EXHIBIT 13
ANNUAL REPORT TO SECURITY HOLDERS
FIRST FEDERAL BANKSHARES, INC.
AND SUBSIDIARIES
Consolidated Financial Statements
and Supplementary Information
June 30, 2003 and 2002
(With Independent Auditors' Report Thereon)
Selected Consolidated Financial and Other Data
The following table sets forth certain selected consolidated financial and other
data of First Federal Bankshares, Inc. (the "Company") at the dates and for the
periods indicated. For additional information about the Company, reference is
made to "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated Financial Statements of the Company and
related notes included elsewhere herein.
-----------------------------------------------------------------------------------------------------------------------
Dollars in thousands, except per share amounts
-----------------------------------------------------------------------------------------------------------------------
Financial Condition at June 30 2003 2002 2001 2000 1999
-------- ------- ------- ------- -------
Total assets $627,879 650,757 660,124 723,382 680,672
Securities available-for-sale 78,526 92,313 87,598 117,326 122,047
Securities held-to-maturity 44,505 63,295 22,725 23,737 32,006
Loans receivable, net 415,267 418,382 417,898 505,090 457,058
Office property and equipment, net 13,166 13,770 14,686 15,315 15,412
Federal Home Loan Bank (FHLB) stock, at cost 5,707 5,038 9,469 8,929 8,094
Goodwill 18,524 18,524 18,524 19,367 20,277
Deposits 448,944 472,648 488,708 471,626 464,169
FHLB advances 102,387 99,065 89,118 174,020 138,617
Stockholders' equity 69,661 71,263 72,587 68,113 68,273
Operations Data for Year Ended June 30
Total interest income $ 35,117 40,020 50,578 47,973 41,136
Total interest expense 16,122 22,947 32,271 29,814 24,864
-------- ------- ------- -------- --------
Net interest income 18,995 17,073 18,307 18,159 16,272
Provision for losses on loans 1,730 3,835 5,155 554 365
-------- ------- ------- -------- --------
Net interest income after provision for
losses on loans 17,265 13,238 13,152 17,605 15,907
-------- ------- ------- -------- --------
Noninterest income:
Fees and service charges 5,324 4,825 3,681 2,901 2,146
Gain on sale of branch deposits -- 165 -- -- 1,088
Net gain (loss) on sale of securities 309 103 1,583 (170) (12)
Gain on sale of loans 862 552 351 180 296
Real estate related activities 1,509 1,453 1,206 1,464 950
Other income 1,792 1,930 1,588 2,135 1,066
-------- ------- ------- -------- --------
Total noninterest income 9,796 9,028 8,409 6,510 5,534
-------- ------- ------- -------- --------
Noninterest expense:
Compensation and benefits 10,215 9,400 8,605 8,992 7,674
Office property and equipment 2,666 2,544 2,419 2,282 1,901
Amortization of goodwill -- -- 844 844 449
Other noninterest expense 5,781 5,116 4,923 4,480 4,154
-------- ------- ------- -------- --------
Total noninterest expense 18,662 17,060 16,791 16,598 14,178
-------- ------- ------- -------- --------
Earnings before income taxes 8,399 5,206 4,770 7,517 7,263
Income taxes 2,794 1,696 1,764 2,641 2,700
-------- ------- ------- -------- --------
Net earnings $ 5,605 3,510 3,006 4,876 4,563
======== ======= ======= ======== ========
Earnings per share (1):
Basic earnings per share $ 1.44 0.85 0.68 1.07 0.97
======== ======= ======= ======== ========
Diluted earnings per share $ 1.41 0.83 0.67 1.07 0.96
======== ======= ======= ======== ========
"Adjusted" earnings per share (2)
Basic earnings per share $ 1.44 0.85 0.87 1.26 1.06
======== ======= ======= ======== ========
Diluted earnings per share $ 1.41 0.83 0.86 1.25 1.06
======== ======= ======= ======== ========
Cash dividends declared per common share $ 0.32 0.32 0.32 0.30 0.29
======== ======= ======= ======== ========
- ----------
(1) Adjusted for stock distributions and April 1999 stock conversion.
(2) "Adjusted" earnings exclude amortization of goodwill.
1
Selected Consolidated Financial and Other Data (Continued)
Key Financial Ratios and Other Data at or for the Years Ended June 30
2003 2002 2001 2000 1999 (6)
------ ------ ------ ------ --------
Performance Ratios:
Return on assets (net income divided
by average total assets) 0.88% 0.54% 0.43% 0.70% 0.78%
Return on equity (net income divided
by average equity) 7.91 4.89 4.16 7.22 9.48
Average net interest rate spread (1) 3.22 2.71 2.44 2.50 2.72
Net yield on average interest-earning
assets (2) 3.37 2.95 2.81 2.81 2.99
Net interest income after provision for
loan losses to total other expenses 92.51 77.60 78.33 106.07 112.20
Average interest-earning assets to
average interest-bearing liabilities 105.21 106.04 107.48 106.64 105.83
Asset Quality Ratios:
Nonperforming loans to total loans 1.13 1.48 0.64 0.42 0.54
Nonperforming loans to total assets 0.75 0.95 0.40 0.29 0.36
Nonperforming assets as a percentage
of total assets (3) 0.81 1.01 0.42 0.30 0.37
Nonperforming loans and real estate
owned to total loans and real
estate owned 1.23 1.58 0.67 0.43 0.54
Allowance for loan losses to total loans 1.10 1.08 1.12 0.67 0.68
Capital, Equity and Dividend Ratios:
Tangible capital (4) 7.65 7.62 7.60 6.71 6.52
Core capital (4) 7.65 7.62 7.60 6.71 6.52
Risk-based capital (4) 12.64 12.66 13.25 12.46 13.20
Average equity to average assets ratio 11.50 11.11 10.22 9.68 8.24
Dividend payout ratio 22.22 37.65 47.06 28.04 30.10
Other Data:
Book value per common share (5) $18.29 $16.95 $15.95 $14.52 $14.17
Number of full-service offices 15 15 17 18 19
- ----------
(1) Represents the difference between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities.
(2) Represents net interest income as a percentage of average interest-earning
assets. Non-performing assets include non-accruing loans, accruing loans
delinquent 90 days or more, and foreclosed assets but
(3) do not include restructured loans.
(4) End of period ratio.
(5) Adjusted for stock distributions and April 1999 stock conversion.
(6) Operating data includes effect of the acquisition of Mid-Iowa Financial
Corp. for periods subsequent to April 13, 1999.
2
Selected Consolidated Financial and Other Data (Continued)
Quarterly Financial Data:
Dollars in thousands, except per share amounts
June March December September
Three Months Ended 2003 2003 2002 2002
------ ----- -------- ---------
Interest income $8,045 8,440 9,145 9,487
Interest expense 3,553 3,797 4,181 4,591
------ ----- ----- -----
Net interest income 4,492 4,643 4,964 4,896
Provision for losses on loans 300 200 400 830
------ ----- ----- -----
Net interest income after provision 4,192 4,443 4,564 4,066
Noninterest income 2,317 2,927 2,465 2,087
Noninterest expense 4,880 4,718 4,689 4,375
------ ----- ----- -----
Earnings before income taxes 1,629 2,652 2,340 1,778
Income taxes 531 870 803 590
------ ----- ----- -----
Net earnings $1,098 1,782 1,537 1,188
====== ===== ===== =====
Earnings per share:
Basic $0.295 0.464 0.389 0.296
====== ===== ===== =====
Diluted $0.287 0.454 0.381 0.290
====== ===== ===== =====
June March December September
Three Months Ended 2002 2002 2001 2001
------ ----- -------- ---------
Interest income $9,585 9,600 9,962 10,873
Interest expense 5,012 5,357 5,989 6,589
------ ----- ----- -----
Net interest income 4,573 4,243 3,973 4,284
Provision for losses on loans 1,520 1,035 400 880
------ ----- ----- -----
Net interest income after provision 3,053 3,208 3,573 3,404
Noninterest income 2,162 2,125 2,356 2,385
Noninterest expense 4,458 4,263 4,219 4,120
------ ----- ----- -----
Earnings before income taxes 757 1,070 1,710 1,669
Income taxes 194 325 581 596
------ ----- ----- -----
Net earnings $ 563 745 1,129 1,073
====== ===== ===== =====
Earnings per share:
Basic $0.138 0.182 0.276 0.255
====== ===== ===== =====
Diluted $0.135 0.179 0.271 0.249
====== ===== ===== =====
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Statements
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for the express purpose of availing itself
of these safe harbor provisions. Forward-looking statements, which are based on
certain assumptions and describe future plans, strategies and expectations of
the Company, are generally identifiable by use of the words "believe," "expect,"
"intend," "anticipate," "estimate," "project" or similar expressions. The
Company's ability to predict results or the actual effect of future plans or
strategies is inherently uncertain. Factors which could have a material adverse
effect on the Company's future activities and operating results include, but are
not limited to, changes in: interest rates, general economic conditions,
legislation, regulation, U.S. monetary and fiscal policies, the quality or
composition of the Company's loan and investment portfolios, deposit flows,
competition, demand for products and services and accounting policies,
principles and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements, and undue reliance should not be placed
on such statements.
General
First Federal Bankshares, Inc. was organized under Delaware law in December 1998
by First Federal Bank (the "Bank") to be the savings and loan holding company of
the Bank in connection with the Bank's April 13, 1999 conversion from mutual
holding company form to the stock form of ownership (the "Conversion"). The
Company's principal activity consists of ownership of all of the stock in the
Bank. The net income of the Company is primarily derived from the operations of
the Bank. In addition to the Bank, the Company owns Equity Services, Inc., a
real estate development company and Mid-Iowa Security Corporation, which
generates revenues primarily by providing real estate brokerage services. The
Bank is a federally chartered stock savings bank headquartered in Sioux City,
Iowa. The Bank is the successor of First Federal Savings and Loan Association of
Sioux City, which was founded in 1923. The Company's results of operations are
primarily dependent on its net interest income. Net interest income is the
difference between interest income earned on loans and investment securities and
interest expense paid on deposits and borrowings. The Company's net income also
is affected by its provision for loan losses, as well as the amount of
noninterest income, including loan fees and service charges, and noninterest
expense, such as salaries and employee benefits, deposit insurance premiums,
occupancy and equipment costs and income taxes. Earnings of the Company also are
affected significantly by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory authorities.
Business Strategy
The Company's mission statement is to "maximize shareholder value through a
strong focus on customer service provided by well-trained and motivated
employees". The Company has sought to execute this mission by: (1) implementing
a heightened focus on commercial loan and deposit relationships in markets
served by the Company; (2) maintaining an emphasis on credit quality and strong
underwriting; (3) developing specific marketing plans, calling programs and
sales goals to support the expansion of commercial banking relationships; (4)
continuing to provide quality products and services within core business lines;
and (5) performing a periodic and comprehensive review of products, services,
business lines and pricing to ensure profitability and competitiveness.
4
Average Balance Sheet
The following table sets forth certain information relating to the Company's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and rates
paid. Such yields and costs are derived by dividing income or expense by the
average balance of assets or liabilities, respectively, for the periods
presented. Average balances are daily averages.
Years Ended June 30
2003 2002 2001
-------------------------------------------------------------------------------------------
Rate at
June 30, Average Average Average Average Average Average
2003 Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost
---- ------- -------- ---------- ------- -------- ---------- ------- -------- ----------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable (1) 6.42% $414,171 29,129 7.03% 422,805 32,797 7.76% 484,911 39,573 8.16%
Mortgage-backed
securities 4.21% 66,701 3,176 4.76% 46,212 2,572 5.57% 38,661 2,678 6.93%
Investment securities (2) 3.28% 77,851 2,766 3.55% 82,963 3,956 4.77% 119,729 7,924 6.62%
Short-term investments
and other interest-
earning assets (3) 0.80% 4,403 46 1.04% 26,977 695 2.58% 9,314 403 4.33%
---- ------ ------ ------ ---- ------ ------
Total interest-earning
assets 5.81% 563,126 35,117 6.24% 578,957 40,020 6.91% 652,615 50,578 7.75%
---- ------ ------ ------ ---- ------ ------
Noninterest-earning assets 71,801 67,523 53,433
-------- ------- -------
TOTAL ASSETS $634,927 646,480 706,048
======== ======= =======
Interest-bearing liabilities:
Deposits 2.12% $429,330 11,064 2.58% 457,001 17,937 3.92% 457,439 23,070 5.04%
Borrowings 4.85% 105,912 5,085 4.78% 88,974 5,010 5.63% 149,756 9,201 6.14%
---- -------- ------ ------ ------- ------ ---- ------- ------ ------
Total interest-bearing
Liabilities 2.66% 535,242 16,122 3.01% 545,975 22,947 4.20% 607,195 32,271 5.31%
---- ------ ------ ------ ---- ------ ------
Noninterest-bearing:
Deposits 21,976 20,032 16,286
Liabilities 6,845 8,622 10,434
-------- ------- -------
TOTAL LIABILITIES 563,422 574,629 633,914
Stockholders' equity 70,864 71,851 72,133
-------- ------- -------
TOTAL LIABILITIES
AND STOCK-
HOLDERS' EQUITY $634,927 646,480 706,048
======== ======= =======
Net interest income $18,995 17,073 18,307
======= ====== ======
Interest rate spread (4) 3.15% 3.22% 2.71% 2.44%
==== ====== ====== ======
Net yield on interest-
earning assets (5) 3.28% 3.37% 2.95% 2.81%
==== ====== ====== ======
Ratio of average interest-
earning assets to
average interest-
bearing liabilities 105.21% 106.04% 107.48%
====== ====== ======
- ----------
(1) Average balances include nonaccrual loans.
(2) Investment securities not tax-effected.
(3) Includes interest-bearing deposits in other financial institutions.
Interest-rate spread represents the difference between the average yield
on interest-earning assets and the average cost of
(4) Iinterest-bearing liabilities. interest-bearing liabilities.
(5) Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
5
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest
income and interest expense of the Company for the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in average volume
(changes in average volume multiplied by old rate); (ii) changes in rates
(change in rate multiplied by old average volume); (iii) changes in rate-volume
(changes in rate multiplied by the change in average volume); and (iv) the net
change.
Years Ended June 30
2003 vs. 2002 2002 vs. 2001
------------------------------------------ -------------------------------------------
Increase (Decrease) Due To TOTAL Increase (Decrease) Due To TOTAL
RATE/ INCREASE RATE/ INCREASE
VOLUME RATE VOLUME (DECREASE) VOLUME RATE VOLUME (DECREASE)
------ ---- ------ ---------- ------ ---- ------ ----------
(In Thousands)
Interest income:
Loans receivable $ (670) (3,061) 63 (3,668) (5,069) (1,940) 233 (6,776)
Mortgage-backed securities 1,140 (371) (165) 604 523 (526) (103) (106)
Investment securities (244) (1,009) 63 (1,190) (2,433) (2,215) 680 (3,968)
Other interest-earning assets (582) (414) 347 (649) 764 (163) (309) 292
------- ------ ---- ------ ------ ------ ---- -------
Total interest-earning assets (356) (4,855) 308 (4,903) (6,215) (4,844) 501 (10,558)
------- ------ ---- ------ ------ ------ ---- -------
Interest expense:
Deposits (1,086) (6,160) 373 (6,873) (22) (5,123) 12 (5,133)
Borrowings 954 (761) (145) 48 (3,735) (764) 308 (4,191)
------- ------ ---- ------ ------ ------ ---- -------
Total interest-bearing liabilities (132) (6,921) 228 (6,825) (3,757) (5,887) 320 (9,324)
------- ------ ---- ------ ------ ------ ---- -------
Net change in net interest income $ (224) 2,066 80 1,922 (2,458) 1,043 181 (1,234)
======= ====== ==== ====== ====== ====== ==== =======
Financial Condition
Total assets decreased by $22.9 million, or 3.5%, to $627.9 million at June 30,
2003 from $650.8 million at June 30, 2002, primarily due to a decrease in
investment securities. The balance of securities held-to-maturity decreased by
$18.8 million, or 29.7%, to $44.5 million at June 30, 2003 from $63.3 million at
June 30, 2002 and the balance of securities available-for-sale decreased by
$13.8 million, or 14.9%, to $78.5 million at June 30, 2003 from $92.3 million at
June 30, 2002. Proceeds from sales and maturities of investment securities more
than offset purchases during fiscal 2003. In addition, net loans receivable
decreased by $3.1 million, or 0.7%, to $415.3 million at June 30, 2003 from
$418.4 million at June 30, 2002 due to loan prepayments. Cash and cash
equivalents increased by $11.1 million, or 47.7%, to $34.3 million at June 30,
2003 from $23.2 million at June 30, 2002. Federal Home Loan Bank ("FHLB") stock
increased by $670,000, or 13.3%, to $5.7 million at June 30, 2003 from $5.0
million at June 30, 2002 due to FHLB requirements tied to total advances
outstanding.
