HCB BANCSHARES, INC
2002 ANNUAL REPORT
TO OUR SHAREHOLDERS:
What an exciting year it's been! Your Company has reached several milestones
this year, and the end is not in sight. For example, net interest income after
provision for loan and investment losses reached an all-time high of $6,733,412.
At the same time, non-interest income also set a new record high of $1,606,460,
more than double the figure of only four years ago. Return on equity was the
highest in seven years, and earnings per share were the highest in the history
of the Company. But, there's more improvement to come.
Our ratio of non-interest expense to average total assets is higher than we
like, and we need to make improvement there. Our nonperforming assets also
reached a new high, primarily due to the faltering economy, but fortunately,
unusually high losses have not occurred. And non-interest income can still be
improved. In short, we aren't satisfied.
Satisfaction - what a variety of ways there are to achieve it. Sometimes
satisfaction comes from mere improvement, such as a marginal student raising his
grade from an F to a C. That's certainly a tremendous achievement, and yet
there's more to be done. Earning that C is very, very satisfying, but it isn't
over yet. Passing is far better than failing, and absolutely deserves favorable
recognition, but shouldn't that C become a B? And shouldn't that B become an A?
Isn't "excellence" more satisfying than "average"? Don't we want to be the best
we can be? And how do we decide when our performance is satisfying enough?
In our business, as in many others, it's never enough. We will always be
disappointed at losing a customer, no matter how many "satisfied" customers we
may have. We will always be thrilled by reaching new levels of success, but then
we will set even higher goals in an effort to reach even higher levels of
success. No matter how many objectives we meet, or how well we meet them, we
will still strive for more. In short, as we review the criteria by which we
measure our achievement, there is no such thing as "enough". We must not . . .
ever! . . . be "satisfied".
During this past fiscal year, your Company has achieved some impressive results.
Net interest income has never been higher. Income from other sources
(non-interest income) has never been higher. Earnings per share have never been
higher. But . . . it is not enough. We want continued improvement. Increased net
income. Tighter control of non-interest expense. New products providing new
sources of non-interest income. Reductions in high-rate borrowings, partly
through repayment and partly through replacement at lower rates. Continued
repurchases of our stock. Negotiated reductions of non-performing assets. And,
or course, increased return on equity.
We want, and expect, to be your best investment. We want to exceed your
expectations, and we want to do that year after year after year. We want the
satisfaction of being a high-performance company.
Even then, we won't be "satisfied"!
/s/ Cameron D. McKeel
President and Chief Executive Officer
2
TABLE OF CONTENTS
HCB Bancshares, Inc......................................................... 3
Market for Common Stock and Related Stockholder Matters..................... 4
Selected Consolidated Financial and Other Data.............................. 5
Quarterly Financial Data.................................................... 7
Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................. 8
Consolidated Financial Statement.............................................18
Consolidated Statements of Financial Condition............................ 20
Consolidated Statements of Income and Comprehensive Income................ 21
Consolidated Statements of Stockholders' Equity........................... 23
Consolidated Statements of Cash Flows..................................... 24
Notes to Consolidated Financial Statements................................ 26
Corporate Information....................................................... 44
HCB BANCSHARES, INC.
HCB Bancshares, Inc. ("Bancshares") was incorporated under the laws of the
State of Oklahoma in December 1996 at the direction of the Board of Directors of
HEARTLAND Community Bank (the "Bank") for the purpose of serving as a savings
institution holding company of the Bank, upon the conversion of the Bank from
mutual to stock form, which was completed on April 30, 1997 (the "Conversion").
The accompanying consolidated financial statements include the accounts of
Bancshares and the Bank and are collectively referred to as the "Company". All
significant intercompany balances and transactions have been eliminated in
consolidation.
Prior to the Conversion, Bancshares did not engage in any material
operations. Bancshares has no significant assets other than the outstanding
capital stock of the Bank, a portion of the net proceeds of the Conversion and
notes receivable, one of which is from the Employee Stock Ownership Plan
("ESOP"). Bancshares' principal business is the business of the Bank. At June
30, 2002, the Company had total assets of $276.4 million, deposits of $165.0
million, and stockholders' equity of $26.7 million, or 9.7% of total assets.
As of June 30, 2002, the Bank operated through six full service-banking
offices located in Camden (2), Fordyce, Bryant, Sheridan, and Monticello,
Arkansas. During July 2002 the Bank sold its Monticello branch and operated
through five full service-banking offices.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS. The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance. The Bank's deposits are
insured up to the maximum limits by the Savings Association Insurance Fund
("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC"). The
FDIC also has the authority to conduct special examinations. The Bank must file
reports with OTS describing its activities and financial condition and is also
subject to certain reserve requirements promulgated by the Federal Reserve
Board.
3
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
Bancshares common stock began trading on the Nasdaq National Market on May
7, 1997, under the symbol "HCBB." Effective February 2, 1999, the Bancshares
common stock was delisted and ceased trading on the Nasdaq National Market.
Bancshares common stock began trading on the OTC Bulletin Board effective
September 16, 1999 and was listed on the Nasdaq Small-Cap Market effective
November 22, 1999. At June 30, 2002, there were 1,503,436 shares of the common
stock outstanding. For the purpose of this disclosure, shares held in the Stock
Option Trust are considered to be outstanding, however, for financial reporting
purposes, such shares are reported as treasury shares. At June 30, 2002, there
were 557 stockholders of record according to the Company's transfer agent
listing. Following are the high and low bid prices, by fiscal quarter, as
reported on the Nasdaq Small-Cap Market July 1, 2000 to June 30, 2002, as well
as the dividends paid during such quarters.
High Low Dividends Per Share
------- ------ -------------------
Fiscal 2002
First Quarter $ 13.00 $ 11.90 $ 0.06
Second Quarter 12.95 12.00 0.07
Third Quarter 15.00 12.61 0.07
Fourth Quarter 16.70 14.27 0.08
Fiscal 2001
First Quarter $ 7.38 $ 6.00 $ 0.06
Second Quarter 9.25 7.19 0.06
Third Quarter 8.88 8.31 0.06
Fourth Quarter 13.20 8.94 0.06
The stated high and low bid prices reflect inter-dealer prices, without
retail mark-up, markdown or commission, and may not represent actual
transactions.
The payment of dividends on common stock is subject to determination and
declaration by the Board of Directors of Bancshares. The payment of future
dividends will be subject to the requirements of applicable law and the
determination by the Board of Directors of Bancshares that the net income,
capital and financial condition of Bancshares and the Bank, thrift industry
trends and general economic conditions justify the payment of dividends, and
there can be no assurance that dividends will continue to be paid in the future.
Since Bancshares has no significant source of income other than dividends
from the Bank, the payment of dividends by Bancshares can be dependent upon
receipt of dividends from the Bank. Payment of cash dividends by the Bank is
limited by certain federal regulations under which the Bank may not declare or
pay a cash dividend on or repurchase any of its common stock if the effect
thereof would cause its regulatory capital to be reduced below (1) the amount
required for the liquidation account established in connection with the Bank's
conversion to stock form or (2) the regulatory capital requirements imposed by
the OTS. In certain circumstances earnings appropriated to bad debt reserves and
deducted for federal income tax purposes may not be available to pay cash
dividends without the payment of federal income taxes by the Bank on the amount
of such earnings removed from the reserves for such purposes at the then current
income tax rate.
Federal regulations impose certain additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank. Under OTS regulations, savings institutions must submit
notice to the OTS prior to making a capital distribution if (a) they would not
be well capitalized after the distribution, (b) the distribution would result in
the retirement of any of the institution's common or preferred stock or debt
counted as its regulatory capital, or (c) the institution is a subsidiary of a
holding company. A savings institution must make application to the OTS to pay a
capital distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS.
4
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT JUNE 30,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- -----------
Total assets.............................. $ 276,425,294 $287,598,650 $291,192,175 $285,396,885 $250,953,770
Loans receivable, net..................... 124,176,898 131,651,421 135,626,505 115,162,883 104,580,165
Allowance for loan losses................. 1,628,515 1,446,114 1,231,709 1,329,201 1,468,546
Cash and due from banks................... 3,492,257 3,302,540 3,211,802 3,560,884 1,531,363
Interest-earning savings deposits......... 14,404,572 15,107,481 236,846 1,693,330 5,073,035
Investment securities:
Available for sale..................... 29,285,376 32,138,434 34,135,726 33,132,916 40,775,807
Held to maturity....................... -- -- -- -- --
Mortgage-backed securities:
Available for sale.................... 88,913,188 87,943,743 98,407,339 113,986,773 58,697,109
Held to maturity...................... -- -- -- -- 27,503,257
Deposits.................................. 165,005,183 161,285,179 144,873,071 146,296,598 141,931,330
FHLB advances............................. 82,263,936 91,915,694 115,609,029 104,523,419 68,121,068
Note payable.............................. -- 80,000 160,000 240,000 320,000
Stockholders' equity...................... 26,736,288 31,934,334 28,240,550 32,117,560 37,678,924
Number of:
Real estate loans outstanding.......... 1,517 1,730 1,820 1,709 2,829
Deposit accounts....................... 18,090 18,538 17,980 18,526 17,158
Offices open........................... 6 6 6 6 6
YEAR ENDED JUNE 30,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- -----------
Interest income........................... $ 17,916,113 $ 20,078,400 $19,808,899 $18,274,647 $15,027,677
Interest expense.......................... 10,823,701 14,079,466 13,099,656 12,093,603 8,942,149
------------- ------------ ----------- ----------- -----------
Net interest income....................... 7,092,412 5,998,934 6,709,243 6,181,044 6,085,528
Provision for loan and investment losses.. 359,000 296,000 -- -- 24,000
------------- ------------ ----------- ----------- -----------
Net interest income after provision
for loan and investment losses.......... 6,733,412 5,702,934 6,709,243 6,181,044 6,061,528
Noninterest income........................ 1,606,460 1,378,612 1,039,622 1,018,654 710,856
Noninterest expense....................... 7,113,145 6,929,118 7,304,110 6,847,715 6,407,976
------------- ------------ ----------- ----------- -----------
Income before income taxes................ 1,226,727 152,428 444,755 351,983 364,408
Income tax provision (benefit)............ 61,027 (467,888) (341,147) (63,658) (20,705)
------------- ------------- ------------ ------------ ------------
Net income................................ $ 1,165,700 $ 620,316 $ 785,902 $ 415,641 $ 385,113
============ =========== ========== ========== ==========
Earnings per share:
Basic................................... $ 0.71 $ 0.33 $ 0.40 $ 0.18 $ 0.16
Diluted................................. 0.68 0.33 0.40 0.18 0.16
Cash dividends declared................... 0.28 0.24 0.24 0.24 0.20
5
YEAR ENDED JUNE 30,
---------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
PERFORMANCE RATIOS:
Return on assets (net income divided
by average total assets) .................... 0.41% 0.21% 0.27% 0.15% 0.18%
Return on average equity (net income
divided by average equity) .................. 3.82 2.02 2.76 1.14 1.02
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost)......... 2.25 1.72 2.12 1.81 2.11
Net interest margin (net interest income
divided by average interest-earning assets).. 2.66 2.19 2.49 2.34 2.96
Ratio of average interest-earning assets
to average interest-bearing liabilities...... 110.06 108.91 107.68 111.55 119.51
Ratio of noninterest expense to average
total assets................................. 2.52 2.38 2.55 2.48 3.00
ASSET QUALITY RATIOS:
Nonperforming assets to total assets
at end of period............................. 0.92 0.48 0.33 0.21 0.34
Nonperforming loans to total loans
at end of period............................. 1.44 0.81 0.64 0.46 0.75
Allowance for loan losses to total
loans at end of period....................... 1.22 0.99 0.85 1.08 1.33
Allowance for loan losses to nonperforming
loans at end of period....................... 84.91 121.48 133.95 234.84 177.25
Provision for loan losses to total loans
at end of period ............................ 0.25 0.20 -- -- 0.02
Net charge-offs to average loans outstanding.... 0.11 0.06 0.08 0.13 0.05
CAPITAL RATIOS:
Equity to total assets at end of period......... 9.67 11.10 9.70 11.25 15.01
Average equity to average assets................ 10.81 10.55 9.95 13.19 17.71
Dividend payout ratio (1)....................... 40.52 76.46 64.50 142.58 137.36
<FN>
- --------------
(1) The fiscal year ended June 30, 1998, was the first full year that
Bancshares was publicly traded. Dividend payout ratio is the total
dividends declared divided by net income.
</FN>
6
QUARTERLY FINANCIAL DATA
The following tables represent summarized data for each of the four
quarters in the years ended June 30, 2002 and June 30, 2001.
