Exhibit 13
1997 Annual Report to Stockholders
HARRINGTON FINANCIAL GROUP, INC.
1997 ANNUAL REPORT
CONTENTS
Financial Highlights
Selected Consolidated Financial Data
Management's Discussion and Analysis
of Financial Condition and Results
of Operations
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Independent Auditors' Report
Financial Highlights
(Dollars in thousands except per share amounts)
For the Years Ended June 30, 1997 1996
- ---------------------------- ---------- ----------
Net interest income $ 8,066 $ 5,480
Income before tax provision and gain (loss) on securities 2,769 1,997
Net realized and unrealized gain (loss) on securities 494
Special SAIF assessment 830 0
Net income 2,002 1,223
Return on average assets before special SAIF assessment 0.50% 0.37%
Return on average assets after special SAIF assessment 0.39% 0.37%
Return on average equity before special SAIF assessment 10.52% 9.49%
Return on average equity after special SAIF assessment 8.34% 9.49%
At June 30
Total assets $ 446,797 $ 418,196
Total loans 93,958 65,925
Total securities 318,480 321,897
Total deposits 136,175 135,143
Stockholders' equity 24,994 23,117
Common shares outstanding 3,256,738 3,256,738
Average Balances
Assets $ 507,407 $ 329,938
Loans 78,545 52,399
Core retail deposits 116,210 92,931
Other deposits 20,592 32,562
Total deposits 136,802 125,493
Per Share
Net income $ 0.61 $ 0.57
After tax income excluding special SAIF assessment 0.78 0.57
Book value, fiscal year end 7.67 7.10
Market price, fiscal year end 12.125 10.50
Asset Quality at June 30
Non-performing assets to total assets 0.25% 0.32%
Loan loss reserves to non-performing loans 63.39% 45.98%
Capital Ratios at June 30 (Harrington Bank)
Tangible capital 6.96% 6.27%
Core capital 6.96% 6.27%
Risk-based capital 31.14% 30.10%
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial and other
data of the Company for the five years in the period ended June 30, 1997. The
selected consolidated financial data should be read in conjunction with the
Consolidated Financial Statements of the Company, including the accompanying
Notes, presented elsewhere herein.
(Dollars in thousands, except per share data)
At or For the Year Ended June 30, 1997 1996 1995 1994 1993
- --------------------------------- ---- ---- ---- ---- ----
Balance Sheet Data
Securities held for trading and available for sale $ 318,480 $ 321,897 $ 249,274 $ 174,347 $ 186,582
Loans receivable-net 93,958 65,925 37,010 20,682 16,620
Total assets 446,797 418,196 300,174 211,688 220,095
Deposits 136,175 135,143 115,312 108,300 89,788
Securities sold under agreements to repurchase 245,571 219,067 130,217 54,651 83,709
Federal Home Loan Bank advances 26,000 26,000 31,000 31,000 31,000
Note payable 9,995 8,998 9,200 7,880 7,431
Stockholders' equity 24,994 23,117 10,361 5,926 5,294
Stockholders' equity per share 7.67 7.10 5.28 4.20 3.75
Income Statement Data
Interest income $ 34,474 $ 23,484 $ 17,560 $ 13,607 $ 12,746
Interest expense 26,408 18,004 12,779 8,284 8,975
--------- --------- --------- --------- ---------
Net interest income 8,066 5,480 4,781 5,323 3,771
Provision for loan losses 92 (1) 15 (3) 66
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 7,974 5,481 4,766 5,326 3,705
Retail banking fees and other income 239 256 238 267 249
--------- --------- --------- --------- ---------
Total net revenue 8,213 5,737 5,004 5,593 3,954
Operating expenses 5,444 3,740 3,167 2,519 2,749(2)
--------- --------- --------- --------- ---------
Income before tax provision and gain (loss) on securities 2,769 1,997 1,837 3,074 1,205
--------- --------- --------- --------- ---------
Gain (loss) on sale of securities held for trading (1,623) 1,834 66 (2,169) --
Gain on sale of securities available for sale -- -- -- 392 1,384
Unrealized gain (loss) on securities held for trading 2,117 (1,960) 1,535 710 --
Permanent impairment of securities available for sale -- -- (414) (610) (2,531)
--------- --------- --------- --------- ---------
Net gain (loss) on securities 494 (126) 1,187 (1,677) (1,147)
--------- --------- --------- --------- ---------
At or For the Year Ended June 30, 1997 1996 1995 1994 1993
- --------------------------------- ---- ---- ---- ---- ----
Income before income tax provision and cumulative effect
of change in accounting for deferred income taxes 3,263 1,871 3,024 1,397 58
Income tax provision 1,261 648 1,171 391 188
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect of change in
accounting for deferred income taxes 2,002 1,223 1,853 1,006 (130)
Cumulative effect of change in accounting for deferred
income taxes (3) -- -- -- (79) --
--------- --------- --------- --------- ---------
Net income (loss) $ 2,002 $ 1,223 $ 1,853 $ 927 $ (130)
========= ========= ========= ========= =========
Net income (loss) per share $ 0.61 $ 0.57 $ 1.20 $ 0.66 $ (0.09)
========= ========= ========= ========= =========
Cash dividends per share $ 0.03 N/A N/A N/A N/A
========= ========= ========= ========= =========
Performance Ratios
Return on average assets (4) 0.50% 0.37% 0.76% 0.44% -0.06%
Return on average equity (4) 10.52 9.49 22.24 14.98 -2.67
Interest rate spread 1.43 1.64 2.13 2.63 1.79
Net interest margin 1.62 1.73 2.10 2.64 1.81
Average interest-earning assets to average interest
bearing liabilities 103.67 101.55 99.57 100.25 100.39
Net interest income after provision for loan losses to total
other expenses (4) 172.82 146.55 150.49 211.43 134.78
Total other expenses to average total assets (4) 0.91 1.13 1.30 1.19 1.27
Full service offices 4 3 2 2 1
Asset Quality Ratios (at end of period)
Non-performing loans to total loans (5) 0.36 0.40 0.95 2.70 3.00
Non-performing assets to total assets (5) 0.25 0.32 0.59 1.34 0.24
Allowance for loan losses to total loans 0.23 0.18 0.33 0.51 0.94
Allowance for loan losses to total non-performing loans 63.39 45.98 34.57 18.96 29.71
Capital Ratios (6)
Tangible capital ratio 6.96 6.27 6.12 6.07 5.58
Core capital ratio 6.96 6.27 6.12 6.07 5.58
Risk-based capital ratio 31.14 30.10 24.62 21.40 18.56
Equity to assets at end of period 5.59 5.53 3.45 2.80 2.41
(1) On May 6, 1996, the Company sold 1,265,000 shares of common stock at $10.00
per share to investors in an initial public offering resulting in gross
proceeds of $12,650,000 to the Company. Net proceeds after offering
expenses were $11,437,000.
(2) Includes a write-off of goodwill and core deposit of $663,000.
(3) Reflects the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes," effective July
1, 1993.
(4) For comparability purposes, the 1997 fiscal year ratios exclude the effect
of the special SAIF assessment of $830,000.
(5) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, real estate acquired by foreclosure or
deed-in-lieu thereof and a single non-agency participation certificate
classified as substandard.
(6) Regulatory capital ratios apply to the Bank (Harrington Bank, FSB) as a
federally chartered savings bank.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Harrington Financial Group, Inc. ("Harrington" or the "Company") is an
Indiana-chartered, registered thrift holding company for Harrington Bank, FSB
(the "Bank"). The following financial review presents an analysis of the
Company's operations and financial position for the periods presented in this
annual report.
GENERAL
Harrington's business strategy focuses on achieving attractive returns
consistent with prudent risk management. Harrington has sought to implement this
strategy by (i) controlling interest rate risk by using interest rate risk
management contracts to match the interest rate sensitivity of its assets to
that of its liabilities; (ii) controlling credit risk by maintaining a
substantial portion of the Company's assets in mortgage-backed and related
securities and single-family residential loans; (iii) expanding its retail
banking locations and product offerings in order to build a strong retail
franchise; and (iv) the pursuit of acquisition opportunities when appropriate.
Harrington invests primarily in mortgage-backed and related securities
and originates (both directly and through correspondents) loans secured by
single-family residences located primarily in Indiana. While Harrington has
greatly expanded its portfolio of originated mortgage loans, over 70% of its
assets currently consist of purchased mortgage-backed and related securities.
Although mortgage-backed securities often carry lower yields than traditional
mortgage loans, such securities generally increase the quality of the Company's
assets by virtue of the securities' underlying insurance or guarantees, are more
liquid than individual mortgage loans and may be used to collateralize
borrowings or other obligations of the Company. Management believes that the
lower operating expenses and reduced credit and interest rate risk associated
with the investment in securities have enhanced Harrington's overall
profitability as well as its ability to remain profitable over a variety of
interest rate scenarios. In addition, the funds invested in the securities
portfolio can be quickly redeployed to pursue retail expansion opportunities as
they arise.
Harrington's funding strategy focuses on accessing cost-efficient
funding sources, including securities sold under agreements to repurchase,
retail and non-retail deposits and FHLB advances. The Company continues to build
a community-oriented retail banking operation in order to sustain loan
originations and deposit growth, benefit from economies of scale, and generate
additional fee income. Management's primary goal is to increase stockholders'
value, as measured on a risk-adjusted total return basis.
To reduce the institution's exposure to interest rate risk, the Company
utilizes interest rate risk management contracts and mortgage-backed derivative
securities in conjunction with regular adjustments to the composition of the
Company's investment portfolio. Harrington marks a substantial portion of its
assets and interest rate contracts to market in order to fully account for the
market value changes in the Company's investment portfolio. This method of
accounting is consistent with Harrington's strategy of active portfolio
management and provides the Company with the flexibility to quickly adjust the
mix of its interest-earning assets in response to changing market conditions or
to take advantage of retail growth opportunities.
The Company recognizes that marking substantially all of its assets to
market subjects Harrington to potential earnings volatility. Market value
volatility is not unique to Harrington as most unhedged financial institutions
have even greater volatility in market values. The difference is that Harrington
reflects the changes in market values directly in earnings, while most other
institutions do not.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
In addition to historical information, forwarding-looking statements
are contained herein that are subject to risks and uncertainties that could
cause actual results to differ materially from those reflected in the
forward-looking statements. Factors that could cause future results to vary from
current expectations, include, but are not limited to, the impact of economic
conditions (both generally and more specifically in the markets in which
Harrington operates), the impact of competition for Harrington's customers from
other providers of financial services, the impact of government legislation and
regulation (which changes from time to time and over which Harrington has no
control), and other risks detailed in this Annual Report and in Harrington's
other Securities and Exchange Commission filings. Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. Harrington undertakes no
obligation to publicly revise these forward-looking statements, to reflect
events or circumstances that arise after the date hereof. Readers should
carefully review the risk factors described in other documents Harrington files
from time to time with the Securities and Exchange Commission, including the
Quarterly Reports on Form 10-Q to be filed by Harrington in 1997 and 1998 and
any Current Reports on Form 8-K filed by Harrington.
ASSET AND LIABILITY MANAGEMENT
In general, financial institutions are negatively affected by an
increase in interest rates to the extent that interest-bearing liabilities
mature or reprice more rapidly than interest-earning assets. The lending
activities of savings institutions have historically emphasized the origination
of long-term, fixed-rate loans secured by single-family residences, and the
primary source of funds of such institutions has been deposits, which largely
mature or are subject to repricing within a shorter period of time.
This factor has historically caused the income and market value of
portfolio equity ("MVPE") of savings institutions to be more volatile than other
financial institutions. MVPE is defined as the net present value of an
institution's existing assets, liabilities and off-balance sheet instruments.
While having liabilities that reprice more frequently than assets is generally
beneficial to net interest income and market value of portfolio equity in times
of declining interest rates, such an asset/liability mismatch is generally
detrimental during periods of rising interest rates.
The Company's management believes that its asset and liability
management strategy, as discussed below, provides Harrington with a competitive
advantage over other financial institutions. Harrington's ability to effectively
hedge its interest rate exposure through the use of various financial
instruments allows the Company to acquire loans and investments which offer
attractive net risk-adjusted spreads whether the individual loans or investments
are fixed-rate or adjustable-rate or short-term or long-term. Similarly, the
Company can choose a cost-effective source of funds and subsequently engage in
an interest rate swap or other hedging transaction so that the interest rate
sensitivities of its interest-earning assets and interest-bearing liabilities
are generally matched.
Harrington's asset and liability management strategy is formulated and
monitored by the Boards of Directors of both the Company and Bank, the Company's
wholly-owned subsidiary. The Boards' written policies and procedures are
implemented by the Investment Committee of the Bank, which is comprised of the
Chief Executive Officer, Chief Financial Officer, Chief Investment Officer, and
three outside directors. The Investment Committee meets at least monthly to
review, among other things, the sensitivity of the Bank's assets and liabilities
to interest rate changes, the book and market values of assets and liabilities
with the resulting unrealized gains and losses, the past month's purchase and
sale activity and maturities of investments and borrowings.
The Investment Committee also consults with the Chief Operating Officer
of the Bank regarding retail pricing and funding decisions with respect to the
Bank's overall asset and liability composition. In accordance therewith, the
Investment Committee reviews the Bank's liquidity, cash flow needs, interest
rate sensitivity of investments, deposits and borrowings, core deposit activity,
current market conditions and interest rates on both a local and national level.
Harrington has contracted with Smith Breeden Associates, Inc. ("Smith
Breeden") for the provision of consulting services regarding, among other
things, the management of its investments and borrowings, the pricing of loans
and deposits, and the use of various financial instruments to reduce interest
rate risk. Smith Breeden is a consulting firm which renders investment advice
and asset and liability management services to financial institutions, corporate
and government pension plans, foundations and government agencies nationally.
Certain directors of the Company and the Bank are principals of Smith Breeden.
The Investment Committee regularly reviews interest rate risk by
utilizing analyses prepared by Smith Breeden with respect to the impact of
alternative interest rate scenarios on net interest income and on the Bank's
market value of portfolio equity. The Investment Committee also reviews analyses
prepared by Smith Breeden concerning the impact of changing market volatility,
prepayment forecast error, changes in option-adjusted spreads and non-parallel
yield curve shifts.
MVPE analysis is used by regulatory authorities for assessing an
institution's interest rate risk. The extent to which assets will gain or lose
value net of the gains or losses of liabilities and/or interest rate contracts
determines the appreciation or depreciation in equity on a market-value basis.
Such market value analysis is intended to evaluate the impact of immediate and
sustained parallel interest rate shifts upon the market value of the current
balance sheet.
In the absence of the Company's hedging activities, the MVPE of the
Company would decline as a result of a general increase in market rates of
interest. This decline would be due to the market values of Harrington's assets
being generally more sensitive to interest rate fluctuations than are the market
values of the Company's liabilities due to Harrington's investment in generally
longer-term assets which are funded with shorter-term liabilities. Consequently,
the elasticity (i.e., the change in the market value of an asset or liability as
a result of a change in interest rates) of Harrington's assets is greater than
the elasticity of its liabilities.