Deposits decreased by $23.7 million, or 5.0%, to $448.9 million at June 30, 2003
from $472.6 million at June 30, 2002 and accrued interest payable decreased by
$1.8 million, or 50.7%, to $1.8 million at June 30, 2003 from $3.6 million at
June 30, 2002 due to a decrease in the average balance of interest bearing
deposits and in the average cost of deposits in fiscal 2003 as compared to
fiscal 2002. During fiscal 2003 the Company changed its pricing strategy for
retail deposits and is generally not a market rate leader for term deposits. In
response to historically low market interest rates, deposit customers have
withdrawn funds from matured time deposits and transferred those funds to more
liquid accounts. The Company offers premium rates to customers with multiple
relationships in order to retain existing deposits and attract new customers. In
addition, the Company offers promotional rates on selected deposit products as
needed to fund loans and maintain adequate liquidity. Partly offsetting the
decrease in deposit balances was an increase in FHLB advances. The balance of
advances from FHLB increased by $3.3 million, or 3.4%, to $102.4 million at June
30, 2003 from $99.1 million at June 30, 2002. Stockholders' equity decreased by
$1.6 million, or 2.3%, to $69.7 million at June 30, 2003 from $71.3
6
million at June 30, 2002. The decrease in stockholders' equity was largely due
to stock repurchase programs under which 422,000 shares of Company common stock
were repurchased during fiscal 2003 at a cost of $6.7 million, or $15.83 per
share. In August 2003 the Company completed a stock repurchase program pursuant
to which a total of 426,000 shares were repurchased and announced a new stock
repurchase program pursuant to which the Company intends to repurchase up to 10%
of its issued and outstanding shares, or up to 377,000 shares. Partially
offsetting the decrease in stockholders' equity due to stock repurchases were
earnings of $5.6 million. Dividends declared during the year ended June 30, 2003
totaled $1.2 million excluding dividends paid on unallocated Employee Stock
Ownership Plan ("ESOP") shares.
Asset Quality
Management believes that asset quality has improved during fiscal 2003.
Non-performing assets decreased to $5.1 million, or 0.81% of total assets, at
June 30, 2003 from $6.6 million, or 1.01% of total assets, at June 30, 2002. The
decrease in non-performing assets was primarily due to a decrease in the balance
of non-performing loans. Non-performing loans decreased to $4.7 million at June
30, 2003 from $6.2 million at June 30, 2002, representing 1.13% and 1.48%,
respectively, of total loans at those dates.
The allowance for loan losses is increased by the provision for loan losses
charged to operations and reduced by net charge-offs. Management establishes the
allowance for loan losses through a process that begins with estimates of
probable loss inherent in the portfolio based on various statistical analyses.
These analyses consider historical and projected default rates and loss
severities; internal risk ratings; and geographic, industry and other
environmental factors. In establishing the allowance for loan losses, management
also considers the Company's current business strategy and credit processes,
including compliance with established guidelines for credit limits, credit
approvals, loan underwriting criteria and loan workout procedures.
The policy of the Company is to segment the allowance to correspond to the
various types of loans in the loan portfolio according to the underlying
collateral, which corresponds to the respective levels of quantified and
inherent risk. The initial assessment takes into consideration non-performing
loans and the valuation of the collateral supporting each loan. Non-performing
loans are risk-rated generally on a case-by-case basis based on qualitative and
quantitative factors that include, but are not limited to, collateral type and
estimated value, financial statement analysis, specific economic factors, cash
flow analysis, delinquency history and loan workout situations and progress.
Based upon this analysis, a quantified risk factor is assigned to each
non-performing loan. This results in an allocation to the overall allowance for
the corresponding type and severity of each non-performing loan.
Performing loans are also reviewed by collateral type, with similar risk factors
being assigned. These risk factors take into consideration, among other matters,
the borrower's ability to pay and the Company's past loan loss experience with
each type of loan. The assigned risk factors result in allocations to the
allowance corresponding to the risk-rated portfolio of performing loans.
In order to determine its overall adequacy, the allowance for loan losses is
reviewed by management on a monthly basis. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary, based on changes in economic and local market conditions beyond
management's control. In addition, various regulatory agencies periodically
review the Company's loan loss allowance as an integral part of the examination
process. Accordingly, the Company may be required to take certain charge-offs
and/or recognize additions to the allowance based on the judgment of regulators
as determined by information provided to them during their examinations.
Based on relevant and presently available information, management believes that
the current allowance for loan losses is adequate. Following are tables
presenting (a) an analysis of the loan portfolio; (b) a summary of the allowance
for loan losses; and (c) non-performing assets at or for the dates indicated.
(a) Analysis of Loan Portfolio.
The following table sets forth information regarding the Company's loan
portfolio, by type of loan on the dates indicated.
7
---------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
Amount % Amount % Amount % Amount % Amount %
---------------------------------------------------------------------------------------------
(Dollars in Thousands)
One- to four-family residential (1) $ 191,890 46.22 164,816 39.40 181,034 43.32 325,057 64.36 326,126 71.36
Multi-family residential (2) 35,051 8.44 56,537 13.51 62,040 14.85 54,455 10.78 40,974 8.96
Commercial real estate (3) 78,064 18.80 81,232 19.42 79,025 18.91 54,594 10.81 31,158 6.82
Commercial business loans 16,256 3.91 15,502 3.71 14,976 3.58 8,533 1.69 6,193 1.35
Home equity & second mortgage 36,962 8.90 40,347 9.64 38,224 9.15 35,695 7.07 32,315 7.07
Auto loans 26,292 6.33 32,168 7.69 24,212 5.79 13,801 2.73 13,603 2.98
Loans on deposits 511 0.12 672 0.16 802 0.19 659 0.13 616 0.13
Other non-mortgage loans (4) 35,077 8.45 32,569 7.78 22,538 5.39 16,887 3.34 10,400 2.28
---------------------------------------------------------------------------------------------
Total 420,103 101.17 423,843 101.31 422,851 101.18 509,681 100.91 461,385 100.95
Less:
Allowance for loan losses (4,615) (1.11) (4,584) (1.10) (4,737) (1.13) (3,394) (0.67) (3,135) (0.69)
Loans in process (410) (0.10) (1,500) (0.36) (458) (0.11) (550) (0.11) (942) (0.21)
Net unearned premiums on loans 1,965 0.47 2,076 0.50 1,537 0.37 1,684 0.33 1,995 0.44
Deferred loan fees (1,776) (0.43) (1,453) (0.35) (1,295) (0.31) (2,331) (0.46) (2,245) (0.49)
---------------------------------------------------------------------------------------------
Total loans, net $ 415,267 100.00 418,382 100.00 417,898 100.00 505,090 100.00 457,058 100.00
=============================================================================================
- ----------
(1) Includes construction loans on one- to four-family residential units.
(2) Includes construction loans on multi-family residential units.
(3) Includes construction loans on commercial real estate.
(4) Includes other secured non-mortgage loans, credit card loans, education
loans and unsecured personal loans.
(b) Analysis of the Allowance for Loan Losses.
The following table sets forth information regarding the Company's allowance for
loan losses at or for the years indicated.
At or for years ended June 30,
2003 2002 2001 2000 1999
------------------------------------------------------------------
(Dollars in Thousands)
Total loans outstanding $ 420,103 423,843 422,851 509,681 461,385
Average loans outstanding 414,171 422,805 484,911 480,377 416,631
Allowance balance (at beginning of period) 4,584 4,737 3,394 3,135 2,607
Additions related to acquisition -- -- -- -- 325
Provision:
Residential 141 60 240 80 110
Commercial real estate 551 1,019 1,120 224 75
Commercial business 150 2,000 3,560 -- --
Consumer 887 755 235 250 180
Charge-offs:
Residential (115) (5) -- (5) (63)
Commercial real estate (721) (697) (70) (30) --
Commercial business (131) (2,640) (3,551) -- --
Consumer (1,097) (858) (269) (346) (184)
Recoveries 366 213 78 86 85
------------------------------------------------------------------
Allowance balance (at end of period) $ 4,615 4,584 4,737 3,394 3,135
==================================================================
Allowance for loan losses as a % of total outstanding 1.10% 1.08 1.12 0.67 0.68
Net loans charged off as a % of average loans outstanding 0.41% 0.94 0.79 0.06 0.04
(c) Non-performing loans.
The following table sets forth information regarding non-accrual loans, accrual
loans and other non-performing assets at the dates indicated.
8
At June 30,
2003 2002 2001 2000 1999
-------------------------------------------------------
(Dollars in Thousands)
Loans accounted for on a non-accrual basis:
One-to four family residential $ 335 527 -- -- 1,003
Multi-family residential 2,426 2,857 -- -- --
Commercial real estate 628 824 -- 15 1,061
Commercial business -- 584 1,094 -- --
Consumer 302 314 -- -- --
-------------------------------------------------------
Total 3,691 5,106 1,094 15 2,064
-------------------------------------------------------
Loans accounted for on an accrual basis (1)(2):
One-to four family residential 997 780 970 1,187 295
Multi-family residential -- -- -- 547 --
Commercial real estate -- -- 233 247 --
Consumer -- 305 363 112 101
-------------------------------------------------------
Total 997 1,085 1,566 2,093 396
-------------------------------------------------------
Total non-performing loans 4,688 6,191 2,660 2,108 2,460
-------------------------------------------------------
Other non-performing assets (3) (4) 412 410 130 65 32
-------------------------------------------------------
$5,100 6,601 2,790 2,173 2,492
=======================================================
Restructured loans not included in
other non-performing categories above (5) $3,005 -- 449 434 441
=======================================================
Non-performing loans as a percentage of total loans 1.13% 1.48 0.64 0.42 0.54
Non-performing loans as a percentage of total assets 0.75% 0.95 0.40 0.29 0.36
Non-performing loans and real estate owned to
total loans and real estate owned 1.23% 1.58 0.67 0.43 0.54
Non-performing assets as a percentage of total assets 0.81% 1.01 0.42 0.30 0.37
- ----------
(1) Includes loans 90 days or more contractually delinquent.
(2) Delinquent FHA/VA guaranteed loans and delinquent loans with past due
interest that, in the opinion of management, is collectible, are not
placed on non-accrual status.
(3) Represents the net book value of real property acquired by the Company
through foreclosure or deed in lieu of foreclosure. Upon acquisition, this
property is carried at the lower of cost or fair market value less
estimated costs of disposition.
(4) For fiscal 2003 and 2002, includes repossessed automobiles, boats and
trailers carried at the lower of cost or fair market value less estimated
costs of disposition. Total carrying amount was $240,000 and $325,000,
respectively, at June 30, 2003 and 2002.
(5) Restructured loans have had amounts added to the principal balance and/or
the terms of the debt modified. Modification terms include payment
extensions, interest only payments and longer amortization periods, among
other possible concessions that would not normally be considered.
9
Comparison of Operating Results for Fiscal Years Ended June 30, 2003 and 2002
General. Net earnings totaled $5.6 million, or $1.41 per diluted share, for the
year ended June 30, 2003 as compared to net earnings totaling $3.5 million, or
$0.83 per diluted share, for the year ended June 30, 2002.
Interest Income. Interest income decreased by $4.9 million, or 12.3%, to $35.1
million in fiscal 2003 from $40.0 million in fiscal 2002. The decrease in
interest income was primarily due to a decrease in the yield on interest-earning
assets. The average yield on interest-earning assets decreased by 67 basis
points to 6.24% for fiscal 2003 from 6.91% for fiscal 2002 due to lower yields
on interest-earning assets in the generally lower market interest rate
environment and to changes in the mix of interest-earning assets. The average
balance of interest-earning assets decreased by $15.9 million, or 2.7%, to
$563.1 million in fiscal 2003 from $579.0 million in fiscal 2002.
Interest income on loans receivable decreased by $3.7 million, or 11.2%, to
$29.1 million for fiscal 2003 from $32.8 million for fiscal 2002. The decrease
in interest income on loans receivable was primarily due to a decrease in the
yield on loans. The average yield on loans receivable decreased by 73 basis
points to 7.03% for fiscal 2003 from 7.76% for fiscal 2002. In addition, the
average balance of loans receivable decreased by $8.6 million, or 2.0%, to
$414.2 million for fiscal 2003 from $422.8 million for fiscal 2002.
Interest income on mortgage-backed securities ("MBS") increased by $604,000, or
23.5%, to $3.2 million in fiscal 2003 from $2.6 million in fiscal 2002. The
increase in interest income on MBS was primarily due to an increase in the
average balance of MBS. The average balance of MBS increased by $20.5 million,
or 44.3%, to $66.7 million for fiscal 2003 from $46.2 million for fiscal 2002.
The average yield on MBS decreased by 81 basis points to 4.76% in fiscal 2003
from 5.57% in fiscal 2002. The decrease in the average yield on MBS was
primarily due to purchases of MBS yielding relatively lower rates during fiscal
2003. In addition, adjustable-rate MBS repriced at lower rates in the generally
lower market interest rate environment during fiscal 2003.
Interest income on investment securities decreased by $1.2 million, or 30.1%, to
$2.8 million for fiscal 2003 from $4.0 million for fiscal 2002. The decrease in
interest income on investment securities was primarily due to a decrease in the
average yield on investment securities. The average yield on investment
securities decreased by 122 basis points to 3.55% for fiscal 2003 from 4.77% for
fiscal 2002. In addition, the average balance of investment securities decreased
by $5.1 million, or 6.2%, to $77.9 million in fiscal 2003 from $83.0 million in
fiscal 2002.
Interest income on other interest-earning assets decreased by $649,000, or
93.4%, to $46,000 for fiscal 2003 from $695,000 for fiscal 2002 due to a
decrease in the average balance of such assets. The average balance of other
interest-earning assets decreased by $22.6 million, or 83.7%, to $4.4 million
for fiscal 2003 from $27.0 million for fiscal 2002 as excess liquid funds were
reinvested in mortgage-backed securities. In addition, the average yield on
other interest-earning assets decreased by 154 basis points to 1.04% in fiscal
2003 from 2.58% in fiscal 2002 in the generally lower market interest rate
environment in the current fiscal year period.
Interest Expense. Interest expense decreased by $6.8 million, or 29.7%, to $16.1
million in fiscal 2003 from $22.9 million in fiscal 2002. The decrease in
interest expense was due to a decrease of 119 basis points in the average cost
of interest-bearing liabilities to 3.01% for fiscal 2003 from 4.20% for fiscal
2002 and to a decrease of $10.7 million in the average balance of
interest-bearing liabilities to $535.2 million for fiscal 2003 from $546.0
million for fiscal 2002. Interest expense on deposits decreased by $6.9 million,
or 38.3%, to $11.0 million in fiscal 2003 from $17.9 million in fiscal 2002. The
decrease in interest expense on deposits was primarily due to a decrease of 134
basis points in the average rate paid on deposits to 2.58% in fiscal 2003 from
3.92% in fiscal 2002. The average balance of deposits decreased by $27.7
million, or 6.1% to $429.3 million for fiscal 2003 from $457.0 million for
fiscal 2002. Interest paid on borrowings totaled $5.1 million and $5.0 million,
respectively, for fiscal 2003 and 2002. The average balance of borrowings
increased by $16.9 million, or 19.0%, to $105.9 million in fiscal 2003 from
$89.0 million in fiscal 2002. The average cost of borrowings decreased by 85
basis points to 4.78% in fiscal 2003 from 5.63% in fiscal 2002 as higher-rate
fixed-term borrowings matured and were replaced with lower-rate borrowings in
the generally lower market interest rate environment during fiscal 2003.
