. As insurer of the Association's deposits, the FDIC has examination, supervisory and enforcement authority over the Association. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1, or core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. The premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis points. However, SAIF insured institutions and BIF insured institutions are required to pay a Financing Corporation assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. This amount is currently equal to about 1.70 points for each $100 in domestic deposits for SAIF and BIF insured institutions. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in 2017 through 2019. Under the Federal Deposit Insurance Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. Management of the Association does not know of any practice, condition or violation that might lead to termination of deposit insurance. Liquidity Requirements. Under OTS regulations, each savings institution is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 4%, but may be changed from time to time by the OTS to any amount within the range of 4% to 10%. Monetary penalties may be imposed for failure to meet liquidity requirements. The Association has never been subject to monetary penalties for failure to meet its liquidity requirements. Prompt Corrective Action. The OTS is required to take certain supervisory actions against undercapitalized savings associations, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk- weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be 29 "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OTS regulations also require that a capital restoration plan be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the institution's assets or the amount which would bring the institution into compliance with all capital standards. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At September 30, 2002, the Association was categorized as "well capitalized" under the prompt corrective action regulations of the OTS. Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits ("Guidelines"). The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that the Association fails to meet any standard prescribed by the Guidelines, it may require the Association to submit to the agency an acceptable plan to achieve compliance with the standard. Management is aware of no conditions relating to these safety and soundness standards which would require submission of a plan of compliance. Qualified Thrift Lender Test. All savings associations, including the Association, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments. At September 30, 2002, the Association met the qualified thrift investment test and its QTL percentage was 79.63%. Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "-- Regulation of the Company." Capital Requirements. Federally insured savings associations, such as the Association, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. 30 The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). At September 30, 2002, the Association had tangible capital of $95.5 million, or 6.6% of adjusted total assets, which is approximately $73.6 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. At September 30, 2002, the Association had $40.3 million of intangible assets consisting of core deposit intangible and other intangible assets related to the Wells Fargo branch acquisition in 1997 and the WAMU branch acquisition in 2001. The capital standards also require core capital equal to at least 3% to 4% of adjusted total assets, depending on an institution's supervisory rating. Core capital generally consists of tangible capital. At September 30, 2002, the Association had core capital equal to $95.5 million, or 6.6% of adjusted total assets, which is $37.2 million above the minimum leverage ratio requirement of 4% as in effect on that date. The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, are multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to- four family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by Fannie Mae or FHLMC. On September 30, 2002, the Association had total risk-based capital of approximately $102.8 million, including $95.5 million in core capital and $7.3 million in qualifying supplementary capital, and risk-weighted assets of $733.7 million, or total capital of 14.0% of risk-weighted assets. This amount was $44.1 million above the 8% requirement in effect on that date. The OTS is authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against savings associations that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations. The OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the OTS or the FDIC of any of these measures on the Company or the Association may have a substantial adverse effect on their operations and profitability. Limitations on Capital Distributions. The OTS imposes various restrictions on savings associations with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. The OTS also prohibits a savings association from declaring or paying any dividends or from repurchasing any of its stock if, as a result of such action, the regulatory 31 capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with the association's mutual to stock conversion. The Association may make a capital distribution without OTS approval provided that the Association notifies the OTS 30 days before it declares the capital distribution and that the following requirements are met: (i) the Association has a regulatory rating in one of the two top examination categories, (ii) the Association is not of supervisory concern, and will remain adequately or well capitalized, as defined in the OTS prompt corrective action regulations, following the proposed distribution, and (iii) the distribution does not exceed the Association's net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid). If the Association does not meet these stated requirements, it must obtain the prior approval of the OTS before declaring any proposed distributions. In the event the Association's capital falls below its regulatory requirements or the OTS notifies it that it is in need of more than normal supervision, the Association's ability to make capital distributions will be restricted. In addition, no distribution will be made if the Association is notified by the OTS that a proposed capital distribution would constitute an unsafe and unsound practice, which would otherwise be permitted by the regulation. Loans to One Borrower. Federal law provides that savings institutions are generally subject to the national bank limit on loans to one borrower. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. At September 30, 2002, the Association's limit on loans to one borrower was $15.9 million. At September 30, 2002, the Association's largest aggregate amount of loans to one borrower was $7.2 million, all of which were performing according to their original terms. Activities of Associations and Their Subsidiaries. When a savings association establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings association must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings associations also must conduct the activities of subsidiaries in accordance with existing regulations and orders. The OTS may determine that the continuation by a savings association of its ownership or control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings association to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly. Transactions with Affiliates. Savings associations must comply with Sections 23A and 23B of the Federal Reserve Act relative to transactions with affiliates in the same manner and to the same extent as if the savings association were a Federal Reserve member association. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association's capital. Affiliates of the Association include the Company and any company which is under common control with the Association. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a savings association holding company or acquire the securities of most affiliates. The OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on 32 loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals. Community Reinvestment Act. Under the federal Community Reinvestment Act ("CRA"), all federally- insured financial institutions have a continuing and affirmative obligation consistent with safe and sound operations to help meet all the credit needs of its delineated community. The CRA does not establish specific lending requirements or programs nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to meet all the credit needs of its delineated community. The CRA requires the federal banking agencies, in connection with regulatory examinations, to assess an institution's record of meeting the credit needs of its delineated community and to take such record into account in evaluating regulatory applications to establish a new branch office that will accept deposits, relocate an existing office, or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, among others. The CRA requires public disclosure of an institution's CRA rating. The Association received a "satisfactory" rating as a result of its latest evaluation. Regulatory and Criminal Enforcement Provisions. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $27,500 per day, or $1.1 million per day in especially egregious cases. Under the FDIA, the FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. 33 REGULATION OF THE COMPANY General The Company is a unitary savings and loan holding company within the meaning of the HOLA. As such, it is registered with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. The Company is also subject to the information, proxy solicitation, insider trading restrictions, and other requirements of the Securities Exchange Act of 1934, as amended. Company Acquisitions The HOLA and OTS regulations issued thereunder generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring more than 5% of the voting stock of any other savings association or savings and loan holding company or controlling the assets thereof. They also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS. Holding Company Activities As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. If the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company. There generally are more restrictions on the activities of a multiple savings and loan holding company than a unitary savings and loan holding company. Specifically, if either federally insured subsidiary savings association fails to meet the QTL test, the activities of the Company and any of its subsidiaries (other than the Company or other federally insured subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not an insured association shall commence or continue for more than two years after becoming a multiple savings and loan association holding company or subsidiary thereof, any business activity other than: (i) furnishing or performing management services for a subsidiary insured institution, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary insured institution, (iv) holding or managing properties used or occupied by a subsidiary insured institution, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987 to be engaged in by multiple holding companies or (vii) those activities authorized by the Federal Reserve Board as permissible for bank holding companies, unless the OTS by regulation, prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above also must be approved by the OTS prior to being engaged in by a multiple holding company. New Federal Legislation Gramm-Leach-Bliley Financial Services Modernization Act of 1999. On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this legislation is to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Generally, the GLBA: a. repealed the historical restrictions and eliminates many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers; b. provided a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; c. broadened the activities that may be conducted by national banks, banking subsidiaries of bank holding companies and their financial subsidiaries; 34 d. provided an enhanced framework for protecting the privacy of consumer information; e. adopted a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the FHLB system; f. modified the laws governing the implementation of the CRA; and g. addressed a variety of other legal and regulatory issues affecting day-to-day operations and long-term activities of financial institutions. The GLBA also imposes certain obligations on financial institutions to develop privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer's request, and establish procedures and practices to protect and secure customer data. These privacy provisions were implemented by regulations that were effective on November 12, 2000. Compliance with the privacy provisions was required by July 1, 2001. The USA Patriot Act. In response to the terrorist events of September 11th, 2001, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions: - Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti- money laundering program. - Section 326 of the Act authorizes the Secretary of the Department of Treasury, in conjunction with other bank regulators, to issue regulations by October 26, 2002 that provide for minimum standards with respect to customer identification at the time new accounts are opened. - Section 312 of the Act requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. - Effective December 25, 2001, financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks. - Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications. To date, it has not been possible to predict the impact the USA PATRIOT Act and its implementing regulations may have on the Company and the Association. Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law by President Bush on July 30, 2002 in response to public concerns regarding corporate accountability in connection with the recent 35 accounting scandals at Enron and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation enacted in some time. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission ("SEC"), under the Securities Exchange Act of 1934 ("Exchange Act"). The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. The Sarbanes- Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. The Sarbanes-Oxley Act addresses, among other matters: - audit committees; - certification of financial statements by the chief executive officer and the chief financial officer; - the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; - a prohibition on insider trading during pension plan black out periods; - disclosure of off-balance sheet transactions; - a prohibition on personal loans to directors and officers; - expedited filing requirements for Form 4s; - disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; - "real time" filing of periodic reports - the formation of a public accounting oversight board; - auditor independence; and - various increased criminal penalties for violations of securities laws. The Sarbanes-Oxley Act contains provisions which became effective upon enactment on July 30, 2002 and provisions which will become effective from within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various of the provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. 36 Affiliate Restrictions The affiliate restrictions contained in Sections 23A and 23B of the Federal Reserve Act apply to all federally insured savings associations and any such "affiliate." A savings and loan holding company, its subsidiaries and any other company under common control are considered affiliates of the subsidiary savings association under the HOLA. Generally, Sections 23A and 23B: (i) limit the extent to which the insured association or its subsidiaries may engage in certain covered transactions with an affiliate to an amount equal to 10% of such institution's capital and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions. Also, a savings association may not make any loan to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies. Only the Federal Reserve may grant exemptions from the restrictions of Sections 23A and 23B. The OTS, however, may impose more stringent restrictions on savings associations for reasons of safety and soundness. Qualified Thrift Lender Test The HOLA requires any savings and loan holding company that controls a savings association that fails the QTL test, as explained under "-- Qualified Thrift Lender Test," to, within one year after the date on which the association ceases to be a QTL, register as and be deemed a bank holding company subject to all applicable laws and regulations. TAXATION Federal Taxation General. The Company and the Association report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations, with some exceptions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Association. Bad Debt Reserve. Historically, savings institutions such as the Association which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrift") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Association's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Association's actual taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non- qualifying reserve. Each year, the Association selected the most favorable way to calculate the deduction attributable to an addition to the tax bad debt reserve. The provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Association has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Association's bad debt deduction will be determined on the basis of net charge-offs during the taxable year. The new rules allow an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996 adjusted for inflation. For this purpose, only 37 home purchase or home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year (fiscal year ending September 30, 1999 for the Company). The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders. Distributions. To the extent that the Association makes "nondividend distributions" to the Company, such distributions will be considered to result in distributions from the balance of its bad debt reserves as of December 31, 1987 (or a lesser amount if the Association's loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans ("Excess Distributions"), and an amount based on the Excess Distributions will be included in the Association's taxable income. Nondividend distributions include distributions in excess of the Association's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Association"s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Association's bad debt reserve. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. The Association does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (" Code"), imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Association's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Association, whether or not an Alternative Minimum Tax ("AMT") is paid. Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Association as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Association will not file a consolidated tax return, except that if the Company or the Association owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. Other Federal Tax Matters. There have not been any Internal Revenue Service audits of the Company's or the Association's federal income tax returns during the past five years. Subsequent to September 30, 2002, the Company was notified by the IRS of its intention to perform an audit of the tax year 1999 (year ended September 30, 2000). State Taxation The Company and the Association are subject to an Oregon corporate excise tax at a statutory rate of 6.6% of income. Neither the Company's nor the Association's Oregon state income tax returns have been audited during the past five years. The Association is subject to Washington state Business and Organization tax at the rate of 1.5% of gross receipts for the operations in that state. There have not been any audits of the Company's Washington state tax returns during the past five years. 38 Competition The Association originates most of its loans to and accepts most of its deposits from residents of its market area. The Association is the oldest financial institution headquartered in Klamath Falls. The Association believes that it is a major competitor in the markets in which it operates. Nonetheless, the Association faces competition in attracting deposits and making real estate loans from various financial institutions, including banks, savings associations and mortgage brokers. In addition, the Association has faced additional significant competition for investors' funds from short-term money market securities and other corporate and government securities. The financial institution industry in the Association's market area is characterized by a mix of local independent financial institutions and offices of larger out-of-state financial institutions, including several multi-national bank holding companies. The ability of the Association to attract and retain savings deposits depends on its ability to generally provide a rate of return and liquidity risk comparable to that offered by competing investment opportunities. The Association competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Competition may increase as restrictions on the interstate operations of financial institutions continue to be reduced. Personnel As of September 30, 2002, the Association had 429 full-time and 103 part-time employees. The employees are not represented by a collective bargaining unit. The Association believes its relationship with its employees is good. Executive Officers. The following table sets forth certain information regarding the executive officers of the Company.
Name Age(1) Position Kermit K. Houser 59 President and Chief Executive Officer Marshall J. Alexander 51 Executive Vice President and Chief Financial Officer Ben A. Gay 55 Executive Vice President and Chief Credit Officer Frank X. Hernandez 47 Senior Vice President and Chief Operations Officer Craig M. Moore 45 Senior Vice President/Chief Auditor/Corporate Counsel/Secretary M. Isabel Castellanos 41 Senior Vice President - Retail Banking Walter F. Dodrill 51 Senior Vice President - Business Banking James E. Essany 48 Senior Vice President - Corporate Marketing Director Nina G. Drake 49 Vice President - Human Resource Manager _________________________________ (1) At September 30, 2002.
Kermit K. Houser has served as President and Chief Executive Officer of the Company and the Association since November 2000. Mr. Houser was previously employed in various capacities by the Bank of America from 1983 to November 2000, as senior vice president and manager for commercial banking, executive vice president and senior credit officer, and most recently, as senior vice president and market executive for Bank of America's South Valley commercial banking, in Fresno, California. Mr. Houser has 31 years of experience in banking, and has been an active member of numerous civic and community organizations. 39 Marshall J. Alexander has 27 years of banking experience, including 16 years with the Association. He has served as Vice President and Chief Financial Officer since August 1994 and was named an Executive Vice President in December 2000. Ben A. Gay joined Klamath First in September 2001 after a 30-year career in commercial banking and finance, on both the East and West coasts. Mr. Gay has served in a variety of managerial positions in lending, credit risk and loan management and has most recently served as a western regional executive for credit risk management for Bank of America. Frank X. Hernandez has been employed by the Association since 1992. He served as Human Resources Officer until July 1998 when he was appointed Senior Vice President and Chief Operating Officer. He has 21 years experience in banking operations. Craig M. Moore has a banking career of more than 25 years, with five of those years at Klamath First. He is an attorney, a Certified Internal Auditor and a Certified Financial Services Auditor. M. Isabel Castellanos has 21 years experience in banking with extensive experience in management, sales, and training. Walter F. Dodrill has served as Senior Vice President and Manager of the Business Banking Group of the Company since January 2002. Mr. Dodrill was previously employed by Western Bank from February 1974 to December 2001. Western Bank became a division of Washington Mutual in January 1996. Mr. Dodrill served as Senior Vice President - Regional Credit Administrator and Senior Vice President - Regional Manager for Western Bank. Mr. Dodrill has 29 years of experience in banking and has been active in civic and community organizations. James E. Essany is a native of Gary, Indiana and a graduate of Indiana University with a Bachelor's of Science in Marketing. He began his banking career in 1979 and worked with three financial institutions in Indiana before joining Klamath First in May of 2000. Nina G. Drake joined Klamath First in June 2002 as Vice President-Human Resources. She has an extensive background in human resource management in financial institutions and related industries. She earned her Master of Business Administration in May 2002 and holds a lifetime certification as a Senior Professional in Human Resource Management (SPHR). 40 Item 2. Properties The following table sets forth the location of the Association's offices and other facilities used in operations as well as certain additional information relating to these offices and facilities as of September 30, 2002.
Year Square Description/Address Opened Leased/Owned Footage Main Office 540 Main Street 1939 Owned 25,660 Klamath Falls, Oregon Branch Offices 2943 South Sixth Street 1972 Owned 3,820 Klamath Falls, Oregon 2420 Dahlia Street 1979 Owned 1,876 Klamath Falls, Oregon 512 Walker Avenue 1977 Owned 4,216 Ashland, Oregon 1420 East McAndrews Road 1990 Owned 4,006 Medford, Oregon 61515 S. Highway 97 1993 Owned 5,415 Bend, Oregon 2300 Madison Street 1995 Owned 5,000 Klamath Falls, Oregon 721 Chetco Avenue 1997 Owned 5,409 Brookings, Oregon 293 North Broadway 1997 Owned 5,087 Burns, Oregon 111 West Main Street 1997 Owned 1,958 Carlton, Oregon 103 South Main Street 1997 Owned 2,235 Condon, Oregon 259 North Adams 1997 Owned 5,803 Coquille, Oregon 106 Southwest 1st Street 1997 Owned 4,700 Enterprise, Oregon 41 Year Square Description/Address Opened Leased/Owned Footage 555 1st Street 1997 Owned 1,844 Fossil, Oregon 708 Garibaldi Avenue 1997 Owned 1,400 Garibaldi, Oregon 29804 Ellensburg Avenue 1997 Owned 3,136 Gold Beach, Oregon 111 North Main Street 1997 Owned 4,586 Heppner, Oregon 810 South Highway 395 1997 Leased 6,000 Hermiston, Oregon 200 West Main Street 1997 Owned 4,552 John Day, Oregon 1 South E Street 1997 Owned 5,714 Lakeview, Oregon 206 East Front Street 1997 Owned 2,920 Merrill, Oregon 165 North 5th Street 1997 Owned 2,370 Monroe, Oregon 217 Main Street 1997 Owned 6,067 Nyssa, Oregon 48257 East 1st Street 1997 Owned 3,290 Oakridge, Oregon 227 West Main Street 1997 Owned 2,182 Pilot Rock, Oregon 716 Northeast Highway 101 1997 Owned 2,337 Port Orford, Oregon 178 Northwest Front Street 1997 Owned 2,353 Prairie City, Oregon 315 North Main Street 1997 Owned 3,638 Riddle, Oregon 38770 North Main Street 1997 Owned 2,997 Scio, Oregon 42 Year Square Description/Address Opened Leased/Owned Footage 508 Main Street 1997 Owned 2,282 Moro, Oregon 144 South Main Street 1997 Owned 2,146 Union, Oregon 165 North Maple Street 1997 Owned 2,192 Yamhill, Oregon 475 NE Windy Knolls Drive 1998 Owned 3,120 Bend, Oregon 185 East California 1998 Owned 2,116 Jacksonville, Oregon 1217 Plaza Boulevard, Suite A 2000 Leased 2,400 Central Point, Oregon 948 Southwest 9th Street 2001 Owned 3,277 Redmond, Oregon 2203 SW Court Place 2001 Leased 540 Pendleton, Oregon 1775 East Idaho Avenue 2001 Leased 693 Ontario, Oregon 2727 South Quillan Street 2001 Leased 693 Kennewick, Washington 2801 Duportail Street 2001 Leased 966 Richland, Washington 303 11th Street 2001 Leased 2,920 Astoria, Oregon 2245 Main Street 2001 Owned 4,911 Baker City, Oregon 1095 Oregon Avenue 2001 Owned 4,382 Bandon, Oregon 110 North Redwood Highway 199 2001 Owned 3,091 Cave Junction, Oregon 199 North Nehalem 2001 Owned 2,400 Clatskanie, Oregon 43 Year Square Description/Address Opened Leased/Owned Footage 212 South 5th Street 2001 Owned 6,200 Coos Bay, Oregon 150 South Wall 2001 Owned 9,271 Coos Bay, Oregon 430 Highway 101 2001 Owned 4,783 Florence, Oregon 2212 Island Avenue 2001 Leased 4,616 LaGrande, Oregon 1611 Virginia Avenue 2001 Leased 5,631 North Bend, Oregon 761 Avenue G 2001 Owned 2,416 Seaside, Oregon 2405 3rd Street 2001 Leased 4,690 Tillamook, Oregon 411 Pacific Avenue 2001 Owned 2,819 Tillamook, Oregon 620 Stewart Avenue 2002 Owned 2,721 Medford, Oregon 2659 Olympic Street 2002 Leased 528 Springfield, Oregon 4550 West 11th Avenue 2002 Leased 528 Eugene, Oregon Backoffice Processing Facilities 600 Main Street 1998 Leased 2,800 Klamath Falls, Oregon 714 Main Street 2001 Leased 14,532 Klamath Falls, Oregon 533 Main Street 2000 Leased 1,325 Klamath Falls, Oregon The net book value of the Company's investment in office, properties and equipment totaled $23.4 million at September 30, 2002. See Note 6 of the Notes to Consolidated Financial Statements contained in the Annual Report.
44 Item 3. Legal Proceedings Periodically, there have been various claims and lawsuits involving the Company, mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Association holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Association's business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2002. 45 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters The information contained under the section captioned "Common Stock Information" on page 16 of the Annual Report is incorporated herein by reference. Item 6. Selected Financial Data The information contained under the section captioned "Selected Consolidated Financial Data" on pages 5 and 6 of the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information contained in the section captioned "Management Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 7 of the Annual Report is incorporated herein by reference. Item 7a. Quantitative and Qualitative Disclosures About Market Risk The information contained in the section captioned "Management Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk and Asset/Liability Management" beginning on page 7 of the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data (a) Financial Statements Independent Auditors' Report* Consolidated Balance Sheets as of September 30, 2002 and 2001* Consolidated Statements of Earnings for the Years Ended September 30, 2002, 2001 and 2000* Consolidated Statements of Shareholders' Equity for the Years Ended September 30, 2002, 2001 and 2000* Consolidated Statements of Cash Flows for the Years Ended September 30, 2002, 2001 and 2000* Notes to the Consolidated Financial Statements* * Included in the Annual Report attached as Exhibit 13 hereto and incorporated herein by reference. All schedules have been omitted as the required information is either inapplicable or included in the Consolidated Financial Statements or related Notes contained in the Annual Report. (b) Supplementary Data The information entitled "Consolidated Supplemental Data - Selected Quarterly Financial Data" on page 35 of the Annual Report is incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There have been no changes in or disagreements with Accountants on accounting and financial disclosure during the year ended September 30, 2002. 46 PART III Item 10. Directors and Executive Officers of the Registrant The information contained under the section captioned "Proposal I - Election of Directors" contained in the Company's Proxy Statement, and "Part I - -- Business -- Personnel -- Executive Officers" of this report, is incorporated herein by reference. Reference is made to the cover page of this report for information regarding compliance with Section 16(a) of the Exchange Act. Item 11. Executive Compensation The information contained under the sections captioned "Executive Compensation" and "Directors' Compensation" under "Proposal I - Election of Directors" in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement. Equity Compensation Plan Information. The following table summarizes share and exercise price information about the Corporations' equity compensation plans as of September 30,2002.
