 | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended December 31, 2004 | |
| OR | |
 | TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ |
| Delaware (State or other jurisdiction of incorporation or organization) | 34-1870418 (I.R.S. Employer Identification No.) | |
| 55 North Main Street, Niles, Ohio (Address of principal executive offices) | 44446-5097 (Zip Code) | |
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 . NO .
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
State the issuer's revenues for its most recent fiscal year: $5.2 million.
The aggregate market value of the voting and nonvoting common equity held by non-affiliates computed by reference to the closing sales price of such stock on the Nasdaq System as of March 18, 2005, was $16.9 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)
As of March 21, 2005, there were issued and outstanding 1,384,553 shares of the Registrant's Common Stock.
; No This document, including information incorporated by reference, contains, and future filings by First Niles Financial, Inc. on Form 10-QSB and Form 8-K and future oral and written statements by First Niles and its management may contain, forward-looking statements about First Niles and its subsidiary which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities, interest rates, cost savings and funding advantages expected or anticipated to be realized by management. Words such as may, could, should, would, believe, anticipate, estimate, expect, intend, plan and similar expressions are intended to identify these forward-looking statements. Forward-looking statements by First Niles and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions of management and are not guarantees of future performance. First Niles disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise. The important factors we discuss below and elsewhere in this document, as well as other factors discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report to Stockholders (attached to this document as Exhibit 13) and identified in our filings with the SEC and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document:
The following factors, many of which are subject to change based on various other factors beyond our control, could cause our financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:
Item 1. Description of Business
General
First Niles Financial, Inc. ("First Niles" or the "Company") is a unitary, non-diversified, Delaware holding company. First Niles has no significant operations outside those of its wholly-owned operating subsidiary, Home Federal Savings and Loan Association of Niles ("Home Federal" or the "Bank"). References in this Form 10-KSB to "we", "us", and "our" refer to First Niles and/or Home Federal as the context requires.
Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent and construction loans secured by first mortgages on one- to four-family residences. We also originate permanent and construction loans secured by first mortgages on commercial and multi-family real estate. To a much lesser extent, we originate consumer and commercial business loans. Competition from other financial institutions has, however, limited the volume of loans we have been able to originate and place in our portfolio. As a result, our excess funds are invested in short-term, lower-yielding investment and mortgage-backed and related securities. Additionally, we borrow funds from the Federal Home Loan Bank ("FHLB") and reinvest the proceeds in investment securities at favorable interest rate spreads.
At December 31, 2004, we had $99.2 million of assets and stockholders' equity of $16.4 million (or 16.5% of total assets). Our common stock is traded on The Nasdaq SmallCap Market under the symbol "FNFI".
Home Federal is a federally chartered stock savings association headquartered in Niles, Ohio. Its deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (the "FDIC") and are backed by the full faith and credit of the United States.
Our results of operations depend primarily on net interest income, which is determined by (i) the difference between rates of interest we earn on interest-earning assets, consisting primarily of mortgage loans, collateralized mortgage obligations and other investments, and the rates we pay on interest-bearing liabilities, consisting primarily of deposits and borrowings, and (ii) the relative amounts of our interest-earning assets and interest-bearing liabilities. The level of non-interest income, such as fees received from customer deposit account service charges and gains on sales of investments, and the level of non-interest expense, such as federal deposit insurance premiums, salaries and benefits, office occupancy costs, and data processing costs, also affect our results of operations. Finally, our results of operations may also be affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities, all of which are beyond our control.
Our offices are located at 55 North Main Street, Niles, Ohio 44446-5097 and our telephone number is (330) 652-2539.
Market Area
Our primary market area is Niles, Ohio. Our primary lending area consists generally of the area within a 30 mile radius of the City of Niles. Although we may grant loans outside of this 30 mile radius upon the approval of our Board of Directors, we do not grant loans outside the State of Ohio.
Trumbull County, where Home Federal is located, consists primarily of suburban and rural communities with manufacturing and wholesale distribution activities serving as the basis of the local economy. Major employers in the area include General Motors Corp. and WCI Steel, Inc.
The level of competition in our market area is strong and dominated by commercial banks, with financial institutions of varying sizes and characteristics. In addition, our market area is projected to experience a continuing decrease in population and no meaningful increase in households over the next several years. Niles and Trumbull County have per capita income and median household income lower than Ohio and the United States and in December 2004, Trumbull County also had an unemployment rate higher than both, Ohio and the United States. These economic conditions and strong competition have resulted in reduced loan demand which, in turn, has resulted in a high concentration of investment securities and mortgage-backed and related securities in our portfolio compared to typical savings institutions. In the event current economic and market conditions persist or worsen, and loan demand remains weak, we cannot give any assurances that we will be able to maintain or increase our mortgage loan portfolio, which could adversely affect our operations and financial results.
Lending Activities
General. Our primary lending activity is the origination of permanent and construction loans secured by first mortgages on one- to four-family residential properties. We also make permanent and construction loans on multi-family and commercial properties, home equity lines of credit, and a limited number of other consumer and commercial business loans. Our mortgage loans carry either a fixed or an adjustable interest rate. Mortgage loans are generally long-term and amortize on a monthly basis with principal and interest due each month. At December 31, 2004, our net loan portfolio totaled $43.0 million, which constituted 43.3% of our total assets.
All loans that we originate are subject to ratification by the Board of Directors. Commercial real estate loans and multi-family loans are generally reviewed by the Board before we extend a lending commitment. Unless we are aware of factors that may lead to an environmental concern, we generally do not require any environmental study at the time a loan is made. If an environmental problem were discovered to exist after a loan has been originated and the loan has become delinquent, we may choose not to foreclose on the property if the potential environmental liability would render foreclosure imprudent.
Management is responsible for presenting to the Board information about the credit-worthiness of a borrower and the estimated value of the subject property. Information relating to credit-worthiness of a borrower generally consists of a summary of the borrower's credit history, employment, employment stability, net worth and income. The estimated value of the property must be supported by an appraisal report prepared in accordance with our appraisal policy.
At December 31, 2004, the maximum amount we could have loaned to any one borrower and the borrower's related entities was approximately $2.3 million. At December 31, 2004, our largest lending relationship to a single borrower or group of related borrowers consisted of three purchased participation loans aggregating $2.2 million. These loans were secured by an apartment complex, a combination warehouse, office, and retail complex and a hotel.
Our second largest lending relationship at December 31, 2004 consisted of six loans totaling $1.1 million. Of the six loans, two were for the construction or development of residential housing, including condominiums, while three loans were secured by apartment rental units and commercial office space.
Our next largest lending relationship consisted of a purchased participation loan for $1,000,000 secured by a single family housing development located in Columbus, Ohio. Approximately $213,000 of this lending relationship was unfunded at December 31, 2004.
Our fourth largest lending relationship at December 31, 2004 totaled $952,000 and consisted of a purchased participation loan secured by a warehouse located in Columbus, Ohio.
Our fifth largest lending relationship consisted of seventeen loans totaling $876,000 secured by residential rental properties and a single family residence. All of the properties securing these loans are within our primary lending area.
Each of the above lending relationships was current and performing in accordance with its terms at December 31, 2004.
We had nine other lending relationships which exceeded $400,000 at December 31, 2004. As of that date, all of these lending relationships were current and performing generally in accordance with their loan terms. One relationship, though performing in accordance with its loan terms at December 31, 2004, was on nonaccrual status. (See "Asset Quality -- Non-Performing Assets").
