UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of
the Security Exchange Act of 1934
For the transition period from _____________ to _____________
Commission file number: 0-28080
UNITED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
MINNESOTA 81-0507591
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
P.O. Box 2779, 120 1st Avenue North, Great Falls, Montana 59403
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (406) 727-6106
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding twelve months (or for such shorter period that
the Registrant was required to file such reports), and (2) has been subject to
such requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form 10-K or
any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by
non-affiliates of the Registrant, computed by reference to the closing price of
such stock on the Nasdaq National Market as of February 26, 1999, was
$25,289,241.
The number of shares of Registrant's common stock outstanding on
February 26, 1999 was 1,698,312. Registrant's common stock is traded on the
Nasdaq National Market, symbol UBMT.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of
Stockholders to be held on May 20, 1999 are incorporated by reference into Part
III of this Form 10-K.
UNITED FINANCIAL CORP.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Item 1. Business............................................................. 1
Item 2. Properties...........................................................16
Item 3. Legal Proceedings....................................................16
Item 4. Submission of Matters to a Vote of Security Holders..................16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..................................................16
Item 6. Selected Financial Data..............................................18
Item 7. Management's Discussion and Analysis of Pro Forma Combined
Financial Condition and Results of Operations of Heritage
and Old United.......................................................19
Item 7a. Quantitative and Qualitative Disclosures about Market Risk...........32
Item 8. Financial Statements and Supplementary Data..........................33
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure...............................34
PART III
Item 10. Directors and Executive Officers of the Registrant...................34
Item 11. Executive Compensation...............................................34
Item 12. Security Ownership of Certain Beneficial Owners
and Management.......................................................34
Item 13. Certain Relationships and Related Transactions.......................34
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K..........................................................35
i
PART I
ITEM 1. BUSINESS
GENERAL. United Financial Corp. ("United") is a bank holding company
headquartered in Great Falls, Montana, with operations in 12 other Montana
communities. Substantially all of United's banking business is currently
conducted through its wholly-owned subsidiaries Heritage Bank F.S.B. ("Heritage
Bank") and Heritage State Bank ("State Bank"), a recently formed banking
subsidiary. United had assets of approximately $232 million, deposits of
approximately $168 million and shareholders' equity of approximately $31 million
at December 31, 1998. United is the result of the merger on February 3, 1998
(the "Heritage Merger") of two Montana-based savings and loan holding companies
of relatively comparable size: United Financial Corp. (as it existed prior to
the merger, "Old United") and Heritage Bancorporation ("Heritage"). Heritage
Bank is the result of the subsequent merger in May 1998 of the savings bank
subsidiaries of these two holding companies: United Savings Bank, F.A., the
savings bank subsidiary of Old United ("United Bank"), and Heritage Bank, the
savings bank subsidiary of Heritage. After the Heritage Merger, the new
management of United significantly changed United's business strategy to a more
growth-oriented expansion strategy. See "Heritage Merger."
Heritage Bank is a federally chartered stock savings bank with full
service banking offices in Chester, Glendive, Great Falls, Havre and Shelby,
Montana, and loan production offices in Bozeman, Hamilton, Kalispell, Libby,
Missoula and Polson, Montana. State Bank is a state chartered bank with full
service banking operations in Fort Benton and Geraldine, Montana. The Banks are
engaged in the community banking business of attracting deposits from the
general public through its offices and using those deposits, together with other
available funds, to originate commercial (including lease financing), commercial
real estate, residential, agricultural and consumer loans primarily in its
market areas in Montana. A majority of United's banking business is conducted in
the Great Falls area. The Banks also invest in mortgage-backed securities, U.S.
Treasury obligations, other U.S. Government agency obligations and other
interest-earning assets.
The Bank's financial condition and results of operations, and
therefore the financial condition and results of operations of United, are
dependent primarily on net interest income and fee income. The Bank's financial
condition and results of operations are also significantly influenced by local
and national economic conditions, changes in market interest rates, governmental
policies, tax laws and the actions of various regulatory agencies.
On August 7, 1998, United, through its newly formed Montana
state-chartered commercial banking subsidiary, State Bank, acquired certain
assets and assumed insured deposits of approximately $12.7 million of Q Bank,
which was declared a failed bank by federal and state banking regulatory
authorities on August 7, 1998. Q Bank's Fort Benton, Montana and Geraldine,
Montana branches were reopened on August 10, 1998 as branches of State Bank.
State Bank paid a $454,000 premium for the right to acquire such assets and
assume Q Bank's insured deposits. As a result of the formation of State Bank,
United, which was formerly regulated by the Office of Thrift Supervision ("OTS")
as a savings and loan holding company, became a bank holding company subject to
supervision by the Federal Reserve Board. Heritage Bank, as a federally
chartered savings bank, remains subject to supervision by the OTS as its
principal regulator and both Heritage Bank and State Bank, as financial
institutions with deposits insured by the Federal Deposit Insurance Corporation
("FDIC"), remain subject to regulation by the FDIC.
On August 26, 1998, United announced that it had signed agreements
to acquire approximately 24.2% of Valley Bancorp. Valley Bancorp is a bank
holding company located in Phoenix, Arizona and is the parent company of Valley
Bank of Arizona, a state chartered commercial bank. In December 1998, United
purchased, for $6.25 per share, 280,718 shares from various shareholders and
150,000 shares from the Chairman and Chief Executive Officer of United. Since
United previously owned 13,000 shares
1
of Valley Bancorp, the December purchase brought United's total ownership to
25%. See Part IV, Item 14 - "Notes to Consolidated Financial Statements -
Acquisition."
United's principal offices are located at 120 First Avenue North,
Great Falls, Montana, and its telephone number is (406) 727-6106. Heritage Bank
has a wholly owned subsidiary, Community Service Corporation ("CSC"), which owns
and manages real estate held for investment, and Heritage Bank holds an 11%
ownership interest in Bankers' Resource Center, a computer data center. United,
Heritage Bank, State Bank and CSC are collectively referred to herein as
"United."
HERITAGE MERGER. On February 3, 1998, Heritage merged into United,
and an aggregate of 475,000 shares (or 28%) of United Common Stock was issued to
the former shareholders of Heritage (the "Former Heritage Shareholders"). At
that time, the United Board was increased to nine members, and five persons
nominated by the Former Heritage Shareholders (the "Heritage Nominees") were
elected to the United Board of Directors ("United Board"). Subsequently, a
non-Heritage Nominee resigned from the United Board. In May 1998, two senior
officers of Heritage Bank were elected to the United Board. The Heritage
Nominees and former Heritage senior officers presently constitute a majority of
the United Board.
The new management of United has changed United's business strategy
as it existed prior to the Heritage Merger and is engaging in a growth-oriented
expansion strategy by pursuing internal and external growth opportunities, when
available. United is in the process of expanding the customer base of Heritage
Bank and State Bank by emphasizing commercial, agricultural and consumer loans
as well as the mortgage business previously emphasized by United Bank.
Management continues to pursue external growth through opening new branches,
possible acquisitions of other financial institutions, and expansion of the
geographic area currently served. This strategy is consistent with the
growth-oriented expansion of Heritage prior to the Heritage Merger.
United's new business strategy may subject United to a greater
degree of risk. Historically, Old United had concentrated on residential
lending, as home loans were believed to present the least amount of risk.
Commercial real estate loans, commercial loans and consumer loans, which
constituted a larger portion of Heritage's portfolio and lending activities, had
been made by Old United only on a limited basis. Risks associated with this new
business strategy include increased risk of losses on loans, provision for loan
losses which exceed historical levels, difficulties in integrating or managing
new branches or acquired institutions, and problems relating to the management
of growth. There can be no assurance that United will be successful in
instituting this new business strategy or in managing growth.
The Heritage Merger was treated as a reverse acquisition and
accounted for as a purchase in accordance with generally accepted accounting
principles. Because the shareholders and management of Heritage controlled the
operations of United after the Heritage Merger, Heritage was considered the
acquirer for accounting purposes. Accordingly, the historical statements of
operations of United now are the historical financial statements of Heritage and
do not include the results of Old United for periods prior to the Heritage
Merger.
At the time of the Heritage Merger, Old United had approximately $96
million of assets, $71 million of deposits and $40 million of loans, and
Heritage had approximately $90 million of assets, $69 million of deposits and
$60 million of loans. Because of the comparable size and importance of the two
combining entities, most of the following discussion in "Business" and, in Item
7, "Management's Discussion and Analysis of Pro Forma Combined Financial
Condition and Results of Operations of Heritage and Old United" describes the
assets, liabilities and results of operation of United on a pro forma combined
basis. In some instances, the respective contributions of Old United and
Heritage to these combined results are also described.
2
LENDING ACTIVITIES
GENERAL. Lending activities are United's primary source of both
interest income and fee income. United's pro forma combined interest income from
loans receivable was approximately $10.7 million, $7.7 million and $6.1 million,
or approximately 73%, 59% and 53% of total interest income for the years ended
December 31, 1998, 1997 and 1996, respectively. To date, United's principal
lending activity has been the origination of real estate loans, including
conventional residential real estate loans (loans which are neither insured nor
partially guaranteed by government agencies) and residential real estate loans
insured by the Federal Housing Administration ("FHA") or partially guaranteed by
the Veterans Administration ("VA"), agricultural loans and commercial loans. In
1998, United used increased Federal Home Loan Bank ("FHLB") borrowings,
repurchase agreements and certain maturing assets that were formerly invested by
Old United in investment securities, as well as cash equivalents and deposits,
to expand its loan portfolio. Accordingly, its interest income from loans
receivable, as well as the percentage of total income from loans receivable,
increased in 1998.
Although Old United and Heritage were of comparable size at the time
of the Heritage Merger, the composition of their assets and loan portfolios, and
their lending policies, differed substantially. Approximately 85% of the loan
portfolio of Old United at December 31, 1997 consisted of first mortgage loans
(including over 55% of the total portfolio in 1-4 residential loans), while only
7%, 7% and 1% represented consumer, commercial and agricultural non-mortgage
loans, respectively. In contrast, only approximately 65% of the loan portfolio
of Heritage at December 31, 1997 consisted of first mortgage loans (including
less than 39% in residential mortgage loans), while 9%, 20% and 4% consisted of
consumer, commercial and agricultural non-mortgage loans, respectively. In
general, the lending operations of Heritage more closely paralleled the lending
activities of a commercial bank than a savings bank. As a result of the Heritage
Merger, United now uses the lending policies, guidelines and procedures of
Heritage and, accordingly, is placing more emphasis on commercial and consumer
lending and effective use of its capital.
3
The following table sets forth the composition of United's loans
receivable at December 31, 1998 and at December 31, 1997 and 1996 (on a pro
forma combined basis-unaudited):
(Dollars in thousands) -------------------- Pro Forma Combined (unaudited)
December 31, December 31,
-------------------- ---------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
Loans secured by real estate:
1 - 4 residential $ 37,384 25.8% $43,156 45.4% $38,755 49.8%
5 or more residential 6,601 4.6 6,705 7.1 4,758 6.1
Construction 9,224 6.4 5,476 5.8 4,405 5.6
Agricultural 2,965 2.1 2,980 3.1 880 1.1
Commercial 27,449 18.9 11,437 12.0 9,932 12.8
-------- ----- ------- ----- ------- -----
Total loans secured by real
estate 83,623 57.8 69,754 73.4 58,730 75.4
Commercial non-real
estate 37,564 25.9 13,435 14.2 11,556 14.8
Municipal 1,477 1.0 795 .8 -- --
Agricultural non-real
estate 5,226 3.6 2,968 3.1 468 .6
Loans secured by deposits 752 .5 616 0.7 278 .4
Consumer loans - real
estate secured 9,066 6.3 2,327 2.5 1,790 2.3
Other consumer 7,160 4.9 5,075 5.3 5,040 6.5
-------- ----- ------- ----- ------- -----
Total loans receivable 144,868 100.0% 94,970 100.0% 77,862 100.0%
===== ===== =====
Less:
Unearned discount and
deferred loan origin
fees 24 33 91
Allowance for loan losses 1,485 1,146 463
-------- ------- -------
Net loans receivable $143,359 $93,791 $77,308
======== ======= =======
RESIDENTIAL (NON-CONSTRUCTION) REAL ESTATE LENDING. Residential
mortgage lending constitutes the largest part of United's lending activities.
United's residential loan originations are conducted by residential loan
production officers in its seven banking offices and its six loan production
offices in Montana. Virtually all of United's residential loan production is
secured by properties located in Montana.
Under United's residential lending policies, most loans originated
conform to Government National Mortgage Association/Federal National Mortgage
Association ("GNMA/FNMA") secondary mortgage market standards and are secured by
residential property with a value of not more than 80% (or 95% if private
mortgage insurance is obtained) of the principal amount of the loan. In
accordance with federal guidelines, an appraisal by an independent licensed or
certified appraiser is required for all residential loans in excess of $250,000.
United generally obtains appraisals or valuations on most residential loans
under $250,000. The terms of United's conventional real estate loans provide
that the loan can be prepaid without penalty and typically include a due-on-sale
clause that provides for acceleration of indebtedness upon the sale or other
disposition of secured property. Evidence of fire, casualty and hazard insurance
with a mortgagee clause in favor of United is required prior to settlement of
residential and commercial real estate loans. Title insurance is generally
required on properties securing such loans to protect United against prior liens
on the property or other claims against the title.
Most of United's residential loans are originated through personal
contacts of loan officers, including contacts with local realtors, and through
referrals from deposit customers. Although the majority of United's loans are
fixed rate loan products, United offers both fixed and adjustable rate
residential loans. United offers a variety of adjustable-rate mortgage loans
("ARMs"), the interest rates on
4
which vary with the movement of the index upon which the interest rates are
based. If the interest rates change, loan payments, balances or terms may be
adjusted. United's primary indexes are the 1, 3, 5, and 10-year constant
maturity Treasury indexes. Most of the ARMs currently originated by United have
loan terms of 10 to 30 years with rate adjustments generally every 1, 3, 5 or 10
years during the term of the loan. Generally, interest rate adjustments on
United's ARMs are limited to changes of 2.5% - 3.25% per year and 6% - 10% for
the life of the loan.
The majority of United's total production of long-term (15 to
30-year maturity) fixed rate residential loans is originated according to
prearranged underwriting standards that result in immediate sale to the
secondary market, primarily to mortgage bankers and pension funds. While
origination and sale of these loans produces fee income, the loans are carried
at their outstanding principal balance, which is the contracted purchase price,
and therefore, no gain or loss is realized at sale. United sold long-term
fixed-rate mortgage loans to the secondary market in aggregate amounts (on a pro
forma combined basis) of $82.9 million in 1998. United also sells long-term
fixed-rate loans that were refinances of existing portfolio loans or permanent
financing of completed construction loans to the secondary market or State of
Montana housing agencies. These loans are carried at their outstanding principal
balance, which was the contracted purchase price, and therefore no gain or loss
was realized at sale. During 1998, United sold portfolio loans in aggregate
amounts (on a pro forma combined basis) of $5.3 million. United retains a
limited number of adjustable rate mortgages and fixed rate mortgage loans up to
15-year maturities for its own portfolio.
REAL ESTATE CONSTRUCTION LOANS. In addition to permanent real estate
mortgage loans, United also provides interim financing for the construction of
single-family and multi-unit dwellings, commercial real estate and improvements
of real estate. Construction loans are generally made for periods of six months,
with interest paid at periodic intervals. Such loans may be extended for several
months due to adverse weather conditions or other justifiable delays in
construction. United provides financing primarily for a small number of
contractors who have demonstrated an ability to complete projects and financial
responsibility in residential development and construction and have operated in
United's lending area for a number of years.
COMMERCIAL AND AGRICULTURAL REAL ESTATE LOANS. United engages in
commercial real estate lending secured by both commercial and agricultural
properties. Occasionally when making such loans, United participates in the U.S.
Small Business Administration's program for guaranteed commercial real estate
loans. United's loans on commercial and agricultural real estate are primarily
first lien loans with 10 to 15-year maturities and adjustable interest rates
based on U.S. Treasury indexes for 1, 3, and 5 years. While OTS regulations
limit the level of commercial real estate lending by a federally charted thrift
institution to 400% of its capital, this limitation has not had a material
impact on the lending activities of Heritage Bank to date.
NON-MORTGAGE COMMERCIAL AND AGRICULTURAL LENDING. In addition to
real estate lending, United offers commercial and agricultural non-mortgage
loans. While OTS regulations limit the level of commercial non-mortgage lending
by a federally chartered thrift institution to 20% of total assets, this
limitation has not had a material impact on the lending activities of Heritage
Bank to date. United offers commercial lines of credit, equipment term loans,
working capital loans and loans guaranteed by the Small Business Administration
to its business customers. It also offers seasonal lines of credit and term
equipment loans to its agricultural borrowers and purchases, on a participation
basis, loans originated outside its normal market areas. These are generally
purchased from commercial banks and third party loan production offices. These
purchased participations allow United to diversify its geographic risk and are
purchased with a higher level of underwriting standards since a direct customer
relationship does not exist. United has not had any credit losses on its
participation portfolio to date. Most of United's commercial non-mortgage loans
are originated or purchased by United's senior lending staff in Great Falls.
5
CONSUMER LENDING. United's consumer loan portfolio includes home
equity, home improvement, line of credit, auto, deposit account, dealer loans
and credit card receivables. United has entered into agreements with certain
local merchants to purchase qualifying conditional sales contracts. Although
some consumer lending is conducted through loan production offices, most of
United's consumer lending is conducted at branch offices and United's home
office in Great Falls. United requires fire, hazard and casualty insurance for
loans secured by home equity and casualty insurance for loans secured by autos
and recreational vehicles.
INVESTMENT ACTIVITIES
The investment activities of United are designed to provide an
investment alternative for funds not presently required to meet loan demand,
assist Heritage Bank and State Bank in meeting potential regulatory liquidity
requirements, assist in maximizing income consistent with quality and liquidity
requirements, supply collateral to secure public funds and retail repurchase
agreements, provide a means for balancing market and credit risks, and provide
consistent income and market value throughout changing economic times.
Historically, interest income from investment securities and
mortgage-backed securities was a major source of Old United's income. Interest
income from these two sources as a percentage of Old United's total interest
income for the years ended December 31, 1997 and 1996 was approximately 52.1%
and 57.1%, respectively. In contrast, interest income from mortgage-backed and
investment securities constituted only 18.0% and 23.6% of the total interest
income of Heritage during the years ended December 31, 1997 and 1996,
respectively. Interest income from investment activities was $3.1 million, or
21.8% of United's total interest income during 1998 and on a pro forma combined
basis, $4.7 million and $5.1 million, or 36.6% and 43.9%, of United's total
interest income during the years ended December 31, 1997 and 1996, respectively.
United's portfolio consists primarily of obligations of the U.S.
government and its agencies and mortgage-backed securities, state and local
governments, and agency collateralized obligation securities. United's
investment portfolio does not contain concentration of investments in any one
issuer in excess of 10% of United's total investment portfolio, except for
securities of the U.S. government and U.S. government agencies. All of the
United's investments are classified as available-for-sale.
(Dollars in thousands) Pro Forma Combined
(unaudited)
---------------------
December December December
31, 31, 31,
1998 1997 1996
------- ------- -------
U.S. government and agencies $13,637 $22,993 $23,374
Mortgage-backed securities 36,353 32,222 39,706
Municipal bonds 885 1,239 864
Kemper U.S. government bond mutual fund -- 5,260 5,182
Other investments 1,025 407 243
------- ------- -------
$51,900 $62,121 $69,369
======= ======= =======
During 1998, United redeployed some of the assets invested by Old
United in investment securities. United sold $5.3 million of a U.S. government
bond mutual fund, sold corporate bonds with book values of $8.9 million,
received $16.7 million in mortgage-backed security principal payments and had
$15.6 million of calls and maturities of investment securities, while purchasing
$36.8 million in investment securities and mortgage-backed securities. The $10.2
million of net proceeds from the decreased investment securities and
mortgage-backed securities was invested primarily in loans.
