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 2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
Total assets $ 615,522 $ 627,879 650,757 660,124 723,382
Securities available-for-sale 84,693 78,526 92,313 87,598 117,326
Securities held-to-maturity 23,186 44,505 63,295 22,725 23,737
Loans receivable, net 431,857 415,267 418,382 417,898 505,090
Office property and equipment, net 13,277 13,166 13,770 14,686 15,315
Federal Home Loan Bank (FHLB) stock, at cost 6,096 5,707 5,038 9,469 8,929
Goodwill 18,524 18,524 18,524 18,524 19,367
Deposits 429,209 448,944 472,648 488,708 471,626
Advances from FHLB and other borrowings 109,886 102,387 99,065 89,118 174,020
Stockholders' equity 71,458 69,661 71,263 72,587 68,113
Operations Data for Years Ended June 30
Total interest income 30,526 $ 35,117 40,020 50,578 47,973
Total interest expense 12,666 16,122 22,947 32,271 29,814
--------- --------- --------- --------- ---------
Net interest income 17,860 18,995 17,073 18,307 18,159
Provision for losses on loans 1,225 1,730 3,835 5,155 554
--------- --------- --------- --------- ---------
Net interest income after provision for
losses on loans 16,635 17,265 13,238 13,152 17,605
--------- --------- --------- --------- ---------
Noninterest income:
Service charges on deposit accounts 3,931 3,702 3,024 2,712 2,333
Service charges on loans 670 940 1,064 415 372
Gain on sale of branch deposits -- -- 165 -- --
Gain on sale of real estate held for
development 150 19 331 282 440
Net gain (loss) on sale of securities (65) 309 103 1,583 (170)
Gain on sale of loans 1,612 1,544 1,289 905 376
Real estate related activities 1,274 1,509 1,453 1,206 1,464
Other income 1,792 1,773 1,599 1,306 1,695
--------- --------- --------- --------- ---------
Total noninterest income 9,364 9,796 9,028 8,409 6,510
--------- --------- --------- --------- ---------
Noninterest expense:
Compensation and benefits 10,402 10,215 9,400 8,605 8,992
Office property and equipment 2,542 2,666 2,544 2,419 2,282
Amortization of goodwill -- -- -- 844 844
Other noninterest expense 4,649 5,781 5,116 4,923 4,480
--------- --------- --------- --------- ---------
Total noninterest expense 17,593 18,662 17,060 16,791 16,598
--------- --------- --------- --------- ---------
Earnings before income taxes 8,406 8,399 5,206 4,770 7,517
Income taxes 2,788 2,794 1,696 1,764 2,641
--------- --------- --------- --------- ---------
Net earnings $ 5,618 $ 5,605 3,510 3,006 4,876
========= ========= ========= ========= =========
Earnings per share:
Basic earnings per share $ 1.54 $ 1.44 0.85 0.68 1.07
========= ========= ========= ========= =========
Diluted earnings per share $ 1.50 $ 1.41 0.83 0.67 1.07
========= ========= ========= ========= =========
"Adjusted" earnings per share (1)
Basic earnings per share $ 1.54 $ 1.44 0.85 0.87 1.26
========= ========= ========= ========= =========
Diluted earnings per share $ 1.50 $ 1.41 0.83 0.86 1.25
========= ========= ========= ========= =========
Cash dividends declared per common share $ 0.36 $ 0.32 0.32 0.32 0.30
========= ========= ========= ========= =========
- ----------
(1) "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
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
Performance Ratios:
Return on assets (net income divided
by average total assets) 0.89% 0.88% 0.54% 0.43% 0.70%
Return on equity (net income divided
by average equity) 7.93 7.91 4.89 4.16 7.22
Average net interest rate spread (1) 3.06 3.27 2.75 2.46 2.54
Net yield on average interest-earning
assets (2) 3.24 3.42 2.99 2.83 2.84
Net interest income after provision for
loan losses to total other expenses 94.56 92.51 77.60 78.33 106.07
Average interest-earning assets to
average interest-bearing liabilities 107.96 105.21 106.04 107.48 106.64
Asset Quality Ratios:
Nonperforming loans to total loans 0.99 1.13 1.48 0.64 0.42
Nonperforming loans to total assets 0.70 0.75 0.95 0.40 0.29
Nonperforming assets as a percentage
of total assets (3) 0.81 0.81 1.01 0.42 0.30
Nonperforming loans and real estate
owned to total loans and real
estate owned 1.16 1.23 1.58 0.67 0.43
Allowance for loan losses to total loans 0.99 1.10 1.08 1.12 0.67
Capital, Equity and Dividend Ratios:
Tangible capital (4) 8.01 7.65 7.62 7.60 6.71
Core capital (4) 8.01 7.65 7.62 7.60 6.71
Risk-based capital (4) 11.92 12.64 12.66 13.25 12.46
Average equity to average assets ratio 11.26 11.50 11.11 10.22 9.68
Dividend payout ratio 23.38 22.22 37.65 47.06 28.04
Other Data:
Book value per common share $ 19.10 $ 18.29 $ 16.95 $ 15.95 $ 14.52
Number of full-service offices 15 15 15 17 18
- --------------------------------------------------------------------------------
(1) Represents the difference between the average tax-equivalent yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(2) Represents net interest income, tax-effected, as a percentage of average
interest-earning assets.
(3) Non-performing assets include non-accruing loans, accruing loans
delinquent 90 days or more, and foreclosed assets but do not include
restructured loans.
(4) End of period ratio.
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 2004 2004 2003 2003
------ ------ -------- ---------
Interest income $7,171 7,629 7,764 7,962
Interest expense 2,978 3,106 3,227 3,355
------ ------ ------ ------
Net interest income 4,193 4,523 4,537 4,607
Provision for losses on loans 150 450 100 525
------ ------ ------ ------
Net interest income after provision 4,043 4,073 4,437 4,082
Noninterest income 2,207 2,759 2,051 2,347
Noninterest expense 4,520 4,568 4,401 4,104
------ ------ ------ ------
Earnings before income taxes 1,730 2,264 2,087 2,325
Income taxes 577 751 673 787
------ ------ ------ ------
Net earnings $1,153 1,513 1,414 1,538
====== ====== ====== ======
Earnings per share:
Basic $ 0.32 0.41 0.39 0.42
====== ====== ====== ======
Diluted $ 0.31 0.40 0.38 0.41
====== ====== ====== ======
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 $ 0.30 0.46 0.39 0.30
====== ====== ====== ======
Diluted $ 0.29 0.45 0.38 0.29
====== ====== ====== ======
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. 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 is dedicated to maximizing shareholder value through a strong focus
on customer service provided by well-trained and motivated employees. The
Company seeks to accomplish this goal by: (1) emphasizing credit quality and
strong underwriting; (2) implementing electronic banking initiatives including
imaging technology, fully-functional internet banking, improved commercial
banking functionality and strategically-placed automatic teller machines; (3)
focusing on continued loan and deposit growth in relationships with commercial
customers in the Company's primary market areas; (4) developing marketing
programs, hiring practices and training programs that enhance customer service
and sales; (5) expanding the Company's presence in the metro Des Moines market
and improving branch office profitability; and, (6) developing specific
marketing and incentive programs that emphasize core deposit growth and
retention.
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
2004 2003
------------------------------------ ------------------------------------
Rate at
June 30, Average Average Average Average
2004 Balance Interest Yield/Cost Balance Interest Yield/Cost
-------- -------- -------- ---------- -------- -------- ----------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable (1) 5.69% $446,030 26,582 5.96% 414,171 29,129 7.03%
Investment securities (2) 3.48% 108,479 4,158 3.83% 144,552 6,184 4.28%
Short-term investments
and other interest-
earning assets (3) 0.83% 5,134 39 0.77% 4,403 46 1.04%
------- -------- ------- ------- -------- ------- -------
Total interest-earning
assets 5.19% 559,643 30,779 5.50% 563,126 35,359 6.28%
------- ------- ------- ------- -------
Noninterest-earning assets 69,026 71,801
-------- --------
TOTAL ASSETS $628,669 634,927
======== ========
Interest-bearing liabilities:
Deposits 1.80% $401,800 7,728 1.92% 429,330 11,064 2.58%
Borrowings 4.26% 116,596 4,938 4.24% 105,912 5,085 4.78%
------- -------- ------- ------- -------- ------- -------
Total interest-bearing
Liabilities 2.33% 518,396 12,666 2.44% 535,242 16,122 3.01%
------- ------- ------- ------- -------
Noninterest-bearing:
Deposits 2.17% 34,405 2.29% 21,976 2.89%
------- ------- -------
Liabilities 5,104 6,845
-------- --------
TOTAL LIABILITIES 557,905 564,063
Stockholders' equity 70,764 70,864
-------- --------
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY $628,669 634,927
======== ========
Net interest income $18,113 19,237
======= =======
Interest rate spread (4) 2.86% 3.06% 3.27%
======= ======= =======
Net yield on average
interest-earning assets (5) 3.08% 3.24% 3.42%
======= ======= =======
Ratio of average interest-
earning assets to
average interest-
bearing liabilities 107.96% 105.21%
======= =======
Years Ended June 30
2002
------------------------------------
Average Average
Balance Interest Yield/Cost
-------- -------- ----------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable (1) 422,805 32,797 7.76%
Investment securities (2) 129,175 6,750 5.23%
Short-term investments
and other interest-
earning assets (3) 26,977 695 2.58%
-------- ------- -------
Total interest-earning
assets 578,957 40,242 6.95%
------- -------
Noninterest-earning assets 67,523
--------
TOTAL ASSETS 646,480
========
Interest-bearing liabilities:
Deposits 457,001 17,937 3.92%
Borrowings 88,974 5,010 5.63%
-------- ------- -------
Total interest-bearing
Liabilities 545,975 22,947 4.20%
------- -------
Noninterest-bearing:
Deposits 20,032 4.05%
-------
Liabilities 8,622
--------
TOTAL LIABILITIES 574,629
Stockholders' equity 71,851
--------
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY 646,480
========
Net interest income 17,295
=======
Interest rate spread (4) 2.75%
=======
Net yield on average
interest-earning assets (5) 2.99%
=======
Ratio of average interest-
earning assets to
average interest-
bearing liabilities 106.04%
=======
- --------------------------------------------------------------------------------
(1) Average balances include nonaccrual loans. Interest income includes loan
fees which are not material.
