At September 30, 2007, the Company had firm commitments to sell $604,000 of residential loans to the FHLMC. Typically, these agreements are short term fixed rate commitments and no material gain or loss is likely.
The Company is party to litigation arising in the ordinary course of business. In the opinion of management, these actions will not have a material adverse effect, if any, on the Company's financial position, results of operations, or liquidity.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis and other portions of this report contain certain forward-looking statements concerning the future operations of the Company. 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 the safe harbor provisions with respect to all forward-looking statements contained in this Quarterly Report. The Company has used forward-looking statements to describe future plans and strategies, including its expectations of 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, the ability of the Company to control costs and expenses, deposit flows, demand for mortgages and other loans, pricing of products and services, real estate values and vacancy rates, the ability of the Company to efficiently incorporate acquisitions into its operations, competition, loan delinquency rates, technological factors affecting operations 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. The Company undertakes no obligation and specifically disclaims any obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results to differ materially from those expressed in any forward-looking statements by, or on behalf of, the Company.
Critical Accounting Policies
Critical accounting policies and estimates are discussed in our 2007 Form 10-K under Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operation - Critical Accounting Policies." That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have not been any material changes in the Company's critical accounting policies and estimates as compared to the disclosure contained in the Company's 2007 Form 10-K.
Non-GAAP Financial Information
This report contains certain financial information determined by methods other than in accordance with GAAP. These measures include net interest income on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis. Management uses these non-GAAP measures in its analysis of the Company's performance. The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 34% tax rate. Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. A reconciliation of net interest income as reported to net interest income on a fully tax equivalent basis are contained in the tables under "Net Interest Income."
14
<PAGE>
Executive Overview
Financial Highlights.
Net income for the three months ended September 30, 2007 was $2.4 million, or $0.22 per basic share ($0.22 per diluted share), compared to net income of $3.0 million, or $0.26 per basic share ($0.26 per diluted share) for the three months ended September 30, 2006. Net interest income after provision for loan losses decreased $233,000 for the three months ended September 30, 2007 compared to the same quarter last year. Non-interest income decreased to $2.2 million for the three months ended September 30, 2007 compared to $2.3 million for the same quarter last year. Non-interest expense increased by $559,000 for the quarter ended September 30, 2007 compared to the same quarter last year.
The annualized return on average assets was 1.19% for the three months ended September 30, 2007, compared to 1.45% for the three months ended September 30, 2006. For the same periods, the annualized return on average common equity was 9.98% compared to 12.22%, respectively. The efficiency ratio, which is defined as the percentage of non-interest expenses to total revenue excluding intangible asset amortization, was 61.98% for the second quarter of fiscal 2008 compared to 54.31% for the same period last year.
Net income for the six months ended September 30, 2007 was $5.3 million, or $0.47 per basic share ($0.47 per diluted share), compared to net income of $5.6 million, or $0.50 per basic share ($0.49 per diluted share) for the six months ended September 30, 2006.
The annualized return on average assets was 1.29% for the six months ended September 30, 2007, compared to 1.41% for the six months ended September 30, 2006. For the same periods, the annualized return on average common equity was 10.58% compared to 11.70%, respectively. The Company's efficiency ratio, net of intangible amortization, was 61.15% for the six months ended September 30, 2007 compared to 57.21% for the same period last year.
The Company is a progressive, community-oriented financial institution, which emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington and Multnomah, Clackamas and Marion counties of Oregon as its primary market area. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial real estate, one- to four- family residential real estate, construction, commercial and consumer loans. Commercial and construction loans have grown from 72.42% of the loan portfolio at March 31, 2003 to 89.07% of the loan portfolio at September 30, 2007. The Company's strategic plan includes targeting the commercial banking customer base in its primary market area, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company emphasizes controlled growth and the diversification of its loan portfolio to include a significant amount of commercial and commercial real estate loans. A related goal is to increase the proportion of personal and business checking account deposits used to fund these new loans. Significant portions of these new loan products carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages. The strategic plan stresses increased emphasis on non-interest income, including increased fees for asset management and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. The Company is well positioned to attract new customers and to increase its market share with 18 branches including ten in fast growing Clark County, three in the Portland metropolitan area and three lending centers.
In order to support the Company's strategy of growth without compromising local, personal service to customers and its commitment to asset quality, the Company has made significant investments in experienced branch, lending, asset management and support personnel and has incurred significant costs in facility expansion and in its infrastructure. The Company's non-interest expense reflects this investment and will remain relatively high as a percentage of its average assets for the foreseeable future as a result of the emphasis on growth and local, personal service. Controlling its non-interest expenses remains a high priority for the Company's management.
The Company continuously reviews new products and services to provide its customers more financial options. With the Company's emphasis on the growth of non-interest income and the control of non-interest expense, all new technology and services are generally reviewed for business development and cost saving purposes. In-house processing of checks and check imaging has supported the Bank's increased service to customers and at the same time has increased efficiency. The Bank has implemented remote check capture at selected branches and is in the process of implementing remote capture of checks on site for selected customers of the Bank. Emphasis on enhancing the Bank's cash management product is in process with the future hire of an experienced cash management team leader. The near future formation of a team consisting of this team leader and existing Bank employees is expected to lead to a more robust cash management product for the Bank's commercial customers. The Company continues to experience growth in customer use of its online banking services, which allows customers to conduct a full range of services on a real-time basis, including balance inquiries, transfers and electronic bill paying. The Company's online service has also enhanced the delivery of cash management services to commercial customers.