Loan Portfolio Composition. The following table sets forth information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated. The dollar amounts and percentages were calculated before deductions for loans in process, deferred fees and discounts and allowances for losses.
| December 31, | ||||||
| 2004 | 2003 | |||||
| Amount | Percent | Amount | Percent | |||
| (Dollars in Thousands) | ||||||
| Real Estate Loans: | ||||||
| One- to four-family | $30,868 | 68.64 | % | $27,745 | 67.54 | % |
| Commercial | 6,641 | 14.77 | 6,147 | 14.96 | ||
| Multi-family | 1,423 | 3.16 | 1,230 | 2.99 | ||
| Construction or development | 3,772 | 8.39 | 3,492 | 8.51 | ||
| Total real estate loans | 42,704 | 94.96 | 38,614 | 94.00 | ||
| Other Loans: | ||||||
| Consumer Loans: | ||||||
| Home equity line of credit | 1,750 | 3.89 | 1,916 | 4.67 | ||
| Other | 349 | .78 | 425 | 1.03 | ||
| Total consumer loans | 2,099 | 4.67 | 2,341 | 5.70 | ||
| Commercial business loans | 167 | .37 | 122 | .30 | ||
| Total other loans | 2,266 | 5.04 | 2,463 | 6.00 | ||
| Total loans | 44,970 | 100.00 | % | 41,077 | 100.00 | % |
| Less: | ||||||
| Loans in process | 1,180 | 1,457 | ||||
| Deferred fees and discounts | 81 | 83 | ||||
| Allowance for losses | 743 | 759 | ||||
| 2,004 | 2,299 | |||||
| Total loans receivable, net | $42,966 | $38,778 | ||||
The following table shows the composition of our loan portfolio by fixed- and adjustable-rate at the dates indicated.
| December 31, | |||||||||
| 2004 | 2003 | ||||||||
| Amount | Percent | Amount | Percent | ||||||
| (Dollars in Thousands) | |||||||||
| Fixed-Rate Loans: | |||||||||
| Real estate: | |||||||||
| One- to four-family | $23,963 | 53.29 | % | $20,978 | 51.07 | % | |||
| Commercial | 2,684 | 5.97 | 2,368 | 5.75 | |||||
| Multi-family | 452 | 1.00 | 248 | .60 | |||||
| Construction or development | 3,097 | 6.89 | 2,992 | 7.29 | |||||
| Total real estate loans | 30,196 | 67.15 | 26,581 | 64.71 | |||||
| Consumer: | |||||||||
| Home Equity | --- | --- | --- | --- | |||||
| Other | 349 | .78 | 425 | 1.03 | |||||
| Commercial business | 167 | .37 | 122 | .30 | |||||
| 516 | 1.15 | 547 | 1.33 | ||||||
| Total fixed-rate loans | 30,712 | 68.30 | 27,128 | 66.04 | |||||
| Adjustable-Rate Loans: | |||||||||
| Real estate: | |||||||||
| One- to four-family | 6,905 | 15.35 | 6,767 | 16.47 | |||||
| Commercial | 3,957 | 8.80 | 3,784 | 9.21 | |||||
| Multi-family | 971 | 2.16 | 982 | 2.39 | |||||
| Construction or development | 675 | 1.50 | 500 | 1.22 | |||||
| Total real estate loans | 12,508 | 27.81 | 12,033 | 29.29 | |||||
| Consumer: | |||||||||
| Home Equity | 1,750 | 3.89 | 1,916 | 4.67 | |||||
| Other | --- | --- | --- | --- | |||||
| Total adjustable-rate loans | 14,258 | 31.70 | 13,949 | 33.96 | |||||
| Total loans | 44,970 | 100.00 | % | 41,077 | 100.00 | % | |||
| Less: | |||||||||
| Loans in process | 1,180 | 1,457 | |||||||
| Deferred fees and discounts | 81 | 83 | |||||||
| Allowance for loan losses | 743 | 759 | |||||||
| 2,004 | 2,299 | ||||||||
| Total loans receivable, net | $42,966 | $38,778 | |||||||
The following schedule illustrates the contractual maturity of our real estate construction and commercial business loan portfolios at December 31, 2004, before net items. Loans that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
| Real Estate Construction or Development | Commercial Business | Total | |||||||
| Amount | Weighted Average Rate | Amount | Weighted Average Rate | Amount | Weighted Average Rate | ||||
| (Dollars in Thousands) | |||||||||
| Due During Periods Ending December 31, | |||||||||
| 2005(1) | $3,660 | 6.03 | % | $ - | --- | % | $3,660 | 6.03 | % |
| 2006 to 2009 | --- | --- | 47 | 7.26 | 47 | 7.26 | |||
| After 2009 | 112 | 6.09 | 120 | 7.12 | 232 | 6.62 | |||
| Totals | $3,772 | 6.03 | $167 | 7.16 | $3,939 | 6.08 | |||
All of the loans in the above table due after December 31, 2005 have fixed interest rates, except for two adjustable rate loans totaling $675,000.
One- to Four-Family Residential Real Estate Lending. Residential loan originations are generated by our marketing efforts, present and walk-in customers, and referrals from real estate brokers and builders. We have focused our lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences in our market area. At December 31, 2004, one- to four-family residential mortgage loans totaled $30.9 million, or 68.6% of our gross loan portfolio.
Home Federal currently originates one- to four-family mortgage loans on either a fixed or adjustable basis, as consumer demand dictates. The pricing strategy for fixed-rate mortgage loans revolves around setting interest rates that are competitive with other local financial institutions. Adjustable-rate mortgage loans are generally offered with either one-year or three-year repricing periods. Due to their wide availability and market rate sensitivity, we generally use the one-year and three-year U.S. Treasury Security Constants plus a stated margin over such indices for pricing of adjustable-rate mortgage loans. During the year ended December 31, 2004, we originated $1.4 million of one- to four-family adjustable-rate mortgage loans and $8.5 million of one- to four-family, fixed-rate mortgage loans. We have not sold any mortgage loans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management; Market Risk Analysis" in our Annual Report to Stockholders.
Fixed-rate loans secured by one- to four-family residences have maximum maturities of 30 years, and are fully amortizing, with payments due monthly. These loans normally remain outstanding, however, for a substantially shorter period of time because of refinancing and other prepayments. A significant change in the current level of interest rates could alter the average life of a residential loan in our portfolio considerably. Our one- to four-family loans are not
assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Our real estate loans generally contain a "due on sale" clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.
Our one- to four-family residential adjustable-rate mortgage loans are fully amortizing with contractual maturities of up to 30 years, and payments due monthly. Our adjustable-rate mortgage loans provide for specified minimum and maximum interest rates. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as our cost of funds. Our adjustable-rate mortgage loans are generally not convertible into fixed-rate loans.
Adjustable-rate mortgage loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower's payment rises, and thus, increases the potential for default. We have not experienced significant delinquencies concerning these loans. See "- Asset Quality -- Non-Performing Assets" and "-Asset Quality -- Classified Assets."
We generally underwrite our one- to four-family loans based on the applicant's employment, credit history, and appraised value of the subject property. Presently, we lend up to 90% of the lesser of the appraised value or purchase price for one- to four-family loans. Properties securing our one- to four-family loans are appraised by independent fee appraisers approved and qualified by our Board of Directors. We generally require our borrowers to obtain title insurance and fire, property and flood insurance, if necessary, in an amount not less than the value of the security property.
