1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1997
-----------------
Securities and Exchange Commission File Number 0-25722
HF BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0576146
(State or other jurisdiction (I.R.S. Employer I.D. No.)
Of incorporation or organization)
445 E. Florida Avenue, Hemet, California 92543
(Address of principal executive offices)
Registrant's telephone number, including area code: (909) 658-4411
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
There were 6,300,906 shares of the Registrant's common stock outstanding
as of February 2, 1998.
2
HF BANCORP, INC. AND SUBSIDIARY
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION PAGE
--------------------- ----
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition as of
December 31, 1997 (unaudited), and June 30, 1997 3-4
Consolidated Statements of Operations (unaudited) for the
Three and Six Months ended December 31, 1997 and 1996 5-6
Earnings Per Share Disclosures (unaudited) 7
Changes in Stockholders' Equity (unaudited) 8
Consolidated Statements of Cash Flows (unaudited) for the
Six Months ended December 31, 1997 and 1996 9-11
Introduction 12
Description of Business 13-16
Notes to Consolidated Financial Statements (unaudited) 17-21
Recent Developments 22-25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 26-55
---------------------------------------------
PART II - OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 56
Item 2. Changes in Securities 56
Item 3. Defaults Upon Senior Securities 56
Item 4. Submission of Matters to a Vote of Security Holders 56
Item 5. Other Information 57
Item 6. Exhibits and Reports on Form 8-K 57
Signature Page 58
2
3
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Dec. 31, June 30,
1997 1997
-------- --------
(Unaudited)
(Dollars In Thousands)
ASSETS
Cash and cash equivalents $ 19,199 $18,411
Investment securities held to maturity (estimated fair value of $10,444
and $26,557 at December 31, 1997 and June 30, 1997, respectively) 10,325 26,794
Investment securities available for sale (amortized cost of $91,829
and $147,507 at December 31, 1997 and June 30, 1997, respectively) 91,641 144,997
Loans held for sale 3,861 335
Loans receivable (net of allowance for estimated loan losses of $3,981
and $4,780 at December 31, 1997 and June 30, 1997, respectively) 590,114 484,334
Mortgage-backed securities held to maturity (estimated fair value of $137,676
and $148,907 at December 31, 1997 and June 30, 1997, respectively) 138,096 151,369
Mortgage-backed securities available for sale (amortized cost of $164,266
and $108,771 at December 31, 1997 and June 30, 1997, respectively) 165,097 109,493
Accrued interest receivable 6,781 7,332
Investment in capital stock of the Federal Home Loan Bank, at cost 6,424 6,224
Premises and equipment, net 7,724 8,289
Real estate owned, net of valuation allowances
Acquired through foreclosure 5,167 5,298
Acquired for sale or investment 0 418
Intangible assets 13,295 14,471
Other assets 5,543 6,984
--------- -------
Total assets $1,063,267 $984,749
========== ========
3
4
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Continued)
Dec 31, June 30,
1997 1997
---- ----
(Unaudited)
(Dollars In Thousands Except Per Share Amounts)
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Checking deposits $ 77,799 $ 73,771
Savings deposits 103,753 111,742
Money market deposits 65,583 38,620
Certificates of deposit 608,429 615,522
------- -------
Total deposits $855,564 $839,655
Advances from the Federal Home Loan Bank 110,000 50,000
Accounts payable and other liabilities 5,739 6,888
Income taxes 8,329 7,179
--------- ----------
Total liabilities 979,632 903,722
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 15,000,000 shares authorized; 6,612,500 issued,
6,292,975 outstanding at December 31, 1997 and 6,281,875 outstanding at 66 66
June 30, 1997
Additional paid-in capital 51,331 51,355
Retained earnings, substantially restricted 39,670 38,441
Net unrealized gain (loss) on securities available for sale, net of taxes 378 (1,050)
Deferred stock compensation (4,575) (4,437)
Treasury stock (3,235) (3,348)
------------ ----------
Total stockholders' equity 83,635 81,027
------------ ----------
Total liabilities and stockholders' equity $1,063,267 $984,749
============ ==========
Nominal book value per share $13.29 $12.90
Tangible book value per share $11.69 $11.15
Average market price per share on the final trading day of the period $17.50 $14.38
Shares utilized in above book value calculations 6,292,975 6,281,875
See notes to consolidated financial statements
4
5
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------- ------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars In Thousands)
INTEREST INCOME:
Interest on loans $10,647 $9,078 $20,476 $14,088
Interest on mortgage-backed securities 4,865 4,357 9,483 9,012
Interest and dividends on investment securities 3,247 4,459 7,036 9,193
-------- -------- -------- --------
Total interest income 18,759 17,894 36,995 32,293
INTEREST EXPENSE:
Interest on deposit accounts 10,370 9,988 20,753 18,127
Interest on advances from the Federal Home Loan
Bank and other borrowings 1,830 915 3,076 1,830
Net interest expense of hedging transactions 462 777 948 1,556
------- ------- -------- --------
Total interest expense 12,662 11,680 24,777 21,513
NET INTEREST INCOME BEFORE PROVISION
FOR ESTIMATED LOAN LOSSES 6,097 6,214 12,218 10,780
PROVISION FOR ESTIMATED LOAN LOSSES 300 29 400 208
------- ------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR ESTIMATED LOAN LOSSES 5,797 6,185 11,818 10,572
OTHER INCOME (EXPENSE):
Loan and other fees 99 96 197 148
Loss from real estate operations, net (198) (135) (641) (187)
Gain on sale of mortgage-backed and investment
securities available for sale 6 664 62 1,030
Gain on sale of loans held for sale 44 10 70 10
Deposit related fees 620 412 1,071 582
Other income 30 30 91 151
Amortization of intangible assets (588) (575) (1,177) (812)
------- ------- -------- ---------
Total other income (expense) 13 502 (327) 992
See notes to consolidated financial statements
5
6
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Unaudited)
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
1997 1996 1997 1996
---- ---- ----- ----
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits $2,065 $2,654 $ 4,610 $ 4,651
Occupancy and equipment expense 926 906 1,908 1,536
FDIC insurance and other assessments 181 504 362 826
SAIF special assessment 0 0 0 4,757
Legal and professional services 222 240 346 408
Data processing service costs 579 461 1,050 753
Marketing 157 150 245 308
Deposit servicing expense 38 141 67 243
Other 400 433 803 783
------- ------- ------- -------
Total general and administrative expenses 4,568 5,489 9,391 14,265
EARNINGS (LOSS) BEFORE INCOME TAX
EXPENSE (BENEFIT) 1,242 1,198 2,100 (2,771)
INCOME TAX EXPENSE (BENEFIT) 515 496 871 (1,134)
------- ------ ------ -----------
NET EARNINGS (LOSS) APPLICABLE TO BOTH BASIC AND
DILUTED EPS $ 727 $ 702 $ 1,229 $ (1,637)
====== ====== ======= ===========
SHARES APPLICABLE TO BASIC EPS 6,286,157 6,281,875 6,284,016 6,281,875
BASIC EARNINGS PER SHARE $0.12 $ 0.11 $0.20 *$(0.26)
========== ========= ========== ========
SHARES APPLICABLE TO DILUTED EPS 6,499,729 6,331,434 6,476,785 6,281,875
DILUTED EARNINGS PER SHARE $0.11 $0.11 $0.19 *($0.26)
========= ========= ========== ========
*$0.18 per share, net of the after-tax effect
of the SAIF special assessment.
See notes to consolidated financial statements
6
7
HF BANCORP, INC. AND SUBSIDIARY
ADDITIONAL INFORMATION FOR EARNINGS PER SHARE DISCLOSURES
(Unaudited)
PLUS: PLUS:
Treasury Treasury
EQUALS: Shares Stock Stock EQUALS: Shares*
LESS: Shares For Method: Method: Shares* For
Average Average For Fiscal Shares Shares For Fiscal Quarterly
Total Shares Quarterly YTD For For Quarterly YTD Average
Quarter Shares Treasury BASIC BASIC Stock Stock DILUTED DILUTED Share
Ending Issued Stock EPS EPS Options Awards EPS EPS Price
------ ------ ----- --- --- ------- ------ --- --- -----
09/30/96 6,612,500 330,625 6,281,875 6,281,875 25 10 6,281,910 6,281,910 $9.54
12/31/96 6,612,500 330,625 6,281,875 6,281,875 41,097 8,462 6,331,434 6,306,672 $10.86
03/31/97 6,612,500 330,625 6,281,875 6,281,875 91,746 15,492 6,389,113 6,334,152 $12.47
06/30/97 6,612,500 330,625 6,281,875 6,281,875 113,369 18,232 6,413,476 6,353,983 $13.47
09/30/97 6,612,500 330,625 6,281,875 6,281,875 148,044 23,922 6,453,841 6,453,841 $14.94
12/31/97 6,612,500 326,343 6,286,157 6,284,016 184,928 30,785 6,499,729 6,476,785 $16.60
HF Bancorp, Inc. Stock Based Incentive Plan: Stock Option Information
Stock Stock Average
Options Stock Options Exercise
Stock Stock Cumulatively Options Available Price Of
Options Options Vested & Cumulatively For Future Vested
Date Authorized Outstanding Outstanding Exercised Grants Options
---- --------- ----------- ----------- --------- ------ -------
09/30/96 661,250 630,340 0 0 30,910 N/A
12/31/96 661,250 618,250 0 0 43,000 N/A
03/31/97 661,250 528,853 112,850 0 132,397 $10.05
06/30/97 661,250 523,185 109,182 0 138,065 $10.04
09/30/97 661,250 638,545 125,182 0 22,705 $10.59
12/31/97 811,250 629,945 115,882 11,100 170,205 $10.65
HF Bancorp, Inc. Stock Based Incentive Plan: Stock Award Information
Stock
Awards
Stock Stock Stock Available
Awards Awards Awards For Future
Date Authorized Outstanding Vested Grants
---- ---------- ----------- ------ ------
09/30/96 198,375 195,075 0 3,300
12/31/96 198,375 189,801 0 8,574
03/31/97 198,375 121,887 37,294 39,194
06/30/97 198,375 121,227 37,954 39,194
09/30/97 198,375 154,527 37,954 5,894
12/31/97 198,375 154,527 37,954 5,894
*Applicable in the event of positive earnings.