15
<PAGE>
The Company conducts operations from its home office in Vancouver and 18 branch offices in Camas, Washougal, Stevenson, White Salmon, Battle Ground, Goldendale, Vancouver (seven branch offices) and Longview, Washington and Portland (two branch offices), Wood Village and Aumsville, Oregon. The Company operates a trust and financial services company, RAM Corp., located in downtown Vancouver. Riverview Mortgage, a mortgage broker division of the Company, originates mortgage loans for various mortgage companies predominantly in the Vancouver/Portland metropolitan areas, as well as for the Company. The Business and Professional Banking Division, with two lending offices in Vancouver and one in Portland, offers commercial and business banking services.
Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Companies located in the Vancouver area include Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory and WaferTech, as well as several support industries. In addition to this industry base, the Columbia River Gorge Scenic Area is a source of tourism, which has helped to transform the area from its past dependence on the timber industry.
Loan Composition
The following table sets forth the composition of the Company's commercial and construction loan portfolio based on loan purpose at the dates indicated.
|
Commercial &
Construction
Total
|
Commercial
|
Other Real
Estate Mortgage
|
Real Estate
Construction
|
September 30, 2007
|
|
(In thousands)
|
|
|
|
|
|
|
Commercial
|
$ 90,515
|
$ 90,515
|
$ -
|
$ -
|
Commercial construction
|
47,829
|
-
|
-
|
47,829
|
Office buildings
|
77,126
|
-
|
77,126
|
-
|
Warehouse/industrial
|
34,892
|
-
|
34,892
|
-
|
Retail/shopping centers/strip malls
|
66,890
|
-
|
66,890
|
-
|
Assisted living facilities
|
11,044
|
-
|
11,044
|
-
|
Single purpose facilities
|
46,248
|
-
|
46,248
|
-
|
Land
|
104,134
|
-
|
104,134
|
-
|
Multi-family
|
27,046
|
-
|
27,046
|
-
|
One-to-four family
|
114,600
|
-
|
-
|
114,600
|
Total
|
$ 620,324
|
$ 90,515
|
$ 367,380
|
$ 162,429
|
|
Commercial &
Construction
Total
|
Commercial
|
Other Real
Estate Mortgage
|
Real Estate
Construction
|
March 31, 2007
|
|
(In thousands)
|
|
|
|
|
|
|
Commercial
|
$ 91,174
|
$ 91,174
|
$ -
|
$ -
|
Commercial construction
|
56,226
|
-
|
-
|
56,226
|
Office buildings
|
62,310
|
-
|
62,310
|
-
|
Warehouse/industrial
|
40,238
|
-
|
40,238
|
-
|
Retail/shopping centers/strip malls
|
70,219
|
-
|
70,219
|
-
|
Assisted living facilities
|
11,381
|
-
|
11,381
|
-
|
Single purpose facilities
|
41,501
|
-
|
41,501
|
-
|
Land
|
103,240
|
-
|
103,240
|
-
|
Multi-family
|
32,041
|
-
|
32,041
|
-
|
One-to-four family
|
109,847
|
-
|
-
|
109,847
|
Total
|
$ 618,177
|
$ 91,174
|
$ 360,930
|
$ 166,073
|
16
<PAGE>
Comparison of Financial Condition at September 30, 2007 and March 31, 2007
At September 30, 2007, the Company had total assets of $820.7 million, compared with $820.3 million at March 31, 2007.
Cash, including interest-earning accounts, totaled $36.9 million at September 30, 2007, compared to $31.4 million at March 31, 2007. The $5.5 million increase was attributable to the maturity of investment securities and the issuance of junior subordinated debentures which were partially offset by an increase in loan production.
Loans held for sale totaled $604,000 at September 30, 2007. There were no loans held for sale at March 31, 2007. The balance of loans held for sale can vary significantly from period to period reflecting the interest rate environment, loan demand by borrowers, and loan origination for sale by mortgage brokers versus loan origination for the Company's loan portfolio. The Company originates fixed-rate residential loans for sale in the secondary market and retains the related loan servicing rights. Selling fixed interest rate mortgage loans allows the Company to reduce the interest rate risk associated with long term, fixed interest rate products. The sale of loans also makes additional funds available to make new loans and diversify the loan portfolio. The Company continues to service the loans it sells, maintaining the customer relationship and generating ongoing non-interest income.
Loans receivable, net, totaled $687.4 million at September 30, 2007, compared to $683.0 million at March 31, 2007, an increase of $4.5 million. Loans receivable increased $24.0 million, or 3.6%, during the quarter ended September 30, 2007 due to continued strong loan growth. A substantial portion of the loan portfolio is secured by real estate, either as primary or secondary collateral, located in the Company's primary market area. The Company has no sub-prime residential real estate loans in portfolio.
Investment securities available for sale totaled $8.8 million at September 30, 2007, compared to $19.3 million at March 31, 2007. The decrease was attributable to maturities and scheduled cash flows.
Mortgage-backed securities available for sale totaled $5.9 million at September 30, 2007, compared to $6.6 million at March 31, 2007. The decrease is attributable to maturities and scheduled cash flows. The Company has no sub-prime mortgage-backed securities.
Goodwill was $25.6 million at September 30, 2007 and March 31, 2007. As of September 30, 2007, there have been no events or changes in circumstances that would indicate a potential impairment.
