Table of Contents
Section 1
Letter to Shareholders ............................................... 1
Selected Consolidated Financial Data ................................. 2
Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................... 3
Section 2
Report of Independent Auditors ....................................... 17
Consolidated Financial Statements
Consolidated Balance Sheets .......................................... 18
Consolidated Statements of Income .................................... 19
Consolidated Statements of Changes
in Shareholders' Equity .......................................... 20
Consolidated Statements of Cash Flows ................................ 22
Notes to Consolidated Financial Statements ........................... 24
Annual Meeting
The Annual Meeting of Shareholders is scheduled for Wednesday, October 27,
1999 at 10:00 a.m., at the Grand Rapids Elks Lodge, located at 2715 Leonard
Street, N.W., Grand Rapids, Michigan.
Corporate Headquarters
2185 Three Mile Rd., N.W.
Grand Rapids, Michgian 49544-1451
To Our Stockholders:
First, let me say it is a distinct privilege to join Bank West as its
President and Chief Executive Officer. I joined the Bank West team on April 13,
1999, with 45 years of banking experience that includes commercial and mortgage
lending and various other areas of responsibility in the banking sector.
After reviewing the Bank's strategic plan, I was pleased to find that the
principles of the plan of core loan and deposit growth were parallel with my
banking philosophy. I recognized, however, that we needed to strengthen our
management team by adding experience in other areas of the Bank if we were to
grow and diversify our balance sheet, continue to portfolio high quality loans,
and significantly improve profitability. Our goal is to establish high caliber,
experienced leadership in the key areas of the Bank which subscribes to our
vision of responsive, personalized community banking. As we work toward
accomplishing this goal, we must continue to differentiate ourselves as a
community bank that values relationships and recognizes the role we play in
enhancing the prosperity of our customers and the communities we serve.
We are excited about the opening of our fourth branch in Jenison, a
southwestern suburb of Grand Rapids, in November 1999. This branch will play an
important role in our loan and deposit growth plans. We also plan on upgrading
our loan origination and processing software that will enable us to improve our
efficiency in various areas of the Bank. The investment we have made in people,
systems and geographical expansion will provide the foundation for continued
growth and profitability.
The Bank achieved 22% net loan growth during fiscal 1999, primarily from
commercial and residential mortgage loans. Net income for 1999 was $176,000 as
compared to $830,000 and $923,000 for 1998 and 1997, respectively. The items
impacting 1999 net income are described in detail in the "Management's
Discussion and Analysis of Financial Condition and Results of
Operations"section. We recognized that such charges were necessary as we
continue to position our Company for future earnings based upon our strategy of
core loan and deposit growth. Although we are disappointed in fiscal 1999's
results, we are optimistic of the Company's success in the years ahead.
Bank West has aggressively addressed the upcoming Year 2000 ("Y2K") event
during the fiscal year, working within FDIC guidelines. We renovated or upgraded
all mission critical computer systems to ensure Y2K compliance. Additionally, we
have evaluated our credit customers to determine the risk that they might pose
as a result of Y2K so that we can take appropriate steps to mitigate those
risks. Policies, plans, and procedures have been developed to guide contingency
business resumption efforts in the event of some unforeseen development, such as
power or telecommunications failure. Like all companies, we face the uncertainty
of external influences on our operations at the turn of the century. However,
the substantial investment of time and resources we have made in this area
allows us to look forward to the new millennium with confidence.
Our directors, management and staff want to thank you, our stockholders, for
your investment and belief in our efforts and vision. We will continue our
efforts to grow and diversify your company, with the goal of enhancing
shareholder value. With this in mind, we look forward to our 113th year of
offering superior banking services throughout the Western Michigan area.
Sincerely,
/s/Ronald A. Van Houten
-----------------------
Ronald A. Van Houten
President and Chief Executive Officer
1
Selected Consolidated Financial Data
(Dollars in thousands except per share data)
Year Ended June 30,
1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------
Summary of Operations
Total interest income $ 13,666 $ 12,549 $ 10,429 10,088 7,848
Net interest income 5,352 4,937 4,279 4,158 3,185
Provision for loan losses 220 81 60 60 21
Other income 621 1,012 1,554 1,202 270
One-time special SAIF assessment -- -- 551 -- --
Other expenses 5,339 4,585 3,821 3,469 2,352
Income taxes 146 453 478 622 366
Income before cumulative effect of
accounting change 268 -- -- -- --
Cumulative effect of change in accounting (92) -- -- -- --
Net income 176 830 923 1,208 716
Balance Sheet Data
Total assets $206,669 $181,469 $155,675 $137,982 $139,648
Cash and cash equivalents 9,106 4,206 3,673 6,694 4,595
Securities 17,733 6,745 3,978 7,422 11,405
Mortgage collateralized securities 24,539 36,507 25,578 17,341 18,335
Loans, net 145,206 118,906 111,530 95,737 95,836
Loans held for sale 2,381 8,157 2,231 4,297 2,746
Deposits 132,401 119,979 102,862 91,028 85,180
FHLB advances 50,000 37,000 29,000 19,000 24,922
Equity 22,552 23,275 22,592 26,810 28,171
Per Share Data(1)
Basic earnings per share(2) $ .07 $ .35 $ .36 $ .39 $ .07
Diluted earnings per share(2) .07 .33 .36 .39 .07
Dividends per share .24 .22 .19 .19 --
Book value per share 8.68 8.87 8.59 8.13 8.11
Ratios
Average yield on interest-earning assets 7.23% 7.74% 7.61% 7.52% 6.97%
Average rate on interest-bearing liabilities 4.88 5.26 5.15 5.37 4.76
Average interest spread 2.35 2.48 2.46 2.15 2.21
Net interest margin 2.83 3.04 3.12 3.10 2.83
Return on average assets (ROA) .09 .49 .64 .87 .62
Return on average equity (ROE) .76 3.58 3.89 4.38 4.34
Efficiency ratio 72.16 76.34 74.89 68.56 69.56
Dividend pay-out ratio 342.86 64.96 54.94 49.93 --
Average equity to average assets 11.72 13.60 16.42 19.77 14.46
Non-performing loans as a % of loans, net .88 .71 .37 .04 .15
(1) All per share data has been adjusted for stock splits.
(2) Earnings per share for the year ended June 30, 1995 was computed by
dividing net income subsequent to the conversion on March 30, 1995 by the
weighted average number of shares outstanding subsequent to March 30, 1995.
2
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following sections are designed to provide a more detailed discussion of
Bank West Financial Corporation's (the "Company's") consolidated financial
condition and results of operations as well as provide additional information on
the Company's asset/liability management strategies, sources of liquidity and
capital resources. Management's Discussion and Analysis should be read in
conjunction with the consolidated financial statements contained herein. This
discussion provides information about the consolidated financial condition and
results of operations of the Company and its wholly owned subsidiary, Bank West
(the "Bank").
This Annual Report includes statements that may constitute forward-looking
statements, usually containing the words "believe," "estimate," "project,"
"expect," "intend" or similar expressions. These statements are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements inherently involve 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 following: changes in
economic conditions (both generally and more specifically in the markets in
which Bank West operates); changes in interest rates, deposit flows, loan
demand, real estate values and competition; changes in accounting principles,
government legislation and regulation; and changes in other risks detailed in
this Annual Report and in the Company'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. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof.
General
Bank West Financial Corporation is the holding company for Bank West, a state
chartered savings bank. Substantially all of the Company's assets are currently
held in, and its operations are conducted through, its sole subsidiary Bank
West. The Company's business consists primarily of attracting deposits from the
general public and using such deposits, together with Federal Home Loan Bank
("FHLB") advances, to originate and purchase residential real estate loans,
including residential construction loans. The Company also originates commercial
loans, home equity loans and consumer loans.
The Company's operations and profitability are subject to changes in interest
rates, applicable regulations and general economic conditions, as well as other
factors beyond the Company's control. The profitability of Bank West depends
primarily on its net interest income, which is dependent upon the level of
interest rates and the extent to which such rates are changing. The Company's
profitability also is dependent on the level of its other income, including
gains on sales of loans in connection with its mortgage banking activities and
fees and service charges.
During December 1997, the Bank formed Sunrise Mortgage Corporation, a wholly
owned subsidiary engaged to originate and purchase non-conforming mortgage
loans, including sub-prime mortgage loans for resale. All of the loans
originated and purchased were required to have a commitment to sell in place to
an investor on a servicing released basis. Recently, management decided to
discontinue non-conforming lending through Sunrise Mortgage Corporation due to
the lower than expected loan volume originated and purchased during the most
recent fiscal year.
The Company's net income was $176,000, $830,000 and $923,000 for fiscal 1999,
1998 and 1997, respectively. Fiscal 1999 net income, and to some degree, fiscal
1998 and 1997 net income were impacted by a number of items which management
feels will no longer significantly impact future earnings. See "Results of
Operations for the Year Ended June 30, 1999 Compared to the Year Ended June 30,
1998" and "Results of Operations for the Year EndedJune 30, 1998 Compared to the
Year ended June 30, 1997" sections for further clarification of such items.
3
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Changes in Financial Condition
Assets. Total assets increased by $25.2 million or 13.9% from June 30, 1998
to June 30, 1999. The increase is primarily due to an increase in net loans of
$26.3 million or 22.1% as greater emphasis was placed on originating commercial
loans and balloon single-family mortgage loans instead of concentrating
primarily on residential mortgage banking activities. The additional emphasis on
the origination of these loans during fiscal 1999 was designed to diversify the
Bank's loan portfolio from its traditional emphasis on adjustable-rate mortgages
("ARM's"), which have recently been out-of-favor due to the overall lower
interest rate environment, and to react to increased competitiveness in the
residential mortgage banking business. Total commercial and consumer loans
increased as a percent of total loans from 18.4% at the end of fiscal 1998 to
23.9% at the end of fiscal 1999. Management expects the next fiscal year and
future years to reflect significant growth in commercial loans due to the
strategic realignment that occurred during March of 1999. The Bank's newly
appointed President/Chief Executive Officer and Vice President of Commercial
Lending both have extensive commercial lending and banking experience. The
Bank's strategic plan and business model has changed in focus to concentrate
greater efforts on commercial lending activities. The growth in commercial
lending is expected to contribute significantly toward improving the Bank's net
interest income and margins.
The Bank's mortgage banking activities consist of selling newly originated
and purchased loans into the secondary market. Total loans sold amounted to
$41.6 million, $45.0 million and $32.9 million in fiscal 1999, 1998 and 1997,
respectively. Loans held for sale amounted to $2.4 million, $8.2 million and
$2.2 million at June 30, 1999, 1998 and 1997, respectively. The dollar amount of
loans sold and loans held for sale decreased in fiscal 1999 due to management's
recent strategy to portfolio ten-year balloon mortgages versus selling them.
Adding ten-year balloon loans to portfolio was designed to offset the
significant prepayments of ARM's and longer-term fixed-rate mortgages during the
fiscal year. In addition, the current strategy will leverage the balance sheet
which is expected to provide additional net interest income. The Bank continues
to explore different options to increase retail and wholesale mortgage loan
volume.
Collateralized mortgage obligations ("CMO's) decreased from $35.7 million at
June 30, 1998 to $21.1 million at June 30, 1999. During the fourth quarter of
fiscal 1999, the Bank sold approximately $15 million of its CMO's that were
lower yielding and had longer average lives than the bonds that replaced them,
taking advantage of the recent rise in overall market interest rates. This
decision will result in higher net interest income and also provide liquidity
over the next few years to fund anticipated commercial loan growth. The fourth
quarter sale of CMO's resulted in a $129,000 loss, net of income taxes. However,
it is anticipated that the higher yielding bonds that were purchased will
recover the loss in the form of higher interest income within twelve months. The
remaining CMO's, which have floating rates based on either the prime or one
month LIBOR rates, are structured with relatively low weighted average note
rates of approximately 7.1% as compared to current market rates, which reduces
prepayment risk. During April of 1999, securities were transferred from the held
to maturity portfolio to the available for sale and trading portfolios in
accordance with the provisions of Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" to
provide the Company with additional flexibility in the management of its
security portfolio as discussed below. At the date of transfer, these securities
had an amortized cost of $14.1 million.
Other securities which are classified as available for sale primarily consist
of U.S. agency securities, corporate bonds, pass-thru mortgage-backed securities
and taxable municipal securities. These types of securities increased from $7.6
million at June 30, 1998 to $21.1 million at June 30, 1999. The increase is
primarily due to the purchase of U.S. agency securities and corporate and
municipal bonds that are higher yielding and have much shorter average lives
than CMO's. The Company also liquidated the majority of its equity securities
during the fiscal year.
4
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Remaining equity securities have a carrying value of approximately $60,000 at
June 30, 1999. The shift in the mix of the security portfolio represents another
step in the Bank's strategy to focus on its principles of long-term loan growth
through liquidity, asset/liability and credit risk management by matching debt
securities with planned loan growth.
At June 30, 1999, the unrealized loss on the Company's entire securities
portfolio was approximately $410,000, net of taxes, which is shown as a
component of stockholders' equity. The unrealized loss is due to the recent rise
in overall market interest rates and wider spreads in the market. Management
believes that the recent decline in the market values of these securities is
temporary.
Liabilities. Deposits increased by $12.4 million or 10.4% from June 30, 1998
to June 30, 1999. The increase in total deposits was primarily attributable to
growth in certificates of deposit of $5.8 million or 6.5%, and growth in NOW and
money market deposits of $5.3 million or 119.4%. Certificates of deposit
accounted for approximately 72% of total deposits at June 30, 1999 and
approximately 74% of total deposits at June 30, 1998. At June 30, 1999, $73.6
million or 77.5% of total certificates of deposit mature in one year or less,
and $20.9 million or 22.0% of the total certificates of deposit had balances of
$100,000 or more. The increase in deposits was achieved primarily through
continued development of new and existing commercial and retail account
relationships. In addition, the Bank has attracted and retained certificates of
deposit including out-of-state jumbo accounts by offering competitive interest
rates. The Bank has become more susceptible to short-term fluctuations in
deposit flows, as customers have become more interest rate conscious. Based on
its experience, management believes that its passbook and statement savings,
demand deposits and NOW accounts are relatively stable sources of deposits.
