Harrington Financial Group, Inc.
1999 Annual Report
to
Stockholders
Financial
Highlights (Dollars in thousands, except per share data)
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For the Years Ended June 30, 1999 1998 1997
---------- --------- ---------
Net interest income $ 6,081 $ 4,924 $ 8,066
Income (loss) before tax provision, gain (loss) on securities
and minority interest (2,497) (1,388) 2,769
Net realized and unrealized gain (loss) on securities (1,647) (1,705) 494
Special SAIF assessment 830
Net income (loss) (2,455) (1,859) 2,002
Return on average assets before special SAIF assessment (0.44)% (0.34)% 0.50%
Return on average assets after special SAIF assessment (0.44)% (0.34)% 0.39%
Return on average equity before special SAIF assessment (12.54)% (7.56)% 10.52%
Return on average equity after special SAIF assessment (12.54)% (7.56)% 8.34%
At June 30,
Total assets $ 471,339 $ 484,397 $ 446,797
Total loans 259,674 163,546 93,958
Total securities 183,702 291,531 318,480
Total deposits 333,245 178,311 136,175
Stockholders' equity 19,139 22,664 24,994
Common shares outstanding 3,205,382 3,275,886 3,256,738
Average Balances
Assets $ 561,670 $ 538,981 $ 507,407
Loans 223,174 116,982 78,545
Core retail deposits 254,843 136,594 116,210
Other deposits 18,245 15,168 20,592
Total deposits 273,088 151,762 136,802
Per Share
Basic earnings (loss) per share $ (0.76) $ (0.57) $ 0.61
Diluted earnings (loss) per share (0.76) (0.57) 0.61
After tax basic earnings (loss) excluding special SAIF assessment (0.76) (0.57) 0.78
Book value, fiscal year end 5.97 6.92 7.67
Market value, fiscal year end 7.250 11.250 12.125
Asset Quality at June 30,
Non-performing assets to total assets 0.13% 0.18% 0.25%
Loan loss reserves to non-performing loans 1142.11% 126.32% 63.39%
Capital Ratios at June 30 (Harrington Bank)
Tangible capital 6.95% 6.88% 6.96%
Core capital 6.95% 6.88% 6.96%
Risk-based capital 12.33% 21.92% 31.14%
14
FINANCIAL REVIEW
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Selected Consolidated Financial Data 16
Management's Discussion and
Analysis of Financial Condition
and Results of Operation 17
Consolidated Balance Sheets 32
Consolidated Statements of Operations 33
Consolidated Statements of
Change in Stockholders' Equity 34
Consolidated Statements
of Cash Flows 35
Notes to Consolidated
Financial Statements 36
Independent Auditors' Report 59
Selected Consolidated
Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial and other data of
the Company for the five years in the period ended June 30, 1999. The selected
consolidated financial data should be read in conjunction with the Consolidated
Financial Statements of the Company, including the accompanying Notes, presented
elsewhere herein.
At or For the Years Ended June 30,
-------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
Balance Sheet Data
Securities held for trading and available for sale $ 183,702 $ 291,531 $ 318,480 $ 321,897 $ 249,274
Loans receivable-net 259,674 163,546 93,958 65,925 37,010
Total assets 471,339 484,397 446,797 418,196 300,174
Deposits 333,245 178,311 136,175 135,143 115,312
Securities sold under agreements to repurchase 60,198 240,396 245,571 219,067 130,217
Federal Home Loan Bank advances 40,000 26,000 26,000 26,000 31,000
Note payable 13,995 13,495 9,995 8,998 9,200
Stockholders' equity 19,139 22,664 24,994 23,117 10,361
Stockholders' equity per share 5.97 6.92 7.67 7.10 5.28
Income Statement Data
Interest income $ 35,204 $ 33,956 $ 34,474 $ 23,484 $ 17,560
Interest expense 29,123 29,032 26,408 18,004 12,779
--------- --------- --------- --------- ---------
Net interest income 6,081 4,924 8,066 5,480 4,781
Provision for loan losses 511 147 92 (1) 15
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 5,570 4,777 7,974 5,481 4,766
Retail banking fees and other income 433 295 239 256 238
--------- --------- --------- --------- ---------
Total net revenue 6,003 5,072 8,213 5,737 5,004
Operating expenses 8,500 6,460 5,444 3,740 3,167
--------- --------- --------- --------- ---------
Income (loss) before tax provision, gain (loss) on securities
and minority interest (2,497) (1,388) 2,769 1,997 1,837
--------- --------- --------- --------- ---------
Gain (loss) on sale of securities held for trading 4,755 (775) (1,623) 1,834 66
Unrealized gain (loss) on securities held for trading (6,402) (930) 2,117 (1,960) 1,535
Permanent impairment of securities available for sale (414)
--------- --------- --------- --------- ---------
Net gain (loss) on securities (1,647) (1,705) 494 (126) 1,187
--------- --------- --------- --------- ---------
Income (loss) before income tax provision and minority interest (4,144) (3,093) 3,263 1,871 3,024
Income tax provision (1,646) (1,234) 1,261 648 1,171
--------- --------- --------- --------- ---------
Income (loss) before minority interest (2,498) (1,859) 2,002 1,223 1,853
Minority interest 43
--------- --------- --------- --------- ---------
Net income (loss) $ (2,455) $ (1,859) $ 2,002 $ 1,223 $ 1,853
========= ========= ========= ========= =========
Basic earnings (loss) per share $ (0.76) $ (0.57) $ 0.61 $ 0.57 $ 1.20
========= ========= ========= ========= =========
Diluted earnings (loss) per share $ (0.76) $ (0.57) $ 0.61 $ 0.56 $ 1.20
========= ========= ========= ========= =========
Cash dividends per share $ 0.12 $ 0.12 $ 0.03 N/A N/A
========= ========= ========= ========= =========
Performance Ratios
Return on average assets (2) (0.44%) (0.34%) 0.50% 0.37% 0.76%
Return on average equity (2) (12.54) (7.56) 10.52 9.49 22.24
Interest rate spread 1.06 0.79 1.43 1.64 2.13
Net interest margin 1.12 0.94 1.62 1.73 2.10
Average interest-earning assets to average interest-
bearing liabilities 101.14 102.73 103.67 101.55 99.57
Net interest income after provision for loan losses to total
other expenses (2) 65.53 73.95 172.82 146.55 150.49
Total other expenses to average total assets (2) 1.51 1.20 0.91 1.13 1.30
Full service offices 8 7 4 3 2
Asset Quality Ratios (at end of period)
Non-performing loans to total loans (3) 0.03 0.17 0.36 0.40 0.95
Non-performing assets to total assets (3) 0.13 0.18 0.25 0.32 0.59
Allowance for loan losses to total loans 0.33 0.22 0.23 0.02 0.03
Allowance for loan losses to total non-performing loans 1,142.11 126.32 63.39 45.98 34.57
Capital Ratios (4)
Tangible capital ratio 6.95 6.88 6.96 6.27 6.12
Core capital ratio 6.95 6.88 6.96 6.27 6.12
Risk-based capital ratio 12.33 21.92 31.14 30.10 24.62
Equity to assets at end of period 4.06 4.68 5.59 5.53 3.45
- -----------------------
(1) On May 6, 1996, the Company sold 1,265,000 shares of common stock at $10.00
per share to investors in an initial public offering resulting in gross
proceeds of $12,650,000 to the Company. Net proceeds after offering
expenses were $11,437,000.
(2) For comparability purposes, the 1997 fiscal year ratios exclude the effect
of the special SAIF assessment of $830,000.
(3) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, assets acquired by foreclosure or
repossession and a single non-agency participation certificate classified
as substandard.
(4) Regulatory capital ratios apply to the Bank (Harrington Bank, FSB) as a
federally chartered savings bank.
16
MANAGEMENT'S DISCUSSION & ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Harrington Financial Group, Inc. ("Harrington" or the "Company") is an
Indiana-chartered, registered thrift holding company for Harrington Bank, FSB
(the "Bank"). The following financial review presents an analysis of the
Company's operations and financial position for the periods presented in this
annual report.
General
- --------------------------------------------------------------------------------
Harrington's business strategy focuses on achieving attractive returns
consistent with prudent risk management. Harrington has sought to implement this
strategy by (1) expanding its banking locations and product offerings in order
to build a strong community banking franchise primarily through de novo
branching; (2) controlling interest rate risk by matching the interest rate
sensitivity of its assets to that of its liabilities; (3) controlling credit
risk by maintaining a substantial portion of the Company's assets in
mortgage-backed securities and single-family residential loans and by applying
conservative underwriting standards and credit risk monitoring; and (4)
utilizing excess capital balances through the management of a hedged investment
portfolio.
Harrington invests primarily in mortgage-backed and related securities and
originates (both directly and through correspondents) loans secured by
single-family residences located primarily in Indiana and the Kansas City
metropolitan area. While Harrington has greatly expanded its portfolio of
originated mortgage loans as well as commercial loans, approximately 39% of its
assets currently consist of purchased mortgage-backed and related securities
that are hedged to reduce interest rate risk. Although mortgage-backed
securities often carry lower yields than traditional mortgage loans, such
securities generally increase the quality of the Company's assets by virtue of
the securities' underlying insurance or guarantees, are more liquid than
individual mortgage loans, and may be used to collateralize borrowings or other
obligations of the Company. The funds invested in the securities portfolio can
be quickly redeployed to pursue expansion opportunities as they arise.
Furthermore, the Company's origination of commercial mortgage and commercial and
industrial loans through the newly developed commercial loan division provides
further diversification of business lines and fulfills a critical component of
the Company's community banking strategy.
Harrington's funding strategy focuses on accessing cost-efficient funding
sources, including securities sold under agreements to repurchase, retail and
non-retail deposits and Federal Home Loan Bank ("FHLB") advances. The Company
continues to build a community-oriented banking operation in order to sustain
loan originations and deposit growth, benefit from economies of scale, and
generate additional fee income. Management's primary goal is to increase
stockholders' value, as measured on a risk-adjusted total return basis.
To reduce the institution's exposure to interest rate risk, the Company utilizes
interest rate risk management contracts and mortgage-backed derivative
securities in conjunction with regular adjustments to the composition of the
Company's investment portfolio. Harrington marks a substantial portion of its
assets and interest rate contracts to market in order to fully account for the
market value changes in the Company's investment portfolio. This method of
accounting is consistent with Harrington's strategy of active portfolio
management and provides the Company with the flexibility to quickly adjust the
mix of its interest-earning assets in response to changing market conditions or
to take advantage of community banking growth opportunities.
The Company recognizes that marking substantially all of its assets to market
subjects Harrington to potential earnings volatility. Market value volatility is
not unique to Harrington as most unhedged financial institutions have even
greater volatility in market values. The difference is that Harrington reflects
the changes in market values directly in earnings, while most other institutions
do not.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
- --------------------------------------------------------------------------------
In addition to historical information, forward-looking statements contained in
this annual report are subject to risks and uncertainties that could cause
actual results to differ materially from those reflected in the forward-looking
statements. Factors that could cause future results to vary from current
expectations include, but are not limited to, the impact of economic conditions
(both generally and more specifically in the markets in which Harrington
operates), the impact of competition for Harrington's customers from other
providers of financial services, the impact of government legislation and
17
regulation (which changes from time to time and over which Harrington has no
control), and other risks detailed in the Annual Report and in Harrington's
other Securities and Exchange Commission ("SEC") filings. Readers are cautioned
not to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. Harrington undertakes no
obligation to publicly revise these forward-looking statements to reflect events
or circumstances that arise after the date hereof. Readers should carefully
review the risk factors described in other documents Harrington files from time
to time with the SEC, including the Quarterly Reports on Form 10-Q to be filed
by Harrington in 1999 and 2000 and any Current Reports on Form 8-K filed by
Harrington.
Asset and Liability Management
- --------------------------------------------------------------------------------
In general, financial institutions are negatively affected by an increase in
interest rates to the extent that interest-bearing liabilities mature or reprice
more rapidly than interest-earning assets. The lending activities of savings
institutions have historically emphasized the origination of long-term,
fixed-rate loans secured by single-family residences, and the primary source of
funds of such institutions has been deposits, which largely mature or are
subject to repricing within a shorter period of time.
This factor has historically caused the income and market value of portfolio
equity ("MVPE") of savings institutions to be more volatile than other financial
institutions. MVPE is defined as the net present value of the cashflows from an
institution's existing assets, liabilities and off-balance sheet instruments.
While having liabilities that reprice more frequently than assets is generally
beneficial to net interest income and MVPE in times of declining interest rates,
such an asset/liability mismatch is generally detrimental during periods of
rising interest rates.
The Company's management believes that its asset and liability management
strategy, as discussed below, provides Harrington with a competitive advantage
over other financial institutions. Harrington's ability to effectively hedge its
interest rate exposure through the use of various financial instruments allows
the Company to acquire loans and investments which offer attractive net
risk-adjusted spreads and meet customer preferences whether the individual loans
or investments are fixed-rate or adjustable-rate or short-term or long-term.
Similarly, the Company can choose a cost-effective source of funds and
subsequently engage in an interest rate swap or other hedging transaction so
that the interest rate sensitivities of its interest-earning assets and
interest-bearing liabilities are generally matched.
Harrington's asset and liability management strategy is formulated and monitored
by the Boards of Directors of both the Company and the Bank, the Company's
wholly owned subsidiary. The Boards' written policies and procedures are
implemented by the Investment Committee of the Bank, which is comprised of the
Chief Executive Officer, Chief Investment Officer, and three outside directors.
The Investment Committee meets at least monthly to review, among other things,
the sensitivity of the Bank's assets and liabilities to interest rate changes,
investment opportunities and the performance of the investment portfolios, and
the past month's purchase and sale activity of securities. The Committee also
provides guidance to management on reducing interest rate risk and on investment
strategy and consults with the Chief Operating Officer of the Bank regarding
retail pricing and funding decisions with respect to the Bank's overall asset
and liability composition. In accordance therewith, the Investment Committee
reviews the Bank's liquidity, cash flow needs, interest rate sensitivity of
investments, deposits and borrowings, core deposit activity, current market
conditions and interest rates on both a local and national level.
Harrington has contracted with Smith Breeden Associates, Inc. ("Smith Breeden")
for the provision of consulting services regarding, among other things, the
management of its investments and borrowings, the pricing of loans and deposits,
and the use of various financial instruments to reduce interest rate risk. Smith
Breeden is a consulting firm which renders investment advice and asset and
liability management services to financial institutions, corporate and
government pension plans, foundations, Smith Breeden's mutual funds, and
government agencies nationally. Certain directors of the Company and the Bank
are principals of Smith Breeden.
The Investment Committee regularly reviews interest rate risk by utilizing
analyses prepared by Smith Breeden with respect to the impact of alternative
interest rate scenarios on net interest income and on the Bank's MVPE. The
Investment Committee also reviews analyses prepared by Smith Breeden concerning
the impact of changing market volatility, prepayment forecast error, and changes
in option-adjusted spreads and non-parallel yield curve shifts.
MVPE analysis is used by regulatory authorities for assessing an institution's
interest rate risk. The extent to which assets will gain or lose value net of
the gains or losses of liabilities and/or interest rate contracts determines the
appreciation or depreciation in equity on a market-value basis. Such market
value analysis is intended to evaluate the impact of immediate and sustained
parallel interest rate shifts upon the market value of the current balance
sheet.
In the absence of the Company's hedging activities, the MVPE of the Company
would decline as a result of a general increase in market rates of interest.
This decline would be due to the market values of Harrington's assets being
generally
18
more sensitive to interest rate fluctuations than are the market values of the
Company's liabilities due to Harrington's investment in and origination of
generally longer-term assets which are funded with shorter-term liabilities.
Consequently, the elasticity (i.e., the change in the market value of an asset
or liability as a result of a change in interest rates) of Harrington's assets
is greater than the elasticity of its liabilities.
Accordingly, the primary goal of Harrington's asset and liability management
policy is to effectively increase the elasticity of the Company's liabilities
and/or effectively contract the elasticity of the Company's assets so that the
respective elasticities are matched as closely as possible. This elasticity
adjustment can be accomplished internally by restructuring Harrington's balance
sheet or externally by adjusting the elasticities of Harrington's assets and/or
liabilities through the use of interest rate contracts, such as interest rate
swaps, collars, caps, floors, options and futures. Harrington's strategy is to
hedge either internally through the use of longer-term certificates of deposits
or less sensitive non-defined maturity (transaction) deposits, FHLB advances and
mortgage-backed derivative securities or externally through the use of various
interest rate contracts.
External hedging involves the use of interest rate swaps, collars, caps, floors,
options and futures. The notional amount of interest rate contracts represents
the underlying amount on which periodic cash flows are calculated and exchanged
between counterparties. However, this notional amount does not necessarily
represent the principal amount of securities which would effectively be hedged
by that interest rate contract.
In selecting the type and amount of interest rate contract to utilize, the
Company compares the elasticity of a particular contract to that of the
securities to be hedged. An interest rate contract with the appropriate
offsetting elasticity could have a notional amount much greater than the face
amount of the securities being hedged.
An interest rate swap is an agreement where one party (generally the Company)
agrees to pay a fixed rate of interest on a notional principal amount to a
second party (generally a broker or money center bank) in exchange for receiving
from the second party a variable rate of interest on the same notional amount
for a predetermined period of time. No actual assets are exchanged in a swap of
this type and interest payments are generally netted. These swaps are generally
utilized by Harrington to synthetically convert fixed-rate assets into
adjustable-rate assets without having to sell or transfer the underlying assets.
