CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company’s Repo Sweep accounts are treated as financings, and the obligations to repurchase securities sold are reflected as borrowed money in the Company’s consolidated statements of condition. The securities underlying these repurchase agreements continue to be reflected as assets of the Company.
During 2006, the Company repaid $87.0 million of maturing FHLB advances.
During 2004, the Company completed a restructuring of its FHLB advances by prepaying $400.0 million of callable fixed-rate advances with an average cost of 5.92% and an average remaining term of 64.2 months. These prepaid advances were replaced with $325.0 million of new non-callable FHLB advances. These new advances included an aggregate $271.0 million of non-callable fixed-rate FHLB advances with an average cost of 3.64% and an average term of 34.3 months in a laddered portfolio with maturities ranging from 21 to 60 months.
In conjunction with the FHLB debt restructure, the Company paid $42.0 million of prepayment penalties related to the prepaid advances and recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during 2004. The remaining $32.2 million of prepayment penalties were deferred as an adjustment to the carrying value of the borrowings and are recognized in interest expense as an adjustment to the cost of the new borrowings over their remaining life.
At December 31, 2006, the Company has a total of $6.2 million of deferred premium on the early extinguishment of debt remaining from the 2004 FHLB debt restructure. The increase in interest expense related to the remaining deferred premium is expected to be $4.5 million, $1.5 million and $200,000 in the years ended December 31, 2007, 2008 and 2009, respectively.
Interest expense on borrowed money totaled $20.5 million, $25.9 million and $26.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. Included in interest expense was $9.6 million, $14.4 million and $2.1 million, respectively, of amortization of the deferred premium on the early extinguishment of debt for the years ended December 31, 2006, 2005 and 2004.
At December 31, 2006, the Company had two lines of credit with a maximum of $40.0 million in unsecured overnight federal funds at the federal funds market rate at the time of any borrowing. At December 31, 2006 and 2005, the Company did not utilize these lines. The maximum amount borrowed during the years ended December 31, 2006 and 2005 was $9.8 million and $11.3 million, respectively, and the weighted-average rate paid was 5.26% and 3.35%.
At December 31, 2006, the Company also had a $10.0 million revolving line of credit with a maturity date of March 31, 2007. Each borrowing under the line carries an interest rate, at the Company’s option, of either the Wall Street Journal Prime Rate minus 75 basis points or the three month London Interbank Offered Rate. The line of credit obtained by the Company is secured by all of the Bank’s common stock which is held by the Company. The Company has not borrowed any funds under this line of credit.
8. EMPLOYEE BENEFIT PLANS
The Company participates in an industry-wide, multi-employer, defined benefit pension plan, which covers full-time employees who have attained at least 21 years of age and completed one year of service. Benefits were frozen under this plan effective March 1, 2003. In addition, employees who would have been eligible after March 1, 2003 are not eligible to enter the plan. Although no further benefits will accrue while the freeze remains in place, the freeze does not reduce the benefits accrued to date.
Calculations to determine full-funding status are made annually as of June 30. Pension expense for the years ended December 31, 2006, 2005 and 2004 was $1.9 million, $840,000 and $200,000, respectively. The increased pension costs are due to higher contributions the Company elected to make to its multi-employer defined benefit plan. The Company anticipates the Pension Protection Act of 2006 (theAct) signed into law in August 2006 will have an
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
impact on its future pension benefit obligations; however, the Company is unable, at this time, to quantify the impact. The Company is currently reviewing its options including withdrawing from the multi-employer defined benefit plan. Asset and plan benefit information is not available for participating associations on an individual basis.
The Company also participates in a single-employer defined contribution plan, which qualifies under Section 401(k) of the Internal Revenue Code. Participation eligibility in this plan is substantially the same as in the aforementioned defined benefit pension plan. This 401(k) plan allows for employee contributions up to 12% of their compensation, which are matched equal to 50% of the first 6% of the compensation contributed. Effective January 1, 2005, the Company’s match under this plan was no longer distributed as an addition to the employees’ contributions. The Plan was amended to allow for the Company match to be paid to eligible employees annually as shares distributed through the Company’s ESOP. Accordingly, the Company did not incur any expense under this Plan for the years ended December 31, 2006 and 2005. Plan expense for the year ended December 31, 2004 was $239,000. Effective January 1, 2007, the Company’s matching contribution will be made to the 401(k) plan directly in the form of a supplemental contribution at the end of 2007. As such, the Company estimates it will incur between $250,000 and $300,000 of expense for the year ended December 31, 2007.
The Company provides supplemental retirement benefits for certain senior officers in the form of payments upon retirement, death, or disability. The annual benefit is based on actuarial computations of existing plans without imposing Internal Revenue Service limits. This plan was frozen in 2003 along with the Company’s pension plan. There was no expense related to this plan in 2006, 2005 and 2004.
9. SHARE-BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),Share-Based Payment (SFAS 123(R)). SFAS 123(R) addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards. The Company has elected the modified prospective application.
During 2005, the Company’s Compensation Committee of the Board of Directors approved the accelerated vesting of all then outstanding unvested stock options (Options) to purchase shares of common stock of the Company. Accordingly, all of the Options became vested as of September 30, 2005. The estimated future option expense associated with these options was $1.7 million, net of tax, and would have been required to be recorded in the Company’s income statement in future periods starting upon its adoption of SFAS 123(R) in January 2006. Since the Company accounted for these Options in accordance with Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25) at the time of acceleration, the Company reported this compensation expense related to these Options for disclosure purposes only in 2005 and 2004. Since all of the stock options granted by the Company vested prior to January 1, 2006, the Company did not record any compensation expense related to its stock options for the year ended December 31, 2006.
Prior to the adoption of SFAS 123(R), unearned compensation related to the Company’s Recognition and Retention Plan (RRP) was classified as a separate component of stockholders’ equity. In accordance with the provisions of SFAS 123(R), on January 1, 2006, the remaining balance of the Company’s unearned common stock related to the RRP was reclassified to additional paid-in capital on the Company’s statement of financial condition.