However, the ability of the Bank to attract and maintain certificates of
deposit, and the rates paid on these deposits, have been and will continue to be
affected by market conditions.
Because the growth in deposits has not matched the growth in assets in recent
years, the Bank has utilized Federal Home Loan Bank ("FHLB") advances. During
fiscal 1999, the Bank increased FHLB advances by $13.0 million. The proceeds of
these advances, as well as deposit growth discussed above, were primarily used
to fund loan and securities growth as well as mortgage banking activities.
Management expects to continue to utilize additional FHLB advances in the next
fiscal year.
Shareholders' Equity. Shareholders' equity amounted to $22.6 million or 10.9%
of total assets at June 30, 1999 compared to $23.3 million or 12.8% of total
assets at June 30, 1998. The Company's trend of profitability continued in
fiscal 1999 with the Company earning $176,000. However, net income was impacted
by a number of items which management feels will no longer significantly impact
future earnings as discussed in the "Results of Operations for the Year Ended
June 30, 1999 Compared to the Year Ended June 30, 1998" section. The decrease in
total shareholders' equity relates primarily to net income offset by dividends,
stock repurchases and an increase in unrealized losses on available for sale
securities.
The cost of shares issued to the Company's Employee Stock Ownership Plan
("ESOP") but not yet allocated to participants totaling $745,000 at June 30,
1999 is presented in the consolidated balance sheet as a reduction of
shareholders' equity. The unearned compensation value of the Company's MRPs
totalled $165,000 at June 30, 1999 and is also shown as a reduction of
shareholders' equity.
The Company's securities classified as available for sale are carried at
market value, with unrealized gains or losses reported as a separate component
of shareholders' equity, net of federal income taxes. At June 30, 1999, the net
unrealized loss was $410,000, while at June 30, 1998, the net unrealized gain
was $5,000. The $14.1 million of CMO securities transferred from the held to
maturity portfolio to the available for sale portfolio during April of 1999
increased the unrealized loss on securities available for sale equity component
by $119,000.
5
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Non-performing Assets and the Allowance for Loan Losses
The table below sets forth the amounts and categories of non-performing
assets at June 30, 1999 and June 30, 1998:
June 30, June 30,
1999 1998
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Non-accrual loans
One- to four-family $ 207 $ 682
Construction and land development 930 --
Commercial -- 32
Consumer 142 127
------ ------
Total 1,279 841
Foreclosed assets
Construction and land development 310 192
------ ------
Total non-performing assets $1,589 $1,033
====== ======
Total non-performing assets
as a percentage of total assets .77% .57%
====== ======
Non-performing assets in the construction and land development category
consist of seven construction spec loans to five builders in the western and
southwestern Michigan area. These loans, which are collateralized by
single-family homes, had a maximum loan-to-value ratio of 75%. The majority of
these homes are substantially complete. Management believes that these loans are
adequately collateralized. Such loans did not require specific reserves against
the allowance for loan losses at June 30, 1999. However, due to an increase in
delinquencies in these types of loans, general reserve allocation percentages
were increased resulting in increased general reserves for those types of loans
at June 30, 1999. The allowance for loan losses totalled $480,000 or 38% of
total non- performing loans at June 30, 1999, and no portion of the allowance
for loan losses was allocated to specific loans. During the year ended June 30,
1999, there were $29,429 in charge-offs. At June 30, 1999, $110.6 million or
71.7% of the Bank's total loan portfolio was collateralized by first liens on
one-to four-family residences, and the net loan portfolio amounted to 70.2% of
total assets.
Results of Operations for the Year Ended June 30, 1999 Compared to the Year
Ended June 30, 1998
Net Income. Net income for fiscal 1999 was $176,000 or $.07 per diluted
share, compared to $830,000 or $.33 per diluted share for fiscal 1998. The
decrease in the Company's net income of $654,000 or 78.8% in fiscal 1999 from
fiscal 1998 was due to several events that are not expected to impact future
earnings which are described below on an after tax basis. First, the Company
realized a $340,000 net of tax loss on investment securities in 1999 compared to
a net of tax loss of $1,100 in 1998 primarily resulting from the liquidation of
the Company's equity investments and the sale of certain CMO's in order to
reposition the securities portfolio as previously mentioned. Second, the Company
incurred $253,000, net of tax, in legal costs associated with a class action
lawsuit filed on July 17, 1998 by a Bank West borrower. Third, the Company
incurred $140,000 net of tax, in a settlement accrual in 1999 related to the
former President and Chief Executive Officer. Fourth, the Company incurred a
$55,000 net of tax loss on disposal of fixed assets in 1999 related to Year 2000
compliance. These items are discussed in greater detail in the following
sections. The above amounts were partially offset by growth in net interest
income of $415,000, or 8.4%.
6
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Net Interest Income. The Company's net income is largely dependent upon net
interest income. Net interest income is the difference between the average yield
earned on loans, securities and other earning assets, and the average rate paid
on deposits and FHLB advances. Net interest income is affected by changes in
volume and composition of interest-earning assets and interest-bearing
liabilities, market rates of interest, the level of nonperforming assets, demand
for loans and other market forces.
Net interest income increased by $415,000 for the year ended June 30, 1999 as
compared to the year ended June 30, 1998. The increase in net interest income
was primarily attributable to a $16.0 million or 13.2% increase in the average
loan portfolio (including loans held for sale). The Company's average interest
spread decreased from 2.48% to 2.35%, reflecting the relatively flat U.S.
Treasury yield curve during the fiscal year.
The yield on total interest-earning assets decreased from 7.74% for fiscal
1998 to 7.23% for fiscal 1999. The yield decreased primarily due to refinances
of a portion of the Bank's existing loan portfolio to lower rates as well as the
downward repricing of the Bank's floating-rate CMO portfolio. During the fiscal
year, the Federal Reserve lowered the federal funds rate by 75 basis points, and
overall market interest rates declined substantially from the previous year.
Since June 30, 1999, single-family mortgage interest rates have risen back to
levels experienced in the recent past. Management expects that its strategy
shift to place greater emphasis on commercial lending will positively impact the
yield on the loan portfolio.
The cost of interest-bearing liabilities decreased from 5.26% for fiscal 1998
to 4.88% for fiscal 1999, primarily due to the decline in the overall interest
rate environment. In addition, the Bank increased its non-CD core deposits to
$37.4 million or 28.3% of total deposits compared to $30.7 million or 25.6% of
total deposits.
Net interest margin decreased from 3.04% for fiscal 1998 to 2.83% for fiscal
1999. The decrease in net interest margin was primarily due to the relatively
flat U.S. Treasury yield curve, which negatively impacted the yield on
interest-earning assets as loans repriced downward faster than the repricing of
certificates of deposit and FHLB advances.
The future trend of the Company's net interest income and net interest margin
may be impacted by the level of loan originations, purchases, repayments,
refinances, and sales, and a resulting change in the Company's composition of
interest-earning assets. The relatively flat yield curve during the fiscal year
resulted in a shift in borrower preference to fixed-rate and balloon mortgage
loans. This resulted in borrowers converting adjustable-rate mortgage loans to
30-year fixed-rate loans which are generally sold in the secondary market, and
balloon loans which are generally portfolioed. A continued high level of
refinances and conversions of adjustable-rate mortgages to fixed-rate and
balloon mortgages could have a negative impact on future net interest income.
Additional factors that may affect the Company's net interest income are changes
in interest rates, slope of the yield curve, asset growth, maturity and
repricing activity and competition.
7
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Average Balances, Interest Rates and Yields. The following table presents for
the periods indicated the total dollar amount of interest income 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. All average balances are based on month end
balances.
Year Ended June 30, Year Ended June 30, Year Ended June 30,
1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate(1) Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable(2) $136,874 $ 10,598 7.74% $120,844 $ 9,795 8.11% $103,324 $ 8,206 7.94%
Securities 46,077 2,677 5.81 36,669 2,446 6.67 28,601 1,907 6.67
Interest-bearing deposits 3,652 191 5.23 2,738 152 5.55 3,633 199 5.48
FHLB stock 2,521 199 7.89 1,958 156 7.97 1,483 116 7.81
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 189,124 13,665 7.23 162,209 12,549 7.74 137,041 10,428 7.61
- --------------------------------------------------------------------------------------------------------------------------------
Noninterest-earning assets 7,547 8,522 7,419
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $196,671 $170,731 $144,460
================================================================================================================================
Interest-bearing liabilities:
Savings, checking and MMDA's $ 31,883 857 2.69 $ 25,821 794 3.08 $23,507 729 3.10
Certificates of deposit 91,307 5,044 5.52 83,032 4,808 5.79 73,465 4,195 5.71
FHLB advances 47,185 2,412 5.11 35,803 2,010 5.61 22,433 1,225 5.46
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 170,375 8,313 4.88 144,656 7,612 5.26 119,405 6,149 5.15
- --------------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing liabilities 3,247 2,853 1,340
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities 173,622 147,509 120,745
Stockholders' equity 23,049 23,222 23,715
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $196,671 $170,731 $144,460
================================================================================================================================
Net interest income; average
interest rate spread $ 5,352 2.35% $ 4,937 2.48% $ 4,279 2.46%
================================================================================================================================
Net interest margin(3)
2.83% 3.04% 3.12%
================================================================================================================================
Average interest-earning assets to
average interest-bearing liabilities 1.11x 1.12x 1.15x
================================================================================================================================
(1) At June 30, 1999, the weighted average yields earned and rates paid were as
follows: loans receivable, 7.73%; securities, 6.11%; interest-bearing deposits,
5.77%; FHLB stock, 8.00%; total interest-earning assets, 7.31%; savings,
checking and MMDA's, 3.11%; certificates of deposits, 5.20%; FHLB advances,
5.22%; total interest-bearing liabilities, 4.86%; and interest spread, 2.45%.
(2) Includes nonaccrual loans and loans held for sale during the respective
periods. Calculated net of deferred fees and discounts and loans in process.
(3) Net interest margin equals net interest income divided by average
interest-earning assets.
8
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
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 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 rate (change in rate multiplied by prior year volume), and (ii)
changes in volume (change in volume multiplied by prior year rate). The combined
effect of changes in both rate and volume has been allocated proportionately to
the change due to rate and the change due to volume.
Year Ended Year Ended
June 30, 1999 June 30, 1998
vs. vs.
Year Ended Year Ended
June 30, 1998 June 30, 1997
- ---------------------------------------------------------------------------------------------------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Due to
- ---------------------------------------------------------------------------------------------------------------------------
Total Total
Increase Increase
Rate Volume (Decrease) Rate Volume (Decrease)
- ---------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Interest income:
Loans receivable $(460) $1,263 $ 803 $178 $1,411 $1,589
Securities (342) 573 231 15 524 539
Interest-bearing deposits (9) 48 39 3 (50) (47)
FHLB stock (2) 45 43 2 38 40
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income (813) 1,929 1,116 198 1,923 2,121
- ---------------------------------------------------------------------------------------------------------------------------
Interest expense:
Savings, checking and MMDA's (109) 172 63 (5) 70 65
Certificates of deposit (230) 466 236 60 553 613
FHLB advances (192) 594 402 35 750 785
- ---------------------------------------------------------------------------------------------------------------------------
Total interest expense (531) 1,232 701 90 1,373 1,463
- ---------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in
net interest income $(282) $ 697 $ 415 $108 $ 550 $ 658
===========================================================================================================================
Provision for Loan Losses. The provision for loan losses is a result of
management's periodic analysis of the allowance for loan losses. The allowance
is maintained by management at a level considered adequate to cover possible
losses that are currently anticipated based on past loss experience, general
economic conditions, information about specific borrower situations, and other
factors and estimates which are subject to change over time.
The provision for loan losses increased by $139,000 or 171.6% when comparing
fiscal 1999 to fiscal 1998. During the fiscal year, management increased the
provision for loan losses as a result of increases in general reserve percentage
assumptions utilized for construction and land development loans due to a recent
increase in delinquencies of builder spec loans. In addition, the increase in
commercial loans, both on a dollar basis and as a percentage of total loans,
required additional general reserves.
9
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Management believes that the allowance is adequate to provide for potential
losses; however, there can be no assurance the related allowance may not have to
be increased in the future. Management expects the provision for loan losses to
increase in the next fiscal year to keep pace with the growth in the loan
portfolio and to reflect the higher risk of loss associated with management's
intention to increase the commercial and consumer loan portfolios.
The Company's ratio of nonperforming assets, consisting of loans 90 days or
more delinquent and foreclosed assets, to total assets was .77% as of June 30,
1999 compared to .57% as of June 30, 1998. The allowance for loan losses as a
percentage of total loans at June 30, 1999 increased to .33% compared to .24% at
June 30, 1998. The allowance for loan losses equalled 37.5% of nonperforming
loans at June 30, 1999. The ratio of net charge-offs to average loans
outstanding was .02% for fiscal 1999 compared to .01% for fiscal 1998.
Total Other Income. Total other income decreased by $392,000 or 38.7% in
fiscal 1999 from fiscal 1998, partially due to a $157,000 increase in the loss
on sales of securities available for sale. In additon, net gains on trading
securites decreased by $217,000. The increase in net loss on securities
available for sale was primarily due to a first quarter change totaling $401,000
related to what management believed to be an other-than-temporary decline in the
market value of certain equity securities. Management decided to liquidate the
majority of the remaining equity securities during fiscal 1999 in order to
reposition the securities portfolio as previously mentioned. The carrying value
of the remaining equity securities was approximately $60,000 at June 30, 1999.
