Exhibit 13
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY - SELECTED CONSOLIDATED
FINANCIAL DATA
(Dollars in Thousands Except Share Data)
The following table presents selected consolidated financial and other data of
the Company for the five years in the period ended June 30, 2000. The selected
consolidated financial data should be read in conjunction with the Consolidated
Financial Statements of the Company, including the accompanying Notes, presented
elsewhere herein.
- -----------------------------------------------------------------------------------------------------------------------------------
At or For the Years Ended June 30, 2000 1999 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data
Securities held for trading and available for sale $ 117,904 $ 183,702 $ 291,531 $ 318,480 $ 321,897
Loans receivable-net 270,970 259,632 163,546 93,958 65,925
Total assets 435,192 471,339 446,797 446,797 418,196
Deposits 361,241 333,245 178,311 136,175 135,143
Core retail deposits 334,467 322,898 166,818 123,489 112,369
Securities sold under agreements to repurchase 28,038 60,198 240,396 245,571 219,067
Federal Home Loan Bank advances 7,000 40,000 26,000 26,000 26,000
Note payable 12,995 13,995 13,495 9,995 8,998
Stockholders' equity 16,257 19,139 22,664 24,994 23,117(1)
Stockholders' equity per share 5.16 5.97 6.92 7.67 7.10
Income Statement Data
Interest income $ 31,893 $ 35,204 $ 33,956 $ 34,474 $ 23,484
Interest expense 23,522 29,123 29,032 26,408 18,004
------- ------- ------ ------- ------
Net interest income 8,371 6,081 4,924 8,066 5,480
Provision for loan losses 587 511 147 92 (1)
---- ---- ---- --- ---
Net interest income after provision for loan losses 7,784 5,570 4,777 7,974 5,481
Retail banking fees and other income 772 433 295 239 256
---- ---- ---- ---- ---
Total net revenue 8,556 6,003 5,072 8,213 5,737
Operating expenses 9,627 8,500 6,460 5,444 3,740
------ ------ ------ ------ -----
Income (loss) before tax provision, gain (loss) on
securities and minority interest (1,071) (2,497) (1,388) 2,769 1,997
-------- -------- -------- ------ -----
Gain (loss) on sale of securities held for training (4,498) 4,755 (775) (1,623) 1,834
Unrealized gain (loss) on securities held for trading 3,494 (6,402) (930) 2,117 (1,960)
Gain (loss) on sale of loans (1,173)
-------- -------- -------- ---- -----
Net gain (loss) on securities and loans (2,177) (1,647) (1,705) 494 (126)
-------- -------- -------- ---- -----
Income (loss) before income tax provision and minority interest (3,248) (4,144) (3,093) 3,263 1,871
Income tax provision (1,277) (1,646) (1,234) 1,261 648
-------- -------- -------- ------ ---
Income (loss) before minority interest (1,971) (2,498) (1,859) 2,002 1,223
Minority interest 92 43
-------- -------- -------- ---- -----
Net income (loss) $ (1,879) $ (2,455) $ (1,859) $ 2,002 $ 1,223
========== ========== ========== ======== =======
Basic earnings (loss) per share $ (0.59) $ (0.76) $ (0.57) $ 0.61 $ 0.57
Diluted earnings (loss) per share $ (0.59) $ (0.76) $ (0.57) $ 0.61 $ 0.56
Cash dividends per share $ 0.12 $ 0.12 $ 0.12 $ 0.03 $ N/A
Market value, fiscal year-end per share $ 6.50 $ 7.25 $ 11.25 $ 12.13 $ 10.50
Performance Ratios
Return on average assets (2) (0.41)% (0.44)% (0.34)% 0.50 % 0.37 %
Return on average equity (2) (10.70) (12.54) (7.56) 10.52 9.49
Interest rate spread 1.75 1.06 0.79 1.43 1.64
Net interest margin 1.87 1.12 0.94 1.62 1.73
Average interest-earning assets to average
interest-bearing liabilities 102.16 101.14 102.73 103.67 101.55
Net interest income after provision for loan losses to
total other expenses (2) 80.86 65.53 73.95 172.82 146.55
Total other expenses to average total assets (2) 2.08 1.51 1.20 0.91 1.13
Full service offices 9 8 7 4 3
Asset Quality Ratios (at end of period)
Non-performing loans to total loans (3) 0.07 0.03 0.17 0.36 0.40
Non-performing assets to total assets (3) 0.13 0.13 0.18 0.25 0.32
Allowance for loan losses to total loans 0.52 0.33 0.22 0.23 0.02
Allowance for loan losses to total non-performing loans 782.22 1,142.11 126.32 63.39 45.98
Capital Ratios (4)
Tangible capital ratio 6.65 6.95 6.88 6.96 6.27
Core capital ratio 6.65 6.95 6.88 6.96 6.27
Risk-based capital ratio 12.75 12.33 21.92 31.14 30.10
Equity to assets at end of period 3.74 4.06 4.68 5.59 5.53
(1) On May 6, 1996, the Company sold 1,265,000 shares of common stock at
$10.00 per share to investors in an initial public offering resulting in
gross proceeds of $12,650,000 to the Company. Net proceeds after offering
expenses were $11,437,000.
(2) For comparability purposes, the 1997 fiscal year ratios exclude the effect
of the special SAIF assessment of $830,000.
(3) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, assets acquired by foreclosure or
repossession and a single non-agency participation certificate classified
as substandard.
(4) Regulatory capital ratios apply to the Bank (Harrington Bank, FSB) as a
federally chartered savings bank.
1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Harrington Financial Group, Inc. ("Harrington" or the "Company") is an
Indiana-chartered, registered thrift holding company for Harrington Bank, FSB
(the "Bank"). The following financial review presents an analysis of the
Company's operations and financial position for the periods presented in this
annual report.
General
Harrington's business strategy focuses on achieving attractive
returns consistent with prudent risk management. Harrington has sought to
implement this strategy by: (1) expanding its banking locations and product
offerings in order to build a strong community banking franchise; (2)
controlling interest rate risk by matching the interest rate sensitivity of its
assets to that of its liabilities; (3) controlling credit risk by originating
well-collateralized loans and by applying conservative underwriting standards
and credit risk monitoring; and (4) utilizing excess capital balances through
the management of a hedged investment portfolio.
Highlights of the principal elements of the Company's business strategy are as
follows:
Expand Banking Locations and Product Offerings. An integral part of
the Company's strategy has been to expand opportunistically the products,
services, and banking locations for business and retail customers in markets
where the Company's management and directors have market knowledge and customer
relationship potential. A total of eight new banking locations have been opened
since May 1994, and the Commercial Loan Division was developed in the Spring of
1998. With the primary expansion complete, the Company is focused on efficiency
and revenue enhancement to improve profitability.
In March 2000, the Company reached a definitive agreement to sell
the Bank's two southern Indianapolis branches. The Company determined that the
branches did not strategically fit with its market development on the north side
of Indianapolis in Hamilton County. On September 8, 2000, the Company sold
deposits and certain assets of the two branch banking locations. The Company
sold $43.5 million of deposits, $0.4 million of office properties and equipment,
and paid approximately $41.7 million. The sale resulted in a pre-tax gain of
approximately $1.4 million.
The Company's lending emphasis is on the origination of loans
secured by first and second liens on single-family (one to four units)
residences and commercial real estate, equipment, inventory, and receivables
lending through its Commercial Loan Division. In fiscal year 2000, the Company
originated $10.7 million in single family related loans, $12.6 million in
consumer related loans, and $53.9 million in commercial related loans. Total
loans have increased to $271.0 million at June 30, 2000 from $94.0 million at
June 30, 1997.
The Company believes that retail deposits are a cost-effective
source of funds, provide an additional source of fee income, and also permit the
further cross selling of additional products and services. Consequently, the
Company is focusing on increasing its retail deposit base while controlling
deposit cost. Core deposits (total consolidated deposits less public funds
deposits and brokered deposits) were $334.4 million at June 30, 2000 and have
increased from $123.5 million at June 30, 1997.
The Company also formed Harrington Wealth Management Company
("HWM") in February 1999. HWM is a strategic alliance between the Bank (51%
owner) and Los Padres Bank (49% owner), a federally chartered savings bank
located in California. HWM provides trust, investment management, and custody
services for individuals and institutions.
Control Interest Rate Risk. The Company attempts to manage its
assets and liabilities in order to maintain a portfolio that produces positive
returns in either an increasing or decreasing interest rate environment. The
Company has sought to control interest rate risk both internally through the
management of the composition of its assets and liabilities and externally
through the utilization of interest rate contracts. Interest rate contracts are
purchased with the intention of protecting the market value of the Bank's
portfolio and net interest income.
2
Control Credit Risk. In order to limit the Company's credit
exposure, the Company originates and adds to portfolio well-secured residential
and commercial loans and maintains strict underwriting standards. As such,
non-performing loans have remained relatively low, with only $180,000 or 0.07%
of total loans at June 30, 2000.
Utilize Excess Capital Balances. The Company utilizes excess
capital balances through the management of a hedged investment portfolio
primarily consisting of mortgage-backed securities and corporate bonds. Although
these securities often carry lower yields than traditional loans, such
securities generally increase the quality of the Company's assets, are more
liquid than individual loans, and may be used to collateralize borrowings or
other obligations of the Company. The funds invested in the securities portfolio
can be quickly redeployed to pursue community bank expansion opportunities as
they arise.
During fiscal year 2000, the Company marked almost all of its
investment securities and related interest rate contracts to market either in
earnings (trading portfolio) or in equity (available for sale portfolio). This
method of accounting was consistent with the Company's strategy of active
portfolio management and provided the Company with the flexibility to adjust
quickly the mix of its interest earning assets in response to changing market
conditions or to take advantage of community banking growth opportunities. With
the growth in the core retail and commercial banking business, the level of
assets subject to mark-to-market accounting has declined.
In summary, the Company continues to build a community-oriented
banking operation in order to sustain loan originations and deposit growth,
benefit from economies of scale, and generate additional fee and net interest
income. Management's primary goal is to increase stockholders' value as measured
on a risk-adjusted total return basis.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
In addition to historical information, forward-looking statements
contained in this annual report are subject to risks and uncertainties that
could cause actual results to differ materially from those reflected in the
forward-looking statements. Factors that could cause future results to vary from
current expectations include, but are not limited to, the impact of economic
conditions (both generally and more specifically in the markets in which
Harrington operates), the impact of competition for Harrington's customers from
other providers of financial services, the impact of government legislation and
regulation (which changes from time to time and over which Harrington has no
control), and other risks detailed in the Annual Report and in Harrington's
other Securities and Exchange Commission ("SEC") filings. Readers are cautioned
not to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. Harrington undertakes no
obligation to publicly revise these forward-looking statements to reflect events
or circumstances that arise after the date hereof. Readers should carefully
review the risk factors described in other documents Harrington files from time
to time with the SEC, including the Quarterly Reports on Form 10-Q to be filed
by Harrington in 2000 and 2001 and any Current Reports on Form 8-K filed by
Harrington.
Changes in Financial Condition
General. At June 30, 2000, Harrington's total assets amounted to
$435.2 million, as compared to $471.3 million at June 30, 1999. The decrease in
total assets was primarily due to a $62.0 million decrease in the Company's
securities portfolio which was partially offset by an $11.3 million increase in
the loan portfolio and a $14.8 million increase in cash and interest bearing
deposits.
Cash and Interest-Bearing Deposits. Cash and interest-bearing
deposits amounted to $24.3 million and $9.5 million at June 30, 2000 and 1999,
respectively. Harrington actively manages its cash and cash equivalents based
upon the Company's operating, investing and financing activities. Based upon the
Company's current size, cash and cash equivalents generally fluctuate within a
range of approximately $10.0 million to $25.0 million. Harrington attempts to
invest its excess liquidity in higher yielding assets such as loans or
securities.
3
Securities Held for Trading and Available for Sale. In order to
reduce the Company's credit risk exposure, to enhance balance sheet liquidity,
and to utilize excess capital balances, Harrington maintains a portion of its
assets in a hedged investment portfolio, the securities of which are primarily
issued or guaranteed by U.S. Government agencies or government sponsored
enterprises. Almost all of these securities and their related interest rate risk
management contracts are classified as held for trading or available for sale
and, pursuant to SFAS 115, are reported at fair value with unrealized gains and
losses included in earnings or equity, respectively.
Securities held for trading (consisting of mortgage-backed
securities, mortgage-backed derivative securities, interest rate contracts and
equity securities) amounted to $53.9 million and $183.2 million at June 30, 2000
and 1999, respectively. Securities classified as available for sale (consisting
of a non-agency mortgage-backed security, corporate bonds, and adjustable rate
mortgage securities) increased from $502,000 at June 30, 1999 to $64.1 million
at June 30, 2000.
Loans Receivable. At June 30, 2000, loans receivable (net of the
Company's allowance for loan losses) amounted to $271.0 million, an increase of
4.4% over the June 30, 1999 total of $259.6 million. This loan growth was
accomplished despite the sale of $22.0 million of low coupon single-family
mortgage loans in June 2000. Harrington has significantly increased its
community banking operations, including the origination of single-family
residential and commercial loans. Loans originated through correspondents must
meet the same pricing and underwriting standards as loans originated internally.
The Bank's consumer and commercial loan portfolio significantly increased from
$42.6 million at June 30, 1999 to $90.1 million at June 30, 2000.
Allowance for Loan Losses. At June 30, 2000, Harrington's
allowance for loan losses totaled $1.4 million, compared to $868,000 at June 30,
1999. At June 30, 2000, the Company's allowance represented approximately 0.52%
of the total loan portfolio as compared to 0.33% at June 30, 1999. The ratio of
total non-performing loans to total loans amounted to 0.07% at June 30, 2000
compared to 0.03% at June 30, 1999, which reflects Harrington's emphasis on
maintaining low credit risk with respect to its operations.
Although Harrington's management believes that its allowance for
loan losses at June 30, 2000 was adequate based on facts and circumstances
available to it (including the historically low level of loan charge-offs),
there can be no assurances that additions to the allowance will not be necessary
in future periods, which could adversely affect the Company's results of
operations.
Deposits. At June 30, 2000, deposits totaled $361.2 million, as
compared to $333.2 million as of June 30, 1999. Core deposits increased $11.5
million, from $322.9 million at June 30, 1999 to $334.4 million at June 30,
2000, primarily due to Harrington's strategy of rapidly building a community
banking franchise which included the opening of the North Carolina Bank in July
1999. The North Carolina branch contributed $43.7 million of the growth in
fiscal year 2000, while deposits in the Bank's other markets declined $32.2
million. Non-retail deposits increased by $16.5 million during the same period,
for a total increase in deposits of $28.0 million.
Borrowings. At June 30, 2000, reverse repurchase agreements and
dollar rolls (both of which are securities sold under agreements to repurchase
and are accounted for as a financing) totaled $28.0 million, as compared to
$60.2 million as of June 30, 1999.
Advances from the FHLB of Indianapolis amounted to $7.0 million
and $40.0 million as of June 30, 2000 and 1999, respectively. At June 30, 2000,
the FHLB advance was scheduled to mature in fiscal 2001, with an average
interest rate thereon of 6.87%, as compared to 4.94% at June 30, 1999.
The Company's note payable amounted to $13.0 million and $14.0
million at June 30, 2000 and 1999, respectively. The note payable relates to a
loan facility that was used to refinance, to a significant extent, the unpaid
balance of a $10.0 million acquisition loan which financed the Company's
acquisition of the Bank.
Stockholders' Equity. Stockholders' equity decreased from $19.1
million at June 30, 1999 to $16.3 million at June 30, 2000. This decrease was
due primarily to the $1.9 million of net loss recognized during fiscal 2000, the
purchase of treasury stock amounting to $326,000, and the payment of the
Company's quarterly dividends of $.03 per share, or $384,000 in total.
4
Results of Operations
Summary of Operations. Harrington reported a net loss of $1.9
million or $0.59 basic loss per share for the year ended June 30, 2000 compared
to a net loss of $2.5 million or $0.76 basic loss per share for the year ended
June 30, 1999. This $576,000 or 23.5% decrease in net loss was due primarily to
a $2.6 million increase in net revenue which was partially offset by a $1.1
million increase in operating expenses, a $481,000 increase in other losses, and
a $369,000 decrease in the income tax benefit.
