AmericanWest Bancorporation 10-K 2008
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 0-18561
41 West Riverside Avenue, Suite 400
Spokane, Washington 99201
(Address of principal executive offices, including zip code)
Securities registered pursuant to Section 12(b) of the Act:
Indicate by a check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO þ
Indicate by a check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. YES o NO þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act. YES o NO þ
The aggregate market value of the common stock held by non-affiliates of the registrant is approximately $313.3 million based on the June 30, 2007 closing price of the registrants common stock as quoted on the Nasdaq Global Select Market of $18.23.
The number of shares of the registrants common stock outstanding at February 27, 2008 was 17,209,428.
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2007
Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K including, but not limited to, matters described in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operation, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA). Such forward looking statements include statements about the financial condition, adequacy of the allowance for credit losses, results of operations, future financial targets and earnings outlook of the Company. The forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Those factors include, but are not limited to, impact of the current national and regional economy on loan demand in the Companys market; loan delinquency rates, non-performing levels and charge-offs; changes in loan portfolio composition; the Companys ability to increase market share; the Companys ability to expand its markets through new financial centers and acquisitions; interest rate movements and the impact on net interest margins such movement may cause; changes in the demographic make-up of the Companys market; changes in the Companys products and services; the Companys ability to attract and retain qualified people; regulatory change; competition with other banks and financial institutions; and other factors. Words such as targets, expects, anticipates, believes, other similar expressions or future or conditional verbs such as will, may, should, would, and could are intended to identify such forward-looking statements. Readers should not place undue reliance on the forward-looking statements, which reflect managements view only as of the date hereto. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. This statement is included for the express purpose of protecting the Company under PSLRAs safe harbor provisions.
AmericanWest Bancorporation, which was formed in 1983, is a Washington corporation registered as a bank holding company under the Bank Holding Company Act of 1956, and is headquartered in Spokane, Washington. The companys wholly-owned subsidiary is AmericanWest Bank (Bank), a Washington state chartered bank that operates in Eastern and Central Washington, Northern Idaho and in Utah doing business as Far West Bank. Unless otherwise indicated, reference to the Company shall include the Bank and its Far West Bank division. The companys unconsolidated information will be referred to as that of the Parent Company. At December 31, 2007, the Company had total assets of $2.1 billion, net loans of $1.7 billion, deposits of $1.5 billion and stockholders equity of $284.0 million. The Company also has four statutory trust subsidiaries which were formed for the sole purpose of issuing trust preferred securities.
The Companys stock trades on the NASDAQ Global Select market under the symbol AWBC. The discussion in this Annual Report of the Company and its financial statements reflects the Companys acquisitions of Far West Bancorporation and its subsidiary on April 1, 2007 and Columbia Trust Bancorp and its subsidiaries on March 15, 2006.
The Companys internet address is www.awbank.net. Copies of the following documents, free of charge, are available from the Companys website by using the Investor Relations hyperlink on that website:
The Company makes these reports and certain other information that it files with the Securities and Exchange Commission (SEC) available on the Companys website as soon as reasonably practicable after filing or furnishing them electronically with the SEC. These and other SEC filings of the Company are also available, free of charge,
from the SEC on its website at www.sec.gov. The information contained on the Companys website is not incorporated by reference into this document and should not be considered a part of this Annual Report. The Companys website address is included in this document as an inactive textual reference only.
The Company completed its merger with Utah-based Far West Bancorporation (FWBC) and its principal operating subsidiary, Far West Bank, on April 1, 2007. All of the Banks operations in Utah are now doing business as Far West Bank, a division of AmericanWest Bank. The Bank also opened another financial center in downtown Salt Lake City, Utah during 2007.
During 2006, the Bank opened new financial centers in Coeur dAlene and Sandpoint, Idaho and in West Plains and Yakima, Washington. The Bank also opened a loan production office in the Salt Lake City, Utah area during 2006. Additionally, on March 15, 2006, the Company acquired Columbia Trust Bancorp and its principal operating subsidiary, Columbia Trust Bank (CTB), in Pasco, Washington. CTB had branches located in Pasco, Kennewick, Sunnyside and Yakima, Washington through which it provided commercial banking services.
The Companys ability to make future acquisitions depends on several factors such as the availability of suitable acquisition targets, obtaining necessary regulatory and shareholder approvals and cash reserves. The Company may need to issue additional debt or equity capital to pursue an acquisition strategy. Its access to capital markets or the costs of this capital could be affected by economic, financial, competitive and other conditions beyond its control. Further, acquisition targets may not be available in the future on favorable terms. Therefore, no assurance can be made that additional acquisitions will occur.
The Banks business consists mainly of gathering deposits and providing loans to enable its customers to meet their financial objectives.
The Bank offers a variety of deposit accounts designed to attract both short term and long term deposits from its retail and business customers. These accounts include checking accounts, negotiable order of withdrawal (NOW) accounts, money market demand accounts (MMDA), savings accounts and time deposits. Interest bearing accounts earn interest at rates established by the Banks management based on competitive market factors and managements desire to increase or decrease certain deposit types or maturities of deposits based on anticipated future funding needs. The Bank places significant emphasis on attracting low cost-of-funds deposits through targeted marketing for checking and money market balances.
The Bank offers numerous services that provide customers convenient access and have a positive impact on the Banks non-interest income through fee generation. Commercial services include ACH origination, merchant bankcard services, sweep accounts and currency services. Additional services offered to both consumers and business customers include ATM and debit cards, wire transfers, official checks and money orders, online banking and bill payment, safe deposit boxes and night deposit boxes. In addition, the Bank generates non-interest income and interest income by offering both consumer and business credit card products.
The Banks loan portfolio consists of the classifications described below. The majority of the loans held by the Bank were to borrowers within the Banks principal market areas.
Commercial Real Estate Loans. Commercial real estate loans primarily consist of loans to purchase or refinance commercial and multifamily properties. These loans are secured by real estate, generally mature in one to ten years and can be fixed or adjustable rate. Commercial real estate loans involve risks associated with real estate values, tenant performance on lease arrangements and interest rate volatility.
Construction, Land Development and Other Land Loans. Construction loans include commercial construction and residential construction. Land development loans include commercial and residential developments.
Construction loans are secured by real estate and the project under construction, generally mature in one to five years and have variable interest rates. Construction and development loans may involve additional risks as loan funds are collateralized by the project under construction, which is of uncertain value prior to completion.
Additional risks associated with speculative construction lending include the borrowers ability to complete the construction process on time and within budget, the leasing or sale of the project at projected lease or sale rates within expected absorption periods, and the economic risks associated with the real estate collateral including the potential of interest rate volatility. The Banks policies generally require that a permanent financing commitment be in place before a commercial construction loan is made to an individual borrower. Delays may arise from labor problems, material shortages, and other unpredictable contingencies. It is important to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. Due to these factors, the analysis of prospective construction loan projects require an expertise that is different in significant respects from the expertise required for other commercial or residential real estate lending. The Banks underwriting criteria are designed to evaluate and minimize the risks of each construction loan. Among other things, the Banks management considers evidence of the availability of permanent financing for the borrower, the reputation of the borrower, the amount of the borrowers equity in the project, the independent appraisal and review of cost estimates, the pre-construction sale and leasing information, and the cash flow projections of the borrower. Management has established underwriting and monitoring criteria to minimize the inherent risks of speculative construction lending.