7
8
HF BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Six Months Ended December 31, 1997
(Unaudited)
Common Additional Retained Unrealized Deferred stock Treasury Total
stock paid-in earnings gain (loss) compensation stock
capital on
securities
available
for sale
------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Balance at June 30, 1997 $66 $51,355 $38,441 ($1,050) ($4,437) ($3,348) $81,027
Net income for the six months
ended December 31, 1997 -- -- 1,229 -- -- -- 1,229
Change in net unrealized loss on
securities available for sale, net
of taxes -- -- -- 1,428 -- -- 1,428
Change in deferred stock
compensation -- (23) -- -- (138) -- (161)
Utilization of Treasury shares for
exercised stock options (1) 113 112
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $66 $51,331 $39,670 $378 ($4,575) ($3,235) $83,635
================================================================================================
See notes to consolidated financial statements
8
9
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS
ENDED DECEMBER 31
------------------
1997 1996
---- ----
(Dollars In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 1,229 $ (1,637)
Adjustments to reconcile net earnings (loss)
to net cash provided by (used in) operating activities:
Origination of loans held for sale (9,298) (457)
Proceeds from sale of loans held for sale 5,507 467
Provisions for estimated loan and real estate losses 960 317
Direct write-offs from real estate operations -- 49
Depreciation and amortization 651 551
Amortization of deferred loan fees (421) (347)
Amortization (accretion) of premiums (discounts) on loans
and investment and mortgage-backed securities, net 161 (64)
Amortization of intangible assets 1,177 812
Federal Home Loan Bank stock dividend (200) (199)
Gain on sales of loans held for sale (70) (10)
Loss (gain) on sales of real estate, net (25) 9
Gain on sale of mortgage-backed and investment securities, available for sale (62) (1,030)
Loss (gain) on sale of premises and equipment 19 (14)
Decrease (increase) in accrued interest receivable 551 (894)
(Decrease) increase in accounts payable and other liabilities (1,149) 2,250
Decrease in other assets 1,440 42
Other, net 83 1,452
-------- --------
Net cash provided by operating activities 553 1,297
9
10
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE SIX MONTHS
ENDED DECEMBER 31
------------------
1997 1996
---- ----
(Dollars In Thousands)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans receivable (108,610) (65,881)
Purchases of mortgage-backed securities held to maturity -- (15,039)
Purchases of mortgage-backed securities available for sale (80,163) (14,272)
Principal repayments on mortgage-backed securities held to maturity 13,131 9,379
Principal repayments on mortgage-backed securities available for sale 16,198 6,148
Purchases of investment securities held to maturity -- --
Purchases of investment securities available for sale -- (37,968)
Principal repayments on investment securities held to maturity 485 363
Principal repayments on investment securities available for sale 2,614 2,992
Proceeds from sales of mortgage-backed and investment securities available for sale 58,254 71,381
Matured / called investment and mortgage backed securities held to maturity 16,000 9,535
Matured / called investment and mortgage backed securities available for sale 3,032 35,428
Proceeds from sales of real estate acquired by foreclosure 3,063 285
Proceeds from sales of real estate held for investment 427 528
Additions to real estate owned -- (6)
Proceeds from sale of premises and equipment 43 (3)
Additions to premises and equipment (148) (1,406)
Cash payment for acquisition, net of cash received -- (14,707)
---------- --------
Net cash used in investing activities (75,674) (13,243)
10
11
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE SIX MONTHS
ENDED DECEMBER 31,
------------------
1997 1996
---- ----
(Dollars In Thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances received from FHLB $ 60,000 $ --
Proceeds from other borrowings 182,000 --
(Decrease) in certificate accounts (7,090) (43)
Net increase in NOW, passbook, money market investment and
non-interest-bearing accounts 22,999 11,752
Repayment of other borrowings (182,000) --
-------- ------
Net cash provided by financing activities 75,909 11,709
------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 788 (237)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 18,411 100,633
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,199 $ 100,396
======== =========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposit accounts and other borrowings $ 4,857 $ 3,648
========= =========
Income taxes paid -- --
========= =========
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES:
Real estate acquired through foreclosure $ 3,823 $ 1,022
Loans to facilitate sale of real estate through foreclosure $ 358 $ 481
Purchase of Palm Springs Savings Bank:
Fair value of assets purchased, excluding cash $ -- $ 184,321
Fair value of liabilities assumed -- 169,614
--------- ---------
Cash payment for acquisition, net of cash received $ -- $ 14,707
========= =========
See notes to consolidated financial statements
11
12
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
INTRODUCTION
In addition to historical information, this document may include certain
forward looking statements within the meaning of the Private Securities Reform
Act of 1995 (the "Reform Act"). These forward looking statements relate to,
among other things, expectations of the business environment in which the
Company operates, projections of future performance, perceived opportunities in
the market, and statements regarding the Company's mission and vision. These
forward looking statements are based upon current management expectations, and
therefore may involve risks and uncertainties. The Company's actual results,
performance, or achievements may differ materially from those suggested,
expressed, or implied by the forward looking statements due to a wide range of
factors, including, but not limited to:
o vacillation in general economic conditions
o legislative and regulatory changes
o monetary and fiscal policies of the federal government
o changes in tax policies, rates and regulations of federal, state, and
local tax authorities
o fluctuations in interest rates
o variation in the cost of funds
o changes in demand for the Company's products and services
o actions by competitors
o changes in the composition of the Company's loan and investment portfolios
o variation in the credit quality of the Company's assets
o alterations in accounting principles, policies, or guidelines
o changes in other economic, competitive, government, and technological
factors
Further description of the risks and uncertainties to the Company and its
business are presented in Form 10-K "Item 1. Description Of Business -- Factors
That May Affect Future Results".
12
13
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
H.F. Bancorp, Inc. (referred to herein on an unconsolidated basis as "HFB"
and on a consolidated basis as the "Company") is a savings and loan holding
company incorporated in the State of Delaware that was organized for the purpose
of acquiring all of the capital stock of Hemet Federal Savings & Loan
Association (the "Bank") upon its conversion from a federally chartered mutual
savings association to a federally chartered stock savings association. On June
30, 1995, the Company completed its sale of 6,612,500 shares of common stock,
and used approximately 50% of the $51.1 million in net proceeds to purchase all
of the Bank's common stock issued in the Bank's conversion to stock form. Such
business combination was accounted for at historical cost in a manner similar to
a pooling of interests.
HFB's principal business is to serve as a holding company for the Bank and
for other banking or banking related subsidiaries which the Company may
establish or acquire. As a legal entity separate and distinct from its
subsidiaries, HFB's principal source of funds is its existing capital and
assets, and future dividends paid by and other funds advanced from its
subsidiaries. Legal limitations are imposed on the amount of dividends that may
be paid and loans that may be made by the Bank to HFB. The Company's common
stock is listed on the Nasdaq National Market ("NASDAQ") under the symbol
"HEMT".
At December 31, 1997, the Company had $1,063.3 million in total assets,
$590.1 million in total net loans receivable, and $855.6 million in total
deposits. The Company is subject to regulation by the Office Of Thrift
Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC"), and the
Securities and Exchange Commission ("SEC"). The principal executive offices of
the Company and the Bank are located at 445 East Florida Avenue, Hemet,
California, 92543, telephone number (909) 658 - 4411, toll free (800) 540-4363,
facsimile number (909) 925 - 5398. The Bank is a member of the Federal Home Loan
Bank of San Francisco ("FHLB") and its deposit accounts are insured by the FDIC
through the Savings Association Insurance Fund ("SAIF") to the maximum extent
permitted by law.
13
14
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
On September 27, 1996, Hemet Federal Savings & Loan Association
consummated the acquisition of Palm Springs Saving Bank ("PSSB") by purchasing
their 1,131,446 shares of common stock for $16.3 million. The acquisition was
accounted for under purchase accounting guidelines and therefore generated
intangible assets (see "Intangible Assets").
On June 21, 1996, the Bank entered the North San Diego County market
through the purchase of three branch offices and the assumption of deposit
liabilities totaling $185.2 million from Hawthorne Savings Bank. In conjunction
with the purchase, the Bank generated a core deposit intangible of $6.6 million,
or 3.6% of the deposits assumed (see "Intangible Assets").
The consolidated financial statements include the accounts of HF Bancorp,
Inc. and its wholly-owned subsidiary Hemet Federal Savings & Loan Association
and its wholly-owned subsidiaries, HF Financial Corporation, Coachella Valley
Financial Services Corporation ("CVFSC"), PSSB Insurance Services, Inc.
("PSSBI") and HF Financial Corporation's subsidiary, First Hemet Corporation
(collectively, the Company). CVFSC served as the trustee on deeds of trust held
by Palm Springs Savings Bank. This service has been transferred to First Hemet
Corporation. PSSBI was formed to offer life insurance and other investment
products to customers of PSSB. In September of 1994, PSSBI discontinued
marketing debt and equity securities, including mutual funds, to the general
public and the PSSB customer base. HF Bancorp, Inc. and Hemet Federal are
currently in the process of consolidating HF Financial Corporation, CVFSC, and
PSSBI with and into First Hemet Corporation. First Hemet Corporation engages in
trustee services for the Bank, and receives commissions from the sale of
mortgage life insurance, fire insurance, and annuities. All material
intercompany transactions, profits, and balances have been eliminated.
14
15
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
The Company conducts business from nineteen branch offices and one
centralized loan servicing center, located as follows:
Greater Hemet / San Jacinto Valley Area
- ----------------------------------------
Hemet - Diamond Valley
Hemet - Downtown (Main Office)
Hemet - East
Hemet - Sanderson (Loan Service Center)
Hemet - West
Idyllwild
San Jacinto
Northern San Diego County Coachella Valley
- ------------------------- ----------------
Oceanside Cathedral City
Rancho Bernardo Desert Hot Springs
Vista Palm Springs
Rancho Mirage
Greater City Of Riverside Area Southwestern Riverside County
- ------------------------------ -----------------------------
Arlington Canyon Lake
Canyon Crest Murrieta
Tyler Mall Sun City
In addition, the Company supports its customers through 24 hour telephone
banking and ATM access through an array of networks including STAR, CIRRUS,
PLUS, and NOVUS.
15
16
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
Through its network of banking offices, the Bank emphasizes personalized
service focused upon two primary markets: households and small businesses. The
Bank offers a wide complement of lending and depository products. The Bank also
supports its customers by functioning as a federal tax depository, providing
merchant bankcard services, and supplying various forms of electronic funds
transfer. In addition, the Bank, through third party relationships, makes
various non FDIC insured investment products available to its customers,
including mutual funds and selected insurance related products.
The Company participates in the wholesale capital markets through the
management of its security portfolio and its use of various forms of wholesale
funding. The Company's security portfolio contains a variety of instruments,
including callable debentures, fixed and adjustable rate mortgage backed
securities, and collateralized mortgage obligations. The Company also
participates in the secondary market for loans as both a purchaser and a seller
of various types of mortgage products.
The Company's revenues are derived from interest on its loan and mortgage
backed securities portfolios, interest and dividends on its investment
securities, and fee income associated with the provision of various customer
services. The Company's primary sources of funds are deposits, principal and
interest payments on its asset portfolios, and various sources of wholesale
borrowings including FHLB advances and reverse repurchase agreements. The
Company's most significant operating expenditures are its staffing expenses and
the costs associated with maintaining its branch network.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation have been included. The results of operations for the six month
period ended December 31, 1997, are not necessarily indicative of the results
that may be expected for the entire fiscal year.
These consolidated financial statements and the information under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations" should be read in conjunction with the audited consolidated
financial statements and notes thereto of HF Bancorp, Inc. for the fiscal year
ended June 30, 1997 included in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1997.
16
17
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
Termination of Swap Agreements
- ------------------------------
On July 10, 1995, the Company terminated four interest rate swap
agreements with an aggregate outstanding notional amount of $60.0 million. At
June 30, 1995, the weighted average fixed payment rate and variable payment
received rate were 9.53% and 6.11%, respectively. The Company paid a termination
fee of $4,856,000 which has been deferred and is being amortized over the
remaining original terms of the respective swap agreements. The expected future
annual amortization is as follows: $343,000 for the last six months of fiscal
1998 and $272,000 for the fiscal year 1999. As of December 31, 1997 the
remaining deferred amount was $615,000.
