10-Q 1 sep01.txt SEP01 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the quarterly period ended September 30, 2001 or ------------------ [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from________________ to____________________. Commission file number 0-27590 INDEPENDENT FINANCIAL NETWORK, INC. (Exact name of issuer as specified in its charter) Oregon 93-0800253 . --------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 170 S. Second St., Coos Bay, Oregon 97420 . ----------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) (541) 267-5356 -------------- (Issuer' telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Class Outstanding at November 8, 2001 ----- ------------------------------- Common Stock, $5.00 par value 5,432,460 ================================================================================ Form 10-Q Table of Contents Part I Item 1. Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis Item 3. Quantitative and Qualitative Disclosures about Market Risk Part II Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Signatures PART I. FINANCIAL INFORMATION Item 1. Financial Statements. INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS-UNAUDITED (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) ASSETS September 30, 2001 Dec. 31, 2000 ------ ------------------ ------------- Cash and cash equivalents: Cash and due from banks $15,265 $12,459 Federal funds sold 15,413 5,750 ------ ----- Total cash and cash equivalents 30,678 18,209 Investment securities available for sale 104,321 108,406 Loans, net 254,868 215,369 Mortgage loans held for sale, at cost which approximates market 4,241 2,280 Net investment in direct financing leases 4,539 3,756 Purchased mortgage servicing rights 4,705 3,137 Premises and equipment, net 14,564 14,917 Federal Home Loan Bank stock, at cost 2,539 2,374 Federal Reserve Bank stock, at cost 767 759 Goodwill, net 1,743 190 Other assets 5,281 4,105 ----- ----- Total assets $428,246 $373,502 ======== ======== LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY ------------------------------------------------------- Liabilities: Deposits: Demand $68,282 $57,503 NOW accounts 43,743 42,360 Money market accounts 65,209 54,117 Savings accounts 23,311 21,038 Time deposit 156,443 137,255 ------- ------- Total deposits 356,988 312,273 Securities sold under agreements to repurchase 10,420 10,619 Short term borrowings -- 139 Other borrowings 3,875 2,000 Federal Home Loan Bank borrowings 15,000 10,000 Other liabilities 4,655 3,207 ----- ----- Total liabilities 390,938 338,238 ------- ------- Minority interest 1,591 2,579 Shareholders' equity: Nonvoting preferred stock, $5 par value. Authorized 5,000,000 shares; none issued -- -- Voting preferred stock, $5 par value. Authorized 5,000,000 shares; none issued -- -- Common stock, $5 par value. Authorized 10,000,000 shares - issued and outstanding 5,427,710 shares in 2001 (5,418,646 shares in 2000) 27,138 27,093 Surplus 4,429 4,543 Retained earnings 2,166 364 Accumulated other comprehensive income 1,984 685 ----- --- Total shareholders' equity 35,717 32,685 ------ ------ Total liabilities, minority interest and shareholders' equity $428,246 $373,502 ======== ======== See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements. INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS-UNAUDITED (DOLLARS IN THOUSANDS) Nine months ended September 30, 2001 2000 ---- ---- Cash flows provided by operating activities: Net income $1,674 $1,499 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation 1,296 1,113 Net amortization of investment premiums/discounts 130 187 Deferred tax expense (benefit) 18 (187) Provision for loan losses 339 356 Net gain on call/sale of investment securities available for sale (177) (4) Federal Home Loan Bank stock dividend (123) (108) Changes in balance sheet items: (Increase)/decrease in mortgage loans held for sale (1,961) 474 Net increase in mortgage servicing rights (1,568) (277) Increase in other assets (2,729) (419) Increase in other liabilities 749 1,137 Net income attributable to minority interest 7 88 - -- Net cash (used in) provided by operating activities (2,345) 3,859 ------ ----- Cash flows from investing activities: Purchase of investment securities available for sale (23,793) (38,698) Proceeds from sale of securities available for sale 11,961 1,057 Proceeds from maturities and call of investment securities available for sale 18,072 16,957 Net loan originations (16,740) (21,212) Purchase of participations (23,098) (7,622) Additions to premises and equipment (943) (1,873) Purchase of Federal Home Loan Bank stock (42) (47) Purchase of Federal Reserve Bank stock (8) (3) Originations of direct financing leases (2,225) (1,655) Gross payments on direct financing leases 1,442 943 Minority interest in subsidiaries (995) (852) ---- ---- Net cash used in investing activities (36,369) (53,005) ------- ------- Cash flows from financing activities: Net increase in deposits 44,715 51,143 Decrease in securities sold with agreements to repurchase (199) (2,376) Federal Home Loan Bank borrowings 5,000 10,000 Payments on Federal Home Loan Bank borrowings -- (4,000) Increase in other borrowings 1,875 500 Purchase of common stock (69) -- Decrease in short term borrowings (139) (118) ---- ---- Net cash provided by financing activities 51,183 55,149 ------ ------ Net increase in cash and cash equivalents 12,469 6,003 Cash and cash equivalents at beginning of period 18,209 16,692 ------ ------ Cash and cash equivalents at end of period $30,678 $22,695 ======= ======= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $9,924 $8,000 Income taxes $295 $206 Supplemental disclosures of investing activities: Unrealized gain on investment securities available for sale, net of tax $1,299 $533 Acquisition of minority interest in Lincoln Security Bank $2,600 $-- See accompanying notes to condensed consolidated financial statements. INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) Basis of Financial Statement Presentation ----------------------------------------- The interim condensed consolidated financial statements include the accounts of Independent Financial Network (IFN, or the Company) (formerly Security Bank Holding Company), a bank holding company, its wholly-owned subsidiaries, IFN Bank (which includes Security Bank and its divisions, Security Mortgage and Roseburg Community Banking Company), Pacific State Bank, Family Security Bank, Lincoln Security Bank, and Alliance Technology Inc., and its majority-owned subsidiaries, McKenzie State Bank and Oregon State Bank. All significant intercompany accounts and transactions have been eliminated in consolidation. The interim condensed consolidated financial statements include all normal recurring adjustments that the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the condensed consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and income and expenses for the periods. Actual results could differ from those estimates. The balance sheet data as of December 31, 2000 was derived from audited financial statements, but does not include all disclosures contained in the Company's 2000 Annual Report to Shareholders. The interim condensed consolidated financial statements should be read in conjunction with the December 31, 2000 consolidated financial statements, including the notes thereto, included in the Company's 2000 Annual Report to Shareholders. Certain amounts for 2000 have been reclassified to conform with the 2001 presentation. The results of operations for the interim periods shown in this report are not necessarily indicative of results for any future interim period or the entire fiscal year. (2) Stock Dividend -------------- On January 16, 2001, the Company declared a 5% stock dividend on the Company's common stock, which was paid on March 16, 2001 to stockholders of record on March 2, 2001. The dividend was charged to retained earnings in the amount of $1.2 million, which was based on the then-current fair value of the common stock issued in respect of the dividend. In connection with the 5% stock dividend, the Company increased the number of stock options and purchase rights under the 1995 Stock Option Plan by 5% and reduced the exercise prices accordingly. All references to weighted average shares outstanding, per share amounts, stock purchase rights, option shares, and exercise prices included in the accompanying consolidated financial statements and notes reflect the 5% stock dividend and its retroactive effect. (3) Earnings Per Share ------------------ Basic and diluted earnings per share are based on the weighted average number of common shares outstanding during each period, with diluted earnings data including the effect of the exercise of all authorized and outstanding options. The effect of stock options outstanding on diluted earnings per share is calculated using the treasury stock method. The following table presents information relating to the weighted average number of common shares outstanding for all periods presented for both basic and diluted earnings per share calculations:

*Options to purchase 6,078 shares of common stock at $10.90 per share were outstanding during the nine months ended September 30, 2001 but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares at that date. **Options to purchase 259,392 shares of common stock at $4.56-$10.90 per share were outstanding during the nine months ended September 30, 2000 but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares at that date. INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) ***Options to purchase 131,279 shares of common stock at $6.68-$10.90 per share were outstanding during the nine months ended September 30, 2001 but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares at that date. (4) Other Borrowings ---------------- At September 30, 2001 the Company had $3,875,000 in borrowings from a third party bank, with interest based on the prime rate (6.00% at September 30, 2001), payable quarterly. The term loan will mature in 2011. (5) Federal Home Loan Bank Borrowings --------------------------------- At September 30, 2001 the Company had outstanding advances from the Federal Home Loan Bank ("FHLB") of $15,000,000 with a weighted average rate of 5.02% and a maturity in 2002. These advances were collateralized by certain investment securities, certain residential first mortgage loans, deposits with the FHLB, and FHLB stock totaling approximately $15,000,000 at September 30, 2001. (6) Acquisition of Lincoln Security Bank ------------------------------------ In January of 2001 the Company completed the purchase of the minority interest in Lincoln Security Bank, resulting in IFN having 100% ownership. IFN had owned approximately 68% of Lincoln Security Bank since its inception in May 1996. The purchase price of the minority interest was $25 per share for a total of approximately $2.6 million. The acquisition was