The risks associated with lending on land parcels include failure to obtain appropriate improvement entitlements, inability to convert the loan to development and construction financing, devaluation of real estate and increased interest rates. Management has established underwriting criteria to minimize these risks on land loans by lending to experienced and well capitalized developers with proven track records together with interest reserves.
Commercial and Industrial Loans. Commercial loans primarily consist of loans to businesses for various purposes, including term loans, revolving lines of credit, equipment financing loans and letters of credit. These loans generally mature within one to five years, have adjustable rates and are secured by inventory, accounts receivable or equipment, although certain loans are unsecured. Commercial lending risk results from dependence on borrower income production for future repayment and, in certain circumstances, the lack of tangible collateral. Commercial loans are underwritten based on the financial strength and the repayment ability of the borrower, as well as the value of any collateral securing the loans. Commercial lending operations rely on a strong credit culture that combines prudent credit policies and individual lender accountability.
Agricultural Loans. Agricultural loans primarily consist of farm loans to finance operating expenses. These loans generally mature within one year, have adjustable rates and are secured by farm real estate, equipment, crops or livestock. Since agricultural loans present risks not associated with other types of lending, such as weather, the policy of the Bank is to make such loans only to agricultural producers that carry crop insurance, thereby mitigating the risk of loss attributable to a crop failure caused by weather factors.
Residential Real Estate Loans. Residential mortgage loans include various types of loans for which residential real property is held as collateral. These loans include adjustable and fixed rate first mortgage loans secured by one to four family residential properties and second mortgage loans secured by one to four family residential properties. Mortgage loans that are held in portfolio typically mature or reprice in one to five years and require payments on amortization schedules ranging from one year to 30 years. The Bank sells most of its fixed rate real estate mortgage loans with maturities of more than ten years. The risks associated with real estate mortgage lending include economic changes, including devaluation of real estate values, decreasing rental rates and increased interest rates. Loans are generally made to well qualified applicants meeting secondary market underwriting criteria.
Installment and Other Loans. Installment and other loans are primarily home equity lines of credit, automobile, bankcard and personal loans, otherwise known as consumer loans. These loans generally have maturities of five years or less, and are offered at adjustable and fixed interest rates. Consumer lending may involve special risks, including decreases in the value of collateral and transaction costs associated with foreclosure and repossession.
The Banks financial centers are located in the four largest metropolitan areas in Eastern and Central Washington (Spokane, Yakima, Walla Walla and the Tri-Cities area, comprised of Pasco, Kennewick and Richland), and in principally suburban and rural communities in Eastern and Central Washington, Northern Idaho and Utah.
The Bank competes primarily with large national and regional banks, community banks, credit unions, savings and loans, mortgage companies and other financial service providers. Management also believes that its competitive position has been strengthened by the continued consolidation in the banking industry, which has resulted in many independent community banks becoming part of large national or regional banks. The Banks strategy, by contrast, is to remain closely tied to a community banking model with strong local connections.
The following table presents the Banks market share percentage and rank for total deposits in each county where it has financial center operations. The table also indicates the ranking by deposit size in each market. All information in the table was obtained from SNL Financial of Charlottesville, Virginia, which compiles deposit data published by the FDIC as of June 30, 2007 and updates the information for any bank mergers completed subsequent to the reporting date. The number of financial centers is as of December 31, 2007.
As of December 31, 2007, the Company had 703 full-time equivalent employees, none of which are covered by a collective bargaining agreement. Management believes employee relations are currently good.
Supervision and Regulation
The laws and regulations applicable to the Company and the Bank are primarily intended to protect depositors of the Bank and not shareholders. Proposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in state legislatures and by various bank regulatory agencies. Changes in applicable laws and regulations or in the policies of banking and other government regulators may have a material effect on the business and prospects of the Company or the Bank. The likelihood and timing of any such proposals or legislation and the impact they might have on the Company or the Bank cannot be determined.
Bank Holding Company Regulation. As a bank holding company, AmericanWest Bancorporation is subject to the Bank Holding Company Act of 1956 (BHCA), as amended, which places it under the supervision of the Board of Governors of the Federal Reserve System (FRB). The Company must file periodic reports with the FRB and must provide it with such additional information as it may require. In addition, the FRB periodically examines the Company.
The BHCA limits bank holding company business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the FRBs approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5% of the voting shares of such bank, (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of any additional bank. Subject to certain state laws, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state and out-of-state banks.
Under the Financial Modernization Act of 1999, a bank holding company may apply to the FRB to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain activities deemed financial in nature, such as securities brokerage and insurance underwriting. The Company has not made this application and is not currently engaged in such activities.
State Law Restrictions. As a Washington business corporation, the Company is subject to certain limitations and restrictions as provided under applicable Washington corporate law. In addition, Washington banking law may restrict certain activities of the Company.
Transactions with Affiliates. The Parent Company and the Bank are deemed affiliates within the meaning of the Federal Reserve Act, and transactions between affiliates are subject to restrictions including compliance with Sections 23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B: (1) limit the extent to which a financial institution or its subsidiaries may engage in covered transactions with an affiliate, as defined, to an amount equal to 10% of such institutions capital and surplus and an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital and surplus, and (2) require all transactions with an affiliate, whether or not covered transactions, to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term covered transaction includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.
Bank Regulation. AmericanWest Bank is subject to regulation by the Washington Department of Financial Institutions (DFI) and the Federal Deposit Insurance Corporation (FDIC). The federal and state laws that apply to the Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds and the nature and amount of collateral for loans.
Premiums for Deposit Insurance. The deposits of the Bank are currently insured to the maximum amount allowable per depositor through the Deposit Insurance Fund (DIF) administered by the FDIC. The FDIC implemented a new risk-based insurance premium system effective January 1, 2007 under which banks are assessed insurance premiums based on how much risk they present to the DIF. Banks with higher levels of capital and a lower degree of supervisory risk are assessed lower premium rates than banks with lower levels of capital and/or a higher degree of supervisory risk. These premium rates are applied to the average balance of deposits in the prior quarter. The FDIC has provided a one time assessment credit to eligible institutions based on the assessment base of the institution as of December 31, 1996, as compared to the combined aggregate assessment base of all eligible institutions as of that date. This one time assessment credit reduced expense by $456 thousand in the year ended December 31, 2007. The remaining assessment credit that is expected to be used fully in the year ending December 31, 2008 is $231 thousand. The FDIC may increase or decrease the assessment rate schedule in order to manage the DIF to prescribed statutory target levels. An increase in the assessment rate could have an adverse effect on the Banks earnings, depending upon the amount of the increase. The FDIC may terminate deposit insurance if it determines the institution involved has engaged in or is engaging in unsafe or unsound banking practices, is in an unsafe or unsound condition, or has violated applicable laws, regulations or orders.