(c) Number of securities (a) (b) remaining available Number of securities Weighted-average for future issuance to be issued upon exercise price under equity exercise of of outstanding compensation plans outstanding options, options, warrants (excluding securities Plan category warrants and rights and rights reflected in column (a)) - ---------------------------------------- ------------------------- ------------------------- ---------------------------- Equity compensation plans approved by security holders: Option............................. 879,951 $13.144 18,024 Restricted stock plan.............. -- -- 21,851 Equity compensation plans not approved by security holders: N/A N/A N/A ------------------------- ------------------------- ---------------------------- Total 879,951 $13.144 39,875
(b) Security Ownership of Management The information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement. 47 (c) Changes in Control The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company. The information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement. Item 13. Certain Relationships and Related Transactions The information set forth under the section captioned "Proposal I - Election of Directors - Certain Transactions with the Association" in the Proxy Statement is incorporated herein by reference. Item 14. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management within the 90-day period preceding the filing date of this annual report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in enduring that the information required to be disclosed by the Company in reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. (b) Changes in Internal Controls: In the year ended September 30, 2002, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls. 48 PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Exhibits 3(a) Articles of Incorporation of the Registrant* 3(b) Bylaws of the Registrant* 10(a) Employment Agreement with Kermit K. Houser*** 10(b) Employment Agreement with Marshall J. Alexander*** 10(c) Employment Agreement with Frank X. Hernandez*** 10(d) Employment Agreement with Craig M. Moore*** 10(e) Employment Agreement with Ben A. Gay*** 10(f) 1996 Stock Option Plan** 10(g) 1996 Management Recognition and Development Plan** 13 Annual Report to Shareholders 21 Subsidiaries of the Registrant 23 Consent of Deloitte & Touche LLP with respect to financial statements of the Registrant 99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act ___________________ * Incorporated by reference to the Registrant's Registration Statement on Form S-1, filed on June 19, 1995. ** Incorporated reference to the Registrant's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. *** Incorporated by reference to the Registrant's Form 10-K for the year ended September 30, 2001, filed on December 29, 2001. (b) Reports on Form 8-K No Current Reports on Form 8-K were filed during the quarter ended September 30, 2002. 49 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KLAMATH FIRST BANCORP, INC. Date: December 27, 2002 By: /s/ Kermit K. Houser Kermit K. Houser President and Chief Executive Officer Pursuant to the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURES TITLE DATE /s/ Kermit K. Houser President, Chief December 27, 2002 Kermit K. Houser Executive Officer and Director (Principal Executive Officer) /s/ Marshall J. Alexander Executive Vice President and December 27, 2002 Marshall J. Alexander Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Rodney N. Murray Chairman of the Board December 27, 2002 Rodney N. Murray of Directors /s/ Bernard Z. Agrons Director December 27, 2002 Bernard Z. Agrons /s/ Timothy A. Bailey Director December 27, 2002 Timothy A. Bailey /s/ James D. Bocchi Director December 27, 2002 James D. Bocchi /s/ William C. Dalton Director December 27, 2002 William C. Dalton /s/ Dianne E. Spires Director December 27, 2002 Dianne E. Spires /s/ Donald N. Bauhofer Director December 27, 2002 Donald N. Bauhofer Certification Required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934 I, Kermit K. Houser, certify that: (1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 27, 2002 /s/ Kermit K. Houser ---------------------- Kermit K. Houser President and Chief Executive Officer Certification Required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934 I, Marshall J. Alexander, certify that: (1) I have reviewed this annual report on Form 10-K of Klamath First Bancorp, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 27, 2002 /s/ Marshall J. Alexander -------------------------- Marshall J. Alexander Executive Vice President and Chief Financial Officer EX-10 4 ex_10.txt EMPLOYMENT CONTRACTS EXHIBIT 10(f) EMPLOYMENT AGREEMENT THIS AGREEMENT is made effective as of October 1, 2001, by and between KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION (the "Association"), Klamath Falls, Oregon; KLAMATH FIRST BANCORP, INC. (the "Company"), an Oregon corporation; and M. Isabel Castellanos (the "Executive"). WHEREAS, the Association wishes to assure itself of the services of Executive for the period provided in this Agreement; and WHEREAS, the Executive is willing to serve in the employ of the Association on a full-time basis for said period. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. POSITION AND RESPONSIBILITIES. During the period of his employment hereunder, Executive agrees to serve as Senior Vice President of the Association. During said period, Executive also agrees to serve, if elected, as an officer of the Company or any subsidiary or affiliate of the Company or the Association. 2. TERMS AND DUTIES. (a) The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twenty-four (24) full calendar months thereafter. Commencing on the first anniversary date, and continuing at each anniversary date thereafter, the Board of Directors of the Association (the "Board") may extend the Agreement for an additional year. Prior to the extension of the Agreement as provided herein, the Board of Directors of the Association will conduct a formal performance evaluation of the Executive for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. (b) During the period of his employment hereunder, except for periods of absence occasioned by illness, reasonable vacation periods, and reasonable leaves of absence, Executive shall devote substantially all his business time, attention, skill, and efforts to the faithful performance of his duties hereunder including activities and services related to the organization, operation and management of the Association; provided, however, that, with the approval of the Board, as evidenced by a resolution of such Board, from time to time, Executive may serve, or continue to serve, on the boards of directors of, and hold any other offices or positions in, companies or organizations, which, in such Board's judgment, will not present any conflict of interest with the Association, or materially affect the performance of Executive's duties pursuant to this Agreement. -14- 3. COMPENSATION AND REIMBURSEMENT. (a) The compensation specified under this Agreement shall constitute the salary and benefits paid for the duties described in Sections 1 and 2. The Association shall pay Executive as compensation a salary of $ 95,000 per year ("Base Salary"). Such Base Salary shall be payable in accordance with the customary payroll practices of the Association. During the period of this Agreement, Executive's Base Salary shall be reviewed at least annually; the first such review will be made no later than one year from the date of this Agreement. Such review shall be conducted by a Committee designated by the Board, and the Board may increase Executive's Base Salary. In addition to the Base Salary provided in this Section 3(a), the Association shall provide Executive at no cost to Executive with all such other benefits as are provided uniformly to permanent full-time employees of the Association. (b) The Association will provide Executive with employee benefit plans, arrangements and perquisites substantially equivalent to those in which Executive was participating or otherwise deriving benefit from immediately prior to the beginning of the term of this Agreement, and the Association will not, without Executive's prior written consent, make any changes in such plans, arrangements or perquisites which would adversely affect Executive's rights or benefits thereunder. Without limiting the generality of the foregoing provisions of this Subsection (b), Executive will be entitled to participate in or receive benefits under any employee benefit plans including, but not limited to, retirement plans, supplemental retirement plans, pension plans, profit-sharing plans, health-and-accident plan, medical coverage or any other employee benefit plan or arrangement made available by the Association in the future to its senior executives and key management employees, subject to, and on a basis consistent with, the terms, conditions and overall administration of such plans and arrangements. Executive will be entitled to incentive compensation and bonuses as provided in any plan, or pursuant to any arrangement of the Association, in which Executive is eligible to participate. Nothing paid to the Executive under any such plan or arrangement will be deemed to be in lieu of other compensation to which the Executive is entitled under this Agreement, except as provided under Section 5(e). (c) In addition to the Base Salary provided for by paragraph (a) of this Section 3, the Association shall pay or reimburse Executive for all reasonable travel and other obligations under this Agreement and may provide such additional compensation in such form and such amounts as the Board may from time to time determine. 4. PAYMENTS TO EXECUTIVE UPON AN EVENT OF TERMINATION. (a) Upon the occurrence of an Event of Termination (as herein defined) during the Executive's term of employment under this Agreement, the provisions of this Section shall apply. As used in this Agreement, an "Event of Termination" shall mean and include any one or more of the following: (i) the termination by the Association of Executive's full-time employment hereunder for any reason other than a Change in Control, as defined in Section 5(a) hereof; disability, as defined in Section 6(a) hereof; death; retirement, as defined in Section 7 hereof; or for Cause, as defined in Section 8 hereof; (ii) Executive's resignation from the Association's employ, upon (A) unless consented to by the Executive, a material change in Executive's function, duties, or responsibilities, which change would cause Executive's position to become one of lesser responsibility, importance, or scope from the position and attributes thereof described in Sections 1 and 2, above, (any such material change shall be deemed a continuing breach of this Agreement), (B) a relocation of Executive's principal place of employment by more than 35 miles from its location at the effective date of this Agreement, or a material reduction in the benefits and perquisites to Executive from those being provided as of the effective date of this Agreement, (C) the liquidation or dissolution of the Association, or (D) any breach of this Agreement by the Association. Upon the occurrence of any event described in clauses (A), (B), (C), or (D), above, Executive shall have the right to elect to terminate his employment under this Agreement by resignation upon not less than sixty (60) days prior written notice given within a reasonable period of time not to exceed, except in case of a continuing breach, four calendar months after the event giving rise to said right to elect. (b) Upon the occurrence of an Event of Termination, the Association shall pay Executive, or, in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to the payments due to the Executive for the remaining term of the Agreement, including Base Salary, bonuses, and any other cash or deferred compensation paid or to be paid (including the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination), to the Executive for the term of the Agreement provided, however, that if the Association is not in compliance with its minimum capital requirements or if such payments would cause the Association's capital to be reduced below its minimum capital requirements, such payments shall be deferred until such time as the Association is in capital compliance. All payments made pursuant to this Section 4(b) shall be paid in substantially equal monthly installments over the remaining term of this Agreement following the Executive's termination; provided, however, that if the remaining term of the Agreement is less than one (1) year (determined as of the Executive's Date of Termination), such payments and benefits shall be paid to the Executive in a lump sum within 30 days of the Date of Termination. (c) Upon the occurrence of an Event of Termination, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination. Such coverage shall cease upon the expiration of the remaining term of this Agreement. 5. CHANGE IN CONTROL. (a) No benefit shall be paid under this Section 5 unless there shall have occurred a Change in Control of the Company or the Association. For purposes of this Agreement, a "Change in Control" of the Company or the Association shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Association pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Association representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Association changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four month period (whether commencing before or after the effective date of this Agreement) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Association approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Association's assets, or a plan of partial or complete liquidation. (b) If any of the events described in Section 5(a) hereof constituting a Change in Control have occurred or the Board of the Association or the Company has determined that a Change in Control has occurred, Executive shall be entitled to the benefits provided in paragraphs (c), (d) and (e) of this Section 5 upon his subsequent involuntary termination of employment at any time during the term of this Agreement (or voluntary termination following a Change of Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits, or relocation of his principal place of employment by more than 35 miles from its location immediately prior to the Change in Control), unless such termination is because of his death, retirement as provided in Section 7, termination for Cause, or termination for Disability. (c) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association shall pay Executive, or in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to 2.99 times the Executive's "base amount," within the meaning of section 280G(b)(3) of the Internal Revenue Code of 1986 ("Code"), as amended. Such payment shall be made in a lump sum paid within ten (10) days of the Executive's Date of Termination. (d) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his severance. In addition, Executive shall be entitled to receive the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination. Such coverage and payments shall cease upon the expiration of thirty-six (36) months. (e) Upon the occurrence of a Change in Control, the Executive shall be entitled to receive benefits due him under, or contributed by the Company or the Association on his behalf, pursuant to any retirement, incentive, profit sharing, bonus, performance, disability or other employee benefit plan maintained by the Association or the Company on the Executive's behalf to the extent that such benefits are not otherwise paid to the Executive upon a Change in Control. (f) Notwithstanding the preceding paragraphs of this Section 5, in the event that the aggregate payments or benefits to be made or afforded to the Executive under this Section would be deemed to include an "excess parachute payment" under section 280G of the Code, such payments or benefits shall be payable or provided to Executive over the minimum period necessary to reduce the present value of such payments or benefits to an amount which is one dollar ($1.00) less than three (3) times the Executive's "base amount" under section 280G(b)(3) of the Code. 6. TERMINATION FOR DISABILITY. (a) If the Executive shall become disabled as defined in the Association's then current disability plan (or, if no such plan is then in effect, if the Executive is permanently and totally disabled within the meaning of Section 22(e)(3) of the Code as determined by a physician designated by the Board), the Association may terminate Executive's employment for "Disability." (b) Upon the Executive's termination of employment for Disability, the Association will pay Executive, as disability pay, a bi-weekly payment equal to three-quarters (3/4) of Executive's bi-weekly rate of Base Salary on the effective date of such termination. These disability payments shall commence on the effective date of Executive's termination and will end on the earlier of (i) the date Executive returns to the full-time employment of the Association in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive attaining the age of 65; or (iv) Executive's death; or (v) the expiration of the term of this Agreement. The disability pay shall be reduced by the amount, if any, paid to the Executive under any plan of the Association providing disability benefits to the Executive. (c) The Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination for Disability. This coverage and payments shall cease upon the earlier of (i) the date Executive returns to the full-time employment of the Association, in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive's attaining the age of 65; or (iv) the Executive's death; or (v) the expiration of the term of this Agreement. (d) Notwithstanding the foregoing, there will be no reduction in the compensation otherwise payable to Executive during any period during which Executive is incapable of performing his duties hereunder by reason of temporary disability. 7. TERMINATION UPON RETIREMENT; DEATH OF EXECUTIVE. Termination by the Association of Executive based on "Retirement" shall mean retirement at age 65 or in accordance with any retirement arrangement established with Executive's consent with respect to him. Upon termination of Executive upon Retirement, Executive shall be entitled to all benefits under any retirement plan of the Association or the Company and other plans to which Executive is a party. Upon the death of the Executive during the term of this Agreement, the Association shall pay to Executive's estate the compensation due to the Executive through the last day of the calendar month in which his death occurred. 8. TERMINATION FOR CAUSE. For purposes of this Agreement, "Termination for Cause" shall include termination because of the Executive's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. In addition, "Termination for Cause" shall include termination because of continuing or repeated problems with the Executive's performance or conduct, the Executive's inattention to duties, the refusal of the Executive to comply with the Association's or the Company's instructions, policies or rules or other conduct of the Executive which reflects adversely on the Association's or the Company 's reputation or operation. For purposes of this Section, no act, or the failure to act, on Executive's part shall be "willful" unless done, or omitted to be done, not in good faith and without reasonable belief that the action or omission was in the best interest of the Association or its affiliates. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the members of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to Executive and an opportunity for him, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive was guilty of conduct justifying termination for Cause and specifying the reasons thereof. The Executive shall not have the right to receive compensation or other benefits for any period after termination for Cause. Any stock options granted to Executive under any stock option plan or any unvested awards granted under any other stock benefit plan of the Association, the Company, or any subsidiary or affiliate thereof, shall become null and void effective upon Executive's receipt of Notice of Termination for Cause pursuant to Section 9 hereof, and shall not be exercisable by Executive at any time subsequent to such Termination for Cause. 9. REQUIRED PROVISIONS. (a) The Association may terminate Executive's employment at any time, but any termination by the Association, other than Termination for Cause, shall not prejudice Executive's right to compensation or other benefits under this Agreement. Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause as defined in Section 8 herein. (b) If Executive is suspended and/or temporarily prohibited from participating in the conduct of the Association's affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and (g)(1)), the Association's obligations under the Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Association may, in its discretion, (i) pay Executive all or part of the compensation withheld while its contract obligations were suspended and (ii) reinstate (in whole or in part) any of its obligations that were suspended. (c) If Executive is removed and/or permanently prohibited from participating in the conduct of the Association's affairs by an order issued under Section 8(e)(4) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Association under the Agreement shall terminate as of the effective date of the order, but vested rights of the contracting parties shall not be affected. (d) If the Association is in default (as defined in Section 3(x)(1) of the FDIA), all obligations under this Agreement shall terminate as of the date of default, but this paragraph shall not affect any vested rights of the parties. (e) All obligations under this Agreement shall be terminated (except to the extent determined that continuation of the Agreement is necessary for the continued operation of the Association): (i) by the Director of the Office of Thrift Supervision (the "Director") or his or her designee at the time the Federal Deposit Insurance Corporation or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Association under the authority contained in Section 13(c) of the FDIA or (ii) by the Director, or his or her designee at the time the Director or such designee approves a supervisory merger to resolve problems related to operation of the Association or when the Association is determined by the Director to be in an unsafe or unsound condition. Any rights of the parties that have already vested, however, shall not be affected by such action. (f) Any payments made to Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. section 1828(k) and any regulations promulgated thereunder. 10. NOTICE. (a) Any purported termination by the Association or by Executive shall be communicated by Notice of Termination to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. (b) "Date of Termination" shall mean (A) if Executive's employment is terminated for Disability, thirty (30) days after a Notice of Termination is given (provided that he shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), and (B) if his employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a Termination for Cause, shall not be less than thirty (30) days from the date such Notice of Termination is given). (c) If, within thirty (30) days after any Notice of Termination is given, the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, except upon the occurrence of a Change in Control and voluntary termination by the Executive in which case the Date of Termination shall be the date specified in the Notice, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding arbitration award, or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal there from having expired and no appeal having been perfected) and provided further that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. Notwithstanding the pendency of any such dispute, the Association will continue to pay Executive his full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary) and continue him as a participant in all compensation, benefit and insurance plans in which he was participating when the notice of dispute was given, until the dispute is finally resolved in accordance with this Agreement. Amounts paid under this Section are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement. 11. NON-COMPETITION. (a) Upon any termination of Executive's employment hereunder pursuant to an Event of Termination as provided in Section 4 hereof, Executive agrees not to compete with the Association and/or the Company for a period of one (1) year following such termination in any city, town or county in which the Association and/or the Company has an office or has filed an application for regulatory approval to establish an office, determined as of the effective date of such termination. Executive agrees that during such period and within said cities, towns and counties, Executive shall not work for or advise, consult or otherwise serve with, directly or indirectly, any entity whose business materially competes with the depository, lending or other business activities of the Association and/or the Company. The parties hereto, recognizing that irreparable injury will result to the Association and/or the Company, its business and property in the event of Executive's breach of this Subsection 11(a) agree that in the event of any such breach by Executive, the Association and/or the Company will be entitled, in addition to any other remedies and damages available, to an injunction to restrain the violation hereof by Executive, Executive's partners, agents, servants, employers, employees and all persons acting for or with Executive. Executive represents and admits that in the event of the termination of his employment pursuant to Section 8 hereof, Executive's experience and capabilities are such that Executive can obtain employment in a business engaged in other lines and/or of a different nature than the Association and/or the Company, and that the enforcement of a remedy by way of injunction will not prevent Executive from earning a livelihood. Nothing herein will be construed as prohibiting the Association and/or the Company from pursuing any other remedies available to the Association and/or the Company for such breach or threatened breach, including the recovery of damages from Executive. (b) Executive recognizes and acknowledges that the knowledge of the business activities and plans for business activities of the Association and affiliates thereof, as it may exist from time to time, is a valuable, special and unique asset of the business of the Association. Executive will not, during or after the term of his employment, disclose any knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof to any person, firm, corporation, or other entity for any reason or purpose whatsoever. Notwithstanding the foregoing, Executive may disclose any knowledge of banking, financial and/or economic principles, concepts or ideas which are not solely and exclusively derived from the business plans and activities of the Association. In the event of a breach or threatened breach by the Executive of the provisions of this Section, the Association will be entitled to an injunction restraining Executive from disclosing, in whole or in part, the knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof, or from rendering any services to any person, firm, corporation, other entity to whom such knowledge, in whole or in part, has been disclosed or is threatened to be disclosed. Nothing herein will be construed as prohibiting the Association from pursuing any other remedies available to the Association for such breach or threatened breach, including the recovery of damages from Executive. 12. SOURCE OF PAYMENTS. All payments provided in this Agreement shall be timely paid in cash or check from the general funds of the Association. The Company, however, guarantees all payments and the provision of all amounts and benefits due hereunder to Executive and, if such payments are not timely paid or provided by the Association, such amounts and benefits shall be paid or provided by the Company. 13. EFFECT ON PRIOR AGREEMENTS AND EXISTING BENEFITS PLANS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Association or any predecessor of the Association and Executive, except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to the Executive of a kind elsewhere provided. No provision of this Agreement shall be interpreted to mean that Executive is subject to receiving fewer benefits than those available to him without reference to this Agreement. 14. NO ATTACHMENT. (a) Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to execution, attachment, levy, or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to affect any such action shall be null, void, and of no effect. (b) This Agreement shall be binding upon, and inure to the benefit of, Executive, the Association, the Company and their respective successors and assigns. 15. MODIFICATION AND WAIVER. (a) This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) No term or condition of this Agreement shall be deemed to have been waived, nor shall there be any estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition waived and shall not constitute a waiver of such term or condition for the future as to any act other than that specifically waived. 16. SEVERABILITY. If, for any reason, any provision of this Agreement, or any part of any provision, is held invalid, such invalidity shall not affect any other provision of this Agreement or any part of such provision not held so invalid, and each such other provision and part thereof shall to the full extent consistent with law continue in full force and effect. 17. HEADINGS FOR REFERENCE ONLY. The headings of sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by the laws of the State of Oregon, unless otherwise specified herein; provided, however, that in the event of a conflict between the terms of this Agreement and any applicable federal or state law or regulation, the provisions of such law or regulation shall prevail. 19. ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of three arbitrators sitting in a location selected by the employee within one hundred (100) miles from the location of the Association, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that Executive shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 20. PAYMENT OF LEGAL FEES. All reasonable legal fees paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Association, if successful pursuant to a legal judgment, arbitration or settlement. 21. INDEMNIFICATION. The Association shall provide Executive (including his heirs, executors and administrators) with coverage under a standard directors' and officers' liability insurance policy at its expense, or in lieu thereof, shall indemnify Executive (and his heirs, executors and administrators) to the fullest extent permitted under law against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suite or proceeding in which he may be involved by reason of his having been a director or officer of the Association (whether or not he continues to be a directors or officer at the time of incurring such expenses or liabilities), such expenses and liabilities to include, but not be limited to, judgment, court costs and attorneys' fees and the cost of reasonable settlements. 22. SUCCESSOR TO THE ASSOCIATION OR THE COMPANY. The Association and the Company shall require any successor or assignee, whether direct or indirect, by purchase, merger, consolidation or otherwise, to all or substantially all the business or assets of the Association or the Company, expressly and unconditionally to assume and agree to perform the Association's or the Company's obligations under this Agreement, in the same manner and to the same extent that the Association or the Company would be required to perform if no such succession or assignment had taken place. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed and their seal to be affixed hereunto by a duly authorized officer or director, and Executive has signed this Agreement, all on the day of , 20 . ATTEST: KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION BY: [SEAL] ATTEST: KLAMATH FIRST BANCORP, INC. BY: ________________________ [SEAL] WITNESS: ___________________________ M. Isabel Castellanos EXHIBIT 10(g) EMPLOYMENT AGREEMENT THIS AGREEMENT is made effective as of January 2, 2002, by and between KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION (the "Association"), Klamath Falls, Oregon; KLAMATH FIRST BANCORP, INC. (the "Company"), an Oregon corporation; and Walt Dodrill (the "Executive"). WHEREAS, the Association wishes to assure itself of the services of Executive for the period provided in this Agreement; and WHEREAS, the Executive is willing to serve in the employ of the Association on a full-time basis for said period. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. POSITION AND RESPONSIBILITIES. During the period of his employment hereunder, Executive agrees to serve as Senior Vice President of the Association. During said period, Executive also agrees to serve, if elected, as an officer of the Company or any subsidiary or affiliate of the Company or the Association. 2. TERMS AND DUTIES. (a) The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twenty-four (24) full calendar months thereafter. Commencing on the first anniversary date, and continuing at each anniversary date thereafter, the Board of Directors of the Association (the "Board") may extend the Agreement for an additional year. Prior to the extension of the Agreement as provided herein, the Board of Directors of the Association will conduct a formal performance evaluation of the Executive for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. (b) During the period of his employment hereunder, except for periods of absence occasioned by illness, reasonable vacation periods, and reasonable leaves of absence, Executive shall devote substantially all his business time, attention, skill, and efforts to the faithful performance of his duties hereunder including activities and services related to the organization, operation and management of the Association; provided, however, that, with the approval of the Board, as evidenced by a resolution of such Board, from time to time, Executive may serve, or continue to serve, on the boards of directors of, and hold any other offices or positions in, companies or organizations, which, in such Board's judgment, will not present any conflict of interest with the Association, or materially affect the performance of Executive's duties pursuant to this Agreement. -23- 3. COMPENSATION AND REIMBURSEMENT. (a) The compensation specified under this Agreement shall constitute the salary and benefits paid for the duties described in Sections 1 and 2. The Association shall pay Executive as compensation a salary of $ 110,000 per year ("Base Salary"). Such Base Salary shall be payable in accordance with the customary payroll practices of the Association. During the period of this Agreement, Executive's Base Salary shall be reviewed at least annually; the first such review will be made no later than one year from the date of this Agreement. Such review shall be conducted by a Committee designated by the Board, and the Board may increase Executive's Base Salary. In addition to the Base Salary provided in this Section 3(a), the Association shall provide Executive at no cost to Executive with all such other benefits as are provided uniformly to permanent full-time employees of the Association. (b) The Association will provide Executive with employee benefit plans, arrangements and perquisites substantially equivalent to those in which Executive was participating or otherwise deriving benefit from immediately prior to the beginning of the term of this Agreement, and the Association will not, without Executive's prior written consent, make any changes in such plans, arrangements or perquisites which would adversely affect Executive's rights or benefits thereunder. Without limiting the generality of the foregoing provisions of this Subsection (b), Executive will be entitled to participate in or receive benefits under any employee benefit plans including, but not limited to, retirement plans, supplemental retirement plans, pension plans, profit-sharing plans, health-and-accident plan, medical coverage or any other employee benefit plan or arrangement made available by the Association in the future to its senior executives and key management employees, subject to, and on a basis consistent with, the terms, conditions and overall administration of such plans and arrangements. Executive will be entitled to incentive compensation and bonuses as provided in any plan, or pursuant to any arrangement of the Association, in which Executive is eligible to participate. Nothing paid to the Executive under any such plan or arrangement will be deemed to be in lieu of other compensation to which the Executive is entitled under this Agreement, except as provided under Section 5(e). (c) In addition to the Base Salary provided for by paragraph (a) of this Section 3, the Association shall pay or reimburse Executive for all reasonable travel and other obligations under this Agreement and may provide such additional compensation in such form and such amounts as the Board may from time to time determine. 4. PAYMENTS TO EXECUTIVE UPON AN EVENT OF TERMINATION. (a) Upon the occurrence of an Event of Termination (as herein defined) during the Executive's term of employment under this Agreement, the provisions of this Section shall apply. As used in this Agreement, an "Event of Termination" shall mean and include any one or more of the following: (i) the termination by the Association of Executive's full-time employment hereunder for any reason other than a Change in Control, as defined in Section 5(a) hereof; disability, as defined in Section 6(a) hereof; death; retirement, as defined in Section 7 hereof; or for Cause, as defined in Section 8 hereof; (ii) Executive's resignation from the Association's employ, upon (A) unless consented to by the Executive, a material change in Executive's function, duties, or responsibilities, which change would cause Executive's position to become one of lesser responsibility, importance, or scope from the position and attributes thereof described in Sections 1 and 2, above, (any such material change shall be deemed a continuing breach of this Agreement), (B) a relocation of Executive's principal place of employment by more than 35 miles from its location at the effective date of this Agreement, or a material reduction in the benefits and perquisites to Executive from those being provided as of the effective date of this Agreement, (C) the liquidation or dissolution of the Association, or (D) any breach of this Agreement by the Association. Upon the occurrence of any event described in clauses (A), (B), (C), or (D), above, Executive shall have the right to elect to terminate his employment under this Agreement by resignation upon not less than sixty (60) days prior written notice given within a reasonable period of time not to exceed, except in case of a continuing breach, four calendar months after the event giving rise to said right to elect. (b) Upon the occurrence of an Event of Termination, the Association shall pay Executive, or, in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to the payments due to the Executive for the remaining term of the Agreement, including Base Salary, bonuses, and any other cash or deferred compensation paid or to be paid (including the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination), to the Executive for the term of the Agreement provided, however, that if the Association is not in compliance with its minimum capital requirements or if such payments would cause the Association's capital to be reduced below its minimum capital requirements, such payments shall be deferred until such time as the Association is in capital compliance. All payments made pursuant to this Section 4(b) shall be paid in substantially equal monthly installments over the remaining term of this Agreement following the Executive's termination; provided, however, that if the remaining term of the Agreement is less than one (1) year (determined as of the Executive's Date of Termination), such payments and benefits shall be paid to the Executive in a lump sum within 30 days of the Date of Termination. (c) Upon the occurrence of an Event of Termination, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination. Such coverage shall cease upon the expiration of the remaining term of this Agreement. 5. CHANGE IN CONTROL. (a) No benefit shall be paid under this Section 5 unless there shall have occurred a Change in Control of the Company or the Association. For purposes of this Agreement, a "Change in Control" of the Company or the Association shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Association pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Association representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Association changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four month period (whether commencing before or after the date of adoption of this Plan) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Association approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Association's assets, or a plan of partial or complete liquidation. (b) If any of the events described in Section 5(a) hereof constituting a Change in Control have occurred or the Board of the Association or the Company has determined that a Change in Control has occurred, Executive shall be entitled to the benefits provided in paragraphs (c), (d) and (e) of this Section 5 upon his subsequent involuntary termination of employment at any time during the term of this Agreement (or voluntary termination following a Change of Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits, or relocation of his principal place of employment by more than 35 miles from its location immediately prior to the Change in Control), unless such termination is because of his death, retirement as provided in Section 7, termination for Cause, or termination for Disability. (c) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association shall pay Executive, or in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to 2.99 times the Executive's "base amount," within the meaning of section 280G(b)(3) of the Internal Revenue Code of 1986 ("Code"), as amended. Such payment shall be made in a lump sum paid within ten (10) days of the Executive's Date of Termination. (d) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his severance. In addition, Executive shall be entitled to receive the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination. Such coverage and payments shall cease upon the expiration of twenty-four (24) months. (e) Upon the occurrence of a Change in Control, the Executive shall be entitled to receive benefits due him under, or contributed by the Company or the Association on his behalf, pursuant to any retirement, incentive, profit sharing, bonus, performance, disability or other employee benefit plan maintained by the Association or the Company on the Executive's behalf to the extent that such benefits are not otherwise paid to the Executive upon a Change in Control. (f) Notwithstanding the preceding paragraphs of this Section 5, in the event that the aggregate payments or benefits to be made or afforded to the Executive under this Section would be deemed to include an "excess parachute payment" under section 280G of the Code, such payments or benefits shall be payable or provided to Executive over the minimum period necessary to reduce the present value of such payments or benefits to an amount which is one dollar ($1.00) less than three (3) times the Executive's "base amount" under section 280G(b)(3) of the Code. 6. TERMINATION FOR DISABILITY. (a) If the Executive shall become disabled as defined in the Association's then current disability plan (or, if no such plan is then in effect, if the Executive is permanently and totally disabled within the meaning of Section 22(e)(3) of the Code as determined by a physician designated by the Board), the Association may terminate Executive's employment for "Disability." (b) Upon the Executive's termination of employment for Disability, the Association will pay Executive, as disability pay, a bi-weekly payment equal to three-quarters (3/4) of Executive's bi-weekly rate of Base Salary on the effective date of such termination. These disability payments shall commence on the effective date of Executive's termination and will end on the earlier of (i) the date Executive returns to the full-time employment of the Association in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive attaining the age of 65; or (iv) Executive's death; or (v) the expiration of the term of this Agreement. The disability pay shall be reduced by the amount, if any, paid to the Executive under any plan of the Association providing disability benefits to the Executive. (c) The Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination for Disability. This coverage and payments shall cease upon the earlier of (i) the date Executive returns to the full-time employment of the Association, in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive's attaining the age of 65; or (iv) the Executive's death; or (v) the expiration of the term of this Agreement. (d) Notwithstanding the foregoing, there will be no reduction in the compensation otherwise payable to Executive during any period during which Executive is incapable of performing his duties hereunder by reason of temporary disability. 