Commercial and Multi-family Real Estate Lending. We are engaged in commercial and multi-family real estate lending. These loans are secured primarily by small retail establishments, small office buildings, warehouses, and other non-residential and multi-family residential properties located in our market area. We also purchase participation interests in loans originated by other financial institutions. At December 31, 2004, commercial real estate loans totaled $6.6 million or 14.8% of our gross loan portfolio and multi-family real estate loans totaled $1.4 million or 3.2% of our gross loan portfolio.
Our loans secured by commercial and multi-family real estate are originated with either a fixed or adjustable interest rate. The interest rate on adjustable-rate loans is based on a variety of indices, which are generally determined upon negotiation with the borrower. Loan-to-value ratios on our commercial and multi-family loans typically do not exceed 80% of the appraised value of the property securing the loan. These loans typically require monthly payments and have maximum maturities of 30 years. While maximum maturities may extend to 30 years, loans frequently have shorter maturities that generally range from 10 to 15 years.
Loans secured by commercial and multi-family real estate are granted based on the income producing potential of the property and the financial strength of the borrower. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. We generally require personal guarantees of the borrowers in addition to the security property as collateral for such loans. Appraisals on properties securing commercial and multi-family real
estate loans are performed by independent fee appraisers approved by our Board of Directors. See "- Loan Originations, Purchases and Repayments."
Loans secured by commercial and multi-family real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans because they typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial and multi-family real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. For example, cash flow from the project is reduced if leases are not obtained or renewed. See "- Asset Quality -- Nonperforming Loans."
Construction and Development Lending. We originate residential construction loans to individuals as well as loans secured by building lots or raw land held for development. Presently, all of these loans are secured by property located within our market area. We also purchase participation interests in construction loans originated by other lenders. At December 31, 2004, we had $3.8 million in construction and development loans outstanding, representing 8.4% of our gross loan portfolio. At December 31, 2004, our largest construction lending relationship consisted of a $550,000 loan secured by a church that is making a significant addition to its building. We also had a second construction lending relationship in the amount of $550,000 secured by a single family dwelling in the Cleveland, Ohio area . Approximately $173,000 and $211,000 of these relationships, respectively, were unfunded at December 31, 2004.
Construction loans to individuals for their residences generally are structured to be converted to permanent loans at the end of the construction phase, which typically runs six months. These construction loans have rates and terms that match the one- to four-family loans then offered by Home Federal, except that during the construction phase the borrower pays only interest on the loan. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.
Loans secured by building lots or raw land held for development are generally granted with terms of up to five years and are available at a fixed interest rate. Payments on loans secured by building lots are due monthly and amortized on a 20-year basis, resulting in a balloon payment at maturity. Payments on raw land held for development are due monthly, and are interest only. Loans secured by building lots or raw land for development are granted based on both the financial strength of the borrower and the value of the underlying property. At December 31, 2004, we had $112,000 of loans secured by building lots and raw land.
Construction loans are obtained principally through continued business from builders who have previously borrowed from Home Federal, as well as referrals from existing and walk-in customers. The application process includes submission of accurate plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building). We also conduct periodic inspections of the construction project being financed.
There are uncertainties inherent in estimating construction costs and the market for the project upon completion. Accordingly, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of success of the project. Construction loans to borrowers other than owner-occupants also involve many of the same risks discussed above regarding commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.
Other Lending. We also originate consumer loans and a nominal amount of commercial business loans. Our consumer loan portfolio consists of home equity lines of credit and other personal loans secured by first or second mortgages on residential real estate, and loans secured by deposits.
The largest component of our consumer lending is home equity lines of credit, which we began offering during 2001. At December 31, 2004, our home equity line of credit portfolio totaled $1.8 million, or 3.9% of our gross loan portfolio. We are currently offering this product with a ten year draw period followed by a ten year repayment period. The minimum monthly payment during the draw period is interest only. The payments during the repayment period will fully amortize the outstanding debt after ten years. At December 31, 2004, we had $1.9 million of unused credit available under our home equity line of credit program.
Our underwriting standards for home equity lines of credit generally include a determination of the applicant's payment history on other debts and their ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, our underwriting process also includes an evaluation of the value of the security property in relation to the proposed line of credit. An individual home equity line of credit, along with any other debt secured by the subject property, may not exceed 89.9% of the appraised value of the property. The appraised value of the property is generally determined using county real estate tax appraisals.
Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Loan Originations, Purchases and Repayments
We originate loans through our marketing efforts, existing and walk-in customers and referrals from real estate brokers and builders. While we originate both adjustable-rate and fixed-rate loans, our ability to originate loans is dependent upon the relative customer demand for loans in our market. Demand is affected by local competition and the interest rate environment.
During the last several years, our dollar volume of fixed-rate, one- to four-family loans has exceeded the dollar volume of the same type of adjustable-rate loans. Although our primary business is the origination of one- to four-family mortgage loans, competition from other financial institutions continues to limit the volume of loans we have been able to originate and place in our portfolio. As a result, we will from time to time purchase mortgage loans, and investment and mortgage-backed and related securities to supplement our portfolios. We do not sell loans and our loans are not originated according to secondary market guidelines.
In periods of economic uncertainty, the ability of financial institutions, including Home Federal, to originate large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in interest income.
The following table shows our loan origination, purchase and repayment activities for the periods indicated.
| Year Ended December 31, | ||||
| 2004 | 2003 | |||
| (In Thousands) | ||||
| Originations by type: | ||||
| Adjustable rate: | ||||
| Real estate - one- to four-family | $ 1,397 | $ 289 | ||
| - commercial | 480 | --- | ||
| - multi-family | 300 | --- | ||
| Non-real estate - home equity | 919 | 850 | ||
| - other consumer | --- | --- | ||
| - commercial business | --- | --- | ||
| Total adjustable-rate | 3,096 | 1,139 | ||
| Fixed rate: | ||||
| Real estate - one- to four-family | 8,515 | 7,338 | ||
| - commercial | 1,063 | 485 | ||
| - multi-family | --- | --- | ||
| - land and development | --- | 27 | ||
| Non-real estate - home equity | 380 | 365 | ||
| - other consumer | --- | --- | ||
| - commercial business | 109 | 42 | ||
| Total fixed-rate | 10,067 | 8,257 | ||
| Total loans originated | 13,163 | 9,396 | ||
| Purchases: | ||||
| Real estate - one- to four-family | --- | --- | ||
| - commercial | --- | 286 | ||
| - multi-family | --- | --- | ||
| - land and development | --- | --- | ||
| Total loans purchased | --- | 286 | ||
| Mortgage-backed and related securities | --- | 30,187 | ||
| Total purchased | --- | 30,473 | ||
| Repayments: | ||||
| Principal repayments | 18,811 | 29,834 | ||
| Total reductions | 18,811 | 29,834 | ||
| Increase (decrease) in other items, net | (39 | ) | (816 | ) |
| Net increase (decrease) | $(5,687 | ) | $9,219 | |
Asset Quality
When a borrower fails to make a payment on a loan on or before the default date, the loan is considered 30 days past due. At that time, we generally send out a delinquent notice to the borrower. All delinquent accounts are reviewed by one of our collection officers, and at his or her discretion, we attempt to cause the delinquency to be cured by contacting the borrower. If the loan becomes 60 days delinquent, our legal counsel will generally send a personal letter to the borrower requesting payment of the delinquent amount in full, or the establishment of an acceptable repayment plan to bring the loan current within 90 days. If the account becomes 90 days delinquent, and an acceptable repayment plan has not been agreed upon, the collection officer will generally refer the account to legal counsel, with instructions to prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. During this 30 day period, the collection officer may accept a written repayment plan from the borrower which would bring the account current within 90 days. Once the loan becomes 120 days delinquent, and an acceptable repayment plan has not been agreed upon, the collection officer, after receiving consent from our Board of Directors, will turn over the account to our legal counsel with instructions to initiate foreclosure.