Accordingly, the primary goal of Harrington's asset and liability
management policy is to effectively increase the elasticity of the Company's
liabilities and/or effectively contract the elasticity of the Company's assets
so that the respective elasticities are matched as closely as possible. This
elasticity adjustment can be accomplished internally by restructuring
Harrington's balance sheet, or externally by adjusting the elasticities of
Harrington's assets and/or liabilities through the use of interest rate
contracts, such as interest rate swaps, collars, caps, floors, options and
futures. Harrington's strategy is to hedge either internally through the use of
longer-term certificates of deposits, FHLB advances and mortgage-backed
derivative securities or externally through the use of various interest rate
contracts.
External hedging involves the use of interest rate swaps, collars, caps,
floors, options and futures. The notional amount of interest rate contracts
represents the underlying amount on which periodic cash flows are calculated and
exchanged between counterparties. However, this notional amount does not
necessarily represent the principal amount of securities which would effectively
be hedged by that interest rate contract.
In selecting the type and amount of interest rate contract to utilize,
the Company compares the elasticity of a particular contract to that of the
securities to be hedged. An interest rate contract with the appropriate
offsetting elasticity may have a notional amount much greater than the face
amount of the securities being hedged.
An interest rate swap is an agreement where one party (generally the
Company) agrees to pay a fixed rate of interest on a notional principal amount
to a second party (generally a broker) in exchange for receiving from the second
party a variable rate of interest on the same notional amount for a
predetermined period of time. No actual assets are exchanged in a swap of this
type and interest payments are generally netted. These swaps are generally
utilized by Harrington to synthetically convert fixed-rate assets into
adjustable-rate assets without having to sell or transfer the underlying assets.
At June 30, 1997, Harrington was a party to nine interest rate swap
agreements in its trading portfolio. The agreements had an aggregate notional
amount of $267.5 million and maturities from September 1997 to April 2001. With
respect to these agreements, Harrington makes fixed interest payments ranging
from 4.55% to 6.58% and receives payments based upon the three-month London
Interbank Offered Rate ("LIBOR").
The net expense (income) relating to Harrington's interest rate swaps
held in the trading portfolio was $330,000, $(168,000) and $(113,000) during the
years ended June 30, 1997, 1996 and 1995, respectively. The approximate market
value of the interest rate swaps which are maintained in the trading portfolio
was $581,000 and $620,000 as of June 30, 1997 and 1996, respectively.
The Company also has one swap whereby it pays a floating rate (based on
three-month LIBOR) and receives a fixed rate of 6.96%. Harrington's floating-pay
swap, which has a notional amount of $7.5 million, is not included in the
Company's trading portfolio. This swap is used to modify the interest rate
sensitivity of certain certificates of deposit issued by the Bank.
The net (income) relating to Harrington's floating-pay swaps was
$(130,000), $(129,000) and $(158,000) during the years ended June 30, 1997, 1996
and 1995, respectively. This income is netted against interest expense in the
Company's Consolidated Statements of Income. The approximate market value of the
Company's floating-pay interest rate swaps (which are not reflected in the
Company's financial statements) was $91,000 and $110,000 as of June 30, 1997 and
1996, respectively.
An interest rate cap or an interest rate floor consists of a guarantee
given by the issuer (i.e., a broker), to the purchaser (i.e., the Company), in
exchange for the payment of a premium. This guarantee states that if interest
rates rise above (in the case of a cap) or fall below (in the case of a floor) a
specified rate on a specified interest rate index, the issuer will pay to the
purchaser the difference between the then current market rate and the specified
rate on a notional principal amount. No funds are actually borrowed or repaid.
Similarly, an interest rate collar is a combination of a purchased cap
and a written floor at different strike rates. Accordingly, an interest rate
collar requires no payments if interest rates remain within a specified range,
but will require the Company to be paid if interest rates rise above the cap
rate or require the Company to pay if interest rates fall below the floor rate.
Consequently, interest rate caps are a means of reducing interest expense by
placing a ceiling on the cost of floating-rate liabilities, or offsetting the
caps on the coupons inherent in the Company's adjustable rate mortgage loans and
securities. Interest rate floors permit Harrington to maintain its desired
interest rate spread in the event that falling interest rates lead to increased
prepayments with respect to the Company's mortgage-backed and related securities
portfolio requiring reinvestment at lower rates.
At June 30, 1997, Harrington held seven interest rate cap agreements,
twelve interest rate floor agreements and one interest rate collar in its
trading portfolio. These contracts, which expire from July 1997 to June 2004,
have an aggregate notional amount of approximately $412.3 million. The interest
rate cap agreements provide for a payment, depending on the particular contract,
whenever the defined floating-rate exceeds 6.5% to 9.0%.
The interest rate floor agreements provide for a payment, depending
on the particular contract, whenever the defined floating rate is less than 5.0%
to 7.5%. The interest rate collar provides for a payment whenever the defined
floating rate is greater than 10.25% or less than 5.25%.
The aggregate net expense (income) relating to the Company's interest
rate caps, collars and floors held in the trading portfolio was $(370,000),
$(220,000) and $58,000 during the years ended June 30, 1997, 1996 and 1995,
respectively. The approximate market value of Harrington's interest rate caps,
collars and floors which are maintained in the trading portfolio was $5.1
million and $6.0 million as of June 30, 1997 and 1996, respectively.
Harrington also has one interest rate cap with a notional amount of
$30.0 million which is not held in the Company's trading portfolio. This cap,
which matures in May 2001, is triggered whenever the defined floating rate
exceeds 7.0%. The instrument is used to effectively cap at 7.0% the interest
rate on the Company's floating-rate borrowings from the FHLB. Net expense on
this cap was $178,000, $25,000 and $0 for the years ended June 30, 1997, 1996
and 1995, respectively. The approximate market value of the cap, which is not
reflected in the Company's financial statements, was $351,000 and $747,000 at
June 30, 1997 and 1996, respectively.
Interest rate futures are commitments to either purchase or sell
designated instruments at a future date for a specified price. Futures contracts
are generally traded on an exchange, are marked to market daily and are subject
to initial and maintenance margin requirements. Harrington generally uses 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off LIBOR as well as Treasury Note and Bond futures contracts.
The Company will from time to time agree to sell a specified number of contracts
at a specified date. To close out a contract, Harrington will enter into an
offsetting position to the original transaction.
If interest rates rise, the value of the Company's short futures
positions increases. Consequently, sales of futures contracts serve as a hedge
against rising interest rates. At June 30, 1997, Harrington had sold Eurodollar
and Treasury Note futures contracts with an aggregate notional amount of
approximately $1.5 billion. The Company had total gains (losses) on its futures
contracts of $(3.9) million, $1.9 million, and $(2.0) million for the fiscal
years ended June 30, 1997, 1996 and 1995, respectively.
Options are contracts which grant the purchaser the right to buy or sell
the underlying asset by a certain date for a specified price. Generally
Harrington will purchase options on financial futures to hedge the changing
elasticity exhibited by mortgage loans and mortgage-backed securities. The
changing elasticity results from the ability of a borrower to prepay a mortgage.
As market interest rates decline, borrowers are more likely to prepay their
mortgages, shortening the elasticity of the mortgages. Consequently, where
interest rates are declining, the value of mortgage loans or mortgage-backed
securities will increase at a slower rate than would be expected if borrowers
did not have the ability to prepay their mortgages.
Harrington, therefore, generally purchases out-of-the-money calls and
puts so that the increase in value of the options resulting from interest rate
movements offsets the reductions in MVPE resulting from the changing elasticity
inherent in the Company's balance sheet. At June 30, 1997, Harrington had 779
purchased options contracts with an aggregate notional amount of approximately
$77.9 million. The net expense relating to the Company's options contracts was
$770,000, $640,000, and $148,000 during the years ended June 30, 1997, 1996 and
1995, respectively. The approximate market value of the Company's options
contracts which are maintained in the trading portfolio was $24,000 and $65,000
as of June 30, 1997 and 1996, respectively.
The following table summarizes the periodic exchanges of interest
payments with counterparties including the amortization of premiums paid for
interest rate contracts as discussed above. Such payments and amortization
amounts are accounted for as adjustments to the yields of securities held for
trading, and are reported as a separate component of interest income.
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- -------------------- ----- ----- -----
Interest rate contract
(income) expense:
Swaps $ 330 $(168) $(113)
Caps, floors, and collars (370) (220) 58
Options 770 640 148
----- ----- -----
Net interest expense on
interest rate contracts $ 730 $ 252 $ 93
===== ===== =====
The above table does not include realized and unrealized gains and
losses with respect to the market value of interest rate contracts held in the
trading portfolio. Such gains and losses are generally offset by fluctuations in
the market value of the Company's assets held for trading. All realized and
unrealized gains and losses pertaining to interest rate contracts in the trading
portfolio are reported as other income in the Company's Consolidated Statements
of Income.
Harrington is subject to the risk that its counterparties with respect
to various interest rate contracts (such as swaps, collar, caps, floors, options
and futures) may default at or prior to maturity of a particular instrument. In
such a case, the Company might be unable to recover any unrealized gains with
respect to a particular contract.
To reduce this potential risk, the Company generally deals with large,
established investment brokerage firms when entering into these transactions. In
addition, if the Company enters into an interest rate contract with a non
AA-rated (or above) entity and the Company has an unrealized gain with respect
to such contract, the Company generally requires the entity to post some form of
collateral to secure its obligations. Furthermore, the Company has a policy
whereby it limits its unsecured exposure to any one counterparty to 25% of the
Bank's equity during any two-month period and 35% of the Bank's equity during
any one-month period.
The Office of Thrift Supervision ("OTS") requires each thrift
institution to calculate the estimated change in the institution's MVPE assuming
an instantaneous, parallel shift in the Treasury yield curve of 100 to 400 basis
points either up or down in 100 basis point increments. The OTS permits
institutions to perform this MVPE analysis using their own internal model based
upon reasonable assumptions. The Company retains Smith Breeden to assist in
performing the required calculation of the sensitivity of its market value to
changes in interest rates.
In estimating the market value of mortgage loans and mortgage-backed
securities, the Company utilizes various prepayment assumptions which vary, in
accordance with historical experience, based upon the term, interest rate and
other factors with respect to the underlying loans. At June 30, 1997, these
prepayment assumptions varied from 4% to 27% for fixed-rate mortgages and
mortgage-backed securities and varied from 14% to 32% for adjustable rate
mortgages and mortgage-backed securities. For deposit accounts with no defined
maturity date, the Company assumes a decay rate which ranged, at June 30, 1997,
from 5% to 70%.
The following table sets forth at June 30, 1997, the estimated
sensitivity of the Bank's MVPE to parallel yield curve shifts using Harrington's
internal market value calculation. The table demonstrates the sensitivity of the
Bank's assets and liabilities both before and after the inclusion of its
interest rate contracts.
(Dollars in thousands)
Change in
Interest Rates (In Basis Points)(1) -400 -300 -200 -100 --
-------- -------- -------- -------- ----
Market value gain (loss) of assets $ 29,306 $ 22,909 $ 17,011 $ 10,174 --
Market value gain (loss) of liabilities (7,028) (5,352) (3,657) (1,813) --
-------- -------- -------- -------- ----
Market value gain (loss) of net
assets before interest rate contracts 22,278 17,557 13,354 8,361 --
Market value gain (loss)
of interest rate contracts (11,253) (11,213) (10,372) (7,029) --
-------- -------- -------- -------- ----
Total change in MVPE(2) $ 11,025 $ 6,344 $ 2,982 $ 1,332 --
======== ======== ======== ======== ====
Change in MVPE as a percent of:
MVPE(2) 34.3% 19.8% 9.3% 4.1% --
Total assets of the Bank 2.5% 1.4% 0.7% 0.3% --
+100 +200 +300 +400
-------- -------- -------- --------
Market value gain (loss) of assets $(14,345) $(30,974) $(48,481) $(66,047)
Market value gain (loss) of liabilities 1,707 3,313 4,865 6,363
-------- -------- -------- --------
Market value gain (loss) of net
assets before interest rate contracts (12,638) (27,661) (43,616) (59,684)
Market value gain (loss)
of interest rate contracts 10,229 24,490 39,800 55,205
-------- -------- -------- --------
Total change in MVPE(2) $ (2,409) $ (3,171) $ (3,816) $ (4,479)
======== ======== ======== ========
Change in MVPE as a percent of:
MVPE(2) (7.5)% (9.9)% (11.9)% (14.0)%
Total assets of the Bank (0.5)% (0.7)% (0.9)% (1.0)%
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $32.1 million at June 30, 1997.
The table set forth above does not purport to show the impact of
interest rate changes on Harrington's equity under generally accepted accounting
principles. Market value changes only impact the Company's income statement or
the balance sheet (i) to the extent the affected instruments are marked to
market, and (ii) over the life of the instruments as an impact on recorded
yields.
Since a large portion of Harrington's assets is recorded at market
value, the following table is included to show the estimated impact on the
Company's equity of instantaneous, parallel shifts in the yield curve. The
assets and interest rate contracts included in the table below are only those
which are either classified by the Company as held for trading or available for
sale and, therefore, reflected at market value. Consequently, Harrington's
liabilities, which are reflected at cost, are not included in the table below.
All amounts are shown net of taxes, with an estimated tax rate of 39.0%.
(Dollars in thousands)
Change in
Interest Rates (In Basis Points) -400 -300 -200 -100 --
-------- -------- -------- -------- ------
After tax market value gain (loss) of assets $ 13,895 $ 10,739 $ 7,870 $ 4,654 --
After tax market value gain (loss) of
interest rate contracts (7,006) (6,890) (6,303) (4,231) --
-------- -------- -------- -------- ------
After tax gain (loss) in equity $ 6,889 $ 3,849 $ 1,567 $ 423 --
======== ======== ======== ======== ======
After tax gain (loss) in equity as a percent of the
company's equity at June 30, 1997 27.6% 15.4% 6.3% 1.7% --
(Dollars in thousands)
Change in
Interest Rates (In Basis Points) +100 +200 +300 +400
-------- -------- -------- --------
After tax market value gain (loss) of assets $ (6,703) $(14,591) $(22,963) $(31,402)
After tax market value gain (loss) of
interest rate contracts 6,052 14,414 23,346 32,322
-------- -------- -------- --------
After tax gain (loss) in equity $ (651) $ (177) $ 383 $ 920
======== ======== ======== ========
After tax gain (loss) in equity as a percent of the
company's equity at June 30, 1997 (2.6)% (0.7)% 1.5% 3.7%
CHANGES IN FINANCIAL CONDITION
General. At June 30, 1997, Harrington's total assets amounted to $446.8
million, as compared to $418.2 million at June 30, 1996. The increase in total
assets was primarily due to a $28.0 million increase in the Bank's loan
portfolio.