Defined Benefit Plan and Retirement Restoration Plan Terminations
- -----------------------------------------------------------------
In the quarter ended June 30, 1997, the Company's management and Board Of
Directors determined to terminate two retirement plans. The defined benefit
pension plan was a traditional pension program which provided employees with
monthly retirement income based upon years of service and the employee's
earnings during the sixty months prior to retirement. The retirement restoration
plan was a non qualified supplemental plan designed to compensate certain highly
salaried employees for the impact of wage caps under the Employee Retirement
Income Security Act ("ERISA"), which are applicable to qualified plans such as
the defined benefit pension plan.
A non-recurring $3.0 million charge to accrue expenses related to the
termination of the two retirement plans was recorded in the fourth quarter of
fiscal 1997. As of December 31, 1997, all of the Plan assets had been
distributed, with vested participants receiving, at their election, either a
lump sum or an annuity contract. The Company has applied for IRS approval of the
defined benefit pension plan termination and liquidation and is in the process
of preparing a final plan annual return. While the amount accrued during the
fourth quarter of fiscal 1997 was sufficient to fund the distributions, future
events could possibly produce an actual expense total higher than that accrued.
The timing of the receipt of the IRS determination letter is beyond the
Company's control.
17
18
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
Change in Accounting Principles
- -------------------------------
Effective January 1, 1998, the Company adopted those components of SFAS
No. 125 "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES" which were postponed under SFAS No. 127
"DEFERRAL OF THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF FASB STATEMENT NO.
125". The Company has recently updated its Master Repurchase Agreements to
permit substitution of collateral involved in its repurchase agreements
conditional upon economic equivalency. Management does not believe that the
adoption of the deferred components of SFAS No. 125 will have a significant
impact on its financial statements.
Effective December 15, 1997, the Company adopted SFAS No. 128, "EARNINGS
PER SHARE". The statement establishes standards for computing and presenting
earnings per share (EPS) and applies to entities with publicly held common stock
or potential common stock. This statement modifies the standards for computing
earnings per share previously found in APB Opinion No. 15, "EARNINGS PER SHARE,"
and makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation. In addition, EPS figures for
prior periods must be restated.
Effective December 15, 1997, the Company adopted SFAS No. 129, "DISCLOSURE
OF INFORMATION ABOUT CAPITAL STRUCTURE". The statement establishes standards for
disclosing information about an entity's capital structure.
In June 1997, the FASB, issued SFAS No. 130, "REPORTING COMPREHENSIVE
INCOME" and SFAS No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND
RELATED INFORMATION". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. SFAS No. 131 establishes standards of
reporting by publicly held business enterprises and disclosure of information
about operating segments in annual financial statements and to a lesser extent,
in interim financial reports issued to shareholders. SFAS Nos. 130 and 131 are
effective for fiscal years beginning after December 15, 1997. As both SFAS Nos.
130 and 131 deal with financial statement disclosure, the Company does not
anticipate the adoption of these new standards will have a material impact on
its financial position or results of operations.
18
19
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
Stock Plans
- -----------
The Company established for eligible employees an Employee Stock Ownership
Plan and Trust ("ESOP"), which became effective upon the conversion of the Bank
from a mutual savings and loan association to a public stock company (the
"Conversion"). On June 30, 1995, the ESOP:
o subscribed for 7.0% (462,875) of the total shares (6,612,500) of common
stock issued in the Conversion pursuant to the subscription rights granted
under the ESOP plan document
o borrowed $3,703,000 from the Company under a 9.5 year loan agreement
bearing a 9.0% interest rate in order to fund the purchase of common
stock, pledging the common stock as collateral for the loan
Under the terms of the ESOP plan, shares are allocated to individual
eligible employee accounts at the conclusion of each calendar year. Under the
terms of the original loan agreement, annual principal and interest payments
were to be made to the Company at the end of each calendar year.
In December 1997, the ESOP and the Company amended their loan agreement,
implementing the following revisions:
o The loan payment for calendar year 1997 would be interest only. No loan
principal would be retired on December 31, 1997.
o The final maturity of the loan was extended from December 31, 2004 to
December 31, 2012, with an associated reduction in periodic loan principal
amortization.
As of December 31, 1997, prior to the 1997 allocation of shares to
eligible employee accounts, a cumulative total of 104,069 shares of common stock
had been allocated to individual employee accounts, leaving a remainder of
358,806 shares to be allocated over the remaining 15 year life of the ESOP,
including 17,841 shares to be assigned in conjunction with the calendar year
1997 allocation.
19
20
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
At the Company's Annual Meeting of Shareholders on January 11, 1996,
shareholders approved the Hemet Federal Savings & Loan Association 1995 Master
Stock Compensation Plan (the "Stock Compensation Plan") and the HF Bancorp, Inc.
1995 Master Stock Option Plan (the "Stock Option Plan"), both of which became
effective as of the date of approval. These two plans were established to
provide Directors and employees in key management positions with a proprietary
interest in the Company, to attract and retain highly qualified staff, and to
more directly align the objectives of the individuals with the success of the
Company.
The Stock Compensation Plan was authorized to acquire 198,375 shares of
common stock in the open market. The Bank contributed funds to the Stock
Compensation Plan to enable the Plan trustees to acquire the authorized shares
of common stock. On February 28, 1996, the Bank acquired 198,375 shares in the
open market at a price of $10.00 per share. Stock shares are held in trust.
The Stock Option Plan was authorized to issue up to 661,250 options for
the purchase of common shares, including both Incentive Stock Options and Non
Qualified Stock Options.
On May 22, 1997, the Board Of Directors of HF Bancorp, Inc. adopted the
Amended and Restated HF Bancorp, Inc. Stock Based Incentive Plan (the "Incentive
Plan"). The Incentive Plan merged the Stock Compensation Plan and the Stock
Option Plan, and amended the provisions of these plans to, among other things:
o Provide benefits that were not available when the two 1995 Plans were
adopted, including the accelerated vesting of stock awards and stock
options following a change in control of the Company or the Bank
o Eliminate a number of outdated regulatory requirements no longer necessary
due to amendments to Section 16(b) of the Securities Exchange Act of 1934
(the "Exchange Act").
At December 31, 1997, a total of 37,954 shares of stock awards have vested
under the Incentive Plan. An additional 154,527 non-vested shares have been
allocated to Directors and employees in key management positions. A total of
5,894 shares remained in the trust on an unallocated basis as of December 31,
1997. Stock awards under the Incentive Plan typically vest over a five year
period.
20
21
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
At the Company's Annual Meeting of Shareholders on October 28, 1997,
shareholders approved an amendment to the Incentive Plan, which increased the
number of option shares authorized for issuance by 150,000 shares, from 661,250
shares to 811,250 shares. The Incentive Plan retains the prior Stock
Compensation Plan's limitation of 198,375 shares authorized for stock awards.
Of the 811,250 option shares authorized under the Incentive Plan at
December 31, 1997, options representing a total of 629,945 shares were
outstanding as of that date. Of these 629,945 options, a total of 115,882
options were vested at a weighted average exercise price of $10.65, with the
exercise price of individual vested options ranging from a low of $9.50 per
share to a high of $14.34 per share. As of December 31, 1997, a total of 11,100
shares had been cumulatively exercised under the Incentive Plan or any of its
predecessor plans, and 170,205 options remained available for future grant.
Commitments and Contingencies
- -----------------------------
At December 31, 1997, the Company maintained commitments to sell $2.1
million in residential fixed rate mortgage loans on a servicing released basis
and to originate $12.7 million in various types of loans. The Company maintained
no commitments to purchase loans or assume borrowings at December 31, 1997.
21
22
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
Recent Developments
- -------------------
Year 2000 Computer Issue
------------------------
The Year 2000 Issue concerns the potential impact of historic computer
software code that only utilizes two digits to represent the calendar year (e.g.
"98" for "1998"). Software so developed could produce inaccurate or
unpredictable results upon January 1, 2000, when current and future dates
present a lower two digit year number than dates in the prior century. The
Company, similar to most financial services providers, is significantly subject
to the potential impact of the "Year 2000 Issue" due to the nature of financial
information. Potential impacts to the Company may arise from software, hardware,
and equipment both within the Company's direct control and outside of the
Company's ownership, yet with which the Company electronically or operationally
interfaces (e.g. vendors providing credit bureau information).
Financial institution regulators have recently increased their focus upon
Year 2000 issues, issuing guidance concerning the responsibilities of senior
management and directors. Year 2000 testing and certification is being addressed
as a key safety and soundness issue in conjunction with regulatory exams.
In order to address the Year 2000 issue, the Company has developed and
implemented a five phase plan divided into the following major components:
o awareness
o assessment
o renovation
o validation
o implementation
The Company has substantially completed the first two phases of the plan
and is currently working internally and with external vendors on the final three
phases. Because the Company outsources its data processing and item processing
operations, a significant component of the Year 2000 plan is to work with
external vendors to test and certify their systems as Year 2000 compliant.
Another important segment of the Year 2000 plan is to identify those loan
customers whose possible lack of Year 2000 preparedness might expose the Bank to
financial loss.
22
23
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
In conjunction with the above efforts, the Company is currently
calculating both capital and operating expenditures required to meet the
objectives of its Year 2000 plan. Many of the costs identified to date relate to
computer hardware (including ATM's) and software that would be replaced in the
next year even without the presence of the Year 2000 Issue in conjunction with
the Company's ongoing programs for updating its delivery infrastructure. Certain
other costs relate exclusively to the Year 2000 Issue, including internal staff
time and external resources hired to perform renovation, validation, and
implementation.
Potential Federal Legislation
-----------------------------
During its past session, the U.S. House Of Representatives failed to
approve a significant financial industry reform bill which had been designated
"HR 10". However, Congress continues to debate a series of issues which could
impact the financial services industry in general and the Company in particular.
Key topics under discussion include:
o the potential merger of the BIF and SAIF deposit insurance funds
o the potential reform of financial institution charters (including the
possible elimination of the federal thrift charter)
o financial services modernization, including a possible relaxation of laws
separating commercial banking and commerce
o potential modifications to the Federal Home Loan Bank system, including a
possible relaxation of the current mandatory membership requirement for
thrift institutions
o possible federal controls on the amount and disclosure of ATM fees
o regulations addressing allowable financial relationships between insured
depository institutions and mortgage brokers, and possible revisions in
the Real Estate Settlement Procedures Act ("RESPA") and the Truth In
Lending Act ("TILA")
o potential federal laws governing private mortgage insurance
23
24
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
Supervisory Goodwill Cases
--------------------------
Approximately 120 cases are pending involving claims for damages resulting
from the U.S. government's alleged breach of contracts related to the
amortization periods for treating supervisory goodwill as regulatory capital.
Recent rulings by U.S. federal courts have generally been in favor of the
plaintiffs. Should the plaintiffs, some of whom are the Company's competitors,
prevail in their litigation and collect the significant sums claimed, the
Company could face a number of competing financial institutions bolstered with
significant financial resources. The Company maintains no supervisory goodwill
claim of its own and cannot predict what results, if any, may arise from the
current litigation.
Financial And Currency Turmoil In Asia
--------------------------------------
While the Company maintains relatively little direct exposure to
businesses and consumers in Asia, the California economy as a whole is impacted
by the significant foreign trade with Asian economies. A slowdown in the volume
of California exports to Asia could cool the State economy, thereby having an
indirect impact upon the Company through less robust personal income growth and
real estate values.