(2) Investment securities are tax-effected.
(3) Includes interest-bearing deposits in other financial institutions.
(4) Interest rate spread represents the difference between the average
tax-equivalent yield on interest-earning assets and the average
Iinterest-bearing liabilities. cost of interest-bearing liabilities.
(5) Net yield on average interest-earning assets represents net interest
income, tax-effected, 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
2004 vs. 2003 2003 vs. 2002
--------------------------------------------- ---------------------------------------------
------------------------------- -------------------------------
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 $ 2,240 (4,432) (355) (2,547) (670) (3,061) 63 (3,668)
Investment securities (1,544) (650) 168 (2,026) 803 (1,223) (146) (566)
Other interest-earning assets 8 (12) (3) (7) (582) (414) 347 (649)
------- ------- ------- ------- ------- ------- ------- -------
Total interest-earning assets 704 (5,094) (190) (4,580) (449) (4,698) 264 (4,883)
------- ------- ------- ------- ------- ------- ------- -------
Interest expense:
Deposits (710) (2,834) 208 (3,336) (1,086) (6,160) 373 (6,873)
Borrowings 511 (572) (59) (120) 954 (761) (145) 48
------- ------- ------- ------- ------- ------- ------- -------
Total interest-bearing liabilities (199) (3,406) 149 (3,456) (132) (6,921) 228 (6,825)
------- ------- ------- ------- ------- ------- ------- -------
Net change in net interest income $ 903 (1,688) (339) (1,124) (317) 2,223 36 1,942
======= ======= ======= ======= ======= ======= ======= =======
Overview
The Company had record earnings of $5.6 million in fiscal 2004 and 2003 despite
a decrease of $1.1 million in net interest income in fiscal 2004 as compared to
fiscal 2003. The extended low market interest rate environment in fiscal 2004
contributed to a decrease in the Company's net yield on average interest-earning
assets when compared to fiscal 2003 and also when compared to its fiscal year
plan. The Company's yield on interest-earning assets decreased at a faster rate
than the cost of interest-bearing liabilities, although the Company mitigated a
portion of this compression by adjustments to the mix of both interest-earning
assets and interest-bearing liabilities. A decrease in noninterest expense
largely offset the decrease in net interest income for fiscal 2004.
In March 2004 the Company sold $37.1 million of fixed-rate residential loans
with 15-year terms in order to mitigate future interest rate risk in a potential
rising market interest rate environment. The net gain on the sale of these loans
totaled $791,000 and a mortgage servicing asset totaling $268,000 was recorded
as a result of the sale. The loan sale negatively impacted, and will continue to
negatively impact, net interest income in the short term since the loans sold
had an average yield of 4.92%, while the proceeds of the sale were received and
invested in a historically low market interest rate environment and have not yet
been re-deployed into higher-yielding loans.
Financial Condition
Total assets decreased by $12.4 million, or 2.0%, to $615.5 million at June 30,
2004 from $627.9 million at June 30, 2003, primarily due to a decrease in cash
and cash equivalents. Cash and cash equivalents decreased by $15.4 million, or
45.0%, to $18.9 million at June 30, 2004 from $34.3 million at June 30, 2003
primarily due to operational changes in item processing that resulted in lower
balance requirements at other financial institutions. The balance of securities
held-to-maturity decreased by $21.3 million, or 47.9%, to $23.2 million at June
30, 2004 from $44.5 million at June 30, 2003 while the balance of securities
available-for-sale increased by $6.2 million, or 7.9%, to $84.7 million at June
30, 2004
6
from $78.5 million at June 30, 2003. Proceeds from sales and maturities of
investment securities were used to fund loan growth during fiscal 2004. Net
loans increased by $16.6 million, or 4.0%, to $431.9 million at June 30, 2004
from $415.3 million at June 30, 2003. Federal Home Loan Bank ("FHLB") stock
increased by $389,000, or 6.8%, to $6.1 million at June 30, 2004 from $5.7
million at June 30, 2003 due to FHLB requirements tied to total advances
outstanding.
Deposits decreased by $19.7 million, or 4.4%, to $429.2 million at June 30, 2004
from $448.9 million at June 30, 2003 and accrued interest payable decreased by
$588,000, or 32.8%, to $1.2 million at June 30, 2004 from $1.8 million at June
30, 2003 due to a decrease in the average balance of interest bearing deposits
and in the average cost of deposits in fiscal 2004 as compared to fiscal 2003.
The Company 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 advances from FHLB and other
borrowings. The balance of advances from FHLB and other borrowings increased by
$7.5 million, or 7.3%, to $109.9 million at June 30, 2004 from $102.4 million at
June 30, 2003. Stockholders' equity increased by $1.8 million, or 2.6%, to $71.5
million at June 30, 2004 from $69.7 million at June 30, 2003. The increase in
stockholders' equity was largely due to earnings of $5.6 million for fiscal
2004. Partly offsetting the increase in stockholders' equity due to earnings
were stock repurchases. Under a stock repurchase program announced in August
2003 the Company repurchased 104,500 shares of Company common stock at a cost of
$2.2 million, or $20.65 per share, in fiscal 2004. The current repurchase
program authorizes an additional repurchase of up to 272,500 issued and
outstanding shares. The Company's management believes that stock repurchases are
an appropriate deployment of a portion of the Company's capital that enhances
shareholder value when the common stock is repurchased at an appropriate price.
Management intends to complete the repurchase program contingent on acceptable
market conditions. The Company's dividend payout ratio for fiscal 2004 was
23.38%. Dividends declared during the year ended June 30, 2004 totaled $1.3
million excluding dividends paid on unallocated Employee Stock Ownership Plan
("ESOP") shares.
Asset Quality
Non-performing assets totaled $5.0 million, or 0.81% of total assets, at June
30, 2004 and $5.1 million, or 0.81% of total assets, at June 30, 2003.
Non-performing loans decreased to $4.3 million at June 30, 2004 from $4.7
million at June 30, 2003, representing 0.99% and 1.13%, 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.
7
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.
At June 30,
-----------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
Amount % Amount % Amount % Amount % Amount %
-----------------------------------------------------------------------------------------------------
(Dollars in Thousands)
One- to four-family
residential(1) $ 164,579 38.11 191,890 46.22 164,816 39.40 181,034 43.32 325,057 64.36
Multi-family residential (2) 45,156 10.45 35,051 8.44 56,537 13.51 62,040 14.85 54,455 10.78
Commercial real estate (3) 101,297 23.46 78,064 18.80 81,232 19.42 79,025 18.91 54,594 10.81
Commercial business loans 29,633 6.86 16,256 3.91 15,502 3.71 14,976 3.58 8,533 1.69
Home equity & second mortgage 38,377 8.89 36,962 8.90 40,347 9.64 38,224 9.15 35,695 7.07
Auto loans 17,755 4.11 26,292 6.33 32,168 7.69 24,212 5.79 13,801 2.73
Loans on deposits 505 0.12 511 0.12 672 0.16 802 0.19 659 0.13
Other non-mortgage loans (4) 39,281 9.09 35,077 8.45 32,569 7.78 22,538 5.39 16,887 3.34
-----------------------------------------------------------------------------------------------------
Total loans $ 436,583 101.09 420,103 101.17 423,843 101.31 422,851 101.18 509,681 100.91
Less:
Allowance for loan losses 4,316 1.00 4,615 1.11 4,584 1.10 4,737 1.13 3,394 0.67
Loans in process 801 0.19 410 0.10 1,500 0.36 458 0.11 550 0.11
Net unearned premiums on
loans (1,880) (0.44) (1,965) (0.47) (2,076) (0.50) (1,537) (0.37) (1,684) (0.33)
Deferred loan fees 1,489 0.34 1,776 0.43 1,453 0.35 1,295 0.31 2,331 0.46
-----------------------------------------------------------------------------------------------------
Total loans, net $ 431,857 100.00 415,267 100.00 418,382 100.00 417,898 100.00 505,090 100.00
=====================================================================================================
- ----------
(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.
8
(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,
--------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------------------------------------------------
(Dollars in Thousands)
Total loans outstanding $ 436,583 420,103 423,843 422,851 509,681
Average loans outstanding 446,030 414,171 422,805 484,911 480,377
Allowance balance (at beginning of period) 4,615 4,584 4,737 3,394 3,135
Provision charged to operations 1,225 1,730 3,835 5,155 554
Charge-offs:
Residential (109) (115) (5) -- (5)
Commercial real estate (229) (721) (697) (70) (30)
Commercial business (691) (131) (2,640) (3,551) --
Consumer (624) (1,098) (859) (269) (346)
Recoveries:
Residential -- -- -- 7 --
Commercial real estate 18 9 6 6 6
Commercial business -- 149 4 -- --
Consumer 111 208 203 65 80
--------------------------------------------------------------
Allowance balance (at end of period) $ 4,316 4,615 4,584 4,737 3,394
==============================================================
Allowance for loan losses as a% of total loans outstanding 0.99% 1.10 1.08 1.12 0.67
Net loans charged off as a% of average loans outstanding 0.34% 0.41 0.94 0.79 0.06
9
(c) Non-performing loans.
The following table sets forth information regarding non-accrual loans, loans
past due 90 days or more and still accruing and other non-performing assets at
the dates indicated.