accounted for using the purchase accounting method, and resulted in approximately $1.4 million in goodwill, which is being amortized over 15 years. (7) Merger Agreement ---------------- On June 22, 2001 Independent Financial Network announced it had entered into an agreement to merge into Umpqua Holdings Corporation, and to merge its six subsidiary banks into Umpqua Holdings' subsidiary bank, Umpqua Bank. The proposed transaction, which is subject to regulatory and shareholder approvals, is structured as a tax-free exchange. The merger of the holding company and the wholly owned subsidiaries is expected to be accounted for as a pooling of interests. The merger of IFN's majority owned subsidiaries into Umpqua Bank will be accounted for using the purchase accounting method. The transaction is expected to close in the fourth quarter of this year. Cost incurred to September 30, 2001, relating to the merger agreement are $369,000. These costs have been captialized and reported in other assets on the balance sheet as of September 30, 2001. Upon finalization of the merger agreement the costs will be expensed in the income statement. INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (8) Segment Information ------------------- The following table presents summary income and balances for reportable segments and reconciles segments to the Company's consolidated totals for the quarter ended September 30, 2001.

The following table presents summary income and balances for reportable segments and reconciles segments to the Company's consolidated totals for the nine months ended September 30, 2001.

INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table presents summary income and balances for reportable segments and reconciles segments to the Company's consolidated totals for the quarter ended September 30, 2000.

The following table presents summary income and balances for reportable segments and reconciles segments to the Company's consolidated totals for the nine months ended September 30, 2000.

INDEPENDENT FINANCIAL NETWORK & SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (9) Recently Issued Accounting Standards ------------------------------------ In July 2001, the Financial Accounting Standards Board ("FASB") issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations initiated after June 30, 2001. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001. The Company will adopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142, the Company will be required to perform a transition goodwill impairment assessment. The Company has not yet determined the impact these standards will have on its results of operations and financial position. Hedging Activities- Deferral of the Effective Date of SFAS No. 133, this SFAS is effective for fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133 effective January 1, 2001. Implementation of this statement did not have a material impact on the Consolidated Financial Statements. In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation-an interpretation of APB Opinion No. 25," (FIN 44). The Company adopted the provision of FIN 44 as of the reported effective dates and this adoption has not had a significant impact on the Company's condition or results of operations. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. FOR THE QUARTER ENDED SEPTEMBER 30, 2001 AND 2000 GENERAL. Net income decreased to $673,000 for the three months ended September 30, 2001 from $712,000 for the same period in 2000. The overall decrease is primarily related to an increase in the provision for loan losses, as discussed below. NET INTEREST INCOME. Net interest income is the difference between interest income (principally from loans and investment securities) and interest expense (principally on customer deposits and borrowings). Changes in net interest income result from changes in volume, net interest spread, and net interest margin. Volume refers to the average dollar level of interest earning assets and interest bearing liabilities. Net interest spread refers to the differences between the average yield on interest earning assets and the average cost of interest bearing liabilities. Net interest margin refers to net interest income divided by average interest earning assets. The Company's profitability, like that of many financial institutions, is dependent to a large extent upon net interest income. Since the Company tends to be asset sensitive, as interest earning assets mature or reprice more quickly than interest bearing liabilities in a given period, a significant decrease in the market rates of interest could adversely affect net interest income. In contrast, an increasing interest rate environment could favorably impact net interest income. Competition and the economy also impact the Company's net interest income. Net interest income before the provision for loan losses increased $447,000 or 11% for the three months ended September 30, 2001 over the same period in 2000. This increase represents an increase in volume of $487,000, which was partially offset by a $40,000 decrease resulting from declining interest rates. Average interest earning assets increased $45.8 million, or 14%, while average interest bearing liabilities increased $50.2 million, or 15%. The increase in average interest earning assets and interest bearing liabilities resulted from the Company's overall growth strategy, primarily in loans and deposits. The average net interest spread