The Company's primary goal in fiscal years 1999 and 2000 was to
improve the value of the banking franchise through profitable deposit, loan, and
market and business line expansion. The market expansion into Kansas and North
Carolina and the establishment of the necessary infrastructure were
substantially completed during fiscal year 2000. The recent losses are due
primarily to the underperformance of the investment portfolio combined with the
necessary investment spending to complete the market expansion and develop the
infrastructure to support continued growth into the future. With the foundation
now in place for its community banks in Indiana, Kansas and North Carolina, the
Company is making marked improvement in its core banking income (net interest
income after provision for loan losses plus fees minus operating expenses). Net
interest income has increased by $2.3 million over fiscal year 1999, which
reflects the growth in the Company's commercial loan portfolio and core
deposits. Furthermore, the core income deficit has been reduced from $2.5
million in fiscal year 1999 to $1.1 million in fiscal year 2000. Contributing to
this improvement is higher spread earning loans, the reduction in deposit costs
related to borrowings, and the control of operating expenses through staff
reductions, a senior management realignment, and a cost reduction program.
The net loss for the year ended June 30, 1999 was $2.5 million or
$0.76 basic loss per share, compared to a net loss of $1.9 million or $0.57
basic loss per share for the year ended June 30, 2000. The $596,000 or 32.1%
increase in net loss was due primarily to a $2.0 million increase in operating
expenses and a $364,000 increase in the provision for loan losses, which was
partially offset by a $1.2 million increase in net interest income, a $196,000
increase in other income (loss) and a $412,000 decrease in the income tax
provision.
Average Balances, Net Interest Income and Yields Earned and Rates
Paid. The following table presents for the periods indicated the total dollar
amount of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. The table does
not reflect any effect of income taxes. All average balances are based on
average daily balances for the Bank during the periods presented.
5
Years Ended June 30,
-----------------------------------------------------------------------------------
2000 1999
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
------- -------- -------- ------- -------- --------
(Dollars in Thousands)
Interest-Earning Assets:
Interest-bearing deposits $ 15,795 $ 784 4.96 % $ 13,489 $ 611 4.53 %
Securities held for trading (2) 132,550 8,816 6.65 % 300,223 18,104 6.03 %
Securities available for sale (3) 17,479 1,094 6.26 % 699 66 9.44 %
Securities held to maturity 2,308 171 7.41 % - - 0.00 %
Loans receivable, net (4) 275,454 20,637 7.49 % 223,174 16,032 7.18 %
Federal Home Loan Bank stock 4,879 391 8.01 % 4,879 391 8.01 %
------ ---- ------ ----
Total interest-earning assets 448,465 31,893 7.11 % 542,464 35,204 6.49 %
====== ======
Non-interest-earning assets 14,773 19,206
------- -------
Total assets $ 463,238 $ 561,670
========== ==========
Interest Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 18,612 1,013 5.44 % $ 13,050 306 2.34 %
Savings accounts 33,291 1,371 4.12 % 30,520 1,279 4.19 %
Money market deposit accounts 117,919 5,148 4.37 % 73,256 3,546 4.84 %
Certificates of deposit 186,308 10,694 5.74 % 156,262 8,969 5.74 %
-------- ------- -------- ------
Total deposits 356,130 18,226 5.12 % 273,088 14,100 5.16 %
Securities sold, repurchase agreement 52,550 2,809 5.35 % 213,428 11,433 5.36 %
Federal Home Loan Bank advances 15,540 1,192 7.67 % 36,172 2,481 6.86 %
Note payable 14,753 1,295 8.78 % 13,672 1,109 8.11 %
------- ------ ------- ------
Total interest-bearing liabilities 438,973 23,522 5.36 % 536,360 29,123 5.43 %
------- ====== ------- ======
Non-interest-bearing liabilities 5,782 5,328
------ ------
Total liabilities 444,755 541,688
Minority interest 916 401
Stockholders' equity 17,567 19,581
------- -------
Total liabilities and stockholders' equity $ 463,238 $ 561,670
========== ==========
Net interest income; interest rate spread (5) $ 8,371 1.75 % $ 6,081 1.06 %
======== ====== ======== ======
Net interest margin (5) (6) 1.87 % 1.12 %
====== ======
Average interest-earning assets
to average intersest-bearing liabilities 102.16 % 101.14 %
======== ========
Years Ended June 30,
-------------------------------------------
1998
Average Yield/
Balance Interest Rate (1)
------- -------- --------
(Dollars in Thousands)
Interest-Earning Assets:
Interest-bearing deposits $ 14,590 $ 792 5.43 %
Securities held for trading (2) 386,640 23,947 6.19 %
Securities available for sale (3) 1,039 91 8.76 %
Securities held to maturity - - 0.00 %
Loans receivable, net (4) 116,982 8,734 7.47 %
Federal Home Loan Bank stock 4,858 392 8.07 %
------ -------
Total interest-earning assets 524,109 33,956 6.48 %
======
Non-interest-earning assets 14,872
--------
Total assets $ 538,981
=========
Interest Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 6,788 166 2.45 %
Savings accounts 25,188 1,091 4.33 %
Money market deposit accounts 2,713 127 4.68 %
Certificates of deposit 117,073 6,919 5.91 %
-------- ------
Total deposits 151,762 8,303 5.47 %
Securities sold, repurchase agreement 319,578 17,905 5.60 %
Federal Home Loan Bank advances 27,488 1,843 6.70 %
Note payable 11,355 981 8.64 %
------- ----
Total interest-bearing liabilities 510,183 29,032 5.69 %
------- ======
Non-interest bearing liabilities 4,200
--------
Total liabilities 514,383
Minority interest
Stockholders' equity 24,598
--------
Total liabilities and stockholders' equity $ 538,981
=========
Net interest income; interest rate spread (5) $ 4,924 0.79 %
======== ======
Net interest margin (5) (6) 0.94 %
======
Average interest-earning assets
to average intersest-bearing liabilities 102.73 %
========
(1) At June 30, 2000, the yields earned and rates paid were as follows:
interest-bearing deposits, 6.36%; securities held for trading, 6.87%;
securities avaliable for sale, 6.79%; securities held to maturity, 7.38%;
loans receivable, net 7.96%; FHLB stock, 8.00%; total interest-earning
assets, 7.55%; deposits, 5.50%; securities sold under agreements to
repurchase, 6.31%; FHLB advances, 6.87%; note payable, 9.50%; total
interest-bearing liabilities, 5.71%; interest rate spread 1.84%.
(2) Both the interest and yields earned on the Company's securities portfolio
reflect the net interest expense incurred with respect to various interest
rate contracts (such as interest rate swaps, collars, caps, floors,
options and futures) which were utilized to hedge the Company's interest
rate exposure. During the years ended June 30, 2000, 1999 and 1998, the
net costs of hedging the Company's interest rate exposure with respect to
its securities held for trading amounted to $85,000 or 0.13%, $1.5 million
or 0.77% and $730,000 or 0.37%, respectively.
(3) The average balance reflects the carrying value of available for sale
investments net of the average valuation allowance related to a single
non-agency participation certificate of $97,000, $114,000 and $155,000 for
the years ended June 30, 2000, 1999 and 1998, respectively.
(4) Net of deferred loan fees, loan discounts and undisbursed loan funds.
Includes nonaccrual loans. Interest on nonaccrual loans is recorded when
received.
(5) Excluding the costs of hedging the Company's interest rate exposure (which
has effectively reduced the yields earned on the Company's securities
portfolio), the Company's interest rate spread amounted to 1.77%, 1.17%
and 1.07%, and the Company's net interest margin amounted to 1.89%, 1.23%
and 1.22% for the years ended June 30, 2000, 1999 and 1998, respectively.
(6) Net interest margin is net interest income divided by average
interest-earning assets.
6
Rate/Volume Analysis. The following table describes the extent to
which changes in interest rates and changes in volume of interest-related assets
and liabilities have affected the Company's interest income and interest expense
during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in volume (change in volume multiplied by prior year rate), (2)
changes in rate (change in rate multiplied by prior year volume), and (3) total
change in rate and volume. The combined effect of changes in both rate and
volume has been allocated in proportion to the absolute dollar amounts of the
changes due to rate and volume.
Year Ended June 30, 2000 vs. 1999 1999 vs. 1998
-------------------------------------- ------------------------------------
(Dollars in Thousands) Increase (Decrease) Increase (Decrease)
Due to Total Due to Total
------------------------- Increase ----------------------- Increase
Rate Volume (Decrease) Rate Volume (Decrease)
Interest earning assets:
Interest bearing deposits $ 63 $ 110 $ 173 $ (124) $ (57) $ (181)
Securities held for trading 2,099 (11,387) (9,288) (617) (5,226) (5,843)
Securities available for sale (14) 1,042 1,028 8 (33) (25)
Securities held to maturity (6) 146 140 12 (4) 8
Loans receivable net 734 3,901 4,635 (319) 7,609 7,290
Federal Home Loan Bank stock - - - (3) 2 (1)
-------- -------- -------- -------- -------- --------
Total interest earning assets $ 2,876 $ (6,188) $ (3,312) $ (1,043) $ 2,291 $ 1,248
======= ========== ========= ========= ======== =======
Interest bearing liabilities:
NOW and DDA accounts $ 534 $ 172 $ 706 $ (7) $ 147 $ 140
Savings accounts (22) 114 92 (34) 222 188
Money market deposits accounts (307) 1,909 1,602 4 3,414 3,418
Certificates of deposits - 1,725 1,725 (193) 2,243 2,050
-- ------ ------ ------ ------ -----
Total deposits 205 3,920 4,125 (230) 6,026 5,796
Securities sold under agreements to repurchase (24) (8,600) (8,624) (756) (5,716) (6,472)
Federal Home Loan Bank advances 338 (1,626) (1,288) 43 594 637
Note payable 95 91 186 (55) 183 128
-------- -------- -------- -------- -------- --------
Total interest bearing liabilities $ 614 $ (6,215) $ (5,601) $ (998) $ 1,087 $ 89
====== ========== ========= ======== ======== ====
Increase (decrease) in net interest income $ 2,289 $ 1,159
======== =======
Interest Income
For the year ended June 30, 2000, Harrington's interest income
decreased by $3.3 million or 9.4% to $31.9 million, compared to the year ended
June 30, 1999. This decrease was primarily due to an $8.1 million decrease in
interest income from the securities portfolio. This decrease was partially
offset by a $4.6 million increase in interest income on the Company's loan
portfolio. The increase in interest income on the loan portfolio was a direct
result of the $52.4 million increase in the level of the average loan portfolio
which was partially offset by a 32 basis point increase in the interest yield
earned caused primarily by an overall increase in the level of interest rates
during fiscal 2000. The decrease in interest income from the investment
portfolio was a result of the $148.7 million decrease in the average balances
offset by a 57 basis point increase in the yield of the portfolio.
For the year ended June 30, 1999, Harrington's interest income
increased by $1.2 million or 3.7% to $35.2 million, compared to the year ended
June 30, 1998. This increase was primarily due to a $7.3 million increase in
interest income from the loan portfolio. This increase was partially offset by a
$5.9 million decrease in interest income on the Company's investment portfolio
including the increase in the net interest expense on interest rate contracts
maintained in the trading portfolio. The increase in interest income on the loan
portfolio was a direct result of the $106.2 million increase in the level of the
average loan portfolio which was partially offset by a 29 basis point decline in
the interest yield earned caused primarily by an overall decline in the level of
interest rates during fiscal 1999. The decrease in interest income from the
investment portfolio was a result of the $86.8 million decrease in the average
balances as well as the 15 basis point decline in the level of interest rates
during fiscal 1999.
7
Interest Expense. For the year ended June 30, 2000, Harrington's
interest expense decreased by $5.6 million or 19.2% to $23.5 million, compared
to the year ended June 30, 1999. This decrease was primarily due to a $97.4
million decrease in the level of average interest-bearing liabilities and a 7
basis point decrease in the cost of interest-bearing liabilities.
For the year ended June 30, 1999, Harrington's interest expense
increased by $91,000 or 0.3% to $29.1 million, compared to the year ended June
30, 1998. This increase was primarily due to a $26.2 million increase in the
level of average interest-bearing liabilities, which was offset by a 26 basis
point decrease in the cost of interest-bearing liabilities.
Net Interest Income. Net interest income increased by $2.3
million or 37.7% to $8.4 million during fiscal year 2000 as compared to fiscal
year 1999. Net interest income increased by $1.2 million or 23.5% to $6.1
million during fiscal year 1999 as compared to fiscal year 1998.
Provision for Loan Losses. The provision for loan losses is
charged to earnings to bring the total allowance to a level considered
appropriate by management based on the estimated net realizable value of the
underlying collateral, general economic conditions, particularly as they relate
to the Company's market areas, historical loan loss experience and other factors
related to the collectibility of the Company's loan portfolio. While management
endeavors to use the best information available in making its evaluations,
future allowance adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations.
Harrington established provisions for loan losses of $587,000,
$511,000, and $147,000 during the years ended June 30, 2000, 1999, and 1998,
respectively. During such respective periods, loan charge-offs (net of
recoveries) amounted to $47,000, $3,000, and $0, respectively. Although the
Company's non-performing loans remain low, given the growth in the commercial
and consumer loan portfolios, the Company's analysis of loan reserve
requirements indicated that additional reserves were prudent. The allowance for
loan losses as a percentage of total loans was 0.5% and 0.3% at June 30, 2000
and 1999, respectively.
Other Income (Loss). Other income (loss) is comprised of two
distinct components: gains and losses on the Company's investment securities and
hedging instruments, and fee and other income from retail bank operations. Gains
or losses on investments and hedges which have been sold are reported as
realized gains or losses, and market value gains or losses on investments and
hedges which remain in the Company's portfolio are reported as unrealized gains
or losses.
Management's goal is to attempt to offset any change in the
market value of its securities portfolio with the change in the market value of
the interest rate risk management contracts and mortgage-backed derivative
securities utilized by the Company to hedge its interest rate exposure. In
addition, management attempts to produce an overall positive return on its
securities portfolio relative to its funding costs through the use of
option-adjusted pricing analysis. The Company utilizes such analysis to select
securities with wider spreads for purchase and to select securities to sell for
a gain as spreads tighten (net of the gain or loss recognized with respect to
related interest rate contracts).
However, the use of mark-to-market accounting for the trading
portfolio can cause volatility in reported earnings due to short-term
fluctuations in the market value of the securities relative to that of the hedge
instruments. Harrington realizes that a major benefit of marking assets to
market is that it provides shareholders with more timely information on the
economic value of the Company's portfolio, and it allows flexibility to grow or
reduce investments as opportunities allow. The Company, however, has reduced the
level of the assets subject to "mark-to-market" accounting through its community
banking expansion and reduction in its investment portfolio.
8
The following table sets forth information regarding other income (loss) for the
periods shown.
(Dollars in Thousands) Years Ended June 30,
--------------------------------------
2000 1999 1998
Gain (loss) on sale of securities held for trading $(4,498) $ 4,755 $ (775)
Gain (loss) on sale of loans (1,173) - -
Unrealized gain (loss) on securities held for trading 3,494 (6,402) (930)
Other (1) 772 433 295
Total other income (loss) $(1,405) $(1,214) $(1,410)
======= ======= =======
(1) Consists primarily of loan servicing fees and late charges, checking
account fees, trust and investment management service fees, rental
income and other miscellaneous fees.
Total other income (loss) amounted to $(1.4) million for the year
ended June 30, 2000. This total consisted of a net realized and unrealized loss
of $1.0 million on the trading portfolio, a loss on sale of loans of $1.2
million plus fee and other retail bank income of $772,000. Total other income
(loss) amounted to $(1.2) million for the year ended June 30, 1999. This total
consisted of a net realized and unrealized loss of $1.6 million on the trading
portfolio, plus fee and other retail bank income of $433,000. The losses on the
trading portfolio, net of hedges, reflect only a portion of the total income
(loss) produced from this portfolio in fiscal 2000 and 1999. Total income from
this portfolio consists of both interest income and net realized and unrealized
gains and losses on the investments and hedges.
The Company seeks to produce a positive spread between the total
income of this portfolio and one month LIBOR, the Company's marginal cost of
borrowing. In the fiscal years 2000, 1999, and 1998, this portfolio produced a
net-hedged spread to one-month LIBOR of (.98)%, 0.28%, and 0.15%, respectively.
Due to the market uncertainty over Federal Reserve action, an oversupply of
corporate debt issuances due to Y2K concerns which increased both financing and
credit margins, concerns that the government sponsored agencies would be
privatized, and spreads of mortgage securities to Treasury widening during
fiscal years 1999 and 2000, the hedge gains therefore lagged the realized and
unrealized losses on securities. The Company's community banking expansion is
expected to reduce the reliance on investment returns over the coming years,
although the Company remains confident in its core competency in fixed income
investments.
Total other income (loss) amounted to $(1.4) million for the year
ended June 30, 1998. This total consisted of a net realized and unrealized loss
of $1.7 million on the trading portfolio, plus fee and other retail bank income
of $295,000. The weaker investment performance of the Company's hedged mortgage
securities portfolio in fiscal year 1998 can be attributed to the low interest
rate and flat yield curve environment which, together with the associated
prepayment uncertainty, caused investors to demand a larger spread between the
rates on mortgage securities and comparable duration securities.