7. TERMINATION UPON RETIREMENT; DEATH OF EXECUTIVE. Termination by the Association of Executive based on "Retirement" shall mean retirement at age 65 or in accordance with any retirement arrangement established with Executive's consent with respect to him. Upon termination of Executive upon Retirement, Executive shall be entitled to all benefits under any retirement plan of the Association or the Company and other plans to which Executive is a party. Upon the death of the Executive during the term of this Agreement, the Association shall pay to Executive's estate the compensation due to the Executive through the last day of the calendar month in which his death occurred. 8. TERMINATION FOR CAUSE. For purposes of this Agreement, "Termination for Cause" shall include termination because of the Executive's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. For purposes of this Section, no act, or the failure to act, on Executive's part shall be "willful" unless done, or omitted to be done, not in good faith and without reasonable belief that the action or omission was in the best interest of the Association or its affiliates. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the members of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to Executive and an opportunity for him, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive was guilty of conduct justifying termination for Cause and specifying the reasons thereof. The Executive shall not have the right to receive compensation or other benefits for any period after termination for Cause. Any stock options granted to Executive under any stock option plan or any unvested awards granted under any other stock benefit plan of the Association, the Company, or any subsidiary or affiliate thereof, shall become null and void effective upon Executive's receipt of Notice of Termination for Cause pursuant to Section 9 hereof, and shall not be exercisable by Executive at any time subsequent to such Termination for Cause. 9. REQUIRED PROVISIONS. (a) The Association may terminate Executive's employment at any time, but any termination by the Association, other than Termination for Cause, shall not prejudice Executive's right to compensation or other benefits under this Agreement. Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause as defined in Section 8 herein. (b) If Executive is suspended and/or temporarily prohibited from participating in the conduct of the Association's affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and (g)(1)), the Association's obligations under the Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Association may, in its discretion, (i) pay Executive all or part of the compensation withheld while its contract obligations were suspended and (ii) reinstate (in whole or in part) any of its obligations that were suspended. (c) If Executive is removed and/or permanently prohibited from participating in the conduct of the Association's affairs by an order issued under Section 8(e)(4) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Association under the Agreement shall terminate as of the effective date of the order, but vested rights of the contracting parties shall not be affected. (d) If the Association is in default (as defined in Section 3(x)(1) of the FDIA), all obligations under this Agreement shall terminate as of the date of default, but this paragraph shall not affect any vested rights of the parties. (e) All obligations under this Agreement shall be terminated (except to the extent determined that continuation of the Agreement is necessary for the continued operation of the Association): (i) by the Director of the Office of Thrift Supervision (the "Director") or his or her designee at the time the Federal Deposit Insurance Corporation or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Association under the authority contained in Section 13(c) of the FDIA or (ii) by the Director, or his or her designee at the time the Director or such designee approves a supervisory merger to resolve problems related to operation of the Association or when the Association is determined by the Director to be in an unsafe or unsound condition. Any rights of the parties that have already vested, however, shall not be affected by such action. (f) Any payments made to Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. section 1828(k) and any regulations promulgated thereunder. 10. NOTICE. (a) Any purported termination by the Association or by Executive shall be communicated by Notice of Termination to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. (b) "Date of Termination" shall mean (A) if Executive's employment is terminated for Disability, thirty (30) days after a Notice of Termination is given (provided that he shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), and (B) if his employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a Termination for Cause, shall not be less than thirty (30) days from the date such Notice of Termination is given). (c) If, within thirty (30) days after any Notice of Termination is given, the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, except upon the occurrence of a Change in Control and voluntary termination by the Executive in which case the Date of Termination shall be the date specified in the Notice, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding arbitration award, or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal there from having expired and no appeal having been perfected) and provided further that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. Notwithstanding the pendency of any such dispute, the Association will continue to pay Executive his full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary) and continue him as a participant in all compensation, benefit and insurance plans in which he was participating when the notice of dispute was given, until the dispute is finally resolved in accordance with this Agreement. Amounts paid under this Section are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement. 11. NON-COMPETITION. (a) Upon any termination of Executive's employment hereunder pursuant to an Event of Termination as provided in Section 4 hereof, Executive agrees not to compete with the Association and/or the Company for a period of one (1) year following such termination in any city, town or county in which the Association and/or the Company has an office or has filed an application for regulatory approval to establish an office, determined as of the effective date of such termination. Executive agrees that during such period and within said cities, towns and counties, Executive shall not work for or advise, consult or otherwise serve with, directly or indirectly, any entity whose business materially competes with the depository, lending or other business activities of the Association and/or the Company. The parties hereto, recognizing that irreparable injury will result to the Association and/or the Company, its business and property in the event of Executive's breach of this Subsection 11(a) agree that in the event of any such breach by Executive, the Association and/or the Company will be entitled, in addition to any other remedies and damages available, to an injunction to restrain the violation hereof by Executive, Executive's partners, agents, servants, employers, employees and all persons acting for or with Executive. Executive represents and admits that in the event of the termination of his employment pursuant to Section 8 hereof, Executive's experience and capabilities are such that Executive can obtain employment in a business engaged in other lines and/or of a different nature than the Association and/or the Company, and that the enforcement of a remedy by way of injunction will not prevent Executive from earning a livelihood. Nothing herein will be construed as prohibiting the Association and/or the Company from pursuing any other remedies available to the Association and/or the Company for such breach or threatened breach, including the recovery of damages from Executive. (b) Executive recognizes and acknowledges that the knowledge of the business activities and plans for business activities of the Association and affiliates thereof, as it may exist from time to time, is a valuable, special and unique asset of the business of the Association. Executive will not, during or after the term of his employment, disclose any knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof to any person, firm, corporation, or other entity for any reason or purpose whatsoever. Notwithstanding the foregoing, Executive may disclose any knowledge of banking, financial and/or economic principles, concepts or ideas which are not solely and exclusively derived from the business plans and activities of the Association. In the event of a breach or threatened breach by the Executive of the provisions of this Section, the Association will be entitled to an injunction restraining Executive from disclosing, in whole or in part, the knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof, or from rendering any services to any person, firm, corporation, other entity to whom such knowledge, in whole or in part, has been disclosed or is threatened to be disclosed. Nothing herein will be construed as prohibiting the Association from pursuing any other remedies available to the Association for such breach or threatened breach, including the recovery of damages from Executive. 12. SOURCE OF PAYMENTS. All payments provided in this Agreement shall be timely paid in cash or check from the general funds of the Association. The Company, however, guarantees all payments and the provision of all amounts and benefits due hereunder to Executive and, if such payments are not timely paid or provided by the Association, such amounts and benefits shall be paid or provided by the Company. 13. EFFECT ON PRIOR AGREEMENTS AND EXISTING BENEFITS PLANS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Association or any predecessor of the Association and Executive, except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to the Executive of a kind elsewhere provided. No provision of this Agreement shall be interpreted to mean that Executive is subject to receiving fewer benefits than those available to him without reference to this Agreement. 14. NO ATTACHMENT. (a) Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to execution, attachment, levy, or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to affect any such action shall be null, void, and of no effect. (b) This Agreement shall be binding upon, and inure to the benefit of, Executive, the Association, the Company and their respective successors and assigns. 15. MODIFICATION AND WAIVER. (a) This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) No term or condition of this Agreement shall be deemed to have been waived, nor shall there be any estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition waived and shall not constitute a waiver of such term or condition for the future as to any act other than that specifically waived. 16. SEVERABILITY. If, for any reason, any provision of this Agreement, or any part of any provision, is held invalid, such invalidity shall not affect any other provision of this Agreement or any part of such provision not held so invalid, and each such other provision and part thereof shall to the full extent consistent with law continue in full force and effect. 17. HEADINGS FOR REFERENCE ONLY. The headings of sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by the laws of the State of Oregon, unless otherwise specified herein; provided, however, that in the event of a conflict between the terms of this Agreement and any applicable federal or state law or regulation, the provisions of such law or regulation shall prevail. 19. ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of three arbitrators sitting in a location selected by the employee within one hundred (100) miles from the location of the Association, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that Executive shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 20. PAYMENT OF LEGAL FEES. All reasonable legal fees paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Association, if successful pursuant to a legal judgment, arbitration or settlement. 21. INDEMNIFICATION. The Association shall provide Executive (including his heirs, executors and administrators) with coverage under a standard directors' and officers' liability insurance policy at its expense, or in lieu thereof, shall indemnify Executive (and his heirs, executors and administrators) to the fullest extent permitted under law against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suite or proceeding in which he may be involved by reason of his having been a director or officer of the Association (whether or not he continues to be a directors or officer at the time of incurring such expenses or liabilities), such expenses and liabilities to include, but not be limited to, judgment, court costs and attorneys' fees and the cost of reasonable settlements. 22. SUCCESSOR TO THE ASSOCIATION OR THE COMPANY. The Association and the Company shall require any successor or assignee, whether direct or indirect, by purchase, merger, consolidation or otherwise, to all or substantially all the business or assets of the Association or the Company, expressly and unconditionally to assume and agree to perform the Association's or the Company's obligations under this Agreement, in the same manner and to the same extent that the Association or the Company would be required to perform if no such succession or assignment had taken place. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed and their seal to be affixed hereunto by a duly authorized officer or director, and Executive has signed this Agreement, all on the day of , 20 . ATTEST: KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION BY: [SEAL] ATTEST: KLAMATH FIRST BANCORP, INC. BY: ________________________ [SEAL] WITNESS: ___________________________ Walt Dodrill EXHIBIT 10(h) EMPLOYMENT AGREEMENT THIS AGREEMENT is made effective as of October 1, 2002, by and between KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION (the "Association"), Klamath Falls, Oregon; KLAMATH FIRST BANCORP, INC. (the "Company"), an Oregon corporation; and James E. Essany (the "Executive"). WHEREAS, the Association wishes to assure itself of the services of Executive for the period provided in this Agreement; and WHEREAS, the Executive is willing to serve in the employ of the Association on a full-time basis for said period. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. POSITION AND RESPONSIBILITIES. During the period of his employment hereunder, Executive agrees to serve as Senior Vice President of the Association. During said period, Executive also agrees to serve, if elected, as an officer of the Company or any subsidiary or affiliate of the Company or the Association. 2. TERMS AND DUTIES. (a) The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twenty-four (24) full calendar months thereafter. Commencing on the first anniversary date, and continuing at each anniversary date thereafter, the Board of Directors of the Association (the "Board") or its Compensation Committee may extend the Agreement for an additional year. Prior to the extension of the Agreement as provided herein, the Board of Directors of the Association will review the Executive's performance evaluation for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. (b) During the period of his employment hereunder, except for periods of absence occasioned by illness, reasonable vacation periods, and reasonable leaves of absence, Executive shall devote substantially all his business time, attention, skill, and efforts to the faithful performance of his duties hereunder including activities and services related to the organization, operation and management of the Association; provided, however, that, with the approval of the Board, as evidenced by a resolution of such Board, from time to time, Executive may serve, or continue to serve, on the boards of directors of, and hold any other offices or positions in, companies or organizations, which, in such Board's judgment, will not present any conflict of interest with the Association, or materially affect the performance of Executive's duties pursuant to this Agreement. 3. COMPENSATION AND REIMBURSEMENT. (a) The compensation specified under this Agreement shall constitute the salary and benefits paid for the duties described in Sections 1 and 2. The Association shall pay Executive as compensation a salary of $85,000 per year ("Base Salary"). Effective November 1, 2002, the Base Salary shall be calculated at $95,000 per year unless subsequently changed as provided below. Such Base Salary shall be payable in accordance with the customary payroll practices of the Association. During the period of this Agreement, Executive's Base Salary shall be reviewed at least annually; the first such review will be made no later than one year from the date of this Agreement. Such review shall be conducted by the Board or its Compensation Committee, and the Board may increase Executive's Base Salary. In addition to the Base Salary provided in this Section 3(a), the Association shall provide Executive at no cost to Executive with all such other benefits as are provided uniformly to regular salaried employees of the Association. (b) The Association will provide Executive with employee benefit plans, arrangements and perquisites substantially equivalent to those in which Executive was participating or otherwise deriving benefit from immediately prior to the beginning of the term of this Agreement, and the Association will not, without Executive's prior written consent, make any changes in such plans, arrangements or perquisites which would adversely affect Executive's rights or benefits thereunder. However, changes in Association-sponsored group insurance plan premiums, deductibles, co-payments, and related coverage limits or conditions are excluded from the prior sentence for any such change which is consistently applied to or available to regular salaried Association employees. Without limiting the generality of the foregoing provisions of this Subsection (b), Executive will be entitled to participate in or receive benefits under any employee benefit plans including, but not limited to, retirement plans, supplemental retirement plans, pension plans, profit-sharing plans, health-and-accident plan, medical coverage or any other employee benefit plan or arrangement made available by the Association in the future to its senior executives and key management employees, subject to, and on a basis consistent with, the terms, conditions and overall administration of such plans and arrangements. Executive will be entitled to incentive compensation and bonuses as provided in any plan, or pursuant to any arrangement of the Association, in which Executive is eligible to participate. Nothing paid to the Executive under any such plan or arrangement will be deemed to be in lieu of other compensation to which the Executive is entitled under this Agreement, except as provided under Section 5(e). (c) In addition to the Base Salary provided for by paragraph (a) of this Section 3, the Association shall pay or reimburse Executive for all reasonable travel and other obligations under this Agreement and may provide such additional compensation in such form and such amounts as the Board may from time to time determine. 4. PAYMENTS TO EXECUTIVE UPON AN EVENT OF TERMINATION. (a) Upon the occurrence of an Event of Termination (as herein defined) during the Executive's term of employment under this Agreement, the provisions of this Section shall apply. As used in this Agreement, an "Event of Termination" shall mean and include any one or more of the following: (i) the termination by the Association of Executive's full-time employment hereunder for any reason other than a Change in Control, as defined in Section 5(a) hereof; disability, as defined in Section 6(a) hereof; death; retirement, as defined in Section 7 hereof; or for Cause, as defined in Section 8 hereof; (ii) Executive's resignation from the Association's employ, upon (A) unless consented to by the Executive, a material change in Executive's function, duties, or responsibilities, which change would cause Executive's position to become one of lesser responsibility, importance, or scope from the position and attributes thereof described in Sections 1 and 2, above, (any such material change shall be deemed a continuing breach of this Agreement), (B) a relocation of Executive's principal place of employment by more than 35 miles from its location at the effective date of this Agreement, or a material reduction in the benefits and perquisites to Executive from those being provided as of the effective date of this Agreement, (C) the liquidation or dissolution of the Association, or (D) any breach of this Agreement by the Association. Upon the occurrence of any event described in clauses (A), (B), (C), or (D), above, Executive shall have the right to elect to terminate his employment under this Agreement by resignation upon not less than sixty (60) days prior written notice given within a reasonable period of time not to exceed, except in case of a continuing breach, four calendar months after the event giving rise to said right to elect. (b) Upon the occurrence of an Event of Termination, the Association shall pay Executive, or, in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to the payments due to the Executive for the remaining term of the Agreement, including Base Salary, bonuses, and any other cash or deferred compensation paid or to be paid (including the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination), to the Executive for the term of the Agreement provided, however, that if the Association is not in compliance with its minimum capital requirements or if such payments would cause the Association's capital to be reduced below its minimum capital requirements, such payments shall be deferred until such time as the Association is in capital compliance. All payments made pursuant to this Section 4(b) shall be paid in substantially equal monthly installments over the remaining term of this Agreement following the Executive's termination; provided, however, that if the remaining term of the Agreement is less than one (1) year (determined as of the Executive's Date of Termination), such payments and benefits shall be paid to the Executive in a lump sum within 30 days of the Date of Termination. (c) Upon the occurrence of an Event of Termination, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination. Such coverage shall cease upon the expiration of the remaining term of this Agreement. 5. CHANGE IN CONTROL. (a) No benefit shall be paid under this Section 5 unless there shall have occurred a Change in Control of the Company or the Association. For purposes of this Agreement, a "Change in Control" of the Company or the Association shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Association pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Association representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Association changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four month period (whether commencing before or after the effective date of this Agreement) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Association approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Association's assets, or a plan of partial or complete liquidation. (b) If any of the events described in Section 5(a) hereof constituting a Change in Control have occurred or the Board of the Association or the Company has determined that a Change in Control has occurred, Executive shall be entitled to the benefits provided in paragraphs (c), (d) and (e) of this Section 5 upon his subsequent involuntary termination of employment at any time during the term of this Agreement (or voluntary termination following a Change of Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits, or relocation of his principal place of employment by more than 35 miles from its location immediately prior to the Change in Control), unless such termination is because of his death, retirement as provided in Section 7, termination for Cause, or termination for Disability. (c) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association shall pay Executive, or in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to 2.99 times the Executive's "base amount," within the meaning of section 280G(b)(3) of the Internal Revenue Code of 1986 ("Code"), as amended. Such payment shall be made in a lump sum paid within ten (10) days of the Executive's Date of Termination. (d) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his severance. In addition, Executive shall be entitled to receive the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination. Such coverage and payments shall cease upon the expiration of thirty-six (36) months. (e) Upon the occurrence of a Change in Control, the Executive shall be entitled to receive benefits due him under, or contributed by the Company or the Association on his behalf, pursuant to any retirement, incentive, profit sharing, bonus, performance, disability or other employee benefit plan maintained by the Association or the Company on the Executive's behalf to the extent that such benefits are not otherwise paid to the Executive upon a Change in Control. (f) Notwithstanding the preceding paragraphs of this Section 5, in the event that the aggregate payments or benefits to be made or afforded to the Executive under this Section would be deemed to include an "excess parachute payment" under section 280G of the Code, such payments or benefits shall be payable or provided to Executive over the minimum period necessary to reduce the present value of such payments or benefits to an amount which is one dollar ($1.00) less than three (3) times the Executive's "base amount" under section 280G(b)(3) of the Code. 6. TERMINATION FOR DISABILITY. (a) If the Executive shall become disabled as defined in the Association's then current disability plan (or, if no such plan is then in effect, if the Executive is permanently and totally disabled within the meaning of Section 22(e)(3) of the Code as determined by a physician designated by the Board), the Association may terminate Executive's employment for "Disability." (b) Upon the Executive's termination of employment for Disability, the Association will pay Executive, as disability pay, a bi-weekly payment equal to three-quarters (3/4) of Executive's bi-weekly rate of Base Salary on the effective date of such termination. These disability payments shall commence on the effective date of Executive's termination and will end on the earlier of (i) the date Executive returns to the full-time employment of the Association in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive attaining the age of 65; or (iv) Executive's death; or (v) the expiration of the term of this Agreement. The disability pay shall be reduced by the amount, if any, paid to the Executive under any plan of the Association providing disability benefits to the Executive. (c) The Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to his termination for Disability. This coverage and payments shall cease upon the earlier of (i) the date Executive returns to the full-time employment of the Association, in the same capacity as he was employed prior to his termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive's attaining the age of 65; or (iv) the Executive's death; or (v) the expiration of the term of this Agreement. (d) Notwithstanding the foregoing, there will be no reduction in the compensation otherwise payable to Executive during any period during which Executive is incapable of performing his duties hereunder by reason of temporary disability. 7. TERMINATION UPON RETIREMENT; DEATH OF EXECUTIVE. Termination by the Association of Executive based on "Retirement" shall mean retirement at age 65 or in accordance with any retirement arrangement established with Executive's consent with respect to him. Upon termination of Executive upon Retirement, Executive shall be entitled to all benefits under any retirement plan of the Association or the Company and other plans to which Executive is a party. Upon the death of the Executive during the term of this Agreement, the Association shall pay to Executive's estate the compensation due to the Executive through the last day of the calendar month in which his death occurred. 8. TERMINATION FOR CAUSE. For purposes of this Agreement, "Termination for Cause" shall include termination because of the Executive's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. In addition, "Termination for Cause" shall include termination because of continuing or repeated problems with the Executive's performance or conduct, the Executive's inattention to duties, the refusal of the Executive to comply with the Association's or the Company's instructions, policies or rules or other conduct of the Executive which reflects adversely on the Association's or the Company 's reputation or operation. For purposes of this Section, no act, or the failure to act, on Executive's part shall be "willful" unless done, or omitted to be done, not in good faith and without reasonable belief that the action or omission was in the best interest of the Association or its affiliates. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the members of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to Executive and an opportunity for him, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive was guilty of conduct justifying termination for Cause and specifying the reasons thereof. The Executive shall not have the right to receive compensation or other benefits for any period after termination for Cause. Any stock options granted to Executive under any stock option plan or any unvested awards granted under any other stock benefit plan of the Association, the Company, or any subsidiary or affiliate thereof, shall become null and void effective upon Executive's receipt of Notice of Termination for Cause pursuant to Section 9 hereof, and shall not be exercisable by Executive at any time subsequent to such Termination for Cause. 9. REQUIRED PROVISIONS. (a) The Association may terminate Executive's employment at any time, but any termination by the Association, other than Termination for Cause, shall not prejudice Executive's right to compensation or other benefits under this Agreement. Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause as defined in Section 8 herein. (b) If Executive is suspended and/or temporarily prohibited from participating in the conduct of the Association's affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and (g)(1)), the Association's obligations under the Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Association may, in its discretion, (i) pay Executive all or part of the compensation withheld while its contract obligations were suspended and (ii) reinstate (in whole or in part) any of its obligations that were suspended. (c) If Executive is removed and/or permanently prohibited from participating in the conduct of the Association's affairs by an order issued under Section 8(e)(4) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Association under the Agreement shall terminate as of the effective date of the order, but vested rights of the contracting parties shall not be affected. (d) If the Association is in default (as defined in Section 3(x)(1) of the FDIA), all obligations under this Agreement shall terminate as of the date of default, but this paragraph shall not affect any vested rights of the parties. (e) All obligations under this Agreement shall be terminated (except to the extent determined that continuation of the Agreement is necessary for the continued operation of the Association): (i) by the Director of the Office of Thrift Supervision (the "Director") or his or her designee at the time the Federal Deposit Insurance Corporation or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Association under the authority contained in Section 13(c) of the FDIA or (ii) by the Director, or his or her designee at the time the Director or such designee approves a supervisory merger to resolve problems related to operation of the Association or when the Association is determined by the Director to be in an unsafe or unsound condition. Any rights of the parties that have already vested, however, shall not be affected by such action. (f) Any payments made to Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. section 1828(k) and any regulations promulgated thereunder. 10. NOTICE. (a) Any purported termination by the Association or by Executive shall be communicated by Notice of Termination to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. (b) "Date of Termination" shall mean (A) if Executive's employment is terminated for Disability, thirty (30) days after a Notice of Termination is given (provided that he shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), and (B) if his employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a Termination for Cause, shall not be less than thirty (30) days from the date such Notice of Termination is given). (c) If, within thirty (30) days after any Notice of Termination is given, the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, except upon the occurrence of a Change in Control and voluntary termination by the Executive in which case the Date of Termination shall be the date specified in the Notice, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding arbitration award, or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal there from having expired and no appeal having been perfected) and provided further that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. Notwithstanding the pendency of any such dispute, the Association will continue to pay Executive his full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary) and continue him as a participant in all compensation, benefit and insurance plans in which he was participating when the notice of dispute was given, until the dispute is finally resolved in accordance with this Agreement. Amounts paid under this Section are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement. 11. NON-COMPETITION. (a) Upon any termination of Executive's employment hereunder pursuant to an Event of Termination as provided in Section 4 hereof, Executive agrees not to compete with the Association and/or the Company for a period of one (1) year following such termination in any city, town or county in which the Association and/or the Company has an office or has filed an application for regulatory approval to establish an office, determined as of the effective date of such termination. Executive agrees that during such period and within said cities, towns and counties, Executive shall not work for or advise, consult or otherwise serve with, directly or indirectly, any entity whose business materially competes with the depository, lending or other business activities of the Association and/or the Company. The parties hereto, recognizing that irreparable injury will result to the Association and/or the Company, its business and property in the event of Executive's breach of this Subsection 11(a) agree that in the event of any such breach by Executive, the Association and/or the Company will be entitled, in addition to any other remedies and damages available, to an injunction to restrain the violation hereof by Executive, Executive's partners, agents, servants, employers, employees and all persons acting for or with Executive. Executive represents and admits that in the event of the termination of his employment pursuant to Section 8 hereof, Executive's experience and capabilities are such that Executive can obtain employment in a business engaged in other lines and/or of a different nature than the Association and/or the Company, and that the enforcement of a remedy by way of injunction will not prevent Executive from earning a livelihood. Nothing herein will be construed as prohibiting the Association and/or the Company from pursuing any other remedies available to the Association and/or the Company for such breach or threatened breach, including the recovery of damages from Executive. (b) Executive recognizes and acknowledges that the knowledge of the business activities and plans for business activities of the Association and affiliates thereof, as it may exist from time to time, is a valuable, special and unique asset of the business of the Association. Executive will not, during or after the term of his employment, disclose any knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof to any person, firm, corporation, or other entity for any reason or purpose whatsoever. Notwithstanding the foregoing, Executive may disclose any knowledge of banking, financial and/or economic principles, concepts or ideas which are not solely and exclusively derived from the business plans and activities of the Association. In the event of a breach or threatened breach by the Executive of the provisions of this Section, the Association will be entitled to an injunction restraining Executive from disclosing, in whole or in part, the knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof, or from rendering any services to any person, firm, corporation, other entity to whom such knowledge, in whole or in part, has been disclosed or is threatened to be disclosed. Nothing herein will be construed as prohibiting the Association from pursuing any other remedies available to the Association for such breach or threatened breach, including the recovery of damages from Executive. 12. SOURCE OF PAYMENTS. All payments provided in this Agreement shall be timely paid in cash or check from the general funds of the Association. The Company, however, guarantees all payments and the provision of all amounts and benefits due hereunder to Executive and, if such payments are not timely paid or provided by the Association, such amounts and benefits shall be paid or provided by the Company. 13. EFFECT ON PRIOR AGREEMENTS AND EXISTING BENEFITS PLANS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Association or any predecessor of the Association and Executive, except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to the Executive of a kind elsewhere provided. No provision of this Agreement shall be interpreted to mean that Executive is subject to receiving fewer benefits than those available to him without reference to this Agreement. 14. NO ATTACHMENT. (a) Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to execution, attachment, levy, or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to affect any such action shall be null, void, and of no effect. (b) This Agreement shall be binding upon, and inure to the benefit of, Executive, the Association, the Company and their respective successors and assigns. 15. MODIFICATION AND WAIVER. (a) This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) No term or condition of this Agreement shall be deemed to have been waived, nor shall there by any estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition waived and shall not constitute a waiver of such term or condition for the future as to any act other than that specifically waived. 16. SEVERABILITY. If, for any reason, any provision of this Agreement, or any part of any provision, is held invalid, such invalidity shall not affect any other provision of this Agreement or any part of such provision not held so invalid, and each such other provision and part thereof shall to the full extent consistent with law continue in full force and effect. 17. HEADINGS FOR REFERENCE ONLY. The headings of sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by the laws of the State of Oregon, unless otherwise specified herein; provided, however, that in the event of a conflict between the terms of this Agreement and any applicable federal or state law or regulation, the provisions of such law or regulation shall prevail. 19. ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of three arbitrators sitting in a location selected by the Executive within one hundred (100) miles from the location of the Association, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that Executive shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 20. PAYMENT OF LEGAL FEES. All reasonable legal fees paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Association, if successful pursuant to a legal judgment, arbitration or settlement. 21. INDEMNIFICATION. The Association shall provide Executive (including his heirs, executors and administrators) with coverage under a standard directors' and officers' liability insurance policy at its expense, or in lieu thereof, shall indemnify Executive (and his heirs, executors and administrators) to the fullest extent permitted under law against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suite or proceeding in which he may be involved by reason of his having been a director or officer of the Association (whether or not he continues to be a directors or officer at the time of incurring such expenses or liabilities), such expenses and liabilities to include, but not be limited to, judgment, court costs and attorneys' fees and the cost of reasonable settlements. 22. SUCCESSOR TO THE ASSOCIATION OR THE COMPANY. The Association and the Company shall require any successor or assignee, whether direct or indirect, by purchase, merger, consolidation or otherwise, to all or substantially all the business or assets of the Association or the Company, expressly and unconditionally to assume and agree to perform the Association's or the Company's obligations under this Agreement, in the same manner and to the same extent that the Association or the Company would be required to perform if no such succession or assignment had taken place. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by a duly authorized officer or director of the Association and the Company, and Executive has signed this Agreement, all on the day of , 20 . KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION BY: Kermit K. Houser, President KLAMATH FIRST BANCORP, INC. BY:____________________________ Kermit K. Houser, President WITNESS: ______________________ _____________________________ James E. Essany EXHIBIT 10(i) EMPLOYMENT AGREEMENT THIS AGREEMENT is made effective as of October 1, 2002, by and between KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION (the "Association"), Klamath Falls, Oregon; KLAMATH FIRST BANCORP, INC. (the "Company"), an Oregon corporation; and Nina G. Drake (the "Executive"). WHEREAS, the Association wishes to assure itself of the services of Executive for the period provided in this Agreement; and WHEREAS, the Executive is willing to serve in the employ of the Association on a full-time basis for said period. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. POSITION AND RESPONSIBILITIES. During the period of her employment hereunder, Executive agrees to serve as Vice President of the Association. During said period, Executive also agrees to serve, if elected, as an officer of the Company or any subsidiary or affiliate of the Company or the Association. 