UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
Commission File No.: 0-19968
SOUTHWEST BANCSHARES, INC.
(exact name of registrant as specified in its charter)
DELAWARE 36-3811042
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
4062 Southwest Highway, Hometown, Illinois 60456
(Address of principal executive offices)
Registrant's telephone number, including area code: (708) 636-2700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting common stock held by non-
affiliates of the registrant, i.e., persons other than directors and executive
officers of the registrant, is $54,596,106 and is based upon the last sales
price as quoted on The Nasdaq Stock Market for February 25, 1998.
As of February 25, 1998, the Registrant had 2,720,285 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
None.
INDEX
PART I PAGE
Item 1. Business.......................................................... 1
Additional Item. Executive Officers of the Registrant..................... 31
Item 2. Properties........................................................ 31
Item 3. Legal Proceedings................................................. 31
Item 4. Submission of Matters to a Vote of Security Holders............... 31
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................... 31
Item 6. Selected Financial Data........................................... 32
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 35
Item 7A. Quantitive and Qualitative Disclosures About Market Risk.......... 48
Item 8. Financial Statements and Supplementary Data....................... 48
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 80
PART III
Item 10. Directors and Executive Officers of the Registrant................ 80
Item 11. Executive Compensation............................................ 83
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 86
Item 13. Certain Relationships and Related Transactions.................... 87
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 88
SIGNATURES................................................................. 90
PART I
Item 1. Business.
- -----------------
General
Southwest Bancshares, Inc. (also referred to as the "Company") was
incorporated under Delaware law on February 11, 1992. On June 11, 1992, the
Registrant acquired Southwest Federal Savings and Loan Association of Chicago
(the "Association" or "Southwest Federal") as a part of the Association's
conversion from a mutual to a stock federally chartered savings and loan
association. The Registrant is a savings and loan holding company and is
subject to regulation by the Office of Thrift Supervision (the "OTS"), the
Federal Deposit Insurance Corporation (the "FDIC") and the Securities and
Exchange Commission (the "SEC"). Currently, the Registrant does not transact
any material business other than through the Association, and Southwest
Bancshares Development Corporation. The Registrant retained 50% of the net
conversion proceeds amounting to $13.4 million which was invested in federal
funds and high-grade, marketable securities. At December 31, 1997, the Company
had total assets of $368.3 million and stockholders' equity of $44.0 million
(12.0% of total assets).
Southwest Federal has operated for over 114 years and was originally
organized in 1883 as an Illinois-chartered building and loan association. In
1937 it converted to a federally chartered and insured savings and loan
association. The Association is a member of the Federal Home Loan Bank (the
"FHLB") System and its deposit accounts are insured up to applicable limits by
the FDIC.
The Association's principal business has been and continues to be
attracting retail deposits from the general public and investing those deposits,
together with funds generated from operations, primarily in one- to four-family,
owner-occupied, fixed-rate loans, and to a lesser extent, multi-family
residential mortgage loans, commercial real estate loans, land and construction
loans, mortgage-backed securities and other short-term investments, including
U.S. Government and federal agency securities and other marketable securities.
The Association's revenues are derived principally from interest on its mortgage
loan and mortgage-backed securities portfolios and interest and dividends on its
investment securities. The Association's primary sources of funds are deposits,
principal and interest payments on loans and mortgage-backed securities and, to
a much lesser extent, FHLB-Chicago advances.
Southwest Bancshares Development Corporation, an Illinois corporation, was
incorporated on November 19, 1992, for the primary purpose of engaging in real
estate development projects as a joint venture partner.
On December 16, 1997, the Board of Directors of the Company approved a
definitive agreement to merge with Alliance Bancorp of Hinsdale, Illinois.
Pursuant to the merger agreement, which is subject to shareholder and regulatory
approval, each common share of the Company's common stock will be exchanged for
1.1981 shares of Alliance Bancorp common stock, subject to adjustment based on
the current value of Alliance Bancorp common stock at the effective date.
Concurrent with the execution of the definitive agreement, the Company granted
Alliance Bancorp an option to purchase an amount of shares equal to 9.9% of its
outstanding common stock, which option is exercisable in certain circumstances.
The transaction is expected to close prior to June 30, 1998.