Other Expense. In order to enhance the Company's profitability,
management strives to maintain a favorable level of operating expenses relative
to its peer group. However, during fiscal years 1998 and 1999, the Company
accelerated its investment spending in operating expenses to accomplish the
business line and facilities expansion in order to grow revenue in future years.
This expansion culminated with the opening of the North Carolina branch in
August 1999. With the primary expansion complete in fiscal year 2000, management
has implemented efficiency enhancements within the 2000 fiscal year, a senior
management realignment, administrative staffing reductions, and a cost
containment program to improve profitability. Also, two underperforming branches
and related deposits were sold in southern Indianapolis on September 8, 2000 for
a pretax gain on sale of $1.4 million. These measures are expected to save the
Company over $1.0 million in operating expenses in fiscal year 2001. The
following table sets forth certain information regarding other expense for the
periods shown.
9
(Dollars in Thousands) Years Ended June 30,
----------------------------------
2000 1999 1998
Salaries and employee benefits $ 5,090 $ 4,290 $ 3,295
Pemises and equipment 1,516 1,262 805
FDIC insurance premiums 133 125 86
Marketing 382 314 183
Computer services 611 509 243
Consulting fees 276 301 287
Other (1) 1,619 1,699 1,561
------ ------ -----
Total other expense $ 9,627 $ 8,500 $ 6,460
======== ======== =======
(1) Consists primarily of costs relating to postage, forms and supplies,
professional fees, supervisory assessments and other miscellaneous
expenses.
The principal category of Harrington's other expense is salaries
and employee benefits, which increased by $800,000 or 18.6%, and $1.0 million or
30.2% during fiscal 2000 and 1999, respectively. The major cause of these
increases was the continuing implementation of Harrington's community bank
expansion strategy. A total of eight new banking locations were opened since May
1994, with three being opened in the third quarter of fiscal year 1998 and one
each in the first quarters of fiscal year 1999 and 2000. In addition, new
employees were hired in connection with the growth in the Bank's development of
the commercial loan division.
Premises and equipment expense increased by $254,000 or 20.1% and
$457,000 or 56.8% during fiscal 2000 and 1999, respectively. The increase in
premises and equipment expense during the periods was primarily due to the
opening of new branches.
Federal Deposit Insurance Corporation ("FDIC") premiums increased
by $8,000 or 6.4% during fiscal year 2000 due to the increase in deposit size.
During fiscal 1999, FDIC insurance premiums increased $39,000 or 45.3% also
primarily due to an increase in the deposit base.
Harrington incurred marketing expenses of $382,000, $314,000, and
$183,000 during the years ended June 30, 2000, 1999, and 1998, respectively. The
fluctuations in marketing expense during the periods reflected the advertising
costs associated with the opening of the Bank's new branch offices.
Computer services expense increased by $102,000 or 20.0% and
$266,000 or 109.5% during fiscal years 2000 and 1999, respectively. Computer
services expense relates to the fees paid by Harrington to a third party who
performs the Company's data processing functions as well as to the third party
servicer who performs the back-office functions with respect to the Company's
trust and investment management services. The increase in expense for the years
presented relates primarily to the increase in the number of deposit and loan
accounts held by Harrington and the cost of the new computer operating system.
In addition, during fiscal year 1999, the Company incurred approximately
$107,000 in non-recurring expense related to on-line system conversions.
Harrington has contracted with Smith Breeden to provide
investment advisory services and interest rate risk analysis. Certain
stockholders of the Company are also principals of Smith Breeden. The consulting
fees paid by Harrington to Smith Breeden during the years ended June 30, 2000,
1999, and 1998, which are based on the Company's asset size, amounted to
$276,000, $301,000, and $287,000, respectively.
Income Tax Provision. The Company received income tax benefits of
$1.3 million, $1.6 million and $1.2 million during the years ended June 30,
2000, 1999 and 1998, respectively. The Company's effective tax rate amounted to
39.3%, 39.7%, and 39.9% during the years ended June 30, 2000, 1999, and 1998,
respectively.
10
Liquidity
The Bank is required under applicable federal regulations to
maintain specified levels of "liquid" investments as defined by the OTS. As of
November 24, 1997, the required level of such liquid investments was changed
from 5% to 4% of certain liabilities as defined by the OTS. In addition to the
change in the percentage of required level of liquid assets, the OTS also
modified its definition of investments that are considered liquid. As a result
of this change, the level of assets eligible for regulatory liquidity
calculations increased considerably.
The total eligible regulatory liquidity of the Bank was 24.4% at
June 30, 2000, as compared to 16.7% at June 30, 1999. At June 30, 2000, the
Bank's liquid assets as defined by the OTS totaled approximately $85.3 million,
which was $71.3 million in excess of the current OTS minimum requirement.
The Bank maintains liquid assets at a level believed adequate to
support its normal operations, including funding loans and paying deposit
withdrawals. Cash flow projections are regularly reviewed and updated to ensure
that adequate liquidity is maintained. Cash for these purposes is generated
through the sale or maturity of securities, the receipt of loan payments, and
increases in deposits and borrowings. While the level of loan and deposit
activity is not entirely under the control of the Bank, the sale of securities
and increases in borrowings are entirely at the Bank's discretion and thus
provide a ready source of cash when needed.
As a member of the FHLB System, the Bank may borrow from the FHLB
of Indianapolis. FHLB advances may be obtained on very short notice due to the
Bank's blanket collateral agreement with the FHLB. In addition, the Bank can
pledge securities for collateralized borrowings such as reverse repurchase
agreements and quickly obtain cash whenever needed. In the opinion of
management, Harrington has sufficient cash flow and borrowing capacity to meet
current and anticipated funding commitments.
The Bank's liquidity, represented by cash and cash equivalents,
is a result of its operating, investing and financing activities. During the
year ended June 30, 2000, there was a net increase of $14.8 million in cash and
cash equivalents. The primary uses of cash during the year included purchases of
securities for the trading portfolio of $319.3 million, purchases of securities
available for sale of $70.4 million, repayments of borrowings including
securities sold under agreements to repurchase and Federal Home Loan Bank
advances of $112.2 million, and the change in loans receivable of $11.9 million.
Partially offsetting these cash uses, the main sources of cash during the fiscal
year were $446.5 million in proceeds from sales and maturities of securities
held for trading, a $28.0 million net increase in deposits and $47,000 from
proceeds from Federal Home Loan Bank advances.
Asset and Liability Management
In general, financial institutions are negatively affected by an
increase in interest rates to the extent that interest-bearing liabilities
mature or reprice more rapidly than interest-earning assets. The lending
activities of savings institutions have historically emphasized the origination
of long-term, fixed-rate loans secured by single-family residences, and the
primary source of funds of such institutions has been deposits, which largely
mature or are subject to repricing within a shorter period of time.
This factor has historically caused the income and market value of
portfolio equity ("MVPE") of savings institutions to be more volatile than other
financial institutions. MVPE is defined as the net present value of the
cashflows from an institution's existing assets, liabilities and off-balance
sheet instruments. While having liabilities that reprice more frequently than
assets is generally beneficial to net interest income and MVPE in times of
declining interest rates, such an asset/liability mismatch is generally
detrimental during periods of rising interest rates.
The Company's management believes that its asset and liability
management strategy, as discussed below, provides Harrington with a competitive
advantage over other financial institutions. Harrington's ability to effectively
hedge its interest rate exposure through the use of various financial
instruments allows the Company to acquire loans and investments that offer
attractive net risk-adjusted spreads and meet customer preferences whether the
11
individual loans or investments are fixed-rate or adjustable-rate or short-term
or long-term. Similarly, the Company can choose a cost-effective source of funds
and subsequently engage in an interest rate swap or other hedging transaction so
that the interest rate sensitivities of its interest-earning assets and
interest-bearing liabilities are generally matched.
Harrington's asset and liability management strategy is formulated
and monitored by the Boards of Directors of the Company and the Bank, the
Company's wholly owned subsidiary. The Boards' written policies and procedures
are implemented by the Investment Committee of the Bank, which is comprised of
the Chief Executive Officer, Chief Investment Officer, Chief Financial Officer
and three outside directors. The Investment Committee meets at least monthly to
review, among other things, the sensitivity of the Bank's assets and liabilities
to interest rate changes, investment opportunities and the performance of the
investment portfolios, and the past month's purchase and sale activity of
securities. The Committee also provides guidance to management on reducing
interest rate risk and on investment strategy and consults with the Chief
Investment Officer of the Bank regarding retail pricing and funding decisions
with respect to the Bank's overall asset and liability composition. In
accordance therewith, the Investment Committee reviews the Bank's liquidity,
cash flow needs, interest rate sensitivity of investments, deposits and
borrowings, core deposit activity, current market conditions and interest rates
on both a local and national level.
Harrington has contracted with Smith Breeden Associates, Inc.
("Smith Breeden") for the provision of consulting services regarding, among
other things, the management of its investments and borrowings, the pricing of
loans and deposits, and the use of various financial instruments to reduce
interest rate risk. Smith Breeden is a consulting firm which renders investment
advice and asset and liability management services to financial institutions,
corporate and government pension plans, foundations, The Managers Mutual Funds,
and government agencies nationally. Certain directors of the Company and the
Bank are principals of Smith Breeden.
The Investment Committee regularly reviews interest rate risk by
utilizing analyses prepared by Smith Breeden with respect to the impact of
alternative interest rate scenarios on net interest income and on the Bank's
MVPE. The Investment Committee also reviews analyses prepared by Smith Breeden
concerning the impact of changing market volatility, prepayment forecast error,
and changes in option-adjusted spreads and non-parallel yield curve shifts.
MVPE analysis is used by regulatory authorities for assessing an
institution's interest rate risk. The extent to which assets will gain or lose
value net of the gains or losses of liabilities and/or interest rate contracts
determines the appreciation or depreciation in equity on a market-value basis.
Such market value analysis is intended to evaluate the impact of immediate and
sustained parallel interest rate shifts upon the market value of the current
balance sheet.
In the absence of the Company's hedging activities, the MVPE of the
Company would decline as a result of a general increase in market rates of
interest. This decline would be due to the market values of Harrington's assets
being generally more sensitive to interest rate fluctuations than are the market
values of the Company's liabilities due to Harrington's investment in and
origination of generally longer-term assets which are funded with shorter-term
liabilities. Consequently, the elasticity (i.e., the change in the market value
of an asset or liability as a result of a change in interest rates) of
Harrington's assets is greater than the elasticity of its liabilities.
Accordingly, the primary goal of Harrington's asset and liability
management policy is to effectively increase the elasticity of the Company's
liabilities and/or effectively contract the elasticity of the Company's assets
so that the respective elasticities are matched as closely as possible. This
elasticity adjustment can be accomplished internally by restructuring
Harrington's balance sheet or externally by adjusting the elasticities of
Harrington's assets and/or liabilities through the use of interest rate
contracts, such as interest rate swaps, collars, caps, floors, options and
futures. Harrington's strategy is to hedge either internally through the use of
longer-term certificates of deposits or less sensitive non-defined maturity
(transaction) deposits, FHLB advances and mortgage-backed derivative securities
or externally through the use of various interest rate contracts.
12
External hedging involves the use of interest rate swaps, collars,
caps, floors, options and futures. The notional amount of interest rate
contracts represents the underlying amount on which periodic cash flows are
calculated and exchanged between counterparties. However, this notional amount
does not necessarily represent the principal amount of securities which would
effectively be hedged by that interest rate contract.
In selecting the type and amount of interest rate contract to
utilize, the Company compares the elasticity of a particular contract to that of
the securities to be hedged. An interest rate contract with the appropriate
offsetting elasticity could have a notional amount much greater than the face
amount of the securities being hedged.
An interest rate swap is an agreement where one party (generally
the Company) agrees to pay a fixed rate of interest on a notional principal
amount to a second party (generally a broker or money center bank) in exchange
for receiving from the second party a variable rate of interest on the same
notional amount for a predetermined period of time. No actual assets are
exchanged in a swap of this type and interest payments are generally netted.
These swaps are generally utilized by Harrington to synthetically convert
fixed-rate assets into adjustable-rate assets without having to sell or transfer
the underlying assets.
At June 30, 2000, Harrington was a party to one interest rate swap
agreement held in its trading portfolio. The agreement had a notional amount of
$5.0 million and a maturity in April 2001. With respect to this agreement,
Harrington makes fixed interest payments at 6.58% and receives payments based
upon the three-month London Interbank Offered Rate ("LIBOR").
The net expense relating to Harrington's interest rate swaps held
in the trading portfolio was $85,000, $580,000, and $313,000 during the years
ended June 30, 2000, 1999, and 1998, respectively. The approximate market value
of the interest rate swaps which are maintained in the trading portfolio was
$(18,000), $(175,000) and $(397,000) as of June 30, 2000, 1999 and 1998,
respectively.
In addition, the Company also has swaps which hedge liabilities,
and are not included in the trading portfolio. The five swap agreements excluded
from the trading portfolio had an aggregate notional amount of $35.0 million and
maturities from February 2004 to February 2009. With respect to these
agreements, Harrington makes fixed interest payments ranging from 5.27% to 6.51%
and receives payments based upon the three-month LIBOR. These fixed-pay swaps,
in addition to cap agreements that are not included in the Company's trading
portfolio, are used to effectively modify the interest rate sensitivity of a
portion of the Bank's short-term LIBOR correlated borrowings which include
short-term deposits, securities sold under agreements to repurchase and the
Federal Home Loan Bank advances.
The net income (expense) relating to Harrington's swaps which are
not included in the trading portfolio was $(75,000), $31,000, and $70,000 during
the years ended June 30, 2000, 1999, and 1998, respectively. This income
(expense) is netted against interest expense in the Company's Consolidated
Statements of Operations. The approximate market value of these interest rate
swaps (which is not reflected in the Company's financial statements) was $1.9
million, $2.3 million and $137,000 as of June 30, 2000, 1999, and 1998,
respectively.
In June, 2000 the Bank, using proceeds from the sale of loans, extinguished $25
million of securities sold under agreements to repurchase and terminated $25
million in interest rate swaps that were being utilized to modify the interest
rate sensitivity of a portion of the Bank's short-term LIBOR correlated
borrowings, which included the extinguished liabilities. As a result of the
termination of the interest rate swaps, the bank recorded a gain of $1.6 million
in interest expense and a deferred gain of approximately $485,000 in other
liabilities. The deferred gain represents interest sensitivity protection
derived from the swaps related to short-term LIBOR correlated borrowings that
are recorded as liabilities of June 30, 2000. This deferred gain will be
reclassed to earnings over the original terms of the swaps as an adjustment to
interest expense.
13
An interest rate cap or an interest rate floor consists of a
guarantee given by the issuer (i.e., a broker), to the purchaser (i.e., the
Company), in exchange for the payment of a premium. This guarantee states that
if interest rates rise above (in the case of a cap) or fall below (in the case
of a floor) a specified rate on a specified interest rate index, the issuer will
pay to the purchaser the difference between the then current market rate and the
specified rate on a notional principal amount. No funds are actually borrowed or
repaid.
Similarly, an interest rate collar is a combination of a purchased
cap and a written floor at different strike rates. Accordingly, an interest rate
collar requires no payments if interest rates remain within a specified range,
but will require the Company to be paid if interest rates rise above the cap
rate or require the Company to pay if interest rates fall below the floor rate.
Consequently, interest rate caps are a means of reducing interest expense by
placing a ceiling on the cost of floating-rate liabilities, or offsetting the
caps on the coupons inherent in the Company's adjustable rate mortgage loans and
securities. Interest rate floors permit Harrington to maintain its desired
interest rate spread in the event that falling interest rates lead to increased
prepayments with respect to the Company's mortgage-backed and related securities
portfolio requiring reinvestment at lower rates.
At June 30, 2000, Harrington held one swaption agreement and one
interest rate collar in its trading portfolio. These contracts, which expire
from August 2003 to June 2009, have an aggregate notional amount of $15.3
million. The swaption agreement provides for a payment beginning in August 2003
to August 2008, whenever the defined floating rate is less than 6.00%. The
interest rate collar provides for a payment to be received whenever the defined
floating rate is greater than 10.25% or a payment to be made whenever the
floating rate is less than 5.25%.
The aggregate net expense (income) relating to the Company's
interest rate caps, collars, swaptions, and floors held in the trading portfolio
was $(87,000), $(343,000), and $223,000 during the years ended June 30, 2000,
1999, and 1998, respectively. The approximate market value of Harrington's
interest rate caps, collars and floors which are maintained in the trading
portfolio was $2,000, $5.0 million and $4.6 million as of June 30, 2000, 1999,
and 1998, respectively.