6
SOURCES OF FUNDS
The primary sources of funds for United's lending and investment
activities are deposits, repurchase agreements, FHLB borrowings, loan and
mortgage-backed securities repayments, proceeds from loan sales, investment
securities interest payments and maturities, and net operating revenues. During
recent periods, United has funded a large portion of the increase in its loan
portfolio through additional FHLB borrowings and maturing of investment
securities, as well as new deposit liabilities and repurchase agreements.
DEPOSIT ACTIVITIES. Deposits are attracted from within United's
market area through the offering of a broad selection of deposit instruments,
including NOW accounts, money market accounts, regular savings accounts,
certificates of deposit and retirement savings plans. Deposit account terms
vary, according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In determining the
terms of its deposit accounts, United considers current market interest rates,
profitability to United, matching deposit and loan products offered by its
competition and its customer preferences and concerns. United reviews its
deposit mix and pricing weekly.
The following table sets forth the composition of United's deposits
at December 31, 1998, and December 31, 1997 and 1996 (on a pro forma combined
basis - unaudited):
(Dollars in thousands) Pro Forma Combined, (unaudited)
December 31, December 31,
----------------- -------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Type: Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
Non-interest bearing $ 18,895 11.3% $ 15,560 11.0% $ 10,393 7.6%
Interest bearing:
NOW & money market
demand accounts 22,907 13.7 17,025 12.1 17,055 12.5
Savings accounts 46,811 27.9 33,479 23.7 35,699 26.2
Time deposits 79,007 47.1 75,199 53.2 73,143 53.7
-------- ----- -------- ----- -------- -----
Total $167,620 100.0% $141,263 100.0% $136,290 100.0%
======== ===== ======== ===== ======== =====
Scheduled maturities of certificates of deposit at December 31, 1998
are as follows:
Due within one year $58,028
Due within two to three years 18,654
Due within four to five years 2,183
Due after five years 142
-------
Totals $79,007
=======
Time deposits of $100,000 or more were approximately $13.0 million
at December 31, 1998 and $9.1 million and $8.6 million at December 31, 1997 and
1996 (on a proforma combined basis, unaudited), respectively. Amounts in excess
of $100,000 are not insured by a federal agency.
Early withdrawal from time deposits subjects the depositor to an
early withdrawal penalty which is currently equal to six months of simple,
nominal interest when the original maturity is longer than one year, three
months of simple, nominal interest when original maturity is 92 days to one
year, and all interest earned when original maturity is 91 days or less.
As a matter of policy, United does not accept, place or solicit
brokered deposits. Although deposits are not solicited outside of Montana,
historically, a small number of United's depositors have resided outside
Montana. As market demand generally dictates deposit maturities and rates,
United intends to continue to offer those types of accounts that have broad
market appeal.
7
BORROWINGS. United relies to a significant extent on borrowings
from the FHLB of Seattle to finance its short-term, and increasingly its longer
term, financing needs. The FHLB of Seattle functions as the central reserve bank
providing credit for savings institutions and certain other member financial
institutions. In recent periods, borrowings from the FHLB of Seattle have been
available at rates that are as favorable, or more favorable, than the rates that
United would be required to pay on deposits. Further, borrowings from the FHLB
are available at various maturities, facilitating the accurate matching of asset
and liability maturity dates. United has used these available borrowings during
the past nine months in part to fund expansion of its lending activities.
As a member of the FHLB of Seattle, Heritage Bank is required to
own capital stock in the FHLB of Seattle and is authorized to apply for advances
on the security of specified collateral. Advances are made pursuant to several
different credit programs. Each credit program has its own interest rate and
range of maturities. Heritage Bank's currently established available FHLB
advance credit line is 25% of assets. The FHLB of Seattle is required to review
its credit limitations and standards at least annually. At December 31, 1998,
1997 and 1996, $22.1 million, $6.4 million and $1.4 million, respectively, of
FHLB advances were outstanding. Old United had no FHLB advances at December 31,
1997 or 1996.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. United also
generates funds through the sale of investment securities under agreements
requiring their repurchase at a premium that represents interest. The securities
underlying agreements to repurchase are for the same securities originally sold
and are held in a custody account by a third party. For the year ended December
31, 1998, securities sold under agreements to repurchase averaged approximately
$7.1 million and the maximum outstanding at any month end during the year was
approximately $11.8 million. United had $9.4 million, $3.2 million and $6.4
million of securities sold under repurchase agreements at December 31, 1998,
1997 and 1996, respectively. Old United had no securities sold under repurchase
agreements at December 31, 1997 or 1996.
OTHER ACTIVITIES
United has no direct subsidiaries other than Heritage Bank and
State Bank. Heritage Bank has a wholly owned service corporation, CSC, which
owns and manages a limited amount of real estate held for investment. At
December 31, 1998 United had an investment of approximately $305,000 in its
service corporation. As a result of United becoming a bank holding company in
1998, United will be required to divest CSC within two years of the date United
became a bank holding company. Heritage Bank also holds an 11% ownership
interest in Bankers' Resource Center, a computer data center, which provides
certain data processing services to Heritage Bank.
MARKET AREA
Prior to the Heritage Merger, United's primary market area had been
the Great Falls, Montana metropolitan area and the areas surrounding its offices
in Glendive, Havre and Shelby, Montana. With the Heritage Merger, Chester,
Montana was added as a market area as well as market areas served by a Loan
Production Office ("LPO") in Bozeman. Since the Heritage Merger, United has also
added LPOs in Hamilton, Kalispell, Libby, Missoula and Polson, Montana.
Great Falls, the county seat of Cascade County and a regional trade
center, is one of the largest cities in Montana. The estimated 1998 Great Falls
and Cascade county populations were approximately 58,000 and 81,000,
respectively. The economy of Great Falls, is largely based on agriculture,
health care and Department of Defense activities. Malmstrom Air Force Base
("MAFB"), which employs over 4,800 people, is the largest employer in Great
Falls and Cascade County. Reduction in size or closure of MAFB would adversely
affect United.
The economies of Chester, Fort Benton, Glendive, Havre and Shelby,
Montana are dependent to a large extent on agricultural, livestock and railroad
activities.
8
Areas served by United's LPOs are less dependent upon agriculture. Areas such as
Bozeman, Hamilton, Kalispell, Missoula and Polson are also supported in part by
tourism and higher education. Nevertheless, agriculture is the predominant
activity in the State of Montana and any adverse trends in agriculture could
adversely affect United.
COMPETITION
Heritage Bank and State Bank, like other depository institutions,
are operating in a rapidly changing environment and, therefore, face
considerable competition in the attraction of deposits and the origination of
loans. Historically, the most direct competition for deposits has come from
other savings banks, credit unions and commercial banks. There are approximately
30 depository institutions, commercial banks, credit unions and savings banks
with offices in United's market areas. Non-depository financial service
organizations, primarily in the securities and insurance industries, have also
become competitors for retail savings and investment funds. United's deposit
programs compete with money market mutual funds, government securities and other
investment alternatives. United competes for deposits by offering a variety of
deposit accounts at interest rates based upon market conditions, convenient
business hours, quality service and convenient branch locations.
EMPLOYEES
At March 15, 1999, Heritage Bank employed 83 full-time employees
and 15 part-time employees, and State Bank employed 5 full-time employees and 2
part-time employees. Management considers its relations with its employees to be
very good. United maintains a comprehensive employee benefit program providing,
among other benefits, hospitalization and major medical insurance, paid sick
leave, disability, life insurance and 401K retirement plans. United's employees
are not represented by any collective bargaining group. See Part IV, Item 14. -
"Notes to Consolidated Financial Statements - Employee Benefit Plan."
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to the
executive officers of United. All executive officers are elected annually by the
Board of Directors and serve at the discretion of the Board of Directors. There
are no arrangements or understandings between individual officers and any other
person pursuant to which he was elected as an officer.
Name Age Position Held
- ---- --- -------------
John M. Morrison 62 Chairman and Chief Executive Officer of United
Kurt R. Weise 42 Director, President and Chief Operations Officer of
United; Vice President of Heritage Bank and Heritage
State Bank
Kevin P. Clark 43 Director, Secretary and Vice President of United;
President and Chief Executive Officer of Heritage Bank
and Heritage State Bank
Steve L. Feurt 43 Director, Chief Credit Officer of United and Senior
Vice President and Chief Credit Officer of Heritage
Bank and Heritage State Bank
MR. MORRISON has served as Chairman and Chief Executive Officer of
United since the Heritage Merger. Mr. Morrison's term of office as a director of
United expires at United's annual shareholder meeting in 2000. Before the
Heritage Merger, he served as Chairman of Heritage since 1994. Mr. Morrison is
the Chief Executive Officer and sole shareholder of Central Bancshares, the
parent company of Central Bank, located in Stillwater, Minnesota, which was
founded by Mr. Morrison in 1988. He is also the sole shareholder and Chairman of
the Board of Directors of Central
9
Financial Services ("CFS"), a bank consulting firm. Mr. Morrison was the
Chairman and majority shareholder of Bank of Montana System, a bank holding
company with approximately $800 million in assets ("BMS"), prior to its sale to
Norwest Corporation in 1994. He is currently involved as a shareholder in
various businesses, including businesses involving cellular phone service and
precision parts manufacturing. Mr. Morrison is also a director of Fingerhut
Corporation, a publicly held company, which engages in direct marketing.
MR. WEISE has served as President, Chief Operations Officer and a
director of United and Vice President of Heritage Bank since the Heritage
Merger. Mr. Weise's term of office as a director of United expires at United's
annual shareholder meeting in 2000. Before the Heritage Merger, he served as
Vice President, Treasurer and a director of Heritage. Mr. Weise also serves as
President of CFS and President of Central Bancshares. He has been involved with
the Central Bank group of companies since they were founded in 1988. He was the
Chief Financial Officer of BMS until its sale to Norwest Corporation.
MR. CLARK has served as Secretary of United and President and Chief
Executive Officer of Heritage Bank since the Heritage Merger. Mr. Clark was
elected as Vice President and a director of United in May 1998, and his term of
office as a director of United expires at United's annual shareholder meeting in
2001. Before the Heritage Merger, he served as President, Chief Executive
Officer and a director of Heritage Bank since 1994. Mr. Clark served in various
capacities with BMS until its sale to Norwest Corporation, including President,
Chief Executive Officer and a director of Bank of Montana, a subsidiary of BMS,
and Regional Vice President of BMS. He has over 22 years of experience in
banking.
MR. FEURT has served as Chief Credit Officer of United and Senior
Vice President and Chief Credit Officer of Heritage Bank since the Heritage
Merger. Mr. Feurt was elected as a director of United in May 1998, and his term
of office as a director of United expires at United's annual shareholder meeting
in 1999. Before the Heritage Merger, he served as Senior Vice President, Senior
Credit Officer and a director of Heritage Bank since 1994. Mr. Feurt served as
Senior Vice President, Senior Credit Officer and a director of BMS and Bank of
Montana from 1984 until the sale of BMS to Norwest Corporation.
SUPERVISION AND REGULATION
UNITED. United became a registered bank holding company under the
Bank Holding Company Act ("BHCA") in 1998 by reason of its ownership of State
Bank.
Bank holding companies are subject to the general supervision and
regulation by the Federal Reserve Bank ("FRB"). Under the BHCA and FRB
regulations, a bank holding company may engage in banking, managing or
controlling banks, furnishing or performing services for banks it controls and
conducting activities that the FRB has determined to be closely related to
banking. Bank holding companies must also obtain the prior approval of the FRB
before acquiring 5% or more of the outstanding shares of another bank or bank
holding company and must provide notice to, and in some situations obtain the
prior approval of, the FRB in connection with the acquisition of 5% or more of
the outstanding shares of a company engaged in a "bank related" business.
Under FRB regulations, a bank holding company is required to serve
as a source of financial and managerial strength to its subsidiary banks and may
not conduct its operations in an unsafe or unsound manner. In addition, it is
the FRB's policy that in serving as a source of strength to its subsidiary
banks, a bank holding company should stand ready to use available resources to
provide adequate capital to its subsidiary banks during periods of financial
stress or adversity. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the FRB to be an unsafe and unsound practice or a violation of FRB
regulations, or both.
10
Bank holding companies are subject to certain limitations on
redemption of common stock or other equity securities. In addition, the FRB has
issued regulations setting minimum capital standards for bank holding companies.
Depending on the capital classification of a bank holding company, it may be
restricted from engaging in certain non-bank activities or from acquiring
interests in additional banks or other depository institutions. As of December
31, 1998 United met all minimum capital requirements issued by the FRB.
Under the BHCA, as amended by the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act"), a bank holding company
may acquire banks throughout the United States subject only to state or federal
deposit caps and state minimum age requirements. Effective June 1, 1997, the
Interstate Act authorized interstate branching by acquisition and consolidation
in those states that had not opted out by that date. Montana has opted out of
the interstate branching by acquisition and consolidation until October 1, 2001.
Although the Interstate Act and Montana law prohibits interstate branching by
State Bank, neither statute applies to Heritage Bank. As a federal savings bank,
Heritage Bank has the ability, subject to the prior approval of the OTS, to
engage in interstate branching activities.
United and its subsidiaries are deemed affiliates within the meaning
of the Federal Reserve Act, and transactions between the affiliates are subject
to certain restrictions. Accordingly, United and its respective subsidiaries
must comply with Sections 23A and 23B of the Federal Reserve Act (the "FRA").
Generally, these sections restrict "covered transactions" (i.e., loans,
purchases of assets, guaranties and similar transactions) to a percentage of the
depository institution's capital and surplus, require that such transaction be
appropriately collateralized and require that such transactions be on terms as
favorable to the depository institution as transactions with non-affiliates.
Loans to insiders (officers, directors and 10% shareholders) of a depository
institution are subject to Sections 22(g) and (h) of the FRA and regulations
thereunder. Among other things, such loans must be made on terms substantially
the same as loans to non-insiders.
DEPOSITORY INSTITUTION SUBSIDIARIES--HERITAGE BANK AND STATE BANK.
Heritage Bank is a federally chartered stock savings bank. State Bank is a
Montana-chartered commercial bank. As such, State Bank is subject to regulation
and supervision by the Montana Department of commerce, Division of Banking and
Financial Institutions (the "Montana division") and the FDIC. The deposits of
each of these banks are insured by the FDIC.
In addition to the federal banking agency statutes and regulation,
State Bank is subject to Montana statutes governing its respective activities
and regulations issued by the Montana Division. The Montana statutes and
regulations place limitations on the business and other activities of State Bank
which may be more restrictive than limitations applicable to depository
institutions that are not Montana-chatered commercial banks. In particulars, and
among other limitations, the establishment and operation of new branch offices,
are limited by, and subject to approval by, the Montana Division. In addition,
Montana-chartered commercial banks are generally not authorized to make
investments in subsidiary companies or to make other investments in equity
securities or to engage in securities or insurance activities. Some federally
chartered depository institutions located in Montana may engage in such
activities without regard to Montana law.
By reason of FDIC insurance, both banks are insured depository
institutions for purposes of certain federal laws and regulations. The federal
laws that apply to the banks regulate, among other things, the scope of their
businesses, their investments, the reserves against deposits, the timing and
availability of deposited funds and certain aspects of their lending activities.
These laws and regulations governing the depository institution activities have
generally been promulgated to protect depositors and not to protect stockholders
of such institutions or their holding companies. These laws and regulations are
designed to ensure that appropriate action is taken to address concerns
regarding the safe and sound operation of insured depository institutions and
generally relate to internal
11
control and information systems, loan documentation and credit underwriting,
asset growth, management performance and earnings. If an insured depository
institution fails to meet the applicable standards and regulatory requirements,
an appropriate banking agency may require that the institution prepare and
submit to the agency an acceptable plan for addressing the regulatory concern.
If the plan submitted is deemed inadequate, or if the institution fails to
submit or comply with the required plan, a banking agency may take further
action with respect to the regulatory concerns, including institution of an
enforcement action with respect to the institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires federal banking regulators to adopt regulations in a number
of specific areas to insure depository institution safety and soundness,
including internal controls, credit underwriting, asset growth, management
compensation, asset quality and earnings performance. FDICIA also contains
provisions intended to change independent auditing requirements, to restrict the
activities of certain insured depository institutions, to change various
consumer banking laws and to limit the ability of "under-capitalized banks" to
borrow from the FRB's discount window or to acquire brokered deposits.
The Financial Institution Reform, Recovery and Enforcement Act of
1989 ("FIRREA") significantly changed existing federal banking legislation and
regulation, including significant increases in FDIC insurance premiums,
separation of the FDIC insurance into two deposit insurance funds, authorizing
bank holding companies to own savings associations, increasing the federal
banking agencies' enforcement powers and increasing the civil and criminal
penalties for violations of federal banking laws and regulations.
Both Banks are subject to certain federal consumer laws, including
the Community Reinvestment Act of 1977, as amended ("CRA") and other fair
lending laws and regulations which impose nondiscriminatory lending requirements
on insured depository institutions. In recent periods, federal regulatory
agencies have sought a more rigorous enforcement of the CRA and other fair
lending laws and regulations. A successful challenge to a depository
institution's performance under the CRA and related fair lending laws and
regulations could result in a variety of sanctions, including the required
payment of damages and civil money penalties, prospective and retrospective
injunctive relief and the imposition of restrictions on mergers and acquisitions
or other activities of the depository institution or the holding companies
controlling such depository institutions. Private parties may also have the
ability to challenge an institution's performance under the fair lending laws in
private class action litigation.
During the most recent OTS compliance examinations of Heritage Bank
(completed in July 1997), the OTS conducted a CRA performance evaluation and
Heritage Bank was rated as having had "an outstanding record of meeting
community credit needs".
Federal regulatory banking agencies have also established uniform
capital requirements for all insured depository institutions. An insured
depository institution that does not achieve and maintain required capital
levels may be subject to supervisory action through the issuance of capital
directives, cease and desist orders or other written orders or agreements with
the appropriate federal banking agency. Failure of an insured depository
institution to meet the required capital levels may also prohibit or limit the
ability of a bank holding company controlling such institution to engage in
merger and acquisition activities or other expansion activities. As of December
31, 1998, Heritage Bank and State Bank met the "well capitalized" requirements
issued by the applicable federal banking agency.
Depository institutions generally depend upon the difference between
the interest rate paid by it on deposits and other borrowings and the interest
rate received on loans extended to customers and on investment securities. The
interest rates are highly sensitive to many factors beyond the control of
depository institutions, including general economic conditions in the primary
market area and
12
the broader economy. In addition to general economic conditions affecting
business generally, depository institutions such as Heritage Bank and State Bank
are affected by federal government policies and actions of regulatory agencies.
In particular, the FRB through its various operations and powers may affect
interest rates charged on loans or paid on deposits. Such changes in interest
rates affect the growth and quality of depository institution loans, investments
and deposits.
Federal banking regulatory agencies may institute enforcement
actions against depository institutions, their parent holding companies and
other institution-affiliated parties with respect to violations of any federal
law or regulation. Enforcement actions may include the appointment of a
conservator or receiver, the issuance of cease and desist orders or other formal
action, termination of insurance of deposits and the imposition of civil money
penalties. Neither bank is currently subject to any such enforcement actions.