2. TERMS AND DUTIES. (a) The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twenty-four (24) full calendar months thereafter. Commencing on the first anniversary date, and continuing at each anniversary date thereafter, the Board of Directors of the Association (the "Board") or its Compensation Committee may extend the Agreement for an additional year. Prior to the extension of the Agreement as provided herein, the Board of Directors of the Association will review the Executive's performance evaluation for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. (b) During the period of her employment hereunder, except for periods of absence occasioned by illness, reasonable vacation periods, and reasonable leaves of absence, Executive shall devote substantially all her business time, attention, skill, and efforts to the faithful performance of her duties hereunder including activities and services related to the organization, operation and management of the Association; provided, however, that, with the approval of the Board, as evidenced by a resolution of such Board, from time to time, Executive may serve, or continue to serve, on the boards of directors of, and hold any other offices or positions in, companies or organizations, which, in such Board's judgment, will not present any conflict of interest with the Association, or materially affect the performance of Executive's duties pursuant to this Agreement. 3. COMPENSATION AND REIMBURSEMENT. (a) The compensation specified under this Agreement shall constitute the salary and benefits paid for the duties described in Sections 1 and 2. The Association shall pay Executive as compensation a salary of $90,000 per year ("Base Salary"). Effective December 1, 2002, the Base Salary shall be calculated at $99,000 per year unless subsequently changed as provided below. Such Base Salary shall be payable in accordance with the customary payroll practices of the Association. During the period of this Agreement, Executive's Base Salary shall be reviewed at least annually; the first such review will be made no later than one year from the date of this Agreement. Such review shall be conducted by the Board or its Compensation Committee, and the Board may increase Executive's Base Salary. In addition to the Base Salary provided in this Section 3(a), the Association shall provide Executive at no cost to Executive with all such other benefits as are provided uniformly to regular salaried employees of the Association. (b) The Association will provide Executive with employee benefit plans, arrangements and perquisites substantially equivalent to those in which Executive was participating or otherwise deriving benefit from immediately prior to the beginning of the term of this Agreement, and the Association will not, without Executive's prior written consent, make any changes in such plans, arrangements or perquisites which would adversely affect Executive's rights or benefits thereunder. However, changes in Association-sponsored group insurance plan premiums, deductibles, co-payments, and related coverage limits or conditions are excluded from the prior sentence for any such change which is consistently applied to or available to regular salaried Association employees. Without limiting the generality of the foregoing provisions of this Subsection (b), Executive will be entitled to participate in or receive benefits under any employee benefit plans including, but not limited to, retirement plans, supplemental retirement plans, pension plans, profit-sharing plans, health-and-accident plan, medical coverage or any other employee benefit plan or arrangement made available by the Association in the future to its senior executives and key management employees, subject to, and on a basis consistent with, the terms, conditions and overall administration of such plans and arrangements. Executive will be entitled to incentive compensation and bonuses as provided in any plan, or pursuant to any arrangement of the Association, in which Executive is eligible to participate. Nothing paid to the Executive under any such plan or arrangement will be deemed to be in lieu of other compensation to which the Executive is entitled under this Agreement, except as provided under Section 5(e). (c) In addition to the Base Salary provided for by paragraph (a) of this Section 3, the Association shall pay or reimburse Executive for all reasonable travel and other obligations under this Agreement and may provide such additional compensation in such form and such amounts as the Board may from time to time determine. 4. PAYMENTS TO EXECUTIVE UPON AN EVENT OF TERMINATION. (a) Upon the occurrence of an Event of Termination (as herein defined) during the Executive's term of employment under this Agreement, the provisions of this Section shall apply. As used in this Agreement, an "Event of Termination" shall mean and include any one or more of the following: (i) the termination by the Association of Executive's full-time employment hereunder for any reason other than a Change in Control, as defined in Section 5(a) hereof; disability, as defined in Section 6(a) hereof; death; retirement, as defined in Section 7 hereof; or for Cause, as defined in Section 8 hereof; (ii) Executive's resignation from the Association's employ, upon (A) unless consented to by the Executive, a material change in Executive's function, duties, or responsibilities, which change would cause Executive's position to become one of lesser responsibility, importance, or scope from the position and attributes thereof described in Sections 1 and 2, above, (any such material change shall be deemed a continuing breach of this Agreement), (B) a relocation of Executive's principal place of employment by more than 35 miles from its location at the effective date of this Agreement, or a material reduction in the benefits and perquisites to Executive from those being provided as of the effective date of this Agreement, (C) the liquidation or dissolution of the Association, or (D) any breach of this Agreement by the Association. Upon the occurrence of any event described in clauses (A), (B), (C), or (D), above, Executive shall have the right to elect to terminate her employment under this Agreement by resignation upon not less than sixty (60) days prior written notice given within a reasonable period of time not to exceed, except in case of a continuing breach, four calendar months after the event giving rise to said right to elect. (b) Upon the occurrence of an Event of Termination, the Association shall pay Executive, or, in the event of her subsequent death, her beneficiary or beneficiaries, or her estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to the payments due to the Executive for the remaining term of the Agreement, including Base Salary, bonuses, and any other cash or deferred compensation paid or to be paid (including the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination), to the Executive for the term of the Agreement provided, however, that if the Association is not in compliance with its minimum capital requirements or if such payments would cause the Association's capital to be reduced below its minimum capital requirements, such payments shall be deferred until such time as the Association is in capital compliance. All payments made pursuant to this Section 4(b) shall be paid in substantially equal monthly installments over the remaining term of this Agreement following the Executive's termination; provided, however, that if the remaining term of the Agreement is less than one (1) year (determined as of the Executive's Date of Termination), such payments and benefits shall be paid to the Executive in a lump sum within 30 days of the Date of Termination. (c) Upon the occurrence of an Event of Termination, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to her termination. Such coverage shall cease upon the expiration of the remaining term of this Agreement. 5. CHANGE IN CONTROL. (a) No benefit shall be paid under this Section 5 unless there shall have occurred a Change in Control of the Company or the Association. For purposes of this Agreement, a "Change in Control" of the Company or the Association shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Association pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Association representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Association changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four month period (whether commencing before or after the effective date of this Agreement) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Association approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Association's assets, or a plan of partial or complete liquidation. (b) If any of the events described in Section 5(a) hereof constituting a Change in Control have occurred or the Board of the Association or the Company has determined that a Change in Control has occurred, Executive shall be entitled to the benefits provided in paragraphs (c), (d) and (e) of this Section 5 upon her subsequent involuntary termination of employment at any time during the term of this Agreement (or voluntary termination following a Change of Control following any demotion, loss of title, office or significant authority, reduction in her annual compensation or benefits, or relocation of her principal place of employment by more than 35 miles from its location immediately prior to the Change in Control), unless such termination is because of her death, retirement as provided in Section 7, termination for Cause, or termination for Disability. (c) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association shall pay Executive, or in the event of her subsequent death, her beneficiary or beneficiaries, or her estate, as the case may be, as severance pay or liquidated damages, or both, a sum equal to 2.99 times the Executive's "base amount," within the meaning of section 280G(b)(3) of the Internal Revenue Code of 1986 ("Code"), as amended. Such payment shall be made in a lump sum paid within ten (10) days of the Executive's Date of Termination. (d) Upon the occurrence of a Change in Control followed by the Executive's termination of employment, the Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to her severance. In addition, Executive shall be entitled to receive the value of employer contributions that would have been made on the Executive's behalf over the remaining term of the agreement to any tax-qualified retirement plan sponsored by the Association as of the Date of Termination. Such coverage and payments shall cease upon the expiration of thirty-six (36) months. (e) Upon the occurrence of a Change in Control, the Executive shall be entitled to receive benefits due her under, or contributed by the Company or the Association on her behalf, pursuant to any retirement, incentive, profit sharing, bonus, performance, disability or other employee benefit plan maintained by the Association or the Company on the Executive's behalf to the extent that such benefits are not otherwise paid to the Executive upon a Change in Control. (f) Notwithstanding the preceding paragraphs of this Section 5, in the event that the aggregate payments or benefits to be made or afforded to the Executive under this Section would be deemed to include an "excess parachute payment" under section 280G of the Code, such payments or benefits shall be payable or provided to Executive over the minimum period necessary to reduce the present value of such payments or benefits to an amount which is one dollar ($1.00) less than three (3) times the Executive's "base amount" under section 280G(b)(3) of the Code. 6. TERMINATION FOR DISABILITY. (a) If the Executive shall become disabled as defined in the Association's then current disability plan (or, if no such plan is then in effect, if the Executive is permanently and totally disabled within the meaning of Section 22(e)(3) of the Code as determined by a physician designated by the Board), the Association may terminate Executive's employment for "Disability." (b) Upon the Executive's termination of employment for Disability, the Association will pay Executive, as disability pay, a bi-weekly payment equal to three-quarters (3/4) of Executive's bi-weekly rate of Base Salary on the effective date of such termination. These disability payments shall commence on the effective date of Executive's termination and will end on the earlier of (i) the date Executive returns to the full-time employment of the Association in the same capacity as she was employed prior to her termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive attaining the age of 65; or (iv) Executive's death; or (v) the expiration of the term of this Agreement. The disability pay shall be reduced by the amount, if any, paid to the Executive under any plan of the Association providing disability benefits to the Executive. (c) The Association will cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Association for Executive prior to her termination for Disability. This coverage and payments shall cease upon the earlier of (i) the date Executive returns to the full-time employment of the Association, in the same capacity as she was employed prior to her termination for Disability and pursuant to an employment agreement between Executive and the Association; (ii) Executive's full-time employment by another employer; (iii) Executive's attaining the age of 65; or (iv) the Executive's death; or (v) the expiration of the term of this Agreement. (d) Notwithstanding the foregoing, there will be no reduction in the compensation otherwise payable to Executive during any period during which Executive is incapable of performing her duties hereunder by reason of temporary disability. 7. TERMINATION UPON RETIREMENT; DEATH OF EXECUTIVE. Termination by the Association of Executive based on "Retirement" shall mean retirement at age 65 or in accordance with any retirement arrangement established with Executive's consent with respect to her. Upon termination of Executive upon Retirement, Executive shall be entitled to all benefits under any retirement plan of the Association or the Company and other plans to which Executive is a party. Upon the death of the Executive during the term of this Agreement, the Association shall pay to Executive's estate the compensation due to the Executive through the last day of the calendar month in which her death occurred. 8. TERMINATION FOR CAUSE. For purposes of this Agreement, "Termination for Cause" shall include termination because of the Executive's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. In addition, "Termination for Cause" shall include termination because of continuing or repeated problems with the Executive's performance or conduct, the Executive's inattention to duties, the refusal of the Executive to comply with the Association's or the Company's instructions, policies or rules or other conduct of the Executive which reflects adversely on the Association's or the Company 's reputation or operation. For purposes of this Section, no act, or the failure to act, on Executive's part shall be "willful" unless done, or omitted to be done, not in good faith and without reasonable belief that the action or omission was in the best interest of the Association or its affiliates. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to her a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the members of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to Executive and an opportunity for her, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive was guilty of conduct justifying termination for Cause and specifying the reasons thereof. The Executive shall not have the right to receive compensation or other benefits for any period after termination for Cause. Any stock options granted to Executive under any stock option plan or any unvested awards granted under any other stock benefit plan of the Association, the Company, or any subsidiary or affiliate thereof, shall become null and void effective upon Executive's receipt of Notice of Termination for Cause pursuant to Section 9 hereof, and shall not be exercisable by Executive at any time subsequent to such Termination for Cause. 9. REQUIRED PROVISIONS. (a) The Association may terminate Executive's employment at any time, but any termination by the Association, other than Termination for Cause, shall not prejudice Executive's right to compensation or other benefits under this Agreement. Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause as defined in Section 8 herein. (b) If Executive is suspended and/or temporarily prohibited from participating in the conduct of the Association's affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and (g)(1)), the Association's obligations under the Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Association may, in its discretion, (i) pay Executive all or part of the compensation withheld while its contract obligations were suspended and (ii) reinstate (in whole or in part) any of its obligations that were suspended. (c) If Executive is removed and/or permanently prohibited from participating in the conduct of the Association's affairs by an order issued under Section 8(e)(4) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Association under the Agreement shall terminate as of the effective date of the order, but vested rights of the contracting parties shall not be affected. (d) If the Association is in default (as defined in Section 3(x)(1) of the FDIA), all obligations under this Agreement shall terminate as of the date of default, but this paragraph shall not affect any vested rights of the parties. (e) All obligations under this Agreement shall be terminated (except to the extent determined that continuation of the Agreement is necessary for the continued operation of the Association): (i) by the Director of the Office of Thrift Supervision (the "Director") or his or her designee at the time the Federal Deposit Insurance Corporation or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Association under the authority contained in Section 13(c) of the FDIA or (ii) by the Director, or his or her designee at the time the Director or such designee approves a supervisory merger to resolve problems related to operation of the Association or when the Association is determined by the Director to be in an unsafe or unsound condition. Any rights of the parties that have already vested, however, shall not be affected by such action. (f) Any payments made to Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. section 1828(k) and any regulations promulgated thereunder. 10. NOTICE. (a) Any purported termination by the Association or by Executive shall be communicated by Notice of Termination to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. (b) "Date of Termination" shall mean (A) if Executive's employment is terminated for Disability, thirty (30) days after a Notice of Termination is given (provided that she shall not have returned to the performance of her duties on a full-time basis during such thirty (30) day period), and (B) if her employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a Termination for Cause, shall not be less than thirty (30) days from the date such Notice of Termination is given). (c) If, within thirty (30) days after any Notice of Termination is given, the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, except upon the occurrence of a Change in Control and voluntary termination by the Executive in which case the Date of Termination shall be the date specified in the Notice, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding arbitration award, or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal there from having expired and no appeal having been perfected) and provided further that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. Notwithstanding the pendency of any such dispute, the Association will continue to pay Executive her full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary) and continue her as a participant in all compensation, benefit and insurance plans in which she was participating when the notice of dispute was given, until the dispute is finally resolved in accordance with this Agreement. Amounts paid under this Section are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement. 11. NON-COMPETITION. (a) Upon any termination of Executive's employment hereunder pursuant to an Event of Termination as provided in Section 4 hereof, Executive agrees not to compete with the Association and/or the Company for a period of one (1) year following such termination in any city, town or county in which the Association and/or the Company has an office or has filed an application for regulatory approval to establish an office, determined as of the effective date of such termination. Executive agrees that during such period and within said cities, towns and counties, Executive shall not work for or advise, consult or otherwise serve with, directly or indirectly, any entity whose business materially competes with the depository, lending or other business activities of the Association and/or the Company. The parties hereto, recognizing that irreparable injury will result to the Association and/or the Company, its business and property in the event of Executive's breach of this Subsection 11(a) agree that in the event of any such breach by Executive, the Association and/or the Company will be entitled, in addition to any other remedies and damages available, to an injunction to restrain the violation hereof by Executive, Executive's partners, agents, servants, employers, employees and all persons acting for or with Executive. Executive represents and admits that in the event of the termination of her employment pursuant to Section 8 hereof, Executive's experience and capabilities are such that Executive can obtain employment in a business engaged in other lines and/or of a different nature than the Association and/or the Company, and that the enforcement of a remedy by way of injunction will not prevent Executive from earning a livelihood. Nothing herein will be construed as prohibiting the Association and/or the Company from pursuing any other remedies available to the Association and/or the Company for such breach or threatened breach, including the recovery of damages from Executive. (b) Executive recognizes and acknowledges that the knowledge of the business activities and plans for business activities of the Association and affiliates thereof, as it may exist from time to time, is a valuable, special and unique asset of the business of the Association. Executive will not, during or after the term of her employment, disclose any knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof to any person, firm, corporation, or other entity for any reason or purpose whatsoever. Notwithstanding the foregoing, Executive may disclose any knowledge of banking, financial and/or economic principles, concepts or ideas which are not solely and exclusively derived from the business plans and activities of the Association. In the event of a breach or threatened breach by the Executive of the provisions of this Section, the Association will be entitled to an injunction restraining Executive from disclosing, in whole or in part, the knowledge of the past, present, planned or considered business activities of the Association or affiliates thereof, or from rendering any services to any person, firm, corporation, other entity to whom such knowledge, in whole or in part, has been disclosed or is threatened to be disclosed. Nothing herein will be construed as prohibiting the Association from pursuing any other remedies available to the Association for such breach or threatened breach, including the recovery of damages from Executive. 12. SOURCE OF PAYMENTS. All payments provided in this Agreement shall be timely paid in cash or check from the general funds of the Association. The Company, however, guarantees all payments and the provision of all amounts and benefits due hereunder to Executive and, if such payments are not timely paid or provided by the Association, such amounts and benefits shall be paid or provided by the Company. 13. EFFECT ON PRIOR AGREEMENTS AND EXISTING BENEFITS PLANS. This Agreement contains the entire understanding between the parties hereto and supersedes any prior employment agreement between the Association or any predecessor of the Association and Executive, except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to the Executive of a kind elsewhere provided. No provision of this Agreement shall be interpreted to mean that Executive is subject to receiving fewer benefits than those available to her without reference to this Agreement. 14. NO ATTACHMENT. (a) Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to execution, attachment, levy, or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to affect any such action shall be null, void, and of no effect. (b) This Agreement shall be binding upon, and inure to the benefit of, Executive, the Association, the Company and their respective successors and assigns. 15. MODIFICATION AND WAIVER. (a) This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) No term or condition of this Agreement shall be deemed to have been waived, nor shall there by any estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition waived and shall not constitute a waiver of such term or condition for the future as to any act other than that specifically waived. 16. SEVERABILITY. If, for any reason, any provision of this Agreement, or any part of any provision, is held invalid, such invalidity shall not affect any other provision of this Agreement or any part of such provision not held so invalid, and each such other provision and part thereof shall to the full extent consistent with law continue in full force and effect. 17. HEADINGS FOR REFERENCE ONLY. The headings of sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by the laws of the State of Oregon, unless otherwise specified herein; provided, however, that in the event of a conflict between the terms of this Agreement and any applicable federal or state law or regulation, the provisions of such law or regulation shall prevail. 19. ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of three arbitrators sitting in a location selected by the Executive within one hundred (100) miles from the location of the Association, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that Executive shall be entitled to seek specific performance of her right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 20. PAYMENT OF LEGAL FEES. All reasonable legal fees paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Association, if successful pursuant to a legal judgment, arbitration or settlement. 21. INDEMNIFICATION. The Association shall provide Executive (including her heirs, executors and administrators) with coverage under a standard directors' and officers' liability insurance policy at its expense, or in lieu thereof, shall indemnify Executive (and her heirs, executors and administrators) to the fullest extent permitted under law against all expenses and liabilities reasonably incurred by her in connection with or arising out of any action, suite or proceeding in which she may be involved by reason of her having been a director or officer of the Association (whether or not she continues to be a directors or officer at the time of incurring such expenses or liabilities), such expenses and liabilities to include, but not be limited to, judgment, court costs and attorneys' fees and the cost of reasonable settlements. 22. SUCCESSOR TO THE ASSOCIATION OR THE COMPANY. The Association and the Company shall require any successor or assignee, whether direct or indirect, by purchase, merger, consolidation or otherwise, to all or substantially all the business or assets of the Association or the Company, expressly and unconditionally to assume and agree to perform the Association's or the Company's obligations under this Agreement, in the same manner and to the same extent that the Association or the Company would be required to perform if no such succession or assignment had taken place. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by a duly authorized officer or director of the Association and the Company, and Executive has signed this Agreement, all on the day of , 20 . KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION BY: Kermit K. Houser, President KLAMATH FIRST BANCORP, INC. BY:____________________________ Kermit K. Houser, President WITNESS: ______________________ _____________________________ Nina G. Drake EXHIBIT 10(j) AMENDMENTS TO EMPLOYMENT AGREEMENTS AMENDMENT #2 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Kermit K. Houser (the "Executive") on November 15, 2000; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants, terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 1. The term of the agreement as outlined in Section 3 is extended for one year effective November 15, 2002, with the new expiration date being November 14, 2004. 2. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #2 to the Agreement as of November 15, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_______________________________________ Kermit K. Houser Rodney N. Murray, Chairman of the Board Klamath First Bancorp, Inc. ______________________________ By:_______________________________________ Witness Rodney N. Murray, Chairman of the Board AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Marshall J. Alexander (the "Executive") on October 1, 2001; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 3. The term of the agreement is extended effective October 1, 2002 for an additional year, with the new expiration date being September 30, 2004, unless further modified as provided in Section 2.a. of the Agreement. 4. The Base Salary as defined in Section 3 of the Agreement is changed to $138,000 per year effective November 1, 2002. 5. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of October 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ Marshall J. Alexander Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Ben A. Gay (the "Executive") on October 1, 2001; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 6. The term of the agreement is extended effective October 1, 2002 for an additional year, with the new expiration date being September 30, 2004, unless further modified as provided in Section 2.a. of the Agreement. 7. The Base Salary as defined in Section 3 of the Agreement is changed to $138,000 per year effective November 1, 2002. 8. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of October 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ Ben A. Gay Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Frank X. Hernandez (the "Executive") on October 1, 2001; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 9. The term of the agreement is extended effective October 1, 2002 for an additional year, with the new expiration date being September 30, 2004, unless further modified as provided in Section 2.a. of the Agreement. 10. The Base Salary as defined in Section 3 of the Agreement is changed to $108,000 per year effective November 1, 2002. 11. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of October 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ Frank X. Hernandez Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Craig M Moore (the "Executive") on October 1, 2001; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 12. The term of the agreement is extended effective October 1, 2002 for an additional year, with the new expiration date being September 30, 2004, unless further modified as provided in Section 2.a. of the Agreement. 13. The Base Salary as defined in Section 3 of the Agreement is changed to $117,000 per year effective November 1, 2002. 14. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of October 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ Craig M Moore Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with M. Isabel Castellanos (the "Executive") on October 1, 2001; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 15. The term of the agreement is extended effective October 1, 2002 for an additional year, with the new expiration date being September 30, 2004, unless further modified as provided in Section 2.a. of the Agreement. 16. The Base Salary as defined in Section 3 of the Agreement is changed to $119,000 per year effective November 1, 2002. 17. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of October 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ M. Isabel Castellanos Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO AMENDMENT #1 TO EMPLOYMENT AGREEMENT WHEREAS Klamath First Federal Savings and Loan Association and Klamath First Bancorp, Inc. (collectively "Klamath") entered into an Employment Agreement (the "Agreement") with Walter F. Dodrill (the "Executive") on January 2, 2002; and WHEREAS, the Board of Directors of Klamath has reviewed the Executive's performance in connection with Klamath's financial results and an independent compensation study; and WHEREAS, Klamath wishes to continue to assure itself of the Executive's services for the period of the Agreement as amended herein; and WHEREAS, the Executive is willing to continue serving in the employ of Klamath on a full-time basis for said period; NOW, THEREFORE, in consideration of the mutual covenants , terms and conditions contained in the Agreement and as amended below, the parties hereby agree that the Agreement is amended as follows: 18. The term of the agreement is extended effective January 2, 2003 for an additional year, with the new expiration date being January 1, 2005, unless further modified as provided in Section 2.a. of the Agreement. 19. The Base Salary as defined in Section 3 of the Agreement is changed to $119,000 per year effective November 1, 2002. 20. This amendment is governed by the laws of the State of Oregon. Except as specifically modified herein, the Agreement, including all terms, conditions and covenants, shall remain fully in force. IN WITNESS WHEREOF, Klamath and the Executive have executed this Amendment #1 to the Agreement as of November 1, 2002. Klamath First Federal Savings and Loan Association ______________________________ By:_________________________________ Walter F. Dodrill Kermit K. Houser, President & CEO Klamath First Bancorp, Inc. ______________________________ By:_________________________________ Witness Kermit K. Houser, President & CEO EX-13 5 ann_rep.txt ANNUAL REPORT Dear Shareholder, It has been two years since joining Klamath First and eighteen months since initiating reorganization of the company from a traditional thrift, focusing upon local markets, into a truly statewide financial institution. This has been an exciting transition period for us, resulting in many new opportunities for staff who wished to accept change and, opportunities provided for others to join us as the transition progressed. We also realigned and expanded our Management Team, adding retail and commercial lending expertise, both complemented by a strong Chief Credit Officer. To complete this team, Nina Drake joined Klamath First in June 2002 as Human Resource Manager, bringing significant personnel management experience. In addition to the Management changes, we have added significant management strength to our Information Systems Group and Operations Support Group. These individuals have been successful in other institutions and their wide range of experience is having a positive affect on both our quality of customer service and our operational efficiencies. During this reorganization, the balance sheet restructure was completed. Klamath First reduced interest rate exposure and added $28 million in Trust Preferred Offerings to assure adequate capital cushion for expansion opportunities. The first expansion was completed in September 2001 with the purchase of 13 Western Bank/Washington Mutual branches which complemented our existing branching structure. In addition to this purchase, we expanded into seven Wal-Mart In-Store Branches in Southeast Washington State, Eastern and Western Oregon with our full service, seven day banking operations plus two de novo full service branches, one in Southwest Medford and the other in Redmond, Oregon. Our agreement with Wal-Mart currently calls for two more In-Store Branches, to be fully operational by July 2003. Throughout this period, we have been in a dramatically declining interest rate environment, which has impacted our earnings due to our large cash position brought about by the earlier balance sheet restructure and the large deposit base acquired through the branch acquisition last year. While it has had a dampening effect on earnings, Klamath First is well positioned for growth, both internally and through acquisition. Our loan portfolio quality is strong and well reserved, our deposit base solid and our infrastructure now in place to quickly pursue opportunities as they arise. We currently have 31% of our loan portfolio in shorter term commercial loans and will complement this portfolio with additional growth in consumer and adjustable rate residential mortgages while continuing to aggressively process and sell fixed rate offerings. As I travel the state, visiting branches and meeting current and potential Klamath First customers, I am hearing that Klamath First has really changed. "Your branches look great and your staff is excited and interested in us." These types of comments are great to hear and indicate that we are on the right track. The expense, time and effort are paying off. Klamath First has changed. We are delivering a much wider variety of banking products to the many communities we serve and have a motivated staff willing to address our customers' needs and, all of us at Klamath First are focused on improved bottom line profitability. Kermit K. Houser President and Chief Executive Officer Year In Review A Year in Review In 2002, we expanded our reach with new banking offices and enhanced delivery channels. We introduced our business banking division to our corporate business customers and focused on the small business market with our Business First Lending Center. Community involvement in the markets we served is evidenced with increased awareness and exposure in a variety of community and civic projects. Meeting Our Customers' Needs This past year our Company expanded our branch network, which serves as a cornerstone for our bank. New strategically located branches have broadened our geographic presence throughout the state of Oregon and into Southern Washington. In November 2001, we enhanced our presence in Washington with the opening of our Richland office. This was our second In-Store location in the Tri-Cities area and serves as a great complement to the Kennewick market. In-Store offices feature expanded service delivery with seven days a week banking and Internet and Voice Response banking access that blend with the Wal-Mart store hours. In February 2002, we opened our second office in Medford with a new banking center on the corner of Stewart and King Street on the city's West Side. The Rogue Valley remains a very vital key to our branch banking network's success and the Stewart location has provided added convenience to our Medford banking customers. Also, in February 2002, we made our debut along the I-5 corridor in the Springfield market with our fifth In-Store Wal-Mart location. Springfield has been an important link in our branch banking network. Our sixth In-Store Wal-Mart location was opened in April 2002 in Hermiston. This is our second banking location in Hermiston and reinforces our commitment to the community. In May 2002, we opened our seventh In-Store location. This new Eugene Wal-Mart office continues to solidify our banking presence along the I-5 corridor. Complementing the Springfield office, the Eugene location has expanded our service delivery in this expanding and highly competitive marketplace. Business First In April 2002, the Business First Lending Center was developed to complement the efforts of the Business Banking Group. Business First was designed to offer lending solutions to businesses that borrow up to $250,000. The strategy of the Business First Lending Center is to provide a quick, efficient and consistent underwriting process and increase the return to our shareholders while providing a competitive commercial lending product in all of the markets we serve. In order to accomplish this, Klamath First's Business First Lending Center has designed a proprietary underwriting template that combines credit scoring and judgment to provide quick decisions at minimal cost to businesses. Klamath First has a strong presence in small communities; however, our mission is to become the preferred choice of business customers needing commercial loans and services in these areas. Business Banking focuses on commercial business with loan needs in excess of $250,000. We now have a dedicated team of commercial banking professionals and a wide range of customized products, all designed to make your banking faster, easier and more flexible. Klamath First's Business Banking Group will be setting the standard for business banking in the Pacific Northwest. Community First We are committed to making a positive difference in every community and region in which we do business. This impact is made both through the Company's Pelican Club activities (a group of volunteer employees at Klamath First) and through our support of local businesses, community groups, civic groups, investments/donations and other banking and community development services. Through financial and volunteer efforts, we have made significant investments in and contributions to charities, affordable housing groups and non-profit organizations within the regions we serve. We have also placed a renewed emphasis on qualifying CRA (Community Reinvestment act) investments and contributions in all of the regions and markets we serve. At Klamath First Our Communities Come First. KLAMATH FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION AND KLAMATH FIRST BANCORP, INC. BOARD OF DIRECTORS Bernard Z. Agrons Mr. Agrons is currently retired. He served as Weyerhauser Company's Vice President for the Eastern Oregon Region until 1981. He was also a State Representative in the Oregon Legislative Assembly from 1983 to 1991. Timothy A. Bailey Mr. Bailey formerly was Senior Vice President with Regence BlueCross BlueShield of Oregon. He presently serves as Executive Director of the KMSB Foundation and is an active member of the Oregon State Bar. James D. Bocchi Mr. Bocchi is currently retired. He was president of Klamath First Federal Savings & Loan Association from 1984-1994. Donald N. Bauhofer Mr. Bauhofer is the Founder and President of the Pennbrook Company, headquartered in Bend, Oregon. He is the Founder and CEO of Pennbrook Homes, Inc. and Praxis Medical Group, the Co-Owner of Arrowood Development, and Co-Owner and Director of Pacific Education Corporation. William C. Dalton Mr. Dalton is currently retired. He is the former owner of W.C. Dalton Company, farming. Kermit K. Houser Mr. Houser serves as President and Chief Executive Officer of Klamath First, positions he has held since November 2000. Dianne E. Spires, CPA Ms. Spires is a Partner in Rusth, Spires & Menefee, LLP, a public accounting firm located in Klamath Falls and Lakeview, Oregon. CHAIRMAN OF THE BOARD Rodney N. Murray Mr. Murray is the former owner and operator of Klamath Falls Creamery & Crater Lake Dairy Products and owner of Rod Murray Ranch in Klamath Falls, Oregon. CORPORATE EXECUTIVE OFFICERS Kermit K. Houser President/CEO Marshall J. Alexander EVP/CFO Ben A. Gay EVP/CCO Frank X. Hernandez SVP/COO Craig M. Moore SVP/Chief Auditor/Corporate Counsel/Secretary James E. Essany SVP/Corporate Marketing Director M. Isabel Castellanos SVP/Retail Banking Walt Dodrill SVP/Business Banking Nina Drake VP/Human Resource Manager All Branch Managers In Memory of J. Gillis Hannigan Long time board member J. Gillis Hannigan died July 30 of complications related to surgery. "Gil was a member of the Klamath First Board of Directors since 1987, and made an outstanding contribution to the organization over the years. We are saddened by his passing, "said Kermit K. Houser, President and CEO. "Our thoughts and deepest sympathy are with his wife Jo Ann, and family." A retired businessman, Mr. Hannigan was previously Executive Vice President of Modoc Lumber, located in Klamath Falls, Oregon and Vice President of DiGiorgio Corporation, headquartered in San Francisco, California. The following tables set forth certain information concerning the consolidated financial position and consolidated results of operations of Klamath First Bancorp, Inc. and its wholly owned subsidiaries (the "Company") at the dates and for the periods indicated. This information does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report.