At June 30,
-----------------------------------------------
2004 2003 2002 2001 2000
-----------------------------------------------
(Dollars in Thousands)
-----------------------------------------------
Loans accounted for on a non-accrual basis:
One-to four family residential $ 966 335 527 -- --
Multi-family residential -- 2,426 2,857 -- --
Commercial real estate 1,645 628 824 -- 15
Commercial business 113 -- 584 1,094 --
Consumer 267 302 314 -- --
-----------------------------------------------
Total 2,991 3,691 5,106 1,094 15
-----------------------------------------------
Loans accounted for on an accrual basis (1)(2):
One-to four family residential 1,332 997 780 970 1,187
Multi-family residential -- -- -- -- 547
Commercial real estate -- -- -- 233 247
Consumer -- -- 305 363 112
-----------------------------------------------
Total 1,332 997 1,085 1,566 2,093
-----------------------------------------------
Total non-performing loans 4,323 4,688 6,191 2,660 2,108
-----------------------------------------------
Other non-performing assets (3) (4) 693 412 410 130 65
-----------------------------------------------
$5,016 5,100 6,601 2,790 2,173
===============================================
Restructured loans not included in
other non-performing categories above (5) $3,691 3,005 -- 449 434
===============================================
Non-performing loans as a percentage of total loans 0.99% 1.13 1.48 0.64 0.42
Non-performing loans as a percentage of total assets 0.70% 0.75 0.95 0.40 0.29
Non-performing loans and real estate owned to
Total loans and real estate owned 1.16% 1.23 1.58 0.67 0.43
Non-performing assets as a percentage of total assets 0.81% 0.81 1.01 0.42 0.30
- ----------
(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 2004, 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 $151,000,
240,000 and $325,000, respectively, at June 30, 2004, 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.
10
Comparison of Operating Results for Fiscal Years Ended June 30, 2004 and 2003
General. Net earnings totaled $5.6 million, or $1.50 per diluted share, for
fiscal 2004 as compared to net earnings totaling $5.6 million, or $1.41 per
diluted share, for fiscal 2003.
Interest Income. Interest income decreased by $4.6 million, or 13.1%, to $30.5
million in fiscal 2004 from $35.1 million in fiscal 2003. The decrease in
interest income was primarily due to a decrease in the average yield on
interest-earning assets which decreased by 78 basis points to 5.50% in fiscal
2004 from 6.28% in fiscal 2003 primarily due to lower yields on interest-earning
assets in the generally lower market interest rate environment.
Interest income on loans decreased by $2.5 million, or 8.7%, to $26.6 million
for fiscal 2004 from $29.1 million for fiscal 2003. The decrease in interest
income on loans was primarily due to a decrease in the average yield on loans.
The average yield on loans decreased by 107 basis points to 5.96% for fiscal
2004 from 7.03% for fiscal 2003. The decrease in yield on loans was partly
offset by increases in the average balance of loans as the Company funded loan
growth with proceeds from investment securities' maturities and sales. The
average balance of loans receivable increased by $31.8 million, or 7.7%, to
$446.0 million for fiscal 2004 from $414.2 million for fiscal 2003.
Interest income on investment securities decreased by $2.0 million, or 34.3%, to
$3.9 million for fiscal 2004 from $5.9 million for fiscal 2003. The decrease in
interest income on investment securities was primarily due to a decrease in the
average balance of investment securities. The average balance of investment
securities decreased by $36.1 million, or 25.0%, to $108.5 million in fiscal
2004 from $144.6 million in fiscal 2003 as the Company reinvested funds from
maturities and sales into loans. In addition, the average tax-equivalent yield
on investment securities decreased by 45 basis points to 3.83% for fiscal 2004
from 4.28% for fiscal 2003. Purchases during the historically low interest rate
environment of fiscal 2004 and the downward repricing of adjustable rate
mortgage-backed securities ("MBS") contributed to the decrease in interest
income on investment securities.
Interest Expense. Interest expense decreased by $3.4 million, or 21.4%, to $12.7
million in fiscal 2004 from $16.1 million in fiscal 2003. The decrease in
interest expense was due to a decrease of 57 basis points in the average cost of
interest-bearing liabilities to 2.44% for fiscal 2004 from 3.01% for fiscal 2003
and to a decrease of $16.8 million in the average balance of interest-bearing
liabilities to $518.4 million for fiscal 2004 from $535.2 million for fiscal
2003. Interest expense on deposits decreased by $3.4 million, or 30.2%, to $7.7
million in fiscal 2004 from $11.1 million in fiscal 2003. The decrease in
interest expense on deposits was primarily due to a decrease of 66 basis points
in the average rate paid on deposits to 1.92% in fiscal 2004 from 2.58% in
fiscal 2003. The average balance of deposits decreased by $27.5 million, or 6.4%
to $401.8 million for fiscal 2004 from $429.3 million for fiscal 2003. Interest
paid on borrowings totaled $4.9 million and $5.1 million, respectively, for
fiscal 2004 and 2003. The average balance of borrowings increased by $10.7
million, or 10.1%, to $116.6 million in fiscal 2004 from $105.9 million in
fiscal 2003. The average cost of borrowings decreased by 54 basis points to
4.24% in fiscal 2004 from 4.78% in fiscal 2003 as higher-rate fixed-term
borrowings matured and were replaced with lower-rate borrowings in the generally
lower market interest rate environment during fiscal 2004.
Net Interest Income. Net interest income before provision for loan losses
decreased by $1.1 million, or 6.0%, to $17.9 million for fiscal 2004 from $19.0
million for fiscal 2003. The Company's interest rate spread decreased by 21
basis points to 3.06% for fiscal 2004 from 3.27% for fiscal 2003 and the net
yield on average interest-earning assets decreased by 18 basis points to 3.24%
for fiscal 2004 from 3.42% for fiscal 2003.
Provision for Loan Losses. Provision for loan loss expense decreased by
$505,000, or 29.2%, to $1.2 million for fiscal 2004 from $1.7 million for fiscal
2003. Net loans charged off as a percentage of average loans outstanding were
0.34% and 0.41%, respectively, for fiscal years 2004 and 2003. 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.
11
Noninterest Income. Noninterest income decreased by $433,000, or 4.4%, to $9.4
million for fiscal 2004 from $9.8 million for fiscal 2003. The decrease in
noninterest income was largely due to a net loss on sale of securities that
totaled $65,000 for fiscal 2004 as compared to a gain of $309,000 on the sale of
securities for fiscal 2003. Service charges on loans receivable decreased by
$270,000 for fiscal 2004 when compared to fiscal 2003. The decrease in service
charges on loans was primarily due to a decrease of $244,000 in prepayment
penalty revenue for fiscal 2004 as compared to such revenue for fiscal 2003.
Partially offsetting these decreases in noninterest income was a $229,000
increase in service charges on deposit accounts for fiscal 2004 as compared to
fiscal 2003. The increase in service charges on deposit accounts was primarily
due to an increase in overdraft activities on retail accounts and the resulting
service fees assessed. In addition, the restructuring of the Company's checking
and savings accounts included a more favorable service charge schedule. Also
partially offsetting the decreases in noninterest income were increases in gain
on sale of loans and gain on sale of real estate held for development. Gain on
sale of loans increased by $67,000, or 4.3%, to $1.6 million for fiscal 2004
from $1.5 million for fiscal 2003. The increase in gain on sale of loans was due
to the sale of $37.1 million of fixed-rate residential mortgage loans to a
government sponsored agency during the three months ended March 31, 2004. The
net gain on the sale of these loans totaled $791,000. The gain generated by this
sale was largely offset by lower gains from the origination and sale of current
mortgage production during fiscal 2004. Gains from the Company's ongoing
origination and concurrent sale of fixed rate mortgages to investors decreased
by $724,000 for fiscal 2004 when compared to fiscal 2003. This was due to a
slowdown in mortgage refinancing activity after the extended low market interest
rate environment in the current fiscal year period. Gain on sale of real estate
held for development increased to $150,000 for fiscal 2004 from $19,000 for
fiscal 2003 as new residential units were completed and sold by the Company's
real estate development subsidiary. Real estate-related income from the
Company's subsidiaries also decreased by $236,000 for fiscal 2004 as compared to
fiscal 2003 as a result of the slowdown in mortgage activity in the current
fiscal year.
Noninterest Expense. Noninterest expense decreased by $1.1 million, or 5.7%, to
$17.6 million for fiscal 2004 from $18.7 million for fiscal 2003. The decrease
in noninterest expense was primarily due to a decrease of $1.2 million in other
noninterest expense. The decrease in other noninterest expense was partly due to
a decrease in expense for the amortization of prior period mortgage servicing
assets which were fully amortized in fiscal 2003. In March 2004 a $268,000
mortgage servicing asset was recorded in conjunction with the sale of $37.1
million in residential loans. Amortization expense related to mortgage servicing
assets totaled $8,000 and $332,000, respectively, for fiscal 2004 and 2003.
Other noninterest expense also decreased due to a decrease of $124,000 in
recruiting expense, a decrease of $165,000 in per account service fee expense
for certain retail transaction accounts and a $79,000 decrease in loan
origination expense resulting from decreases in loan production volumes for
fiscal 2004 as compared to fiscal 2003. During fiscal 2004, the Company reduced
expense for contributions and various professional services by $296,000 when
compared to fiscal 2003. Additionally, losses on other real estate owned
properties and repossessed assets decreased by $105,000 for fiscal 2004 as
compared to fiscal 2003.
Noninterest expense also decreased due to decreases in office property and
equipment expense and advertising expense that totaled $125,000 and $59,000,
respectively, for fiscal 2004 as compared to fiscal 2003. The decreases in
noninterest expense were partly offset by an increase of $188,000, or 1.8%, in
compensation and benefits expense. Within compensation and benefits expense,
pension expense increased by $343,000 for fiscal 2004 as compared to fiscal
2003. The increase in pension expense was more than offset by a decrease in
incentive payments related to loan production since production volumes declined
in fiscal 2004 from fiscal 2003 levels. Also offsetting the decreases in
noninterest expense was an increase in data processing expense. Data processing
expense increased by $122,000, or 38.7%, in fiscal 2004 as compared to fiscal
2003 as the Company invested in software and data lines in order to enhance
products and expedite data communications.
Income Tax Expense. Net earnings before income taxes totaled $8.4 million for
both fiscal 2004 and 2003, and income tax expense totaled $2.8 million for both
fiscal 2004 and 2003. The Company's effective tax rate was 33.2% and 33.3%,
respectively, for fiscal 2004 and 2003.