Deposits totaled $659.8 million at September 30, 2007, compared to $665.4 million at March 31, 2007. At September 30, 2007, the balance of interest checking accounts had decreased $12.1 million to $132.3 million from $144.5 million at March 31, 2007. Money market deposit accounts totaled $235.1 million at September 30, 2007, compared to $205.0 million at March 31, 2007. The growth in the higher yielding money market deposit accounts reflects the impact that the inverted/flat yield curve has had on the customers' choice of deposit accounts.
Junior subordinated debentures totaled $22.7 million at September 30, 2007 and $7.2 million at March 31, 2007. The $15.5 million increase was the result of the issuance of additional trust preferred securities in June 2007.
Shareholders' Equity and Capital Resources
Shareholders' equity decreased $7.6 million to $92.6 million at September 30, 2007 from $100.2 million at March 31, 2007. The decrease in equity from cash dividends declared to shareholders of $2.4 million and stock repurchases of $11.2 million were partially offset by earnings of $5.3 million for the six months ended September 30, 2007. Exercise of stock options, earned ESOP shares, FIN 48 adjustments and the net tax effect of SFAS No. 115 adjustment to securities comprised the remaining $769,000 net increase.
The Bank 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 actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated in accordance with regulatory accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios of total capital to risk-weighted assets, Tier I capital to risk-weighted assets, Tier I capital to adjusted tangible assets and tangible capital to tangible assets (set forth in the table below). Management believes the Bank meets all capital adequacy requirements to which it is subject as of September 30, 2007.
17
<PAGE>
As of September 30, 2007, the most recent notification from the OTS categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total capital and Tier I capital to risk-weighted assets, Tier I capital to adjusted tangible assets and tangible capital to tangible assets (set forth in the table below). There are no conditions or events since that notification that management believes have changed the Bank's regulatory capital categorization.The Bank's actual and required minimum capital amounts and ratios are presented in the following table (dollars in thousands):
|
Actual
|
For Capital
Adequacy Purposes
|
Categorized as
"Well
Capitalized"
Under Prompt
Corrective
Action Provision
|
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
September30, 2007
|
|
|
|
|
|
|
Total Capital:
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
$ 83,846
|
11.37%
|
$ 58,983
|
8.0%
|
$ 73,729
|
10.0%
|
Tier I Capital:
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
74,809
|
10.15
|
29,492
|
4.0
|
44,238
|
6.0
|
Tier I Capital:
|
|
|
|
|
|
|
(To Adjusted Tangible Assets)
|
74,809
|
9.59
|
23,399
|
3.0
|
38,998
|
5.0
|
Tangible Capital:
|
|
|
|
|
|
|
(To Tangible Assets)
|
74,809
|
9.59
|
11,700
|
1.5
|
N/A
|
N/A
|
|
Actual
|
For Capital
Adequacy Purposes
|
Categorized as
"Well
Capitalized"
Under Prompt
Corrective
Action Provision
|
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
March 31, 2007
|
|
|
|
|
|
|
Total Capital:
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
$ 84,363
|
11.38%
|
$ 59,310
|
8.0%
|
$ 74,137
|
10.0%
|
Tier I Capital:
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
75,740
|
10.22
|
29,655
|
4.0
|
44,482
|
6.0
|
Tier I Capital:
|
|
|
|
|
|
|
(To Adjusted Tangible Assets)
|
75,740
|
9.60
|
23,662
|
3.0
|
39,436
|
5.0
|
Tangible Capital:
|
|
|
|
|
|
|
(To Tangible Assets)
|
75,740
|
9.60
|
11,831
|
1.5
|
N/A
|
N/A
|
Liquidity
The Bank's primary source of funds are customer deposits, proceeds from principal and interest payments on loans, proceeds from the sale of loans, maturing securities and FHLB advances. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan originations, deposit withdrawals and continuing operations, satisfy other financial commitments and take advantage of investment opportunities. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2007, cash totaled $36.9 million, or 4.5% of total assets. The Bank has a line of credit with the FHLB of Seattle in the amount of 30% of total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At September 30, 2007, the Bank had $33.6 million in outstanding advances from the FHLB of Seattle under an available credit facility of $244.5 million, limited to available collateral. The Bank also had a $10.0 million line of credit available from Pacific Coast Bankers Bank at September 30, 2007. The Bank had no borrowings outstanding under this credit arrangement at September 30, 2007.
Sources of capital and liquidity for the Bancorp include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory restrictions.
18
<PAGE>
Asset Quality
The allowance for loan losses was $9.1 million at September 30, 2007 and $8.7 million at March 31, 2007, respectively. Management believes the allowance for loan losses at September 30, 2007 is adequate to cover probable credit losses existing in the loan portfolio at that date. The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluating known and inherent risks in the loan portfolio. Pertinent factors considered include size and composition of the portfolio, actual loss experience, current economic conditions, industry trends and data, and detailed analysis of individual loans. The appropriate allowance level is estimated based upon factors and trends identified by management at the time the consolidated financial statements are prepared. Commercial loans are considered to involve a higher degree of credit risk than one-to-four family residential loans, and tend to be more vulnerable to adverse conditions in the real estate market and deteriorating economic conditions. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of the Bank's allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
Non-performing assets were $206,000 or 0.03% of total assets at September 30, 2007, compared with $226,000 or 0.03% of total assets at March 31, 2007. The $132,000 balance of nonaccrual loans is comprised of one commercial real estate loan. The $74,000 balance of real estate owned is comprised of one land loan. The following table sets forth information regarding the Company's non-performing assets.
