UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-27940
HARRINGTON FINANCIAL GROUP, INC.
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(Exact name of registrant as specified in its charter)
Indiana 48-1050267
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(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification Number)
722 East Main
Richmond, Indiana 47374
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(Address of principal executive office) (Zip Code)
(765) 962-8531
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: As of November 10, 1999,
there were issued and outstanding 3,205,382 shares of the Registrant's Common
Stock, par value $.125 per share.
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
TABLE OF CONTENTS
Page
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Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1999
(unaudited) and June 30, 1999 1
Consolidated Statements of Operations (unaudited) for the three
months ended September 30, 1999 and 1998 2
Consolidated Statements of Cash Flows (unaudited) for the three
months ended September 30, 1999 and 1998 3
Notes to Unaudited Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Part II. Other Information
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Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security-Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(Dollars in Thousands)
(Unaudited)
September 30, June 30,
1999 1999
--------- ---------
ASSETS
Cash $ 2,357 $ 1,414
Interest-bearing deposits 13,002 8,087
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Total cash and cash equivalents 15,359 9,501
Securities held for trading - at fair value
(amortized cost of $200,890 and $188,130) 194,968 183,200
Securities available for sale - at fair value
(amortized cost of $1,426 and $461) 1,474 502
Securities held to maturity - at amortized cost 1,662 --
Loans receivable, net 265,754 259,674
Interest receivable, net 2,213 2,340
Premises and equipment, net 6,369 6,499
Federal Home Loan Bank of Indianapolis stock 4,879 4,878
Other 5,544 4,745
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Total assets $ 498,222 $ 471,339
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 342,832 $ 333,245
Securities sold under agreements to repurchase 77,745 60,198
Federal Home Loan Bank advances 40,000 40,000
Interest payable on securities sold under agreements to
repurchase 3 66
Other interest payable 2,399 1,925
Note payable 14,495 13,995
Advance payments by borrowers for taxes & insurance 1,307 795
Accrued expenses payable and other liabilities 1,018 1,039
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Total liabilities 479,799 451,263
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Minority interest 908 937
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Common stock 425 425
Additional paid-in-capital 16,946 16,946
Treasury stock, 194,556 shares at cost (2,162) (2,162)
Retained earnings 2,277 3,905
Accumulated other comprehensive income, net of taxes 29 25
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Total stockholders' equity 17,515 19,139
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Total liabilities and stockholders' equity $ 498,222 $ 471,339
========= =========
See notes to unaudited consolidated financial statements.
1
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Statements of Operations
(Dollars in Thousands Except Share Data)
(Unaudited)
Three Months Ended
September 30,
--------------------
1999 1998
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INTEREST INCOME
Securities held for trading $ 3,257 $ 5,768
Securities available for sale 11 20
Securities held to maturity 5 --
Loans receivable 4,740 3,196
Dividends on Federal Home Loan Bank stock 98 99
Deposits 172 117
Net interest expense on interest rate contracts
maintained in the trading portfolio (96) (282)
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Interest income 8,187 8,918
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INTEREST EXPENSE
Deposits 4,198 2,726
Federal Home Loan Bank advances 754 501
Short-term borrowings 961 4,454
Long-term borrowings 291 294
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Interest expense 6,204 7,975
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NET INTEREST INCOME 1,983 943
PROVISION FOR LOAN LOSSES 117 150
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NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,866 793
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OTHER INCOME (LOSS)
Loss on sale of securities held for trading (1,050) (9,240)
Unrealized gain (loss) on securities held for trading (992) 5,771
Other 140 100
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Total other income (loss) (1,902) (3,369)
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OTHER EXPENSE
Salaries and employee benefits 1,355 947
Premises and equipment expense 403 288
FDIC insurance premiums 47 26
Marketing 102 100
Computer services 142 82
Consulting fees 73 74
Other 399 397
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Total other expenses 2,521 1,914
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LOSS BEFORE INCOME TAX
PROVISION AND MINORITY INTEREST (2,557) (4,490)
INCOME TAX BENEFIT (997) (1,780)
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NET LOSS BEFORE MINORITY INTEREST (1,560) (2,710)
MINORITY INTEREST 29 --
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NET LOSS $(1,531) $(2,710)
======= =======
BASIC LOSS PER SHARE $ (0.48) $ (0.83)
======= =======
DILUTED LOSS PER SHARE $ (0.48) $ (0.83)
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See notes to unaudited consolidated financial statements.