Community Reinvestment Act. The Community Reinvestment Act (CRA) requires that, in connection with examinations of financial institutions within their jurisdiction, regulators must evaluate the records of the financial
institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. As of the Banks most recent CRA examination in 2005, the Banks rating was satisfactory.
Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders and any related interests of such persons. Extensions of credit must: (1) be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not covered by such restrictions and who are not employees; and (2) not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order and other regulatory sanctions.
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Under FDICIA, each federal banking agency has prescribed, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards cover internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Management believes that the Bank met all such standards as of December 31, 2007.
Privacy. The FDIC and other bank regulatory agencies, pursuant to the Financial Modernization Act of 1999, have published guidelines and adopted final regulations (Privacy Rules) which, among other things, require each financial institution to: (1) develop, implement and maintain, under the supervision and ongoing oversight of its Board of Directors or committee thereof, a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against anticipated threats to the security or integrity of such information, and protect against unauthorized access to or use of such information; and (2) provide notice to customers (and other consumers under certain circumstances) about its privacy policies, describe the conditions under which the institution may disclose nonpublic information to nonaffiliated third parties and provide a method for consumers to prevent the institution from disclosing that information to most nonaffiliated third parties by opting out of its disclosure policy, subject to certain exceptions. In addition, sections 501 and 505(b) of the Gramm-Leach-Bliley Act (GLBA) require financial institutions to establish appropriate policies, procedures and processes relating to administrative, technical and physical safeguards for customer records and information. Management believes the Bank is currently in substantive compliance with the Privacy Rules and the GLBA.
Dividends. The Bank is subject to restrictions on the payment of cash dividends to the Parent Company. The principal source of the Parent Companys cash flow is dividends received from its subsidiary bank, the issuance of junior subordinated debentures and cash received from the exercise of stock options. Regulatory authorities may prohibit banks and bank holding companies from paying dividends which would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the adequately capitalized level in accordance with regulatory capital requirements. Also, the payment of cash dividends by the Bank must satisfy a net profits test and an undivided profits test or the Bank must obtain prior approval of its regulators before such dividend is paid. The net profits test limits the dividend declared in any calendar year to the net profits of the current year plus retained net income of the preceding two years. The undivided profits test limits the dividends declared to the undivided profits on hand after deducting bad debts in excess of the allowance for loan and lease losses. Based on the regulatory restrictions noted above, the Bank could pay up to $44.4 million in dividends as of December 31, 2007 and remain adequately capitalized, but regulatory approval would be required to pay more than $25.9 million. During the year ended December 31, 2007, the Bank paid $11.5 million of dividends to the Parent Company. The Parent Company is not currently subject to any regulatory restrictions on dividends other than those noted above.
The Bank and the Parent Company are also subject to Washington State law, which provides that no cash dividend may be paid if, after giving effect to the dividend, (1) the corporation would not be able to pay its debts as they become due in the usual course of business, or (2) the Companys total assets would be less than the sum of its total liabilities.
Capital Adequacy. Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of banks and bank holding companies. If regulatory capital falls below minimum guideline levels, a bank or bank holding company may be denied approval, among other things, to acquire or establish additional banks or non-bank businesses or to open new facilities.
The FDIC and FRB use risk-based capital guidelines for banks and bank holding companies. These are designed to make such capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, using a formula that assigns specific risk weights to different groups of assets and off-balance sheet items. The resulting capital ratios represent regulatory capital as a percentage of total risk-weighted assets.
Federal regulations establish minimum requirements for the capital adequacy of depository institutions, such as banks and bank holding companies. The FRB may require that a banking organization maintain ratios in excess of the minimums, particularly organizations contemplating significant expansion programs. Current guidelines require all bank holding companies and federally regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier I capital. Tier I capital for bank holding companies includes common shareholders equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less specified intangible assets and accumulated other comprehensive income or loss. The Companys and Banks regulatory capital ratios are reported in Note 22 to the Consolidated Financial Statements under Item 8.
The federal regulations also establish, as a supplement to risk-based guidelines, minimum requirements for a leverage ratio, which is Tier I capital as a percentage of total average assets less intangibles. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank or bank holding company may leverage its tangible equity capital base. The FRB requires a minimum leverage ratio of 3%. However, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, the FRB generally expects an additional amount of capital of at least 1% to 2%.
FDICIA created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the FDIC, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, leverage ratio and certain subjective factors. The Bank is considered well capitalized as of December 31, 2007, which is the highest of the five categories. Institutions which are deemed to be undercapitalized may be subject to certain mandatory supervisory corrective actions.
Effects of Government Monetary Policy. The earnings and growth of the Company are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the FRB. The FRB can and does implement national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the FRB, and establishment of reserve requirements against certain deposits also influence the growth of bank loans, investments and deposits and affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary policies and their impact on the Company and the Bank cannot be predicted with certainty.
Sarbanes-Oxley Controls and Procedures. The Sarbanes-Oxley Act of 2002 and related rulemaking by the SEC, which effected corporate disclosure and financial reporting reform, generally require public companies to maintain and carefully monitor a system of disclosure and internal controls and procedures. As a result, public companies such as AmericanWest Bancorporation must make disclosures about the adequacy of controls and procedures in periodic SEC reports (i.e., Forms 10-K and 10-Q) and their chief executive and chief financial officers must certify in these filings, among other things, that they are responsible for establishing and maintaining
disclosure controls and procedures and disclose their conclusions about the effectiveness of such controls and procedures based on their evaluation as of the end of the period covered by the relevant report. As a result, most public companies have enhanced internal controls and procedures. The Company is monitoring the status of other related ongoing rulemaking by the SEC. Management believes that the Company is in compliance with the Sarbanes-Oxley Act of 2002.
Anti-Terrorism Legislation. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, had a significant impact on depository institutions. The USA PATRIOT Act, together with the implementing regulations of various federal regulatory agencies, required financial institutions to implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting and due diligence on customers. They also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. Management believes that the Bank is currently in substantive compliance with all effective requirements prescribed by the USA PATRIOT Act.
The following risk factors should not be considered to include all risks to the Company.
The allowance for credit losses may not be adequate to cover actual losses. In accordance with generally accepted accounting principles in the United States of America (GAAP), the Company maintains an allowance for credit losses. The allowance for credit losses may not be adequate to cover actual loan losses, and future provisions for loan losses could adversely impact operating results. The allowance for credit losses is based on prior experience, as well as an evaluation of the inherent risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions that may be beyond the Companys control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the loans and allowance for credit losses. While management believes that the allowance for credit losses is adequate to cover current losses, management may decide to increase the allowance for credit losses in future periods or regulators may require the Company to increase this allowance. Either of these occurrences could reduce future earnings.