10
Net Interest Income. Net interest income before provision for loan losses
increased by $1.9 million, or 11.3%, to $19.0 million for fiscal 2003 from $17.1
million for fiscal 2002. The Company's interest rate spread increased by 51
basis points to 3.22% for fiscal 2003 from 2.71% for fiscal 2002 and the net
yield on interest-earning assets increased by 42 basis points to 3.37% for
fiscal 2003 from 2.95% for fiscal 2002.
Provision for Loan Losses. Provision for loan loss expense decreased by $2.1
million, or 54.9%, to $1.7 million for fiscal 2003 from $3.8 million for fiscal
2002. Provision for loan loss expense in fiscal 2002 was largely due to a $2.2
million charge-off of loans to a local commercial and industrial borrower.
Provision for loan loss expense increased in fiscal 2003 and 2002 in comparison
with prior fiscal years due to increased growth in commercial real estate and
business loan balances and in consumer loan balances, which generally involve a
greater degree of risk than one-to-four family residential mortgage loans. Net
charge-offs as a percentage of average loans outstanding were 0.41% and 0.94%,
respectively, for fiscal years 2003 and 2002. The Company has established a
systematic method of reviewing the credit quality of the loan portfolio in order
to establish a sufficient allowance for losses on loans. See "Asset Quality" for
information regarding the Company's loan loss allowance policy and loan loss
experience.
Noninterest Income. Noninterest income increased by $768,000, or 8.5%, to $9.8
million for fiscal 2003 from $9.0 million for fiscal 2002. The increase in
noninterest income was partly due to an increase of $499,000, or 10.4%, in
income from fees and service charges to $5.3 million for fiscal 2003 from $4.8
million for fiscal 2002. The increase in fees and service charges resulted from
an increase in loan origination activity in the generally lower market interest
rate environment and from increases in service fees on deposit accounts. The
increase in loan origination activity in the favorable rate environment for
borrowers during fiscal 2003 also contributed to increases in gain on sale of
loans. Gain on sale of loans held for sale increased by $310,000, or 56.3%, to
$862,000 for fiscal 2003 from $552,000 for fiscal 2002. In addition, the Company
recorded a net gain on sale of securities that increased to $309,000 in fiscal
2003 from $103,000 in fiscal 2002. Other noninterest income increased by
$378,000, or 27.7%, to $1.7 million for fiscal 2003 from $1.4 million for fiscal
2002. The increase in other noninterest income was partly due to increases in
revenues in the Company's non-banking subsidiaries. In addition, earnings from
the Company's investment in bank owned life insurance ("BOLI") increased by
$117,000, or 41.7%, to $396,000 for fiscal 2003 from $279,000 for fiscal 2002.
The Company purchased BOLI in November and December 2001 in order to use the
tax-exempt earnings to offset rising health care and pension expenses. The
Company's investment in BOLI totaled $7.9 million and $7.5 million,
respectively, at June 30, 2003 and 2002. Management has established limits on
the amount of insurance to be purchased through any single insurer, monitors the
credit ratings of the insurers annually and applies reasonable capital and risk
limits to the amount of the BOLI investment.
Noninterest Expense. Noninterest expense increased by $1.6 million, or 9.4%, to
$18.7 million in fiscal 2003 from $17.1 million in fiscal 2002. The principal
component of the Company's noninterest expense is salaries and employee
benefits. Compensation and benefit expense increased by $815,000, or 8.7%, to
$10.2 million in fiscal 2003 from $9.4 million in fiscal 2002. The increase in
compensation and benefits expense was partly due to pension contribution
expense. The Financial Institutions Retirement Fund (the "FIRF"), of which the
Company is a participant, notified the Company that a pension contribution,
estimated at $340,000, was required for the year ended June 30, 2003. The FIRF
had been in fully-funded status since July 1987; therefore, no pension
contribution expense had been recorded since fiscal 1988. In addition, annual
salary increases, an increase in the number of full-time-equivalent employees
and increases in commission and bonus expenses contributed to the increase in
compensation and benefits expense. Office property and equipment expense and
advertising expense increased by $122,000, or 4.8%, and by $35,000, or 8.9%,
respectively, in fiscal 2003 as compared to fiscal 2002. Other noninterest
expense increased by $666,000, or 15.5%, to $5.0 million for fiscal 2003 from
$4.3 million for fiscal 2002. The increase in other noninterest expense during
fiscal 2003 was partly due to the cost of handling the higher loan origination
volume, to increases in professional and consulting fees, and to losses related
to disposal of repossessed assets and other real estate owned properties.
Income tax expense. Net earnings before income
11
taxes increased by $3.2 million, or 61.3%, to $8.4 million for fiscal 2003 from
$5.2 million for fiscal 2002. Income tax expense increased by $1.1 million, or
64.7%, to $2.8 million for fiscal 2003 from $1.7 million for fiscal 2002. The
Company's effective tax rate increased to 33.3% for fiscal 2003 from 32.6% for
fiscal 2002. The effective tax rate increased for fiscal 2003 largely because
tax-exempt income comprised a smaller percentage of pre-tax income for fiscal
2003 than for fiscal 2002.
Comparison of Operating Results for Fiscal Years Ended June 30, 2002 and 2001
General. Net earnings totaled $3.5 million, or $0.83 per diluted share, for the
year ended June 30, 2002 as compared to net earnings totaling $3.0 million, or
$0.67 per diluted share, for the year ended June 30, 2001. The Company early
adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill
and Other Intangible Assets on July 1, 2001. As required by the Statement,
amortization of goodwill was discontinued in fiscal 2002.
Interest Income. Interest income decreased by $10.6 million, or 20.9%, to $40.0
million in fiscal 2002 from $50.6 million in fiscal 2001. The decrease in
interest income was primarily due to a decrease in the balance of
interest-earning assets. The average balance of interest-earning assets
decreased by $73.6 million, or 11.3%, to $579.0 million in fiscal 2002 from
$652.6 million in fiscal 2001. In addition, the average yield on
interest-earning assets decreased by 84 basis points to 6.91% for fiscal 2002
from 7.75% for fiscal 2001 due to lower yields on interest-earning assets in the
generally lower market interest rate environment and to changes in the mix of
interest-earning assets.
Interest income on loans receivable decreased by $6.8 million, or 17.1%, to
$32.8 million for fiscal 2002 from $39.6 million for fiscal 2001. The decrease
in interest income on loans receivable was primarily due to a decrease of $62.1
million, or 12.8%, in the average balance of loans receivable to $422.8 million
for fiscal 2002 from $484.9 million for fiscal 2001. The decrease in the average
balance of loans receivable for fiscal 2002 as compared to fiscal 2001 was
largely due to a reduction in the Company's one-to-four family fixed-rate
residential loan portfolio that resulted from the securitization and sale of
$112.7 million of such loans in March 2001. The average yield on loans
receivable decreased by 40 basis points to 7.76% for fiscal 2002 from 8.16% for
fiscal 2001, which also contributed to the decrease in interest income on loans
receivable.
Interest income on mortgage-backed securities ("MBS") decreased by $106,000, or
4.0%, to $2.6 million in fiscal 2002 from $2.7 million in fiscal 2001. The
decrease in interest income on MBS was primarily due to a decrease in the
average yield on MBS. The average yield on MBS decreased by 136 basis points to
5.57% in fiscal 2002 from 6.93% in fiscal 2001. The decrease in the average
yield on MBS was primarily due to purchases of MBS yielding relatively lower
rates during fiscal 2002. In addition, adjustable-rate MBS repriced at lower
rates in the generally lower market interest rate environment during fiscal
2002. Partly offsetting the decrease in yield on MBS was an increase in the
average balance of those securities. The average balance of MBS increased by
$7.5 million, or 19.5%, to $46.2 million for fiscal 2002 from $38.7 million for
fiscal 2001.
Interest income on investment securities decreased by $4.0 million, or 50.1%, to
$4.0 million for fiscal 2002 from $7.9 million for fiscal 2001. The decrease in
interest income on investment securities was primarily due to a decrease of
$36.7 million, or 30.7%, in the average balance of investment securities to
$83.0 million in fiscal 2002 from $119.7 million in fiscal 2001. In addition,
the average yield on investment securities decreased by 185 basis points to
4.77% for fiscal 2002 from 6.62% for fiscal 2001.
Interest income on other interest-earning assets increased by $292,000, or
72.4%, to $695,000 for fiscal 2002 from $403,000 for fiscal 2001 due to an
increase in the average balance of such assets. The average balance of other
interest-earning assets increased by $17.7 million, or 189.7%, to $27.0 million
for fiscal 2002 from $9.3 million for fiscal 2001 due to increased liquidity in
fiscal 2002. Partly offsetting the increases in the average balance of other
interest-earning assets was a decrease in the average yield. The average yield
on other interest-earning assets decreased by 175 basis points to 2.58% in
fiscal 2002 from 4.33% in fiscal 2001 in the generally lower market interest
rate environment in the current fiscal year period.
Interest Expense. Interest expense decreased by $9.3 million, or 28.9%, to $22.9
million in fiscal 2002
12
from $32.3 million in fiscal 2001. The decrease in interest expense was due to a
decrease of 111 basis points in the average cost of interest-bearing liabilities
to 4.20% for fiscal 2002 from 5.31% for fiscal 2001 and to a decrease of $61.2
million in the average balance of interest-bearing liabilities to $546.0 million
for fiscal 2002 from $607.2 million for fiscal 2001. Interest expense on
deposits decreased by $5.1 million, or 22.3%, to $17.9 million in fiscal 2002
from $23.1 million in fiscal 2001. The decrease in interest expense on deposits
was primarily due to a decrease of 112 basis points in the average rate paid on
deposits to 3.92% in fiscal 2002 from 5.04% in fiscal 2001. The average balance
of deposits decreased by 0.1% to $457.0 million for fiscal 2002 from $457.4
million for fiscal 2001. Interest paid on borrowings decreased by $4.2 million,
or 45.6%, to $5.0 million for fiscal 2002 from $9.2 million for fiscal 2001. The
average balance of borrowings decreased by $60.8 million, or 40.6%, to $89.0
million in fiscal 2002 from $149.8 million in fiscal 2001. The Company repaid
short-term borrowings during the final quarter of fiscal 2001 with proceeds from
the securitization and sale of residential mortgage loans and consequently the
average balance of borrowings during fiscal 2002 was lower than that balance in
fiscal 2001. The average cost of borrowings decreased by 51 basis points to
5.63% in fiscal 2002 from 6.14% in fiscal 2001 as higher-rate fixed-term
borrowings matured and were replaced with lower-rate borrowings in the generally
lower market interest rate environment during fiscal 2002.
Net Interest Income. Net interest income before provision for loan losses
decreased by $1.2 million, or 6.7%, to $17.1 million for fiscal 2002 from $18.3
million for fiscal 2001. The Company's interest rate spread increased by 27
basis points to 2.71% for fiscal 2002 from 2.44% for fiscal 2001 and the net
yield on interest-earning assets increased by 14 basis points to 2.95% for
fiscal 2002 from 2.81% for fiscal 2001. The increase in the interest rate spread
and net yield on interest-earning assets was more than offset by the decrease in
the volume of interest-earning assets during fiscal 2002 as compared to fiscal
2001.
Provision for Loan Losses. Provision for loan loss expense decreased by $1.3
million, or 25.6%, to $3.8 million for fiscal 2002 from $5.2 million for fiscal
2001. Provision for loan loss expense in fiscal 2002 was largely due to a $2.2
million charge-off of loans to a local commercial and industrial borrower.
Provision for loan loss expense in fiscal 2001 was largely due to a $3.5 million
charge-off of loans to a local borrower in a high technology industry. In
addition, provision for loan loss expense increased in fiscal 2002 and 2001 in
comparison with prior fiscal years due to increased growth in commercial real
estate and business loan balances and in consumer loan balances, which generally
involve a greater degree of risk than one-to-four family residential mortgage
loans. Net charge-offs as a percentage of average loans outstanding were 0.94%
and 0.79%, respectively, for fiscal years 2002 and 2001. The Company has
established a systematic method of reviewing the credit quality of the loan
portfolio in order to establish a sufficient allowance for losses on loans. See
"Asset Quality" for information regarding the Company's loan loss allowance
policy and loan loss experience.
Noninterest Income. Noninterest income increased by $619,000, or 7.4%, to $9.0
million for fiscal 2002 from $8.4 million for fiscal 2001. The increase in
noninterest income was partly due to a pretax gain of $456,000 on the sale of a
northwest Iowa branch office in July 2001 to a local financial institution. The
purchaser assumed deposits of $8.9 million and acquired loans totaling $2.8
million in addition to the branch building and certain fixtures. The gain on the
sale of the branch deposits, loans and building and fixtures totaled $165,000,
$44,000 and $247,000, respectively. The increase in noninterest income was also
due to an increase of $1.1 million, or 31.1%, in income from fees and service
charges to $4.8 million for fiscal 2002 from $3.7 million for fiscal 2001. The
increase in fees and service charges resulted from an increase in loan
origination activity in the generally lower market interest rate environment and
from increases in service fees on deposit accounts. The increase in loan
origination activity in the favorable rate environment for borrowers during
fiscal 2002 also contributed to increases in gain on sale of loans and other
real estate-related activities. Gain on sale of loans held for sale, including
the sale of the branch office loans mentioned earlier, increased by $201,000, or
57.4%, to $552,000 for fiscal 2002 from $351,000 for fiscal 2001 and income from
other real estate-related activities increased by $247,000, or 20.5%, to $1.5
million for fiscal 2002 from $1.2 million for fiscal 2001. Income from other
real estate-related activities consists primarily of real estate sales
commissions and fees for abstracting services generated by subsidiaries of the
Company. Increases in all categories of noninterest income, other than gain on
sale of securities, more than offset a much
13
lower gain on sale of securities in fiscal 2002 as compared to fiscal 2001. In
fiscal 2002 the Company recorded a net gain on sale of securities that totaled
$103,000 as compared to a net gain on sale of securities that totaled $1.6
million in fiscal 2001. The fiscal 2001 gain was primarily due to a $1.7 million
gain realized on the sale of $112.7 million of the Company's residential
fixed-rate mortgage loans securitized in March 2001.
Noninterest Expense. Noninterest expense increased by $269,000, or 1.6%, to
$17.1 million in fiscal 2002 from $16.8 million in fiscal 2001. The principal
component of the Company's noninterest expense is salaries and employee
benefits. Compensation and benefit expense increased by $795,000, or 9.2%, to
$9.4 million in fiscal 2002 from $8.6 million in fiscal 2001. The increase in
compensation and benefits expense was largely due to the cost of discontinuing
the Company's self-insured health insurance plan that totaled approximately
$395,000 during fiscal 2002 and to annual salary increases. Office property and
equipment expense and advertising expense increased by $125,000, or 5.2%, and by
$33,000, or 9.3%, respectively, in fiscal 2002 as compared to fiscal 2001.
Partly offsetting the increases in noninterest expense for fiscal 2002 as
compared to fiscal 2001, were decreases in other noninterest expense categories.
Due to the Company's early adoption of SFAS No.142, amortization of goodwill was
discontinued in fiscal 2002. Amortization of goodwill expense totaled $844,000
in fiscal 2001. Data processing expense decreased by $150,000, or 30.6%, to
$340,000 for fiscal 2002 from $490,000 for fiscal 2001 largely due to a decrease
in software amortization expense. Other general and administrative expense
increased by $317,000, or 8.0%, to $4.3 million for fiscal 2002 from $4.0
million for fiscal 2001. The increase in other expense during fiscal 2002 was
partly due to the cost of handling the higher loan origination volume, to higher
costs of recruiting new staff members and to increased costs related to an
increase in the volume of transaction accounts. Transaction accounts generally
involve a higher cost to the Company than certificates of deposit due to the
ability of the account holder to withdraw funds by check, automated teller
machine and debit card, over the counter transactions and other means. Losses
due to fraud, forgery and overdrawn accounts add to the Company's cost of
maintaining transaction accounts.