|
September 30, 2007
|
March 31, 2007
|
|
(Dollars in thousands)
|
Loans accounted for on a nonaccrual basis:
|
|
|
Other real estate mortgage
|
$ 132
|
$ 226
|
Commercial
|
-
|
-
|
Total
|
132
|
226
|
|
|
|
Accruing loans which are contractually
past due 90 days or more
|
-
|
-
|
|
|
|
Total of nonaccrual and
90 days past due loans
|
132
|
226
|
|
|
|
Real estate owned (net)
|
74
|
-
|
|
|
|
Total non-performing assets
|
$
206
|
$
226
|
|
|
|
Total loans delinquent 90 days
or more to net loans
|
0.02%
|
0.03%
|
|
|
|
Total loans delinquent 90 days or
more to total assets
|
0.02%
|
0.03%
|
|
|
|
Total non-performing assets to total assets
|
0.03%
|
0.03%
|
As of September 30, 2007 and March 31, 2007, other loans of concern totaled $4.4 million and $3.9 million, respectively. Other loans of concern consist of loans which known information concerning possible credit problems with the borrowers or the cash flows of the collateral securing the respective loans has caused management to be concerned about these isolated instances of the ability of the borrowers to comply with present loan repayment terms, which may result in the future inclusion of such loans in the nonaccrual category.
19
<PAGE>
Off-Balance Sheet Arrangements and Other Contractual Obligations
Through the normal course of operations, the Company enters into certain contractual obligations and other commitments. Obligations generally relate to funding of operations through deposits and borrowings as well as leases for premises. Commitments generally relate to lending operations.
The Company has obligations under long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period, with options to extend, and are not subject to cancellation.
The Company has commitments to originate fixed and variable rate mortgage loans to customers. Because some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Undisbursed loan funds and unused lines of credit include funds not disbursed, but committed to construction projects and home equity and commercial lines of credit. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
For further information regarding the Company's off-balance sheet arrangements and other contractual obligations, see Note 15 of the Notes to Consolidated Financial Statements contained herein.
Comparison of Operating Results for the Three Months Ended September 30, 2007 and 2006
Net Interest Income.
The Company's profitability depends primarily on its net interest income, which is the difference between the income it receives on interest-earning assets and its cost of funds, which consists of interest paid on deposits and borrowings. When interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and regulation, and monetary and fiscal policies.
Net interest income for the three months ended September 30, 2007 was $8.7 million, representing a decrease of $433,000, or 4.7%, from $9.1 million during the same prior year period. The ratio of average interest-earning assets to average interest-bearing liabilities decreased to 117.73% for the three months ended September 30, 2007, compared to 119.63% in the same prior year period which indicates that the interest-earning asset growth is being funded more by interest-bearing liabilities as compared to capital and non-interest-bearing demand deposits. The net interest margin for the quarter ended September 30, 2007 was 4.72%, compared to 4.97% for the quarter ended September 30, 2006. The growth in the higher yielding money market deposit accounts reflects the impact that the inverted/flat yield curve has had on the customers' choice of deposit accounts. The Company's balance sheet interest rate sensitivity achieves better net interest rate margins in a stable or increasing interest rate environment due to the balance sheet being slightly asset interest rate sensitive. In a decreasing interest rate environment the Company requires time to recover the decline in the net interest rate margin. The Company's interest-earning asset's interest rates reprice down faster than interest rates on our interest-bearing liabilities. As a result of the Federal Reserve's 50 basis points reduction in short term fed funds rate on September 18, 2007, approximately 40% of the Company's loans immediately repriced down 50 basis points. The Company immediately reduced the interest rate paid on certain interest-bearing deposits. Further reductions will be reflected in our future deposit offering rates. The amount and timing of these reductions is dependent on competitive pricing pressures, yield curve shape and changes in spreads.
Interest Income .
Interest income remained stable at $15.3 million for the quarter ended September 30, 2007 compared to the quarter ended September 30, 2006. Interest income on loans receivable and investment securities decreased for the three months ended September 30, 2007 compared to the same prior year period due to the decrease in loan balances and the maturity and scheduled cash flows of investment securities. These decreases were offset by an increase in interest income from interest-earning cash accounts primarily held at the FHLB of Seattle. The yield on interest-earning assets was 8.31% for the three months ended September 30, 2007, compared to 8.32% for the same three months ended September 30, 2006.
Interest Expense.
Interest expense increased $445,000 to $6.6 million for the three months ended September 30, 2007, or 7.2%, compared to $6.2 million for the same prior year period. For the same periods, average interest-bearing liabilities were $621.7 million and $610.4 million, respectively. Much of this growth was in the higher yielding money market deposit accounts whose average balance increased 71.0% for the three months ended September 30, 2007 compared to same prior year period. This growth was partially offset by the 60.8% decrease in other interest-bearing liabilities due to the pay down of our line of credit with FHLB. The increase in interest expense was also attributable to the higher rates of interest paid on deposits and other interest-bearing liabilities. The weighted average interest rate on total deposits increased to 4.09% for the three months ended September 30, 2007 from 3.76% for the same period in the prior year. The weighted average cost of FHLB borrowings, junior subordinated debenture and capital lease obligations increased to 6.45% for the three months ended September 30, 2007 from 5.46% for the same period in the prior year.