Changes in economic conditions, in particular an economic slowdown in the Companys market area, could harm business. The Companys business is directly impacted by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond the Companys control. A deterioration in economic conditions, whether caused by national or local factors, in particular an economic slowdown in Central and Eastern Washington, Northern Idaho or Utah, could result in the following consequences, any of which could materially hurt the business of the Company: loan delinquencies may increase; problem assets and foreclosures may increase; demand for products and services may decrease; low cost or non-interest bearing deposits may decrease; and collateral for loans made by the Bank, especially real estate, may decline in value, in turn reducing customers borrowing power and reducing the value of assets and collateral associated with existing loans. The States of Washington, Idaho and Utah and certain local governments in the market area presently face fiscal challenges the long term impact of which on State or local economies cannot be predicted.
A downturn in the real estate market is harming business. A significant downturn in the real estate market, especially in those markets served by the Bank, is harming business as a significant portion of the Banks loans are secured by real estate. The ability to recover on defaulted loans by selling the real estate collateral could then be diminished, and the Bank would be more likely to suffer losses on defaulted loans.
A substantial amount of the Banks real property collateral is located in Central and Eastern Washington and Utah. The bank has significant concentrations of credit in commercial real estate loans. Real estate values could
be affected by, among other things, an economic slowdown, an increase in interest rates, drought and other natural disasters, specific to Washington or Utah.
The greater Salt Lake City area and Utah economies each have grown rapidly during the past several years, and the failure of these economies to sustain such growth in the future could affect the Companys ability to grow. Salt Lake City, surrounding communities and other Utah communities served by the Banks Far West Bank division each have experienced significant economic growth in recent years, which has created a demand for the Companys loan and deposit products. Failure to sustain this growth or deterioration in local economic conditions could result in, among other things, an increase in loan delinquencies, a decrease in property values, a change in housing turnover rate or a reduction in the level of bank deposits. Particularly, a weakening of the real estate or employment market in Utah, which with the Far West Bank merger has become one of the Companys largest markets, could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans. These events could have an adverse effect on the Companys profitability and asset quality.
The Companys business is subject to interest rate risk, and variations in interest rates may harm financial performance. Unfavorable changes in the interest rate environment may reduce profits. It is expected that the Company will continue to realize income from the differential, or spread, between the interest earned on loans, securities and other interest earning assets and the interest paid on deposits, borrowings and other interest bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest earning assets and interest bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may increase the net interest margin and loan yield, but it may adversely affect the ability of borrowers with variable rate loans to pay the interest on and principal of their obligations. The Company does not have control of these factors. Accordingly, changes in levels of market interest rates could materially harm the net interest spread, asset quality, loan origination volume and overall profitability.
The Company faces strong competition from financial services companies and other companies that offer banking services, which could harm business. The Company currently conducts its banking operations primarily in Central and Eastern Washington, Northern Idaho and Utah. Increased competition in our markets may result in reduced loans and/or deposits. Ultimately, the Company may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services within the market area of the Bank. These competitors include national banks, regional banks and other community banks. The Company also faces competition from many other types of financial institutions including, without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs and conduct extensive promotional and advertising campaigns.
Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and the range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services. The Company also faces competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in the Banks market areas. If the Bank is unable to attract and retain banking customers, the Company may be unable to continue to grow the loan and deposit portfolios, and results of operations and financial condition may otherwise be harmed.
The Company is subject to extensive regulation which could harm business. The Companys operations are subject to extensive regulation by federal, state and local governmental authorities and to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. Because the banking business is highly regulated, the laws, rules and regulations applicable to the Company are subject to frequent change. There are typically proposed laws, rules and regulations that, if adopted, would adversely impact
operations. These proposed laws, rules and regulations, or any other laws, rules or regulations, could (1) make compliance more difficult or expensive, (2) restrict the ability to originate, broker or sell loans or accept certain deposits, (3) further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold, or (4) otherwise harm business or prospects for business.
The Company is exposed to risk of environmental liabilities with respect to properties to which it takes title. In the ordinary course of business, the Bank may own or foreclose and take title to real estate and could be or become subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, the Company may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If the Company ever became subject to significant environmental liabilities, the business, financial condition, liquidity and results of operations could be harmed.
The Company is dependent on key personnel and the loss of one or more of those key personnel may harm prospects. The Company currently depends heavily on the services of its president and chief executive officer, Robert M. Daugherty, and a number of other key management personnel. The loss of Mr. Daughertys services or that of other key personnel could harm the results of operations and financial condition. Success also depends in part on the ability to attract and retain additional qualified management personnel. Competition for such personnel is strong in the banking industry, and the Company may not be successful in attracting or retaining the personnel required.
At December 31, 2007, the Bank had 65 banking locations including 37 in Eastern and Central Washington, 10 in Northern Idaho and 18 in Utah. The Companys main office is located in downtown Spokane, Washington, which is leased. The Bank owns 38 banking facilities, leases 16 banking facilities and has 11 owned buildings on leased land at which banking services are provided. About 8,200 square feet is used for the Administrative Offices. In addition, the Bank leases approximately 9,000 square feet for its Data Processing Center.
Periodically and in the ordinary course of business, various claims and lawsuits are brought against the Company or the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank held a security interest, claims involving the making and servicing of real property loans, actions relating to employee claims and other issues incident to the business of the Company and the Bank. In the opinion of management, the ultimate liability, if any, resulting from current claims or lawsuits will not have a material adverse effect on the financial position or results of operations of the Company.
No matters were submitted to a vote of the Companys shareholders during the fourth quarter of 2007.
The common stock of AmericanWest Bancorporation is traded on the Nasdaq Global Select Market (NASDAQ) under the symbol AWBC. The following table sets out the high and low prices per share and cash dividends per share for the common stock for each quarter of 2007 and 2006 as reported by NASDAQ. The following quotes reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions:
As of February 27, 2008, there were 1,548 holders of record of the Companys common stock.
The payment of future cash dividends is at the discretion of the Board of Directors and is subject to a number of factors, including results of operations, general business conditions, growth, financial condition and other factors deemed relevant. Further, the Companys ability to pay future cash dividends is subject to certain regulatory requirements and restrictions discussed in the Supervision and Regulation section in Item 1 above.
During the year ended December 31, 2006, the Board of Directors authorized the repurchase of up to 250,000 shares. No shares were repurchased under this authorization during 2007 or 2006. In 2007, there were 1,532 shares tendered as payment for the exercise of stock options.
The following table provides information as of December 31, 2007 with respect to the Companys compensation plans under which shares of the Companys common stock are authorized for issuance:
The following graph, which is furnished not filed, compares the cumulative total shareholder return on the Companys common stock during the period beginning December 31, 2002, and ending December 31, 2007, with cumulative total returns on the NASDAQ Composite, SNL Western Bank Index and the SNL Bank Index for the same period. The graph and table assume that $100 was invested on December 31, 2002, and that all dividends were reinvested during each year presented. The information shown on the graph is not necessarily indicative of future performance. The source for the information is SNL Financial LC, Charlottesville, VA. In the prior year, the Regional Pacific Banks Index was included in the below graph. This index is no longer and has been removed from the graph.