2002
(IN THOUSANDS, EXCEPT SHARE DATA)
-----------------------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
Interest income $ 4,248 $ 4,458 $ 4,509 $ 4,701
Interest expense 2,430 2,559 2,796 3,039
------ ----- ------ -----
Net interest income 1,818 1,899 1,713 1,662
Provision for loan and investment losses 140 60 99 60
------ ----- ------ -----
Net interest income after provision
for loan and investment losses 1,678 1,839 1,614 1,602
Noninterest income 401 402 429 375
Noninterest expenses 1,949 1,650 1,799 1,715
------ ----- ------ -----
Income before income taxes 130 591 244 262
Income tax provision (benefit) (16) 110 (9) (24)
------ ----- ------ -----
Net income $ 146 $ 481 $ 253 $ 286
====== ===== ====== =====
Basic earnings per common share $ 0.12 $ 0.28 $ 0.15 $ 0.16
Diluted earnings per common share 0.12 0.27 0.14 0.15
Cash dividends declared per common share 0.08 0.07 0.07 0.06
Weighted average common shares outstanding
Basic 1,391,685 1,689,348 1,691,522 1,768,494
Diluted 1,489,017 1,774,003 1,762,565 1,843,429
2002
(IN THOUSANDS, EXCEPT SHARE DATA)
-----------------------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
Interest income $ 4,858 $ 4,990 $ 5,137 $ 5,093
Interest expense 3,222 3,519 3,712 3,626
------ ----- ------ -----
Net interest income 1,636 1,471 1,425 1,467
Provision for loan losses 60 60 60 116
------ ----- ------ -----
Net interest income after provision
for loan losses 1,576 1,411 1,365 1,351
Noninterest income 460 264 331 323
Noninterest expenses 1,801 1,693 1,730 1,705
------ ----- ------ -----
Income (loss) before income taxes 235 (18) (34) (31)
Income tax provision (benefit) (103) (124) (134) (107)
------ ----- ------ -----
Net income $ 338 $ $ 106 $ 100 $ 76
====== ===== ====== =====
Basic earnings per common share $ 0.18 $ 0.06 $ 0.05 $ 0.04
Diluted earnings per common share 0.18 0.06 0.05 0.04
Cash dividends declared per common share 0.06 0.06 0.06 0.06
Weighted average common shares outstanding
Basic 1,842,259 1,840,580 1,863,269 1,918,473
Diluted 1,842,259 1,840,580 1,863,269 1,918,473
7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, and competition that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
GENERAL
The Bank's principal business consists of attracting savings deposits from
the general public and investing those funds in loans secured by first mortgages
on existing owner-occupied single-family residences in the Bank's primary market
area, commercial and multi-family real estate loans, and consumer and commercial
business loans. The Bank also maintains a substantial investment portfolio of
mortgage-related securities, nontaxable municipal securities, and U.S.
government and agency securities.
The Bank's net income is dependent primarily on its net interest income,
which is the difference between interest income earned on its loans,
mortgage-backed securities and securities portfolio and interest paid on
customers' deposits and other borrowings. The Bank's net income is also affected
by the level of noninterest income, such as service charges on customers'
deposit accounts, net gains or losses on the sale of loans and securities and
other fees. In addition, net income is affected by the level of noninterest
expense, which primarily consists of employee compensation expenses, occupancy
expenses, and other expenses.
The financial condition and results of operations of the Bank and the
thrift and banking industries as a whole are significantly affected by
prevailing economic conditions, competition and the monetary and fiscal policies
of governmental agencies. Lending activities are influenced by demand for and
supply of credit, competition among lenders and the level of interest rates in
the Bank's market area. The Bank's deposit flows and costs of funds are
influenced by prevailing market rates of interest, primarily on competing
investments, as well as account maturities and the levels of personal income and
savings in the Bank's market area.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Bank's net income, is
determined by the difference or "spread" between the yield earned on the Bank's
interest-earning assets and the rates paid on its interest-bearing liabilities
and the relative amounts of such assets and liabilities. Key components of a
successful asset/liability strategy are the monitoring and managing of interest
rate sensitivity on both the interest-earning assets and interest-bearing
liabilities. It has been the Bank's historical policy to mitigate the interest
rate risk inherent in the historical savings institution business of originating
long-term single-family mortgage loans funded by short-term savings deposits by
maintaining substantial liquidity and capital levels to withstand unfavorable
movements in market interest rates, by purchasing investment securities with
adjustable-rates and/or short terms to maturity and by originating relatively
shorter term consumer loans. In the future, however, it is anticipated that the
Bank will sell more of its long term loan originations and originate for its
portfolio more commercial and multi-family real estate loans and consumer and
commercial business loans with relatively shorter terms to maturity or
repricing, the Bank's interest rate risk exposure may decline somewhat. The
matching of the Bank's assets and liabilities may be analyzed
8
by examining the extent to which its assets and liabilities are interest rate
sensitive and by monitoring both its interest rate sensitivity "gap" and the
expected effects of interest rate changes on its net portfolio value.
For the fiscal year ending June 30, 2002, the Bank's strategy was to
continue to use cash flows from investment securities and deposit growth to fund
loans and reduce Federal Home Loan Bank borrowings.
Interest Rate Sensitivity Gap. An asset or liability is interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. The interest rate sensitivity gap is defined as the difference
between the amount of interest-earning assets maturing or repricing within a
specific time period and the amount of interest-bearing liabilities maturing or
repricing within that time period. A gap is considered positive when the amount
of interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
During a period of rising interest rates, a negative gap would tend to adversely
affect net interest income while a positive gap would tend to positively affect
net interest income. Similarly, during a period of falling interest rates, a
negative gap would tend to positively affect net interest income while a
positive gap would tend to adversely affect net interest income.
At June 30, 2002, the Bank's total interest-bearing liabilities maturing or
repricing within one year exceeded its total interest-earning assets maturing or
repricing in the same period, and the Bank's cumulative one-year gap ratio
totaled a negative 26.0%. In addition, the Bank's total interest-earning assets
maturing or repricing within five years were slightly less than its total
interest-bearing liabilities maturing or repricing in the same period, and the
Bank's cumulative five-year gap ratio totaled a negative 12.7%. The Bank's gap
measures indicate that net interest income would be exposed to increases in
interest rates in the short term, but would be much less exposed to increases in
interest rates over the longer term.
MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods. The Company's market risk arises primarily from interest rate
risk inherent in lending and deposit-taking activities. The Company does not
maintain a trading account for any class of financial instrument nor does it
engage in hedging activities or purchase derivative instruments. Furthermore,
the Company is not subject to foreign currency exchange rate risk or commodity
price risk.
The OTS currently requires savings institutions to measure and evaluate
interest rate risk on a quarterly basis. A savings institution's interest rate
risk is measured in terms of the sensitivity of its net portfolio value (NPV) to
changes in interest rates. Net portfolio value is defined, generally, as the
present value of expected cash inflows from existing assets and off-balance
sheet contracts less the present value of expected cash outflows from existing
liabilities and off-balance sheet contracts. The Bank presently monitors and
evaluates the potential impact of interest rate changes upon the market value of
the Bank's NPV on a quarterly basis. These computations estimate the effect on
the Bank's NPV of sudden and sustained 100 Basis Points (BP) to 300 BP increases
and decreases in market interest rates. The Bank's Board of Directors has
adopted an interest rate risk policy which in the event of an assumed immediate
and sustained 100 BP, 200 BP, or 300 BP, increase or decrease in market interest
rates, the board has set as minimum post shock NPV ratio of 4.66%, 4.33%, and
4.00% respectively.
The following tables present the Bank's projected change in NPV as of June
30, 2002 and June 30, 2001, as calculated by OTS, based on information provided
to the OTS by the Bank. Based on such information, from June 30, 2001 to June
30, 2002, the Bank's interest rate risk has become slightly more liability
sensitive over the period.
9
June 30, 2002
-----------------------------------------------------------------------------------------------
CHANGE IN NPV
INTEREST RATES NET PORTFOLIO VALUE RATIO (1) BP CHANGE IN NPV RATIO
IN BP ----------------------------------- --------- ------------------------
(RATE SHOCK) AMOUNT $ CHANGE % CHANGE
------------ ------ -------- --------
+300 $16,344 $(9,884) (38)% 6.33 % (298)
+200 19,671 (6,556) (25) 7.40 (191)
+100 22,968 (3,260) (12) 8.39 (92)
+0 26,228 9.31
-100 28,115 1,888 7 9.73 43
June 30, 2002
-----------------------------------------------------------------------------------------------
CHANGE IN NPV
INTEREST RATES NET PORTFOLIO VALUE RATIO (1) BP CHANGE IN NPV RATIO
IN BP ----------------------------------- --------- ------------------------
(RATE SHOCK) AMOUNT $ CHANGE % CHANGE
------------ ------ -------- --------
+300 $24,498 $(10,785) (31)% 9.17 % (292)
+200 28,096 (7,187) (20) 10.21 (188)
+100 31,525 (3,758) (11) 11.13 (96)
+0 35,283 12.09
-100 38,158 2,875 8 12.72 64
-200 39,912 4,629 13 12.98 89
-300 41,855 6,572 19 13.27 118
<FN>
___________
(1) NPV Ratio is defined as the NPV divided by the portfolio value of assets.
</FN>
At June 30, 2002, it was estimated that the Bank's NPV could decrease 12%,
25%, and 38% in the event of 100 BP, 200 BP, and 300 BP respective increases in
market interest rates, and could increase 7%, if market interest rates decreased
by 100 BP. These calculations indicate that the Bank's NPV could be adversely
affected by significant increases in interest rates. The Bank's interest-rate
risk has increased moderately compared to June 30, 2001, primarily due to the
Bank paying Bancshares $9.0 million in dividends during the period.
Changes in interest rates also may affect the Bank's net interest income.
In a declining rate environment, more borrowers would be expected to refinance
fixed rate loans at lower rates. This would have the effect of cutting the
Bank's yield on fixed rate assets at a time when its liability costs would
decline more slowly. In a rising rate environment fewer borrowers would be
expected to refinance while more depositors would be expected to liquidate their
certificates of deposit and reinvest them in higher rate certificates of
deposit. Depositors would tend to exhibit this behavior once rates had increased
sufficiently to offset early withdrawal penalties. This would have the effect of
maintaining the asset yield at a time when liability costs would tend to rise.
The Bank's Board of Directors is responsible for reviewing the Bank's asset
and liability policies. On at least a quarterly basis, the Board reviews
interest rate risk, as well as liquidity and capital ratios and requirements.
The Bank's management is responsible for administering the policies and
determinations of the Board of Directors with respect to the Bank's asset and
liability goals and strategies. At June 30, 2002, the Bank's estimated changes
in net interest income and NPV were within the targets established by the Board
of Directors.
Computations of prospective effects of hypothetical interest rate changes,
such as the above computations, are based on numerous assumptions, including
relative levels of market interest rates, loan prepayments and deposit decay,
and should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions the Bank may undertake in response
to changes in interest rates.
10
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth information regarding the Company's average
interest-earning assets and interest-bearing liabilities and reflects the
average yield of interest-earning assets and the average cost of
interest-bearing liabilities for the periods indicated. Average balances are
derived from daily balances. The table also presents information for the periods
indicated with respect to the difference between the weighted average yield
earned on interest-earning assets and the weighted average rate paid on
interest-bearing liabilities, or "interest rate spread," which savings
institutions have traditionally used as an indicator of profitability. Another
indicator of an institution's net interest income is its "net yield on
interest-earning assets," which is its net interest income divided by the
average balance of interest-earning assets. Net interest income is affected by
the interest rate spread and by the relative amounts of interest-earning assets
and interest-bearing liabilities. The yield on non-taxable securities has not
been adjusted to a tax equivalent basis. Yield on available for sale securities
is based on market value. Loans on a nonaccrual basis are included in the
computation of the average balance of loans receivable. Loan fees deferred and
accreted into income are included in interest earned. Whenever interest-earning
assets equal or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income.
Year Ended June 30,
-----------------------------------------------------------------------------
2002 2001
---------------------------------- ------------------------------------
Average Average
Average Interest Yield/ Average Interest Yield/
Balance Earned/Paid Rate Balance Earned/Paid Rate
------- ----------- ------- -------- ----------- ------
Interest-earning assets:
Loans receivable......................... $131,434,245 $10,735,729 8.17% $136,107,616 $11,622,492 8.54%
Investment and mortgage-backed securities
Taxable................................ 91,762,885 5,418,567 5.90 99,455,695 6,401,378 6.44
Nontaxable............................. 26,709,166 1,344,478 5.03 29,246,420 1,529,550 5.23
FHLB stock............................... 4,680,945 148,101 3.16 6,138,292 355,715 5.80
FHLB DDA................................. 12,254,561 264,337 2.16 3,466,854 161,693 4.66
Other interest-earning assets.............. 153,854 4,901 3.19 115,486 7,572 6.56
------------ ----------- ---- ------------ ----------- ----
Total interest-earning assets ......... 266,995,656 17,916,113 6.71 274,530,363 20,078,400 7.31
Noninterest-earning assets................. 15,411,663 16,144,665
------------ ------------
Total assets........................... $282,407,319 $290,675,028
============ ============
Interest-bearing liabilities:
NOW, MMDA, statement savings............. $ 43,566,756 792,670 1.82 $ 39,540,714 1,543,181 3.90
Time deposits............................ 112,568,794 4,913,494 4.36 106,806,416 6,156,303 5.76
FHLB advances............................ 86,442,890 5,116,537 5.92 105,619,861 6,372,982 6.03
Note payable............................. 14,685 1,000 6.81 94,685 7,000 7.39
------------ ----------- ---- ------------ ----------- ----
Total interest-bearing liabilities..... 242,593,125 10,823,701 4.46 252,061,676 14,079,466 5.59
Noninterest-bearing liabilities............ 9,290,121 7,948,247
------------ ------------
Total liabilities...................... 251,883,246 260,009,923
Equity..................................... 30,524,073 30,665,105
------------ ------------
Total liabilities and equity........... $282,407,319 $290,675,028
============ ============
Net interest income........................ $ 7,092,412 $ 5,998,934
========== ===========
Net interest rate spread................... 2.25% 1.72%
==== ====
Net yield on interest-earning assets 2.66% 2.19%
==== ====
Ratio of average interest-earning assets
to average interest-bearing liabilities 110.06% 108.91%
====== ======
Year Ended June 30,
-------------------------------------
2000
-------------------------------------
Average
Average Interest Yield/
Balance Earned/Paid Rate
-------- ----------- --------
Interest-earning assets:
Loans receivable......................... $123,535,536 $10,491,741 8.49%
Investment and mortgage-backed securities
Taxable................................ 112,065,588 7,352,290 6.56
Nontaxable............................. 27,102,813 1,479,536 5.46
FHLB stock............................... 5,784,385 441,291 7.63
FHLB DDA................................. 543,475 28,729 5.29
Other interest-earning assets.............. 208,296 15,312 7.35
------------ ----------- ----
Total interest-earning assets ......... 269,240,093 19,808,899 7.36
Noninterest-earning assets................. 16,659,326
------------
Total assets........................... $285,899,419
============
Interest-bearing liabilities:
NOW, MMDA, statement savings............. $ 32,873,541 1,067,350 3.25
Time deposits............................ 104,443,704 5,439,824 5.21
FHLB advances............................ 112,554,831 6,579,482 5.85
Note payable............................. 175,082 13,000 7.43
------------ ----------- ----
Total interest-bearing liabilities..... 250,047,158 13,099,656 5.24
Noninterest-bearing liabilities............ 7,392,828
------------
Total liabilities...................... 257,439,986
Equity..................................... 28,459,433
------------
Total liabilities and equity........... $285,899,419
============
Net interest income........................ $ 6,709,243
===========
Net interest rate spread................... 2.12%
====
Net yield on interest-earning assets 2.49%
====
Ratio of average interest-earning assets
to average interest-bearing liabilities 107.68%
======
11
RATE/VOLUME ANALYSIS
The following table analyzes dollar amounts of changes in interest income
and expense for major components of interest-earning assets and interest-bearing
liabilities. The table distinguishes between (i) changes attributable to volume
(changes in volume multiplied by the prior period's rate), (ii) changes
attributable to rate (changes in rate multiplied by the prior period's volume)
and (iii) changes in rate/volume (changes in rate multiplied by changes in
volume).