FINANCIAL CONDITION DATA (In thousands) At September 30, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------ Assets .................................................... $1,513,495 $1,468,572 $ 995,575 $1,041,641 $1,031,302 Cash and cash equivalents ................................. 45,791 118,389 29,947 24,523 66,985 Loans receivable, net ..................................... 607,465 679,990 729,037 739,793 668,146 Investment securities held to maturity .................... -- 135 267 560 2,889 Investment securities available for sale .................. 119,542 154,676 116,628 158,648 203,224 Mortgage-backed & related securities held to maturity .......................................... -- 1,621 2,160 2,601 3,662 Mortgage-backed & related securities available for sale ........................................ 650,796 421,638 75,331 72,695 43,336 Stock in FHLB of Seattle, at cost ......................... 13,510 12,698 11,877 10,957 10,173 Advances from FHLB of Seattle ............................. 205,250 168,000 173,000 197,000 167,000 Deposit liabilities ....................................... 1,142,006 1,152,824 695,381 720,401 689,541 Shareholders' equity ...................................... 119,938 114,141 108,725 109,585 145,081 SELECTED OPERATING DATA (In thousands, except per share data) Year Ended September 30, 2002 2001 2000 1999 1998 ---------------------------------------------------------------------------------------------------------------------------- Total interest income ..................................... $ 87,293 $ 70,133 $ 72,158 $ 71,691 $ 69,733 Total interest expense .................................... 39,531 40,751 40,756 38,382 37,848 ---------- ---------- ---------- ---------- ---------- Net interest income ....................................... 47,762 29,382 31,402 33,309 31,885 Provision for loan losses ................................. 156 387 1,764 932 674 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses ........................... 47,606 28,995 29,638 32,377 31,211 Non-interest income ....................................... 12,614 11,013 4,094 3,629 3,202 Non-interest expense ...................................... 50,171 28,720 23,773 21,186 19,523 ---------- ---------- ---------- ---------- ---------- Earnings before income taxes .............................. 10,049 11,288 9,959 14,820 14,890 Provision for income tax .................................. 3,260 3,717 3,533 5,665 5,339 ---------- ---------- ---------- ---------- ---------- Net Earnings .............................................. $ 6,789 $ 7,571 $ 6,426 $ 9,155 $ 9,551 ========== ========== ========== ========== ========== Basic earnings per share .................................. $ 1.06 $ 1.14 $ 0.94 $ 1.21 $ 1.05 ========== ========== ========== ========== ========== KEY OPERATING RATIOS At or for the Year Ended September 30, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------ Performance Ratios Return on average assets (net earnings divided by average assets) .................. 0.46% 0.72% 0.62% 0.88% 0.96% Return on average equity (net earnings divided by average equity) .................. 5.92% 6.64% 5.82% 7.55% 6.52% Interest rate spread (difference between average yield on interest-earning assets and average cost of interest-bearing liabilities) ............................. 3.04% 2.18% 2.50% 2.73% 2.57% Net interest margin (net interest income as a percentage of average interest-earning assets) .......................... 3.48% 2.93% 3.14% 3.37% 3.36% Average interest-earning assets to average interest-bearing liabilities ...................... 115.18% 118.37% 115.71% 116.47% 119.84% Net interest income after provision for loan losses to total non-interest expenses ..................... 94.89% 100.96% 124.39% 152.82% 159.87% Non-interest expense to average total assets ................................... 3.37% 2.74% 2.29% 2.05% 1.96% Efficiency ratio (non-interest expense divided by net interest income plus non-interest income) ...................................... 83.10% 55.48% 66.97% 57.36% 55.64% Dividend payout ratio (dividends declared per share divided by net earnings per share) ........................ 49.06% 45.61% 54.79% 38.98% 34.50% Book value per share ...................................... $ 18.84 $ 17.40 $ 16.25 $ 15.52 $ 16.30 Asset Quality Ratios Allowance for loan losses to total loans at end of period ........................... 1.19% 1.13% 0.54% 0.32% 0.28% Non-performing assets to total assets ..................... 0.12% 0.05% 0.16% 0.46% 0.05% Non-performing loans to total loans, before net items .......................................... 0.18% 0.04% 0.11% 0.43% 0.07% Capital Ratios Equity to assets ratio .................................... 7.92% 7.77% 10.92% 10.52% 14.07% Tangible capital ratio .................................... 6.55% 5.16% 10.35% 8.91% 8.26% Core capital ratio ........................................ 6.55% 5.16% 10.35% 8.91% 8.26% Risk-based capital ratio .................................. 14.01% 10.36% 20.30% 17.41% 16.13% Other Data Number of loans outstanding ............................... 11,835 12,624 8,807 9,297 9,155 Number of deposit accounts ................................ 131,001 111,542 85,706 85,112 82,585 Number of full service offices ............................ 57 52 35 34 34
Special Note Regarding Forward-Looking Statements Management's Discussion and Analysis of Financial Condition and Results of Operations and other portions of this Annual Report contain certain "forward-looking statements" concerning the future operations of Klamath First Bancorp, Inc. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in the Annual Report. We have used "forward-looking statements" to describe future plans and strategies, including our expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole which could affect the collectibility of loan balances, the ability to increase non-interest income through expansion of new lines of business, the ability of the Company to control costs and expenses, competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements", and undue reliance should not be placed on such statements. General Klamath First Bancorp, Inc. (the "Company"), an Oregon corporation, is the unitary savings and loan holding company for Klamath First Federal Savings and Loan Association (the "Association"). The Association is a progressive, community-oriented financial institution that focuses on customer service within its primary market area. Accordingly, the Association is primarily engaged in attracting deposits from the general public through its offices and using those and other available sources of funds to originate permanent residential one- to four-family real estate loans and loans on commercial real estate, multi-family residential properties, and to consumers and businesses within its market area. While the Association has historically emphasized fixed-rate mortgage lending, it has been diversifying its loan portfolio by focusing on increasing the number of originations of commercial real estate, multi-family residential loans, residential construction loans, commercial and industrial loans, business loans and non-mortgage consumer loans. A significant portion of these newer loan products carry adjustable rates, higher yields, or shorter terms than the traditional fixed rate mortgages. This lending strategy is designed to enhance earnings, reduce interest rate risk, and provide a more complete range of financial services to customers and the local communities served by the Association. The acquisition of 13 branches from Washington Mutual Bank, which was completed in September 2001, moved the Company strongly in this direction. The Company's profitability depends primarily on its net interest income, which is the difference between interest and dividend income on interest-earning assets, principally loans and investment securities, and interest expense on interest-bearing deposits and borrowings. Because the Company is primarily dependent on net interest income for its earnings, the focus of the Company's planning is to devise and employ strategies that provide stable, positive spreads between the yield on interest-bearing assets and the cost of interest-bearing liabilities in order to maximize the dollar amount of net interest income. The Company's net earnings are dependent, to a lesser extent, on the level of its non-interest income, such as service charges, commission income, and other fees, and the controlling of its non-interest expense, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums and miscellaneous other expenses, as well as federal and state income taxes. The Association is regulated by the Office of Thrift Supervision ("OTS") and its deposits are insured up to applicable limits under the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Association is a member of the Federal Home Loan Bank system. The Association conducts its business through 57 office facilities, with the main office located in Klamath Falls, Oregon. The Association considers its primary market area to be the state of Oregon, particularly the 26 counties in which the offices are located. During 2001, the Company expanded into the Tri-Cities area of Washington state by opening in-store branches in Kennewick and Richland. Federal Legislation In Federal legislation enacted in 1996, the reserve method of accounting for thrift bad debt reserves (including the percentage of taxable income method) was repealed for tax years beginning after December 31, 1995. The resulting change in accounting method triggers bad debt reserve recapture for post-1987 reserves over a six-year period, thereby generating an additional tax liability. At September 30, 2002 and 2001, the Association's post-1987 reserves amounted to $2.0 million and $2.6 million, respectively. Pre-1988 reserves would only be subject to recapture if the institution fails to qualify as a thrift. Recapture of post-1987 reserves was required to begin during the tax year ended September 30, 1999. The Sarbanes-Oxley Act was enacted by Congress during the summer of 2002 to enhance corporate governance practices. The Company's management and board of directors are informed about the requirements of the Sarbanes-Oxley Act and the Company is actively monitoring regulatory implementation of the Act. However, due to the regulated environment in which financial institutions operate, many requirements of the new legislation are already part of the Company's internal control structure. Therefore, the Act is not expected to result in material changes to the Company's corporate governance processes. Market Risk and Asset/Liability Management The Company's financial performance is affected by the success of the fee generating products it offers to its customers, the credit quality of its loans and securities, and the extent to which its earnings are affected by changes in interest rates. Credit risk is the risk that borrowers will become unable to repay their debts as they become due. The Company relies on high quality underwriting standards, loan review, and an adequate allowance for loan losses to mitigate its credit risk. Interest rate risk is the risk of loss in principal value and risk of earning less net interest income due to changes in interest rates. Put simply, savings institutions solicit deposits and lend the funds they receive to borrowers. The difference between the rate paid on deposits and the rate received on loans is the interest rate spread. If the rates paid on deposits change, or reprice, with the same timing and magnitude as the rates change on loans, there is perfect matching of interest rate changes and thus, no change in interest rate spread and no interest rate risk. In actuality, interest rates on deposits and other liabilities do not reprice at the same time or with the same magnitude as those on loans, investments and other interest-earning assets. For example, historically the Company primarily originated fixed-rate residential loans for its portfolio. Because fixed-rate loans do not reprice until payoff and because the majority of residential loans have terms of 15 to 30 years (with actual expected lives of seven to ten years), the interest rate characteristics of the loan portfolio do not exactly match the Company's liabilities, which consist of deposits with maturities ranging up to ten years and borrowings which mature or reprice in five years or less. When interest rates change, this mismatch creates changes in interest rate spread that influence net interest income and result in interest rate risk. Changes in interest rates also impact the fair value of the assets and liabilities on the Company's balance sheet, expressed as changes in the net portfolio value ("NPV"). NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities plus or minus the estimated market value of off-balance sheet instruments. For example, the market value of investment securities and loans is impacted by changes in interest rates. Fixed-rate loans and investments held in the Company's portfolio increase in market value if interest rates decline. Conversely, the market value of fixed-rate portfolio assets decreases in an increasing interest rate environment. It is generally assumed that assets with adjustable rates are less subject to market value changes due to interest rate fluctuations based on the premise that their rates will adjust with the market. The OTS Thrift Bulletin 13a ("TB 13a") contains the prevailing guidance on the management of interest rate risk and provides a description of how the "Sensitivity to Market Risk" rating is to be determined. Sensitivity to Market Risk represents the "S" component of the CAMELS rating which is used by regulators in their evaluation of financial institutions. The OTS has established detailed minimum guidelines for two areas of interest rate risk management. These guidelines establish minimum expectations for (1) the establishment and maintenance of board-approved risk limits and (2) an institution's ability to measure interest rate risk exposure. Each thrift's board of directors is responsible for establishing risk limits for the institution. The interest rate risk limits are expected to include limits on the change in NPV as well as limits on earnings sensitivity. NPV limits include minimums for the NPV ratio, which is calculated by dividing the NPV by the present value of the institution's assets for a given rate scenario. The board of directors has specified the minimum NPV ratio it is willing to allow under interest rate shifts of 100 and 200 basis points up and down. Both the NPV limits and the actual NPV forecast calculations play a role in determining a thrift's Sensitivity to Market Risk. The prudence of the limits and the compliance with board-prescribed limits are factors in the determination of whether or not the institution's risk management is sufficient. In addition, the NPV ratio permitted by the institution's policies under an adverse 200 basis point rate shift scenario is combined with the institution's current interest rate sensitivity to determine the institution's "Level of Interest Rate Risk". The Level of Interest Rate Risk is then utilized in conjunction with an assessment of the "Quality of Risk Management Practices" to determine the "S" component of the CAMELS rating. The Company's exposure to interest rate risk is reviewed on at least a quarterly basis by the Board of Directors and the Asset Liability Management Committee ("ALCO"), which includes senior management representatives. The ALCO monitors and considers methods of managing interest rate risk by monitoring changes in NPV, the NPV ratio, and net interest income under various interest rate scenarios. The ALCO attempts to manage the various components of the Company's balance sheet to minimize the impact of sudden and sustained changes in interest rates on NPV and the NPV ratio. If potential changes to NPV and the NPV ratio resulting from hypothetical interest rate swings are not within the limits established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources. Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments, and deposit decay, and should not be relied upon as indicative of actual future results. Further, the computations do not contemplate any actions the ALCO could undertake in response to changes in interest rates. The Company has historically originated primarily fixed-rate residential loans. Many of these loans have been sold to the Federal National Mortgage Association ("FNMA") with servicing retained, and currently loans are sold to other entities with servicing released, while few are held in the Company's portfolio. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, shorten the effective maturities and increase the repricing of certain interest-earning assets, and increase the effective maturities of certain interest-bearing liabilities. During recent years, the Company undertook significant projects to manage and reduce interest rate risk. In February 2001, the Company securitized $190.3 million in fixed-rate single family mortgage loans. The loans were sold to FNMA with servicing retained and the resulting FNMA mortgage-backed securities ("MBS") were recorded as available for sale securities on the Company's books. Subsequently, the MBS were sold with the two-fold benefit of producing $5.4 million in gain on sale of investments and reducing long term fixed-rate assets from the interest rate risk profile. The second significant event impacting interest rate risk was the acquisition of 13 branches from Washington Mutual Bank in September 2001. These were commercial bank branches which included $118.8 million of commercial loans and $50.7 million of consumer loans. Most of these loans are adjustable rate shorter term loans. Cash obtained in the transaction was primarily invested in MBS and collateralized mortgage obligations ("CMO's") having shorter terms than conventional single-family mortgage loans. All these events serve to improve the Company's interest rate risk position. The Company's Board of Directors has established risk limits which are in compliance with TB 13a. NPV values for the Association are regularly calculated by the OTS based on regulatory guidelines. The following table presents the Association's projected change in NPV and the NPV ratio for the various rate shock levels as of September 30, 2002 and 2001, using the regulatory calculations. The assets and liabilities at the parent company level are not considered in the analysis. The exclusion of holding company assets and liabilities does not have a significant effect on the analysis of NPV sensitivity. All market rate sensitive instruments presented in these tables are classified as either held-to-maturity or available-for-sale. The Association has no trading securities.
PROJECTED CHANGES IN NET PORTFOLIO VALUE: At September 30, 2002 2001 - ------------------------------------------------------------------------------ Sensitivity Sensitivity NPV Measure NPV Measure Change in Interest Rates Ratio(Basis Points) Ratio(Basis Points) 200 basis point rise ....... 6.67% (126) 5.22% (208) 100 basis point rise ....... 7.79% (14) 6.53% (77) Base Rate Scenario ......... 7.93% -- 7.30% -- 100 basis point decline .... 7.11% (82) 7.12% (19) 200 basis point decline .... N/A N/A 6.68% (62)
The improvement noted in the sensitivity measure is an ongoing result of the actions taken as noted above, including the sale of fixed-rate single family mortgage loans and the branch acquisition, which provided a portfolio of primarily adjustable-rate and shorter term loans. In addition, fiscal 2002 saw significant prepayments on fixed-rate mortgage loans, reducing the balances of such long term assets. Proceeds from loan repayments were reinvested in shorter term, less than five years, mortgage-backed assets. Also, new single family loan production is being sold in the secondary market, again acting to reduce such long term asset balances. The preceding table indicates that at September 30, 2002, in the event of a sudden and sustained increase in prevailing market interest rates, the Association's NPV and NPV ratio would be expected to decrease, but would decrease to a lesser extent than under previous asset/liability mixes. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections presented, if market conditions vary from assumptions used in the calculation of NPV. Certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. In addition, the proportion of adjustable-rate loans in the Association's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinance activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the NPV. Finally, the ability of many borrowers to repay their adjustable-rate mortgage loans may decrease in the event of interest rate increases. A conventional measure of interest rate sensitivity for savings institutions is the calculation of interest rate "gap". This measure of interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature within a given period of time. The difference, or the interest rate repricing "gap", provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceed the amount of interest-rate sensitive liabilities, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. Generally, during a period of rising interest rates, a negative gap within shorter maturities would result in a decrease in net interest income. Conversely, during a period of falling interest rates, a negative gap within shorter maturities would result in an increase in net interest income. At September 30, 2002, the Association's one-year cumulative gap was a negative 20.61% of total assets compared to a negative 15.13% of total assets at September 30, 2001. The increased negative balance is a result of balances held in cash and short term investments on September 30, 2001 being reinvested during 2002 in investments and MBS with stated maturities greater than one year. The following table sets forth certain historical information relating to the Company's interest-earning assets and interest-bearing liabilities that are estimated to mature or are scheduled to reprice within one year.
At September 30, 2002 2001 2000 - ---------------------------------------------------------------------- (In thousands) Earning assets maturing or repricing within one year..... $221,598 $318,777 $209,072 Interest-bearing liabilities maturing or repricing within one year......................... 533,486 541,016 291,681 Deficiency of earning assets over interest-bearing liabilities as a percent of total assets..... (20.61%) (15.13%) (8.31%) Percent of assets to liabilities maturing or repricing within one year......................... 41.54% 58.92% 71.68%
The following table presents the difference between the Company's interest-earning assets and interest-bearing liabilities within specified maturities at September 30, 2002. This table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is subject to competitive and other limitations. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes.
3 Months > 3 Months > 6 Months > 1 to 3 > 3 to 5 > 5 to 10 > 10 to 20 > 20 or Less to 6 Months to 1 Year Years Years Years Years Years TOTAL -------- ----------- ---------- -------- -------- --------- ---------- -------- ---------- ASSETS (In thousands) Permanent 1-4 Mortgages: - ---------------------------------------------------------------------------------------------------------------------------------- Adjustable-rate............ $2,123 $4,452 $12,541 $4,539 $4,717 $-- $-- $-- $28,372 Fixed-rate................. 312 92 449 308 1,318 13,828 52,436 242,684 311,427 Other Mortgage Loans: Adjustable-rate............ 10,976 11,460 10,560 48,888 23,388 237 -- -- 105,509 Fixed-rate................. 219 191 199 1,309 3,207 11,361 5,397 5,627 27,510 Mortgage-Backed Securities. 25,287 1,291 1,576 46,341 85,819 163,176 170,356 146,458 640,304 Non-Real Estate Loans: Adjustable-rate............ 60,455 2,137 1,965 5,834 3,117 20 49 -- 73,577 Fixed-rate................. 2,081 631 904 7,636 11,608 15,462 32,575 665 71,562 Investment Securities...... 40,792 16,813 14,092 30,108 -- 790 35,735 2,468 140,798 Other Interest-Bearing Assets -- -- -- -- -- 457 -- -- 457 - ---------------------------------------------------------------------------------------------------------------------------------- Total Rate Sensitive Assets $142,245 $37,067 $42,286 $144,963 $133,174 $205,331 $296,548 $397,902 $1,399,516 ======== ======= ======= ======== ======== ======== ======== ======== ========== LIABILITIES - ---------------------------------------------------------------------------------------------------------------------------------- Deposits - Fixed Maturity.. $93,539 $77,690 $104,467 $114,477 $34,047 $32,081 $318 $100 $456,719 Deposits - Interest Bearing Checking................... 5,145 5,145 10,290 13,153 11,227 36,313 28,496 16,098 125,867 Deposits - Money Market.... 17,144 17,144 34,288 81,901 54,424 52,639 72,544 562 330,646 Deposits - Passbook and Statement Savings.......... 2,182 2,182 4,365 7,379 9,778 20,537 18,344 21,234 86,001 Other Interest Bearing Liabilities............. 115,905 20,000 24,000 43,000 8,000 -- -- -- 210,905 - ---------------------------------------------------------------------------------------------------------------------------------- Total Rate Sensitive Liabilities............. $233,915 $122,161 $177,410 $259,910 $117,476 $141,570 $119,702 $37,994 $1,210,138 ======== ======== ======== ======== ======== ======== ======== ======= ========== Interest Rate Sensitivity Gap..................... ($91,670) ($85,094) ($135,124)($114,947) $15,698 $63,761 $176,846 $359,908 $189,378 Cumulative Interest Rate Sensitivity Gap............ ($91,670) ($176,764) ($311,888)($426,835)($411,137) ($347,376) ($170,530) $189,378 -- Sensitivity Gap to Total Assets.................. (6.06%) (5.62%) (8.93%) (7.59%) 1.04% 4.21% 11.68% 23.78% -- Cumulative Interest Rate Sensitivity Gap to Total Assets.................. (6.06%) (11.68%) (20.61%) (28.20%) (27.16%) (22.95%) (11.27%) 12.51% --
Liquidity and Capital Resources The Company generates cash through operating activities, primarily as a result of net income. The adjustments to reconcile net income to net cash provided by operations during the years presented consists primarily of the provision for loan losses, deferred income taxes, depreciation and amortization, stock-based compensation expense, amortization of deferred loan origination fees, net gain on the sale of investment and mortgage-backed securities, increases or decreases in various escrow accounts and increases or decreases in other assets and liabilities. The primary investing activity of the Association is lending, which is funded with cash provided from operations and financing activities, as well as proceeds from amortization and prepayments on existing loans and mortgage-backed and related securities. For additional information about cash flows from operating, financing, and investing activities, see the Consolidated Statements of Cash Flows included in the Consolidated Financial Statements. The Association is required under applicable federal regulations to maintain specified levels of "liquid" investments in qualifying types of U.S. government, federal agency and other investments having maturities of five years or less. Current OTS regulations require that a savings association maintain liquid assets of not less than 4.00% of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. At September 30, 2002, the Association's liquidity, as measured for regulatory purposes, was 10.3%. The Company has borrowing agreements with banks that can be used if funds are needed. (See Notes 10 and 11 to the Consolidated Financial Statements.) OTS capital regulations require the Association to have: (i) tangible capital equal to 1.5% of adjusted total assets, (ii) core capital equal to 4.0% of adjusted total assets, and (iii) total risk-based capital equal to 8.0% of risk-weighted assets. At September 30, 2002, the Association was in compliance with all regulatory capital requirements effective as of such date, with tangible, core and risk-based capital of 6.6%, 6.6% and 14.0%, respectively. (See Note 20 to the Consolidated Financial Statements.) Changes in Financial Condition At September 30, 2002, the consolidated assets of the Company totaled $1.5 billion, consistent with $1.5 billion at September 30, 2001. Total cash and cash equivalents decreased $72.6 million, or 61.32%, from $118.4 million at September 30, 2001 to $45.8 million at September 30, 2002. The decrease is primarily the result of the cash from the branch purchase from Washington Mutual Bank in September 2001 being held in federal funds at September 30, 2001 while other appropriate investment alternatives were researched. During 2002, the excess cash was invested as reflected in the increase in mortgage-backed securities. Net loans receivable decreased by $72.5 million, or 10.67%, to $607.5 million at September 30, 2002, compared to $680.0 million at September 30, 2001. The decrease is the result of increased prepayments on loans coupled with sale of new one- to four- family loan production. Investment securities decreased $35.3 million, or 22.78%, from $154.8 million at September 30, 2001 to $119.5 million at September 30, 2002. This decrease was the result of $41.9 million in purchases offset by $15.1 million in scheduled maturities and the sale of $62.0 million of investment securities available for sale. During the year ended September 30, 2002, $109.5 million of principal payments were received on mortgage-backed and related securities ("MBS") and $87.1 million were sold, thus reducing the balance of MBS. This reduction was more than offset by the purchase of $419.4 million in MBS, resulting in a net increase in total MBS from $423.3 million at September 30, 2001 to $650.8 million at September 30, 2002. The purchases of investment securities and MBS were funded by cash obtained in the branch acquisition, maturities of securities, funds generated by loan repayments, and borrowings. Real estate owned and repossessed assets increased from $445,855 at September 30, 2001 to $758,663 at September 30, 2002. The balance at September 30, 2001 consists of single family residences. The balance at September 30, 2002 consisted primarily of four single family residences and one commercial property. Other assets decreased $5.6 million from $9.3 million at September 30, 2001 to $3.7 million at September 30, 2002. The majority of the decrease resulted from payment of a $4.1 million receivable from Washington Mutual Bank ("WAMU") related to the final settlement for the branch acquisition, which was included in the balance at September 30, 2001 and collected in October 2001. Deposit liabilities decreased $10.8 million, or 0.94%, from $1.2 billion at September 30, 2001 to $1.1 billion at September 30, 2002. The decrease is primarily due to a reduction in time deposits as a result of a strategy to reduce interest expense. Advances from the FHLB of Seattle increased from $168.0 million at September 30, 2001 to $205.3 million at September 30, 2002. Total shareholders' equity increased $5.8 million from $114.1 million at September 30, 2001 to $119.9 million at September 30, 2002. The increase is the combined effect of $4.8 million paid for stock repurchases and $3.3 million in dividends paid on common shares offset by net earnings for the year and a $4.7 million increase in net unrealized gain on securities available for sale. Asset Quality Non-Performing Assets At September 30, 2002, the ratio of non-performing assets (including nonaccrual loans, accruing loans greater than 90 days delinquent, real estate owned, and other repossessed assets) to total assets was 0.12%, compared to 0.05% at September 30, 2001. The increase is due to an increase in the balance of nonaccrual loans from $271,000 at September 30, 2001 to $1,091,000 at September 30, 2002 and a $312,808 increase in real estate owned and repossessed assets. The Association intends to maintain asset quality by continuing its focus on conscientious underwriting. With the expansion of other lending options such as commercial and multi-family real estate loans, equity lines of credit, other consumer loan products, and commercial loans, the Association has evaluated the trade off associated with planned loan growth and the greater credit risk associated with such forms of lending. Classified Assets The Association has established a Classification of Assets Committee that meets at least quarterly to approve and develop action plans to resolve problems associated with the assets. The Committee also reviews recommendations for new classifications and makes any changes in present classifications, as well as making recommendations for the adequacy of reserves. In accordance with regulatory requirements, the Association reviews and classifies on a regular basis its assets as "special mention", "substandard", "doubtful", and "loss", as appropriate. All nonaccrual loans and non-performing assets are included in classified assets. Allowance for Loan Losses The Association has established a systematic methodology for determination of provisions for loan losses. The methodology is set forth in a formal policy and takes into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual loans. Provision for loan losses is recorded based on the Association's evaluation of specific loans in its portfolio, historical loan loss experience, the volume and type of lending, general economic conditions, and the existing level of the Association's allowance for loan losses. The following table sets forth at the dates indicated the loan loss allowance, charge-offs, and recoveries:
At or For the Year Ended September 30, 2002 2001 2000 - -------------------------------------------------------------------------- (In thousands) General loan loss allowance........... $7,376 $7,951 $4,062 Specific loss allowance............... -- -- 20 Charge-offs........................... 747 90 607 Recoveries............................ 16 42 441
Comparison of Operating Results for the Years Ended September 30, 2002 and 2001 General The purchase of 13 branches from Washington Mutual Bank in September 2001 had significant impact on the operations of the Company during fiscal 2002. The transaction contributed significantly to loan and deposit balances, added 13 locations, and introduced 124 employees to the Klamath First family at year end 2001. Therefore, the income and expenses related to this significant change had little effect on fiscal 2001, but had a dominant impact on fiscal 2002. The influence of this change is evident in all categories of income and expenses during the current fiscal year. During fiscal 2002, the Company operated in an economy that experienced declining interest rates and a relatively normal yield curve. Strategic decisions to revise interest rates paid on deposits to lower interest expense resulted in improvement in both interest rate spread and interest rate margin over the previous year. Net earnings decreased by $782,226, or 10.3% from $7.6 million for the year ended September 30, 2001 to $6.8 million for the year ended September 30, 2002. Net earnings for the year ended September 30, 2001 were enhanced by gains on sale of securities totaling $5.4 million which were not repeated to that extent for 2002. Interest Income Interest income increased $17.2 million, or 24.5%, from $70.1 million for the year ended September 30, 2001 to $87.3 million for the year ended September 30, 2002. The general interest rate environment during the year had declining interest rates but the branch acquisition in September 2001 included significant commercial and consumer loan balances, increasing the earning assets, and also providing loans with slightly higher yields. Rates on short term investments such as federal funds and interest-earning deposits decreased sharply over the year. The combined result of these changes is reflected in the average yield on interest earning assets, which decreased from 6.99% for the year ended September 30, 2001 to 6.35% for the year ended September 30, 2002. Average loans receivable increased $49.2 million and the yield on loans increased 4 basis points, resulting in a $4.1 million increase in interest income on loans. Purchases of MBS boosted interest income on MBS by $14.8 million. The average balance of investment securities increased $22.6 million, or 17.5%, however the average rate decreased by 92 basis points, resulting in a $131,061 decrease in interest income on investment securities compared with the same period in 2001. Interest Expense Average deposits increased by $349.7 million for the year ended September 30, 2002 compared to the year ended September 30, 2001, due to the deposit balances acquired in the WAMU branch transaction in September 2001. The average interest paid on interest-bearing deposits decreased significantly, from 4.52% for the year ended September 30, 2001 to 2.92% for the year ended September 30, 2002. During the year ended September 30, 2002, the Company reduced interest rates paid on deposit accounts as part of a strategic plan to improve profitability. This strategic move is evidenced by the decrease in interest expense which was coupled with a 52.1% increase in average deposit balances. As a result, interest expense decreased $1.2 million, or 3.0%, comparing the year ended September 30, 2002 to 2001. Interest expense on deposits decreased $521,672 from $30.3 million for the year ended September 30, 2001 to $29.8 million for the year ended September 30, 2002. Interest expense on FHLB borrowings decreased $457,332 due to decreased average borrowings of $3.7 million which was partially offset by a 26 basis point increase in the average rate paid. As noted previously, the general interest rate environment during the year was represented by declining rates. The impact of this environment is evident in the decrease in interest rates on interest-earning assets from 6.99% for the year ended September 30, 2001 to 6.35% for the year ended September 30, 2002. Decreases were noted in yields for most categories of assets. However, due to the strategic moves made by the Company in deposit pricing, overall rates on interest-bearing liabilities decreased 150 basis points from 4.81% for the year ended September 30, 2001 to 3.31% for the year ended September 30, 2002. As a result, interest rate spread increased from 2.18% for the year ended September 30, 2001 to 3.04% for the year ended September 30, 2002. Net interest margin (net interest income as a percent of average interest-earning assets) also improved significantly, from 2.93% for the fiscal year ended September 30, 2001 to 3.48% for the year ended September 30, 2002. Provision for Loan Losses The provision for loan losses was $156,000, recoveries were $16,224, and charge offs were $747,092 during the year ended September 30, 2002 compared to a provision for loan losses of $387,000, with $42,406 of recoveries, and charge offs of $90,173 during the year ended September 30, 2001. Charge offs during the year ended September 30, 2002 related primarily to a land development loan and various consumer loans. Charge offs during the year ended September 30, 2001 related primarily to construction loans from one borrower and various consumer loans. The provision for loan losses for the year ended September 30, 2002 was less than for the previous year because the strategy to sell newly originated one- to four-family loans in the secondary market meant that fewer loans were added to the loan portfolio. The loans added in the branch acquisition were allocated allowance as part of the purchase accounting and thus did not significantly impact the provision for fiscal years 2002 and 2001. The composition of the loan portfolio is monitored on a regular basis. Significant increases in commercial and consumer loans, which are considered to have more associated credit risk than the Company's traditional portfolio of one- to four-family residential mortgages, are considered in the determination of the appropriate level of allowance for loan losses. As part of the branch acquisition, a loan loss allowance was allocated to the acquired loans. At September 30, 2001, the allowance for loan losses was equal to 1,108.9% of non-performing assets compared to 398.7% at September 30, 2002. The decrease in the coverage ratio at year end 2002 was the result of an increase in non-performing assets. The following table presents, for the periods indicated, information regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities. Dividends received are included as interest income. The table does not reflect any effect of income taxes. Nonaccrual loans are reflected as carrying a zero yield.