From time to time, various types of federal and state legislation
have been proposed that would result in additional regulation of, or
restrictions on, the business of depository institutions generally. It cannot be
predicted whether such legislation will be adopted or how such legislation would
affect the business of the banks.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS. The OTS has extensive
authority over the operations of Heritage Bank, including, among other things,
the ability to assess civil money penalties, to issue cease and desist orders or
removal orders, and to initiate injunctive actions for violations of laws and
regulations and for unsafe or unsound practices. Heritage Bank is required to
file periodic reports with the OTS and is also subject to periodic examinations
by the OTS and the FDIC. The OTS and the FDIC have entered into an agreement
that provides for joint examinations by the FDIC and the OTS.
Under federal law, the aggregate amount of loans that Heritage Bank
is permitted to make to any one borrower ("LTOB") cannot exceed 15% of
unimpaired capital and surplus. Amounts up to an additional 10% of unimpaired
capital and surplus may be extended for loans and extensions of credit fully
secured by readily marketable collateral, which is defined to include certain
financial instruments and bullion having a market value at least equal to the
loan amount.
The OTS has amended the LTOB limitation to permit savings
associations meeting certain requirements, including capital requirements, to
extend loans to one borrower in additional amounts under certain circumstances
limited essentially to loans to develop or complete residential housing units.
At December 31, 1998, Heritage Bank's LTOB limit was approximately $3,202,900.
The aggregate amount of loans outstanding to one borrower at December 31, 1998
was approximately $2,115,000. At December 31, 1998, Heritage Bank was in
compliance with the LTOB limitations.
DEPOSIT INSURANCE AND FDIC REGULATION. Heritage Bank is a member of
the Savings Association Insurance Fund ("SAIF"), which is administered by the
FDIC. Savings deposits are insured up to the applicable limits (generally
$100,000 per insured depositor) by the FDIC. The FDIC is empowered to impose
deposit insurance premiums, conduct examinations and require reporting by
Heritage Bank. The FDIC may also prohibit Heritage Bank from engaging in any
activity the FDIC determines by regulation or order to pose a serious risk to
the FDIC. The FDIC can also initiate enforcement actions against Heritage Bank,
after giving the OTS an opportunity to take such action, and may terminate the
deposit insurance of Heritage Bank if it determines that Heritage Bank has
engaged or is engaging in any unsafe or unsound practice, or is in an unsafe or
unsound condition.
Legislation was enacted in 1996 that provided for a special
assessment against SAIF member insured depository institutions that capitalized
the SAIF insurance reserve to the prescribed 1.25% of insured deposits level.
For Heritage Bank, this one-time special assessment was $239,300, or 65.7 basis
points per $100 of Heritage Bank's insured deposit base on March 31, 1995.
Heritage Bank's FDIC/SAIF assessment rate, beginning January 1, 1997 decreased
from 23 basis points
13
to 6.5 basis points per $100 of insured deposits. Most commercial banks, which
are insured by the Bank Insurance Fund ("BIF") administered by the FDIC,
beginning January 1, 1997, were assessed 1.3 basis points per $100 of insured
deposits. For the second half of 1997, Heritage Bank's SAIF assessment rate was
6.3 basis points per $100 of insured deposits, compared to 1.26 basis points for
State Bank. As a result, Heritage Bank's and State Bank's 1998 FDIC deposit
insurance premium was $82,873.
REGULATORY CAPITAL REQUIREMENTS. OTS capital regulations require
federal savings institutions such as Heritage Bank to satisfy three capital
requirements: (i) tangible capital must not be less than 1.5% of adjusted total
assets, (ii) core capital must not be less than 3% of adjusted total assets and
(iii) risk-based capital must not be less than 8.0% of "risk-adjusted" assets.
Heritage Bank exceeded these minimum standards at December 31, 1998.
Heritage Bank's tangible and core capital includes shareholder's
equity, less intangible assets and certain investments in subsidiaries that
conduct activities not permissible for a national bank. Purchased mortgage
servicing rights may be included in tangible capital at the lower of 90% of fair
market value, 90% of original cost, or 100% of current amortized book value.
Risk-based capital is determined by assigning a risk-weight, ranging
from 0% for government securities to 100% for certain equity investments, to
each of an institution's assets, including the credit-equivalent amount of
off-balance sheet assets. An institution is required to maintain total
regulatory capital (consisting of both "core capital" and supplementary capital;
primarily comprised of the allowance for loan losses) equal to the regulatory
mandated percentage (8%) of the sum of its assets multiplied by their respective
risk-weights. The OTS also requires institutions with more than a "normal" level
of interest-rate risk ("IRR") to maintain additional risk-based capital. A
savings institution with a greater than normal IRR is required to deduct from
total capital, for purposes of calculating its risk-based capital requirement,
an amount equal to one-half the difference between the institution's measured
IRR and the normal level of IRR, multiplied by the present value of its total
assets. Based on its current capital position, most recent OTS calculated IRR,
and proposed exemption criteria, Heritage Bank would not have an IRR capital
adjustment.
FDICIA places much greater emphasis on capital as a measure of
performance and establishes a rigid regulatory scheme based almost entirely on
capital levels. The five statutory capital categories established by FDICIA are
"well capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Heritage Bank's capital
position substantially exceeds the definition of "well capitalized." FDICIA also
mandates that regulations be promulgated adding other risk-based capital
requirements covering (a) concentrations of credit risk, (b) risks from
nontraditional activities and (c) the capital impact of fair value adjustments
associated with FASB Statement No. 115, "Accounting for Certain Investments in
Debt and Equity Securities."
QUALIFIED THRIFT LENDER TEST. Unless a savings institution meets the
Qualified Thrift Lender ("QTL") test, it is classified and subject to regulation
as a national bank or becomes subject to a number of limitations on investment,
branching, advances, dividends and other activities. The QTL test generally
requires that an insured institution's Qualified Thrift Investments ("QTIs")
(primarily residential mortgages and related investments, including certain
mortgage-related securities and loans for education purposes, loans to small
businesses and loans made through credit cards or credit card accounts) equal or
exceed 65% of the institution's portfolio assets (defined as all assets minus
intangible assets, property used by the institution in conducting its business
and qualifying liquid assets up to 20% of total assets). Certain assets are
subject to a percentage limitation of 20% of portfolio assets. Savings
associations may include shares of stock of the FHLBs, Federal National Mortgage
Association, and Federal Home Loan Mortgage Corporation as QTIs. As of December
31, 1998, over 83% of Heritage Bank's assets were invested in QTIs.
14
LIQUIDITY. All savings associations are required to maintain
qualifying liquid assets equal to a percentage designated by the Director of the
OTS (currently 4%) of the balance of its withdrawable deposit accounts and
borrowings payable in one year or less. Liquid assets for purposes of this ratio
include specified short-term assets (e.g., cash, certain time deposits, certain
banker's acceptances and short-term United States Government obligations), and
long-term assets (e.g., United States Government obligations and certain state
agency obligations). Monetary penalties will be imposed, unless waived, for
failure to meet liquidity requirements.
FEDERAL HOME LOAN BANK SYSTEM. Heritage Bank is a member of the FHLB
of Seattle, Washington, one of several regional banks that administer the home
financing credit function for savings associations. Each FHLB serves as a
reserve or central bank for its members within its assigned region, is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB system and makes loans (advances) to its members in accordance with the
policies and the procedures established by the FHLB board of directors. All
advances from the FHLB are required to be fully secured by sufficient collateral
as is determined by the FHLB. Heritage Bank is required to purchase and maintain
FHLB stock in an amount equal to the greater of 1% of the unpaid principal of
residential mortgage loans, .3% of total assets or 5% of FHLB advances
outstanding. State Bank currently has a membership application pending with the
FHLB of Seattle, Washington.
TAXATION
GENERAL. United and its subsidiaries report their income on a
calendar year basis. The State of Montana allowed the filing of a combined
Montana income tax return for the first time in 1997. United, Heritage Bank and
State Bank plan to file combined tax returns in the future pursuant to a tax
sharing agreement. Generally, with some exceptions, including Heritage Bank's
reserve for bad debts discussed below, United is subject to federal income taxes
in the same manner as other corporations.
The following discussion of tax matters is intended solely as a
summary and does not purport to be a comprehensive description of all the tax
rules applicable to United.
TAX BAD DEBT RESERVES. For taxable years beginning prior to January
1, 1996, savings institutions, such as Heritage Bank, which met certain
definitional tests primarily relating to their assets and the nature of their
business ("qualifying thrifts"), were permitted to establish a reserve for bad
debts and to make annual additions thereto, which additions may, within
specified formula limits, have been deducted in arriving at their taxable
income. Heritage Bank's deduction with respect to "qualifying loans," which are
generally loans secured by certain interests in real property, including various
types of mortgage-backed securities, may have been computed using an amount
based on its actual loss experience or a percentage equal to 8% of its taxable
income, computed with certain modifications and reduced by the amount of any
permitted additions to the nonqualifying reserve. Heritage Bank's deduction with
respect to nonqualifying loans was computed under the experience method, which
essentially allows a deduction based on Heritage Bank's actual loss experience
over a period of several years. Each year Heritage Bank selected the most
favorable way to calculate the deduction attributable to an addition to the tax
bad debt reserve.
Federal legislation repealed the reserve method of accounting for
bad debt reserves for tax years beginning after December 31, 1995. As a result,
savings associations could no longer calculate their deduction for bad debts
using the percentage-of-taxable-income method. Instead, savings associations
were required to compute their deduction based on actual charge-offs during the
taxable year or, if the savings association or its controlled group had assets
of less than $500 million, based on actual loss experience over a period of
years. This legislation also required savings associations to recapture into
income over a six-year period
15
their post-1987 additions to their bad debt tax reserves, thereby generating
additional current tax liability. At December 31, 1998, Heritage Bank's bad debt
reserve for tax purposes was approximately $3,477,000. At December 31, 1998,
there was $62,000 remaining of post-1987 reserves which are being recaptured
into taxable income over a period of two years. For additional information
regarding federal and state income taxes, see Part IV, Item 14 - "Notes to
Consolidated Financial statements - Income Taxes."
ITEM 2. PROPERTIES
The physical assets of United as of December 31, 1998 consist of a
modern banking facility located at 120 First Avenue North, Great Falls, Montana,
which is the location of the corporate offices as well as the main branch
location for Heritage Bank. This facility includes a full service bank with 4
drive-up lanes, a loan production office, accounting and loan servicing
departments, and support staff for United's employees and is owned by Heritage
Bank. Heritage Bank also leases a drive-up detached facility located at 10th
Avenue South, Great Falls, Montana, and owns a facility located at 601 First
Avenue North, Great Falls, Montana that services its deposit customers through a
three-lane independent drive-up facility. Heritage Bank has four full-service
branches located in Chester, Glendive, Havre, and Shelby, Montana. These four
facilities are owned by Heritage Bank and have drive-up services. Heritage Bank
also leases six Loan Production Offices in Bozeman, Hamilton, Kalispell, Libby,
Missoula and Polson, Montana. State Bank facilities include two full service
locations, located in Fort Benton and Geraldine, Montana. There is no debt on
any of the owned facilities. In February 1999, Heritage Bank purchased property
in Missoula, Montana. A full service banking branch is planned, though
construction and build-out have not been finalized. Regulatory approval has been
granted by the Office of Thrift Supervision.
ITEM 3. LEGAL PROCEEDINGS
Although not involved in any pending material litigation as of the
date here of, United engages in litigation normal for its type of business from
time to time.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders though the
solicitation of proxies or otherwise during the quarter ended December 31, 1998.
PART II
ITEM 5. MARKET FOR UNITED COMMON EQUITY AND RELATED STOCKHOLER MATTERS
MARKET INFORMATION
United Common Stock is quoted on the Nasdaq National Market under
the symbol "UBMT." The closing sale price per share of United Common Stock on
February 26, 1999 was $22.75.
SHAREHOLDER DATA
As of February 8, 1999, there were approximately 233 owners of
record of United Common Stock and an estimated 1,130 additional beneficial
holders whose shares of United Common Stock were held in street name by
brokerage houses.
16
COMMON STOCK MARKET PRICES
The Company's quarterly (high and low) stock prices for the past two
years are as follows:
UBMT Stock Price
------------------
High Low
------ ------
1997 First Quarter $19.75 $18.75
Second Quarter 22.25 18.94
Third Quarter 24.25 21.75
Fourth Quarter 27.00 23.75
1998 First Quarter $28.50 $25.13
Second Quarter 31.50 27.00
Third Quarter 29.00 23.50
Fourth Quarter 24.86 19.00
DIVIDEND PAYMENT HISTORY ON UNITED COMMON STOCK
The Board of Directors of Old United declared per share dividends
of: (i) $.215, $.22, $.225 and $.23 for the four quarters of 1996, for a total
of $.89 per share; and (ii) $.235, $.24, $.245 and $.25 for the four quarters of
1997, for a total of $.97 per share. An additional $.25 per share dividend was
declared by Old United in January 1998 prior to the Heritage Merger. Heritage
had not declared any dividends prior to the Heritage Merger. The United Board
declared dividends of $.25 for each of the second, third and fourth quarters of
1998, for a total of $.75 per share.
The declaration and payment of future dividends by the United Board
is dependent upon the combined entity's net income, financial condition,
economic and market conditions, industry standards, certain regulatory and tax
considerations and other conditions. See "Supervision and Regulation." No
assurance can be given, or should be assumed, as to the amount, timing or
frequency of future dividend payments.
17
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR SUMMARY OF OPERATIONS AND SELECTED FINANCIAL DATA
The following table includes 1998 historical audited balances for
United and the comparative balances for 1997, 1996, 1995 and 1994 are historical
audited balances for Heritage.
(Dollars in thousands, except per
share and share data) Year ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994(1)
-------- -------- -------- -------- --------
OPERATING DATA:
Interest income $ 14,249 $ 5,773 $ 4,520 $ 3,469 $ 1,528
Interest expense 7,393 3,157 2,419 1,941 830
-------- -------- -------- -------- --------
Net interest income 6,856 2,616 2,101 1,528 698
Provision for loan losses 335 492 160 46 --
-------- -------- -------- -------- --------
Net interest income after provision
for loan losses 6,521 2,124 1,941 1,482 698
Non-interest income 3,292 1.103 1,059 631 282
Non-interest expense 6,147 2,361 2,251 1,505 775
-------- -------- -------- -------- --------
Income before income taxes 3,666 866 749 608 205
Provision for income taxes 1,399 324 263 214 87
-------- -------- -------- -------- --------
Net income $ 2,267 $ 542 $ 486 $ 394 $ 118
======== ======== ======== ======== ========
RESTATED PER SHARE DATA(2):
Income per share $ 1.43 $ 1.14 $ 1.02 $ .83 $ .25
Dividends per share -- -- -- -- --
Book value per share 19.22 5.78 4.59 3.57 2.48
Shares used to calculate per share
data 1,588 475 475 475 475
FINANCIAL CONDITION DATA(3):
Assets $232,561 $ 86,269 $ 71,280 $ 55,210 $ 42,514
Net loans and loans held for sale 149,076 58,263 43,853 29,169 21,609
Investment securities 51,900 14,219 14,172 16,090 12,365
Deposits 167,620 70,386 57,641 42,742 37,936
Long-term debt -- 2,350 2,550 2,650 2,725
Stockholders' equity 30,528 2,748 2,178 1,694 1,179
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
Return on average assets 1.06% .73% .81% .83% .55%
Return on average stockholders'
equity 7.47% 21.45% 25.78% 27.81% 18.39%
Net interest margin 3.34% 3.83% 3.74% 3.45% 3.57%
Efficiency ratio (4) 60.06% 63.46% 63.67% 69.71% 79.08%
Net charge-offs to average loans .03% .06% .27% .18% .01%
Nonperforming loans to total loans .47% .06% .02% .42%
Allowance for loan losses to total
loans 1.02% 1.43% .88% 1.10% 1.46%
Nonperforming loans to allowance for
loan losses 3.90% 31.56% 6.96% 1.84% 27.78%
Stockholders' equity to assets (3) 13.13% 3.19% 3.05% 3.07% 2.77%
(1) Represents only seven months of operations of Heritage Bank which was
acquired by Heritage effective as of June 1, 1994.
(2) Share and per share amounts for Heritage have been restated to
retroactively reflect the issuance of 475,000 shares of United common
stock in exchange for all outstanding shares of common stock of Heritage.
(3) At period end.
(4) Excludes September 1996 pretax charge for SAIF assessment of $239,000.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA COMBINED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF HERITAGE AND OLD UNITED
SELECTED PRO FORMA COMBINED FINANCIAL DATA OF HERITAGE AND OLD UNITED
General. Certain statements in this Report, including the following
section, constitute "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which involve risks and uncertainties.
United's actual results may differ significantly from the results discussed in
such forward-looking statements. Factors that might cause such a difference
include, but are not limited to, economic conditions, competition and weather
conditions in the geographic and business areas in which United conducts its
operations, fluctuations in interest rates, credit quality and government
regulations.
United is the result of the combination on February 3, 1998 of two
savings and loan holding companies operating in Montana: Heritage and Old
United. Although United was the surviving corporation, the merger was treated as
a reverse merger for accounting purposes because the shareholders and management
of Heritage controlled the operation of United after the Heritage Merger. Using
purchase accounting, the historical financial statements of United included in
this Report for periods preceding the Heritage Merger reflect only the
operations of Heritage, while the historical financial statements for periods
after the Heritage Merger reflect combined operations.
United believes that discussion and analysis of United's results of
operations on a pro forma basis, which includes the results of operations of
both Old United and Heritage prior to the Heritage Merger, provides a more
meaningful comparison than discussion and analysis of United's actual results of
operations.
The following unaudited pro forma combined financial information gives
effect to the Heritage Merger based on the purchase accounting adjustments,
estimates and other assumptions described in the accompanying notes. The
unaudited pro forma combined balance sheets and statements of income as of and
for the years ending December 31, 1997 and 1996 are based upon the audited
annual consolidated balance sheets and statements of income of Heritage and Old
United. The unaudited pro forma combined balance sheets combine the historical
consolidated balance sheets of Heritage and Old United as if the Heritage Merger
had become effective as of the respective balance sheet date. The actual audited
consolidated balance sheet of United as of December 31, 1998, and the unaudited
pro forma combined statement of income for the year ended December 31, 1998
which combines United's results of operations for the year ended December 31,
1998 and the operations of Old United for the period from January 1, 1998 to
January 31, 1998, are also presented for comparative purposes. The unaudited pro
forma combined statements of income combines the historical consolidated
statements of income of Heritage and Old United as if the Heritage Merger had
become effective as of the beginning of the period presented. The selected pro
forma consolidated financial data is unaudited and is not necessarily indicative
of the results of operations that would have been achieved had the Heritage
Merger occurred on such dates or of the results of operations that may be
achieved in the future.
While the operations of United on a pro forma basis for the years ended
December 31, 1997 and 1996 reflect the counterbalancing of operations of two
different financial institutions and their differing operating policies, the pro
forma and historical operations of United for the year ended December 31, 1998
reflect a unified operating policy that more closely parallels the historical
policy of Heritage. During 1998, United focused its attention on expanding
commercials, residential real estate, agricultural borrowings and some assets
that were formerly maintained by United Bank in investment securities to invest
in additional loans. The result during 1998 has been increased balances of loans
receivable and higher net interest income.