Harrington also has four interest rate caps with aggregate
notional amounts of $90.0 million which are not held in the Company's trading
portfolio. These caps, which mature from May 2001 to May 2008, provide for a
payment, depending on the particular contract, whenever the defined floating
rate exceeds 6.00% to 7.00%. These caps, in addition to fixed-pay swaps that are
not included in the Company's trading portfolio, are used to effectively modify
the interest rate sensitivity of a portion of the Bank's short-term LIBOR
correlated liabilities which include short-term deposits, securities sold under
agreements to repurchase and the Federal Home Loan Bank Advances. Net expense on
the caps was $247,000, $494,000, and $257,000 for the years ended June 30, 2000,
1999, and 1998, respectively. The approximate market value of the caps, which is
not reflected in the Company's financial statements, was $5.1 million, $4.4
million and $2.5 million at June 30, 2000, 1999, and 1998, respectively.
Interest rate futures are commitments to either purchase or sell
designated instruments at a future date for a specified price. Futures contracts
are generally traded on an exchange, are marked-to-market daily and are subject
to initial and maintenance margin requirements. Harrington generally uses 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off LIBOR as well as Treasury Note and Bond futures contracts.
The Company will from time to time agree to sell a specified number of contracts
at a specified date. To close out a contract, Harrington will enter into an
offsetting position to the original transaction.
If interest rates rise, the value of the Company's short futures
positions increase. Consequently, sales of futures contracts serve as a hedge
against rising interest rates. At June 30, 2000, Harrington had sold Eurodollar
and Treasury Note futures contracts with an aggregate notional amount of
approximately $516 million. The Company had total gains (losses) on its futures
contracts of $1.9 million, $3.2 million, and $(8.6) million for the fiscal years
ended June 30, 2000, 1999, and 1998, respectively.
Options are contracts which grant the purchaser the right to buy or
sell the underlying asset by a certain date for a specified price. Generally,
Harrington will purchase options on financial futures to hedge the changing
elasticity exhibited by mortgage loans and mortgage-backed securities. The
changing elasticity results from the ability of a borrower to prepay a mortgage.
As market interest rates decline, borrowers are more likely to prepay their
14
mortgages, shortening the elasticity of the mortgages. Consequently, where
interest rates are declining, the value of mortgage loans or mortgage-backed
securities will increase at a slower rate than would be expected if borrowers
did not have the ability to prepay their mortgages.
Harrington, therefore, generally purchases out-of-the-money calls
and puts so that the increase in value of the options resulting from interest
rate movements offsets the reductions in MVPE resulting from the changing
elasticity inherent in the Company's balance sheet. At June 30, 2000, Harrington
did not have any purchased options contracts in portfolio. The net expense
relating to purchased options contracts was $172,000, $466,000, and $943,000
during the years ended June 30, 2000, 1999, and 1998, respectively.
The following table summarizes the periodic exchanges of interest
payments with counterparties including the amortization of premiums paid for
interest rate contracts as discussed above. Such payments and amortization
amounts are accounted for as adjustments to the yields of securities held for
trading and are reported as a separate component of interest income.
(Dollars in Thousands) Years Ended June 30,
-------------------------
2000 1999 1998
Interest rate contract (income) expense:
Swaps $ - $ 457 $ 313
Caps, floors, and collars (87) (343) 223
Options 172 466 943
---- ---- ---
Net interest expense on interest rate contracts $ 85 $ 580 $1,479
===== ====== ======
The above table does not include realized and unrealized gains and
losses with respect to the market value of interest rate contracts held in the
trading portfolio. Such gains and losses are generally offset by fluctuations in
the market value of the Company's assets held for trading. All realized and
unrealized gains and losses pertaining to interest rate contracts in the trading
portfolio are reported as other income in the Company's Consolidated Statements
of Operations.
Harrington is subject to the risk that its counterparties with
respect to various interest rate contracts (such as swaps, collar, caps, floors,
options and futures) may default at or prior to maturity of a particular
instrument. In such a case, the Company might be unable to recover any
unrealized gains with respect to a particular contract.
To reduce this potential risk, the Company generally deals with
large, established investment brokerage firms when entering into these
transactions. In addition, if the Company enters into an interest rate contract
with a non AA-rated (or above) entity and the Company has an unrealized gain
with respect to such contract, the Company generally requires the entity to post
some form of collateral to secure its obligations. Furthermore, the Company has
a policy whereby it limits its unsecured exposure to any one counterparty to 25%
of the Bank's equity during any two-month period and 35% of the Bank's equity
during any one-month period.
The Office of Thrift Supervision ("OTS") requires each thrift
institution to calculate the estimated change in the institution's MVPE assuming
an instantaneous, parallel shift in the Treasury yield curve of 100 to 300 basis
points either up or down in 100 basis point increments. The OTS permits
institutions to perform this MVPE analysis using their own internal model based
upon reasonable assumptions. The Company retains Smith Breeden to assist in
performing the required calculation of the sensitivity of its market value to
changes in interest rates.
In estimating the market value of mortgage loans and
mortgage-backed securities, the Company utilizes various prepayment assumptions
which vary, in accordance with historical experience, based upon the term,
interest rate and other factors with respect to the underlying loans. At June
30, 2000, these prepayment assumptions varied from 4% to 18% for fixed-rate
mortgages and mortgage-backed securities and varied from 12% to 22% for
adjustable rate mortgages and mortgage-backed securities.
15
The following table sets forth at June 30, 2000 the estimated
sensitivity of the Bank's MVPE to parallel yield curve shifts using Harrington's
internal market value calculation. The table demonstrates the sensitivity of the
Bank's assets and liabilities both before and after the inclusion of its
interest rate contracts.
Change in Interest Rates (in Basis Points) (1)
---------------------------------------------------------------------------------------
(Dollars in Thousands) -300 -200 -100 -- +100 +200 +300
---------------------------------------------------------------------------------------
Market value gain (loss) of assets $ 20,556 $ 15,590 $ 8,644 -- $(10,076) $(20,884) $(31,752)
Market value gain (loss) of
liabilities (9,160) (6,494) (3,494) -- 4,137 8,806 13,683
------- ------ ------ ----- ------ ------
Market value gain (loss) of net
assets before interest rate contracts 11,396 9,096 5,150 -- (5,939) (12,078) (18,069)
Market value gain (loss) of
interest rate contracts (12,150) (8,770) (4,790) -- 5,312 10,757 16,103
------- ------ ------ ----- ------ ------
Total change in MVPE(2) $ (754) $ 326 $ 360 -- $ (627) $ (1,321) $ (1,966)
======== ======== ======== ======== ======== ========
Change in MVPE as a percent of:
MVPE(2) (2.8)% 1.2% 1.3% -- (2.3)% (4.9)% (7.3)%
Total assets of the Bank (0.2)% 0.1% 0.1% -- (0.1)% (0.3)% (0.5)%
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $27.0 million at June 30, 2000.
The table set forth above does not purport to show the impact of
interest rate changes on Harrington's equity under generally accepted accounting
principles. Market value changes only impact the Company's income statement or
the balance sheet (1) to the extent the affected instruments are marked to
market, and (2) over the life of the instruments as an impact on recorded
yields.
Since a portion of Harrington's assets is recorded at market value,
the following table is included to show the estimated impact on the Company's
equity of instantaneous, parallel shifts in the yield curve, and constant option
adjusted spreads on assets and liabilities. The assets and interest rate
contracts included in the table below are only those which are either classified
by the Company as held for trading or available for sale and, therefore,
reflected at market value. Consequently, Harrington's liabilities, which are
reflected at cost, are not included in the table below. All amounts are shown
net of taxes, with an estimated effective tax rate of 39.0%.
Change in Interest Rates (in Basis Points)
--------------------------------------------------------------------------------
(Dollars in Thousands) -300 -200 -100 -- +100 +200 +300
--------------------------------------------------------------------------------
After tax market value gain (loss)
of assets $ 2,898 $ 1,792 $ 886 -- $(1,084) $(2,381) $(3,765)
After tax market value gain (loss)
of interest rate contracts (1,792) (1,277) (676) -- 733 1,497 2,276
--------- ---------------- --------- --------- ---------
After tax gain (loss) in equity $ 1,106 $ 515 $ 210 -- $ (351) $ (884) $(1,489)
========== ================= ========= =========== =========
After tax gain (loss) in equity as a
percent of the Company's
equity at June 30, 2000 6.8% 3.2% 1.3% -- (2.2)% (5.4)% (9.2)%
16
Inflation and Changing Prices
The Consolidated Financial Statements and related data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars (except with respect to securities which
are carried at market value), without considering changes in the relative
purchasing power of money over time due to inflation. Unlike most industrial
companies, substantially all of the assets and liabilities of the Company are
monetary in nature. As a result, interest rates have a more significant impact
on the Company's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services.
Recent Accounting Pronouncements
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, was issued in June 1998 and amended by SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date of
SFAS 133, and SFAS 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities - An Amendment of SFAS 133. SFAS 133 as amended by
SFAS 137 and SFAS 138, is effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as a fair value hedge, a cash flow hedge, or a hedge of
foreign currency exposure. The accounting for changes in the fair value of a
derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting designation. The adoption of SFAS 133 by the
Company on July 1, 2000 resulted in the cumulative effect of an accounting
change of an $800,000 loss net of tax being recognized in the statement of
operations and an increase in other comprehensive income totaling $3.8 million
in Shareholders' Equity net of tax.
17
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Harrington Financial Group, Inc.
Richmond, Indiana
We have audited the accompanying consolidated balance sheets of Harrington
Financial Group, Inc. and its subsidiary (the "Company") as of June 30, 2000 and
1999, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Harrington Financial Group, Inc.
and its subsidiary as of June 30, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2000 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
- -------------------------
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
August 18, 2000
18
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands Except Share Data)
- --------------------------------------------------------------------------------
June 30,
----------------------------
2000 1999
ASSETS
Cash $ 2,314 $ 1,414
Interest-bearing deposits (Note 13) 22,007 8,087
--------- ---------
Total cash and cash equivalents 24,321 9,501
Securities held for trading - at fair value (amortized cost of $55,288 and $188,130)
(Notes 2,8,13) 53,852 183,200
Securities available for sale - at fair value (amortized cost of $64,495 and $461) (Note 2) 64,052 502
Securities held to maturity - at amortized cost (fair value of $3,875 and $0) (Note 2) 3,857
Loans receivable (net of allowance for loan losses of $1,408 and $868) (Note 3) 270,970 259,674
Interest receivable, net (Note 4) 2,186 2,340
Premises and equipment, net (Note 5) 5,828 6,499
Federal Home Loan Bank of Indianapolis stock - at cost 4,878 4,878
Deferred income taxes, net (Note 10) 2,089 596
Income taxes receivable (Note 10) 51 569
Other 3,108 3,580
--------- ---------
TOTAL ASSETS $ 435,192 $ 471,339
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 6) $ 361,241 $ 333,245
Securities sold under agreements to repurchase (Note 7) 28,038 60,198
Federal Home Loan Bank advances (Note 8) 7,000 40,000
Note payable (Note 9) 12,995 13,995
Interest payable on securities sold under agreements to repurchase (Note 7) 5 66
Other interest payable 2,360 1,925
Advance payments by borrowers for taxes and insurance 746 795
Accrued expenses payable and other liabilities 5,705 1,039
--------- ---------
Total liabilities 418,090 451,263
========= =========
COMMITMENTS AND CONTINGENCIES (Notes 13, 14, 16)
MINORITY INTEREST (Note 1) 845 937
--------- ---------
STOCKHOLDERS' EQUITY (Notes 1, 10, 11, 12 16):
Preferred stock ($1 par value) authorized and unissued - 5,000,000 shares
Common stock:
Voting ($.125 par value) authorized - 10,000,000 shares, issued 3,399,938
shares, outstanding 3,150,632 and 3,205,382 shares 425 425
Additional paid-in capital 16,946 16,946
Treasury stock, 249,306 and 194,556 shares at cost (2,488) (2,162)
Accumulated other comprehensive income (loss), net of deferred tax of $(173) and $16 (268) 25
Retained earnings 1,642 3,905
--------- ---------
Total stockholders' equity 16,257 19,139
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 435,192 $ 471,339
========= =========
See notes to consolidated financial statements.
19
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands Except Share Data)
- --------------------------------------------------------------------------------
Years Ended June 30,
----------------------------------------
2000 1999 1998
INTEREST INCOME:
Securities held for trading $ 8,901 $ 18,684 $ 25,426
Net interest expense on interest rate contracts maintained in
the trading portfolio (Note 13) (85) (580) (1,479)
Securities available for sale 1,094 66 91
Securities held to maturity 171 31 23
Loans receivable (Note 3) 20,637 16,001 8,711
Dividends on Federal Home Loan Bank of Indianapolis stock 391 391 392
Deposits 784 611 792
---- ---- ---
31,893 35,204 33,956
------- ------- ------
INTEREST EXPENSE:
Deposits (Notes 6, 13) 18,226 14,100 8,303
Federal Home Loan Bank advances (Note 8) 1,192 2,481 1,843
Securities sold under agreements to repurchase (Note 7) 2,809 11,433 17,905
Note payable (Note 9) 1,295 1,109 981
------ ------ ---
23,522 29,123 29,032
------- ------- ------
NET INTEREST INCOME 8,371 6,081 4,924
PROVISION FOR LOAN LOSSES (Note 3) 587 511 147
---- ---- ---
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,784 5,570 4,777
------ ------ -----
OTHER INCOME (LOSS):
Loss on sale of securities held for trading (Notes 2, 13) (4,498) 4,755 (775)
Loss on sale of loans (1,173)
Unrealized gain (loss) on securities held for trading (Notes 2, 13) 3,494 (6,402) (930)
Other 772 433 295
---- ---- ---
(1,405) (1,214) (1,410)
-------- -------- -------
OTHER EXPENSE:
Salaries and employee benefits (Note 12) 5,090 4,290 3,295
Premises and equipment expense (Note 5) 1,516 1,262 799
FDIC insurance premiums 133 125 86
Marketing 382 314 183
Computer services 611 509 243
Consulting fees (Note 15) 276 301 287
Other 1,619 1,699 1,567
------ ------ -----
9,627 8,500 6,460
------ ------ -----
LOSS BEFORE INCOME TAX BENEFIT AND MINORITY INTEREST (3,248) (4,144) (3,093)
INCOME TAX BENEFIT (Note 10) (1,277) (1,646) (1,234)
-------- -------- -------
NET LOSS BEFORE MINORITY INTEREST (1,971) (2,498) (1,859)
MINORITY INTEREST 92 43
--- --
NET LOSS $ (1,879) $ (2,455) $ (1,859)
========== ========== =========
BASIC LOSS PER SHARE (Note 1) $ (0.59) $ (0.76) $ (0.57)
========= ========= ========
DILUTED LOSS PER SHARE (Note 1) $ (0.59) $ (0.76) $ (0.57)
========= ========= ========
See notes to consolidated financial statements.
20
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in Thousands Except Share Data)
- -------------------------------------------------------------------------------
Accumulated
Additional Other
Shares Common Paid-in Treasury Comprehensive Retained
Outstanding Stock Capital Stock Income (Loss) Earnings
BALANCES, JUNE 30, 1997 3,256,738 $ 407 $ 15,623 $ (35) $ 8,999
Stock options exercised (Note 12) 143,200 18 1,056
Tax benefit from exercise of non-qualified
stock options 283
Net loss (1,859)
Cash dividends declared on common
stock ($0.12 per share) (395)
Purchase of treasury stock (124,052) $ (1,467)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $22 34
--------- ---- ------ ------ ---- -----
BALANCES, JUNE 30, 1998 3,275,886 425 16,962 (1,467) (1) 6,745
Net loss (2,455)
Cash dividends declared on common stock
($0.12 per share) (385)
Purchase of treasury stock (78,178) (784)
Issuance of treasury stock 7,674 (16) 89
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $17 26
--------- ---- ------ ------ ---- -----
BALANCES, JUNE 30, 1999 3,205,382 425 16,946 (2,162) 25 3,905
Net loss (1,879)
Cash dividends declared on common stock
($0.12 per share) (384)
Purchase of treasury stock (54,750) (326)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $(195) (293)
--------- ---- ------ ------ ---- -----
BALANCES, JUNE 30, 2000 3,150,632 $ 425 $ 16,946 $ (2,488) $ (268) $ 1,642
========= ====== ========= ========== ======== ========
Total Comprehensive
Stockholders' Income
Equity (Loss)
BALANCES, JUNE 30, 1997 $ 24,994
Stock options exercised (Note 12) 1,074
Tax benefit from exercise of non-qualified
stock options 283
Net loss (1,859) $ (1,859)
Cash dividends declared on common
stock ($0.12 per share) (395)
Purchase of treasury stock (1,467)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $22 34 34
--- --
BALANCES, JUNE 30, 1998 22,664 $ (1,825)
=========
Net loss (2,455) $ (2,455)
Cash dividends declared on common stock
($0.12 per share) (385)
Purchase of treasury stock (784)
Issuance of treasury stock 73
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $17 26 26
--- ---
BALANCES, JUNE 30, 1999 19,139 $ (2,429)
=========
Net loss (1,879) $ (1,879)
Cash dividends declared on common stock
($0.12 per share) (384)
Purchase of treasury stock (326)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $(195) (293) (293)
------ -----
BALANCES, JUNE 30, 2000 $ 16,257 $ (2,172)
========= =========
See notes to consolidated financial statements.