Income tax expense. Net earnings before income taxes increased by $436,000, or
9.1%, to $5.2 million for fiscal 2002 from $4.8 million for fiscal 2001. Income
tax expense decreased by $68,000, or 3.9%, to $1.7 million for fiscal 2002 from
$1.8 million for fiscal 2001. The Company's effective tax rate decreased to
32.6% for fiscal 2002 from 37.0% for fiscal 2001. The lower effective tax rate
for fiscal 2002 resulted from an increase in tax-exempt investments such as
municipal bonds and BOLI. In addition, non-deductible goodwill amortization in
fiscal 2001 resulted in a higher effective tax rate when compared to fiscal 2002
in which no goodwill expense was recorded.
Asset and Liability Management - Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity
gap is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. Interest rate sensitivity is based on
numerous assumptions, such as prepayment estimates, which are revised annually
to reflect the anticipated interest rate environment. During a period of rising
interest rates, a negative gap would tend to adversely affect net interest
income while a positive gap would tend to positively affect net interest income.
During a period of falling interest rates a negative gap would tend to
positively affect net interest income while a positive gap would tend to
negatively affect net interest income.
The Company has utilized the following strategies in recent years in an effort
to reduce interest rate risk: (a) the Company seeks to originate and hold in
portfolio adjustable rate loans which have annual
14
interest rate adjustments; (b) the Company seeks to originate commercial and
consumer loans; (c) the Company closely manages the extent to which fixed-rate
residential mortgage loans are held in portfolio; (d) the Company seeks to
lengthen the maturity of deposits, when cost effective, through the pricing and
promotion of certificates of deposit; (e) the Company seeks to attract checking
and other transaction accounts which generally have a lower interest cost and
which tend to be less interest rate sensitive when interest rates rise; (f) the
Company uses Federal Home Loan Bank advances, within approved limits, to fund
the origination of fixed rate loans; (g) the Company utilizes various investment
portfolio strategies to manage the cash flow, prepayment and effective maturity
of the investment portfolio within the context of the entire balance sheet; and
(h) while not currently a part of the Company's strategy, the Asset/Liability
Management Policy (the "ALM Policy") allows the use of brokered deposits and
retail repurchase agreements, within approved limits, to fund loan production.
The Company has an asset/liability committee (the "ALCO"), which includes the
Company's President, Chief Financial Officer and other senior Company officers.
The ALCO meets monthly to review loan pricing and production, deposit pricing
and production, interest rate risk analysis, investment portfolio activities,
liquidity position and compliance with the ALM Policy and Investment Policy of
the Company. The ALM Policy and the Investment Policy were established by the
ALCO and approved by the Company's Board of Directors. These policies contain
specific guidance regarding balance sheet and investment portfolio management.
The ALM Policy specifically limits the exposure of earnings at risk. ALCO
reports are provided to the Board of Directors on a monthly basis detailing
asset/liability management performance measurements.
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices
and rates. The Company's market risk is comprised primarily of interest rate
risk resulting from its core banking activities of lending and deposit taking.
Interest rate risk is the risk that changes in market interest rates might
adversely affect the Company's net interest income or the economic value of its
portfolio of assets, liabilities, and off-balance sheet contracts. Management
continually develops and applies strategies to mitigate this risk. Management
does not believe that the Company's primary market risk exposures and how those
exposures were managed in fiscal 2003 have changed significantly when compared
to fiscal 2002. The net portfolio value (the "NPV") of the Company, assuming no
change in interest rates (the "Base Case Scenario"), was $49.4 million and $64.4
million, respectively, at June 30, 2003 and 2002. The NPV ratio in the Base Case
Scenario was 7.90% and 9.86%, respectively, at June 30, 2003 and 2002. The Board
of Directors has established market risk limits based on the Company's tolerance
for risk. At June 30, 2003, the NPV ratio was inside the board limits in all
measured rate-change scenarios except the +300 basis point rate-change, where
the NPV ratio is 8 basis points lower than the policy limit. Management will
address this non-compliance in future ALCO meetings. The Company primarily
relies on the Office of Thrift Supervision (the "OTS") Net Portfolio Value Model
(the "Model") to measure its susceptibility to interest rate changes. Net
portfolio value is defined as the present value of expected net cash flows from
existing assets minus the present value of expected net cash flows from existing
liabilities plus or minus the present value of net expected cash flows from
existing off-balance-sheet contracts. The Model estimates the current economic
value of each type of asset, liability, and off-balance sheet contract after
various assumed instantaneous, parallel shifts in the Treasury yield curve both
upward and downward.
The Model uses an option-based pricing approach to value one-to-four family
mortgages, mortgages serviced by or for others, and firm commitments to buy,
sell, or originate mortgages. This approach makes use of an interest rate
simulation program to generate numerous random interest rate paths that, in
conjunction with a prepayment model, are used to estimate mortgage cash flows.
Prepayment options and interest rate caps and floors contained in mortgages and
mortgage-related securities introduce significant uncertainty in estimating the
timing of cash flows for these instruments that warrants the use of this
sophisticated methodology. All other financial instruments are valued using a
static discounted cash flow method. Under this approach, the present value is
determined by discounting the cash flows the instrument is expected to generate
by the yields currently available to investors from an instrument of
15
comparable risk and duration.
The following table sets forth the present value estimates for major categories
of financial instruments of the Company at June 30, 2003, as calculated by the
Model. The table shows the present value of the instruments under rate shock
scenarios of -100 basis points to +300 basis points in increments of 100 basis
points. The OTS suppressed NPV estimates for interest rate scenarios of -300
basis points and -200 basis points beginning with the September 2001 and
December 2001 cycles, respectively, due to the abnormally low market interest
rate environment. Therefore, no data is presented in the table for those rate
shock scenarios. As illustrated in the table, the Company's NPV decreases in the
rising rate scenarios and increases in the falling rate scenario. As market
interest rates increase, the market values of the Company's portfolio of loans
and securities decrease and prepayments slow. As market interest rates decrease,
the market values of loans and securities increase, but less dramatically than
in the rising rate scenarios, due to prepayment risk, periodic rate caps, and
other embedded options.
Present Value Estimates by Interest Rate Scenario
Calculated at June 30, 2003
----------------------------------Base------------------------------------
-100 bp 0 bp +100 bp +200 bp +300 bp
-------- -------- -------- -------- --------
(Dollars in Thousands)
Financial Instrument:
Mortgage loans and securities $417,784 412,260 404,221 395,279 386,003
Non-mortgage loans 75,085 73,442 71,867 70,365 68,921
Cash, deposits and securities 98,607 96,514 93,732 91,257 89,066
Other assets 39,081 42,825 47,100 51,190 55,195
-------- -------- -------- -------- --------
Total assets 630,557 625,041 616,920 608,091 599,185
Deposits 460,113 456,585 453,161 449,846 446,613
Borrowings 114,760 111,379 108,347 105,641 103,249
Other liabilities 7,758 7,750 7,743 7,733 7,728
-------- -------- -------- -------- --------
Total liabilities 582,631 575,714 569,251 563,220 557,590
-------- -------- -------- -------- --------
Commitments 829 63 (884) (1,943) (3,151)
-------- -------- -------- -------- --------
Net portfolio value $ 48,755 49,390 46,785 42,928 38,444
======== ======== ======== ======== ========
Net portfolio value ratio 7.73% 7.90% 7.58% 7.06% 6.42%
======== ======== ======== ======== ========
NPV minimum: policy limit 6.50% 6.50% 6.50% 6.50% 6.50%
======== ======== ======== ======== ========
Liquidity and Capital Resources
The Company is required by OTS regulation to maintain sufficient liquidity to
assure its safe and sound operation. The Company's liquidity ratio averaged
29.5% during the quarter ended June 30, 2003. The Company adjusts its liquidity
levels in order to meet funding needs for deposit outflows, payment of real
estate taxes from escrowed funds, when applicable, and loan commitments. The
Company also adjusts liquidity as appropriate to meet its asset/liability
objectives. The Company's primary sources of funds are deposits, amortization
and prepayment of loans and mortgage-backed securities, FHLB advances,
maturities of investment securities and other short-term investments, and funds
provided from operations. While scheduled loan and mortgage-backed securities
repayments are a relatively predictable source of funds, deposit flows and loan
prepayments are greatly influenced by general interest rates, economic
conditions and competition. The Company manages the pricing of its deposits to
maintain a steady deposit balance. In addition, the Company invests excess funds
in interest-bearing deposits in other financial institutions, investment
securities and other short-term interest-earning assets that provide liquidity
to meet lending requirements. Investments and other assets qualifying for
liquidity, outstanding at June 30, 2003,
16
2002, and 2001, totaled $134.9 million, $156.8 million, and $172.4 million,
respectively.
Deposits are the Company's primary source of externally generated funds. The
level of deposit inflows during any given period is heavily influenced by
factors outside of management's control, such as the general level of short-term
and long-term interest rates in the economy, as well as higher alternative
yields that investors may obtain on competing investment instruments such as
money market mutual funds. Deposits decreased by $23.7 million and $15.9
million, respectively in fiscal 2003 and 2002. Deposits increased by $17.1
million in fiscal 2001. Similarly, the general level of market interest rates
heavily influences the amount of principal repayments on loans and mortgage
securities. Principal repayments on loans during fiscal 2003 totaled $200.8
million as compared to $219.7 million in fiscal 2002 and $177.9 million in
fiscal 2001. Funds received from principal repayments on mortgage-backed
securities for fiscal 2003, 2002 and 2001, totaled $30.3 million, $9.9 million
and $7.1 million, respectively. Liquidity management is both a daily and
long-term function of business management. If the Company requires funds beyond
its ability to generate them internally, borrowing agreements exist with the
FHLB, which provide an additional source of funds. At June 30, 2003 and 2002,
the Company had $102.4 million and $99.1 million, respectively, in outstanding
advances from the FHLB.
At June 30, 2003, the Company had outstanding loan commitments and consumer and
commercial approved, but unused, lines of credit totaling $59.9 million.
Certificates of deposit scheduled to mature or reprice in one year or less at
June 30, 2003 totaled $129.1 million. Management believes that a significant
portion of such deposits will remain with the Company.
Impact of Inflation and Changing Prices
The consolidated financial statements of the Company and notes thereto have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without considering the
change in the relative purchasing power of money over time and due to inflation.
The impact of inflation is reflected in the increased cost of the Company's
operations. Unlike most industrial companies, nearly all the assets and
liabilities of the Company are monetary. As a result, interest rates have a
greater impact on the Company's performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
Effect of New Accounting Standards
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145 Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This Statement rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. The provisions of this Statement related to the rescission of
Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The
provisions in paragraphs 8 and 9(c) of this Statement related to Statement 13
are effective for transactions occurring after May 15, 2002. All other
provisions of this Statement are effective for financial statements issued on or
after May 15, 2002. The adoption of this Statement did not have a material
effect on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or
17
Disposal Activities. This Statement addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring). The Company adopted this Statement
on January 1, 2003. The adoption of this Statement did not have a material
effect on the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions ("SFAS 147"), which amends SFAS No. 72, Accounting for Certain
Acquisitions of Banking or Thrift Institutions ("SFAS 72"). This Statement no
longer requires the separate recognition and subsequent amortization of goodwill
that was originally required by SFAS 72. SFAS 147 also amends SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, to include in
its scope long-term customer-relationship intangible assets (such as core
deposit intangibles). The effects of implementation on the Company's
consolidated financial statements were not material.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002. The effects
of the implementation on the Company's consolidated financial statements were
not material. The disclosure requirements are effective for financial statements
of interim and annual periods ending after December 15, 2002 and have been
included in these consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures of both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. Certain of
the disclosure modifications are required for fiscal years ending after December
15, 2002 and are included in the Notes to Consolidated Financial Statements (the
"Notes").
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by business
enterprises of variable interest entities that have certain characteristics. It
requires a business enterprise that has a controlling interest in a variable
interest entity (as defined by FIN 46) to include the assets, liabilities and
results of the activities of the variable interest entity in the consolidated
financial statements of the business enterprise. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
For variable interest entities acquired before February 1, 2003, it applies in
the first fiscal year or interim period beginning after June 15, 2003. The
impact of adopting FIN 46 will not be material, as the Company does not
presently have any variable interest entities.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, ("SFAS 149"). SFAS 149 amends
Statement 133 for decisions made (1) as part of the Derivatives Implementation
Group process that effectively required amendments to Statement 133; (2) in
connection with other FASB projects dealing with financial instruments; and (3)
in connection with implementation issues raised in relation to the application
of the definition of a derivative, in particular, the meaning of "an initial net
investment that is smaller than would be required for other types of contracts
that would be expected to have a similar response to changes in market factors,"
the meaning of "underlying," and the characteristics of a derivative that
contains financing components. SFAS 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging
18
relationships designated after June 30, 2003. The Company will adopt SFAS 149,
as indicated above, and such adoption is not expected to have a material effect
on its financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
SFAS 150 established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or asset in some circumstances). Many of those instruments were
previously classified as equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003, except for
mandatory redeemable financial instruments of nonpublic entities. The Company
will adopt SFAS 150 on July 1, 2003 and such adoption is not expected to have a
material effect on its financial position or results of operations.
Critical Accounting Policies
The Company's critical accounting policies relate to the allowance for loan
losses and intangible assets. A description of the Company's critical accounting
policy related to intangible assets is summarized in Note 1 of the Notes to
Consolidated Financial Statements (the "Notes") under "Excess of Cost Over Fair
Value of Assets Acquired". In addition, Note 7 of the Notes includes information
about the carrying amounts and amortization expense related to intangible
assets. With regard to the Company's critical accounting policy for the
allowance for loan losses, the Company has established a systematic method of
periodically reviewing the credit quality of the loan portfolio in order to
establish a sufficient allowance for losses on loans. The allowance for losses
on loans is based on management's current judgments about the credit quality of
individual loans and segments of the loan portfolio. The allowance for losses on
loans is established through a provision for loan losses based on management's
evaluation of the risk inherent in the loan portfolio, and considers all known
internal and external factors that affect loan collectibility as of the
reporting date. Such evaluation, which includes a review of all loans on which
full collectibility may not be reasonably assured, considers among other
matters, the estimated net realizable value or the fair value of the underlying
collateral, economic conditions, historical loan loss experience, management's
knowledge of inherent risks in the portfolio that are probable and reasonably
estimable and other factors that warrant recognition in providing an appropriate
loan loss allowance. This evaluation involves a high degree of complexity and
requires management to make subjective judgments that often require assumptions
or estimates about uncertain matters. The Company's critical accounting policies
and their application are periodically reviewed by the Audit Committee of the
Board of Directors and by the full Board of Directors. See also "Asset Quality"
in Management's Discussion and Analysis of Financial Condition and Results of
Operations.
19
Independent Auditors' Report
The Board of Directors
First Federal Bankshares, Inc.
and Subsidiaries
Sioux City, Iowa:
We have audited the accompanying consolidated balance sheets of First Federal
Bankshares, Inc. and subsidiaries (the Company) as of June 30, 2003 and 2002,
and the related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended June 30, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Federal
Bankshares, Inc. and subsidiaries as of June 30, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended June 30, 2003, in conformity with
accounting principles generally accepted in the United States of America.