Year Ended June 30
--------------------------------------------------------------------------------------
2002 vs. 2001 2001 vs 2001
--------------------------------------- -----------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------------------- -----------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
Interest income:
Loans receivable $ (399) $ (505) $ 17 $ (887) $ 1,068 $ 57 $ 6 $ 1,131
Investment and mortgage-
backed securities
Taxable (495) (529) 42 (982) (827) (139) 15 (951)
Nontaxable (133) (57) 4 (186) 117 (62) (5) 50
FHLB stock (84) (162) 38 (208) 27 (106) (7) (86)
FHLB DDA 410 (87) (220) 103 155 (3) (19) 133
Other interest-earning
assets 3 (4) (1) (2) (7) (2) 2 (7)
------- ------- ------ ------- ------- ------- ------ -------
Total interest-earning
assets (698) (1,344) (120) (2,162) 533 (255) (8) 270
------- ------- ------ ------- ------- ------- ------ -------
Interest expense:
NOW, MMDA,
statement savings 157 (824) (84) (751) 216 216 44 476
Time deposits 332 (1,494) (81) (1,243) 123 580 13 716
FHLB advances (1,157) (121) 23 (1,255) (406) 212 (12) (206)
Note payable (6) (1) 1 (6) (6) -- -- (6)
------- ------- ------ ------- ------- ------- ------ -------
Total interest-bearing
liabilities (674) (2,440) (141) (3,255) (73) 1,008 45 980
------- ------- ------ ------- ------- ------- ------ -------
Change in net interest
income $ (24) $ 1,096 $ 21 $ 1,093 $ 606 $(1,263) $ (53) $ (710)
======= ======= ====== ======= ======= ======= ====== =======
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2002 AND 2001
The Company had consolidated total assets of $276.4 million and $287.6
million at June 30, 2002, and 2001, respectively. During the twelve-month period
ended June 30, 2002 the Company experienced a decrease in its net consolidated
loan portfolio from $131.7 million at June 30, 2001, to $124.2 million at June
30, 2002. During this same period, investments and mortgage-backed securities
and other short-term interest-earning assets decreased slightly from $135.2
million at June 30, 2001 to $132.6 million at June 30, 2002.
Deposits increased from $161.3 million at June 30, 2001, to $165.0 million
at June 30, 2002. The outstanding balances of FHLB borrowings were $91.9 million
and $82.3 million at June 30, 2001 and June 30, 2002, respectively. The decrease
in FHLB borrowings was primarily due to slower loan demand combined with
increases in deposits and investment securities paydowns.
Stockholders' equity amounted to $26.7 million at June 30, 2002, and $31.9
million at June 30, 2001. The decreases in equity were primarily due to the to
the purchase of treasury stock, offset by a reduction of the unrealized
12
loss on investment securities available for sale and the Company's net income
earned for the fiscal year ended June 30, 2002. During the year ended June 30,
2002, the Company purchased 510,389 shares (net of options exercised) of its
common stock at a cost of approximately $7.6 million, or $14.82 per share. At
June 30, 2002, the Bank's regulatory capital exceeded all applicable regulatory
capital requirements and meets the definition of "well" capitalized under the
Prompt Corrective Action provisions.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2002 AND 2001
Net Income. Net income for the year ended June 30, 2002, was approximately
$1,166,000 compared to net income of $620,000 for the year ended June 30, 2001.
The changes resulted primarily from an increase in net interest income of
$1,093,000, an increase in noninterest income of $228,000, offset by an increase
in the provision for loan and investment loss of $63,000, a decrease in the
income tax benefit of $529,000, and a increase in noninterest expense of
$184,000.
Interest Income. Interest income for the year ended June 30, 2002, was
$17.9 million, or $2.2 million less than interest income for the year ended June
30, 2001. The total average interest-earning assets decreased $7.5 million,
while the yield decreased from 7.31% to 6.71%, due to rate and volume decreases
on loans and investment securities.
The average balance of loans receivable decreased $4.7 million, total loan
interest income decreased $0.9 million, and the average yield on loans decreased
37 basis points. The average balance of investments and mortgage-backed
securities receivable decreased $10.2 million, interest income decreased $1.2
million, and the average yield decreased 45 basis points. The average balance of
other interest-earning assets (primarily FHLB DDA's and FHLB stock) increased
$7.4 million, interest income decreased $108,000, and the average yield
decreased 296 basis points.
Interest Expense. Total average interest-bearing liabilities decreased $9.5
million, while the interest rate on such liabilities decreased from 5.59% to
4.46%. The average balance of interest-bearing deposits increased $9.8 million,
deposit interest expense decreased $2.0 million, and the average cost decreased
161 basis points. The average balance of FHLB advances decreased $19.2 million,
FHLB interest expense decreased $1.3 million, and the average cost decreased 11
basis points.
Net Interest Income. Net interest income for the year ended June 30, 2002,
was $7.1 million, or $1.1 million more than net interest income for the year
ended June 30, 2001. The increase in net interest income from June 30, 2001 to
2002, was the result of an increase in our interest rate spread of 53 basis
points. During the year ended June 30, 2002, the Federal Reserve dropped
interest rates 5 times totaling 200 basis points, and the prime interest rate
decreased 225 basis points from 7.00% on June 30, 2001 to 4.75% on June 30,
2002. These interest rate decreases caused a greater reduction in the average
rates we paid on deposits and borrowed money than the average yield which we
earned on loans, investments, and interest-bearing deposits. This trend reflects
the liability sensitive nature of the Company which would, keeping all other
things equal, typically show improved net interest income in a decreasing
interest rate environment.
Provision for Loan and Investment Losses. During the year ended June 30,
2002, the Bank's management continued its review of the appropriateness of the
amount of the allowance for loan and investment losses. Based on these reviews,
management made a $330,000 provision for loan losses and a $29,000 provision for
investment losses for the year ended June 30, 2002. The allowance for loan
losses of $1.6 million at June 30, 2002, represented 1.22% of gross outstanding
loans which compares to 0.99% as of June 30, 2001. The provision was made in
consideration of reviews of individual loans and the fact that nonperforming
loans as of June 30, 2002 as a percent of total loans increased to 1.44% from
0.81% as of June 30, 2001. In addition, total classified assets as a percent of
the Bank's tangible capital plus allowance for loan loss was 31.0% as of June
30, 2002, which compares to 8.1% as of June 30, 2001. Part of this increase is
due to an increase in classified assets and part is due to the Bank paying
Bancshares $9.0 million in dividends, thus reducing capital at the Bank. As of
June 30, 2002, the Bank had $7.1 million in assets classified substandard or
doubtful as compared to $2.5 million as of June 30, 2001.
Management evaluates the carrying value of the loan portfolio periodically
and provisions are made, if necessary. While management uses the best
information available to make evaluations, future provisions to the
13
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require the Bank to
recognize changes to the allowance based upon their judgments and the
information available to them at the time of their examination.
There were no significant changes in loan terms during the year, nor were
there significant changes in the estimation methodologies employed or
assumptions utilized. Nonperforming loan and loss trends did not indicate a need
to substantially modify loss experience factors during the year.
Noninterest Income. Noninterest income is comprised primarily of gains on
the sales of loans and service charges on deposit accounts. Noninterest income
for the year ended June 30, 2002, was approximately $1,606,000 compared to
approximately $1,378,000 for the year ended June 30, 2001. This increase of
approximately $228,000 is the result of loan fee income, growth of the Bank's
checking and savings accounts resulting in increased service charges, and
increases in the deposit account fee structure.
Noninterest Expense. The major components of noninterest expense are
salaries and employee benefits paid to or on behalf of the Company's employees
and directors, professional fees paid to consultants, attorneys, and
accountants, occupancy expense for ownership and maintenance of the Company's
buildings, furniture, and equipment, and data processing expenses. Total
noninterest expense for the year ended June 30, 2002, was $7.1 million compared
to $6.9 million for the year ended June 30, 2001. Significant components of the
increase in noninterest expense are an $86,000 increase in salaries and employee
benefits, a $52,000 increase in net occupancy expense, a $56,000 increase in
data processing expense, a $146,000 increase in other expenses, offset with a
$136,000 decrease in professional fees as a result of improved internal and
accounting controls.
In light of the substantial costs associated with the recent, pending and
planned expansions of the Bank's activities, facilities and staff, including
additional costs associated with adding staff, building or renovating branches,
and introducing new deposit and loan products and services, it is expected that
the Bank's noninterest expense levels may remain high relative to the historical
levels for the Bank, as well as the prevailing levels for institutions that are
not undertaking such expansions, for an indefinite period of time, as management
implements the Bank's business strategy.
Income Taxes. The effective income tax rates for the Company for the fiscal
years ended June 30, 2002 and 2001 were 5.0% and (307.0)%, respectively. The
variance in the effective rate from the expected statutory rate is due primarily
to tax exempt interest.
The negative rate for fiscal year ended June 30, 2001, is a net tax
benefit, and increases net income. The net tax benefit is primarily due to tax
exempt income. The corresponding deferred tax asset totals approximately $1.7
million as of June 30, 2002, and $1.5 million as of June 30, 2001. The
recoverability of this asset is entirely contingent upon the production of
taxable income for income tax reporting purposes. Management anticipates that
the Company will produce such income in the near future based on management's
current forecasts of earnings and management's tax and interest-rate risk
planning strategy of selling available for sale tax exempt securities and
reinvesting the proceeds into taxable income producing securities. The strategy
does not anticipate significant taxable gains on the sale of the tax-exempt
securities, but rather a shift of nontaxable interest income to taxable interest
income. See Note 10 to the Consolidated Financial Statements.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2001 AND 2000
The Company had consolidated total assets of $287.6 million and $291.2
million at June 30, 2001 and 2000, respectively. During the twelve-month period
ended June 30, 2001, the Company experienced a decrease in its net consolidated
loan portfolio from $135.6 million at June 30, 2000, to $131.7 million at June
30, 2001. During this same period, investments and mortgage-backed securities
and other short-term interest-earning assets increased from $132.8 million at
June 30, 2000, to $135.2 million at June 30, 2001, due to increases in the
bank's FHLB DDA account and increases in the market value of investment
securities.
Deposits increased from $144.9 million at June 30, 2000, to $161.3 million
at June 30, 2001. This represents an 11.3
14
percent increase in deposits. The outstanding balances of FHLB borrowings were
$91.9 million and $115.6 million at June 30, 2001 and June 30, 2000,
respectively. The decrease in FHLB borrowings was primarily due to slower loan
demand combined with increases in deposits and investment securities paydowns.
Stockholders' equity amounted to $31.9 million at June 30, 2001, and $28.2
million at June 30, 2000. The changes in equity were primarily due to the
reduction of the unrealized loss on investment securities available for sale and
the Company's net income earned for the fiscal year ended June 30, 2001, net of
the decrease due to the purchase of treasury stock. At June 30, 2001, the Bank's
regulatory capital exceeded all applicable regulatory capital requirements and
meets the definition of "well" capitalized under the Prompt Corrective Action
provisions.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2001 AND 2000
Net Income. Net income for the year ended June 30, 2001, was approximately
$620,000 compared to net income of $786,000 for the year ended June 30, 2000.
The changes resulted primarily from a decrease in net interest income of
$710,000, an increase in the provision for loan loss of $296,000, offset by an
increase in the income tax benefit of $127,000, an increase in noninterest
income of $339,000, and a decrease in noninterest expense of $375,000.