(Dollars in thousands) Pro Forma Combined Statements
of Income
---------------------------------------
Year Ended December 31,
---------------------------------------
1998 1997 1996
------- ------- -------
Total interest income $14,730 $12,951 $11,584
Total interest expense 7,649 6,445 5,808
------- ------- -------
Net interest income 7,081 6,506 5,776
Provision for loan losses 340 717 160
------- ------- -------
Net interest income after
provision for loan losses 6,741 5,789 5,616
Total non-interest income 3,450 1,778 1,918
Total non-interest expense 6,427 4,578 5,101
------- ------- -------
Income before income taxes 3,764 2,989 2,433
Provision for income tax expense 1,434 1,118 886
------- ------- -------
Net income $ 2,330 $ 1,871 $ 1,547
======= ======= =======
Net income per share $ 1.37 $ 1.10 $ .91
------- ------- -------
Weighted average shares
outstanding 1,698 1,698 1,698
------- ------- -------
See Notes to Pro Forma Combined Financial Data
19
Historical
audited Pro forma Combined
December unaudited December
(Dollars in thousands) 31, 31,
--------- -------------------------
1998 1997 1996
--------- --------- ---------
ASSETS
Cash and cash equivalents $ 9,056 $ 11,498 $ 13,023
Time deposits in banks 10,200 5,898 6,098
Investment securities available-for-sale 51,900 62,121 69,369
Loans receivable, net 143,359 93,791 77,308
Loans held for sale 5,717 2,575 3,638
Premises and equipment, net 3,482 3,279 2,891
Real estate owned, net 304 827 904
Accrued interest receivable 1,918 1,597 1,298
Federal Home Loan Bank stock, at cost 1,232 939 707
Identifiable intangibles 606 -- --
Goodwill, net 1,400 571 827
Investment in Valley Bancorp 2,684 -- --
Other assets 703 751 571
--------- --------- ---------
Total assets $ 232,561 $ 183,847 $ 176,634
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 167,620 $ 141,263 $ 136,290
FHLB advances 22,175 6,425 1,425
Securities sold under agreements to
repurchase 9,451 3,173 6,375
Accrued interest payable and other liabilities 2,787 3,183 3,129
--------- --------- ---------
Total liabilities 202,033 154,044 147,219
Stockholders' equity:
Common stock 28,002 28,116 28,318
Paid in capital -- -- --
Retained earnings-substantially
restricted 2,533 1,559 997
Accumulated other comprehensive income
(loss) (7) 128 100
--------- --------- ---------
Total stockholders' equity 30,528 29,803 29,415
--------- --------- ---------
Total liabilities and stockholders' equity $ 232,561 $ 183,847 $ 176,634
========= ========= =========
Tangible Equity/Assets 12.26% 15.90% 16.18%
Tangible Book Value/Share $ 16.79 $ 17.21 $ 16.83
See Notes to Pro Forma Combined Financial Data
NOTES TO PRO FORMA COMBINED FINANCIAL DATA
HERITAGE MERGER. On February 3, 1998, United Financial Corp. and
Heritage Bancorporation ("Heritage") merged (the "Heritage Merger"). United
Financial Corp. as it existed prior to the Heritage Merger is referred to herein
as "Old United," and United Financial Corp. as currently existing is referred to
herein as "United." In connection with the Heritage Merger, which was structured
as a merger of Heritage into Old United, each outstanding share of Heritage
common stock was converted into 47.5 shares of Old United's common stock. An
aggregate of 475,000 shares (or 28%) of Old United's common stock was issued in
connection with the Heritage Merger. A capital contribution of $2,275,000 was
made to Heritage by its shareholders just prior to the Heritage Merger and the
proceeds were used to pay-off the outstanding long-term debt as a condition of
the Heritage Merger.
20
The Heritage Merger was treated as a reverse acquisition and
accounted for as a purchase of Old United by Heritage in accordance with
generally accepted accounting principles ("GAAP"). Heritage was considered the
accounting acquirer because Heritage effectively acquired the operations of Old
United as a result of the change in control and other related consequences of
the Heritage Merger.
BASIS OF PRESENTATION. The unaudited pro forma combined balance
sheets combine the historical consolidated balance sheets of Heritage and Old
United as of December 31, 1997 and 1996 as if the Heritage Merger, which was
effective February 3, 1998 (the "Heritage Merger Effective Date"), had become
effective on December 31, 1997 and 1996, respectively. The unaudited pro forma
combined statements of income for each of the years presented combines the
historical consolidated statements of income of Heritage and Old United as if
the Heritage Merger had become effective at the beginning of the respective
period. Certain amounts in the historical financial statements of Old United
have been reclassified in the unaudited pro forma combined financial information
to conform to Heritage's historical financial statements.
The Heritage Merger was accounted for using the purchase method of
accounting. Under this method of accounting, assets and liabilities of Old
United are adjusted to their estimated fair value and combined with the
historical recorded book values of the assets and liabilities of Heritage.
Applicable income tax effects of such adjustments are included as a component of
net deferred taxes with a corresponding offset to goodwill. Additionally, Old
United's unrealized loss on securities available-for-sale and retained earnings
are eliminated.
Accordingly, for financial reporting purposes, the Heritage Merger
is reported as if Heritage was recapitalized on the Heritage Merger Effective
Date, with 475,000 common shares outstanding and Old United thereafter acquired
through the issuance of 1,223,312 shares of common stock to shareholders of Old
United. The total purchase price consideration of Old United is calculated based
on an average of the market price of Old United common stock immediately prior
to and after the announcement of the Heritage Merger ($20.25) times the number
of shares deemed issued to shareholders of Old United plus direct acquisition
costs. The difference between the purchase price so determined and the fair
value of identifiable tangible and intangible net assets of Old United at the
Heritage Merger Effective Date is recorded as goodwill.
Any transactions conducted in the ordinary course of business
between Heritage and Old United were immaterial and, accordingly, have not been
eliminated. United also expects to achieve certain operating cost savings as a
result of the Heritage Merger, however, no pro forma adjustment has been
included in the unaudited pro forma combined financial information for operating
cost savings. See Part IV,Item 14 "Notes to Consolidated Financial Statements,
Acquisitions."
RESULTS OF OPERATIONS
NET INTEREST INCOME. Like most financial institutions, the most
significant component of United's earnings is net interest income, which is the
difference between the interest earned on interest-earning assets (loans,
investment securities, mortgage-backed securities and other interest-earning
assets), and the interest paid on deposits and borrowings. This amount, when
divided by average interest-earning assets, is referred to as the net interest
margin, expressed as a percentage. Net interest income and net interest margin
are affected by changes in interest rates, the volume and the mix of
interest-earning assets and interest-bearing liabilities, and the level of
non-performing assets. The difference between the yield on interest-earning
assets and the cost of interest-bearing liabilities expressed as a percentage is
referred to as the net interest rate spread.
The following table illustrates the changes in United's net interest
income due to changes in volume and changes in net interest income due to
changes in rate (in each case on a pro forma combined basis):
21
(Dollars in thousands,
unaudited) Pro Forma Combined
--------------------------------------------------------------------------------------------------
Year Ended December 31, Year Ended December 31,
1998 vs. 1997 1997 vs. 1996
---------------------------------------------- ----------------------------------------------
Increase (decrease) due to Increase (decrease) due to
---------------------------------------------- ----------------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------- ------- ------- ------- ------- ------- ------- -------
Interest earning assets:
Loans 4,161 (710) (385) 3066 $ 1,594 $ (19) $ (5) $ 1,570
Investment securities (1,208) (226) 58 (1,376) (496) 150 (15) (361)
Other interest earning
assets 47 88 9 144 96 6 1 103
------- ------- ------- ------- ------- ------- ------- -------
Total interest earning
assets 3,000 (848) (318) 1,834 1,194 137 (19) 1,312
Interest bearing
liabilities:
Interest bearing
checking 606 (245) (312) 49 (17) (16) 1 (32)
Savings deposits 299 9 2 310 (55) 30 (1) (26)
Time deposits 25 31 1 57 437 16 2 455
Short-term borrowings 476 (40) 352 788 189 30 21 240
------- ------- ------- ------- ------- ------- ------- -------
Total interest bearing
liabilities 1,406 (245) 43 1,204 554 60 23 637
------- ------- ------- ------- ------- ------- ------- -------
Net interest income $ 1,594 $ (603) $ (361) $ 630 $ 640 $ 77 $ (42) $ 675
======= ======= ======= ======= ======= ======= ======= =======
The following table sets forth average balances for assets and
interest-bearing liabilities, the interest and yield on interest earning assets,
the interest and rate paid on interest bearing liabilities, the net interest
income and net interest spread, and the net interest margin for the periods
indicated (in each case on a pro forma combined basis):
Average Balance Sheet Pro Forma Combined
(Dollars in thousands, unaudited) Year Ended December 31, 1998
------------------------------------
Average Average
Balance Interest Yield/Rate
-------- -------- --------
Interest earning assets:
Loans (1) $130,307 $ 10,743 8.25%
Investment securities 55,440 3,348 6.04
Other interest earning assets 9,765 639 6.54
-------- -------- --------
Total interest earning assets 195,512 14,730 7.53
Non-interest earning assets 18,770
--------
Total assets 214,282
========
Interest bearing liabilities:
Interest bearing checking $ 38,105 $ 526 1.38%
Savings deposits 42,842 1,525 3.56
Time deposits 74,767 4,309 5.76
Short-term borrowings 25,625 1,289 5.03
-------- -------- --------
Total interest bearing liabilities $181,339 $ 7,649 4.22%
========
--------
Net interest income $ 7,081
========
Net interest spread 3.32%
Net interest margin(2) 3.62%
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent
yields.
22
Average Balance Sheet
(Dollars in thousands, unaudited) Pro Forma Combined
Year Ended December 31, 1997 (2)
------------------------------------
Average Average
Balance Interest Yield/Rate
-------- -------- --------
Interest earning assets:
Loans (1) $ 84,505 $ 7,677 9.08%
Investment securities 74,493 4,724 6.34
Other interest earning assets 8,916 495 5.55
-------- --------
Total interest earning assets 167,914 12,896 7.68
Non-interest earning assets 8,637
--------
Total assets $176,551
========
Interest bearing liabilities:
Interest bearing checking $ 16,790 $ 477 2.84%
Savings deposits 34,381 1,215 3.53
Time deposits 74,332 4,252 5.72
Short-term borrowings 8,874 501 5.65
-------- --------
Total interest bearing liabilities $134,377 $ 6,445 4.80%
========
--------
Net interest income $ 6,451
========
Net interest spread 2.88%
Net interest margin(3) 3.84%
(1) Includes nonaccrual loans.
(2) Includes average pro forma adjustments to loans, investments, non-interest
earning assets and time deposits.
(3) Computed on a fully taxable basis, without regard to tax equivalent
yields.
Average Balance Sheet
(Dollars in thousands, unaudited) Pro Forma Combined
Year Ended December 31, 1996 (2)
------------------------------------
Average Average
Balance Interest Yield/Rate
-------- -------- --------
Interest earning assets:
Loans (1) $ 67,012 $ 6,107 9.11%
Investment securities 83,090 5,085 6.16
Other interest earning assets 6,626 392 5.47
-------- -------- --------
Total interest earning assets 156,728 11,584 7.39
Non-interest earning assets 11,914
--------
Total assets $168,642
========
Interest bearing liabilities:
Interest bearing checking $ 17,350 $ 509 2.93
Savings deposits 35,972 1,241 3.45
Time deposits 66,664 3,797 5.70
Short-term borrowings 5,146 261 5.07
-------- -------- --------
Total interest bearing liabilities $125,132 $ 5,808 4.64%
========
--------
Net interest income $ 5,776
========
Net interest spread 2.75%
Net interest margin(3) 3.69%
(1) Includes nonaccrual loans.
(2) Includes average pro forma adjustments to loans, investments, non-interest
earning assets and time deposits.
(3) Computed on a fully taxable basis, without regard to tax equivalent
yields.
As illustrated in the preceding tables, the principal reason for
the increase in net interest income from 1996 to 1997, and 1997 to 1998, was an
increase in the volume of United's interest earning assets. The decrease in
interest income from a planned decrease in the volume of investment securities
held in portfolio was more than offset by a large positive contribution from
increased loan volumes, as funds from borrowings, deposits and repayments of
investment securities were applied to increase the volume of higher yielding
loan assets. This increased volume of loans
23
was largely responsible for the $1.2 million increase in interest income due to
volume from 1996 to 1997 and the $3.0 million increase in interest income due to
volume from 1997 to 1998. Average interest rates earned on loans declined during
these periods as market interest rates declined slightly. Rates earned on
investment securities increased from 1996 to 1997 and declined only slightly
from 1997 to 1998.
Rates paid on deposits remained relatively constant from 1996 to
1997 and from 1997 to 1998, resulting in only minimal changes in interest
expense as a result of changes in such rates. A $7.7 million increase in
certificate accounts from 1996 to 1997 and a $3.7 million increase in short-term
borrowings, offset slightly by a decrease in average balances of savings and
interest-bearing checking accounts, resulted in a $.55 million increase in
interest expense due to volume from 1996 to 1997. Further increases in
borrowings from 1997 to 1998, particularly in repurchase agreements and FHLB
borrowings as United worked to expand its portfolio, caused an increase in
interest expense in 1998 as compared to 1997.
The increased interest expense was more than offset by the
increased interest income resulting from expansion of United's loan portfolio
during both periods. United's net interest income increased $.6 million from
$6.5 million for 1997 to $7.1 million for 1998 and increased $.7 million from
$5.8 million for the year ended December 31, 1996 to $6.5 million for the year
ended December 31, 1997.
PROVISION FOR LOAN LOSS. United provided $340,000 for loan losses in
1998. United provided $717,000 for loan losses in 1997 as compared with $160,000
in 1996. The increase in the provision for loan losses from 1996 to 1997 is in
part because of the increased average balance in loans receivable and in part
because of management's evaluation of overall economic conditions, both
regionally and nationally.
The provision for loan losses is determined by management as the
amount to be added to the allowance for loan losses after net charge-offs have
been deducted to bring the allowance to a level which is considered adequate to
absorb losses inherent in the loan portfolio in accordance with GAAP. Future
additions to United's allowance for loan losses and any change in the related
ratio of the allowance for loan losses to non-performing assets are dependent
upon the performance and composition of United's loan portfolio, the economy,
inflation, changes in real estate values and interest rates and the view of the
regulatory authorities toward adequate reserve levels.
NON-INTEREST INCOME. In addition to net interest income, United
generates significant non-interest income from a wide range of retail banking
services, including mortgage banking activities and service charges for deposit
services. Non-interest income increased $1.7 million, or 94.0%, to $3.5 million
for 1998. In contrast, non-interest income decreased $.1 million, or 5.3%, in
1997 as compared to 1996. The principal reason for the fluctuations were the
strength of the home lending market, and particularly the refinancing market
during 1998, as interest rates were relatively low and stable. The active
refinancing market during this period resulted in a substantial increase in loan
origination fees and discounts on sale of mortgage loans. United believes that
any increase in interest rates is likely to result in a decreased refinancing
market and would negatively affect United's fee income. Other non-interest
income, including servicing fees on mortgage loans, service charges and FHLB
stock dividends, remained relatively constant from period to period and are
expected to remain relatively constant in future periods. United also recognized
a small amount of gain on sale of investment securities in 1996 and 1998, while
no investment securities were sold in 1997.
NON-INTEREST EXPENSE. Non-interest expense increased $1.9 million,
or 41.0%, to $6.4 million in 1998, but decreased $.5 million, or 10.0%, to $4.6
million in 1997 from $5.1 million in 1996. Salary and employee benefit expense,
which increased $1.1 million to $3.5 million in 1998 from $2.4 million in 1997,
accounted for most of the increase in 1998. This increase was due primarily to
increased salary and commission expense associated with the refinancing activity
and growth in the size
24
of United's overall operations. To a lesser extent, this increase was also due
to one-time merger related charges of $85,000 and increased data processing
charges in the first quarter of 1998. The decrease in non-interest expense in
1997 as compared to 1996 was due primarily to a one-time FDIC insurance charge
assessed against all savings institutions to recapitalize the SAIF deposit
insurance fund, which resulted in a $789,000 charge for United in 1996.
INCOME TAXES. Income tax expense increased $.3 million to $1.4
million for 1998 from $1.1 million for 1997, and increased $239,000 to
$1,125,000 during 1997 from $886,000 during 1996. The principal reason for the
increase in both periods was increased income, after adjustment for
non-deductible goodwill amortization and tax-free interest on municipal bonds
and loans.
FINANCIAL CONDITION
GENERAL. United's total assets increased $48.7 million to $232.5
million at December 31, 1998 from $183.8 million at December 31, 1997, and
increased $7.2 million in 1997 from $176.6 million at December 31, 1996. The
principal reason for the increases in both periods was growth in United's loan
portfolio, which increased $49.5 million during 1998 and $16.5 million during
1997. The aggregate balance of mortgage-backed and investment securities
declined in both periods, as United worked to apply some of these resources in
higher yielding assets. The more rapid growth in 1998 reflects the application
of the lending and investment policies of Heritage to the United organization.
LOANS. Net loans receivable increased $49.5 million during 1998 to
$143.3 million at December 31, 1998. Residential mortgage loans increased as
United expanded its loan production offices and added residential lending staff.
Although smaller in dollar amount, United's construction, agricultural and
commercial real estate loans, and its non-real estate commercial and
agricultural loans, grew even more rapidly during 1998. Substantial increases in
commercial and agricultural loans, which are consistent with new loan policies
adopted after the Heritage Merger, resulted from increased marketing through
officer call programs, primarily through United's Great Falls office.
Net loans increased $16.5 million during 1997 to $93.8 million at
December 31, 1997. Virtually all of the increase is a result of expansion at
Heritage as a result of the same focused loan call programs instituted company
wide at United during 1998. Old United's loans increased only approximately $1
million during 1997.
MORTGAGE-BACKED AND INVESTMENT SECURITIES. United's mortgage-backed
and investment securities decreased $10.2 million to $51.9 million during the
year ended December 31, 1998, and decreased $7.3 million to $62.1 million during
1997. Declining balances of investment securities from calls and maturities, and
from the sale of $5.7 million of bonds and government mutual funds during 1998,
accounted for the majority of the decrease. Mortgage-backed securities increased
during 1998, as a result of net purchases of $8.4 million of mortgage-backed
securities.
OTHER ASSETS. Real estate owned decreased $523,000 during 1998 to
$304,000 at December 31, 1998, as United sold one of its two remaining apartment
complexes in Glendive, Montana for $360,000 (for no gain or loss) and recorded
depreciation of $28,000. Real estate owned decreased $77,000 during 1997 as the
result of the sale of two vacant lots previously acquired in foreclosure for
$40,000 and depreciation of $37,000. United is currently actively marketing the
remaining Glendive apartment complex.
United purchased $210,600 of additional FHLB stock during 1998 and
purchased $167,000 of FHLB stock during 1997, primarily as required to support
the increased scope of its operations. United received FHLB stock dividends of
$82,800 in 1998. Premises and equipment increased $.9 million during 1998, as
the result of the purchase of additional computer equipment and remodeling of
United's home office,
25
and increased $.4 million during 1997, primarily as a result of the purchase of
the second floor of United's home office ($425,000).
Goodwill and identifiable intangibles increased $1.6 million during
1998 as a result of the acquisition of Old United in the Heritage Merger
($981,000), the purchase of two loan production offices ($184,000), and the
purchase premium paid on State Bank deposits ($454,000), offset by amortization
of $107,000 and changes to Old United's historical net assets of $87,000.
Goodwill decreased $276,000 during 1997, of which $233,000 was due to changes in
Old United's historical net assets and $43,000 of amortization.