The decrease in net gain on trading securities was due to the Company's decision
to eliminate its equity trading account in the prior fiscal year in light of
stock market volatility.
Total Other Expenses. Total other expenses increased by $754,000 or 16.4% in
fiscal 1999 as compared to fiscal 1998. The increase was primarily due to the
factors discussed below. Compensation and benefits expense was higher by
$149,000 or 5.3%. This expense category included a $225,000 settlement accrual
related to the former President and Chief Executive Officer. The former
President and Chief Executive Officer was replaced by Ronald A. Van Houten.
Absent the settlement accrual, compensation and benefits expense was lower by
$76,000, or 2.7% primarily due to lower ESOP expense of $112,000 resulting from
a general decline in the market value of the Company's stock in 1999 as compared
to 1998. Except for expected personnel additions in the commercial lending area,
the Bank has completed the majority of personnel additions necessary to support
continued growth in its lending areas and existing branches. Management expects
that additional loan and deposit growth given the current staffing level should
result in an improvement to the Bank's efficiency ratio for fiscal 2000.
Professional fees increased by $404,000, or 153.2%. The Company incurred
approximately $384,000 in legal costs during fiscal 1999 associated with
defending a class action lawsuit filed on July 17, 1998 by a Bank West borrower.
See Note 10 to Consolidated Financial Statements for more information.
Management anticipates additional legal defense costs in fiscal 2000, however,
management is unable to determine the amount to be incurred.
The Company incurred an $83,000 loss on the disposal of fixed assets
considered non-complaint with respect to the Year 2000. See "The Year 2000"
section for additional information on the status of the Bank's Year 2000
efforts.
Data processing expense increased by $64,000 or 32.2% in fiscal 1999 from
fiscal 1998 primarily due to $25,000 of Year 2000-related pass-through costs
from the service bureau the Bank utilizes. In addition, maintenance agreement
costs increased due to utilizing additional software products, and the volume of
transactions processed increased resulting in higher data processing expense.
Cumulative Effect of a Change in Accounting Principle. During 1999, the
Company changed the accounting for certain securities by transferring certain
held to maturity securities to the trading portfolio under the provisions of
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and
10
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Hedging Activities. The transfer resulted in the recognition of a $92,000 net of
tax charge in 1999. The transfer allowed the Company to subsequently sell such
securities in 1999, consistent with management's strategy to reposition the
security portfolio as previously mentioned.
Federal Income Tax Expense. Federal income tax expense decreased by $355,000
or 78.4% in fiscal 1999 from fiscal 1998, due to a decrease in pre-tax income.
Results of Operations for the Year Ended June 30, 1998 Compared to the Year
Ended June 30, 1997
Net Income. Net income for fiscal 1998 was $830,000 or $.35 per basic share,
compared to $923,000 or $.36 per basic share for fiscal 1997. The Company's net
income decreased by $93,000 or 10.1% in fiscal 1998 from fiscal 1997. The
results of operations for fiscal 1997 include a one-time assessment of $364,000,
net of taxes, or $.14 per share relating to legislation signed into law on
September 30, 1996 to recapitalize the SAIF. Net income for fiscal 1997 without
the SAIF assessment would have been $1.3 million or $.50 per share. On a SAIF
adjusted basis, net income decreased $457,000 or 35.5% for the year ended June
30, 1998 compared to June 30, 1997. The decrease was primarily due to a
reduction of other income by $542,000 as a result of less successful equity
securities trading activities by $531,000, a write-down of available for sale
equity securities of $260,000 relating to an other-than-temporary market decline
and an increase in other expenses (excluding the one-time SAIF assessment) of
$764,000, primarily due to an increase in compensation and benefits. These
decreases were partially offset by growth in net interest income and in gain on
sale of loans of $658,000 and $163,000, respectively.
Net Interest Income. Net interest income increased $658,000 for the year
ended June 30, 1998 as compared to the year ended June 30, 1997. The increase in
net interest income was primarily attributable to a $17.5 million or 17.0%
increase in the average loan portfolio (including loans held for sale) and a
$8.1 million or 28.2% increase in the average securities portfolio, primarily
mortgage collateralized securities. The Company's average interest spread
improved slightly from 2.46% to 2.48%, with improvements in yield on total
interest-earning assets substantially offset by an increase in the cost of
interest-bearing liabilities.
The yield on total interest-earning assets improved from 7.61% for fiscal
1997 to 7.74% for fiscal 1998. The yield improved primarily due to the growth in
the commercial and consumer loan portfolios, which in total represented 23.1% of
total loans at the end of fiscal 1998 compared to 14% of total loans at the end
of fiscal 1997.
The cost of interest-bearing liabilities increased from 5.15% for fiscal 1997
to 5.26% for fiscal 1998. The higher cost was primarily due to an increase in
FHLB advances as a percent of total interest-bearing liabilities and, to a
lesser extent, a shift in mix from lower costing demand deposit and savings
accounts to higher costing money market and certificate accounts.
Net interest margin decreased from 3.12% for fiscal 1997 to 3.04% for fiscal
1998. The reduction in net interest margin was primarily attributable to the
Company becoming more leveraged through internal growth. This increase in
leverage is reflected in the ratio of average interest-earning assets to average
interest-bearing liabilities, which declined to 1.12x for the year ended June
30,1998 compared to 1.15x for the same period in 1997.
Provision for Loan Losses. The provision for loan losses increased by $21,000
or 35.0% when comparing fiscal 1998 and 1997. The Company's ratio of
nonperforming assets, consisting of loans 90 days or more delinquent and
foreclosed assets, to total assets was .57% as of June 30, 1998 compared to .28%
as of June 30, 1997. The allowance for loan losses as a percentage of net loans
at June 30, 1998 increased to .24% compared to .20% at June 30, 1997. The
allowance for loan losses equalled 34.5% of nonperforming loans at June 30,
1998. Nonperforming loans consisted primarily of one- to four-family properties.
The ratio of net charge-offs to average loans outstanding was .01% for fiscal
1998 compared to none for fiscal 1997.
11
Total Other Income. Total other income decreased by $542,000 or 34.9% in
fiscal 1998 from fiscal 1997, primarily due to a $531,000 or 72.6% decrease in
the net gains on trading equity securities and a $202,000 increase in net loss
on securities available for sale. This amount was partially offset by a $163,000
or 32.7% increase in gain on sale of loans. The decrease in net gain on trading
equity securities was primarily due to the Company's decision to stop trading
equity securities in light of increased stock market volatility in fiscal 1998.
The increase in net loss on securities available for sale was due to an
other-than-temporary decline in certain equity securities resulting in a
write-down of $260,000. The increase in gain on sale of loans is a result of
higher refinancing volume from lower prevailing market interest rates compared
to the prior fiscal year.
Total Other Expenses. Total other expenses increased by $213,000 or 4.9% in
fiscal 1998 from fiscal 1997. The increase was primarily due to higher
compensation and benefits expense of $576,000 or 25.8%, and higher professional
fees of $75,000 or 39.7%. In addition, fiscal 1997 total other expenses include
a one-time assessment of $551,000 relating to legislation signed into law on
September 30, 1996 to recapitalize the SAIF. On a SAIF adjusted basis, total
other expenses increased $764,000 or 20.0% for the year ended June 30, 1998
compared to June 30, 1997.
The increase in compensation and benefits was due in part to a greater number
of full-time equivalent employees to support the growth in the mortgage banking,
consumer and commercial loan departments, and a $157,000 increase in ESOP
expense attributable to the higher market price of the Company's stock in fiscal
1998 compared to fiscal 1997. Professional fees increased due to higher
consulting fees and out-sourcing the human resources function.
Federal Income Tax Expense. Federal income tax expense decreased by $26,000
or 5.4% in fiscal 1998 from fiscal 1997, due to a decrease in pre-tax income.
Market Risk
Derivative financial instruments include futures, forwards, interest rate
swaps, option contracts and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps or options. However, the Company is party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve to
varying degrees elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates. Standby letters of credit are conditional commitments issued
by the Bank to guarantee the performance of a customer to a third party up to a
stipulated amount and with specified terms and conditions. Commitments to extend
credit and standby letters of credit are not recorded as an asset or liability
by the Bank until the instrument is exercised.
The Bank's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. See "Asset and Liability Management" section for
additional information. Interest rate risk is the potential for economic losses
due to future interest rate changes. These economic losses can be reflected as a
loss of future net interest income and/or a loss of current fair market values.
Management realizes that certain risks are inherent and the goal is to identify
and minimize the risks. The Bank has no market risk sensitivity instruments held
for trading purposes.
Asset and Liability Management
Consistent net interest income is largely dependent upon the achievement of a
positive interest rate spread that can be sustained during fluctuations in
prevailing interest rates. Interest rate sensitivity is a measure of the
12
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
difference between amounts of interest-earning assets and interest-bearing
liabilities which either reprice or mature within a given period of time. The
difference, or the interest rate repricing "gap," provides an indication of the
extent to which an institution's interest rate spread will be affected by
changes in interest rates.
The Bank attempts to manage its interest rate risk by maintaining a high
percentage of its assets in adjustable-rate assets (consisting of ARM's,
commercial and home equity loans and floating rate CMO's). Significant effort
has been made to reduce the duration and average life of the Bank's
interest-earning assets. This has been accomplished by management's current
strategy to portfolio balloon mortgages versus longer-term fixed-rate mortgages
as well as portfolio commercial and home equity loans. During fiscal 1999, the
Bank's ratio of interest-sensitive assets to interest-sensitive liabilities
remained approximately the same as in the prior year.
Another way the Bank has managed interest rate risk is by selling most of the
newly originated or purchased, fixed-rate mortgages with terms of fifteen years
or greater, while originating adjustable-rate and balloon mortgage loans for
retention in the loan portfolio. In addition, the Bank continues to emphasize
commercial and home equity loans which have shorter average lives than the
mortgage portfolio. At June 30, 1999, the Bank's adjustable-rate and balloon
mortgage loans amounted to $70.7 million or 48.7% of total loans. The Bank
experienced a high level of ARM prepayments during fiscal 1999 due to the
relatively flat yield curve. Management anticipates that the Bank will retain a
sufficient amount of newly originated balloons and other loan types to offset
loan prepayments in the next fiscal year.
With its funding sources, management has attempted to reduce the impact of
interest rate changes by emphasizing non-interest-bearing products, and advances
from the FHLB.
Management presently measures the Bank's interest rate risk by computing
estimated changes in net interest income ("NII") and the net portfolio value
("NPV") of equity in the event of a range of assumed changes in market interest
rates. The Bank's exposure to interest rates is reviewed quarterly by senior
management and the Board of Directors. Exposure to interest rate risk is
measured with the use of interest rate sensitivity analysis to determine the
anticipated changes in NII and NPV in the event of hypothetical changes in
interest rates. If estimated changes to NPV and net interest income are not
within the limits established by the Board, the Board may direct management to
adjust the Bank's asset and liability mix to bring interest rate risk within
Board approved limits.
Net Portfolio Value is equal to the market value of assets minus the market
value of liabilities, with adjustments made for off-balance sheet items. This
analysis assesses the risk of loss in market sensitive instruments in the event
of sudden and sustained 1% to 4% increases and decreases in market interest
rates. The following table presents the Bank's projected change in NPV and NII
for the various rate shock levels at June 30, 1999:
Net Portfolio Value Net Interest Income
---------------------------------- --------------------------------
Change in Interest $ Amount % Change $ Amount % Change
Rate (Basis Points) of NPV in NPV of NII in NII
- ------------------- ------ ------ ------ ------
(Dollars in Thousands)
+400 $ 9,740 (50.04)% $5,380 (11.38)%
+300 12,065 (38.11) 5,603 (7.70)
+200 14,683 (24.67) 5,830 (3.95)
+100 17,121 (12.17) 5,960 (1.82)
Static 19,493 -- 6,070 --
(100) 19,946 2.33 5,917 (2.53)
(200) 19,446 (0.24) 5,701 (6.08)
(300) 18,517 (5.00) 5,415 (10.80)
(400) 17,771 (8.84) 5,166 (14.90)
13
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
As illustrated in the table, an increase in interest rates will result in
larger net decreases in the Bank's NPV as compared to a decrease in interest
rates. This occurs principally because, when rates increase, the Bank's deposits
reprice faster than its ARM's and other adjustable-rate loans. An increase in
interest rates also will negatively impact the securities available for sale
which is shown as a component of stockholders' equity.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react differently to changes in market interest
rates. The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. In addition, certain
assets, such as adjustable-rate mortgage loans, have features which restrict
changes in interest rates on a short-term basis and over the life of the asset.
In the event of a change in interest rates, expected rates of prepayments on
loans, decay rates of deposits and early withdrawals from certificates could
likely deviate significantly from those assumed in calculating the table.
Liquidity and Capital Resources
The Bank has no regulatory mandated minimum liquidity requirements. The Bank
maintains a level of liquidity consistent with management's assessment of
expected loan demand, proceeds from loan sales, deposit flows and yields
available on interest-earning deposits and investment securities. When overnight
deposits fall below management's targeted level, management generally borrows
FHLB advances instead of selling securities.
The Bank's principal sources of liquidity are deposits, principal and
interest payments on loans, proceeds from loan sales, maturities of securities,
sales of securities available for sale and FHLB advances. While scheduled loan
repayments and maturing investments are relatively predictable, deposit flows
and loan prepayments are more influenced by interest rates, general economic
conditions and competition.
The Bank routinely borrows FHLB advances when overnight deposits are drawn to
low levels. These borrowings are made pursuant to the blanket collateral
agreement with the FHLB. At June 30, 1999, the Bank has approximately $23.6
million of excess borrowing capacity under the blanket collateral agreement with
the FHLB.