Interest Income. Interest income for the year ended June 30, 2001, was
$20.1 million, or $0.3 million more than interest income for the year ended June
30, 2000. The total average interest-earning assets increased $5.3 million,
while the yield decreased from 7.36% to 7.31%, primarily due to average yield
decreases on investment securities and other interest-earning assets.
The average balance of loans receivable increased $12.6 million, total loan
interest income increased $1.1 million, and the average yield on loans increased
5 basis points. The average balance of investments and mortgage-backed
securities receivable decreased $10.5 million, interest income decreased $0.9
million, and the average yield decreased 19 basis points. The average balance of
other interest-earning assets (primarily FHLB DDA's and FHLB stock) increased
$3.2 million, interest income increased $40,000, and the average yield decreased
203 basis points.
Interest Expense. Total average interest-bearing liabilities increased $2.0
million, while the interest rate on such liabilities increased from 5.24% to
5.59%. The average balance of interest-bearing deposits increased $9.0 million,
deposit interest expense increased $1.2 million, and the average cost increased
35 basis points. The average balance of FHLB advances decreased $6.9 million,
FHLB interest expense decreased $0.2 million, and the average cost increased 18
basis points.
Provision for Loan Losses. During the year ended June 30, 2001, the Bank's
management continued its review of the appropriateness of the amount of the
allowance for loan losses. Based on these reviews, management made a $296,000
provision for loan losses for the year ended June 30, 2001. The allowance for
loan losses of $1.4 million at June 30, 2001, represented 0.99% of gross
outstanding loans. The provision was made in consideration of reviews of
individual loans and the fact that nonperforming loans as of June 30, 2001, as a
percent of total loans increased to 0.81% from 0.64% as of June 30, 2000.
Management evaluates the carrying value of the loan portfolio periodically
and provisions are made, if necessary. While management uses the best
information available to make evaluations, future provisions to the allowance
may be necessary if conditions differ substantially from the assumptions used in
making the evaluations. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Bank's allowance for
loan losses. Such agencies may require the Bank to recognize changes to the
allowance based upon their judgments and the information available to them at
the time of their examination.
There were no significant changes in loan terms during the year, nor were
there significant changes in the estimation methodologies employed or
assumptions utilized. Nonperforming loan and loss trends did not indicate a need
to substantially modify loss experience factors during the year.
Noninterest Income. Noninterest income is comprised primarily of gains on
the sales of loans and service charges on deposit accounts. Noninterest income
for the year ended June 30, 2001, was approximately $1,379,000
15
compared to approximately $1,040,000 for the year ended June 30, 2000. This
increase of approximately $339,000 is the result of loan fee income, growth of
the Bank's checking and savings accounts resulting in increased service charges,
and increases in the deposit account fee structure.
Noninterest Expense. The major components of noninterest expense are
salaries and employee benefits paid to or on behalf of the Company's employees
and directors, professional fees paid to consultants, attorneys, and
accountants, occupancy expense for ownership and maintenance of the Company's
buildings, furniture, and equipment, and data processing expenses. Total
noninterest expense for the year ended June 30, 2001, was $6.9 million compared
to $7.3 million for the year ended June 30, 2000. Significant components of the
decrease in noninterest expense are a $133,000 increase in occupancy expense
primarily resulting from a new full service branch in Bryant, Arkansas, and a
$426,000 decrease in professional fees as a result of improved internal and
accounting controls.
In light of the substantial costs associated with the recent, pending and
planned expansions of the Bank's activities, facilities and staff, including
additional costs associated with adding staff, building or renovating branches,
and introducing new deposit and loan products and services, it is expected that
the Bank's noninterest expense levels may remain high relative to the historical
levels for the Bank, as well as the prevailing levels for institutions that are
not undertaking such expansions, for an indefinite period of time, as management
implements the Bank's business strategy.
Income Taxes. The effective income tax rates for the Company for the fiscal
years ended June 30, 2001 and 2000, were (307.0)% and (76.7)%, respectively. The
variance in the effective rate from the expected statutory rate is due primarily
to tax exempt interest.
These negative rates are a result of net tax benefits, which increases net
income. These benefits are due primarily to increases in net operating loss
carryforwards for income tax reporting purposes. The corresponding deferred tax
asset totals approximately $1.5 million and $1.1 million as of June 30, 2001 and
June 30, 2000, respectively. The recoverability of this asset is entirely
contingent upon the production of taxable income for income tax reporting
purposes. Management anticipates that the Company will produce such income in
the near future based on management's current forecasts of earnings and
management's tax planning strategy of selling certain available for sale tax
exempt securities to generate taxable income.
SUBSEQUENT EVENTS - BRANCH SALE
On July 19, 2002, the bank sold its Monticello branch to Simmons First Bank
of South Arkansas. The sale included approximately $8.3 million in loans, $1.5
million in fixed assets, $0.2 million in other assets, and $13.2 million in
deposits. The Bank recognized a premium on the deposits of approximately $0.9
million and the difference was paid in cash to the buyer. The resulting after
tax gain on the sale of the Monticello branch of approximately $440,000
translates into $0.29 in earnings per share.
SOURCES OF CAPITAL AND LIQUIDITY
The Company has no business other than that of the Bank. Bancshares'
primary sources of liquidity are cash, dividends paid by the Bank and earnings
on investments and loans. In addition, the Bank is subject to regulatory
limitations with respect to the payment of dividends to Bancshares.
The Bank has historically maintained substantial levels of capital. The
assessment of capital adequacy is dependent on several factors including asset
quality, earnings trends, liquidity and economic conditions. Maintenance of
adequate capital levels is integral to provide stability to the Bank. The Bank
seeks to maintain substantial levels of regulatory capital to give it maximum
flexibility in the changing regulatory environment and to respond to changes in
the market and economic conditions.
The Bank's primary sources of funds are customer deposits, proceeds from
principal and interest payments on loans and mortgage-backed securities,
interest payments and maturities of investment securities, and earnings. While
scheduled principal repayments on loans and mortgage-backed securities and
interest payments on investment securities are a relatively predictable source
of funds, deposit flows and loan and mortgage-backed prepayments are greatly
16
influenced by general interest rates, economic conditions, competition and other
factors. The Bank does not solicit customer deposits outside of its market area
through brokers or other financial institutions.
At June 30, 2002, the Bank had designated securities with a fair value of
approximately $118.2 million as available for sale. In addition to internal
sources of funding, the Bank as a member of the FHLB has substantial borrowing
authority with the FHLB. The Bank's use of a particular source of funds is based
on need, comparative total costs and availability.
At June 30, 2002, the Bank had outstanding approximately $6.1 million in
commitments to originate loans (including unfunded portions of construction
loans) and $1.6 million in unused lines of credit. At the same date, the total
amount of certificates of deposit which were scheduled to mature in one year or
less was $86.8 million. Management anticipates that the Bank will have adequate
resources to meet its current commitments through internal funding sources
described above. Historically, the Bank has been able to retain a significant
amount of its savings deposits as they mature.
Management is not aware of any current recommendations by its regulatory
authorities, legislation, competition, trends in interest rate sensitivity, new
accounting guidance or other material events and uncertainties that would have a
material effect on the Bank's ability to meet its liquidity demands.
17
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
HCB Bancshares, Inc.
Camden, Arkansas
We have audited the accompanying consolidated statement of financial condition
of HCB Bancshares, Inc. and its subsidiary (the "Company") as of June 30, 2001,
and the related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for the years ended June 30, 2001 and 2000.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of HCB Bancshares, Inc. and its
subsidiary as of June 30, 2001, and the results of their operations and their
cash flows for the years ended June 30, 2001 and 2000, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
September 21, 2001
18
INDEPENDENT AUDITORS' REPORT
The Board of Directors
HCB Bancshares, Inc.
Camden, Arkansas
We have audited the accompanying consolidated statement of financial condition
of HCB Bancshares, Inc. as of June 30, 2002, and the related consolidated
statements of income and comprehensive income, stockholders' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 2002 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HCB
Bancshares, Inc. as of June 30, 2002, and the results of its operations and its
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ BKD, LLP
Little Rock, Arkansas
August 1, 2002
19
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2002 AND 2001
- --------------------------------------------------------------------------------
ASSETS 2002 2001
Cash and due from banks $ 3,492,257 $ 3,302,540
Interest-bearing deposits with banks 14,404,572 15,107,481
------------ ------------
Cash and cash equivalents 17,896,829 18,410,021
Investment securities:
Available for sale, at fair value (amortized cost at June 30, 2002
and 2001, of $115,796,195 and $120,222,942, respectively) 118,198,564 120,082,177
Loans receivable, net of allowance at June 30, 2002 and 2001,
of $1,628,515 and $1,446,114, respectively 124,176,898 131,651,421
Accrued interest receivable 1,721,612 2,017,188
Federal Home Loan Bank stock 4,709,900 4,735,800
Premises and equipment, net 7,112,211 7,564,681
Goodwill, net 131,250 206,250
Real estate held for sale 910,587 398,132
Other assets 1,567,443 2,532,980
------------ ------------
TOTAL $ 276,425,294 $ 287,598,650
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits $ 165,005,183 $ 161,285,179
Federal Home Loan Bank advances 82,263,936 91,915,694
Advance payments by borrowers for
taxes and insurance 110,446 199,470
Accrued interest payable 740,008 972,900
Note payable -- 80,000
Other liabilities 1,569,433 1,211,073
------------ ------------
Total liabilities 249,689,006 255,664,316
------------ -----------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 14)
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 10,000,000 shares authorized, 2,645,000 shares
issued, 1,425,056 and 1,935,445 shares
outstanding at June 30, 2002 and 2001, respectively 26,450 26,450
Additional paid-in capital 25,832,641 25,914,132
Unearned ESOP shares (846,400) (1,058,000)
Unearned MRP shares (116,169) (155,601)
Accumulated other comprehensive income (loss) 1,441,942 (59,600)
Retained earnings 14,950,088 14,256,684
------------ ------------
41,288,552 38,924,065
------------ ------------
Treasury stock, at cost, 1,219,944 and 709,555
shares at June 30, 2002 and 2001, respectively (14,552,264) (6,989,731)
------------- -------------
Total stockholders' equity 26,736,288 31,934,334
------------ ------------
TOTAL $ 276,425,294 $ 287,598,650
============ ===========
See notes to consolidated financial statements.
20
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000
INTEREST INCOME:
Interest and fees on loans $ 10,735,729 $ 11,622,492 $ 10,491,741
Investment securities:
Taxable 5,418,567 6,401,378 7,352,290
Nontaxable 1,344,478 1,529,550 1,479,536
Other 417,339 524,980 485,332
----------- ----------- -----------
Total interest income 17,916,113 20,078,400 19,808,899
INTEREST EXPENSE:
Deposits 5,706,164 7,699,484 6,507,174
Federal Home Loan Bank advances 5,116,537 6,372,982 6,579,482
Note payable 1,000 7,000 13,000
----------- ----------- -----------
Total interest expense 10,823,701 14,079,466 13,099,656
----------- ----------- ----------
NET INTEREST INCOME 7,092,412 5,998,934 6,709,243
PROVISION FOR LOAN AND INVESTMENT LOSSES 359,000 296,000 --
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND INVESTMENT LOSSES 6,733,412 5,702,934 6,709,243
----------- ----------- -----------
NONINTEREST INCOME:
Service charges on deposit accounts 984,089 765,532 555,292
Gain on sales of investment securities
available for sale 1,518 -- --
Gain on sales of loans available for sale, net 381,733 223,906 276,841
Other 239,120 389,174 207,489
----------- ----------- -----------
Net noninterest income 1,606,460 1,378,612 1,039,622
----------- ----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits 3,961,413 3,875,094 3,904,807
Net occupancy expense 1,085,602 1,033,684 900,948
Federal insurance premiums 29,439 50,330 79,692
Data processing 368,176 312,551 326,528
Professional fees 489,360 624,622 1,050,873
Amortization of goodwill 75,000 75,000 75,000
Other 1,104,155 957,837 966,262
----------- ----------- -----------
Total noninterest expenses 7,113,145 6,929,118 7,304,110
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,226,727 152,428 444,755
INCOME TAX PROVISION (BENEFIT) 61,027 (467,888) (341,147)
----------- ------------ ------------
NET INCOME $ 1,165,700 $ 620,316 $ 785,902
----------- ----------- -----------
(Continued)
21
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF TAX
Unrealized holding gain (loss) on securities
arising during period $ 1,503,060 $ 4,342,068 $ (1,780,995)
Reclassification adjustment for
gains included in net income (1,518) -- --
------------ ----------- -----------
Other comprehensive income (loss) 1,501,542 4,342,068 (1,780,995)
----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 2,667,242 $ 4,962,384 $ (995,093)
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING
BASIC 1,635,669 1,866,387 1,988,984
=========== =========== ===========
DILUTED 1,719,903 1,866,387 1,988,984
=========== =========== ===========
EARNINGS PER SHARE:
Basic $ 0.71 $ 0.33 $ 0.40
==== ==== ====
Diluted $ 0.68 $ 0.33 $ 0.40
==== ==== ====
DIVIDENDS PER SHARE $ 0.28 $ 0.24 $ 0.24
==== ==== ====
(Concluded)
See notes to consolidated financial statements.