Also prior to the adoption of SFAS 123(R), the Company accounted for its stock option plans under the recognition and measurement principles of APB 25 and related interpretations. No stock-based employee compensation cost was reflected in net income as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the grant date. Pursuant to SFAS No. 123,Accounting for Stock-Based Compensation(SFAS 123), pro forma net income and pro forma earnings per share for the years ended December 31, 2005 and 2004 are presented in the following table as if the fair value method of accounting for stock-based compensation plans had been utilized.
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
| | Year Ended December 31, |
| | 2005 | | 2004 |
| | (Dollars in thousands |
| | except per share data) |
| Net income (loss) (as reported) | $ | 5,017 | | $ | (6,577 | ) |
| Stock-based compensation expense determined using fair value method, net of tax (1) | | 2,176 | | | 678 | |
| Pro forma net income (loss) | $ | 2,841 | | $ | (7,255 | ) |
| Basic earnings (loss) per share (as reported) | $ | 0.43 | | $ | (0.57 | ) |
| Pro forma basic earnings (loss) per share | | 0.24 | | | (0.63 | ) |
| Diluted earnings (loss) per share (as reported) | | 0.42 | | | (0.57 | ) |
| Pro forma diluted earnings (loss) per share | | 0.24 | | | (0.63 | ) |
____________________
| (1) | | A Black-Scholes option pricing model was used to determine the fair values of the options granted. |
Stock Options
The Company has stock option plans under which shares of Company common stock are reserved for the grant of both incentive and non-qualified stock options to directors, officers and employees. The dates the stock options are first exercisable and expire are determined by the Compensation Committee of the Company’s Board of Directors at the time of the grant. The exercise price of the stock options is equal to the fair market value of the common stock on the grant date. All of the Company’s options were fully vested as of December 31, 2005.
The Company did not grant any options during 2006. On July 25, 2005, the Company granted stock options under its 1998 and 2003 Stock Option Plans to directors, officers and employees of the Company. The number of stock options granted in 2005 totaled 234,945 shares, all of which have an exercise price equal to the fair market value of the Company’s common stock on the day of grant of $13.48. The stock options originally were to vest ratably over five years. Subsequently, on September 30, 2005, the Company accelerated the vesting of all of its stock options. Accordingly, 622,705 stock options which would have otherwise vested from time to time over the next five years became immediately exercisable as a result of the accelerated vesting. The remaining terms for each of the stock options granted remain the same. Based on the Company’s closing stock price of $13.40 per share on the date of accelerated vesting, 95% of the total accelerated stock options had exercise prices above the closing market price at the time of acceleration. All of the accelerated stock options have exercise prices between $10.38 and $14.76 per share, with a total weighted average exercise price per share of $13.82 per share.
The fair value of the stock options granted in 2005 and 2004 was estimated using the Black-Scholes option value model with the following assumptions:
| | 2005 | | 2004 |
| Dividend yield | 3.6 | % | | 3.3 | % |
| Expected volatility | 25.9 | | | 27.4 | |
| Risk-free interest | 4.1 | | | 3.9 | |
| Original expected life | 6 years | | | 6 years | |
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The following table presents the activity related to options under the Company’s stock option plans for the years ended 2006, 2005 and 2004. The numbers of shares presented are in thousands.
| | 2006 | | 2005 | | 2004 |
| | | | Weighted- | | | | Weighted- | | | | Weighted- |
| | Number of | | Average | | Number of | | Average | | Number of | | Average |
| | Shares | | Exercise Price | | Shares | | Exercise Price | | Shares | | Exercise Price |
| Outstanding at beginning of year | 1,823 | | | $ | 11.78 | | 1,765 | | | $ | 11.57 | | 1,814 | | | $ | 11.02 |
| Granted | — | | | | — | | 235 | | | | 13.48 | | 223 | | | | 14.64 |
| Exercised | (321 | ) | | | 10.29 | | (144 | ) | | | 10.28 | | (246 | ) | | | 9.49 |
| Forfeited | (6 | ) | | | 13.48 | | (33 | ) | | | 13.67 | | (26 | ) | | | 14.13 |
| Outstanding at end of year | 1,496 | | | $ | 12.09 | | 1,823 | | | $ | 11.78 | | 1,765 | | | $ | 11.57 |
At December 31, 2006, there were 34,450 shares available for future grants under the Company’s stock option plans. There were no stock options granted during 2006. The fair value of stock options granted during 2005 and 2004 was $2.81 and $3.27 per share, respectively.
Options outstanding and exercisable at December 31, 2006 are presented in the table below. The number of shares are in thousands.
| | | As of December 31, 2006 |
| | | Outstanding and Exercisable |
| | | | | Weighted | | |
| | | | | Average | | Weighted |
| | | | | Remaining | | Average |
| | | | | Contractual | | Exercise |
| Range of Exercise Prices: | | Number | | Life | | Price |
| $8.19 — $8.99 | | 98 | | 3.3 | | $ | 8.48 |
| $10.00 — $10.99 | | 453 | | 2.3 | | | 10.00 |
| $11.00 — $11.99 | | 180 | | 4.3 | | | 11.25 |
| $13.00 — $13.99 | | 490 | | 7.1 | | | 13.68 |
| $14.00 — $14.76 | | 275 | | 6.9 | | | 14.56 |
| Outstanding | | 1,496 | | 5.0 | | | 12.09 |
At December 31, 2006, the aggregate intrinsic value of options outstanding totaled $3.8 million. This value represents the difference between the Company’s closing stock price on the last day of trading for 2006 and the exercise price multiplied by the number of in-the-money options assuming all option holders had exercised their stock options on December 31, 2006.
The aggregate intrinsic value of options exercised at the time of exercise during the years ended December 31, 2006, 2005 and 2004 was $1.4 million, $514,000 and $1.2 million, respectively. Cash received from option exercises during the years ended December 31, 2006, 2005 and 2004 totaled $3.3 million, $1.5 million and $2.3 million, respectively. The actual tax benefit realized for the tax deduction from option exercises totaled $463,000, $179,000 and $233,000, respectively, for the years ended December 31, 2006, 2005 and 2004.
The Company reissues treasury shares to satisfy option exercises.