At June 30, 1999, Harrington was a party to three interest rate swap agreements
held in its trading portfolio. The agreements had an aggregate notional amount
of $21.0 million and maturities from April 2000 to April 2001. With respect to
these agreements, Harrington makes fixed interest payments ranging from 6.14% to
6.58% and receives payments based upon the three-month London Interbank Offered
Rate ("LIBOR").
The net expense (income) relating to Harrington's interest rate swaps held in
the trading portfolio was $457,000, $313,000 and $330,000 during the years ended
June 30, 1999, 1998 and 1997, respectively. The approximate market value of the
interest rate swaps which are maintained in the trading portfolio was
$(175,000), and $(397,000) as of June 30, 1999 and 1998, respectively.
In addition, the Company also has swaps that are not included in the trading
portfolio. One of these swaps, whereby the Company pays a floating rate (based
on three-month LIBOR) and receives a fixed rate of 6.96%, had a notional amount
of $7.5 million and is used to modify the interest rate sensitivity of certain
certificates of deposit issued by the Bank. This floating-pay swap matures in
December of 1999. The remaining six swap agreements excluded from the trading
portfolio had an aggregate notional amount of $50.0 million and maturities from
February 2004 to February 2009. With respect to these agreements, Harrington
makes fixed interest payments ranging from 5.27% to 6.48% and receives payments
based upon the three-month LIBOR. These fixed-pay swaps, in addition to cap
agreements that are not included in the Company's trading portfolio, are used to
effectively modify the interest rate sensitivity of a portion of the Bank's
short-term LIBOR correlated borrowings which include short-term deposits,
securities sold under agreements to repurchase and the Federal Home Loan Bank
advances.
The net income relating to Harrington's swaps which are not included in the
trading portfolio was $31,000, $70,000 and $130,000 during the years ended June
30, 1999, 1998 and 1997, respectively. This income is netted against interest
expense in the Company's Consolidated Statements of Operations. The approximate
market value of these interest rate swaps (which is not reflected in the
Company's financial statements) was $2.3 million and $137,000 as of June 30,
1999 and 1998, respectively.
An interest rate cap or an interest rate floor consists of a guarantee given by
the issuer (i.e., a broker), to the purchaser (i.e., the Company), in exchange
for the payment of a premium. This guarantee states that if interest rates rise
above (in the case of a cap) or fall below (in the case of a floor) a specified
rate on a specified interest rate index, the issuer will pay to the purchaser
the difference between the then current market rate and the specified rate on a
notional principal amount. No funds are actually borrowed or repaid.
Similarly, an interest rate collar is a combination of a purchased cap and a
written floor at different strike rates. Accordingly, an interest rate collar
requires no payments if interest rates remain within a specified range, but will
require the
19
Company to be paid if interest rates rise above the cap rate or require the
Company to pay if interest rates fall below the floor rate. Consequently,
interest rate caps are a means of reducing interest expense by placing a ceiling
on the cost of floating-rate liabilities, or offsetting the caps on the coupons
inherent in the Company's adjustable rate mortgage loans and securities.
Interest rate floors permit Harrington to maintain its desired interest rate
spread in the event that falling interest rates lead to increased prepayments
with respect to the Company's mortgage-backed and related securities portfolio
requiring reinvestment at lower rates.
At June 30, 1999, Harrington held seven interest rate cap agreements, eleven
interest rate floor agreements and one interest rate collar in its trading
portfolio. These contracts, which expire from July 1999 to June 2009, have an
aggregate notional amount of $378.6 million. The interest rate cap agreements
provide for a payment, depending on the particular contract, whenever the
defined floating rate exceeds 6.50% to 9.00%. The interest rate floor agreements
provide for a payment, depending on the particular contract, whenever the
defined floating rate is less than 5.00% to 7.00%. The interest rate collar
provides for a payment whenever the defined floating rate is greater than 10.25%
or less than 5.25%.
The aggregate net expense (income) relating to the Company's interest rate caps,
collars and floors held in the trading portfolio was $(343,000), $223,000 and
$(370,000) during the years ended June 30, 1999, 1998 and 1997, respectively.
The approximate market value of Harrington's interest rate caps, collars and
floors which are maintained in the trading portfolio was $5.0 million and $4.6
million as of June 30, 1999 and 1998, respectively.
Harrington also has four interest rate caps with aggregate notional amounts of
$90.0 million which are not held in the Company's trading portfolio. These caps,
which mature from May 2001 to May 2008, provide for a payment, depending on the
particular contract, whenever the defined floating rate exceeds 6.00% to 7.00%.
These caps, in addition to fixed-pay swaps that are not included in the
Company's trading portfolio, are used to effectively modify the interest rate
sensitivity of a portion of the Bank's short-term LIBOR correlated borrowings
which include short-term deposits, securities sold under agreements to
repurchase and the Federal Home Loan Bank advances. Net expense on the caps was
$494,000, $257,000 and $178,000 for the years ended June 30, 1999, 1998 and
1997, respectively. The approximate market value of the caps, which is not
reflected in the Company's financial statements, was $4.4 million and $2.5
million at June 30, 1999 and 1998, respectively.
Interest rate futures are commitments to either purchase or sell designated
instruments at a future date for a specified price. Futures contracts are
generally traded on an exchange, are marked-to-market daily and are subject to
initial and maintenance margin requirements. Harrington generally uses 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off LIBOR as well as Treasury Note and Bond futures contracts.
The Company will from time to time agree to sell a specified number of contracts
at a specified date. To close out a contract, Harrington will enter into an
offsetting position to the original transaction.
If interest rates rise, the value of the Company's short futures positions
increases. Consequently, sales of futures contracts serve as a hedge against
rising interest rates. At June 30, 1999, Harrington had sold Eurodollar and
Treasury Note futures contracts with an aggregate notional amount of
approximately $2.7 billion. The Company had total gains (losses) on its futures
contracts of $3.2 million, $(8.6) million and $(3.9) million for the fiscal
years ended June 30, 1999, 1998 and 1997, respectively.
Options are contracts which grant the purchaser the right to buy or sell the
underlying asset by a certain date for a specified price. Generally, Harrington
will purchase options on financial futures to hedge the changing elasticity
exhibited by mortgage loans and mortgage-backed securities. The changing
elasticity results from the ability of a borrower to prepay a mortgage. As
market interest rates decline, borrowers are more likely to prepay their
mortgages, shortening the elasticity of the mortgages. Consequently, where
interest rates are declining, the value of mortgage loans or mortgage-backed
securities will increase at a slower rate than would be expected if borrowers
did not have the ability to prepay their mortgages.
Harrington, therefore, generally purchases out-of-the-money calls and puts so
that the increase in value of the options resulting from interest rate movements
offsets the reductions in MVPE resulting from the changing elasticity inherent
in the Company's balance sheet. At June 30, 1999, Harrington had 180 purchased
options contracts with an aggregate notional amount of approximately $33.0
million that were included in the trading portfolio. The net expense relating to
these options contracts was $466,000, $943,000 and $770,000 during the years
ended June 30, 1999, 1998 and 1997, respectively. The approximate market value
of the Company's options contracts, which are maintained in the trading
portfolio, was $328,000 and $50,000 as of June 30, 1999 and 1998, respectively.
The following table summarizes the periodic exchanges of interest payments with
counterparties including the amortization of premiums paid for interest rate
contracts as discussed above. Such payments and amortization amounts are
accounted for as adjustments to the yields of securities held for trading and
are reported as a separate component of interest income.
20
Years Ended June 30, 1999 1998 1997
------- ------- -------
(Dollars In Thousands)
Interest rate contract (income) expense:
Swaps $ 457 $ 313 $ 330
Caps, floors, and collars (343) 223 (370)
Options 466 943 770
------- ------- -------
Net interest expense on
interest rate contracts $ 580 $ 1,479 $ 730
======= ======= =======
The above table does not include realized and unrealized gains and losses with
respect to the market value of interest rate contracts held in the trading
portfolio. Such gains and losses are generally offset by fluctuations in the
market value of the Company's assets held for trading. All realized and
unrealized gains and losses pertaining to interest rate contracts in the trading
portfolio are reported as other income in the Company's Consolidated Statements
of Operations.
Harrington is subject to the risk that its counterparties with respect to
various interest rate contracts (such as swaps, collar, caps, floors, options
and futures) may default at or prior to maturity of a particular instrument. In
such a case, the Company might be unable to recover any unrealized gains with
respect to a particular contract.
To reduce this potential risk, the Company generally deals with large,
established investment brokerage firms when entering into these transactions. In
addition, if the Company enters into an interest rate contract with a non
AA-rated (or above) entity and the Company has an unrealized gain with respect
to such contract, the Company generally requires the entity to post some form of
collateral to secure its obligations. Furthermore, the Company has a policy
whereby it limits its unsecured exposure to any one counterparty to 25% of the
Bank's equity during any two-month period and 35% of the Bank's equity during
any one-month period.
The Office of Thrift Supervision ("OTS") requires each thrift institution to
calculate the estimated change in the institution's MVPE assuming an
instantaneous, parallel shift in the Treasury yield curve of 100 to 300 basis
points either up or down in 100 basis point increments. The OTS permits
institutions to perform this MVPE analysis using their own internal model based
upon reasonable assumptions. The Company retains Smith Breeden to assist in
performing the required calculation of the sensitivity of its market value to
changes in interest rates.
In estimating the market value of mortgage loans and mortgage-backed securities,
the Company utilizes various prepayment assumptions which vary, in accordance
with historical experience, based upon the term, interest rate and other factors
with respect to the underlying loans. At June 30, 1999, these prepayment
assumptions varied from 4% to 21% for fixed-rate mortgages and mortgage-backed
securities and varied from 14% to 22% for adjustable rate mortgages and
mortgage-backed securities.
The following table sets forth at June 30, 1999 the estimated sensitivity of the
Bank's MVPE to parallel yield curve shifts using Harrington's internal market
value calculation. The table demonstrates the sensitivity of the Bank's assets
and liabilities both before and after the inclusion of its interest rate
contracts.
Change in
Interest Rates (in Basis Points) (1) -300 -200 -100 - +100 +200 +300
-------- -------- -------- ---- -------- -------- --------
(Dollars in Thousands)
Market value gain (loss) of assets $ 31,783 $ 27,669 $ 16,604 - $(21,142) $(45,579) $(72,166)
Market value gain (loss) of liabilities (5,319) (3,902) (2,150) - 2,591 5,642 9,096
-------- -------- -------- ---- -------- -------- --------
Market value gain (loss) of net
assets before interest rate contracts 26,464 23,767 14,454 - (18,551) (39,937) (63,070)
Market value gain (loss) of
interest rate contracts (29,705) (21,859) (12,223) - 15,112 32,257 50,377
-------- -------- -------- ---- -------- -------- --------
Total change in MVPE(2) $ (3,241) $ 1,908 $ 2,231 - $ (3,439) $ (7,680) $(12,693)
======== ======== ======== ==== ======== ======== ========
Change in MVPE as a percent of:
MVPE(2) (10.8)% 6.4% 7.5% - (11.5)% (25.7)% (42.5)%
Total assets of the Bank (0.7)% 0.4% 0.5% - (0.7)% (1.6)% (2.7)%
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $29.9 million at June 30, 1999.
21
The table set forth above does not purport to show the impact of interest rate
changes on Harrington's equity under generally accepted accounting principles.
Market value changes only impact the Company's income statement or the balance
sheet (1) to the extent the affected instruments are marked to market, and (2)
over the life of the instruments as an impact on recorded yields.
Since a large portion of Harrington's assets is recorded at market value, the
following table is included to show the estimated impact on the Company's equity
of instantaneous, parallel shifts in the yield curve, and constant option
adjusted spreads on assets and liabilities. The assets and interest rate
contracts included in the table below are only those which are either classified
by the Company as held for trading or available for sale and, therefore,
reflected at market value. Consequently, Harrington's liabilities, which are
reflected at cost, are not included in the table below. All amounts are shown
net of taxes, with an estimated effective tax rate of 39.0%.
Change in
Interest Rates (in Basis Points) -300 -200 -100 - +100 +200 +300
-------- -------- -------- ---- -------- -------- --------
(Dollars in Thousands)
After tax market value gain (loss)
of assets $ 10,573 $ 8,684 $ 5,050 - $ (6,256) $(13,463) $(21,308)
-------- -------- -------- ---- -------- -------- --------
After tax market value gain (loss)
of interest rate contracts (9,988) (7,712) (4,524) - 6,019 13,120 20,852
-------- -------- -------- ---- -------- -------- --------
After tax gain (loss) in equity $ 585 $ 972 $ 526 - $ (237) $ (343) $ (456)
======== ======== ======== ==== ======== ======== ========
After tax gain (loss) in equity as a
percent of the Company 's
equity at June 30, 1999 3.1% 5.1% 2.7% - (1.2)% (1.8)% (2.4)%
Changes in Financial Condition
- --------------------------------------------------------------------------------
General. At June 30, 1999, Harrington's total assets amounted to $471.3 million,
as compared to $484.4 million at June 30, 1998. The decrease in total assets was
primarily due to a $107.8 million decrease in the Company's securities portfolio
which was partially offset by a $96.1 million increase in the loan portfolio.
Cash and Interest-Bearing Deposits. Cash and interest-bearing deposits amounted
to $9.5 million and $11.8 million at June 30, 1999 and 1998, respectively.
Harrington actively manages its cash and cash equivalents based upon the
Company's operating, investing and financing activities. Based upon the
Company's current size, cash and cash equivalents generally fluctuate within a
range of approximately $8.0 million to $17.0 million. Harrington attempts to
invest its excess liquidity in higher yielding assets such as loans or
securities.
Securities Held for Trading and Available for Sale. In order to reduce the
Company's credit risk exposure, to enhance balance sheet liquidity, and to
utilize excess capital balances, Harrington maintains a substantial portion of
its assets in a hedged mortgage-backed and related securities portfolio, the
securities of which are primarily issued or guaranteed by U.S. Government
agencies or government sponsored enterprises. Almost all of these securities and
their related interest rate risk management contracts are classified as held for
trading and, pursuant to SFAS 115, are reported at fair value with unrealized
gains and losses included in earnings. The remainder of the securities are
classified as available for sale and thus also reported at fair value, but with
unrealized gains and losses excluded from earnings and reported instead as a
separate component of stockholders' equity.
Securities held for trading (consisting of mortgage-backed securities,
mortgage-backed derivative securities, interest rate contracts and equity
securities) amounted to $183.2 million and $290.6 million at June 30, 1999 and
1998, respectively. Securities classified as available for sale (consisting of a
non-agency mortgage-backed security and municipal bonds) declined from $922,000
at June 30, 1998 to $502,000 at June 30, 1999.
Loans Receivable. At June 30, 1999, loans receivable (net of the Company's
allowance for loan losses) amounted to $259.7 million, an increase of 58.8% over
the June 30, 1998 total of $163.5 million. Harrington has significantly
increased its community banking operations, particularly the origination (both
directly and through correspondent mortgage banking companies) of single-family
residential loans. Loans originated through correspondents must meet the same
pricing and underwriting standards as loans originated internally. In addition,
the Bank has increased its commercial loan portfolio from $4.7 million at June
30, 1998 to $33.8 million at June 30, 1999.
22
Allowance for Loan Losses. At June 30, 1999, Harrington's allowance for loan
losses totaled $868,000, compared to $360,000 at June 30, 1998. At June 30,
1999, the Company's allowance represented approximately 0.3% of the total loan
portfolio as compared to 0.2% at June 30, 1998. The ratio of total
non-performing loans to total loans amounted to 0.03% at June 30, 1999 compared
to 0.2% at June 30, 1998, which reflects Harrington's emphasis on maintaining
low credit risk with respect to its operations.
Although Harrington management believes that its allowance for loan losses at
June 30, 1999 was adequate based on facts and circumstances available to it
(including the historically low level of loan charge-offs), there can be no
assurances that additions to the allowance will not be necessary in future
periods, which could adversely affect the Company's results of operations.
Deposits. At June 30, 1999, deposits totaled $333.2 million, as compared to
$178.3 million as of June 30, 1998. Retail deposits increased $154.0 million,
from $166.8 million at June 30, 1998 to $320.8 million at June 30, 1999,
primarily due to Harrington's strategy of rapidly building a community banking
franchise which included the opening of the Kansas branch in August of 1998.
Non-retail deposits increased by $933,000 during the same period, for a total
increase in deposits of $154.9 million.
Borrowings. At June 30, 1999, reverse repurchase agreements and dollar rolls
(both of which are securities sold under agreements to repurchase and are
accounted for as a financing) totaled $60.2 million, as compared to $240.4
million as of June 30, 1998.
Advances from the FHLB of Indianapolis amounted to $40.0 million and $26.0
million as of June 30, 1999 and 1998, respectively. At June 30, 1999, the FHLB
advance was scheduled to mature in fiscal 2000, with an average interest rate
thereon of 4.9%, as compared to 5.6% at June 30, 1998.
The Company's note payable amounted to $14.0 million and $13.5 million at June
30, 1999 and 1998, respectively. The note payable relates to a loan facility
that was used to refinance, to a significant extent, the unpaid balance of a
$10.0 million acquisition loan which financed the Company's acquisition of the
Bank.
Stockholders' Equity. Stockholders' equity decreased from $22.7 million at June
30, 1998 to $19.1 million at June 30, 1999. This decrease was due primarily to
the $2.5 million of net loss recognized during fiscal 1999, the purchase of
treasury stock amounting to $784,000 and the payment of the Company's quarterly
dividends of $.03 per share, or $385,000 in total. This decrease was partially
offset by the $73,000 proceeds from the issuance of treasury stock.