Delinquent Loans. The following table sets forth our loan delinquencies by type, number, amount and percentage of type at December 31, 2004.
| Loans Delinquent For: | ||||||||||||
| 30-89 Days | 90 Days and Over | Total Delinquent Loans | ||||||||||
| Number | Amount | Percent of Loan Category | Number | Amount | Percent of Loan Category | Number | Amount | Percent of Loan Category | ||||
| (Dollars in Thousands) | ||||||||||||
| Real Estate: | ||||||||||||
| One- to four-family | 4 | $351 | 1.14 | % | 6 | $378 | 1.22 | % | 10 | $729 | 2.36 | % |
| Commercial | 1 | 342 | 5.15 | 1 | 1 | 0.01 | 2 | 343 | 5.16 | |||
| Multi-family | --- | --- | --- | --- | --- | --- | --- | --- | ||||
| Construction or development | --- | --- | --- | --- | --- | --- | --- | --- | --- | |||
| Consumer: | ||||||||||||
| Home Equity | --- | --- | --- | --- | --- | --- | --- | --- | --- | |||
| Other | --- | --- | --- | 2 | 70 | 3.33 | 2 | 70 | 3.33 | |||
| Commercial | --- | --- | --- | --- | --- | --- | --- | --- | --- | |||
| Total | 5 | $693 | 1.54 | % | 9 | $449 | 100.00 | % | 14 | $1,142 | 2.54 | % |
Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets. Loans are placed on non-accrual status when the collection of principal and/or interest becomes doubtful. For all years presented, we have had no troubled debt restructurings which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates.
| December 31, | ||||
| 2004 | 2003 | |||
| (Dollars in Thousands) | ||||
| Non-accruing loans: | ||||
| One- to four-family | $283 | $485 | ||
| Commercial real estate | 342 | 378 | ||
| Construction or development | --- | --- | ||
| Land | --- | 91 | ||
| Total | 625 | 954 | ||
| Accruing loans delinquent more than 90 days: | ||||
| One- to four-family | 95 | 23 | ||
| Multi-family | --- | --- | ||
| Commercial real estate | 1 | --- | ||
| Construction or development | --- | --- | ||
| Consumer: | ||||
| Home Equity | --- | --- | ||
| Other | 70 | 24 | ||
| Commercial business | --- | --- | ||
| Total | 166 | 47 | ||
| Real Estate Owned | 51 | --- | ||
| Total non-performing assets | $842 | $1,001 | ||
| Total as a percentage of gross loans receivable | 1.87 | % | 2.44 | % |
Except as discussed below, there were no nonperforming loans to any one borrower or group of related borrowers that exceeded either individually or in the aggregate $250,000.
Included in the table above is a commercial real estate loan with an outstanding balance of $342,000 at December 31, 2004. This loan is secured by an individual commercial property and was originated in December 1994 for $582,000, with a loan-to-value ratio of approximately 78%. In February 2001, this loan was placed on non-accrual status due to the financial condition of the borrower and the value of the collateral securing the loan. The loan was subsequently brought current and thereafter modified by agreement among the parties. Due to financial difficulties during 2003 due to changes in regulations affecting the borrower business, the borrower requested, and we agreed to, a temporary reduction in the amount of the borrower's monthly payments. The borrower has made all payments required under this revised schedule. We will consider removing this loan from nonaccrual status when the borrower demonstrates both a consistent payment history for at least 12 consecutive months and submits verifiable financial statements that indicate the ability to service its debt consistent with the loan terms.
For the year ended December 31, 2004, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $54,000, of which none was included in interest income.
Other Loans of Concern. At December 31, 2004, there were no loans that were not included in the table above where known information about the possible credit problems of borrowers caused management to have serious doubts as to the ability of the borrower to comply with present loan repayment terms and which may result in disclosure of such loans in the future.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of Thrift Supervision to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is unwarranted.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off that particular amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision and the FDIC, which may order the establishment of additional general or specific loss allowances.
In connection with the filing of our periodic reports with the Office of Thrift Supervision and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management's review of our assets, at December 31, 2004, we had classified $721,000 of our assets as substandard, which represents 4.4% of stockholders' equity and 0.7% of total assets. No assets were classified as doubtful or as loss.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses which is based on management's evaluation of past loss experience, current trends in the level of delinquent and specific problem loans, loan concentration to single borrowers, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current and anticipated economic conditions in our market area. A significant portion of our loan portfolio is concentrated in one- to four-family mortgage loans which, historically, has not led to any significant loan losses. Management prepares quarterly analyses of loans classified as substandard and non-performing, and evaluates these loans in connection with its determination of the appropriate provision for loan losses to be recorded for the period. Management also analyzes borrowers with significant outstanding balances
to reevaluate credit risk, the quality of the loan and factors that may affect the borrowers' ability to pay. Accordingly, the allowance represents managements's estimate of losses inherent in our loan portfolio as of a specified date.
Although management believes that it uses the best information available to determine the allowance, unforeseen market conditions could result in adjustments and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Future additions to our allowance will be the result of periodic loan, property and collateral reviews and thus, cannot be predicted in advance. At December 31, 2004, our total allowance for loan losses represented coverage of 93.9% of non-performing loans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations -- Provision for Loan Losses" and Notes A and C of the Notes to Consolidated Financial Statements contained in our Annual Report to Stockholders filed as Exhibit 13 to this Annual Report on Form 10-KSB.
The following table sets forth an analysis of our allowance for loan losses.
| At and For the Years Ended December 31, | ||||
| 2004 | 2003 | |||
| (Dollars in Thousands) | ||||
| Balance at beginning of period | $759 | $ 762 | ||
| Charge-offs: One- to four-family | 16 | 3 | ||
| Total charge-offs | 16 | 3 | ||
| Recoveries: | --- | --- | ||
| Net (charge-offs) recoveries | (16 | ) | (3 | ) |
| Additions charged to operations | --- | --- | ||
| Balance at end of period | $743 | $ 759 | ||
| Ratio of net charge-offs (recoveries) during the period to average loans outstanding during the period | 0.04 | % | 0.01 | % |
| Ratio of net charge-offs (recoveries) during the period to average non-performing loans | 1.70 | % | --- | % |
The distribution of our allowance for loan losses at the dates indicated is summarized as follows:
| December 31, | ||||||||
| 2004 | 2003 | |||||||
| Amount of Loan Loss Allowance | Loan Amounts by Category | Percent of Loans in Each Category to Total Loans | Amount of Loan Loss Allowance | Loan Amounts by Category | Percent of Loans in Each Category to Total Loans | |||
| (Dollars in Thousands) | ||||||||
| One- to four-family | $209 | $30,868 | 68.64 | % | $247 | $27,745 | 67.54 | % |
| Multi-family, commercial, real estate, construction or development | 378 | 11,836 | 26.32 | 398 | 10,869 | 26.46 | ||
| Consumer and commercial business | 12 | 2,266 | 5.04 | 13 | 2,463 | 6.00 | ||
| Unallocated | 144 | --- | --- | 101 | --- | --- | ||
| Total | $743 | $44,970 | 100.00 | % | $759 | $41,077 | 100.00 | % |
Investment Activities
Home Federal must maintain sufficient levels of investments that qualify as liquid assets to meet the safety and soundness requirement under Office of Thrift Supervision regulations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets at levels believed adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. See "Regulation - Federal Regulation of Savings Associations" for a discussion of additional restrictions on our investment activities.