Cash and Interest-Bearing Deposits. Cash and interest-bearing deposits
amounted to $9.5 million and $17.1 million at June 30, 1997 and 1996,
respectively. Harrington actively manages its cash and cash equivalents based
upon the Company's operating, investing and financing activities. Based upon the
Company's current size, cash and cash equivalents generally fluctuate within a
range of $5.0 million to $20.0 million. Harrington generally attempts to invest
its excess liquidity into higher yielding assets such as loans or securities.
Securities Held for Trading and Available for Sale. In order to reduce
the Company's credit risk exposure and to earn a positive interest rate spread,
Harrington maintains a substantial portion of its assets in mortgage-backed and
related securities, which are primarily issued or guaranteed by U.S. Government
agencies or government sponsored enterprises. Almost all of these securities and
their related interest rate risk management contracts are classified as held for
trading and, pursuant to SFAS 115, are reported at fair value with unrealized
gains and losses included in earnings. The remainder of the securities are
classified as available for sale and thus also reported at fair value, but with
unrealized gains and losses excluded from earnings and reported instead as a
separate component of stockholders' equity.
Securities held for trading (consisting of mortgage-backed securities,
mortgage-backed derivative securities, interest rate contracts and equity
securities) amounted to $317.4 million and $319.8 million at June 30, 1997 and
1996, respectively. Securities classified as available for sale (consisting of a
non-agency mortgage-backed security and municipal bonds) declined from $2.1
million at June 30, 1996 to $1.1 million at June 30, 1997.
Loans Receivable. At June 30, 1997, loans receivable (net of the
Company's allowance for loan losses) amounted to $94.0 million, an increase of
42.5% over the June 30, 1996 total of $65.9 million. Harrington has
significantly increased its retail banking operations, particularly the
origination (both directly and through correspondent mortgage banking companies)
of single-family residential loans. Loans originated through correspondents must
meet the same pricing and underwriting standards as loans originated internally.
Allowance for Loan Losses. At June 30, 1997, Harrington's allowance for
loan losses totaled $213,000, compared to $120,000 at June 30, 1996. At June 30,
1997, the Company's allowance represented approximately 0.2% of the total loan
portfolio and 63.4% of total non-performing loans, as compared to 0.2% and 46.0%
at June 30, 1996. The ratio of total non-performing loans to total loans
amounted to 0.4% at June 30, 1997 and 1996, which reflects Harrington's emphasis
on maintaining low credit risk with respect to its operations.
Although Harrington management believes that its allowance for loan
losses at June 30, 1997 was adequate based on facts and circumstances available
to it (including the historically low level of loan charge-offs), there can be
no assurances that additions to the allowance will not be necessary in future
periods, which could adversely affect the Company's results of operations.
Deposits. At June 30, 1997, deposits totaled $136.2
million, as compared to $135.1 million as of June 30, 1996. Retail deposits
increased $11.1 million, from $112.4 million at June 30, 1996, to $123.5 million
at June 30, 1997, primarily due to Harrington's program of retail expansion.
Non-retail deposits declined by $10.0 million during the same period, for a
total increase in deposits of $1.1 million.
Borrowings. At June 30, 1997, reverse repurchase agreements and dollar
rolls (both of which are securities sold under agreements to repurchase and are
accounted for as a financing) totaled $245.6 million, as compared to $219.1
million as of June 30, 1996.
Advances from the FHLB of Indianapolis remained stable at $26.0 million
as of June 30, 1997 and 1996. At June 30, 1997, the FHLB advances were scheduled
to mature in fiscal 1998, with an average interest rate thereon of 5.8%, as
compared to 5.4% at June 30, 1996.
The Company's note payable amounted to $10.0 million and $9.0 million
at June 30, 1997 and 1996, respectively. The note payable relates to a loan
facility which was used to refinance, to a significant extent, the unpaid
balance of a $10.0 million acquisition loan which financed the Company's
acquisition of the Bank.
Stockholders' Equity. Stockholders' equity increased from $23.1 million
at June 30, 1996 to $25.0 million at June 30, 1997. This increase was due
primarily to $2.0 million of net income recognized during fiscal 1997, which was
partially offset by the payment of the Company's first quarterly dividend of
$.03 per share, or $98,000 in total, on May 30, 1997.
RESULTS OF OPERATIONS
Summary of Earnings. Harrington reported net income of $2.0 million or
$0.61 per share for the year ended June 30, 1997 compared to $1.2 million or
$0.57 per share for the year ended June 30, 1996. This $779,000 or 63.7%
increase in net income was due primarily to a $2.6 million increase in net
interest income, which was partially offset by a $1.7 million increase in
operating expenses which includes the Savings Association Insurance Fund
("SAIF") special assessment of $830,000, and a $613,000 increase in the income
tax provision.
Net income for the year ended June 30, 1996, was $1.2 million or $0.57
per share, compared to $1.9 million or $1.20 per share for the year ended June
30, 1995. The $630,000 or 34.0% decrease in net income was due to a $1.7 million
decrease in the net realized and unrealized gain on the trading portfolio and a
$573,000 increase in other expense, which were partially offset by a $699,000
increase in net interest income and a $523,000 decrease in the income tax
provision.
Average Balances, Net Interest Income and Yields Earned and Rates Paid.
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in dollars and rates, and the net interest margin. The table does not
reflect any effect of income taxes. All average balances are based on average
month end balances for the Company and average daily balances for the Bank
during the periods presented.
(Dollars in thousands)
Years Ended June 30, 1997 1996
- -------------------------------------------------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate
----------------------------------------------------------------------------
Interest-Earning Assets:
Interest-bearing deposits $ 22,727 $ 1,197 5.27% $ 14,520 $ 780 5.37%
Securities held for trading (2) 390,867 26,808 6.86 243,862 18,034 7.40
Securities available for sale (3) 1,375 133 9.67 2,672 194 7.26
Loans receivable, net (4) 78,545 6,087 7.75 52,399 4,276 8.16
Federal Home Loan Bank stock 3,179 249 7.83 2,533 200 7.90
-------- ------- ------ -------- ------- ------
Total interest-earning assets 496,693 34,474 6.94% 315,986 23,484 7.43%
Non-interest-earning assets 10,714 13,952
-------- --------
Total assets $507,407 $329,938
======== ========
Interest-Bearing Liabilities:
Deposits:
NOW and checking accounts $ 4,697 124 2.64% $ 3,813 110 2.88%
Savings accounts 20,463 844 4.12 15,922 613 3.85
Money market deposit accounts 1,886 82 4.35 1,777 77 4.33
Certificates of deposit 109,756 6,416 5.85 103,981 6,351 6.11
-------- ------- ------ -------- ------- ------
Total deposits 136,802 7,466 5.46 125,493 7,151 5.70
Securities sold under agreements
to repurchase 306,034 16,391 5.36 148,523 8,352 5.62
Federal Home Loan Bank advances 26,089 1,644 6.30 27,586 1,596 5.79
Note payable 10,168 907 8.92 9,553 905 9.47
-------- ------- ------ -------- ------- ------
Total interest-bearing liabilities 479,093 26,408 5.51% 311,155 18,004 5.79%
Non-interest bearing liabilities 4,307 5,894
-------- --------
Total liabilities 483,400 317,049
Stockholders' equity 24,007 12,889
-------- --------
Total liabilities and stockholders'
equity $507,407 $329,938
======== ========
Net interest income; interest
rate spread (5) $ 8,066 1.43% $ 5,480 1.64%
======= ==== ======= ====
Net interest margin (5)(6) 1.62% 1.73%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 103.67% 101.55%
====== ======
(Dollars in thousands)
Years Ended June 30, 1995
- -----------------------------------------------------------------------------
Average Yield/
Balance Interest Rate
--------------------------------
Interest-Earning Assets:
Interest-bearing deposits $ 11,493 $ 603 5.25%
Securities held for trading (2) 185,014 14,332 7.75
Securities available for sale (3) 3,110 250 8.04
Loans receivable, net (4) 25,467 2,223 8.73
Federal Home Loan Bank stock 2,172 152 7.00
-------- ------- ------
Total interest-earning assets 227,256 17,560 7.73%
Non-interest-earning assets 15,654
--------
Total assets $242,910
========
Interest-Bearing Liabilities:
Deposits:
NOW and checking accounts $$ 3,352 94 2.80%
Savings accounts 16,068 568 3.53
Money market deposit accounts 2,147 88 4.10
Certificates of deposit 99,443 5,904 5.94
-------- ------- ------
Total deposits 121,010 6,654 5.50
Securities sold under agreements
to repurchase 68,277 3,654 5.35
Federal Home Loan Bank advances 31,051 1,722 5.55
Note payable 7,890 749 9.49
-------- ------- ------
Total interest-bearing liabilities 228,228 12,779 5.60%
Non-interest bearing liabilities 6,349
--------
Total liabilities 234,577
Stockholders' equity 8,333
--------
Total liabilities and stockholders'
equity $242,910
========
Net interest income; interest
rate spread (5) $ 4,781 2.13%
======= ====
Net interest margin (5)(6) 2.10%
====
Average interest-earning assets
to average interest-bearing
liabilities 99.57%
=====
(1) At June 30, 1997, the yields earned and rates paid were as follows:
interest-bearing deposits, 5.30%; securities held for trading, 6.67%;
securities available for sale, 7.84%; loans receivable, net 7.56%; FHLB
stock, 7.73%; total interest-earning assets, 6.85%; deposits, 5.48%;
securities sold under agreements to repurchase, 5.47%; FHLB advances,
5.78%; note payable, 8.65%; total interest-bearing liabilities, 5.57%;
interest rate spread, 1.28%.
(2) Both the interest and yields earned on the Company's securities portfolio
reflect the net interest expense incurred with respect to various interest
rate contracts (such as interest rate swaps, collars, caps, floors, options
and futures) which were utilized to hedge the Company's interest rate
exposure. During the years ended June 30, 1997, 1996 and 1995, the net
costs of hedging the Company's interest rate exposure with respect to its
securities held for trading amounted to $730,000 or 0.37%, $252,000 or
0.21% and $93,000 or 0.05%, respectively.
(3) The average balance reflects the carrying value of available for sale
investments net of the average valuation allowance related to a single
non-agency participation certificate of $276,000, $447,000, and $272,000
for the years ended June 30, 1997, 1996 and 1995, respectively.
(4) Net of deferred loan fees, loan discounts and undisbursed loan funds.
Includes nonaccrual loans. Interest on nonaccrual loans is recorded when
received.
(5) Excluding the costs of hedging the Company's interest rate exposure (which
has effectively reduced the yields earned on the Company's securities
portfolio), the Company's interest rate spread amounted to 1.58%, 1.72% and
2.17%, and the Company's net interest margin amounted to 1.77%, 1.81% and
2.14% for the years ended June 30, 1997, 1996 and 1995, respectively.
(6) Net interest margin is net interest income divided by average
interest-earning assets.
Rate/Volume Analysis - The following table describes the extent to which
changes in interest rates and changes in volume of interest-related assets and
liabilities have affected the Company's interest income and interest expense
during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated in proportion to the absolute dollar amounts of the
changes due to rate and volume.
Years Ended June 30, 1997 vs. 1996 1996 vs. 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Increase Increase
(Decrease) Total (Decrease) Total
Due to Increase Due to Increase
Rate Volume Rate Volume (Decrease)
-------- -------- -------- -------- -------- --------
Interest-earning assets:
Interest-bearing deposits $ (16) $ 433 $ 417 $ 15 $ 162 $ 177
Securities held for trading and
securities available for sale (1,377) 10,090 8,713 (700) 4,346 3,646
Loans receivable, net (225) 2,036 1,811 (154) 2,207 2,053
Federal Home Loan Bank stock (2) 51 49 21 27 48
-------- -------- -------- -------- -------- --------
Total interest-earning assets $ (1,620) $ 12,610 10,990 $ (818) $ 6,742 5,924
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
NOW and checking accounts $ (10) $ 24 14 $ 3 $ 13 16
Savings accounts 46 185 231 50 (5) 45
Money market deposit accounts 5 5 5 (16) (11)
Certificates of deposit (279) 344 65 173 274 447
-------- -------- -------- -------- -------- --------
Total deposits (243) 558 315 231 266 497
Securities sold under agreements
to repurchase (415) 8,454 8,039 194 4,504 4,698
Federal Home Loan Bank advances 138 (90) 48 72 (198) (126)
Note payable (54) 56 2 (2) 158 156
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ (574) $ 8,978 8,404 $ 495 $ 4,730 5,225
======== ======== ======== ======== ======== ========
Increase in net
interest income $ 2,586 $ 699
======== ========
Net Interest Income. Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities. For the year ended June 30, 1997, Harrington's net interest income
increased by $2.6 million or 47.2% to $8.1 million, compared to the year ended
June 30, 1996. The increase was primarily due to a $180.7 million increase in
the amount of average interest-earning assets.
The growth in asset size is a major component of Harrington's strategic
plan. As capital is raised, the proceeds are invested initially in the Company's
securities portfolio. As retail expansion opportunities become available and as
mortgage loans are originated, these funds will be redeployed in those sectors.
The increase in net interest income caused by asset growth was
partially offset by a 21 basis point decline in the Company's interest rate
spread during the year, from 1.64% to 1.43%. Interest rate spread is the
difference between interest income as a percentage of interest-earning assets
and interest expense as a percentage of interest-bearing liabilities. This
decline was primarily due to the Bank investing the capital raised in
Harrington's initial public stock offering in mortgage-backed and related
securities, which earn somewhat lower option-adjusted spreads than the mortgage
loans in the Company's portfolio. The 49 basis point decline in the Company's
average yield on interest-earning assests from 7.43% to 6.94% during fiscal 1997
was partially offset by a 28 basis point decrease in the average cost of
interest-bearing liabilities, from 5.79% to 5.51%. These decreases were
primarily caused by an overall decline in the level of interest rates during
fiscal 1997.
For the year ended June 30, 1996, Harrington's net interest income
amounted to $5.5 million, compared to $4.8 million for the year ended June 30,
1995. The $699,000 increase was primarily due to a $88.7 million increase in the
average amount of interest-earning assets, which was partially offset by a 49
basis point decline in the Company's interest rate spread during fiscal 1996,
from 2.13% to 1.64%. During fiscal 1996, the average cost of interest-bearing
liabilities increased 19 basis points, from 5.60% to 5.79%, due to a general
increase in the level of interest rates.
Provision for Loan Losses. The provision for loan losses is charged to
earnings to bring the total allowance to a level considered appropriate by
management based on the estimated net realizable value of the underlying
collateral, general economic conditions, particularly as they relate to the
Company's market area, historical loan loss experience and other factors related
to the collectibility of the Company's loan portfolio. While management
endeavors to use the best information available in making its evaluations,
future allowance adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations.