decreased from 4.92% to 4.85%, mainly due to the additional borrowings. Average rates paid decreased 38 basis points to 3.39% in the third quarter of 2001 from 3.77% in the third quarter of 2000. Average earning asset yields decreased 45 basis points from 8.69% to 8.24%, resulting from the decline in interest rates. The Company's tax-equivalent net interest margin for the third quarter of 2001 was 4.84%, a decrease of 13 basis points from 4.97% for the third quarter of 2000. PROVISION FOR LOAN LOSSES. The loan loss provision during the three-month period ended September 30, 2001, was $197,000 compared to $92,000 for the same period in 2000. The loan loss provision was increased due to significant loan growth and in light of current and expected economic conditions. At September 30, 2001, the consolidated loan loss ratio was 1.08% of total loans, compared to 1.22% at December 31, 2000. The decrease in loan loss ratio is due primarily to two factors. First, while we have experienced loan growth within all business units, a significant portion has come from our mortgage company, of which the loans are lower risk and short-term in nature and will be sold into the secondary market within the next two quarters. Second, recent guidance from regulatory agencies has been incorporated into the analysis of the Company's allowance, resulting in a smaller loan loss ratio. Management believes the loan loss provision maintains the allowance for loan losses at an appropriate level based on anticipated losses inherent in the portfolio. Beginning in late 2000, the Company began performing a detailed assessment of potential risk in the loan portfolio, using several methodologies including local economic conditions, to estimate the appropriate allowance for loan losses. Additional provision may be necessary in future periods based on changes in loan quality and growth in the overall loan portfolio. The allowance for loan losses was $2,879,000 at September 30, 2001, compared to $2,742,000 at December 31, 2000. Net charge-offs during the three-month periods were $128,000 and $107,000 for 2001 and 2000, respectively. Non-performing assets (defined as loans on non-accrual status, loans 90 days or more past due, and other real estate owned) were $1,371,000 and $650,000 at September 30, 2001 and December 31, 2000, respectively. Management believes these loans are adequately secured and that no material losses will be incurred in excess of established reserves. OTHER INCOME. Other income increased to $1,903,000 for the three months ended September 30, 2001 as compared to $1,167,000 for the same period in 2000. The increase in other income is due primarily to an increase in fees from sold real estate loans, due to increased real estate lending activity as interest rates have declined. Loan servicing fees also have increased due to an increase in the mortgage-servicing portfolio. Due to the overall increase in deposits, income from service charges on deposit accounts also increased. OTHER EXPENSE. Other expense increased 26% to $5,180,000 for the three months ended September 30, 2001 compared to $4,118,000 for the same period in 2000. Salaries and employee benefits, the largest non-interest expense, increased $628,000 or 27% for the same period. The increase in salaries is primarily due to the additions of Alliance Technology Inc., the new branches in Winston, Lakeside and Waldport, as well as annual increases in personnel costs. An increase in occupancy expense was also experienced due to the new branches and the addition of Alliance Technology Inc. The decline in market rates also led to an increase of $76,000 in early payoffs of mortgage servicing rights. FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 GENERAL. Net income increased 12% to $1,674,000 for the nine months ended September 30, 2001 from $1,499,000 for the same period in 2000. The increase is primarily due to growth in the overall balance sheet associated with the Company's expansion. Fees from sold real estate loans also increased, with higher real estate lending activity due to the decline in interest rates. A $177,000 gain on the sale of investment securities available for sale was recognized in the nine months ended September 30, 2001. Increases were offset by higher expenses due to expansion in Alliance Technology Inc., new branch offices in Winston, Lakeside and Waldport, Oregon, early payoffs of mortgage servicing rights and other recurring personnel related increases. NET INTEREST INCOME. Net interest income before the provision for loan losses increased $1,288,000 or 11% for the nine months ended September 30, 2001 over the same period in 2000. Of the increase of $1,288,000, an increase in volume accounted for an increase of $1,446,000, offset by a decrease in rate of $158,000. Average interest earning assets increased $47.3 million, while average interest bearing liabilities increased $48.5 million. The increase in average interest earning assets and interest bearing liabilities resulted from the Company's overall growth and its leverage of loans and deposits. The average net interest spread decreased from 4.89% to 4.79%, mainly due to the higher cost of additional borrowings. Average rates paid increased 5 basis points to 3.67% for the nine months ended September 30, 2001 from 3.62% for the same period of 2000. Average earning asset yields decreased 5 basis points from 8.51% to 8.46%, resulting from a decrease in market interest rates for loans and