21
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
- -------------------------------------------------------------------------------
Years Ended June 30,
------------------------------------------
2000 1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,879) $ (2,455) $ (1,859)
Adjustments to reconcile net loss to net cash from operating activities:
Provision for loan losses 587 511 147
Depreciation 770 549 348
Premium and discount amortization on securities, net 1,213 2,624 1,434
(Gain) loss on sale of securities held for trading 4,498 (4,755) 775
Unrealized (gain) loss on securities held for trading (3,494) 6,402 930
Effect of minority interest (92) (43)
Purchases of securities held for trading (319,334) (780,260) (657,211)
Decrease in amounts due from brokers 11,308
Proceeds from maturities of securities held for trading 11,554 51,419 28,438
Proceeds from sales of securities held for trading 434,911 831,978 652,380
Deferred income tax provision and other (883) (68) (980)
Net increase (decrease) in assets and liabilities 5,703 617 (1,815)
------ ---- -------
Net cash from operating activities 133,554 106,519 33,895
-------- -------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities available for sale (70,408)
Proceeds from maturities of securities available for sale 6,394 446 259
Change in securities held to maturity (3,813)
Change in loans receivable, net (11,925) (96,927) (69,885)
Minority interest and other 980 (26)
Purchases of premises and equipment (108) (1,436) (1,653)
------ -------- -------
Net cash from investing activities (79,860) (96,937) (71,305)
--------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 27,996 154,934 42,136
Decrease in securities sold under agreements to repurchase (32,160) (180,198) (5,175)
Proceeds from Federal Home Loan Bank advances 47,000 83,000 99,000
Principal repayments on Federal Home Loan Bank advances (80,000) (69,000) (99,000)
Dividends paid on common stock (384) (385) (395)
Purchase of treasury stock (326) (784) (1,467)
Other, net (1,000) 573 4,574
-------- ---- -----
Net cash from financing activities (38,874) (11,860) 39,673
--------- --------- ------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,820 (2,278) 2,263
CASH AND CASH EQUIVALENTS, beginning of year 9,501 11,779 9,516
------ ------- -----
CASH AND CASH EQUIVALENTS, end of year $ 24,321 $ 9,501 $ 11,779
========= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 23,431 $ 28,682 $ 29,624
Cash paid for income taxes $ 43 $ 321
Noncash activities occurred consisting of a decrease in current and deferred
income tax payable and a corresponding increase in additional paid in capital
from the tax benefit from exercise of non-qualified stock options of $283 during
fiscal year 1998.
See notes to consolidated financial statements.
22
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business of the Company - Harrington Financial Group, Inc. ("HFG" or
the "Company") is a savings and loan holding company incorporated on
March 3, 1988 to acquire and hold all of the outstanding common stock
of Harrington Bank, FSB (the "Bank"), a federally chartered savings
bank with principal offices in Richmond, Indiana and nine full-service
branch offices located in Carmel, Fishers, Noblesville and
Indianapolis, Indiana; Mission, Kansas; and Chapel Hill, North
Carolina. The Company is a community bank with a focus on the
origination and management of mortgage loans and securities. The Bank
also operates a commercial loan division for business customers and
owns a 51% interest in Harrington Wealth Management Company (HWM),
which provides trust, investment management, and custody services for
individuals and institutions.
Basis of Presentation - The consolidated financial statements include
the accounts of HFG, the Bank and HWM. All significant intercompany
accounts and transactions have been eliminated.
Harrington West Financial Group, Inc. ("HWFG"), the holding company
for Los Padres Bank ("LPB"), is a related party to Harrington
Financial Group, Inc. ("HFGI") and Harrington Bank, FSB ("HB") in that
certain officers and directors of HWFG and LPB are also officers and
directors of HFGI and HB.
In February 1999, the Company formed HWM. HWM is a strategic alliance
between the Bank (51% owner) and Los Padres Bank (49% owner), a
federally chartered savings bank located in California. The
accompanying consolidated balance sheet includes 100 percent of the
assets and liabilities of HWM, and the ownership of Los Padres Bank is
recorded as "minority interest." The results of operations include 100
percent of the revenues and expenses of HWM from the date of
formation, and the ownership of Los Padres Bank is recorded as
"minority interest" net of income taxes.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
Cash and Cash Equivalents - All highly liquid investments with an
original maturity of three months or less are considered to be cash
equivalents.
Securities Held for Trading, Held to Maturity, and Available for Sale
- The Company classifies its securities in one of three categories and
accounts for the investments as follows:
o Debt securities that the Company has the positive intent and
ability to hold to maturity are classified as "securities held to
maturity" and reported at amortized cost.
o Debt and equity securities that are acquired and held principally
for the purpose of selling them in the near term with the
objective of generating economic profits on short-term
differences in market characteristics are classified as
"securities held for trading" and reported at fair value, with
unrealized gains and losses included in earnings.
o Debt and equity securities not classified as either held to
maturity or trading securities are classified as "securities
available for sale" and reported at fair value, with unrealized
gains and losses, after applicable taxes, excluded from earnings
and reported in a separate component of stockholders' equity.
Declines in the value of debt securities and marketable equity
securities that are considered to be other than temporary are
recorded as a permanent impairment of securities available for
sale in the statement of operations.
23
As discussed below, SFAS No. 133, "Accounting For Derivative
Investments," as amended permits a one time transfer of securities
previously classified as held to maturity into the available for sale
category. On July 1, 2000 the Company transferred mortgage-backed
securities previously classified as held to maturity to the available
for sale category at fair value. At the time of the transfer these
securities had an amortized cost of $3,822,000 and a fair value of
$3,840,000.
Premiums and discounts are amortized over the contractual lives of the
related securities using the level yield method. Purchases and sales
of securities are recorded in the balance sheet on the trade date.
Gains and losses from security sales or disposals are recognized as of
the trade date in the statement of operations for the period in which
securities are sold or otherwise disposed of. The Company also enters
into forward contracts to purchase or sell securities held for
trading. Changes in the fair value of the forward contract are
recognized in earnings as they occur. Securities purchased or sold
under a forward contract are recorded at their fair values at the
settlement date.
The Company's trading portfolio consists of mortgage-backed
securities, mortgage-backed security derivatives, equity securities
and interest rate contracts, which accordingly are carried at fair
value. Realized and unrealized changes in fair values are recognized
in other income in the period in which the changes occur. Interest
income from trading activities is included in the statement of
operations as a component of net interest income.
The Company's available for sale portfolio consists of a non-agency
participation certificate and mortgage backed securities.
Fair values of securities are based on quoted market prices or dealer
quotes. Where such quotes are not available, estimates of fair value
of securities are based upon a number of assumptions such as
prepayments which may shorten the life of such securities. Although
prepayments of underlying mortgages depend on many factors, including
the type of mortgages, the coupon rate, the age of mortgages, the
geographical location of the underlying real estate collateralizing
the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and
the prevailing mortgage interest rates generally is the most
significant determinant of the rate of prepayments. While management
endeavors to use the best information available in determining
prepayment assumptions, actual results could differ from those
assumptions.
Financial Instruments Held for Asset and Liability Management Purposes
- The Bank is party to a variety of interest rate contracts consisting
of interest rate futures, options, caps, swaps, floors and collars in
the management of the interest rate exposure of its trading portfolio.
These financial instruments are included in the trading portfolio and
are reported at fair value with realized and unrealized gains and
losses on these instruments recognized in other income (see Note 2).
The Bank entered into a floating-pay interest rate swap agreement as a
means of managing the interest rate exposure of certain inverse
variable rate deposits. The Bank also entered into fixed-pay interest
rate swap agreements and interest rate cap agreements to modify the
interest rate sensitivity of a portion of the Bank's short-term LIBOR
correlated borrowings, which include short-term deposits, securities
sold under agreements to repurchase and the Federal Home Loan Bank
advances. The premiums paid to enter into such interest rate cap
agreements are included in other assets and are amortized using the
straight-line method over the related term of the agreements. These
interest rate agreements are accounted for under the accrual method.
Under this method, the differential to be paid or received on these
interest rate agreements is recognized over the lives of the
agreements in interest expense. Changes in fair value of interest rate
swaps and of the interest rate caps accounted for under the accrual
method are not reflected in the accompanying financial statements.
Realized gains and losses on terminated interest rate swaps accounted
for under the accrual method are deferred as an adjustment to the
carrying amount of the designated instruments and amortized over the
remaining original life of the agreements. If the designated
instruments are disposed of, the fair value of the interest rate swap,
interest rate cap or unamortized deferred gains or losses are included
in the determination of the gain or loss on
24
the disposition of such instruments. To qualify for such accounting,
the floating-pay interest rate swap is designated to the inverse
variable rate deposits, and the fixed-pay interest rate swaps and the
interest rate caps are designated to a portion of the Bank's
short-term LIBOR correlated borrowings which include short-term
deposits, securities sold under agreements to repurchase and the
Federal Home Loan Bank advances.
Loans Receivable are carried at the principal amount outstanding,
adjusted for premiums or discounts which are amortized or accreted
using a level-yield method. SFAS No. 114 and No. 118, Accounting by
Creditors for Impairment of a Loan and Income Recognition and
Disclosures, require that impaired loans be measured based on the
present value of future cash flows discounted at the loan's effective
interest rate or the fair value of the underlying collateral, and
specifies alternative methods for recognizing interest income on loans
that are impaired or for which there are credit concerns. For purposes
of applying these standards, impaired loans have been defined as all
nonaccrual commercial loans which have not been collectively evaluated
for impairment. An impaired loan is charged off by management as a
loss when deemed uncollectible although collection efforts continue
and future recoveries may occur.
Discounts and premiums on purchased residential real estate loans are
amortized to income using the effective interest method over the
remaining period to contractual maturity.
Nonrefundable origination fees net of certain direct origination costs
are deferred and recognized, as a yield adjustment, over the life of
the underlying loan.
Allowance for Losses - A provision for estimated losses on loans is
charged to operations based upon management's evaluation of the
potential losses. Such an evaluation, which includes a review of all
loans for which full collectibility may not be reasonably assured,
considers, among other matters, the estimated net realizable value of
the underlying collateral, as applicable, economic conditions,
historical loan loss experience and other factors that are
particularly susceptible to changes that could result in a material
adjustment in the near term. While management endeavors to use the
best information available in making its evaluations, future allowance
adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations.
Interest Receivable - Interest income on securities and loans is
accrued according to the contractual terms of the underlying asset
including interest rate, basis and date of last payment. Income on
derivatives of mortgage-backed securities is recorded based on
projected cash flows using the median of major brokers' prepayment
assumptions for the underlying securities. The Bank provides an
allowance for the loss of uncollected interest on loans which are more
than 90 days past due. The allowance is established by a charge to
interest income equal to all interest previously accrued, and income
is subsequently recognized only to the extent that cash payments are
received until, in management's judgment, the borrower's ability to
make periodic interest and principal payments returns to normal, in
which case the loan is returned to accrual status.
Premises and Equipment are carried at cost less accumulated
depreciation. Depreciation is computed on the straight-line method
over the estimated useful lives ranging from 3 to 40 years.
Maintenance and repairs are expensed as incurred while major additions
and improvements are capitalized. Gains and losses on dispositions are
included in current operations.
Federal Income Taxes - The Company and its wholly owned subsidiary,
the Bank, file a consolidated tax return. HWM files a separate tax
return, as the total ownership of the company does not qualify for
consolidated tax filing. Deferred income tax assets and liabilities
reflect the impact of temporary differences between amounts of assets
and liabilities for financial reporting purposes and basis of such
assets and liabilities as measured by tax laws and regulations.
Earnings Per Share - Earnings per share of common stock is based on
the weighted average number of common shares outstanding during the
year.
25
The following is a reconciliation of the weighted average common
shares for the basic and diluted earnings per share computations:
Years Ended June 30,
-------------------------------------------------
2000 1999 1998
Basic earnings per share:
Weighted average common shares 3,199,034 3,216,626 3,285,166
========== ========== =========
Diluted earnings per share:
Weighted average common shares 3,199,034 3,216,626 3,285,166
Dilutive effect of stock options (1) 24,876
--------- --------- ---------
Weighted average common and incremental
shares (2) 3,199,034 3,216,626 3,310,042
========== ========= =========
(1) The impact of stock options was not included due to the
anti-dilutive effect for the fiscal years ended June 30, 2000 and
1999.
(2) The calculation for diluted earnings per share for the fiscal year
ended June 30, 1998 was based upon the weighted average common
shares as the effect of the stock options were anti-dilutive due
to the net loss for the year.
Comprehensive Income - The Company adopted SFAS No. 130, Comprehensive
Income, effective July 1, 1998. It requires that changes in the
amounts of certain items, including gains and losses on certain
securities, be shown in the financial statements. SFAS No. 130 does
not require a specific format for the financial statement in which
comprehensive income is reported but does require that an amount
representing total comprehensive income be reported in that statement.
All prior year financial statements have been reclassified for
comparative purposes.
New Accounting Pronouncements - SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, was issued in June 1998
and amended by SFAS No. 137, Accounting for Derivative Instruments and
Hedging Activities-Deferral of the Effective Date of SFAS 133, and
SFAS 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities - An Amendment of SFAS 133. SFAS 133 as amended by
SFAS 137 and SFAS 138, is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. This statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically
designated as a fair value hedge, a cash flow hedge, or a hedge of
foreign currency exposure. The accounting for changes in the fair
value of a derivative (that is, gains and losses) depends on the
intended use of the derivative and the resulting designation. The
adoption of SFAS 133 by the Company on July 1, 2000 resulted in the
cumulative effect of an accounting change of an $800,000 loss net of
tax being recognized in the statement of operations and an increase in
other comprehensive income totaling $3.8 million in Shareholders'
Equity net of tax.
Reclassifications of certain amounts in the 1999 and 1998 consolidated
financial statements have been made to conform to the 2000
presentation.
Changes in Presentation - Certain items appearing in the 1999 and 1998
financial statements have been reclassified to conform to the 2000
presentation.
26
2. SECURITIES
The amortized cost and estimated fair values of securities held for
trading and securities available for sale are summarized as follows:
(Dollars in Thousands) June 30, 1999
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Securities held for trading:
GNMA certificates $24,662 $ 111 $ 242 $24,531
FHLMC CERTIFICATES 14,921 102 645 14,378
FNMA certificates 8,830 3 371 8,462
Collateralized mortgage obligations 5,609 34 57 5,586
Residuals 139 40 179
Interest-only strips 631 374 257
Principal-only strips 306 86 392
Interest rate swaps 18 (18)
Interest rate collar 3 - 1 2
Swaptions 181 - 68 113
Futures 41 (41)
Equity securities 6 5 - 11
--------- ---- ------ --------
Totals $55,288 $ 381 $ 1,817 $53,852
========= ====== ======== ========
Securities available for sale:
GNMA certificates $63,806 $ 3 $ 488 $63,321
Commercial mortgage backed securities 353 - - 353
Non-agency participation certificate 336 42 - 378
--------- ---- ------ --------
Totals $64,495 $ 45 $ 488 $64,052
========= ===== ====== ========
Securities held to maturity:
Mortgage backed securities $ 3,821 $ 14 $ - $ 3,835
Other 1 4 - 5
Mortgage revenue bonds 35 - - 35
--------- ---- ------ --------
Totals $ 3,857 $ 18 $ - $ 3,875
======== ===== ==== =======
The Bank's collateralized mortgage obligation (CMO) portfolio at June
30, 2000 consisted of three agency investments with an estimated
remaining weighted average life of 9.9 years.