Harrington established provisions (recoveries) for loan losses of
$92,000, $(1,000), and $15,000 during the years ended June 30, 1997, 1996 and
1995, respectively. During such respective periods, loan charge-offs (net of
recoveries) amounted to $(1,000), $0 and $0, respectively. The provision for
loan losses was significantly increased during fiscal 1997 because of the
substantial increase in the Company's mortgage loan portfolio. The allowance for
loan losses as a percentage of total non-performing loans was 63.4% and 46.0% at
June 30, 1997 and 1996, respectively. The allowance for loan losses as a
percentage of total loans was 0.2% at June 30, 1997 and 1996.
Other Income. Other income is comprised of two distinct components:
gains and losses on the Company's investment portfolios, and fee and other
income from retail bank operations. Gains or losses on assets and hedges which
have been sold are reported as realized gains or losses, and market value gains
or losses on assets and hedges which remain in the Company's portfolio are
reported as unrealized gains or losses.
Management's goal is to attempt to offset any change in the market
value of its securities portfolio with the change in the market value of the
interest rate risk management contracts and mortgage-backed derivative
securities utilized by the Company to hedge its interest rate exposure. In
addition, management attempts to produce an overall gain with respect to its
securities portfolio through the use of option-adjusted pricing analysis. The
Company utilizes such analysis to select securities with wider spreads for
purchase and to select securities to sell for a gain as spreads tighten (net of
the gain or loss recognized with respect to related interest rate contracts).
However, the use of mark-to-market accounting for the trading portfolio
can cause volatility in reported earnings due to short-term fluctuations in the
market value of the securities relative to that of the hedge instruments.
Harrington accepts this volatility and realizes that a major benefit of marking
assets to market is that it provides shareholders with more timely information
on the economic value of the Company's portfolio and it allows flexibility in
the management of the Company's assets to capitalize on growth or investment
opportunities.
The following table sets forth information regarding other income for
the periods shown.
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Gain (loss) on sale of securities
held for trading $(1,623) $ 1,834 $ 66
Unrealized gain (loss) on securities
held for trading 2,117 (1,960) 1,535
Permanent impairment of
securities available for sale (414)
Other(1) 239 256 238
------- ------- -------
Total other income $ 733 $ 130 $ 1,425
======= ======= =======
(1) Consists primarily of loan servicing fees and late charges, checking
account fees, trust and investment management service fees, rental income
and other miscellaneous fees.
Total other income amounted to $733,000 for the year ended June 30,
1997. This total consisted of a net realized and unrealized gain of $494,000 on
the trading portfolio, plus fee and other retail bank income of $239,000. The
gain on the trading portfolio net of hedges reflects only a portion of the total
income produced from this portfolio in fiscal 1997. Total income from this
portfolio consists of both interest income and net realized and unrealized gains
and losses on the investments and hedges. The net gain in fiscal 1997 can be
attributed to such factors as opportunistic trades between fixed and adjustable
rate securities at favorable relative option adjusted spreads, the general
tightening of mortgage spreads to the related hedge instruments, and the use of
a higher mix of interest rate swaps to financial futures in hedging that shifts
a portion of hedge expense from the trading portfolio gain to net interest
income.
Total other income amounted to $130,000 for the year ended June 30,
1996. This total was comprised of fee and other retail bank income of $256,000
which was reduced by a net realized and unrealized loss of $126,000 on
securities held for trading. The securities loss resulted from changes in the
market values of mortgage-backed securities which were not entirely offset by
changes in the market values of the interest rate contracts in the trading
portfolio.
Total other income amounted to $1.4 million during the year ended June
30, 1995, primarily due to $1.6 million of net realized and unrealized gains on
securities held for trading. This gain was partially offset by a $414,000 charge
relating to the permanent impairment of securities classified as available for
sale, specifically a non-agency participation certificate secured by a
significant amount of delinquent single-family residential loans.
Other Expense. In order to enhance the Company's profitability,
management strives to maintain a low level of operating expenses relative to its
peer group. During the years ended June 30, 1997, 1996 and 1995, total other
expense, excluding the special SAIF assessment, as a percentage of average total
assets amounted to 0.9%, 1.1%, and 1.3%, respectively. The following table sets
forth certain information regarding other expense for the periods shown.
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Salaries and employee benefits $2,174 $1,776 $1,470
Premises and equipment 532 466 414
Special SAIF assessment 830
FDIC insurance premiums 180 276 260
Marketing 136 200 122
Computer services 165 143 112
Consulting fees 281 232 195
Other (1) 1,146 647 594
------ ------ ------
Total other expenses $5,444 $3,740 $3,167
====== ====== ======
(1) Consists primarily of costs relating to postage, forms and supplies,
professional fees, supervisory assessments and other miscellaneous
expenses.
The principal category of Harrington's other expense is salaries and
employee benefits, which increased by $398,000 or 22.4% and $306,000 or 20.8%
during fiscal 1997 and 1996, respectively. A major cause of these increases was
the continuing implementation of Harrington's retail expansion strategy. A total
of three new banking locations were opened since May, 1994, and the
administrative support at the home office was increased as well. In addition,
new employees were hired in connection with the growth in the Bank's mortgage
lending operations.
Premises and equipment expense increased by $66,000 or 14.2% and
$52,000 or 12.6% during fiscal 1997 and 1996, respectively. The increase in
premises and equipment expense during the periods was primarily due to the
opening of new branches during fiscal years 1997 and 1996.
During the year ended June 30, 1997, all SAIF-insured financial
institutions were required to pay a special assessment to recapitalize that
fund. Harrington's special assessment, which was based on the Bank's level of
deposits at March 31, 1995, was $830,000. However, beginning January 1, 1997,
the Bank's FDIC insurance rate dropped from 23 basis points to 6 basis points on
its deposits. Excluding the special SAIF assessment, FDIC insurance premiums
decreased $96,000 or 34.8% for fiscal 1997 compared to fiscal 1996. During
fiscal 1996, FDIC insurance premiums increased $16,000 or 6.2% due to the
increase in the Bank's deposit base.
Harrington incurred marketing expense of $136,000, $200,000, and
$122,000 during the years ended June 30, 1997, 1996 and 1995, respectively. The
fluctuations in marketing expense during the periods reflected the advertising
costs associated with the opening of the Bank's new branch offices during fiscal
1997 and 1996.
Computer services expense increased by $22,000 or 15.4% and $31,000 or
27.7% during fiscal 1997 and 1996, respectively. Computer services expense
relates to the fees paid by Harrington to a third party who performs the
Company's data processing functions as well as to the third party servicer who
performs the back-office functions with respect to the Company's trust and
investment management services. The increase in expense for the years presented
relates primarily to the increase in the number of deposit and loan accounts
held by Harrington.
Harrington has contracted with Smith Breeden to provide investment
advisory services and interest rate risk analysis. Certain stockholders of the
Company are also principals of Smith Breeden. The consulting fees paid by
Harrington to Smith Breeden during the years ended June 30, 1997, 1996 and 1995,
which are based on the Company's asset size, amounted to $281,000, $232,000, and
$195,000, respectively.
Income Tax Provision. The Company incurred income tax expense of $1.3
million, $648,000, and $1.2 million during the years ended June 30, 1997, 1996
and 1995, respectively. The Company's effective tax rate amounted to 38.6%,
34.6%, and 38.7% during the years ended June 30, 1997, 1996 and 1995,
respectively. The Company's effective tax rate for the year ended June 30, 1996,
was lower than the effective rates for fiscal years 1997 and 1995 primarily due
to increased permanent differences relative to the level of pre-tax income in
fiscal 1996.
LIQUIDITY
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of U.S. Government
and government agency obligations and other similar investments having
maturities of five years or less. Such investments are intended to provide a
source of relatively liquid funds upon which the Bank may rely if necessary to
fund deposit withdrawals and for other short-term funding needs. The required
level of such liquid investments is currently 5% of certain liabilities as
defined by the OTS.
The regulatory liquidity of the Bank was 5.25% at June 30, 1997, as
compared to 5.53% at June 30, 1996. At June 30, 1997, the Bank's liquid assets
as defined by the OTS totaled approximately $23.4 million, which was $1.1
million in excess of the current OTS minimum requirement.
The Bank maintains liquid assets at a level believed adequate to
support its normal operations, including funding loans and paying deposit
withdrawals. Cash flow projections are regularly reviewed and updated to ensure
that adequate liquidity is maintained. Cash for these purposes is generated
through the sale or maturity of securities, the receipt of loan payments, and
increases in deposits and borrowings. While the level of loan and deposit
activity is not entirely under the control of the Bank, the sale of securities
and increases in borrowings are entirely at the Bank's discretion and thus
provide a ready source of cash when needed.
As a member of the FHLB System, the Bank may borrow from the FHLB of
Indianapolis. FHLBadvances may be obtained on very short notice due to the
Bank's blanket collateral agreement with the FHLB. In addition, the Bank can
pledge securities for collateralized borrowings such as reverse repurchase
agreements and quickly obtain cash whenever needed. In the opinion of
management, Harrington has sufficient cash flow and borrowing capacity to meet
current and anticipated funding commitments.
The Bank's liquidity, represented by cash and cash equivalents, is a
result of its operating, investing and financing activities. During the year
ended June 30, 1997, there was a net decrease of $7.6 million in cash and cash
equivalents. The major uses of cash during the year were purchases of securities
for the trading portfolio of $913.8 million and loan originations, net of
repayments, of $28.1 million. Partially offsetting these uses of cash, the major
sources of cash provided during the year included $888.4 million in proceeds
from sales of securities held for trading and a net increase of $26.5 million in
reverse repurchase agreements.
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars (except with respect to securities which are carried
at market value), without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement Nos. 125,
128, 130, and 131 that the Company will be required to adopt in future periods.
See Note 1 to the consolidated financial statements for further discussion of
these pronouncements.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share data)
June 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash $ 1,207 $ 1,036
Interest-bearing deposits (Note 13) 8,309 16,107
Total cash and cash equivalents 9,516 17,143
Securities held for trading - at fair value (amortized cost of
$314,953 and $319,562) (Notes 2, 8, 13) 317,355 319,847
Securities available for sale - at fair value (amortized cost of
$1,183 and $2,062) (Note 2) 1,125 2,050
Due from brokers 11,308 4,374
Loans receivable (net of allowance for loan losses of
$213 and $120) (Note 3) 93,958 65,925
Interest receivable, net (Note 4) 2,080 1,807
Premises and equipment, net (Note 5) 4,424 3,105
Federal Home Loan Bank of Indianapolis stock - at cost 4,852 2,645
Income taxes receivable (Note 10) 1,118 --
Other 1,061 1,300
--------- ---------
TOTAL ASSETS $ 446,797 $ 418,196
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 6) $ 136,175 $ 135,143
Securities sold under agreements to repurchase (Note 7) 245,571 219,067
Federal Home Loan Bank advances (Note 8) 26,000 26,000
Interest payable on securities sold under agreements to repurchase (Note 7) 300 115
Other interest payable 787 1,855
Note payable (Note 9) 9,995 8,998
Advance payments by borrowers for taxes and insurance 585 392
Deferred income taxes, net (Note 10) 1,249 663
Accrued income taxes payable (Note 10) 115
Deferred compensation payable (Note 12) 89 119
Accrued expenses payable and other liabilities 1,052 2,612
--------- ---------
Total liabilities 421,803 395,079
--------- ---------
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share data)
June 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (NOTES 13, 14, 16)
STOCKHOLDERS' EQUITY (NOTES 1, 10, 11, 12, 16):
Preferred Stock ($1 par value) Authorized and unissued -
5,000,000 shares
Common Stock:
Voting ($.125 par value) Authorized - 10,000,000 shares
issued and outstanding 3,256,738 shares 407 407
Additional paid-in capital 15,623 15,623
Unrealized loss on securities available for sale, net of deferred
taxes of $23 and $4 (35) (8)
Retained earnings 8,999 7,095
--------- ---------
Total stockholders' equity 24,994 23,117
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 446,797 $ 418,196
========= =========
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except share data)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Securities held for trading $ 27,538 $ 18,286 $ 14,421
Net interest expense on interest rate contracts maintained in
the trading portfolio (Note 13) (730) (252) (93)
Securities available for sale 133 194 254
Loans receivable (Note 3) 6,087 4,276 2,223
Dividends on Federal Home Loan Bank of Indianapolis stock 249 200 152
Deposits 1,197 780 603
-------- -------- --------
34,474 23,484 17,560
-------- -------- --------
INTEREST EXPENSE:
Deposits (Notes 6, 13) 7,466 7,151 6,654
Federal Home Loan Bank advances (Note 8) 1,644 1,596 1,722
Short-term borrowings (Note 7) 16,391 8,352 3,654
Long-term borrowings (Note 9) 907 905 749
-------- -------- --------
26,408 18,004 12,779
-------- -------- --------
NET INTEREST INCOME 8,066 5,480 4,781
PROVISION (CREDIT) FOR LOAN LOSSES (NOTE 3) 92 (1) 15
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,974 5,481 4,766
-------- -------- --------
OTHER INCOME (LOSS):
Gain (loss) on sale of securities held for trading (Note 2, 13) (1,623) 1,834 66
Unrealized gain (loss) on securities held for trading (Notes 2, 13) 2,117 (1,960) 1,535
Permanent impairment of securities available for sale (Note 2) -- -- (414)
Other 239 256 238
-------- -------- --------
733 130 1,425
-------- -------- --------
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except share data)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER EXPENSE:
Salaries and employee benefits (Note 12) 2,174 1,776 1,470
Premises and equipment expense (Note 5) 532 466 414
SAIF assessment (Note 16) 830
FDIC insurance premiums 180 276 260
Marketing 136 200 122
Computer services 165 143 112
Consulting fees (Note 15) 281 232 195
Other 1,146 647 594
-------- -------- --------
5,444 3,740 3,167
-------- -------- --------
INCOME BEFORE INCOME TAX PROVISION 3,263 1,871 3,024
INCOME TAX PROVISION (NOTE 10) 1,261 648 1,171
-------- -------- --------
NET INCOME $ 2,002 $ 1,223 $ 1,853
======== ======== ========
EARNINGS PER SHARE (NOTE 1) $ 0.61 $ 0.57 $ 1.20
======== ======== ========
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands except share data)
Additional Unrealized Total
Shares Common Paid-in Gain Retained Stockholders'
Outstanding Stock Capital (Loss) Earnings Equity
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCES, JULY 1, 1994 176,548 $ 176 $ 1,730 $ 4,019 $ 5,925
Stock split 4 for 1 529,644
Issuance of common stock under
equity offering (Note 16) 263,821 66 2,355 2,421
Stock options exercised (Note 12) 10,800 3 98 101
Net income 1,853 1,853
Net change in unrealized gain (loss)
on securities available for sale,
net of deferred tax of $36 $ 61 61
--------- --------- --------- --------- --------- ---------
BALANCES, JUNE 30, 1995 980,813 245 4,183 61 5,872 10,361
Stock split 2 for 1 980,813
Stock options exercised (Note 12) 30,112 4 161 165
Issuance of common stock under initial
public offering (Note 1) 1,265,000 158 11,279 11,437
Net income 1,223 1,223
Net change in unrealized gain (loss)
on securities available for sale,
net of deferred tax of $(4) (69) (69)
--------- --------- --------- --------- --------- ---------
BALANCES, JUNE 30, 1996 3,256,738 407 15,623 (8) 7,095 23,117
Net income 2,002 2,002
Cash dividends declared on common stock
($0.03 per share) (98) (98)
Net change in unrealized gain (loss)
on securities available for sale,
net of deferred tax of $(23) (27) (27)
--------- --------- --------- --------- --------- ---------
BALANCES, JUNE 30, 1997 3,256,738 $ 407 $ 15,623 $ (35) $ 8,999 $ 24,994
========= ========= ========= ========= ========= =========
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,002 $ 1,223 $ 1,853
Adjustments to reconcile net income to net cash used in operating activities:
Provision (credit) for loan losses 92 (1) 15
Depreciation 235 210 176
Premium and discount amortization on securities, net 1,925 1,887 1,485
Amortization of premiums and discounts on loans receivable 9 (37) (132)
(Gain) loss on sale of securities held for trading 1,623 (1,834) (66)
Unrealized (gain) loss on securities held for trading (2,117) 1,960 (1,535)
Permanent impairment of securities available for sale -- -- 414
Deferred income tax provision 605 (913) 673
Increase in interest receivable (273) (454) (41)
Increase (decrease) in interest payable (883) 278 219
Decrease in accrued income taxes (115) (80) (254)
Purchases of securities held for trading (913,766) (390,743) (510,309)
Increase in amounts due from brokers (6,934) (4,374) --
Proceeds from maturities of securities held for trading 26,398 25,407 15,798
Proceeds from sales of securities held for trading 888,429 290,209 419,340
(Increase) decrease in other assets 239 640 (1,511)
Increase in income taxes receivable (1,118) -- --
Increase (decrease) in accrued expenses (1,590) 2,374 (642)
Increase in other liabilities 193 128 124
--------- --------- ---------
Net cash used in operating activities (5,046) (74,120) (74,393)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Federal Home Loan Bank of Indianapolis stock (2,207) (145) (657)
Proceeds from maturities of securities available for sale 879 422 574
Loan originations, net of principal repayments (28,134) (28,877) (16,211)
Purchases of premises and equipment (1,554) (923) (411)
--------- --------- ---------
Net cash used in investing activities (31,016) (29,523) (16,705)
--------- --------- ---------
(continued)
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 1,032 19,831 7,011
Increase in securities sold under agreements to repurchase 26,504 88,850 75,565
Proceeds from issuance of common stock under equity offering -- -- 2,421
Proceeds from issuance of common stock under initial public offering -- 11,437 --
Proceeds from stock options exercised -- 165 101
Proceeds from Federal Home Loan Bank advances 3,300 10,000 --
Proceeds from note payable 2,300 800 1,900
Principal repayments on Federal Home Loan Bank advances (3,300) (15,000) --
Principal repayments on note payable (1,303) (1,002) (600)
Dividends paid on common stock (98) -- --
--------- --------- ---------
Net cash provided by financing activities 28,435 115,081 86,398
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7,627) 11,438 (4,700)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 17,143 5,705 10,405
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,516 $ 17,143 $ 5,705
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 25,434 $ 18,354 $ 12,562
Cash paid for income taxes 1,889 1,600 753
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business of the Company - Harrington Financial Group, Inc. ("HFG" or
the "Company") is a savings and loan holding company incorporated on March 3,
1988 to acquire and hold all of the outstanding common stock of Harrington Bank,
FSB (the "Bank"), a federally chartered savings bank with principal offices in
Richmond, Indiana and branch locations in Hamilton County, Indiana. On May 6,
1996 the Company sold 1,265,000 shares of common stock at $10.00 per share to
investors in an initial public offering resulting in gross proceeds of
$12,650,000 to the Company. Net proceeds to the Company after offering expenses
were $11,437,000.