2
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
Three Months Ended
September 30,
------------------------
1999 1998
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,531) $ (2,710)
Adjustments to reconcile net loss to net cash used
in operating activities:
Provision for loan losses 117 150
Depreciation 192 123
Premium and discount amortization of securities, net 687 400
Loss on sale of securities held for trading 1,050 9,240
Unrealized (gain) loss on securities held for trading 992 (5,771)
Purchases of securities held for trading (179,682) (189,265)
Proceeds from maturities of securities held for trading 5,730 10,076
Proceeds from sales of securities held for trading 159,455 117,984
Deferred income tax provision and other 1,040 (97)
Net decrease in assets and other liabilities (810) (1,737)
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Net cash used in operating activities (12,760) (61,607)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities held to maturity (1,662) --
Purchases of securities available for sale (980) --
Proceeds from maturities of securities available for sale (5) 13
Change in loans receivable, net (6,240) (25,395)
Minority interest 29 --
Purchases of premises and equipment (62) (469)
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Net cash used in investing activities (8,920) (25,851)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 9,587 32,101
Increase in securities sold under agreements to repurchase 17,547 52,074
Proceeds from Federal Home Loan Bank advances -- 13,000
Principal repayments on Federal Home Loan Bank advances -- (13,000)
Proceeds from note payable 500 --
Purchase of treasury stock -- (784)
Proceeds from issuance of treasury stock -- 73
Dividends paid on common stock (96) (98)
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Net cash provided by financing activities 27,538 83,366
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NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 5,858 (4,092)
CASH AND CASH EQUIVALENTS
Beginning of period 9,501 11,779
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CASH AND CASH EQUIVALENTS
End of period $ 15,359 $ 7,687
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid for interest $ 6,372 $ 8,440
Cash paid for income taxes 4 43
See notes to unaudited consolidated financial statements.
3
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
Note 1 - Business of the Company
-----------------------
Harrington Financial Group, Inc. (the "Company") is an
Indiana-chartered, registered thrift holding company incorporated in
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 eight full-service
banking offices, four of which were opened within the past three years.
The Company is a community bank with three distinct banking units in
Indiana, Kansas, and North Carolina. The Company's business includes the
gathering of deposits and the origination of mortgage related and
consumer loans. It 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 (see Note 2). The
Company manages a hedged mortgage investment portfolio, on a
mark-to-market basis, to utilize excess capital until it can be deployed
in community banking assets.
Earnings per Share
------------------
The following is a reconciliation of the weighted average common shares
for the basic and diluted earnings per share computations in accordance
with Statement of Accounting Standards (SFAS) No. 128:
Three Months Ended
September 30,
------------------------------
1999 1998
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Basic earnings per share:
Weighted average common shares 3,205,382 3,250,049
============== ==============
Diluted earnings per share:
Weighted average common shares 3,205,382 3,250,049
Dilutive effect of stock options (1) --- ---
-------------- --------------
Weighted average common and
incremental shares 3,205,382 3,250,049
============== ==============
(1) No dilutive effect of stock options for the three months ended
September 30, 1999 and 1998 was used in the calculation as the effects
of the stock options were anti-dilutive.
Note 2 - Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statements. However, such information reflects all adjustments
(consisting solely of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of results for
the interim periods.
4
The results of operations for the three months ended September 30, 1999
are not necessarily indicative of the results to be expected for the
year ending June 30, 2000. The unaudited consolidated financial
statements and notes thereto should be read in conjunction with the
audited financial statements and notes thereto for the year ended June
30, 1999.
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. HWM provides
trust and investment management services for individuals and
institutions. The accompanying unaudited consolidated balance sheets
include 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 for the three months ended September 30, 1999
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 taxes.
Note 3 - Recent Accounting Pronouncements
--------------------------------
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.
The following is a summary of the Company's total comprehensive income
(loss) for the interim three month periods ended September 30, 1999 and
1998 under SFAS No. 130:
Three Months Ended
September 30,
1999 1998
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Net loss $(1,531) $(2,710)
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Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period
4 13
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Other comprehensive income
4 13
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COMPREHENSIVE INCOME (LOSS) $(1,527) $(2,697)
======= =======
5
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, if
any, of the new standard on the financial statements.