The Company (excluding the Bank) also has a need for, and sources of,
liquidity. Dividends from the Bank and interest income and gains on investments
are its primary sources. The Company also has modest operating costs and has
paid a regular quarterly cash dividend.
The Bank is subject to three capital to asset requirements in accordance with
banking regulations. Bank West's capital ratios are well in excess of minimum
capital requirements specified by federal banking regulations. See Note 13 to
consolidated financial statements for more information on the Bank's capital
requirements.
Impact of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which generally require the measurement of financial position and
operating results in terms of historical dollars, without considering changes in
relative purchasing power over time due to inflation. Unlike most industrial
companies, virtually all of the Company's assets and liabilities are monetary in
nature. As a result, interest rates generally have a more significant impact on
the Company's performance than does the effect of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates.
14
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The Year 2000
General. The Year 2000 issue confronting us, as well as our suppliers,
customers' suppliers and competitors, centers on the inability of many computer
systems to recognize the Year 2000. Many existing computer programs and systems
originally were programmed with six digit dates that provided only two digits to
identify the calendar year in the date field. With the impending millennium,
these programs and computers will recognize "00" as the year 1900 rather than
the year 2000 unless they are corrected or replaced.
Like most financial service providers, we may be significantly affected by
the Year 2000 issue due to our dependence on technology and date-sensitive data.
Computer software, hardware and other equipment, both within and outside the
Bank's direct control and third parties with whom the Bank electronically or
operationally interfaces are likely to be affected. If computer systems are not
modified in order to be able to identify the Year 2000, many computer
applications could fail or create erroneous results. In this event, calculations
which rely on date field information, such as interest, payment or due dates and
other operating functions, could generate results which are significantly
misstated.
In accordance with federal regulatory pronouncements, the Bank's Year 2000
plan addressed issues involving awareness, assessment, renovation, validation,
implementation and contingency planning. These phases are discussed below.
Awareness and Assessment. The Bank has a Year 2000 team, consisting of a
committee of the Board of Directors which consists of two outside directors, the
Chief Executive Officer, three Vice Presidents, and an Information Systems
Coordinator. The Year 2000 Committee meets monthly and the Chairman of the
Committee, an outside director, reports to the Board of Directors on a monthly
basis.
Management has conducted an assessment of all software, hardware,
environmental systems and other computer-controlled systems. In addition,
management has identified and developed an inventory of all technological
components and vendors. All "mission critical" areas have been identified.
Renovation Phase. The Bank completed its upgrade of in-house hardware and
software considered mission critical prior to June 30, 1999. The Bank's core
data processing software is provided by Fiserv Milwaukee, Inc. ("Fiserv"), an
outside vendor. Fiserv represents that they are fully compliant.
Validation or Testing Phase. Utilizing a test lab environment, the Bank
during 1998 tested its loan origination, loan servicing, savings deposits,
savings withdrawal, general ledger and other activities for Year 2000
compliance. Extensive testing also took place with applications that interface
with Fiserv. Management explored during 1998 the steps involved in switching its
data processing to a different service provider in the event its current
provider was unable to become Year 2000 compliant in a timely manner. Based on
their review, management does not believe that a switch to a new service
provider will be necessary.
Implementation Phase. Additional testing was conducted during the first half
of 1999, and the Bank completed the implementation phase by June 30, 1999.
Contingency Planning. The Bank has adopted a contingency plan in the event
that one or more of its internal and external computer systems fail to operate
on or after January 1, 2000. In a worst case scenario, the Bank would need to
post accounts and general ledger entries manually. This system is in the process
of being set up. Testing of the Bank's business resumption plan was completed by
June 30, 1999.
The Bank has in place a $2 million line of credit from the Federal Home Loan
Bank of Indianapolis that can be used for liquidity purposes if other sources of
funds are not available when needed. The Bank can also obtain short-term FHLB
advances if necessary.
15
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Risks. If one or more internal or external computer systems fail to operate
properly on or after January 1, 2000, the Bank may be unable to process
transactions, prepare statements or engage in similar normal business
activities. If all transactions were required to be handled manually due to
computer or other failures, the Bank would need to hire additional personnel
which could significantly increase expenses.
In the event any of our local utility companies were unable to provide
electricity or other needed services, our operations would be disrupted. Our
electricity provider has represented that they are Year 2000 compliant; however,
the Bank is unable to provide any assurances as to the Year 2000 readiness of
the electricity provider or other utility companies.
We believe we have taken appropriate steps with respect to matters that are
within our control in order to become ready for the Year 2000 in a timely
manner. Based on the steps taken to date, including testing and other
documentation, management believes that issues related to Year 2000 will not
have a material adverse effect on the Company's liquidity, capital resources or
consolidated results of operations. However, we are unable to provide any
assurances that we have foreseen all problems that may develop on or after
January 1, 2000 or that we have taken all actions that may be considered
necessary in hindsight. In addition, the readiness of all third parties,
including customers and suppliers, is inherently uncertain and cannot be
guaranteed by us. While our outside service providers have shared with us their
testing results, none of the service providers have provided us with enforceable
assurances.
Costs. The Bank currently estimates the total cost of becoming Year 2000
compliant is approximately $150,000. These costs cover the replacement of
depreciable assets, primarily personal computers and consulting costs. The costs
associated with Year 2000 readiness are based on management's best estimates. In
addition, the Bank incurred a loss of $83,460 on disposal of non-Year 2000
compliant hardware and software.
Status of Borrowers and Other Customers. The Bank's customer base consists
primarily of individuals who use the Bank's services for personal, household or
consumer uses. Management believes these customers are not likely to
individually pose material Year 2000 risks directly. It is not possible at this
time to gauge the indirect risks which could be faced if the employers of these
customers encounter unresolved Year 2000 issues. Most of the Bank's loans are
residential or consumer in nature. The Bank had approximately 130 commercial
borrowers as of June 30, 1999. Management has performed a review of these
commercial borrowers to determine if there are any Year 2000 issues or concerns
of the borrower that could affect repayment of the Bank's loan. To-date, no
issues or concerns have been identified. Accordingly, no specific Year 2000
related reserves have been assigned to these loans.
For new commercial loans, the Bank is requiring the borrower to represent
that it expects to become Year 2000 compliant in a timely manner and that it
will promptly notify the Bank if the borrower or any of its material vendors or
suppliers will not achieve compliance timely, in each case excluding any
noncompliance that would not have a material adverse effect on the borrower's
financial condition. The Bank believes these representations will assist
management in monitoring the status of new commercial borrowers.
Impact of New Accounting Standards
Information pertaining to this topic appears at the conclusion of Note 1 to
the consolidated financial statements, which are included as part of this
report.
16
Report of Independent Auditors
[CROWE CHIZEK LETTERHEAD]
Shareholders and Board of Directors
Bank West Financial Corporation
Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of Bank West
Financial Corporation (the "Company") as of June 30, 1999 and 1998 and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for each of the three years in the period ended June 30, 1999. 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Bank West
Financial Corporation as of June 30, 1999 and 1998, and the results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1999 in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for certain securities effective April 1, 1999
to conform with the provisions of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities.
/s/Crowe, Chizek and Company LLP
--------------------------------
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
August 16, 1999
17
Consolidated Balance Sheets
June 30, 1999 and 1998
1999 1998
------------ ------------
ASSETS
Cash and due from financial institutions $ 1,527,481 $ 2,408,476
Interestbearing deposits in financial institutions 7,578,387 1,797,063
------------ ------------
Total cash and cash equivalents 9,105,868 4,205,539
Securities available for sale 42,272,306 32,167,697
Securities held to maturity (fair value:
1998 - $11,079,178) -- 11,084,361
Loans held for sale 2,380,576 8,156,572
Loans, net 145,205,691 118,905,611
Federal Home Loan Bank (FHLB) stock 2,700,000 2,100,000
Premises and equipment net 3,000,951 3,164,905
Accrued interest receivable 1,019,165 879,082
Mortgage servicing rights 232,561 280,869
Real estate owned 309,826 192,080
Other assets 442,257 332,136
------------ ------------
$206,669,201 $181,468,852
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits $132,401,205 $119,979,379
FHLB borrowings 50,000,000 37,000,000
Accrued interest payable 292,289 253,037
Advanced payments by borrowers for taxes and insurance 509,218 512,538
Deferred federal income tax 67,362 335,182
Other liabilities 846,996 114,029
------------ ------------
Total liabilities 184,117,070 158,194,165
Commitments and contingencies
Shareholders' equity
Preferred stock, 5,000,000 shares authorized, none issued
Common stock, $.01 par value; 10,000,000 shares authorized;
2,597,729 and 2,623,629 issued at June 30, 1999 and 1998 25,978 26,237
Additional paid-in capital 11,328,830 11,551,136
Retained earnings, substantially restricted 12,517,215 12,928,028
Accumulated other comprehensive income, net of tax
of $211,018 in 1999 and ($2,644) in 1998 (409,623) 5,132
Management Recognition Plan (unearned shares) (165,021) (360,998)
Employee Stock Ownership Plan (unallocated shares) (745,248) (874,848)
------------ ------------
22,552,131 23,274,687
------------ ------------
$206,669,201 $181,468,852
============ ============
See accompanying notes to consolidated financial statements.
18
Consolidated Statements of Income
Years ended June 30, 1999, 1998 and 1997
1999 1998 1997
---------- ----------- ------------
Interest and dividend income
Loans $10,598,406 $ 9,795,291 $ 8,206,364
Securities 2,677,378 2,446,042 1,907,129
Other interest-earning deposits 190,711 152,152 199,210
Dividends on FHLB stock 199,142 155,825 115,838
---------- ----------- ------------
13,665,637 12,549,310 10,428,541
Interest expense
Deposits 5,900,947 5,601,870 4,924,144
FHLB borrowings 2,412,433 2,010,465 1,224,959
---------- ----------- ------------
8,313,380 7,612,335 6,149,103
---------- ----------- ------------
Net interest income 5,352,257 4,936,975 4,279,438
Provision for loan losses 220,000 81,000 60,000
---------- ----------- ------------
Net interest income after provision for loan losses 5,132,257 4,855,975 4,219,438
Other income
Net gain on sales of loans 664,568 662,203 498,666
Fees and service charges 319,884 340,967 317,286
Net gain (loss) on trading securities (16,498) 200,148 731,156
Net gain (loss) on securities available for sale (358,784) (201,890) (285)
Other income 11,199 10,911 7,050
---------- ----------- ------------
620,369 1,012,339 1,553,873
Other expenses
Compensation and benefits 2,959,351 2,809,557 2,234,337
Federal deposit insurance expense 70,427 64,306 121,246
FDIC special assessment -- -- 550,556
Professional fees 666,946 263,374 188,561
Data processing expense 261,093 197,487 177,878
Occupancy expense 336,370 301,185 266,457
Furniture, fixtures and equipment expense 183,228 153,899 137,249
Advertising 89,876 111,351 119,993
Loss on disposal of fixed assets 83,460 -- --
Other expense 687,861 683,532 575,481
---------- ----------- ------------
5,338,612 4,584,691 4,371,758
---------- ----------- ------------
Income before federal income tax expense and
cumulative effect of accounting change 414,014 1,283,623 1,401,553
Federal income tax expense 145,600 453,255 478,724
---------- ----------- ------------
Income before cumulative effect of accounting change 268,414 830,368 922,829
Cumulative effect of change in accounting for certain
securities, net of tax benefit of $47,600 (92,399) -- --
---------- ----------- ------------
Net Income $ 176,015 $ 830,368 $ 922,829
========== =========== ============
Basic earnings per share:
Income before cumulative effect of accounting change $ 0.11 $ 0.35 $ 0.36
Cumulative effect of accounting change (0.04) -- --
---------- ----------- ------------
Net Income $ 0.07 $ 0.35 $ 0.36
========== =========== ============
Diluted earnings per share:
Income before cumulative effect of accounting change $ 0.11 $ 0.33 $ 0.36
Cumulative effect of accounting change (0.04) -- --
---------- ----------- ------------
Net Income $ 0.07 $ 0.33 $ 0.36
========== =========== ============
See accompanying notes to consolidated financial statements.
19
Consolidated Statements of Changes in Shareholders' Equity
Years Ended June 30, 1999, 1998 and 1997
Accumulated
Additional Other Unearned Unallocated Total
Common Paid-in Retained Comprehensive MRP ESOP Shareholders'
Stock Capital Earnings Income Shares Shares Equity
-------- ----------- ----------- --------- --------- ----------- -----------
Balance at July 1, 1996 $21,996 $16,542,107 $12,231,242 $(207,387) $(643,464) $(1,134,048) $26,810,446
Net income for the year
ended June 30, 1997 922,829 922,829
Other comprehensive
income, net of tax:
Unrealized gains (losses)
arising during the year 219,909 219,909
Less reclassification
adjustments for net losses
included in net income 188 188
--------- ----------
Other comprehensive income 220,097 220,097
----------
Comprehensive income 1,142,926
Net grant of 1,742 shares of
common stock for MRP 19,852 (19,852)
Shares earned under MRP 149,918 149,918
Cash dividends of
$.19 per share (506,959) (506,959)
Repurchase of 446,100
shares of stock (4,461) (5,189,405) (5,193,866)
Shares committed to be
released under Employee
Stock Ownership Plan 60,244 129,600 189,844
-------- ----------- ----------- --------- --------- ----------- -----------
Balance at June 30, 1997 17,535 11,432,798 12,647,112 12,710 (513,398) (1,004,448) 22,592,309
Net income for the year
ended June 30, 1998 830,368 830,368
Other comprehensive
income, net of tax:
Unrealized losses arising
during the year (140,825) (140,825)
Less reclassification
adjustments for net losses
included in net income 133,247 133,247
--------- ----------
Other comprehensive
income (loss) (7,578) (7,578)
----------
Comprehensive income 822,790
Shares earned under MRP $152,400 $ 152,400
Cash dividends of $.22 per share $(539,433) (539,433)
See accompanying notes to consolidated financial statements.