20
<PAGE>
The following table sets forth, 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, ratio of interest-earning assets to interest-bearing liabilities and net interest margin.
|
Three Months Ended September 30,
|
|
2007
|
|
2006
|
|
Average
Balance
|
|
Interest
and
Dividends
|
|
Yield/
Cost
|
|
Average
Balance
|
|
Interest
and
Dividends
|
|
Yield/
Cost
|
|
(Dollars in thousands)
|
Interest-earning assets:
|
|
Mortgage loans
|
$571,750
|
|
$ 12,453
|
|
8.64%
|
|
$583,779
|
|
$ 12,709
|
|
8.64%
|
Non-mortgage loans
|
101,304
|
|
2,178
|
|
8.53
|
|
99,599
|
|
2,125
|
|
8.46
|
Total net loans (1)
|
673,054
|
|
14,631
|
|
8.62
|
|
683,378
|
|
14,834
|
|
8.61
|
|
|
Mortgage-backed securities (2)
|
7,313
|
|
85
|
|
4.61
|
|
9,352
|
|
109
|
|
4.62
|
Investment securities (2)(3)
|
12,940
|
|
197
|
|
6.04
|
|
23,009
|
|
284
|
|
4.90
|
Daily interest-bearing assets
|
30,538
|
|
397
|
|
5.16
|
|
7,002
|
|
92
|
|
5.21
|
Other earning assets (4)
|
8,031
|
|
23
|
|
1.14
|
|
7,567
|
|
4
|
|
0.21
|
Total interest-earning assets
|
731,876
|
|
15,333
|
|
8.31
|
|
730,308
|
|
15,323
|
|
8.32
|
|
|
Non-interest-earning assets:
|
|
Office properties and equipment, net
|
20,997
|
|
|
|
|
|
19,486
|
|
|
|
|
Other non-interest-earning assets
|
58,643
|
|
|
|
|
|
61,498
|
|
|
|
|
Total assets
|
$811,516
|
|
|
|
|
|
$811,292
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
Regular savings accounts
|
$ 27,738
|
|
38
|
|
0.55
|
|
$ 34,242
|
|
47
|
|
0.55
|
Interest checking accounts
|
137,678
|
|
1,148
|
|
3.31
|
|
148,320
|
|
1,221
|
|
3.27
|
Money market deposit accounts
|
242,822
|
|
2,741
|
|
4.48
|
|
141,966
|
|
1,524
|
|
4.26
|
Certificates of deposit
|
177,286
|
|
2,106
|
|
4.71
|
|
193,854
|
|
2,116
|
|
4.33
|
Total interest-bearing deposits
|
585,524
|
|
6,033
|
|
4.09
|
|
518,382
|
|
4,908
|
|
3.76
|
|
|
Other interest-bearing liabilities
|
36,130
|
|
587
|
|
6.45
|
|
92,065
|
|
1,267
|
|
5.46
|
Total interest-bearing liabilities
|
621,654
|
|
6,620
|
|
4.22
|
|
610,447
|
|
6,175
|
|
4.01
|
|
|
Non-interest-bearing liabilities:
|
|
Non-interest-bearing deposits
|
85,092
|
|
|
|
|
|
96,736
|
|
|
|
|
Other liabilities
|
8,206
|
|
|
|
|
|
7,548
|
|
|
|
|
Total liabilities
|
714,952
|
|
|
|
|
|
714,731
|
|
|
|
|
Shareholders' equity
|
96,564
|
|
|
|
|
|
96,561
|
|
|
|
|
Total liabilities and shareholders' equity
|
$811,516
|
|
|
|
|
|
$811,292
|
|
|
|
|
Net interest income (5)
|
|
|
$ 8,713
|
|
|
|
|
|
$ 9,148
|
|
|
Interest rate spread
|
|
|
|
|
4.09%
|
|
|
|
|
|
4.31%
|
Net interest margin
|
|
|
|
|
4.72%
|
|
|
|
|
|
4.97%
|
Ratio of average interest-earning assets
to average interest-bearing liabilities
|
|
|
|
|
117.73%
|
|
|
|
|
|
119.63%
|
Tax equivalent adjustment (3)
|
|
|
$ 19
|
|
|
|
|
|
$ 21
|
|
|
|
|
(1)
|
Includes non-accrual loans.
|
(2)
|
For purposes of the computation of average yield on investments available for sale, historical cost balances were utilized; therefore, the yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity.
|
(3)
|
Tax-equivalent adjustment relates to non-taxable investment interest income. Interest and rates are presented on a fully tax-equivalent basis under a tax rate of 34%.
|
(4)
|
In December 2006, FHLB of Seattle announced that quarterly cash dividends would resume after having operated under a regulatory directive since May 2005.
|
(5)
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
2007
|
2006
|
|
Net interest income as reported
|
$ 8,694
|
$ 9,127
|
|
Tax equivalent effect
|
19
|
21
|
|
Net interest income on a fully
Tax equivalent basis
|
$ 8,713
|
$ 9,148
|
|
21
<PAGE>
The following table sets forth the effects of changing rates and volumes on net interest income of the Company for the quarter ended September 30, 2007 compared to the quarter ended September 30, 2006. Variances that were immaterial have been allocated based upon the percentage relationship of changes in volume and changes in rate to the total net change.