DEPOSITS AND BORROWINGS. United experienced a net increase in
deposits of $26.4 million in 1998 and a net increase in deposits of $5.0 million
for the year ended December 31, 1997. The increase in deposits during 1998
resulted primarily from the application of competitive rates on all deposit
offerings by United as well as the offering of a greater array of loan products
to attract depositors. The increase in 1997 was solely from deposit growth of
Heritage as a result of the same policies. Old United had offered deposits with
uncompetitive rates in order to maintain adequate margin over lower yielding
assets, resulting in a net outflow of $7.8 million deposits at Old United during
1997.
Borrowings increased $22.0 million to $31.6 million at December 31,
1998, from $9.6 million at December 31, 1997, and increased $1.8 million during
1997 from $7.8 million at December 31, 1996. All of the borrowings prior to
February 3, 1998 represent borrowings by Heritage, as old United had no
outstanding borrowings during such periods. The additional borrowings in 1998,
comprised of a net increase of $15.7 million in FHLB advances and $6.3 million
in securities sold under repurchase agreements, were used to fund increases in
United's loan portfolio.
NONPERFORMING ASSETS. When a borrower fails to make a scheduled
payment on a loan and does not cure the delinquency within 15 days, United's
policy is to contact the borrower between the 15th and 30th day of delinquency
to establish a repayment schedule. If a loan is not current, or a realistic
repayment schedule is not being followed by the 90th day of delinquency, United
will generally proceed with legal action to foreclose the property after the
loan has become contractually delinquent 90 days. Loans contractually past due
90 days are classified as nonperforming. However, not all loans past due 90 days
automatically result in the non-accrual of interest income. If a 90 days past
due loan has adequate collateral, or is FHA insured or VA guaranteed, leading to
the conclusion that loss of principal and interest would likely not be realized,
then interest income will continue to be accrued.
The following schedule details the amounts of United's
nonperforming assets, consisting of nonaccrual loans, accruing loans past due
over 90 days and restructured loans.
(Dollars in thousands) Pro Forma Combined
(unaudited)
-------- ------------------------
December December December
31, 1998 31, 1997 31, 1996
-------- -------- --------
Principal Balances:
Accruing loans past due over 90
days $ 387 $ 437 $ 45
Non-accrual loans 594 4 --
Restructured loans -- -- --
-------- -------- --------
Total $ 981 $ 441 $ 45
-------- -------- --------
Interest:
Due on non-accrual loans $ 12 $ -- $ --
Included in income none none none
United is required to review, classify and report to its Board of
Directors its assets on a regular basis and classify them as "substandard"
(distinct possibility that some loss will be sustained), "doubtful" (high
likelihood of loss),
26
or "loss" (uncollectible). Adequate valuation allowances are required to be
established for assets classified as substandard or doubtful in accordance with
generally accepted accounting principles. If an asset is classified as a loss,
the institution must either establish a specific valuation allowance equal to
the amount classified as loss or charge off such amount. At December 31, 1998,
United had $553,000 of reported doubtful assets and no assets classified as
loss. The doubtful balance represents one loan to a company which originates and
securitizes home equity loans. With the disruption in the securitization market,
liquidity constraints forced a subsidiary of the borrower to file for Chapter 11
bankruptcy protection in March 1999. United had placed the loan on non-accrual
in December 1998, and has allocated loss reserves for any potential loss on the
loan. As of March 31, 1999, the loan was current with regard to principal and
interest payments. As of December 31, 1997 and 1996 (on a pro forma combined
basis), United had no assets classified as doubtful or loss. At December 31,
1998, 1997 and 1996 (on a pro forma combined basis), United had $405,000,
$116,000 and $40,000, respectively, of reported substandard assets. As a percent
of total assets, substandard assets were approximately .17%, .06% and .02% at
December 31, 1998, 1997 and 1996, respectively.
PROVISION FOR LOAN LOSSES. The following schedule details changes in
United's loan loss reserve at December 31 for each of the three years indicated:
Pro Forma Combined
(Dollars in thousands) (unaudited)
------------------------------
Year Ended Year Ended Year Ended
December December December
31, 1998 31, 1997 31, 1996
---------- ---------- ----------
Balance beginning of period $ 1,146 $ 463 $ 401
Provision for loan losses 340 717 160
Acquired from State Bank 43 -- --
Charge-offs:
Commercial (4) (10) (98)
Consumer (52) (25) --
---------- ---------- ----------
Total charge-offs (56) (35) (98)
Recoveries 12 1 --
---------- ---------- ----------
Net charge-offs (44) (34) (98)
---------- ---------- ----------
Balance end of period end $ 1,485 $ 1,146 $ 463
========== ========== ==========
Allowance for loan losses to:
Total loans at period end 1.03% 1.21% .59%
========== ========== ==========
Net charge-offs to average
loans .04% .04% .15%
========== ========== ==========
The following schedule allocates the loan loss reserve based on
management's judgment of potential losses in the respective areas. While
management has allocated the reserve to various portfolio segments for purposes
of this table, the reserve is general in nature and is available for the
portfolio in its entirety:
Pro Forma Combined
(Dollars in thousands) (unaudited)
--------------------------------------------------
December 31, 1998 December 31, 1997 December 31, 1996
---------------------- ---------------------- ----------------------
Allowance % to Allowance % to Allowance % to
for loan loans in for loan loans in for loan loans in
losses category losses category losses category
--------- -------- --------- -------- --------- --------
Real estate loans:
1 - 4 residential $ 124 .25% $ 387 .90% $ 195 .50%
5 or more residential 66 1.00 67 1.00 33 .70
Construction 92 1.00 55 1.00 35 .80
Commercial and agricultural 462 1.41 217 1.50 86 .80
Non-real estate loans:
Commercial and agricultural 601 1.56 259 1.50 96 .80
Consumer 140 2.00 161 2.00 18 .25
--------- ------ --------- ------ --------- ------
Total $ 1,485 1.03% $ 1,146 1.21% $ 463 .59%
========= ====== ========= ====== ========= ======
27
REAL ESTATE OWNED. Total real estate owned ("REO") of United was
$304,000, $827,000 and $904,000 at December 31, 1998, 1997 and 1996 (on a pro
forma combined basis) respectively. The schedule below details REO both held for
sale and investment) by United as of the dates indicated.
Pro Forma Combined
(Dollars in thousands) (unaudited)
----------------------------
December 31, December 31, December 31,
1998 1997 1996
------------ ------------ ------------
REO held for sale $ -- $ -- $ --
Allowance for possible losses -- -- --
REO held for investment 328 827 904
Accumulated depreciation (24) -- --
------------ ------------ ------------
Total REO held for investment $ 304 $ 827 $ 904
============ ============ ============
As a percent of total assets .13% .45% .53%
============ ============ ============
ASSET/LIABILITY MANAGEMENT. United's earnings depend to a large
extent on the level of its "net interest income." Net interest income depends
upon the difference (referred to as "interest rate spread") between the yield on
United's loan and investment portfolios and interest-earning cash balances
("interest-earning assets"), and the rates paid on its deposits and borrowings
("interest-bearing liabilities"). Net interest income is further affected by the
relative amounts of United's interest-earning assets and interest-bearing
liabilities. In recent years, United's interest-earning assets have exceeded
interest-bearing liabilities. However, when interest-earning assets decrease as
a result of non-accrual loans and investments in non-interest earning assets,
net interest income and interest rate spread also decrease and any continued
decrease in the level of interest-earning assets would generally result in
negative impact on earnings.
One of the primary objectives of United's management has been to
restructure United's balance sheet to reduce its vulnerability to changes in
interest rates (Interest Rate Risk). Savings institutions historically have
suffered from a mismatch in the term to maturity of their assets and
liabilities, with mortgage loan assets tending to be of a much longer term than
deposits, the primary liabilities of savings institutions. In periods of rising
interest rates, this mismatch can render savings institutions vulnerable to
increases in costs of funds (deposits and borrowings) that can outstrip
increases in returns on longer-term fixed rate loans and investments, resulting
in a decrease in positive interest rate spread and lower earnings.
Several strategies have been employed by United to minimize the
mismatch of asset and liability maturities. For the past several years, United
has maintained the policy of selling the majority of newly-originated long-term
(15 to 30-year maturity) fixed-rate mortgage loans to the secondary market.
These loans are sold at their outstanding principal balance, which is the
prearranged contract purchase price, and therefore, no gain or loss is realized
at sale. United promotes the origination and retention of loans providing for
periodic interest rate adjustments, shorter terms to maturity or balloon
provisions. United also emphasizes investment in adjustable rate or shorter-term
mortgage-backed securities and other interest-earning investments. When
maturities of loans increase, United offsets the increased interest rate risk
with matching funds and maturities with the FHLB borrowings.
28
The following tables provide information regarding the maturity of
loans included in United's portfolio as of December 31, 1998. The amounts
reflected in the following table give no effect to assumptions regarding loan
prepayments or payoffs. Loans with variable rates of interest are classified as
due when the loan principal balances are contractually due, not when the
interest rate reprices.
(Dollars in thousands)
December 31, 1998
--------------------------------------------
5 Years
Up to 1 - 5 and
1 Year Years Beyond Total
-------- -------- -------- --------
Loans:
Loans secured by real estate:
Adjustable rate (all
property types) $ 4,530 $ 7,768 $ 4,718 $ 17,016
1-4 family residential 5,129 10,572 22,749 38,450
Multi-family and commercial 452 1,213 4,986 6,651
Construction and undeveloped
land 9,224 -- -- 9,224
-------- -------- -------- --------
Total loans secured by real
estate 19,335 19,553 32,453 71,341
Commercial non-real
estate(1) 14,727 29,766 9,234 53,727
Agricultural non-real estate 4,330 6,520 1,338 12,188
Consumer(2) 1,478 4,161 464 6,103
-------- -------- -------- --------
Total loans $ 39,870 $ 60,000 $ 43,489 $143,359
======== ======== ======== ========
Total loans
due after
December 31,
1999
---------
Fixed interest rates $ 91,003
Floating or adjustable rates
or balloon payments 12,486
---------
$ 103,489
=========
(1) Includes loans on commercial savings accounts
(2) Includes consumer loans secured by real estate
29
The following table sets forth the amortized cost, maturities and
weighted average yield of United's investment portfolio at the dates indicated:
(Dollars in thousands)
December 31, 1998
--------------------------------------------------------------------
10
Up to 1 - 5 5 - 10 years
1 year years years and Total
beyond
-------- -------- -------- -------- --------
U.S. government and agencies $ 2,322 $ 6,201 $ 3,120 $ 2,001 $ 13,644
Mortgage-backed securities 1,567 10,477 550 23,776 36,370
Municipal bonds 10 192 605 52 859
Other 993 -- -- 45 1,038
-------- -------- -------- -------- --------
Total investments $ 4,892 $ 16,870 $ 4,275 $ 25,874 $ 51,911
======== ======== ======== ======== ========
Weighted average yield 6.41% 6.39% 6.25% 5.89% 6.20%
Pro Forma Combined (unaudited)
December 31, 1997
--------------------------------------------------------------------
10
Up to 1 - 5 5 - 10 years
1 year years years and Total
beyond
-------- -------- -------- -------- --------
U.S. government and agencies $ 6,037 $ 13,449 $ 3,507 -- $ 22,993
Mortgage backed securities 2,393 17,244 6,138 6,447 32,222
Municipal bonds -- 67 1,069 103 1,239
Kemper U.S. Gov't bond mutual
fund 5,260 -- -- -- 5,260
Other -- -- 407 -- 407
-------- -------- -------- -------- --------
Total investments $ 13,690 $ 30,760 $ 11,121 $ 6,550 $ 62,121
======== ======== ======== ======== ========
Weighted average yield 5.71% 6.61% 6.70% 6.93% 6.46%
Maturity of time deposits of $100,000 or more at the dates indicated
are as follows:
(Dollars in thousands)
Pro Forma Combined
(unaudited)
----------------------
December December December
31, 1998 31, 1997 31, 1996
-------- -------- --------
Less than three months $ 2,578 $ 1,822 $ 1,461
Three to six months 3,043 1,454 2,105
Six to twelve months 3,970 3,015 2,394
Greater than twelve months 3,407 2,833 2,604
-------- -------- --------
Total $ 12,998 $ 9,124 $ 8,564
======== ======== ========
STOCKHOLDERS' EQUITY. Stockholders' equity at December 31, 1998 was $30.5
million, or 13.1% of total assets, up slightly from $29.8 million, or 16.2% of
total assets, at December 31, 1997 (on a pro forma combined basis). At December
31, 1998, book value was $17.98 per share. The increase in stockholders' equity
is primarily due to net income of $2.3 million for 1998, partially offset by the
payment of $1.3 million in dividends on United's Common Stock.
30
The following table sets forth certain information regarding returns
on average assets and average equity, dividend payout ratio and equity to assets
ratio (average equity divided by average total assets), (i) Heritage for the
years ended December 31, 1997 and 1996 and (ii) Old United for the years ended
December 31, 1997 and 1996:
United
Pro Forma
Combined
December Heritage Old United
31, December 31, December 31,
-------- -------------------- --------------------
1998 1997 1996 1997 1996
-------- -------- -------- -------- --------
Return on average assets 1.09% 0.73% 0.81% 1.30% 1.03%
Return on average equity 7.68 21.45 25.78 5.50% 4.50
Dividend payout ratio 54.64 -- -- 88.00 99.00
Average equity to average assets
ratio 14.17 3.40 3.20 23.70 23.00
An additional $.25 per share dividend was declared in January 1998
prior to the Heritage Merger.
YEAR 2000
Many currently installed computer systems and software are coded to
accept only two-digit entries in the date code fields. These date code fields
will need to accept four-digit entries to distinguish 21st century dates from
20th century dates. This problem could result in system failures or
miscalculations causing disruptions of business operations, including production
of erroneous data, inability to process transactions, and other operational
problems. As a result, many companies' computer systems and software will need
to be upgraded or replaced in order to comply with Year 2000 requirements. The
potential global impact of the Year 2000 problem is not known, and, if not
corrected in a timely manner, could affect United as well as the U.S. and world
economy generally.
United has undertaken efforts to address Year 2000 computer issues.
United has formed a project team including the President and Operations Officer
of Heritage Bank and a contracted Year 2000 compliance person, and it contracted
with a computer consulting firm, to evaluate the Year 2000 impact on United's
mission-critical computer hardware and software and embedded technologies in its
physical plant and automated equipment (such as ATMs, proof machines, vaults and
security systems). The Banks are also in the process of ascertaining the Year
2000 readiness of its customers. As a result of the merger in May 1998 of United
Bank into Heritage Bank and the acquisition of Heritage State Bank in August
1998, the project team is in the process of reevaluating its Year 2000
readiness. In addition to evaluating the scope of Year 2000 issues, the project
team is prioritizing tasks, developing implementation plans and establishing
completion and testing schedules. United is replacing, modifying or
reprogramming certain systems, is requiring that new purchased hardware and
software be Year 2000 compliant, and continuing to test its systems.
The majority of United's information processing is performed by
Banker's Resource Center, of which Heritage Bank is an 11% owner. Banker's
Resource Center is regulated by banking regulators, has had various exams by
banking regulators, and is currently in the process of conducting Year 2000
certification testing. Banker's Resource Center provides periodic reports to
United on the status of its Year 2000 project readiness. During the past two
years, and also in conjunction with merging the operations of Heritage Bank and
United Bank, United has upgraded the majority of its internal computer hardware
and software to Year 2000 compliant systems. Additionally, all of United's
personal computers are being tested by its computer consulting firm. United has
a budget of $105,000 for replacement of teller equipment, its telephone system
and other Year 2000 costs. To date, approximately $60,000 has been spent on the
Year 2000 project.
31
Apart from United's Year 2000 efforts, federal banking regulators
conduct special examinations of FDIC-insured banks and savings associations to
determine whether they are taking necessary steps to prepare for the Year 2000
issue. These agencies are closely monitoring the progress made by these
institutions in completing key steps required by their individual Year 2000
plans. The OTS, which regulates Heritage Bank, conducted an onsite Year 2000
examination in May 1998 and a follow-up examination in November 1998.
The replacement, renovation and testing of its critical internal
computer hardware and software and embedded technologies have progressed as
scheduled as of December 31, 1998, which is expected to allow United time for
necessary refinements and additional testing before December 31, 1999.
Ultimately, the potential impact of Year 2000 issues will depend
not only on the success of the corrective measures that United undertakes, but
also on the way in which the Year 2000 issue is addressed by customers, vendors,
service providers, counterparts, utilities, governmental agencies and other
entities with which United does business. United is communicating with certain
of these parties to heighten their awareness of Year 2000 issues, to learn how
they are addressing them and to evaluate any likely impact on United. United
also is asking important vendors for commitment dates for their Year 2000
readiness and delivery of compliance software and other products. In addition,
United is monitoring the Year 2000 preparations of entities such as the Federal
Reserve Bank, which provides services for processing and settling payments and
securities transactions between banks. Year 2000 efforts of third parties are
not within United's control, however, and their failure to remediate Year 2000
issues successfully could result in business disruption, increased operating
cost and increased credit risk for United. At the present time, it is not
possible to determine whether any such events are likely to occur, or to
quantify any potential negative impact they may have on United's future results
of operations and financial condition. The United Board evaluated the possible
allocation of a portion of its loss reserve specifically to potential losses
from Year 2000 complications, particularly with its commercial loan customers.
Although this risk will be closely monitored in 1999 by both senior management
and the Board, no allocation of the loss reserve has been deemed necessary at
this time. United is developing a contingency plan to mitigate potential delays
or other problems, in the event of various problem scenarios and intends to
assess such a plan based on the outcome of its validation phase of its Year 2000
compliance program and the results of surveying its major suppliers and
customers.
The foregoing discussion regarding Year 2000, including the
discussion of the timing and effectiveness of implementation and cost of
United's Year 2000 project, contains forward-looking statements, which are based
on management's best estimates derived using various assumptions. These
forward-looking statements involve inherent risks and uncertainties, and actual
results could differ materially from those contemplated by such statements.
Factors that might cause material differences include, but are not limited to,
the availability to locate and correct all relevant computer codes, and its
ability to respond to unforeseen Year 2000 complications. Such material
differences could result in, among other things, business disruption, operating
problems, financial loss, legal liability and similar risks.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK. Market risk is the risk of loss in a financial
instrument arising from adverse changes in market rates/prices such as interest
rates, foreign currency exchange rates, commodity prices and equity prices.
Since United's earnings depend on its level of interest rate spread, its primary
market risk exposure is interest rate risk ("IRR").
INTEREST RATE RISK. United has established a formal IRR policy, and
Heritage Bank has an Asset/Liability Management Committee and an Investment
Committee, which meet at least quarterly to review and report on management's
efforts to minimize IRR. Several asset/liability management strategies have been
employed by United to
32
minimize its exposure to IRR. These include selling most newly-originated
long-term fixed-rate mortgages, promoting the origination and retention of loans
providing for periodic interest rate adjustments, shorter terms to maturity or
balloon provisions, and investing in adjustable rate or shorter-term
mortgage-backed securities and other interest-earning investments.
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE. Interest rate risk
sensitivity of net portfolio value ("NPV") measurement seeks to establish a
methodology to measure the potential for the reduction of earnings and
stockholders' equity resulting from both lower net interest income ("NII") and
lower NPV caused by changes in market interest rates. NPV thus provides a
leading indicator of future potential changes in both NII and stockholders'
equity. Because of its asset size (less than $500 million), Heritage Bank falls
under an OTS exemption that allows utilization of an asset/liability computer
simulation program prepared and distributed by the OTS. The OTS Thrift Financial
Report includes Schedule CMR that provides detailed information about the
balances, interest rates, repricing, and maturity characteristics of the Bank's
financial instruments. By utilizing the Bank's Schedule CMR data, the OTS runs
computer simulations ("Net Portfolio Value Model") utilizing OTS assumptions.