22
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
- -----------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
ISSUED ADDITIONAL UNEARNED UNEARNED OTHER
COMMON STOCK PAID-IN ESOP MRP COMPREHENSIVE RETAINED
SHARES AMOUNT CAPITAL SHARES SHARES INCOME EARNINGS
--------- -------- ------------ ------------ ----------- ---------- -------------
BALANCE, JULY 1, 1999 2,645,000 26,450 25,993,872 (1,481,200) (390,056) (2,620,673) 13,831,694
Net income 785,902
Common stock committed
to be released for ESOP (48,022) 211,600
MRP shares earned 169,952
Net change in unrealized
gain (loss) on securities
available for sale,
net of tax (1,780,995)
Treasury stock purchased
Dividends paid (506,929)
--------- -------- ------------ ------------ ----------- ---------- -------------
BALANCE, JUNE 30, 2000 2,645,000 26,450 25,945,850 (1,269,600) (220,104) (4,401,668) 14,110,667
Net income 620,316
Common stock committed
to be released for ESOP (31,718) 211,600
MRP shares earned 64,503
Net change in unrealized
gain (loss) on securities
available for sale,
net of tax 4,342,068
Treasury stock purchased
Dividends paid (474,299)
--------- -------- ------------ ------------ ----------- ---------- -------------
BALANCE, JUNE 30, 2001 2,645,000 $ 26,450 $ 25,914,132 $ (1,058,000) $ (155,601) $ (59,600) $ 14,256,684
Net income 1,165,700
Common stock committed
to be released for ESOP 77,065 211,600
MRP shares earned 39,432
Net change in unrealized
gain (loss) on securities
available for sale, net of tax 1,501,542
Stock options exercised (158,556)
Treasury stock purchased
Dividends paid (472,296)
--------- -------- ------------ ------------ ----------- ---------- -------------
BALANCE, JUNE 30, 2002 2,645,000 $ 26,450 $ 25,832,641 $ (846,400) $ (116,169) $1,441,942 $ 14,950,088
========= ======== ============ ============ =========== ========== =============
TREASURY TREASURY TOTAL
STOCK STOCK STOCKHOLDERS'
SHARES AMOUNT EQUITY
-------- ------------- ------------
BALANCE, JULY 1, 1999 315,456 (3,242,527) 32,117,560
Net income 785,902
Common stock committed
to be released for ESOP 163,578
MRP shares earned 169,952
Net change in unrealized
gain (loss) on securities
available for sale,
net of tax (1,780,995)
Treasury stock purchased 282,964 (2,708,518) (2,708,518)
Dividends paid (506,929)
-------- ------------- ------------
BALANCE, JUNE 30, 2000 598,420 (5,951,045) 28,240,550
Net income 620,316
Common stock committed
to be released for ESOP 179,882
MRP shares earned 64,503
Net change in unrealized
gain (loss) on securities
available for sale,
net of tax 4,342,068
Treasury stock purchased
111,135 (1,038,686) (1,038,686)
Dividends paid (474,299)
-------- ------------- ------------
BALANCE, JUNE 30, 2001 709,555 $ (6,989,731) $ 31,934,334
Net income 1,165,700
Common stock committed
to be released for ESOP 288,665
MRP shares earned 34,432
Net change in unrealized
gain (loss) on securities
available for sale,
net of tax 1,501,542
Stock options exercised (50,473) (619,821) 461,265
Treasury stock purchased 560,862 (8,182,354) (8,182,354)
Dividends paid (472,296)
--------- ------------- ------------
BALANCE, JUNE 30, 2002 1,219,944 $ (14,552,264) $ 26,736,288
========= ============= ============
See notes to consolidated financial statements.
23
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000
OPERATING ACTIVITIES:
Net income $ 1,165,700 $ 620,316 $ 785,902
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 743,412 730,212 649,779
Amortization (accretion) of:
Deferred loan origination fees 117,153 116,232 (116,260)
Goodwill 75,000 75,000 75,000
Premiums and discounts on loans, net (14,412) (4,487) (4,619)
Premiums and discounts on investment securities, net 49,942 68,487 119,181
Provision for loan and investment loss 359,000 296,000 --
Deferred income taxes (269,037) (403,424) (477,356)
Net gain on sale of investment securities
available for sale (1,518) -- --
Origination of loans held for sale (26,675,718) (13,502,308) (9,239,668)
Proceeds from sales of loans held for sale 27,117,741 12,732,692 10,160,826
Stock compensation expense 169,541 244,385 333,530
Change in accrued interest receivable 295,576 (164,301) (135,064)
Change in accrued interest payable (232,892) 55,485 102,218
Change in other assets 192,983 (720,084) 826,402
Change in other liabilities 358,360 (41,483) (23,113)
------------ ------------ ------------
Net cash provided by operating activities 3,450,831 102,722 3,056,758
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of investment securities available for sale (23,053,591) -- (3,302,892)
Purchases of loans -- -- (82,547)
Redemption (purchase) of Federal Home Loan Bank stock 25,900 1,487,700 (844,400)
Proceeds from sales of investment securities - available
for sale 4,995,347 -- --
Loan (originations), net of repayments 6,599,759 4,336,955 (21,181,354)
Principal payments on investment securities 22,407,566 19,629,225 14,768,810
Proceeds from maturities of other interest-bearing deposits -- 99,000 619,000
Net (increase) decrease in real estate held for resale (512,455) (38,524) 103,870
Purchases of premises and equipment (290,942) (1,742,409) (701,559)
------------ ------------ ------------
Net cash provided (used) by investing activities 10,171,584 23,771,947 (10,621,072)
------------ ------------ ------------
(Continued)
24
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000
FINANCING ACTIVITIES:
Net increase (decrease) in deposits $ 3,720,004 $ 16,412,108 $ (1,423,527)
Advances from Federal Home Loan Bank 6,464,838 213,740,000 281,234,000
Repayment of Federal Home Loan Bank advances (16,116,596) (237,433,335) (270,148,390)
Net increase (decrease) in advance payments by
borrowers for taxes and insurance (89,024) 59,916 11,112
Purchase of treasury stock, net (7,562,533) (1,038,686) (2,708,518)
Repayment of note payable (80,000) (80,000) (80,000)
Dividends paid (472,296) (474,299) (506,929)
------------ ------------- -------------
Net cash provided (used) by financing activities (14,135,607) (8,814,296) 6,377,748
------------ ------------- -------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (513,192) 15,060,373 (1,186,566)
CASH AND CASH EQUIVALENTS:
Beginning of year 18,410,021 3,349,648 4,536,214
------------ ------------- -------------
End of year $ 17,896,829 $ 18,410,021 $ 3,349,648
============ ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid for:
Interest $ 11,056,593 $ 14,023,981 $ 12,997,438
============ ============= =============
Income taxes paid (received) $ (94,698) $ 150,000 $ --
============ ============= =============
(Concluded)
See notes to consolidated financial statements.
25
HCB BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION - HCB Bancshares, Inc.
("Bancshares"), a bank holding company, owns 100 percent of Heartland Community
Bank and its subsidiary (collectively the "Bank"). Bancshares' business is
primarily that of owning the Bank and participating in the Bank's activities.
The Bank provides a broad line of financial products to individuals and small to
medium-sized businesses through banking offices located in Camden, Fordyce,
Sheridan, Bryant, and Monticello, Arkansas
The accompanying consolidated financial statements include the accounts of
Bancshares and the Bank and are collectively referred to as the "Company". All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of the deferred
tax asset.
CASH AND CASH EQUIVALENTS - For purposes of presentation in the
consolidated statements of cash flows, "cash and cash equivalents" includes cash
on hand and amounts due from depository institutions, which includes
interest-bearing amounts available upon demand.
INVESTMENT SECURITIES - The Company classifies investment securities into
one of two categories: held to maturity or available for sale. The Company does
not engage in trading activities. Debt securities that the Company has the
positive intent and ability to hold to maturity are classified as held to
maturity and recorded at cost, adjusted for the amortization of premiums and the
accretion of discounts.
Investment securities that the Company intends to hold for indefinite
periods of time are classified as available for sale and are recorded at fair
value. Unrealized holding gains and losses are excluded from earnings and
reported net of tax as a separate component of stockholders' equity until
realized. Investment securities in the available for sale portfolio may be used
as part of the Company's asset and liability management practices and may be
sold in response to changes in interest rate risk, prepayment risk or other
economic factors.
Premiums are amortized into interest income using the interest method to
the earlier of maturity or call date. Discounts are accreted into interest
income using the interest method over the period to maturity. The specific
identification method of accounting is used to compute gains or losses on the
sales of investment securities.
If the fair value of an investment security declines for reasons other than
temporary market conditions, the carrying value of such a security is written
down to fair value by a charge to operations.
LOANS RECEIVABLE - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off are
stated at unpaid principal balances adjusted for any charge-offs, the allowance
for loan losses, deferred loan fees or costs, and unamortized premiums or
discounts. Deferred loan fees or costs and premiums and discounts on loans are
amortized or accreted to income using the level-yield method over the remaining
period to contractual maturity.
26
The accrual of interest on impaired loans is generally discontinued when,
in management's opinion, the borrower may be unable to meet payments as they
become due or when the loan becomes ninety days past due, whichever occurs
first. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments in excess of principal due are received, until such time that in
management's opinion, the borrower will be able to meet payments as they become
due.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a valuation
allowance to provide for incurred but not yet realized losses. The Bank reviews
its loans for impairment on a quarterly basis. Impairment is determined by
assessing the probability that the borrower will not be able to fulfill the
contractual terms of the agreement. If a loan is determined to be impaired, the
amount of the impairment is measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or by use of
the observable market price of the loan or fair value of collateral if the loan
is collateral dependent. Throughout the year management estimates the level of
probable losses to determine whether the allowance for loan losses is
appropriate considering the estimated losses existing in the portfolio. Based on
these estimates, an amount is charged to the provision for loan losses and
credited to the allowance for loan losses in order to adjust the allowance to a
level determined by management to be appropriate relative to losses. The
allowance for loan losses is increased by charges to income (provisions) and
decreased by charge-offs, net of recoveries.
Management's periodic evaluation of the appropriateness of the allowance is
based on 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 and current economic
conditions.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis. The
Company considers the characteristics of (1) one-to-four family residential
first mortgage loans; (2) automobile loans and; (3) consumer and home
improvement loans to permit consideration of the appropriateness of the
allowance for losses of each group of loans on a pool basis. The primary
methodology used to determine the appropriateness of the allowance for losses
includes segregating certain specific, poorly performing loans based on their
performance characteristics from the pools of loans as to type and then applying
a loss factor to the remaining pool balance based on several factors including
classification of the loans as to grade, past loss experience, inherent risks,
economic conditions in the primary market areas and other factors which usually
are beyond the control of the Company. Those segregated specific loans are
evaluated using the present value of future cash flows, usually determined by
estimating the fair value of the loan's collateral reduced by any cost of
selling and discounted at the loan's effective interest rate if the estimated
time to receipt of monies is more than three months.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans and multi-family and commercial first
mortgage loans, but which differ in other characteristics to the extent that
valuation on a pool basis is not valid. After segregating specific, poorly
performing loans and applying the methodology as noted in the preceding
paragraph for such specific loans, the remaining loans are evaluated based on
payment experience, known difficulties in the borrowers business or geographic
area, loss experience, inherent risks and other factors usually beyond the
control of the Company. These loans are then graded and a factor, based on
experience, is applied to estimate the probable loss.
Estimates of the probability of loan losses involve an exercise of
judgment. While it is possible that in the near term the Company may sustain
losses which are substantial in relation to the allowance for loan losses, it is
the judgment of management that the allowance for loan losses reflected in the
consolidated statements of financial condition is appropriate considering the
estimated probable losses in the portfolio.
REAL ESTATE HELD FOR SALE - Real estate acquired in settlement of loans is
initially recorded at estimated fair value less estimated costs to sell and is
subsequently carried at the lower of carrying amount or fair value less
estimated disposal costs. Management periodically performs valuations, and an
allowance for losses is established by a charge to operations to the extent that
the carrying value of a property exceeds its estimated fair value. Costs
relating to the development and improvement of the property are capitalized,
whereas those relating to holding the property are expensed. Real estate
acquired for sale is carried of the lower of cost or fair value less costs to
sell.
27
PREMISES AND EQUIPMENT - Office premises and equipment are stated at cost
less accumulated depreciation and amortization. The Company computes
depreciation of premises and equipment using the straight-line method over the
estimated useful lives of the individual assets which range from 5 to 50 years
for buildings and improvements and from 3 to 10 years for furniture and
equipment.
GOODWILL AND INTANGIBLE ASSETS - Goodwill and other long-lived assets are
tested periodically for impairment and written down to their fair value as
necessary.
LOAN ORIGINATION FEES - Loan origination fees and certain direct loan
origination costs are deferred and the net fee or cost is recognized as an
adjustment to interest income using the level-yield method over the contractual
life of the loans. When a loan is fully repaid or sold, the amount of
unamortized fee or cost is recorded in income.
INCOME TAXES - The Company recognizes deferred tax assets and liabilities
for the expected future tax consequences of temporary differences between the
carrying amounts and the tax bases of assets and liabilities. Deferred tax
assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled. As changes in tax laws or rates are enacted,
deferred tax assets and liabilities are adjusted through the provision for
income taxes. The Company considers the need for a valuation allowance if, based
on available evidence, deferred tax assets are not expected to be realized.