|
Three Months Ended September 30,
|
|
2007 vs. 2006
|
|
Increase (Decrease)
Due to
|
Total
|
|
Volume
|
Rate
|
Increase
(
Decrease
)
|
|
(In thousands)
|
Interest Income:
|
|
|
|
Mortgage Loans
|
$ (256)
|
$ -
|
$ (256)
|
Non-mortgage loans
|
35
|
18
|
53
|
Mortgage-backed securities
|
(24)
|
-
|
(24)
|
Investment securities (1)
|
(143)
|
56
|
(87)
|
Daily interest-bearing
|
306
|
(1)
|
305
|
Other earning assets
|
-
|
19
|
19
|
Total interest income
|
(82)
|
92
|
10
|
|
|
|
|
Interest Expense:
|
|
|
|
Regular savings accounts
|
(9)
|
-
|
(9)
|
Interest checking accounts
|
(88)
|
15
|
(73)
|
Money market deposit accounts
|
1,135
|
83
|
1,218
|
Certificates of deposit
|
(189)
|
178
|
(11)
|
Other interest-bearing liabilities
|
(879)
|
199
|
(680)
|
Total interest expense
|
(30)
|
475
|
445
|
Net interest income (1)
|
$ (52)
|
$ (383)
|
$ (435)
|
(1) Interest is presented on a fully tax-equivalent basis under a tax rate of 34%
|
Provision for Loan Losses.
The provision for loan losses for the three months ended September 30, 2007 was $400,000, compared to $600,000 for the same period in the prior year. Net charge-offs for the current period were $66,000, compared to $37,000 net recoveries for the same period last year. The ratio of allowance for loan losses and unfunded loan commitments to total net loans was 1.36% at September 30, 2007, compared to 1.24% at September 30, 2006. Annualized net charge-offs to average net loans for the three-month period ended September 30, 2007 was 0.04%, compared to annualized net recoveries of 0.02% for the same period in the prior year. During the quarter ended September 30, 2007, management evaluated known and inherent risks in the loan portfolio and based on this analysis no changes were made in the estimation, assumptions and allocation of the allowance for loan losses. Management considers the allowance for loan losses at September 30, 2007 to be adequate to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio as described above under "Asset Quality."
Non-Interest Income.
Non-interest income decreased $75,000 to $2.2 million for the quarter ended September 30, 2007 compared to $2.3 million for the quarter ended September 30, 2006. Decreases in mortgage broker loan fees that are reported in fees and service charges, gain on sale of loans held for sale, loan servicing income and gain on sale of credit card portfolio offset the increases in asset management fees and bank owned life insurance. For the three months ended September 30, 2007 broker loan fees decreased by $79,000 compared to the same prior year period.
Non-Interest Expense.
Non-interest expense increased to $6.8 million for the quarter ended September 30, 2007 compared to $6.3 million for the same prior year period. The principal component of the Company's non-interest expense is salaries and employee benefits. Salaries and employee benefits increased $376,000 to $3.9 million for the three months ended September 30, 2007 compared to $3.5 million for the three months ended September 30, 2006. The majority of the increase is a result of the expansion of our lending team, the opening of a new branch and the increasing costs of employee benefits. Full-time equivalent employees increased to 260 at September 30, 2007 from 256 at September 30, 2006.
22
<PAGE>
Provision for Income Taxes.
Provision for income taxes was $1.2 million for the three months ended September 30, 2007, compared to $1.6 million for the three months ended September 30, 2006. The effective tax rate for the three months ended September 30, 2007 was 33.9% compared to 34.6% for the three months ended September 30, 2006. The 0.7% decrease in the effective tax rate for the three months ended September 30, 2007 is primarily attributable to the impact of the ESOP market value adjustment. The Company's overall effective tax rate at September 30, 2007 and 2006 takes into account the estimated Oregon apportionment factors for property, payroll and sales.
Comparison of Operating Results for the Six Months Ended September 30, 2007 and 2006
Net Interest Income.
Net interest income for the six months ended September 30, 2007 was $17.5 million, representing a decrease of $618,000, or 3.4%, compared to $18.1 million for the same prior year period. This decline reflected a 4.8% increase in the average balance of interest-bearing liabilities (an increase in both interest checking and money market deposit accounts) to $621.3 million. The ratio of average interest-earning assets to average interest-bearing liabilities decreased to 117.98% in the six-month period ended September 30, 2007 from 120.03% in the same prior year period. The ratio indicates that the interest-earning asset growth is being funded more by interest-bearing liabilities as compared to capital and non-interest-bearing demand deposits.
Interest Income
. Interest income totaled $30.7 million and $29.5 million, for the six months ended September 30, 2007 and 2006, respectively. The increased interest income of $1.2 million reflects the 3.0% increase in the average balance of interest earning assets for the current six month period compared to the same period in the prior year, which was attributable to increased loan originations and interest-earning cash accounts. The yield on interest-earning assets was 8.37% for the six months ended September 30, 2007 compared to 8.28% for the six months ended September 30, 2006.
Interest Expense
. Interest expense was $13.2 million for the six months ended September 30, 2007 an increase of 16.3% from $11.4 million for the same period in the prior year. The increase in interest expense reflects the higher market rates of interest paid on deposits and FHLB borrowings and the increased balance of interest-bearing liabilities when comparing average balances at September 30, 2007 and September 30, 2006. Average interest-bearing liabilities increased $28.6 million to $621.3 million for the six months ended September 30, 2007 from $592.7 million for the same prior year period. The weighted average interest rate on total deposits increased to 4.13% for the six months ended September 30, 2007 from 3.58% for the same period in the prior year. The weighted average interest rate of FHLB borrowings, junior subordinated debenture and capital lease obligations increased to 6.38% for the six months ended September 30, 2007 from 5.32% for same period in the prior year.