Results of Operations
- --------------------------------------------------------------------------------
Summary of Operations. Harrington reported net loss of $2.5 million or $0.76
basic loss per share for the year ended June 30, 1999 compared to a net loss of
$1.9 million or $0.57 basic loss per share for the year ended June 30, 1998.
This $596,000 or 32.1% increase in net loss was due primarily to a $2.0 million
increase in operating expenses and a $364,000 increase in the provision for loan
losses, which was partially offset by a $1.2 million increase in net interest
income, a $196,000 increase in other income (loss) and a $412,000 decrease in
the income tax provision.
The Company's primary goal in fiscal years 1999 and 1998 was to improve the
value of the banking franchise through profitable deposit, loan, market and
business line expansion. The market expansion into Kansas and North Carolina and
the establishment of the necessary infrastructure were substantially completed
during fiscal years 1999 and 1998. The recent losses are due primarily to the
underperformance of the investment portfolio combined with the necessary
investment spending to complete the market expansion and develop the
infrastructure to support continued growth into the future. With the foundation
now in place for its community banks in Indiana, Kansas and North Carolina, the
Company is making marked improvement in its core banking income (net interest
income after provision for loan losses plus fees minus operating expenses). Net
interest income has increased by $1.2 million over fiscal year 1998, which
reflects the tremendous growth in the Company's loan portfolio and deposits.
Furthermore, the core income deficit has been reduced from $1.1 million in the
June 1998 quarter to $219,000 in the June 1999 quarter. Contributing to this
margin improvement is a lower cost of deposits compared to initial promotional
levels, falling from 5.50% at June 30, 1998 to 4.80% at June 30, 1999. The net
interest margin also increased from 0.69% in the June 1998 quarter to 1.77% in
the June 1999 quarter.
Net loss for the year ended June 30, 1998 was $1.9 million or $0.57 basic loss
per share, compared to $2.0 million or $0.61 basic earnings per share for the
year ended June 30, 1997. The $3.9 million or 192.9% decrease in net income was
due primarily to a $3.1 million decrease in net interest income, a $2.1 million
decrease in other income (loss) and a $1.0 million increase in operating
expenses, which was partially offset by a $2.5 million decrease in the income
tax provision.
23
Average Balances, Net Interest Income and Yields Earned and Rates Paid. The
following table presents for the periods indicated the total dollar amount of
interest from average interest-earning assets and the resultant yields, as well
as the interest expense on average interest-bearing liabilities, expressed both
in dollars and rates, and the net interest margin. The table does not reflect
any effect of income taxes. All average balances are based on average daily
balances during the periods presented.
Years Ended June 30,
--------------------------------------------------------------------
1999 1998
--------------------------------- --------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
------------ --------- --------- ----------- --------- ----------
(dollars in thousands)
Interest-Earning Assets:
Interest-bearing deposits $ 13,489 $ 610 4.52% $ 14,590 $ 792 5.43%
Securities held for trading (2) 300,223 18,104 6.03% 386,640 23,947 6.19%
Securities available for sale (3) 699 66 9.44% 1,039 91 8.76%
Loans receivable, net (4) 223,174 16,033 7.18% 116,982 8,734 7.47%
Federal Home Loan Bank stock 4,879 391 8.01% 4,858 392 8.07%
-------- ------- -------- -------
Total interest-earning assets 542,464 35,204 6.49% 524,109 33,956 6.48%
Non-interest-earning assets 19,206 14,872
Total assets $561,670 $538,981
Interest-Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 13,050 306 2.34% $ 6,788 166 2.45%
Savings accounts 30,520 1,279 4.19% 25,188 1,091 4.33%
Money market deposit accounts 73,256 3,546 4.84% 2,713 127 4.68%
Certificates of deposit 156,262 8,969 5.74% 117,073 6,919 5.91%
-------- ------- -------- -------
Total deposits 273,088 14,100 5.16% 151,762 8,303 5.47%
Securities sold under agreements
to repurchase 213,428 11,433 5.36% 319,578 17,905 5.60%
Federal Home Loan Bank advances 36,172 2,481 6.86% 27,488 1,843 6.70%
Note payable 13,672 1,109 8.11% 11,355 981 8.64%
-------- ------- -------- -------
Total interest-bearing liabilities 536,360 29,123 5.43% 510,183 29,032 5.69%
Non-interest bearing liabilities 5,729 4,200
Total liabilities 542,089 514,383
Minority interest 401
Stockholders' equity 19,581 24,598
--------- --------
Total liabilities and stockholders' equity $ 561,670 $538,981
========= ========
Net interest income; interest rate spread(5) $ 6,081 1.06% $ 4,924 0.79%
======= ==== ======= ====
Net interest margin (5)(6) 1.12% 0.94%
==== ====
Average interest-earning assets
to average interest-bearing liabilities 101.14% 102.73%
====== ======
---------------------------------
1997
---------------------------------
Average Yield/
Balance Interest Rate
------------ --------- ----------
Interest-Earning Assets:
Interest-bearing deposits $ 22,727 $ 1,197 5.27%
Securities held for trading (2) 390,867 26,808 6.86%
Securities available for sale (3) 1,375 133 9.67%
Loans receivable, net (4) 78,545 6,087 7.75%
Federal Home Loan Bank stock 3,179 249 7.83%
-------- -------
Total interest-earning assets 496,693 34,474 6.94%
Non-interest-earning assets 10,714
Total assets $507,407
Interest-Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 4,697 124 2.64%
Savings accounts 20,463 844 4.12%
Money market deposit accounts 1,886 82 4.35%
Certificates of deposit 109,756 6,416 5.85%
-------- -------
Total deposits 136,802 7,466 5.46%
Securities sold under agreements
to repurchase 306,034 16,391 5.36%
Federal Home Loan Bank advances 26,089 1,644 6.30%
Note payable 10,168 907 8.92%
-------- -------
Total interest-bearing liabilities 479,093 26,408 5.51%
Non-interest bearing liabilities 4,307
Total liabilities 483,400
Minority interest
Stockholders' equity 24,007
--------
Total liabilities and stockholders' equity $507,407
========
Net interest income; interest rate spread(5) $ 8,066 1.43%
======= ====
Net interest margin (5)(6) 1.62%
====
Average interest-earning assets
to average interest-bearing liabilities 103.67%
======
- ----------------------
(1) At June 30, 1999, the yields earned and rates paid were as follows:
interest-bearing deposits, 5.05%; securities held for trading, 6.28%;
securities avaliable for sale, 7.95%; loans receivable, net 7.06%; FHLB
stock, 8.00%; total interest-earning assets, 6.72%; deposits, 4.80%;
securities sold under agreements to repurchase, 4.85%; FHLB advances
6.25%; note payable, 7.81%; total interest-bearing liabilities, 5.03%;
interest rate spread 1.69%.
(2) Both the interest and yields earned on the Company's securities portfolio
reflect the net interest expense incurred with respect to various
interest rate contracts (such as interest rate swaps, collars, caps,
floors, options and futures) which were utilized to hedge the Company's
interest rate exposure. During the years ended June 30, 1999, 1998 and
1997, the net costs of hedging the Company's interest rate exposure with
respect to its securities held for trading amounted to $580,000 or 0.39%,
$1.5 million or 0.77% and $730,000 or 0.37%, respectively.
(3) The average balance reflects the carrying value of available for sale
investments net of the average valuation allowance related to a single
non-agency participation certificate of $114,000, $155,000 and $276,000
for the years ended June 30, 1999, 1998 and 1997 respectively.
(4) Net of deferred loan fees, loan discounts and undisbursed loan funds.
Includes nonaccrual loans. Interest on nonaccrual loans is recorded when
received.
(5) Excluding the costs of hedging the Company's interest rate exposure
(which has effectively reduced the yields earned on the Company's
securities portfolio), the Company's interest rate spread amounted to
1.17%, 1.07% and 1.58%, and the Company's net interest margin amounted to
1.23%, 1.22% and 1.77% for the years ended June 30, 1999, 1998 and 1997,
respectively.
(6) Net interest margin is net interest income divided by average
interest-earning assets.
24
Rate/Volume Analysis. The following table describes the extent to which changes
in interest rates and changes in volume of interest-related assets and
liabilities have affected the Company's interest income and interest expense
during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in volume (change in volume multiplied by prior year rate), (2)
changes in rate (change in rate multiplied by prior year volume), and (3) total
change in rate and volume. The combined effect of changes in both rate and
volume has been allocated in proportion to the absolute dollar amounts of the
changes due to rate and volume.
Years Ended June 30,
-----------------------------------------------------------------------
1998 vs. 1997 1998 vs. 1997
---------------------------------- ------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
-------------------- Increase ----------------- Increase
Rate Volume (Decrease) Rate Volume (Decrease)
---- ------ ---------- ---- ------ ----------
(dollars in thousands)
Interest-earning assets:
Interest-bearing deposits $ (125) $ (57) $ (182) $ 36 $ (441) $ (405)
Securities held for trading and securities
available for sale (615) (5,253) (5,868) (2,593) (310) (2,903)
Loans receivable, net (342) 7,641 7,299 (230) 2,877 2,647
Federal Home Loan Bank stock (3) 2 (1) 8 135 143
------- ------- ------- ------- ------- -------
Total interest-earning assets $(1,085) $ 2,333 1,248 $(2,779) $ 2,261 (518)
======= ======= ------- ======= ======= -------
Interest-bearing liabilities:
NOW and DDA accounts $ (7) $ 147 140 $ (10) $ 52 42
Savings accounts (36) 224 188 44 203 247
Money market deposit accounts 4 3,415 3,419 7 38 45
Certificates of deposit (205) 2,255 2,050 71 432 503
------- ------- ------- ------- ------- -------
Total deposits (244) 6,041 5,797 112 725 837
Securities sold under agreements to repurchase (755) (5,717) (6,472) 772 742 1,514
Federal Home Loan Bank advances 43 595 638 108 91 199
Note payable (63) 191 128 (29) 103 74
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities $(1,019) $ 1,110 91 $ 963 $ 1,661 2,624
======= ======= ------- ======= ======= -------
Increase (decrease) in net interest income $ 1,157 $(3,142)
======= =======
Interest Income. For the year ended June 30, 1999, Harrington's interest income
increased by $1.2 million or 3.7% to $35.2 million, compared to the year ended
June 30, 1998. This increase was primarily due to a $7.3 million increase in
interest income from the loan portfolio. This increase was partially offset by a
$5.9 million decrease in interest income on the Company's investment portfolio
including the increase in the net interest expense on interest rate contracts
maintained in the trading portfolio. The increase in interest income on the loan
portfolio was a direct result of the $106.2 million increase in the level of the
average loan portfolio which was partially offset by a 29 basis point decline in
the interest yield earned caused primarily by an overall decline in the level of
interest rates during fiscal 1999. The decrease in interest income from the
investment portfolio was a result of the $86.8 million decrease in the average
balances as well as the 15 basis point decline in the level of interest rates
during fiscal 1999.
For the year ended June 30, 1998, Harrington's interest income decreased by
$518,000 or 1.5% to $34.0 million, compared to the year ended June 30, 1997.
This decrease was primarily due to a $2.9 million decrease in interest income on
the Company's investment portfolio including the increase in the net interest
expense on interest rate contracts maintained in the trading portfolio. This
decrease was partially offset by a $2.6 million increase in interest income from
the loan portfolio. The 67 basis point decline in interest income from the
investment portfolio was largely a result of the Company's shifting of assets to
low initial rate GNMA one-year adjustable rate mortgage securities and the
shifting of the portfolio's fixed rate mortgage investments to lower coupons
with lower accounting yields but higher option adjusted spreads. The increase in
interest income on the loan portfolio was a direct result of the $38.4 million
increase in the level of the average loan portfolio which was partially offset
by a 28 basis point decline in the interest yield earned caused primarily by an
overall decline in the level of interest rates during fiscal 1998.
25
Interest Expense. For the year ended June 30, 1999, Harrington's interest
expense increased by $91,000 or 0.3% to $29.1 million, compared to the year
ended June 30, 1998. This increase was primarily due to a $26.2 million increase
in the level of average interest-bearing liabilities, which was offset by a 26
basis point decrease in the cost of interest-bearing liabilities.
For the year ended June 30, 1998, Harrington's interest expense increased by
$2.6 million or 9.9% to $29.0 million, compared to the year ended June 30, 1997.
This increase was primarily due to a $31.1 million increase in the level of
average interest-bearing liabilities and an 18 basis point increase in the cost
of interest-bearing liabilities resulting mainly from an increase in the funding
costs for securities sold under agreements to repurchase.
Net Interest Income. Net interest income increased by $1.2 million or 23.5% to
$6.1 million during fiscal year 1999 as compared to fiscal year 1998. For the
year ended June 30, 1998, Harrington's net interest income amounted to $4.9
million, compared to $8.1 million for the year ended June 30, 1997.
Provision for Loan Losses. The provision for loan losses is charged to earnings
to bring the total allowance to a level considered appropriate by management
based on the estimated net realizable value of the underlying collateral,
general economic conditions, particularly as they relate to the Company's market
areas, historical loan loss experience and other factors related to the
collectibility of the Company's loan portfolio. While management endeavors to
use the best information available in making its evaluations, future allowance
adjustments may be necessary if economic conditions change substantially from
the assumptions used in making the evaluations.
Harrington established provisions for loan losses of $511,000, $147,000 and
$92,000 during the years ended June 30, 1999, 1998 and 1997, respectively.
During such respective periods, loan charge-offs (net of recoveries) amounted to
$(1,000), $0 and $0, respectively. Although the Company's non-performing loans
remain low, given the growth in the mortgage loan portfolio and the initial
production of commercial related loans, the Company's analysis of loan reserve
requirements indicated that additional reserves were prudent. The allowance for
loan losses as a percentage of total loans was 0.3% and 0.2% at June 30, 1999
and 1998, respectively.
Other Income (Loss). Other income (loss) is comprised of two distinct
components: gains and losses on the Company's investment securities and hedging
instruments, and fee and other income from retail bank operations. Gains or
losses on investments and hedges which have been sold are reported as realized
gains or losses, and market value gains or losses on investments and hedges
which remain in the Company's portfolio are reported as unrealized gains or
losses.
Management's goal is to attempt to offset any change in the market value of its
securities portfolio with the change in the market value of the interest rate
risk management contracts and mortgage-backed derivative securities utilized by
the Company to hedge its interest rate exposure. In addition, management
attempts to produce an overall gain with respect to its securities portfolio
through the use of option-adjusted pricing analysis. The Company utilizes such
analysis to select securities with wider spreads for purchase and to select
securities to sell for a gain as spreads tighten (net of the gain or loss
recognized with respect to related interest rate contracts).
However, the use of mark-to-market accounting for the trading portfolio can
cause volatility in reported earnings due to short-term fluctuations in the
market value of the securities relative to that of the hedge instruments.
Harrington accepts this volatility and realizes that a major benefit of marking
assets to market is that it provides shareholders with more timely information
on the economic value of the Company's portfolio and it allows flexibility to
grow or reduce investments as opportunities allow.
The following table sets forth information regarding other income (loss) for the
periods shown.
Years Ended June 30, 1999 1998 1997
-------- --------- --------
(Dollars In Thousands)
Gain (loss) on sale of
securities held for trading $ 4,755 $ (775) $ (1,623)
Unrealized gain (loss) on
securities held for trading (6,402) (930) 2,117
Other (1) 433 295 239
-------- --------- --------
Total other income (loss) $ (1,214) $ (1,410) $ 733
======== ========= ========
(1) Consists primarily of loan servicing fees and late charges, checking
account fees, trust and investment management service fees, rental
income and other miscellaneous fees.
26
Total other income (loss) amounted to $(1.2) million for the year ended June 30,
1999. This total consisted of a net realized and unrealized loss of $1.6 million
on the trading portfolio, plus fee and other retail bank income of $433,000. The
loss on the trading portfolio, net of hedges, reflects only a portion of the
total income (loss) produced from this portfolio in fiscal 1999. Total income
from this portfolio consists of both interest income and net realized and
unrealized gains and losses on the investments and hedges.
The Company seeks to produce a positive spread between the total income of this
portfolio and one month LIBOR, the Company's marginal cost of borrowing. In the
fiscal years 1999, 1998, and 1997, this portfolio produced a net-hedged spread
to one-month LIBOR of 0.28%, 0.15% and 1.47%, respectively. Due to the market
uncertainty over Federal Reserve action, a glut of corporate debt issuance which
increased both financing and credit margins, and spreads of mortgage securities
to Treasury widening during fiscal year 1999, the hedge gains lagged the
realized and unrealized losses on securities. The Company's community banking
expansion is expected to reduce the reliance on investment returns over the
coming years, although the Company remains confident in its core competency in
mortgage investments.
Total other income (loss) amounted to $(1.4) million for the year ended June 30,
1998. This total consisted of a net realized and unrealized loss of $1.7 million
on the trading portfolio, plus fee and other retail bank income of $295,000. The
weaker investment performance of the Company's hedged mortgage securities
portfolio in fiscal year 1998 can be attributed to the low interest rate and
flat yield curve environment which, together with the associated prepayment
uncertainty, caused investors to demand a larger spread between the rates on
mortgage securities and comparable duration securities.
Total other income amounted to $733,000 for the year ended June 30, 1997. This
total consisted of a net realized and unrealized gain of $494,000 on the trading
portfolio, plus fee and other retail bank income of $239,000. The net gain in
fiscal 1997 can be attributed to such factors as opportunistic trades between
fixed and adjustable rate securities at favorable relative option adjusted
spreads, the general tightening of mortgage spreads to the related hedge
instruments, and the use of a higher mix of interest rate swaps to financial
futures in hedging that shifts a portion of hedge expense from the trading
portfolio gain to net interest income.