Basis of Presentation - The consolidated financial statements include
the accounts of HFG and the Bank. 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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash and Cash Equivalents - All highly liquid investments with an
original maturity of three months or less are considered to be cash equivalents.
Securities Held for Trading and Available for Sale - Statement of
Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities addresses the accounting and reporting
for investments in equity securities that have readily determinable fair values
and all investments in debt securities. SFAS No. 115 requires these securities
to be classified in one of three categories and accounted for as follows:
o Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as "securities held to maturity"
and reported at amortized cost.
o Debt and equity securities that are acquired and held principally for
the purpose of selling them in the near term with the objective of
generating economic profits on short-term differences in market
characteristics are classified as "securities held for trading" and
reported at fair value, with unrealized gains and losses included in
earnings.
o Debt and equity securities not classified as either held to maturity
or trading securities are classified as "securities available for
sale" and reported at fair value, with unrealized gains and losses,
after applicable taxes, excluded from earnings and reported in a
separate component of stockholders' equity. Declines in the value of
debt securities and marketable equity securities that are considered
to be other than temporary are recorded as a permanent impairment of
securities available for sale in the statement of income.
Premiums and discounts are amortized over the contractual lives of the
related securities using the level yield method. Purchases and sales of
securities are recorded in the balance sheet on the trade date. Gains and losses
from security sales or disposals are recognized as of the trade date in the
statement of income for the period in which securities are sold or otherwise
disposed of. The Company also enters into forward contracts to purchase or sell
securities held for trading. Changes in the fair value of the forward contract
are recognized in earnings as they occur. Securities purchased or sold under a
forward contract are recorded at their fair values at the settlement date .
The Company's trading portfolio consists of mortgage-backed securities,
mortgage-backed security derivatives, equity securities and interest rate
contracts, which accordingly are carried at fair value. Realized and unrealized
changes in fair values are recognized in other income in the period in which the
changes occur. Interest income from trading activities is included in the
statement of income as a component of net interest income.
The Company's available for sale portfolio consists of municipal bonds and
a non-agency participation certificate.
Fair values of securities are based on quoted market prices or dealer
quotes. Where such quotes are not available, estimates of fair value of
securities are based upon a number of assumptions such as prepayments which may
shorten the life of such securities. Although prepayments of underlying
mortgages depend on many factors, including the type of mortgages, the coupon
rate, the age of mortgages, the geographical location of the underlying real
estate collateralizing the mortgages and general levels of market interest
rates, the difference between the interest rates on the underlying mortgages and
the prevailing mortgage interest rates generally is the most significant
determinant of the rate of prepayments. While management endeavors to use the
best information available in determining prepayment assumptions, actual results
could differ from those assumptions.
Financial Instruments Held for Asset and Liability Management Purposes
- - Effective June 30, 1995, the Bank adopted the provisions of SFAS No. 119,
Disclosure About Derivative Instruments and Fair Value of Financial Instruments.
The statement addresses disclosures of derivative financial instruments such as
futures, forward rate agreements, interest rate swap agreements, option
contracts and other financial instruments with similar characteristics. SFAS No.
119 requires disclosures about amounts and the nature and terms of derivative
financial instruments regardless of whether they result in off-balance-sheet
risk or accounting loss. The Bank has incorporated the requirements of this
statement in Note 13.
The Bank is party to a variety of interest rate contracts consisting of
interest rate futures, options, caps, swaps, floors and collars in the
management of the interest rate exposure of its trading portfolio. These
financial instruments are included in the trading portfolio and are reported at
market value with realized and unrealized gains and losses on these instruments
recognized in other income (see Note 2).
The Bank enters into certain other interest rate swap agreements as a
means of managing the interest rate exposure of certain inverse variable rate
deposits. The Bank also entered into an interest rate cap agreement to
effectively fix the interest rate on floating-rate Federal Home Loan Bank
advances. These interest rate agreements are accounted for under the accrual
method. Under this method, the differential to be paid or received on these
interest rate agreements is recognized over the lives of the agreements in
interest expense. Changes in market value of interest rate swaps and of the
interest rate cap accounted for under the accrual method are not reflected in
the accompanying financial statements. Realized gains and losses on terminated
interest rate swaps accounted for under the accrual method are deferred as an
adjustment to the carrying amount of the designated instruments and amortized
over the remaining original life of the agreements. If the designated
instruments are disposed of, the fair value of the interest rate swap, interest
rate cap or unamortized deferred gains or losses are included in the
determination of the gain or loss on the disposition of such instruments. To
qualify for such accounting, the interest rate swaps are designated to the
inverse variable rate deposits and the interest rate cap is designated to the
Federal Home Loan Bank advances which alter the designated instruments' interest
rate characteristics.
Due from Brokers consists of amounts receivable from sales of
securities in which the transactions have not settled as of the balance sheet
date.
Loans Receivable are carried at the principal amount outstanding,
adjusted for premiums or discounts which are amortized or accreted using a
level-yield method. The Company adopted SFAS No. 114 and No. 118, Accounting by
Creditors for Impairment of a Loan and Income Recognition and Disclosures, as
amended, effective July 1, 1995. These statements require that impaired loans be
measured based on the present value of future cash flows discounted at the
loan's effective interest rate or the fair value of the underlying collateral,
and specifies alternative methods for recognizing interest income on loans that
are impaired or for which there are credit concerns. For purposes of applying
these standards, impaired loans have been defined as all nonaccrual commercial
loans which have not been collectively evaluated for impairment. The Company's
policy for income recognition was not affected by adoption of these standards.
An impaired loan is charged off by management as a loss when deemed
uncollectible although collection efforts continue and future recoveries may
occur. The adoption of SFAS No. 114 and No. 118 did not have any effect on the
total reserve for credit losses or related provision. At June 30, 1997 and June
30, 1996, the Company had no impaired loans required to be disclosed under SFAS
No. 114 and No. 118.
Discounts and premiums on purchased residential real estate loans are
amortized to income using the interest method over the remaining period to
contractual maturity.
Nonrefundable origination fees net of certain direct origination costs
are deferred and recognized, as a yield adjustment, over the life of the
underlying loan.
Allowance for Losses - A provision for estimated losses on loans is
charged to operations based upon management's evaluation of the potential
losses. Such an evaluation, which includes a review of all loans for which full
collectibility may not be reasonably assured, considers, among other matters,
the estimated net realizable value of the underlying collateral, as applicable,
economic conditions, historical loan loss experience and other factors that are
particularly susceptible to changes that could result in a material adjustment
in the near term. While management endeavors to use the best information
available in making its evaluations, future allowance adjustments may be
necessary if economic conditions change substantially from the assumptions used
in making the evaluations.
Interest Receivable - Interest income on securities and loans is
accrued according to the contractual terms of the underlying asset including
interest rate, basis and date of last payment. Income on derivatives of
mortgage-backed securities is recorded based on projected cashflows using the
median of major brokers' prepayment assumptions for the underlying securities.
The Bank provides an allowance for the loss of uncollected interest on loans
which are more than 90 days past due. The allowance is established by a charge
to interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent that cash payments are received
until, in management's judgment, the borrower's ability to make periodic
interest and principal payments returns to normal, in which case the loan is
returned to accrual status.
Premises and Equipment are carried at cost less accumulated
depreciation. Depreciation is computed on the straight-line method over
estimated useful lives ranging from 3 to 40 years. Maintenance and repairs are
expensed as incurred while major additions and improvements are capitalized.
Gains and losses on dispositions are included in current operations.
Federal Income Taxes - The Company and its wholly- owned subsidiary
file a consolidated tax return. Deferred income tax assets and liabilities
reflect the impact of temporary differences between amounts of assets and
liabilities for financial reporting purposes and basis of such assets and
liabilities as measured by tax laws and regulations.
Earnings Per Share - Earnings per share of common stock is based on the
weighted average number of common shares outstanding during the year. The
weighted average number of common shares outstanding was 3,256,738, 2,160,233,
and 1,544,080 for fiscal years 1997, 1996 and 1995, respectively. All per share
information has been restated to reflect the Company's four-for-one stock split
in October 1994 and the Company's two-for-one stock split in October 1995. The
assumed exercise of stock options does not have a materially dilutive effect.
New Accounting Pronouncements - SFAS No. 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, was issued
in June 1996 and provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. SFAS No. 125
was amended by SFAS No. 127, Deferral of the Effective Date of Certain
Provisions of SFAS No. 125. SFAS No. 127 defers certain provisions of SFAS No.
125 relating to repurchase agreements, dollar-roll, securities lending, and
similar transactions and is effective for transactions occurring after December
31, 1997. Management has not yet quantified the effect, if any, of this new
standard on the consolidated financial statements.
SFAS 128, Earnings Per Share, applies to financial statements for
public companies for both interim and annual periods ending after December 15,
1997. This statement establishes new accounting standards for the calculation of
basic earnings per share as well as diluted earnings per share. Management does
not believe the adoption of this statement will have a material effect on the
Company's calculation of earnings per share.
In June 1997, SFAS No. 130, Comprehensive Income, was issued and
becomes effective for fiscal years beginning after December 15, 1997 and
requires reclassification of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including foreign currency translation adjustments and gains and losses on
certain securities, be shown in the financial statements. SFAS No. 130 does not
require a specific format for the financial statement in which comprehensive
income is reported, but does require that an amount representing total
comprehensive income be reported in that statement. Management has not yet
determined the effect, if any, of SFAS No. 130 on the consolidated financial
statements.
Also in June 1997, SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, was issued. This Statement will change the
way public companies report information about segments of their business in
their annual financial statements and requires them to report selected segment
information in their quarterly reports issued to shareholders. It also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues, and its major
customers. SFAS No. 131 is effective for fiscal years beginning after December
15, 1997. Management has not yet determined the effect, if any, of SFAS No. 131
on the consolidated financial statements.
The Financial Accounting Standards Board issued Exposure Draft,
Accounting for Derivative and Similar Financial Instruments and for Hedging
Activities, in June 1996. Management has not yet quantified the effect, if any,
of this Exposure Draft on the consolidated financial statements.
Reclassifications of certain amounts in the 1996 and 1995 consolidated
financial statements have been made to conform to the 1997 presentation.
2. SECURITIES
The amortized cost and estimated fair values of securities held for
trading and securities available for sale are summarized as follows:
Gross Gross
(Dollars in thousands) Amortized Unrealized Unrealized Fair
June 30, 1997 Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
SECURITIES HELD FOR TRADING:
GNMA certificates $ 165,894 $ 2,291 $ 83 $ 168,102
FHLMC certificates 41,194 401 79 41,516
FNMA certificates 68,800 628 73 69,355
Non-agency participation certificates 2,545 42 85 2,502
Collateralized mortgage obligations 25,789 295 52 26,032
Residuals 508 566 38 1,036
Interest-only strips 2,028 41 620 1,449
Principal-only strips 821 42 3 860
Interest rate swaps -- 626 45 581
Interest rate collar 50 -- 58 (8)
Interest rate caps 3,025 -- 1,480 1,545
Interest rate floors 3,916 572 947 3,541
Options 78 -- 54 24
Futures -- 356 -- 356
Equity securities 305 159 -- 464
--------- --------- --------- ---------
Totals $ 314,953 $ 6,019 $ 3,617 $ 317,355
========= ========= ========= =========
SECURITIES AVAILABLE FOR SALE:
Municipal bonds $ 317 $ 18 -- $ 335
Non-agency participation certificate 866 -- $ 76 790
--------- --------- --------- ---------
Totals $ 1,183 $ 18 $ 76 $ 1,125
========= ========= ========= =========
The Bank's CMO portfolio at June 30, 1997 consisted of four agency
investments with an estimated remaining weighted average life of 16.1 years.