KPMG LLP
Des Moines, Iowa
August 8, 2003
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 2003 and 2002
Assets 2003 2002
------------- -------------
Cash and due from banks $ 34,006,405 23,114,024
Interest-bearing deposits in other financial institutions 280,548 103,197
------------- -------------
Cash and cash equivalents 34,286,953 23,217,221
------------- -------------
Securities available-for-sale (note 2) 78,526,104 92,313,472
Securities held-to-maturity (fair value of $45,659,510 in 2003
and $64,009,952 in 2002) (note 2) 44,505,464 63,294,694
Loans receivable (note 3) 419,882,438 422,965,769
Less: Allowance for loan losses (note 4) 4,615,285 4,583,897
------------- -------------
Net loans 415,267,153 418,381,872
------------- -------------
Office property and equipment, net (note 5) 13,165,804 13,770,198
Federal Home Loan Bank (FHLB) stock, at cost 5,707,300 5,037,800
Accrued interest receivable (note 6) 2,488,460 2,803,663
Refundable income taxes (note 10) -- 146,741
Deferred tax asset (note 10) 514,000 --
Goodwill (note 7) 18,523,607 18,523,607
Other assets 14,894,532 13,267,904
------------- -------------
Total assets $ 627,879,377 650,757,172
============= =============
Liabilities and Stockholders' Equity
Deposits (note 8) $ 448,944,039 472,648,336
Advances from FHLB (note 9) 102,386,888 99,064,679
Advance payments by borrowers for taxes and insurance 1,458,955 1,482,743
Accrued taxes on income (note 10) 346,167 --
Deferred tax liability (note 10) -- 103,000
Accrued interest payable (notes 8 and 9) 1,795,348 3,640,039
Accrued expenses and other liabilities 3,286,615 2,555,580
------------- -------------
Total liabilities 558,218,012 579,494,377
------------- -------------
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares;
issued none shares -- --
Common stock, $0.01 par value. Authorized 12,000,000 shares;
issued 4,896,857 shares and 4,871,112 shares at June 30, 2003
and 2002, respectively 48,969 48,711
Additional paid-in capital 36,537,133 36,247,480
Retained earnings, substantially restricted (note 13) 47,900,781 43,542,299
Treasury stock, at cost, 1,088,466 shares and 665,764 shares
at June 30, 2003 and 2002, respectively (14,264,674) (7,577,646)
Accumulated other comprehensive income:
Net unrealized gain on securities available-for-sale 710,378 490,458
Unearned ESOP (note 11) (1,185,700) (1,330,000)
Unearned RRP (note 11) (85,522) (158,507)
------------- -------------
Total stockholders' equity 69,661,365 71,262,795
Contingencies (note 16)
------------- -------------
Total liabilities and stockholders' equity $ 627,879,377 650,757,172
============= =============
See accompanying notes to consolidated financial statements
2
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended June 30, 2003, 2002, and 2001
2003 2002 2001
------------ ------------ ------------
Interest income:
Loans receivable $ 29,129,117 32,797,235 39,573,543
Mortgage-backed securities 3,176,080 2,571,732 2,677,812
Investment securities 2,765,662 3,956,160 7,924,018
Other interest-earning assets 45,911 694,957 403,045
------------ ------------ ------------
Total interest income 35,116,770 40,020,084 50,578,418
------------ ------------ ------------
Interest expense:
Deposits (note 8) 11,063,560 17,936,952 23,069,897
Advances from FHLB and other borrowings 5,058,338 5,009,983 9,201,508
------------ ------------ ------------
Total interest expense 16,121,898 22,946,935 32,271,405
------------ ------------ ------------
Net interest income 18,994,872 17,073,149 18,307,013
Provision for losses on loans (note 4) 1,730,000 3,835,000 5,155,000
------------ ------------ ------------
Net interest income after provision
for losses on loans 17,264,872 13,238,149 13,152,013
------------ ------------ ------------
Noninterest income:
Fees and service charges 5,324,187 4,825,009 3,681,102
Gain on sale of branch deposits -- 164,730 --
Gain on sale of real estate owned and held
for development 53,516 314,558 291,923
Net gain on sale of securities 308,626 102,828 1,583,419
Gain on sale of loans 862,403 551,926 350,758
(Loss)/gain on sale of office property and equipment (5,551) 249,979 (1,811)
Real estate related activities 1,509,468 1,453,255 1,206,120
Other income 1,743,788 1,365,724 1,297,235
------------ ------------ ------------
Total noninterest income 9,796,437 9,028,009 8,408,746
------------ ------------ ------------
Noninterest expense:
Compensation and benefits (note 11) 10,214,874 9,400,076 8,605,079
Office property and equipment 2,666,028 2,543,772 2,419,203
Deposit insurance premiums 78,272 88,804 95,249
Data processing 315,198 340,136 490,393
Advertising 423,640 388,975 355,917
Amortization of goodwill -- -- 843,680
Other expense 4,963,880 4,298,297 3,981,345
------------ ------------ ------------
Total noninterest expense 18,661,892 17,060,060 16,790,866
------------ ------------ ------------
Earnings before income taxes 8,399,417 5,206,098 4,769,893
Income taxes (note 10) 2,794,000 1,696,000 1,764,000
------------ ------------ ------------
Net earnings $ 5,605,417 3,510,098 3,005,893
============ ============ ============
Earnings per share:
Basic earnings per share $ 1.44 0.85 0.68
Diluted earnings per share 1.41 0.83 0.67
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended June 30, 2003, 2002, and 2001
Additional
Common paid-in Retained Treasury
stock capital earnings stock
----------- ----------- ----------- -----------
Balance at June 30, 2000 $ 48,336 36,002,723 39,782,321 (1,273,138)
----------- ----------- ----------- -----------
Net earnings -- -- 3,005,893 --
Net change in unrealized gains on
securities available-for-sale -- -- -- --
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) -- -- -- --
----------- ----------- ----------- -----------
Total comprehensive
income -- -- 3,005,893 --
Stock options exercised 159 55,478 -- --
Treasury stock acquired -- -- -- (1,530,694)
Amortization of RRP -- -- -- --
ESOP shares allocated -- -- -- --
Stock depreciation of allocated
ESOP shares -- (4,309) -- --
Dividends on common stock
at $0.32 per share (note 13) -- -- (1,430,679) --
----------- ----------- ----------- -----------
Balance at June 30, 2001 48,495 36,053,892 41,357,535 (2,803,832)
----------- ----------- ----------- -----------
Net earnings -- -- 3,510,098 --
Net change in unrealized gains on
securities available-for-sale -- -- -- --
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) -- -- -- --
----------- ----------- ----------- -----------
Total comprehensive
income -- -- 3,510,098 --
Stock options exercised 216 140,777 -- --
Treasury stock acquired -- -- -- (4,772,014)
Recognition and retention plan
(RRP) awarded -- 15,700 -- (1,800)
Amortization of RRP -- -- -- --
ESOP shares allocated -- -- -- --
Stock appreciation of allocated
ESOP shares -- 37,111 -- --
Dividends on common stock
at $0.32 per share (note 13) -- -- (1,325,334) --
----------- ----------- ----------- -----------
Balance at June 30, 2002 48,711 36,247,480 43,542,299 (7,577,646)
----------- ----------- ----------- -----------
Net earnings -- -- 5,605,417 --
Net change in unrealized gains on
securities available-for-sale -- -- -- --
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) -- -- -- --
----------- ----------- ----------- -----------
Total comprehensive
income -- -- 5,605,417 --
Stock options exercised 258 206,293 -- --
Treasury stock acquired -- -- -- (6,685,228)
Recognition and retention plan
(RRP) awarded -- 9,050 (1,800)
Amortization of RRP -- -- -- --
ESOP shares allocated -- -- -- --
Stock appreciation of allocated
ESOP shares -- 74,310 -- --
Dividends on common stock
at $0.32 per share (note 13) -- -- (1,246,935) --
----------- ----------- ----------- -----------
Balance at June 30, 2003 $ 48,969 36,537,133 47,900,781 (14,264,674)
=========== =========== =========== ===========
Accumulated
other
comprehensive Unearned Unearned
income ESOP RRP Total
----------- ----------- ----------- -----------
Balance at June 30, 2000 (4,343,049) (1,634,600) (469,674) 68,112,919
----------- ----------- ----------- -----------
Net earnings -- -- -- 3,005,893
Net change in unrealized gains on
securities available-for-sale 4,992,022 -- -- 4,992,022
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) 992,804 -- -- 992,804
----------- ----------- ----------- -----------
Total comprehensive
income 3,999,218 -- -- 7,005,111
Stock options exercised -- -- -- 55,637
Treasury stock acquired -- -- -- (1,530,694)
Amortization of RRP -- -- 218,332 218,332
ESOP shares allocated -- 161,130 -- 161,130
Stock depreciation of allocated
ESOP shares -- -- -- (4,309)
Dividends on common stock
at $0.32 per share (note 13) -- -- -- (1,430,679)
----------- ----------- ----------- -----------
Balance at June 30, 2001 (343,831) (1,473,470) (251,342) 72,587,447
----------- ----------- ----------- -----------
Net earnings -- -- -- 3,510,098
Net change in unrealized gains on
securities available-for-sale 898,762 -- -- 898,762
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) 64,473 -- -- 64,473
----------- ----------- ----------- -----------
Total comprehensive
income 834,289 -- -- 4,344,387
Stock options exercised -- -- -- 140,993
Treasury stock acquired -- -- -- (4,772,014)
Recognition and retention plan
(RRP) awarded -- -- (13,900) --
Amortization of RRP -- -- 106,735 106,735
ESOP shares allocated -- 143,470 -- 143,470
Stock appreciation of allocated
ESOP shares -- -- -- 37,111
Dividends on common stock
at $0.32 per share (note 13) -- -- -- (1,325,334)
----------- ----------- ----------- -----------
Balance at June 30, 2002 490,458 (1,330,000) (158,507) 71,262,795
----------- ----------- ----------- -----------
Net earnings -- -- -- 5,605,417
Net change in unrealized gains on
securities available-for-sale 413,429 -- -- 413,429
Less reclassification adjustment for
net realized gains included in
net income (net of tax expense) 193,509 -- -- 193,509
----------- ----------- ----------- -----------
Total comprehensive
income 219,920 -- -- 5,825,337
Stock options exercised -- -- -- 206,551
Treasury stock acquired -- -- -- (6,685,228)
Recognition and retention plan
(RRP) awarded -- -- (7,250) --
Amortization of RRP -- -- 80,235 80,235
ESOP shares allocated -- 144,300 -- 144,300
Stock appreciation of allocated
ESOP shares -- -- -- 74,310
Dividends on common stock
at $0.32 per share (note 13) -- -- -- (1,246,935)
----------- ----------- ----------- -----------
Balance at June 30, 2003 710,378 (1,185,700) (85,522) 69,661,365
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended June 30, 2003, 2002, and 2001
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net earnings $ 5,605,417 3,510,098 3,005,893
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Loans originated for sale to investors (62,703,013) (69,916,000) (51,027,680)
Proceeds from sale of loans originated for sale 64,447,843 70,871,101 49,374,634
Provision for losses on loans and other assets 1,730,000 3,835,000 5,155,000
Depreciation and amortization 1,858,764 2,144,912 2,702,411
Provision for deferred taxes (746,000) 104,000 (516,000)
Net gain on sale of loans (862,403) (551,926) (350,758)
Net gain on sale of securities available-for-sale (308,626) (102,828) (1,583,419)
Net gain on sale of branch deposits -- (164,730) --
Net loss (gain) on sale of office property and equipment 5,551 (249,979) 1,811
Net gain on sale of real estate owned and held for
development (53,516) (314,558) (291,923)
Net loan fees deferred 322,922 157,716 (79,841)
Amortization of premiums and discounts on loans,
mortgage-backed securities, and investment securities 334,044 853,791 741,313
Decrease in accrued interest receivable 315,203 989,395 1,007,357
Increase in other assets (1,411,738) (258,732) (658,979)
(Decrease) increase in accrued interest payable (1,844,691) (2,036,784) 1,379,309
Increase (decrease) in accrued expenses and other liabilities 731,334 431,669 (80,128)
Increase (decrease) in accrued taxes on income 492,908 (34,376) (405,105)
------------ ------------ ------------
Net cash provided by operating activities 7,913,999 9,267,769 8,373,895
------------ ------------ ------------
Cash flows from investing activities:
Purchase of securities held-to-maturity (1,375,682) (52,047,645) (2,375,000)
Proceeds from maturities of securities held-to-maturity 20,024,583 8,441,621 3,388,388
Proceeds from sale of securities available-for-sale 36,421,869 14,442,044 130,677,652
Purchase of securities available-for-sale (38,825,509) (82,950,770) (12,553,258)
Proceeds from maturities of securities available-for-sale 16,671,842 68,145,813 31,182,842
Purchase of bank owned life insurance -- (6,984,000) --
(Purchase) redemption of FHLB stock (669,500) 4,430,900 (539,800)
Loans purchased (15,827,000) (19,001,000) (21,760,000)
Decrease (increase) in loans receivable 15,225,908 13,127,299 (6,910,671)
Proceeds from sale of office property and equipment 1,215 523,725 525
Purchase of office property and equipment (462,321) (584,482) (607,930)
Proceeds from sale of foreclosed real estate 578,238 222,750 373,789
Proceeds from sale of real estate held for development 54,298 703,500 792,000
Net expenditures on real estate held for development (363,000) (9,001) (508,728)
------------ ------------ ------------
Net cash provided by (used in) investing activities 31,454,941 (51,539,246) 121,159,809
------------ ------------ ------------
Cash flows from financing activities:
(Decrease) increase in deposits (23,704,297) (15,895,163) 17,082,698
Proceeds from advances from FHLB 50,167,000 31,075,000 36,500,000
Repayment of advances from FHLB and other borrowings (47,012,511) (21,256,704) (121,509,920)
Net decrease in advance payments by borrowers
for taxes and insurance (23,788) (427,633) (917,899)
Issuance of common stock, net 206,551 140,993 55,637
Repurchase of common stock (6,685,228) (4,772,014) (1,530,694)
Cash dividends paid (1,246,935) (1,325,334) (1,430,679)
------------ ------------ ------------
Net cash used in financing activities (28,299,208) (12,460,855) (71,750,857)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 11,069,732 (54,732,332) 57,782,847
5
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended June 30, 2003, 2002, and 2001
2003 2002 2001
------------ ------------ ------------
Cash and cash equivalents at beginning of year 23,217,221 77,949,553 20,166,706
------------ ------------ ------------
Cash and cash equivalents at end of year $ 34,286,953 23,217,221 77,949,553
============ ============ ============
Supplemental disclosures:
Cash paid during the year for:
Interest $ 17,966,589 24,983,719 30,892,096
Income taxes 3,047,092 1,626,371 2,687,949
Noncash activities:
Loans converted to securities available-for-sale -- -- 111,495,480
See accompanying notes to consolidated financial statements
6
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(1) Summary of Significant Accounting Policies and Practices
Organization
First Federal Bankshares, Inc. (the Company) is the holding company for
First Federal Bank (the Bank). The Company owns 100% of the Bank's common
stock. Currently, the Company engages in no other significant activities
beyond its ownership of the Bank's common stock. Consequently, its net
income is derived primarily from the Bank. The Bank is organized as a
federally chartered stock savings bank engaging in retail and commercial
banking and related financial services, in Sioux City, Iowa and adjacent
counties of northwest Iowa; West Des Moines, Newton, Grinnell and
surrounding areas of central Iowa; and in parts of Nebraska and South
Dakota. The Bank provides traditional products and services of banking,
such as deposits and mortgage, consumer, and commercial loans.
Principles of Presentation
The accompanying consolidated financial statements include the accounts of
First Federal Bankshares, Inc., its wholly owned subsidiaries, a real
estate brokerage company, a real estate development company, the Bank and
the Bank's wholly owned subsidiaries. In consolidation, all significant
intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, the Company includes cash and due
from other financial institutions and interest-bearing deposits with
original maturities of three months or less in cash and cash equivalents.
Earnings Per Share
Basic earnings per share computations for the years ended June 30, 2003,
2002, and 2001 were determined by dividing net earnings by the weighted
average number of common shares outstanding during the years then ended.
Diluted net earnings per common share amounts are computed by dividing net
income by the weighted average number of common shares and all dilutive
potential common shares outstanding during the year.