20
Consolidated Statements of Changes in Shareholders' Equity (Continued)
Years Ended June 30, 1999, 1998 and 1997
Accumulated
Additional Other Unearned Unallocated Total
Common Paid-in Retained Comprehensive MRP ESOP Shareholders'
Stock Capital Earnings Income Shares Shares Equity
------- ----------- ----------- --------- --------- --------- -----------
Issuance of 876,654 shares
of common stock for
three-for-two stock split,
net of cash paid on
fractional shares $ 8,767 (10,019) (1,252)
Repurchase of 7,500 shares
of stock (75) $ (105,863) (105,938)
Shares committed to be
released under Employee
Stock Ownership Plan 216,928 $ 129,600 346,528
Shares issued upon exercise
of stock options 10 7,273 7,283
------- ----------- ----------- --------- --------- --------- -----------
Balance at June 30, 1998 26,237 11,551,136 12,928,028 $ 5,132 (360,998) (874,848) 23,274,687
Net income for the year
ended June 30, 1999 176,015 176,015
Other comprehensive
income, net of tax:
Unrealized loss on transfer
of securities held to maturity
to available for sale (26,469) (26,469)
Unrealized losses arising
during the year (728,371) (728,371)
Less reclassification
adjustments for net losses
included in net income 340,085 340,085
--------- ----------
Other comprehensive
income (loss) (414,755) (414,755)
----------
Comprehensive income (loss) (238,740)
Shares earned under MRP 107,800 107,800
Shares forfeited under MRP (88,177) 88,177 --
Cash dividends of $.24 per share (586,828) (586,828)
Repurchase of 46,000 shares
of stock $ (460) $ (415,852) $ (416,312)
Shares committed to be
released under Employee
Stock Ownership Plan 105,047 $ 129,600 234,647
Shares issued upon exercise
of stock options 201 139,462 139,663
Tax benefit relating to
employee stock
compensation plans 37,214 37,214
------- ----------- ----------- --------- --------- --------- -----------
Balance at June 30, 1999 $25,978 $11,328,830 $12,517,215 $(409,623) $(165,021) $(745,248) $22,552,131
======= =========== =========== ========= ========= ========= ===========
See accompanying notes to consolidated financial statements.
21
Consolidated Statements of Cash Flows
Years ended June 30, 1999, 1998 and 1997
1999 1998 1997
----------- ----------- -----------
Cash flows from operating activities
Net income $ 176,015 $ 830,368 $ 922,829
Adjustments to reconcile net income to
net cash from operating activities
Purchase of trading securities -- (2,530,635) (5,428,775)
Proceeds from sales of trading securities -- 4,486,385 3,947,118
Origination and purchase of mortgage
loans for sale (35,127,650) (50,245,577) (30,350,557)
Proceeds from sales of mortgage loans 41,568,214 44,982,359 32,915,164
Net (gain) loss on sales of:
Loans (664,568) (662,203) (498,666)
Securities 515,281 1,742 (730,871)
Real estate owned 2,501 (2,241) (210)
Depreciation 247,685 213,787 192,495
Amortization of premium, net 242,923 79,741 13,848
Loss on disposal of fixed assets 83,460 -- --
ESOP expense 234,647 346,528 189,844
MRP expense 107,800 152,400 149,918
Provision for loan losses 220,000 81,000 60,000
Change in:
Deferred loan fees (191,521) (180,698) (77,301)
Other assets and accrued interest receivable (218,843) (541,027) (85,866)
Other liabilities and accrued interest payable 768,899 (2,039) (36,442)
----------- ----------- -----------
Net cash from operating activities 7,964,843 (2,990,110) 1,182,528
Cash flows from investing activities
Purchase of FHLB stock (600,000) (550,000) (75,000)
Net decrease in interest-bearing time deposits -- 99,000 199,000
Loan originations, net of repayments (19,099,197) (4,296,879) (13,664,118)
Loans purchased for portfolio (7,539,188) (3,295,025) (2,156,750)
Securities available for sale:
Purchases (36,282,467) (24,143,884) (14,725,895)
Proceeds from sales 27,518,645 15,634,260 10,731,577
Proceeds from maturities, calls
and principal repayments 11,450,457 2,786,772 1,545,498
Securities held to maturity:
Purchases (3,093,501) (11,102,747) (3,002,813)
Proceeds from maturities, calls
and principal repayments -- 4,000,625 1,000,000
Property and equipment expenditures (170,143) (250,534) (213,681)
Proceeds from disposal of fixed assets 2,952 -- --
Proceeds from sale of real estate owned 189,579 162,918 25,566
----------- ----------- -----------
Net cash from investing activities (27,622,863) (20,955,494) (20,336,616)
See accompanying notes to consolidated financial statements.
22
Consolidated Statements of Cash Flows (Continued)
Years ended June 30, 1999, 1998 and 1997
1999 1998 1997
------------ ------------ ------------
Cash flows from financing activities
Net increase in deposits $ 12,421,826 $ 17,117,227 $ 11,834,080
Repayment of FHLB borrowings (39,000,000) (43,000,000) (11,000,000)
Proceeds from FHLB borrowings 52,000,000 51,000,000 21,000,000
Repurchase of common stock (416,312) (105,938) (5,193,866)
Issuance of shares upon exercise of stock options 139,663 7,283 --
Dividends paid on common stock (586,828) (540,685) (506,959)
------------ ------------ ------------
Net cash from financing activities 24,558,349 24,477,887 16,133,255
------------ ------------ ------------
Net change in cash and cash equivalents 4,900,329 532,283 (3,020,833)
Cash and cash equivalents at beginning of period 4,205,539 3,673,256 6,694,089
------------ ------------ ------------
Cash and cash equivalents at end of period $ 9,105,868 $ 4,205,539 $ 3,673,256
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 8,274,128 $ 7,561,515 $ 6,103,832
Income taxes 281,000 768,119 456,050
Supplemental disclosure of noncash investing activities:
Transfer of securities from held to maturity
to available for sale 6,096,798 -- --
Transfer of securities from held to maturity to trading 8,024,251 -- --
Transfer of securities from trading to available for sale -- 1,165,649 --
Transfer from loans to real estate owned 309,826 316,083 45,268
See accompanying notes to consolidated financial statements.
23
Notes to Consolidated Financial Statements
June 30, 1999, 1998 and 1997
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Reporting: Bank West Financial Corporation (the "Company") was
organized as a thrift holding company for Bank West (the "Bank"), a state
chartered stock savings bank. The consolidated financial statements include the
accounts of the Company and the Bank. All significant intercompany transactions
and balances have been eliminated in consolidation.
Nature of Operations and Line of Business: The Company and the Bank provide a
broad range of banking and financial services in the banking industry.
Substantially all revenues and services are derived from banking products and
services. The Bank's primary services include accepting deposits and making
commercial, mortgage and installment loans in Kent County and Eastern Ottawa
County, Michigan. The Bank also engages in mortgage banking activities
consisting of selling originated and purchased loans into the secondary market.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions based on available information. These estimates and assumptions
affect the amounts reported in the financial statements and the disclosures
provided, and future results could differ. The primary estimates incorporated
into the Company's consolidated financial statements which are susceptible to
change in the near term include the allowance for loan losses, the
classification and carrying value of securities, mortgage servicing rights, and
loans held for sale, and the fair value of stock options and other financial
instruments.
Concentrations of Credit Risk: The Bank grants mortgage loans to customers
primarily in Kent County and Eastern Ottawa County, Michigan. No significant
number of the Bank's customers are employed at any one specific entity or in any
one specific industry. The Bank grants primarily one- to four-family residential
real estate loans. Substantially all loans are secured by specific items of
collateral, primarily single-family residences.
Cash Flow Reporting: Cash and cash equivalents are defined as cash and due
from banks and other investments with original maturities of three months or
less. Net cash flows are reported for customer loan transactions, deposit
transactions, and deposits made with other financial institutions.
Trading Securities: Securities that are bought and held principally for
resale in the near term (thus held for only a short period of time) are
classified as trading securities and recorded at their fair values. Realized and
unrealized gains and losses on trading securities are included immediately in
other income.
Securities: Securities which the Company has the positive intent and ability
to hold to maturity are classified as held to maturity and carried at amortized
cost. Securities, other than trading securities, that might be sold prior to
maturity are classified as available for sale. Securities available for sale are
carried at fair value, with unrealized holding gains and losses reported in
other comprehensive income. Securities are written down to fair value when a
decline in fair value is not temporary.
Gains and losses on the sale of securities are based on the amortized cost of
the security sold. Premiums and discounts on securities are recognized in
interest income using the level yield method over the period to maturity.
Loans Held for Sale: Mortgage loans originated and purchased for sale in the
secondary market are carried at the lower of cost or estimated market value on
an individual loan basis. Net unrealized losses are recognized in a valuation
allowance by charges to income. Gains on sales of loans are recognized when
proceeds from the loan sales are received by the Bank.
Loans: Loans are stated at unpaid principal balances, less the allowance for
loan losses, net deferred loan fees and costs, and charge-offs. Interest income
on loans is accrued over the term of the loans based upon the principal
24
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
outstanding. Interest income is not reported when full loan repayment is in
doubt, typically when payments are past due ninety days or more. Payments
received on such loans are reported as principal reductions.
Loan fees, net of certain direct loan origination costs, are deferred. The
net amount deferred is reported as part of loans and is recognized as interest
income over the term of the loan using the level yield method.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Estimating the risk of loss and
the amount of loss on any loan is necessarily subjective. Accordingly, the
allowance is maintained by management at a level considered adequate to cover
possible losses that are currently anticipated based on past loss experience,
general economic conditions, information about specific borrower situations
including their financial position and collateral values and other factors and
estimates which are subject to change over time. While management may
periodically allocate portions of the allowance for specific problem loan
situations, the whole allowance is available for any loan charge-offs that
occur. A loan is charged-off against the allowance by management when deemed
uncollectible, although collection efforts continue and future recoveries may
occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage, consumer, and credit card loans, and on an
individual loan basis for other loans. If a loan is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value
of estimated future cash flows using the loan's existing rate. Loans are
evaluated for impairment when payments are delayed, typically ninety days or
more, or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
Mortgage Loan Servicing Rights: Servicing rights represent both purchased
rights and the allocated value of servicing rights retained on loans sold.
Servicing rights are expensed in proportion to, and over the period of,
estimated net servicing revenues. Impairment is evaluated based on the fair
value of the rights, using groupings of the underlying loans as to interest
rates and then, secondarily, as to geographic and prepayment characteristics.
Any impairment of a grouping is reported as a valuation allowance.
Premises and Equipment: Premises and equipment are stated at cost less
accumulated depreciation. Premises and related components are depreciated using
the straight-line-method with useful lives ranging from thirty-one to forty
years. Furniture and equipment are depreciated using the straight-line-method
with useful lives ranging from three to ten years. Maintenance and repairs are
charged to expense and improvements are capitalized. These assets are reviewed
for impairment when events indicate the carrying amount may not be recoverable.
Real Estate Owned: Real estate properties acquired through, or in lieu of,
loan foreclosure are to be sold and are initially recorded at fair value less
estimated costs to sell at the date of acquisition, establishing a new cost
basis. Any reduction to fair value from the carrying value of the related loan
at the time of acquisition is accounted for as a loan loss and charged against
the allowance for loan losses. After acquisition, the property is carried at the
lower of cost or fair value, less estimated costs to sell. A valuation allowance
is recorded through a charge to income for the amount of selling costs.
Valuations are periodically performed by management and valuation allowances are
adjusted through a charge to income for changes in fair value or estimated
selling costs. Costs relating to improvement of property are capitalized,
whereas costs and revenues relating to the holding of property are expensed.
Income Taxes: Income tax expense is the total of the current year income tax
due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax amounts for the
25
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
temporary differences between carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
Employee Stock Ownership Plan (ESOP): The cost of shares issued to the ESOP
but not yet allocated to participants is presented as a reduction of
shareholders' equity. Compensation expense is recorded based on the market price
of the shares as they are committed to be released for allocation to participant
accounts. The difference between the market price and the cost of shares
committed to be released is recorded as an adjustment to additional paid-in
capital. Dividends on allocated ESOP shares are recorded as a reduction of
retained earnings while dividends on unallocated ESOP shares are reflected as a
reduction of debt and accrued interest.
Management Recognition Plan (MRP): The MRP is a stock award plan for which
the measurement of total compensation cost is based upon the fair value of the
shares on the date of grant. MRP awards vest in five equal annual installments
from the date of grant, subject to the continuous employment of the recipients
as defined under such plans. Compensation expense for the MRPs is recognized on
a prorata basis over the vesting period of the awards. The unearned compensation
value of the MRPs is shown as a reduction of shareholders' equity.
Stock Option Plan (SOP): Expense for employee compensation under SOPs is
recognized only if options are granted below the market price at the grant date.
As shown in a separate note, pro forma disclosures of net income and earnings
per share are provided as if the fair value method were used for stock-based
compensation.
Preferred Stock: The Company is authorized to issue 5,000,000 shares of
preferred stock. Such stock may be issued with such preferences and designations
as the Board of Directors may determine. The Board of Directors can, without
stockholder approval, issue preferred stock with voting, dividend, liquidation
and conversion rights which could dilute the voting strength of the holders of
the Common Stock and may have the effect of impeding an unfriendly takeover or
attempted change in control.
Financial Instruments: Financial instruments include credit instruments, such
as commitments to make loans and standby letters of credit, issued to meet
customer financing needs. The face amount for these items represents the
exposure to loss, before considering customer collateral or ability to repay.
Derivatives include interest rate swaps, futures, and similar items.