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition
At September 30, 1999, the Company's total assets amounted to $498.2
million, as compared to $471.3 million at June 30, 1999. The $26.9 million or
5.7% increase in total assets during the three months ended September 30, 1999
was primarily the result of a $11.8 million increase in securities held for
trading, a $6.1 million increase in net loans receivable and a $5.9 million
increase in cash and cash equivalents. The increase in securities held for
trading is a result of the Company's utilization of available capital. The
increase in net loans receivable primarily reflected the Company's increase in
the origination of business loans through its commercial division. The increase
in the Company's assets from June 30, 1999 to September 30, 1999 was funded by a
$17.5 million increase in securities sold under agreements to repurchase and a
$9.6 million increase in deposits, which was primarily due to the retail deposit
growth from the new North Carolina banking unit.
Minority interest decreased by $29,000 to $908,000 at September 30,
1999. The financial statements as of and for the three month periods ended
September 30, 1999 include all of the assets, liabilities, and results of
operations for HWM. The minority interest represents the portion of the assets,
liabilities, and results of operations attributable to the ownership interest of
Los Padres Bank.
At September 30, 1999, the Company's stockholders' equity amounted to
$17.5 million, as compared to $19.1 million at June 30, 1999. The 8.5% decrease
in stockholders' equity was primarily due to the $1.5 million of net loss
recognized during the three month period and the quarterly $0.03 per share
payment of cash dividends totaling $96,000. At September 30, 1999, the Bank's
Tier 1 core capital amounted to $31.4 million or 6.3% of adjusted total assets,
which exceeded the minimum 4.0% requirement by $11.5 million. Additionally, as
of such date, the Bank's risk-based capital totaled $32.3 million or 11.8% of
total risk-adjusted assets, which exceeded the minimum 8.0% requirement by $10.4
million.
Results of Operations
General. The Company reported losses of $1.5 million or $0.48 per share
during the three months ended September 30, 1999, as compared to $2.7 million or
$0.83 per share during the prior comparable period. The $1.2 million decrease in
losses during the three months ended September 30, 1999, as compared to the same
period in the prior year, was primarily due to a $1.5 million decrease in
realized and unrealized net losses on securities held for trading and a $1.0
million increase in net interest income which were partially offset by a
$783,000 increase in the Company's income tax provision and a $607,000 increase
in operating expenses.
7
Selected Financial Ratios. The following schedule shows selected
financial ratios for the three months ended September 30, 1999 and 1998.
At or for the Three
Months Ended
September 30,
-------------------------------
1999 1998
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Return on average assets -1.24% -1.90%
Return on average equity -34.67 -50.70
Interest rate spread (1) 1.51 0.60
Net interest margin (2) 1.63 0.68
Operating expenses to average assets 2.04 1.34
Efficiency ratio (3) 125.66 214.33
Non-performing assets to total assets 0.16 0.16
Loan loss reserves to non-performing loans 328.73 188.19
- ------------------------------------
(1) Interest rate spread is the difference between interest income as a
percentage of interest-earning assets and interest expense as a percentage of
interest-bearing liabilities.
(2) Net interest margin is net interest income divided by average
interest-earning assets.
(3) The efficiency ratio is total other expense as a percentage of the net
interest income after provision for loan losses plus other income, excluding
gains and losses on securities held for trading.
Interest Income. Interest income decreased by $731,000 or 8.2% during
the three months ended September 30, 1999, as compared to the same period in the
prior year. This decrease was primarily due to a $2.5 million decrease in
interest from the investment portfolio which was partially offset by a $1.5
million increase in interest income from the loan portfolio. The decrease in
interest income from the Company's investment portfolio was mainly due to the
$159.9 million decrease in the level of the average investment portfolio. The
increase in interest income on the loan portfolio was mainly due to the $85.5
million increase in the level of the average loan portfolio.
Interest Expense. Interest expense decreased by $1.8 million during the
three months ended September 30, 1999, as compared to the same period in the
prior year. This decrease was primarily due to a 59 basis point decrease in the
cost of interest-bearing liabilities resulting from an overall decrease in the
wholesale and retail funding costs and a $73.8 million decrease in the level of
the average interest-bearing liabilities.
Net Interest Income. Net interest income increased by $1.0 million or
110.3% during the three months ended September 30, 1999, as compared to the same
period in the prior year.