12
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 6.28% for fiscal 2003 from 6.95% 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 investment securities decreased by $586,000, or 9.0%, to $5.9
million for fiscal 2003 from $6.5 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 tax-equivalent yield on
investment securities decreased by 95 basis points to 4.28% for fiscal 2003 from
5.23% for fiscal 2002. The average balance of investment securities increased by
$15.4 million, or 11.9%, to $144.6 million in fiscal 2003 from $129.2 million in
fiscal 2002. The increase in the average balance of investment securities was
primarily due to an increase in the average balance of MBS which increased by
$20.5 million, or 44.3% to $66.7 million for fiscal 2003 from $46.2 million for
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 primarily 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 $10.8 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.
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 52
basis points to 3.27% for fiscal 2003 from 2.75% for fiscal 2002 and the net
yield on average interest-earning assets increased by 43 basis points to 3.42%
for fiscal 2003 from 2.99% for fiscal 2002.
13
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 largely due to an increase of $678,000, or 22.4%, in
income from service charges on deposit accounts to $3.7 million for fiscal 2003
from $3.0 million for fiscal 2002. The increase in service charges on deposit
accounts resulted partly from an increase in overdraft activity. In addition,
the fee amount charged for each overdraft occurrence was increased in fiscal
2003.
An increase in loan origination activity in the generally lower market interest
rate environment during fiscal 2003 contributed to increases in gain on sale of
loans. Gain on sale of loans increased by $256,000, or 19.9%, to $1.5 million
for fiscal 2003 from $1.3 million for fiscal 2002. Additionally, 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. Partly offsetting the increases in
noninterest income were decreases in gain on sale of real estate held for
development and gain on sale of office property and equipment. Gain on sale of
real estate held for development totaled $19,000 and $331,000, respectively, for
fiscal 2003 and 2002. A loss on sale of office property and equipment $6,000 was
recorded for fiscal 2003 while a gain of $250,000 was recorded in fiscal 2002
primarily due to the sale of a branch office location.
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 $655,000, or 14.9%, to $5.0 million for fiscal 2003 from
$4.4 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.
14
Income Tax Expense. Net earnings before income 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.
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 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) the
Company also uses 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.
15
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 2004 have changed significantly when compared
to fiscal 2003. The net portfolio value (the "NPV") of the Company, assuming no
change in interest rates (the "Base Case Scenario"), was $56.1 million and $49.4
million, respectively, at June 30, 2004 and 2003. The NPV ratio in the Base Case
Scenario was 9.22% and 7.90%, respectively, at June 30, 2004 and 2003. The Board
of Directors has established market risk limits based on the Company's tolerance
for risk. At June 30, 2004, the NPV ratio was inside the board limits in all
measured rate-change scenarios. 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 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, 2004, 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. Interest rate risk limits established by ALCO include:
(a) a post-shock NPV ratio of 4.0% or greater; (b) the interest rate sensitivity
measure resulting from an adverse rate shock of 200 basis points should not
exceed 200 basis points; and (c) the OTS "level of risk" should be "minimal" or
"moderate". As of June 30, 2004 the Company's interest rate risk, as measured by
the Model, was within ALCO guidelines and the OTS "level of risk" was reported
as "minimal".
16
Present Value Estimates by Interest Rate Scenario
Calculated at June 30, 2004
-------------------------------Base--------------------------------
-100 bp 0 bp +100 bp +200 bp +300 bp
-------- -------- -------- -------- --------
(Dollars in Thousands)
Financial Instrument:
Mortgage loans and securities $393,816 387,329 379,763 371,627 363,229
Non-mortgage loans 80,767 79,009 77,330 75,719 74,182
Cash, deposits and securities 91,951 90,084 87,866 85,238 82,563
Other assets 47,973 51,995 55,795 59,389 62,826
-------- -------- -------- -------- --------
Total assets 614,507 608,417 600,754 591,973 582,800
Deposits 435,731 432,972 430,275 427,642 425,076
Borrowings 115,807 113,211 110,994 109,128 107,567
Other liabilities 5,681 5,672 5,663 5,656 5,648
-------- -------- -------- -------- --------
Total liabilities 557,219 551,855 546,932 542,426 538,291
-------- -------- -------- -------- --------
Commitments 324 (456) (1,395) (2,450) (3,629)
-------- -------- -------- -------- --------
Net portfolio value $ 57,612 56,106 52,427 47,097 40,880
======== ======== ======== ======== ========
Net portfolio value ratio 9.38% 9.22% 8.73% 7.96% 7.01%
======== ======== ======== ======== ========
Interest rate sensitivity +15bp Base -50bp -127bp -221bp
======== ======== ======== ======== ========
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
19.7% during the quarter ended June 30, 2004. 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, 2004, 2003, and 2002, totaled $82.7 million,
$134.9 million, and $156.8 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 $19.7 million, $23.7 million
and $15.9 million, respectively, in fiscal 2004, 2003 and 2002. 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 2004 totaled $192.5 million as compared to $200.8 million in
fiscal 2003 and $219.7 million in fiscal 2002. Funds received from principal
repayments on mortgage-backed securities for fiscal 2004, 2003 and 2002, totaled
$22.9 million, $30.3 million and $9.9 million, respectively. Liquidity
management is both a daily and long-term function of business management. If the
Company requires funds beyond its ability to
17
generate them internally, borrowing agreements exist with the FHLB, which
provide an additional source of funds. At June 30, 2004 and 2003, the Company
had $109.5 million and $102.4 million, respectively, in outstanding advances
from the FHLB.
At June 30, 2004, the Company had outstanding loan commitments and consumer and
commercial approved, but unused, lines of credit totaling $82.6 million.
Certificates of deposit scheduled to mature in one year or less at June 30, 2004
totaled $114.8 million. Management believes that a significant portion of such
deposits will remain with the Company.
Subsequent Event
On June 29, 2004, First Federal Bank, a wholly-owned subsidiary of the Company,
and Iowa State Bank, Orange City, Iowa entered into a definitive agreement
providing for the sale of the Bank's branch offices located in Orange City, Iowa
and Sheldon, Iowa. The transaction is expected to be completed on or about
September 20, 2004. Deposits totaling approximately $27.9 million and loans
totaling approximately $17.1 million are included in the sale. The gain on the
sale of the branches is expected to range from $2.0 million to $2.5 million.
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
The Accounting Standards Executive Committee has issued Statement of Position
03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer.
This Statement applies to all loans acquired in a transfer, including those
acquired in the acquisition of a bank or a branch, and provides that such loans
be accounted for at fair value with no allowance for loan losses, or other
valuation allowance, permitted at the time of acquisition. The difference
between cash flows expected at the acquisition date and the investment in the
loan should be recognized as interest income over the life of the loan. If
contractually required payments for principal and interest are less than
expected cash flows, this amount should not be recognized as a yield adjustment,
a loss accrual, or a valuation allowance. For the Company this Statement is
effective for fiscal year 2006 and early adoption, although permitted, is not
planned. No significant impact is expected on the Company's consolidated
financial statements at the time of adoption.
On March 9, 2004 Securities and Exchange Commission Staff Accounting Bulletin
105 ("SAB 105"), Application of Accounting Principles to Loan Commitments, was
issued. SAB 105 summarizes the views of the Staff regarding the application of
generally accepted accounting principles to loan commitments accounted for as
derivative instruments. It is anticipated that the adoption of the guidance in
SAB 105 for all new loan commitments signed after April 1, 2004 will not have a
material effect on the Company's financial position, liquidity or results of
operations.
18
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
McGladrey & Pullen
Certified Public Accountants
Report of Independent Registered Public Accounting Firm
The Board of Directors
First Federal Bankshares, Inc.
Sioux City, Iowa
We have audited the accompanying consolidated balance sheet of First Federal
Bankshares, Inc. and subsidiaries as of June 30, 2004, and the related
consolidated statements of income, stockholders' equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provided a
reasonable basis for our opinion.
In our opinion, the 2004 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, 2004 and the results of
their operations and their cash flows for the year then ended in conformity with
U.S. generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Des Moines, Iowa
August 6, 2004
McGladrey & Pullen, LLP is a member firm of RSM International -
an affiliation of separate and independent legal entities.
20
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 the
related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years in the two-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 the consolidated
results of their operations and their cash flows for each of the years in the
two-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
21
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2004 and 2003
ASSETS 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 16,574,986 $ 34,006,405
Interest-bearing deposits in other financial institutions 2,282,875 280,548
--------------------------------
Cash and cash equivalents 18,857,861 34,286,953
--------------------------------
Securities available-for-sale (Note 2) 84,693,332 78,526,104
Securities held-to-maturity (fair value of $23,762,072 in 2004
and $45,659,510 in 2003) (Note 2) 23,185,899 44,505,464
Loans receivable (Note 3) 436,173,780 419,882,438
Less allowance for loan losses (Note 4) 4,316,286 4,615,285
--------------------------------
Net loans 431,857,494 415,267,153
--------------------------------
Office property and equipment, net (Note 5) 13,276,834 13,165,804
Federal Home Loan Bank (FHLB) stock, at cost 6,096,100 5,707,300
Accrued interest receivable (Note 6) 2,230,053 2,488,460
Refundable income taxes 17,872 --
Deferred tax asset (Note 10) 943,000 514,000
Goodwill 18,523,607 18,523,607
Other assets 15,840,057 14,894,532
--------------------------------
Total assets $ 615,522,109 $ 627,879,377
================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits (Note 8) $ 429,208,928 $ 448,944,039
Advances from FHLB and other borrowings (Note 9) 109,886,261 102,386,888
Advance payments by borrowers for taxes and insurance 1,119,486 1,458,955
Accrued taxes on income -- 346,167
Accrued interest payable (Note 8 and 9) 1,206,994 1,795,348
Accrued expenses and other liabilities 2,642,718 3,286,615
--------------------------------
Total liabilities 544,064,387 558,218,012
--------------------------------
CONTINGENCIES (Note 16)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 1,000,000 shares; issued none -- --
Common stock, $.01 par value, authorized 12,000,000 shares;
issued 2004 4,939,262 shares; issued 2003 4,896,857 shares 49,393 48,969
Additional paid-in capital 37,086,235 36,537,133
Retained earnings, substantially restricted (Note 13) 52,240,273 47,900,781
Treasury stock, at cost, 2004 1,198,990 shares; 2003 1,088,466 shares (16,519,093) (14,264,674)
Accumulated other comprehensive income (loss), net unrealized
gain (loss) on securities available-for-sale (329,644) 710,378
Unearned ESOP (Note 11) (1,044,710) (1,185,700)
Unearned RRP (Note 11) (24,732) (85,522)
--------------------------------
Total stockholders' equity 71,457,722 69,661,365
--------------------------------
Total liabilities and stockholders' equity $ 615,522,109 $ 627,879,377
================================
See Notes to Consolidated Financial Statements.