President Stephens, Vice President Safarek and Compliance Officer Csontos have the basic responsibility for the management of our investment portfolio, subject to the direction and guidance of the Board of Directors. These officers consider various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loans.
The general objectives of our investment portfolio are to: (i) provide and maintain liquidity within the guidelines prescribed by Office of Thrift Supervision regulations; (ii) provide liquidity when loan demand is high and to assist in maintaining earnings when loan demand is low; and (iii) maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management; Market Risk Analysis" in our Annual Report to Stockholders.
Our investment securities consist primarily of U.S. agency securities. The U.S. agency securities consist of different callable securities, issued by either the Federal Home Loan Bank system, Fannie Mae or Freddie Mac. These securities have original maturities ranging from 30 months to 15 years and original call periods ranging from one month to three years.
Our mortgage-backed and related securities portfolio consists of securities issued under government-sponsored agency programs. We hold entirely collateralized mortgage obligations. Collateralized mortgage obligations are special types of pass-through debt securities in which the principal and interest payments on the underlying mortgages or mortgage-backed securities are used to create classes with different maturities and, in some cases, amortization schedules, as well as a residual interest, with each such class possessing different risk characteristics.
Our policy is to purchase only collateralized mortgage obligations that are in the first or second repayment tranche (investment class) and are AAA rated. The expected life of our collateralized mortgage obligations is typically under five years at the time of purchase, although the contractual life may exceed 20 years. Premiums associated with collateralized mortgage obligations purchased are not significant; therefore, the risk of significant yield adjustments because of accelerated prepayments is limited. Yield adjustments are encountered as interest rates rise or decline, which in turn slows or increases prepayment rates and affects the average life of the collateralized mortgage obligations. The purpose of our collateralized mortgage obligation investment strategy is to: (i) assist in maintaining Home Federal's qualified thrift lender status (see "Regulation - Qualified Thrift Lender"); (ii) generate high cash flow so as to lessen liquidity and reinvestment risk; (iii) preserve asset quality; and (iv) generate additional interest income. At December 31, 2004, we held collateralized mortgage obligations with a fair market value of $16.0 million, all of which were secured by underlying collateral issued under government agency-sponsored programs. Substantially all of our collateralized mortgage obligations and mortgage-backed securities are currently classified as available for sale. We anticipate classifying as available for sale all new purchases of collateralized mortgage obligations. At December 31, 2004, $14.3 million of our collateralized mortgage obligations qualified as high risk mortgage securities under Office of Thrift Supervision regulations. These securities qualified as high-risk mortgage-related securities because of the current low interest rate environment. The low rate environment increases the likelihood that the underlying mortgages will prepay, which causes the estimated life of the securities, and therefore their market value, to become uncertain. At the time of purchase none of these securities qualified as high risk.
While mortgage-backed and related securities, such as collateralized mortgage obligations, carry reduced credit risk as compared to conventional loans, mortgage-backed and
related securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of such mortgage loans and thus, affect both the prepayment speed, and value, of such securities.
The following table sets forth the composition of our investment and mortgage-backed and related securities portfolio at the dates indicated. Our investment securities portfolio at December 31, 2004, contained neither tax-exempt securities nor securities of any issuer with an aggregate book value in excess of 10% of our retained earnings, excluding those issued by the U.S. Government or its agencies.
| December 31, | ||||||
| 2004 | 2003 | |||||
| Book Value | % of Total | Book Value | % of Total | |||
| (Dollars in Thousands) | ||||||
| Investment securities: | ||||||
| Freddie Mac stock | $ 1,842 | 5.60 | % | $ 1,691 | 6.22 | % |
| U.S. agency securities | 29,899 | 90.89 | 24,387 | 89.70 | ||
| Federal Home Loan Bank stock | 1,141 | 3.47 | 1,095 | 4.03 | ||
| Other | 15 | 0.04 | 15 | .05 | ||
| Total investment securities and Federal Home Loan Bank stock | $32,897 | 100.00 | % | $27,188 | 100.00 | % |
| Mortgage-backed and related securities: | ||||||
| Collateralized mortgage obligations | $16,031 | 100.0 | % | $25,129 | 98.11 | % |
| Freddie Mac | --- | --- | --- | --- | ||
| Fannie Mae | --- | --- | 484 | 1.89 | ||
| Unamortized discounts, net | --- | --- | --- | --- | ||
| Total mortgage-backed and related securities | $16,031 | 100.00 | % | $25,613 | 100.00 | % |
| Other interest-earning investments: | ||||||
| Money market mutual fund | $ 1,582 | 31.00 | % | $ 882 | 13.72 | % |
| Interest-bearing deposits with banks | 2,521 | 49.40 | 2,946 | 45.83 | ||
| Federal funds sold | 1,000 | 19.60 | 2,600 | 40.45 | ||
| Total | $ 5,103 | 100.00 | % | $ 6,428 | 100.00 | % |
The following table sets forth the contractual maturities of our investment and mortgage-backed and related securities at December 31, 2004.
| 1 Year or Less | After 1 to 3 Years | After 3 to 5 Years | After 5 to 10 Years | After 10 to 20 Years | Over 20 Years | December 31, 2004 Balance Outstanding | |
| (In Thousands) | |||||||
| U.S. agency securities | $--- | $3,000 | $10,966 | $11,939 | $3,994 | $ --- | $29,899 |
| Collateralized mortgage obligations | --- | 61 | --- | --- | 5,044 | 10,926 | 16,031 |
| Total | $--- | $2,061 | $11,966 | $11,939 | $9,038 | $10,926 | $45,930 |
| Weighted average yield | --- | 3.344% | 3.42% | 4.03% | 5.12% | 4.60% | 4.19% |
Sources of Funds
General. Our sources of funds are deposits and borrowings, payment of principal and interest on loans, interest earned on or maturation of other investment securities and short-term investments, and funds provided from operations.
Deposits. We offer a variety of deposit accounts having a wide range of interest rates and terms. Our deposits consist of passbook and statement savings accounts, money market deposit accounts, NOW accounts and certificate of deposit accounts currently ranging in terms from six months to five years. We only solicit deposits from our market area and do not use brokers to obtain deposits. We primarily rely on competitive pricing policies, advertising and customer service to attract and retain these deposits. The flow of deposits is influenced significantly by general economic conditions, changes in market interest rates, and competition.
The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. We endeavor to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives. Based on our experience, we believe that our savings and checking accounts are relatively stable sources of funds. Our ability to attract and maintain certificates of deposit and the rates paid on these deposits, however, has been and will continue to be significantly affected by market conditions.