Provision for Loan Losses. During the three months ended September 30,
1999 and 1998, the Company increased the general allowance for loan losses by
$117,000 and $150,000, respectively, in response to the continued loan growth.
Delinquencies and loan write-offs continue to be minimal, and the non-performing
assets remain stable.
Other Income (Loss). Total other loss amounted to $1.9 million during
the three months ended September 30, 1999, as compared to $3.4 million during
the respective period in the prior year. Other income (loss) principally
represents the net market value gain or loss (realized or
8
unrealized) on securities held for trading, offset by the net market value gain
or loss (realized or unrealized) on interest rate contracts used for hedging
such securities. Management's goal is to attempt to offset any change in the
fair value of its securities portfolio with the change in the fair 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 a positive hedged excess return (i.e.
total return, which includes interest income plus realized and unrealized net
gains/losses on investments minus the one month LIBOR funding cost for the
period) on the investment portfolio using option-adjusted pricing analysis.
During the three months ended September 30, 1999, the Company recognized
$814,000 of realized losses on the sale of securities held for trading, $236,000
realized losses on futures instruments and $992,000 of unrealized losses on
securities and hedges held for trading. The total net realized and unrealized
loss for the quarter was attributable to the spread widening between comparable
duration U.S. Treasury hedges and mortgage rates. This period's spread widening
was supply-driven, as issuance of corporate bonds was very heavy in the quarter
and financing spreads were put under pressure. Broker/dealers have also kept
their inventories low as they approach the end of the calendar year,
contributing to the pressure on spreads. Management anticipates that spreads may
remain volatile as the new millennium approaches.
During the three months ended September 30, 1998, the Company recognized
$10.0 million of realized losses on future instruments which was partially
offset by $5.8 million of unrealized gains on securities held for trading (which
include interest rate contracts used for hedging purposes) and $807,000 in
realized gains on the sale of securities held for trading. Losses on hedge
contracts during the quarter ended September 30, 1998 substantially exceeded
gains on mortgage investments as U.S. Treasury and mortgage rates declined to
the lowest level in many years and the spread relationship widened.
Other Expense. Total other expense amounted to $2.5 million during the
three months ended September 30, 1999, as compared to $1.9 million during the
respective period in the prior year. The increase in total other expense was due
to increases in salaries, premises and equipment expense, and other operating
expenses, which were primarily the result of the Company's retail growth
(including the opening of new branch offices in Mission, Kansas and Chapel Hill,
North Carolina).
Income Tax Benefit. The Company recorded an income tax benefit of
$997,000 during the three months ended September 30, 1999 as compared to $1.8
million during the respective period in the prior year.
Liquidity and Capital Resources
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments as defined by the Office of Thrift
Supervision ("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.
9
The total eligible regulatory liquidity of the Bank was 18.3% at
September 30, 1999, as compared to 16.7% and 15.6% at June 30, 1999 and 1998,
respectively. At September 30, 1999, the Bank's average "liquid" assets totaled
approximately $89.5 million, which was $70.0 million in excess of the current
OTS minimum requirement.
At September 30, 1999, the Company's total approved originated loan
commitments outstanding amounted to $7.8 million, and the unused lines of credit
outstanding totaled $11.1 million. At the same date, commitments outstanding to
purchase investment securities and loans were $33.0 million. Certificates of
deposit scheduled to mature in one year or less at September 30, 1999 totaled
$120.7 million. The Company believes that it has adequate resources to fund
ongoing commitments such as investment security and loan purchases as well as
deposit account withdrawals and loan commitments.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
In addition to historical information, forward-looking statements are
contained herein that are subject to risks and uncertainties that could cause
actual results to differ materially from those reflected in the forward-looking
statements. Factors that could cause future results to vary from current
expectations, include, but are not limited to, the impact of economic conditions
(both generally and more specifically in the markets in which the Company
operates), the impact of competition for the Company's customers from other
providers of financial services, the impact of government legislation and
regulation (which changes from time to time and over which the Company has no
control), and other risks detailed in this Form 10-Q and in the Company'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. The Company 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 the Company files
from time to time with the SEC.
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
10
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. Over 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, have provided the Company with materials that show
that they are Year 2000 compliant. As part of the Company's Year 2000 compliance
program, the Company has been monitoring the vendors' progress toward compliance
and, if necessary, has tested 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
11
to the Company. Capital market counterparties, such as trading counterparties or
interest rate swap or interest rate cap/floor counterparties, provide 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 the 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.