Other Expense. In order to enhance the Company's profitability, management
strives to maintain a favorable level of operating expenses relative to its peer
group. However, during fiscal years 1999 and 1998, the Company has accelerated
its investment spending in operating expenses to accomplish the business line
and facilities expansion in order to grow revenue in future years. The following
table sets forth certain information regarding other expense for the periods
shown.
Years Ended June 30, 1999 1998 1997
-------- -------- --------
(Dollars In Thousands)
Salaries and employee benefits $ 4,290 $ 3,295 $ 2,174
Premises and equipment 1,287 805 532
Special SAIF assessment 830
FDIC insurance premiums 125 86 180
Marketing 314 183 136
Computer services 509 243 165
Consulting fees 301 287 281
Other(1) 1,674 1,561 1,146
-------- -------- --------
Total other expense $ 8,500 $ 6,460 $ 5,444
======== ======== ========
(1) Consists primarily of costs relating to postage, forms and supplies,
professional fees, supervisory assessments and other miscellaneous
expenses.
The principal category of Harrington's other expense is salaries and employee
benefits, which increased by $995,000 or 30.2%, and $1.1 million or 51.6% during
fiscal 1999 and 1998, respectively. The major cause of these increases was the
continuing implementation of Harrington's community bank expansion strategy. A
total of seven new banking locations were opened since May 1994, with three
being opened in the third quarter of fiscal year 1998 and one in the first
quarter of fiscal year 1999, and the administrative support at the home office
was increased as well. In addition, new employees were hired in connection with
the growth in the Bank's mortgage lending operations and the development of the
Bank's commercial loan division.
27
Premises and equipment expense increased by $482,000 or 59.9% and $273,000 or
51.3% during fiscal 1999 and 1998, respectively. The increase in premises and
equipment expense during the periods was primarily due to the opening of new
branches during fiscal years 1999 and 1998.
Federal Deposit Insurance Corporation ("FDIC") premiums increased by $39,000 or
45.3% during fiscal year 1999 due to the increase in deposit size. During fiscal
1998, FDIC insurance premiums decreased $94,000 or 52.2% primarily due to the
decrease in the FDIC insurance rate which was offset by an increase in deposit
base. During the year ended June 30, 1997, all SAIF-insured financial
institutions were required to pay a special assessment to recapitalize that
fund. Harrington's special assessment, which was based on the Bank's level of
deposits at March 31, 1995, was $830,000. However, beginning January 1, 1997,
the Bank's FDIC insurance rate dropped from 23 basis points to 6 basis points on
its deposits.
Harrington incurred marketing expense of $314,000, $183,000 and $136,000 during
the years ended June 30, 1999, 1998 and 1997, respectively. The fluctuations in
marketing expense during the periods reflected the advertising costs associated
with the opening of the Bank's new branch offices during fiscal 1999 and 1998.
Computer services expense increased by $266,000 or 109.5% and $78,000 or 47.3%
during fiscal 1999 and 1998, respectively. Computer services expense relates to
the fees paid by Harrington to a third party who performs the Company's data
processing functions as well as to the third party servicer who performs the
back-office functions with respect to the Company's trust and investment
management services. The increase in expense for the years presented relates
primarily to the increase in the number of deposit and loan accounts held by
Harrington. In addition, during fiscal year 1999, the Company incurred
approximately $107,000 in non-recurring expense related to on-line system
conversions.
Harrington has contracted with Smith Breeden to provide investment advisory
services and interest rate risk analysis. Certain stockholders of the Company
are also principals of Smith Breeden. The consulting fees paid by Harrington to
Smith Breeden during the years ended June 30, 1999, 1998 and 1997, which are
based on the Company's asset size, amounted to $301,000, $287,000 and $281,000,
respectively.
Income Tax Provision. The Company received an income tax benefit of $1.6 million
during fiscal 1999 as compared to an income tax benefit of $1.2 million and
income tax expense of $1.3 million during the years ended June 30, 1998 and
1997, respectively. The Company's effective tax rate amounted to 39.7%, 39.9%
and 38.6% during the years ended June 30, 1999, 1998 and 1997, respectively.
Liquidity
- --------------------------------------------------------------------------------
The Bank is required under applicable federal regulations to maintain specified
levels of "liquid" investments as defined by the OTS. As of November 24, 1997,
the required level of such liquid investments was changed from 5% to 4% of
certain liabilities as defined by the OTS. In addition to the change in the
percentage of required level of liquid assets, the OTS also modified its
definition of investments that are considered liquid. As a result of this
change, the level of assets eligible for regulatory liquidity calculations
increased considerably.
The total eligible regulatory liquidity of the Bank was 16.65% at June 30, 1999,
as compared to 15.58% at June 30, 1998. At June 30, 1999, the Bank's liquid
assets as defined by the OTS totaled approximately $87.7 million, which was
$66.6 million in excess of the current OTS minimum requirement.
The Bank maintains liquid assets at a level believed adequate to support its
normal operations, including funding loans and paying deposit withdrawals. Cash
flow projections are regularly reviewed and updated to ensure that adequate
liquidity is maintained. Cash for these purposes is generated through the sale
or maturity of securities, the receipt of loan payments, and increases in
deposits and borrowings. While the level of loan and deposit activity is not
entirely under the control of the Bank, the sale of securities and increases in
borrowings are entirely at the Bank's discretion and thus provide a ready source
of cash when needed.
As a member of the FHLB System, the Bank may borrow from the FHLB of
Indianapolis. FHLB advances may be obtained on very short notice due to the
Bank's blanket collateral agreement with the FHLB. In addition, the Bank can
pledge securities for collateralized borrowings such as reverse repurchase
agreements and quickly obtain cash whenever needed. In the opinion of
management, Harrington has sufficient cash flow and borrowing capacity to meet
current and anticipated funding commitments.
The Bank's liquidity, represented by cash and cash equivalents, is a result of
its operating, investing and financing activities.
28
During the year ended June 30, 1999, there was a net decrease of $2.3 million in
cash and cash equivalents. The primary uses of cash during the year included
purchases of securities for the trading portfolio of $780.3 million, repayments
of borrowings including securities sold under agreements to repurchase and
Federal Home Loan Bank advances of $249.2 million and the change in loans
receivable of $96.9 million. Partially offsetting these uses of cash, the main
sources of cash during the fiscal year were $883.4 million in proceeds from
sales and maturities of securities held for trading, a $154.9 million net
increase in deposits and $83,000 from proceeds from Federal Home Loan Bank
advances.
Year 2000
- --------------------------------------------------------------------------------
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. The Company's computer
programs and those of third-party computer related providers may recognize a
date using "00" as the year 1900 rather than the year 2000. This situation could
result in system failures or miscalculations causing disruption of operations
that could affect the ability of the Company to operate effectively and service
customers.
I. THE COMPANY'S STATE OF READINESS
The Company has prepared for the Year 2000 by testing and evaluating both its
information technology (IT) and non-information technology systems. The Company
does not have any mission critical processes that are dependent on non-IT
systems. The non-IT systems, such as the telephone system, are currently Year
2000 compliant. The IT systems used by the Company have been extensively tested.
The components of the IT systems that were examined are: 1) personal computers
(PCs), hardware and software, 2) data service bureau, and 3) other service
providers.
The hardware and software on all the PCs used by the Company have been
inventoried and tested. The limited number of PCs and software that were not
Year 2000 compliant were replaced in the first quarter of calendar year 1999.
The Company converted its data service provider to the Vision platform supplied
by FISERV. The conversion was accomplished in April of 1999. FISERV provided the
Company with assurances and documentation that the Vision product was Year 2000
compliant. One hundred sixty (160) FISERV clients tested the Vision platform in
1998 and did not find any material Year 2000 problems. The Company conducted
tests in May 1999 on the Vision software system to confirm this compliance. The
tests performed by the Company did not find any problems related to the Year
2000.
Other service providers, such as the Company's financial advisors or the FHLB of
Indianapolis, are either Year 2000 compliant or are keeping the Company apprised
of their progress towards being Year 2000 compliant. As part of the Company's
Year 2000 compliance program, the Company will be monitoring the vendors'
progress toward compliance and, if necessary, testing systems to help ensure
compliance.
II. THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The limited number of PCs and software that were not Year 2000 compliant were
replaced in the first quarter of calendar year 1999. The cost of replacing these
machines and software was approximately $43,500 in capitalized fixed assets in
fiscal year 1999. The Company does not foresee any significant outlays related
to Year 2000 issues or readiness for the remainder of the 1999 calendar year.
III. THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES
The Company has established parameters and processes for management to identify
material customers, evaluate their preparedness, assess their credit risk and
implement controls to manage the risk arising from their failure to properly
address Year 2000 technology issues. The Company faces increased credit,
liquidity, or counterparty trading risk when customers encounter Year
2000-related problems. Customers that must be evaluated and monitored are those
that, if adversely impacted by Year 2000 technology issues, represent a
significant financial exposure to the Company in terms of either credit loss or
liquidity. The organizations that have been identified as material customers of
the Company are being monitored because of their reliance on technology for
their successful business operations.
Failure of borrowers, counterparties or servicers to address Year 2000 problems
may increase credit risk to the Company through the inability of these parties
to meet the terms of their contracts and make timely payments of principal and
interest to the Company. Liquidity risk may result if depositors, lenders or
counterparties experience Year 2000-related business disruption or operational
failures and are unable to provide funds or fulfill funding commitments to the
Company. Capital market counterparties, such as trading counterparties or
interest rate swap or interest rate cap/floor counterparties, provide
29
contracts that allow the Company to enter into forward commitments to purchase
or sell securities or to use hedges to reduce interest rate risk. Liquidity and
credit risk may result if capital market counterparties are unable to fulfill
contractual commitments due to operational problems caused by the Year 2000 date
change.
In those cases where the Company is not fully satisfied that its counterparties
will be Year 2000 ready, mitigating controls will be established such as early
termination agreements, additional collateral, netting arrangements, and
third-party payment arrangements or guarantees. In cases where the Company has a
high degree of uncertainty regarding a counterparty's ability to address its
Year 2000 problems, the Company will avoid all transactions with that
counterparty that mature on or after January 1, 2000 with liquidity, credit, or
settlement risk. The Company will not resume normal transaction activities until
the counterparty has demonstrated that it is prepared for the Year 2000.
IV. THE COMPANY'S CONTINGENCY PLAN
DATA SERVICE BUREAU
In the event, the data service bureau used by the Bank fails to operate
satisfactorily after the turn of the century, the Bank would be forced to
operate on a manual system until a conversion could be made to a different
service bureau or the existing service bureau corrects its problems. The Bank
would establish ledger cards for each customer account and would manually post
transactions to the cards each day. Transactions would also be batched and
manually posted to the general ledger. The ledger cards would be balanced to the
general ledger frequently to provide some assurance that the manual system is
functioning accurately.
The Bank would have to make some temporary changes in its product menu during
the time operating on a manual system. For instance, the Bank would probably
discontinue originating mortgage loans because of the complexities involved with
them. The Bank would also stop opening new checking accounts. The Bank might
have to convert its existing checking accounts to savings accounts (with
appropriate advance notice and disclosures to the customers) so that the Bank
could more efficiently process these accounts.
Undoubtedly, the Bank would experience significant deposit run-off were the Bank
to function in such a limited capacity for any length of time. However, the Bank
has a substantial mortgage-backed security portfolio which provides the Bank
with ready liquidity should the need arise to liquidate deposits.
INVESTMENT SECURITIES
The Company has received assurances that most major brokers with which it trades
are Year 2000 compliant. Some of the smaller regional brokers have yet to
provide these assurances. Beginning in November 1999, the Company will no longer
enter into any transactions with any brokers that are not Year 2000 compliant.
In this way, the Company will control its exposure to Year 2000 risks with these
brokers. After the turn of the millennium, the Company will carefully evaluate
regional brokers individually before resuming business with them.
Most of the Company's securities are in safekeeping at the FHLB of Indianapolis,
which has provided documentation to the Company that they are Year 2000
compliant. If any assets are pledged with brokers, the Company will verify well
before the end of 1999 that those brokers are already Year 2000 compliant and if
not, these assets will be pledged only with Year 2000 compliant brokers.
PERSONAL COMPUTERS
By the end of the first quarter of calendar year 1999, the Company had replaced
or upgraded all of its personal computers that failed Year 2000 compliance
tests. Thus, it is expected that the Company's PCs will be in compliance when
the century turns. The Company has previously tested the software used on its
PCs, and those software packages that did not properly handle the Year 2000 have
been replaced.
OTHER VENDORS AND SERVICE PROVIDERS
The Company is closely monitoring all of its other vendors and service providers
to determine if they will be Year 2000 compliant on a timely basis. As of June
1999, the majority of the vendors and service providers used by the Company had
provided the Company with assurances that they were or would be Year 2000
compliant by September 1999. The Company does not, at this time, believe that it
will have to replace any of its vendors or service providers. If the Company
does have to replace a vendor or service provider, it is possible that an
increased cost to the institution could result from this.
30
GENERAL
The costs of the project and the date on which the Company plans to complete the
Year 2000 compliance program are based on management's best estimates which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ materially from these estimates.
Inflation and Changing Prices
- --------------------------------------------------------------------------------
The Consolidated Financial Statements and related data presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars (except with respect to securities which are carried at
market value), without considering changes in the relative purchasing power of
money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
Recent Accounting Pronouncements
- --------------------------------------------------------------------------------
The Financial Accounting Standards Board has issued Statement No. 133, as
amended by Statement No. 137, that the Company will be required to adopt in
future periods. See Note 1 to the Consolidated Financial Statements for further
discussion of this pronouncement.
31
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share data)
June 30,
--------------------------
ASSETS 1999 1998
---------- ----------
Cash $ 1,414 $ 1,567
Interest-bearing deposits (Note 13) 8,087 10,212
---------- ----------
Total cash and cash equivalents 9,501 11,779
Securities held for trading - at fair value (amortized cost of
$188,130 and $289,137) (Notes 2, 8, 13) 183,200 290,609
Securities available for sale - at fair value (amortized cost of
$461 and $924) (Note 2) 502 922
Loans receivable (net of allowance for loan losses of
$868 and $360) (Note 3) 259,674 163,546
Interest receivable, net (Note 4) 2,340 2,318
Premises and equipment, net (Note 5) 6,499 5,614
Federal Home Loan Bank of Indianapolis stock - at cost 4,878 4,878
Deferred income taxes, net (Note 10) 596 240
Income taxes receivable (Note 10) 569 435
Other 3,580 4,056
---------- ----------
TOTAL ASSETS $ 471,339 $ 484,397
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits (Note 6) $ 333,245 $ 178,311
Securities sold under agreements to repurchase (Note 7) 60,198 240,396
Federal Home Loan Bank advances (Note 8) 40,000 26,000
Note payable (Note 9) 13,995 13,495
Interest payable on securities sold under agreements to repurchase (Note 7) 66 282
Other interest payable 1,925 1,596
Advance payments by borrowers for taxes and insurance 795 785
Accrued expenses payable and other liabilities 1,039 868
---------- ----------
Total liabilities 451,263 461,733
---------- ----------
COMMITMENTS AND CONTINGENCIES (Notes 13, 14, 16)
MINORITY INTEREST (Note 1) 937
---------- ----------
STOCKHOLDERS' EQUITY (Notes 1, 10, 11, 12, 16):
Preferred Stock ($1 par value) Authorized and unissued -
5,000,000 shares
Common Stock:
Voting ($.125 par value) Authorized - 10,000,000 shares,
Issued 3,399,938 shares,
Outstanding 3,205,382 and 3,275,886 shares 425 425
Additional paid-in capital 16,946 16,962
Treasury stock, 194,556 and 124,052 shares at cost (2,162) (1,467)
Accumulated other comprehensive income (loss), net of deferred tax
of $16 and $(1) 25 (1)
Retained earnings 3,905 6,745
---------- ----------
Total stockholders' equity 19,139 22,664
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 471,339 $ 484,397
========== ==========
See notes to consolidated financial statements.
32
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands except share data)
Years Ended June 30,
-------------------------------------------
1999 1998 1997
----------- ---------- ----------
INTEREST INCOME:
Securities held for trading $ 18,684 $ 25,426 $ 27,538
Net interest expense on interest rate contracts maintained in
the trading portfolio (Note 13) (580) (1,479) (730)
Securities available for sale 66 91 133
Loans receivable (Note 3) 16,033 8,734 6,087
Dividends on Federal Home Loan Bank of Indianapolis stock 391 392 249
Deposits 610 792 1,197
----------- ---------- ----------
35,204 33,956 34,474
----------- ---------- ----------
INTEREST EXPENSE:
Deposits (Notes 6, 13) 14,100 8,303 7,466
Federal Home Loan Bank advances (Note 8) 2,481 1,843 1,644
Securities sold under agreements to repurchase (Note 7) 11,433 17,905 16,391
Note payable (Note 9) 1,109 981 907
----------- ---------- ----------
29,123 29,032 26,408
----------- ---------- ----------
NET INTEREST INCOME 6,081 4,924 8,066
PROVISION FOR LOAN LOSSES (Note 3) 511 147 92
----------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,570 4,777 7,974
----------- ---------- ----------
OTHER INCOME (LOSS):
Gain (loss) on sale of securities held for trading (Notes 2, 13) 4,755 (775) (1,623)
Unrealized gain (loss) on securities held for trading (Notes 2, 13) (6,402) (930) 2,117
Other 433 295 239
----------- ---------- ----------
(1,214) (1,410) 733
----------- ---------- ----------
OTHER EXPENSE:
Salaries and employee benefits (Note 12) 4,290 3,295 2,174
Premises and equipment expense (Note 5) 1,287 805 532
SAIF assessment (Note 16) 830
FDIC insurance premiums 125 86 180
Marketing 314 183 136
Computer services 509 243 165
Consulting fees (Note 15) 301 287 281
Other 1,674 1,561 1,146
----------- ---------- ----------
8,500 6,460 5,444
----------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) AND
MINORITY INTEREST (4,144) (3,093) 3,263
INCOME TAX PROVISION (BENEFIT) (Note 10) (1,646) (1,234) 1,261
----------- ---------- ----------
NET INCOME (LOSS) BEFORE MINORITY INTEREST (2,498) (1,859) 2,002
MINORITY INTEREST 43
----------- ---------- ----------
NET INCOME (LOSS) $ (2,455) $ (1,859) $ 2,002
=========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE (Note 1) $ (0.76) $ (0.57) $ 0.61
=========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE (Note 1) $ (0.76) $ (0.57) $ 0.61
=========== ========== ==========
See notes to consolidated financial statements.