The following table sets forth the deposit flows at Home Federal during the periods indicated.
| Years Ended December 31, | ||||
| 2004 | 2003 | |||
| (Dollars in Thousands) | ||||
| Opening balance | $61,936 | $60,895 | ||
| Deposits | 50,774 | 47,762 | ||
| Withdrawals | (52,191 | ) | (47,829 | ) |
| Interest credited | 939 | 1,108 | ||
| Ending balance | $61,458 | $61,936 | ||
| Net increase (decrease) | $ (478 | ) | $ 1,041 | ) |
| Percent increase (decrease) | (0.77 | )% | 1.68 | % |
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs we offered for the periods indicated.
| December 31, | ||||||
| 2004 | 2003 | |||||
| Amount | Percent of Total | Amount | Percent of Total | |||
| (Dollars in Thousands) | ||||||
| Transactions and Savings Deposits: | ||||||
| Passbook and statement savings accounts (.75%)(1) | $18,978 | 30.88 | % | $20,193 | 32.60 | % |
| NOW accounts (.50%)(1) | 4,533 | 7.38 | 4,378 | 7.07 | ||
| Money market accounts (1.00%)(1) | 3,732 | 6.07 | 3,830 | 6.19 | ||
| Total non-certificates | 27,243 | 44.33 | 28,401 | 45.86 | ||
| Certificates: | ||||||
| 0.51 - 2.00% | 15,982 | 26.00 | 23,029 | 37.18 | ||
| 2.01 - 4.00% | 14,563 | 23.70 | 10,104 | 16.31 | ||
| 4.01 - 6.00% | 3,670 | 5.97 | 402 | .65 | ||
| Total certificates | 34,215 | 55.67 | 33,535 | 54.14 | ||
| Total deposits | $61,458 | 100.00 | % | $61,936 | 100.00 | % |
The following table shows rate and maturity information for our certificates of deposit as of December 31, 2004.
| 0.51- 2.00% | 2.01- 4.00% | 4.01- 6.00% | Total | Percent | ||||||
| (Dollars in Thousands) | ||||||||||
| Certificate accounts maturing in quarter ending: | ||||||||||
| March 31, 2005 | $ 5,057 | $ 153 | $ 176 | $ 5,386 | 15.74 | % | ||||
| June 30, 2005 | 6,043 | --- | 544 | 6,587 | 19.25 | |||||
| September 30, 2005 | 2,313 | 722 | 166 | 3,201 | 9.36 | |||||
| December 31, 2005 | 2,242 | 1,497 | 114 | 3,853 | 11.26 | |||||
| March 31, 2006 | 327 | 1,874 | --- | 2,201 | 6.43 | |||||
| June 30, 2006 | --- | 2,198 | 30 | 2,228 | 6.51 | |||||
| September 30, 2006 | --- | 3,291 | --- | 3,291 | 9.62 | |||||
| December 31, 2006 | --- | 1,241 | --- | 1,241 | 3.63 | |||||
| March 31, 2007 | --- | 456 | 606 | 1,062 | 3.10 | |||||
| June 30, 2007 | --- | 1,373 | --- | 1,373 | 4.01 | |||||
| September 30, 2007 | --- | 733 | 1,000 | 1,733 | 5.07 | |||||
| December 31, 2007 | --- | 469 | 265 | 734 | 2.15 | |||||
| Thereafter | --- | 556 | 769 | 1,325 | 3.87 | |||||
| Total | $15,982 | $14,563 | $3,670 | $34,215 | 100.00 | % | ||||
| Percent of total | 46.71 | % | 42.56 | % | 10.73 | % | 100.00 | % | ||
The following table indicates the amount of our certificates of deposit and other deposits by time remaining until maturity as of December 31, 2004.
| Maturity | |||||
| 3 Months or Less | Over 3 to 6 Months | Over 6 to12 Months | Over 12 Months | Total | |
| (In Thousands) | |||||
| Certificates of deposit less than $100,000 | $3,075 | $3,690 | $4,534 | $9,079 | $20,378 |
| Certificates of deposit of $100,000 or more | 2,311 | 2,897 | 2,520 | 6,109 | 13,837 |
| Total certificates of deposit | $5,386 | $6,587 | $7,054 | $15,188 | $34,215 |
Borrowings. Although deposits are our primary source of funds, we utilize borrowings when they are a less costly source of funds, and can be invested at a positive interest rate spread or when we desire additional capacity to fund loan demand. At December 31, 2004, we had borrowings totaling $20.5 million. The average balance of our borrowings during this period was $20.5 million. Our current borrowings consist of twelve different Federal Home Loan Bank advances. Eleven advances have a fixed interest rate initial term, followed by a period where the advance converts to a variable rate, at the option of the Federal Home Loan Bank. The fixed initial terms range from three months to five years. Each advance is subject to a prepayment penalty if paid prior to its maturity date, except for when prior to maturity an advance is converted to a variable rate. The advances can be prepaid without penalty at the time of conversion from a fixed to a variable rate, and quarterly thereafter. After the fixed interest rate
period expires, each advance converts to a variable rate equivalent to the three-month London Interbank Offered Rate. Eleven of the advances have an initial maturity of 10 years. We also have one fixed rate advance with an original maturity of three years. The weighted average interest rate of the twelve FHLB advances is 4.51% at December 31, 2004. See Note H of the Notes to Consolidated Financial Statements.
Subsidiary and Other Activities
As a federally chartered savings association, Home Federal is permitted by Office of Thrift Supervision regulations to invest up to 2% of its total assets, or $2.0 million at December 31, 2004, in the stock of, or unsecured loans, to service corporation subsidiaries. Home Federal may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. At December 31, 2004, Home Federal had no subsidiaries.
In 1996, we acquired a 17.5% interest in an Ohio limited partnership formed to construct multi-family housing units. Under the terms of the limited partnership agreement, we have made a total capital contribution to the partnership of $500,000 and are allocated tax losses and affordable housing federal income tax credits. See Note D of Notes to Consolidated Financial Statements.
Regulation
General. Home Federal is a federally chartered savings institution, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, we are subject to broad federal regulation and oversight, primarily by the Office of Thrift Supervision, extending to all our operations. As the holding company of Home Federal, First Niles also is subject to federal regulation and oversight by the Office of Thrift Supervision.
The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. The current assessment rates range from zero to 0.27% per $100 of assessable deposits.
Federal Regulation of Savings Associations. The Office of Thrift Supervision has extensive authority over the operations of savings associations. As part of this authority, we are required to file periodic reports with the Office of Thrift Supervision and are subject to periodic examinations by the Office of Thrift Supervision.
The Office of Thrift Supervision also has extensive enforcement authority over all savings associations and their holding companies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.
Home Federal's general permissible lending limit for loans to a single borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus, except for loans fully
secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus. Under applicable regulations, multiple borrowers may be treated as a single borrower for purposes of applying this lending limit. At December 31, 2004, our lending limit under this restriction was $2.3 million.
Regulatory Capital Requirements. To be considered adequately capitalized, a savings association must maintain the following capital ratios: a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 4% (unless its supervisory condition allows a 3% ratio), a Tier 1 risk-based ratio (the ratio of Tier 1 capital to risk-weighted assets) of at least 4%, and a total risk-based capital ratio (the ratio of total capital to risk-weighted assets) of at least 8%. Total capital consists of Tier 1 and Tier 2 capital.
Tier 1 capital generally consists of common stockholders equity, noncumulative perpetual preferred stock and other tangible capital plus certain intangible assets, including a limited amount of purchased credit card receivables. Tier 2 capital consists generally of certain permanent and maturing capital instruments and allowances for loan and lease losses up to 1.25% of risk-weighted assets. When determining total capital, Tier 2 capital may not exceed Tier 1 capital. At December 31, 2004, Home Federal had no intangible assets which were included in Tier 1 capital.