Proposed Accounting Statement
-----------------------------
FASB has delayed issuing a final statement entitled "ACCOUNTING FOR
DERIVATIVE AND SIMILAR FINANCIAL INSTRUMENTS AND FOR HEDGING ACTIVITIES". This
extensive and complex drafted statement has generated significant response
throughout industry and government. The FASB recently delayed the proposed
implementation date to fiscal years commencing after June 15, 1999. In addition,
the FASB has recently issued several modifications to the proposed statement in
response to issues raised by industry and government. Legislation has been
introduced in Congress that would empower bank regulators to reject the proposed
statement. The Company's management cannot predict what, if any, final statement
might be issued, what legislation might be adopted, the response of federal
banking and thrift regulators, and the potential impact of such statement,
legislation, and regulatory response upon the Company's reported earnings and
financial disclosure.
24
25
HF BANCORP, INC. AND SUBSIDIARY
DECEMBER 31, 1997
(UNAUDITED)
Credit Unions
-------------
The U.S. Supreme Court is currently reviewing the extent to which credit
unions may extend their affiliations to various groups. In addition, members of
the U.S. Congress have circulated legislative proposals which would define
limitations on credit union membership and potentially extend Community
Reinvestment Act ("CRA") requirements to larger credit unions. To the extent
that credit union membership is restricted, the Company would benefit, as it
competes with a number of credit unions in its market areas. However, the
Company's management cannot predict what, if any, Supreme Court rulings or
legislation may evolve, and the potential impact of such events upon the
Company.
Federal Reserve
---------------
Various proposals involving the regulations developed or administered by
the Federal Reserve are under consideration, including the potential ability of
insured depository institutions to pay interest on commercial demand deposit
accounts and the potential payment of interest on balances maintained by
depository institutions at Federal Reserve Banks. The Company's management
cannot predict what, if any, changes may arise from these proposals.
Consolidation In The Financial Services Industry
------------------------------------------------
During calendar year 1997, a series of mergers and acquisitions of
financial institutions were consummated or announced in the Company's primary
market areas. Acquired companies range from small community banks to large
financial services providers such as Great Western Bank. These mergers and
acquisitions have presented both opportunities and risks to the Company.
Opportunities have included the chance to acquire former customers of purchased
institutions, many of whom are receptive to the idea of altering their financial
institution affiliation once informed that their historical bank will disappear.
Risks have included the development of an expanded number of larger competitors,
which enjoy greater financial resources, market reach, and product depth than
the Company.
The opportunities and risks described above have been manifested in the
Company's recent experiences in various markets. For example, the closure of
competitor branches in several locations has led to an inflow of new business,
particularly transaction related deposit accounts. On the other hand, in some
markets, larger competitors with stronger and more diversified income streams
have priced selected products and services very aggressively, causing the
Company to either lose business relationships or decrease profit margins to
retain customers.
25
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
General
- -------
During the six months ended December 31, 1997, the Company continued the
implementation of the business strategy presented in Form 10-K for the fiscal
year ended June 30, 1997. This strategy centered upon the Company's evolution
into a community bank offering a more comprehensive array of products and
services while at the same time augmenting earnings. Key objectives within this
strategy included:
o Increasing long term shareholder returns
o Improving customer service
o Enhancing employee relations
o Bolstering profitability
o Instilling a sales culture throughout the Company
o Strengthening the Company's involvement in and contributions to the
communities it serves
During the second quarter of fiscal 1998, the Company advanced its
evolution on several fronts:
o The Company's strong equity position was more effectively deployed, as
total assets expanded by $12.9 million, net loans receivable grew by $66.0
million, and the Company exited the real estate development business,
freeing over $1.0 million in regulatory capital for more effective
investment in other Company operations.
o The Company became more active in fulfilling the credit needs of
California consumers and businesses, with the Company's ratio of net loans
receivable to deposits increasing from 61.2% to 69.0%. As recently as June
30, 1996, this ratio stood at just 33.6%.
o The Company experienced a significant improvement in its aggregate credit
profile, with total gross nonperforming assets declining from $10.4
million to $8.2 million, spurred by both the improvement in Southern
California's economy and real estate markets and by management's
aggressive efforts to complete the liquidation of the portfolio of
troubled assets obtained in conjunction with the acquisition of PSSB. Loan
loss reserves to non-performing loans increased to 179.01%, with the vast
majority of the Company's non-performing loans secured by real estate.
26
27
o In conjunction with the Trustees of the ESOP, the Company refinanced its
loan to the ESOP, resulting in a $533,000 reduction in periodic personnel
expense during the second quarter of fiscal 1998, as well as calendar 1998
operating expense savings of approximately $350,000 based upon the
Company's recent stock price.
o The Company continued its focus upon fee revenue growth, implementing a
new safe deposit box inventory and billing system, and commencing plans to
offer debit cards, credit cards, and foreign banknote services through its
retail branch network.
o Management continued its emphasis upon improving the Company's efficiency
ratio, implementing revised transit settlement, inclearings management,
courier, and cash vault operations during the second quarter of fiscal
1998. In addition, favorable revisions in vendor pricing for check
printing, branch rent, and certain data processing services were
negotiated during the most recent quarter, with effect commencing in the
third quarter of fiscal 1998.
o The Company's exposure to rising interest rates significantly declined
during the three months ended December 31, 1997, reducing the volatility
of the Company's net interest income and net portfolio value during
periods of increasing interest rates.
To some extent, the above accomplishments were offset by the particularly
flat and low state of the Treasury security yield curve during much of the
second fiscal quarter, as exhibited by the differential between the 1 year
Treasury security and the 10 year Treasury security totaling just 27 basis
points at December 31, 1997. Flat and nominally low yield curves present
particular challenges to portfolio lenders such as the Company, who maintain net
liability sensitive positions. The shape of the yield curve discourages
borrowers from selecting the adjustable rate loans that the Company utilizes to
build its balance sheet, while encouraging refinancing of existing loans and
securities, a significant volume of which the Company owns at a premium to par.
In addition, the flatness of the yield curve reduces the interest spread derived
from the Company's net liability sensitive position, pressuring net interest
income. Management has responded to this environment by augmenting its mortgage
banking activity and aggressively focusing upon reducing the Company's cost of
funds. However, should the current capital markets environment persist, there
can be no assurance that the Company will be successful in offsetting its
unfavorable financial effects.
Additional information concerning the above accomplishments and challenges is
presented in the pages which follow.
27
28
Changes In Financial Condition From June 30, 1997 to December 31, 1997
- ----------------------------------------------------------------------
Total assets increased $78.5 million, or 8.0%, from $984.7 million at June
30, 1997 to $1,063.3 million at December 31, 1997. Net loans receivable rose
$105.8 million, or 21.8%, from $484.3 million at June 30, 1997 to $590.1 million
at December 31, 1997. The nominal and relative increases in the loan portfolio
have been strategic objectives of management, as such increases, when conducted
with prudent underwriting, provide for:
o a more effective deployment of the Company's strong capital position
o a greater return on shareholders' equity
o enhanced support of the communities in which the Company operates
The loan portfolio growth during fiscal 1998 has been augmented with the
purchase of $107.7 million in adjustable rate residential mortgage loans,
primarily new and seasoned "3/1" loans which reprice based upon a margin over
the Treasury 1 Year Constant Maturities Index ("CMT"). In purchasing these
mortgages, the Company utilized the same underwriting criteria employed for its
own internal originations.
Net loans held for sale increased from $335,000 at June 30, 1997 to $3.9
million at December 31, 1997, as the Company continued building its mortgage
banking operation. The Company has been expanding the volume of loans originated
for sale and the range of secondary market avenues utilized for selling in order
to:
o better manage the Company's interest rate risk position
o maintain strong liquidity
o generate a recurring stream of non-interest income
o obtain improved sales execution
o respond to increased customer demand for fixed rate financing in light of
the recent state of general capital market interest rates
Investment securities held to maturity declined from $26.8 million at June
30, 1997 to $10.3 million at December 31, 1997 primarily due to the call of
Agency debentures. Investment securities available for sale declined from $145.0
million at June 30, 1997 to $91.6 million at December 31, 1997 primarily due to
the sale of long term, fixed rate Agency debentures in conjunction with the
Company's interest rate risk management program (see "Interest Rate Risk
Management and Exposure").
28
29
Mortgage backed securities held to maturity declined 8.8% from $151.4
million at June 30, 1997 to $138.1 million at December 31, 1997, due to
amortization, which generally increased during the most recent quarter in
conjunction with new, 30 year, fixed rate, first mortgage loans being available
with interest rates as low as 7.0%.
Mortgage backed securities available for sale rose $55.6 million, or
50.8%, from $109.5 million at June 30, 1997 to $165.1 million at December 31,
1997. During the six months fiscal year to date, the Company redirected
substantially all cash flows which would not be deployed into whole loans into
low duration mortgage backed securities designated as available for sale. The
low duration securities were selected in order to avoid adding significantly to
the Company's net liability sensitive interest rate risk exposure and in order
to moderate value sensitivity until the funds could be redeployed into loan
originations or purchases.
The Company's investment in the capital stock of the Federal Home Loan
Bank Of San Francisco increased from $6.2 million at June 30, 1997 to $6.4
million at December 31, 1997 due to dividends credited.
The Company's net investment in real estate acquired through foreclosure
fell slightly from $5.3 million at June 30, 1997 to $5.2 million at December 31,
1997. However, the portfolios of foreclosed properties at June 30, 1997 and
December 31, 1997 varied considerably, as the Company continued to aggressively
dispose of problem assets acquired in conjunction with the PSSB purchase.
Net real estate acquired for investment declined from $418,000 at June 30,
1997 to none at December 31, 1997, as the Company sold its final two projects,
"VISTA BONITA II" and "MAYBERRY ESTATES", during the first six months of fiscal
1998 at a small gain, and in doing so exited the real estate development
business.
Other assets declined from $21.5 million at June 30, 1997 to $18.8 million
at December 31, 1997, in part due to the continued amortization of the
intangible assets generated in conjunction with the branch purchase from
Hawthorne Savings Bank and the PSSB acquisition.
Although deposits increased $15.9 million during the six months ended
December 31, 1997, they declined $1.4 million during the second quarter of
fiscal 1998 due to management's focus upon moderating the cost of its portfolio
of certificates of deposit. Key trends within the deposit portfolio include:
29
30
o Management continued the Bank's emphasis upon attracting consumer and
small business checking accounts as a means of lowering the Bank's cost of
funds, bolstering fee income, and establishing customer relationships for
the future sale of other products and services. Checking deposits
increased $4.0 million, or 5.5%, fiscal year to date.
o Towards the end of the second fiscal quarter, the Bank introduced a new
high balance, tiered rate consumer checking product ("Premium Access")
which generated favorable initial response. In addition, the Bank is
currently developing two new small business checking programs to provide a
comprehensive range of transaction services to various sizes of small
businesses.
o Customers continued their positive response to the Bank's "Platinum" money
market deposit account, which provides competitive money market interest
rates for liquid funds. In conjunction with this product, total money
market deposits increased from $38.6 million at June 30, 1997 to $65.6
million at December 31, 1997.
o The introduction of new "President's Special" CD products which roll over
upon maturity into lower cost accounts.
o The ongoing consolidation in the financial services industry continues to
leave more customers without a local and / or full service branch of their
former bank, and therefore receptive to sampling Hemet Federal's quality
customer service.