INTEREST RATE RISK - The Bank's asset base is exposed to risk including the
risk resulting from changes in interest rates and changes in the timing of cash
flows. The Bank monitors the effect of such risks by considering the mismatch of
the maturities of its assets and liabilities in the current interest rate
environment and the sensitivity of assets and liabilities to changes in interest
rates. The Bank's management has considered the effect of significant increases
and decreases in interest rates and believes such changes, if they occurred,
would be manageable and would not affect the ability of the Bank to hold its
assets as planned. However, the Bank is exposed to significant market risk in
the event of significant and prolonged interest rate changes.
EMPLOYEE STOCK OWNERSHIP PLAN - Compensation expense for the Employee Stock
Ownership Plan ("ESOP") is determined based on the average fair value of shares
committed to be released during the period and is recognized as the shares are
committed to be released. For the purposes of earnings per share, ESOP shares
are included in weighted-average common shares outstanding as the shares are
committed to be released.
MANAGEMENT RECOGNITION PLAN - Compensation for Management Recognition Plan
shares granted is based on the fair value of the shares at the date of grant and
is recognized ratably over the vesting period.
EARNINGS PER SHARE - Earnings per share ("EPS") of common stock has been
computed on the basis of the weighted-average number of shares of common stock
outstanding, assuming the Company was a public company since July 1, 1996. Basic
and diluted earnings per share were both calculated with 1,866,387, and
1,988,984 weighted-average common shares outstanding for the years ended June
30, 2001, and 2000, respectively. Weighted-average common shares outstanding was
the same for basic and diluted in those years. For the year ended June 30, 2002,
basic earnings per share was calculated using 1,635,669 shares and dilutive
earnings per share was calculated using 1,719,903 shares. Potential dilutive
common shares include the Stock Option Plan shares and the Management
Recognition Plan shares, all of which were granted May 1, 1998. These potential
common shares had no dilutive effect for the years ended June 30, 2001, and
2000. However, for the year ended June 30, 2002, the Management Recognition Plan
was antidilutive, but the Stock Option Plan was dilutive by 84,234 shares.
STOCK PURCHASED FOR OPTION BENEFIT TRUST - As of June 30, 2002, the Company
has a total of 78,380 shares of its common stock in its stock option plan trust.
These shares are included in treasury stock on the accompanying consolidated
statement of financial condition, are available for sale, and are managed by the
trustees specifically for funding stock option benefits provided to key
employees.
RECLASSIFICATIONS - Certain amounts in the 2001 and 2000 consolidated
financial statements have been reclassified to conform to the classifications
adopted for reporting in 2002. These reclassifications had no effect on net
earnings.
28
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In July 2001, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations". The statement discontinues the use of
the pooling of interest method of accounting for business combinations and is
effective for all business combinations initiated after June 30, 2001.
Management has completed an evaluation of the effects of this statement and does
not believe that it will have a material effect on the Company's consolidated
financial statements.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142,
"Goodwill and Other Intangible Assets". The statement will require discontinuing
the amortization of goodwill and other intangible assets with indefinite useful
lives. Instead, these assets will be tested periodically for impairment and
written down to their fair value as necessary. This statement is effective for
fiscal years beginning after December 15, 2001. The Company plans to adopt the
provisions of this statement on July 1, 2002, and has determined that the effect
on the Company's consolidated financial statements will not be material.
2. INVESTMENT SECURITIES
Investment securities consisted of the following at June 30:
2002
--------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
U.S. Government and agencies $ 1,500,000 $ 30,945 $ 1,530,945
Municipal securities 25,520,671 323,090 $ 154,570 25,689,191
Equity securities 39,750 30,490 70,240
Other securities 2,000,000 5,000 1,995,000
Mortgage-backed securities 75,820,993 1,820,096 38,053 77,603,036
Collateralized mortgage obligations 10,914,781 395,371 11,310,152
------------ ---------- -------- ------------
Total $115,796,195 $2,599,992 $197,623 $118,198,564
============ ========== ======== ============
2001
--------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
U.S. Government and agencies $ 1,854,215 $ 46,233 $ 1,900,448
Municipal securities 30,488,774 159,481 $451,069 30,197,186
Equity securities 39,750 1,050 40,800
Mortgage-backed securities 75,714,645 424,709 355,094 75,784,260
Collateralized mortgage obligations 12,125,558 54,622 20,697 12,159,483
------------ -------- -------- ------------
Total $120,222,942 $686,095 $826,860 $120,082,177
============ ======== ======== ============
For the year ended June 30, 2002, the Company realized $11,659 in gains and
$10,141 in losses on sales of investment securities available for sale. There
were no realized gains or losses on sales of available for sale securities for
the years ended June 30, 2001 and 2000.
While at June 30, 2002, no securities were pledged to collateralize public
deposits, as of June 30, 2001, municipal securities with a carrying value of
approximately $2.1 million were pledged as collateral for public deposits. At
June 30, 2002 and 2001, mortgage-backed securities with a carrying value of
approximately $16.7 million and $20.7 million, respectively, were pledged as
collateral for Federal Home Loan Bank advances.
29
The scheduled maturities of available for sale securities at June 30, 2002,
by contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
Due in one year or less $ 1,500,000 $ 1,530,945
Due from one year to five years -- --
Due from five years to ten years -- --
Due after ten years 27,520,671 27,684,191
------------ ------------
29,020,671 29,215,136
Equity securities 39,750 70,240
Mortgage-backed securities 75,820,993 77,603,036
Collateralized mortgage obligations 10,914,781 11,310,152
------------ ------------
Total $115,796,195 $118,198,564
============ ============
3. LOANS RECEIVABLE
Loans receivable consisted of the following at June 30:
2002 2001
First mortgage loans:
One- to four- family residences $ 41,724,098 $ 50,579,375
Multi-family and commercial 50,626,236 57,041,028
Real estate construction loans 12,449,965 16,008,775
Less undisbursed loan funds (5,945,029) (12,020,255)
------------ ------------
Total first mortgage loans 98,855,270 111,608,923
Consumer and other loans:
Commercial loans 14,406,499 11,289,519
Automobile 6,836,399 6,779,218
Consumer and home improvement loans 4,807,218 2,073,650
Loans collateralized by deposits 2,469,033 2,488,948
Less undisbursed loan funds (1,718,669) (1,274,468)
------------ ------------
Total consumer and other loans 26,800,480 21,356,867
Allowance for loan losses (1,628,515) (1,446,114)
Net deferred loan costs and discounts 149,663 131,745
------------ ------------
Loans receivable, net $124,176,898 $131,651,421
============ ============
The Company originates and maintains loans receivable which are
substantially concentrated in its lending territory (primarily Southern
Arkansas) but also originates commercial real estate loans in other areas of
Arkansas and in contiguous states. The Company's policy calls for collateral or
other forms of repayment assurance to be received from the borrower at the time
of loan origination. Such collateral or other form of repayment assurance is
subject to changes in economic value due to various factors beyond the control
of the Company.
At June 30, 2002, impaired loans totaled approximately $4,900,000. All
impaired loans had designated reserves for possible loan losses. Reserves
relative to impaired loans at June 30, 2002, was approximately $426,000.
Approximately $173,000 in interest income was recognized on average impaired
loans of approximately $2,200,000 for the year ended June 30, 2002. At June 30,
2001, loans identified by management as impaired were
30
not significant. Interest recognized on impaired loans on a cash basis during
2002 and 2001 was immaterial. The Company is not committed to lend additional
funds to debtors whose loans have been modified.
The subsidiary Bank had extensions of credit to executive officers,
directors and to companies in which the Banks' directors were principal owners,
in the amount of approximately $1.8 million as of June 30, 2002 and 2001.
Balance, June 30, 2001 $1,833,111
New extensions of credit 119,100
Repayments (192,382)
----------
Balance, June 30, 2002 $1,759,829
==========
In management's opinion, such loans were made in the ordinary course of
business and were made on substantially the same terms (including interest rates
and collateral) as those prevailing at the time for comparable transactions with
other persons. Further, in management's opinion, these extensions of credit did
not involve more than the normal risk of collectability or present other
unfavorable features.
Certain loans are originated for sale. These loans are typically held for
sale only a short time, and do not represent a material amount in the aggregate
prior to their sale. Normally the short time between origination and sale does
not provide for significant differences between cost and market values.
4. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at June 30:
2002 2001
Investment securities $ 839,287 $ 931,985
Loans 882,325 1,085,203
---------- ----------
Total $1,721,612 $2,017,188
========== ==========
5. ALLOWANCE FOR LOAN LOSSES
A summary of the activity in the allowance for loan losses is as follows
for the years ended June 30:
2002 2001 2000
Balance, beginning of year $ 1,446,114 $ 1,231,709 $ 1,329,201
Provision 330,000 296,000 --
Charge-offs (234,382) (101,761) (99,798)
Recoveries 86,783 20,166 2,306
------------ ------------ ------------
Balance, end of year $ 1,628,515 $ 1,446,114 $ 1,231,709
============ ============ ============
6. FEDERAL HOME LOAN BANK STOCK
The Bank is a member of the Federal Home Loan Bank System. As a member of
this system, it is required to maintain an investment in capital stock of the
Federal Home Loan Bank ("FHLB") in an amount equal to the greater of 1% of its
outstanding home loans or 1/20 of its advances (borrowings) from the FHLB. No
ready market exists for such stock and it has no quoted market value but may be
redeemed at par. The carrying value of the stock is its cost.
31
7. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at June 30:
2002 2001
Land and buildings $ 7,153,233 $ 7,154,882
Furniture and equipment 3,667,962 3,404,811
------------ ------------
Total 10,821,195 10,559,693
Accumulated depreciation (3,708,984) (2,995,012)
------------ ------------
Premises and equipment, net $ 7,112,211 $ 7,564,681
============ ============
8. DEPOSITS
Deposits are summarized as follows at June 30:
2002 2001
Demand and NOW accounts, including noninterest-bearing
deposits of $8,889,867 and $7,379,892 in 2002 and
2001, respectively $ 39,092,410 $ 38,055,320
Money market 5,911,715 5,733,865
Statement savings 8,010,973 6,903,036
Certificates of deposit 111,990,085 110,592,958
------------ ------------
Total $165,005,183 $161,285,179
============ ============
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100,000 was approximately $19.3 million and $13.6
million at June 30, 2002 and 2001, respectively.
At June 30, 2002, scheduled maturities of certificates of deposit are as
follows:
Years ending June 30:
2003 $ 86,819,911
2004 19,993,891
2005 5,092,669
Thereafter 83,614
------------
Total $111,990,085
============
Eligible deposits of the Bank are insured up to $100,000 by the Savings
Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation
("FDIC").
9. FEDERAL HOME LOAN BANK ADVANCES
The Bank pledges as collateral for FHLB advances its FHLB stock and has
entered into blanket collateral agreements with the FHLB whereby the Bank agrees
to maintain, free of other encumbrances, qualifying single family first mortgage
loans with unpaid principal balances, when discounted to 75% of such balances,
of at least 100% of total outstanding advances. Additionally the Bank has
pledged mortgage-backed securities with a carrying value of approximately $16.7
million at June 30, 2002, as additional collateral. Advances at June 30, 2002
and 2001, have maturity dates as follows:
32
2002 2001
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RATE AMOUNT RATE AMOUNT
Years ending June 30:
2002 -- % $ -- 5.82% $ 8,050,000
2003 5.70 12,007,051 5.70 12,030,126
2004 5.65 9,875,000 5.65 9,875,000
2005 5.95 7,141,929 5.42 9,721,318
2006 5.92 4,859,326 5.92 4,889,509
2007 5.91 6,477,709 6.14 8,400,629
Thereafter 6.06 41,902,921 6.05 38,949,112
---- ----------- ---- -----------
Total 5.93% $82,263,936 5.88% $91,915,694
==== =========== ==== ===========
10. INCOME TAXES
Income tax provisions (benefits) are summarized as follows:
YEARS ENDED JUNE 30,
-----------------------------------------------
2002 2001 2000
Income tax provision (benefit):
Current $ 330,065 $ (64,464) $ 136,209
Deferred (269,038) (403,424) (477,356)
--------- --------- ---------
Total $ 61,027 $(467,888) $(341,147)
========= ========= =========
The reasons for the differences between the statutory federal income tax
rates and the effective tax rates are summarized as follows:
YEARS ENDED JUNE 30,
-----------------------------------------------------------------------------
2002 2001 2000
Taxes at statutory rate $ 417,087 34.0% $ 51,826 34.0% $ 151,217 34.0%
Increase (decrease)
resulting from:
Tax exempt income (457,123) (37.26) (520,047) (341.18) (503,043) (113.11)
Disallowed interest expense 66,972 5.46 85,650 56.19 67,735 15.23
Change in estimate 0 0.00 (67,000) (43.95) 0 0.00
Compensation (38,289) (3.12) (19,825) (13.01) (77,301) (17.38)
Other, net 72,380 5.89 1,508 0.99 20,245 4.56
--------- ---- --------- ------- --------- ------
Total $ 61,027 4.97% $(467,888) (306.96)% $(341,147) (76.70)%
========= ==== ========= ======= ========= ======
During the year ended December 31, 1996, new legislation was enacted which
provides for the recapture into taxable income of certain amounts previously
deducted as additions to the bad debt reserves for income tax purposes. The Bank
changed its method of determining bad debt reserves for tax purposes following
the year ended June 30, 1997. The amounts to be recaptured for income tax
reporting purposes are considered by the Bank in the determination of the net
deferred tax liability.