(Continued)
7
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
The following information was used in the computation of net income per
common share on both a basic and diluted basis for the years ended June
30, 2003, 2002, and 2001:
2003 2002 2001
---------- ---------- ----------
Basic EPS computation:
Net earnings $5,605,417 3,510,098 3,005,893
Weighted average common shares
outstanding 3,879,569 4,115,350 4,407,780
---------- ---------- ----------
Basic EPS $ 1.44 0.85 0.68
========== ========== ==========
Diluted EPS computation:
Net earnings $5,605,417 3,510,098 3,005,893
---------- ---------- ----------
Weighted average common
shares outstanding 3,879,569 4,115,350 4,407,780
Incremental option shares using
treasury stock method 91,827 90,654 55,545
---------- ---------- ----------
Diluted shares outstanding 3,971,396 4,206,004 4,463,325
---------- ---------- ----------
Diluted EPS $ 1.41 0.83 0.67
========== ========== ==========
Securities
Securities which the Company has the positive intent and ability to hold
to maturity are classified as held-to-maturity. Such securities are
carried at cost, adjusted for unamortized premiums and unearned discounts.
Premiums are amortized and discounts are accreted using the interest
method over the remaining period to contractual maturity, adjusted in the
case of mortgage-backed securities for actual prepayments. Original issue
discounts on short-term securities are accreted as accrued interest
receivable over the lives of such securities.
Securities classified as available-for-sale are carried at estimated fair
value. Unrealized gains and losses on such securities are reported as a
separate component of stockholders' equity, net of deferred taxes.
Realized gains and losses from the sale of securities are recognized using
the specific identification method.
Unrealized losses on securities determined to be other than temporary are
charged to operations.
Loans Receivable
Loans receivable are stated at unpaid principal balances less the
allowances for loan losses and net of deferred loan origination fees and
discounts. Discounts on first mortgage loans are amortized to income using
the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments.
(Continued)
8
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Allowances for Losses on Loans and Real Estate
The allowance for losses on loans is based on management's current
judgments about the credit quality of individual loans and segments of the
loan portfolio. The allowance for losses on loans is established through a
provision for loan losses based on management's evaluation of the risk
inherent in the loan portfolio, and considers all known internal and
external factors that affect loan collectibility as of the reporting date.
Such evaluation, which includes a review of all loans on which full
collectibility may not be reasonably assured, considers among other
matters, the estimated net realizable value or the fair value of the
underlying collateral, economic conditions, historical loan loss
experience, management's knowledge of inherent risks in the portfolio that
are probable and reasonably estimable and other factors that warrant
recognition in providing an appropriate loan loss allowance.
Under the Company's credit policies, loans with interest more than 90 days
in arrears and restructured loans are generally considered impaired loans.
Loan impairment is measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate, except where
more practical, at the observable market price of the loan or the fair
value of the collateral if the loan is collateral dependent.
Real estate acquired is carried at the lower of cost or fair value less
estimated costs of disposition. When a property is acquired through
foreclosure or a loan is considered impaired, any excess of the loan
balance over fair value of the property is charged to the allowance for
losses on loans. When circumstances indicate additional loss on the
property, a direct charge to the provision for losses on real estate is
made, and the real estate is recorded net of such provision.
Accrued interest receivable in arrears which management believes is
doubtful of collection (generally when a loan becomes 90 days delinquent)
is charged to income. Subsequent interest income is not recognized on such
loans until collected or until determined by management to be collectible.
Financial Instruments with Off-balance Sheet Risk
In the normal course of business to meet the financing needs of its
customers, the Company is a party to financial instruments with
off-balance sheet risk, which include commitments to extend credit. The
Company's exposure to credit loss in the event of nonperformance by the
other party to the commitments to extend credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for on-balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there are no violations of any conditions established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since certain of the commitments
are expected to expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company, upon
extension of credit is based on management's credit evaluation of the
counterparty.
(Continued)
9
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Unearned Loan Fees and Discounts
Certain fees and direct expenses incurred in the loan origination process
are deferred, with recognition thereof over the contractual life of the
related loan as a yield adjustment using the interest method of
amortization. Any unamortized fees on loans sold are credited to income in
the year such loans are sold.
Premiums and discounts in connection with mortgage loans purchased are
amortized over the terms of the loans using the interest method.
Office Property and Equipment
Office property and equipment are recorded at cost, and depreciation is
provided primarily on a straight-line basis over the estimated useful
lives of the related assets, which range from 15 to 40 years for office
buildings and from 3 to 10 years for furniture, fixtures, automobiles,
software, and equipment.
Maintenance and repairs are charged against income. Betterments are
capitalized and subsequently depreciated. The cost and accumulated
depreciation of properties retired or otherwise disposed of are eliminated
from the asset and accumulated depreciation accounts. Related gain or loss
from such transactions is credited or charged to income.
Excess of Cost Over Fair Value of Assets Acquired
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, Goodwill and Other Intangible Assets, on July 1, 2001. Prior to the
adoption, the excess of cost over fair value of assets acquired was being
amortized on a straight-line basis over its estimated useful life of 25
years. The asset is evaluated by management for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset
may not be recoverable based on facts and circumstances related to the
value of net assets acquired that gave rise to the asset. After the
adoption date, Statement 142 requires that intangible assets with
indefinite useful lives no longer be amortized, but instead evaluated for
impairment at least annually in accordance with the provisions of
Statement 142. The Company performed their annual impairment analysis
during 2003 and determined the recorded goodwill of $18,523,607 was not
impaired.
Taxes on Income
The Company files a consolidated Federal income tax return. Federal income
taxes are allocated based on taxable income or loss included on the
consolidated return. For state tax purposes, the Bank files a franchise
tax return, while the Company, its other subsidiaries, and the Bank's
subsidiaries file corporate income tax returns.
The Company utilizes the asset and liability method for taxes on income,
and deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
of a change in tax rates on deferred tax assets and liabilities is
recognized in income in the period that includes the enactment date.
(Continued)
10
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Stock Option Plan
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its plans. Accordingly, no compensation
cost has been recognized for its stock options in the consolidated
financial statements. Had compensation cost for the Company's stock option
plans been determined consistent with SFAS No. 123, the Company's net
income and earnings per share for options granted and vested would have
been reduced to the pro forma amounts indicated below:
2003 2002 2001
------------- --------- ---------
Net income:
As reported $ 5,605,417 3,510,098 3,005,893
Pro forma 5,534,479 3,446,038 2,942,362
Basic earnings per share:
As reported 1.44 0.85 0.68
Pro forma 1.43 0.84 0.67
Diluted earnings per share:
As reported 1.41 0.83 0.67
Pro forma 1.39 0.82 0.66
The fair value of each option grant has been estimated using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in fiscal year 2003, 2002, and 2001: dividend
yield of 3.41%; expected volatility of 22.76%; risk free interest rate of
6.29%; and expected life of 7.5 years.
Reclassifications
Certain amounts previously reported have been reclassified to conform with
the presentation in these consolidated financial statements. These
reclassifications did not affect previously reported net income or
retained earnings.
Fair Value of Financial Instruments
The Company's fair value estimates, methods, and assumptions for its
financial instruments are set forth below:
Cash and Cash Equivalents
The recorded amount of cash and cash equivalents approximates fair
value.
Securities
The fair value of securities is estimated based on bid prices
published in financial newspapers, bid quotations received from
securities dealers, or quoted market prices of similar instruments,
adjusted for differences between the quoted instruments and the
instruments being valued. The fair value of mortgage-backed and
related securities is estimated based on bid prices published in
financial newspapers and bid quotations received from securities
dealers.
(Continued)
11
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Loans
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as real
estate, consumer, and commercial.
The fair value of loans is calculated by discounting scheduled cash
flows through the estimated maturity using estimated market discount
rates that reflect the credit and interest rate risk inherent in the
loan. The estimate of maturity is based on the Company's historical
experience with repayments for each loan classification, modified,
as required, by an estimate of the effect of current economic and
lending conditions. The effect of nonperforming loans is considered
in assessing the credit risk inherent in the fair value estimate.
Federal Home Loan Bank Stock
The value of Federal Home Loan Bank (FHLB) stock is equivalent to
its carrying value because it is redeemable at par value.
Accrued Interest Receivable
The recorded amount of accrued interest receivable approximates fair
value.
Deposits
The fair value of deposits with no stated maturity, such as
passbook, money market, noninterest bearing checking, and checking
accounts, is equal to the amount payable on demand. The fair value
of certificates of deposit is based on the discounted value of
contractual cash flows. The discount rate is estimated using the
rates currently offered for deposits of similar remaining
maturities. The fair value estimates do not include the benefit that
results from the low-cost funding provided by the deposit
liabilities compared to the cost of borrowing funds in the market.
Advances from Federal Home Loan Bank
The fair value of advances from FHLB is based on the discounted
value of contractual cash flows.
Advance Payments by Borrowers for Taxes and Insurance
The recorded amount of advance payments by borrowers for taxes and
insurance approximates fair value.
Accrued Interest Payable
The recorded amount of accrued interest payable approximates fair
value.
Limitations
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. Because no market exists for a significant portion of
the Company's financial instruments, fair value estimates are based
on judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and
(Continued)
12
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
matters of significant judgment and, therefore, cannot be determined
with precision. Changes in assumptions could significantly affect
these estimates.
Effect of New Accounting Standards
In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 145 Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. This Statement rescinds SFAS
No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an
amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements. This Statement also rescinds SFAS No.
44, Accounting for Intangible Assets of Motor Carriers. This Statement
amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the
required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement
also amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability
under changed conditions. The provisions of this Statement related to the
rescission of Statement 4 are applied in fiscal years beginning after May
15, 2002. The provisions in paragraphs 8 and 9(c) of this Statement
related to Statement 13 are effective for transactions occurring after May
15, 2002. All other provision of this Statement are effective for
financial statements issued on or after May 15, 2002. The adoption of this
Statement did not have a material effect on the consolidated financial
statements.
In June 2002, the FASB issued SFAS No. 146 Accounting for Costs Associated
with Exit or Disposal Activities. This Statement addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The provisions of this Statement are effective for exit
and disposal activities that are initiated after December 31, 2002. The
Company adopted this Statement on January 1, 2003, the adoption of the
Statement did not have a material effect on the consolidated financial
statements.
In October 2002, the FASB issued SFAS No. 147 (FAS 147), Acquisitions of
Certain Financial Institutions, which amends SFAS No. 72 (FAS 72),
Accounting for Certain Acquisitions of Banking or Thrift Institutions.
This Statement no longer requires the separate recognition and subsequent
amortization of goodwill that was originally required by FAS 72. FAS 147
also amends SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets (such as core deposit intangibles). The effects of
implementation on the Company's consolidated financial statements were not
material.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements
No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the
fair value of the obligation undertaken. The initial recognition and
measurement provisions of the Interpretation are applicable to guarantees
issued or modified after December 31, 2002. The effects of implementation
on the Company's financial statements were not material. The disclosure
requirements are effective for financial statements of interim and annual
(Continued)
13
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
periods ending after December 15, 2002 and have been included in these
consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement
No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement No. 123 to require prominent disclosures of both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002 and are included in the notes
to these consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by
business enterprises of variable interest entities that have certain
characteristics. It requires a business enterprise that has a controlling
interest in a variable interest entity (as defined by FIN 46) to include
the assets, liabilities and results of the activities of the variable
interest entity in the consolidated financial statements of the business
enterprise. FIN 46 applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which
an enterprise obtains an interest after that date. For variable interest
entities acquired before February 1, 2003, it applies in the first fiscal
year or interim period beginning after June 15, 2003. The impact of
adopting FIN 46 will not be material as the Company does not presently
have any variable interest entities.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, (SFAS 149). SFAS 149 amends
Statement 133 for decisions made (1) as part of the Derivatives
Implementation Group process that effectively required amendments to
Statement 133, (2) in connection with other FASB projects dealing with
financial instruments, and (3) in connection with implementation issues
raised in relation to the application of the definition of a derivative,
in particular, the meaning of "an initial net investment that is smaller
than would be required for other types of contracts that would be expected
to have a similar response to changes in market factors," the meaning of
"underlying," and the characteristics of a derivative that contains
financing components. SFAS 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The Company will adopt SFAS 149 as
indicated above and such adoption is not expected to have a material
effect on its financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 established standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or asset in some
circumstances). Many of those instruments were previously classified as
equity. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003, except for
mandatory redeemable financial instruments of nonpublic entities. The
Company will adopt SFAS 150 on July 1, 2003 and such adoption is not
expected to have a material effect on its financial position or results of
operations.
(Continued)
14
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(2) Securities
Following is a schedule of amortized costs and estimated fair values as of
June 30, 2003 and 2002:
2003
-----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
----------- ----------- ----------- -----------
Available-for-sale:
Mortgage-backed securities:
Government National
Mortgage Association
(GNMA) $17,971,925 348,635 -- 18,320,560
Federal Home Loan
Mortgage Association
(FHLMC) 12,307,896 213,109 -- 12,521,005
Federal National Mortgage
Association (FNMA) 7,393,020 96,375 197 7,489,198
United States government
agency securities 9,119,872 71,969 -- 9,191,841
Investments in mutual funds 13,591,185 30,791 -- 13,621,976
Other investment securities 17,008,829 384,857 12,162 17,381,524
----------- ----------- ----------- -----------
$77,392,727 1,145,736 12,359 78,526,104
=========== =========== =========== ===========
Held-to-maturity:
Mortgage-backed securities:
GNMA $ 644,935 39,636 -- 684,571
FHLMC 5,863,640 159,647 -- 6,023,287
FNMA 15,824,184 524,938 -- 16,349,122
United States treasury
securities 9,998,210 45,540 -- 10,043,750
Local government securities 10,666,860 359,688 20,268 11,006,280
Other investment securities 1,507,635 44,865 -- 1,552,500
----------- ----------- ----------- -----------
$44,505,464 1,174,314 20,268 45,659,510
=========== =========== =========== ===========
(Continued)
15
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
2002
-----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
----------- ----------- ----------- -----------
Available-for-sale:
Mortgage-backed securities:
Government National Mortgage
Association (GNMA) $17,849,350 134,390 14,799 17,968,941
Federal Home Loan Mortgage
Corporation (FHLMC) 14,151,314 223,999 -- 14,375,313
Federal National Mortgage
Association (FNMA) 3,841,150 42,379 3,692 3,879,837
Investments in mutual funds 45,281,762 33,252 2,618 45,312,396
Other investment securities 10,405,438 372,886 1,339 10,776,985
----------- ----------- ----------- -----------
$91,529,014 806,906 22,448 92,313,472
=========== =========== =========== ===========
Held-to-maturity:
Mortgage-backed securities:
GNMA $ 1,141,609 53,014 3,582 1,191,041
FHLMC 11,235,890 78,608 -- 11,314,498
FNMA 26,108,262 360,423 -- 26,468,685
United States treasury securities 9,993,287 75,463 -- 10,068,750
Local government securities 11,289,873 144,864 14,342 11,420,395
Other investment securities 3,525,773 22,544 1,734 3,546,583
----------- ----------- ----------- -----------
$63,294,694 734,916 19,658 64,009,952
=========== =========== =========== ===========
The amortized cost and fair value at June 30, 2003 are shown below by
contractual maturity. Expected maturities will differ from contractual
maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Available-for-sale Held-to-maturity
--------------------------- ---------------------------
Estimated Estimated
Amortized fair Amortized fair
cost value cost value
----------- ----------- ----------- -----------
Due in 1 year or less $13,591,185 13,621,823 10,543,211 10,595,144
Due after 1 year through 5 years 9,119,872 9,191,841 4,348,677 4,493,837
Due after 5 years through 10 years 1,788,938 1,790,553 2,626,838 2,762,414
Due after 10 years 15,219,891 15,591,124 4,653,979 4,751,135
----------- ----------- ----------- -----------
39,719,886 40,195,341 22,172,705 22,602,530
Mortgage-backed securities 37,672,841 38,330,763 22,332,759 23,056,980
----------- ----------- ----------- -----------
$77,392,727 78,526,104 44,505,464 45,659,510
=========== =========== =========== ===========
(Continued)
16
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Proceeds from the sale of securities available for sale were $36,421,869,
$14,442,044, and $130,677,652, during 2003, 2002, and 2001, respectively.
Gross realized gains on these sales were $322,226, $155,960, and
$1,731,569 and gross realized losses on these sales were $13,600, $53,132,
and $148,150 in 2003, 2002, and 2001, respectively.
Securities with an amortized cost of $7,939,414 and an estimated fair
value of approximately $8,082,000 at June 30, 2003 were pledged to various
entities.