The following table sets forth certain selected consolidated financial data of the Company at and for the years ended December 31:
The following discussion should be read together with the Companys consolidated financial statements, related notes and supplementary data of the Company and its subsidiaries, which are included under Item 8. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. The actual results of the Company could differ materially from those discussed in the forward-looking statements.
The Company must manage and control certain inherent risks in the normal course of business. These include credit risk, interest rate risk, fraud risk, operations and settlement risk. The Company has established an allowance for loan losses which represents an estimate of the probable amount of loans that the Bank will be unable to collect as of the date of the financial statements. Refer to the Analysis of Allowance for Loan Losses section within this Item for further information. Additionally, refer to Note 1 of the Consolidated Financial Statements included in Item 8 for other critical accounting policies, including the accounting policies for goodwill and other intangible assets.
Results of Operations
The Companys net income was $8.5 million in 2007 which was $0.9 million more than 2006 and $5.3 million less than 2005. Basic earnings per share in 2007 of $0.54 was $0.14 lower than 2006 and $0.79 less than 2005. Diluted earnings per share in 2007 was $0.54 which is $0.13 less than 2006 and $0.77 less than 2005.
The return on average assets of 0.45% in 2007 is 13 basis points lower than 2006 and 84 basis points lower than 2005. The return on average equity for 2007 was 3.36%, as compared to 5.33% and 12.34% for 2006 and 2005, respectively.
The 2007 financial results were shaped by the following:
The 2006 financial results were shaped by the following:
Net Interest Income. Net interest income increased 39.5% to $84.1 million in 2007 compared to $60.3 million in 2006. The increase in 2007 is primarily due to the growth in average earning assets, including the impact of the FWBC merger, which was partially offset by declining market rates in the second half of the year as the Company is asset sensitive (as discussed under Item 7A Quantitative and Qualitative Disclosures About Market Risk).
The Companys tax equivalent net interest margin for 2007 was 5.09% as compared to 5.06% in 2006. The tax equivalent net interest margin for 2005 was 5.47%. The earning assets yield increased to 8.11% as compared to 7.86% in 2006 and 7.33% in 2005. The increase in the average yield on loans during 2007 was principally attributed to the acquisition of FWBCs loan portfolio of $350.9 million, which had higher yielding loans. Partially offsetting the increased yield from the FWBC portfolio was the impact of an adjustment to the Companys deferral of loan fees effective January 1, 2007. Prior to January 1, 2007, the Company did not defer loan fees or direct loan origination costs on loans with contractual maturities of one year or less as the amount was deemed immaterial. Based on the increased origination of large short-term loans with increasing fee amounts, effective January 1, 2007, the Company began deferring all loan fees and loan origination costs. The interest income on loans includes $5.5 million, $4.8 million and $2.7 million in loan fees for the years ended December 31, 2007, 2006 and 2005 respectively. The
loan fee income as a percentage of average gross loans decreased to 34 basis points from 42 basis points in the year ended December 31, 2007 as compared to 2006.
The cost of funds increased to 3.88% as compared to 3.59% in 2006 and 2.38% in 2005. The increase from 2006 is due partially to increasing market interest rates in the first half of the year and increasing market competition for deposits throughout the year.
The following table sets forth information with regard to average balances of assets and liabilities, and interest income from interest earning assets and interest expense on interest bearing liabilities, resultant yields or costs, net interest income, net interest spread (the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities) and the net interest margin:
The following table sets forth a summary of changes in the components of net interest income due to changes in average interest earning assets and interest earning liabilities and the resultant changes in interest income and interest expense:
The interest rates on loans vary with the degree of risk and amount of the loan, and are further subject to competitive pressures, market rates, the availability of funds and government regulations. As of December 31, 2007 and 2006, approximately 73% and 71%, respectively, of the total loans had interest rates that adjust based on a spread to market reference rates. The market reference rates are based on various indices such as the prime rates of interest charged by money center banks, the Federal Home Loan Bank of Seattle (FHLB) borrowing rates or London Interbank Offering Rates (LIBOR). Some of these rate adjustments are immediate while some will reprice in up to five years.
Provision for Loan Losses. Provision for loan losses was $17.3 million in 2007 as compared to $5.4 million in 2006 and $2.1 million in 2005. The increase in the provision is principally due to the charge-off of $15.3 million of loans during the year. Charge-offs related to three borrowers totaled $11.1 million. These loans had an aggregate remaining carrying value of $13.2 million at December 31, 2007 and are included in the non-performing loan discussion. Additionally, the increase in 2007 reflected the deterioration in the residential construction and development segment of the loan portfolio. The increase in the provision during 2006 was principally due to charge-offs totaling $4.8 million related to one borrower. In 2005 the provision was in-line with expectations at $2.1 million.
The provision for loan losses is an estimate and the use of different estimates or assumptions could produce a different provision for loan losses. If negative trends and expectations of management do not materialize, the allowance may be high relative to the actual loss performance of the loan portfolio. This may lead to decreased
future provisions. Likewise, if positive trends and expectations of management fail to come to fruition, the provision for loan losses in the current period may be inadequate and increased future provisions may be necessary.
Non-interest Income. Non-interest income increased $6.8 million to $16.1 million for 2007 as compared to $9.3 million in 2006. Non-interest income was $8.4 million in 2005. The following table summarizes certain non-interest income categories for the years ended December 31, 2007, 2006 and 2005.
The increase in fees and service charges in 2007 is mainly a result of the deposits acquired through the FWBC merger and income from new products offered beginning in late 2006. The debit card service fees included in the fees and service charges on deposits increased $1.4 million as compared to 2006. The increase in fees on mortgage loan sales from the prior year is related to both the FWBC merger and increased staffing in mortgage lending. The bankcard revenue increase of $729 thousand is related to both the acquired portfolio from FWBC and revenue sharing on the bankcard portfolio sold in 2005. The bank owned life insurance increase is related to new policies acquired through the FWBC merger.
Non-interest Expense. Non-interest expense increased by 35% to $70.5 million in 2007 compared to $52.2 million in 2006. Non-interest expense for 2005 was $41.4 million. The following table summarizes the major non-interest expense categories for the years ended December 31, 2007, 2006 and 2005.
The increase in salaries and employee benefits is related to the higher number of full-time equivalent employees including FWBC employees and increases to mortgage lending staff and increasing benefit costs. During the years ended December 31, 2007 and 2006, there were $367 thousand and $248 thousand, respectively, of salaries and employee benefits expense related to restricted performance stock not recognized as performance criteria for those grants was not achieved.
The increases in the occupancy and equipment expenses relate mainly to new locations acquired through the FWBC merger and new financial centers. The increase in the intangible assets amortization expense relates primarily to the FWBC merger which occurred on April 1, 2007. The increase in debit and bankcard expense is related mainly to increased transactions and servicing costs on debit cards and the bankcard portfolio acquired through the FWBC merger.