Heritage Bank, per OTS requirements, has established maximum percentage changes
for NPV resulting from instantaneous changes in interest rates of 100 to 400
basis points. A maximum change of -15% for an instantaneous 200 basis point
change in interest rate has been established. A 200 basis point change is used
by the OTS as the current Interest Rate Sensitivity Measure by which thrifts are
evaluated. Heritage Bank periodically reviews and makes changes to established
limits for NPV changes due to mergers and other market factors.
The following table demonstrates Heritage Bank's December 31, 1998
NPV and the $ present value of total assets, NPV ratio and basis point change
for four instantaneous increases and the four instantaneous decreases in
interest rates:
Interest Rate Sensitivity of Net Portfolio Value
(Dollars in thousands)
Instantaneous Net Portfolio Value NPV as % of PV of Assets
Change in ---------------------------------------------------------------
Rates $ Amount $ Change % Change Total Assets NPV Ratio Change
- ------------- -------- -------- -------- ------------ --------- --------
+400 bp 17,799 -6,240 -26% 207,356 8.58% -245 bp
+300 bp 19,517 -4,521 -19% 210,123 9.29% -174 bp
+200 bp 21,173 -2,866 -12% 212,850 9.95% -108 bp
+100 bp 22,662 -1,376 -6% 215,443 10.52% -51 bp
0 bp 24,039 - -% 217,948 11.03% -
-100 bp 25,593 1,554 +6% 220,664 11.60% +57 bp
-200 bp 27,362 3,324 +14% 223,626 12.24% +121 bp
-300 bp 29,604 5,566 +23% 227,092 13.04% +201 bp
-400 bp 31,617 7,578 +32% 230,361 13.73% +270 bp
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operation results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of assets and liability cash flows
and others. Sensitivity analysis does not reflect actions that United might take
in responding to or anticipating changes in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The management of United Financial Corp. has prepared and is
responsible for the consolidated financial statements of the Company. These
statements have been
33
prepared in accordance with generally accepted accounting principles
applied on a consistent basis.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the captions "Election of Directors"
and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission on or before April 25, 1999
(the Proxy Statement is incorporated herein by reference). Information regarding
executive officers is set forth in Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "Executive Compensation
and Other Information," "Compensation of Directors" and "Stock Price Performance
Graph" in the Proxy Statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the captions "Securities Ownership
of Certain Beneficial Owners" and " Securities Ownership of Management" in the
Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships
and Related Transactions between Management and the Company" in the Proxy
Statement is incorporated herein by reference.
34
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
List of Documents filed by Company as part of this Report.
(a) (1) FINANCIAL STATEMENTS:
The following financial statements of United Financial are included herein
as follows:
Page Number
-----------
Independent Auditors' Reports F-1
Consolidated Statements of Financial Condition, F-3
December 31, 1998 and 1997
Consolidated Statements of Income - Years Ended F-4
December 31, 1998, 1997, and 1996
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income - Years Ended F-5
December 31, 1998, 1997, and 1996
Consolidated Statements of Cash Flows - Years Ended F-6
December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements F-7
(2) FINANCIAL STATEMENT SCHEDULES:
Financial statement schedules have been omitted because they are
inapplicable or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
(3) EXHIBITS.
The exhibits listed in the accompanying index are filed as part of this
Report or incorporated by reference as indicated therein.
(b) REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 1998
None
35
SIGNATURES
Pursuant to 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:
UNITED FINANCIAL CORP.
By: /s/ John M. Morrison By: /s/ Kurt R. Weise
------------------------ ---------------------
John M. Morrison Kurt R. Weise
Chairman of the Board and President and Chief Operating Officer
Chief Executive Officer (Duly Authorized Representative)
(Duly Authorized Representative)
Date: March 30, 1999 Date: March 30, 1999
----------------------- --------------------
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:
By: /s/ John M. Morrison By: /s/ Kurt R. Weise
--------------------------- ------------------------------
John M. Morrison Kurt R. Weise
Director Director
Date: March 30, 1999 Date: March 30, 1999
--------------------------- -------------------------
By: /s/ Larry D. Albert By: /s/ Dr. J. William Bloemendaal
--------------------------- ------------------------------
Larry D. Albert Dr. J. William Bloemendaal
Director Director
Date: March 30, 1999 Date: March 30, 1999
--------------------------- -------------------------
By: /s/ Elliott L. Dybdal By: /s/ Janice M. Graser
--------------------------- ------------------------------
Elliott L. Dybdal Janice M. Graser
Director Director
Date: March 30, 1999 Date: March 30, 1999
--------------------------- -------------------------
By: /s/ Jerome H. Hentges By: /s/ William L. Madison
--------------------------- ------------------------------
Jerome H. Hentges William L. Madison
Director Director
Date: March 30, 1999 Date: March 30, 1999
--------------------------- -------------------------
By: /s/ Kevin P. Clark By: /s/ Steve Feurt
--------------------------- ------------------------------
Kevin P. Clark Steve Feurt
Director Director
Date: March 30, 1999 Date: March 30, 1999
--------------------------- -------------------------
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
United Financial Corp.:
We have audited the accompanying consolidated statements of financial condition
of United Financial Corp. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, stockholders' equity and
comprehensive income, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1998 and 1997 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of United
Financial Corp. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
Billings, Montana
February 19, 1999
F-1
Certified
Public
Accountants
To the Board of Directors
Heritage Bancorporation
Great Falls, Montana
INDEPENDENT AUDITOR'S REPORT
We have audited the accompanying consolidated statements of income,
stockholders' equity and cash flows of Heritage Bancorporation and subsidiary
for the year ended December 31, 1996. These consolidated financial statements
are the responsibility of the management of Heritage Bancorporation. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
Heritage Bancorporation for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ Douglas Wilson & Company, P.C.
Great Falls, Montana
March 31, 1997
F-2
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
DECEMBER 31,
---------------------------------
ASSETS 1998 1997
------------- -------------
Cash and cash equivalents $ 19,255,570 9,868,985
Time deposits in banks -- 98,000
Securities available-for-sale 51,899,657 14,219,330
Loans receivable, net 143,359,113 56,795,635
Loans held for sale 5,716,976 1,467,387
Stock in Federal Home Loan Bank of Seattle, at cost 1,232,300 404,000
Accrued interest receivable 1,918,365 687,820
Premises and equipment, net 3,482,411 1,635,873
Real estate owned, net of accumulated depreciation
of $24,420 304,224 --
Deferred income taxes 101,780 133,270
Investment in Valley Bancorp, Inc. 2,683,791 --
Goodwill, net of accumulated amortization of $225,573 and
$150,444 at December 31, 1998 and 1997, respectively 1,399,783 494,345
Identifiable intangibles, net of accumulated
amortization of $30,554 606,762 --
Other assets 600,477 547,632
------------- -------------
$ 232,561,209 86,352,277
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Interest bearing deposits $ 148,724,735 58,617,191
Non-interest bearing deposits 18,895,349 11,768,903
Federal Home Loan Bank advances 22,175,000 6,425,000
Securities sold under agreements to repurchase 9,450,572 3,173,149
Long-term debt -- 2,350,000
Advances from borrowers for taxes and insurance 342,607 137,582
Income taxes payable 115,634 167,243
Accrued interest payable 1,267,108 807,061
Accrued expenses and other liabilities 1,062,237 158,233
------------- -------------
Total liabilities 202,033,242 83,604,362
------------- -------------
Stockholders' equity:
Preferred stock, no par value; authorized 2,000,000
shares; no shares issued -- --
Common stock, no par value; authorized 8,000,000
shares; 1,698,312 shares issued and outstanding 28,001,579 100
Additional paid-in capital -- 1,080,028
Retained earnings, substantially restricted 2,533,289 1,539,605
Accumulated other comprehensive income (loss) (6,901) 128,182
------------- -------------
Total stockholders' equity 30,527,967 2,747,915
------------- -------------
Commitments and contingencies
$ 232,561,209 86,352,277
============= =============
See accompanying notes to consolidated financial statements.
F-3
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31,
---------------------------------------------
1998 1997 1996
----------- ----------- -----------
Interest income:
Loans receivable $10,515,655 4,529,566 3,225,854
Mortgage-backed securities 2,189,305 832,182 873,379
Investment securities 914,676 209,263 194,484
Time deposits in banks 6,709 6,860 21,923
Other interest-earning assets 622,694 195,579 204,724
----------- ----------- -----------
Total interest income 14,249,039 5,773,450 4,520,364
----------- ----------- -----------
Interest expense:
Deposits 6,090,923 2,635,234 2,058,630
Long-term debt 11,917 189,657 191,234
Federal Home Loan Bank (FHLB) advances 898,446 253,407 31,559
Securities sold under agreements to repurchase 391,281 79,035 137,565
----------- ----------- -----------
Total interest expense 7,392,567 3,157,333 2,418,988
----------- ----------- -----------
Net interest income 6,856,472 2,616,117 2,101,376
Provision for loan losses 335,000 492,400 160,000
----------- ----------- -----------
Net interest income after provision for
loan losses 6,521,472 2,123,717 1,941,376
----------- ----------- -----------
Non-interest income:
Loan origination fees on loans sold 2,606,436 649,354 678,575
Loan servicing fees 78,600 65,739 45,687
Customer service charges 336,684 275,509 253,493
Gain on sale of investment securities 43,162 -- --
Equity in income of Valley Bancorp, Inc. 1,550 -- --
Other 225,603 112,992 81,143
----------- ----------- -----------
Total non-interest income 3,292,035 1,103,594 1,058,898
----------- ----------- -----------
Non-interest expense:
Compensation and benefits 3,369,524 1,206,812 1,006,825
Occupancy and equipment 625,110 227,861 191,693
Deposit insurance premiums 82,873 27,389 104,144
Special assessment by the SAIF -- -- 239,297
Data processing fees 349,251 199,263 156,715
Other 1,720,734 699,604 552,114
----------- ----------- -----------
Total non-interest expense 6,147,492 2,360,929 2,250,788
----------- ----------- -----------
Income before income taxes 3,666,015 866,382 749,486
Income taxes 1,398,595 324,161 263,457
----------- ----------- -----------
Net income $ 2,267,420 542,221 486,029
=========== =========== ===========
Net income per share $ 1.43 1.14 1.02
=========== =========== ===========
Weighted average shares outstanding 1,587,711 475,000 475,000
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended December 31, 1998, 1997 and 1996
Accumulated
other Total
Common Additional Retained comprehensive stockholders'
stock paid-in capital earnings income equity
----------- ----------- ----------- ----------- -----------
Balances at December 31, 1995 $ 100 1,080,028 511,355 102,037 1,693,520
Comprehensive income:
Net income -- -- 486,029 -- 486,029
Decrease in net unrealized gains on securities
available-for-sale -- -- -- (1,848) (1,848)
-----------
Total comprehensive income 484,181
----------- ----------- ----------- ----------- -----------
Balances at December 31, 1996 100 1,080,028 997,384 100,189 2,177,701
Comprehensive income:
Net income -- -- 542,221 -- 542,221
Increase in net unrealized gains on securities
available-for-sale -- -- -- 27,993 27,993
-----------
Total comprehensive income 570,214
----------- ----------- ----------- ----------- -----------
Balances at December 31, 1997 100 1,080,028 1,539,605 128,182 2,747,915
Comprehensive income:
Net income -- -- 2,267,420 -- 2,267,420
Decrease in net unrealized gains on securities
available-for-sale, net of reclassification
adjustment -- -- -- (135,083) (135,083)
-----------
Total comprehensive income 2,132,337
-----------
Issuance of 1,223,312 shares, net of issuance costs
of $125,617 24,646,451 -- -- -- 24,646,451
Change in par value of stock to no par 1,080,028 (1,080,028) -- -- --
Capital contribution 2,275,000 -- -- -- 2,275,000
Dividends declared ($.75 per share) -- -- (1,273,736) -- (1,273,736)
----------- ----------- ----------- ----------- -----------
Balances at December 31, 1998 $28,001,579 -- 2,533,289 (6,901) 30,527,967
=========== =========== =========== =========== ===========
Year ended December 31,
------------------------------------------
Reclassification adjustment: 1998 1997 1996
----------- ----------- -----------
Holding gains (losses) arising during the period $ (262,810) 45,517 (3,005)
Tax expense 101,182 (17,524) 1,157
----------- ----------- -----------
Net, after tax (161,628) 27,993 (1,848)
----------- ----------- -----------
Reclassification adjustment for amounts included
in income 43,162 -- --
Tax expense (16,617) -- --
----------- ----------- -----------
Net, after tax 26,545 -- --
----------- ----------- -----------
Net unrealized gain (loss) on securities $ (135,083) 27,993 (1,848)
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-5
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31,
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 2,267,420 542,221 486,029
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 335,000 492,400 160,000
Amortization of goodwill and identifiable intangibles 105,683 42,984 42,984
Depreciation of premises and equipment and
real estate held for investment 320,080 110,329 87,582
Equity in income of Valley Bancorp, Inc. (1,550) -- --
Amortization of loan origination fees 3,292 (54,037) (42,770)
Amortization of premiums and discounts on
investment securities and loans (30,636) (2,040) (91,541)
Mortgage loans originated and held for sale (85,999,406) (30,718,295) (30,341,574)
Proceeds from sales of mortgage loans held for sale 81,749,817 31,649,850 39,337,311
FHLB stock dividends (82,800) (26,800) (24,300)
Increase in accrued interest receivable (404,023) (207,127) (80,394)
Decrease (increase) in deferred income taxes 117,440 (133,003) (64,745)
Decrease (increase) in other assets 2,185,394 (32,448) (156,099)
Increase (decrease) in income taxes payable (168,053) 102,349 21,512
Increase in accrued interest payable 129,408 233,664 136,772
Increase (decrease) in accrued expenses
and other liabilities (2,568,482) (172,248) 32,981
------------ ------------ ------------
Net cash provided by (used in) operating
activities (2,041,416) 1,827,799 (496,252)
------------ ------------ ------------
Cash flows from investing activities:
Net decrease in time deposits in banks 98,000 -- 247,485
Net increase in loans receivable (46,501,033) (15,777,452) (13,705,750)
Purchases of securities available-for-sale (37,033,497) (6,872,431) (4,561,250)
Proceeds from maturities, paydowns and sales of securities
available-for-sale 44,257,269 6,869,640 6,476,883
Purchases of Federal Home Loan Bank stock (210,600) (49,100) --
Purchase of Valley Bancorp, Inc. stock (2,682,241) -- --
Purchases of premises and equipment (940,655) (556,554) (341,070)
Proceeds from sale of real estate owned 360,000 -- --
Acquisition of real estate owned (4,756) -- --
Acquisition of identifiable intangibles (183,316) -- --
Increase (decrease) in minority interest -- (451) 39
Acquired cash and cash equivalents in merger 8,112,629 -- --
Acquired cash and cash equivalents of failed bank 11,553,977 -- --
------------ ------------ ------------
Net cash used in investing activities (23,174,223) (16,386,348) (11,883,663)
------------ ------------ ------------
Cash flows from financing activities:
Net increase in deposits 13,982,987 12,745,405 14,899,047
Net increase in FHLB advances 15,750,000 5,000,000 1,425,000
Payments on long-term debt (2,350,000) (200,000) (100,000)
Net increase (decrease) in securities sold under
repurchase agreements 6,277,423 (3,201,637) (716,196)
Increase (decrease) in advances from borrowers for
taxes and insurance (59,450) (5,437) 16,453
Capital contribution 2,275,000
Dividends paid to stockholders (1,273,736) -- --
------------ ------------ ------------
Net cash provided by financing activities 34,602,224 14,338,331 15,524,304
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 9,386,585 (220,218) 3,144,389
Cash and cash equivalents at beginning of year 9,868,985 10,089,203 6,944,814
------------ ------------ ------------
Cash and cash equivalents at end of year $ 19,255,570 9,868,985 10,089,203
============ ============ ============
Cash paid during the year for:
Interest $ 6,933,000 2,924,000 2,282,000
Income taxes 1,449,000 355,000 130,000
============ ============ ============
See accompanying notes to consolidated financial statements.
F-6
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) GENERAL
On February 3, 1998, Heritage Bancorporation merged with United
Financial Corp. ("United"). Heritage Bancorporation was the parent
company of Heritage Bank (acquired by Heritage Bancorporation in
June 1994) and United Financial Corp. was the parent company of
United Savings Bank. The merger resulted in a combined entity,
United Financial Corp., with the subsidiary banks. The subsidiary
banks were combined into one bank called Heritage Bank in May
1998.
The merger was treated as a reverse acquisition accounted for as a
purchase of United by Heritage Bancorporation. Heritage
Bancorporation is considered the accounting acquiror because
Heritage Bancorporation effectively acquired the operations of
United, including its assets and liabilities, as a result of the
change in control and other related consequences of the merger.
Consistent with Heritage Bancorporation being the acquiring
corporation, the historical financial statements of the combined
entity are those of Heritage Bancorporation. Accordingly, the
historical statements of operations of the combined entity only
reflect the operations of United commencing on and after the
closing date of the merger.
The accompanying consolidated financial statements include the
accounts of United Financial Corp. (UFC) and its wholly-owned
subsidiaries, Heritage Bank (Heritage) and Heritage State Bank
(Heritage State). The consolidated financial statements also
include Community Service Corporation (CSC), a wholly-owned
subsidiary of Heritage. UFC, Heritage, Heritage State and CSC are
herein referred to collectively as "the Company." All significant
intercompany balances and transactions have been eliminated in
consolidation.
The Company, through its subsidiary banks, provides a full range
of banking services to individual and corporate customers in
central and western Montana. The subsidiary banks are subject to
competition from other financial service providers. The Company
and its subsidiary banks are also subject to the regulations of
certain government agencies and undergo periodic examinations by
those regulatory authorities.
(b) BASIS OF PRESENTATION
The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. In
preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the
statement of financial condition and income and expenses for the
period. Actual results could differ significantly from those
estimates.
(Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination of
the allowance for loan losses. Management believes the allowance
for loan losses is adequate, however, future additions to the
allowance may be necessary based on changes in factors affecting
the borrowers' ability to repay. In addition, various regulatory
agencies, as an integral part of their examination process,
periodically review the allowance for loan losses. Such agencies
may require the Company to recognize additions to the allowance
based on their judgments about information available to them at
the time of their examination.
(c) CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the
Company considers all cash, daily interest demand deposits,
amounts due from banks and interest-bearing deposits with banks
with original maturities of three months or less to be cash
equivalents.
(d) INVESTMENT AND MORTGAGE-BACKED SECURITIES
Investment and mortgage-backed securities available-for-sale
include securities that management intends to use as part of its
overall asset/liability management strategy and that may be sold
in response to changes in interest rates and resultant prepayment
risk and other related factors. Securities available-for-sale are
carried at fair value and unrealized gains and losses (net of
related tax effects) are excluded from earnings and reported as a
separate component of stockholders' equity. Investment securities
and mortgage-backed securities, other than those designated as
available-for-sale or trading, are comprised of debt securities
for which the Company has positive intent and ability to hold to
maturity and are carried at cost. Management determines the
appropriate classification of investment and mortgage-backed
securities as either available-for-sale or held-to-maturity at the
purchase date.
Declines in the fair value of available-for-sale or
held-to-maturity securities below carrying value that are other
than temporary are charged to expense as realized losses and the
related carrying value reduced to fair value. The cost of any
investment, if sold, is determined by specific identification.