12
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 September 1999, the vendors and service providers used by the Company had
provided the Company with assurances that they were Year 2000 compliant. 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.
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.
The information contained within this document is intended to provide
general information regarding the efforts of the Company to address the Year
2000 computer problem and is not intended to be a formal or legally binding
representation as to Year 2000 compliance. Any assessment or proposed timetable
is subject to change without prior notice. This information constitutes a "Year
2000 Readiness Disclosure."
13
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 HWM (see Notes 1 and 2). 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, available for sale and held to maturity securities, as well as the
treasury management function. 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.
(Dollars in Thousands) Quarter Ended September 30, 1999
----------------------------------------------------------------------
COMMUNITY BANKING
------------------------
Indiana Kansas INVESTMENTS OTHER TOTAL
--------- --------- --------- --------- ---------
Net interest income (1) $ 878 $ (31) $ 1,432 $ (296) $ 1,983
Provision for loan losses 45 53 -- 19 117
--------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 833 (84) 1,432 (315) 1,866
Other operating income 112 8 1 19 140
Depreciation expense 133 23 12 25 193
Other operating expense 1,269 352 213 494 2,328
--------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (457) (451) 1,208 (815) (515)
Realized and unrealized loss on
securities, net of hedging -- -- (2,048) 6 (2,042)
--------- --------- --------- --------- ---------
Loss before income taxes (457) (451) (840) (809) (2,557)
Applicable income taxes (178) (175) (327) (317) (997)
--------- --------- --------- --------- ---------
NET LOSS BEFORE
MINORITY INTEREST (279) (276) (513) (492) (1,560)
Minority interest, net of taxes -- -- -- 29 29
--------- --------- --------- --------- ---------
NET LOSS $ (279) $ (276) $ (513) $ (463) $ (1,531)
========= ========= ========= ========= =========
Identifiable assets $ 220,555 $ 47,180 $ 217,884 $ 12,603 $ 498,222
========= ========= ========= ========= =========
(1) Interest income is presented net of interest expense
14
(Dollars in Thousands) Quarter Ended September 30, 1998
----------------------------------------------------------------------
COMMUNITY BANKING
------------------------
Indiana Kansas INVESTMENTS OTHER TOTAL
--------- --------- --------- --------- ---------
Net interest income (1) $ 728 $ 12 $ 217 $ (14) $ 943
Provision for loan losses 123 27 -- -- 150
--------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 605 (15) 217 (14) 793
Other operating income 75 1 2 22 100
Depreciation expense 101 12 6 4 123
Other operating expense 1,200 245 231 115 1,791
--------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (621) (271) (18) (111) (1,021)
Realized and unrealized loss on
securities, net of hedging (29) (3) (3,435) (2) (3,469)
--------- --------- --------- --------- ---------
Loss before income taxes (650) (274) (3,453) (113) (4,490)
Applicable income taxes (258) (108) (1,369) (45) (1,780)
--------- --------- --------- --------- ---------
NET LOSS $ (392) $ (166) $ (2,084) $ (68) $ (2,710)
========= ========= ========= ========= =========
Identifiable assets $ 184,585 $ 8,815 $ 365,057 $ 7,461 $ 565,918
========= ========= ========= ========= =========
(1) Interest income is presented net of interest expense
15
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The OTS requires each thrift institution to calculate the estimated
change in the institution's market value of portfolio equity (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. MVPE is defined as the
net present value of an institution's existing assets, liabilities and
off-balance sheet instruments. The OTS permits institutions to perform this MVPE
analysis using their own internal model based upon reasonable assumptions. The
Company has contracted with Smith Breeden Associates, Inc. for the provision of
consulting services regarding, among other things, the management of its
investments and borrowings, the pricing of loans and deposits, the use of
various financial instruments to reduce interest rate risk and assistance 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.