(Dollars in thousands)
June 30, 1996 Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
SECURITIES HELD FOR TRADING:
GNMA certificates $ 148,674 $ 1,515 $ 323 $ 149,866
FHLMC certificates 83,329 211 156 83,384
FNMA certificates 66,182 304 489 65,997
Non-agency participation certificates 3,209 55 110 3,154
Collateralized mortgage obligations 6,131 248 -- 6,379
Residuals 707 115 44 778
Interest-only strips 3,442 105 755 2,792
Principal-only strips 1,028 16 34 1,010
Interest rate swaps -- 620 -- 620
Interest rate collar 83 -- 91 (8)
Interest rate caps 3,692 214 832 3,074
Interest rate floors 2,535 1,049 614 2,970
Options 54 12 1 65
Futures -- -- 784 (784)
Equity securities 496 58 4 550
--------- --------- --------- ---------
Totals $ 319,562 $ 4,522 $ 4,237 $ 319,847
========= ========= ========= =========
SECURITIES AVAILABLE FOR SALE:
Municipal bonds $ 921 $ 41 -- $ 962
Non-agency participation certificate 1,141 -- $ 53 1,088
--------- --------- --------- ---------
Totals $ 2,062 $ 41 $ 53 $ 2,050
========= ========= ========= =========
The Bank's CMO portfolio at June 30, 1996, consisted of two agency
investments with an estimated remaining weighted average life of 13.6 years.
For a complete discussion of the Bank's Risk Management Activities, see
Note 13.
The amortized cost and estimated fair values of securities by
contractual maturity are as follows:
(Dollars in thousands)
June 30, 1997
Held for Trading Available for Sale
- ------------------------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- ------------------------------------------------------------------------------------------------------------------------------------
Debt securities:
Due after 1 year through 5 years $ 317 $ 335
Mortgage-backed securities $275,888 $278,973
Non-agency participation certificates 2,545 2,502 866 790
Collateralized mortgage obligations 25,789 26,032
Mortgage-backed derivatives 3,357 3,345
Interest rate contracts 7,069 6,039
Equity securities 305 464
-------- -------- -------- --------
$314,953 $317,355 $ 1,183 $ 1,125
======== ======== ======== ========
Securities with a total amortized cost of $255,387,000 and $230,558,000
and a total fair value of $257,826,000 and $229,680,000 were pledged at June 30,
1997 and 1996, respectively, to secure interest rate swaps and securities sold
under agreements to repurchase. As of June 30, 1997 and 1996, the Bank had a
blanket collateral agreement for the Federal Home Loan Bank advances instead of
utilizing specific securities as collateral.
Activities related to the sale of securities are summarized as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Proceeds from sales of securities held for trading $888,429 $290,209 $419,340
Gross gains on sales of securities held for trading 44,324 30,492 12,761
Gross losses on sales of securities held for trading 45,947 28,658 12,695
A decline in the value of a non-agency participation certificate which
is included in the available for sale portfolio and which is considered to be
other than temporary totaling $414,000 was recorded in the statement of income
for the year ended June 30, 1995.
3. LOANS RECEIVABLE
Approximately 88% of the Bank's loans are to customers in Wayne and
Hamilton counties in Indiana or surrounding counties. The portfolio consists
primarily of owner occupied single family residential mortgages.
Loans receivable are summarized as follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Loans secured by one to
four family residences:
Real estate mortgage $ 90,871 $ 64,537
Participation loans purchased 226 305
Commercial 258 441
Property improvement 690 315
Loans on savings accounts 252 267
Consumer and home equity lines of credit 1,446 417
Real estate sold on contract 43 57
-------- --------
Subtotal 93,786 66,339
Unamortized push-down
accounting adjustment (136) (182)
Undisbursed loan proceeds (9) (420)
Net deferred loan fees,
premiums and discounts 530 308
Allowance for loan losses (213) (120)
-------- --------
Loans receivable, net $ 93,958 $ 65,925
======== ========
The principal balance of loans on nonaccrual status totaled
approximately $336,000 and $261,000 at June 30, 1997 and 1996, respectively. For
the years ended June 30, 1997, 1996 and 1995, gross interest income which would
have been recorded had the Bank's non-accruing loans been current with their
original terms amounted to $6,000, $6,000, and $13,000, respectively.
The Bank had commitments to originate or purchase loans consisting
primarily of real estate mortgages secured by one to four family residences
approximating $3,182,000 and $1,003,000 excluding undisbursed portions of loans
in-process at June 30, 1997 and 1996, respectively.
The Bank has transactions in the ordinary course of business with
directors, officers and employees. Loans to such individuals totaled $228,000
and $293,000 at June 30, 1997 and 1996, respectively.
The amount of loans serviced for others totaled $4,657,000, $5,587,000,
and $6,820,000 at June 30, 1997, 1996 and 1995, respectively. Servicing loans
for others generally consists of collecting mortgage payments, maintaining
escrow amounts, disbursing payments to investors and foreclosure processing. In
connection with loans serviced for others, the Bank held borrowers' escrow
balances of $31,000 and $44,000 at June 30, 1997 and 1996, respectively.
Loan servicing fee income included in other income for the years ended
June 30, 1997, 1996 and 1995 was $19,000, $23,000, and $27,000, respectively.
An analysis of the allowance for loan losses is as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Beginning balance $ 120 $ 121 $ 106
Provision for loan losses 92 (1) 15
Recoveries 1
----- ----- -----
Ending balance $ 213 $ 120 $ 121
===== ===== =====
As a federally-chartered savings bank, aggregate commercial real estate
loans may not exceed 400% of capital as determined under the capital standards
provisions of FIRREA. This limitation was approximately $124 and $104 million at
June 30, 1997 and 1996, respectively. Also under FIRREA, the loans-to-one
borrower limitation is generally 15% of unimpaired capital and surplus which,
for the Bank, was approximately $4 million at June 30, 1997 and 1996. The Bank
was in compliance with all of these requirements at June 30, 1997 and 1996.
4. INTEREST RECEIVABLE
Interest receivable is summarized as follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Loans (less allowance for
uncollectibles - $6) $ 413 $ 328
Interest-bearing deposits 34 26
Securities held for trading 1,599 1,380
Securities available for sale 34 73
------ ------
Interest receivable, net $2,080 $1,807
====== ======
5. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Land $ 1,003 $ 395
Buildings and leasehold improvements 3,357 2,631
Parking lot improvements 153 148
Furniture, fixtures and equipment 1,059 844
------- -------
Total 5,572 4,018
Less accumulated depreciation (1,148) (913)
------- -------
Premises and equipment, net $ 4,424 $ 3,105
======= =======
Depreciation expense included in operations during the years ended June
30, 1997, 1996 and 1995, totaled $235,000, $210,000, and $176,000, respectively.
6. DEPOSITS
(Dollars in thousands)
June 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
- ------------------------------------------------------------------------------------------------------------------------------------
NOW accounts $ 4,778 2.42% $ 4,529 3.04%
Savings accounts 20,523 4.18 17,342 3.96
Money market deposit accounts 1,930 4.00 1,576 4.05
-------- --------
27,231 23,447
-------- --------
Certificates of deposit:
1 year and less 74,586 75,343
1 to 2 years 19,437 19,890
2 to 3 years 7,486 8,093
3 to 4 years 1,845 2,636
Over 4 years 5,590 5,734
-------- ---- -------- ----
108,944 5.88 111,696 5.98
-------- ---- -------- ----
Total deposits $136,175 $135,143
======== ========
Certificates of deposit in the amount of $100,000 or more totaled
approximately $18 million and $20 million at June 30, 1997 and 1996,
respectively.
A summary of certificate accounts by scheduled fiscal year maturities
at June 30, 1997, is as follows:
(Dollars in thousands) 1998 1999 2000 2001 2002 Thereafter Total
- ------------------------------------------------------------------------------------------------------------------------------------
3.00% or less $ 10 $ 10
3.01% - 5.00% $ 4,894 $ 464 $ 65 $ 17 $ 909 99 6,448
5.01% - 7.00% 68,462 16,298 6,359 962 2,005 2,167 96,253
7.01% - 9.00% 1,135 2,446 1,055 127 390 5,153
9.01% or greater 95 229 7 739 10 1,080
-------- -------- -------- -------- -------- -------- --------
Totals $ 74,586 $ 19,437 $ 7,486 $ 1,845 $ 2,914 $ 2,676 $108,944
======== ======== ======== ======== ======== ======== ========
Interest expense on deposits is as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
NOW accounts $ 124 $ 110 $ 94
Savings accounts 844 613 568
Money market deposit accounts 82 77 88
Certificates of deposit 6,416 6,351 5,904
------ ------ ------
$7,466 $7,151 $6,654
====== ====== ======
Interest expense on certificates of deposit is net of interest income
on interest rate contracts of $130,000, $129,000, and $158,000 for the years
ended June 30, 1997, 1996 and 1995, respectively.
For a complete discussion of the Bank's Risk Management Activities, see
Note 13.
7. SECURITIES SOLD UNDER AGREEMENTS
TO REPURCHASE
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Securities sold under
agreements to repurchase:
Same securities $191,664 $ 98,724
Substantially identical securities 53,907 120,343
-------- --------
$245,571 $219,067
-------- --------
Accrued interest on securities sold
under agreements to repurchase $ 300 $ 115
======== ========
At June 30, 1997, securities sold under agreements to repurchase mature
within one month.
An analysis of securities sold under agreements to repurchase,
excluding related accrued interest, is as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Maximum amount outstanding at
any month-end $343,427 $219,067 $130,217
Daily average amount outstanding 306,034 148,524 68,277
Weighted average interest rate at
end of year 5.47% 5.21% 6.01%
==== ==== ====
Assets pledged to secure securities sold under agreements to repurchase
are concentrated among seven and six dealers as of June 30, 1997 and 1996,
respectively. The Bank exercises control over the securities pledged when the
same security is repurchased. Assets pledged are as follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Mortgage-backed securities:
At amortized cost $249,018 $226,091
At fair value $251,317 $225,161
An analysis of the amount at risk under repurchase agreements with
counterparties exceeding 10% of stockholders' equity at June 30, 1997 is as
follows:
Weighted
Amount Accrued Average
Outstanding Interest Maturity
(Dollars in thousands) (in days)
- ------------------------------------------------------------------------------------
Federal Home Loan
Mortgage Corporation $115,431 $ 165 12
Federal National Mortgage
Association 86,683 132 14
Merrill Lynch 17,224 21
Morgan Stanley Market
Products, Inc. 4,336 14
Nomura Securities
International, Inc. 9,484 14
Smith Barney 11,216 3 17
-------- -------- --
$244,374 $ 300
======== ========
8. FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis are as
follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Variable Variable
Weighted Weighted
Average Average
Fiscal Year Maturity Amount Rate Amount Rate
- --------------------------------------------------------------------------------
1998 $26,000 5.78% $ 26,000 5.41%
As of June 30, 1997 and 1996, the Bank had a blanket collateral agreement for
the Federal Home Loan Bank advances instead of utilizing specific securities as
collateral.
9. NOTE PAYABLE
At June 30, 1997, the Company maintained a $15,000,000 loan facility
from Mercantile Bancorporation, Inc. (formerly Mark Twain Bank) consisting of a
revolving line of credit of $5,000,000 and a $10,000,000 term loan of which
$5,000 had been repaid under the term loan at June 30, 1997. Quarterly
interest-only payments, based on the prime rate published in the Wall Street
Journal (8.50% at June 30, 1997), are payable through maturity of June 2000. The
unpaid principal balance outstanding is payable in full in June 2000.
As of June 30, 1997, the loan was secured by the Harrington Bank, FSB
stock held by HFG, a blanket security interest in all of the Company's assets
and the assignment of certain life insurance policies owned by HFG. Under the
terms of the agreement, the Company is bound by certain restrictive debt
covenants. As of June 30, 1997, HFG was in compliance with all such debt
covenants.
10. INCOME TAXES
An analysis of the income tax provision is as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Current:
Federal $ 451 $ 1,203 $ 372
State 205 358 126
Deferred:
Federal 484 (776) 572
State 121 (137) 101
------- ------- -------
Total income tax provision $ 1,261 $ 648 $ 1,171
======= ======= =======
The difference between the financial statement provision and amount
computed by using the statutory rate of 34% is reconciled as follows:
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Federal statutory income
tax at 34% $ 1,109 $ 636 $ 1,028
Tax exempt interest and dividends (14) (29) (32)
State income taxes,
net of federal tax benefit 185 129 83
Amortization of fair value adjustments (12) (53) (19)
Other, net (7) (35) 111
------- ------- -----
Total income tax provision $ 1,261 $ 648 1,171
======= ======= =====
The Company's deferred income tax assets and liabilities are as
follows:
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation $ 35 $ 48
Deferred loan fees/costs, net 9 6
Differences in depreciation methods 2 16
Unrealized loss on securities
available for sale 23 4
Other 27 31
------ ------
96 105
------ ------
Deferred tax liabilities:
Bad debt reserves, net 43 79
Unrealized gain on securities
held for trading 951 114
Differences in income recognition
on investments 351 575
------ ------
1,345 768
------ ------
Deferred income taxes, net $1,249 $ 663
====== ======
Retained earnings at June 30, 1997 and 1996 includes approximately $3
million of income that has not been subject to tax because of deductions for bad
debts allowed for federal income tax purposes. Deferred income taxes have not
been provided on such bad debt deductions since the Company does not intend to
use the accumulated bad debt deductions for purposes other than to absorb loan
losses. If, in the future, this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, federal income taxes may be
imposed on such amounts at the then current corporation income tax rate.
In August 1996, the "Small Business Job Protection Act of 1996" was
passed into law. One provision of the act repeals the special bad debt reserve
method for thrift institutions currently provided for in Section 593 of the IRC.
The provision requires thrifts to recapture any reserve accumulated after 1987
but forgives taxes owed on reserves accumulated prior to 1988. Thrift
institutions will be given six years to account for the recaptured excess
reserves, beginning with the first taxable year after 1995, and will be
permitted to delay the timing of this recapture for one or two years, subject to
whether they meet certain residential loan test requirements. The adoption of
the act did not have a material adverse effect on the Company's consolidated
financial position.