To determine the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the Office of Thrift Supervision has assigned a risk weight of 50% for prudently underwritten permanent one-to four-family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac.
To be considered well-capitalized, a savings association must have a leverage ratio of at least 5%, a Tier 1 risk-based ratio of at least 6% and a total risk-based capital ratio of 10%. As of December 31, 2004, Home Federal qualified as well capitalized, with a leverage ratio of 14.2%, a Tier 1 risk-based capital ratio of 33.6% and a total risk-based capital ratio of 36.9%. The OTS may reclassify a savings association in a lower capital category or require it to hold additional capital based upon supervisory concerns on a case-by-case basis.
Under the prompt corrective action regulations, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation are authorized, and under certain circumstances required, to take certain actions against a savings association that is not at least adequately capitalized. Such an association must submit a capital restoration plan and until the plan is approved by the Office of Thrift Supervision may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. For a savings association controlled by a holding company, the capital restoration plan must include a guarantee by the holding company limited to the lesser of 5% of the association's assets when it failed the "adequately capitalized" standard or the amount needed to satisfy the plan, and, in the event of the bankruptcy of the holding company, the guaranty would have priority over the claims of general creditors. Additional and more stringent restrictions may be applicable, depending on the financial condition of the association and other circumstances. If an
association becomes critically undercapitalized, because it has a ratio of tangible equity to total assets of 2% or less, appointment of a receiver or conservator may be required.
Limitations on Dividends and Other Capital Distributions. Office of Thrift Supervision regulations impose various restrictions on savings associations with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.
A savings association that is a subsidiary of a holding company, such as Home Federal, may make a capital distribution with prior notice to the Office of Thrift Supervision, in an amount that does not exceed its net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid) if the savings association has a regulatory rating in the two top examination categories, is not of supervisory concern, and would remain well capitalized following the proposed distribution. All other institutions or those seeking to exceed the noted amounts must obtain OTS approval of an application for a capital distribution before making the distribution.
Qualified Thrift Lender Test. All savings institutions are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its portfolio assets, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. Under either test, these assets primarily consist of residential housing related loans and investments. At December 31, 2004, Home Federal met the test.
Any savings institution that fails to meet the qualified thrift lender test must either convert to a national bank, or restrict its branching rights, new activities and investments and dividends to those permissible for a national bank. If the institution has not requalified or converted to a national bank within three years after the failure, it must sell all investments and stop all activities not permissible for a national bank. If any institution that fails the qualified thrift lender test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies.
Transactions with Affiliates. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association's capital and are subject to collateralization requirements. Affiliates of Home Federal include First Niles and any company which is under common control with Home Federal. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of an affiliate. The Office of Thrift Supervision has the discretion to further restrict transactions of a savings associations with an affiliate on a case-by-case basis.
Holding Company Regulation. First Niles is a unitary savings and loan holding company subject to regulatory oversight by the Office of Thrift Supervision. First Niles is required to register and file reports with the Office of Thrift Supervision and is subject to regulation and examination by the Office of Thrift Supervision. In addition, the Office of Thrift Supervision has enforcement authority over us and our non-savings institution subsidiaries.
First Niles generally is not subject to activity restrictions. If First Niles acquired control of another savings institution as a separate subsidiary, it would become a multiple savings and loan holding company, and its activities and any of its subsidiaries (other than Home Federal or any other savings institution) would generally become subject to additional restrictions.
Federal and State Taxation
Federal Taxation. In August 1996, legislation was enacted that repealed the percentage of taxable income method used by many thrifts to calculate their bad debt reserve for federal income tax purposes. As a result, small thrifts must recapture that portion of the reserve that exceeds the amount that could have been taken under the experience method for tax years beginning after December 31, 1987. Due to certain limitations as to allowable additions to the bad debt reserve, Home Federal has not made additions to its allowance since 1987 and will not be subject to federal income tax recapture.
In addition to the regular income tax, corporations, including savings institutions, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income.
A portion of our reserves for losses on loans which are presented on the statement of financial condition as retained earnings, may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder, including distributions on redemption, dissolution or liquidation, or for any other purpose except to absorb bad debt losses. As of December 31, 2004, the portion of our reserves subject to this treatment for tax purposes totaled approximately $2.5 million.
We file federal income tax returns on a fiscal year basis using the accrual method of accounting. First Niles intends to file a consolidated federal income tax return with Home Federal for the year ended December 31, 2004.
The federal income tax returns of First Niles and Home Federal for the last three years are open to possible audit by the Internal Revenue Service. No returns are being audited by the Internal Revenue Service at the current time. In the opinion of management, any examination of still open returns would not result in a deficiency which could have a material adverse effect on the consolidated financial condition of First Niles.
Ohio Taxation. Home Federal is subject to the Ohio corporate franchise tax. As a financial institution, we compute our franchise tax based on our net worth. Under this method, we will compute our Ohio corporate franchise tax by multiplying our net worth, as specifically adjusted pursuant to Ohio law, by the applicable tax rate, which is currently 1.3%. First Niles is also subject to the Ohio corporate franchise tax. The tax imposed is the greater of the tax on net worth, or the tax on net income.
Delaware Taxation. As a Delaware holding company, First Niles is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. First Niles is also subject to an annual franchise tax imposed by the State of Delaware.
Competition
We face strong competition in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers. Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.
We attract all of our deposits through Home Federal's one office in Niles, Ohio. Competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in our market area, as well as mutual funds. We compete for these deposits by offering a variety of deposit accounts at competitive rates and superior service.
Executive Officers of First Niles
William L. Stephens. Mr. Stephens, age 73, serves as Chairman of the Board, President and Chief Executive Officer of Home Federal and First Niles. He has served in such capacities for Home Federal since 1969 and for First Niles since its formation in October 1998.
Lawrence Safarek. Mr. Safarek, age 56, currently serves as Vice President and Treasurer of Home Federal and First Niles. He has served in such capacities with Home Federal since 1995 and for First Niles since its formation in October 1998. Mr. Safarek has been employed with Home Federal in numerous other capacities since 1971.
Employees
At December 31, 2004, we had a total of 12 employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
Item 2. Description of Property
We conduct our business through Home Federal's only office located in Niles, Ohio, which is owned by Home Federal. We believe that our current facilities are adequate to meet the present and foreseeable needs of Home Federal and First Niles. The total net book value of Home Federal's premises and equipment, including land, building and leasehold improvements and furniture, fixtures and equipment, at December 31, 2004 was $289,000. See Note E of Notes to Consolidated Financial Statements.
We maintain an on-line data base with a service bureau servicing financial institutions. The net book value of the data processing and computer equipment utilized by Home Federal at December 31, 2004 was $31,000.
Item 3. Legal Proceedings
From time to time First Niles is involved as plaintiff or defendant in various legal actions arising in the normal course of business. Presently, First Niles is not involved in any legal proceedings that are expected to have a material adverse impact on its consolidated financial position.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of securityholders, through the solicitation of proxies or otherwise during the quarter ended December 31, 2004.
Item 5. Market for Common Equity and Related Stockholder Matters
Page 46 of First Niles' 2004 Annual Report to Stockholders attached to this document as Exhibit 13 is incorporated herein by reference. In addition, the "Equity Compensation Plan Information" contained in Part III, Item 11 of this Form 10-KSB is incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 2 to 17 of First Niles' 2004 Annual Report to Stockholders attached to this document as Exhibit 13 is incorporated herein by reference.