Recognition and Retention Plan
In February 1999, the Company, with shareholder approval, established the RRP, which is a stock-based incentive plan, and a stock option plan. The Bank contributed $7.5 million to the RRP to purchase an aggregate total of 714,150 shares of Company common stock. On April 1, 1999, the Compensation Committee of the Board of Directors granted
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
an aggregate of 707,000 shares under this plan to 92 participants. On April 1, 2003, the Compensation Committee made an additional grant of an aggregate of 21,000 shares to five participants. On April 1, 2004, the remaining 1,050 shares were granted to two participants.
The shares granted in the RRP vest to the participants at the rate of 20% per year. As a result, expense for this plan is being recorded over a 60-month period from the date of grant and is based on the market value of the Company’s stock as of the date of grant. The remaining unamortized cost of the RRP is reflected as a reduction in additional paid-in capital. At December 31, 2006, the remaining unamortized cost of the RRP totaled $98,000. The cost is expected to be recognized over a period of 1.5 years. The total grant date fair value of shares vested during 2006, 2005 and 2004 was $48,000, $48,000 and $414,000, respectively.
The following table presents the activity for the RRP during 2006.
| | | Number of | | Weighted-Average |
| | | Shares | | Grant Date Fair Value |
| Unvested at December 31, 2005 | | 10,620 | | | | $ | 13.83 | |
| Granted | | — | | | | | — | |
| Vested | | (3,505 | ) | | | | 13.83 | |
| Forfeited | | — | | | | | — | |
| Unvested as of December 31, 2006 | | 7,115 | | | | | 13.84 | |
Employee Stock Ownership Plan
In 1998, the Company established an internally leveraged ESOP for the employees of the Company and the Bank. The ESOP is a qualified benefit plan under Internal Revenue Service guidelines. It covers all full-time employees who have attained at least 21 years of age and completed one year of service. Upon formation, the ESOP borrowed $14.3 million from the Company and purchased 1,428,300 shares of common stock. Compensation expense related to the Company’s ESOP was $1.4 million, $1.3 million and $1.7 million, respectively, for the years ended December 31, 2006, 2005 and 2004. The Bank made contributions to the ESOP plan in order to pay down the outstanding loan totaling $1.4 million during 2006 and $1.3 million during 2005 and 2004.
Effective January 1, 2005, the ESOP plan was amended to allow for the distribution of the Company’s 401(k) match to be made by distributing shares from the ESOP to the employees. This annual distribution for 2006 and 2005 was made in conjunction with the annual allocations of the ESOP. Effective January 1, 2007, the Company elected to amend the ESOP plan to remove the Company match for the 401(k) plan from the ESOP. All future matching contributions will be made directly to the 401(k) plan.
During March 2007, the Company renegotiated the terms of the loan to the ESOP with the plan’s trustee which reduced the interest rate from 8.50% to 4.64% and extended the term of the loan by an additional eight years from 2009 to 2017. The Company anticipates the restructured loan will reduce its annual compensation expense by approximately $1.1 million for the year ended December 31, 2007. The loan modification reduces the average ESOP benefit from approximately 15.0% of eligible compensation to approximately 4.1% which was also established as the average minimum benefit level through the end of the new loan term. The modification also includes event protection if the ESOP is terminated before the new maturity date of the loan due to merger, sale or otherwise. In the event the ESOP is terminated due to one of these events, the unallocated stock will be distributed to the Plan participants instead of being applied to the repayment of the ESOP loan.
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The following table summarizes shares of Company common stock held by the ESOP:
| | December 31, |
| | 2006 | | 2005 |
| | (Dollars in thousands) |
| Shares allocated to participants | | 822,382 | | | 736,982 |
| Unallocated and unearned shares | | 356,429 | | | 476,188 |
| | | 1,178,811 | | | 1,213,170 |
| Fair value of unearned ESOP shares | $ | 5,222 | | $ | 6,809 |
The Company also provides supplemental retirement benefits for certain senior officers under the ESOP. This benefit is also based on computations for the existing plan exclusive of Internal Revenue Service limits. Compensation expense related to this supplemental plan for the years ended December 31, 2006, 2005 and 2004, was $31,000, $22,000 and $47,000, respectively.
10. INCOME TAXES
The income tax provision consists of the following:
| | Year Ended December31, |
| | 2006 | | 2005 | | 2004 |
| | (Dollars in thousands) |
| Current tax expense (benefit): | | | | | | | | | | | |
| Federal | $ | 685 | | | $ | 1,283 | | | $ | (6,066 | ) |
| State | | 263 | | | | 204 | | | | — | |
| Deferred tax expense (benefit): | | | | | | | | | | | |
| Federal | | (88 | ) | | | (190 | ) | | | 114 | |
| State | | (242 | ) | | | (121 | ) | | | (1,252 | ) |
| | $ | 618 | | | $ | 1,176 | | | $ | (7,204 | ) |
A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
| | Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
| Statutory rate | 35.0 | % | | 35.0 | % | | (35.0 | )% |
| State taxes | 0.2 | | | 0.9 | | | (5.9 | ) |
| Bank-owned life insurance | (9.4 | ) | | (8.6 | ) | | (3.7 | ) |
| Low-income housing tax credits | (5.6 | ) | | (8.2 | ) | | (3.1 | ) |
| Reversal of allocated tax reserves | (8.8 | ) | | — | | | — | |
| Other | (1.0 | ) | | (0.1 | ) | | (4.6 | ) |
| Effective rate | 10.4 | % | | 19.0 | % | | (52.3 | )% |
The decrease in the Company’s effective tax rate for 2006 was primarily a result of the recognition of tax benefits relating to certain tax positions taken on the Company’s prior year tax returns that had not been recognized for financial reporting purposes. During 2006, tax liabilities established for these tax uncertainties were no longer required primarily as a result of favorable outcomes during the fourth quarter of 2006 in tax audits of other entities that had taken similar tax positions.