(3) Loans Receivable
Loans receivable at June 30, 2003 and 2002 are summarized as follows:
2003 2002
------------- -------------
First mortgage loans:
Secured by one to four family residences $ 191,890,309 164,815,983
Secured by other properties 113,115,061 137,769,304
Home equity and second mortgage loans 36,962,433 40,347,072
Automobile loans 26,291,962 32,167,935
Commercial business loans 16,255,976 15,502,233
Other nonmortgage loans 35,587,669 33,241,139
------------- -------------
420,103,410 423,843,666
Less:
Allowance for loan losses (note 4) 4,615,285 4,583,897
Undisbursed portion of loans in process 409,867 1,500,316
Net unearned premiums on loans (1,965,046) (2,075,647)
Deferred loan fees 1,776,151 1,453,228
------------- -------------
$ 415,267,153 418,381,872
============= =============
At June 30, 2003, 2002, and 2001, the Company had nonaccrual loans of
$3,691,000, $5,106,000, and $1,094,000, respectively, and restructured
loans of $3,005,000, $393,000, and $130,000, respectively. Interest income
recorded during 2003, 2002, and 2001 on restructured loans was not
materially different than interest income which would have been recorded
if these loans had been current in accordance with their original terms.
Interest forgone on nonaccrual loans was $238,531 in 2003, $313,300 in
2002, and $105,653 in 2001.
Loan Servicing
The Company originates mortgage loans for portfolio investment or sale in
the secondary market. During the period of origination, mortgage loans are
designated as held either for sale or for investment purposes. Mortgage
loans held for sale are carried at the lower of cost or market value,
determined on an aggregate basis. There were no mortgage loans held for
sale at June 30, 2003.
(Continued)
17
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal
balance of these loans was $50,794,000, $98,772,000, and $142,730,000 at
June 30, 2003, 2002, and 2001, respectively. Servicing loans for others
generally consists of collecting mortgage payments, maintaining escrow
accounts, disbursing payments to investors, and foreclosure processing.
Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from
borrowers, such as late payment fees. In connection with these loans
serviced for others, the Company held borrowers' escrow balances of
$430,000, $648,000, and $815,000 at June 30, 2003, 2002, and 2001,
respectively.
Concentrations of Credit Risk
The Company conducts the majority of its loan origination activities in
its market area, which includes Northwest and Central Iowa and portions of
Nebraska and South Dakota. In addition to loan origination, the Company
has purchased loans outside of its primary lending area. Although the
Company has a diversified geographic loan portfolio, a substantial portion
of its borrowers' ability to repay their loans is dependent upon economic
conditions in the Company's market area.
Loans purchased outside the Company's primary lending area totaled
approximately $52.9 million at June 30, 2003, and included approximately
$41.5 million in loans that are geographically distributed in the
Midwestern United States. The remaining loans are distributed throughout
the United States, with the largest geographic concentrations including
Colorado with $8.5 million and Connecticut with $1.1 million.
Included in the totals of loans purchased outside the Company's primary
lending area are loans purchased from a mortgage banking firm in Madison,
Wisconsin. The Company formerly had an exclusive agreement with this firm,
which gave the Company first right of refusal on any real estate loans
generated by this firm and which were located primarily in the Madison,
Wisconsin area. The exclusive relationship with the mortgage banking firm
has been terminated as the Company seeks to emphasize loan originations
from its primary markets. Loans purchased from this firm declined from
$51.0 million as of June 30, 2002 to $20.9 million as of June 30, 2003.
The Company's commercial mortgage loan portfolio consists of $59.0 million
of commercial real estate loans, $30.0 million of multi-family housing
loans, and $24.1 million of construction, land acquisition and development
and other loans as of June 30, 2003.
Commercial construction loans and land acquisition and development loans
total $23.4 million and $12.4 million, respectively, at June 30, 2003 and
2002.
Securitized Mortgage Loans
In March 2001, the Company sold approximately $112.7 million of fixed rate
single family mortgage loans in securitized transactions. In those
securitizations, the Company retained servicing responsibilities. The
Company recognized pretax gains of approximately $1,714,000 on the sale of
the securitized mortgage loans. There were no mortgage loans sold in
securitized transactions during the fiscal years ended June 30, 2003 and
2002.
(Continued)
18
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(4) Allowance for Loan Losses
A summary of the allowance for loan losses follows:
2003 2002 2001
----------- ----------- -----------
Balance at beginning of year $ 4,583,897 4,736,738 3,394,448
Provision for losses 1,730,000 3,835,000 5,155,000
Charge-offs (2,064,179) (4,200,710) (3,890,291)
Recoveries 365,567 212,869 77,581
----------- ----------- -----------
Balance at end of year $ 4,615,285 4,583,897 4,736,738
=========== =========== ===========
(5) Office Property and Equipment
At June 30, 2003 and 2002, the cost and accumulated depreciation of office
property and equipment were as follows:
2003 2002
----------- -----------
Office property and equipment:
Land and improvements $ 3,688,053 3,688,053
Building and improvements 12,996,431 12,857,264
Furniture, fixtures, automobiles, software, and equipment 6,503,059 6,303,356
Deposits on assets not in service and not depreciated 10,225 9,949
----------- -----------
Total cost - office properties 23,197,768 22,858,622
Less accumulated depreciation 10,031,964 9,088,424
----------- -----------
Office property and equipment, net $13,165,804 13,770,198
=========== ===========
Depreciation expense on premises, furniture, fixtures, automobiles,
software, and equipment was $1,059,949, $1,226,043 and $1,234,094 for
fiscal 2003, 2002, and 2001, respectively.
(6) Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
2003 2002
---------- ----------
Loans receivable $1,809,657 2,113,906
Securities 678,803 689,757
---------- ----------
$2,488,460 2,803,663
========== ==========
(Continued)
19
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(7) Goodwill and Other Intangible Assets
The table below reconciles reported earnings for the fiscal year ended
June 30, 2001 to "adjusted" earnings, which exclude goodwill amortization.
2003 2002 2001
------------- --------- ------------------------------------------
Reported Reported Reported Goodwill Adjusted
earnings earnings earnings amortization earnings
------------- --------- --------- ------------ ---------
Net income $ 5,605,417 3,510,098 3,005,893 843,680 3,849,573
Earnings per share:
Basic EPS 1.44 0.85 0.68 0.19 0.87
Diluted EPS 1.41 0.83 0.67 0.19 0.86
The gross carrying amount of intangible assets subject to amortization and
the associated accumulated amortization at June 30, 2003 is presented in
the table below. Amortization expense for intangible assets was $398,770,
$428,198, and $135,499 for fiscal 2003, 2002, and 2001, respectively.
2003
--------------------------------------------
Gross Unamortized
carrying Accumulated intangible
amount amortization assets
---------- ------------ -----------
Intangible assets:
Core deposit premium $ 690,140 423,670 266,470
Mortgage servicing rights 700,250 700,250 --
---------- ---------- ----------
Total $1,390,390 1,123,920 266,470
========== ========== ==========
2002
--------------------------------------------
Gross Unamortized
carrying Accumulated intangible
amount amortization assets
---------- ------------ -----------
Intangible assets:
Core deposit premium $ 690,140 357,150 332,990
Mortgage servicing rights 700,250 368,000 332,250
---------- ---------- ----------
Total $1,390,390 725,150 665,240
========== ========== ==========
(Continued)
20
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Projections of amortization expense are based on existing asset balances
and the existing interest rate environment as of June 30, 2003. What the
Company actually experiences may be significantly different depending upon
changes in mortgage interest rates and market conditions. The following
table shows the estimated future amortization expense for amortizing
intangible assets for each of the years ended June 30:
Core deposit
premium
------------
2004 52,374
2005 45,396
2006 44,604
2007 44,604
2008 44,604
Thereafter 34,888
(8) Deposits
At June 30, 2003 and 2002, deposits are summarized as follows:
2003 2002
------------ ------------
Noninterest-bearing checking $ 20,302,813 21,129,556
Savings accounts 33,958,843 31,322,593
Interest-bearing checking accounts 71,453,575 55,255,465
Money market accounts 86,910,959 108,190,942
Certificates of deposit 236,317,849 256,749,780
------------ ------------
$448,944,039 472,648,336
============ ============
The aggregate amount of certificates of deposit with a minimum
denomination of $100,000 was approximately $24.8 million and $25.8 million
at June 30, 2003 and 2002, respectively.
At June 30, 2003, the scheduled maturities of certificates of deposit were
as follows:
2004 $ 129,082,611
2005 42,486,045
2006 33,977,517
2007 14,033,686
2008 16,478,403
Thereafter 259,587
-------------
$ 236,317,849
=============
(Continued)
21
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Interest expense on deposits is summarized as follows:
2003 2002 2001
----------- ----------- -----------
Savings $ 92,585 247,323 392,534
Money market and checking 1,200,752 2,776,654 4,396,509
Certificates of deposit 9,770,223 14,912,975 18,280,854
----------- ----------- -----------
$11,063,560 17,936,952 23,069,897
=========== =========== ===========
At June 30, 2003 and 2002, accrued interest payable on deposits totaled
$1,784,660 and $3,627,634, respectively.
(9) Advances from FHLB
A summary at June 30, 2003 and 2002 follows:
Weighted Weighted
average average
interest interest
rate 2003 rate 2002
-------- ------------- -------- -------------
FHLB of Des Moines (A)
Stated maturity in fiscal year
ending June 30:
2003 (B) --% $ -- 5.22% $ 17,575,000
2004 4.35 9,000,000 4.35 9,000,000
2005 3.20 12,500,000 4.00 7,500,000
2006 3.57 8,000,000 4.87 3,000,000
2007 3.64 12,500,000 4.91 2,500,000
2008 (C) 5.41 24,000,000 5.35 32,989,139
Thereafter (C) 5.03 32,500,000 5.89 18,343,141
------------- -------------
98,500,000 90,907,280
Amortizing advances (D) 5.25 3,886,888 5.25 4,157,399
Fed Funds advance with FHLB (E) -- Variable 4,000,000
------------- -------------
$ 102,386,888 $ 99,064,679
============= =============
(A) Advances from the FHLB are secured by stock in the FHLB. In
addition, the Company has agreed to maintain unencumbered additional
security in the form of certain residential mortgage loans
aggregating no less than 120% of outstanding balances.
(B) Includes one FHLB short-term Repo Advance for year 2002 that matured
on July 25, 2002 in the amount of $2,075,000. The interest on this
advance was paid at maturity at a rate of 2.07% and the term was 30
days.
(Continued)
22
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(C) Includes FHLB convertible advances. Convertible advances are
advances that the FHLB may terminate and require the Company to
repay prior to the stated maturity date of the advance. Usage of
this type of advance is limited to a range of 10% to 20% of the
Company's total assets by the FHLB. At June 30, 2003 and 2002, the
advances included in these maturity ranges are callable after an
initial lock-out period according to the following schedule:
Weighted Weighted
average average
interest interest
rate 2003 rate 2002
-------- ------------- -------- ------------
Callable in fiscal year
ending June 30:
2003 --% $ -- 5.35% $ 32,989,139
2004 5.32 51,000,000 5.91 17,843,141
------------- ------------
$ 51,000,000 $ 50,832,280
============= ============
(D) Amortizing advances are advances that amortize over a 15 year period
matched to a weighted average rate of comparable FHLB bonds.
(E) The Fed Funds Advance does not require the Company to establish a
committed line to obtain an advance. The Fed Funds Advance rate on
new borrowings is based on the Fed Funds Market rate at the time of
borrowing. There are no minimum advance amounts, no commitment fees,
and no prepayment penalties. Outstanding Fed Funds Advances
automatically renew each day and are repriced based on the FHLB's
return on overnight investments. Fed Funds Advances have no stated
maturity and may be prepaid at will. During fiscal 2003, the
interest rate at which these advances repriced ranged from 1.26% to
2.17%. Fed Funds Advances are collateralized as described in (A)
above.
At June 30, 2003 and 2002, accrued interest payable on advances from FHLB
totaled $10,688 and $12,405, respectively.
(Continued)
23
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(10) Taxes on Income
Taxes on income for the years ended June 30, 2003, 2002, and 2001 were
comprised as follows:
Current Deferred Total
----------- ---------- ----------
2003:
Federal $ 3,021,000 (646,000) 2,375,000
State 519,000 (100,000) 419,000
----------- ---------- ----------
Total $ 3,540,000 (746,000) 2,794,000
=========== ========== ==========
2002:
Federal $ 1,343,000 90,000 1,433,000
State 249,000 14,000 263,000
----------- ---------- ----------
Total $ 1,592,000 104,000 1,696,000
=========== ========== ==========
2001:
Federal $ 1,975,000 (447,000) 1,528,000
State 305,000 (69,000) 236,000
----------- ---------- ----------
Total $ 2,280,000 (516,000) 1,764,000
=========== ========== ==========
Taxes on income differ from the amounts computed by applying the Federal
income tax rate of 34% to earnings from continuing operations before taxes
on income for the following reasons:
2003 2002 2001
----------- ---------- ----------
Computed "expected" tax expense $ 2,855,802 1,770,073 1,621,764
Purchase accounting adjustments -- -- 278,000
Nontaxable income (297,683) (234,313) (97,000)
State income taxes 276,540 173,580 155,760
Other, net (40,659) (13,340) (194,524)
----------- ---------- ----------
$ 2,794,000 1,696,000 1,764,000
=========== ========== ==========
(Continued)
24
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June
30, 2003 and 2002 are presented below:
2003 2002
----------- ----------
Deferred tax assets:
Allowance for loan losses $ 1,025,000 816,000
Deferred compensation 140,000 148,000
Accrued vacation pay 120,000 103,000
Deferred directors fees 145,000 134,000
Reserve for uncollected interest 127,000 82,000
Other 51,000 39,000
----------- ----------
Total gross deferred tax assets 1,608,000 1,322,000
----------- ----------
Deferred tax liabilities:
FHLB stock dividends (347,000) (347,000)
Fixed assets (215,000) (413,000)
Mortgage servicing rights -- (124,000)
Unrealized gain on securities available-for-sale (423,000) (294,000)
Purchase accounting adjustments (99,000) (165,000)
Bad debt reserves in excess of base year (10,000) (82,000)
----------- ----------
Total gross deferred tax liabilities (1,094,000) (1,425,000)
----------- ----------
Net deferred tax asset (liability) $ 514,000 (103,000)
=========== ==========
Based upon the Company's level of historical taxable income and
anticipated future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not the
Company will realize the benefits of these deductible differences.
(11) Employee Benefit Plans
Pension
The Bank is a participant in the Financial Institutions Retirement Fund
(FIRF), and substantially all of its officers and employees are covered by
the plan. FIRF does not segregate the assets, liabilities, or costs by
participating employer. According to FIRF's administrators, as of July 1,
2002, the date of the latest actuarial valuation, the Company's estimated
contribution for the plan year ended June 30, 2003 was $340,000. The
Company expensed and paid this contribution amount during fiscal 2003.
According to the FIRF valuation as of July 1, 2001, the book and market
values of the fund assets exceeded the value of vested benefits in the
aggregate. Therefore, there was no pension contribution in 2002 and 2001
because the plan was fully funded.
(Continued)
25
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Profit Sharing Plan
Bank employees participate in the First Federal Bank Employees' Savings &
Profit Sharing Plan and Trust (the Profit Sharing Plan). Employees who are
at least 21 years of age become eligible for participation after 12 months
of continuous employment (during which at least 1,000 hours of service are
completed). The Bank matches an amount equal to 25% of the first 4% of the
employee's compensation. The Profit Sharing Plan expense for the years
ended June 30, 2003, 2002, and 2001 was $51,991, $48,265, and $44,555,
respectively.
ESOP
In July 1992, as part of the reorganization to the stock form of
ownership, the Bank's Employee Stock Ownership Plan (ESOP) purchased
143,809 shares of the Company's common stock at $3.066 per share, or
$441,000, which was funded by a loan from an unaffiliated lender. This
loan was repaid in December 1996, and the shares were fully allocated to
participants at June 30, 1998. In April 1999, as part of the
reorganization and conversion of First Federal Bankshares, M.H.C., the
Bank's ESOP purchased 184,450 shares of the Company's common stock at $10
per share, which was funded by a 15-year, 7% loan from the Company.