23
<PAGE>
|
Six Months Ended September 30,
|
|
2007
|
|
2006
|
|
Average
Balance
|
|
Interest
and
Dividends
|
|
Yield/
Cost
|
|
Average
Balance
|
|
Interest
and
Dividends
|
|
Yield/
Cost
|
|
(Dollars in thousands)
|
Interest-earning assets:
|
|
Mortgage loans
|
$577,300
|
|
$25,158
|
|
8.69%
|
|
$568,206
|
|
$24,505
|
|
8.60%
|
Non-mortgage loans
|
101,346
|
|
4,353
|
|
8.57
|
|
97,023
|
|
4,098
|
|
8.42
|
Total net loans (1)
|
678,646
|
|
29,511
|
|
8.67
|
|
665,229
|
|
28,603
|
|
8.58
|
|
|
Mortgage-backed securities (2)
|
7,547
|
|
176
|
|
4.65
|
|
9,640
|
|
223
|
|
4.61
|
Investment securities (2)(3)
|
14,884
|
|
427
|
|
5.72
|
|
23,413
|
|
569
|
|
4.85
|
Daily interest-bearing assets
|
24,094
|
|
625
|
|
5.17
|
|
5,523
|
|
141
|
|
5.09
|
Other earning assets (4)
|
7,828
|
|
38
|
|
0.97
|
|
7,567
|
|
7
|
|
0.18
|
Total interest-earning assets
|
732,999
|
|
30,777
|
|
8.37
|
|
711,372
|
|
29,543
|
|
8.28
|
|
|
Non-interest-earning assets:
|
|
Office properties and equipment, net
|
21,124
|
|
|
|
|
|
19,328
|
|
|
|
|
Other non-interest-earning assets
|
59,855
|
|
|
|
|
|
61,777
|
|
|
|
|
Total assets
|
$813,978
|
|
|
|
|
|
$792,477
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
Regular savings accounts
|
$ 27,987
|
|
77
|
|
0.55
|
|
$ 35,283
|
|
97
|
|
0.55
|
Interest checking accounts
|
141,910
|
|
2,380
|
|
3.35
|
|
137,809
|
|
2,105
|
|
3.05
|
Money market deposit accounts
|
231,752
|
|
5,284
|
|
4.55
|
|
137,948
|
|
2,781
|
|
4.02
|
Certificates of deposit
|
188,590
|
|
4,482
|
|
4.74
|
|
198,041
|
|
4,147
|
|
4.18
|
Total deposits
|
590,239
|
|
12,223
|
|
4.13
|
|
509,081
|
|
9,130
|
|
3.58
|
|
|
Other interest-bearing liabilities
|
31,056
|
|
993
|
|
6.38
|
|
83,598
|
|
2,230
|
|
5.32
|
Total interest-bearing liabilities
|
621,295
|
|
13,216
|
|
4.24
|
|
592,679
|
|
11,360
|
|
3.82
|
|
|
Non-interest-bearing liabilities:
|
|
Non-interest-bearing deposits
|
84,513
|
|
|
|
|
|
95,602
|
|
|
|
|
Other liabilities
|
8,871
|
|
|
|
|
|
8,701
|
|
|
|
|
Total liabilities
|
714,679
|
|
|
|
|
|
696,982
|
|
|
|
|
Shareholders' equity
|
99,299
|
|
|
|
|
|
95,495
|
|
|
|
|
Total liabilities and shareholders' equity
|
$813,978
|
|
|
|
|
|
$792,477
|
|
|
|
|
Net interest income
|
|
|
$ 17,561
|
|
|
|
|
|
$ 18,183
|
|
|
Interest rate spread
|
|
|
|
|
4.13%
|
|
|
|
|
|
4.46%
|
Net interest margin
|
|
|
|
|
4.78%
|
|
|
|
|
|
5.10%
|
Ratio of average interest-earning assets
to average interest-bearing liabilities
|
|
|
|
|
117.98%
|
|
|
|
|
|
120.03%
|
Tax equivalent adjustment (3)
|
|
|
$ 39
|
|
|
|
|
|
$ 43
|
|
|
|
|
(1)
|
Includes non-accrual loans.
|
(2)
|
For purposes of the computation of average yield on investments available for sale, historical cost balances were utilized; therefore, the yield information does not give effect to change in fair value that are reflected as a component of shareholders' equity.
|
(3)
|
Tax-equivalent adjustment relates to non-taxable investment interest income. Interest and rates are presented on a fully tax-equivalent basis under a tax rate of 34%.
|
(4)
|
In December 2006, FHLB of Seattle announced that quarterly cash dividends would resume after having operated under a regulatory directive since May 2005.