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Significant components of deferred tax assets and liabilities are as follows:
| | December 31, |
| | 2006 | | 2005 |
| | (Dollars in thousands) |
| Deferred tax assets: | | | | | |
| Allowance for losses on loans | $ | 4,335 | | $ | 5,051 |
| Deferred compensation | | 819 | | | 645 |
| Deferred loan fees | | 773 | | | 962 |
| Net operating loss carryforwards | | 1,378 | | | 4,766 |
| Alternative minimum tax carryforwards | | 1,583 | | | 735 |
| General business tax credit carryforwards | | 1,650 | | | 1,315 |
| Other | | 153 | | | 684 |
| | | 10,691 | | | 14,158 |
| Deferred tax liabilities: | | | | | |
| Unamortized deferred premium on early extinguishment of debt | | 2,378 | | | 6,131 |
| FHLB stock dividends | | 1,063 | | | 1,263 |
| Other | | 487 | | | 331 |
| | | 3,928 | | | 7,725 |
| Net deferred tax asset | | 6,763 | | | 6,433 |
| Tax effect of adjustment related to unrealized depreciation on available-for-sale securities | | 156 | | | 903 |
| Net deferred tax assets including adjustments | $ | 6,919 | | $ | 7,336 |
Based upon historical taxable income as well as projections of future taxable income, management believes that it is more likely than not that the deferred tax assets will be realized. Therefore, no valuation reserve has been recorded at December 31, 2006 or 2005.
Prior to 1988, the Bank qualified as a bank under provisions of the Internal Revenue Code which permitted it to deduct from taxable income an allowance for bad debts, which differed from the provision for such losses charged to income. Retained earnings at December 31, 2006 and 2005 included approximately $12.5 million, for which no provision for income taxes has been made. If in the future this portion of retained earnings is distributed, or the Bank no longer qualifies as a bank for tax purposes, income taxes may be imposed at the then applicable rates. The unrecorded deferred tax liability at December 31, 2006 and 2005 would have been approximately $4.9 million.
At December 31, 2006, the Company had federal and state net operating losses of $716,000 and $17.4 million, respectively, which are being carried forward to reduce future taxable income. The carryforwards expire between 2016 and 2024. At December 31, 2006, the Company had $1.7 million of general business tax credit carryforwards available to reduce future tax liabilities. The carryforwards expire between 2022 and 2026.
11. RELATED PARTY DISCLOSURES
The Company has no material related party transactions which would require disclosure. In compliance with applicable banking regulations, the Company may extend credit to certain officers and directors of the Company and its subsidiaries in the ordinary course of business under substantially the same terms as comparable third-party lending arrangements.
12. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL
During 2006, the Company completed its 1,200,000 share repurchase plan announced in March 2003 by repurchasing 655,982 shares remaining under this plan at an average price of $14.65. In June 2006, the Company announced a new share repurchase plan for an additional 600,000 shares. The Company plans to use existing funds
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
to finance the repurchases. Total shares available for repurchase under this plan are 188,283 at December 31, 2006. During February 2007, the Company announced that its Board of Directors approved a new share repurchase plan for an additional 600,000 shares.
The following table presents information with respect to the Company’s 2006 and 2003 share repurchase plans.
| | | 2006 Repurchase Plan | | 2003 Repurchase Plan |
| | | Shares | | Cost of | | Average | | Shares | | Cost of | | Average |
| | | Repurchased | | Shares | | Cost | | Repurchased | | Shares | | Cost |
| | | in Period | | Repurchased | | per Share | | in Period | | Repurchased | | per Share |
| | | (Dollars in thousands) |
| Years ended: | | | | | | | | | | | | | | | | | | | | | | |
| 2004 | | — | | | $ | — | | | $ | — | | | 19,844 | | | $ | 269 | | | $ | 13.56 | |
| 2005 | | — | | | | — | | | | — | | | 524,174 | | | | 7,253 | | | | 13.84 | |
| 2006 | | 411,717 | | | | 6,119 | | | | 14.86 | | | 655,982 | | | | 9,611 | | | | 14.65 | |
| Plan to date | | 411,717 | | | $ | 6,119 | | | | 14.86 | | | 1,200,000 | | | $ | 17,133 | | | | 14.28 | |
OTS regulations impose limitations upon all capital distributions by a savings institution if the institution would not be “well-capitalized” after the distributions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire its own stock, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The regulations provide that an institution must submit an application to the OTS to receive approval of the capital distributions if the institution (i) is not eligible for expedited treatment; or (ii) for which its total amount of capital distributions for the applicable calendar year exceeds its net income for that year to date plus its retained income for the preceding two years; or (iii) would not be at least adequately capitalized following the distribution; or (iv) would violate a prohibition contained in a statute, regulation or agreement between the institution and the OTS by performing the capital distribution. Under any other circumstances, the institution would be required to provide a written notice to the OTS prior to the capital distribution. Based on its retained income for the preceding two years, the Bank is currently restricted from making any capital distributions without prior written approval from the OTS. During May 2006, the Bank requested approval from the OTS to pay dividends to the Company in the amount of $15.0 million to be paid on a quarterly basis through January 2007. During 2006, the Bank paid $13.1 million in dividends to the Company.
The principal sources of cash flow for the Company are dividends from the Bank. Various federal banking regulations and capital guidelines limit the amount of dividends that may be paid to the Company by the Bank. Future payments of dividends by the Bank are dependent upon individual regulatory capital requirements and levels of profitability.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum requirements can initiate certain mandatory and possible 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 under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to quantitative 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, set forth in the table below of the total risk-based, tangible, and core capital, as defined in the regulations. As of December 31, 2006, the Bank met all capital adequacy requirements to which it is subject.