Quarterly principal payments of $30,742 commenced on June 30, 1999. All
employees meeting the age and service requirements are eligible to
participate in the ESOP. Contributions made by the Bank to the Plan are
allocated to participants by using a formula based on compensation.
Participant benefits become 100% vested after five years of service. The
ESOP is accounted for under "Employers' Accounting for Employee Stock
Ownership Plans" (SOP 93-6). Dividends paid on unallocated shares reduce
the Company's cash contributions to the ESOP. The ESOP's borrowing from
the Company is eliminated in consolidation.
At June 30, 2003 and 2002, allocated shares were 156,234 and 153,801,
respectively. Shares committed to be released were 7,118 and 7,398,
respectively. The fair value of the 118,570 and 133,000 unallocated shares
was approximately $2.1 million and $1.8 million, respectively.
Plan expense was $217,928, $180,581, and $156,821 for the years ended June
30, 2003, 2002, and 2001, respectively. Interest expense was $96,959,
$105,566, and $114,174 on the Plan's borrowing for the years ended June
30, 2003, 2002, and 2001.
Stock Options
The Company's 1992 stock option plan permitted the board of directors to
grant options to purchase up to 124,510 shares of the Company's $0.01 par
value common stock. The options may be granted to directors and officers
of the Company. The price at which options may be exercised cannot be less
than the fair value of the shares at the date the options are granted. The
options are subject to certain vesting requirements and maximum exercise
periods, as established by the board of directors.
In October 1999, the Company established the 1999 stock option plan (1999
Plan). The Company's 1999 Plan permits the board of directors to grant
options to purchase up to 263,500 shares of the Company's $0.01 par value
common stock. The options may be granted to directors and officers of the
Company. The price at which options may be exercised cannot be less than
the fair value of the shares at the date the options are granted. The
options are subject to certain vesting requirements and maximum exercise
periods, as established by the board of directors.
(Continued)
26
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Changes in options outstanding and exercisable during 2003, 2002, and 2001
were as follows:
Exercisable Outstanding Option price
----------- ----------- ---------------
options options per share
----------- ----------- ---------------
June 30, 2000 41,074 283,720 3.066 - 20.341
Forfeited (400) (5,400) 9.25
Vested 49,247 -- 7.6875 - 20.341
Exercised (15,930) (15,930) 3.066 - 9.25
-------- --------
June 30, 2001 73,991 262,390 3.066 - 20.341
Granted -- 2,000 11.00
Forfeited (500) (22,200) 9.25
Vested 47,000 -- 7.6875 - 9.25
Exchange of shares (335) (335) 12.25
Exercised (21,577) (21,577) 3.066 - 9.25
-------- --------
June 30, 2002 98,579 220,278 3.066 - 20.341
Granted -- 25,000 13.80 - 14.41
Forfeited (200) (7,500) 9.25
Vested 40,200 -- 7.6875 - 11.00
Exchange of shares (902) (902) 13.00 - 15.70
Exercised (25,746) (25,746) 3.066 - 11.00
-------- --------
June 30, 2003 111,931 211,130 7.6875 - 20.341
======== ========
Recognition and Retention Plan
In October 1999, the Company established the 1999 Recognition and
Retention Plan (RRP) for certain executive officers. The Company
contributed funds to the RRP to acquire 79,050 or 3% of the shares of
common stock sold in April 1999. The shares of stock vest over a five year
period. RRP expense for the years ended June 30, 2003, 2002, and 2001 was
$80,235, $106,735, and $218,332, respectively.
(Continued)
27
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Changes in the number of recognition and retention plan shares awarded
under the Plan and yet to vest were as follows:
June 30, 2000 71,000
Vested (14,200)
-------
June 30, 2001 56,800
Granted 7,000
Forfeited (7,200)
Vested (14,200)
-------
June 30, 2002 42,400
Granted 2,000
Forfeited (2,200)
Vested (13,200)
-------
June 30, 2003 29,000
=======
(12) Related Party Transactions
In the ordinary course of business, the Bank has granted loans to
principal officers and directors and their affiliates amounting to $2.7
million and $1.9 million, respectively, at June 30, 2003 and 2002. During
the year ended June 30, 2003, total principal additions were $1.4 million
and total principal payments were $602,000.
Deposits from related parties held by the Bank at June 30, 2003 and 2002
amounted to $4.0 million and $4.2 million, respectively.
(13) Stockholders' Equity
Regulatory Capital Requirements
The Financial Institution Reform, Recovery, and Enforcement Act of 1989
(FIRREA) and the capital regulations of the Office of Thrift Supervision
(OTS) promulgated thereunder require institutions to have minimum
regulatory tangible capital equal to 1.5% of total assets, a minimum 3%
leverage capital ratio, and a minimum 8% risk-based capital ratio. These
capital standards set forth in the capital regulations must generally be
no less stringent than the capital standards applicable to national banks.
FIRREA also specifies the required ratio of housing-related assets in
order to qualify as a savings institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
established additional capital requirements which require regulatory
action against depository institutions in one of the undercapitalized
categories defined in implementing regulations. Institutions such as the
Bank, which are defined as well capitalized, must generally have a
leverage capital (core) ratio of at least 5%, a tier risk-based capital
ratio of at least 6%, and a total risk-based capital ratio of at least
10%. FDICIA also provides for increased supervision by federal regulatory
agencies, increased reporting requirements for insured depository
institutions, and other changes in the legal and regulatory environment
for such institutions.
(Continued)
28
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
The Bank met all regulatory capital requirements at June 30, 2003 and
2002.
The Bank's actual and required capital amounts and ratios as of June 30,
2003 are presented in the following table:
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
--------------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------- ------ ------------ ---- ----------- ------
Tangible capital $ 46,352,000 7.65% $ 9,092,000 1.50% $ -- --%
Tier 1 leverage (core) 46,352,000 7.65 18,184,000 3.0 30,307,000 5.0
Tier 1 risk-based capital 46,352,000 11.50 15,942,000 4.0 23,913,000 6.0
Risk-based capital 50,981,000 12.64 32,254,000 8.0 40,318,000 10.0
Retained earnings at June 30, 2003 included approximately $9,165,000,
which constitute allocations to bad debt reserves for Federal income tax
purposes and for which no provision for taxes on income has been made. If
such allocations are charged for other than bad debt losses, taxable
income is created to the extent of the charges.
Dividends and Restrictions Thereon
In July 1992, the Bank converted from a mutual to a stock organization
through the formation of a Mutual Holding Company. In April 1999, the
Mutual Holding Company converted to a stock organization.
The 1992 and 1999 Plans of Conversion provided for the establishment of a
special "liquidation account" for the benefit of Eligible Account Holders
and Supplemental Eligible Account Holders in an amount equal to the
greater of:
1. the sum of the Mutual Holding Company's ownership interests in the
surplus and reserves of the Bank as of the date of its latest
balance sheet contained in the final offering circular, and the
amount of any dividends waived by the Mutual Holding Company; or
2. the retained earnings of the Bank at the time that the Bank
reorganized into the Mutual Holding Company in July 1992.
Each eligible Account Holder and Supplemental Eligible Account Holder, if
such person were to continue to maintain such person's deposit account at
the Bank, would be entitled, upon a complete liquidation of the Bank after
the conversion, to an interest in the liquidation account prior to any
payment to the Company as the sole stockholder of the Bank.
Federal regulations impose certain limitations on the payment of dividends
and other capital distributions by the Bank. Under these regulations, a
savings institution, such as the Bank, that will meet the fully phased-in
capital requirements (as defined by OTS regulations) subsequent to a
capital distribution is generally permitted to make such a capital
distribution without OTS approval, subject to certain limitations and
restrictions as described in the regulations. A savings institution with
total capital in excess of current minimum capital requirements, but not
in excess of the fully phased-in requirements, is permitted by the new
regulations to make, without OTS approval, capital distributions of
between 25% and 75% of its net
(Continued)
29
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
earnings for the previous four quarters less dividends already paid for
such period. A savings institution that fails to meet current minimum
capital requirements is prohibited from making any capital distributions
without prior approval from the OTS. The Bank's current compliance with
fully phased-in capital requirements would permit payment of dividends
upon notice to the OTS.
(14) Financial Instruments with Off-balance Sheet Risk
The Company is a party to various transactions with off-balance sheet risk
in the normal course of business. These transactions are primarily
commitments to originate loans. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recorded in the consolidated financial statements.
At June 30, 2003 and 2002, the Company had commitments to originate and
purchase loans approximating $44,442,000 and $31,530,000, respectively,
excluding undisbursed portions of loans in process. Commitments, which are
disbursed subject to certain limitations, extend over various periods of
time. Generally, unused commitments are canceled upon expiration of the
commitment term as outlined in each individual contract. Because the
credit worthiness of each customer is reviewed prior to extension of the
commitment, the Company adequately controls its credit risk on these
commitments, as it does for loans recorded on the statement of financial
condition.
The Company had approved, but unused, consumer lines of credit of
approximately $7,905,000 and $12,489,000 at June 30, 2003 and 2002,
respectively. The Company sold its credit card portfolio in January 2003.
At June 30, 2002, approximately 67% of the consumer lines outstanding were
for the Company's credit card program. The Company had approved, but
unused, commercial lines of credit of approximately $7,561,000 and
$4,907,000 at June 30, 2003 and 2002, respectively.
At June 30, 2003 and 2002, the Company had commitments to sell loans
approximating $2,212,000 and $4,155,000, respectively.
(Continued)
30
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(15) Fair Value of Financial Instruments
The estimated fair values of Company's financial instruments (as described
in note 1) were as follows:
2003 2002
------------------------------ ----------------------------
Carrying Fair Carrying Fair
amount value amount value
------------- ---------- ----------- -----------
Financial assets:
Cash and due from banks $ 34,006,405 34,006,405 23,114,024 23,114,024
Interest-bearing deposits in
other financial institutions 280,548 280,548 103,197 103,197
Investment securities
available-for-sale 78,526,104 78,526,104 92,313,472 92,313,472
Investment securities
held-to-maturity 44,505,464 45,659,510 63,294,694 64,009,952
Loans receivable, net 415,267,153 422,213,000 418,381,872 425,259,000
FHLB stock 5,707,300 5,707,300 5,037,800 5,037,800
Accrued interest receivable 2,488,460 2,488,460 2,803,663 2,803,663
Financial liabilities:
Deposits $ 448,944,039 456,585,000 472,648,336 476,548,000
Advances from FHLB 102,386,888 111,368,000 99,064,679 103,219,000
Advances payments by borrowers
for taxes and insurance 1,458,955 1,458,955 1,482,743 1,482,743
Accrued interest payable 1,795,348 1,795,348 3,640,039 3,640,039
Notional Unrealized Notional Unrealized
amount gain (loss) amount gain (loss)
------------- ----------- ----------- -----------
Off-balance sheet assets (liabilities):
Commitments to extend credit $ 44,442,000 -- 31,530,000 --
Consumer lines of credit 7,905,000 -- 12,489,000 --
Commercial lines of credit 7,561,000 -- 4,907,000 --
Commitments to sell loans (2,212,000) -- (4,155,000) --
(16) Contingencies
The Company is involved with various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's financial position or results of its operations.
(Continued)
31
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
(17) Parent Company Financial Information
Condensed Statements of Financial Condition at June 30, 2003 and 2002 and
Condensed Statements of Operations and Cash Flows for the years ended June
30, 2003 and 2002 are shown below for First Federal Bankshares, Inc.:
Condensed Statements of Financial Condition
Assets 2003 2002
------------ -----------
Cash deposited at First Federal Bank $ 1,901,009 109,048
Interest-bearing deposits in other financial institutions 454,423 103,198
------------ -----------
Cash and cash equivalents 2,355,432 212,246
Investment securities available-for-sale at fair value 646,671 3,271,908
Loans receivable, net 1,454,362 1,431,025
Investment in subsidiaries 65,296,504 66,484,451
Refundable income taxes 37,816 20,993
Other assets 15,217 15,835
------------ -----------
Total assets $ 69,806,002 71,436,458
============ ===========
Liabilities and Stockholders' Equity
Liabilities:
Deferred tax liability $ 64,000 126,000
Accrued expenses and other liabilities 80,637 47,663
------------ -----------
Total liabilities 144,637 173,663
------------ -----------
Stockholders' equity:
Preferred stock, $.01 par value
Authorized 1,000,000 shares; none issued -- --
Common stock, $.01 par value. Authorized 12,000,000
shares; issued and outstanding 4,896,857 and 4,871,112
shares at June 30, 2003 and 2002, respectively 48,969 48,711
Additional paid in capital 36,537,133 36,247,480
Retained earnings 47,900,781 43,542,299
Treasury stock (14,264,674) (7,577,646)
Accumulated other comprehensive income:
Net unrealized loss on securities available-for-sale 710,378 490,458
Unearned ESOP (1,185,700) (1,330,000)
Unearned RRP (85,522) (158,507)
------------ -----------
Total stockholders' equity 69,661,365 71,262,795
------------ -----------
Total liabilities and stockholders' equity $ 69,806,002 71,436,458
============ ===========
(Continued)
32
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Condensed Statements of Operations
2003 2002 2001
----------- ---------- ----------
Interest income:
Loans receivable $ 100,677 105,566 115,889
Investment securities 45,743 105,842 186,707
Other interest-earning assets 10,326 12,203 109,478
Gain (loss) on sale of investment securities 221,143 (25,332) 17,143
Other general and administrative expense (409,753) (367,717) (478,266)
----------- ---------- ----------
Losses before income taxes (31,864) (169,438) (49,049)
Taxes on income (10,000) (72,000) (25,000)
----------- ---------- ----------
Losses before subsidiary
income (21,864) (97,438) (24,049)
Equity in undistributed earnings of
subsidiaries 5,627,281 3,607,486 3,029,942
----------- ---------- ----------
Net income $ 5,605,417 3,510,048 3,005,893
=========== ========== ==========
(Continued)
33
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003 and 2002
Condensed Statements of Cash Flows
2003 2002 2001
----------- ---------- ----------
Cash flows from operating activities:
Net income $ 5,605,417 3,510,098 3,005,893
Adjustments to net income:
Equity in undistributed earnings of
subsidiaries (5,627,281) (3,607,486) (3,029,942)
Net (gain) loss on sale of securities
available-for-sale (221,143) 25,332 (17,143)
(Decrease) increase in income
tax payable (16,823) 27,264 (38,879)
Decrease in other assets 620 42,849 (7,844)
Amortization of premiums and
discounts 53,915 66,236 7,875
Decrease in accrued interest
receivable -- 12,498 24,346
Increase in accrued expense and
other liabilities 32,973 21,376 10,288
----------- ---------- ----------
Net cash (used in) provided
by operating activities (172,322) 98,167 (45,406)
----------- ---------- ----------
Cash flows from investing activities:
Proceeds from maturities of securities
available-for-sale -- -- 100,000
Proceeds from sale of securities
available-for-sale 2,646,855 2,960,168 1,032,143
Purchase of investment securities
available-for-sale (17,823) (2,867,021) (1,500,453)
(Increase) decrease in loans receivable (23,337) 122,966 122,967
----------- ---------- ----------
Net cash provided by
investing activities 2,605,695 216,113 (245,343)
----------- ---------- ----------
Cash flows from financing activities:
Net proceeds from issuance of
common stock 206,550 140,993 55,637
Purchase of common stock (6,685,228) (4,772,014) (1,530,694)
Cash dividends paid (1,246,935) (1,325,334) (1,430,679)
Dividends received from subsidiaries 7,435,426 4,545,536 2,795,440
----------- ---------- ----------
Net cash used in financing
activities (290,187) (1,410,819) (110,296)
----------- ---------- ----------
Net (decrease) in cash and
cash equivalents 2,143,186 (1,096,539) (401,045)
Cash and cash equivalents - beginning
of period 212,246 1,308,785 1,709,830
----------- ---------- ----------
Cash and cash equivalents - end of period $ 2,355,432 212,246 1,308,785
=========== ========== ==========
34