Advances from the FHLB-SF increased $60.0 million during fiscal 1998 from
$50.0 million at June 30, 1997 to $110.0 million at December 31, 1997. A new
$15.0 million one year fixed rate advance was added during the second fiscal
quarter. These incremental borrowings:
o have been utilized to expand the Company's balance sheet and thereby
decrease net interest income
o were all fixed rate, composed of terms from 6 months through 3 years
o included some advances callable by the FHLB-SF
Total stockholder's equity increased from $81.0 million at June 30, 1997
to $83.6 million at December 31, 1997 primarily due to the net income generated
fiscal year to date and the appreciation in the portfolios of securities
designated as available for sale. The appreciation in the market value of
available for sale securities largely stemmed from a decline in Treasury rates,
as exemplified by the bond equivalent yield for the 10 year Treasury note
declining from 6.49% at June 30, 1997 to 5.74% at December 31, 1997. Deferred
stock compensation reversed its long term trend during the second fiscal
quarter, and increased, in conjunction with the refinancing of the Company's
loan to the ESOP. The amount of Treasury stock declined during the second fiscal
quarter due to the Company's use of Treasury shares to fund the exercise of
vested stock options.
30
31
Interest Rate Risk Management And Exposure
- ------------------------------------------
In an effort to limit the Company's exposure to interest rate changes,
management monitors and evaluates interest rate risk on an ongoing basis,
through an internal simulation and modeling process, various management reports,
and via participation with the Office of Thrift Supervision Market Value Model.
Management acknowledges that interest rate risk and credit risk compose the two
greatest financial exposures faced by the Company in the normal course of its
business.
In recent quarters, the Company has maintained a net liability
sensitivity, meaning that, in aggregate, the Company's liabilities reprice more
quickly and by a greater magnitude than do its assets. This net liability
sensitivity primarily arises from the longer term, higher duration mortgage
backed and investment securities and whole loans maintained on the Company's
balance sheet, for which the Company's only current match funding sources are
demand deposit accounts, non interest bearing liabilities, a segment of core
deposit transaction accounts, certain borrowings, and capital. The net liability
sensitivity typically translates to improved profitability and higher economic
value during decreasing rate environments. Conversely, this position presents
the likelihood of constrained net interest income and average spreads during
periods of increases in general market interest rates. In addition, due to the
significant volume of mortgage related assets maintained on the balance sheet,
and the embedded optionality present in such assets, the Company is financially
exposed to both the nominal levels of interest rates and the relative levels in
interest rates, most often characterized by the shape or slope of the Treasury
yield curve.
During the six months ended December 31, 1997, the Company continued its
program of moderating interest rate risk while building a less volatile base of
core earnings. Specific actions during the six months ended December 31, 1997
included:
o The sale of $50.0 million and the call of $16.0 million in longer term,
fixed rate Agency debentures.
o The sale of $5.4 million in current, fixed rate, residential loan
originations on a servicing released basis.
o The secondary market purchase of $107.7 million in adjustable rate
residential mortgages which, when added to the impact of internal
originations, increased the percentage of loans presenting adjustable
interest rates to 74.2% of total gross loans at December 31, 1997.
o The continuation of the Company's loan origination program which
encourages the generation of adjustable rate mortgages through favorable
pricing and terms to the customer combined with incentives to the
Company's sales force.
31
32
o The continued migration away from originations and purchases which
reprice based upon the 11th District Cost Of Funds Index ("COFI") in
favor of loans which reprice based upon Prime Rate or Treasury indices,
including the Company's recent development of a loan product based upon
the "12MAT" index. The Company has emphasized the non-COFI indices due to
their greater responsiveness to changes in capital markets interest rates
and due to increased concentration of control of the COFI into a small
number of very large thrifts. At December 31, 1997, approximately 27.2%
of the Company's gross loans repriced based upon COFI.
o The development and marketing of new products which improve the Company's
interest rate risk profile by addressing both the asset and liability
sides of the balance sheet, including new checking programs, and Prime
based home equity lines of credit ("HELOC's").
o The redeployment of periodic cash flows from longer term, fixed rate
mortgage backed securities and loans into adjustable rate loans or
securities presenting much lower duration.
Management believes that, although investment in adjustable rate assets,
some of which present introductory discount rates, may reduce short term
earnings below amounts obtainable through investment in fixed rate or higher
duration assets, an asset portfolio containing a greater percentage of
adjustable rate product reduces the Company's exposure to adverse interest rate
fluctuations and enhances longer term profitability and economic value. This is
consistent with the overall investment policy of the Company, which is designed
to manage its aggregate interest rate sensitivity, to generate a favorable
return without incurring undue interest rate risk, to supplement the Company's
lending activities, and to provide and maintain liquidity. However, there can be
no assurance that any substantial quantity of adjustable rate loans meeting the
Company's underwriting standards will be available in the future.
The Company has also utilized a variety of financial instruments to manage
its interest rate risk, including off balance sheet transactions such as
interest rate agreements including swaps, caps, and floors. The Company
originally entered into its existing off balance sheet positions to
synthetically adjust the duration of the Company's liabilities to more closely
match that of its assets. On July 10, 1995, the Bank terminated four interest
rate swap contracts with an aggregate notional amount of $60.0 million, invoking
a termination fee of $4.9 million which, for accounting purposes, is being
amortized to interest expense over the individual remaining contract lives of
each swap.
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33
During the six months ended December 31, 1997, the Bank amortized $456,000
of the deferred loss to interest expense, and charged interest expense for
$493,000 related to current existing interest rate swaps with an aggregate
notional amount of $35.0 million. During the quarter ended December 31, 1997,
the conclusion of the amortization period for one of the terminated interest
rate swaps was realized, leaving a single terminated swap to be amortized
through November 21, 1998. Additional information concerning the Bank's current
and terminated interest rate swap positions is provided in the following table:
Summary Of Interest Rate Swaps
------------------------------
Active Interest Rate Swaps
--------------------------
Rate Basis Rate Basis
Notional Maturity Bank Bank Bank Bank Swap
Amount Date Receives Receives Pays Pays Resets
------ ---- -------- -------- ---- ---- ------
$20,000,000 01/06/99 3 month LIBOR Actual/360 9.800% Fixed 360/360 quarterly
$15,000,000 01/30/99 3 month LIBOR Actual/360 7.274% Fixed 360/360 quarterly
Total $35,000,000
Terminated Interest Rate Swaps
------------------------------
Original 12/31/97 Loss Daily
Notional Termination Deferred Deferred Amortization Loss
Amount Date Loss Loss Completion Amortization
------ ---- ---- ---- ---------- ------------
$10,000,000 07/10/95 $557,730 $0 03/27/97 $890
$20,000,000 07/10/95 $1,338,145 $0 04/30/97 $2,024
$10,000,000 07/10/95 $631,816 $0 11/25/97 $726
$20,000,000 07/10/95 $2,328,601 $614,784 11/21/98 $1,892
Total $60,000,000 $4,856,292 $614,784
33
34
INTANGIBLE ASSETS
- -----------------
The purchase of three branches from Hawthorne Savings and the acquisition
of PSSB each generated intangible assets. The following tables provide
information concerning the initial amount of such intangible assets, their
periodic amortization against income, and their current balances as of December
31, 1997. Under OTS regulations, intangible assets reduce regulatory capital,
resulting in lower capital ratios than would otherwise be the case.
Acquisition of Three Hawthorne Savings Branches
- -----------------------------------------------
Transaction Date 06/21/96
Deposits Acquired $185,189,446
Initial Core Deposit Intangible Created $6,642,079
Book Amortization Method / Term Straight Line / Seven Years
Tax Return Amortization Method / Term Straight Line / Fifteen Years
Monthly Pre-Tax Charge To Book Income $79,072
Monthly Book Amortization Reported As Non Operating Expense
Core Deposit Intangible Balance As Of 12/31/97 $5,218,776
Reduction In Regulatory Capital As Of 12/31/97 $5,218,776
Reduction In Tangible Book Value As Of 12/31/97 $5,218,776
34
35
Acquisition of Palm Springs Savings Bank ("PSSB")
- -------------------------------------------------
Transaction Date 09/27/96
Nature of Transaction Non Taxable Acquisition
Accounting Methodology Employed Purchase Accounting
Total Purchase Price $16,264,536
Less: Net Book Value of Assets & Liabiliies $ 9,287,912
-----------
Premium Paid Over Net Book Value $ 6,976,624
Initial Accounting For The Acquisition Debits Credits
------ -------
Loan Premium Created $ 2,441,000
Core Deposit Intangible Created $ 9,445,475
Deferred Tax Liability On Loan Premium $1,008,284
Deferred Tax Liability On Core Deposit Intangible $3,901,567
Cash Payment For PSSB Shares Above Net Book Value $6,976,624
----------- ----------
Total $11,886,475 $11,886,475
----------- -----------
Book Amortization Method / Term
Loan Premium Effective Yield / Life Of Loans Acquired
Core Deposit Intangible Straight Line / Seven Years
Tax Return Amortization Method / Term
Loan Premium Not Tax Deductible Due To Non Taxable
Acquisition
Core Deposit Intangible Not Tax Deductible Due To Non Taxable
Acquisition
Monthly Pre-Tax Charge To Book Income
Loan Premium variable based upon loan amortization
Core Deposit Intangible: Gross / Net $112,446 / $65,999
Monthly Book Amortization Reported As
Loan Premium Reduction In Interest Income
Core Deposit Intangible Non Operating Expense
Nominal Deferred
Balances As Of 12/31/97 Assets Tax Liabilities Net
------ --------------- ---
Loan Premium $ 1,915,355 $ 791,160 $1,124,195
Core Deposit Intangible $ 7,758,783 $3,204,859 $4,553,924
----------- ---------- ----------
Total $ 9,674,138 $3,996,019 $5,678,119
Reduction In Regulatory Capital As Of 12/31/97
Loan Premium None
Core Deposit Intangible, Net $ 4,553,924
Reduction In Tangible Book Value As Of 12/31/97
Loan Premium None
Core Deposit Intangible, Net $ 4,553,924
35
36
Acquisition of Palm Springs Savings Bank ("PSSB")
- -------------------------------------------------
Subsequent Adjustment
- ---------------------
Adjustment Date 03/01/97
Nature of Adjustment Recognition of Additional Core Deposit
Intangible Resulting From Trigger of PSSB
Officer 24 Month Salary Continuation
Agreement
Additional Core Deposit Intangible Created $362,804
Book Amortization Method / Term Straight Line / 79 months
Tax Return Amortization Method / Term Straight Line / 24 months
Monthly Pre-Tax Charge To Book Income $4,592
Monthly Book Amortization Reported As Non Operating Expense
Core Deposit Intangible Balance As Of 12/31/97 $316,879
Reduction In Regulatory Capital As Of 12/31/97 $316,879
Reduction In Tangible Book Value As Of 12/31/97 $316,879
In March of 1997, the Bank commenced payment to a former officer of Palm
Springs Savings Bank following the resignation of the executive while he was
covered under a salary continuation contract. The total payments due under the
contract were capitalized as an adjustment to the core deposit intangible
associated with the Palm Springs Savings Bank acquisition, as the potential cost
of the contract, which existed prior to the acquisition, was included within the
initial valuation of the core deposits acquired. The payments due under the
contract were not capitalized at the date of acquisition due to uncertainty
regarding whether the contract would be triggered; i.e. whether the executive
would remain with the Bank. This adjustment to the core deposit intangible will
be amortized over the remaining initial life of the core deposit intangible.