Provision for Income Tax. Provision for income tax as a percentage of income before income tax for the year ended December 31, 2007 decreased to 30.6% as compared to 36.3% for the year ended December 31, 2006. The effective tax rate was reduced by 108 basis points during 2007 as a result of certain adjustments related to the Companys 2006 federal tax return filed during 2007. Income related to bank owned life insurance decreased the effective rate by 287 and 156 basis points for the years ended December 31, 2007 and 2006, respectively. Additionally, the effective tax rate for the years ended December 31, 2007 and 2006 were increased by approximately 97 and 381 basis points due to the recapture of certain historical rehabilitation tax credits recognized in prior years.
For the year ended December 31, 2005 the effective tax rate was 26.5%. During the year ended December 31, 2005 the Company recorded $280 thousand in historical rehabilitation tax credits and reversed $870 thousand of a tax reserve related to the anticipated cash surrender of certain bank owned life insurance policies. These items decreased the effective tax rate in that year by 610 basis points.
Balance Sheet Management
Lending and Credit Risk Management. The Company follows loan policies that establish limits of loan commitment by loan type, credit review and grading criteria, and other matters such as loan administration, loans to affiliates, loan costs, problem loans and loan loss reserves, and related items. Loans are analyzed at origination and on a periodic basis as conditions warrant as outlined in the Companys loan policies.
Management has established guidelines and underwriting policies for approval of all loan applications. Delegated credit approval limits generally vary according to the type of loan and the lenders experience. The maximum loan approval limits per aggregate relationship that are available to any one employee are established up to $10.0 million. Aggregate lending relationships in excess of $10.0 million require the approval of the credit committee, which is comprised of members of executive management and members of the board of directors.
Under applicable state laws, loans by the Bank to a single borrower or related entity are limited. The Bank may purchase or sell whole or portions of loans without recourse to third parties. At December 31, 2007 and 2006, the outstanding balance of loan participations sold was $36.3 million and $17.7 million, respectively. At December 31, 2007 and 2006, the Bank had outstanding purchased loans of $117.4 million and $104.9 million, respectively.
During the year ended December 31, 2005, the Bank purchased $76.2 million loans at a premium. At December 31, 2007 and 2006, the remaining unamortized premium on these purchased loans was $368 thousand and $434 thousand, respectively, and is included in the commercial real estate loan category with the remaining principal on these loans. All of these loans were classified as performing as of December 31, 2007.
Loan Concentrations. The aggregate maturities of certain loans in the Banks loan portfolio at December 31, 2007 are shown in the following table. Additionally, the table identifies the balance of loans with variable and adjustable interest rates which mature in greater than one year. Actual maturities may differ from the contractual maturities shown below as a result of renewals and prepayments:
The following table provides a summary of the major categories of loans and the percentage of the total composition for each as of December 31, 2007 and 2006.
Management has assessed, and will continue to assess on an on-going basis, the effect of the economy within the Banks principal market area on the credit risk in the loan portfolio and of overall economic conditions on the entire balance sheet. Management is aware of recent downturns in the residential real estate economy which has adversely affected the credit quality of that portion of the loan portfolio. Additionally, management recognizes
certain geographical concentrations in the market areas serviced and continues to closely monitor the Banks credit quality and focus on identifying potential problem credits and any loss exposure in a timely manner. Industry concentration and related limits will continue to be subject to on-going assessments.
The following table provides a summary of certain loan types included within the construction, land development and other land loans as of December 31, 2007:
As of December 31, 2007, the Banks largest 20 credit relationships consisted of loans and loan commitments ranging from $10.1 million to $25.5 million, with an aggregate total credit exposure of $304.8 million and outstanding balances of $224.9 million. Bank management believes that these credits have been underwritten in an appropriate manner and structured to minimize the Banks potential exposure to loss.
Asset Quality and Non-performing Assets. The following table provides information for the Companys non-performing assets:
Non-performing assets include loans that are 90 or more days past due or in non-accrual status, and real estate and other loan collateral acquired through foreclosure and repossession. Accruing loans 90 days or more past due may remain on an accrual basis because they are adequately collateralized and in the process of collection. For non-accrual loans, no interest income is recognized unless the borrower demonstrates an ability to resume payments of
principal and interest, and the loan is returned to accrual status. Interest previously accrued, but not collected, is reversed and charged against income at the time a loan is placed on non-accrual status.
Total non-performing assets, net of government guarantees, were $40.3 million or 1.90% of total assets as of December 31, 2007. This compares to $12.1 million or 0.86% of total assets, at December 31, 2006. These amounts exclude government guarantees of $992 thousand and $4.0 million for the years ended December 31, 2007 and 2006, respectively.
Significant events in non-performing assets during the year ended December 31, 2007 are discussed below.
The Bank has evaluated adequacy for all collateral dependent impaired loans that are included in non-performing loans and believes the carrying values are supported. Had the non-performing loans been performing during the year, the Company would have recognized an additional $1.3 million in interest income.
Analysis of Allowance for Loan Losses
The allowance for loan losses is established to absorb known and inherent losses primarily resulting from loans outstanding as of the statement of condition date. Accordingly, all loan losses are charged to the allowance and all recoveries are credited to it. The provision for loan losses charged to operating expense is based on past credit loss experience and other factors which in managements judgment deserve current recognition in estimating probable credit losses. Such other factors include growth and composition of the loan portfolio, credit concentrations, trends in portfolio volume, maturities, delinquencies and non-accruals, historical loss trends and general economic conditions. While management uses the best information available to base its estimates, future adjustments to the allowance may be necessary if economic conditions, particularly in the Companys market areas, differ substantially from the assumptions initially used. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The Company utilizes a loan loss reserve methodology and documentation process which it believes is consistent with SEC Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation
Issues. Additionally, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures. These accounting pronouncements require specific identification of an allowance for loan loss for an impaired loan. To this end, the Company developed a systematic methodology using a nine-grade risk rating system to determine its allowance for loan losses. Current collateral values, less costs to sell, are considered in cases where this type of analysis is applicable. On a quarterly basis, the allowance is recalculated using the methodology to determine if the allowance is adequate.
This methodology includes a detailed analysis of the loan portfolio that is performed by competent and well-trained personnel who have the skills and experience to perform analyses, estimates, reviews and other loan loss methodology functions. All loans are considered in the analysis, either on an individual or group basis, using current data. Loans are evaluated for impairment on an individual basis, if applicable, and the remainder of the portfolio is segmented into groups of loans with similar risk characteristics. Additionally, the methodology includes consideration of particular risks inherent in different kinds of lending. The analysis ensures the loan loss allowance balance and methodology is in accordance with accounting principles generally accepted in the United States of America and, further, that it also complies with the provisions of the Interagency Policy Statement issued in 2006 by the federal bank regulatory agencies. Management believes that the allowance for loan losses is adequate as of December 31, 2007.