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CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
As of December 31, 2006, the Bank is categorized as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain minimum total risk-based, tangible, and core ratios as set forth in the following table. There are no conditions or events since that date that management believes have changed the institution’s category. At December 31, 2006, the Bank’s adjusted total assets were $1.3 billion and its risk-weighted assets were $941.6 million.
| | | | | | To Be Well-Capitalized |
| | | | For Capital Adequacy | | Under Prompt Corrective |
| | Actual | | Purposes | | ActionProvisions |
| | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| | | | | | (Dollars in thousands) | | | | |
| As of December 31, 2006: | | | | | | | | | | | | | | | | |
| Risk-based | $ | 132,762 | | 14.10 | % | | $ | 75,332 | | > | 8.00 | % | | $ | 94,165 | | > | 10.00 | % |
| Tangible | | 121,599 | | 9.71 | | | | 18,780 | | > | 1.50 | | | | 25,040 | | > | 2.00 | |
| Core | | 121,599 | | 9.71 | | | | 50,080 | | > | 4.00 | | | | 62,600 | | > | 5.00 | |
| As of December 31, 2005: | | | | | | | | | | | | | | | | | | | |
| Risk-based | $ | 140,102 | | 13.63 | % | | $ | 82,244 | | > | 8.00 | % | | $ | 102,806 | | > | 10.00 | % |
| Tangible | | 128,884 | | 10.38 | | | | 18,624 | | > | 1.50 | | | | 24,832 | | > | 2.00 | |
| Core | | 128,884 | | 10.38 | | | | 49,665 | | > | 4.00 | | | | 62,080 | | > | 5.00 | |
13. COMMITMENTS
| | December31, |
| | 2006 | | 2005 |
| | (Dollars in thousands) |
| Type of commitment | | | | | |
| To originate retail loans: | | | | | |
| Fixed rates ( 5.625% – 9.00% in 2006 and 5.38% – 13.25% in 2005) | $ | 4,807 | | $ | 7,800 |
| Variable rates | | 2,402 | | | 1,635 |
| To originate commercial real estate loans: | | | | | |
| Fixed rates (6.30% – 8.77% in 2006 and 6.30% – 7.00% in 2005) | | 8,743 | | | 2,109 |
| Variable rates | | 11,568 | | | 16,800 |
| To originate commercial and industrial loans: | | | | | |
| Fixed rates (4.80% – 8.25% in 2006 and 7.00% in 2005) | | 6,640 | | | 5 |
| Variable rates | | 8,823 | | | 861 |
| To purchase loans secured by commercial real estate: | | | | | |
| Variable rates | | 18,000 | | | 2,500 |
| Unused lines of credit and construction loans | | 141,815 | | | 154,570 |
| Letters of credit: | | | | | |
| Secured by cash | | 568 | | | 255 |
| Real estate | | 11,777 | | | 7,457 |
| Business assets | | 195 | | | 445 |
| Unsecured | | — | | | 9 |
| Other – Credit enhancements | | 42,465 | | | 48,017 |
The commitments listed above do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. All commitments to extend credit or to purchase loans expire within the following year. Letters of credit expire at various times through 2014.
84
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company also has commitments to fund community investments through investments in various limited partnerships, which represent future cash outlays for the construction and development of properties for low-income housing, small business real estate, and historic tax credit projects that qualify under the Community Reinvestment Act. These commitments include $2.1 million to be funded over eight years. The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the project. These commitments are not included in the commitment table above. See additional disclosures in Note 14.
Letters of credit include credit enhancements which are related to the issuance by municipalities of taxable and nontaxable revenue bonds. The proceeds from the sale of such bonds are loaned to for-profit and not-for-profit companies for economic development projects. In order for the bonds to receive a triple-A rating, which provides for a lower interest rate, the FHLB-IN issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for the account of the Bank. Since the Bank, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB-IN and the Bank, would be required to reimburse the FHLB-IN for draws against the IDPLOC, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if the Bank had funded the project initially.
The letters of credit and credit enhancements provided by the Company are considered financial guarantees under FASB Interpretation 45Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Othersand were carried at a fair value of $407,000 in the aggregate as of December 31, 2006.
14. VARIABLE INTEREST ENTITIES
The Company has investments in nine low-income housing tax credit limited partnerships and one limited liability partnership for the development of shopping centers, for-sale housing, and the restoration of historic properties in low and moderate income areas. Although these partnerships generate operating losses, the Company realizes a return on its investment through reductions in income tax expense that result from tax credits and the deductibility of the entities’ operating losses. These investments were acquired at various times between 1996 and 2004 and are accounted for under the equity method. These entities are considered variable interest entities in accordance with FASB Interpretation No. 46 (Revised December 2003),Consolidation of Variable Interest Entities (FIN 46(R)). Since the Company is not considered the primary beneficiary of these entities, it is not required to consolidate these investments. The Company’s exposure is limited to its current recorded investment of $1.5 million plus $2.1 million that the Company is obligated to pay over the next eight years but has not yet funded.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosure of fair value information about financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate their value, is summarized below. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.
No fair value disclosure is required with respect to certain financial instruments and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
85
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The carrying amounts and fair values of financial instruments consist of the following:
| | December 31, |
| | 2006 | | 2005 |
| | Carrying | | Fair | | Carrying | | Fair |
| | Amount | | Value | | Amount | | Value |
| | (Dollars in thousands) |
| Financial Assets | | | | | | | | | | | |
| Cash and cash equivalents | $ | 67,167 | | $ | 67,167 | | $ | 24,177 | | $ | 24,177 |
| Securities, available-for-sale | | 298,925 | | | 298,925 | | | 218,550 | | | 218,550 |
| Federal Home Loan Bank stock | | 23,944 | | | 23,944 | | | 28,252 | | | 28,252 |
| Loans receivable, net of allowance for losses on loans | | 791,199 | | | 784,192 | | | 904,466 | | | 902,175 |
| Interest receivable | | 7,523 | | | 7,523 | | | 6,142 | | | 6,142 |
| Total financial assets | $ | 1,188,758 | | $ | 1,181,751 | | $ | 1,181,587 | | $ | 1,179,296 |
| Financial Liabilities | | | | | | | | | | | |
| Deposits | $ | 907,095 | | $ | 906,148 | | $ | 828,635 | | $ | 828,728 |
| Borrowed money | | 202,275 | | | 200,441 | | | 257,326 | | | 269,710 |
| Interest payable | | 749 | | | 749 | | | 739 | | | 739 |
| Total financial liabilities | $ | 1,110,119 | | $ | 1,107,338 | | $ | 1,086,700 | | $ | 1,099,177 |
The carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, and accrued interest receivable and payable. Securities fair values are based on quotes received from a third-party pricing source.
The Company determined that for both variable-rate and fixed-rate loans, fair values are estimated using discounted cash flow analyses, with interest rates currently being offered for loans with similar terms and collateral to borrowers of similar credit quality.
The fair value of checking, savings, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
The fair value of borrowed money is estimated based on rates currently available to the Company for debt with similar terms and remaining maturities.