33
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands except share data)
Accumulated
Other
Shares Common Additional Treasury Comprehensive Retained
Outstanding Stock Paid-in Capital Stock Income (Loss) Earnings
----------- ----- --------------- ----- ------------- --------
BALANCES, JULY 1, 1996 3,256,738 $407 $ 15,623 $ (8) $ 7,095
Net income 2,002
Cash dividends declared on
common stock ($0.03 per share) (98)
Net change in unrealized gain
(loss) on securities available
for sale, net of deferred
tax of $(23) (27)
--------- ---- -------- ------- -------
BALANCES, JUNE 30, 1997 3,256,738 407 15,623 (35) 8,999
Stock options exercised
(Note 12) 143,200 18 1,056
Tax benefit from exercise of
non-qualified stock options 283
Net loss (1,859)
Cash dividends declared on
common stock ($0.12 per share) (395)
Purchase of treasury stock (124,052) $ (1,467)
Net change in unrealized gain
(loss) on securities available for
sale, net of deferred tax of $22 34
--------- ---- -------- -------- ------- -------
BALANCES, JUNE 30, 1998 3,275,886 425 16,962 (1,467) (1) 6,745
Net loss (2,455)
Cash dividends declared on
common stock ($0.12 per share) (385)
Purchase of treasury stock (78,178) (784)
Issuance of treasury stock 7,674 (16) 89
Net change in unrealized gain
(loss) on securities available for
sale, net of deferred tax of $17 26
--------- ---- -------- -------- ------- -------
BALANCES, JUNE 30, 1999 3,205,382 $425 $ 16,946 $ (2,162) $ 25 $ 3,905
========= ==== ======== ======== ======= =======
Total
Stockholders' Comprehensive
Equity Income (Loss)
------ -------------
BALANCES, JULY 1, 1996 $ 23,117
Net income 2002 $ 2,002
Cash dividends declared on
common stock ($0.03 per share) (98)
Net change in unrealized gain
(loss) on securities available
for sale, net of deferred
tax of $(23) (27) (27)
-------- -------
BALANCES, JUNE 30, 1997 24,994 $ 1,975
=======
Stock options exercised
(Note 12) 1,074
Tax benefit from exercise of
non-qualified stock options 283
Net loss (1,859) $(1,859)
Cash dividends declared on
common stock ($0.12 per share) (395)
Purchase of treasury stock (1,467)
Net change in unrealized gain
(loss) on securities available for
sale, net of deferred tax of $22 34 34
-------- -------
BALANCES, JUNE 30, 1998 22,664 $(1,825)
=======
Net loss (2,455) $(2,455)
Cash dividends declared on
common stock ($0.12 per share) (385)
Purchase of treasury stock (784)
Issuance of treasury stock 73
Net change in unrealized gain
(loss) on securities available for
sale, net of deferred tax of $17 26 26
-------- -------
BALANCES, JUNE 30, 1999 $ 19,139 $(2,429)
======== =======
See notes to consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended June 30,
-------------------------------------------
1999 1998 1997
----------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,455) $ (1,859) $ 2,002
Adjustments to reconcile net income (loss) to net
cash provided by (used) in operating activities:
Provision for loan losses 511 147 92
Depreciation 549 348 235
Premium and discount amortization on securities, net 2,624 1,434 1,925
(Gain) loss on sale of securities held for trading (4,755) 775 1,623
Unrealized (gain) loss on securities held for trading 6,402 930 (2,117)
Effect of minority interest 43
Purchases of securities held for trading (780,260) (657,211) (913,766)
(Increase) decrease in amounts due from brokers 11,308 (6,934)
Proceeds from maturities of securities held for trading 51,419 28,438 26,398
Proceeds from sales of securities held for trading 831,978 652,380 888,429
Deferred income tax provision and other (68) (980) 614
Net increase (decrease) in assets and liabilities 617 (1,815) (3,547)
----------- ---------- ----------
Net cash provided by (used in) operating activities 106,605 33,895 (5,046)
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Federal Home Loan Bank of Indianapolis stock (26) (2,207)
Proceeds from maturities of securities available for sale 446 259 879
Change in loans receivable, net (96,927) (69,885) (28,134)
Minority interest 894
Purchases of premises and equipment (1,436) (1,653) (1,554)
----------- ---------- ----------
Net cash used in investing activities (97,023) (71,305) (31,016)
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 154,934 42,136 1,032
Increase (decrease) in securities sold under agreements to
repurchase (180,198) (5,175) 26,504
Proceeds from Federal Home Loan Bank advances 83,000 99,000 3,300
Principal repayments on Federal Home Loan Bank advances (69,000) (99,000) (3,300)
Dividends paid on common stock (385) (395) (98)
Purchase of treasury stock (784) (1,467)
Other 573 4,574 997
----------- ---------- ----------
Net cash provided by (used in) financing activities (11,860) 39,673 28,435
----------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,278) 2,263 (7,627)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 11,779 9,516 17,143
----------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,501 $ 11,779 $ 9,516
=========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 28,682 $ 29,624 $ 25,434
Cash paid for income taxes 43 321 1,889
Noncash activities occurred consisting of a decrease in current and deferred
income tax payable and a corresponding increase in additional paid in capital
from the tax benefit from exercise of non-qualified stock options of $283 during
fiscal year 1998.
See notes to consolidated financial statements.
35
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Business of the Company - Harrington Financial Group, Inc. ("HFG" or the
"Company") is a savings and loan holding company incorporated on March 3, 1988
to acquire and hold all of the outstanding common stock of Harrington Bank, FSB
(the "Bank"), a federally chartered savings bank with principal offices in
Richmond, Indiana and seven full-service branch offices located in Carmel,
Fishers, Noblesville and Indianapolis, Indiana, and Mission, Kansas. The Company
also opened an additional branch in July of 1999 in Chapel Hill, North Carolina.
The Company is a growing community bank with a focus on the origination and
management of mortgage loans and securities. The Bank also operates a commercial
loan division for business customers and owns a 51% interest in Harrington
Wealth Management Company (HWM), which provides trust, investment management,
and custody services for individuals and institutions.
Basis of Presentation - The consolidated financial statements include the
accounts of HFG, the Bank and HWM. All significant intercompany accounts and
transactions have been eliminated.
In February 1999, the Company formed HWM. HWM is a strategic alliance between
the Bank (51% owner) and Los Padres Bank (49% owner), a federally chartered
savings bank located in California. The accompanying consolidated balance sheet
includes 100 percent of the assets and liabilities of HWM, and the ownership of
Los Padres Bank is recorded as "Minority interest." The results of operations
include 100 percent of the revenues and expenses of HWM from the date of
formation, and the ownership of Los Padres Bank is recorded as "Minority
interest" net of income taxes.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash and Cash Equivalents - All highly liquid investments with an original
maturity of three months or less are considered to be cash equivalents.
Securities Held for Trading and Available for Sale - The Company classifies its
securities in one of three categories and accounts for the investments as
follows:
o Debt securities that the Company has the positive intent and ability to hold
to maturity are classified as "securities held to maturity" and reported at
amortized cost.
o Debt and equity securities that are acquired and held principally for the
purpose of selling them in the near term with the objective of generating
economic profits on short-term differences in market characteristics are
classified as "securities held for trading" and reported at fair value, with
unrealized gains and losses included in earnings.
o Debt and equity securities not classified as either held to maturity or
trading securities are classified as "securities available for sale" and
reported at fair value, with unrealized gains and losses, after applicable
taxes, excluded from earnings and reported in a separate component of
stockholders' equity. Declines in the value of debt securities and
marketable equity securities that are considered to be other than temporary
are recorded as a permanent impairment of securities available for sale in
the statement of operations.
Premiums and discounts are amortized over the contractual lives of the related
securities using the level yield method. Purchases and sales of securities are
recorded in the balance sheet on the trade date. Gains and losses from security
sales or disposals are recognized as of the trade date in the statement of
operations for the period in which securities are sold or otherwise disposed of.
The Company also enters into forward contracts to purchase or sell securities
held for trading. Changes in the fair value of the forward contract are
recognized in earnings as they occur. Securities purchased or sold under a
forward contract are recorded at their fair values at the settlement date.
The Company's trading portfolio consists of mortgage-backed securities,
mortgage-backed security derivatives, equity securities and interest rate
contracts, which accordingly are carried at fair value. Realized and unrealized
changes in fair values are recognized in other income in the period in which the
changes occur. Interest income from trading activities is included in the
statement of operations as a component of net interest income.
36
The Company's available for sale portfolio consists of a non-agency
participation certificate and municipal bonds which were called during fiscal
year 1999.
Fair values of securities are based on quoted market prices or dealer quotes.
Where such quotes are not available, estimates of fair value of securities are
based upon a number of assumptions such as prepayments which may shorten the
life of such securities. Although prepayments of underlying mortgages depend on
many factors, including the type of mortgages, the coupon rate, the age of
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant determinant
of the rate of prepayments. While management endeavors to use the best
information available in determining prepayment assumptions, actual results
could differ from those assumptions.
Financial Instruments Held for Asset and Liability Management Purposes - The
Bank is party to a variety of interest rate contracts consisting of interest
rate futures, options, caps, swaps, floors and collars in the management of the
interest rate exposure of its trading portfolio. These financial instruments are
included in the trading portfolio and are reported at fair value with realized
and unrealized gains and losses on these instruments recognized in other income
(see Note 2).
The Bank entered into a floating-pay interest rate swap agreement as a means of
managing the interest rate exposure of certain inverse variable rate deposits.
The Bank also entered into fixed-pay interest rate swap agreements and interest
rate cap agreements to modify the interest rate sensitivity of a portion of the
Bank's short-term LIBOR correlated borrowings, which include short-term
deposits, securities sold under agreements to repurchase and the Federal Home
Loan Bank advances. The premiums paid to enter into such interest rate cap
agreements are included in other assets and are amortized using the
straight-line method over the related term of the agreements. These interest
rate agreements are accounted for under the accrual method. Under this method,
the differential to be paid or received on these interest rate agreements is
recognized over the lives of the agreements in interest expense. Changes in fair
value of interest rate swaps and of the interest rate caps accounted for under
the accrual method are not reflected in the accompanying financial statements.
Realized gains and losses on terminated interest rate swaps accounted for under
the accrual method are deferred as an adjustment to the carrying amount of the
designated instruments and amortized over the remaining original life of the
agreements. If the designated instruments are disposed of, the fair value of the
interest rate swap, interest rate cap or unamortized deferred gains or losses
are included in the determination of the gain or loss on the disposition of such
instruments. To qualify for such accounting, the floating-pay interest rate swap
is designated to the inverse variable rate deposits, and the fixed-pay interest
rate swaps and the interest rate caps are designated to a portion of the Bank's
short-term LIBOR correlated borrowings which include short-term deposits,
securities sold under agreements to repurchase and the Federal Home Loan Bank
advances.
Loans Receivable are carried at the principal amount outstanding, adjusted for
premiums or discounts which are amortized or accreted using a level-yield
method. SFAS No. 114 and No. 118, Accounting by Creditors for Impairment of a
Loan and Income Recognition and Disclosures, require that impaired loans be
measured based on the present value of future cash flows discounted at the
loan's effective interest rate or the fair value of the underlying collateral,
and specifies alternative methods for recognizing interest income on loans that
are impaired or for which there are credit concerns. For purposes of applying
these standards, impaired loans have been defined as all nonaccrual commercial
loans which have not been collectively evaluated for impairment. An impaired
loan is charged off by management as a loss when deemed uncollectible although
collection efforts continue and future recoveries may occur.
Discounts and premiums on purchased residential real estate loans are amortized
to income using the effective interest method over the remaining period to
contractual maturity.
Nonrefundable origination fees net of certain direct origination costs are
deferred and recognized, as a yield adjustment, over the life of the underlying
loan.
Allowance for Losses - A provision for estimated losses on loans is charged to
operations based upon management's evaluation of the potential losses. Such an
evaluation, which includes a review of all loans for which full collectibility
may not be reasonably assured, considers, among other matters, the estimated net
realizable value of the underlying collateral, as applicable, economic
conditions, historical loan loss experience and other factors that are
particularly susceptible to changes that could result in a material adjustment
in the near term. While management endeavors to use the best information
available in making its evaluations, future allowance adjustments may be
necessary if economic conditions change substantially from the assumptions used
in making the evaluations.
Interest Receivable - Interest income on securities and loans is accrued
according to the contractual terms of the underlying asset including interest
rate, basis and date of last payment. Income on derivatives of mortgage-backed
37
securities is recorded based on projected cash flows using the median of major
brokers' prepayment assumptions for the underlying securities. The Bank provides
an allowance for the loss of uncollected interest on loans which are more than
90 days past due. The allowance is established by a charge to interest income
equal to all interest previously accrued, and income is subsequently recognized
only to the extent that cash payments are received until, in management's
judgment, the borrower's ability to make periodic interest and principal
payments returns to normal, in which case the loan is returned to accrual
status.
Premises and Equipment are carried at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the estimated useful
lives ranging from 3 to 40 years. Maintenance and repairs are expensed as
incurred while major additions and improvements are capitalized. Gains and
losses on dispositions are included in current operations.
Federal Income Taxes - The Company and its wholly owned subsidiary, the Bank,
file a consolidated tax return. HWM will file a separate tax return, as the
total ownership of the company does not qualify for consolidated tax filing.
Deferred income tax assets and liabilities reflect the impact of temporary
differences between amounts of assets and liabilities for financial reporting
purposes and basis of such assets and liabilities as measured by tax laws and
regulations.
Earnings Per Share - Earnings per share of common stock is based on the weighted
average number of common shares outstanding during the year.
The Company adopted SFAS No. 128, Earnings per Share, for fiscal year 1998 with
all prior period earnings per share data restated. This statement established
new accounting standards for the calculation of basic earnings per share as well
as diluted earnings per share. The adoption of this statement did not have a
material effect on the Company's calculation of earnings per share. The
following is a reconciliation of the weighted average common shares for the
basic and diluted earnings per share computations:
Years Ended June 30, 1999 1998 1997
- ---------------------------------------------------- --------- ----------
Basic earnings per share:
Weighted average common shares 3,216,626 3,285,166 3,256,738
========= ========= =========
Diluted earnings per share:
Weighted average common shares 3,216,626 3,285,166 3,256,738
Dilutive effect of stock options (1) 24,876 42,214
--------- --------- ---------
Weighted average common and
incremental shares (2) 3,216,62 3,310,042 3,298,952
======== ========= =========
(1) The impact of stock options was not included due to the anti-dilutive
effect for the fiscal year ended June 30, 1999.
(2) The calculation for diluted earnings per share for the fiscal year ended
June 30, 1998 was based upon the weighted average common shares as the
effect of the stock options were anti-dilutive due to the net loss for the
year.
Comprehensive Income - The Company adopted SFAS No. 130, Comprehensive Income,
effective July 1, 1998. It requires that changes in the amounts of certain
items, including gains and losses on certain securities, be shown in the
financial statements. SFAS No. 130 does not require a specific format for the
financial statement in which comprehensive income is reported but does require
that an amount representing total comprehensive income be reported in that
statement. All prior year financial statements have been reclassified for
comparative purposes.
New Accounting Pronouncements - SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, was issued in June 1998 and amended by SFAS
No. 137, Accounting for Derivative Instruments and Hedging Activities-Deferral
of the Effective Date of SFAS 133. SFAS 133, as amended by SFAS 137, is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000. This statement establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as a fair value
hedge, a cash flow hedge, or a hedge of foreign currency exposure. The
accounting for changes in the fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the resulting
designation. Management is currently in the process of determining the effect of
the new standard on the financial statements.
Reclassifications of certain amounts in the 1998 and 1997 consolidated financial
statements have been made to conform to the 1999 presentation.