Year Ended September 30, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate INTEREST-EARNING ASSETS (In thousands) Loans receivable........... $660,246 $52,179 7.90% $611,095 $48,051 7.86% $747,842 $57,134 7.64% Mortgage backed and related securities......... 508,712 26,369 5.18% 192,976 11,611 6.02% 85,874 5,036 5.86% Investment securities...... 151,749 7,159 4.72% 129,171 7,282 5.64% 145,504 8,737 6.00% Federal funds sold......... 21,092 440 2.09% 38,686 1,599 4.13% 3,224 180 5.59% Interest earning deposits.. 19,027 333 1.75% 18,930 768 4.06% 5,552 312 5.63% FHLB stock................. 13,013 813 6.25% 12,175 822 6.75% 11,345 759 6.69% --------- ------- --------- ------- ------- ------- Total interest-earning assets..................1,373,839 87,293 6.35% 1,003,033 70,133 6.99% 999,341 72,158 7.22% Non-interest-earning assets.................. 114,405 44,817 40,566 --------- ------- --------- ------- ------- ------- Total Assets..............$1,488,244 $1,047,850 $1,039,907 ========== ========== ========== INTEREST-BEARING LIABILITIES Tax and insurance reserve.. $2,316 $66 2.85% $2,952 $114 3.85% $4,401 $ 89 2.02% Passbook and statement savings................. 82,358 930 1.13% 47,278 1,067 2.26% 53,890 959 1.78% Interest-bearing checking.. 122,610 907 0.74% 75,070 812 1.08% 69,831 779 1.12% Money market............... 319,336 6,377 2.00% 164,523 6,332 3.85% 149,088 6,218 4.17% Certificates of deposit.... 496,070 21,569 4.35% 383,796 22,093 5.76% 377,934 20,408 5.40% FHLB advances/ Short term borrowings...... 170,037 9,682 5.69% 173,786 10,333 5.95% 208,508 12,303 5.90% --------- ------ ------- ------ ------- ------ Total interest-bearing liabilities.............1,192,727 39,531 3.31% 847,405 40,751 4.81% 863,652 40,756 4.72% Non-interest-bearing liabilities............. 180,765 86,406 65,762 --------- ------- --------- ------- ------- ------- Total liabilities..........1,373,492 933,811 929,414 Shareholders' equity....... 114,752 114,039 110,493 ---------- ---------- ---------- Total Liabilities and Shareholders' Equity......$1,488,244 $1,047,850 $1,039,907 ========== ========== ========== Net interest income........ $47,762 $29,382 $31,402 ======= ======= ======= Interest rate spread....... 3.04% 2.18% 2.50% ==== ==== ==== Net interest margin........ 3.48% 2.93% 3.14% ==== ==== ==== Average interest-earning assets to average interest-bearing liabilities............. 115.18% 118.37% 115.71% ====== ====== ======
Non-Interest Income Non-interest income increased $1.6 million, or 14.5%, to $12.6 million for the year ended September 30, 2002 from $11.0 million for the year ended September 30, 2001. During the year ended September 30, 2001, the Company realized $5.4 million in gains on sales of investments when it sold MBS resulting from securitization of single family mortgage loans. This is compared to $1.7 million in gain on sale of securities for the year ended September 30, 2002. Disregarding the gains on sale of investments, non-interest income increased 93.4%, from $5.6 million for the year ended September 30, 2001 to $10.9 million for the year ended September 30, 2002. The increase is the result of continued improvement in fees and service charges due to more accounts and a revised fee structure and a $502,860 increase in gain on sale of mortgage loans. Growth in the activity in the Association's investment subsidiary, Klamath First Financial Services, increased commission income by over $1.0 million. Non-Interest Expense Non-interest expense increased $21.5 million, or 74.7%, from a total of $28.7 million for the prior year to $50.2 million for the year ended September 30, 2002. The increase is primarily attributed to the expansion of the branch network through the branch acquisition in September 2001 and addition of de novo branches. Compensation, employee benefits, and related expense increased $7.7 million, or 53.1%, from $14.4 million for the year ended September 30, 2001 to $22.1 million for the same period of 2002. Increases in compensation expense arose from the addition of 124 employees as part of the WAMU branch acquisition and other back office personnel added to handle the increased activity resulting from a 48% increase in accounts, as well as personnel added at five de novo branches opened during the year ended September 30, 2002. Other expense increased $5.8 million, or 71.4%, from $8.2 million for the year ended September 30, 2001 to $14.0 million for the current year. Increases were noted as a result of the branch acquisition, the opening of the second Medford, Oregon branch and the opening of four new in-store branches. For example, postage and courier expense increased $629,632, and supplies expense increased $411,765. Checking department expense increased by $1.2 million and ATM expense increased by $274,301, both due to the increase in number of locations and deposit accounts. Advertising expense increased $294,808 due to the expansion of the branch network. Professional service fees increased $131,468 with items relating to recruitment of executives, training enhancements, and the hiring of a consulting firm for a commercial loan project. The ratio of non-interest expense to average total assets was 3.4% and 2.7% for the years ended September 30, 2002 and 2001, respectively. The following table sets forth the effects of changing rates and volumes on net interest income of the Company. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in average volume multiplied by prior rate); (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior average volume); and (iii) changes in rate/volume (change in rate multiplied by change in average volume).
For the Year Ended September 30 2001 vs. 2002 2000 vs. 2001 - ------------------------------------------------------------------------------------------------------------------------------- Increase (Decrease) Due To Increase (Decrease) Due To Net Increase Net Increase Rate Volume Rate/Vol (Decrease) Rate Volume Rate/Vol (Decrease) - ------------------------------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS (in thousands) Loans................................. $ 242 $3,864 $20 $4,126 $1,670 ($10,447) ($306) ($9,083) Mortgage-backed and related securities (1,608) 18,997 (2,631) 14,758 131 6,281 163 6,575 Investment securities................. (1,187) 1,273 (208) (122) (534) (981) 60 (1,455) Federal funds sold.................... (791) (727) 360 (1,158) (47) 1,982 (516) 1,419 Interest-bearing deposits............. (437) 4 (2) (435) (87) 752 (209) 456 FHLB stock............................ (61) 57 (4) (8) 7 56 -- 63 -------------------------------------------------------------------------------------- Total Interest-Earning Assets......... ($3,842) $23,468 ($2,465) $17,161 $1,140 ($2,357) ($808) ($2,025) ======= ======= ====== ======= ====== ====== ==== ====== INTEREST-BEARING LIABILITIES Tax and insurance reserves............ ($29) ($24) $6 ($47) $81 ($29) ($27) $25 Savings............................... (532) 791 (395) (136) 257 (118) (31) 108 Interest-bearing checking............. (257) 514 (163) 94 (27) 59 1 33 Money market.......................... (3,047) 5,959 (2,867) 45 (479) 644 (51) 114 Certificates of deposit............... (5,406) 6,463 (1,581) (524) 1,347 317 21 1,685 FHLB advances/Short term borrowings... (437) (223) 9 (651) 96 (2,049) (17) (1,970) ------------------------------------------------------------------------------------- Total Interest-Bearing Liabilities.... ($9,708) $13,480 ($4,991) ($1,219) $1,275 ($1,176) ($104) ($5) ====== ======= ====== ====== ====== ====== ==== == Increase (Decrease) in Net Interest Income............................... $18,380 ($2,020) ======= ======
Income Taxes The provision for income taxes was $3.3 million for the year ended September 30, 2002, representing an effective tax rate of 32.4% compared with $3.7 million for the year ended September 30, 2001 representing an effective tax rate of 32.9%. The decrease in effective tax rate for 2002 is primarily due to an increase in income on tax-exempt municipal securities. (See Note 12 to the Consolidated Financial Statements.) COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2001 AND 2000 General Significant transactions marked the year ended September 30, 2001, as the Company positioned itself for growth in the future. Strategic decisions had a mixed impact on earnings. The sale and securitization of $190.3 million in fixed-rate single family mortgages left the Company holding the resulting MBS. The timing of the securitization provided the opportunity to sell the MBS at a gain totaling $5.4 million before tax. Ultimately, the transaction removed $190.3 million in long term fixed-rate assets from the interest rate risk profile and provided significant earnings. The other transaction that impacted most aspects of the Company was the WAMU branch acquisition. As discussed above, the transaction contributed significantly to loan and deposit balances, added 13 locations, and introduced 124 employees to the Klamath First family. During fiscal 2001, the Company operated in an economy that experienced declining interest rates and a gradual return to a more normal yield curve, in contrast to the inverted yield curve at the end of the prior year wherein short term rates were higher than long term rates. However, with the rapidly declining rates and strategic decisions to make the balance sheet less liability sensitive, interest rate spread continued to be squeezed. Net earnings increased by $1.1 million, or 17.8% from $6.4 million for the year ended September 30, 2000 to $7.6 million for the year ended September 30, 2001, primarily as a result of the gain on sale of securities. Interest Income Interest income decreased from $72.2 million for the year ended September 30, 2000 to $70.1 million for the year ended September 30, 2001. The general interest rate environment during the year showed declining interest rates but movement toward a more normal yield curve. Rates on short term investments such as federal funds and interest-earning deposits decreased sharply over the year. Of course, interest income was negatively impacted by the reduction in loan balances with the securitization of loans in February 2001. The acquisition of loans with the WAMU branches boosted the loan balances but only contributed to interest income for part of one month. The combined result of these movements is reflected in the average yield on interest earning assets which decreased from 7.22% for the year ended September 30, 2000 to 6.99% for the year ended September 30, 2001. While average loans receivable decreased $136.7 million, the yield on loans increased 22 basis points, resulting in a $9.1 million decrease in interest income on loans. Purchases of MBS boosted interest income on MBS by $6.6 million. This increase was offset by a $1.4 million decrease in interest income on investment securities. The average balance of investments decreased by $16.3 million, or 11.2%, for the year ended September 30, 2001 compared with the same period in 2000. Interest Expense Interest expense remained constant at $40.8 million. Interest expense on deposits increased $1.9 million from $28.4 million for the year ended September 30, 2000 to $30.3 million for the year ended September 30, 2001. Average deposits decreased by $19.9 million for the year ended September 30, 2001 compared to the year ended September 30, 2000 while the average interest paid on interest-bearing deposits increased slightly from 4.34% for the year ended September 30, 2000 to 4.52% for the year ended September 30, 2000. Interest expense on FHLB borrowings decreased $2.1 million due to decreased average borrowings of $34.7 million. As noted previously, the general interest rate environment during fiscal 2001 was represented by a normalizing yield curve with much lower rates throughout the curve and especially lower on the short maturities. The impact of this environment is evident in the decrease in interest rate spread from 2.50% for the year ended September 30, 2000 to 2.18% for the year ended September 30, 2001. While yields on assets decreased by 23 basis points, cost of interest bearing liabilities increased by 18 basis points, resulting in a lower spread for the current year. Net interest margin (net interest income as a percent of average interest-earning assets) also decreased from 3.14% for the fiscal year ended September 30, 2000 to 2.93% for the year ended September 30, 2001. Provision for Loan Losses The provision for loan losses was $387,000, recoveries were $42,406, and charge offs were $90,173 during the year ended September 30, 2001 compared to a provision for loan losses of $1.8 million, with $441,639 of recoveries, and charge offs of $606,999 during the year ended September 30, 2000. Charge offs during the year ended September 30, 2001 related primarily to construction loans from one borrower and various consumer loans. Charge offs during the year ended September 30, 2000 primarily related to write downs on commercial real estate. The provision for loan losses for the year ended September 30, 2001 was lower than for the previous year because the strategy to sell newly originated one- to four-family loans in the secondary market meant that few loans were added to the loan portfolio. The loans added in the branch acquisition were allocated allowance as part of the purchase accounting and thus did not impact the provision for the year. During the year ended September 30, 2001, the composition of the loan portfolio changed dramatically, with significant increases in commercial and consumer loans, which are considered to have more associated credit risk than the Company's traditional portfolio of one- to four-family residential mortgages. As part of the branch acquisition, an appropriate loan loss allowance was allocated to the acquired loans. At September 30, 2000, the allowance for loan losses was equal to 251.5% of non-performing assets compared to 1,108.9% at September 30, 2001. The increase in the coverage ratio at year end 2001 was the result of a decrease in non-performing assets and a higher allowance which incorporates the risk factors associated with the significant increase in commercial and consumer loans. Non-Interest Income Non-interest income increased $6.9 million, or 169.0%, to $11.0 million for the year ended September 30, 2001 from $4.1 million for the year ended September 30, 2000. The Company realized $5.4 million in gains on sales of investments when it sold MBS resulting from securitization of single family mortgage loans. However, disregarding the gain on sale of investments, there remained a $1.6 million increase in non-interest income from $4.1 million for the year ended September 30, 2000 to $5.6 million for the year ended September 30, 2001. The increase was the result of continued improvement in fees and service charges and a $487,000 increase in gain on sales of mortgage loans. Non-Interest Expense Non-interest expense increased $4.9 million, or 20.8%, from a total of $23.8 million for the prior year to $28.7 million for the year ended September 30, 2001. Compensation, employee benefits, and related expense increased $2.6 million, or 21.4%, from $11.9 million for the year ended September 30, 2000 to $14.4 million for the same period of 2001. Of this increase, $388,000 relates to early retirement accruals associated with the termination of the defined-benefit pension plan and retirement of five of the Company's long-time employees. Other increases in compensation expense arose from the addition of 124 employees as part of the WAMU branch acquisition and other back office personnel added to handle the increased activity resulting from a 48% increase in accounts. Other expense increased $1.5 million, or 21.7%, from $6.7 million for the year ended September 30, 2000 to $8.2 million for the current year. Increases were noted as a result of the branch acquisition, opening of the Redmond, Oregon branch and opening of four new in-store branches. For example, postage and courier expense increased $247,803, and supplies expense increased $114,937. Professional service fees increased $118,174 with items relating to recruitment of executives and training enhancements. Expense related to loan pools sold to FNMA totaled $419,289 and is a new cost associated with the securitization of mortgage loans. The ratio of non-interest expense to average total assets was 2.7% and 2.3% for the years ended September 30, 2001 and 2000, respectively. Income Taxes The provision for income taxes was $3.7 million for the year ended September 30, 2001, representing an effective tax rate of 32.9% compared with $3.5 million for the year ended September 30, 2000 representing an effective tax rate of 35.5%. The decrease in effective tax rate for 2001 was primarily due to an increase in income on tax-exempt municipal securities and the effect of $270,000 in tax refunds received during this fiscal year related to amended tax returns for a prior year. (See Note 12 to the Consolidated Financial Statements.) COMMON STOCK INFORMATION Since October 4, 1995, the Company's common stock has traded on The Nasdaq Stock Market, Inc. under the symbol "KFBI". As of September 30, 2002, there were approximately 1,256 shareholders of record. This total does not reflect the number of persons or entities who hold stock in nominee or "street" name through various brokerage firms.
The high and low common stock prices by quarter were as follows: Year Ended September 30, 2002 2001 - --------------------------------------------------------------------------- High Low High Low - --------------------------------------------------------------------------- First quarter............... $13.28 $12.40 $12.88 $11.50 Second quarter.............. 13.62 13.01 14.00 12.13 Third quarter............... 16.65 13.13 14.89 12.95 Fourth quarter.............. 16.19 14.00 15.20 12.70
The per share cash dividends declared by quarter were as follows: Year Ended September 30, 2002 2001 - --------------------------------------------------------------------------- First quarter............... $0.130 $0.130 Second quarter.............. 0.130 0.130 Third quarter............... 0.130 0.130 Fourth quarter.............. 0.130 0.130
Any dividend payments by the Company are subject to the sole discretion of the Board of Directors and depend primarily on the ability of the Association to pay dividends to the Company. Under Federal regulations, the dollar amount of dividends a federal savings association may pay depends on the association's capital surplus position and recent net income. Generally, if an association satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the OTS regulations. However, an institution that has converted to the stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in accordance with OTS regulations and the association's Plan of Conversion. In addition, earnings of the association appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of cash dividends without payment of taxes at the then current tax rate by the association on the amount removed from the reserves for such distributions. The Association does not contemplate any distributions that would limit the Association's bad debt deduction or create federal tax liabilities. Board of Directors Klamath First Bancorp, Inc. Klamath Falls, Oregon We have audited the accompanying consolidated balance sheets of Klamath First Bancorp, Inc.and Subsidiaries (the "Company") as of September 30, 2002 and 2001, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended September 30, 2002. These consolidated 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Klamath First Bancorp, Inc. and Subsidiaries as of September 30, 2002 and 2001 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2002, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Portland, Oregon November 1, 2002
Consolidated Balance Sheets Sept. 30, 2002 Sept. 30, 2001 - ----------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks ................................................. $ 38,444,500 $ 40,446,042 Interest bearing deposits with banks .................................... 5,762,373 3,791,252 Federal funds sold and securities purchased under agreements to resell ........................................... 1,584,540 74,151,272 --------------- --------------- Total cash and cash equivalents ......................................... 45,791,413 118,388,566 Investment securities available for sale, at fair value (amortized cost: $119,940,845 and $154,190,612) ......................... 119,542,052 154,675,760 Investment securities held to maturity, at amortized cost (fair value: $-- and $137,429) ........................................... -- 135,388 Mortgage-backed and related securities available for sale, at fair value (amortized cost: $640,304,722 and $419,639,650) ......................... 650,796,164 421,637,670 Mortgage-backed and related securities held to maturity, at amortized cost (fair value: $-- and $1,642,174) ......................................... -- 1,620,612 Loans receivable, net ................................................... 607,464,660 679,990,308 Real estate owned and repossessed assets ................................ 758,663 445,855 Premises and equipment, net ............................................. 23,410,847 16,911,912 Stock in Federal Home Loan Bank of Seattle, at cost ..................... 13,510,400 12,698,000 Accrued interest receivable ............................................. 8,177,014 8,657,586 Core deposit intangible and other intangible assets ..................... 40,298,989 44,088,926 Other assets ............................................................ 3,745,151 9,321,227 -------------- -------------- Total assets ............................................................ $1,513,495,353 $1,468,571,810 ============== ============== Liabilities and Shareholders' Equity Liabilities Deposit liabilities ..................................................... $1,142,005,997 $1,152,824,144 Accrued interest on deposit liabilities ................................. 721,810 1,574,606 Advances from borrowers for taxes and insurance ......................... 5,105,955 6,637,994 Advances from Federal Home Loan Bank of Seattle ......................... 205,250,000 168,000,000 Short term borrowings ................................................... 1,700,000 1,700,000 Accrued interest on borrowings .......................................... 820,975 801,743 Pension liabilities ..................................................... 842,272 942,148 Deferred federal and state income taxes ................................. 1,466,556 597,345 Other liabilities ....................................................... 8,438,245 6,799,241 -------------- -------------- Total liabilities ....................................................... 1,366,351,810 1,339,877,221 -------------- -------------- Mandatorily redeemable preferred securities ............................. 27,205,507 14,553,684 -------------- -------------- Commitments and contingent liabilities Shareholders' Equity Preferred stock, $.01 par value, 500,000 shares authorized; none issued. -- -- Common stock, $.01 par value, 35,000,000 shares authorized, September 30, 2002 - 6,744,040 issued, 6,366,546 outstanding September 30, 2001 - 7,060,667 issued, 6,561,461 outstanding ............ 67,440 70,607 Additional paid-in capital .............................................. 30,282,059 33,926,796 Retained earnings-substantially restricted .............................. 87,265,334 83,816,307 Unearned shares issued to ESOP .......................................... (2,935,130) (3,913,510) Unearned shares issued to MRDP .......................................... (999,111) (1,298,859) Accumulated other comprehensive income .................................. 6,257,444 1,539,564 --------------- -------------- Total shareholders' equity .............................................. 119,938,036 114,140,905 --------------- -------------- Total liabilities and shareholders' equity .............................. $1,513,495,353 $1,468,571,810 ============== ==============
Consolidated Statements of Earnings - Year Ended Sept. 30 2002 2001 2000 - ----------------------------------------------------------------------------------------------------------------- Interest income Loans receivable ................................................... $52,178,747 $48,051,228 $57,133,422 Mortgage-backed and related securities ............................. 26,368,930 11,611,184 5,035,957 Investment securities .............................................. 7,972,257 8,103,318 9,495,804 Federal funds sold and securities purchased under agreements to resell ............................... 440,220 1,598,662 180,253 Interest bearing deposits .......................................... 333,019 768,192 312,293 ----------- ---------- ---------- Total interest income .............................................. 87,293,173 70,132,584 72,157,729 ----------- ---------- ---------- Interest expense Deposit liabilities ................................................ 29,782,599 30,304,271 28,363,916 Advances from FHLB of Seattle ...................................... 9,608,659 10,065,991 12,184,341 Other .............................................................. 139,857 380,579 207,963 ---------- ---------- ---------- Total interest expense ............................................. 39,531,115 40,750,841 40,756,220 ---------- ---------- ---------- Net interest income ................................................ 47,762,058 29,381,743 31,401,509 Provision for loan losses .......................................... 156,000 387,000 1,764,000 ---------- ---------- ---------- Net interest income after provision for loan losses ................ 47,606,058 28,994,743 29,637,509 ---------- ---------- ---------- Non-interest income Fees and service charges ........................................... 7,876,902 4,293,983 3,212,434 Gain on sale of investments ........................................ 1,707,172 5,374,723 6,836 Gain on sale of real estate owned .................................. 25,852 86,927 154,661 Gain on sale of loans .............................................. 1,076,745 573,885 86,826 Brokerage and annuity commissions .................................. 1,368,057 362,387 164,025 Other income ....................................................... 559,103 321,758 469,892 ---------- ---------- ---------- Total non-interest income .......................................... 12,613,831 11,013,663 4,094,674 ---------- ---------- ---------- Non-interest expense Compensation, employee benefits and related expense................. 22,125,329 14,448,997 11,898,041 Occupancy expense .................................................. 4,811,472 2,858,504 2,413,316 Data processing expense ............................................ 1,499,490 1,007,040 913,531 Insurance premium expense .......................................... 181,449 133,407 186,557 Loss on sale of investments ........................................ 628,823 30,632 -- Loss on sale of real estate owned .................................. 771 39,911 7,863 Amortization of core deposit intangible ............................ 5,520,680 1,794,330 1,652,677 Mandatorily redeemable preferred securities expense ................ 1,423,774 252,367 -- Other expense ...................................................... 13,979,591 8,154,956 6,700,888 ---------- ---------- ---------- Total non-interest expense ......................................... 50,171,379 28,720,144 23,772,873 ---------- ---------- ---------- Earnings before income taxes ....................................... 10,048,510 11,288,262 9,959,310 Provision for income taxes ......................................... 3,259,734 3,717,260 3,533,158 ---------- ---------- ---------- Net earnings ....................................................... $ 6,788,776 $ 7,571,002 $ 6,426,152 =========== =========== =========== Earnings per common share - basic .................................. $ 1.06 $ 1.14 $ 0.94 Earnings per common share - fully diluted .......................... $ 1.05 $ 1.13 $ 0.94 Weighted average common shares outstanding - basic.................. 6,411,351 6,627,200 6,822,025 Weighted average common shares outstanding - with dilution......... 6,495,498 6,702,045 6,822,025 See notes to consolidated financial statements
Consolidated Statements of Shareholders' Equity - ----------------------------------------------------------------------------------------------------------------------------------- Unearned Unearned Accumulated Common Common Additional shares shares Other Total stock stock paid-in Retained issued issued comprehensive shareholders' shares amount capital earnings to ESOP to MRDP income (loss) equity ---------- ------- ----------- ----------- ------------ ------------ ------------ ------------- Balance at October 1, 1999 7,062,092 $79,084 $43,794,535 $76,866,452 ($5,871,900) ($3,519,296) ($1,763,412) $109,585,463 Cash dividends -- -- -- (3,579,349) -- -- -- (3,579,349) Stock repurchased and retired (542,151) (5,422) (6,249,273) -- -- -- -- (6,254,695) ESOP contribution 97,865 -- 142,826 -- 978,650 -- -- 1,121,476 MRDP contribution 74,622 -- 13,708 -- -- 1,020,918 -- 1,034,626 - ----------------------------------------------------------------------------------------------------------------------------------- 6,692,428 73,662 37,701,796 73,287,103 (4,893,250) (2,498,378) (1,763,412) 101,907,521 - ----------------------------------------------------------------------------------------------------------------------------------- Comprehensive income Net earnings 6,426,152 6,426,152 Other comprehensive income: Unrealized gain on securities, net of tax and reclassification adjustment1 390,888 390,888 - ----------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 6,817,040 - ----------------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2000 6,692,428 73,662 37,701,796 79,713,255 (4,893,250) (2,498,378) (1,372,524) 108,724,561 - ----------------------------------------------------------------------------------------------------------------------------------- Cash dividends -- -- -- (3,467,950) -- -- -- (3,467,950) Stock repurchased and retired (550,221) (5,502) (7,393,921) -- -- -- -- (7,399,423) ESOP contribution 97,974 -- 396,471 -- 979,740 -- -- 1,376,211 MRDP contribution 76,618 -- 13,708 -- -- 1,199,519 -- 1,213,227 Exercise of stock options 244,662 2,447 3,208,742 -- -- -- -- 3,211,189 - ----------------------------------------------------------------------------------------------------------------------------------- 6,561,461 70,607 33,926,796 76,245,305 (3,913,510) (1,298,859) (1,372,524) 103,657,815 - ----------------------------------------------------------------------------------------------------------------------------------- Comprehensive income Net earnings 7,571,002 7,571,002 Other comprehensive income: Unrealized gain on securities, net of tax and reclassification adjustment2 2,912,088 2,912,088 - ----------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 10,483,090 - ----------------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2001 6,561,461 70,607 33,926,796 83,816,307 (3,913,510) (1,298,859) 1,539,564 114,140,905 - ----------------------------------------------------------------------------------------------------------------------------------- Cash dividends -- -- -- (3,339,749) -- -- -- (3,339,749) Stock repurchased and retired (345,986) (3,460) (4,747,387) -- -- -- -- (4,750,847) ESOP contribution 97,865 -- 410,593 -- 978,380 -- -- 1,388,973 MRDP contribution 23,847 -- 11,511 -- -- 299,748 -- 311,259 Exercise of stock options 29,359 293 369,295 -- -- -- -- 369,588 Tax benefit of stock options -- -- 311,251 -- -- -- -- 311,251 - ----------------------------------------------------------------------------------------------------------------------------------- 6,366,546 67,440 30,282,059 80,476,558 (2,935,130) ( 999,111) 1,539,564 108,431,380 - ----------------------------------------------------------------------------------------------------------------------------------- Comprehensive income Net earnings 6,788,776 6,788,776 Other comprehensive income: Unrealized gain on securities, net of tax and reclassification adjustment3 4,717,880 4,717,880 - ----------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 11,506,656 - ----------------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2002 6,366,546 $67,440 $30,282,059 $87,265,334 ($2,935,130) ($999,111) $6,257,444 $119,938,036 ========= ======= =========== =========== ========== ======== ========== ============ 1Net unrealized holding gain on securities of $440,870 (net of $270,211 tax expense) less reclassification adjustment for net gains included in net earnings of $49,982 (net of $30,634 tax expense). 2Net unrealized holding gain on securities of $2,893,883 (net of $1,773,670 tax expense) less reclassification adjustment for net losses included in net earnings of $18,205 (net of $11,158 tax benefit). 3Net unrealized holding gain on securities of $5,095,497 (net of $3,123,389 tax expense) less reclassification adjustment for net gains included in net earnings of $377,617 (net of $231,443 tax expense). See notes to consolidated financial statements.