Item 7. Financial Statements
The following information appearing in First Niles 2004 Annual Report to Stockholders attached hereto as Exhibit 13 is incorporated herein by reference.
| Annual Report Section | Pages in Annual Report |
| Report of Independent Registered Accounting Firm | 18 |
| Consolidated Statements of Financial Condition as of December 31, 2004 and 2003 | 19 |
Consolidated Statements of Income for the Years Ended December 31, 2004 and 2003 | 20 |
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2004 and 2003 | 21 |
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004 and 2003 | 22 |
Notes to Consolidated Financial Statements | 23-45 |
With the exception of the information contained in this Part II of the Form 10-KSB, First Niles' Annual Report to Stockholders for the year ended December 31, 2004, is not deemed filed as part of this Annual Report on Form 10-KSB.
| Item 8. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure.
On February 9, 2005, First Niles Financial, Inc. filed a Current Report on Form 8-K announcing that Anness, Gerlach ∓ Williams would not be standing for re-election as its independent public accountants for the year ended December 31, 2005. The Audit Committee is currently seeking and evaluating proposals from several accounting firms. A representative of Anness, Gerlach ∓ Williams is expected to attend the meeting to respond to appropriate questions and will have an opportunity to make a statement if he or she so desires.
In the report the Company stated that the audit reports of Anness, Gerlach ∓ Williams on the First Niles' financial statements for the last two fiscal years ended December 31, 2004 did not contain a qualified, adverse or disclaimed opinion and that during the two fiscal years ended December 31, 2004 and through February 7, 2005, there were no disagreements with Anness, Gerlach ∓ Williams on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which if not resolved to Anness, Gerlach ∓ Williams' satisfaction, would have caused them to make reference to the subject matter of such disagreement in connection with issuing their reports.
Item 8A. Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as defined in Section 13a-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act")) as of December 31, 2004, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Principal Financial Officer and several other members of the Company's senior management. The Company's Chief Executive Officer and Principal Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Principal Financial Officer) in a timely manner and (ii) recorded processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no changes in our internal control over financial reporting (as defined in 13a-15(f) of the Act) that occurred during the quarter ended December 31, 2004, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material non-financial information concerning the Company's business. While the Company believes the present design of its disclosure controls
and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures.
Item 8B. Other Information
None.
| Item 9. | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act |
Directors
Information concerning Directors of First Niles is incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
Executive Officers
Information concerning Executive Officers of First Niles is contained under the caption "Executive Officers of First Niles" in Part I of this Form 10-KSB, and is incorporated herein by this reference.
Audit Committee Financial Expert
Information concerning the audit committee of the Company's Board of Directors, including information regarding audit committee financial experts serving on the audit committee, is incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
Compliance with Section 16(a)
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires First Niles directors and executive officers, and persons who own more than 10% of a registered class of its equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of First Niles. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish First Niles with copies of all Section 16(a) forms they file.
Information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated herein by reference from the definitive proxy statement for the
Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
Code of Ethics
The Company has adopted a written Code of Ethics based upon the standards set forth under Item 406 of Regulation S-B of the Securities Exchange Act. The Code of Ethics applies to all of the Company's directors, officers and employees. A copy of the Company's Code of Ethics was filed with the SEC as Exhibit 14 to its Annual Report on Form 10-KSB for the year ended December 31, 2003. You may obtain a copy of the Code of Ethics free of charge from the Company by writing to our Corporate Secretary at First Niles Financial, Inc., 55 North Main Street, Niles Ohio 44446, or by calling (330) 652-2539.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
| Item 11. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
Equity Compensation Plan Information. The following table summarizes our equity compensation plans as of December 31, 2004.
| Plan Category | Number of securities to be issued upon exercise of outstanding options warrants and rights | Weighted-average exercise price of outstanding options warrants and rights | Number of Securities remaining available for future issuance under equity compensation plans |
| Equity compensation plans approved by security holders | 55,971 | $12.53 | 24,911(1) |
| Equity compensation plans not approved by security holders | --- | --- | --- |
| (1) | Includes 17,894 shares available for future grants under First Niles Financial, Inc's Stock Option and Incentive Plan and 7,017 shares available for future grants under First Niles Financial, Inc's Recognition and Retention Plan. |
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed not later than 120 days after the close of the fiscal year.
Item 13. Exhibits
See Index to Exhibits
Item 14. Principal Accountant Fees and Services
Information concerning principal accountant fees and services are incorporated herein by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held in April 2005, except for information contained under the heading "Report of the Audit Committee," a copy of which will be filed no later than 120 days after the close of the fiscal year.
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
| FIRST NILES FINANCIAL, INC. | ||||
| Date: | March 31, 2005 | By: | /s/ William L. Stephens William L. Stephens Chairman of the Board, President and Chief Executive Officer (Duly Authorized Representative) | |
In accordance with 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.
| /s/ William L. Stephens William L. Stephens, Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) | Date: | March 31, 2005 |
| /s/ Leonard T. Gantler Leonard T. Gantler, Director | Date: | March 31, 2005 |
| /s/ P. James Kramer P. James Kramer, Director | Date: | March 31, 2005 |
| /s/ William S. Eddy William S. Eddy, Director | Date: | March 31, 2005 |
| /s/ Ralph A. Zuzolo Ralph A. Zuzolo, Sr., Director | Date: | March 31, 2005 |
| /s/ Thomas G. Maley Thomas G. Maley, Controller (Principal Accounting Officer) | Date: | March 31, 2005 |
| Exhibit Number | Document | |
| 3 | The Certificate of Incorporation and Bylaws, filed on July 10, 1998 as Exhibits 3.1 and 3.2, respectively, to Registrant's Registration Statement on Form SB-2 (File No. 333-58883), are incorporated by reference. | |
| 4 | Registrant's Specimen Stock Certificate, filed on July 10, 1998 as Exhibit 4 to Registrant's Registration Statement on Form SB-2 (File No. 333-58883), is incorporated by reference. | |
| 10.1 | Employment Agreement between Registrants operating bank subsidiary and William L. Stephens and Lawrence Safarek filed as Exhibits 10.1 and 10.3 to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1998 (File No. 0-24849), is incorporated herein by reference. | |
| 10.2 | Registrant's 1999 Stock Option and Incentive Plan, filed on November 12, 1999 as Appendix A to Registrant's Proxy Statement on Schedule 14A (File No. 0-24849), is incorporated herein by reference. | |
| 10.3 | Registrant's 1999 Recognition and Retention Plan filed on November 12, 1999 as Appendix B to Registrant's Proxy Statement on Schedule 14A (File No. 000-24849), is incorporated herein by reference. | |
| 10.4 | Form of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreement. | |
| 10.5 | Named Executive Officer Salary and Bonus Arrangements for 2005 | |
| 10.6 | Current Director Fee Arrangements | |
| 13 | Annual Report to Stockholders | |
| 14 | Code of Ethics filed as Exhibit 14 to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 2003 (File No. 0-24849), is incorporated herein by reference. | |
| 21 | Subsidiaries of the Registrant filed as Exhibit 21 to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1998 (File No. 0-24849), is incorporated herein by reference. | |
| 23 | Consent of Accountants | |
| 31.1 | Rule 13(a)-14(a) Certification (Chief Executive Officer) | |
| 31.2 | Rule 13(a)-14(a) Certification (Chief Financial Officer) | |
| 32 | Section 1350 Certification | |