38
2. SECURITIES
- --------------------------------------------------------------------------------
The amortized cost and estimated fair values of securities held for trading and
securities available for sale are summarized as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 1999 Cost Gains Losses Value
- ------------------------------------------------------ ---------- ---------- ---------
(Dollars In Thousands)
Securities held for trading:
GNMA certificates $ 37,986 $ 315 $ 185 $ 38,116
FHLMC certificates 69,114 304 1,568 67,850
FNMA certificates 28,034 43 478 27,599
Commercial mortgage backed securities 34,896 1,088 33,808
Collateralized mortgage obligations 10,738 331 11,069
Residuals 205 21 226
Interest-only strips 818 1 442 377
Principal-only strips 403 103 506
Interest rate swaps 175 (175)
Interest rate collar 4 4
Interest rate caps 1,744 1,157 587
Interest rate floors 3,821 976 415 4,382
Options 298 92 62 328
Futures 1,611 (1,611)
Equity securities 69 65 134
-------- -------- --------- ---------
Totals $188,130 $ 2,251 $ 7,181 $ 183,200
======== ========= ========= =========
Securities available for sale:
Non-agency participation certificate $ 461 $ 41 $ 502
======== ========= ========= =========
The Bank's collateralized mortgage obligation (CMO) portfolio at June 30, 1999
consisted of three agency investments with an estimated remaining weighted
average life of 9.2 years.
39
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 1998 Cost Gains Losses Value
- ----------------------------------------------------- -------- --------- ---------
(Dollars In Thousands)
Securities held for trading:
GNMA certificates $142,951 $ 1,282 $ 14 $ 144,219
FHLMC certificates 50,555 808 134 51,229
FNMA certificates 57,252 1,000 8 58,244
Commercial mortgage backed securities 17,540 248 17,788
Non-agency participation certificates 1,884 33 42 1,875
Collateralized mortgage obligations 10,930 484 11,414
Residuals 309 55 364
Interest-only strips 1,118 5 605 518
Principal-only strips 599 119 718
Interest rate swaps 397 (397)
Interest rate collar 38 60 (22)
Interest rate caps 2,384 2,157 227
Interest rate floors 3,410 1,423 393 4,440
Options 68 19 37 50
Futures 257 (257)
Equity securities 99 100 199
-------- -------- --------- ---------
Totals $289,137 $ 5,576 $ 4,104 $ 290,609
======== ======== ========= =========
Securities available for sale:
Municipal bonds $ 319 $ 16 $ 335
Non-agency participation certificate 605 $ 18 587
-------- -------- --------- ---------
Totals $ 924 $ 16 $ 18 $ 922
======== ======== ========= =========
The Bank's collateralized mortgage obligation (CMO) portfolio at June 30, 1998
consisted of three agency investments with an estimated remaining weighted
average life of 7.5 years.
For a complete discussion of the Bank's Risk Management Activities, see Note 13.
The amortized cost and estimated fair values of securities by contractual
maturity are as follows:
Held for Trading Available for Sale
------------------------- -------------------------
Amortized Fair Amortized Fair
June 30, 1999 Cost Value Cost Value
- ------------------------------------------------------ --------- --------- ---------
(Dollars In Thousands)
Debt securities (due after 1 year through
5 years):
Mortgage-backed securities $170,030 $ 167,373
Non-agency participation certificates $ 461 $ 502
Collateralized mortgage obligations 10,738 11,069
Mortgage-backed derivatives 1,426 1,109
Interest rate contracts 5,867 3,515
Equity securities 69 134
-------- --------- --------- ---------
$188,130 $ 183,200 $ 461 $ 502
======== ========= ========= =========
Securities with a total amortized cost of $66,550,000 and $252,445,000 and a
total fair value of $65,572,000 and $255,568,000 were pledged at June 30, 1999
and 1998, respectively, to secure interest rate swaps and securities sold under
agreements to repurchase. As of June 30, 1999 and 1998, the Bank had a blanket
collateral agreement for the Federal Home Loan Bank advances instead of
utilizing specific securities as collateral.
40
Activities related to the sale of securities are summarized as follows:
June 30, 1999 1998 1997
- --------------------------------------------- --------- ---------
(Dollars In Thousands)
Proceeds from sales of securities
held for trading $ 831,978 $ 652,380 $ 888,429
Gross gains on sales of securities
held for trading 64,966 46,537 44,324
Gross losses on sales of securities
held for trading 60,218 47,312 45,947
Gross gains on sales of securities
available for sale 7
3. LOANS RECEIVABLE
- --------------------------------------------------------------------------------
Approximately 86% of the Bank's loans is to customers located in the immediate
market areas of its offices in Richmond and Indianapolis, Indiana as well as
Mission, Kansas and Chapel Hill, North Carolina. The portfolio consists
primarily of owner occupied single family residential mortgages.
Loans receivable are summarized as follows:
June 30, 1999 1998
- ----------------------------------------------------------- ---------
(Dollars In Thousands)
Loans secured by one to four family residences:
Real estate mortgage $ 216,402 $ 154,148
Participation loans purchased 109 188
Commercial 33,778 4,723
Property improvement 2,119 1,248
Loans on savings accounts 426 221
Consumer and home equity lines of credit 3,324 2,288
Automobile loans 2,811 13
Other consumer loans 369 240
--------- ---------
Subtotal 259,338 163,069
Unamortized push-down accounting adjustment (54) (113)
Undisbursed loan proceeds (2) (6)
Net deferred loan fees, premiums and discounts 1,260 956
Allowance for loan losses (868) (360)
--------- ---------
Loans receivable, net $ 259,674 $ 163,546
========= =========
The principal balance of loans on nonaccrual status totaled approximately
$76,000 and $285,000 at June 30, 1999 and 1998, respectively. For the years
ended June 30, 1999, 1998 and 1997, gross interest income which would have been
recorded had the Bank's nonaccruing loans been current with their original terms
amounted to $1,000, $15,000, and $6,000, respectively. At June 30, 1999 and June
30, 1998, the Company had no impaired loans.
The Bank had commitments to originate or purchase loans consisting primarily of
real estate mortgages secured by one to four family residences approximating
$1,589,000 and $11,863,000 excluding undisbursed portions of loans in-process at
June 30, 1999 and 1998, respectively. In addition, as of June 30, 1999, the Bank
had commitments to fund approximately $5,125,000 in commercial loans secured
primarily by commercial real estate.
The Bank has granted loans to its directors, officers, employees and an
affiliate (Smith Breeden Associates, Inc., see Note 15). Such loans were made in
the ordinary course of business at the Bank's normal credit terms, including
interest rate and collateralization and do not represent more than the normal
risk of collection. These loans to related parties are summarized as follows:
June 30, 1999 1998
- ----------------------------------------------------------- ---------
(Dollars In Thousands)
Beginning balance $ 1,927 $ 228
Loans made 2,969 1,716
Principal repayments (189) (17)
Change due to status of officers and employees (192)
--------- ---------
Ending balance $ 4,515 $ 1,927
========= =========
41
The amount of loans serviced for others totaled $2,020,000, $3,411,000, and
$4,657,000 at June 30, 1999, 1998 and 1997, respectively. Servicing loans for
others generally consists of collecting mortgage payments, maintaining escrow
amounts, disbursing payments to investors and foreclosure processing. In
connection with loans serviced for others, the Bank held borrowers' escrow
balances of $16,000 and $27,000 at June 30, 1999 and 1998, respectively.
Loan servicing fee income included in other income for the years ended June 30,
1999, 1998 and 1997 was $10,000, $15,000 and $19,000, respectively.
An analysis of the allowance for loan losses is as follows:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------- --------- ---------
(Dollars In Thousands)
Beginning balance $ 360 $ 213 $ 120
Provision for loan losses 509 147 93
Recoveries (1)
--------- --------- ---------
Ending balance $ 868 $ 360 $ 213
========= ========= =========
As a federally chartered savings bank, aggregate commercial real estate loans
may not exceed 400% of capital as determined under the capital standards
provisions of FIRREA. This limitation was approximately $127 and $133 million at
June 30, 1999 and 1998, respectively. Also under FIRREA, the loans-to-one
borrower limitation is generally 15% of unimpaired capital and surplus which,
for the Bank, was approximately $5 million at June 30, 1999 and 1998. The Bank
was in compliance with all of these requirements at June 30, 1999 and 1998.
4. INTEREST RECEIVABLE
- --------------------------------------------------------------------------------
Interest receivable is summarized as follows:
June 30, 1999 1998
- ---------------------------------------------------------------- --------
(Dollars In Thousands)
Loans (less allowance for uncollectibles - $1 and $15) $1,375 $ 744
Interest-bearing deposits 18 2
Securities held for trading 943 1,543
Securities available for sale 4 29
--------- ---------
Interest receivable, net $ 2,340 $ 2,318
========= =========
5. PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
Premises and equipment are summarized as follows:
June 30, 1999 1998
- ----------------------------------------------------------- ---------
(Dollars In Thousands)
Land $ 1,003 $ 1,003
Buildings and leasehold improvements 4,672 4,422
Furniture, fixtures and equipment 2,857 1,673
--------- ---------
Total 8,532 7,098
Less accumulated depreciation (2,033) (1,484)
--------- ---------
Premises and equipment, net $ 6,499 $ 5,614
========= =========
Depreciation expense included in operations during the years ended June 30,
1999, 1998 and 1997 totaled $551,000, $348,000, and $235,000 respectively.
42
6. DEPOSITS
- --------------------------------------------------------------------------------
June 30, 1999 1998
- ---------------------------------------------------------------------- -------------------------
(Dollars in Thousands) Weighted Weighted
Amount Average Rate Amount Average Rate
------ ------------ ------ ------------
NOW and DDA accounts $ 16,911 2.35% $ 8,202 2.39%
Savings accounts 33,163 4.12 26,688 4.36
Money market deposit accounts 137,463 4.89 7,093 4.42
-------- ---------
187,537 41,983
-------- ---------
Certificates of deposit:
1 year and less 126,592 113,237
1 to 2 years 9,543 13,169
2 to 3 years 4,730 3,570
3 to 4 years 2,867 3,198
Over 4 years 1,976 3,154
-------- ---------
145,708 5.16 136,328 5.96
-------- ---------
Total deposits $333,245 $ 178,311
======== =========
Certificates of deposit in the amount of $100,000 or more totaled approximately
$31 million and $25 million at June 30, 1999 and 1998, respectively.
A summary of certificate accounts by scheduled fiscal year maturities at June
30, 1999, is as follows:
2000 2001 2002 2003 2004 Thereafter Total
- -------------------------------- ------- ------ ------- ------ ---------- --------
(Dollars In Thousands)
3.00% or less $ 4 $ 4 $ 8
3.01%-5.00% 81,554 $ 3,594 $ 467 $ 612 $ 358 26 86,611
5.01%-7.00% 43,809 5,148 2,177 1,603 996 416 54,149
7.01%-9.00% 1,216 127 1,311 652 100 76 3,482
9.01% or greater 9 674 775 1,458
-------- ------- ------ ------- ------- ------- --------
Totals $126,592 $ 9,543 $4,730 $ 2,867 $ 1,454 $ 522 $145,708
======== ======= ====== ======= ======= ======= ========
Interest expense on deposits is as follows:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------- --------- ---------
(Dollars In Thousands)
NOW and DDA accounts $ 306 $ 166 $ 124
Savings accounts 1,279 1,091 844
Money market deposit accounts 3,546 127 82
Certificates of deposit 8,969 6,919 6,416
--------- --------- ---------
$ 14,100 $ 8,303 $ 7,466
========= ========= =========
Interest expense on certificates of deposit is net of interest income on
interest rate contracts of $31,000, $70,000, and $130,000 for the years ended
June 30, 1999, 1998 and 1997, respectively.
For a complete discussion of the Bank's Risk Management Activities, see Note 13.
43
7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
- --------------------------------------------------------------------------------
June 30, 1999 1998
- ----------------------------------------------------------- ---------
(Dollars In Thousands)
Securities sold under agreements to repurchase:
Same securities $ 43,323 $ 240,396
Substantially identical securities 16,875
--------- ---------
$ 60,198 $ 240,396
========= =========
Accrued interest on securities sold under
agreements to repurchase $ 66 $ 282
========= =========
At June 30, 1999, securities sold under agreements to repurchase mature within
one month.
An analysis of securities sold under agreements to repurchase, excluding related
accrued interest, is as follows:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------- --------- ---------
(Dollars In Thousands)
Maximum amount outstanding
at any month-end $ 334,160 $ 342,094 $ 343,427
Daily average amount outstanding 213,428 319,579 306,034
Weighted average interest rate at
end of year 4.85% 5.65% 5.47%
Assets pledged to secure securities sold under agreements to repurchase are
concentrated among three dealers and five business customers and six dealers as
of June 30, 1999 and 1998, respectively. The Bank exercises control over the
securities pledged when the same security is repurchased. Assets pledged are as
follows:
June 30, 1999 1998
- ----------------------------------------------------------- ---------
(Dollars In Thousands)
Mortgage-backed securities:
At amortized cost $ 63,158 $ 245,510
At fair value 62,191 248,537
An analysis of the amount at risk under repurchase agreements with
counterparties exceeding 10% of stockholders' equity at June 30, 1999 is as
follows:
Weighted
Average
Amount Accrued Maturity
Outstanding Interest (in days)
- ---------------------------------------------- --------- --------
(Dollars In Thousands)
Federal Home Loan
Mortgage Corporation $ 30,723 $ 64 9
Salomon Smith Barney, Inc. 16,875 14
BB&T Capital Markets 11,150 2 14
========= =========
$ 58,748 $ 66
========= =========
8. FEDERAL HOME LOAN BANK ADVANCES
- --------------------------------------------------------------------------------
Advances from the Federal Home Loan Bank of Indianapolis are as follows:
June 30, 1999 1998
- -------------------------------------------------------------------------- -----------------------------
(Dollars in Thousands) Variable Weighted Variable Weighted
Amount Average Rate Amount Average Rate
------ ------------ ------ ------------
Fiscal Year Maturity:
2000 $ 40,000 4.94%
1999 $ 26,000 5.64%
As of June 30, 1999 and 1998, the Bank had a blanket collateral agreement for
the Federal Home Loan Bank advances instead of utilizing specific securities as
collateral.
44
9. NOTE PAYABLE
- --------------------------------------------------------------------------------
At June 30, 1999 and 1998, the Company maintained a $15,000,000 loan facility
from Mercantile Bancorporation, Inc. (formerly Mark Twain Bank) consisting of a
revolving line of credit of $5,000,000, of which $4,000,000 and $3,500,000 was
outstanding as of June 30, 1999 and 1998, respectively, and a $10,000,000 term
loan of which $5,000 had been repaid under the term loan at June 30, 1999 and
1998. Quarterly interest-only payments, based on the prime rate published in the
Wall Street Journal (7.75% at June 30, 1999), are payable through maturity of
June 2000. The unpaid principal balance outstanding is payable in full in June
2000.
As of June 30, 1999, the loan was secured by the Harrington Bank, FSB stock held
by HFG, a blanket security interest in all of the Company's assets and the
assignment of certain life insurance policies owned by HFG. Under the terms of
the agreement, the Company is bound by certain restrictive debt covenants. As of
June 30, 1999, HFG was in compliance with all such debt covenants.
10. INCOME TAXES
- --------------------------------------------------------------------------------
An analysis of the income tax provision (benefit) is as follows:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------- --------- ---------
(Dollars In Thousands)
Current:
Federal $ 7 $ 451
State 4 205
Deferred:
Federal $ (1,304) (989) 484
State (342) (256) 121
--------- --------- ---------
Total income tax provision
(benefit) $ (1,646) $ (1,234) $ 1,261
========= ========= =========
The difference between the financial statement provision (benefit) and amount
computed by using the statutory rate of 34% is reconciled as follows:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------------- --------- ---------
(Dollars In Thousands)
Federal statutory income tax at 34% $ (1,409) $ (1,052) $ 1,109
Tax exempt interest and dividends (7) (12) (14)
State income taxes, net of
federal tax benefit (226) (166) 185
Amortization of fair value adjustments (10) (1) (12)
Other, net 6 (3) (7)
--------- -------- ---------
Total income tax provision (benefit) $ (1,646) $ (1,234) $ 1,261
========= ======== =========
The Company's deferred income tax assets and liabilities are as follows:
June 30, 1999 1998
- ----------------------------------------------------------------- ---------
(Dollars In Thousands)
Deferred tax assets:
Net operating loss carryforward $ 1,164 $ 1,016
Tax benefit from exercise of non-qualified options 266
Bad debt reserves, net 293 15
Deferred compensation 18 24
Other 89 62
--------- ---------
1,564 1,383
--------- ---------
Deferred tax liabilities:
Unrealized gain on securities available for
sale included in accumulated other
comprehensive income 16
Unrealized gain on securities held for trading 634 793
Differences in income recognition on investments 306 350
Other 12
--------- ---------
968 1,143
--------- ---------
Deferred income taxes, net $ 596 $ 240
========= =========
45
As of June 30, 1999, $208,000 and $956,000 of the Company's net operating loss
carryforward expire in fiscal years 2018 and 2019, respectively.
Retained earnings at June 30, 1999 and 1998 includes approximately $3 million of
income that has not been subject to tax because of deductions for bad debts
allowed for federal income tax purposes. Deferred income taxes have not been
provided on such bad debt deductions since the Company does not intend to use
the accumulated bad debt deductions for purposes other than to absorb loan
losses. If, in the future, this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, federal income taxes may be
imposed on such amounts at the then current corporation income tax rate.
In August 1996, the "Small Business Job Protection Act of 1996" was passed into
law. One provision of the act repeals the special bad debt reserve method for
thrift institutions currently provided for in Section 593 of the IRC. The
provision requires thrifts to recapture any reserve accumulated after 1987 but
forgives taxes owed on reserves accumulated prior to 1988. The Bank delayed the
timing of this recapture for taxable years 1998 and 1997 as certain residential
loan test requirements were met. The six-year recovery period for the excess
reserves began in taxable year 1999. The adoption of the act did not have a
material adverse effect on the Company's consolidated financial position.