Market Area
The Association has been, and continues to be, a community-oriented savings
institution offering a variety of financial sources to meet the needs in the
communities it serves. The Association's deposit-gathering area is concentrated
in the neighborhoods surrounding its six offices, one of which is located in
southwest Chicago with the five others located in the Chicago suburbs of Cicero,
Hometown, Oak Lawn and Orland Park, all in Cook County. The Association's
lending base primarily covers the same area and extends, to a lesser extent, to
Will and DuPage counties. The Association's home office is located in southwest
Chicago. Management believes that all of its branches are located in
communities that can generally be characterized as stable, residential
neighborhoods of predominately one- to four-family residences.
1
Lending Activities
Loan and Mortgage-Backed Securities Portfolio Compositions. The loan
portfolio consists primarily of conventional fixed-rate, first-mortgage loans
secured by one- to four-family residences and, to a lesser extent, multi-family
residences. At December 31, 1997, the total mortgage loans outstanding were
$271.6 million, of which $176.0 million were one- to four-family residential
mortgage loans, or 62.9% of the loan portfolio. At that same date, multi-family
residential mortgage loans totaled $51.2 million, or 18.3% of the loan
portfolio.
The remainder of the mortgage loans, which totaled $43.8 million, or 15.6%
of total loans outstanding at December 31, 1997, consisted of commercial real
estate loans which totaled $29.0 million, or 10.4% of the loan portfolio, land
loans which totaled $8.7 million, or 3.1% of the loan portfolio and construction
loans which totaled $6.0 million, or 2.2% of the loan portfolio. At
December 31, 1997, purchased mortgage loans totaled $9.6 million, or 3.4% of the
loan portfolio. All purchased mortgage loans were originated in the Chicago
metropolitan area, except for a participation loan in DeKalb, Illinois of
$849,000. Other loans held by the Association, which principally consist of line
of credit and share loans, totaled $8.9 million, or 3.2% of total loans
outstanding at December 31, 1997.
The Company and its subsidiaries also invest in mortgage-backed securities.
At December 31, 1997, the amortized cost and carrying (market) value of total
mortgage-backed securities aggregated $20.8 million and $20.9 million,
respectively, or 5.7% of total assets, of which 82.9% were backed by adjustable
rate mortgage ("ARM") loans and 17.1% were backed by fixed-rate loans. All of
the mortgage-backed securities at December 31, 1997 were insured or guaranteed
by either the Government National Mortgage Association ("GNMA"), Fannie Mae
("FNMA") or Freddie Mac ("FHLMC").
2
The following table sets forth the composition of the loan portfolio
and mortgage-backed securities portfolio of the Company and its subsidiaries in
dollar amounts and in percentages of the respective portfolios at the dates
indicated. Mortgage-backed securities are shown at amortized cost and not market
value. This table does not include unrealized gains on mortgage-backed
securities classified available for sale in the amount of $72,000 at December
31, 1997.
At December 31,
--------------------------------------------------------------------------------------
1997 1996 1995
------------------------ --------------------------- ------------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
----------- ----------- ------------- ------------ -------------- -------------
(Dollars in Thousands)
Mortgage loans:
One- to four-family ........................ $176,007 62.88% $167,303 61.14% $157,374 61.99%
Multi-family ............................... 51,248 18.31 50,504 18.46 48,453 19.08
Commercial real estate ..................... 28,957 10.35 26,534 9.70 24,075 9.48
Construction ............................... 6,044 2.16 11,409 4.16 7,216 2.84
Land ....................................... 8,702 3.10 10,558 3.86 15,560 6.13
-------- ------ -------- ------ -------- ------
Total mortgage loans ................. 270,958 96.80 266,308 97.32 252,678 99.52
Other loans .................................. 8,943 3.20 7,328 2.68 1,229 0.48
-------- ------ -------- ------ -------- ------
Total loans receivable ............... 279,901 100.00% 273,636 100.00% 253,907 100.00%
====== ====== ======
Less:
Loans in process ........................... 5,493 7,187 6,826
Unearned discounts and deferred loan fees .. 3,041 3,267 3,468
Allowance for loan losses .................. 775 751 754
-------- -------- --------
Loans receivable, net ................ $ 270,592 $262,431 $242,859
========= ======== ========
Mortgage-backed securities:
CMOs and REMICs ............................ $8,993 43.08% $ 9,218 27.50% $ 9,542 30.28%