investment securities. The Company's tax-equivalent net interest margin for the nine months ended September 30, 2001 was 4.80%, a decrease of 14 basis points from 4.94% for the same period of 2000. PROVISION FOR LOAN LOSSES. The loan loss provision during the nine-month period ended September 30, 2001, was $339,000 compared to $356,000 for the same period in 2000. At September 30, 2001, the consolidated loan loss ratio was 1.08% of total loans, compared to 1.31% at September 30, 2000. The decrease in provision and the loan loss ratio is due primarily to two factors. First, while we have experienced loan growth within all business units, a significant portion has come from our mortgage company, of which the loans are lower risk and short-term in nature and will be sold into the secondary market within the next two quarters. Second, recent guidance from regulatory agencies has been incorporated into the analysis of the Company's allowance. Management believes the loan loss provision maintains the allowance for loan losses at an appropriate level based on anticipated losses inherent in the portfolio. The Company has performed a detailed assessment of potential risk in the loan portfolio, using several methodologies including local economic conditions, to estimate the appropriate allowance for loan losses. Additional provision may be necessary in future periods based on changes in loan quality and growth in the overall loan portfolio. The allowance for loan losses was $2,879,000 at September 30, 2001, as compared to $2,870,000 at September 30, 2000. Net charge-offs during the nine-month periods were $202,000 and $132,000 for 2001 and 2000, respectively. Non-performing assets (defined as loans on non-accrual status, loans 90 days or more past due, and other real estate owned) were $1,371,000 and $798,000 at September 30, 2001 and 2000, respectively. Management believes these non-performing loans are adequately secured and that no significant losses will be incurred. OTHER INCOME. Other income increased 60% to $5,624,000 for the nine months ended September 30, 2001 as compared to $3,513,000 for the same period in 2000. The increase is primarily due to increases in fees from sold real estate loans and gains on the sale of investment securities. Fees from sold real estate loans increased due to higher real estate lending activity as interest rates declined. Fees from loan servicing also increased with the increase in mortgage loans serviced. Increases were experienced in all other income categories due primarily to the Company's growth. OTHER EXPENSE. Other expense increased 26% to $15,480,000 for the nine months ended September 30, 2001 compared to $12,252,000 for the same period in 2000. Salaries and employee benefits, the largest non-interest expense, increased $2,056,000. The increase in salaries is primarily due to the additions of Alliance Technology Inc., the new branches in Winston, Lakeside and Waldport, and annual increases in personnel costs. Additional increases were experienced in all other categories resulting from the Company's overall growth strategy. Increased expense also resulted from the increase in early pay-offs on mortgage servicing rights associated with the decline in market rates and resulting refinancings. -------------------------------------------------------------------------------- FINANCIAL CONDITION Total assets increased 15% to $428 million at September 30, 2001 compared to $374 million at December 31, 2000, resulting from increased deposit and borrowing levels associated with the Company's expansion. Investment securities available for sale decreased $4 million to $104 million at September 30, 2001. The Company sold investments to fund loan growth. Loans and leases, net of reserves, increased from $221 million at December 31, 2000 to $264 million at September 30, 2001. The increase is due to the Company's growth strategy and the addition of the new bank branches. Purchased mortgage servicing rights increased 50% to $4.7 million at September 30, 2001. The increase is due to increases in the amount of new loans sold, with IFN retaining servicing. The increase in bank premises and equipment owned at September 30, 2001 resulted from the Company's expansion activities, including the addition of Alliance Technology Inc. and the construction of the new Winston/Green branch of Roseburg Community Banking Company in Winston, Oregon and the new Waldport branch of Lincoln Security Bank in Waldport, Oregon. Goodwill increased from $190,000 at December 31, 2000 to $1,743,000 at September 30, 2001. The increase is due to goodwill created from the buyout of Lincoln Security Bank in January of 2001 and additional purchases of McKenzie State Bank common stock over the past year, which have been accounted for under the purchase method. Deposit growth continued during the third quarter of 2001, increasing $45 million, or 14% to $357 million at September 30, 2001, compared to $312 million at December 31, 2000. The growth in 2001 has been spread predominantly between demand accounts, money market accounts, and time certificates of deposit. Other borrowings increased to $3,875,000 at September 30, 2001. The increase is due to borrowings from a third party bank, the majority of which the Company used for the purchase of the minority shares in Lincoln Security Bank in January 2001. Federal Home Loan Bank borrowings increased to $15 million at September 30, 2001, compared to $10 million at December 