The following table sets forth at September 30, 1999, the estimated
sensitivity of the Bank's MVPE to parallel yield curve shifts using the
Company's internal market value calculation. This analysis incorporates an
option adjusted cashflow discount model for all financial assets and liabilities
other than fixed rate mortgages, loans, and securities. For these loans and
securities, the Company evaluates the market value changes using time varying
empirical (TVE) elasticity analysis. This analysis measures the market value
changes of the mortgage investment based on historical price relationships to
changes in Treasury rates and other variables. Management believes this
empirical based analysis is a valuable and more accurate tool in estimating the
level of net market value changes of the mortgage related investment and loan
portfolios with fixed rates and will be expanding it to other mortgage
instruments in the future.
The Company actively manages the interest rate risk of the balance sheet
and investment portfolio by dynamically rebalancing the hedges on a frequent
basis. This rebalancing is undertaken to further reduce the interest rate risk
for large rate changes. Since the following analysis is based on instantaneous
changes in rates, the benefits of the dynamic rebalancing process on interest
rate risk reduction are, therefore, not reflected in this analysis.
16
The table set forth below does not purport to show the impact of
interest rate changes on the Company'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.
Change in Interest Rates
(In Basis Points)(1)
(Dollars in Thousands) -300 -200 -100 - +100 +200 +300
- ----------------------------------------------------------------------------------------------------------------------------------
Market value gain (loss) of assets $ 37,194 $ 30,323 $ 17,545 -- $(21,010) $(43,243) $(64,715)
Market value gain (loss) of liabilities (7,568) (5,430) (2,946) -- 3,523 7,723 12,554
-------- -------- -------- --- -------- -------- --------
Market value gain (loss) of net
assets before interest rate contracts 29,626 24,893 14,599 -- (17,487) (35,520) (52,161)
Pre-tax market value gain (loss) of
interest rate contracts (34,860) (24,361) (12,914) -- 14,766 31,437 48,977
-------- -------- -------- --- -------- -------- --------
Total change in MVPE (2) (Model) $ (5,234) $ 532 $ 1,685 -- $ (2,721) $ (4,083) $ (3,184)
======== ======== ======== === ======== ======== ========
Change in MVPE as a percent of:
MVPE (2) (Model) (17.5)% 1.8% 5.6% -- (9.1)% (13.7)% (10.7)%
Total assets of the Bank (1.1)% 0.1% 0.3% -- (0.5)% (0.8)% (0.6)%
(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 September 30, 1999.
Since a portion of the Company'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, using the methodology
described above. 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 fair value.
Consequently, the Company'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)
(Dollars in Thousands) -300 -200 -100 - +100 +200 +300
- ----------------------------------------------------------------------------------------------------------------------------------
After tax market value gain (loss) $ 11,979 $ 9,221 $ 5,161 -- $ (6,063) $(12,746) $(19,424)
of assets
After tax market value gain (loss)
of interest rate contracts (11,919) (8,538) (4,629) -- 5,557 12,082 19,156
-------- -------- -------- --- -------- ------- --------
After tax gain (loss) in equity (Model) $ 60 $ 683 $ 532 -- $ (506) $ (664) $ (268)
======== ======== ======== === ======== ======= ========
After tax gain (loss) in equity as
a percent of the Company's equity
at September 30, 1999 0.3% 3.9% 3.0% -- 2.9% (3.8)% (1.5)%
17
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Part II
Item 1. Legal Proceedings
-----------------
Neither the Company nor the Bank is involved in any pending legal
proceedings other than non-material legal proceedings occurring
in the ordinary course of business.
Item 2. Changes in Securities
---------------------
Not applicable.
Item 3. Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security-Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
None.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibit 3.1: Amended and Restated Articles of
Incorporation of Harrington Financial Group, Inc. This
exhibit is incorporated herein by reference from the
Registration Statement on Form S-1 (Registration No.
333-1556) filed by the Company with the SEC on February
20, 1996, as amended.
b) Exhibit 3.2: Amended and Restated Bylaws of Harrington
Financial Group, Inc. This exhibit is incorporated herein
by reference from the Registration Statement on Form S-1
(Registration No. 333-1556) filed by the Company with the
SEC on February 20, 1996, as amended.
c) Exhibit 27: Financial Data Schedule
d) No Form 8-K reports were filed during the quarter.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARRINGTON FINANCIAL GROUP, INC.
Date: November 12, 1999 By: /s/ Craig J. Cerny
------------------
Craig J. Cerny
President
Date: November 12, 1999 By: /s/ John E. Fleener
-------------------
John E. Fleener
Principal Financial &
Accounting Officer
EXHIBIT 27
Financial Data Schedule