FHLMC ...................................... 2,639 12.64 4,555 13.59 5,410 17.17
FNMA ...................................... 6,743 32.30 7,699 22.97 3,432 10.89
GNMA ...................................... 2,500 11.98 12,049 35.94 13,126 41.66
-------- ------ -------- ------ -------- -------
Total mortgage-backed securities ....... 20,875 100.00% 33,521 100.00% 31,510 100.00%
====== ====== ======
Net premiums (discounts) ..................... (34) (145) (111)
-------- -------- --------
Net mortgage-backed securities ......... $20,841 $ 33,376 $ 31,399
======= ======== ========
At December 31,
------------------------------------------------------------
1994 1993
---------------------------- ----------------------------
Percent Percent
Amount of Total Amount of Total
------------- ------------ ------------ -------------
(Dollars in Thousands)
Mortgage loans:
One- to four-family ........................ $161,932 65.17% $143,127 65.75%
Multi-family ............................... 46,785 18.83 41,771 19.19
Commercial real estate ..................... 20,479 8.24 17,646 8.11
Construction ............................... 5,378 2.16 7,765 3.57
Land ....................................... 12,937 5.21 7,147 3.28
-------- ------ -------- ------
Total mortgage loans ................. 247,511 99.61 217,456 99.90
Other loans .................................. 968 0.39 227 0.10
-------- ------ -------- ------
Total loans receivable ............... 248,479 100.00% 217,683 100.00%
====== ======
Less:
Loans in process ........................... 6,031 5,950
Unearned discounts and deferred loan fees .. 3,607 3,398
Allowance for loan losses .................. 738 708
-------- --------
Loans receivable, net ................ $238,103 $207,627
======== ========
Mortgage-backed securities:
CMOs and REMICs ............................ $ 9,826 28.84% $ 10,658 34.55%
FHLMC ...................................... 6,195 18.18 6,065 19.66
FNMA ...................................... 4,174 12.25 5,182 16.80
GNMA ...................................... 13,873 40.73 8,941 28.99
-------- ------ -------- ------
Total mortgage-backed securities ....... 34,068 100.00% 30,846 100.00%
====== ======
Net premiums (discounts) ..................... (88) 116
-------- --------
Net mortgage-backed securities ......... $ 33,980 $ 30,962
========= =========
3
The following table sets forth the Company and its subsidiaries'
loan originations and loan and mortgage-backed securities purchases, sales and
principal repayments for the periods indicated. Mortgage-backed securities are
shown at market value.
Year Ended December 31,
-----------------------------------------------------------------
1997 1996 1995
-------------- -------------- -----------------
(Dollars In Thousands)
Mortgage loans (gross):
At beginning of period......................... $266,308 $252,678 $247,511
-------- -------- --------
Mortgage loans originated:
One-to four-family.......................... 22,031 31,558 13,511
Multi-family................................ 4,607 7,993 6,556
Commercial real estate...................... 1,575 2,211 5,169
Construction................................ 9,369 15,779 10,060
Land........................................ 8,416 1,931 13,242
-------- -------- --------
Total mortgage loans originated.......... 45,998 59,472 48,538
-------- -------- --------
Mortgage loans purchased:
One-to four-family.......................... 519 48 77
Multi-family................................ 540 2,619 --
Commercial real estate...................... 2,778 2,196 --
Land........................................ 121 1,191 --
-------- -------- --------
Total mortgage loans purchased........... 3,958 6,054 77
-------- -------- --------
Total mortgage loans originated and
purchased................................ 49,956 65,526 48,615
-------- -------- --------
Transfer of mortgage loans to real estate owned (103) (134) (156)
Principal repayments........................... (41,771) (49,754) (38,499)
Sales of loans................................. (3,432) (2,008) (4,793)
-------- -------- --------
At end of period............................... $270,958 $266,308 $252,678
======== ======== ========
Other loans (gross):
At beginning of period......................... $ 7,328 $ 1,229 $ 968
Other loans originated...................... 9,094 7,131 2,092
Principal repayments........................ (7,479) (1,032) (1,831)
-------- -------- --------
At end of period............................... $ 8,943 $ 7,328 $ 1,229
======== ======== ========
Mortgage-backed securities (gross):
At beginning of period......................... $ 33,521 $ 31,510 $ 34,068
Mortgage-backed securities purchased........ -- 4,996 --
Mortgage-backed securities sold............. (9,797) -- --