Because the payments are taxable to the executive, the Bank can deduct the
payments for tax purposes on a faster schedule than they will be recognized for
book reporting purposes, thus generating a deferred tax liability under SFAS
109.
36
37
LIQUIDITY
- ---------
Liquidity is actively managed to ensure sufficient funds are available to
meet the ongoing needs of both the Company in general and the Bank in
particular. Liquidity management includes projections of future sources and uses
of funds to ensure the availability of sufficient liquid reserves to provide for
unanticipated circumstances.
For the Bank, the primary sources of liquidity are:
o deposits (both retail and wholesale)
o principal and interest payments on loans, mortgage backed, and investment
securities
o retained earnings
o FHLB advances
o other borrowings, including reverse repurchase agreements
For the Bank, the primary uses of funds include:
o loan originations
o customer drawdowns on lines of credit
o loan purchases
o investment and mortgage backed securities purchases
o customer withdrawals of deposits
o interest paid on liabilities
o operating expenses
The Bank's investment portfolio is structured to provide an ongoing
source of cash from scheduled payments and anticipated prepayments from mortgage
backed securities, in addition to cash flows from periodic maturities, typically
from securities with balloon final payments. The Company's strategy over the
past year has been to reinvest available monthly cash flows, to the extent
economically and operationally feasible, into new whole loan originations and
purchases, in order to bolster net interest income and better utilize the Bank's
strong risk based capital position.
37
38
During the quarter ended December 31, 1997, the Bank was granted an
unsecured "federal funds" line of credit from one of the institution's primary
correspondent banks, as an additional means to provide for contingent liquidity
needs. In addition, at December 31, 1997 the Bank was in the process of pursuing
two additional unsecured "federal funds" lines of credit. However, there can be
no assurance that the Bank will be successful in securing such additional lines
of credit.
At December 31, 1997, the Bank maintained untapped borrowing capacity at
the FHLB-San Francisco in the amount of $210.6 million, up $82.4 million from
the prior quarter end. During the quarter ended December 31, 1997, the Bank
pledged additional loans to the FHLB to augment its liquidity position. In
addition, due to the Company's relatively low loan to deposit ratio of 69.0% at
December 31, 1997, the Company maintained significant excess collateral in both
loans and securities; collateral which is available for either liquidation or
secured borrowings in order to meet future liquidity requirements.
At December 31, 1997, cash and cash equivalents totaled $19.2 million,
compared to $18.4 million at June 30, 1997. It is management's intention, while
ensuring adequate cash availability for operating needs, to constrain cash and
cash equivalent balances in favor of higher yielding assets, subject to meeting
all regulatory liquidity requirements.
Effective November 24, 1997, the OTS reduced the thrift regulatory
liquidity requirement from 5.0% to 4.0%, removed the 1.0% short term liquidity
requirement, significantly increased the range of assets qualifying for the
"numerator" in the liquidity formula, and decreased the "denominator" of the
formula. The Bank elected to adopt the new requirement as of January 1, 1998.
Under the prior formula, the Bank's regulatory liquidity ratio for the month of
December, 1997 was 10.65%, placing the Bank in compliance. The revision in the
OTS liquidity requirement is a favorable event for the Company, as the Bank will
be able to focus its liquidity management upon almost purely operational
criteria, no longer pursuing certain positions and assets solely for the purpose
of meeting a regulatory formula. Congress has been petitioned to eliminate the
thrift regulatory liquidity requirement in its entirety, thereby providing the
same regulatory treatment to thrifts that is enjoyed by national banks.
Liquidity needs for HFB on a stand alone basis are met through available
cash, periodic earnings, and cash flows from its investment portfolio.
38
39
CAPITAL RESOURCES
- -----------------
The Bank must maintain capital standards as set forth by federal
regulations. As of December 31 1997, these requirements are: 1) tangible capital
of 1.5 % of adjusted assets; 2) core capital of 4.0% of adjusted assets; and 3)
risk-based capital of 8.0 % of risk-weighted assets. At December 31, 1997, the
Bank exceeded all minimum regulatory capital requirements as shown in the table
below:
PERCENT OF
ADJUSTED
AMOUNT TOTAL ASSETS
------ ------------
(DOLLARS IN THOUSANDS)
Tangible Capital
- ----------------
Actual capital $64,580 6.17%
Minimum required 15,700 1.50
------ -----
Excess $48,880 4.67%
======= =====
Core Capital
- ------------
Actual capital $64,580 6.17%
Minimum required 41,866 4.00
------- -----
Excess $22,714 2.17%
======= =====
PERCENT OF RISK-
AMOUNT WEIGHTED ASSETS
------ ---------------
Risk-based Capital
- ------------------
Actual capital $67,540 15.58%
Minimum required 34,688 8.00
------- ------
Excess $32,852 7.58%
======= ======
39
40
OTS regulations contain "prompt corrective action" provisions under which
insured depository institutions are to be classified into one of five categories
based primarily upon capital adequacy. The categories range from "well
capitalized" to "critically under capitalized." OTS guidelines define a "well
capitalized" institution as one which maintains:
A. A total risk-based capital ratio of 10% or greater,
B. A Tier 1 risk-based capital ratio of 6%
C. A core capital ratio of 5% or greater, and
D. Is not subject to any written capital order or directive to meet and
maintain a specific capital level of any capital measure.
The Bank's Tier 1 risk based capital ratio as of December 31, 1997 was
14.89%. At December 31, 1997, the Bank's regulatory capital levels exceed the
thresholds required to be classified as a "well capitalized" institution. The
Bank's capital ratios detailed above do not reflect the additional capital (and
assets) maintained by the holding company.
Management believes that, under the current regulations, the Bank will
continue to meet its minimum capital requirements in the coming year. However,
events beyond the control of the Bank, such as changing interest rates or a
downturn in the economy in the areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its future minimum capital requirements.
40
41
CREDIT PROFILE
- --------------
Nonperforming Assets
--------------------
The following table sets forth information regarding nonaccrual loans and
real estate acquired through foreclosure.
December 31, 1997 June 30, 1997
----------------- -------------
(Dollars In Thousands)
Nonaccrual loans before valuation reserves $2,224 $5,217
Investment in foreclosed real estate before
valuation reserves 5,989 6,308
Investment in repossessed consumer assets before
valuation reserves 0 10
------- -------
Total nonperforming assets $8,213 $11,535
======= =======
Nonperforming loans to gross loans net of
undisbursed loan funds 0.37% 1.06%
Nonperforming assets to total assets 0.77% 1.17%
The reduction in nonperforming assets during the first half of fiscal 1998
primarily resulted from the Company's continuing to cycle through the portfolio
of troubled assets acquired in conjunction with the purchase of PSSB on
September 27, 1996, as highlighted by the table presented below. In addition, a
gradual recovery in real estate markets and the economy in the Company's primary
lending areas has favorably impacted the Company's aggregate credit profile.
41
42
Classified Assets
-----------------
The following table presents information concerning classified assets. The
category "OAEM" refers to "Other Assets Especially Mentioned", or those assets
which present indications of potential future credit deterioration.
HF Bancorp, Inc.
History of Classified Assets
(Dollars In Thousands)
OAEM Substandard Loss Total
---- ----------- ---- -----
December 31, 1995 $9,217 $ 9,130 $2,618 $20,965
March 31, 1996 $8,287 $10,207 $3,030 $21,524
June 30,1996 $11,070 $ 8,189 $3,140 $22,399
September 30, 1996 $17,454 $22,007 $4,037 $43,498
December 31, 1996 $17,793 $20,588 $2,820 $41,201
March 31, 1997 $16,646 $18,733 $3,035 $38,414
June 30, 1997 $9,586 $19,834 $2,952 $32,372
September 30, 1997 $8,656 $15,805 $3,051 $27,512
December 31, 1997 $9,572 $12,932 $1,843 $24,347
The Company experienced an anticipated significant increase in classified
assets upon the acquisition of PSSB in September, 1996. Since the acquisition,
management has worked to reduce the classified asset total through various means
including aggressive collection efforts, foreclosure with subsequent property
sales, and settlement of troubled assets for less than face value. As a result
of its due diligence process in conjunction with the acquisition of PSSB,
management required PSSB to recognize $2.2 million in additional loan and real
estate loss provisions prior to the consummation of the acquisition.
42
43
Impaired Loans
--------------
The Bank adopted Statement of Financial Accounting Standards (SFAS)
No.114, "ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN" as amended by SFAS
118, "ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN - INCOME RECOGNITION AND
DISCLOSURES", as of July 1, 1995. These statements generally require all
creditors to account for impaired loans, except those loans that are accounted
for at fair value or at the lower of cost or fair value, at the present value of
the expected future cash flows discounted at the loan's effective interest rate
or as a practical expedient, at the loans's observable market price or the fair
value of the collateral if the loan is collateral dependent. SFAS No. 114
indicates that a creditor should evaluate the collectability of both contractual
interest and contractual principal when assessing the need for loss recognition.
The Bank applies the provisions of SFAS No. 114 to all loans in its
portfolio. As a majority of the Bank's loans are collateral dependent, most
impaired loans are accounted for based upon the fair value of their collateral.
In applying the provisions of SFAS No. 114, the Bank considers a loan to be
impaired when it is probable that the Bank will be unable to collect all
contractual principal and interest in accordance with the terms of the loan
agreement. However, in determining when a loan is impaired, management also
considers the loan documentation, current loan to value ratios, and the
borrowers' current financial position. The Bank considers all nonaccrual loans
and all loans that have a specific loss allowance applied to adjust the loan to
fair value as impaired.
At December 31, 1997, the Company maintained total gross impaired loans,
before specific reserves, of $9.3 million, constituting 95 credits. This
compares favorably to total gross impaired loans of $16.3 million at June 30,
1997. A total of $1.0 million in specific reserves were established against
impaired loans at December 31, 1997. The average recorded investment in impaired
loans during the quarter ended December 31, 1997 was $10.7 million, and the
average recorded investment in impaired loans during fiscal 1998 was $11.9
million. The Company's impaired loan portfolio at December 31, 1997 was
disproportionately represented by credits originated by PSSB prior to its
acquisition, as highlighted in the following table.
Gross Impaired Loans At December 31, 1997
(Dollars In Thousands)
Originated Originated
By By
PSSB Hemet Federal TOTAL
---- ------------- -----
Accrual Status $3,982 $3,131 $7,113
Non Accrual Status $1,203 $1,021 $2,224
TOTAL $5,185 $4,152 $9,337
43
44
The above table also highlights that many of the Company's impaired loans
at December 31, 1997 were either fully current or with only minor delinquency,
as $7.1 million (76.2%) were maintained on accrual status. Interest is accrued
on impaired loans on a monthly basis except for those loans that are 90 or more
days delinquent or those loans which are less than 90 days delinquent but where
management has identified concerns regarding the collection of the credit. For
the six months ended December 31, 1997, accrued interest on impaired loans was
$82,000 and interest of $318,000 was received in cash.