At December 31, 2007 and 2006, the Company had $26.5 million and $19.3 million, respectively of loans that were not classified as non-performing but for which known information about the borrowers financial condition caused management to have concern about the ability of the borrowers to comply with the repayment terms of the loans. These loans were identified through the loan review process described above that provides for assignment of a risk rating based on a nine-grade scale. Based on the evaluation of current market conditions, loan collateral, other secondary sources of repayment and cash flow generation, management does not anticipate any significant losses related to these loans. These loans are subject to continuing management attention and are considered in the determination of the allowance for loan losses. A decline in the economic conditions in the Companys market areas or other factors could adversely impact individual borrowers or the loan portfolio in general. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on non-accrual or transferred to foreclosed real estate and other foreclosed assets in the future.
The following table sets forth information by loan type regarding charge-offs and recoveries in the Companys allowance for loan losses for the years ended December 31, as follows:
The following table presents an allocation of the allowance for loan losses by category. In making the allocation, consideration was given to such factors as managements evaluation of risk in each category, current economic conditions and charge-off experience. An allocation of the allowance for loan losses is an estimate of the portion of the allowance which will be used to cover future charge-offs in each loan category, but it does not preclude any portion of the allowance allocated to one type of loan from being used to absorb losses of another loan type.
Investment activities are undertaken in accordance with the Asset/Liability Management Policy that has been approved by the Board of Directors of the Company. Activities are reviewed by the Asset/Liability Management Committee and the Board of Directors of the Company. The following table sets forth the carrying value, by type, of the securities in the Companys portfolio at December 31, 2007, 2006 and 2005:
At December 31, 2007, the amortized cost of the Companys securities exceeded fair value by $197 thousand. At December 31, 2006 and 2005, the fair value of the Companys securities exceeded amortized cost by $100 thousand and $95 thousand, respectively. Government agency and privately issued securities comprised 86% and 14%, respectively, of total mortgage-backed securities at December 31, 2007. There were no sub-prime securities in the portfolio at December 31, 2007, 2006 or 2005. No portion of the Companys investment portfolio is invested in derivative securities (meaning securities whose value derives from the value of an underlying security or securities, or market index of underlying securities values).
The following table sets forth the carrying values, maturities and approximate average aggregate yields of securities in the Companys investment portfolio by type at December 31, 2007:
The weighted average yield related to states and political subdivisions reflects the actual yield and is not presented on a tax equivalent basis. Mortgage-backed securities have been classified above based on contractual maturities. Other non-maturity securities have been included in the over 10 years classification above.
At December 31, 2007, AWBC had goodwill and intangible assets of $127.9 million and $16.9 million, respectively, as compared to $33.1 million and $7.5 million, respectively at December 31, 2006. The goodwill recorded in connection with the FWBC and CTB mergers represented the excess of the purchase price over the estimated fair value of the net assets acquired. A portion of the purchase price was allocated to the value of FWBC and CTBs core deposits, which included all deposits except time deposits. Additionally, the intangible assets include covenants not to compete. The FWB core deposit intangible is being amortized on an accelerated basis with an anticipated life of 10 years. The CTB core deposit intangible asset is being amortized on a straight-line basis with an anticipated life of 8 years. The goodwill is evaluated for impairment on an annual basis, or sooner if events or circumstances indicate a potential impairment.
The Banks primary source of funds is customer deposits. The Bank strives to maintain a high percentage of non-interest bearing deposits, which lowers the Banks cost of funds and results in higher net interest margins. At
December 31, 2007, 2006 and 2005, the Companys ratios of non-interest bearing deposits to total deposits were 22.4%, 21.0% and 21.3%, respectively.
The following table sets forth the average balances for each major category of deposits and the weighted average interest rate paid for deposits for the years ended 2007, 2006 and 2005:
The following table shows the amounts and maturities of time deposits that had balances of $100,000 or more at December 31, 2007, 2006 and 2005:
Time deposits in the table above include brokered certificates of deposits of $103.1 million, $56.4 million, and $27.3 million as of December 31, 2007, 2006 and 2005, respectively. All of the brokered certificates of deposit mature prior to December 31, 2008. Brokered certificates of deposit provide a source of liquidity for the Bank.
Overnight borrowings consist of borrowings with the FHLB, federal funds (Fed Funds) purchased through correspondent institutions and borrowings on the line of credit by the Parent Company. The following table sets forth the outstanding overnight borrowings and the maximum amount outstanding at any month-end during the respective years:
Borrowings increased $159.2 million to $285.9 million at December 31, 2007 as compared to December 31, 2006. This increase includes $35.7 million of Fed Funds purchased and the issuance of junior subordinated debt during the year of $20.6 million related to the FWBC merger. The increase in borrowings is related mainly to the increase in loan demand and a slower than expected growth in deposit balances.
Management believes that the Companys cash flow will be sufficient to support its existing operations for the foreseeable future. Cash flows from operations contribute significantly to liquidity, as do proceeds from maturities of securities and increasing customer deposits. In 2007, the Company generated $28.9 million in net cash flows from its operating activities, compared to $20.7 million in 2006. Additionally, the Company generated $179.5 million and $83.3 million in net cash from financing activities in 2007 and 2006, respectively.
The Banks primary source of funds is its deposits. In addition, the Bank has the ability to borrow from various sources, including the FHLB and correspondent banks that provide Fed Funds lines. At December 31, 2007, the Bank had $102.7 million of available credit (after deducting outstanding borrowings) from these sources compared to $244.2 million at December 31, 2006.
The Parent Company had cash balances of $757 thousand as of December 31, 2007. The Parent Company received cash dividends of $11.5 million from the Bank, which was principally used to fund a portion of the cash consideration paid related to the merger with FWB, pay interest costs related to junior subordinated debt and pay cash dividends. Additionally, the Parent Company issued junior subordinated debentures of $20.6 million related to the merger. The Parent Company paid $0.15 and $0.09 per share of dividends on its common stock during 2007 and 2006, respectively. There were no common stock repurchases during the year ended December 31, 2007.
The Parent Companys ability to service borrowings is generally dependent upon the availability of dividends from the Bank. The payments of dividends by the Bank are subject to limitations imposed by law and governmental regulations. In determining whether the Bank or the Company will declare a dividend, the respective boards of directors consider factors including financial condition, anticipated growth, acquisition opportunities, and applicable laws, regulations and regulatory capital requirements. Another potential source of cash is a line of credit of $20.0 million that the Parent Company has with a correspondent bank. There were no outstanding borrowings on the line of credit at December 31, 2007.
The Companys total stockholders equity increased to $284.0 million at December 31, 2007 as compared to $152.0 million at December 31, 2006. This increase is related to retained net income of $6.1 million and stock issued related to the FWBC merger of $124.4 million. At December 31, 2007, stockholders equity was 13.4% of total assets, compared to 10.7% at December 31, 2006. At December 31, 2007 and 2006, the Company also held cash and cash equivalent assets of $47.1 million and $55.7 million, respectively.