The fair value of the Company’s off-balance sheet instruments is nominal.
16. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
| | Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
| | (Dollars in thousands except per share data) |
| Net income (loss) | $ | 5,340 | | $ | 5,017 | | $ | (6,577 | ) |
| Weighted-average common shares outstanding | | 11,045,857 | | | 11,728,073 | | | 11,599,996 | |
| Weighted-average common share equivalents (1) | | 348,006 | | | 236,941 | | | 297,498 | |
| Weighted-average common shares and common share equivalents | | | | | | | | | |
| outstanding | | 11,393,863 | | | 11,965,014 | | | 11,897,494 | |
| Basic earnings (loss) per share | $ | 0.48 | | $ | 0.43 | | $ | (0.57 | ) |
| Diluted earnings (loss) per share | | 0.47 | | | 0.42 | | | (0.57 | ) |
____________________
| (1) | | Assumes exercise of dilutive stock options, a portion of the unearned awards under the RRP and treasury shares held in Rabbi Trust accounts. |
| |
86
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
For the years ended December 31, 2006, 2005 and 2004, the Company had 114,000, 231,750 and 546,700 anti-dilutive options, respectively. The anti-dilutive options were not included in the above earnings per share calculations.
17. OTHER COMPREHENSIVE INCOME
The related income tax effect and reclassification adjustments to the components of other comprehensive income for the periods indicated are as follows:
| | Year Ended December31, |
| | 2006 | | 2005 | | 2004 |
| | (Dollars in thousands) |
| Unrealized holding gains (losses) arising during the period: | | | | | | | | | | | |
| Unrealized net gains (losses) | $ | 2,744 | | | $ | (2,274 | ) | | $ | (2,309 | ) |
| Related tax (expense) benefit | | (1,035 | ) | | | 856 | | | | 806 | |
| Net | | 1,709 | | | | (1,418 | ) | | | (1,503 | ) |
| Less: reclassification adjustment for net gains realized during the period: | | | | | | | | | | | |
| Realized net gains (losses) | | 750 | | | | (478 | ) | | | (299 | ) |
| Related tax (expense) benefit | | (289 | ) | | | 184 | | | | 126 | |
| Net | | 461 | | | | (294 | ) | | | (173 | ) |
| Total other comprehensive income (loss) | $ | 1,248 | | | $ | (1,124 | ) | | $ | (1,330 | ) |
18. LEGAL PROCEEDINGS
The Bank’s suit filed against the U.S. government in 1993, which was denominated asCitizens FinancialServices, FSB v. United States, went to trial in June 2004 in the U.S. Court of Claims. The Bank previously had been granted summary judgment on its breach of contract claim, leaving for trial the issue of damages. The trial concluded in early July 2004. On March 7, 2005, the Court of Claims entered judgment in favor of the Government holding that the Bank was not entitled to recover any damages. The Court of Claims also ruled that the Government is entitled to recover certain minimal costs from the Bank with respect to one claim that the Bank had voluntarily dismissed during the proceeding. The Government has indicated that these costs are less than $5,000. The Company filed an appeal on May 17, 2005, in the case ofCitizens Financial Services, FSB v. United States (Case No. 05-5116) in the U.S. Court of Appeals for the Federal Circuit. Oral argument was held on March 6, 2006. The Bank’s appeal was denied on March 10, 2006 and on April 24, 2006, the Bank filed a petition for re-hearing of its appeal. The petition was denied on May 17, 2006. On August 16, 2006, the Bank filed a petition for writ of certiorari with the United States Supreme Court,Citizens Financial Services, FSB, fka Citizens Federal Savings and Loan Association,Petitioner v. United States (Docket No. 06-231) which was denied November 27, 2006. The Bank’s cost, including attorneys’ fees, expert witness fees, and related expenses of the litigation was approximately $10,000, $171,000 and $1.4 million in 2006, 2005 and 2004, respectively. No additional expenses relating to this litigation are anticipated.
The case ofBetty and Raymond Crenshaw v. CFS Bancorp, et al. was filed in the United States District Court for the Northern District of Indiana sitting in Hammond, Indiana on December 6, 2005 under Cause No. 2:05 CV 440. The lawsuit names the Company, a police officer who was purportedly acting as the Bank’s security guard, along with three other police officers and the City of East Chicago as defendants. The lawsuit was brought in connection with an incident that occurred at a Bank branch on February 6, 2004. The complaint seeks compensation for alleged personal injuries, violations of civil rights, battery, false arrest, intentional infliction of emotional distress and loss of consortium. The plaintiffs also seek punitive damages and attorneys’ fees in this cause of action. The Company’s defense in this matter has been tendered to and accepted by the Company’s insurance carrier. An appearance has been filed on behalf of the Company by trial counsel retained by the Company’s insurance carrier. The case remained in the discovery phase throughout 2006. In the event that judgment is entered for the plaintiff, insurance would not be available to indemnify the Company for punitive damages should they be assessed. The
87
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
total potential exposure to the Company is not quantifiable at this stage of the proceedings insofar as the amount of damages being sought was not specifically set forth in the complaint and no other demand has been made by the plaintiff to the Company.
Other than the above-referenced matters, the Company is involved in routine legal proceedings occurring in the ordinary course of its business, which, in the aggregate, are believed to be immaterial to the financial condition of the Company.
19. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The following tables represent the condensed statement of financial condition as of December 31, 2006 and 2005 and condensed statement of income and cash flows for the three years ended December 31, 2006 for CFS Bancorp, Inc., the parent company.