22
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2004, 2003 and 2002
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------
Interest income:
Loans receivable $ 26,581,896 $ 29,129,117 $ 32,797,235
Investment securities 3,904,681 5,941,742 6,527,892
Other interest-earning assets 39,673 45,911 694,957
----------------------------------------------
30,526,250 35,116,770 40,020,084
----------------------------------------------
Interest expense:
Deposits (Note 8) 7,727,545 11,063,560 17,936,952
Advances from FHLB and other borrowings 4,938,640 5,058,338 5,009,983
----------------------------------------------
12,666,185 16,121,898 22,946,935
----------------------------------------------
Net interest income 17,860,065 18,994,872 17,073,149
Provision for loan losses (Note 4) 1,225,000 1,730,000 3,835,000
----------------------------------------------
Net interest income after provision for
losses on loans 16,635,065 17,264,872 13,238,149
----------------------------------------------
Noninterest income:
Service charges on deposit accounts 3,930,651 3,701,711 3,023,855
Service charges on loans 670,081 939,887 1,064,326
Gain (loss) on sale of branch deposits -- -- 164,730
Gain (loss) on sale of real estate owned (21,763) 34,955 (16,221)
Gain (loss) on sale of real estate held for development 150,000 18,561 330,779
Net gain (loss) on sale of securities (64,797) 308,626 102,828
Gain (loss) on sale of loans 1,611,901 1,544,992 1,288,754
Gain (loss) on sale of office property and equipment 69,977 (5,551) 249,979
Real estate related activities 1,273,605 1,509,468 1,453,255
Other income 1,743,939 1,743,788 1,365,724
----------------------------------------------
Total noninterest income 9,363,594 9,796,437 9,028,009
----------------------------------------------
Noninterest expense:
Compensation and benefits (Note 11) 10,402,497 10,214,874 9,400,076
Office property and equipment 2,541,500 2,666,028 2,543,772
Data processing 437,123 315,198 340,136
Advertising 364,626 423,640 388,975
Other expense 3,847,033 5,042,152 4,387,101
----------------------------------------------
Total noninterest expense 17,592,779 18,661,892 17,060,060
----------------------------------------------
Income before income taxes 8,405,880 8,399,417 5,206,098
Income taxes (Note 10) 2,788,000 2,794,000 1,696,000
----------------------------------------------
Net income $ 5,617,880 $ 5,605,417 $ 3,510,098
==============================================
Earnings per share:
Basic earnings per share $ 1.54 $ 1.44 $ 0.85
==============================================
Diluted earnings per share $ 1.50 $ 1.41 $ 0.83
==============================================
See Notes to Consolidated Financial Statements.
23
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 2004, 2003 and 2002
Comprehensive Common Additional Retained
Income Stock Paid-in Capital Earnings
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2001 $ 48,495 $ 36,053,892 $ 41,357,535
Net income $3,510,098 -- -- 3,510,098
Net change in unrealized gains on securities
available-for-sale 898,762 -- -- --
Less reclassification adjustment for net realized gains
included in net income (net of tax expense) (64,473) -- -- --
----------
Total comprehensive income $4,344,387
==========
Stock options exercised 216 140,777 --
Treasury stock acquired -- -- --
Recognition and retention plan (RRP) award -- 15,700 --
Amortization of RRP -- -- --
ESOP shares allocated -- -- --
Stock appreciation of allocated ESOP shares -- 37,111 --
Dividends on common stock at $.32 per share (Note 13) -- -- (1,325,334)
--------------------------------------------------
Balance at June 30, 2002 48,711 36,247,480 43,542,299
Net income $5,605,417 -- -- 5,605,417
Net change in unrealized gains on securities
available-for-sale 413,429 -- -- --
Less reclassification adjustment for net realized gains
included in net income (net of tax expense) (193,509) -- -- --
----------
Total comprehensive income $5,825,337
==========
Stock options exercised 258 206,293 --
Treasury stock acquired -- -- --
Recognition and retention plan (RRP) award -- 9,050 --
Amortization of RRP -- -- --
ESOP shares allocated -- -- --
Stock appreciation of allocated ESOP shares -- 74,310 --
Dividends on common stock at $.32 per share (Note 13) -- -- (1,246,935)
--------------------------------------------------
Balance at June 30, 2003 48,969 36,537,133 47,900,781
Net income $5,617,880 -- -- 5,617,880
Net change in unrealized gains (losses) on
securiites available-for-sale (1,080,650) -- -- --
Less reclassification adjustment for net realized
losses included in net income (net of tax expense) 40,628 -- -- --
----------
Total comprehensive income $4,577,858
==========
Stock options exercised 424 385,804 --
Treasury stock acquired -- -- --
Recognition and retention plan (RRP) award (forfeiture) -- (7,000) --
Amortization of RRP -- -- --
ESOP shares allocated -- -- --
Stock appreciation of allocated ESOP shares -- 170,298 --
Dividends on common stock at $.36 per share (Note 13) -- -- (1,278,388)
--------------------------------------------------
Balance at June 30, 2004 $ 49,393 $ 37,086,235 $ 52,240,273
==================================================
Accumulated
Other
Treasury Comprehensive Unearned Unearned
Stock Income ESOP RRP Total
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2001 $ (2,803,832) $ (343,831) $ (1,473,470) $ (251,342) $ 72,587,447
Net income -- -- -- -- 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
Stock options exercised -- -- -- -- 140,993
Treasury stock acquired (4,772,014) -- -- -- (4,772,014)
Recognition and retention plan (RRP) award (1,800) -- -- (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 $.32 per share (Note 13) -- -- -- -- (1,325,334)
------------------------------------------------------------------------
Balance at June 30, 2002 (7,577,646) 490,458 (1,330,000) (158,507) 71,262,795
Net income -- -- -- -- 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
Stock options exercised -- -- -- -- 206,551
Treasury stock acquired (6,685,228) -- -- -- (6,685,228)
Recognition and retention plan (RRP) award (1,800) -- -- (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 $.32 per share (Note 13) -- -- -- -- (1,246,935)
------------------------------------------------------------------------
Balance at June 30, 2003 (14,264,674) 710,378 (1,185,700) (85,522) 69,661,365
Net income -- -- -- -- 5,617,880
Net change in unrealized gains (losses) on
securiites available-for-sale -- (1,080,650) -- -- (1,080,650)
Less reclassification adjustment for net realized
losses included in net income (net of tax expense) -- 40,628 -- -- 40,628
Total comprehensive income
Stock options exercised -- -- -- -- 386,228
Treasury stock acquired (2,229,219) -- -- -- (2,229,219)
Recognition and retention plan (RRP) award (forfeiture) (25,200) -- -- 14,981 (17,219)
Amortization of RRP -- -- -- 45,809 45,809
ESOP shares allocated -- -- 140,990 -- 140,990
Stock appreciation of allocated ESOP shares -- -- -- -- 170,298
Dividends on common stock at $.36 per share (Note 13) -- -- -- -- (1,278,388)
------------------------------------------------------------------------
Balance at June 30, 2004 $(16,519,093) $ (329,644) $ (1,044,710) $ (24,732) $ 71,457,722
========================================================================
See Notes to Consolidated Financial Statements.