Amortization and repayments................. (2,849) (4,985) (2,558)
-------- -------- --------
At end of period............................... $ 20,875 $ 33,521 $ 31,510
======== ======== ========
4
Loan Maturity and Repricing. The following table shows the maturity or
period to repricing of the Company and its subsidiaries' loan and mortgage-
backed securities portfolios at December 31, 1997. Mortgage-backed securities
are shown at amortized cost, not market value, and consist of loans with
adjustable rates and fixed rates. Information for a presentation of such
adjustable rate loans based on contractual terms to maturity is unavailable and
therefore such loans are shown as being due in the period during which the
interest rates are next subject to change. The table does not include
prepayments or scheduled principal amortization. Prepayments and scheduled
principal amortization on mortgage loans totaled $41.8 million, $49.8 million,
and $38.5 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
At December 31, 1997
---------------------------------------------------------------------------------
One-to Four Multi- Commercial
Family Family Real Estate Land Construction
------------------ ------------ --------------- ------------- ---------------
(Dollars In Thousands)
Amounts due:
Within one year................................ $2,086 $2,386 $ -- $8,702 $6,044
After one year:
One to three years........................... 1,187 4,554 -- -- --
Three to five years.......................... 2,147 8,779 6,719 -- --
Five to 10 years............................. 11,520 3,213 2,676 -- --
10 to 20 years............................... 48,092 25,064 14,469 -- --
Over 20 years................................ 110,975 7,252 5,093 -- --
------- ----- ----- -- --
Total due or repricing after one year..... 173,921 48,862 28,957 -- --
------- ------ ------ ------ ------
Total amount due or repricing............. $176,007 $51,248 $28,957 $8,702 $6,044
======== ======= ======= ====== ======
Less:
Loans in process...............................
Unearned discounts, premiums and
deferred loan fees, net.......................
Allowance for possible loan losses.............
Loans receivable and mortgage-
backed securities, net........................
At December 31, 1997
-----------------------------------------------------------------
Totals
-------------------------------------------------
Total Mortgage-
Other Loans Backed
Loans Receivable Securities Total
-------------- ----------------- --------------- ------------
(Dollars In Thousands)
Amounts due:
Within one year................................ $8,799 $28,017 $17,485 $45,502
After one year:
One to three years........................... 144 5,885 -- 5,885
Three to five years.......................... -- 17,645 -- 17,645
Five to 10 years............................. -- 17,409 -- 17,409
10 to 20 years............................... -- 87,625 890 88,515
Over 20 years................................ -- 123,320 2,500 125,820
------ ------- ----- -------
Total due or repricing after one year..... 144 251,884 3,390 255,274
------ ------- ----- -------
Total amount due or repricing............. $8,943 279,901 20,875 300,776
====== ------- ------ -------
Less:
Loans in process............................... (5,493) -- (5,493)
Unearned discounts, premiums and
deferred loan fees, net....................... (3,041) (34) (3,075)
Allowance for possible loan losses............. (775) -- (775)
------- ------- --------
Loans receivable and mortgage-
backed securities, net........................ $270,592 $20,841 $291,433
======== ======= ========
5
The following table sets forth at December 31, 1997, the dollar amount of
all loans and mortgage-backed securities due or repricing after December 31,
1998, and whether such loans have fixed interest rates or adjustable interest
rates.
Due or Repricing after
December 31, 1998
-------------------------------------------------------
Fixed Adjustable Total
----------- -------------- -----------
(Dollars In Thousands)
Mortgage loans:
One- to four-family................................ $173,921 -- $173,921
Other.............................................. 77,819 -- 77,819
Other loans.......................................... 144 -- 144
-------- --------
Total loans receivable............................... 251,884 -- 251,884
Mortgage-backed securities(1)........................ 3,390 -- 3,390
-------- --------
Total loans receivable and
mortgage-backed securities........................ $255,274 -- $255,274
======== ======== ========
- ----------------------------------
(1) Does not include CMOs and REMICs which are backed by ARMs because the
repricing period is immeasurable. Mortgage-backed securities are carried at
amortized cost.