31, 2000. Management increased its borrowings to provide for the Company's liquidity needs associated with strong loan growth. Other liabilities increased 45% to $4.7 million at September 30, 2001, compared to $3.2 million at December 31, 2000, due primarily to increases in temporary suspense items and accrued expenses. LIQUIDITY Liquidity enables the Company to meet the withdrawals of its depositors and the borrowing needs of its loan customers. The Company maintains its liquidity position by managing its cash resources and maintaining a stable core deposit base. A further source of liquidity is the Company's ability to borrow funds. The Company maintains four unsecured lines of credit totaling $33 million for the purchase of funds on an overnight basis. The Company is also a member of the Federal Home loan Bank, which provides a secured line of credit in the amount of $54 million, as well as other funding opportunities for liquidity and asset/liability matching. As of September 30, 2001, the Company had no borrowings under unsecured lines of credit and $15 million from the Federal Home Loan Bank. Interest rates charged on the lines are determined by market factors. The Company's liquidity has been stable and, in management's opinion, adequate over the past several years. Short-term deposits have continued to grow and excess cash is invested on a short-term basis into Federal funds sold. The Company's primary source of funds is consumer deposits and commercial accounts. These funds are not subject to significant movements as a result of changing interest rates and other economic factors, and therefore enhance the Company's long-term liquidity. CAPITAL RESOURCES Beginning in 1990, federal regulators required banks and bank holding companies to measure and disclose their Risk-Based Capital Ratios. This analysis weights balance sheet and off-balance sheet items for their inherent risk. It requires minimum standards for Risk-Based Capital by Capital Tier. Full implementation of this analysis was required in 1992, requiring a minimum Total Risk-Based Capital Ratio of 8.00%, a minimum Tier 1 Capital Ratio of 4.00% and a minimum Leverage Capital Ratio of 4.00%. At September 30, 2001, the Company's estimated regulatory capital ratios were as follows: Total Risk-Based Capital Ratio of 11.71%, Tier 1 Capital Ratio of 10.77% and Leverage Capital Ratio of 7.95%. This compares to 13.53%, 12.51% and 9.86% for total Risk-Based Capital Ratio, Tier 1 Capital Ratio and Leverage Capital Ratio, respectively, at December 31, 2000. If the Company were fully leveraged, further growth would be restricted to the level attainable by generating and reinvesting net income unless the additional capital were available from outside sources. The decrease in regulatory capital from December 2000 results primarily from the purchase of the outstanding minority interest in Lincoln Security Bank and the related increase in goodwill amortization. INCOME TAXES The effective tax rate differs from the federal statutory rate primarily because of tax-exempt interest income and the provision for state taxes. Item 3. Quantitative and Qualitative Disclosures about Market Risk. The Company considers interest rate risk, credit risks and operations risks as the most significant risks impacting its operations and financial condition. Other types of market risk, such as foreign exchange risk and commodity price risk, do not materially impact the Company in the normal course of operations. The Company relies on prudent underwriting standards, loan reviews and an adequate allowance for loan losses to mitigate credit risk. Internal controls and periodic internal audits of business operations mitigate operations risk. The Company uses an asset/liability model to measure and monitor interest rate risk. The model projects net interest income for the upcoming twelve months in various interest rate scenarios. The model the Company uses includes assumptions regarding prepayments of assets and early withdrawals of liabilities, the level and mix of interest earning assets and interest bearing liabilities, the level and responsiveness of interest rates on deposit products without stated maturities and the level of nonperforming assets. These assumptions are based on management's judgment and future expected pricing behavior. Actual results could vary significantly from the results derived from the model. The Company's interest rate risk has not changed materially since December 31, 2000. The Company also has increased its emphasis on noninterest sources of revenue in order to further stabilize future earnings. INFLATION The primary impact of inflation on the Company's 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 institution's 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. Increased inflation can magnify asset growth and require the Company to increase its interest expense, and significant inflationary pressures could require the Company to increase equity capital at a faster rate than would otherwise be necessary. PART II. OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Securities Holders. None. Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. None. (b) Reports on Form 8-K. None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATED: November 8, 2001. INDEPENDENT FINANCIAL NETWORK, INC. By: /s/ Charles D. Brummel ----------------------- Charles D. Brummel Chairman and Chief Executive Officer

INDEPENDENT FINANCIAL NETWORK 10-Q