If all nonaccrual loans had been performing in accordance with their
original loan terms, the Company would have recorded interest income of $172,000
during the six months ended December 31, 1997, instead of interest income
actually recognized on cash payments of $50,000.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risks inherent in its loan
portfolio and the general economy. Management reviews the Bank's loan loss
allowance on a monthly basis. In determining levels of risk, management
considers a variety of factors, including asset classifications, economic
trends, industry experience and trends, geographic concentrations, estimated
collateral values, management's assessment of the credit risk inherent in the
portfolio, historical loan loss experience, and the Bank's underwriting
policies. The allowance for loan losses is maintained at an amount management
considers adequate to cover losses in loans receivable which are deemed probable
and estimable.
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 additions to the allowance based
on judgments different from those of management.
While management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory, and other conditions that may be beyond the
Bank's control.
44
45
The following tables set forth activity in the Bank's allowances for
estimated loan losses and estimated real estate losses during the six months
ended December 31, 1997 and 1996:
Six Months Ended December 31,
-----------------------------
1997 1996
---- ----
(Dollars In Thousands)
Allowance for Loan Losses:
- --------------------------
Balance at June 30 $4,780 $3,068
Allowance acquired from PSSB --- 2,963
Loan chargeoffs:
Residential real estate (402) (345)
Multifamily real estate (121) ---
Commercial real estate (313) (69)
Construction --- (16)
Land/Lots (265) (119)
Consumer (98) ---
Commercial business --- ---
-------- --------
Total chargeoffs (1,199) (549)
Loan recoveries --- 20
Provision for estimated loan losses 400 208
-------- --------
Balance at December 31 $3,981 $ 5,710
====== =======
December 31, June 30,
------------ --------
1997 1997
---- ----
Allowance for estimated loan losses as a percent of
nonperforming loans 179.01% 91.63%
Allowance for estimated loan losses as a percent of
gross loans receivable net of loans in process 0.67% 0.97%
45
46
Six Months Ended December 31,
-----------------------------
1997 1996
---- ----
(Dollars In Thousands)
Valuation Allowances : Real Estate Foreclosure
- ----------------------------------------------
Balance at June 30 $ 1,020 $ 381
Allowance acquired from PSSB 0 491
Net chargeoffs (758) (53)
Provision to increase valuation allowances 560 60
--------- ------
Balance at December 31 $ 822 $ 879
Valuation Allowances : Real Estate-Development
- ----------------------------------------------
Balance at June 30 $577 $1,536
Net chargeoffs (577) (1,008)
Provision to increase valuation allowances 0 49
------- ------
Balance at December 31 $ 0 $ 577
Total Valuation Allowances For Real Estate $ 822 $1,456
======= ======
Loan charge-offs during the second quarter of fiscal 1998 were
concentrated in credits obtained in conjunction with the acquisition of PSSB,
with a particular concentration in loans secured by land and commercial real
estate. While the Company continues to originate new land and commercial real
estate loans, the terms and underwriting for such new credits are significantly
more conservative than those historically extended by PSSB.
46
47
The ratio of allowance for estimated loan losses to nonaccrual loans
increased from 91.63% at June 30, 1997 to 179.01% at December 31, 1997 due to a
decline in nonaccrual loans from $5.2 million to $2.2 million. The ratio of
allowance for estimated losses to gross loans receivable net of loans in process
declined from 0.97% at June 30, 1997 to 0.67% at December 31, 1997 due to a
combination of a lower nominal reserve balance and an expanded loan portfolio.
The lower ratio (0.67%) at December 31, 1997 is supported by the reductions in
classified assets and nonaccrual loans experienced by the Company, the general
recovery in real estate values in the Company's primary market areas, and by the
high concentration of residential mortgages in the current loan portfolio. At
December 31, 1997, 75.9% of the Bank's gross loan portfolio was comprised of
residential real estate loans, while 97.3% of the gross loan portfolio was
composed of loans secured by real estate.
A $290,000 chargeoff against the Company's valuation allowance for real
estate held for investment was recorded in the quarter ended December 31, 1997
in conjunction with the sale of the "MAYBERRY ESTATES" project. With the sale of
the Mayberry Estates parcel, the Company exited the real estate development
business completely, freeing both human and capital resources for redeployment
into other areas of the Company's business presenting opportunities for improved
financial returns.
The Company's inventory of foreclosed properties and repossessed consumer
assets at December 31, 1997 is summarized in the following table. During the
three and six months ended December 31, 1997, the Company recognized $134,000
and $560,000, respectively, in post acquisition writedowns primarily in order to
speed the liquidation of the remaining problem assets acquired in conjunction
with the PSSB purchase.
Real Estate Acquired By Foreclosure and Repossessed Consumer Assets
(Dollars In Thousands)
Gross Valuation Net Percent
Type Of Property Balance Reserves Balance Of Total
- ---------------- ------- -------- ------- --------
Residential 1 - 4 Units $1,540 $37 $1,503 29.1%
Multifamily more than 4 Units 69 0 69 1.3%
Commercial / Industrial 1,523 55 1,468 28.4%
Land / Developed Lots 2,857 730 2,127 41.2%
Repossessed Consumer Assets 0 0 0 0.0%
------ ------ ------ ------
Total $5,989 $ 822 $5,167 100.0%
The Bank accounts for real estate owned through foreclosure at fair market
value upon acquisition, and management believes that adequate valuation reserves
have been established based upon current market conditions. At December 31,
1997, approximately $2.3 million in foreclosed real estate was in escrow under
contract for sale. However, management can offer no assurances regarding whether
and when such escrows will close.
47
48
Comparison Of Operating Results For The Three Months And Six Months Ended
- -------------------------------------------------------------------------
December 31, 1997 and December 31, 1996
- ----------------------------------------
General
- -------
The Company reported net earnings of $727,000 for the three months ended
December 31, 1997, compared to $702,000 in earnings for the three months ended
December 31, 1996. Basic earnings per share were $0.12 for the three months
ended December 31, 1997 and $0.11 per share for the three months ended December
31, 1996; while diluted earnings per share were $0.11 for both quarters. The
consistency in these quarterly net income figures, however, fails to highlight
the significant changes in the sources of revenue and expense between the two
periods. These changes are detailed in the following paragraphs. In addition,
the $727,000 in net income for the most recent quarter represents a sequential
improvement from the $502,000 in earnings reported for the first quarter of
fiscal 1998.
The Company reported net earnings of $1.2 million for the six months ended
December 31, 1997, compared to net earnings of $1.2 million for the same period
the prior fiscal year, excluding the prior year impact of the one time
assessment to recapitalize the SAIF. Including the non recurring assessment,
earnings for the six months ended December 31, 1996 were a loss of $1.6 million.
When reviewing results for the six months ended December 31 for current
and prior fiscal years, it is important to note that the prior year period
included slightly more than one quarter's impact of the PSSB acquisition. Due to
the timing of the PSSB purchase and the growth experienced by the Company in
recent quarters, the Company maintained a significantly larger average balance
sheet during the six months ended December 31, 1997 than in the prior year,
somewhat offset by the impact of the additional costs associated with operating
a larger financial institution.
Net Interest Income
- -------------------
Net interest income declined slightly from $6.2 million during the three
months ended December 31, 1996 to $6.1 million during the three months ended
December 31, 1997. This decline coincided with a reduction in the Company's
average spread on total assets from 2.47% during the prior year quarter to 2.26%
during the most recent three months. Net interest income during the three months
ended December 31, 1997 was unfavorably impacted by the multiple financial
impacts stemming from a relatively flat and low Treasury yield curve and by the
Company's sale of long term, fixed rate, relatively high yielding Agency
debentures in conjunction with its interest rate risk management program. The
unfavorable impacts from the relatively flat and low Treasury yield curve
included:
48
49
o an increase in prepayment rates on loans and securities, with a majority
of the security and purchased loan positions maintained at a premium to
par, including the portfolio of loans added in conjunction with the PSSB
acquisition and recorded under purchase accounting
o diminished customer demand for new adjustable rate originations in favor
of fixed rate products, resulting in both constrained volume and curtailed
pricing margins
o less net interest income resulting from the Company's net liability
sensitive position due to the relatively small rate differentials present
in the Treasury yield curve
The average spread on total assets during the second quarter of fiscal
1998 was also constrained by the maintenance of several short term investment
positions which generated additional nominal net interest income, but reduced
the average spread on total assets. In addition, a significant portion of the
Company's balance sheet growth during recent months has occurred at incremental
spreads below the Company's average spread due to constrained interest rate risk
exposure and the continued focus upon assets presenting relatively high credit
quality, and therefore lower yields.
The Company's ratio of average interest earning assets to average interest
bearing liabilities improved from 1.07 during the second quarter of fiscal 1997
to 1.09 during the most recent quarter due to the Company's continued
amortization of intangible assets, the growth in demand deposits, and an
increase in capital.
Net interest income for the six months ended December 31, 1997 was $12.2
million, up 13.3% from $10.8 million during the first two quarters of fiscal
1997. This increase stemmed from the impact of the PSSB acquisition throughout
the entire six month period during the current fiscal year and from the
Company's internally generated balance sheet growth. Average interest earning
assets increased from $865.9 million during the first six months of fiscal 1997
to $1,001.0 million during the same period in fiscal 1998. The Company's average
spread on total assets declined from 2.36% during the first six months of fiscal
1997 to 2.31% during the first six months of fiscal 1998, in part because of
those factors described above which impacted average spreads during the most
recent quarter.
During the six months ended December 31, 1997, the Company implemented
revised transit courier schedules and modified its transit settlement in order
to minimize lost float on checks deposited by customers. In addition, the
Company has recently expanded its cash management activities to improve yields
obtained on daily available cash balances. The full impact of these improvements
will be reflected in the Company's financial results commencing in the third
quarter of fiscal 1998.
49
50
Interest Income
- ---------------
Interest income increased 4.8% from $17.9 million during the quarter ended
December 31, 1996 to $18.8 million during the three months ended December 31,
1997, as increased interest on loans and mortgage backed securities was somewhat
offset by a decline in interest and dividends on investment securities. Interest
income for the six months ended December 31, 1997 totaled $37.0 million, up
14.6% from the $32.3 million reported for the same period during the prior
fiscal year, with the acquisition of PSSB significantly contributing to the
increase.
Interest income on loans increased from $9.1 million during the three
months ended December 31, 1996 to $10.6 million during the quarter ended
December 31, 1997 due to an expansion in the average balance of loans
outstanding during the quarter from $444.0 million to $554.2 million. The
favorable effect of this increase in average loan balances was somewhat offset
by a decline in the average rate earned on loans, from 8.18% during the fiscal
1997 period to 7.68% during the fiscal 1998 period. This decline in average rate
stemmed in part from an increased concentration in residential adjustable rate
loans, which typically present interest rates below those available from fixed
rate mortgages, unsecured loans, and loans secured by other types of collateral
(e.g. income property). During the most recent quarter, the Company's portfolio
of commercial and industrial real estate loans declined from 10.5% to 8.9% of
the gross loan portfolio.
For the six months ended December 31, 1997, interest income on loans
totaled $20.5 million, up 45.3% from the same period the prior year. Similar to
the results for the most recent quarter, a significant rise in average balance
more than offset a decline in the average rate earned.
Interest income on mortgage backed securities rose from $4.4 million
during the quarter ended December 31, 1996 to $4.9 million during the most
recent quarter, as an increase in average balance from $244.1 million to $303.2
million more than offset a decline in average rate from 7.14% to 6.42%. Over the
past two years, the Company has sold a substantial portion of its long term,
fixed rate mortgage backed securities portfolio, with new purchases focusing
upon adjustable rate and low duration fixed rate mortgage backed securities.