One- to Four-Family Mortgage Lending. The Association offers first
mortgage loans secured by one- to four-family residences, including townhouse
and condominium units, in the Association's primary lending area. Typically,
such residences are single- or two-family homes that serve as the primary
residence of the owner. Loan originations are generally obtained from existing
or past customers, members of the local communities, local real estate agent
referrals and builder/developer referrals within the Association's area. The
Association does not use mortgage brokers to solicit loan applicants.
The Association offers fixed-rate and ARM loans on one- to four-family
residential properties. The Association's mortgage loans are made for terms of
15 to 30 years. Interest rates charged on mortgage loans are competitively
priced based on market conditions and the cost of funds. Origination fees range
from zero points to 2.5% depending on the interest rate charged and other
factors. Generally, the Association's standard underwriting guidelines conform
to FHLMC guidelines with periodic exceptions granted to customers with a long-
standing relationship on a case-by-case basis, which are approved by the Chief
Lending Officer or the President. On occasion, the Association sells a portion
of its fixed-rate mortgage loans to FHLMC. The Association may sell additional
fixed-rate mortgage loans to assist in controlling its interest-rate risk. The
Association retains the servicing on any fixed-rate loans it sells.
The Association makes one- to four-family residential mortgage loans in
amounts up to 80% of the appraised value of the secured property and will
originate loans with loan-to-value ratios of up to 95% with private mortgage
insurance ("PMI"). On a case-by-case basis, PMI on the amount in excess of such
80% ratio is waived for borrowers with whom the Association generally has had a
long-standing relationship. At December 31, 1997, of the total one- to four-
family residential mortgage loans of the Association, $2.9 million, or 1.6% of
these loans with balances greater than the 80% loan-to-value ratio, did not have
PMI. Originated mortgage loans in the Association's portfolio generally include
due-on-sale clauses which provide the Association with the contractual right to
deem the loan immediately due and payable in the event that the borrower
transfers ownership of the property without the Association's consent. It is
the Association's policy to enforce due-on-sale provisions.
The Association also originates fixed-rate equity mortgage loans secured by
one- to four-family residences in its primary market area. These loans
generally are originated with a fixed interest rate for amortization periods of
up to 15 years. A 1% to 1.5% origination fee is usually charged. These
mortgage loans on owner-occupied, one- to four-family residences are
traditionally subject to a 75% loan-to-value limitation, including the first
mortgage.
6
Typically, the Association provides a fixed-rate equity mortgage loan on
property for which it has a first mortgage. As of December 31, 1997, $1.3
million, or 0.5% of the Association's total loans outstanding, consisted of
fixed-rate equity mortgage loans on which the Association did not make the first
mortgage.
Multi-Family Lending. In the Chicago metropolitan area, the Association
originates fixed-rate multi-family loans with terms of 15 to 20 years, with an
origination fee of 1% to 2%. In addition, the Association also offers two
balloon loans, amortized over 25 years with an origination fee of 1% to 1.5%.
One is a five year balloon and the other is a seven year balloon. These loans
are generally made in amounts up to 75% of the appraised value of the secured
property. Most of the Association's multi-family loans are not owner-occupied.
In making such loans, the Association bases its underwriting decision primarily
on the net operating income generated by the real estate to support the debts,
the financial resources and income level of the borrower, the borrower's
experience in owning or managing similar property, the marketability of the
property and the Association's lending experience with the borrower. The
Association also receives a personal guarantee from the borrower.
As of December 31, 1997, $51.2 million, or 18.3% of the loan portfolio,
consisted of originated multi-family residential loans located in the
Association's primary lending area. The typical multi-family property in the
Association's local multi-family lending portfolio has between five and twelve
dwelling units, some of which also include retail units, with an average loan
balance of approximately $214,000. At December 31, 1997, the Association had
$6.0 million outstanding in balloon loans with an average interest rate of 8.1%.
The largest multi-family loan at December 31, 1997 is in the Association's
primary market area and had an outstanding balance of $2.8 million. This loan
is secured by an 84 unit apartment complex located in the Chicago metropolitan
area. The Association has sold a 50% participation interest in this loan to
another local financial institution.
At December 31, 1997, the Association had a participation interest in four
multi-family loans totaling $2.9 million. The same underwriting criteria
described above were used in determining to enter into these agreements.