24
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2004, 2003 and 2002
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,617,880 $ 5,605,417 $ 3,510,098
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Loans originated for sale to investors (38,683,060) (62,703,013) (69,916,000)
Proceeds from sale of loans originated for sale 40,329,362 64,447,843 70,871,101
Provision for losses on loans and other assets 1,225,000 1,730,000 3,835,000
Depreciation and amortization 1,433,963 1,858,764 2,144,912
Provision for deferred taxes 189,000 (746,000) 104,000
Net (gain) loss on sale of loans (1,611,901) (1,544,992) (1,288,754)
Net (gain) loss on sale of securities available-for-sale 64,797 (308,626) (102,828)
Net (gain) loss on sale of branch deposits -- -- (164,730)
Net (gain) loss on sale of office property and equipment (69,977) 5,551 (249,979)
Net (gain) loss on sale of real estate held for development (150,000) (18,561) (330,779)
Net loan fees deferred 11,051 322,922 157,716
Amortization of premiums and discounts on loans,
mortgage-backed securities and investment securities 493,932 334,044 853,791
(Increase) decrease in accrued interest receivable 258,407 315,203 989,395
(Increase) decrease in other assets 2,203,436 (1,446,693) (242,511)
Increase (decrease) in accrued interest payable (588,354) (1,844,691) (2,036,784)
Increase (decrease) in accrued expenses and other liabilities (643,898) 731,334 431,669
Increase (decrease) in accrued taxes on income (346,167) 492,908 (34,376)
----------------------------------------------
Net cash provided by (used in) operating activities 9,733,471 7,231,410 8,530,941
----------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities held-to-maturity -- (1,375,682) (52,047,645)
Proceeds from maturities of securities held-to-maturity 21,232,413 20,024,583 8,441,621
Proceeds from sale of securities available-for-sale 13,585,515 36,421,869 14,442,044
Purchase of securities available-for-sale (38,356,923) (38,825,509) (82,950,770)
Proceeds from maturities of securities available-for-sale 16,437,392 16,671,842 68,145,813
Purchase of bank owned life insurance (2,555,755) -- (6,984,000)
(Purchase) redemption of FHLB stock (388,800) (669,500) 4,430,900
Loans purchased (36,666,000) (15,827,000) (19,001,000)
Proceeds from sale of loans 37,370,941 2,357,433 --
(Increase) decrease in loans receivable (19,088,995) 13,551,064 13,864,127
Proceeds from sale of office property and equipment 108,972 1,215 523,725
Purchase of office property and equipment (1,236,002) (462,321) (584,482)
Proceeds from sale of foreclosed real estate 122,585 578,238 222,750
Proceeds from sale of real estate held for development 1,733,683 54,298 703,500
Net expenditures on real estate held for development (1,765,003) (363,000) (9,001)
----------------------------------------------
Net cash provided by (used in) investing activities (9,465,977) 32,137,530 (50,802,418)
----------------------------------------------
25
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended June 30, 2004, 2003 and 2002
2004 2003 2002
- --------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in deposits $(19,735,111) $(23,704,297) $(15,895,163)
Proceeds from advances from FHLB 25,386,261 50,167,000 31,075,000
Repayment of advances from FHLB and other borrowings (17,886,888) (47,012,511) (21,256,704)
Net increase (decrease) in advance payments by borrowers
for taxes and insurance (339,469) (23,788) (427,633)
Issuance of common stock, net 386,228 206,551 140,993
Repurchase of common stock (2,229,219) (6,685,228) (4,772,014)
Cash dividends paid (1,278,388) (1,246,935) (1,325,334)
----------------------------------------------
Net cash provided by (used in) financing activities (15,696,586) (28,299,208) (12,460,855)
----------------------------------------------
Net increase (decrease) in cash and cash equivalents (15,429,092) 11,069,732 (54,732,332)
CASH AND CASH EQUIVALENTS
Beginning of year 34,286,953 23,217,221 77,949,553
----------------------------------------------
End of year $ 18,857,861 $ 34,286,953 $ 23,217,221
==============================================
SUPPLEMENTAL DISCLOSURES
Cash paid during the year for:
Interest $ 13,254,539 $ 17,966,589 $ 24,983,719
Income taxes 2,963,039 3,047,092 1,626,371
See Notes to Consolidated Financial Statements.
26
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 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 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 generally accepted
accounting principles 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, 2004, 2003 and 2002 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.
27
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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, 2004, 2003
and 2002:
2004 2003 2002
--------------------------------------
Basic EPS computation:
Net earnings $5,617,880 $5,605,417 $3,510,098
Weighted average common shares outstanding 3,642,977 3,879,569 4,115,350
--------------------------------------
Basic EPS $ 1.54 $ 1.44 $ 0.85
======================================
Diluted EPS computation:
Net earnings $5,617,880 $5,605,417 $3,510,098
--------------------------------------
Weighted average common shares outstanding 3,642,977 3,879,569 4,115,350
Incremental option and RRP shares using
treasury stock method 113,072 91,827 90,654
--------------------------------------
Diluted shares outstanding 3,756,049 3,971,396 4,206,004
======================================
Diluted EPS $ 1.50 $ 1.41 $ 0.83
======================================
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.
28
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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
operations is made, and the real estate is written down to fair value less
estimated costs of disposition.
Accrued interest receivable in arrears which management believes is doubtful of
collection (generally when a loan becomes 90 days delinquent) is charged against
operations. 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.
29
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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. Improvements 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 2004 and
determined the recorded goodwill of $18,523,607 was not impaired.
Mortgage servicing assets: The Company recognizes the rights to service mortgage
loans for others, whether acquired or internally originated. Mortgage servicing
assets are initially recorded at fair value based on comparable market quotes
and are amortized as other expense in proportion to and over the period of
estimated net servicing income.
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.
30
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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:
2004 2003 2002
--------------------------------------
Basic EPS computation:
Net earnings $5,617,880 $5,605,417 $3,510,098
Pro forma 5,536,867 5,534,479 3,446,038
Basic earnings per share:
Net earnings 1.54 1.44 0.85
Pro forma 1.52 1.43 0.84
Diluted earnings per share:
Net earnings 1.50 1.41 0.83
Pro forma 1.47 1.39 0.82
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 2004, 2003 and 2002, respectively: dividend yield of
3.31%, 3.41% and 3.41%; expected volatility of 22.96%, 22.76% and 22.76%; risk
free interest rate of 6.08%, 6.29% and 6.29%; and expected life of 7.5 years for
all fiscal years presented.
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 pricing
quotations provided by a national industry source. These market prices are
automatically integrated into the Company's investment securities
accounting and reporting software.
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.
31
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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
checking, money market and savings 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 matters of significant judgment and, therefore, cannot
be determined with precision. Changes in assumptions could significantly
affect these estimates.
Effect of New Accounting Standards:
The Accounting Standards Executive Committee has issued Statement of Position
03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer.
This Statement applies to all loans acquired in a transfer, including those
acquired in the acquisition of a bank or a branch, and provides that such loans
be accounted for at fair value with no allowance for loan losses, or other
valuation allowance, permitted at the time of acquisition. The difference
between cash flows expected at the acquisition date and the investment in the
loan should be recognized as interest income over the life of the loan. If
contractually required payments for principal and interest are less than
expected cash flows, this amount should not be recognized as a yield adjustment,
a loss accrual, or a valuation allowance. For the Company, this Statement is
effective for fiscal year 2006 and, early adoption, although permitted, is not
planned. No significant impact is expected on the Company's consolidated
financial statements at the time of adoption.
On March 9, 2004 Securities and Exchange Commission Staff Accounting Bulletin
105 ("SAB 105"), Application of Accounting Principles to Loan Commitments, was
issued. SAB 105 summarizes the views of the Staff regarding the application of
generally accepted accounting principles to loan commitments accounted for as
derivative instruments. It is anticipated that the adoption of the guidance in
SAB 105 for all new loan commitments signed after April 1, 2004 will not have a
material effect on the Company's financial position, liquidity or results of
operations.
32
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Securities
Following is a schedule of amortized costs and estimated fair values as of June
30, 2004 and 2003:
2004
-----------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains (Losses) Fair Value
-----------------------------------------------------------------------
Available-for-sale:
Mortgage-backed securities:
Governmental National Mortgage
Association (GNMA) $ 11,950,908 $ 4,828 $ (347,860) $ 11,607,876
Federal Home Loan Mortgage
Association (FHLMC) 7,145,615 39,063 (46,830) 7,137,848
Federal National Mortgage
Association (FNMA) 5,746,287 32,813 (46,073) 5,733,027
United States treasury securities 7,910,113 -- (67,925) 7,842,188
United States government agency securities 9,077,741 -- (139,616) 8,938,125
Investments in mutual funds 30,154,923 -- (151,669) 30,003,254
Other investment securities 13,232,388 268,603 (69,977) 13,431,014
-----------------------------------------------------------------------
$ 85,217,975 $ 345,307 $ (869,950) $ 84,693,332
=======================================================================
Held-to-maturity:
Mortgage-backed securities:
GNMA $ 360,887 $ 26,924 $ -- $ 387,811
FHLMC 2,548,433 49,323 -- 2,597,756
FNMA 9,201,034 335,103 -- 9,536,137
Local government securities 9,575,141 205,607 (46,530) 9,734,218
Other investment securities 1,500,404 5,746 -- 1,506,150
-----------------------------------------------------------------------
$ 23,185,899 $ 622,703 $ (46,530) $ 23,762,072
=======================================================================
33
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2004
-----------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains (Losses) Fair Value
-----------------------------------------------------------------------
Available-for-sale:
Mortgage-backed securities:
Governmental 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
=======================================================================
The amortized cost and fair value at June 30, 2004 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
------------------------------- --------------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
------------------------------- --------------------------------
Due in 1 year or less $ 30,154,923 $ 30,003,254 $ 2,165,404 $ 2,184,371
Due after 1 year through 5 years 16,987,854 16,780,313 2,668,116 2,733,509
Due after 5 years through 10 years 1,500,000 1,500,000 2,391,325 2,457,710
Due after 10 years 11,732,388 11,931,014 3,850,700 3,864,778
------------------------------- --------------------------------
60,375,165 60,214,581 11,075,545 11,240,368
Mortgage-backed securities 24,842,810 24,478,751 12,110,354 12,521,704
------------------------------- --------------------------------
$ 85,217,975 $ 84,693,332 $ 23,185,899 $ 23,762,072
=============================== ================================
34
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Proceeds from the sale of securities available for sale were $13,585,515,
$36,421,869 and $14,442,044 during 2004, 2003 and 2002, respectively. Gross
realized gains on these sales were $0, $322,226 and $155,960 and gross realized
losses on these sales were $64,797, $13,600 and $53,132 in 2004, 2003 and 2002,
respectively.
Securities with an amortized cost of $8.1 million and an estimated fair value of
approximately $8.1 million at June 30, 2004 were pledged to various entities and
depositors.
The following table shows the fair value and gross unrealized losses, aggregated
by investment category and length of time that individual securities have been
in a continuous loss position, at June 30, 2004.
Less than 12 months 12 months or longer Total
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value (Losses) Value (Losses) Value (Losses)
-------------------------- -------------------------- --------------------------
United States treasury securities $ 7,842,187 $ (67,925) $ -- $ -- $ 7,842,187 $ (67,925)
United States government
agency securities 8,938,125 (139,616) -- -- 8,938,125 (139,616)
Local government securities 3,232,374 (73,257) 363,125 (12,867) 3,595,499 (86,124)
Mutual fund investments 30,003,254 (151,669) -- -- 30,003,254 (151,669)
Other investment securities 5,768,331 (30,383) -- -- 5,768,331 (30,383)
-------------------------- -------------------------- --------------------------
$ 55,784,271 $ (462,850) $ 363,125 $ (12,867) $ 56,147,396 $ (475,717)
========================== ========================== ==========================
As of June 30, 2004, the investment portfolio included one municipal bond with a
current unrealized loss which has existed for longer than one year. The bond
resides in the Company's held to maturity portfolio and is an obligation of an
Illinois community considered to be an acceptable credit risk. The carrying
amount of this bond is not considered permanently impaired as of June 30, 2004
due to the Company's intent and ability to hold it until final maturity and the
perceived credit-worthiness of the municipality which is rated A3 (high quality)
by Moody's.