The capital levels of the Company and the Bank exceeded applicable regulatory well-capitalized guidelines at December 31, 2007 and 2006. Regulatory capital ratios can be reviewed in Note 22 Regulatory Matters under Item 8 of this report.
Effects of Inflation and Changing Prices. The primary impact of inflation on the Companys operations is increased asset yields, deposit costs and operating overhead. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institutions performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. The effects of inflation can magnify the growth of assets, and if significant, would require that equity capital increase at a faster rate than would otherwise be necessary.
The following summarizes the Companys contractual obligations at December 31, 2007:
The table above does not include time deposit liabilities or accrued interest liabilities.
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit and standby letters of credit and financial guarantees written. Such financial instruments are held for purposes other than trading and are recorded in the financial statements when they are funded or related fees are incurred or received. Since many of the commitments will expire without being drawn upon, the total commitment amounts do not necessarily reflect future cash requirements. The following summarizes the amount of commitments per expiration period:
Refer to Note 2 under Item 8 of this Report.
The primary form of market risk to which financial institutions are exposed is interest rate risk. This is the effect of changes in market interest rates on a financial institutions income, fair values of assets and liabilities and capital. Any changes in market interest rates may impact the financial institutions net interest income, the spread between the interest earned on loans, securities and other interest earning assets, and interest paid on deposits, borrowings and other interest bearing liabilities.
The Company has an Asset/Liability Management Committee (ALCO), consisting of senior managers and a board of directors representative, to monitor interest rate risk. The ALCO meets quarterly to review current interest rate sensitivity and plan balance sheet and pricing strategies. The ALCO looks at many components of interest rate
risk. Repricing risk results from differences between the timing of market rate changes and the timing of cash flows of the Banks assets and liabilities. Basis risk comes from changes in the relationship between different market rates on assets and liabilities and their impact on the Banks earnings. Yield curve risk arises from changes in the shape of the yield curve. All of these aspects of interest rate risk are considered by management in monitoring the Banks market risk profile.
As is true for any banking services provider, unfavorable changes in the interest rate environment may reduce net interest income. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest earning assets and interest bearing liabilities. In addition, loan volumes and yields are affected by market interest rates on loans. While an increase in the general level of interest rates may increase the net interest margin and loan yields, it may adversely affect the ability of borrowers with variable rate loans to make principal and interest payments. Accordingly, changes in levels of market interest rates could materially and adversely affect the net interest spread, asset quality, loan origination volume and overall profitability.
To monitor the impact of changing interest rates on net interest income, the Company employs an interest rate simulation model. The model integrates existing balance sheet maturity and repricing detail with various assumptions including prepayment projections and interest rate spreads over key index rates. This simulation measures changes in net interest income over one year that would occur if market interest rates move in even increments up or down by 100 and 200 basis points; that is, if rates change by 8.3 and 16.7 basis points each month over 12 months. All yield curve shifts are parallel in this simulation and any loans or deposits that prepay or mature are replaced by like instruments to keep the balance sheet composition constant.
Based on the simulation results, shown below as of December 31, 2007 and 2006, the Companys net interest income may increase under rising interest rates and decline under falling interest rates, indicating that the Company is slightly asset sensitive.
The Companys rate sensitivity at December 31, 2007 decreased and the expected impact of rising or falling rates on income was more balanced than at December 31, 2006. This difference resulted primarily from a model change made after an external review that reduces deposit rates quickly as market rates decline, mirroring the prompt rise in deposit rates as market rates increase. As market rates declined during the second half of 2007, the Bank reduced its rates on deposits in a manner consistent with what had been modeled and still maintained the deposit balances.
It should be noted that the preceding interest rate sensitivity analysis does not represent a forecast by the Company and should not be relied upon as being indicative of future operating results. These hypothetical estimates are based on numerous assumptions including, but not limited to: the nature and timing of interest rate levels; yield curve shape; repayments on loans and securities; and pricing decisions on loans and deposits. As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to prepayment and refinancing levels deviating from those assumed, the varying impact on adjustable rate assets of interest rate change caps and floors, the potential effect of changing debt service levels on customers with adjustable rate loans, and depositor early withdrawals and product preference changes. Also, the sensitivity analysis does not reflect future actions that the ALCO might take in responding to or anticipating changes in interest rates. While assumptions are developed based upon current economic and local market conditions, the Company cannot give any assurance as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
The Companys policy sets limits on the allowable change in one year of net interest income if rates rise or fall by 200 basis points. Percentage changes noted in the table above are within these limits.
As a further means of quantifying interest rate risk, the Companys management looks at the economic perspective by capturing the impact of interest rate changes on the net value of future cash flows, or Economic Value of Equity (EVE).
To determine the economic value of equity, cash flows projected from the Companys current assets and liabilities are discounted based on current market rates. Investment securities are valued using current market prices. Loans are discounted at current Bank pricing spreads to market reference rates. Deposits and borrowings are discounted based on the FHLB yield curve as of the simulation date. Deposit cash flows include Federal Reserve Bank estimates of operating costs for each deposit type.
The table below shows the effect on equity of market value changes of the Companys financial assets and liabilities if interest rates change immediately up or down by 100 or 200 basis points as of December 31, 2007:
The Companys policy sets limits on allowable changes in the economic value of equity if rates rise or fall by 200 basis points. Percentage changes noted in the table above are within these limits. Since the market value of the Companys equity would increase with rising interest rates, this table again indicates the Company is slightly asset sensitive.
Interest Rate Sensitivity Gap
The table below presents the Companys balance sheet with estimated repricing information as of December 31, 2007. It indicates that the Company has more liabilities than assets repricing during the first year. It should be noted that transaction deposits (interest bearing demand deposits, savings and MMDA) comprise the major portion of these liabilities, and changes in rates on these deposits often occur after changes to key index rates on loans.
To the Board of Directors and Stockholders
We have audited the accompanying consolidated statements of financial condition of AmericanWest Bancorporation and subsidiaries (Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders equity and comprehensive income, and cash flows for the three years in the period ended December 31, 2007. We also have audited the Companys internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of AmericanWest Bancorporation and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, AmericanWest Bancorporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ Moss Adams LLP
March 3, 2008
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2007 AND 2006
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
The accompanying notes are an integral part of the financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AmericanWest Bancorporation (Company) is a Washington corporation and a bank holding company headquartered in Spokane, Washington. The Companys wholly-owned banking subsidiary is AmericanWest Bank (Bank), a Washington state chartered bank that operates in Eastern and Central Washington, Northern Idaho and Utah. The Banks operations in Utah are doing business as Far West Bank, a division of AmericanWest Bank. Unless otherwise indicated, reference to the Company shall include the Bank. The Companys unconsolidated information will be referred to as the Parent Company. As of December 31, 2007, the Company had four wholly-owned trusts (Trusts) that were formed to issue trust preferred securities and related common securities of the Trusts.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP) and with prevailing practices within the banking industry.
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, excluding the Trusts, after eliminating all intercompany balances and transactions.