Consolidated Statements of Cash Flows - Year Ended Sept. 30, 2002 2001 2000 - ----------------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities Net earnings $6,788,776 $7,571,002 $6,426,152 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Depreciation and amortization 7,715,652 3,161,017 2,927,853 Deferred income taxes (2,022,392) (956,590) (1,050,197) Provision for loan losses 156,000 387,000 1,764,000 Provision for losses on real estate owned -- -- 120,000 Compensation expense related to ESOP benefit 1,388,973 1,376,211 1,121,476 Compensation expense related to MRDP Trust 311,259 1,213,227 1,034,626 Tax benefit associated with stock options 311,251 -- -- Net amortization of premiums paid on investment and mortgage-backed and related securities 3,930,135 249,371 266,018 Decrease in deferred loan fees, net of amortization (688,264) (2,848,812) (547,429) Net (gain) loss on sale of real estate owned and premises and equipment (25,081) 39,452 (177,493) Net gain on sale of investment and mortgage-backed and related securities (1,078,350) (5,344,091) (6,836) FHLB stock dividend (812,400) (821,500) (758,300) Changes in assets and liabilities: Accrued interest receivable 480,572 (2,225,513) 721,745 Other assets 3,685,333 (7,456,909) (329,286) Accrued interest on deposit liabilities (852,796) 389,530 605 Accrued interest on borrowings 19,232 (55,420) 822,679 Pension liabilities (99,876) 54,252 54,252 Other liabilities 1,916,542 3,194,579 984,855 - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 21,124,566 (2,073,194) 13,374,720 - ----------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturity of investment securities held to maturity 135,000 130,000 290,000 Proceeds from maturity of investment securities available for sale 15,000,000 33,425,000 33,360,000 Principal repayments received on mortgage-backed and related securities held to maturity 1,238,278 531,435 434,252 Principal repayments received on mortgage-backed and related securities available for sale 108,276,166 46,429,807 26,859,810 Principal repayments received on loans 286,803,701 145,496,311 99,031,327 Loan originations (281,665,175) (136,492,447) (97,246,615) Loans purchased (1,683,363) -- (507,600) Loans sold 68,661,105 30,708,858 6,315,261 Purchase of investment securities available for sale (41,854,162) (78,456,931) (1,110,000) Purchase of mortgage-backed and related securities available for sale (419,414,542) (383,198,597) (29,396,069) Purchase of FHLB stock -- -- (160,900) Proceeds from sale of investment securities available for sale 61,977,158 10,367,746 10,051,563 Proceeds from sale of mortgage-backed and related securities available for sale 87,131,357 187,991,361 -- Consolidated Statements of Cash Flows - Year Ended Sept. 30 2002 2001 2000 - ----------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES (cont.) Proceeds from sale of real estate owned and premises and equipment $653,574 $1,261,175 $2,722,397 Investment in real estate owned -- (86,742) -- Purchases of premises and equipment (8,533,907) (5,392,241) (2,271,628) Acquisitions, net of cash acquired -- 206,548,213 -- - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities (123,274,810) 59,262,948 48,371,798 ------------ ----------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposit liabilities (10,818,147) 33,986,127 (25,020,241) Proceeds from FHLB advances 99,950,000 2,000,000 614,650,000 Repayments of FHLB advances (62,700,000) (7,000,000) (638,650,000) Proceeds from short term borrowings 200,000 3,400,000 3,700,000 Repayments of short term borrowings (200,000) (4,700,000) (700,000) Issuance of mandatorily redeemable preferred securities 12,651,823 14,553,684 -- Stock repurchase and retirement (4,750,847) (7,399,423) (6,254,695) Proceeds from exercise of stock options 369,588 3,211,189 -- Advances from borrowers for taxes and insurance (1,532,039) (3,015,382) (105,251) Dividends paid (3,617,287) (3,783,983) (3,942,320) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 29,553,091 31,252,212 (56,322,507) ------------ ----------- ---------- Net (decrease) increase in cash and cash equivalents (72,597,153) 88,441,966 5,424,011 Cash and cash equivalents at beginning of year 118,388,566 29,946,600 24,522,589 - ----------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $45,791,413 $118,388,566 $29,946,600 ============ =========== ========== Supplemental schedule of interest and income taxes paid Interest paid $40,364,979 $42,020,217 $39,932,938 Income taxes paid 2,795,000 3,930,000 4,745,000 Supplemental schedule of noncash investing and financing activities Net unrealized gain on securities available for sale $4,717,880 $2,912,088 $390,888 Dividends declared and accrued in other liabilities 883,136 934,233 957,609 Loans transferred to real estate owned 949,830 870,128 2,291,059 Write down of real estate owned -- -- 343,450 Loans securitized and recorded as mortgage-backed securities available for sale -- 190,300,518 -- Mortgaged-backed securities held to maturity transferred to available for sale, at fair value 376,335 -- --
[1] Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Klamath First Bancorp, Inc. (the "Company") and its wholly-owned subsidiaries, Klamath Capital Trust I, Klamath Capital Trust II and Klamath First Federal Savings and Loan Association (the "Association"), including the Association's subsidiaries, Klamath First Financial Services, Inc. and Pacific Cascades Financial, Inc. All intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year presentation. Nature of Operations The Company provides banking and limited non-banking services to its customers who are located throughout the state of Oregon and in adjoining areas of Washington state. These services primarily include attracting deposits from the general public and using such funds, together with other borrowings, to invest in various real estate loans, consumer and commercial loans, investment securities and mortgage-backed and related securities. Use of Estimates in the Presentation of the Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions. These assumptions result in estimates that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenue and expense during the reporting period. Actual results could differ from those estimates. Cash Equivalents For purposes of the Consolidated Statements of Cash Flows, the Company considers cash and due from banks, interest-bearing deposits held at domestic banks, federal funds sold, and security resale agreements to be cash and cash equivalents, all of which mature within 90 days. Investment Securities In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, investment securities held to maturity are stated at amortized cost only if the Company has the positive intent and the ability to hold the securities to maturity. Securities available for sale, including mutual funds, and trading securities are stated at fair value. Unrealized gains and losses from available for sale securities are excluded from earnings and reported (net of tax) as a net amount in a separate component of shareholders' equity until realized. Realized gains and losses on the sale of securities, recognized on a specific identification basis, and valuation adjustments of trading account securities are included in non-interest income or expense. Net unrealized gains or losses on securities resulting from an other than temporary decline in the fair value are recognized in earnings when incurred. Stock Investments The Company holds stock in the Federal Home Loan Bank of Seattle ("FHLB of Seattle"). This investment is carried at historical cost. Loans Loans held for investment are stated at the principal amount outstanding, net of deferred loan fees and unearned income. Loan origination fees, commitment fees and certain direct loan origination costs are capitalized and recognized as a yield adjustment over the lives of the loans using the level-yield method. Unearned discounts are accreted to income over the average lives of the related loans using the level-yield method, adjusted for estimated prepayments. Interest income is recorded as earned. Management ceases to accrue interest income on any loan that becomes 90 days or more delinquent and reverses all interest accrued up to that time. Thereafter, interest income is accrued only if and when, in management's opinion, projected cash proceeds are deemed sufficient to repay both principal and interest. All loans for which interest is not being accrued are referred to as loans on non-accrual status. Allowance for Loan Losses The allowance for loan losses is established to absorb known and inherent losses in the loan portfolio. Allowances for losses on specific problem real estate loans are charged to earnings when it is determined that the value of these loans is impaired. In addition to specific reserves, the Company also maintains general provisions for loan losses based on evaluating known and inherent risks in the loan portfolio, including management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. The allowance is an estimate based upon factors and trends identified by management at the time financial statements are prepared. The ultimate recovery of loans is susceptible to future market factors beyond the Company's control, which may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance on loans. Delinquent interest on loans past due 90 days or more is charged off or an allowance established by a charge to income equal to all interest previously accrued. Interest is subsequently recognized only to the extent cash payments are received until delinquent interest is paid in full and, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal, in which case the loan is returned to accrual status. Real Estate Owned and Repossessed Assets Property acquired through foreclosure, repossession action, or deed in lieu of foreclosure is carried at the lower of estimated fair value, less estimated costs to sell, or the balance of the loan on the property at date of acquisition, not to exceed net realizable value. Costs excluding interest, relating to the improvement of property are capitalized, whereas those relating to acquiring and holding the property are charged to expense. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation. Depreciation is generally computed on the straight-line basis over the estimated useful lives of the various classes of assets from their respective dates of acquisition. Estimated useful lives range up to 30 years for buildings, up to the lease term for leasehold improvements, three years for automobiles, and three to 15 years for furniture and equipment. Mortgage Servicing Fees earned for servicing loans are reported as income when the related mortgage loan payments are collected. Loan servicing costs are charged to expense as incurred. The Company accounts for mortgage servicing rights ("MSR") in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. SFAS No. 140 requires the Company to allocate the total cost of all mortgage loans sold, whether originated or purchased, to the MSR and the loans (without MSR) based on their relative fair values if it is practicable to estimate those fair values. MSR are capitalized at their allocated carrying value and amortized in proportion to, and over the period of, estimated future net servicing income. The Company assesses impairment of the MSR based on the fair value of those rights. For purposes of measuring impairment, the MSR are stratified based on interest rate characteristics (fixed-rate and adjustable-rate), as well as by coupon rate. In order to determine the fair value of the MSR, the Company uses a model that estimates the present value of expected future cash flows. Assumptions used in the model include market discount rates and anticipated prepayment speeds. In addition, the Company uses market comparables for estimates of the cost of servicing, inflation rates and ancillary income. An impairment allowance of $180,739 was recorded at September 30, 2002. No impairment allowance was considered necessary at September 30, 2001. Future interest rate decreases could have a negative impact on the recorded MSR. Intangible Assets In conjunction with branch acquisitions, the Company has recorded intangible assets, including core deposit intangible and other intangible assets. Core deposit intangibles are amortized over the estimated average remaining life of the deposit base acquired. Other intangible assets are amortized over a period no greater than the estimated remaining life of the long term assets acquired. At September 30, 2002, core deposit intangibles totaled $17.4 million and other intangible assets totaled $22.9 million. Because other intangible assets were recorded in conjunction with the purchase of branches, they were accounted for in accordance with SFAS No. 72, Accounting for Certain Acquisitions of Bank and Thrift Institutions. In October 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 147, Acquisitions of Certain Financial Institutions, which requires such intangible assets to be accounted for under the provisions of SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under this guidance, other intangible assets will be evaluated for impairment but will no longer be amortized. The Company plans to adopt SFAS No. 147 as of October 1, 2002. Income Taxes The Company accounts for income taxes using the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Employee Stock Ownership Plan The Company sponsors an Employee Stock Ownership Plan ("ESOP"). The ESOP is accounted for in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position 93-6, Employer's Accounting for Employee Stock Ownership Plans. Accordingly, the shares held by the ESOP are reported as unearned shares issued to the employee stock ownership plan in the balance sheets. The ESOP authorizes release of the shares over a ten-year period, of which three years are remaining. As shares are released from collateral, compensation expense is recorded equal to the then current market price of the shares, and the shares become outstanding for earnings per share calculations. Management Recognition and Development Plan The Company sponsors a Management Recognition and Development Plan ("MRDP"). The MRDP is accounted for in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. The MRDP authorizes the grant of common stock shares to certain officers and directors, which vest over a five-year period in equal installments. The Company recognizes compensation expense in the amount of the fair value of the common stock in accordance with the vesting schedule during the years in which the shares are payable. When the MRDP awards are allocated, the common stock shares become common stock equivalents for earnings per share calculations. Compensation expense for the years ended September 30, 2002, 2001 and 2000 was $311,259, $1.2 million and $1.0 million, respectively. Stock Based Compensation The Company accounts for stock option grants using the intrinsic value method as prescribed in Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under the intrinsic value based method, compensation cost for stock options is measured as the excess, if any, of the quoted market price of stock at grant date over the amount an employee must pay to acquire the stock. Stock options granted by the Company have no intrinsic value at the grant date and, under APB No. 25, there is no compensation expense to be recorded. SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The fair value approach measures compensation costs based on factors such as the term of the option, the market price at grant date, and the option exercise price, with expense recognized over the vesting period. See Note 17 for the pro forma effect on net earnings and earnings per share as if the fair value method had been used. Recently Issued Accounting Pronouncements In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which is effective October 1, 2002. SFAS No. 142 will require that goodwill no longer be amortized and instead be tested for impairment at least annually. In addition, the standard includes provisions for the accounting and reporting of certain existing recognized intangibles and goodwill. Management is currently evaluating the impact that SFAS No. 142 may have on its consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets, which is effective October 1, 2002. This statement supersedes SFAS No. 121 and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 for the disposal of a segment of a business. The Company is currently evaluating the impact that adoption of SFAS No. 144 may have on the consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces previous accounting guidance which was provided by EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. In October 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 147, Acquisitions of Certain Financial Institutions, which requires certain intangible assets to be accounted for under the provisions of SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under this guidance, other intangible assets will be evaluated for impairment but will no longer be amortized. The Company plans to adopt SFAS No. 147 as of October 1, 2002. Expense related to amortization of other intangibles totaled $1.1 million for the year ended September 30, 2002. A similar expense will not be recorded in fiscal year 2003. (2) Acquisition On September 7, 2001, the Company completed the acquisition of 13 branches from Washington Mutual. These branches are located along the Oregon coast and in northeastern Oregon, complementing and expanding the existing branch network. The transaction, which was accounted for as a purchase in accordance with SFAS No. 72, Accounting for Certain Acquisitions of Bank and Thrift Institutions, included acquisition of $179.3 million in loans and assumption of $423.5 million in deposit liabilities. The balance sheet at September 30, 2001 reflects inclusion of all assets and liabilities related to the transaction. Income and expense related to the transaction and operation of the branches for the period from September 7, 2001 to September 30, 2001 are reflected in the statement of earnings. As a result of this transaction, the Company recorded core deposit intangible of $15.0 million which will be amortized over the estimated life of the deposit base. The Company also recorded other intangible assets of $24.1 million related to the transaction. (3) Cash and Due from Banks The Company is required to maintain an average reserve balance with the Federal Reserve Bank, or maintain such reserve balance in the form of cash. The amount of this required reserve balance was approximately $4,024,000 and $766,000 at September 30, 2002 and 2001, respectively, and was met by holding cash and maintaining an average balance with the Federal Reserve Bank in excess of this amount. (4) Investments and Mortgage-backed Securities Amortized cost and approximate fair value of securities available for sale and held to maturity are summarized by type and maturity as follows:
INVESTMENT SECURITIES AVAILABLE-FOR-SALE Amortized Gross Unrealized Fair September 30, 2002 Cost Gains Losses Value - -------------------------------------------------------------------------------------------- State and municipal obligations Maturing within one year..........$ 100,000 $ 565 $ -- $ 100,565 Maturing after one year through five years ...................... 485,300 12,929 -- 498,229 Maturing after five years through ten years ....................... 790,110 56,682 -- 846,792 Maturing after ten years ......... 38,202,338 2,381,961 4,044 40,580,255 Corporate obligations Maturing within one year ......... 17,890,090 -- 55,225 17,834,865 Maturing after one year through five years ...................... 23,922,805 489,819 14,498 24,398,126 Maturing after ten years ......... 19,834,958 -- 2,644,508 17,190,450 Federal agency preferred stock Maturing after ten years ........ 18,715,244 -- 622,474 18,092,770 ------------ ---------- ------------ ------------ $119,940,845 $2,941,956 $ 3,340,749 $119,542,052 ============ ========== ============ ============
INVESTMENT SECURITIES AVAILABLE-FOR-SALE Amortized Gross Unrealized Fair September 30, 2001 Cost Gains Losses Value - ------------------------------------------------------------------------------------------- U.S. Government obligations Maturing within one year $15,003,079 $435,049 $-- $15,438,128 through five years 15,200,000 251,500 -- 15,451,500 Maturing after five years and through ten years 9,916,677 45,223 -- 9,961,900 State and municipal obligations Maturing after one year through five years 585,530 12,993 -- 598,523 Maturing after five years through ten years 397,962 7,610 -- 405,572 Maturing after ten years 31,967,069 746,540 77,519 32,636,090 Corporate obligations Maturing within one year 10,011,936 185,414 -- 10,197,350 Maturing after one year through five years 35,562,330 942,817 -- 36,505,147 Maturing after ten years 19,830,093 -- 1,814,343 18,015,750 Federal agency preferred stock Maturing after ten years 15,715,936 -- 250,136 15,465,800 - ------------------------------------------------------------------------------------------- $154,190,612 $2,627,146 $2,141,998 $154,675,760 ============ ========== ========== ============= INVESTMENT SECURITIES HELD-TO-MATURITY Amortized Gross Unrealized Fair September 30, 2001 Cost Gains Losses Value State and municipal obligations - ------------------------------------------------------------------------------------------- Maturing within one year $135,388 $2,041 $ -- $137,429 ============ ========== ========== ============= MORTGAGE-BACKED AND RELATED SECURITIES AVAILABLE-FOR-SALE Amortized Gross Unrealized Fair September 30, 2001 Cost Gains Losses Value - ------------------------------------------------------------------------------------------- FNMA maturing after one year through five years $2,944,195 $26,810 $ -- $2,971,005 CMO's maturing after one year through five years 11,520,162 237,265 -- 11,757,427 FHLMC maturing after one year through five years 12,634,495 231,613 -- 12,866,108 FNMA maturing after five years through ten years 133,151,422 4,006,978 -- 137,158,400 CMO's maturing after five years through ten years 7,182,143 83,445 -- 7,265,588 FNMA maturing after ten years 116,232,557 1,134,165 -- 117,366,722 FHLMC maturing after ten years 37,902,266 425,289 2,515 38,325,040 GNMA maturing after ten years 24,346,010 247,888 346 24,593,552 CMO's maturing after ten years 294,391,472 4,108,891 8,041 298,492,322 - ------------------------------------------------------------------------------------------- $640,304,722 $10,502,344 $10,902 $650,796,164 ============ =========== ========= ============= MORTGAGE-BACKED AND RELATED SECURITIES AVAILABLE-FOR-SALE Amortized Gross Unrealized Fair September 30, 2001 Cost Gains Losses Value - ------------------------------------------------------------------------------------------- FNMA maturing after one year through five years $1,315,698 $27,973 $ -- $1,343,671 CMO's maturing after one year through five years 25,958,997 174,744 -- 26,133,741 FHLMC maturing after one year through five years 10,057,380 104,104 -- 10,161,484 FNMA maturing after five years through ten years 10,057,489 165,138 -- 10,222,627 CMO's maturing after five years through ten years 90,827,507 67,227 608,387 90,286,347 FNMA maturing after ten years 45,459,792 200,295 32,745 45,627,342 FHLMC maturing after ten years 9,480,629 155,121 197 9,635,553 GNMA maturing after ten years 6,816,570 160,234 -- 6,976,804 CMO's maturing after ten years 219,665,588 1,693,975 109,462 221,250,101 - ------------------------------------------------------------------------------------------- $419,639,650 $2,748,811 $750,791 $421,637,670 ============ ========== ========= ============= MORTGAGE-BACKED AND RELATED SECURITIES HELD-TO-MATURITY Amortized Gross Unrealized Fair September 30, 2001 Cost Gains Losses Value - ------------------------------------------------------------------------------------------- GNMA maturing after ten years $1,620,612 $21,562 $ -- $1,642,174 ============ ========== ========= =============
Expected maturities of mortgage-backed and related securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At September 30, 2002 and 2001, the Company pledged securities totaling $40.5 million and $42.0 million, respectively, to secure certain public deposits and for other purposes as required or permitted by law. The Company has also pledged securities of zero and $1.5 million to secure short term borrowings at September 30, 2002 and 2001, respectively. (See Note 11.) [5] Loans receivable
September 30, 2002 2001 - ----------------------------------------------------------------- Real estate loans Permanent residential 1-4 family $339,403,368 $421,499,010 Multi-family residential 21,595,322 23,257,194 Construction 15,223,441 21,673,519 Agricultural 4,888,861 4,218,263 Commercial 91,703,262 99,318,389 Land 4,164,394 3,696,487 - ----------------------------------------------------------------- Total real estate loans 476,978,648 573,662,862 ----------- ----------- Non-real estate loans Savings account 1,261,448 2,090,840 Home improvement and home equity 65,092,250 50,464,521 Other consumer 16,926,304 18,696,626 Commercial 62,102,347 56,098,520 - ----------------------------------------------------------------- Total non-real estate loans 145,382,349 127,350,507 ----------- ----------- Total loans 622,360,997 701,013,369 Less Undisbursed portion of loans 3,609,164 8,472,757 Deferred loan fees 3,911,361 4,599,624 Allowance for loan losses 7,375,812 7,950,680 - ----------------------------------------------------------------- $607,464,660 $679,990,308 ============ =============
The weighted average interest rate on loans at September 30, 2002 and 2001 was 7.36% and 7.92%, respectively. Included in loans receivable are $9.5 million and $77,500 of loans held for sale at September 30, 2002 and 2001, respectively. All these loans are one- to four-family mortgage loans. In the aggregate there was no lower of cost or market adjustment required; fair value approximates cost. Aggregate loans to officers and directors, all of which were current, consist of the following (in thousands):
Year Ended September 30, 2002 2001 2000 - ------------------------------------------------------------------ Beginning balance $2,990 $2,089 $2,380 Originations 1,018 1,227 83 Principal repayments (788) (326) (374) - ------------------------------------------------------------------ Ending balance $3,220 $2,990 $2,089 ====== ====== ======
Activity in the allowance for loan losses is summarized as follows:
Year Ended September 30, 2002 2001 2000 - ------------------------------------------------------------------- Balance, beginning of year $7,950,680 $4,082,265 $2,483,625 Charge offs (747,092) (90,173) (606,999) Recoveries 16,224 42,406 441,639 Additions 156,000 387,000 1,764,000 Acquisitions -- 3,761,024 -- Allowance reclassified with loan securitization -- (231,842) -- - ------------------------------------------------------------------- Balance, end of year $7,375,812 $7,950,680 $4,082,265 ========== ========== ===========
At September 30, 2002 and 2001, impaired loans totalled $200,000 and zero, respectively. There were no specifically allocated loan loss reserves related to these loans. The average investment in impaired loans for the years ended September 30, 2002 and 2001 was $43,590 and $33,226, respectively. [6] Premises and Equipment Premises and equipment consist of the following:
September 30, 2002 2001 - ------------------------------------------------------------------ Land $ 4,872,673 $ 2,828,648 Office buildings and construction in progress 17,766,655 13,022,085 Furniture, fixtures and equipment 9,559,681 8,021,564 Automobiles 20,928 38,856 Less accumulated depreciation (8,809,090) (6,999,241) - ------------------------------------------------------------------ $23,410,847 $16,911,912 =========== =========== Depreciation expense was $2.0 million, $1.2 million, and $1.1 million for the years ended September 30, 2002, 2001, and 2000, respectively.
[7] Accrued Interest Receivable The following is a summary of accrued interest receivable: September 30, 2002 2001 - ------------------------------------------------------------------ Loans receivable $ 3,578,678 $ 4,557,093 Mortgage-backed and related securities 3,028,121 2,212,276 Investment securities 1,570,154 1,881,592 Federal funds sold and securities purchased under agreements to resell 61 6,625 - ------------------------------------------------------------------ $ 8,177,014 $ 8,657,586 =========== ===========
[8] Mortgage Servicing Rights Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others was $140.3 million and $186.4 million at September 30, 2002 and 2001, respectively. The mortgage servicing rights are included in other assets in the consolidated balance sheets. During the quarter ended March 31, 2001, the Company sold $190.3 million in seasoned fixed-rate single-family loans to FNMA. The mortgages were aggregated into 14 pools and securitized with the resulting MBS being retained by the Company and classified as available for sale. The loans were sold with servicing retained by the Company. The fair value of MSR was determined using a discounted cash flow model, which incorporates the expected life of the loans, estimated costs to service the loans, servicing fees to be received, and other factors. Mortgage servicing rights for the loans securitized through FNMA were valued at $1.7 million. The key assumptions used to initially value the MSR recorded in 2001 included a constant prepayment rate ("CPR") of 20%, an average life of 6.3 years and a discount rate of 10%. The Company pays a guarantee fee to FNMA as part of the securitization and servicing of the loans, thus transferring all credit risk to FNMA. The final resulting basis in the MBS recorded was $185.9 million. As of September 30, 2001, all the resulting MBS were sold with a gain of $5.4 million. The balance of the Company's originated MSR as of September 30, 2002, 2001 and 2000, and changes during the years then ended, were as follows:
Year Ended September 30, 2002 2001 2000 - ---------------------------------------------------------------------------- Balance, beginning of year $1,596,930 $95,420 $52,432 Additions for loans securitized -- 1,653,830 -- Additions for other loans sold -- 54,693 59,868 Amortization of servicing rights for loans securitized (327,542) (167,857) -- Amortization of servicing rights for other loans sold (52,989) (39,156) (16,880) Valuation allowance (180,739) -- -- - ---------------------------------------------------------------------------- Balance, end of year $1,035,660 $1,596,930 $95,420 ========== ========== =======
The changes in the Company's valuation allowance for impairment of MSR are as follows for the years indicated:
Year Ended September 30, 2002 2001 2000 - -------------------------------------------------------------------------- Balance, beginning of year $ 0 $ -- $ -- Additions for impairment (180,739) -- -- - -------------------------------------------------------------------------- Balance, end of year ($180,739) $ -- $ -- ========== ======= =======
The Company evaluates MSR for impairment by stratifying MSR based on the predominant risk characteristics of the underlying financial assets. At September 30, 2002 and 2001, the fair values of the Company's MSR were $1,045,964 and $1,678,344, respectively, which were estimated using a discount rate of 8.5% and Public Securities Association prepayment assumptions ("PSA") ranging from 217 to 679 and 175 to 437, respectively. At September 30, 2002, the key economic assumptions and the sensitivity of the current value for purchased MSR to immediate 10% and 20% adverse changes in those assumptions were as follows:
At September 30, 2002 - -------------------------------------------------------------- Fair value of capitalized MSR $1,045,964 PSA 217 to 679 Impact on fair value of 10% adverse change (55,655) Impact on fair value of 20% adverse change (105,232) Discount rate 8.5% Impact on fair value of 10% adverse change (22,103) Impact on fair value of 20% adverse change (43,263)
These sensitivities are hypothetical and should be used with caution. As the amounts indicate, changes in fair value based on a change in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, however, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. [9] Deposit Liabilities The following is a summary of deposit liabilities:
September 30, 2002 2001 - ------------------------------------------------------------------------------------------- Amount Percent Amount Percent - ------------------------------------------------------------------------------------------- Checking accounts, non-interest bearing $142,772,746 12.5% $130,649,571 11.3% -------------- ------ -------------- ------ Interest-bearing checking 125,866,951 11.0 116,755,784 10.1 -------------- ------ -------------- ------ Passbook and statement savings 86,000,755 7.5 77,646,048 6.7 -------------- ------ -------------- ------ Money market deposits 330,646,410 29.0 283,893,020 24.6 -------------- ------ -------------- ------ Certificates of deposit Less than 4% 241,617,671 21.1 136,034,530 11.8 4.00% to 5.99% 110,380,428 9.7 209,800,703 18.2 6.00% to 7.99% 104,395,224 9.1 197,755,646 17.2 8.00% to 9.99% 325,812 0.1 288,842 0.1 - ------------------------------------------------------------------------------------------- 456,719,135 40.0 543,879,721 47.3 - ------------------------------------------------------------------------------------------- $1,142,005,997 100.0% $1,152,824,144 100.0% ============== ====== ============== ======
The following is a summary of interest expense on deposits:
Year Ended September 30, 2002 2001 2000 - --------------------------------------------------------------------------------- Interest-bearing checking $ 906,544 $ 812,210 $ 779,335 Passbook and statement savings 930,450 1,066,607 958,558 Money market 6,376,625 6,332,507 6,217,783 Certificates of deposit 21,691,878 22,199,640 20,575,944 - --------------------------------------------------------------------------------- 29,905,497 30,410,964 28,531,620 Less early withdrawal penalties 122,898 106,693 167,704 - --------------------------------------------------------------------------------- Net interest on deposits $29,782,599 $30,304,271 $28,363,916 =========== =========== ===========
At September 30, 2002 maturities of certificates of deposits were as follows: Within 1 year $275,696,478 1 year to 3 years 114,476,601 3 years to 5 years 34,046,546 Thereafter 32,499,510 - -------------------------------------------------------------- $456,719,135 ============
Weighted average interest rates at September 30 were as follows: 2002 2001 - --------------------------------------------------------------------------------------- Interest-bearing checking 0.44% 1.37% Passbook and statement savings 0.75% 2.05% Money market 1.44% 3.21% Certificates of deposit 4.00% 5.32% Weighted average rate for all deposits 2.42% 4.03%
Deposits in excess of $100,000 totaled $297.8 million and $280.9 million at September 30, 2002 and 2001, respectively. Customer deposits in excess of $100,000 are not insured by the Federal Deposit Insurance Corporation ("FDIC"). [10] Advances from FHLB As a member of the FHLB of Seattle, the Association maintains a credit line that is a percentage of its total regulatory assets, subject to collateralization requirements. At September 30, 2002, the credit line was 30 percent of total assets of the Association. Advances are collateralized in the aggregate, as provided for in the Advances, Security and Deposit Agreements with the FHLB of Seattle, by certain mortgages or deeds of trust, and securities of the U.S. Government and agencies thereof. At September 30, 2002 the minimum book value of eligible collateral for these borrowings was $232.7 million. Scheduled maturities of advances from the FHLB were as follows:
September 30, 2002 September 30, 2001 Range of Weighted Range of Weighted interest average interest average Amount rates interest rate Amount rates interest rate - -------------------------------------------------------------------------------------------------------------------- Due within one year $31,250,000 1.91% - 2.20% 2.09% $10,000,000 3.60% 3.60% After one but within five years 16,000,000 2.48% - 3.58% 3.06% -- -- -- After five but within ten years 158,000,000 4.77% - 7.05% 5.86% 158,000,000 4.77% - 7.05% 5.86% - -------------------------------------------------------------------------------------------------------------------- $205,250,000 $168,000,000 ============ ============
Financial data pertaining to the weighted average cost, the level of FHLB advances and the related interest expense are as follows:
Year Ended September 30, 2002 2001 2000 - ------------------------------------------------------------------------------ Weighted average interest rate at end of year 5.07% 5.73% 5.90% Weighted daily average interest rate during the year 5.71% 5.90% 5.88% Daily average FHLB advances $168,332,740 $170,520,548 $207,218,306 Maximum FHLB advances at any month end 205,250,000 173,000,000 230,000,000 Interest expense during the year 9,608,659 10,065,991 12,184,341
[11] Short Term Borrowings The Company had short term borrowings of $1.7 million and $1.7 million at September 30, 2002 and 2001, respectively. At September 30, 2002, the borrowings consisted of one unsecured line of credit with Key Bank that was fully disbursed. The interest rate of this line is the prime rate, which was 4.75% at September 30, 2002. At September 30, 2001, the borrowings consisted of one secured line of credit with Key Bank that was fully disbursed. This line carried interest based on one-month LIBOR plus 1.95%, which was 5.58% at September 30, 2001. The Company also had an unused line of credit totaling $15.0 million with U.S. National Bank of Oregon at September 30, 2002 and 2001. The Company is in compliance with all debt covenants imposed by the lenders. Financial data pertaining to the weighted average cost, the level of short term borrowings and the related interest expense are as follows:
Year Ended September 30, 2002 2001 2000 - --------------------------------------------------------------------------- Weighted average interest rate at end of year 4.75% 5.58% 9.01% Weighted daily average interest rate during the year 4.32% 8.22% 9.34% Daily average of short term borrowings $1,704,521 $3,265,205 $1,289,617 Maximum short term borrowings at any month end 1,700,000 6,400,000 3,000,000 Interest expense during the year 73,690 268,447 120,413 [12] Taxes on Income The following is a summary of income tax expense (benefit):
Year Ended September 30, 2002 2001 2000 - --------------------------------------------------------------------------- Current Taxes Federal $4,306,047 $3,560,966 $3,735,797 State 978,105 835,250 847,558 - --------------------------------------------------------------------------- Current tax provision 5,284,152 4,396,216 4,583,355 - --------------------------------------------------------------------------- Deferred Taxes Federal (1,684,353) (564,904) (873,784) State (340,065) (114,052) (176,413) - --------------------------------------------------------------------------- Deferred tax benefit (2,024,418) (678,956) (1,050,197) - --------------------------------------------------------------------------- Provision for income taxes $3,259,734 $3,717,260 $3,533,158 ========== ========== ==========
An analysis of income tax expense, setting forth the reasons for the variation from the "expected" federal corporate income tax rate and the effective rate provided, is as follows:
Year Ended September 30, 2002 2001 2000 - --------------------------------------------------------------------------- Federal income taxes computed at statutory rate 35.0% 35.0% 35.0% Tax effect of: State income taxes, net of Federal income tax benefit 4.2 4.2 4.4 Nondeductible ESOP compensation expense 1.8 1.1 0.5 Deductible MRDP compensation expense -- -- 1.6 Interest income on municipal securities (5.7) (4.1) (4.1) Other (2.9) (3.3) (1.9) - --------------------------------------------------------------------------- Income tax expense included in the statement of earnings 32.4% 32.9% 35.5% ===== ===== =====
Deferred income taxes at September 30, 2002 and 2001 reflect the impact of "temporary differences" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. The tax effects of temporary differences which give rise to a significant portion of deferred tax assets and deferred tax liabilities are as follows:
September 30, 2002 2001 - -------------------------------------------------------------- Deferred Tax Assets - -------------------------------------------------------------- Allowance for losses on loans $1,679,909 $1,908,133 Pension liability 330,929 370,170 Unearned ESOP shares 353,036 392,295 Core deposit premium 2,264,290 1,255,293 Basis difference in fixed assets 788,381 587,537 Other -- 25,870 - -------------------------------------------------------------- Total gross deferred tax assets 5,416,545 4,539,298 - -------------------------------------------------------------- Deferred Tax Liabilities - -------------------------------------------------------------- FHLB stock dividends 1,834,035 1,514,843 Capitalized loan servicing income 360,498 627,434 Capitalized conversion costs -- 306,687 Unrealized gain on securities available for sale 3,135,399 647,859 Deferred loan fees 485,179 900,473 Branch acquisition costs 241,928 -- Tax bad debt reserve in excess of base- year reserve 475,116 723,698 Other 350,946 415,649 - -------------------------------------------------------------- Total gross deferred tax liabilities 6,883,101 5,136,643 - -------------------------------------------------------------- Net deferred tax liability ($1,466,556) ($597,345) ============ ==========
The Company has qualified under provisions of the Internal Revenue Code to compute federal income taxes after deductions of additions to the bad debt reserves. At September 30, 2002, the Company had a taxable temporary difference of approximately $10.5 million that arose before 1988 (base-year amount). In accordance with SFAS No. 109, Accounting for Income Taxes, a deferred tax liability has not been recognized for the temporary difference. Management does not expect this temporary difference to reverse in the foreseeable future. [13] Mandatorily Redeemable Preferred Securities In July 2001, the Company issued $15 million of mandatorily redeemable preferred securities through a subsidiary grantor trust. The Trust holds debt instruments of the parent company purchased with the proceeds of the securities issuance. The capital qualifying securities bear interest at a floating rate indexed to six-month LIBOR and mature in July 2031. At September 30, 2002 and 2001, the interest rate was 5.61% and 7.57%, respectively. The Company has the right to redeem the securities after five years at a premium, and after ten years at par. Certain changes in tax law or Office of Thrift Supervision regulations regarding the treatment of the capital securities as core capital could result in early redemption, at par, or a shortening in the maturity of the securities. In April 2002, the Company issued $13 million of mandatorily redeemable preferred securities through a subsidiary grantor trust. The Trust holds debt instruments of the parent company purchased with the proceeds of the securities issuance. The capital qualifying securities bear interest at a floating rate indexed to six-month LIBOR and mature in April 2032. At September 30, 2002, the interest rate was 6.02%. The Company has the right to redeem the securities at a premium up to five years from issuance, and after five years at par. Certain changes in tax law or Office of Thrift Supervision regulations regarding the treatment of the capital securities as core capital could result in early redemption, at par, or a shortening in the maturity of the securities. (14) Commitments and Contingencies In the ordinary course of business, the Company has various outstanding commitments and contingencies that are not reflected in the accompanying consolidated financial statements. In addition, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition, results of operations, or liquidity of the Company. The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to extend credit are conditional 45 day agreements to lend to a customer subject to the Company's usual terms and conditions. At September 30, 2002, loan commitments amounted to approximately $33.0 million comprised of $12.9 million in variable rate loans ranging from 3.38% to 14.25% and $20.1 million in fixed rate loans ranging from 3.75% to 10.75%. At September 30, 2002, the Company had $18.3 million in commitments to sell loans.. The Company originates residential real estate loans secured by residential, multi-family and commercial properties as well as consumer and commercial business loans. Substantially all of the Company's lending portfolio resides in the state of Oregon. An economic downturn in this area would likely have a negative impact on the Company's results of operations depending on the severity of the downturn. [15] Shareholders' Equity The Company's Articles of Incorporation authorize the issuance of 500,000 shares of preferred stock, having a par value of $.01 per share, in series and to fix and state the powers, designations, preferences and relative rights of the shares of such series, and the qualifications, limitations and restrictions thereof. [16] Earnings Per Share Earnings per share ("EPS") is computed in accordance with SFAS No. 128, Earnings per Share. Shares held by the Company's ESOP that are committed for release are considered contingently issuable shares and are included in the computation of basic EPS. Diluted EPS is computed using the treasury stock method, giving effect to potential additional common shares that were outstanding during the period. Potential dilutive common shares include shares awarded but not released under the Company's MRDP, and stock options granted under the Stock Option Plan. Following is a summary of the effect of dilutive securities on weighted average number of shares (denominator) for the basic and diluted EPS calculations. There are no resulting adjustments to net earnings.