|
(5)
|
|
|
Six Months Ended
September 30,
|
|
|
2007
|
2006
|
|
Net interest income as reported
|
$ 17,522
|
$ 18,140
|
|
Tax equivalent effect
|
39
|
43
|
|
Net interest income on a fully
Tax equivalent basis
|
$ 17,561
|
$ 18,183
|
|
24
<PAGE>
The following table sets forth the effects of changing rates and volumes on net interest income of the Company for the six months ended September 30, 2007 compared to the six months ended September 30, 2006. Variances that were immaterial have been allocated based upon the percentage relationship of changes in volume and changes in rate to the total net change
|
Six Months Ended September 30,
|
|
2007 vs. 2006
|
|
Increase (Decrease)
Due to
|
Total
|
|
Volume
|
Rate
|
Increase
(
Decrease
)
|
|
(In thousands)
|
Interest Income:
|
|
|
|
Mortgage Loans
|
$ 395
|
$ 258
|
$ 653
|
Non-mortgage loans
|
182
|
73
|
255
|
Mortgage-backed securities
|
(49)
|
2
|
(47)
|
Investment securities (1)
|
(232)
|
90
|
(142)
|
Daily interest-bearing
|
482
|
2
|
484
|
Other earning assets
|
-
|
31
|
31
|
Total interest income
|
778
|
456
|
1,234
|
|
|
|
|
Interest Expense:
|
|
|
|
Regular savings accounts
|
(20)
|
-
|
(20)
|
Interest checking accounts
|
64
|
211
|
275
|
Money market deposit accounts
|
2,096
|
407
|
2,503
|
Certificates of deposit
|
(204)
|
539
|
335
|
Other interest-bearing liabilities
|
(1,614)
|
377
|
(1,237)
|
Total interest expense
|
322
|
1,534
|
1,856
|
Net interest income (1)
|
$ 456
|
$ (1,078)
|
$ (622)
|
(1) Interest is presented on a fully tax-equivalent basis under a tax rate of 34%
|
Provision for Loan Losses
. The provision for loan losses for the six months ended September 30, 2007 was $450,000, compared to $950,000 for the same period in the prior year. Net charge-offs for the six months ended September 30, 2007 were $41,000, compared to $92,000 net recoveries for the same period of last year. The ratio of allowance for loan losses to total net loans increased to 1.30% at September 30, 2007, compared to 1.18% at September 30, 2006. Annualized net charge-offs to average net loans for the six-month period ended September 30, 2007 was 0.01%, compared to annualized net recoveries of 0.03% for the same period in the prior year. During the six months ended September 30, 2007, management evaluated known and inherent risks in the loan portfolio and based on this analysis changes were made in the estimation, assumptions and allocation of the allowance for loan losses. The national and local economy housing market continues to be experiencing a slow down in housing sales which is impacting land developers' ability to sell their products. The estimated loan loss rate was increased by 0.25% to 1.50% for the loans consisting of land and lots for development and builder lot loans. Management considers the allowance for loan losses at September 30, 2007 to be adequate to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio as described above under "Asset Quality."
Non-Interest Income
. Non-interest income increased $112,000 or 2.5%, to $4.5 million for the six months ended September 30, 2007 from $4.4 million for the six months ended September 30, 2006. Asset management fees from fiduciary services increased by $170,000 to $1.1 million for the six months ended September 30, 2007, compared to $891,000 for the six months ended September 30, 2006. RAM Corp. had $302.9 million in assets under management at September 30, 2007 compared to $276.3 million at September 30, 2006.
Non-Interest Expense
. Non-interest expense increased $571,000, or 4.4%, to $13.6 million for the six months ended September 30, 2007, compared to $13.0 million for the same period last year. The principal component of the Company's non-interest expense is salaries and employee benefits. Salaries and employee benefits increased $509,000 to $7.9 million for the six months ended September 30, 2007 compared to $7.4 million for the same period in the prior year. The majority of the increase is a result of the expansion of our lending team, opening a new branch and the increasing costs of employee benefits. Full-time equivalent employees increased to 260 at September 30, 2007 from 256 at September 30, 2006.
Occupancy and depreciation expense totaled $2.5 million for the six months ended September 30, 2007, compared to $2.2 million for the same period in prior year. This increase is the result of increases in rent and related costs at several banking facilities, increased software depreciation expense and the opening of the Gateway branch in November 2006.
25
<PAGE>
Data processing expense was $376,000 for the six months ended September 30, 2007 compared to the $557,000 for the six months ended September 30, 2006. The $181,000 decrease reflects the savings attributable to the April 2006 change in the service bureau that performs the Bank's core computer system processing.
Provision for Income Taxes
. Provision for income taxes was $2.7 million for the six months ended September 30, 2007, compared to $3.0 million for the six months ended September 30, 2006 as a result of the decrease in income before taxes. The effective tax rate for the six months ended September 30, 2007 was 34.0% compared to 34.5% for the six months ended September 30, 2006. The 0.5% decrease in the effective tax rate for the six months ended September 30, 2007 is primarily attributable to the impact of the ESOP market value adjustment. The Company's overall effective tax rate at September 30, 2007 takes into account Oregon apportionment factors for property, payroll and sales.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's Asset Liability Committee is responsible for implementing the interest rate risk policy which sets forth limits established by the Board of acceptable changes in net interest income and the portfolio value from specified changes in interest rates. The OTS defines net portfolio value as the present value of expected cash flows from existing assets minus the present value of expected cash flows from existing liabilities plus the present value of expected cash flows from existing off-balance sheet contracts. The Asset Liability Committee reviews, among other items, economic conditions, the interest rate outlook, the demand for loans, the availability of deposits and borrowings, and the Company's current operating results, liquidity, capital and interest rate exposure. In addition, the Asset Liability Committee monitors asset and liability characteristics on a regular basis and performs analyses to determine the potential impact of various business strategies in controlling interest rate risk and other potential impact of these strategies upon future earnings under various interest rate scenarios. Based on these reviews, the Asset Liability Committee formulates a strategy that is intended to implement the objectives contained in its business plan without exceeding limits set forth in the Company's interest rate risk policy for losses in net interest income and net portfolio value.
There has not been any material change in the market risk disclosures contained in the 2007 Form 10-K.
Item 4. Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13(a) - 15(e) of the Securities Exchange Act of 1934) was carried out as of September 30, 2007 under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management as of the end of the period covered by this report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Securities and Exchange Act of 1934 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.
In the quarter ended September 30, 2007, the Company did not make any changes in its internal control over financial reporting that has materially affected, or is reasonably likely to materially affect these controls. The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business.
While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
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