11. REGULATORY CAPITAL REQUIREMENTS
- --------------------------------------------------------------------------------
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures that have been established by regulation to ensure capital
adequacy require the Bank to maintain minimum capital amounts and ratios (set
forth in the table below). The Bank's primary regulatory agency, the OTS,
currently requires that the Bank maintain minimum ratios of tangible capital (as
defined in the regulations) of 1.5%, core capital (as defined) of 4%, and total
risk-based capital (as defined) of 8%. The Bank is also subject to prompt
corrective action capital requirement regulations set forth by the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC requires the Bank to maintain
minimum capital amounts and ratios of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of June 30,
1999, that the Bank meets all capital adequacy requirements to which it is
subject.
As of June 30, 1999 and 1998, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well capitalized" the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
46
To Be Categorized as
"Well Capitalized"
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
- --------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------- ------------------------ ----------------------
As of June 30, 1999:
Tangible capital (to total assets) $ 32,681 6.95% $ 7,049 1.50% N/A N/A
Core capital (to total assets) 32,681 6.95 18,797 4.00 N/A N/A
Total risk-based capital
(to risk weighted assets) 33,546 12.33 21,769 8.00 $ 27,211 10.00%
Tier I risk-based capital
(to risk weighted assets) 32,681 12.01 N/A N/A 16,327 6.00
Tier I leverage capital
(to average assets) 32,681 6.95 N/A N/A 23,497 5.00
-------- ---- -------- ---- -------- -----
As of June 30, 1998:
Tangible capital (to total assets) $ 33,240 6.88% $ 7,247 1.50% N/A N/A
Core capital (to total assets) 33,240 6.88 19,326 4.00 N/A N/A
Total risk-based capital
(to risk weighted assets) 33,596 21.92 12,262 8.00 $ 15,328 10.00%
Tier I risk-based capital
(to risk weighted assets) 33,240 21.69 N/A N/A 9,197 6.00
Tier I leverage capital
(to average assets) 33,240 6.88 N/A N/A 24,158 5.00
12. EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
Profit-sharing plan - The Company has a qualified noncontributory profit-sharing
plan for all eligible employees. The plan provides for contributions by the
Company in such amounts as its Board of Directors may annually determine.
Contributions charged to expense for the years ended June 30, 1999, 1998 and
1997 were $99,000, $87,000, and $85,000, respectively.
Stock options - The Company has granted stock options to existing stockholders,
officers, directors and other affiliated individuals to purchase shares of the
Company's stock at prices at least equal to the fair value of the stock on the
date of the grant. The options are nontransferable and are forfeited upon
termination of employment, as applicable. At June 30, 1999, all outstanding
stock options were exercisable through May 2009. The following is an analysis of
stock option activity for each of the three years in the period ended June 30,
1999 and the stock options outstanding at the end of the respective years:
Years ended June 30, 1999 1998 1997
- ------------------------------------------------------- ----------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
(Dollars In Thousands)
Outstanding, beginning
of fiscal year 60,000 $11.33 176,450 $ 8.08 155,700 $ 7.70
Granted 43,000 9.52 31,950 12.11 21,000 10.89
Exercised (143,200) 7.50
Forfeited or expired (800) 10.00 (5,200) 11.25 (250) 10.00
------- ------ ------ ------ ------- --------
Outstanding, end of fiscal year 102,200 $10.57 60,000 $11.33 176,450 $ 8.08
======= ====== ====== ====== ======= ========
Options exercisable at end
of fiscal year 20,290 $10.98 8,310 $10.42 2,500 $ 10.00
======= ====== ====== ====== ======= ========
As of June 30, 1999, options outstanding have exercise prices between $8.125 and
$12.50 and a weighted average remaining contractual life of 8.7 years.
The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for the options;
accordingly, since the grant price of the stock options is at least 100% of the
fair value at the date of the grant no compensation expense has been recognized
by the Company in connection with the option grants. Had compensation cost for
the plans been determined based on the fair value at the grant dates for awards
under the plan
47
consistent with the fair value method of SFAS No. 123, Accounting for
Stock-Based Compensation, the Company's net income (loss) per share would have
decreased to the pro forma amounts indicated below:
Years Ended June 30, 1999 1998 1997
- --------------------------------------------- -------- ---------
(Dollars in thousands,
except per share data)
Net income (loss):
As reported $ (2,455) $ (1,859) $ 2,002
Pro forma $ (2,482) $ (1,875) $ 1,995
Basic earnings (loss) per share:
As reported $ (0.76) $ (0.57) $ 0.61
Pro forma $ (0.77) $ (0.57) $ 0.61
Diluted earnings (loss) per share:
As reported $ (0.76) $ (0.57) $ 0.61
Pro forma $ (0.77) $ (0.57) $ 0.60
The weighted average fair value of options granted was $1.69, $3.72 and $3.42 in
fiscal years 1999, 1998 and 1997, respectively. The fair value of the option
grants is estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions: dividend yields ranging from 0% to 1.60%,
risk-free interest rates ranging from 4.38% to 6.62%, expected volatilities
ranging from 15.80% to 27.25% and expected lives of five years. The pro forma
amounts are not representative of the effects on reported net income for future
years.
Employee Stock Ownership Plan - The Company has an Employee Stock Ownership Plan
(ESOP) for all eligible employees of the Company, the Bank and HWM. Employees
who have been credited with at least 1,000 hours of service during a
twelve-month period are eligible to participate in the ESOP. During the 1999
fiscal year, the ESOP purchased 22,674 shares at prices ranging from $8.06 to
$9.63 per share. Of these purchases, 6,947 shares have been allocated to
eligible employees. During the 1997 fiscal year, the ESOP purchased 5,000 shares
at $10.25 per share, which have been allocated to eligible employees.
Contributions are allocated to eligible employees based on their eligible
compensation as defined in the ESOP Agreement. Gross compensation expense (i.e.
the value of shares contributed or committed to be contributed to the ESOP by
the Company) for fiscal years 1999, 1998 and 1997 was $121,000, $73,000 and
$51,000, respectively.
13. RISK MANAGEMENT ACTIVITIES
- --------------------------------------------------------------------------------
The Bank closely monitors the sensitivity of its balance sheet and income
statement to potential changes in the interest rate environment. Derivative
financial instruments such as interest rate swaps, caps, floors, collars,
futures, and options are used on an aggregate basis to protect the trading
portfolio and certain liabilities from adverse rate movements. The Bank's
objective, with regard to managing interest rate risk, is to maintain at an
acceptably low level the sensitivity to rising or falling rates of its market
value of portfolio equity.
Interest rate swaps are contracts in which the parties agree to exchange fixed
and floating rate payments for a specified period of time on a specified
(notional) amount. The notional amount is only used to calculate the amount of
the periodic interest payments to be exchanged, and does not represent the
amount at risk. The Bank uses swaps to modify the effective duration of various
assets and liabilities. The floating rates are generally indexed to the
three-month London Interbank Offered Rates (LIBOR).
Interest rate caps and floors are instruments in which the writer (seller)
agrees to pay the holder (purchaser) the amount that an agreed-upon index is
above or below the specified cap or floor rate, respectively, times the notional
amount. In return for this promise of future payments, the purchaser pays a
premium to the seller. The notional amount is never exchanged between the two
parties and does not represent the amount at risk. The Bank purchases interest
rate caps and floors to reduce the impact of rising or falling interest rates on
the market value of its trading portfolio. The interest rate caps and floors
generally have indexes equal to one or three month LIBOR, except for one
interest rate cap which is tied to the five year Constant Maturity Treasury.
The Bank is a party to an interest rate collar which also is used to manage
interest rate risk in the trading portfolio. The interest rate collar consists
of an interest rate cap held by the Bank and an interest rate floor written by
the Bank. The notional amount of the interest rate collar is based on the
balance in the collection accounts of certain Merrill Lynch collateralized
mortgage obligation trusts.
48
Interest rate futures contracts are commitments to either purchase or sell
designated instruments at a future date for a specified price. Initial margin
requirements are met in cash or other instruments, and changes in the contract
values are settled in cash daily. The Bank enters into futures contracts when
these instruments are economically advantageous to interest rate swaps, caps and
floors. The Bank uses primarily Eurodollar contracts which are structured in
calendar quarter increments and therefore result in a much larger notional
amount than longer maturity swap, cap or floor contracts which represent a
series of quarterly repricings.
Financial options are contracts which grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer a specified
financial instrument under agreed-upon terms. Financial options to buy or sell
securities are typically traded in standardized contracts on organized
exchanges. The Bank purchases financial options to reduce the risk of the
written financial options embedded in mortgage related assets.
Cash restrictions - The Bank maintained $2,298,000 and $2,100,000 at June 30,
1999 and 1998, respectively, in U.S. Treasury Securities, which are considered
cash equivalents, as a deposit with a broker for its futures activities.
Credit risk - The Bank is dedicated to managing credit risks associated with
hedging activities. The Bank maintains trading positions with a variety of
counterparties or obligors (counterparties). To limit credit exposure arising
from such transactions, the Bank evaluates the credit standing of
counterparties, establishes limits for the total exposure to any one
counterparty, monitors exposure against the established limits and monitors
trading portfolio composition to manage concentrations. In addition, the Bank
maintains qualifying netting agreements with its counterparties and records
gains and losses on derivative financial instruments net in the trading
portfolio.
The Bank's exposure to credit risk from derivative financial instruments is
represented by the fair value of instruments. Credit risk amounts represent the
replacement cost the Bank could incur should counterparties with contracts in a
gain position completely fail to perform under the terms of those contracts and
any collateral underlying the contracts proves to be of no value to the Bank.
Counterparties are subject to the credit approval and credit monitoring policies
and procedures of the Bank. Certain instruments require the Bank or the
counterparty to maintain collateral for all or part of the exposure. Limits for
exposure to any particular counterparty are established and monitored. Notional
or contract amounts indicate the total volume of transactions and significantly
exceed the amount of the Bank's credit or market risk associated with these
instruments.
The following positions are included in the Bank's trading portfolio and are
thus reported in the financial statements at current fair value.
Contract Estimated
or Notional Fair Value Weighted Average Interest Rate
- --------------------------------- -------------------- -----------------------------------------
June 30, 1999 Amount Asset Liability Payable Receivable Cap Floor
- --------------------------------- ------ --------- ------- ---------- ---- -----
(Dollars In Thousands)
Interest rate swaps:
Pay fixed rate $ 21,000 $ 175 6.34% 5.17% N/A N/A
Interest rate caps 133,000 $ 587 N/A N/A 7.92% N/A
Interest rate floors 245,000 4,382 N/A N/A N/A 6.11%
Interest rate collar 587 4 N/A N/A 10.25 5.25
Futures 2,699,700 1,611 N/A N/A N/A N/A
Options 33,000 328 N/A N/A N/A N/A
----------- ------ -------
$ 3,132,287 $ 5,301 $ 1,786
=========== ======= =======
Contract Estimated
or Notional Fair Value Weighted Average Interest Rate
- --------------------------------- -------------------- -----------------------------------------
June 30, 1998 Amount Asset Liability Payable Receivable Cap Floor
- --------------------------------- ----- --------- ------- ---------- ---- ------
(Dollars In Thousands)
Interest rate swaps:
Pay fixed rate $ 121,000 $ 397 6.16% 5.67% N/A N/A
Interest rate caps 133,000 $ 227 N/A N/A 7.92% N/A
Interest rate floors 250,000 4,440 N/A N/A N/A 6.25%
Interest rate collar 3,076 22 N/A N/A 10.25 5.25
Futures 2,780,300 257 N/A N/A N/A N/A
Options 66,000 50 N/A N/A N/A N/A
----------- ------- -------
$ 3,353,376 $ 4,717 $ 676
=========== ======= =======
49
Year Ended June 30, 1999 1998
- --------------------------------------------------------------------- -------------------------
(Dollars in Thousands) Monthly Average Monthly Average
Fair Value Fair Value
- --------------------------------------------------------------------- -------------------------
Asset Liability Asset Liability
- ----------------------------------------------------- --------- --------- ----------
Interest rate swaps:
Pay fixed rate $ 340 $ 376
Interest rate caps $ 280 $ 720
Interest rate floors 5,643 4,946
Interest rate collar 13 19
Futures 98 256
Options 411 125
-------- -------- --------- -------
$ 6,334 $ 451 $ 5,791 $ 651
======== ======== ========= =======
The following table shows the various components of the Company's recorded net
gain on its trading portfolio. All realized and unrealized gains and losses are
reported as other income in the statement of operations. The periodic exchanges
of interest payments and the amortization of premiums paid for contracts are
accounted for as adjustments to the yields, and are reported on the statements
of operations as interest income.
Realized Unrealized Net Trading
Year Ended June 30, 1999 Gains/(Losses) Gains/(Losses) Gains/(Losses)
- ----------------------------------------------- --------------- --------------
(Dollars In Thousands)
Interest rate contracts:
Swaps $ 13 $ 222 $ 235
Caps 1,000 1,000
Floors (469) (469)
Collar 60 60
Futures 4,591 (1,354) 3,237
Options 48 48
-------- -------- ---------
Total 4,604 (493) 4,111
MBS and other trading assets 144 (5,909) (5,765)
-------- -------- ---------
Total trading portfolio $ 4,748 $ (6,402) $ (1,654)
======== ======== =========
Realized Unrealized Net Trading
Year Ended June 30, 1998 Gains/(Losses) Gains/(Losses) Gains/(Losses)
- ----------------------------------------------- -------------- --------------
(Dollars In Thousands)
Interest rate contracts:
Swaps $ 13 $ (978) $ (965)
Caps (677) (677)
Floors 1,405 1,405
Collar (2) (2)
Futures (7,961) (613) (8,574)
Options 332 36 368
-------- -------- ---------
Total (7,616) (829) (8,445)
MBS and other trading assets 6,841 (101) 6,740
-------- -------- ---------
Total trading portfolio $ (775) $ (930) $ (1,705)
======== ======== =========
Realized Unrealized Net Trading
Year Ended June 30, 1997 Gains/(Losses) Gains/(Losses) Gains/(Losses)
- ------------------------------------------------ -------------- --------------
(Dollars In Thousands)
Interest rate contracts:
Swaps $ (39) $ (39)
Caps (862) (862)
Floors (810) (810)
Collar 32 32
Futures $ (5,045) 1,140 (3,905)
Options 114 (65) 49
-------- -------- ---------
Total (4,931) (604) (5,535)
MBS and other trading assets 3,308 2,721 6,029
-------- -------- ---------
Total trading portfolio $ (1,623) $ 2,117 $ 494
======== ======== =========
50
The following table sets forth the maturity distribution and weighted average
interest rates of financial instruments used on an aggregate basis to protect
the trading portfolio from adverse rate movements at June 30, 1999.
Maturities During Fiscal
Years Ending June 30, 2000 2001 2002 2003 2004 Thereafter
- -----------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Interest rate swaps-Pay fixed rate
Notional amount $ 16,000 $ 5,000
Weighted average payable rate 6.27% 6.58%
Weighted average receivable rate 5.23% 5.00%
Interest rate caps
Notional amount $ 37,000 $ 10,000 $ 66,000 $ 20,000
Weighted average cap rate 8.09% 6.50% 7.71% 9.00%
Interest rate floors
Notional amount $ 30,000 $ 70,000 $ 20,000 $ 60,000 $ 35,000 $ 30,000
Weighted average floor rate 6.50% 6.50% 6.00% 5.75% 5.79% 6.00%
Interest rate collar
Notional amount $ 587
Weighted average cap rate 10.25%
Weighted average floor rate 5.25%
Futures
Notional amount $1,019,700 $ 585,000 $513,000 $ 346,000 $124,000 $ 112,000
Options
Notional amount $ 18,000 $ 15,000
The following interest rate hedges are not included in the Bank's trading
portfolio. One of the interest rate swaps is used to modify the interest rate
sensitivity of certain certificates of deposit issued by the Bank. These
certificates of deposit, called inverse variable rate CDs, adjust according to a
formula in such a way as to pay a higher rate of interest when the index falls,
and a lower rate of interest when the index rises. As of June 30, 1999 and 1998,
the Bank held approximately $2.9 million and $5.2 million of inverse variable
rate CDs, with original terms to maturity ranging from three to ten years. The
Bank utilizes the interest rate swap to convert the inverse variable rate
certificates of deposit effectively to fixed rate deposits. The interest rate
swap protects the Bank against the exposure to falling interest rates inherent
in these CDs. As of June 30, 1999, the swap had a notional amount of $7.5
million.
In addition, the Bank also has interest rate swaps which are used to modify the
interest rate sensitivity of a portion of the Bank's short-term LIBOR correlated
borrowings, which include short-term deposits, securities sold under agreements
to repurchase and the Federal Home Loan Bank advances. As of June 30, 1999,
these swaps had a total notional amount of $50 million. The repricing
characteristics of the Bank's short-term borrowings are similar in nature to
those of the related interest rate swap instruments. The short term borrowings
reach their maturities before the maturities of the matched interest rate swaps;
however, it is the Bank's intent to consistently maintain such short term LIBOR
correlated borrowings in the normal course of business which will be designated
against these specific interest rate swaps.
The Bank also has interest rate caps which are used to effectively cap the
interest rates on its short-term LIBOR correlated borrowings. As of June 30,
1999 and 1998, the Bank held three 6% and one 7% interest rate caps which are
used to effectively cap the interest rates on a portion of the Company's
short-term LIBOR correlated borrowings, which include short-term deposits,
securities sold under agreements to repurchase and the Federal Home Loan Bank
advances. As of June 30, 1999 and 1998, the caps had a total notional amount of
$90 million and reprice based on the three month LIBOR. The repricing
characteristics of the Company's short-term borrowings are similar in nature to
those of the related interest rate cap agreements. The short-term borrowings
reach their maturities before the maturities of the matched interest rate caps;
however, it is the Bank's intent to replace the short-term borrowings when they
mature with additional short-term liabilities, which will be designated against
the interest rate caps.