For the Year Ended September 30, 2002 2001 2000 - ----------------------------------------------------------------------------------------- Weighted average common shares outstanding - basic 6,411,351 6,627,200 6,822,025 - ----------------------------------------------------------------------------------------- Effect of Dilutive Securities on Number of Shares: MRDP shares 8,108 9,252 -- Stock options 76,039 65,593 -- - ----------------------------------------------------------------------------------------- Total Dilutive Securities 84,147 74,845 -- - ----------------------------------------------------------------------------------------- Weighted average common shares outstanding - with dilution 6,495,498 6,702,045 6,822,025 ========= ========= =========
[17] Employee Benefit Plans Employee Retirement Plan As of September 30, 2001, the Company terminated its participation in a multiple-employer trusteed pension plan ("Plan") covering all employees with at least one year of service and which paid direct pensions to certain retired employees. Benefits were based on years of service with the Company and salary excluding bonuses, fees, and commissions. Participants were vested in their accrued benefits after five years of service. Pension expense of $452,592 and $367,916 was incurred during the years ended September 30, 2001 and 2000, respectively. Separate actuarial valuations, including computed value of vested benefits, were not made with respect to each contributing employer, nor were the plan assets so segregated by the trustee. As part of the termination of the plan, early retirement was offered to certain long-time employees of the Company. The Company recorded expense of $378,887 in the year ended September 30, 2001 related to these retirements. Effective October 1, 2001, the Company implemented a 401(k) plan for all employees. The Company will match 50% of the employee contributions up to a maximum of 6% of the employee's compensation. Expense of $451,649 was recorded in the year ended September 30, 2002 related to this plan. Postretirement Benefit Plan The Company has an unfunded postretirement benefit plan for certain retirees and all currently active employees who retire with at least ten years of service. The plan provides for payment of all or a portion of the Medicare Supplement premium for qualified retirees and their spouses. This plan was revised effective October 1, 2001 to limit benefits to those already retired and discontinue the benefit for current employees. The table below reflects the result of this change on the actuarial valuation of the plan. Information related to the years ended September 30, 2002, 2001 and 2000 is presented below.
Year Ended September 30, 2002 2001 2000 - ----------------------------------------------------------------------------- Change in benefit obligation at beginning of year $401,461 $324,279 $193,861 Service cost -- 27,386 24,276 Interest cost 13,121 25,852 23,937 Actuarial changes (166,365) 35,109 92,453 Benefits paid (10,818) (11,165) (10,248) - ----------------------------------------------------------------------------- Benefit obligation at end of year $237,399 $401,461 $324,279 ======== ======== ======== Components of net periodic benefit cost - ----------------------------------------------------------------------------- Service cost $ -- $27,386 $24,276 Interest cost 13,121 25,852 23,937 Recognition of changes in actuarial assumptions, prior service cost, benefit changes, and actuarial gains and losses -- 9,475 9,475 - ----------------------------------------------------------------------------- Net periodic benefit cost $13,121 $62,713 $57,688 ======== ======== ========
For measurement of the net periodic cost of the post retirement benefit plan, a 5.0% annual increase in the medical care trend rate was assumed. The assumed discount rate was 6.0% for 2002 and 7.5% for 2001 and 2000. If the assumed medical trend rates were increased by 1%, the September 30, 2002 benefit obligation would increase from $237,399 to $268,479 and the net periodic benefit cost for the year ended September 30, 2002 would increase from $13,121 to $31,080. Director Deferred Compensation Plan The Company also has an unfunded supplemental benefits plan to provide members of the Board of Directors with supplemental retirement benefits. Supplemental benefits are based on monthly fees approved by the Compensation Committee of the Board. Pension costs recognized for the years ended September 30, 2002, 2001, and 2000 were zero, $71,052 and $71,052, respectively. At September 30, 2002 and 2001, the projected benefit obligation was $516,170 and $942,148, respectively. An actuarial valuation completed for the year ended September 30, 2002 showed a lower projected benefit obligation due to fewer covered directors and shorter expected benefit periods due to the increasing age of the directors covered under the plan. The difference between the projected benefit obligation and the amount recorded is being taken to income over five years which is the expected remaining average service life of the participants. Stock Option Plan In February 1996, the Board of Directors adopted a Stock Option Plan ("Stock Plan") for the benefit of certain employees and directors. The Stock Plan was approved by the Company's shareholders on April 9, 1996. The maximum number of common shares which may be issued under the Stock Plan is 1,223,313 shares with a maximum term of ten years for each option from the date of grant. The initial awards were granted on April 9, 1996 at the fair value of the common stock on that date ($13.125). All initial awards vest in equal installments over a five year period from the grant date and expire during April 2006. Unvested options become immediately exercisable in the event of death or disability. Option activity under the Stock Plan is as follows:
Weighted Number of Shares Average Exercise Price - ---------------------------------------------------------------------- Outstanding, October 1, 1999 916,258 $13.314 - ---------------------------------------------------------------------- Granted -- -- Exercised -- -- Canceled -- -- - ---------------------------------------------------------------------- Outstanding, September 30, 2000 916,258 $13.314 - ---------------------------------------------------------------------- Granted 207,500 $12.412 Exercised (244,662) $13.125 Canceled -- -- - ---------------------------------------------------------------------- Outstanding, September 30, 2001 879,096 $13.154 - ---------------------------------------------------------------------- Granted 40,000 $12.900 Exercised (19,572) $13.125 Canceled (19,573) $13.125 - ---------------------------------------------------------------------- Outstanding, September 30, 2002 879,951 $13.144 ======= =======
At September 30, 2002, 18,024 shares were available for future grants under the Stock Plan.
Additional information regarding options outstanding as of September 30, 2002 is as follows: Range of Options Options Weighted Av. Remaining Exercise Prices Outstanding Exercisable Contractual Life - ------------------------------------------------------------------------------- $11.625-$13.144 207,500 77,500 8.3 $12.700-$13.100 40,000 10,000 9.3 $13.125 609,208 589,635 3.5 $20.577 23,243 18,594 5.1 - ------------------------------------------------------------------------------- 879,951 695,729 ======= =======
Additional Stock Plan Information As discussed in Note 1, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations. Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements. SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1996. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The weighted average grant-date fair value of options granted during fiscal years 2002, 2001, 1998 and 1996 were $1.63, $2.03, $6.65 and $4.12, respectively. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. Had compensation cost for these awards been determined under SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the following pro forma amounts:
Year ended September 30, 2002 2001 2000 - ----------------------------------------------------------------------------- Net earnings: - ----------------------------------------------------------------------------- As reported $6,788,776 $7,571,002 $6,426,152 - ----------------------------------------------------------------------------- Pro forma 6,662,157 7,457,552 5,885,826 Earnings per common share - basic: - ----------------------------------------------------------------------------- As reported $1.06 $1.14 $0.94 - ----------------------------------------------------------------------------- Pro forma $1.04 $1.13 $0.86 Earnings per common share - fully diluted: - ----------------------------------------------------------------------------- As reported $1.05 $1.13 $0.94 - ----------------------------------------------------------------------------- Pro forma $1.03 $1.11 $0.86 - -----------------------------------------------------------------------------
The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions:
2002 Grant 2001 Grant 1998 Grant 1996 Grant - ------------------------------------------------------------------------------- Risk free interest rates 3.69% 5.09% 5.79% 6.33% Expected dividend 4.03% 4.33% 1.75% 1.75% Expected lives, in years 3.5 3.3 7.5 7.5 Expected volatility 20.29% 28.73% 23.24% 19.63%
[18] Employee Stock Ownership Plan As part of the stock conversion consummated on October 4, 1995, the Company established an ESOP for all employees that are age 21 or older and have completed two years of service with the Company. The ESOP borrowed $9,786,500 from the Company and used the funds to purchase 978,650 shares of the common stock of the Company issued in the conversion which would be distributed over a ten year period. The loan will be repaid principally from the Company's discretionary contributions to the ESOP over a period of ten years. The loan had an outstanding balance of $2.9 million and $3.9 million at September 30, 2002 and 2001, respectively, and an interest rate of 8.75%. The loan obligation of the ESOP is considered unearned compensation and, as such, recorded as a reduction of the Company's shareholders' equity. Both the loan obligation and the unearned compensation are reduced by the amount of loan repayments made by the ESOP. Shares purchased with the loan proceeds are held in a suspense account for allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account are allocated among participants on the basis of compensation in the year of allocation. Benefits are fully vested at all times under the ESOP. Forfeitures are reallocated to remaining plan participants and may reduce the Company's contributions. Benefits may be payable on retirement, death, disability, or separation from service. Since the Company's annual contributions are discretionary, benefits payable under the ESOP cannot be estimated. Compensation expense is recognized to the extent of the fair value of shares committed to be released. The Company recorded compensation expense under the ESOP of $1.4 million, $1.4 million, and $1.1 million for the years ended September 30, 2002, 2001 and 2000, respectively, and approximately 98,000 shares were allocated among the participants in each of those years. [19] Fair Value of Financial Instruments Financial instruments have been construed to generally mean cash or a contract that implies an obligation to deliver cash or another financial instrument to another entity.
September 30, 2002 September 30, 2001 Carrying Fair Carrying Fair amount value amount value Financial Assets: - ------------------------------------------------------------------------------------------------- Cash and due from banks $38,444,500 $38,444,500 $40,446,042 $40,446,042 Interest earning deposits with banks 5,762,373 5,762,373 3,791,252 3,791,252 Federal funds sold and securities purchased under agreements to resell 1,584,540 1,584,540 74,151,272 74,151,272 Investment securities available for sale 119,542,052 119,542,052 154,675,760 154,675,760 Investment securities held to maturity -- -- 135,388 137,429 Mortgage-backed and related securities available for sale 650,796,164 650,796,164 421,637,670 421,637,670 Mortgage-backed and related securities held to maturity -- -- 1,620,612 1,642,174 Loans receivable, net 607,464,660 649,490,130 679,990,308 708,259,917 FHLB stock 13,510,400 13,510,400 12,698,000 12,698,000 Mortgage servicing rights 1,035,660 1,045,964 1,596,931 1,678,344 Financial Liabilities: Deposit liabilities 1,142,005,997 1,155,611,434 1,152,824,144 1,170,696,536 FHLB advances 205,250,000 218,125,349 168,000,000 172,328,142 Short term borrowings 1,700,000 1,700,000 1,700,000 1,700,000 Mandatorily redeemable preferred securities 27,205,507 27,205,507 14,553,684 14,553,684
Fair value estimates, methods, and assumptions are set forth below: Investments and Mortgage-Backed Securities - Fair values were based on quoted market rates and dealer quotes. Loans Receivable - Loans were priced using a discounted cash flow method. The discount rate was the rate currently offered on similar products. No adjustment was made to the entry-value interest rates for changes in credit of performing loans for which there are not known credit concerns. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the loan portfolio for which there are no known credit concerns, result in a fair valuation of such loans on an entry-value basis. Mortgage Servicing Rights - The fair value of MSRs is determined by estimating the present value of expected future cash flows, using a discount rate that is considered commensurate with the risks involved. The amounts and timing of the cash flows are estimated after considering various economic factors including prepayment speeds, delinquency and default assumptions. Deposits - The fair value of deposits with no stated maturity such as non-interest-bearing demand deposits, savings, NOW accounts and money market accounts was equal to the amount payable on demand. The fair value of time deposits with stated maturity was based on the discounted value of contractual cash flows. The discount rate was estimated using rates currently available in the local market. Federal Home Loan Bank Advances - The fair value of FHLB advances was based on the discounted cash flow method. The discount rate was estimated using rates currently available from FHLB. Other - The carrying value of other financial instruments was determined to be a reasonable estimate of their fair value. Limitations - The fair value estimates presented herein were based on pertinent information available to management as of September 30, 2002 and 2001. Although management was not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements on those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. Fair value estimates were based on existing financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that were not considered financial instruments. [20] Regulatory Capital Requirements The Company is not subject to any regulatory capital requirements. The Association, however, is subject to various regulatory capital requirements administered by the Office of Thrift Supervision ("OTS"). Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Association's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Association must meet specific capital guidelines that involve quantitative measures of the Association's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Association's capital amounts and classification 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 Association to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, of Tier I capital to total assets, and tangible capital to tangible assets (set forth in the table below). Management believes that the Association meets all capital adequacy requirements to which it is subject as of September 30, 2002. As of September 30, 2002, the most recent notification from the OTS categorized the Association as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well-capitalized", the Association must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. At periodic intervals, the OTS routinely examines the Association as part of its legally prescribed oversight of the thrift industry. Based on these examinations, the regulators can direct that the Association's financial statements be adjusted in accordance with their findings. A future examination by the OTS could include a review of certain transactions or other amounts reported in the Association's 2002 financial statements. In view of the uncertain regulatory environment in which the Association now operates, the extent, if any, to which a forthcoming regulatory examination may ultimately result in adjustments to the 2002 financial statements cannot be presently determined. The Association's actual and required minimum capital ratios are presented in the following table:
Categorized as "Well Capitalized" Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provision --------------------------- ------------------------- ----------------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ------ ------------ ------ ------------ ------- As of September 30, 2002 Total Capital: $102,759,108 14.0% $58,696,528 8.0% $73,370,660 10.0% (To Risk Weighted Assets) Tier I Capital: 95,497,095 13.0% N/A N/A 44,022,396 6.0% (To Risk Weighted Assets) Tier I Capital: 95,497,095 6.6% 58,297,476 4.0% 72,871,846 5.0% (To Total Assets) Tangible Capital: 95,497,095 6.6% 21,861,554 1.5% N/A N/A (To Tangible Assets) As of September 30, 2001 - ------------------------------------------------------------------------------------------------------------------------------------ Total Capital: $81,046,601 10.4% $62,600,992 8.0% $78,251,240 10.0% (To Risk Weighted Assets) Tier I Capital: 73,162,799 9.3% N/A N/A 46,950,744 6.0% (To Risk Weighted Assets) Tier I Capital: 73,162,799 5.2% 56,671,203 4.0% 70,839,004 5.0% (To Total Assets) Tangible Capital: 73,162,799 5.2% 21,251,701 1.5% N/A N/A (To Tangible Assets)
The following table is a reconciliation of the Association's capital, calculated according to generally accepted accounting principles, to regulatory tangible and risk-based capital:
At September 30, 2002 2001 - ------------------------------------------------------------------ Association's equity $ 142,052,659 $ 118,772,559 Unrealized securities losses (6,256,575) (1,520,834) Core deposit intangible (40,298,989) (44,088,926) - ------------------------------------------------------------------ Tangible capital 95,497,095 73,162,799 General valuation allowances 7,262,013 7,883,802 - ------------------------------------------------------------------ Total capital $102,759,108 $81,046,601 ============ ===========
[21] Parent Company Financial Information Condensed financial information as of September 30, 2002 and 2001 and for each of the three years in the period ended September 30, 2002, for Klamath First Bancorp, Inc. is presented and should be read in conjunction with the consolidated financial statements and the notes thereto: BALANCE SHEETS
At September 30, 2002 2001 Assets: - ------------------------------------------------------------------- Cash and cash equivalents $5,608,620 $5,637,989 Investment and mortgage-backed securities 149,077 1,500,584 Investment in wholly-owned subsidiary 142,052,659 118,772,559 Deferred tax asset 310,718 -- Other assets 2,157,987 5,269,368 - ------------------------------------------------------------------- Total assets $150,279,061 $131,180,500 ============ ============ Liabilities: - ------------------------------------------------------------------- Short-term borrowings $1,700,000 $1,700,000 Other liabilities 1,435,518 785,911 - ------------------------------------------------------------------- Total liabilities 3,135,518 2,485,911 - ------------------------------------------------------------------- Mandatorily redeemable preferred securities 27,205,507 14,553,684 - ------------------------------------------------------------------- Shareholders' equity: Common stock 67,440 70,607 Additional paid-in capital 30,282,059 33,926,796 Retained earnings 93,522,778 85,355,871 Unearned ESOP shares at cost (2,935,130) (3,913,510) Unearned MRDP shares at cost (999,111) (1,298,859) - ------------------------------------------------------------------- Total shareholders' equity 119,938,036 114,140,905 - ------------------------------------------------------------------- Total liabilities and shareholders' equity $150,279,061 $131,180,500 ============ ============
STATEMENTS OF EARNINGS
Year Ended September 30, 2002 2001 2000 - ---------------------------------------------------------------------------- Equity in undistributed income of subsidiary $7,868,854 $8,271,234 $7,065,690 Total interest income 560,127 730,727 789,684 Total interest expense 74,650 268,185 120,412 Non-interest income 11,972 -- 203 Non-interest expense 2,315,762 1,641,346 1,746,138 - ---------------------------------------------------------------------------- Earnings before income taxes 6,050,541 7,092,430 5,989,027 Provision for income taxes (738,235) (478,572) (437,125) - ---------------------------------------------------------------------------- Net earnings $6,788,776 $7,571,002 $6,426,152 ========== ========== ==========
STATEMENTS OF CASH FLOWS
Year Ended September 30, 2002 2001 2000 - ------------------------------------------------------------------------------- Net cash flows from operating activities $3,200,786 $8,229,769 $721,914 - ------------------------------------------------------------------------------- Cash flows from investing activities: Investment in subsidiary (10,264,911) (10,306,546) (278,916) Maturity of investment and mortgage- backed securities 533,743 683,893 610,081 Purchase of investment and mortgage-backed securities 782,597 -- -- - ------------------------------------------------------------------------------- Net cash flows provided by (used in) investing activities (8,948,571) (9,622,653) 331,165 ---------- ---------- -------- Cash flows from financing activities: Cost of ESOP shares released 978,380 979,740 978,650 Proceeds from short-term borrowings 1,900,000 3,400,000 3,700,000 Repayments of short-term borrowings (1,900,000) (4,700,000) (700,000) Issuance of mandatorily redeemable preferred securities 12,651,823 14,553,684 -- Stock repurchase and retirement (4,750,847) (7,399,423) (6,254,695) Stock options exercised 369,588 3,211,189 -- Dividends paid (3,530,528) (3,746,304) (3,889,202) - ------------------------------------------------------------------------------- Net cash flows provided by (used in) financing activities 5,718,416 6,298,886 (6,165,247) - ------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (29,369) 4,906,002 (5,112,168) Cash and cash equivalents beginning of year 5,637,989 731,987 5,844,155 - ------------------------------------------------------------------------------- Cash and cash equivalents end of year $5,608,620 $5,637,989 $731,987 ========== ========== ========
Consolidated Supplemental Data Selected Quarterly Financial Data (unaudited)
Year Ended September 30, 2002 December March June September - ---------------------------------------------------------------------------------------- (In thousands, except per share data) Total interest income $22,995 $21,922 $21,530 $20,846 Total interest expense 11,719 9,897 9,208 8,707 - ---------------------------------------------------------------------------------------- Net interest income 11,276 12,025 12,322 12,139 Provision for loan losses 153 3 -- -- - ---------------------------------------------------------------------------------------- Net interest income after provision 11,123 12,022 12,322 12,139 Non-interest income 2,282 2,921 3,054 4,356 Non-interest expense 12,129 12,396 12,404 13,241 - ---------------------------------------------------------------------------------------- Earnings before income taxes 1,276 2,547 2,972 3,254 Provision for income tax 454 876 1,044 886 - ---------------------------------------------------------------------------------------- Net earnings $ 822 $ 1,671 $ 1,928 $ 2,368 ======= ======= ======= ======= Net earnings per share - basic $ 0.13 $ 0.26 $ 0.30 $ 0.37 ======= ======= ======= ======= Net earnings per share - fully diluted $ 0.13 $ 0.26 $ 0.30 $ 0.36 ======= ======= ======= =======
Year Ended September 30, 2001 December March June September - ---------------------------------------------------------------------------------------- (In thousands, except per share data) Total interest income $17,816 $17,450 $16,782 $18,085 Total interest expense 10,338 10,153 9,916 10,344 - ---------------------------------------------------------------------------------------- Net interest income 7,478 7,297 6,866 7,741 Provision for loan losses 228 153 3 3 ------- ------- ------- ------- Net interest income after provision 7,250 7,144 6,863 7,738 Non-interest income 1,114 3,708 3,200 2,991 Non-interest expense 5,783 6,209 6,862 9,866 - ---------------------------------------------------------------------------------------- Earnings before income taxes 2,581 4,643 3,201 863 Provision for income tax 896 1,688 1,085 48 - ---------------------------------------------------------------------------------------- Net earnings $1,685 $2,955 $2,116 $815 ====== ====== ====== ==== Net earnings per share - basic $0.25 $0.45 $0.32 $0.12 ====== ====== ====== ===== Net earnings per share - fully diluted $0.25 $0.45 $0.31 $0.12 ====== ====== ====== =====
EX-21 6 exhibit21.txt SUBSIDIARIES Exhibit 21 Subsidiaries of Registrant
Percentage Jurisdiction or Subsidiary (1) Owned State of Incorporation - ------------------------------------------ ---------- ---------------------- Klamath First Federal Savings and Loan Association 100% United States Klamath First Capital Trust I 100% Oregon Klamath First Capital Trust II 100% Oregon Klamath First Financial Services, Inc. (2) 100% Oregon Pacific Cascades Financial, Inc. (2) 100% Oregon (1) The operations of the Company's subsidiary are included in the Company's consolidated financial statements. (2) Wholly-owned subsidiary of Klamath First Federal Savings and Loan Association
EX-23 7 ex_23.txt AUDITOR'S CONSENT Exhibit 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-4002 of Klamath First Bancorp, Inc. on Form S-8 of our report dated November 1, 2002, appearing in the Annual Report on Form 10-K of Klamath First Bancorp, Inc. and subsidiaries for the year ended September 30, 2002. /s/ Deloitte & Touche LLP Portland, Oregon December 26, 2002 EX-99 8 ex_991.txt EXHIBIT 99.1 CERTIFICATIONS - SARBANES-OXLEY EXHIBIT 99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF KLAMATH FIRST BANCORP, INC. PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that: 1. the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. /s/ Kermit K. Houser /s/ Marshall J. Alexander Kermit K. Houser Marshall J. Alexander Chief Executive Officer Chief Financial Officer Dated: December 27, 2002 -----END PRIVACY-ENHANCED MESSAGE-----