27
(Dollars in Thousands) June 30, 1999
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Securities held for trading:
GNMA certificates $ 37,986 $ 315 $ 185 $ 38,116
FHLMC certificates 69,114 304 1,568 67,850
FNMA certificates 28,034 43 478 27,599
Commercial mortgage backed securities 34,896 1,088 33,808
Collateralized mortgage obligations 10,738 331 11,069
Residuals 205 21 226
Interest-only strips 818 1 442 377
Principal-only strips 403 103 506
Interest rate swaps 175 (175)
Interest rate collar 4 4
Interest rate caps 1,744 1,157 587
Interest rate floors 3,821 976 415 4,382
Options 298 92 62 328
Futures 1,611 (1,611)
Equity securities 69 65 134
--- --- ---
Totals $188,130 $ 2,251 $ 7,181 $183,200
========== ======== ======== =========
Securities available for sale:
Non-agency participation certificate $ 461 $ 41 $ 502
========== ======== ========
The Bank's collateralized mortgage obligation (CMO) portfolio at June
30, 1999 consisted of three agency investments with an estimated
remaining weighted average life of 9.2 years.
For a complete discussion of the Bank's Risk Management Activities,
see Note 13.
The amortized cost and estimated fair values of securities by
contractual maturity are as follows:
(Dollars in Thousands) June 30, 2000
-------------------------------------------------------------------------
Held for Trading Available for Sale Held to Maturity
-------------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
Debt securities (due after 1 year through 5 years):
Mortgage-backed securities $48,413 $47,371 $64,159 $63,674 $ 3,821 $ 3,835
Non-agency participation certificates 336 378
Collateralized mortgage obligations 5,609 5,586
Mortgage-backed derivatives 1,076 828
Interest rate contracts 184 56
Mortgage revenue bonds 35 35
Other 6 11 1 5
-------- --------- --------- --------- -------- -------
$55,288 $53,852 $64,495 $64,052 $ 3,857 $ 3,875
======== ========= ========= ========= ======== =======
28
Securities with a total amortized cost of $35,889,000 and $66,550,000
and a total fair value of $35,633,000 and $65,572,000 were pledged at
June 30, 2000 and 1999, respectively, to secure interest rate swaps,
securities sold under agreements to repurchase, and letters of credit.
As of June 30, 2000 the Bank had $149,000,000 in mortgages pledged as
collateral for Federal Home Loan Bank advances. At June 30, 1999, the
Bank had a blanket collateral agreement for the Federal Home Loan Bank
advances.
Activities related to the sale of securities are summarized as
follows:
(Dollars in Thousands) June 30,
------------------------------------
2000 1999 1998
Proceeds from sale of securities held for trading $ 434,910 $ 831,978 $ 652,380
Gross gains on sales of securities held for trading 40,381 64,966 46,537
Gross losses on sales of securities held for trading 44,879 60,218 47,312
Gross gains on sales of securities available for sale 7
3. LOANS RECEIVABLE
Approximately 87% of the Bank's loans are to customers located in the
immediate market areas of its offices in Richmond and Indianapolis,
Indiana as well as Mission, Kansas and Chapel Hill, North Carolina.
The portfolio consists primarily of owner occupied single family
residential mortgages.
Loans receivable are summarized as follows:
(Dollars in Thousands) June 30,
-------------------------
2000 1999
Loans secured by one to four family residences:
Real estate mortgage $ 181,350 $ 216,402
Commercial 72,965 33,778
Property improvement 4,935 2,119
Consumer and home equity lines of credit 9,313 3,324
Automobile loans 2,371 2,811
Other loans 997 904
---------- ---------
Subtotal 271,931 259,338
Net deferred loan fees and origination costs, premiums and discounts 549 1,260
Allowance for loan losses (1,408) (868)
Other (102) (56)
---------- ---------
Loans receivable, net $ 270,970 $ 259,674
========== =========
The principal balance of loans on nonaccrual status totaled
approximately $180,000 and $76,000 at June 30, 2000 and 1999,
respectively. For the years ended June 30, 2000, 1999 and 1998, gross
interest income which would have been recorded had the Bank's
nonaccruing loans been current with their original terms amounted to
$6,000, $1,000, and $15,000, respectively. At June 30, 2000 and June
30, 1999, the Company had no impaired loans.
29
The Bank had commitments to originate or purchase loans consisting
primarily of real estate mortgages secured by one to four family
residences approximating $1,379,000 and $1,589,000 excluding
undisbursed portions of loans in-process at June 30, 2000 and 1999,
respectively. In addition, as of June 30, 2000 and 1999, the Bank had
commitments to fund approximately $7,151,000 and $5,125,000,
respectively in commercial loans secured primarily by commercial real
estate.
The Bank has granted loans to its directors, officers, employees and
an affiliate (Smith Breeden Associates, Inc., see Note 15). Such loans
were made in the ordinary course of business at the Bank's normal
credit terms, including interest rate and collateralization and do not
represent more than the normal risk of collection. These loans to
related parties are summarized as follows:
(Dollars in Thousands) June 30,
-----------------------
2000 1999
Beginning balance $ 4,515 $ 1,927
Loans made 4,358 2,969
Principal repayments (38) (189)
Change due to status of officers and employees (1) (192)
-------- -------
Ending balance $ 8,834 $ 4,515
======== =======
The amount of loans serviced for others totaled $24,163,000 and
$2,020,000 at June 30, 2000 and 1999, respectively. Servicing loans
for others generally consists of collecting mortgage payments,
maintaining escrow amounts, disbursing payments to investors and
foreclosure processing. In connection with loans serviced for others,
the Bank held borrowers' escrow balances of $13,000 and $16,000 at
June 30, 2000 and 1999, respectively.
Loan servicing fee income included in other income for the years ended
June 30, 2000, 1999 and 1998 was $7,000, $10,000 and $15,000,
respectively.
An analysis of the allowance for loan losses is as follows:
(Dollars in Thousands) June 30,
----------------------------------------
2000 1999 1998
Beginning balance $ 868 $ 360 $ 213
Provision for loan losses 587 511 147
Net charge-offs (47) (3)
------- ------- -------
Ending balance $ 1,408 $ 868 $ 360
======= ======= =======
As a federally chartered savings bank, aggregate commercial real
estate loans may not exceed 400% of capital as determined under the
capital standards provisions of FIRREA. This limitation was
approximately $110 million at June 30, 2000. Also under FIRREA, the
loans-to-one borrower limitation is generally 15% of unimpaired
capital and surplus which, for the Bank, was approximately $4 million
at June 30, 2000. The Bank was in compliance with all of these
requirements at June 30, 2000.
30
4. INTEREST RECEIVABLE
Interest receivable is summarized as follows:
(Dollars in Thousands) June 30,
--------------------
2000 1999
Loans (less allowance for uncollectibles - $6 and $1) $1,479 $1,375
Interest-bearing deposits 22 18
Securities held for trading 317 943
Securities available for sale 345 4
Securities held to maturity 23
------ ------
Interest receivable, net $2,186 $2,340
====== ======
5. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
(Dollars in Thousands) June 30,
-------------------------
2000 1999
Land $ 1,003 $ 1,003
Buildings and leasehold improvements 4,684 4,672
Furniture, fixtures and equipment 2,709 2,857
------ -----
Total 8,396 8,532
Less accumulated depreciation (2,568) (2,033)
-------- -------
Premises and equipment, net $ 5,828 $ 6,499
======== =======
Depreciation expense included in operations during the years ended
June 30, 2000, 1999 and 1998 totaled $770,000, $549,000 and $348,000
respectively.
6. DEPOSITS
(Dollars in Thousands) June 30,
----------------------------------------------------
2000 1999
----------------------- -----------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
NOW and DDA accounts $ 37,879 3.29 % $ 16,911 2.35 %
Savings accounts 35,646 4.37 % 33,163 4.12 %
Money market deposit accounts 62,159 5.20 % 137,463 4.89 %
------- --------
135,684 187,537
-------- -------
Certificates of deposit:
1 year and less 162,795 126,592
1 to 2 years 37,936 9,543
2 to 3 years 11,586 4,730
3 to 4 years 2,431 2,867
Over 4 years 10,809 1,976
------- -----
225,557 6.13 % 145,708 5.16 %
-------- --------
Total deposits $ 361,241 $ 333,245
========== ==========
31
Certificates of deposit in the amount of $100,000 or more totaled
approximately $57 million and $31 million at June 30, 2000 and 1999,
respectively.
A summary of certificate accounts by scheduled fiscal year maturities
at June 30, 2000, is as follows:
(Dollars in Thousands)
2001 2002 2003 2004 2005 Thereafter Total
3.00% or less $ 28 $ 182 $ 3 $ 213
3.01% - 5.00% 7,444 428 $ 660 $ 415 8,947
5.01% - 7.00% 139,375 33,785 10,547 1,909 $ 8,436 719 194,771
7.01% - 9.00% 15,273 3,541 379 107 1,607 44 20,951
9.01% or greater 675 675
---------- -------- -------- ------- -------- ----- ---------
Totals $ 162,795 $ 37,936 $ 11,586 $ 2,431 $ 10,043 $ 766 $ 225,557
========== ======== ======== ======= ======== ===== =========
Interest expense on deposits is as follows:
(Dollars in Thousands)
Years Ended June 30,
-----------------------------------
2000 1999 1998
NOW and DDA accounts $ 1,013 $ 306 $ 166
Savings accounts 1,371 1,279 1,091
Money market deposits accounts 5,148 3,546 127
Certificates of deposit 10,694 8,969 6,919
------- ------ -----
$18,226 $14,100 $ 8,303
======= ======= =======
Interest expense on certificates of deposit is net of interest income
(expense) on interest rate contracts of $(75,000), $31,000, and
$70,000 for the years ended June 30, 2000, 1999 and 1998,
respectively.
For a complete discussion of the Bank's Risk Management Activities,
see Note 13.
7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
(Dollars in Thousands) June 30,
-----------------------
2000 1999
Securities sold under agreements to repurchase:
Same securities $28,038 $43,323
Substantially identical securities 16,875
------- -------
$28,038 $60,198
========= ========
Accrued interest on securities sold under agreements to repurchase $ 5 $ 66
======= =======
]
At June 30, 2000, securities sold under agreements to repurchase
mature within one month.
32
An analysis of securities sold under agreements to repurchase,
excluding related accrued interest, is as follows:
(Dollars in Thousands) Years Ended June 30,
-----------------------------------
2000 1999 1998
Maximum amount outstanding at any month-end $102,953 $334,160 $342,094
Daily average amount outstanding 52,466 213,428 319,579
Weighted average interest rate at end of year 6.31 % 4.85 % 5.65 %
Assets pledged to secure securities sold under agreements to
repurchase are concentrated among one dealer and eight business
customers and three dealers and five business customers as of June 30,
2000 and 1999, respectively. The Bank exercises control over the
securities pledged when the same security is repurchased. Assets
pledged are as follows:
(Dollars in Thousands) June 30,
---------------------
2000 1999
Mortgage-backed securities:
At amortized cost $30,932 $63,158
At fair value 30,675 62,191
An analysis of the amount at risk under repurchase agreements with
counterparties exceeding 10% of stockholders' equity at June 30, 2000
is as follows:
(Dollars in Thousands) Weighted
Average
Amount Accrued Maturity
Outstanding Interest (in days)
Dean Witter $ 24,884 $ 5 25
========= ====
8. FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis are as
follows:
(Dollars in Thousands) June 30,
---------------------------------------------------
2000 1999
----------------------- ---------------------
Variable Variable
Weighted Weighted
Average Average
Fiscal Year Maturity Amount Rate Amount Rate
2001 $ 7,000 6.87 %
2000 $ 40,000 4.94 %
The Bank was eligible to receive advances from the Federal Home Loan
Bank up to $93,700,000 and $86,400,000 at June 30, 2000 and 1999,
respectively. The Bank has pledged qualifying mortgage loans and
Federal Home Loan Bank stock as collateral.
33
9. NOTE PAYABLE
At June 30, 2000, the Company maintained a $13,000,000 term loan from
Firstar Bank Midwest., N.A. (formerly Mercantile Bancorporation, Inc.
and Mark Twain Bank) of which $12,995,000 was outstanding as of June
30, 2000. Quarterly interest-only payments, based on the prime rate
published in the Wall Street Journal (9.50% at June 30, 2000), are
payable through maturity of January 31, 2001. The unpaid principal
balance outstanding is payable in full on January 31, 2001. At June
30, 1999, the Company maintained a $15,000,000 loan facility from
Mercantile Bancorporation consisting of a revolving line of credit of
$5,000,000, of which $4,000,000 was outstanding as of June 30, 1999,
and a $10,000,000 term loan of which $5,000 had been repaid under the
term loan at June 30, 1999.
As of June 30, 2000, the loan was secured by the Harrington Bank, FSB
stock held by HFG, a blanket security interest in all of the Company's
assets and the assignment of certain life insurance policies owned by
HFG. Under the terms of the agreement, the Company is bound by certain
restrictive debt covenants. As of June 30, 2000, HFG was in compliance
with all such debt covenants.
10. INCOME TAXES
An analysis of the income tax benefit is as follows:
(Dollars in Thousands Years Ended June 30,
------------------------------------------
2000 1999 1998
Current:
Federal $ 7
State 4
Deferred:
Federal $(1,161) (1,304) (989)
State (116) (342) (256)
------ ------ -------
Total income tax benefit $(1,277) $(1,646) $(1,234)
======= ======= =======
The difference between the financial statement income tax rate and the
amount computed by using the statutory rate of 34% is reconciled as follows:
(Dollars in Thousands) Years Ended June 30,
-------------------------------------
2000 1999 1998
Federal statutory income tax at 34% $(1,104) $(1,409) $(1,052)
State income taxes, net of federal tax benefit (186) (226) (166)
Other, net 13 (11) (16)
-------- -------- --------
Total income tax benefit $(1,277) $(1,646) $(1,234)
======== ======== ========
34
The Company's deferred income tax assets (liabilities) are as follows:
(Dollars in Thousands) June 30,
----------------------------
2000 1999
Net operating loss carryforwards $ 2,112 $ 1,164
Bad debt reserves, net 520 293
Unrealized (gain) loss on securities available for sale included in
accumulated other comprehensive income 173 (16)
Unrealized gain on securities held for trading (505) (634)
Differences in income recognition on investments (246) (306)
Other, net 35 95
------- -----
Deferred income taxes, net $ 2,089 $ 596
======= =====
As of June 30, 2000, the Company's net operating loss carryforwards
expire in fiscal years 2018 through 2020. Based on management's
assessment, it is more likely than not that all the net deferred tax
assets will be realized through future taxable earnings or
implementation of tax planning strategies.
Retained earnings at June 30, 2000 and 1999 includes approximately $3
million of income that has not been subject to tax because of
deductions for bad debts allowed for federal income tax purposes.
Deferred income taxes have not been provided on such bad debt
deductions since the Company does not intend to use the accumulated
bad debt deductions for purposes other than to absorb loan losses. If,
in the future, this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, federal income taxes may
be imposed on such amounts at the then current corporation income tax
rate.
In August 1996, the "Small Business Job Protection Act of 1996" was
passed into law. One provision of the act repeals the special bad debt
reserve method for thrift institutions currently provided for in
Section 593 of the IRC. The provision requires thrifts to recapture
any reserve accumulated after 1987 but forgives taxes owed on reserves
accumulated prior to 1988. The Bank delayed the timing of this
recapture for taxable years 1998 and 1997 as certain residential loan
test requirements were met. The six-year recovery period for the
excess reserves began in taxable year 1999. The adoption of the act
did not have a material adverse effect on the Company's consolidated
financial position.
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures that have been established by regulation to
ensure capital adequacy require the Bank to maintain minimum capital
amounts and ratios (set forth in the table below). The Bank's primary
regulatory agency, the OTS, currently requires that the Bank maintain
minimum ratios of tangible capital (as defined in the regulations) of
1.5%, core capital (as defined) of 4%, and total risk-based capital
(as defined) of 8%. The Bank is also subject to prompt corrective
action capital requirement regulations set forth by the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC requires the Bank to
maintain minimum capital amounts and ratios of total and Tier I
capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as
defined). Management believes, as of June 30, 2000, that the Bank
meets all capital adequacy requirements to which it is subject.
35
As of June 30, 2000, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory
framework for prompt corrective action. To be categorized as "well
capitalized" the Bank must maintain minimum total risk-based, Tier I
risk-based and Tier I leverage ratios as set forth in the table. There
are no conditions or events since that notification that management
believes have changed the institution's category.