For the six months ended December 31, 1997, interest on mortgage backed
securities totaled $9.5 million, up 5.2% from $9.0 million during the same
period during the prior year, as the effect of increases in average volumes more
than offset a decline in average rate. During the past six months, the Company
has experienced an increase in prepayments on its portfolio of GNMA2 adjustable
rate mortgage backed securities, which totaled $160.6 million in par value at
December 31, 1997. Because the Company owns the securities at a premium to par,
the accelerated amortization lowers the effective yield on the portfolio.
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Interest income on investment securities for the three months ended
December 31, 1997 was $3.2 million, down from $4.5 million during the same
quarter the prior year. Similarly, interest income on investment securities
during the six months ended December 31, 1997 decreased 23.5% versus the same
period during the prior year. Over the past year, a number of long term, fixed
rate investment securities have been called, while the Company has sold other
long term, fixed rate investment securities as part of its interest rate risk
management program. Somewhat offsetting these factors, in fiscal 1998, the
Company has maintained, on average, a more fully invested position, with a
smaller portion of the balance sheet maintained in federal funds sold and short
term repurchase agreements.
Interest Expense
- ----------------
Interest expense rose 8.4% from $11.7 million during the three months
ended December 31, 1996 to $12.7 million during the same period for the most
recent fiscal year, as increases in interest expense on deposits and borrowings
more than offset a decline in net hedging expense. For the six months ended
December 31, 1997, interest expense increased 15.2% versus the same period the
prior year, in large part due to the greater impact of the PSSB acquisition upon
current fiscal year to date financial results.
Interest expense on deposits increased from $10.0 million during the
quarter ended December 31, 1996 to $10.4 million during the most recent quarter,
as the average volume of interest bearing deposits rose from $812.6 million to
$822.6 million, while the average interest rate paid rose from 4.92% to 5.04%.
During the most recent quarter, the Company has had to respond to credit unions
and originators of sub-prime loans aggressively marketing relatively high
certificate of deposits rates in selected markets. Including the effect of
increased demand deposit balances, however, the Company's average total cost of
deposits declined from 4.83% on September 30, 1997 to 4.76% at December 31,
1997.
For the six months ended December 31, 1997, interest expense on deposits
rose to $20.8 million from $18.1 million during the same period the prior fiscal
year. The average balance of interest bearing deposits rose from $736.3 million
during the first six months of fiscal 1997 to $820.7 million during the similar
period in the current fiscal year, while the average rate rose from 4.92% to
5.06%.
Interest expense on borrowings rose from $915,000 during the three months
ended December 31, 1996 to $1.8 million during the most recent quarter, as the
average balance of borrowings increased from $70.0 million to $121.3 million,
while the average rate rose from 5.23% to 6.04%. During the 1998 fiscal year,
the Company has increased its use of both short term borrowings (to fund short
term security positions) and longer term borrowings (to fund loan portfolio
growth) as a means of generating increased net interest income.
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For the six months ended December 31, 1997, interest expense on borrowings
totaled $3.1 million, versus $1.8 million during the same period the prior
fiscal year. Consistent with the results for the most recent quarter, average
balances rose from $70.0 million to $103.4 million, while the average rate
increased from 5.23% to 5.94%.
Net interest expense on hedging transactions declined from $777,000 during
the three months ended December 31, 1996 to $462,000 during the most recent
quarter. For the six months ended December 31, 1997, interest expense on hedging
transactions declined to $948,000, versus $1.6 million during the same period
the prior year. As detailed under "Summary Of Interest Rate Swaps", the
conclusions of the amortization periods for the deferred losses associated with
terminated interest rate swaps have been accretive to the Company's reported net
interest income in recent periods.
Provision For Estimated Loan Losses
- -----------------------------------
The provision for estimated loan losses increased from $29,000 during the
quarter ended December 31, 1996 to $300,000 during the most recent quarter, as
the Company significantly expanded its loan portfolio during the past three
months and charged income for general reserves associated with that loan growth.
For the six months ended December 31, 1997, the provision for estimated loan
losses totaled $400,000, up from $208,000 during the first six months of fiscal
1997.
The Company's ratio of loan loss reserves to non-performing loans
increased to 179.01% at December 31, 1997 from 91.63% at the end of the prior
fiscal year, as a reduction in the nominal reserve balance due to net
charge-offs exceeding provision expense was more than offset by the decline in
non-performing loans.
Other Income And Expense
- ------------------------
Other income and expense declined from $502,000 in income during the
quarter ended December 31, 1996 to $13,000 in income during the most recent
quarter, as:
o the prior fiscal year period included $658,000 more in gains on the sale
of securities
o net gains on loans held for sale increased from $10,000 in fiscal 1997 to
$44,000 in fiscal 1998, as the Company expanded its mortgage banking
operation, including the addition of a new fixed rate conduit at the
conclusion of the second quarter of fiscal 1998
o net loss from real estate operations increased from $135,000 to $198,000,
as the Company's management continued to aggressively pursue the
liquidation of troubled assets acquired through the PSSB purchase
o deposit related fees increased 50.5%, from $412,000 to $620,000 in
conjunction with a
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revised fee schedule, the growth in the Company's transaction account
base, and enhanced management scrutiny of fee waivers
Other income and expense for the six months ended December 31, 1997
totaled $327,000 in expense, versus income of $922,000 during the same period
the prior year. The factors impacting the financial results for the most recent
quarter were also applicable to the six month period, augmented by a significant
increase in intangible asset amortization during the six month period ending
December 31, 1997. The rise in this non-cash charge stemmed from a full six
months' amortization in fiscal 1998 of the intangible asset arising from the
PSSB acquisition , versus only three months' amortization in fiscal 1997.
General and Administrative Expenses
- ---------------------------------
General and administrative expenses decreased from $5.5 million during the
quarter ended December 31, 1996 to $4.6 million during the most recent quarter,
primarily due to:
o a $533,000 savings in salaries and employee benefits resulting from the
refinancing of the Company's loan to the ESOP
o a $323,000 decline in FDIC insurance and other assessments stemming from
reduced FDIC insurance premium rates following the recapitalization of the
SAIF
For the six months ended December 31, 1997, general and administrative
expenses totaled $9.4 million, down from $14.3 million for the same period the
prior year. The $14.3 million figure included a $4.8 million non recurring
assessment to recapitalize the SAIF. Excluding this charge, general and
administrative expenses during the six months ended December 31, 1996 totaled
$9.5 million. General and administrative expenses for the six month period in
the current fiscal year include the impact of the PSSB acquisition throughout
the period, while prior year to date figures include only about three months of
the operating costs associated with four additional full service branches, a
significantly increased deposit portfolio, and an expanded lending territory.
General and administrative expenses during the six months ended December 31,
1996 included certain non-recurring costs associated with the integration of
PSSB, including check printing expenses and various costs for outside
professionals.
The ratio of general and administrative expenses to average assets
declined from 2.18% during the quarter ended December 31, 1996 to 1.69% during
the most recent three months. This improvement was also reflected in the
Company's efficiency ratio, which declined from 83.47% for the second quarter of
fiscal 1997 to 77.64% for the same period in fiscal 1998. Over the past six
months, the Company has implemented a series of initiatives targeted at
improving its productivity while still providing the caliber of customer service
which differentiates community banks from large money center or super regional
institutions, including:
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o the aforementioned refinance of the loan to the ESOP, which will reduce
operating expenses in calendar 1998 by approximately $350,000 based upon
the Company's recent stock price
o a significantly more favorable check printing contract was negotiated and
the Company revised its selection of check printing services to further
reduce periodic expense
o the Company's health benefits program was modified to reduce annual
operating expense by approximately $75,000 per year
o two of the Company's four vehicles were sold
o the Company realized the first ongoing cost reduction from the decision to
terminate its defined benefit and supplemental retirement pension plans
during the quarter ended June 30, 1997
o several vendors were replaced with more cost effective organizations
providing equal or better support to the Company
o the Company commenced more aggressively managing its real estate
resources, resulting in three lease revisions which will save the firm in
excess of $40,000 per year
o correspondent bank services were restructured to provide ongoing operating
expense savings
o a new safe deposit box inventory and billing system was implemented that
will both reduce future operating costs and increase the generation of
non-interest income
o flexible spending accounts were introduced January 1, 1998, enhancing the
Company's employee benefits while saving the Company payroll tax expense
Management is continuing to pursue multiple avenues for further improving
the Company's efficiency ratio, with several initiatives slated for introduction
during the third quarter of fiscal 1998. These initiatives address both
bolstering revenues from client services and reducing operating expenses,
particularly those associated with administrative functions. On the other hand,
the Company is experiencing some increases in operating costs stemming from its
development of a more robust sales organization and an expanded array of
products and services. There can be no assurance regarding the range of
additional initiatives which might be implemented, nor concerning the degree of
success to be realized from such initiatives.
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Income Taxes
- ------------
Income tax expense increased slightly in the quarter ended December 31,
1997 versus the same quarter the prior year due to an expansion in pre-tax
income. Fiscal 1998 year to date income tax expense totaled $871,000, versus a
benefit of $1.1 million during the six months ended December 31, 1997, due to
changes in the Company's pre-tax income. The Company's nominal tax rate remained
substantially unchanged between current and prior fiscal year.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Company is not involved in any material pending legal proceedings
other than routine legal proceedings occurring in the ordinary course of
business. Such other routine legal proceedings in the aggregate are
believed by management to be immaterial to the Company's financial
condition or results of operations.
Item 2. Changes in Securities
---------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
a) The Company's Annual Meeting of Stockholders was held on October 28,
1997.
b) Not applicable.
c) At such meeting the Company's stockholders approved the following:
1. The election of the following individuals as Directors for the term of
three years each.
For Withheld
--- --------
J. Robert Eichinger 4,687,889 35,268
Harold L. Fuller 4,688,664 34,493
Richard S. Cupp 4,688,194 34,963
2. The ratification of the Amended and Restated HF Bancorp, Inc.
Stock-Based Incentive Plan and the amendment to the plan to increase the
aggregate number of shares of common stock authorized for issuance under
such Plan by 150,000.
For Against Abstain Not Voted
--- ------- ------- ---------
4,462,721 136,551 40,055 83,830
3. The appointment of Deloitte & Touche, L.L.P., as independent auditors
of the Company for the fiscal year ending June 30, 1998.
For Against Abstain
--- ------- -------
4,689,954 14,990 18,213
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Item 5. Other Information
-----------------
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
A. Exhibits
(3) (i) Articles of Incorporation*
(ii) By-laws*
(4) Stock Certificate*
(27) Financial Data Schedule
- ------------------------------------
*Incorporated herein by reference into this document from the Exhibits to Form
S-1 Registration Statement and any amendments thereto, filed March 14, 1994,
Registration No. 33-90286.
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SIGNATURES
Pursuant to the requirements of The Securities Exchange Act Of
1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
HF BANCORP INC.
(Registrant)
Date: February 3, 1998 By: /s/ Richard S. Cupp
--------------------
Richard S. Cupp
President
Chief Executive Officer
Date: February 3, 1998 By: /s/ Mark R. Andino
-------------------
Mark R. Andino
Vice President
Treasurer
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