Premiums and discounts on investment securities are amortized or
accreted into income using a method which approximates the
level-yield interest method.
(e) LOANS RECEIVABLE AND LOAN FEES
Loans receivable are stated at unpaid principal balances, less
unearned discounts and net deferred loan origination fees.
Interest on loans is credited to income as earned. Interest
receivable is accrued only if deemed collectible. Discounts on
purchased loans are amortized into interest income using the
level-yield method over the remaining period to contractual
maturity, adjusted for anticipated prepayments.
2 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Material loan origination fees and related direct origination
costs are deferred and the net fee or cost is recognized as
interest income using the level-yield method over the contractual
life of the loans, adjusted for prepayments. Origination fees on
loans sold to the secondary market are recognized when the loan is
sold. Amortization of deferred loan origination fees and costs and
the accretion of unearned discounts are suspended during periods
in which the related loan is on nonaccrual status.
(f) ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is based on management's evaluation
of the adequacy of the allowance, including an assessment of the
Company's past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying
collateral, current economic conditions and independent
appraisals.
Additions to the allowance arise from charges to operations
through the provision for loan losses or from the recovery of
amounts previously charged off. The allowance is reduced by loans
charged off. Loans are charged off when management believes there
has been permanent impairment of their carrying values.
The Company also provides an allowance for losses on specific
loans which are deemed to be impaired. Groups of small balance
homogeneous loans (generally consumer loans) are evaluated for
impairment collectively. A loan is considered impaired when, based
upon current information and events, it is probable that the
Company will be unable to collect, on a timely basis, all
principal and interest according to the contractual terms of the
loan's original agreement. When a specific loan is determined to
be impaired, the allowance for loan losses is increased through a
charge to expense for the amount of the impairment. The amount of
the impairment is measured using cash flows discounted at the
loan's effective interest rate, except when it is determined that
the sole source of repayment for the loan is the operation or
liquidation of the underlying collateral. In such cases, the
current value of the collateral, reduced by anticipated selling
costs, will be used in place of discounted cash flows. Generally,
when a loan is deemed impaired, current period interest previously
accrued but not collected is reversed against current period
interest income. Income on such impaired loans is then recognized
only to the extent that cash in excess of any amounts charged off
to the allowance for loan losses is received and where the future
collection of principal is probable. Interest accruals are resumed
on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of
management, the loans are estimated to be fully collectible as to
both principal and interest.
At December 31, 1998 and 1997, the amount of impaired loans was
not material.
(g) LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary
market are carried at the lower of cost or estimated market value.
Net unrealized losses are recognized by charges to income.
3 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(h) GOODWILL AND IDENTIFIABLE INTANGIBLES
Goodwill and identifiable intangibles represent the excess of cost
over the fair value of the net assets at the date acquired.
Goodwill is being amortized against income using the straight-line
method over 15 years. Identifiable intangibles are being amortized
against income using the straight-line method over 5 years.
(i) STOCK IN FEDERAL HOME LOAN BANK
Member institutions of the Federal Home Loan Bank (FHLB) are
required to hold stock of its district FHLB according to
predetermined formulas. This investment is carried at cost.
(j) PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed on straight-line and
accelerated methods over the estimated useful lives of 39 years
for the building, 5 to 15 years for improvements, and 5 to 10
years for furniture, fixtures and equipment.
(k) REAL ESTATE OWNED
Real estate owned represents real estate assets acquired through
foreclosure or deed in lieu and is comprised of properties held
for sale and held for investment. Foreclosed assets held for sale
are carried at the lower of fair value minus estimated costs to
sell, or cost. Fair value is determined as the amount that could
be reasonably expected in a current sale (other than a forced or
liquidation sale) between a willing buyer and a willing seller.
Foreclosed assets held for the production of income are held by
CSC and carried at cost, less accumulated depreciation, which is
computed using the straight-line method over the estimated useful
lives of the assets. During 1998, the Company sold real estate
held for investment with a book value of $360,000. No gain or loss
was recorded on the sale.
(l) INVESTMENT IN VALLEY BANCORP, INC.
The investment in the common stock of Valley Bancorp, Inc. is
accounted for by the equity method.
(m) INCOME TAXES
Deferred tax assets and liabilities are recognized for the
estimated future consequences attributable to differences between
the financial statement carrying amounts of assets and liabilities
and their respective tax bases. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in tax
expense in the period that includes the enactment date.
4 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(n) NET INCOME PER SHARE
Basic earnings per share (EPS) is calculated by dividing net
income by the weighted average number of common shares outstanding
during the period. Diluted EPS is calculated by dividing net
income by the weighted average number of common shares used to
compute basic EPS plus the incremental amount of potential common
stock determined by the treasury stock method. The Company had no
potential common stock during the years ended December 31, 1998,
1997 or 1996.
Net income per share for the years ended December 31, 1997 and
1996 is calculated by dividing net income by the pro forma
weighted average Heritage Bancorporation common shares
outstanding. Pro forma weighted average shares outstanding is
based on the 475,000 shares assumed to be outstanding after the
February 3, 1998 assumed recapitalization effected in conjunction
with the acquisition of United (see note 18).
(o) IMPAIRMENT AND DISPOSAL OF LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangibles are
reviewed for impairment whenever events or circumstances indicate
that the carrying amount of the asset may not be recoverable. An
asset is deemed impaired if the sum of the expected future cash
flows is less than the carrying amount of the asset. If impaired,
an impairment loss is recognized to reduce the carrying amount of
the asset. At December 31, 1998 and 1997, there were no assets
that were considered impaired. Long-lived assets to be disposed of
are reported at the lower of carrying value or fair value less
costs to sell.
(p) RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1996
financial statements to conform with the 1998
presentation.
(q) COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," was adopted by the Company
effective January 1, 1998. SFAS No. 130 requires companies to
report comprehensive income, which includes net income, as well as
other changes in stockholders' equity that result from
transactions and economic events other than those with
stockholders in a separate statement. The Company's only
significant element of comprehensive income is unrealized gains
and losses on available-for-sale securities.
5 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(r) NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" was issued. SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an
asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria
are met. Management of the Company is currently assessing the
effect, if any, on its financial statements of implementing SFAS
No. 133. The Company will be required to adopt SFAS No. 133 on
January 1, 2000.
(2) CASH ON HAND AND IN BANKS
The subsidiary banks are required to maintain an average reserve balance
with the Federal Reserve Bank, or maintain such reserve in cash on hand.
The amount of this required reserve balance at December 31, 1998 was
approximately $504,000. An additional $200,000 compensating balance is
required to be maintained with the Federal Reserve Bank for wire
transfers.
(3) SECURITIES AVAILABLE-FOR-SALE
The amortized cost, unrealized gains and losses, and estimated fair
values of investment and mortgage-backed securities available-for-sale at
December 31 are as follows:
1998
----------------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
U.S. Government and
Federal agencies $13,643,490 26,394 (33,159) 13,636,725
Mortgage-backed
securities 36,369,874 76,794 (93,923) 36,352,745
Municipal bonds 858,660 30,641 (4,510) 884,791
Other 1,038,800 -- (13,404) 1,025,396
----------- ----------- ----------- -----------
$51,910,824 133,829 (144,996) 51,899,657
=========== =========== =========== ===========
1997
----------------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
U.S. Government and
Federal agencies $ 2,528,702 21,100 (4,937) 2,544,865
Mortgage-backed
securities 9,890,471 154,354 (17,179) 10,027,646
Municipal bonds 1,206,893 40,401 (7,905) 1,239,389
Other 389,799 17,631 -- 407,430
----------- ----------- ----------- -----------
$14,015,865 233,486 (30,021) 14,219,330
=========== =========== =========== ===========
6 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company has not entered into any swaps, options, or futures
contracts. Included in the municipal bonds, U.S. Government and Federal
agencies security amounts are investments which have call features.
Maturities of securities available-for-sale by contractual maturity at
December 31, 1998 are shown below. Maturities of securities do not
reflect repricing opportunities present in many adjustable rate
securities.
ESTIMATED
AMORTIZED FAIR
COST VALUE
------------ ------------
Due within one year $ 1,301,159 1,294,596
Due after one year through five years 8,434,564 8,444,619
Due after five years through ten years 3,724,679 3,746,036
Due after ten years 2,080,548 2,061,661
------------ ------------
15,540,950 15,546,912
Mortgage-backed securities 36,369,874 36,352,745
------------ ------------
$ 51,910,824 51,899,657
============ ============
Gross proceeds from sales of investment securities were $7,594,567 for
the year ended December 31, 1998 resulting in gross gains of $63,880 and
gross losses of $20,718. There were no sales of investment securities
available-for-sale during the years ended December 31, 1997 and 1996.
(4) LOANS RECEIVABLE, NET
Loans receivable, net at December 31 are summarized as follows:
1998 1997
------------ ------------
First mortgage loans and contracts secured by real estate $ 53,208,295 16,857,570
Commercial real estate loans 27,449,222 11,108,988
Commercial loans 37,564,411 10,931,879
Second mortgage consumer loans 9,065,655 7,375,192
Auto and other consumer loans 7,159,864 5,304,928
Agricultural loans 8,191,121 4,952,483
Savings account loans 752,320 431,190
Tax exempt municipal loans 1,476,736 710,180
------------ ------------
144,867,624 57,672,410
Less:
Unearned discount and deferred loan origination fees 23,831 30,870
Allowance for loan losses 1,484,680 845,905
------------ ------------
$143,359,113 56,795,635
============ ============
7 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A summary of activity in the allowance for loan losses for the years
ended December 31 follows:
1998 1997 1996
----------- ----------- -----------
Balance, beginning of year $ 845,905 387,656 325,492
Balance acquired in merger 347,900 -- --
Provision for loan losses 335,000 492,400 160,000
Losses charged off, net of recoveries (44,125) (34,151) (97,836)
----------- ----------- -----------
Balance, end of year $ 1,484,680 845,905 387,656
=========== =========== ===========
Loans receivable include approximately $37,163,000 and $19,114,000 in
adjustable rate loans at December 31, 1998 and 1997, respectively.
Real estate loans serviced for others totaled approximately $23,021,000
and $17,693,000 at December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997 approximately $36,117,000 and $8,015,000,
respectively, of the Company's loans receivable are obligations of
customers located outside of the Company's trade area.
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit and letters of credit and involve, to varying degrees, elements of
credit risk. The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
Financial instruments outstanding at December 31, 1998 whose contract
amounts represent credit risk include:
Letters of credit $ 12,550
============
Commitment outstanding - fixed rate $ 4,756,000
Commitment outstanding - variable rate 2,400,000
------------
$ 7,156,000
============
Unused lines of credit $ 10,375,000
============
(5) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at December 31 is summarized as follows:
1998 1997
---------- ----------
Loans receivable $1,483,478 527,128
Mortgage-backed securities 190,691 62,477
Investment securities 207,105 81,264
Time deposits in banks and other interest-earning assets 37,091 16,951
---------- ----------
$1,918,365 687,820
========== ==========
8 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
1998 1997
----------- -----------
Land $ 384,912 120,531
Building and improvements 2,538,110 1,365,533
Furniture, fixtures and equipment 1,442,947 757,079
----------- -----------
4,365,969 2,243,143
Accumulated depreciation (883,558) (607,270)
----------- -----------
$ 3,482,411 1,635,873
=========== ===========
Included in building and improvements is approximately $550,000 related
to a duplicate facility acquired in the merger which is currently held
for sale.
(7) DEPOSITS
Deposits at December 31 are summarized as follows:
1998 1997
------------------------------------- --------------------
WEIGHTED
AVERAGE RATE AMOUNT % AMOUNT %
------------- ------------- ----- ------------ -----
Demand accounts 0.00% $ 18,895,349 11.3% $ 11,768,903 16.7%
NOW and money market accounts 1.96% 22,906,877 13.7 12,397,277 17.6
Savings accounts 4.02% 46,810,631 27.9 12,007,918 17.1
------------- ----- ------------ -----
88,612,857 52.9 36,174,098 51.4
------------- ----- ------------ -----
Certificates of deposit: 2.00 to 2.99% 147 - 272 -
3.00 to 3.99% 6,229 - 19,961 -
4.00 to 4.99% 4,981,241 3.0 404,541 .6
5.00 to 5.99% 53,790,598 32.1 9,615,525 13.7
6.00 to 6.99% 20,108,513 12.0 23,320,442 33.1
7.00 to 7.99% 120,499 - 851,255 1.2
------------- ----- ------------ -----
Total certificates of deposit 5.65% 79,007,227 47.1 34,211,996 48.6
------------- ----- ------------ -----
4.09% $ 167,620,084 100.0% $ 70,386,094 100.0%
============= ===== ============ =====
Scheduled maturities of certificates of deposit at December 31, 1998 are
as follows:
Due within one year $ 58,027,629
Due within two to three years 18,654,044
Due within four to five years 2,183,107
Due after five years 142,447
------------
$ 79,007,227
============
9 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Certificates of deposit of $100,000 or more are approximately $12,998,000
and $5,442,000 at December 31, 1998 and 1997, respectively. Amounts in
excess of $100,000 are not insured by a federal agency.
Interest expense on deposits for the years ended December 31 is
summarized as follows:
1998 1997 1996
---------- ---------- ----------
Savings accounts $1,610,134 468,392 376,563
NOW and money market accounts 267,275 229,475 251,771
Certificates of deposit 4,213,514 1,937,367 1,430,296
---------- ---------- ----------
$6,090,923 2,635,234 2,058,630
========== ========== ==========
(8) FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances at December 31 are summarized as follows:
1998 1997
----------- -----------
4.79% to 6.01% fixed rate advances, interest payable monthly $19,175,000 3,425,000
5.39% to 5.52% putable advances, put options exercisable quarterly,
interest payable monthly 3,000,000 1,000,000
Adjustable rate advance, repaid in June 1998 -- 2,000,000
----------- -----------
$22,175,000 6,425,000
=========== ===========
Contractual principal repayments on advances from the Federal Home Loan
Bank subsequent to December 31, 1998 are as follows:
Years ending December 31,
-------------------------
1999 $ 5,000,000
2000 3,000,000
2001 5,175,000
2002 2,000,000
2003 5,000,000
Thereafter 2,000,000
------------
$ 22,175,000
============
These advances are collateralized by the Federal Home Loan Bank of
Seattle stock held by the Company, unpledged investment and
mortgage-backed securities and qualifying real estate loans.
The weighted average interest rate on these advances was 5.65% and 5.81%
at December 31, 1998 and 1997, respectively.
10 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1998, the Company had a Cash Management Advance (CMA)
note with a maximum allowable advance of $9,478,900. There were no
outstanding advances on the CMA note as of December 31, 1998.
(9) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase at December 31 consist of
the following:
1998
-------------------------------------------------------
WEIGHTED BOOK VALUE MARKET VALUE
REPURCHASE AVERAGE OF UNDERLYING OF UNDERLYING
AMOUNT RATE SECURITIES SECURITIES
----------- -------- ----------- -----------
To repurchase within:
1 - 30 days $ 3,615,604 4.69% $ 3,826,972 3,862,197
31 - 90 days 1,863,000 5.31 1,987,526 2,009,188
Greater than 90
days 3,971,968 5.02 5,253,786 5,300,364
----------- -------- ----------- -----------
$ 9,450,572 4.95% $11,068,284 11,171,749
=========== ======== =========== ===========
1997
-------------------------------------------------------
WEIGHTED BOOK VALUE MARKET VALUE
REPURCHASE AVERAGE OF UNDERLYING OF UNDERLYING
AMOUNT RATE SECURITIES SECURITIES
----------- -------- ----------- -----------
To repurchase within:
1 - 30 days $ 845,000 5.60% $ 888,683 884,187
31 - 90 days 600,000 5.72 914,445 926,230
Greater than 90
days 1,728,149 5.78 2,147,951 2,202,701
----------- -------- ----------- -----------
$ 3,173,149 5.72% $ 3,951,079 4,013,118
=========== ======== =========== ===========
The securities underlying agreements to repurchase are for the same
securities originally sold and are held in a custody account by a third
party. For the year ended December 31, 1998, securities sold under
agreements to repurchase averaged approximately $7,114,000 and the
maximum outstanding at any month end during the year was approximately
$11,786,000.
(10) LONG-TERM DEBT
Long-term debt consisted of a note payable due in annual installments
beginning July 1996 with a $1,000,000 final payment on January 15, 2005.
The note was secured by the outstanding shares of Heritage and was
guaranteed by certain principal shareholders of the Company. Interest was
at an annual rate equal to 2% over the Federal Funds rate. The note was
paid in full in February 1998 in conjunction with the acquisition of
United. (see note 18).
11 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(11) INCOME TAXES
Income tax expense for the years ended December 31 is summarized as
follows:
FEDERAL STATE TOTAL
----------- ----------- -----------
1998:
Current $ 1,057,210 223,945 1,281,155
Deferred 92,662 24,778 117,440
----------- ----------- -----------
$ 1,149,872 248,723 1,398,595
=========== =========== ===========
1997:
Current $ 417,425 39,739 457,164
Deferred (112,368) (20,635) (133,003)
----------- ----------- -----------
$ 305,057 19,104 324,161
=========== =========== ===========
1996:
Current $ 248,541 79,661 328,202
Deferred (52,530) (12,215) (64,745)
----------- ----------- -----------
$ 196,011 67,446 263,457
=========== =========== ===========
Income tax expense for the years ended December 31 differs from
"expected" income tax expense (computed by applying the Federal corporate
income tax rate of 34% to income before income taxes) as follows:
1998 1997 1996
----------- ---------- ----------
Computed "expected" tax expense $ 1,246,445 294,570 254,845
Increase (decrease) resulting from:
State taxes, net of Federal income tax
effects 166,483 40,159 44,514
Goodwill amortization 25,544 14,615 14,615
Decrease in valuation allowance -- (41,743) --
Other, net (39,877) 16,560 (50,517)
----------- ---------- ----------
$ 1,398,595 324,161 263,457
=========== ========== ==========
12 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Differences between the financial statement carrying amounts and the tax
bases of assets and liabilities that give rise to significant portions of
deferred tax assets and liabilities at December 31 are as follows:
1998 1997
-------- --------
Deferred tax assets:
Loans, principally due to allowance for loan losses $549,976 297,250
Investments, due to difference in basis 136,388 28,666
Loans, due to difference in basis -- 15,242
Premises and equipment and real estate owned, due to difference in
basis 8,293 --
Basis differences, due to purchase accounting 16,782 --
Unrealized losses on securities available-for-sale 4,266 --
Other 52,012 11,651
-------- --------
Total gross deferred tax assets 767,717 352,809
Deferred tax liabilities:
Loans, due to difference in basis 222,946 --
Stock in Federal Home Loan Bank of Seattle, principally due to stock
dividends not recognized for tax purposes 205,823 110,935
Unrealized gains on securities available-for-sale -- 75,283
Premises and equipment, principally due to differences in
depreciation 218,777 25,300
Prepaid SAIF assessment 18,391 8,021
-------- --------
Total gross deferred tax liabilities 665,937 219,539
-------- --------
Net deferred tax asset $101,780 133,270
======== ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the existence of, or generation of,
taxable income in the periods which those temporary differences are
deductible. Management considers the scheduled reversal of deferred tax
liabilities, taxes paid in carryback years, projected future taxable
income, and tax planning strategies in making this assessment. Based upon
the level of historical taxable income and estimates of future taxable
income over the periods which the deferred tax assets are deductible, at
December 31, 1998 and 1997 management believes it is more likely than not
that the Company will realize the benefits of these deductible
differences.