35
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. Loans receivable
Loans receivable at June 30, 2004 and 2003 are summarized as follows:
2004 2003
-------------------------------
First mortgage loans:
Secured by one to four family residences $ 164,578,993 $ 191,890,309
Secured by other properties 146,452,772 113,115,061
Home equity and second mortgage loans 38,377,251 36,962,433
Automobile loans 17,755,328 26,291,962
Commercial business loans 29,633,251 16,255,976
Other nonmortgage loans 39,785,522 35,587,669
-------------------------------
436,583,117 420,103,410
Less:
Allowance for loan losses (Note 4) 4,316,286 4,615,285
Undisbursed portion of loans in process 800,838 409,867
Net unearned premiums on loans (1,880,738) (1,965,046)
Deferred loan fees 1,489,237 1,776,151
-------------------------------
$ 431,857,494 $ 415,267,153
===============================
At June 30, 2004, 2003 and 2002, the Company had nonaccrual loans of $2,991,000,
$3,691,000 and $5,106,000, respectively, and restructured loans of $3,691,000,
$3,005,000 and $393,000, respectively. Interest income recorded during 2004,
2003 and 2002 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
$129,046 in 2004, $238,531 in 2003 and $313,300 in 2002.
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, 2004.
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balance of
these loans was $66,713,000, $50,794,000 and $98,772,000 at June 30, 2004, 2003
and 2002, 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 $477,000, $430,000 and $648,000 at June 30,
2004, 2003 and 2002, respectively.
36
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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
$42.5 million at June 30, 2004, and included approximately $14.2 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 concentration in Colorado with $25.4 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. The aggregate
principal balance of loans purchased from this firm declined to $6.2 million at
June 30, 2004 from $20.9 million at June 30, 2003.
The Company's commercial mortgage loan portfolio consists of $81.8 million of
commercial real estate loans, $38.5 million of multi-family housing loans, and
$26.2 million of construction, land acquisition and development loans as of June
30, 2004.
Note 4. Allowance for Loan Losses
A summary of the allowance for loan losses follows:
2004 2003 2002
-------------------------------------------
Balance, beginning of year $ 4,615,285 $ 4,583,897 $ 4,736,738
Provision for losses 1,225,000 1,730,000 3,835,000
Charge-offs (1,652,716) (2,064,179) (4,200,710)
Recoveries 128,717 365,567 212,869
-------------------------------------------
Balance, ending of year $ 4,316,286 $ 4,615,285 $ 4,583,897
===========================================
37
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 5. Office Property and Equipment
At June 30, 2004 and 2003, the cost and accumulated depreciation of office
property and equipment were as follows:
2004 2003
--------------------------
Office property and equipment:
Land and improvements $ 3,667,038 $ 3,688,053
Building and improvements 13,016,637 12,996,431
Furniture, fixtures, automobiles, software and equipment 6,985,556 6,503,059
Deposits on assets not in service 111,386 10,225
--------------------------
Total cost 23,780,617 23,197,768
Less accumulated depreciation 10,503,783 10,031,964
--------------------------
Office property and equipment, net $13,276,834 $13,165,804
==========================
Depreciation expense on premises, furniture, fixtures, automobiles, software,
and equipment was $1,085,977, $1,059,949 and $1,226,043 for fiscal 2004, 2003
and 2002, respectively.
Note 6. Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
2004 2003
-----------------------------
Loans receivable $1,724,717 $1,809,657
Securities 505,336 678,803
-----------------------------
$2,230,053 $2,488,460
=============================
38
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 7. Intangible Assets
The gross carrying amount of intangible assets subject to amortization and the
associated accumulated amortization at June 30, 2004 is presented in the table
below. Amortization expense for intangible assets was $60,482, $398,770 and
$428,198 for fiscal 2004, 2003 and 2002, respectively.
2004
--------------------------------------------------
Gross Unamortized
Carrying Accumulated Intangible
Amount Amortization Assets
--------------------------------------------------
Intangible assets:
Core deposit premium $ 690,140 $ 476,044 $ 214,096
Mortgage servicing rights 268,379 8,108 260,271
--------------------------------------------------
$ 958,519 $ 484,152 $ 474,367
==================================================
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 --
--------------------------------------------------
$1,390,390 $1,123,920 $ 266,470
==================================================
Projections of amortization expense are based on existing asset balances and the
existing interest rate environment as of June 30, 2004. 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 Mortgage
Premium Servicing Rights Total
-------------------------------------------
2005 $ 45,396 $ 34,831 $ 80,227
2006 44,604 40,361 84,965
2007 44,604 35,983 80,587
2008 44,604 30,536 75,140
2009 34,888 25,611 60,499
Thereafter -- 92,949 92,949
-----------------------------------------
Total estimated amortization expense $214,096 $260,271 $474,367
=========================================
39
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Deposits
At June 30, 2004 and 2003, deposits are summarized as follows:
2004 2003
----------------------------
Noninterest-bearing checking $ 36,408,235 $ 20,302,813
Interest-bearing checking accounts 49,338,938 71,453,575
Money market accounts 84,521,513 86,910,959
Savings accounts 35,862,059 33,958,843
Certificates of deposit 223,078,183 236,317,849
----------------------------
$429,208,928 $448,944,039
============================
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $32.5 million and $24.8 million at June 30, 2004 and
2003, respectively.
At June 30, 2004, the scheduled maturities of certificates of deposit were as
follows:
2005 $114,835,724
2006 56,117,808
2007 34,026,398
2008 16,110,478
2009 1,852,750
Thereafter 135,025
------------
$223,078,183
============
Interest expense on deposits is summarized as follows:
2004 2003 2002
-----------------------------------------
Interest-bearing checking accounts $ 113,276 $ 140,156 $ 463,952
Money market accounts 573,890 1,060,596 2,312,702
Savings accounts 73,489 92,585 247,323
Certificates of deposit 6,966,890 9,770,223 14,912,975
-----------------------------------------
$ 7,727,545 $11,063,560 $17,936,952
=========================================
At June 30, 2004 and 2003, accrued interest payable on deposits totaled
$1,197,413 and $1,784,660, respectively.
40
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Advances from FHLB
A summary at June 30, 2004 and 2003 follows:
Weighted Weighted
Average Average
Interest Interest
Rate 2004 Rate 2003
-----------------------------------------------------
FHLB of Des Moines (A)
Stated maturity in fiscal year ending June 30:
2004 --% $ -- 4.35% $ 9,000,000
2005 3.20 12,500,000 3.20 12,500,000
2006 2.85 17,000,000 3.57 8,000,000
2007 3.35 20,500,000 3.64 12,500,000
2008 (B) 4.98 32,000,000 5.14 29,000,000
2009 (B) 5.21 24,500,000 5.21 24,500,000
Thereafter (B) 5.49 3,000,000 5.49 3,000,000
------------ ------------
109,500,000 98,500,000
Amortizing advances (C) -- 5.25 3,886,888
Fed Funds advance with FHLB (D) -- --
------------ ------------
$109,500,000 $102,386,888
============ ============
(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 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, 2004 $51.0 million of convertible advances with a
weighted average interest rate of 5.32% are callable quarterly. At June
30, 2003 the same convertible advances were callable in fiscal 2004 after
the expiration of the remaining initial lock-out periods in October 2003.
(C) Amortizing advances are advances that amortize over a 15 year period
matched to a weighted average rate of comparable FHLB bonds.
(D) 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 2004, the Company's average outstanding balance of
Fed Funds Advances was $5.7 million and the interest rate at which these
advances repriced ranged from 1.11% to 1.63%. Fed Funds Advances are
collateralized as described in (A) above.
At June 30, 2004 and 2003, accrued interest payable on advances from FHLB
totaled $9,581 and $10,688, respectively.
41
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 10. Taxes on Income
Taxes on income for the years ended June 30, 2004, 2003 and 2002 were comprised
as follows:
Current Deferred Total
-----------------------------------------------
2004:
Federal $ 2,208,000 $ 169,000 $ 2,377,000
State 391,000 20,000 411,000
-----------------------------------------------
$ 2,599,000 $ 189,000 $ 2,788,000
===============================================
2003:
Federal $ 3,021,000 $ (646,000) $ 2,375,000
State 519,000 (100,000) 419,000
-----------------------------------------------
$ 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
-----------------------------------------------
$ 1,592,000 $ 104,000 $ 1,696,000
===============================================
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:
2004 2003 2002
-------------------------------------------
Computed "expected" tax expense $ 2,857,999 $ 2,855,802 $ 1,770,073
Nontaxable income (374,561) (297,683) (234,313)
State income taxes 227,895 276,540 173,580
Other, net 76,667 (40,659) (13,340)
-------------------------------------------
$ 2,788,000 $ 2,794,000 $ 1,696,000
===========================================
42
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Tax effects of temporary differences that give rise to significant portions of
the deferred tax assets and deferred tax liabilities at June 30, 2004 and 2003
are presented below:
2004 2003
---------------------------
Deferred tax assets:
Allowance for loan losses $ 1,184,000 $ 1,025,000
Deferred compensation 110,000 140,000
Accrued vacation pay 112,000 120,000
Deferred directors fees 155,000 145,000
Reserve for uncollected interest 19,000 127,000
Unrealized loss on securities available-for-sale 195,000 --
Other 16,000 51,000
---------------------------
Total gross deferred tax assets 1,791,000 1,608,000
---------------------------
Deferred tax liabilities:
FHLB stock dividends (347,000) (347,000)
Fixed assets (324,000) (215,000)
Mortgage servicing rights (97,000) --
Unrealized gain on securities available-for-sale -- (423,000)
Purchase accounting adjustments (80,000) (99,000)
Bad debt reserves in excess of base year -- (10,000)
---------------------------
Total gross deferred tax liabilities (848,000) (1,094,000)
---------------------------
Net deferred tax asset $ 943,000 $ 514,000
===========================
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.