Commercial Real Estate Lending. At December 31, 1997, the Association's
commercial real estate loan portfolio totaled $29.0 million, or 10.4% of the
loan portfolio. All the Association's commercial real estate loans are secured
by improved property such as office buildings, retail strip shopping centers,
industrial condominium units and other small businesses which are located in the
Chicago metropolitan area. At December 31, 1997, the Association had $5.5
million outstanding in balloon loans, at an average interest rate of 8.6%. The
largest commercial real estate loan at December 31, 1997 was a $3.1 million loan
on a 26 unit shopping center to a borrower with whom the Association has a long-
standing business relationship. The Company and the Association are major
tenants of this center. The interest rates, terms of loans and underwriting
criteria for commercial real estate are similar to the criteria for multi-family
residential properties.
At December 31, 1997, the Association had a participation interest in four
commercial real estate loans totaling $4.9 million. The underwriting criteria
used in determining to enter into these agreements were similar to those of
multi-family loans.
Land and Construction Lending. In its primary market area, the Association
originates loans for the acquisition of land (either unimproved land or improved
lots), and for making the necessary improvements to prepare land for sale as
improved residential or commercial property on which the purchaser can then
build (collectively, "land loans"). In addition, the Association originates
loans to finance the construction of one- to four-family homes and, to a much
lesser extent, multi-family residential and commercial real estate property
(collectively, "construction loans"). At December 31, 1997, land and
construction loans totaled $8.7 million, or 3.1%, and $6.1 million, or 2.1%,
respectively, of the loan portfolio. The Association generally has a policy of
originating land and construction loans only in Chicago and the surrounding
suburban area. Land and construction loans afford the Association the
opportunity to increase the interest rate sensitivity of its loan portfolio and
to receive yields higher than those obtainable on fixed-rate loans secured by
existing residential properties. These higher yields correspond to the higher
risks associated with land and construction loans.
7
Land loans include loans to developers for the development of residential
subdivisions and loans on raw land and on improved lots to contractors and
individuals. At December 31, 1997, the Association had 23 land loans to
developers and contractors totaling $8.7 million. Land development loans
typically are short-term loans. The interest rate on land loans is generally at
1% to 2% over the prime rate as reported in The Wall Street Journal and is
-----------------------
adjusted monthly. The loan-to-value ratio generally does not exceed 75%. Loans
typically are made to customers of the Association and developers and
contractors with whom the Association has had previous lending experience. The
Association generally requires an independent appraisal of the property and
feasibility studies may be required to determine the profit potential of the
development. All of the Association's land loans have been made in the Chicago
metropolitan area. Although the Association may make land loans to current
customers, the Association is presently not actively marketing this type of
loan.
The Association principally finances the construction of individual, owner
and non owner-occupied houses with preference given to contractors with whom the
Association has had long-term, successful relationships. Construction loans
generally are adjustable rate interest only loans with terms of 12 to 18 months.
The interest rate on construction loans is generally 1/2% to 2% over the prime
rate as reported in The Wall Street Journal and is adjusted monthly. Such loans
-----------------------
typically have loan-to-value ratios of up to 80%. Loan proceeds are disbursed
in increments as construction progresses and as inspections warrant. The
Association also offers construction permanent financing for owner-occupied
residences. These loans are originated for current market interest rates, terms
and origination fees. There is generally an additional origination fee of 1%
for this loan product. Interest only is generally charged for four months and
the loan automatically converts in the sixth month to principal and interest
payments for a maturity of 30 years or less. Construction pay outs are
disbursed in four increments as construction progresses and inspections warrant.
Of the $6.1 million construction loans outstanding on December 31, 1997, all
were one- to four-family residences including townhouses and condominium units.
During 1997 the Association entered into a participation agreement with a
local lender for 30% participation in an $8.4 million loan for the construction
of a 69 unit residential condominium building. The Association has a long-
standing relationship with this developer.
At December 31, 1997, the Association had a participation interest in two
land and construction loans totaling $1.1 million. The underwriting criteria
used in determining to enter into these agreements was similar to those of land
and construction lending used by the Association.
Also during 1997, the Association originated an acquisition and improvement
loan with a long-standing customer in the amount of $6.0 million. The
Association negotiated the sale of a portion of this loan to two other local
financial institutions.