Condensed Statements of Condition
(Parent Company Only)
| | December 31, |
| | 2006 | | 2005 |
| | (Dollars in thousands) |
| ASSETS |
| Cash on hand and in banks | $ | 5,364 | | $ | 6,958 |
| Securities available-for-sale | | 180 | | | 305 |
| Investment in subsidiary | | 124,160 | | | 129,349 |
| Loan receivable from ESOP | | 4,813 | | | 6,177 |
| Other assets | | 389 | | | 1,201 |
| Total assets | $ | 134,906 | | $ | 143,990 |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
| Liabilities: | | | | | |
| Accrued taxes and other liabilities | $ | 3,100 | | $ | 1,623 |
| Total stockholders’ equity | | 131,806 | | | 142,367 |
| Total liabilities and stockholders’ equity | $ | 134,906 | | $ | 143,990 |
| Condensed Statements of Income |
| (Parent Company Only) |
| | Year Ended December31, |
| | 2006 | | 2005 | | 2004 |
| | (Dollars in thousands) |
| Dividends from subsidiary | $ | 13,134 | | | $ | 3,366 | | | $ | 2,941 | |
| Interest income | | 490 | | | | 639 | | | | 1,019 | |
| Net realized gains (losses) on the sale available-for-sale investment securities | | 878 | | | | (32 | ) | | | (1,038 | ) |
| Non-interest expense | | (728 | ) | | | (993 | ) | | | (1,276 | ) |
| Net income before income taxes and equity in earnings (loss) of subsidiary | | 13,774 | | | | 2,980 | | | | 1,646 | |
| Income tax benefit (expense) | | (244 | ) | | | 152 | | | | 528 | |
| Net income before equity in undistributed earnings (loss) of subsidiary | | 13,530 | | | | 3,132 | | | | 2,174 | |
| Equity in undistributed earnings (loss) of subsidiary | | (8,190 | ) | | | 1,885 | | | | (8,751 | ) |
| Net income (loss) | $ | 5,340 | | | $ | 5,017 | | | $ | (6,577 | ) |
88
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
| Condensed Statements of Cash Flows |
| (Parent Company Only) |
| | Year Ended December31, |
| | 2006 | | 2005 | | 2004 |
| | (Dollars in thousands) |
| Operating activities: | | | | | | | | | | | |
| Net income (loss) | $ | 5,340 | | | $ | 5,017 | | | $ | (6,577 | ) |
| Adjustments to reconcile net income (loss) to net cash used by operating | | | | | | | | | | | |
| activities: | | | | | | | | | | | |
| Net accretion of premiums/discounts | | — | | | | — | | | | (3 | ) |
| Impairment of securities | | — | | | | 32 | | | | 1,018 | |
| Equity in undistributed (earnings) loss of the Bank | | 8,190 | | | | (1,885 | ) | | | 8,751 | |
| Net (gains) losses on the sale of available-for-sale investment | | | | | | | | | | | |
| securities | | (878 | ) | | | — | | | | 20 | |
| Decrease in interest receivable | | — | | | | — | | | | 32 | |
| Decrease (increase) in other assets | | 812 | | | | 1,663 | | | | (631 | ) |
| Increase in other liabilities | | 667 | | | | 424 | | | | 106 | |
| Net cash provided by operating activities | | 14,131 | | | | 5,251 | | | | 2,716 | |
| Investing activities: | | | | | | | | | | | |
| Proceeds from paydowns and sales of securities | | 963 | | | | 81 | | | | 6,415 | |
| Net loan originations and principal payment on loans | | 1,364 | | | | 1,252 | | | | 3,572 | |
| Net cash provided by investing activities | | 2,327 | | | | 1,333 | | | | 9,987 | |
| Financing activities: | | | | | | | | | | | |
| Purchase of treasury stock | | (15,730 | ) | | | (7,253 | ) | | | (869 | ) |
| Net purchase of Rabbi Trust shares | | (18 | ) | | | — | | | | — | |
| Proceeds from exercise of stock options | | 3,300 | | | | 1,484 | | | | 2,345 | |
| Dividends paid on common stock | | (5,604 | ) | | | (5,783 | ) | | | (4,847 | ) |
| Net cash used by financing activities | | (18,052 | ) | | | (11,552 | ) | | | (3,371 | ) |
| (Decrease) increase in cash and cash equivalents | | (1,594 | ) | | | (4,968 | ) | | | 9,332 | |
| Cash and cash equivalents at beginning of year | | 6,958 | | | | 11,926 | | | | 2,594 | |
| Cash and cash equivalents at end of year | $ | 5,364 | | | $ | 6,958 | | | $ | 11,926 | |
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table reflects summarized quarterly data for the periods presented (unaudited):
| | | | Net | | | | Earnings |
| | Interest | | Interest | | Net | | perShare |
| | Income | | Income | | Income | | Basic | | Diluted |
| | (Dollars in thousands, except per share data) |
| 2006 | | | | | | | | | | | | | | |
| First quarter | $ | 17,957 | | $ | 8,236 | | $ | 1,309 | | $ | 0.12 | | $ | 0.11 |
| Second quarter | | 18,962 | | | 8,732 | | | 1,621 | | | 0.15 | | | 0.14 |
| Third quarter | | 18,905 | | | 7,853 | | | 780 | | | 0.07 | | | 0.07 |
| Fourth quarter | | 19,723 | | | 8,082 | | | 1,630 | | | 0.15 | | | 0.15 |
| 2005 | | | | | | | | | | | | | | |
| First quarter | $ | 16,663 | | $ | 6,054 | | $ | 266 | | $ | 0.02 | | $ | 0.02 |
| Second quarter | | 17,342 | | | 7,200 | | | 1,012 | | | 0.09 | | | 0.08 |
| Third quarter | | 17,208 | | | 7,913 | | | 1,887 | | | 0.16 | | | 0.16 |
| Fourth quarter | | 18,251 | | | 8,694 | | | 1,852 | | | 0.16 | | | 0.16 |
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred during the quarter ended December 31, 2006 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of CFS Bancorp, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with United States generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, and that receipts and expenditures of the Company are being made in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on its financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.
The Company’s management assessed its internal control over financial reporting as of December 31, 2006, as required by Section 404 of the Sarbanes-Oxley Act of 2002, based on the criteria for effective internal control over financial reporting described in theInternal Control-Integrated Framework adopted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concludes that, as of December 31, 2006, the Company’s internal controls over financial reporting is effective.
90
The Company’s independent registered public accounting firm that audited the Company’s consolidated financial statements for the year ended December 31, 2006 has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. The report appears below.
| /s/ THOMAS F. PRISBY | | /s/ CHARLES V. COLE |
| THOMASF. PRISBY | | CHARLESV. COLE |
| Chairman and | | Executive Vice President and |
| Chief Executive Officer | | Chief Financial Officer |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
CFS Bancorp, Inc.