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, requires all derivatives to be recorded at
fair value. Unless designated as hedges, changes in these fair values will be
recorded in the income statement. Fair value changes involving hedges will
generally be recorded by offsetting gains and losses on the hedge and the hedged
item, even if the fair value of the hedged item is not otherwise recorded. As of
April 1, 1999, the Company adopted this statement and, in accordance with its
provisions, chose to reclassify certain securities from held to maturity to
available for sale and trading, as more fully disclosed in a separate note.
TheCompany does not have derivative instruments in its portfolio to account for
under the provisions of this statement.
Fair Values of Financial Instruments: Fair values of financial instruments
are estimated using relevant market information and other assumptions, as more
fully disclosed in a separate note. Fair value estimates involve uncertainties
and matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on- and
off-balance-sheet financial instruments does not include the value of
anticipated future business or the values of assets and liabilities not
considered financial instruments.
26
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings and Dividends Per Share: Basic earnings per share is based on
weighted average common shares outstanding. ESOP shares are considered
outstanding as they are committed to be released; unearned shares are not
considered outstanding. MRP shares are considered outstanding as they vest.
Diluted earnings per share further assumes issuance of dilutive potential common
shares relating to outstanding stock options and unvested MRP shares. All 1997
earnings and dividends per share amounts have been retroactively adjusted for a
three-for-two stock split paid in December, 1997.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale, net of tax, which are also recognized
as a separate component of shareholders' equity. The accounting standard that
requires reporting comprehensive income first applies for fiscal 1999, with
prior information restated to be comparable.
New Accounting Pronouncements: Mortgage loans originated in mortgage banking
are converted into securities on occasion. A new accounting standard for fiscal
2000 will allow classifying these securities as available for sale, trading, or
held to maturity, instead of the current requirement to classify as trading.
This is not expected to have a material effect but the effect will vary
depending on the level and designation of securitizations as well as on market
price movements.
Reclassifications: Certain prior year amounts have been reclassified to
conform to the current year presentation.
NOTE 2 - SECURITIES
The amortized cost and estimated market values of securities at June 30, are
as follows:
Available for Sale
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- -------- ---------- -----------
1999
U.S. agencies $10,898,521 $ 5,382 $ (130,128) $10,773,775
Mortgage-backed securities 3,501,610 -- (94,083) 3,407,527
Collateralized mortgage obligations 21,485,867 40,689 (395,670) 21,130,886
Corporate bonds 3,285,678 570 (7,723) 3,278,525
Taxable municipal bonds 3,659,131 -- (37,463) 3,621,668
Equity securities 62,140 -- (2,215) 59,925
----------- -------- ---------- -----------
$42,892,947 $ 46,641 $ (667,282) $42,272,306
=========== ======== ========== ===========
1998
U.S. agencies $ 3,995,488 -- $ (3,613) $ 3,991,875
Mortgage-backed securities 817,236 -- (9,916) 807,320
Collateralized mortgage obligations 24,596,237 $230,029 (210,089) 24,616,177
Equity securities 2,750,960 61,250 (59,885) 2,752,325
----------- -------- ---------- -----------
$32,159,921 $291,279 $ (283,503) $32,167,697
=========== ======== ========== ===========
Held to Maturity
1998
Collateralized mortgage obligations $11,084,361 $ 42,498 $ (47,681) $11,079,178
=========== ======== ========== ===========
27
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 2 - SECURITIES (Continued)
The scheduled maturities of securities available for sale at June 30, 1999
are shown below. Securities not due at a single maturity date are shown
separately. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
Amortized Fair
Cost Value
----------- -----------
Due after one year through
five years $15,184,791 $15,047,130
Due after five years through
ten years 2,658,539 2,626,838
Mortgagebacked securities
and collateralized
mortgage obligations 24,987,477 24,538,413
Equity securities 62,140 59,925
----------- -----------
$42,892,947 $42,272,306
=========== ===========
Proceeds from sales of securities amounted to approximately $27,518,000,
$20,121,000 and $14,679,000 for the years ended June 30, 1999, 1998 and 1997,
respectively, including approximately $4,486,000 and $3,947,000 relative to
trading securities for the years ended June 30, 1998 and 1997.
Gains (losses) on securities, reflected in the consolidated statements of
income, were as follows for the years ended June 30:
1999 1998 1997
--------- -------- --------
Gross realized gains on:
Securities available for sale $ 263,474 $ 59,447 $ 17,075
Trading securities -- 667,238 602,570
--------- -------- --------
263,474 726,685 619,645
Gross realized losses on:
Securities available for sale (622,258) (261,337) (17,360)
Trading securities (156,497) -- (1,977)
--------- -------- --------
(778,755) (261,337) (19,337)
--------- -------- --------
Net realized gains (losses) (515,281) 465,348 600,308
Net unrealized gain (loss)
on trading securities -- (467,090) 130,563
--------- -------- --------
$(515,281) $ (1,742) $730,871
========= ======== ========
During April of 1999, securities were transferred from the held to maturity
portfolio to the available for sale portfolio and the trading portfolio in
accordance with the provisions of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities. At the
date of transfer, the securities transferred to the available for sale portfolio
had an amortized cost of $6,096,798 and increased the unrealized loss on
securities available for sale by $40,104 and decreased shareholders' equity by
$26,469 (net of tax of $13,635). The securities transferred to the trading
portfolio had an amortized cost of $8,024,251 and a fair
28
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 2 - SECURITIES (Continued)
value of $7,884,252, resulting in a loss of $139,999 at the date of transfer.
This amount has been shown net of tax of $47,600 as a cumulative effect of an
accounting change in the consolidated statements of income. These trading
securities were subsequently sold during 1999 at a loss of $16,498, resulting in
a gross realized loss on trading securities of $156,497, as shown in the table
above. There are no trading securities held at June 30, 1999.
During May of 1998, securities with a carrying value and fair value of
$1,165,649 were transferred from trading securities to securities available for
sale to reflect management's intent to realize the long-term potential
underlying such securities rather than to benefit from short-term changes in
market values.
NOTE 3 - SECONDARY MARKET MORTGAGE ACTIVITIES
The following summarizes the Bank's secondary market mortgage activities,
which consist solely of one- to four-family real estate loans:
1999 1998 1997
------------ ----------- -----------
Loans held for sale - beginning of period $ 8,156,572 $ 2,231,151 $ 4,297,092
Activity during the periods:
Loans originated and purchased for sale 35,127,650 50,245,577 30,350,557
Proceeds from sales of mortgage loans (41,568,214) (44,982,359) (32,915,164)
Gain on sale of loans 664,568 662,203 498,666
------------ ----------- -----------
Loans held for sale end of period $ 2,380,576 $ 8,156,572 $ 2,231,151
=========== =========== ===========
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of these loans at
June 30 are summarized as follows:
1999 1998 1997
----------- ----------- -----------
Mortgage loan portfolios serviced for
FHLMC $27,179,312 $33,201,177 $26,980,056
=========== =========== ===========
Loan servicing fee income $ 77,241 $ 78,433 $ 70,661
=========== =========== ===========
Custodial escrow balances maintained in connection with the foregoing loan
servicing were $173,793 and $192,262 at June 30, 1999 and 1998.
Following is the activity for mortgage servicing rights for the years ended
June 30:
1999 1998 1997
--------- -------- --------
Balance at July 1 $ 280,869 $148,569 $142,697
Additions 65,692 190,800 16,372
Amortization (114,000) (58,500) (10,500)
--------- -------- --------
Balance at June 30 $ 232,561 $280,869 $148,569
========= ======== ========
29
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
Note 4 - LOANS
A valuation allowance for mortgage servicing rights was not considered
necessary for 1999, 1998 and 1997.
Loans are classified as follows at June 30:
1999 1998
------------ ------------
Real estate loans:
One-to four-family residential - fixed rate $ 14,559,680 $ 15,383,013
One-to four-family residential - balloon 51,842,742 24,413,846
One-to four-family residential - adjustable 18,833,825 32,599,924
Construction 25,395,916 24,730,805
Commercial mortgages 15,457,293 6,485,449
Home equity lines of credit 10,512,823 9,877,359
Second mortgages 10,820,377 8,148,412
Land development 1,189,394 675,498
------------ ------------
Total mortgage loans 148,612,050 122,314,306
Consumer loans 1,849,363 1,665,606
Commercial non-mortgage 3,823,834 3,253,091
------------ ------------
Total 154,285,247 127,233,003
Less:
Loans in process 9,001,424 8,248,310
Net deferred fees (costs) (402,135) (210,614)
Allowance for loan losses 480,267 289,696
------------ ------------
$145,205,691 $118,905,611
============ ============
Activity in the allowance for loan losses for the years ended June 30 is as
follows:
1999 1998 1997
-------- -------- --------
Beginning balance $289,696 $225,862 $165,862
Provision charged to operations 220,000 81,000 60,000
Charge-offs, net of recoveries (29,429) (17,166) --
-------- -------- --------
Ending balance $480,267 $289,696 $225,862
======== ======== ========
During the years ended June 30, 1999, 1998 and 1997, the Company had no loans
which were considered impaired.
Certain directors and executive officers of the Company and the Bank
(including family members, affiliates, and companies in which they are principal
owners) had loans outstanding with the Bank in the ordinary course of business.
Related party loan activity during 1999 and 1998 and balances as of June 30,
1999 and 1998 did not exceed $600,000.
30
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 5 - PREMISES AND EQUIPMENT NET
A summary of premises and equipment is as follows at June 30:
1999 1998
---------- ----------
Land $ 529,300 $ 529,300
Bank building and improvements 2,411,654 2,399,476
Furniture and equipment 1,051,429 1,180,697
---------- ----------
3,992,383 4,109,473
Accumulated depreciation (991,432) (944,568)
---------- ----------
$3,000,951 $3,164,905
========== ==========
NOTE 6 - DEPOSITS
Deposits at June 30 are summarized as follows:
1999 1998
------------------------- ----------------------------
Amount % Amount %
------------ ------ ------------ ------
Noninterest-bearing $ 8,419,022 6.36% $ 7,010,473 5.84%
Now accounts and MMDAs 9,731,425 7.35 4,434,858 3.70
Passbook and statement savings 19,267,901 14.55 19,334,577 16.11
Certificates of deposit 94,982,857 71.74 89,199,471 74.35
------------ ------ ------------ ------
$132,401,205 100.00% $119,979,379 100.00%
============ ====== ============ ======
At June 30, 1999, the scheduled maturities of certificates of deposit are as
follows by fiscal year-end:
2000 $73,607,227
2001 15,046,159
2002 2,408,500
2003 2,193,413
2004 1,689,478
Thereafter 38,080
-----------
$94,982,857
===========
As of June 30, 1999 and 1998, the Bank had time deposit accounts with
balances of $100,000 or more of $20,890,000 and $17,183,000. Related party
deposits were $1,704,000 and $2,095,000 at June 30, 1999 and 1998.
31
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 6 - DEPOSITS (Continued)
On September 30, 1996, as part of the omnibus appropriations package signed
by President Clinton, the government mandated a special assessment to
recapitalize the Savings Association Insurance Fund ("SAIF"), which is
administered by the Federal Deposit Insurance Corporation ("FDIC"). The
one-time, special SAIF assessment amounted to $.657 for every $100 of
SAIF-insured deposits as of March 31, 1995. The FDIC notified the Bank that the
Bank's special assessment was $551,000 which, after taxes, reduced the Company's
net income by $364,000 or $.14 per share for the year ended June 30, 1997. The
Bank's deposit premiums, which were $.23 for every $100 of assessable deposits
in 1996, were reduced to $.064 for every $100 of assessable deposits beginning
January 1, 1997.
NOTE 7 - FEDERAL HOME LOAN BANK BORROWINGS
Advances from the Federal Home Loan Bank (FHLB) of Indianapolis consist of
the following at June 30:
1999 1998
----------- -----------
Putable advances with maturities January 2003
through January 2009, with rates ranging from
4.65% to 5.34% at June 30, 1999, averaging 5.22%
at June 30, 1999 and 5.23% at June 30, 1998 $30,000,000 $22,000,000
Adjustable-rate advances with maturities October
1999 through December 1999, with rates ranging
from 4.90% to 5.38% at June 30, 1999, averaging
5.01% at June 30, 1999 and 5.78% at June 30, 1998 20,000,000 15,000,000
----------- -----------
$50,000,000 $37,000,000
=========== ===========
For the putable advances, the FHLB has the option to convert the advance to
an adjustable rate beginning one, two or five years after the purchase date,
depending on the advance, and quarterly thereafter.
Maturities of borrowings outstanding at June 30, 1999 are as follows for the
next 5 years:
2000 $20,000,000
2001 --
2002 --
2003 10,000,000
2004 --
Thereafter 20,000,000
-----------
$50,000,000
===========
Prepayment of certain remaining advances is permitted only upon the Bank's
termination of its FHLB membership, while others are subject to prepayment
penalties under the provisions and conditions of the credit policy of the FHLB.
The Bank did not incur prepayment penalties for the years ended June 30, 1999
and 1998.
In addition to FHLB stock, the advances are collateralized at a minimum of
160% of the advances outstanding by approximately $121,000,000 and $118,000,000
of first mortgage loans and securities under a blanket lien arrangement at June
30, 1999 and 1998.