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures that have been established by regulation to
ensure capital adequacy require the Bank to maintain minimum capital amounts and
ratios (set forth in the table below). The Bank's primary regulatory agency, the
OTS, requires that the Bank maintain minimum ratios of tangible capital (as
defined in the regulations) of 1.5%, core capital (as defined) of 3%, and total
risk-based capital (as defined) of 8%. The Bank is also subject to prompt
corrective action capital requirement regulations set forth by the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC requires the Bank to maintain
minimum capital amounts and ratios of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of June 30,
1997, that the Bank meets all capital adequacy requirements to which it is
subject.
As of June 30, 1997 and 1996, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well capitalized" the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
To Be Categorized as
"Well Capitalized"
Under Prompt
For Capital Corrective Action
(Dollars in thousands) Actual Adequacy Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------------------------
AS OF JUNE 30, 1997:
Tangible capital (to total assets) $ 31,031 6.96% $ 6,687 1.50% N/A N/A
Core capital (to total assets) 31,031 6.96% 13,375 3.00% N/A N/A
Total risk-based capital (to risk weighted assets) 31,239 31.14% 8,025 8.00% $ 10,032 10.00%
Tier I risk-based capital (to risk weighted assets) 31,031 30.93% N/A N/A 6,020 6.00%
Tier I leverage capital (to average assets) 31,031 6.96% N/A N/A 22,292 5.00%
===============================================================================
Tangible capital (to total assets) $ 26,046 6.27% $ 6,228 1.50% N/A N/A
Core capital (to total assets) 26,046 6.27% 12,456 3.00% N/A N/A
Total risk-based capital (to risk weighted assets) 26,161 30.10% 6,953 8.00% $ 8,691 10.00%
Tier I risk-based capital (to risk weighted assets) 26,046 29.97% N/A N/A 5,214 6.00%
Tier I leverage capital (to average assets) 26,046 6.27% N/A N/A 20,770 5.00%
===============================================================================
12. EMPLOYEE BENEFIT PLANS
Profit-sharing plan - The Bank has a qualified noncontributory
profit-sharing plan for all eligible employees. The plan provides for
contributions by the Bank in such amounts as its Board of Directors may annually
determine. Contributions charged to expense for the years ended June 30, 1997,
1996 and 1995 were $85,000, $39,000, and $79,000, respectively.
Deferred compensation plan - On September 30, 1988, three senior
officers of the Bank entered into consulting agreements with the Bank to take
effect at their retirement. The agreements obligate the Bank to make monthly
payments to these individuals for the remainder of their lives. At September 30,
1988, the Bank recorded a liability for this deferred compensation calculated as
the present value of the estimated future cash payments. The amount of benefit
expense for fiscal years 1997, 1996 and 1995 was $32,000, $29,000, and $26,000,
respectively.
Stock options - The Company has granted stock options to existing
stockholders, officers, directors and other affiliated individuals to purchase
shares of the Company's stock at prices at least equal to the fair market value
of the stock on the date of the grant. The options are nontransferable and are
forfeited upon termination of employment, as applicable. At June 30, 1997, all
outstanding stock options were exercisable through May 2007. The following is an
analysis of stock option activity for each of the three years in the period
ended June 30, 1997 and the stock options outstanding at the end of the
respective years:
1997 1996 1995
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding, beginning of fiscal year 155,700 $ 7.70 163,200 $ 7.32 155,200 $ 7.50
Granted 21,000 10.89 26,612 7.51 41,000 5.04
Exercised (30,112) 5.48 (21,600) 4.66
Forfeited or expired (250) 10.00 (4,000) 7.50 (11,400) 6.66
------- --------- ------- --------- ------- ---------
Outstanding, end of fiscal year 176,450 $ 8.08 155,700 $ 7.70 163,200 $ 7.32
------- --------- ------- --------- ------- ---------
Options exercisable at end of fiscal year 2,500 $ 10.00
======= =========
As of June 30, 1997, options outstanding have exercise prices between
$7.50 and $11.50 and a weighted average remaining contractual life of 2.2 years.
Of the stock options outstanding at June 30, 1997, 143,200 have exercise prices
of $7.50 with a weighted average remaining contractual life of 6.5 months.
The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for the plans; accordingly,
since the grant price of the stock options is at least 100% of the fair value at
the date of the grant no compensation expense has been recognized by the Company
in connection with the option grants. Had compensation cost for the plans been
determined based on the fair value at the grant dates for awards under the plan
consistent with the fair value method of SFAS No. 123, Accounting for
Stock-Based Compensation, the Company's net income and net income per share
would have decreased to the pro forma amounts indicated below:
(Dollars in thousands except per share data)
Years Ended June 30, 1997 1996
- --------------------------------------------------------------------------------
Net income:
As reported $ 2,002 $ 1,223
Pro forma $ 1,995 $ 1,221
Net income per share:
As reported $ 0.61 $ 0.57
Pro forma $ 0.61 $ 0.57
The weighted average fair value of options granted was $3.42 in fiscal
year 1997 and $1.51 in fiscal year 1996. The fair value of the option grants are
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions: no dividend yield (except for the May 1997 grant),
risk-free interest rates ranging from 5.42% - 6.62%, expected volatilities
ranging from 0% - 22.49% and expected lives ranging from 23 days to five years.
The pro forma amounts are not representative of the effects on reported net
income for future years.
Employee Stock Ownership Plan - The Company established an Employee
Stock Ownership Plan (ESOP) on February 5, 1996 for employees of the Company and
the Bank. Full-time employees of the Company and the Bank who have been credited
with at least 1,000 hours of service during a twelve month period are eligible
to participate in the ESOP. During the 1997 fiscal year, the ESOP purchased
5,000 shares at $10.25 per share which have not been allocated as of fiscal year
end. During the 1996 fiscal year, the ESOP purchased 7,000 shares in the initial
public offering at $10.00 per share which have been allocated to eligible
employees. Contributions are allocated to eligible employees based on their
eligible compensation as defined in the ESOP Agreement. Gross compensation
expense (i.e. the value of shares contributed to the ESOP by the Company) for
fiscal years 1997 and 1996 was $51,000 and $70,000, respectively.
13. RISK MANAGEMENT ACTIVITIES
The Bank closely monitors the sensitivity of its balance sheet and
income statement to potential changes in the interest rate environment.
Derivative financial instruments such as interest rate swaps, caps, floors,
collars, futures, and options are used on an aggregate basis to protect the
trading portfolio and certain liabilities from adverse rate movements. The
Bank's objective, with regard to managing interest rate risk, is to maintain at
an acceptably low level the sensitivity to rising or falling rates of its market
value of portfolio equity.
Interest rate swaps are contracts in which the parties agree to
exchange fixed and floating rate payments for a specified period of time on a
specified (notional) amount. The notional amount is only used to calculate the
amount of the periodic interest payments to be exchanged, and does not represent
the amount at risk. The Bank uses swaps to modify the effective duration of
various assets and liabilities. The floating rates are generally indexed to the
three-month London Interbank Offered Rates (LIBOR).
Interest rate caps and floors are instruments in which the writer
(seller) agrees to pay the holder (purchaser) the amount that an agreed-upon
index is above or below the specified cap or floor rate, respectively, times the
notional amount. In return for this promise of future payments, the purchaser
pays a premium to the seller. The notional amount is never exchanged between the
two parties and does not represent the amount at risk. The Bank purchases
interest rate caps and floors to reduce the impact of rising or falling interest
rates on the market value of its trading portfolio. The interest rate caps and
floors generally have indexes equal to one or three month LIBOR, except for one
interest rate cap which is tied to the five year Constant Maturity Treasury.
The Bank is a party to an interest rate collar which also is used to
manage interest rate risk in the trading portfolio. The interest rate collar
consists of an interest rate cap held by
the Bank and an interest rate floor written by the Bank. The notional amount of
the interest rate collar is based on the balance in the collection accounts of
certain Merrill Lynch collateralized mortgage obligation trusts.
Interest rate futures contracts are commitments to either purchase or
sell designated instruments at a future date for a specified price. Initial
margin requirements are met in cash or other instruments, and changes in the
contract values are settled in cash daily. The Bank enters into futures
contracts when these instruments are economically advantageous to interest rate
swaps, caps and floors. The Bank uses primarily Eurodollar contracts which are
structured in calendar quarter increments and therefore result in a much larger
notional amount than longer maturity swap, cap or floor contracts which
represent a series of quarterly repricings.
Financial options are contracts which grant the purchaser, for a
premium payment, the right to either purchase from or sell to the writer a
specified financial instrument under agreed-upon terms. Financial options to buy
or sell securities are typically traded in standardized contracts on organized
exchanges. The Bank purchases financial options to reduce the risk of the
written financial options embedded in mortgage related assets.
Cash restrictions - The Bank maintained $1,300,000 and $1,548,000 at
June 30, 1997 and 1996, respectively, in U.S. Treasury Securities, which are
considered cash equivalents, as a deposit with a broker for its futures
activities.
Credit risk - The Bank is dedicated to managing credit risks associated
with hedging activities. The Bank maintains trading positions with a variety of
counterparties or obligors (counterparties). To limit credit exposure arising
from such transactions, the Bank evaluates the credit standing of
counterparties, establishes limits for the total exposure to any one
counterparty, monitors exposure against the established limits and monitors
trading portfolio composition to manage concentrations. In addition, the Bank
maintains qualifying netting agreements with its counterparties and records
gains and losses on derivative financial instruments net in the trading
portfolio.
The Bank's exposure to credit risk from derivative financial
instruments is represented by the fair value of instruments. Credit risk amounts
represent the replacement cost the Bank could incur should counterparties with
contracts in a gain position completely fail to perform under the terms of those
contracts and any collateral underlying the contracts proves to be of no value
to the Bank. Counterparties are subject to the credit approval and credit
monitoring policies and procedures of the Bank. Certain instruments require the
Bank or the counterparty to maintain collateral for all or part of the exposure.
Limits for exposure to any particular counterparty are established and
monitored. Notional or contract amounts indicate the total volume of
transactions and significantly exceed the amount of the Bank's credit or market
risk associated with these instruments.
The following off balance sheet positions are included in the Bank's
trading portfolio and are thus reported in the financial statements at current
fair value.
(Dollars in thousands)
June 30, 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Estimated
Contract or Fair Value Weighted Average Interest Rate
Notional ---------------------------------------------------------------------------
Amount Asset Liability Payable Receivable Cap Floor
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Pay fixed rate $ 267,500 $ 581 5.92% 5.80% N/A N/A
Interest rate caps 133,000 1,545 N/A N/A 7.92% N/A
Interest rate floors 275,000 3,541 N/A N/A N/A 6.38%
Interest rate collar 4,268 $ 8 N/A N/A 10.25% 5.25%
Futures 1,546,400 356 N/A N/A N/A N/A
Options 77,900 24
---------- ------ ----
$2,304,068 $6,047 $ 8
========== ====== ====
(Dollars in thousands)
June 30, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Estimated
Contract or Fair Value Weighted Average Interest Rate
Notional ---------------------------------------------------------------------------
Amount Asset Liability Payable Receivable Cap Floor
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Pay fixed rate $ 63,500 $ 620 5.56% 5.52% N/A N/A
Interest rate caps 158,000 3,074 N/A N/A 7.46% N/A
Interest rate floors 165,000 2,970 N/A N/A N/A 6.41%
Interest rate collar 6,484 $ 8 N/A N/A 10.25% 5.25%
Futures 1,361,900 784 N/A N/A N/A N/A
Options 13,000 65 N/A N/A N/A N/A
------------ ------ ----
$ 1,767,884 $6,729 $792
============ ====== ====
(Dollars in thousands)
YEAR ENDED JUNE 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Monthly Monthly
Average Average
Fair Value Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
Asset Liability Asset Liability
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Pay fixed rate $ 952 $ 45 $ 534 $1,469
Interest rate caps 2,389 3,228
Interest rate floors 4,945 4,370
Interest rate collar 13 48
Futures 95 134
Options 154 136
------ ------ ------ ------
$8,440 $ 153 $8,268 $1,651
====== ====== ====== ======
The following table shows the various components of the Company's
recorded net gain on its trading portfolio. All realized and unrealized gains
and losses are reported as other income in the statement of income. The periodic
exchanges of interest payments and the amortization of premiums paid for
contracts are accounted for as adjustments to the yields, and are reported on
the statements of income as interest income.
(Dollars in thousands)
Year Ended June 30, 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate contracts:
Swaps $ (39) $ (39)
Caps (862) (862)
Floors (810) (810)
Collar 32 32
Futures $(5,045) 1,140 (3,905)
Options 114 (65) 49
------- ------- -------
Total (4,931) (604) (5,535)
MBS and other trading assets 3,308 2,721 6,029
------- ------- -------
Total trading portfolio $(1,623) $ 2,117 $ 494
======= ======= =======
(Dollars in thousands)
Year Ended June 30, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate contracts:
Swaps $(1,116) $ 839 $ (277)
Caps -- (316) (316)
Floors -- (1,430) (1,430)
Collar -- 135 135
Futures 2,522 (650) 1,872
Options 256 76 332
------- ------- -------
Total 1,662 (1,346) 316
MBS and other trading assets 172 (614) (442)
------- ------- -------
Total trading portfolio $ 1,834 $(1,960) $ (126)
======= ======= =======
(Dollars in thousands)
Year Ended June 30, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Realized Unrealized Net Trading
Gains/ Gains/ Gains/
(Losses) (Losses) (Losses)
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate contracts:
Swaps $ (651) $(3,577) $(4,228)
Caps (110) (1,783) (1,893)
Floors 42 2,737 2,779
Collar -- (14) (14)
Futures (1,854) (134) (1,988)
Options 135 (65) 70
------- ------- -------
Total (2,438) (2,836) (5,274)
MBS and other trading assets 2,504 4,371 6,875
------- ------- -------
Total trading portfolio $ 66 $ 1,535 $ 1,601
======= ======= =======
The following table sets forth the maturity distribution and weighted
average interest rates of financial instruments used on an aggregate basis to
protect the trading portfolio from adverse rate movements at June 30, 1997.