Munster, Indiana
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that CFS Bancorp, Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that CFS Bancorp, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, CFS Bancorp Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
91
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of CFS Bancorp, Inc. and our report dated March 12, 2007 expressed an unqualified opinion thereon.
Indianapolis, Indiana
March 12, 2007
ITEM 9B. OTHER INFORMATION
Not applicable.
92
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement which is expected to be filed on or about March 23, 2007 (Proxy Statement) titledElection of Directors, Information Concerning Continuing Directors and Executive Officers, Section 16(a) Beneficial Ownership Reporting Complianceand Report of the Audit Committee. Information related to the Company’s Code of Conduct and Ethics is incorporated by reference from the Proxy Statement under the headingCode of Conduct and Ethics.
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titledExecutive Compensation, Director Compensationand Report of the Compensation Committee.
| ITEM 12. | | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required herein by Item 403 of Regulation S-K is incorporated by reference from the section of the Registrant’s Proxy Statement titledBeneficial Ownership of Common Stock by Certain Beneficial Owners and Management.
Equity Compensation Plan Information. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of December 31, 2006.
| | | | | | | Number of Shares |
| | | Number of Shares to Be | | | | Remaining Available |
| | | Issued Upon the | | | | for Future Issuance |
| | | Exercise of Outstanding | | Weighted-Average | | (Excluding Shares |
| | | Options, Warrants and | | Exercise Price of | | Reflected in the |
| Plan Category | | Rights | | Outstanding Options | | First Column) |
| Equity Compensation Plans Approved by Security | | | | | | |
| Holders | | 1,495,951 | | $12.09 | | 34,450 |
| Equity Compensation Plans Not Approved by Security | | | | | | |
| Holders | | — | | — | | — |
| Total | | 1,495,951 | | $12.09 | | 34,450 |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titledDirector Independenceand Transactions with Certain Related Persons.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required herein is incorporated by reference from the section of the Registrant’s Proxy Statement titledFees Paid to the Independent Registered Public Accounting Firm.
93
PART IV.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this Report:
(1) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto.
(2)(a) The following exhibits are filed with the SEC as part of this Form 10-K, and this list includes the Exhibit Index.
| 3.1 | | Certificate of Incorporation of CFS Bancorp, Inc. (1) |
| |
| 3.2 | | Bylaws of CFS Bancorp, Inc. (1) |
| |
| 4.0 | | Form of Stock Certificate of CFS Bancorp, Inc. |
| |
| 10.1 | | Employment Agreement entered into between Citizens Financial Bank and Thomas F. Prisby (2) |
| |
| 10.2 | | Employment Agreement entered into between CFS Bancorp, Inc. and Thomas F. Prisby (2) |
| |
| 10.3 | | CFS Bancorp, Inc. Amended and Restated 1998 Stock Option Plan (3) |
| |
| 10.4 | | CFS Bancorp, Inc. Amended and Restated 1998 Recognition and Retention Plan and Trust Agreement (3) |
| |
| 10.5 | | CFS Bancorp, Inc. 2003 Stock Option Plan (4) |
| |
| 10.6 | | Employment Agreement entered into between Citizens Financial Bank and Charles V. Cole (2) |
| |
| 10.7 | | Employment Agreement entered into between Citizens Financial Bank and Thomas L. Darovic (2) |
| |
| 10.8 | | Employment Agreement entered into between CFS Bancorp, Inc. and Charles V. Cole (2) |
| |
| 10.9 | | Employment Agreement entered into between CFS Bancorp, Inc. and Thomas L. Darovic (2) |
| |
| 10.10 | | Employment Agreement entered into between Citizens Financial Services, FSB and Zoran Koricanac (5) |
| |
| 10.11 | | Employment Agreement entered into between CFS Bancorp, Inc. and Zoran Koricanac (5) |
| |
| 10.12 | | Amended and Restated Supplemental ESOP Benefit Plan of CFS Bancorp, Inc. and Citizens Financial Services, FSB (5) |
| |
| 10.13 | | CFS Bancorp, Inc. Directors’ Deferred Compensation Plan (5) |
| |
| 23.0 | | Consent of Crowe Chizek and Company LLC |
| |
| 23.1 | | Consent of BKD, LLP |
| |
| 31.1 | | Rule 13a-14(a) Certification of Chief Executive Officer |
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| 31.2 | | Rule 13a-14(a) Certification of Chief Financial Officer |
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| 32.0 | | Section 1350 Certifications |
___________________
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| (1) | | Incorporated by Reference from the Company’s Definitive Proxy Statement from the Annual Meeting of Stockholders filed on March 25, 2005. |
| |
| (2) | | Incorporated by Reference from the Company’s Form 8-K filed on July 7, 2006. |
| |
| (3) | | Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed on March 23, 2001. |
| |
| (4) | | Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed on March 31, 2003. |
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| (5) | | Incorporated by Reference from the Company’s annual report on Form 10-K for the year ended December 31, 2004. |
| |
94
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | CFS BANCORP, INC. |
| |
| By: | /s/ THOMAS F. PRISBY |
| | THOMASF. PRISBY |
| | Chairman of the Board and |
| | Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Name | | Title | | Date |
| /s/ THOMAS F. PRISBY | | Chairman of the Board and Chief Executive Officer | | |
| THOMASF. PRISBY | | (principal executive officer) | | March 14, 2007 |
| |
| /s/ CHARLES V. COLE | | Executive Vice President and Chief Financial Officer | | |
| CHARLESV. COLE | | (principal financial and accounting officer) | | March 14, 2007 |
| |
| /s/ GREGORY W. BLAINE | | Director | | March 14, 2007 |
| GREGORYW. BLAINE | | | | |
| |
| /s/ GENE DIAMOND | | Director | | March 14, 2007 |
| GENEDIAMOND | | | | |
| |
| /s/ FRANK D. LESTER | | Director | | March 14, 2007 |
| FRANKD. LESTER | | | | |
| |
| /s/ JOYCE M. SIMON | | Director | | March 14, 2007 |
| JOYCEM. SIMON | | | | |
| |
| /s/ ROBERT R. ROSS | | Director | | March 14, 2007 |
| ROBERTR. ROSS | | | | |
95