Retained earnings at December 31, 1998 includes approximately $3,477,000
for which no provision for Federal income tax has been made. This amount
represents the base year income tax bad debt reserve. This amount is
treated as a permanent difference and deferred taxes are not recognized
unless it appears this reserve will be reduced and thereby result in
taxable income in the foreseeable future. The Company is not currently
contemplating any changes to its business or operations which would
result in a recapture of the base year bad debt reserve into taxable
income.
13 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) RELATED PARTIES
Central Financial Services (CFS) provides various management services to
the Company, including accounting, tax and insurance advisory services,
and investment, personnel and regulatory consulting. CFS is owned by the
Company's Chairman of the Board of Directors and largest shareholder. The
charges were $209,335, $81,347 and $70,009 for the years ended December
31, 1998, 1997 and 1996, respectively.
(13) EMPLOYEE BENEFIT PLAN
The Company has a savings plan under Section 401(k) of the Internal
Revenue Code. The Company allows eligible employees to contribute up to
15% of their monthly wages. The Company matched an amount equal to 75%,
50% and 50% of the employee's contribution, up to 6% of total wages, for
the years ended December 31, 1998, 1997 and 1996, respectively.
Participants are at all times fully vested in their contributions and are
immediately vested in the Company's contributions. The Company's 401(k)
contributions and administrative costs were approximately $104,000,
$36,000 and $28,000 during the years ended December 31, 1998, 1997 and
1996, respectively.
The Company has a deferred compensation agreement with an employee that
provides for predetermined periodic payments over 15 years upon
retirement or death. In the event of acquisition of the Company by a
third party, disability or early retirement, the predetermined payments
are based on years of service. Amounts expensed under this agreement were
approximately $3,300, $3,300 and $2,800 during the years ended December
31, 1998, 1997 and 1996, respectively. The Company owns two single
premium insurance policies in connection with this agreement. The
policies have a cash value, which is included in other assets on the
statements of financial condition, of approximately $267,500 and $256,000
at December 31, 1998 and 1997, respectively.
During July 1998, the Company adopted a stock appreciation rights plan.
The plan is a cash bonus program tied to the price movement of the
Company's common stock. During July 1998, the Company awarded 26,500
shares under the plan at a strike price of $28.06. At December 31, 1998,
800 shares had been forfeited. The Company awarded an additional 2,400
shares during January 1999 at a strike price of $23.03. The cash award
payable under the plan will equal the number of shares awarded to an
employee multiplied by the employee's vesting percentage, multiplied by
the excess of the then current stock price over the strike price. Each
award has a three year vesting period. As of December 31, 1998, no
liability under the plan was necessary.
(14) REGULATORY MATTERS
Heritage and Heritage State are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory--and
possibly additional discretionary--actions by regulators that, if
undertaken, could have a direct material effect on the Company's
operations. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Heritage and Heritage State must
meet specific capital guidelines that involve quantitative measures of
the assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting guidelines. Heritage's and
Heritage State's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk
weightings, and other factors.
14 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Quantitative measures established by regulation to ensure capital
adequacy require Heritage and Heritage State to maintain minimum amounts
and ratios (set forth in the tables below). Management believes, as of
December 31, 1998, that Heritage and Heritage State meet all capital
adequacy requirements to which they are subject.
As of December 31, 1998, Heritage and Heritage State were categorized as
"well capitalized" under the regulatory framework for prompt corrective
action (PCA). To be categorized as "well capitalized" the banks must
maintain minimum ratios as set forth in the following tables. There are
no conditions or events that management believes have changed the
institutions' PCA category.
MINIMUM TO BE
MINIMUM FOR CAPITAL "WELL CAPITALIZED"
ACTUAL ADEQUACY PURPOSES UNDER PCA PROVISIONS
-------------- ------------- --------------
HERITAGE: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------- ------- ----- ------ ----- ------ -----
December 31, 1998:
Total capital $20,956 16.78 $9,989 8.0 $12,486 10.0
Tier I capital 19,517 15.63 -- -- 7,492 6.0
Tier I leverage 19,517 9.17 6,386 3.0 10,643 5.0
Tangible capital 19,517 9.17 3,193 1.5 -- --
December 31, 1997:
Total capital 4,956 9.6 4,126 8.0 5,158 10.0
Tier I capital 4,308 8.4 -- -- 3,905 6.0
Core capital 4,308 5.0 2,570 3.0 4,308 5.0
Tangible capital 4,308 5.0 1,285 1.5 -- --
HERITAGE STATE:
- --------------
December 31, 1998:
Total 948 20.66 367 8.0 459 10.0
Tier I 902 19.66 184 4.0 275 6.0
Tier I leverage 902 8.84 408 4.0 510 5.0
The total capital and Tier I capital ratios are determined based on
risk-weighted assets. The Tier I leverage and tangible capital ratios are
determined based on tangible assets.
Savings banks, such as Heritage, that meet or exceed their capital
requirements may make capital distributions during any one year up to an
amount that would reduce its surplus capital ratio to no less than
one-half of its surplus capital ratio at the beginning of the calendar
year. State banks, such as Heritage State, may pay dividends up to the
total of the prior two years earnings without permission of the State
regulator.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required to disclose the fair value for financial
instruments, whether or not recognized in the statements of financial
condition. A financial instrument is defined as cash, evidence of an
ownership interest in an entity, or a contract that both imposes a
contractual obligation on one entity to deliver cash or another financial
instrument to a second entity.
15 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following assumptions and methods were used by the Company in
estimating the fair value of its financial instruments:
FINANCIAL ASSETS. Due to the liquid nature of the instruments, the
carrying value of cash and cash equivalents and time deposits in
banks approximates fair value. For all investment and
mortgage-backed securities available-for-sale, the fair value is
based upon quoted market prices. The fair value of loans
receivable held by Heritage was obtained from the Federal Home
Loan Bank (FHLB) Rate Shock Analysis (FHLB Analysis). The FHLB
Analysis primarily employs the discounted cash flow method which
estimates fair value by discounting the cash flows the instruments
are expected to generate by the yields currently available to
investors on instruments of comparable risk and duration.
Therefore, to calculate present value, the FHLB model has
assumptions about the size and timing of expected cash flows and
appropriate discount rates. The fair value of loans receivable was
estimated by discounting future cash flow using current rates at
which similar loans would be made. The fair value of loans held
for sale approximates carrying fair, as the carrying value is the
lower of cost or fair value, and the Company expects the loans to
be sold, with no gain or loss, in the short-term. The fair value
of FHLB stock approximates redemption value. The fair value of
accrued interest receivable approximates book value as the Company
expects contractual receipt in the near-term. The fair value of
the investment in Valley Bancorp, Inc. approximates book value due
to the purchase of the stock occurring near December 31, 1998.
FINANCIAL LIABILITIES. The fair value of NOW, money market
accounts, demand accounts and non-term savings deposits
approximates book values as rates are periodically adjusted to
market rates. The fair value of time deposits held by Heritage was
obtained from the FHLB Analysis. The fair value of time deposits
was estimated by discounting the future cash flows using current
rates for similar deposits. Because the interest rate on the
long-term debt approximates the Company's current long-term
borrowing rate, the fair value of long-term debt approximates the
carrying value. The fair value of Federal Home Loan Bank advances
and securities sold under agreements to repurchase was obtained
from the FHLB Analysis. The fair value of accrued interest payable
approximates book value due to contractual payment in the
near-term.
OFF-BALANCE SHEET. Commitments made to extend credit represent
commitments for loan originations, the majority of which are
contracted for immediate sale and therefore no fair value
adjustment is necessary.
LIMITATIONS. Fair value estimates are made at a specific point in
time, based on relevant market information and information about
the financial instrument. These estimates do not reflect any
premium or discount that could result from offering for sale at
one time the Company's entire holdings of a particular instrument.
Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on
judgments regarding comparable market interest rates, future
expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
16 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Fair value estimates are based on existing on-and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. In addition, the tax effect of
the difference between the fair value and carrying value of financial
instruments can have a significant effect on fair value estimates and
have not been considered in the estimates presented herein.
The approximate book value and fair value of the Company's financial
instruments as of December 31 are as follows:
1998 1997
----------------------------- ----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------ ------------ ------------ ------------
Financial assets:
Cash and cash equivalents $ 19,256,000 19,256,000 9,869,000 9,869,000
Time deposits in banks -- -- 98,000 98,000
Securities available-for-sale 51,900,000 51,900,000 14,219,000 14,219,000
Loans receivable, net 143,359,000 151,130,000 56,796,000 57,076,000
Loans held for sale 5,717,000 5,717,000 1,467,000 1,467,000
Stock in FHLB of Seattle 1,232,000 1,232,000 404,000 404,000
Accrued interest receivable 1,918,000 1,918,000 688,000 688,000
Financial liabilities:
Deposits 167,620,000 168,410,000 70,386,000 70,528,000
Long-term debt -- -- 2,350,000 2,350,000
FHLB advances and securities sold under
agreements to repurchase 31,626,000 31,544,000 9,598,000 9,565,000
Accrued interest payable 1,267,000 1,267,000 807,000 807,000
(16) COMMITMENTS AND CONTINGENCIES
Heritage has sold loans to various investors in the secondary market
under sales agreements which contain repurchase provisions. Under the
repurchase provisions, Heritage may be required to repurchase a loan if a
borrower fails to make three monthly payments within 120 days after the
sale of the loan. The balance of loans sold with repurchase provisions
remaining at December 31, 1998 is approximately $30,123,000. There were
no loans repurchased during 1998. Total loans sold during 1998 were
approximately $81,750,000.
In June 1997, the Company entered into a five-year service contract for
data processing services. In the event of early termination of the
service contract by the Company, the Company has agreed to pay an amount
equal to fifty percent of the average monthly fee paid for services
multiplied by the number of months remaining under the term of the
contract.
17 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(17) PARENT COMPANY INFORMATION (CONDENSED)
The summarized financial information for United Financial Corp. (Heritage
Bancorporation in 1997) is presented below:
CONDENSED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31,
-------------------------------
ASSETS 1998 1997
------------ ------------
Cash (deposited with Heritage) $ 103,401 60,795
Interest-bearing deposits 2,192,320 --
Investment securities available-for-sale 2,063,775 --
Investment in subsidiary banks 22,690,294 4,929,946
Investment in Valley Bancorp, Inc. 2,683,791 --
Loans receivable 698,006 --
Accrued interest receivable 74,271 --
Other assets 133,454 157,347
------------ ------------
Total assets $ 30,639,312 5,148,088
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Long-term debt $ -- 2,350,000
Other liabilities 111,345 50,173
------------ ------------
Total liabilities 111,345 2,400,173
------------ ------------
Common stock 28,001,579 100
Additional paid-in capital -- 1,080,028
Retained earnings 2,533,289 1,539,605
Accumulated other comprehensive income (loss) (6,901) 128,182
------------ ------------
Total stockholders' equity 30,527,967 2,747,915
------------ ------------
Total liabilities stockholders' equity $ 30,639,312 5,148,088
============ ============
18 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
CONDENSED STATEMENTS OF INCOME YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
Revenues:
Cash dividends from bank subsidiaries $ 1,225,828 320,000 200,000
Interest income 432,153 4,323 16,665
Other income 1,988 -- --
----------- ----------- -----------
1,659,969 324,323 216,665
----------- ----------- -----------
Expenses:
Interest expense 11,917 189,657 191,234
Other operating expenses 407,075 81,850 43,846
----------- ----------- -----------
418,992 271,507 235,080
----------- ----------- -----------
Income (loss) before equity in
undistributed earnings of
subsidiaries and income taxes 1,240,977 52,816 (18,415)
Equity in undistributed earnings of
subsidiaries 1,028,932 388,461 400,112
----------- ----------- -----------
Income before income taxes 2,269,909 441,277 381,697
Income tax expense (benefit) 2,489 (100,944) (104,332)
----------- ----------- -----------
Net income $ 2,267,420 542,221 486,029
=========== =========== ===========
CONDENSED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 2,267,420 542,221 486,029
Adjustments to reconcile net income to
net cash provided by operating
activities:
Equity in undistributed earnings of
subsidiaries (1,028,932) (388,461) (400,112)
Equity in income of Valley
Bancorp, Inc. (1,550) -- --
Amortization of investment
securities premiums and
discounts, net 3,649 -- --
Increase (decrease) in other assets
and liabilities, net (76,098) 15,839 72,259
----------- ----------- -----------
Net cash provided by
operating activities 1,164,489 169,599 158,176
----------- ----------- -----------
19 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
Cash flows from investing activities:
Purchases of securities available-for-sale (45,192) -- --
Proceeds from maturities of securities
available-for-sale 3,000,000 -- --
Purchases of Valley Bancorp, Inc. stock (2,682,241) -- --
Net decrease in loans receivable 52,006 -- --
Capital contribution to Heritage State
Bank (1,374,000) -- --
Acquired cash and cash equivalents in
merger 3,468,600 -- --
----------- ----------- -----------
Net cash provided by investing
activities 2,419,173 -- --
----------- ----------- -----------
Cash flows from financing activities:
Payments on long-term debt (2,350,000) (200,000) (100,000)
Capital contribution 2,275,000 -- --
Dividends paid to stockholders (1,273,736) -- --
----------- ----------- -----------
Net cash used in financing activities (1,348,736) (200,000) (100,000)
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents 2,234,926 (30,401) 58,176
Cash and cash equivalents at beginning of
year 60,795 91,196 33,020
----------- ----------- -----------
Cash and cash equivalents at end of year $ 2,295,721 60,795 91,196
=========== =========== ===========
(18) ACQUISITIONS
On February 3, 1998, Heritage Bancorporation merged with United Financial
Corp. ("United"). The merger was treated as a reverse acquisition
accounted for as a purchase of United by Heritage Bancorporation and,
accordingly, the consolidated statement of income for 1998 includes the
results of operations of United commencing February 3, 1998. Under this
method of accounting, assets and liabilities of United are adjusted to
their estimated fair value and combined with the historical recorded book
values of the assets and liabilities of the Company. Immediately
preceding the closing, Heritage Bancorporation was required to pay off
its long-term debt with funding from a corresponding contribution of
capital. In connection with the merger, each outstanding share of
Heritage Bancorporation common stock was converted into 47.50 shares of
United common stock (an aggregate of 475,000 shares of United's common
stock). Accordingly, the merger is reported as if Heritage Bancorporation
was recapitalized at the closing date with 475,000 common shares
outstanding and United was acquired through the issuance of 1,223,312
shares of common stock to United shareholders.
20 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The premiums paid over the historical carrying value of net assets of
United at the date of purchase were as follows:
Issuance of common shares $ 24,772,068
Common stock issuance costs (125,617)
Direct acquisition costs 179,100
------------
Total consideration paid 24,825,551
Historical carrying value of United net assets acquired (24,335,128)
------------
Premium paid over historical carrying value $ 490,423
============
The increase (decrease) in the historical carrying value of United's net
assets as a result of estimated fair value adjustments are as follows:
Goodwill $ 980,567
Investment securities 183,250
Loans 678,000
Premises and equipment (153,822)
Real estate owned 353,949
Deposits 47,000
Non-deductible merger costs (666,874)
Accrued severance and contract termination (821,010)
Deferred income taxes (110,637)
------------
$ 490,423
============
The premium paid and estimated fair value adjustments have been "pushed
down" to Heritage.
The estimated fair values of United net assets at the acquisition date
are summarized as follows:
Cash and due from banks $ 8,112,629
Securities available-for-sale 44,383,986
Loans 39,550,987
Premises and equipment 1,186,036
Goodwill 980,567
Other real estate 699,395
Deferred income taxes 117,038
Other assets 3,460,887
------------
98,491,525
------------
Deposits (70,586,345)
Income taxes (116,444)
Other liabilities (2,963,185)
------------
(73,665,974)
------------
Fair value of net assets acquired $ 24,825,551
============
21 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The information below presents, on a pro forma basis, amounts as if
United had been acquired as of the beginning of each year presented:
Year ended December 31,
-------------------------------
1998 1997
------------ ------------
Interest income $ 14,730,203 12,950,816
Interest expense 7,648,923 6,444,451
------------ ------------
Net interest income 7,081,280 6,506,365
Provision for loan losses 340,000 717,400
------------ ------------
Net interest income after provision for loan losses 6,741,280 5,788,965
Noninterest income 3,449,801 1,778,289
Noninterest expense (6,427,091) (4,578,028)
------------ ------------
Income before income taxes 3,763,990 2,989,226
Income taxes 1,433,886 1,118,646
------------ ------------
Pro forma net income $ 2,330,104 1,870,580
============ ============
Pro forma net income per share $ 1.37 1.11
============ ============
In February 1998, the Company purchased the assets of three loan
production facilities, located in Missoula, Hamilton and Libby, Montana,
for approximately $225,000.
In August 1998, the Company organized a Montana state chartered banking
subsidiary, Heritage State Bank to acquire a portion of the business of a
failed commercial bank in Fort Benton, Montana. On August 7, 1998, the
Company, through Heritage State, acquired certain assets of approximately
$1,582,000 and assumed certain liabilities of approximately $13,590,000.
The failed bank's Fort Benton, Montana and Geraldine, Montana branches
were reopened on August 10, 1998 as branches of Heritage State. Heritage
State paid a $454,000 premium for the right to acquire such assets and
assume the bank's insured deposits.
As a result of the formation of Heritage State, UFC, which was formerly
regulated by the Office of Thrift Supervision ("OTS") as a savings and
loan holding company, became a bank holding company subject to
supervision by the Federal Reserve Board. Heritage, as a federally
chartered savings institution, remains subject to supervision by the OTS
as its principal regulator and both Heritage and Heritage State, as
financial institutions with deposits insured by the Federal Deposit
Insurance Corporation ("FDIC"), remain subject to regulation by the FDIC.
22 (Continued)
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In December 1998, the Company acquired approximately 25% of Valley
Bancorp, Inc. through the purchase, for $6.25 per share, of 280,718
shares from various stockholders and 150,000 shares from the Company's
Chairman of the Board of Directors. Prior to these acquisitions, the
Company owned 13,000 shares of Valley Bancorp, Inc. Valley Bancorp, Inc.
is a bank holding company located in Phoenix, Arizona and is the parent
company of Valley Bank of Arizona, a state chartered commercial bank.
Summary unaudited financial information (in thousands) of Valley Bancorp,
Inc. as of and for the year ended December 31, 1998 follows:
Total assets $ 49,123
========
Total liabilities $ 41,750
========
Stockholders' equity $ 7,373
========
Interest income $ 3,447
Interest expense 1,610
--------
Net interest income $ 1,837
========
Net income $ 731
--------
23
EXHIBITS INDEX.
Exhibit Number Description
- -------------- ------------------------------------------------------------
2.1 Agreement and Plan of Merger (the "Merger agreement") dated
August 25, 1997 by and between United Financial and Heritage
(incorporated by reference to Exhibit B of the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997).
2.2 Amendment No. 1 to the Merger Agreement by and between
United Financial and Heritage, effective as of August 25,
1997 (incorporated by reference to Exhibit 2.2 of the
Company's Current Report on Form 8-K dated March 31, 1998).
3.1 Articles of Incorporation of United Financial Corp., as
amended (incorporated by reference to Exhibit 3.1 of the
Company's current Report on Form 10-K dated March 31, 1998).
3.2 Bylaws of United Financial Corp. as amended (incorporated by
reference to Exhibit 3.2 of the Company's current Report on
form 10-K dated March 31, 1988).
21.1 Subsidiaries of the Company.
27.0 Financial Data Schedule.