32
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 8 - FEDERAL INCOME TAXES
The provision for federal income taxes for the years ended June 30 consists
of the following:
1999 1998 1997
--------- -------- --------
Current income tax expense $ 199,758 $401,804 $530,231
Deferred income tax expense (benefit) (54,158) 51,451 (51,507)
--------- -------- --------
Total expense attributable to operations 145,600 453,255 478,724
Tax benefit attributable to cumulative
effect of accounting change (47,600) -- --
Deferred expense allocated to other
comprehensive income items:
Unrealized loss on transfer of
securities held to maturity
to available for sale (13,635)
Unrealized gains (losses) arising
during the year (375,222) (72,546) 113,286
Less reclassification adjustments
for net losses included
in net income 175,195 68,642 97
--------- -------- --------
Other comprehensive income (213,662) (3,904) 113,383
--------- -------- --------
$(115,662) $449,351 $592,107
========= ======== ========
Deferred tax assets and liabilities at June 30 consist of the following:
1999 1998
-------- ---------
Deferred tax assets:
Accrued expenses $ 70,963 $ 15,300
Management Recognition Plan 18,744 34,054
Loans marked-to-market (938) 89,422
Unrealized loss on securities
available for sale 211,018 --
Other 72,774 31,084
-------- ---------
372,561 169,860
Deferred tax liabilities
Loan fees 139,329 81,172
Bad debt allowance 58,019 162,555
FHLB stock dividend 49,116 49,116
Fixed assets 114,389 114,060
Mortgage servicing rights 79,070 95,495
Unrealized gain on securities
available for sale -- 2,644
-------- ---------
439,923 505,042
-------- ---------
Net deferred tax liability $(67,362) $(335,182)
======== =========
No valuation allowance was provided on deferred tax assets.
33
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 8 - FEDERAL INCOME TAXES (Continued)
The provision for federal income taxes attributable to continuing operations
differs from that computed at the statutory corporate tax rate as follows:
Years ended
----------------- June 30, ----------------
1999 1998 1997
-------- -------- --------
Statutory rate 34% 34% 34%
Tax expense at statutory rate $140,765 $436,432 $476,528
Stock compensation plans 35,717 16,982 3,150
Other (30,882) (159) (954)
-------- -------- --------
$145,600 $453,255 $478,724
======== ======== ========
Effective rate 35% 35% 34%
Differences in the deduction for bad debts for tax and financial statement
purposes after 1988 are included in deferred taxes. For years prior to 1988, the
Bank had determined taxable income after deducting a provision for bad debts in
excess of such provisions recorded in the financial statements. Accordingly,
retained earnings at June 30, 1999 and 1998 includes approximately $3,364,000 on
which no provision for federal income taxes has been made. The amount of
unrecorded deferred taxes is $1,144,000. If this portion of retained earnings is
used for any purpose other than to absorb bad debts, the amount used will be
added to future taxable income.
The Company files consolidated federal income tax returns on a fiscal year
basis. Prior to July 1, 1997, if certain conditions were met in determining
taxable income, the Bank was allowed a special bad debt deduction based on a
percentage of taxable income. Tax legislation passed in August 1996 now requires
the Bank to deduct a provision for bad debts for tax purposes based on actual
loss experience and recapture the excess bad debt reserve accumulated in tax
years after 1987. The related amount of deferred tax liability which must be
recaptured is approximately $265,572 and is payable over a six-year period
beginning with the year ending June 30, 1999.
34
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 9 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of basic and diluted
earnings per share for the years ended June 30 are as follows:
1999 1998 1997
---------- ---------- ----------
Basic earnings per share
Net income available to common shareholders $ 176,015 $ 830,368 $ 922,829
---------- ---------- ----------
Weighted average common shares outstanding 2,399,997 2,370,243 2,572,335
---------- ---------- ----------
Basic earnings per share $ .07 $ .35 $ .36
========== ========== ==========
Diluted earnings per share
Net income available to common shareholders $ 176,015 $ 830,368 $ 922,829
---------- ---------- ----------
Weighted average common shares outstanding 2,399,997 2,370,243 2,572,335
Add: dilutive effects of assumed exercise of
stock options and unvested MRP's
Stock options 49,155 107,670 10,827
MRP shares 5,913 10,413 --
---------- ---------- ----------
Weighted average common and dilutive
potential common shares outstanding 2,455,065 2,488,326 2,583,162
---------- ---------- ----------
Diluted earnings per share $ .07 $ .33 $ .36
========== ========== ==========
Stock options for 67,995 and 26,026 shares of common stock were not
considered in the computation of diluted earnings per share for the years ended
June 30, 1999 and 1997, respectively, as they were antidilutive. All share and
per share amounts have been retroactively adjusted for stock splits.
NOTE 10 - COMMITMENTS, CONTINGENCIES AND FINANCIAL
INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to make loans, unused lines of
credit, loans in process and letters of credit. The Company's exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument is represented by the contractual amount of those instruments. The
Company follows the same credit policy to make such commitments as is followed
for those loans recorded in the financial statements.
The contract amounts of these financial instruments are as follows at June
30:
1999 1998
----------- -----------
Commitments to make loans $ 7,092,000 $ 7,035,000
Unused lines of credit 14,392,000 11,172,000
Loans in process 9,001,000 8,248,000
Letters of credit 330,000 278,000
Approximately 80% and 61% of commitments to make loans and to fund loans in
process were made at fixed rates as of June 30, 1999 and 1998. Rate ranges for
these fixed rate commitments were 6.625% to 9.125% and 7.0% to 9.125% as of June
30, 1999 and 1998. Lines of credit are issued at current market rates.
35
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 10 - COMMITMENTS, CONTINGENCIES AND FINANCIAL
INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (Continued)
The Company does not anticipate any losses as a result of these commitments.
Collateral obtained upon exercise of the commitment is determined using the
Bank's credit evaluation of the borrower, and may include real estate, business
assets and other items. Since many commitments to make loans expire without
being used, the amount does not necessarily represent future cash commitments.
The Bank is a defendant under two legal proceedings alleging the unauthorized
practice of law and various violations of law. Management intends to continue to
contest these cases vigorously. Based on a review of current facts and
circumstances, management is unable to determine the amount of loss, if any,
that is possible.
The Company and the Bank are also subject to certain other legal actions
arising in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material adverse effect on the consolidated financial
position or results of operations of the Company.
During 1999, a settlement agreement totaling $225,000 was reached with a
former management executive. Per the provisions of the agreement, the total
settlement is being paid in 52 equal monthly installments, ending in March of
2001. Approximately $190,000 is included in other liabilities at June 30, 1999
and represents the remaining amount to be paid under the agreement.
The Company has entered into employment agreements with four executive
officers of the Company. Under the terms of those agreements, certain events
leading to separation from the Company could result in a cash payment equal to
two times the affected emloyee's compensation payable in twenty four equal
monthly installments, and continued participation in medical and dental plans
the employee was entitled to prior to the date of separation.
The Company has also entered into a separate employment agreement with the
President/CEO of the Company. Under the terms of this agreement, certain events
leading to separation from the Company could result in the immediate vesting of
the 33,334 stock options granted inApril of 1999 under the Stock OptionPlan, as
more fully disclosed in Note 12. At the date of separation, such immediate
vesting could result in a cash payment up to an amount equal to the 33,334
options multiplied by the difference between the market value of the Company's
stock at the date of separation and the exercise price of the options.
NOTE 11 - EMPLOYEE BENEFIT PLANS
The Company participates in the Financial Institutions Retirement Fund, a
multi-employer defined benefit pension plan. Substantially all employees are
eligible for participation in the Plan. The benefits are based on a percentage
of the participant's career average salary for each year of service. An employee
becomes fully vested upon completion of five years of qualifying service. The
plan is currently overfunded and did not require contributions or charges
against income for the years ended June 30, 1999, 1998 and 1997. Specific plan
assets and accumulated benefit information for the Company's portion of the Fund
is not available. Under the Employee Retirement Income Security Act (ERISA), a
contributor to a multi-employer pension plan may be liable in the event of
complete or partial withdrawal for the benefit payments guaranteed under ERISA.
Since the plan is overfunded, no liability for contributions is necessary.
The Company maintains a qualified 401(k) plan covering substantially all
employees. Employees who are 18 years and older and who have completed 1,000
hours of service in a 12 consecutive-month period are eligible.
36
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 11 - EMPLOYEE BENEFIT PLANS (Continued)
Employees may elect to contribute to the plan from 1% to 15% of their salary
subject to statutory limitations. The Company makes matching contributions equal
to 25% of the first 3% of employee contributions. Although not required, the
Company also has the option to make an additional, nonelective contribution to
the plan. Beginning after 2 years of service, employees become vested in the
Company's contributions at the rate of 20% per year, with 100% vesting occurring
after 6 years of service. The Company's contributions for fiscal 1999, 1998 and
1997 were approximately $10,600, $9,600 and $5,200, respectively.
NOTE 12 - STOCK-BASED COMPENSATION PLANS
Employee Stock Ownership Plan (ESOP)
An ESOP was established for the benefit of substantially all employees. The
ESOP borrowed $1,296,048 from the Company and used those funds to acquire
243,009 shares of the Company's stock at $5.33 per share.
Shares issued to the ESOP are committed to be released based on the number of
unallocated shares held immediately before release for the current plan year
multiplied by a fraction. The numerator of the fraction is the amount of
quarterly principal and interest paid. The denominator of the fraction is the
sum of the numerator plus the principal and interest to be paid for all future
periods. The loan is secured by shares purchased with the loan proceeds and will
be repaid by the ESOP with funds from the Company's contributions to the ESOP
and earnings on ESOP assets. Principal and interest payments are scheduled to
occur in quarterly amounts of $45,326 over a ten-year period. The balance of the
loan was $852,176 at June 30, 1999. An employee becomes fully vested upon
completion of seven years of qualifying service. Upon withdrawal from the plan,
participants are entitled to a distribution in cash or Company stock, or both.
During 1999, 1998 and 1997, 24,300 shares of stock with an average fair value
of $9.66 per share in 1999, $14.26 per share in 1998 and $7.81 per share in 1997
were committed to be released. Distributions of 2,244 and 4,802 shares were made
to participants during the years ended June 30, 1999 and 1998. ESOP compensation
expense for the years ended June 30, 1999, 1998 and 1997 was $234,647, $346,528
and $189,844. Shares held by the ESOP at June 30 are as follows:
1999 1998
---------- ----------
Allocated to participants 94,934 72,878
Unallocated 139,734 164,034
---------- ----------
Total ESOP shares 234,668 236,912
========== ==========
Fair value of unallocated shares $1,406,073 $2,316,980
========== ==========
All share and per share amounts have been retroactively adjusted for stock
splits.
Stock Option Plan (SOP) and Management Recognition Plan (MRP)
Employee and director Stock Option Plans (SOPs) and officer and director
Management Recognition Plans (MRPs) were authorized by the shareholders at the
October 25, 1995 annual meeting. The MRPs are restricted stock award plans. The
employee SOP and the officers' MRP are administered by a committee of directors
of the Company, while grants under the directors' SOP and the directors' MRP are
pursuant to formulas set forth in the plans. MRP shares are granted at the
closing market price of the Company's stock on the date of grant and vest in
37
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 12 - STOCK-BASED COMPENSATION PLANS (Continued)
five equal annual installments from the date of grant. SOP options are granted
at the average of the high and low market prices of the Company's stock on the
date of grant and vest in five equal annual installments and expire ten years
from the date of grant.
Directors' SOP Employees' SOP Directors' MRP Employees' MRP
Weighted Weighted Weighted Weighted
Average Average Average Average
Exercise Exercise Grant Date Grant Date
Options Price Options Price Shares Fair Value Shares Fair Value
------- ----- ------- ----- ------ --------- ------ ----------
Total options/shares available 104,146 243,009 41,657 97,206
Balance outstanding
July 1, 1996 78,113 6.96 36,000 6.63 37,488 6.67 73,875 6.67
Granted 7/8/96 21,450 7.33
Granted 10/25/96 26,026 7.25 4,169 7.25
Granted 12/20/96 88,350 7.17
Forfeited (6,150) 7.08 (1,555) 6.67
------- ------- ------ -------
Balance outstanding
June 30, 1997 104,139 7.03 139,650 7.06 41,657 6.73 72,320 6.67
Granted 9/2/97 69,000 11.38
Exercised (1,000) 7.28
Forfeited (3,150) 7.36
------- ------- ------ -------
Balance outstanding
June 30, 1998 104,139 7.03 204,500 8.51 41,657 6.73 72,320 6.67
Granted 7/30/98 37,495 13.25
Granted 4/14/99 33,334 8.66
Granted 5/6/99 5,000 9.00
Exercised (20,100) 6.95
Forfeited (62,320) 10.02 (13,221) 6.67
------- ------- ------ -------
Balance outstanding
June 30, 1999 104,139 7.03 197,909 9.11 41,657 6.73 59,099 6.67
======= ======= ====== ======
Options/shares exercisable
(vested) 57,278 49,380 24,160 43,164
======= ======= ====== ======
Options/shares available for
future grant 7 24,000 0 38,107
======= ======= ====== ======
During the years ended June 30, 1999, 1998 and 1997, $107,800, $152,400 and
$149,918 was charged to compensation expense for the MRPs.
Had compensation cost for stock options been measured using FASB Statement
No. 123, net income and earnings per share would have been the pro forma amounts
indicated below. The pro forma effect may increase in the future if more options
are granted.
38
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 12 - STOCK-BASED COMPENSATION PLANS (Continued)
Years ending
---------------- June 30, ---------------
1999 1998 1997
-------- -------- --------
Net income as reported $176,015 $830,368 $922,829
Pro forma net income 113,933 716,649 885,286
Basic earnings per share as reported .07 .35 .36
Pro forma basic earnings per share .05 .30 .33
Diluted earnings per share as reported .07 .33 .36
Pro forma diluted earnings per share .05 .29 .33
Weighted-average fair value of options granted
during the year 1.39 2.07 .96
The fair value of options granted during the years ended June 30, 1999, 1998
and 1997, respectively, is estimated using the following weighted-average
information: risk-free interest rate of 5.33%, 6.22%, and 6%, expected life of 5
years, expected monthly volatility of stock price of 8.7%, 7.1% and 6.3% and
expected dividends of 2.7%, 1.9% and 3% per year.