(Dollars in Thousands) To Be Categorized
as "Well Capitalized"
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------------------------- ----------------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
As of June 30, 2000:
Tangible capital (to total assets) $28,735 6.65% $ 6,483 1.50% N/A N/A
Core capital (to total assets) 28,735 6.65 17,288 4.00 N/A N/A
Total risk-based capital (to risk weighted assets) 30,143 12.75 18,919 8.00 $23,649 10.00%
Tier I risk-based capital (to risk weighted assets) 28,735 12.15 N/A N/A 14,190 6.00
Tier I leverage capital (to average assets) 28,735 6.65 N/A N/A 21,610 5.00
As of June 30, 1999
Tangible capital (to total assets) $32,681 6.95% $ 7,049 1.50% N/A N/A
Core capital (to total assets) 32,681 6.95 18,797 4.00 N/A N/A
Total risk-based capital (to risk weighted assets) 33,546 12.33 21,769 8.00 $27,211 10.00%
Tier I risk-based capital (to risk weighted assets) 32,681 12.01 N/A N/A 16,327 6.00
Tier I leverage capital (to average assets) 32,681 6.95 N/A N/A 23,497 5.00
12. EMPLOYEE BENEFIT PLANS
Profit-sharing plan - The Company has a qualified noncontributory
profit-sharing plan for all eligible employees. The plan provides for
contributions by the Company in such amounts as its Board of Directors
may annually determine. Contributions charged to expense for the years
ended June 30, 2000, 1999 and 1998 were $49,000, $99,000, and $87,000,
respectively.
Stock options - The Company has granted stock options to existing
stockholders, officers, directors and other affiliated individuals to
purchase shares of the Company's stock at prices at least equal to the
fair value of the stock on the date of the grant. The options are
nontransferable and are forfeited upon termination of employment, as
applicable. Awarded options vest at a rate of 20% per year. At June
30, 2000, all outstanding stock options were exercisable up to May
2010. The following is an analysis of stock option activity for each
of the three years in the period ended June 30, 2000 and the stock
options outstanding at the end of the respective years:
Years ended June 30,
--------------------------------------------------------------------------
2000 1999 1998
----------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
Outstanding, beginning of fiscal year 102,200 $ 10.57 60,000 $ 11.33 176,450 $ 8.08
Granted 62,000 7.02 43,000 9.52 31,950 12.11
Exercised (143,200) 7.50
Forfeited or expired (10,500) 10.29 (800) 10.00 (5,200) 11.25
-------- ------ ------ ------ -------- -----
Outstanding, end of fiscal year 153,700 $ 9.16 102,200 $ 10.57 60,000 $ 11.33
======== ======= ======== ======== ======= =======
Options exercisable at end of fiscal year 37,230 $ 10.75 20,290 $ 10.98 8,310 $ 10.42
======= ======== ======= ======== ====== =======
As of June 30, 2000, options outstanding have exercise prices between
$6.00 and $12.50 and a weighted average remaining contractual life of
8.5 years.
36
The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for the options;
accordingly, since the grant price of the stock options is at least
100% of the fair value at the date of the grant no compensation expense
has been recognized by the Company in connection with the option
grants. Had compensation cost for the plans been determined based on
the fair value at the grant dates for awards under the plan consistent
with the fair value method of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net loss per share would have increased the
pro forma amounts indicated below:
(Dollars in Thousands, except per share data)
Years Ended June 30,
--------------------------------------------
2000 1999 1998
Net loss:
As reported $ (1,879) $ (2,455) $ (1,859)
Pro forma $ (1,910) $ (2,482) $ (1,875)
Basic loss per share:
As reported $ (0.59) $ (0.76) $ (0.57)
Pro forma $ (0.60) $ (0.77) $ (0.57)
Diluted loss per share:
As reported $ (0.59) $ (0.76) $ (0.57)
Pro forma $ (0.60) $ (0.77) $ (0.57)
The weighted average fair value of options granted was $1.99, $1.69
and $3.72 in fiscal years 2000, 1999 and 1998, respectively. The fair
value of the option grants is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
dividend yields ranging from 0% to 2.00%, risk-free interest rates
ranging from 4.38% to 6.74%, expected volatilities ranging from 15.80%
to 28.13% and expected lives of five years. The pro forma amounts are
not representative of the effects on reported net income for future
years.
Employee Stock Ownership Plan - The Company has an Employee Stock
Ownership Plan (ESOP) for all eligible employees of the Company, the
Bank and HWM. Employees who have been credited with at least 1,000
hours of service during a twelve-month period are eligible to
participate in the ESOP. During the 2000 fiscal year, the ESOP
purchased 7,250 shares at a price of $5.75 per share. These shares
have been allocated to eligible employees. During the 1999 fiscal
year, the ESOP purchased 22,674 shares at prices ranging from $8.06 to
$9.63 per share, which have been allocated to eligible employees.
Contributions are allocated to eligible employees based on their
eligible compensation as defined in the ESOP Agreement. Gross
compensation expense (i.e. the value of shares contributed or
committed to be contributed to the ESOP by the Company) for fiscal
years 2000, 1999 and 1998 was $49,000, $121,000 and $73,000,
respectively.
37
13. RISK MANAGEMENT ACTIVITIES
The Bank closely monitors the sensitivity of its balance sheet and
income statement to potential changes in the interest rate
environment. Derivative financial instruments such as interest rate
swaps, caps, floors, collars, futures, and options are used on an
aggregate basis to protect the trading portfolio and certain
liabilities from adverse rate movements. The Bank's objective, with
regard to managing interest rate risk, is to maintain at an acceptably
low level the sensitivity to rising or falling rates of its market
value of portfolio equity.
Interest rate swaps are contracts in which the parties agree to
exchange fixed and floating rate payments for a specified period of
time on a specified (notional) amount. The notional amount is only
used to calculate the amount of the periodic interest payments to be
exchanged, and does not represent the amount at risk. The Bank uses
swaps to modify the effective duration of various assets and
liabilities. The floating rates are generally indexed to the
three-month London Interbank Offered Rates (LIBOR).
Interest rate caps and floors are instruments in which the writer
(seller) agrees to pay the holder (purchaser) the amount that an
agreed-upon index is above or below the specified cap or floor rate,
respectively, times the notional amount. In return for this promise of
future payments, the purchaser pays a premium to the seller. The
notional amount is never exchanged between the two parties and does
not represent the amount at risk. The Bank purchases interest rate
caps and floors to reduce the impact of rising or falling interest
rates on the market value of its trading portfolio. The interest rate
caps and floors generally have indexes equal to one or three month
LIBOR.
The Bank is a party to an interest rate collar which also is used to
manage interest rate risk in the trading portfolio. The interest rate
collar consists of an interest rate cap held by the Bank and an
interest rate floor written by the Bank. The notional amount of the
interest rate collar is based on the balance in the collection
accounts of certain Merrill Lynch collateralized mortgage obligation
trusts.
Interest rate futures contracts are commitments to either purchase or
sell designated instruments at a future date for a specified price.
Initial margin requirements are met in cash or other instruments, and
changes in the contract values are settled in cash daily. The Bank
enters into futures contracts when these instruments are economically
advantageous to interest rate swaps, caps and floors. The Bank uses
primarily Eurodollar contracts which are structured in calendar
quarter increments and therefore result in a much larger notional
amount than longer maturity swap, cap or floor contracts which
represent a series of quarterly repricings.
Financial options are contracts which grant the purchaser, for a
premium payment, the right to either purchase from or sell to the
writer a specified financial instrument under agreed-upon terms.
Financial options to buy or sell securities are typically traded in
standardized contracts on organized exchanges. The Bank purchases
financial options to reduce the risk of the written financial options
embedded in mortgage related assets.
Cash restrictions - The Bank maintained $999,000 and $2,298,000 at
June 30, 2000 and 1999, respectively, in U.S. Treasury Securities,
which are considered cash equivalents, as a deposit with a broker for
its futures activities.
Credit risk - The Bank is dedicated to managing credit risks
associated with hedging activities. The Bank maintains trading
positions with a variety of counterparties or obligors
("counterparties"). To limit credit exposure arising from such
transactions, the Bank evaluates the credit standing of
counterparties, establishes limits for the total exposure to any one
counterparty, monitors exposure against the established limits and
monitors trading portfolio composition to manage concentrations. In
addition, the Bank maintains qualifying netting agreements with its
counterparties and records gains and losses on derivative financial
instruments net in the trading portfolio.
The Bank's exposure to credit risk from derivative financial
instruments is represented by the fair value of instruments. Credit
risk amounts represent the replacement cost the Bank could incur
should counterparties with contracts in a gain position completely
fail to perform under the terms of those contracts and any collateral
underlying the contracts proves to be of no value to the Bank.
Counterparties are subject to the credit approval and credit
38
monitoring policies and procedures of the Bank. Certain instruments
require the Bank or the counterparty to maintain collateral for all or
part of the exposure. Limits for exposure to any particular
counterparty are established and monitored. Notional or contract
amounts indicate the total volume of transactions and significantly
exceed the amount of the Bank's credit or market risk associated with
these instruments.
The following positions are included in the Bank's trading portfolio
and are thus reported in the financial statements at current fair
value.
(Dollars in Thousands) June 30, 2000
--------------------------------------------------------------------------
Estimated
Contract or Fair Value Weighted Average Interest Rate
Notional ------------------- ------------------------------------
Amount Asset Liability Payable Receivable Cap Floor
Interest rate swaps:
Pay fixed rate $5,000 $ 18 6.58 % 6.28 % N/A N/A
Interest rate collar 343 $ 2 6.57 % 6.23 % 10.25 5.25
Futures 516,000 41 N/A N/A N/A N/A
Swaptions 15,000 113 N/A N/A N/A N/A
------- ----
$ 536,343 $ 115 $ 59
========== ====== =====
(Dollars in Thousands) June 30, 2000
--------------------------------------------------------------------------
Estimated
Contract or Fair Value Weighted Average Interest Rate
Notional ------------------- ------------------------------------
Amount Asset Liability Payable Receivable Cap Floor
Interest rate swaps:
Pay fixed rate $ 21,000 $ 175 6.34 % 5.17 % N/A N/A
Interest rate caps 133,000 $ 587 N/A N/A 7.92 % N/A
Interest rate floors 245,000 4,382 N/A N/A N/A 6.11 %
Interest rate collar 587 4 N/A N/A 10.25 5.25
Futures 2,699,700 1,611 N/A N/A N/A N/A
Swaptions 33,000 328 N/A N/A N/A N/A
---------- ----
$ 3,132,287 $ 5,301 $ 1,786
=========== ======== =======
(Dollars in Thousands) Years Ended June 30,
---------------------------------------------------
2000 1999
------------------------- ----------------------
Monthly Monthly
Average Average
Fair Value Fair Value
------------------------- ----------------------
Asset Liability Asset Liability
Interest rate swaps:
Pay fixed rate $ (9) $ 340
Interest rate caps $ 280
Interest rate floors 5,643
Interest rate collar $ 3 13
Futures 190 98
Swaptions 184 411
---- ---
$ 187 $ 181 $ 6,334 $ 451
====== ====== ======== =====
The following table shows the various components of the Company's
recorded net gain on its trading portfolio. All realized and
unrealized gains and losses are reported as other income in the
statement of operations. The periodic exchanges of interest payments
and the amortization of premiums paid for contracts are accounted for
as adjustments to the yields, and are reported on the statements of
operations as interest income.
39
(Dollars in Thousands) Years Ended June 30, 2000
---------------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
Interest rate contracts:
Swaps $ 129 $ 192 $ 321
Caps (746) 596 (150)
Floors (1,008) (1,008)
Collar (1) (1)
Futures 2,667 1,570 4,237
Swaptions (43) (99) (142)
-------- ------ -------
Total 999 2,258 3,257
MBS and other trading asssets (5,497) 1,235 (4,262)
-------- ------ -------
Total trading portfolio $(4,498) $ 3,493 $(1,005)
========= ======== =========
(Dollars in Thousands) Years Ended June 30, 1999
-----------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
Interest rate contracts:
Swaps $ 13 $ 222 $ 235
Caps 1,000 1,000
Floors (469) (469)
Collar 60 60
Futures 4,591 (1,354) 3,237
Options 48 48
-------- ------ -------
Total 4,604 (493) 4,111
MBS and other trading assets 144 (5,909) (5,765)
-------- ------ -------
Total trading portfolio $ 4,748 $(6,402) $(1,654)
======== ========= =========
(Dollars in Thousands) Years Ended June 30, 1998
--------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
Interest rate contracts:
Swaps $ 13 $ (978) $ (965)
Caps (677) (677)
Floors 1,405 1,405
Collar (2) (2)
Futures (7,961) (613) (8,574)
Options 332 36 368
---- --- ---
Total (7,616) (829) (8,445)
MBS and other trading assets 6,841 (101) 6,740
------ ------ -----
Total trading portfolio $ (775) $ (930) $(1,705)
======== ======== =========
40
The following table sets forth the maturity distribution and weighted
average interest rates of financial instruments used on an aggregate
basis to protect the trading portfolio from adverse rate movements at
June 30, 2000.
(Dollars in Thousands) Maturities During Fiscal Years Ending June 30,
---------------------------------------------------------------------------------
2001 2002 2003 2004 2005 Thereafter
Interest rate swaps-Pay fixed rate
Notional amount $ 5,000
Weighted average payable rate 6.58 %
Weighted average receivable rate 6.28 %
Interest rate collar
Notional amount $ 343
Weighted average cap rate 10.25 %
Weighted average floor rate 5.25 %
Futures
Notional amount $ 37,000 $ 148,000 $ 125,000 $ 142,000 $ 64,000
Options
Notional amount $ 15,000
The following interest rate hedges are not included in the Bank's
trading portfolio. At June 30, 1999, one of the interest rate swaps
was used to modify the interest rate sensitivity of certain
certificates of deposit issued by the Bank. These certificates of
deposit, called inverse variable rate CDs, adjust according to a
formula in such a way as to pay a higher rate of interest when the
index falls, and a lower rate of interest when the index rises. As of
June 30, 2000 and 1999, the Bank held approximately $2.7 million and
$2.9 million of inverse variable rate CDs, with original terms to
maturity ranging from three to ten years. In 1999, the Bank utilized
the interest rate swap to convert the inverse variable rate
certificates of deposit effectively to fixed rate deposits. The
interest rate swap protects the Bank against the exposure to falling
interest rates inherent in these CDs. As of June 30, 1999, the swap
had a notional amount of $7.5 million.
In addition, the Bank also has interest rate swaps which are used to
modify the interest rate sensitivity of a portion of the Bank's
short-term LIBOR correlated borrowings, which include short-term
deposits, securities sold under agreements to repurchase and the
Federal Home Loan Bank advances. As of June 30, 2000, these swaps had
a total notional amount of $35 million. The repricing characteristics
of the Bank's short-term borrowings are similar in nature to those of
the related interest rate swap instruments. The short term borrowings
reach their maturities before the maturities of the matched interest
rate swaps; however, it is the Bank's intent to consistently maintain
such short term LIBOR correlated borrowings in the normal course of
business which will be designated against these specific interest rate
swaps.
The Bank also has interest rate caps which are used to effectively cap
the interest rates on its short-term LIBOR correlated borrowings. As
of June 30, 2000 and 1999, the Bank held three 6% and one 7% interest
rate caps which are used to effectively cap the interest rates on a
portion of the Company's short-term LIBOR correlated borrowings, which
include short-term deposits, securities sold under agreements to
repurchase and the Federal Home Loan Bank advances. As of June 30,
2000 and 1999, the caps had a total notional amount of $90 million and
reprice based on the three month LIBOR. The repricing characteristics
of the Company's short-term borrowings are similar in nature to those
of the related interest rate cap agreements. The short-term borrowings
reach their maturities before the maturities of the matched interest
rate caps; however, it is the Bank's intent to replace the short-term
borrowings when they mature with additional short-term liabilities,
which will be designated against the interest rate caps.
41
The fair values of the following interest rate swaps and interest rate
caps are not reflected in the Company's financial statements. The
periodic exchanges of interest payments and the net expense of the
interest rate caps are included in interest expense in the statements
of operations.