The Company's deferred tax asset account was comprised of the following at
June 30:
2002 2001
Deferred tax assets:
Allowance for loan losses $ 543,084 $ 326,016
Unrealized loss on available for sale investments -- 81,165
Deferred compensation 388,868 312,942
Net operating loss carryforward 801,281 1,147,149
AMT credit carryforward 445,313 278,496
Other 140,367 13,425
----------- ----------
33
Total deferred tax assets 2,318,913 2,159,193
----------- ----------
Deferred tax liabilities:
Premises and equipment 106,624 262,610
Unrealized gains on available for sale investments 960,427 --
Investment premiums and discount -- 10,432
Loan fees 1,200 1,553
FHLB dividends 465,675 327,057
----------- ----------
Total deferred tax liabilities 1,533,926 601,652
----------- ----------
Net deferred tax asset $ 784,987 $1,557,541
=========== ==========
A deferred tax liability has not been recognized for the bad debt reserves
of the Bank created in the tax years which began prior to December 31, 1987 (the
base year). At June 30, 2002, the amount of these reserves totaled approximately
$3,462,590 with an unrecognized deferred tax liability of $1,177,281. Such
unrecognized deferred tax liability could be recognized in the future, in whole
or in part, if (i) there is a change in federal tax law, (ii) the Bank fails to
meet certain definitional tests and other conditions in the federal tax law,
(iii) certain distributions are made with respect to the stock of the Bank, or
(iv) the bad debt reserves are used for any purpose other than absorbing bad
debt losses.
The Company has a net operating loss carryforward of $2,300,832, of which
$625,146, $1,120,698, and $554,988 expire in 2019, 2020, and 2021, respectively.
The Company's AMT credit carryforward of $445,313 does not have an expiration
date.
The portion of the net deferred tax asset resulting from net operating loss
carryforward and AMT credit carryforward totals $1,246,594 as of June 30, 2002.
The Company has approved a tax-planning strategy intended to provide for the
realization of these carryforwards. The success of this strategy is contingent
on several factors including (1) the sale of a sufficient amount of tax-exempt
investment securities and corresponding reduction in tax-exempt income and
increase in taxable income and (2) sufficient taxable earnings from operations
or other sources to provide aggregate net taxable income and permit utilization
of the carryforwards prior to their expirations. Should this strategy not result
in a sufficient amount of net taxable income, the Company will determine the
need for a valuation allowance for the portion of the net deferred tax asset
resulting from the carryforwards. This tax strategy does not anticipate
significant taxable gains on the sale of the tax exempt securities, but rather a
shift of nontaxable interest income to taxable interest income.
11. BENEFIT PLANS
EMPLOYEE STOCK OWNERSHIP PLAN - The Company has established an employee
stock ownership plan ("ESOP") to benefit substantially all employees. The ESOP
has a note payable to Bancshares, the proceeds from which were used to purchase
shares of common stock of Bancshares.
The note receivable, presented in the statements of stockholders' equity as
unearned ESOP shares, is to be repaid in installments of $211,600 on June 30th
each year through 2006. Interest is based upon the prime rate, which is to be
adjusted and paid annually. The note may be prepaid without penalty. The ESOP is
funded by contributions made by the Bank in amounts sufficient to retire the
debt. Compensation expense of $288,665, $179,882, and $163,578 was recognized
during the years ended June 30, 2002, 2001 and 2000, respectively.
Shares no longer required to be held to collateralize the debt and earnings
from the common stock held by the ESOP are allocated among participants on the
basis of compensation in the year of allocation. Benefits become 100% vested
after three years of credited service. Forfeitures of nonvested benefits will be
reallocated among remaining participating employees in the same proportion as
contributions. At both June 30, 2002 and 2001, 21,160 shares were committed to
be released by the ESOP to participant accounts. At June 30, 2002, there were
126,960 shares allocated to participant accounts and 84,640 unallocated shares.
The fair value of the unallocated shares amounted to approximately $1,265,368
(84,640 shares at $14.95 per share) at June 30, 2002.
Participants with vested account balances leaving employment, generally,
may elect to have their allocated shares distributed. In the case of a
distribution of shares, which at the time of distribution are not readily
tradable on an established securities market, the Company is required to issue a
put option to the participant. The put option is priced using the fair market
value as determined as of the most recent valuation date (prior to the exercise
of such
34
right) by an independent appraiser. Any excess of the total purchase
price at which the participant may put the shares to the Company over the fair
value of the shares at the date of the issuance of the option is recognized as
expense to the Company with the fair value of the shares recorded as treasury
stock. During the years ended June 30, 2002, and June 30, 2001, no put options
were issued. During the year ended June 30, 2000, put options were issued to two
employees but without any material expense to the Company.
STOCK OPTION PLAN - The Stock Option Plan ("SOP"), approved by the
Company's stockholders during the year ended June 30, 1998, provides for a
committee of the Company's Board of Directors to award incentive or
non-incentive stock options, representing up to 317,400 shares of Company stock.
Options granted to executive officers and directors vest 25% immediately and 25%
on each of the three subsequent anniversary dates of the grant. Options granted
to employee's vest 20% immediately upon grant, with the balance vesting in equal
amounts on the four subsequent anniversary dates of the grant. Options granted
vest immediately in the event of disability or death. Outstanding stock options
can be exercised over a ten-year period from the date of grant. Vested options
of terminated participants expire one year after the participant's termination
date.
Under the SOP, options have been granted to directors and key employees to
purchase common stock of the Company. The exercise price in each case equals the
fair market value of the Company's stock at the date of grant. No new options
were granted during the years ended June 30, 2002, 2001, or 2000.
A summary of the status of the Company's stock option plan as of June 30,
2002, and changes during the years ending June 30, 2001 and 2000, is presented
below:
WEIGHTED
AVERAGE
EXERCISE
OPTIONS SHARES PRICE
Outstanding at June 30, 1999 315,296 $ 9.14
Granted -- --
Exercised -- --
Forfeited 2,316 9.22
------- ----
Outstanding at June 30, 2000 312,980 9.14
Granted -- --
Exercised -- --
Forfeited 18,513 9.18
------- ----
Outstanding at June 30, 2001 294,467 9.14
------- ----
Granted -- --
Exercised 50,473 9.14
Forfeited 25,444 9.13
------- ----
Outstanding at June 30, 2002 218,550 9.14
------- ----
Options exercisable at June 30, 2002 (vested) 216,330 $ 9.13
======= ====
Exercise prices for options outstanding at June 30, 2002, range from $9.125
to $9.375 per share. The weighted average remaining contractual life of such
shares was 5.9 years at June 30, 2002.
The Company applies the provisions of Accounting Principles Board Opinion
No. 25 in accounting for its stock option plan, as allowed under SFAS No. 123,
Accounting for Stock-Based Compensation. Accordingly, no compensation cost has
been recognized for options granted to employees. Had compensation cost for
these plans been determined based on the fair value at the grant dates or
repricing date for awards under those plans consistent with the methods of SFAS
No. 123, the Company's pro forma net income and pro forma earnings per share
would have been as follows:
35
2002
AS REPORTED PRO FORMA
Net income (in thousands) $ 1,166 $ 1,146
Earnings per share:
Basic $ 0.71 $ 0.70
Diluted $ 0.68 $ 0.67
2001
AS REPORTED PRO FORMA
Net income (in thousands) $ 620 $ 529
Earnings per share:
Basic $ 0.33 $ 0.28
Diluted $ 0.33 $ 0.28
2000
AS REPORTED PRO FORMA
Net income (in thousands) $ 786 $ 676
Earnings per share:
Basic $ 0.40 $ 0.34
Diluted $ 0.40 $ 0.34
In determining the above pro forma disclosure, the fair value of options
granted was estimated on the date of grant using the binomial option-pricing
model with the following weighted average assumptions:
1999 1998
GRANTS GRANTS
Volatility 54% 15%
Life of options 7.5 years 7.5 years
Risk-free interest rate 5.3% 5.7%
Dividend rate 2.56% 2.63%
The weighted average fair value of options granted during the fiscal year
ended June 30, 1999, was $2.25 per share.
MANAGEMENT RECOGNITION PLAN - The Management Recognition Plan ("MRP"),
approved by the Company's stockholders during the year ended June 30, 1998,
provides for a committee of the Company's Board of Directors to award restricted
stock to key officers as well as non-employee directors. The MRP authorizes the
Company to grant up to 52,900 shares of Company stock, all of which were granted
during 1998. Compensation expense is recognized based on the fair market value
of the shares on the grant date of $16.00 over the vesting period. Under the
original plan, shares granted to directors (37,024, of which 1,322 were
forfeited as of June 30, 2002) vest 25% at the grant date and 25% each May 1
afterward. Shares granted to non-directors (15,876, of which 1,908 were
forfeited as of June 30, 2002) vest 20% at the grant date and 20% each May 1
afterward. Shares granted will be deemed vested in the event of disability, or
death. At June 30, 2002, all shares have been acquired that are necessary to
meet the Plan's award requirements. The difference between the price at the date
of grant and the actual purchase price was recorded as an adjustment to
stockholders' equity. Approximately $40,000, $65,000 and $170,000 in
compensation expense was recognized during the years ended June 30, 2002, 2001,
and 2000, respectively. On May 17, 2000, all directors voluntarily elected to
extend their vesting period three additional years to May 1, 2004. In addition,
certain officers also voluntarily elected to adopt the three-year extension of
their vesting period.
36
DEFINED BENEFIT PLAN - The Bank had a qualified, noncontributory defined
benefit retirement plan (the "Plan") covering all of its eligible employees.
Employees were eligible when they had attained at least twenty-one years of age
and six months of service with the Bank. The Board of Directors initially
adopted a resolution on July 1, 1996, to terminate the Plan as of September 16,
1996, and to freeze benefit accruals as of July 31, 1996. The Company
experienced delays in terminating the Plan and on June 18, 1998, a resolution
was adopted to terminate the Plan as of September 1, 1998, with benefit accruals
remaining frozen as of July 31, 1996. Settlement of the related pension
obligation occurred on August 30, 1999.
All active participants became fully vested for their accrued benefits. The
Plan provides that any excess assets will be allocated to participants. As such,
based on the funded status of the Plan, no gain or loss occurred upon
settlement.
OFFICERS' AND DIRECTORS RETIREMENT PLAN - During the year ended June 30,
1996, the Bank adopted a "non-qualified" retirement plan for its officers and
directors in recognition of their years of service to the Bank. The plan is an
annuity contract plan whereby funds are to be set aside annually in a grantor
trust, with the Bank acting as trustee of the Trust. Distributions are scheduled
to be paid upon completion of six to ten years of service to the Bank. No tax
deduction for the Plan is claimed until funds are paid to the beneficiaries.
Future funding is dependent on continued service to the Bank and therefore is
expensed as the plan is funded each year. For the years ended June 30, 2002,
2001 and 2000, contributions to the plan totaled approximately $124,000,
$181,000, and $184,000, respectively.
401(k) PLAN - Effective July 1, 1993, employees of the Bank may participate
in a 401(k) savings plan, whereby the employees may elect to make contributions
pursuant to a salary reduction agreement upon reaching age 21 and completing one
year of service. At its discretion, the Bank may make matching contributions to
the plan. Employer contributions vest 20% each year beginning in the third year
of service and become 100% vested in seven years. The Bank made no matching
contribution during the years ended June 30, 2002, 2001 or 2000.
EMPLOYMENT AGREEMENTS - Certain executive officers of the Bank and the
Company have employment agreements with one to three year renewable terms. Such
agreements provide for termination pay and other benefits under certain
circumstances. As of June 30, 2002, aggregate termination pay is approximately
$0.90 million.
CHANGE-IN-CONTROL AGREEMENTS - As of June 30, 2002, certain officers of the
Bank and the Company had change-in-control agreements with three-year renewable
terms. Such agreements provide for benefits under circumstances of
changes-in-control as defined in the agreements. The benefits provide for a
range of 25% to 299% of the officers' compensation. As of June 30, 2002, the
aggregate benefits total approximately $0.70 million.
12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
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 standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the consolidated statements of
financial condition. The Company does not use financial instruments with
off-balance sheet risk as part of its asset/liability management program or for
trading purposes. 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 and standby letters of credit is represented by the contractual
amounts of those instruments. The Company uses the same credit policies in
making commitments and conditional obligations as it does for on-balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the credit
applicant. Such collateral consists primarily of residential properties. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.