(Dollars in thousands)
Maturities During Fiscal
Years Ending June 30, 1998 1999 2000 2001 2002 Thereafter
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps-Pay fixed rate
Notional amount $ 146,500 $ 100,000 $ 16,000 $ 5,000
Weighted average payable rate 5.72% 6.12% 6.27% 6.58%
Weighted average receivable rate 5.79% 5.82% 5.79% 5.82%
Interest rate caps
Notional amount 37,000 10,000 $ 86,000
Weighted average cap rate 8.09% 6.50% 8.01%
Interest rate floors
Notional amount 35,000 60,000 30,000 70,000 $ 20,000 60,000
Weighted average floor rate 7.50% 6.42% 6.50% 6.50% 6.00% 5.63%
Interest rate collar
Notional amount 4,268
Weighted average cap rate 10.25%
Weighted average floor rate 5.25%
Futures
Notional amount 152,400 145,000 182,000 348,000 278,000 441,000
Options
Notional amount 77,900
The following interest rate hedges are not included in the Bank's
trading portfolio. Interest rate swaps are used to modify the interest rate
sensitivity of certain certificates of deposit issued by the Bank. These
certificates of deposit, called inverse variable rate CDs, adjust according to a
formula in such a way as to pay a higher rate of interest when the index falls,
and a lower rate of interest when the index rises. As of June 30, 1997 and 1996,
the Bank held approximately $6.2 million and $8.4 million of inverse variable
rate CDs, with original terms to maturity ranging from three to ten years. The
Bank utilizes interest rate swaps with the same notional amount as the inverse
variable rate CDs to convert such certificates of deposit effectively to fixed
rate deposits. An additional notional amount of interest rate swaps are then
utilized to convert a portion of such certificates from fixed rate to variable
rate deposits. During fiscal year 1996, the notional amount of the interest rate
swaps was approximately twice that of the inverse variable rate CDs which
effectively converted all such certificates from fixed rate to variable rate
deposits. The interest rate swaps protect the Bank against the exposure to
falling interest rates inherent in these CDs.
The Bank also has a 7% interest rate cap which is used to effectively
cap the interest rate on the Company's floating rate Federal Home Loan Bank
advances. As of June 30, 1997, the Bank held two advances totaling $26 million
that reprice based on the three month LIBOR quarterly. The interest rate cap has
a notional amount of $30 million and reprices based on the three month LIBOR
quarterly within a few days of the advances. The interest rate cap matures May
2001 and the advances mature October and November 1997, however, it is the
Bank's intent to replace the advances when they mature with additional floating
rate liabilities, which will be designated against the interest rate cap.
The market values of the following interest rate swaps and interest
rate cap are not reflected in the Company's financial statements. The periodic
exchanges of interest payments and the net expense of the interest rate cap are
included in interest expense in the statements of income.
(Dollars in thousands)
June 30, 1997
Contract or Estimated Fair Value Weighted Average Interest Rate
Notional -----------------------------------------------------------------------
Amount Asset Liability Payable Receivable
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Pay floating rate $ 7,500 $ 91 6.00% 6.96%
Interest rate cap $ 30,000 $ 351 N/A N/A
(Dollars in thousands)
June 30, 1996
Contract or Estimated Fair Value Weighted Average Interest Rate
Notional -----------------------------------------------------------------------
Amount Asset Liability Payable Receivable
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Pay floating rate $ 17,500 $ 110 5.57% 6.48%
Interest rate cap $ 30,000 $ 747 N/A N/A
The following table sets forth the maturity distribution and weighted
average interest rates of the interest rate swaps used to protect the inverse
variable rate CDs from adverse rate movements and the interest rate cap used to
cap the Federal Home Loan Bank advances at 7% as of June 30, 1997:
(Dollars in thousands)
Maturities During Fiscal
Years Ending June 30, 1998 1999 2000 2001 2002 Thereafter
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps-Pay floating rate
Notional amount $7,500
Weighted average payable rate 6.00%
Weighted average receivable rate 6.96%
Interest rate cap
Notional amount $30,000
Weighted average cap rate 7.00%
14. CREDIT COMMITMENTS
The Bank is a party to commitments to extend credit as part of its
normal business operations to meet the financing needs of its customers. These
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheet. Exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument for commitments to extend credit is represented by the contract
amount of those instruments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. Unless noted otherwise,
the Bank does not require collateral or other security to support financial
instruments with credit risk.
The following table sets forth the Bank's real estate loan commitments
whose contract amounts represent credit risk and the applicable range of
interest rates for such loan commitments.
(Dollars in thousands)
June 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Interest
Amount Rates Amount Rates
- ------------------------------------------------------------------------------------------------------------------------------------
Fixed rate $ 573 7.625-8.375% $ 703 7.75-8.875%
Adjustable rate 2,609 6.50-7.50% 300 5.75-7.25%
------- -------
$ 3,182 $ 1,003
======= =======
15. RELATED PARTY TRANSACTIONS
The Company has contracted with Smith Breeden Associates, Inc. ("SBA")
to provide investment advisory services and interest rate risk analysis. Certain
stockholders of HFG are also principals of SBA. The amount of consulting expense
relating to SBA for fiscal years ending June 30, 1997, 1996 and 1995 was
$281,000, $232,000 and $195,000, respectively.
16. STOCKHOLDERS' EQUITY AND
REGULATORY MATTERS
Equity offering - Under the terms of an offering memorandum, the
Company offered up to 555,556 shares of stock to certain stockholders, directors
and officers of the Company and the Bank during fiscal 1995. The shares of
common stock were offered at $4.50 per share beginning on November 1, 1994;
however, the purchase price increased each day thereafter at a rate of prime
plus 2% until the closing of the equity offering on January 31, 1995.
Liquidation account - On July 10, 1985, the Bank converted from a
federally chartered mutual association to a federally chartered stock
association through the issuance of 463,173 shares of common stock ($1 par
value) at a price of $8 per share. From the proceeds, $463,000 was allocated to
capital stock at the par value of $1 per share and $2,919,000 which is net of
conversion costs of $324,000 was allocated to additional paid-in-capital.
The Bank established a special liquidation account (in memorandum form)
in an amount equal to its total retained earnings as of June 1, 1984 for the
purpose of granting to eligible savings account holders a priority in the event
of future liquidation. In the event of future liquidation of the converted
institution (and only in such event), an eligible account holder who continues
to maintain his savings account shall be entitled to receive a distribution from
the liquidation account. The total amount of the liquidation account will be
decreased in an amount proportionately corresponding to decreases in the savings
accounts of eligible account holders on each subsequent annual determination
date.
Dividend restrictions - Regulations provide that the Bank may not
declare or pay a cash dividend on or repurchase any of its stock if the result
thereof would be to reduce the consolidated stockholders' equity of the Bank
below the amount required for the liquidation account (as defined by
regulations). Under the capital distribution regulations of the OTS, the Bank,
as a "Tier 1" institution, is permitted to make capital distributions during a
calendar year up to one hundred percent of its net income to date during the
calendar year plus the amount that would reduce by one-half its surplus capital
ratio, as defined, at the beginning of the calendar year. Under this limitation,
$6,440,000 was available for dividends at June 30, 1997.
Reserve Requirements - As of June 30, 1997, the Bank was not required
to maintain reserve balances with the Federal Reserve Bank.
SAIF Assessment - On September 30, 1996, the President signed into law
an omnibus appropriations act for fiscal year 1997 that included, among other
things, the recapitalization of the Savings Association Insurance Fund (SAIF) in
a section entitled "The Deposit Insurance Funds Act of 1996" (the Act). The Act
included a provision where all insured depository institutions would be charged
a one-time special assessment on their SAIF assessable deposits as of March 31,
1995. The Company recorded a pre-tax charge of $830,000 during the year ended
June 30, 1997.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments:
(Dollars in thousands)
JUNE 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Cash $ 1,207 $ 1,207 $ 1,036 $ 1,036
Interest-bearing deposits 8,309 8,309 16,107 16,107
Securities held for trading 317,355 317,355 319,847 319,847
Securities available for sale 1,125 1,125 2,050 2,050
Loans receivable, net 93,958 94,800 65,925 65,900
Interest receivable 2,080 2,080 1,807 1,807
Federal Home Loan Bank stock 4,852 4,852 2,645 2,645
Due fr0m brokers 11,308 11,308 4,374 4,374
LIABILITIES:
Deposits 136,175 136,200 135,143 134,951
Securities sold under agreements
to repurchase 245,571 245,600 219,067 218,967
Federal Home Loan Bank advances 26,000 26,000 26,000 26,000
Interest payable on securities sold
under agreements to repurchase 300 300 115 115
Other interests payable 787 787 1,855 1,855
Note payable 9,995 9,995 8,998 8,998
Advance payments by borrowers for
taxes and insurance 585 585 392 392
OFF BALANCE SHEET HEDGING
INSTRUMENTS:
Interest rate swaps 91 110
Interest rate cap 685 351 863 747
The estimated fair value amounts are determined by the Company, using
available market information and appropriate valuation methodologies. However,
considerable judgment is required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Cash, interest-bearing deposits, interest receivable and payable, advance
payments by borrowers for taxes and insurance and note payable - The carrying
amounts of these items are a reasonable estimate of their fair value.
Loans receivable - The fair value of loans receivable is estimated by
discounting future cash flows at market interest rates for loans of similar
terms and maturities, taking into consideration repricing characteristics and
prepayment risk.
Securities held for trading consist of mortgage-backed securities,
collateralized mortgage obligations, residuals, interest-only strips,
principal-only strips, interest rate swaps, an interest rate collar, interest
rate caps, interest rate floors, options, futures and equity securities. Fair
values are based on quoted market prices or dealer quotes. Where such quotes are
not available, fair value is estimated by using quoted market prices for similar
securities or by discounting future cash flows at a risk adjusted spread to
Treasury.
Due from brokers consists of amounts receivable from sales of
securities in which the transactions have not settled as of the balance sheet
date. The fair value is determined by the carrying amounts of the securities
sold.
Federal Home Loan Bank stock - The fair value is estimated to be the
carrying value which is par. All transactions in the capital stock of the
Federal Home Loan Bank of Indianapolis are executed at par.
Deposits - The fair value of NOW, savings and money market deposit
accounts is the amount payable on demand at the reporting date. The fair value
of fixed maturity certificates is estimated using rates currently offered for
deposits of similar remaining maturities.
Securities sold under agreements to repurchase - Fair values are based
on the discounted value of contractual cash flows using dealer quoted rates for
agreements of similar terms and maturities.
Federal Home Loan Bank advances - The fair value is estimated by
discounting future cash flows using rates currently available to the bank for
advances of similar maturities.
Off balance sheet hedging instruments consist of interest rate swaps
and an interest rate cap used to modify the interest rate sensitivity of certain
certificates of deposits and Federal Home Loan Bank advances, respectively. Fair
values are based on quoted market prices or dealer quotes. Where such quotes are
not available, fair value is estimated by using quoted market prices for similar
securities or by discounting future cash flows at a risk adjusted spread to
Treasury.
Commitments - The estimated fair value of commitments to originate
fixed-rate loans is determined based on the fees currently charged to enter into
similar agreements and the difference between current levels of interest rates
and the committed rates. Based on that analysis, the estimated fair value of
such commitments is a reasonable estimate of the loan commitments at par.
The fair value estimates presented herein are based on information
available to management as of June 30, 1997 and 1996. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these consolidated financial statements since such dates, and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
18. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION
(PARENT COMPANY ONLY)
The following condensed balance sheets as of June 30, 1997 and 1996, and
condensed statements of income and cash flows for the three years in the period
ended June 30, 1997 for Harrington Financial Group, Inc. should be read in
conjunction with the consolidated financial statements and notes thereto.
CONDENSED BALANCE SHEETS
(Dollars in thousands)
June 30, 1997 1996
- --------------------------------------------------------------------------------
Cash and cash equivalents $ 3,500 $ 5,271
Securities held for trading 464 550
Income taxes receivable 124
Other assets 55 82
Intercompany receivable (payable) (1) 70
Investment in subsidiary 30,997 26,039
-------- --------
Total assets $ 35,139 $ 32,012
======== ========
Note payable $ 9,995 $ 8,998
Deferred income taxes, net 63 10
Accrued income taxes (210)
Accrued expenses payable
and other liabilities 87 97
-------- --------
Total liabilities 10,145 8,895
-------- --------
Common stock 407 407
Additional paid-in capital 15,623 15,623
Unrealized loss
on securities available
for sale (35) (8)
Retained earnings 8,999 7,095
-------- --------
Total stockholders' equity 24,994 23,117
-------- --------
Total liabilities and
stockholders' equity $ 35,139 $ 32,012
======== ========
CONDENSED STATEMENTS OF INCOME
(Dollars in thousands)
Years Ended
June 30, 1997 1996 1995
- --------------------------------------------------------------------------------
Dividends from subsidiary $ 4,000 $ 855 --
Interest income from securities
held for trading 76 8 $ 18
Interest on deposits 8 12 12
Gain on sale of securities
held for trading 12 42 24
Unrealized gain on securities
held for trading 105 28 26
------- ------- -------
Total income 4,201 945 80
------- ------- -------
Interest expense on
long-term borrowings 907 905 749
Salaries and employee benefits 231 105 31
Other expenses 315 12 46
------- ------- -------
Total expenses 1,453 1,022 826
------- ------- -------
Income (loss) before equity in
undistributed earnings 2,748 (77) (746)
Income tax provision (benefit) (509) (359) (296)
Equity in undistributed earnings
of subsidiary (1,255) 941 2,303
------- ------- -------
Net income $ 2,002 $ 1,223 $ 1,853
======= ======= =======
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,002 $ 1,223 $ 1,853
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Decrease in other assets 27 8 23
Increase in income taxes receivable (124)
Decrease (increase) in intercompany receivable 71 (70)
Increase (decrease) in accrued expenses
and other liabilities (10) 83 14
Gain on sale of securities held for trading (12) (42) (24)
Unrealized gain on securities held for trading (105) (28) (26)
Purchases of securities held for trading (545) (880)
Proceeds from sales of securities held for trading 203 314 1,081
Deferred income tax provision 53 16 (4)
Increase (decrease) in accrued income taxes 210 211 (189)
Decrease (increase) in undistributed earnings of subsidary 1,255 (941) (2,303)
-------- -------- --------
Net cash provided by (used in)
operating activities 3,570 229 (455)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to subsidiary (6,240) (6,792) (3,250)
-------- -------- --------
Net cash used in investing activities (6,240) (6,792) (3,250)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock under
equity offering -- -- 2,421
Proceeds from issuance of common stock
under initial public offering -- 11,437 --
Proceeds from stock options exercised -- 165 101
Proceeds from note payable 2,300 800 1,900
Principal repayments on note payable (1,303) (1,002) (600)
Dividends paid on common stock (98) -- --
-------- -------- --------
Net cash provided by financing activities 899 11,400 3,822
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (1,771) 4,837 117
Cash and cash equivalents,
Beginning of year 5,271 434 317
-------- -------- --------
Cash and cash equivalents,
End of year $ 3,500 $ 5,271 $ 434
======== ======== ========
19. SUBSEQUENT EVENT
On August 7, 1997, the Board of Directors of the Company approved the
repurchase of up to 5% of the Company's outstanding common stock.
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Harrington Financial Group, Inc.
Richmond, Indiana
We have audited the accompanying consolidated balance sheets of
Harrington Financial Group, Inc. and its subsidiary (the "Company") as of June
30, 1997 and 1996, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Harrington Financial Group,
Inc. and its subsidiary as of June 30, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1997 in conformity with generally accepted accounting principles.
/s/DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
July 23, 1997
(August 7, 1997 as to Note 19)