51
The fair values of the following interest rate swaps and interest rate caps are
not reflected in the Company's financial statements. The periodic exchanges of
interest payments and the net expense of the interest rate caps are included in
interest expense in the statements of operations.
Contract Estimated
or Notional Fair Value Weighted Average Interest Rate
- --------------------------------- -------------------- -------------------------------
June 30, 1999 Amount Asset Liability Payable Receivable
- --------------------------------- ----- --------- ------- ----------
(Dollars In Thousands)
Interest rate swaps:
Pay floating rate $ 7,500 $ 60 5.25% 6.96%
Pay fixed rate 50,000 2,282 $ 41 5.76 5.14
Interest rate caps 90,000 4,387 N/A N/A
Contract Estimated
or Notional Fair Value Weighted Average Interest Rate
- --------------------------------- --------------------- --------------------------------
June 30, 1998 Amount Asset Liability Payable Receivable
- --------------------------------- ------ --------- ------- -----------
(Dollars In Thousands)
Interest rate swaps:
Pay floating rate $ 7,500 $ 137 5.74% 6.96%
Interest rate cap 90,000 2,495 N/A N/A
The following table sets forth the maturity distribution and weighted average
interest rates of the interest rate swap used to protect the inverse variable
rate CDs from adverse rate movements and the interest rate swaps and interest
rate caps used to cap a portion of the Bank's LIBOR correlated borrowings which
include short-term deposits, securities sold under agreements to repurchase and
the Federal Home Loan Bank advance as of June 30, 1999:
Maturities During Fiscal
Years Ending June 30, 2000 2001 2002 2003 2004 Thereafter
- -----------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Interest rate swaps-pay floating rate
Notional amount $ 7,500
Weighted average payable rate 5.25%
Weighted average receivable rate 6.96%
Interest rate swaps-pay fixed rate
Notional amount $ 5,000 $ 45,000
Weighted average payable rate 5.27% 5.81%
Weighted average receivable rate 5.00% 5.15%
Interest rate caps
Notional amount $ 30,000 $ 60,000
Weighted average cap rate 7.00% 6.00%
52
14. CREDIT COMMITMENTS
- --------------------------------------------------------------------------------
The Bank is a party to commitments to extend credit as part of its normal
business operations to meet the financing needs of its customers. These
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheet. Exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument for commitments to extend credit is represented by the contract
amount of those instruments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. Unless noted otherwise,
the Bank does not require collateral or other security to support financial
instruments with credit risk.
The following table sets forth the Bank's loan commitments whose contract
amounts represent credit risk and the applicable range of interest rates for
such loan commitments.
June 30, 1999 1998
- ------------------------------------------------------------------------- -------------------------
(Dollars in Thousands) Interest Interest
Amount Rates Amount Rates
- ----------------------------------------------------- ----------------- --------- -----------
One to four family real estate-fixed rate $ 1,589 6.75%-8.375% $ 11,863 6.75-10.00%
Commercial loans-fixed rate 450 Priced at closing
Commercial loans-adjustable rate 4,675 7.75%-8.75%
-------- ---------
$ 6,714 $ 11,863
======== =========
At June 30, 1999, the Company was obligated under noncancelable leases for
buildings. Several of these leases contain renewal options and escalation
clauses calling for rentals to be adjusted for increased real estate taxes and
other operating expenses or proportionately adjusted for increases in the
consumer price indices or other basis.
The following summary reflects the future minimum rental payments, by fiscal
year, required under operating leases that have remaining noncancelable lease
terms in excess of one year as of June 30, 1999:
Years Ended June 30,
- --------------------------------------------------------------------------
(Dollars in thousands)
2000 $ 330
2001 322
2002 306
2003 298
2004 277
2005 and thereafter 1,828
---------
Total minimum payments $ 3,361
=========
Rental expense under operating leases for fiscal years 1999, 1998 and 1997 was
$292,000, $100,000 and $70,000.
15. RELATED PARTY TRANSACTIONS
- --------------------------------------------------------------------------------
The Company has contracted with Smith Breeden Associates, Inc. ("SBA") to
provide investment advisory services and interest rate risk analysis. Certain
stockholders and directors of HFG are also principals of SBA. The amount of
consulting expense relating to SBA for fiscal years ending June 30, 1999, 1998
and 1997 was $301,000, $287,000 and $281,000 respectively. SBA has a commercial
loan outstanding with the Bank at June 30, 1999, see Note 3.
16. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
- --------------------------------------------------------------------------------
Liquidation account - On July 10, 1985, the Bank converted from a federally
chartered mutual association to a federally chartered stock association through
the issuance of 463,173 shares of common stock ($1 par value) at a price of $8
per share. From the proceeds, $463,000 was allocated to capital stock at the par
value of $1 per share and $2,919,000, which is net of conversion costs of
$324,000, was allocated to additional paid-in-capital.
The Bank established a special liquidation account (in memorandum form) in an
amount equal to its total retained earnings as of June 1, 1984 for the purpose
of granting to eligible savings account holders a priority in the event of
future liquidation. In the event of future liquidation of the converted
institution (and only in such event), an eligible account holder who continues
to maintain his savings account shall be entitled to receive a distribution from
the liquidation account. The total amount of the liquidation account will be
decreased in an amount proportionately corresponding to decreases in the savings
accounts of eligible account holders on each subsequent annual determination
date.
53
Dividend restrictions - Regulations provide that the Bank may not declare or pay
a cash dividend on or repurchase any of its stock if the result thereof would be
to reduce the consolidated stockholders' equity of the Bank below the amount
required for the liquidation account (as defined by regulations). Under the
capital distribution regulations of the OTS, the Bank, as a "Tier 1"
institution, is permitted to make capital distributions during a calendar year
up to one hundred percent of its net income to date from the current calendar
year plus the prior two calendar years. Under this limitation, as of June 30,
1999, the Bank would be required to file an application with the OTS for any
proposed capital distribution.
Reserve Requirements - As of June 30, 1999, the Bank was not required to
maintain reserve balances with the Federal Reserve Bank.
SAIF Assessment - On September 30, 1996, the President signed into law an
omnibus appropriations act for fiscal year 1997 that included, among other
things, the recapitalization of the Savings Association Insurance Fund (SAIF) in
a section entitled "The Deposit Insurance Funds Act of 1996" (the Act). The Act
included a provision where all insured depository institutions would be charged
a one-time special assessment on their SAIF assessable deposits as of March 31,
1995. The Company recorded a pre-tax charge of $830,000 during the year ended
June 30, 1997.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
The following disclosures of the estimated fair value of financial instruments
are made in accordance with the requirements of SFAS No. 107, Disclosures about
Fair Value of Financial Instruments:
June 30, 1999 1998
- -------------------------------------------------------------------- ------------------------
(Dollars in Thousands) Carrying Fair Carrying Fair
Value Value Value Value
- ----------------------------------------------------- --------- --------- --------
ASSETS:
Cash $ 1,414 $ 1,414 $ 1,567 $ 1,567
Interest-bearing deposits 8,087 8,087 10,212 10,212
Securities held for trading 183,200 183,200 290,609 290,609
Securities available for sale 502 502 922 922
Loans receivable, net 259,674 253,500 163,546 166,400
Interest receivable 2,340 2,340 2,318 2,318
Federal Home Loan Bank stock 4,878 4,878 4,878 4,878
LIABILITIES:
Deposits 333,245 330,300 178,311 178,400
Securities sold under agreements
to repurchase 60,198 60,200 240,396 240,400
Federal Home Loan Bank advances 40,000 40,000 26,000 26,000
Interest payable on securities sold
under agreements to repurchase 66 66 282 282
Other interest payable 1,925 1,925 1,596 1,596
Note payable 13,995 13,995 13,495 13,495
Advance payments by borrowers for
taxes and insurance 795 795 785 785
OFF BALANCE SHEET HEDGING
INSTRUMENTS:
Interest rate swaps 2,301 137
Interest rate caps 3,101 4,387 3,595 2,495
The estimated fair value amounts are determined by the Company, using available
market information and appropriate valuation methodologies. However,
considerable judgment is required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Cash, interest-bearing deposits, interest receivable and payable, advance
payments by borrowers for taxes and insurance and note payable - The carrying
amounts of these items are a reasonable estimate of their fair value.
54
Loans receivable - The fair value of loans receivable is estimated by
discounting future cash flows at market interest rates for loans of similar
terms and maturities, taking into consideration repricing characteristics and
prepayment risk.
Securities held for trading consist of mortgage-backed securities,
collateralized mortgage obligations, residuals, interest-only strips,
principal-only strips, interest rate swaps, an interest rate collar, interest
rate caps, interest rate floors, options, futures and equity securities. Fair
values are based on quoted market prices or dealer quotes. Where such quotes are
not available, fair value is estimated by using quoted market prices for similar
securities or by discounting future cash flows at a risk adjusted spread to
Treasury.
Federal Home Loan Bank stock - The fair value is estimated to be the carrying
value which is par. All transactions in the capital stock of the Federal Home
Loan Bank of Indianapolis are executed at par.
Deposits - The fair value of NOW, DDA, savings and money market deposit accounts
is the amount payable on demand at the reporting date. The fair value of fixed
maturity certificates is estimated using rates currently offered for deposits of
similar remaining maturities.
Securities sold under agreements to repurchase - Fair values are based on the
discounted value of contractual cash flows using dealer quoted rates for
agreements of similar terms and maturities.
Federal Home Loan Bank advances - The fair value is estimated by discounting
future cash flows using rates currently available to the bank for advances of
similar maturities.
Off balance sheet hedging instruments consist of interest rate swaps and
interest rate caps used to modify the interest rate sensitivity of certain
certificates of deposit and a portion of the Bank's LIBOR correlated short-term
borrowings, including short-term deposits, securities sold under agreements to
repurchase and the Federal Home Loan Bank advances. Fair values are based on
quoted market prices or dealer quotes. Where such quotes are not available, fair
value is estimated by using quoted market prices for similar securities or by
discounting future cash flows at a risk adjusted spread to Treasury.
Commitments - The estimated fair value of commitments to originate fixed-rate
loans is determined based on the fees currently charged to enter into similar
agreements and the difference between current levels of interest rates and the
committed rates. Based on that analysis, the estimated fair value of such
commitments is a reasonable estimate of the loan commitments at par.
The fair value estimates presented herein are based on information available to
management as of June 30, 1999 and 1998. Although management is not aware of any
factors that would significantly affect the estimated fair value amounts, such
amounts have not been comprehensively revalued for purposes of these
consolidated financial statements since such dates, and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
55
18. SEGMENT INFORMATION
- --------------------------------------------------------------------------------
The Company's principal business lines include community banking in the Indiana
and Kansas markets, investment activities, including treasury management, and
other activities including the start-up of the North Carolina community bank and
Harrington Wealth Management. The community banking segment provides a full
range of deposit products as well as mortgage, consumer and commercial loans.
The investment segment is comprised of the Company's held for trading and
available for sale securities, as well as the treasury management function.
Results of operations and asset information by operating segment are presented
below for the fiscal year ended June 30, 1999. No comparative segment
information is available for prior years. The financial information for each
operating segment is reported on the basis used internally by the Company's
management to evaluate performance and allocate resources.
The measurement of the performance of the operating segments is based on the
management and corporate structure of the Company and is not necessarily
comparable with similar information for any other financial institution. The
information presented is also not necessarily indicative of the segments' asset
size and results of operations if they were independent entities.
Year Ended COMMUNITY BANKING
--------------------------------------------------------------------------
June 30, 1999 Indiana Kansas INVESTMENTS OTHER TOTAL
- ------------- ------- ------ ----------- ----- -----
(Dollars In Thousands)
Net interest income (1) $ 3,826 $ 748 $ 1,504 $ 3 $ 6,081
Provision for loan losses 192 318 1 511
---------- --------- ---------- --------- -----------
Net interest income after
provision for loan losses 3,634 430 1,504 2 5,570
Other operating income 343 8 9 73 433
Depreciation expense 439 70 30 11 550
Other operating expense 5,129 1,244 955 622 7,950
---------- --------- ---------- --------- -----------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (1,591) (876) 528 (558) (2,497)
Realized and unrealized loss on
securities, net of hedging (10) (1) (1,636) (1,647)
---------- --------- ---------- --------- -----------
Loss before income taxes (1,601) (877) (1,108) (558) (4,144)
Applicable income taxes (636) (348) (441) (221) (1,646)
---------- --------- ---------- --------- -----------
NET LOSS BEFORE
MINORITY INTEREST (965) (529) (667) (337) (2,498)
Minority interest, net of taxes 43 43
---------- --------- ---------- --------- -----------
NET LOSS $ (965) $ (529) $ (667) $ (294) $ (2,455)
---------- --------- ---------- --------- -----------
Identifiable assets $ 219,607 $ 42,851 $ 198,672 $ 10,209 $ 471,339
========== ========= ========== ========= ===========
(1) Interest income is presented net of interest expense
56
19. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION (PARENT COMPANY ONLY)
- --------------------------------------------------------------------------------
The following condensed balance sheets as of June 30, 1999 and 1998, and
condensed statements of operations and cash flows for the three years in the
period ended June 30, 1999 for Harrington Financial Group, Inc. should be read
in conjunction with the consolidated financial statements and notes thereto.
June 30,
---------------------------
CONDENSED BALANCE SHEETS 1999 1998
- --------------------------------------------------------------------------------------------- -----------
(Dollars In Thousands)
ASSETS
Cash and cash equivalents $ 277 $ 1,944
Securities held for trading 134 199
Deferred income taxes, net 854 791
Income taxes receivable 143 23
Other assets 27 146
Intercompany receivable 107 5
Investment in subsidiary 31,769 33,240
---------- ----------
TOTAL ASSETS $ 33,311 $ 36,348
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable $ 13,995 $ 13,495
Accrued expenses payable and other liabilities 177 189
---------- ----------
Total liabilities 14,172 13,684
---------- ----------
Common stock 425 425
Additional paid-in capital 16,946 16,962
Treasury stock (2,162) (1,467)
Accumulated other comprehensive income (loss), net of taxes 25 (1)
Retained earnings 3,905 6,745
---------- ----------
Total stockholders' equity 19,139 22,664
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 33,311 $ 36,348
========== ==========
For the Years Ended June 30,
- -------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS 1999 1998 1997
- ------------------------------------------------------------------------------ ---------- ----------
(Dollars In Thousands)
Dividends from subsidiary $ 4,000
Interest income from securities held for trading $ 2 $ 6 76
Interest on deposits 3 18 8
Gain on sale of securities held for trading 21 94 12
Unrealized gain (loss) on securities held for trading (35) (59) 105
----------- ---------- ----------
Total income (loss) (9) 59 4,201
----------- ---------- ----------
Interest expense on long-term borrowings 1,109 981 907
Salaries and employee benefits 294 263 231
Other expenses 174 249 315
----------- ---------- ----------
Total expenses 1,577 1,493 1,453
----------- ---------- ----------
Income (loss) before equity in undistributed earnings (1,586) (1,434) 2,748
Income tax provision (benefit) (627) (566) (509)
Equity in undistributed earnings of subsidiary (1,496) (991) (1,255)
----------- ---------- ----------
Net income (loss) $ (2,455) $ (1,859) $ 2,002
=========== ========== ==========
57
For the Years Ended June 30,
-------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS 1999 1998 1997
- ------------------------------------------------------------------------------ ----------- -----------
(Dollars In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,455) $ (1,859) $ 2,002
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Net increase (decrease) in assets and liabilities (91) 123 174
Gain on sale of securities held for trading (21) (94) (12)
Unrealized gain (loss) on securities held for trading 35 59 (105)
Purchases of securities held for trading (2,000)
Proceeds from sales of securities held for trading 52 2,300 203
Deferred income tax provision (62) (588) 53
Decrease in undistributed earnings of subsidiary 1,471 991 1,255
----------- ---------- ----------
Net cash provided by (used in)
operating activities (1,071) (1,068) 3,570
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to subsidiary (3,200) (6,240)
----------- ---------- ----------
Net cash used in investing activities (3,200) (6,240)
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock options exercised 1,074
Proceeds from note payable 500 3,500 2,300
Principal repayments on note payable (1,303)
Dividends paid on common stock (385) (395) (98)
Purchase of treasury stock (784) (1,467)
Proceeds from issuance of treasury stock 73
----------- ---------- ----------
Net cash provided by (used in) financing activities (596) 2,712 899
----------- ---------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,667) (1,556) (1,771)
CASH AND CASH EQUIVALENTS,
Beginning of year 1,944 3,500 5,271
----------- ---------- ----------
CASH AND CASH EQUIVALENTS,
End of year $ 277 $ 1,944 $ 3,500
=========== ========== ==========
58
Independent Auditor's Report
Board of Directors and Stockholders
Harrington Financial Group, Inc.
Richmond, Indiana
We have audited the accompanying consolidated balance sheets of Harrington
Financial Group, Inc. and its subsidiary (the "Company") as of June 30, 1999 and
1998, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Harrington Financial Group, Inc.
and its subsidiary as of June 30, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1999 in conformity with generally accepted accounting principles.
/s/Deloitte & Touche LLP
Indianapolis, Indiana
July 27, 1999