Note 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. Pension expense for fiscal 2004 and 2003 totaled $686,000 and
$340,000, respectively. 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 expense in fiscal 2002 because
the plan was fully funded.
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, 2004, 2003 and 2002 was $60,489, $51,991 and $48,265,
respectively.
43
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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, 2004 and 2003, allocated shares were 159,530 and 156,234,
respectively. Shares committed to be released were 7,072 and 7,118,
respectively. The fair value of the 104,471 and 118,570 unallocated shares was
approximately $2.4 million and $2.1 million, respectively.
Plan expense was $311,288, $217,928 and $180,581 for the years ended June 30,
2004, 2003 and 2002, respectively. Interest expense was $88,590, $96,959 and
$105,566 on the Plan's borrowing for the years ended June 30, 2004, 2003 and
2002, respectively.
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.
44
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Changes in options outstanding and exercisable during 2004, 2003 and 2002 were
as follows:
Exercisable Outstanding Option Price
Options Options Per Share
------------------------------------------------------
June 30, 2001 73,991 262,390 3.066 - 20.341
Granted -- 2,000 11.00
Forfeited (500) (22,200) 9.00
Vested 47,000 -- 7.6875 - 9.25
Exchange of shares (335) (335) 12.00
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) 9.00
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
Granted -- 5,000 20.85 - 22.00
Forfeited (1,647) (3,047) 9.25 - 20.341
Vested 41,699 -- 7.6875 - 14.41
Exercised (42,405) (42,405) 7.6875 - 11.00
----------------------------
June 30, 2004 109,578 170,678 7.6875 - 22.00
============================
The weighted-average fair value per option of options granted during fiscal
years 2004, 2003 and 2002 was $6.09, $3.63 and $2.84, respectively.
45
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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, 2004, 2003 and 2002 was
$28,590, $80,235 and $106,735, respectively.
Changes in the number of recognition and retention plan shares awarded under the
Plan and yet to vest were as follows:
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
Granted --
Forfeited (2,800)
Vested (11,800)
-------
June 30, 2004 14,400
=======
Note 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 $1.5 million and $1.2
million, respectively, at June 30, 2004 and 2003. During the year ended June 30,
2004, total principal additions were $384,000 and total principal payments were
$69,000.
Deposits from related parties held by the Bank at June 30, 2004 and 2003
amounted to $8.8 million and $4.0 million, respectively.
Note 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.
46
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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.
The Bank met all regulatory capital requirements at June 30, 2004 and 2003.
The Bank's actual and required capital amounts and ratios as of June 30, 2004
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 $47,689,000 8.01% $ 8,934,000 1.50% $ -- --%
Tier 1 leverage (core) 47,689,000 8.01 17,867,000 3.00 29,779,000 5.00
Tier 1 risk-based capital 47,689,000 10.93 17,280,000 4.00 25,919,000 6.00
Risk-based capital 52,005,000 11.92 34,905,000 8.00 43,631,000 10.00
Retained earnings at June 30, 2004 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.
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.
47
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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 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.
Note 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, 2004 and 2003, the Company had commitments to originate and purchase
loans approximating $50,693,000 and $44,442,000, 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
$18,027,000 and $7,905,000 at June 30, 2004 and 2003, respectively. The Company
had approved, but unused, commercial lines of credit of approximately
$13,924,000 and $7,561,000 at June 30, 2004 and 2003, respectively.
At June 30, 2004 and 2003, the Company had commitments to sell loans
approximating $4,565,000 and $2,212,000, respectively.
48
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 15. Fair Value of Financial Instruments
The estimated fair values of Company's financial instruments (as described in
note 1) were as follows:
2004 2003
-------------------------------- --------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------------------------------------------------------------
Financial assets:
Cash and due from banks $ 16,574,986 $ 16,574,986 $ 34,006,405 $ 34,006,405
Interest-bearing deposits in other
financial institutions 2,282,875 2,282,875 280,548 280,548
Investment securities available-for-sale 84,693,332 84,693,332 78,526,104 78,526,104
Investment securities held-to-maturity 23,185,899 23,762,072 44,505,464 45,659,510
Loans receivable, net 431,857,494 427,438,000 415,267,153 422,213,000
FHLB stock 6,096,100 6,096,100 5,707,300 5,707,300
Accrued interest receivable 2,230,053 2,230,053 2,488,460 2,488,460
Financial liabilities:
Deposits $ 429,208,928 $ 432,972,000 $ 448,944,039 $ 456,585,000
Advances from FHLB and other borrowings 109,886,261 113,174,000 102,386,888 111,368,000
Advance payments by borrowers for
taxes and insurance 1,119,486 1,119,486 1,458,955 1,458,955
Accrued interest payable 1,206,994 1,206,994 1,795,348 1,795,348
2004 2003
-------------------------------- --------------------------------
Notional Unrealized Notional Unrealized
Amount Gain (loss) Amount Gain (loss)
---------------------------------------------------------------------
Off-balance-sheet assets (liabilities):
Commitments to extend credit $ 50,693,000 $ -- $ 44,442,000 $ --
Consumer lines of credit 18,027,000 -- 7,905,000 --
Commercial lines of credit 13,924,000 -- 7,561,000 --
Commitments to sell loans (4,565,000) -- (2,212,000) --
Note 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.
Note 17. Subsequent event
On June 29, 2004, First Federal Bank, a wholly-owned subsidiary of the Company,
and Iowa State Bank, Orange City, Iowa entered into a definitive agreement
providing for the sale of the Bank's branch offices located in Orange City, Iowa
and Sheldon, Iowa. The transaction is expected to be completed on or about
September 20, 2004. Deposits totaling approximately $27.9 million and loans
totaling approximately $17.1 million are included in the sale. The gain on the
sale of such branches is expected to range from $2.0 million to $2.5 million.
49
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Information
Condensed statements of financial condition at June 30, 2004 and 2003 and
condensed statements of income and cash flows for the years ended June 30, 2004,
2003 and 2002 are shown below for First Federal Bankshares, Inc.:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
2004 2003
ASSETS
Cash deposited at First Federal Bank $ 3,366,634 $ 1,901,009
Interest-bearing deposits in other financial institutions 316,167 454,423
------------------------------
Cash and cash equivalents 3,682,801 2,355,432
Investment securities available-for-sale at fair value 700,300 646,671
Loans receivable, net 1,329,806 1,454,362
Investment in subsidiaries 65,770,034 65,296,504
Refundable income taxes 99,371 37,816
Other assets 19,604 15,217
------------------------------
Total assets $ 71,601,916 $ 69,806,002
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deferred tax liability $ 74,000 $ 64,000
Accrued expenses and other liabilities 70,194 80,637
------------------------------
Total liabilities 144,194 144,637
------------------------------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 1,000,000 shares; issued none -- --
Common stock, $.01 par value, authorized 12,000,000 shares;
issued and outstanding 2004 4,939,262 shares; 2003 4,896,857 shares 49,393 48,969
Additional paid-in capital 37,086,235 36,537,133
Retained earnings 52,240,273 47,900,781
Treasury stock (16,519,093) (14,264,674)
Accumulated other comprehensive income (loss), net unrealized
gain (loss) on securities available-for-sale (329,644) 710,378
Unearned ESOP (1,044,710) (1,185,700)
Unearned RRP (24,732) (85,522)
------------------------------
Total stockholders' equity 71,457,722 69,661,365
------------------------------
Total liabilities and stockholders' equity $ 71,601,916 $ 69,806,002
==============================
50
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
CONDENSED STATEMENTS OF INCOME
2004 2003 2002
---------------------------------------------
Interest income:
Loans receivable $ 113,802 $ 100,677 $ 105,566
Investment securities 46,798 45,743 105,842
Other interest-earning assets 45,041 10,326 12,203
Gain (loss) on sale of investment securities -- 221,143 (25,332)
Other income 34,420 -- --
Other general and administrative expenses (307,572) (409,753) (367,717)
---------------------------------------------
(Losses) before income taxes (67,511) (31,864) (169,438)
Taxes on income 28,000 10,000 72,000
---------------------------------------------
(Losses) before subsidiary income (39,511) (21,864) (97,438)
Equity in earnings of subsidiaries 5,657,391 5,627,281 3,607,486
---------------------------------------------
Net income $ 5,617,880 $ 5,605,417 $ 3,510,048
=============================================
51
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
2004 2003 2002
------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,617,880 $ 5,605,417 $ 3,510,098
Adjustments to net income:
Equity in earnings of subsidiaries (5,657,391) (5,627,281) (3,607,486)
Net (gain) loss on sale of securities available-for-sale -- (221,143) 25,332
Increase (decrease) in income tax payable (61,555) (16,823) 27,264
(Increase) decrease in other assets (4,387) 620 42,849
Amortization of premiums and discounts (3,029) 53,915 66,236
Decrease in accrued interest receivable -- -- 12,498
Increase (decrease) in accrued expense and other liabilities (10,443) 32,973 21,376
------------------------------------------------
Net cash provided by (used in)
operating activities (118,925) (172,322) 98,167
------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available-for-sale -- 2,646,855 2,960,168
Purchase of investment securities available-for-sale -- (17,823) (2,867,021)
(Increase) decrease in loans receivable 124,556 (23,337) 122,966
Dividends received from subsidiaries 4,443,117 7,435,426 4,545,536
------------------------------------------------
Net cash provided by investing activities 4,567,673 10,041,121 4,761,649
------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of common stock 386,228 206,550 140,993
Purchase of common stock (2,229,219) (6,685,228) (4,772,014)
Cash dividends paid (1,278,388) (1,246,935) (1,325,334)
------------------------------------------------
Net cash provided by (used in)
financing activities (3,121,379) (7,725,613) (5,956,355)
------------------------------------------------
Net increase (decrease) in cash and
cash equivalents 1,327,369 2,143,186 (1,096,539)
CASH AND CASH EQUIVALENTS
Beginning 2,355,432 212,246 1,308,785
------------------------------------------------
Ending $ 3,682,801 $ 2,355,432 $ 212,246
================================================
52