(Dollars in Thousands) June 30, 2000
---------------------------------------------------------------------------
Contract or Weighted Average
Notional Fair Value Interest Rate
Amount Asset Liability Payable Receivable
Interest rate swaps:
Pay floating rate
Pay fixed rate $ 35,000 $ 1,929 6.03 % 6.64 %
Interest rate caps 90,000 5,124 N/A 6.83
(Dollars in Thousands) June 30, 2000
---------------------------------------------------------------------------
Contract or Weighted Average
Notional Fair Value Interest Rate
Amount Asset Liability Payable Receivable
Interest rate swaps:
Pay floating rate $ 7,500 $ 60 5.25 % 6.96 %
Pay fixed rate 50,000 2,282 $ 41 5.76 5.14
Interest rate caps 90,000 4,387 N/A N/A
The following table sets forth the maturity distribution and weighted
average interest rates of the interest rate swaps and interest rate
caps used to cap a portion of the Bank's LIBOR correlated borrowings
which include short-term deposits, securities sold under agreements to
repurchase and the Federal Home Loan Bank advance as of June 30, 2000:
2001 2002 2003 2004 2005 Thereafter
Interest rate swaps-pay fixed rate
Notional amount $ 5,000 $ 30,000
Weighted average payable rate 5.27 % 6.15 %
Weighted average receivable rate 6.39 % 6.68 %
Interest rate caps
Notional amount $ 30,000 60,000
Weighted average cap rate 7.00 % 6.00%
In June, 2000 the Bank, using proceeds from the sale of loans,
extinguished $25 million of securities sold under agreements to
repurchase and terminated $25 million in interest rate swaps that were
being utilized to modify the interest rate sensitivity of a portion of
the Bank's short-term LIBOR correlated borrowings, which included the
extinguished liabilities. As a result of the termination of the
interest rate swaps, the bank recorded a gain of $1.6 million in
interest expense and a deferred gain of approximately $485,000 in
other liabilities. The deferred gain represents interest sensitivity
protection derived from the swaps related to short-term LIBOR
correlated borrowings that are recorded as liabilities of June 30,
2000. This deferred gain will be reclassed to earnings over the
original terms of the swaps as an adjustment to interest expense.
42
14. COMMITMENTS
The Bank is a party to commitments to extend credit as part of its
normal business operations to meet the financing needs of its
customers. These commitments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in
the balance sheet. Exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contract amount of
those instruments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. Unless noted
otherwise, the Bank does not require collateral or other security to
support financial instruments with credit risk.
The following table sets forth the Bank's loan commitments whose
contract amounts represent credit risk and the applicable range of
interest rates for such loan commitments.
(Dollars in Thousands) June 30,
-------------------------------------------------------------
2000 1999
-------------------------- --------------------------------
Interest Interest
Amount Rates Amount Rates
One to four family real estate-fixed rate $ 1,379 7.63%-8.63% $ 1,589 6.75%-8.375%
Commercial loans-fixed rate 126 9.00% 450 Priced at closing
Commercial loans-adjustable rate 7,025 9.50%-11.00% 4,675 7.75%-8.75%
------ ------
$ 8,530 $ 6,714
======= =======
At June 30, 2000, the Company was obligated under noncancelable leases
for buildings. Several of these leases contain renewal options and
escalation clauses calling for rentals to be adjusted for increased
real estate taxes and other operating expenses or proportionately
adjusted for increases in the consumer price indices or other basis.
The following summary reflects the future minimum rental payments, by
fiscal year, required under operating leases that have remaining
noncancelable lease terms in excess of one year as of June 30, 2000:
Year Ended June 30,
(Dollars in Thousands)
2001 $ 303
2002 296
2003 297
2004 287
2005 218
2006 and thereafter 1,750
-----
Total minimum payments $ 3,151
=======
Rental expense under operating leases for fiscal years 2000, 1999 and
1998 was $320,000, $292,000 and $100,000, respectively.
43
15. RELATED PARTY TRANSACTIONS
The Company has contracted with Smith Breeden Associates, Inc. ("SBA")
to provide investment advisory services and interest rate risk
analysis. Certain stockholders and directors of HFG are also
principals of SBA. The amount of consulting expense relating to SBA
for fiscal years ending June 30, 2000, 1999 and 1998 was $276,000,
$301,000 and $287,000 respectively. SBA has a commercial loan
outstanding with the Bank at June 30, 2000, see Note 3.
16. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
Liquidation account - On July 10, 1985, the Bank converted from a
federally chartered mutual association to a federally chartered stock
association through the issuance of 463,173 shares of common stock ($1
par value) at a price of $8 per share. From the proceeds, $463,000 was
allocated to capital stock at the par value of $1 per share and
$2,919,000, which is net of conversion costs of $324,000, was
allocated to additional paid-in-capital.
The Bank established a special liquidation account (in memorandum
form) in an amount equal to its total retained earnings as of June 1,
1984 for the purpose of granting to eligible savings account holders a
priority in the event of future liquidation. In the event of future
liquidation of the converted institution (and only in such event), an
eligible account holder who continues to maintain his savings account
shall be entitled to receive a distribution from the liquidation
account. The total amount of the liquidation account will be decreased
in an amount proportionately corresponding to decreases in the savings
accounts of eligible account holders on each subsequent annual
determination date.
Dividend restrictions - Regulations provide that the Bank may not
declare or pay a cash dividend on or repurchase any of its stock if
the result thereof would be to reduce the consolidated stockholders'
equity of the Bank below the amount required for the liquidation
account (as defined by regulations). Under the capital distribution
regulations of the OTS, the Bank, as a "Tier 1" institution, is
permitted to make capital distributions during a calendar year up to
one hundred percent of its net income to date from the current
calendar year plus the prior two calendar years. Under this
limitation, as of June 30, 2000, the Bank would be required to file an
application with the OTS for any proposed capital distribution.
Reserve Requirements -As of June 30, 2000, the Bank was not required
to maintain reserve balances with the Federal Reserve Bank.
44
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of SFAS No.
107, Disclosures about Fair Value of Financial Instruments:
(Dollars in Thousands) June 30,
----------------------------------------------------
2000 1999
------------------------ -------------------------
Carrying Fair Carrying Fair
Value Value Value Value
ASSETS:
Cash $ 2,314 $ 2,314 $ 1,414 $ 1,414
Interest-bearing deposits 22,007 22,007 8,087 8,087
Securities held for trading 53,852 53,852 183,200 183,200
Securities available for sale 64,052 64,052 502 502
Securities held to maturity 3,857 3,871
Loans receivable, net 270,970 261,500 259,632 253,400
Interest receivable 2,186 2,186 2,340 2,340
Federal Home Loan Bank stock 4,878 4,878 4,878 4,878
LIABILITIES:
Deposits 361,241 356,200 333,245 330,300
Securities sold under agreements to repurchase 28,038 28,036 60,198 60,200
Federal Home Loan Bank advances 7,000 7,000 40,000 40,000
Interest payable on securities sold under
agreements to repurchase 5 5 66 66
Other interest payable 2,360 2,360 1,925 1,925
Note payable 12,995 12,995 13,995 13,995
Advance payments by borrowers for taxes and insurance 746 746 795 795
OFF BALANCE SHEET HEDGING INSTRUMENTS:
Interest rate swaps 1,929 2,301
Interest rate caps 2,606 5,124 3,101 4,387
The estimated fair value amounts are determined by the Company, using
available market information and appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data
to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have
a material effect on the estimated fair value amounts.
Cash, interest-bearing deposits, interest receivable and payable,
advance payments by borrowers for taxes and insurance and note payable
- The carrying amounts of these items are a reasonable estimate of
their fair value.
Loans receivable - The fair value of loans receivable is estimated by
discounting future cash flows at market interest rates for loans of
similar terms and maturities, taking into consideration repricing
characteristics and prepayment risk.
Securities held for trading consist of mortgage-backed securities,
collateralized mortgage obligations, residuals, interest-only strips,
principal-only strips, interest rate swaps, an interest rate collar,
interest rate caps, interest rate floors, options, futures and equity
securities. Fair values are based on quoted market prices or dealer
quotes. Where such quotes are not available, fair value is estimated
by using quoted market prices for similar securities or by discounting
future cash flows at a risk adjusted spread to Treasury.
Federal Home Loan Bank stock - The fair value is estimated to be the
carrying value which is par. All transactions in the capital stock of
the Federal Home Loan Bank of Indianapolis are executed at par.
45
Deposits - The fair value of NOW, DDA, savings and money market
deposit accounts is the amount payable on demand at the reporting
date. The fair value of fixed maturity certificates is estimated using
rates currently offered for deposits of similar remaining maturities.
Securities sold under agreements to repurchase - Fair values are based
on the discounted value of contractual cash flows using dealer quoted
rates for agreements of similar terms and maturities.
Federal Home Loan Bank advances - The fair value is estimated by
discounting future cash flows using rates currently available to the
bank for advances of similar maturities.
Off balance sheet hedging instruments consist of interest rate swaps
and interest rate caps used to modify the interest rate sensitivity of
certain certificates of deposit and a portion of the Bank's LIBOR
correlated short-term borrowings, including short-term deposits,
securities sold under agreements to repurchase and the Federal Home
Loan Bank advances. Fair values are based on quoted market prices or
dealer quotes. Where such quotes are not available, fair value is
estimated by using quoted market prices for similar securities or by
discounting future cash flows at a risk adjusted spread to Treasury.
Commitments - The estimated fair value of commitments to originate
fixed-rate loans is determined based on the fees currently charged to
enter into similar agreements and the difference between current
levels of interest rates and the committed rates. Based on that
analysis, the estimated fair value of such commitments is a reasonable
estimate of the loan commitments at par.
The fair value estimates presented herein are based on information
available to management as of June 30, 2000 and 1999. Although
management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these consolidated financial
statements since such dates, and therefore, current estimates of fair
value may differ significantly from the amounts presented herein.
46
18. SEGMENT INFORMATION
The Company's principal business lines include community banking in
the Indiana, Kansas, and North Carolina markets, investment
activities, including treasury management, and other activities. The
community banking segment provides a full range of deposit products as
well as mortgage, consumer and commercial loans. The investment
segment is comprised of the Company's held for trading and available
for sale securities, as well as the treasury management function.
Results of operations and asset information by operating segment are
presented below for the fiscal years ended June 30, 2000 and 1999. No
comparative segment information is available for prior years. The
financial information for each operating segment is reported on the
basis used internally by the Company's management to evaluate
performance and allocate resources.
The measurement of the performance of the operating segments is based
on the management and corporate structure of the Company and is not
necessarily comparable with similar information for any other
financial institution. The information presented is also not
necessarily indicative of the segments' asset size and results of
operations if they were independent entities.
Segment Information Year Ended June 30, 2000
(Dollars in Thousands) ------------------------------------------------------------------------------------------
Community Banking
--------------------------------------
North
Indiana Kansas Carolina Investments HWM Other Total
Net interest income (1) $ 4,093 $ 2,267 $ 245 $ 1,701 $ 88 $ (23) $ 8,371
Provision for loan losses 179 362 49 (3) 587
--------- --------- --------- --------- --------- --------- ---------
Net interest income after
provision loan losses 3,914 1,905 196 1,701 88 (20) 7,784
Other operating income 643 49 3 6 106 18 825
Depreciation expense 316 61 55 4 8 351 795
Other operating expense 4,590 1,362 1,025 876 494 485 8,832
--------- --------- --------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (349) 531 (881) 827 (308) (838) (1,018)
Realized and unrealized loss on
securities, net of hedging (1,096) (47) (1,025) (62) (2,230)
--------- --------- --------- --------- --------- --------- ---------
Loss before income taxes (1,445) 484 (881) (198) (308) (900) (3,248)
Applicable income taxes (549) 193 (340) (44) (121) (416) (1,277)
--------- --------- --------- --------- --------- --------- ---------
NET LOSS BEFORE
MINORITY INTEREST (896) 291 (541) (154) (187) (484) (1,971)
Minority interest, net of taxes 92 92
--------- --------- --------- --------- --------- --------- ---------
NET LOSS $ (896) $ 291 $ (541) $ (154) $ (187) $ (392) $ (1,879)
========= ========= ========= ========== ======== ========= =========
Identifiable assets $ 127,264 $ 54,471 $ 11,510 $ 148,651 $ 1,760 $ 91,536 $ 435,192
========= ========= ========= ========== ======== ========= =========
(1) Interest income is presented net of interest expense
47
Segment Information Year Ended June 30, 1999
------------------------------------------------------------------------
(Dollars in Thousands) Community Banking
--------------------------
Indiana Kansas Investments Other Total
Net interest income (1) $ 3,826 $ 748 $ 1,504 $ 3 $ 6,081
Provision for loan losses 192 318 1 511
--------- --------- --------- --------- ---------
Net interest income after
provision loan losses 3,634 430 1,504 2 5,570
Other operating income 343 8 9 73 433
Depreciation expense 439 70 30 11 550
Other operating expense 5,129 1,244 955 622 7,950
--------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (1,591) (876) 528 (558) (2,497)
Realized and unrealized loss on
securities, net of hedging (10) (1) (1,636) (1,647)
--------- --------- --------- --------- ---------
Loss before income taxes (1,601) (877) (1,108) (558) (4,144)
Applicable income taxes (636) (348) (441) (221) (1,646)
--------- --------- --------- --------- ---------
NET LOSS BEFORE
MINORITY INTEREST (965) (529) (667) (337) (2,498)
Minority interest, net of taxes 43 43
--------- --------- --------- --------- ---------
NET LOSS $ (965) $ (529) $ (667) $ (294) $ (2,455)
========= ======== ======== ======== =========
Identifiable assets $ 219,607 $ 42,851 $ 198,672 $ 10,209 $ 471,339
========== ========= ========= ========= =========
(1) Interest income is presented net of interest expense
48
19. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION (PARENT COMPANY
ONLY)
The following condensed balance sheets as of June 30, 2000 and 1999,
and condensed statements of operations and cash flows for the three
years in the period ended June 30, 2000 for Harrington Financial Group,
Inc. should be read in conjunction with the consolidated financial
statements and notes thereto.
CONDENSED BALANCE SHEETS June 30,
---------------------
(Dollars in Thousands) 2000 1999
ASSETS
Cash and cash equivalents $ 215 $ 277
Securities held for trading 11 134
Deferred income taxes, net 1,533 854
Income taxes receivable 28 143
Other assets 21 27
Intercompany receivable 1 107
Investment in subsidiary 27,623 31,769
------- ------
TOTAL ASSETS $ 29,432 $ 33,311
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable $ 12,995 $ 13,995
Accrued expenses payable and other liabilities 180 177
---- ---
Total liabilities 13,175 14,172
------- ------
Common stock 425 425
Additional paid-in capital 16,946 16,946
Treasury stock (2,488) (2,162)
Accumulated other comprehensive income (loss), net of taxes (268) 25
Retained earnings 1,642 3,905
------ -----
Total stockholders' equity 16,257 19,139
------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,432 $ 33,311
========= ========
CONDENSED STATEMENTS OF OPERATIONS June 30,
-----------------------------------
(Dollars in Thousands) 2000 1999 1998
Interest income from securities held for trading $ 1 $ 2 $ 6
Interest on deposits 6 3 18
Gain on sale of securities held for trading 81 21 94
Unrealized gain (loss) on securities held for trading (60) (35) (59)
----- ----- ----
Total income (loss) 28 (9) 59
--- ---- --
Interest expense on long-term borrowings 1,295 1,109 981
Salaries and employee benefits 274 294 263
Other expenses 158 174 249
---- ---- ---
Total expenses 1,727 1,577 1,493
------ ------ -----
Income (loss) before equity in undistributed earnings (1,699) (1,586) (1,434)
Income tax provision (benefit) (673) (627) (566)
Equity in undistributed earnings of subsidiary (853) (1,496) (991)
------ -------- -----
Net income (loss) $(1,879) $(2,455) $(1,859)
========== ========== =========
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CONDENSED STATEMENTS OF CASH FLOWS Years Ended June 30,
------------------------------------
(Dollars in Thousands) 2000 1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,879) $(2,455) $(1,859)
Adjustments to reconcile net loss to net cash from
operating activities:
Net increase (decrease) in assets and liabilities 230 (91) 123
Gain on sale of securities held for trading (81) (21) (94)
Unrealized (gain) loss on securities held for trading 60 35 59
Purchases of securities held for trading (2,000)
Proceeds from sales of securities held for trading 144 52 2,300
Deferred income tax provision (679) (62) (588)
Decrease in undistributed earnings of subsidiary 3,853 1,471 991
------ ------ ---
Net cash from operating activities 1,648 (1,071) (1,068)
------ -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to subsidiary (3,200)
-------- ------ -----
Net cash from investing activities (3,200)
-------- ------ -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock options exercised 1,074
Proceeds from note payable 1,000 500 3,500
Principal repayments on note payable (2,000)
Dividends paid on common stock (384) (385) (395)
Purchase of treasury stock (326) (784) (1,467)
Proceeds from issuance of treasury stock 73
--
Net cash from financing activities (1,710) (596) 2,712
-------- ------ -----
NET DECREASE IN CASH AND CASH EQUIVALENTS (62) (1,667) (1,556)
CASH AND CASH EQUIVALENTS, beginning of year 277 1,944 3,500
---- ------ -----
CASH AND CASH EQUIVALENTS, end of year $ 215 $ 277 $ 1,944
====== ====== =======
20. SUBSEQUENT EVENT (UNAUDITED)
On September 8, 2000 the Company sold deposits and certain assets of
two branch banking locations. The Company sold $43.5 million of
deposits, $0.4 million of office properties and equipment and paid
approximately $41.7 million. The sale resulted in a pre-tax gain of
approximately $1.4 million.
50