37
The Company had the following outstanding commitments at June 30, 2002:
Undisbursed construction loans $4,614,879
Commitments to originate mortgage loans 1,330,150
Commitments to originate commercial loans 149,500
Unused lines of credit 1,569,169
----------
Total $7,663,698
==========
The funding period for construction loans is generally less than nine
months and commitments to originate mortgage loans are generally outstanding for
60 days or less. At June 30, 2002, interest rates on commitments are believed by
management to approximate market rates.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair values of financial instruments are as follows:
JUNE 30, 2002 JUNE 30, 2001
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
ASSETS:
Cash and due from banks $ 3,492,257 $ 3,492,257 $ 3,302,540 $ 3,302,540
Interest bearing deposits with banks 14,404,572 14,404,572 15,107,481 15,107,481
Investment securities:
Available for sale 118,198,564 118,198,564 120,082,177 120,082,177
Loans receivable, net 124,176,898 127,424,573 131,651,421 133,015,674
Accrued interest receivable 1,721,612 1,721,612 2,017,188 2,017,188
Federal Home Loan Bank stock 4,709,900 4,709,900 4,735,800 4,735,800
LIABILITIES:
Deposits:
Demand, NOW, money
market and statement savings 53,015,098 53,015,098 50,692,221 50,692,221
Certificates of deposit 111,990,085 112,396,949 110,592,958 111,361,694
Federal Home Loan Bank advances 82,263,936 86,780,344 91,915,694 92,800,235
Advance payments by
borrowers for taxes and insurance 110,446 110,446 199,470 199,470
Accrued interest payable 740,008 740,008 972,900 972,900
Note payable -- -- 80,000 80,019
For cash and due from banks, interest bearing deposits with banks, Federal
Home Loan Bank stock and accrued interest receivable, the carrying value is a
reasonable estimate of fair value primarily because of the short-term nature of
instruments or, as to Federal Home Loan Bank stock, the ability to sell the
stock back to the Federal Home Loan Bank at cost. The fair value of investment
securities is based on quoted market prices, dealer quotes and prices obtained
from independent pricing services. The fair value of loans receivable is
estimated based on present values using the rates currently offered for loans of
similar remaining maturities at the reporting date.
38
The fair value of demand deposit accounts, NOW accounts, savings accounts
and money market deposits is the amount payable on demand at the reporting date.
The fair value of fixed-maturity certificates of deposit, Federal Home Loan Bank
advances, and note payable is estimated using the rates currently offered for
deposits and borrowings of similar remaining maturities at the reporting date.
For advance payments by borrowers for taxes and insurance and accrued interest
payable the carrying value is a reasonable estimate of fair value, primarily
because of the short-term nature of instruments. Commitments are generally made
at prevailing interest rates at the time of funding and are relatively short
term. Therefore, there is no difference between the contract amount and fair
value.
The fair value estimates presented herein are based on pertinent
information available to management as of June 30, 2002 and 2001. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since the reporting date
and, therefore, current estimates of fair value may differ significantly from
the amounts presented herein.
14. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. In addition, the Company is a
defendant in certain claims and legal actions arising in the ordinary course of
business. In the opinion of management, after consultation with legal counsel,
the ultimate disposition of these matters is not expected to have a material
adverse effect on the consolidated financial statements of the Company.
In May, 1999, a shareholder filed a putative class action complaint against
the Company and several current and former officers alleging that the defendants
defrauded the plaintiff and other shareholder class members through various
public statements and reports that had the supposed effect of artificially
inflating the price the plaintiff and other putative class members paid to
purchase the Company's common stock.
The Company and the other defendants moved to dismiss the complaint. The
federal district court granted the motion on March 31, 2001, but allowed
plaintiffs 30 days from the date of the order to file an amended class action
complaint. On August 28, 2001, the Company was informed by the federal district
court that the case was dismissed with prejudice on August 27, 2001.
15. RETAINED EARNINGS
Upon the Conversion, the Company established a special liquidation account
for the benefit of eligible account holders and the supplemental eligible
account holders in an amount equal to the net worth of the Bank as of the date
of its latest statement of financial condition contained in the final offering
circular used in connection with the Conversion. The liquidation account will be
maintained for the benefit of eligible account holders and supplemental eligible
account holders who continue to maintain their accounts in the Bank after
Conversion. In the event of a complete liquidation (and only in such event),
each eligible and supplemental eligible account holder will be entitled to
receive a liquidation distribution from the liquidation account in an amount
proportionate to the current adjusted qualifying balances for accounts then
held.
The Bank may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause the Bank's stockholders' equity to be
reduced below applicable regulatory capital maintenance requirements for insured
institutions or below the amount of the special liquidation account referred to
above. This requirement effectively limits the dividend paying ability of the
Company in that the Company must maintain an investment in equity of the Bank
sufficient to enable the Bank to meet its requirements as noted above. Required
capital amounts are shown in Note 16 to the consolidated financial statements.
Liquidation account balances are not maintained because of the cost of
maintenance and the remote likelihood of complete liquidation. Additionally, the
Bank is limited to distributions it may make to Bancshares without OTS approval
if the distribution would cause the total distributions to exceed the Bank's net
income for the year to date plus the Bank's net income (less distributions) for
the preceding two years. Bancshares may use assets other than its investment in
the Bank as a source of dividends.
39
16. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory--and possible additional discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of tangible capital (as defined in the regulations) to tangible assets
(as defined) and core capital (as defined) to adjusted total assets (as
defined), and of total risk-based capital (as defined) to risk-weighted assets
(as defined).
As of June 30, 2002 and 2001, the most recent notification from the Office
of Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum core (Tier I core), Tier I
risk-based, and total risk-based ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the tables:
TO BE CATEGORIZED
AS WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------------- ---------------- ------ -----
AS OF JUNE 30, 2002:
Tier I (Core) Capital to Adjusted Total Assets $ 21,396 7.88 % $ 10,861 4.00 % $ 13,576 5.00 %
Total Risk-Based Capital to Risk-weighted Assets 23,025 17.06 % 10,798 8.00 % 13,497 10.00 %
Tier I (Core) Capital to Risk-weighted Assets 21,396 15.85 % N/A N/A 8,098 6.00 %
Tangible Capital to Tangible Assets 21,396 7.88 % 4,073 1.50 % N/A N/A
AS OF JUNE 30, 2001:
Tier I (Core) Capital to Adjusted Total Assets $ 29,132 10.20 % $ 11,420 4.00 % $ 14,274 5.00 %
Total Risk-Based Capital to Risk-weighted Assets 30,578 22.17 % 11,032 8.00 % 13,790 10.00 %
Tier I (Core) Capital to Risk-weighted Assets 29,132 21.12 % N/A N/A 8,274 6.00 %
Tangible Capital to Tangible Assets 29,132 10.20 % 4,282 1.50 % N/A N/A
Regulations require the Bank to maintain an amount equal to 4% of deposits
(net of loans collateralized by deposits) plus short-term borrowings in cash and
U.S. Government and other approved securities.
40
17. PARENT COMPANY ONLY FINANCIAL INFORMATION
The following condensed statements of financial condition as of June 30,
2002 and 2001, and condensed statements of income and cash flows for the years
ended June 30, 2002, 2001 and 2000, for HCB Bancshares, Inc. should be read in
conjunction with the consolidated financial statements and the notes herein.
HCB BANCSHARES, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2002 AND 2001
ASSETS 2002 2001
Deposit in Bank $ 1,221,185 $ 515,975
Cash equivalents 175,817 134,522
----------- -----------
Cash and cash equivalents 1,397,002 650,497
Investment in Bank 21,927,797 29,861,612
Loans receivable 1,060,298 700,000
Investment securities 70,240 40,800
Other assets 821,076 909,850
----------- -----------
TOTAL ASSETS $25,276,413 $32,162,759
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 143,058 $ 228,425
Stockholders' equity 25,133,354 31,934,334
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $25,276,413 $32,162,759
=========== ===========
CONDENSED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
INCOME: 2002 2001 2000
Dividend from Bank $ 9,000,000 $ 1,000,000 $ --
Interest and dividend income 205,248 230,421 346,007
----------- ----------- -----------
Total income 9,205,248 1,230,421 346,007
EXPENSES:
Operating expenses 48,944 191,509 301,181
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND DISTRIBUTIONS IN
(EXCESS) LESS THAN BANK SUBSIDIARY INCOME 9,156,304 1,038,912 44,826
INCOME TAX PROVISION 59,849 13,000 15,242
----------- ----------- -----------
INCOME BEFORE DISTRIBUTIONS IN (EXCESS) LESS
THAN BANK SUBSIDIARY INCOME 9,096,455 1,025,912 29,584
DISTRIBUTIONS IN (EXCESS) LESS THAN BANK
SUBSIDIARY INC (7,930,755) (405,596) 756,318
----------- ----------- -----------
NET INCOME $ 1,165,700 $ 620,316 $ 785,902
=========== =========== ===========
41
HCB BANCSHARES, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2002, 2001 AND 2000
OPERATING ACTIVITIES: 2002 2001 2000
Net income $ 1,165,700 $ 620,316 $ 785,902
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Distributions in excess (less) than bank subsidiary income 7,930,755 405,596 (756,318)
Changes in operating assets and liabilities:
Other assets 239,824 (259,752) 954,507
Accrued expenses and other liabilities (194,647) 228,425 (1,179,190)
------------- ------------ ------------
Net cash provided (used) by operating activities 9,141,632 994,585 (195,099)
------------- ------------ ------------
INVESTING ACTIVITIES:
Purchase loan, net of repayments (360,298) -- 1,713,019
------------- ------------ ------------
Net cash provided (used) by investing activities (360,298) -- 1,713,019
------------- ------------ ------------
FINANCING ACTIVITIES:
Dividends paid (472,296) (474,299) (506,929)
Purchase of treasury stock, net (7,562,533) (1,038,686) (2,708,518)
------------- ------------ ------------
Net cash used by financing activities (8,034,829) (1,512,985) (3,215,447)
------------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 746,505 (518,400) (1,697,527)
CASH AND CASH EQUIVALENTS:
Beginning of period 650,497 1,168,897 2,866,424
------------- ------------ ------------
End of period $ 1,397,002 $ 650,497 $ 1,168,897
============= ============ ============
42
18. OTHER COMPREHENSIVE INCOME
The amount of income tax expense or benefit allocated to each component of
comprehensive income, including reclassification adjustments, are shown below:
YEAR ENDED JUNE 30, 2002
-----------------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
AMOUNT
UNREALIZED GAINS ON SECURITIES:
Unrealized holding gain on securities
arising during period $ 2,544,652 $ (1,041,592) $ 1,503,060
Less reclassification adjustment for
(gains) losses included in net income (1,518) -- (1,518)
------------- ------------ -----------
Other comprehensive income $ 2,543,134 $ (1,041,592) $ 1,501,542
============= ============ ===========
YEAR ENDED JUNE 30, 2001
-----------------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
AMOUNT
UNREALIZED GAINS ON SECURITIES:
Unrealized holding gain on securities
arising during period $ 7,236,824 $ 2,894,756 $ 4,342,068
Less reclassification adjustment for
(gains) losses included in net income -- -- --
------------- ----------- -----------
Other comprehensive income $ 7,236,824 $ 2,894,756 $ 4,342,068
============= =========== ===========
YEAR ENDED JUNE 30, 2000
-----------------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
AMOUNT
UNREALIZED LOSSES ON SECURITIES:
Unrealized holding loss on securities
arising during period $ (2,991,525) $ (1,210,530) $ (1,780,995)
Less reclassification adjustment for
(gains) losses included in net income -- -- --
------------ ------------ ------------
Other comprehensive loss $ (2,991,525) $ (1,210,530) $ (1,780,995)
============ ============ ============
19. SUBSEQUENT EVENTS
On July 19, 2002, the bank sold its Monticello branch to Simmons First Bank
of South Arkansas. The sale included approximately $8.3 million in loans, $1.5
million in fixed assets, $0.2 million in other assets, and $13.2 million in
deposits. The bank recognized a premium on the deposits of approximately $0.9
million and the difference was paid in cash to the buyer. The resulting after
tax gain on the sale of the Monticello branch of approximately $440,000
translates into $0.29 in earnings per share.
43
CORPORATE INFORMATION
DIRECTORS MAIN OFFICE:
Vida H. Lampkin 237 Jackson Street, S.W.
Chairman of the Board Camden, Arkansas
Cameron D. McKeel BRANCH OFFICES:
President and Chief
Executive Officer 4937 Highway 5 North
Bryant, Arkansas
Bruce D. Murry
Retired Owner, Bruce's 1125 Fairview Road SW
Camden, Arkansas Camden, Arkansas
Carl E. Parker, Jr. 610 West 4th Street
General Manager, Camden Monument Co. Fordyce, Arkansas
Camden, Arkansas
473 Highway 425 North
Clifford Steelman Monticello, Arkansas
Retired Human Resource Administrator,
Camden, Arkansas 108 South Main Street
Sheridan, Arkansas
F. Michael Akin
President, CEO - Akin Industries INDEPENDENT AUDITOR:
Monticello, Arkansas
BKD, LLP
John G. Rich 400 West Capital
Of Counsel, Eppenstein & Eppenstein Suite 2500, P.O. Box 3667
New York, New York Little Rock, AR 72203-3667
EXECUTIVE OFFICERS: GENERAL COUNSEL:
Charles T. Black Robert S. Laney
Senior Vice President and Chief P.O. Box 777
Lending Officer Camden, Arkansas 71711-0777
Paula J. Bergstrom
Senior Vice President Administration SECURITIES AND REGULATORY
and Secretary COUNSEL:
Scott A. Swain
Senior Vice President and Chief Stradley Ronon Stevens & Young, LLP
Financial Officer 1220 19th Street, N.W., Suite 700
ANNUAL STOCKHOLDERS MEETING: Washington, D.C. 20036
November 21, 2002 - 10:00 a.m. STOCK REGISTRAR & TRANSFER
Camden Country Club AGENT:
1915 Washington Street SW
Camden, Arkansas 71701 Registrar and Transfer Company
Record Date - October 7, 2002 Cranford, New Jersey 07016-3572
ANNUAL REPORT ON FORM 10-K:
A copy of the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 2002, as filed with the Securities and Exchange Commission, will be
furnished without charge to stockholders as of the record date for the 2002
Annual Meeting upon written request to: Corporate Secretary, HCB Bancshares,
Inc., 237 Jackson Street, S.W, Camden, Arkansas 71701-3941.
44