At June 30, 1999, options outstanding were as follows:
Number of options 302,048
Range of exercise prices $6.63 - $13.25
Weighted-average exercise price $8.39
Weighted-average remaining option life 7.59 Years
For options now exercisable: number 106,810
Weighted-average exercise price $7.36
All share and per share amounts have been retroactively adjusted for stock
splits.
NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED
EARNINGS
Effective December 29, 1997, Bank West, the Company's wholly-owned
subsidiary, completed its conversion to a Michigan chartered savings bank. As a
state chartered savings bank, Bank West's primary regulatory agencies are the
Financial Institutions Bureau of the State of Michigan and the Federal Deposit
Insurance Corporation.
The Bank is subject to regulatory capital requirements administered by state
and federal regulatory agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and other
factors, and the regulators can lower classifications in certain cases. Failure
to meet various capital requirements can initiate regulatory action that could
have a direct material effect on the financial statements.
39
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED
EARNINGS (Continued)
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
Capital to Risk-
Weighted Assets
--------------------- Tier 1 Capital
Total Tier 1 to Adjusted Assets
----- ------ ------------------
Well capitalized 10% 6% 5%
Adequately capitalized 8 4 4
Undercapitalized 6 3 3
At year end, actual capital levels (dollars in millions) and minimum required
levels were:
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
----------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ----- ------ ------ -----
1999
Total capital (to risk weighted assets) $21.1 18.0% $9.4 8.0% $11.7 10.0%
Tier 1 capital (to risk weighted assets) 20.6 17.6 4.7 4.0 7.0 6.0
Tier 1 capital (to average total assets) 20.6 10.4 7.9 4.0 9.9 5.0
1998
Total capital (to risk weighted assets) $20.1 20.9% $7.7 8.0% $9.6 10.0%
Tier 1 capital (to risk weighted assets) 19.8 20.6 3.9 4.0 5.8 6.0
Tier 1 capital (to average total assets) 19.8 11.3 7.0 4.0 8.8 5.0
At June 30, 1999 and 1998, the Bank was categorized as well capitalized.
During fiscal 1997, the Bank made a capital distribution to the Company in
the amount of $2,500,000. This distribution was made primarily to allow the
Company to make stock repurchase transactions.
At the time of conversion to a stock association, the Bank established a
liquidation account with an initial balance of $11,150,000, which is equal to
its total net worth as of the date of the latest balance sheet appearing in the
final conversion prospectus. The liquidation account is maintained for the
benefit of eligible depositors who continue to maintain their accounts at the
Bank after the conversion. The liquidation account is reduced annually to the
extent that eligible depositors have reduced their qualifying deposits.
Subsequent increases will not restore an eligible account holder's interest in
the liquidation account. In the event of a complete liquidation, each eligible
depositor will be entitled to receive a distribution from the liquidation
account in an amount proportionate
40
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED
EARNINGS (Continued)
to the current adjusted qualifying balancesfor accounts then held. The Bank may
not pay dividends that would reduce shareholders' equity below the required
liquidation account balance.
Federal and state banking laws and regulations place certain restrictions on
the amount of dividends a bank can pay to its holding company. Under the most
restrictive of these dividend limitations, at June 30, 1999, approximately
$11,300,000 was available to the Bank for the payment of dividends to the
holding company without prior regulatory approval.
NOTE 14 - STOCK REPURCHASE PROGRAMS
During fiscal 1999 and 1998, the Company repurchased 46,000 and 7,500 shares
of its common stock after receiving approval from its federal regulator to
repurchase up to 5%, or 133,500 shares of the Company's common stock. The shares
were repurchased at an average price of $9.05 and $14.125 during fiscal 1999 and
1998 and remain available for general corporate purposes, including issuance in
connection with stock-based compensation plans. Subsequent to June 30, 1999,
80,000 shares of the Company's common stock were repurchased at an average price
of $9.38.
NOTE 15 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Bank West Financial Corporation is as
follows:
CONDENSED BALANCE SHEETS
as of:
---------- June 30, ----------
1999 1998
----------- -----------
ASSETS
Cash and cash equivalents $ 1,409,630 $ 284,085
Securities available for sale 59,925 2,752,325
Federal income tax receivable 13,921 149,171
Loan receivable from Employee
Stock Ownership Plan 852,176 968,684
Investment in subsidiary bank 20,204,318 19,857,357
Accrued interest receivable 4,249 894
Other assets 7,208 12,670
----------- -----------
Total assets $22,551,427 $24,025,186
=========== ===========
LIABILITIES
Note payable to subsidiary $ -- $ 750,000
Deferred taxes (benefit) (751) 464
Other liabilities 47 35
SHAREHOLDERS' EQUITY 22,552,131 23,274,687
----------- -----------
Total liabilities and shareholders' equity $22,551,427 $24,025,186
=========== ===========
41
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 15 - PARENT COMPANY ONLY CONDENSED FINANCIAL
INFORMATION (Continued)
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME,
for the years ended:
----------------- June 30, -----------------
1999 1998 1997
--------- ----------- -----------
Interest and dividend income
Securities $ 76,079 $ 150,447 $ 55,455
Loan to Employee Stock Ownership Plan 64,794 72,605 79,892
Other interest-bearing deposits 47,064 18,595 53,732
Dividends from subsidiary bank -- -- 2,500,000
--------- ----------- -----------
187,937 241,647 2,689,079
Interest expense 3,719 99,850 11,794
--------- ----------- -----------
Net interest income 184,218 141,797 2,677,285
Other income
Net gain on trading securities -- 200,148 731,156
Net gain (loss) on securities
available for sale (332,714) (259,730) (14,995)
--------- ----------- -----------
(332,714) (59,582) 716,161
Operating expenses 95,806 152,108 88,468
--------- ----------- -----------
Income before federal income taxes and
equity in undistributed earnings of
subsidiary bank (244,302) (69,893) 3,304,978
Federal income tax expense (benefit) (83,000) (23,745) 273,700
--------- ----------- -----------
Income (loss) before equity in undistributed
earnings of subsidiary bank (161,302) (46,148) 3,031,278
Equity in undistributed (excess distributed)
earnings of subsidiary Bank 337,317 876,516 (2,108,449)
--------- ----------- -----------
Net income 176,015 830,368 922,829
Other comprehensive income, net of tax:
Change in unrealized gain (loss) on
securities, net of reclassification effects (414,755) (7,578) 220,097
--------- ----------- -----------
Comprehensive income $(238,740) $ 822,790 $ 1,142,926
========= =========== ===========
42
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 15 - PARENT COMPANY ONLY CONDENSED FINANCIAL
INFORMATION (Continued)
CONDENSED STATEMENTS OF CASH FLOWS,
for the years:
------------------ June 30, -----------------
1999 1998 1997
----------- ----------- -----------
Cash flows from operating activities
Net income $ 176,015 $ 830,368 $ 922,829
Adjustments to reconcile net income to
cash provided by operations
Equity in undistributed (excess
distributed) earnings of subsidiary Bank (337,317) (876,516) 2,108,449
Trading securities:
Purchases -- (2,530,635) (5,428,775)
Proceeds from sales -- 4,486,385 3,947,118
(Gain) loss on sales of securities 332,714 59,582 (716,161)
Change in
Accrued interest receivable (3,355) 228 18,611
Other assets 140,712 (156,302) 30,089
Other liabilities 12 (34,441) 22,495
----------- ----------- -----------
Net cash provided by operating
activities 308,781 1,778,669 904,655
Cash flows from investing activities
Securities available for sale:
Purchases (350,000) (1,904,438)
Proceeds from sales 2,706,107 59,399 2,481,875
Principal reduction on ESOP note receivable 116,508 108,698 101,410
Contribution to subsidiary Bank (42,374) (38,426) (37,921)
Net (increase) decrease in interest-bearing
time deposits -- 99,000 99,000
----------- ----------- -----------
Net cash used in investing activities 2,430,241 (1,675,767) 2,644,364
Cash flows from financing activities
Proceeds of loan from subsidiary Bank -- 2,450,000 1,300,000
Repayment of loan to subsidiary Bank (750,000) (1,700,000) (1,300,000)
Dividends paid on common stock (586,828) (540,685) (506,959)
Repurchase of common stock (416,312) (105,938) (5,193,866)
Issuance of shares upon exercise of
stock options 139,663 7,283 --
----------- ----------- -----------
Net cash from financing activities (1,613,477) 110,660 (5,700,825)
----------- ----------- -----------
Net change in cash and cash equivalents 1,125,545 213,562 (2,151,806)
Cash and cash equivalents at beginning of period 284,085 70,523 2,222,329
----------- ----------- -----------
Cash and cash equivalents at end of period $ 1,409,630 $ 284,085 $ 70,523
=========== =========== ===========
Supplemental disclosure of cash flow information:
During May of 1998, securities with a carrying value and fair value of
$1,165,649 were transferred from trading securities to securities available for
sale.
Notes to Consolidated Financial Statements (Continued)
June 30, 1999, 1998 and 1997
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair values for
financial instruments. The carrying amount is considered to estimate fair value
for cash and cash equivalents, Federal Home Loan Bank stock, demand, savings and
money market deposits, accrued interest, the allowance for loan losses, and
variable-rate loans or deposits that reprice frequently and fully. Securities
fair values are based on quoted market prices or, if no quotes are available, on
the rate and term of the security and on information about the issuer. For
fixed-rate loans or deposits and for variable-rate loans or deposits with
infrequent repricing or repricing limits, the fair value is estimated by
discounted cash flow analysis using current market rates for the estimated life
and credit risk. Fair value of loans held for sale is based on market estimates.
The fair value of Federal Home Loan Bank borrowings is based on currently
available rates for similar financing. The fair value of off-balance-sheet items
is based on the fees or costs that would currently be charged to enter into or
terminate such arrangements. The fair value of off-balance sheet items was not
material for this presentation.
The estimated fair values of the Company's financial instruments (in
thousands) are as follows at June 30:
1999 1998
---- ----
Carrying Fair Carrying Fair
Value Value Value Value
------- ------- ------- -------
Financial assets
Cash and cash equivalents $ 9,106 $ 9,106 $ 4,206 $ 4,206
Securities 42,272 42,272 43,252 43,247
Loans, net 145,206 144,517 118,906 119,380
Loans held for sale 2,381 2,407 8,157 8,298
Mortgage servicing rights 233 233 281 281
Federal Home Loan Bank stock 2,700 2,700 2,100 2,100
Accrued interest receivable 1,019 1,019 879 879
Financial liabilities
Deposits 132,401 132,496 119,979 120,229
Federal Home Loan Bank borrowings 50,000 50,019 37,000 36,802
Accrued interest payable 292 292 253 253
Advance payments by borrowers
for taxes and insurance 509 509 513 513
44
Your Partners in Bank West Financial Corporation
DIRECTORS
George A. Jackoboice, Chairman of the Board;
President of Monarch Hydraulics, Inc.
Carl A. Rossi, Treasurer; Contract Manager and
part-owner of Bay Area Interiors
Jacob Haisma, Owner of Jacob Haisma Builders, Inc.
Thomas D. DeYoung, Owner and President
of DeYoung & Associates
Robert J. Stephan, Vice Chairman of the Board;
President, Chief Executive Officer
of SecureOne Benefit Administrators, Inc.
Richard L. Bishop, President of Jurgens &
Holtvluwer Men's Store, Inc.
John H. Zwarensteyn, President, Chief Executive Officer
and owner of Gemini Corporation
Harry E. Mika, Private Investor, Director for 29 years
at five different banks in Western Michigan
Wallace D. Riley, President and Senior Partner of
Riley and Roumell, P.C.
SPECIAL COUNSEL
Elias, Matz, Tiernan & Herrick L.L.P.
Suite 1200
734 15th Street, N.W.
Washington, D.C. 20005
GENERAL COUNSEL
Siebers Mohney Associates, P.L.C.
The Ledyard Building
Suite 340
125 Ottawa Avenue N.W.
Grand Rapids, Michigan 49503
TRANSFER AGENT
Registrar and Transfer Company
10 Commerce Drive
Cranford, N.J. 07016
INDEPENDENT AUDITORS
Crowe, Chizek and Company LLP
400 Riverfront Plaza Building
55 Campau, N.W.
Grand Rapids, Michigan 49502
EXECUTIVE OFFICERS
Ronald A. Van Houten, President,
Chief Executive Officer
James A. Koessel, Senior Vice President
of Mortgage Lending
Laurie S.Adams, Vice President,
Director of RetailBanking
Louis D. Knooihuizen, Vice President
of Commercial Lending
Kevin A. Twardy, Vice President,
Chief Financial Officer
STOCK INFORMATION
Bank West Financial Corporation is traded on the Nasdaq National Market under
the symbol of "BWFC." Total shares outstanding as of June 30, 1999 were
2,597,729. As of September 15, 1999, the Company had approximately 611
shareholders of record. The high and low bid quotations for the common stock as
reported on the Nasdaq, as well as dividends declared per share, were as
follows:
Quarter Ended High Low Dividends
- ------------- ---- --- ---------
September 30, 1997 $12.667 $ 9.000 $.05
December 31, 1997 17.625 12.583 .05
March 31, 1998 16.250 12.750 .06
June 30, 1998 14.750 13.500 .06
September 30, 1998 14.250 9.500 .06
December 31, 1998 11.250 8.750 .06
March 31, 1999 10.000 8.250 .06
June 30, 1999 10.938 8.250 .06
The information set forth in the table above was provided by The Nasdaq Stock
Market. Such information reflects interdealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions.
INVESTOR INFORMATION
A copy of Bank West Financial Corporation's Annual Report on Form 10-K and a
list of the exhibits thereto, as filed with the Securities and Exchange
Commission, may be obtained without charge upon written request to Kevin A.
Twardy, Chief Financial Officer, Bank West Financial Corporation, 2185 Three
Mile Road, N.W., Grand Rapids, MI 49544, or by calling (616) 785-3400.