At December 31, 1997, the largest aggregate amount of loans outstanding to
one borrower totaled $4.9 million. These six outstanding loans are secured by a
single-family residence and multi-family dwellings with a building containing
limited office space. All loans to this borrower are current and are within the
Association's "loans to one borrower" limitation established by OTS regulations.
Other Lending. During the year ended December 31, 1997 the Association
offered an adjustable rate line of credit for builders with whom the Association
has had a long-standing relationship. These loans are secured by real estate
with an interest rate adjusted to the prime rate, generally from 0.5% to 1.5%
above the prime rate, as reported in The Wall Street Journal and is adjusted
-----------------------
monthly. During 1997, the Company originated a line of credit loan to a joint
venture project. At December 31, 1997, the Association had line of credit loans
totaling $8.8 million with $4.3 million being drawn by borrowers which represent
1.6% of the loan portfolio.
The Association also offered an adjustable home equity line of credit,
secured by real estate with an interest rate at prime rate or 1% over the prime
rate, as reported in The Wall Street Journal, which is adjusted monthly. At
------------------------
December 31, 1997, the Association had loans totaling $7.0 million with $4.5
million being drawn by borrowers which represents 1.6% of the loan portfolio.
8
The Association also offers other loans, primarily share loans secured by
deposit accounts. At December 31, 1997, $144,000, or 0.1% of the loan
portfolio, consisted of these loans.
Loan Approval Procedures and Authority. Certain loan officers can approve
real estate mortgage loans in an amount up to $200,000. Real estate mortgage
loans in an amount up to $500,000 can be approved by the Association's President
or Chief Lending Officer. All loans in excess of $500,000 and up to $1.0
million must have the approval of two of the members of the Loan Committee of
the Board of Directors, which currently consists of the Association's President,
Chief Lending Officer and two outside directors. This Committee meets monthly
as well as on an as-needed basis. Real estate loans in excess of $1.0 million
require the Board of Directors approval before a commitment can be issued.
For loans originated by the Association, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered. Income,
source of down payment and certain other information is verified and, if
necessary, additional financial information is required. An appraisal of the
real estate intended to secure the proposed loan is required, which currently is
performed by an independent appraiser designated and approved by the
Association. The Board annually approves appraisers used by the Association and
reviews the Association's Appraisal Policy. The Association also has a Quality
Control System which includes a director, who is a member of the Member
Appraisal Institute ("MAI"), who reviews appraisal reports on a random basis.
It is the Association's policy to obtain title insurance on all real estate
mortgage loans. Borrowers must also obtain hazard insurance and flood
insurance, which is required prior to closing. Borrowers generally are required
to advance funds on a monthly basis together with each payment of principal and
interest to a mortgage escrow account from which the Association makes
disbursements for real estate taxes, hazard insurance, flood insurance and
private mortgage insurance premiums.
Mortgage-Backed Securities. The Company and its subsidiaries have
significant investments in mortgage-backed securities and have, at times,
utilized such investments to complement its mortgage lending activities. At
December 31, 1997, the amortized cost of mortgage-backed securities totaled
$20.8 million, or 5.7% of total assets, of which all were available for sale and
are carried at market value. The market value of such securities totaled
approximately $20.9 million at December 31, 1997. See "Impact of New Accounting
Standards". Included in the total mortgage-backed securities are Collateralized
Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits
("REMICs"), which had a carrying (market) value of $8.7 million. In order to
reduce its interest rate risk, the Association, in recent years, has sold
mortgage-backed securities backed by fixed-rate GNMA and FHLMC loans and
purchased CMOs and REMICs backed by ARM loans. The weighted average life of
CMOs and REMICs at December 31, 1997 was 24 years. However, based on current
prepayment rates, the weighted average life is expected to be approximately six
years. The Company and its subsidiaries typically purchase CMOs and REMICs
rated in one of the two highest rating categories by a nationally recognized
rating agency. At December 31, 1997, $11.8 million, or 56.7% of the amortized
cost of the Company and its subsidiaries' mortgage-backed securities portfolio,
was directly insured or guaranteed by the GNMA, FNMA or FHLMC. An additional
$9.0 million, or 43.3% of the amortized cost of the Company and its
subsidiaries' mortgage-backed securities portfolio consisted of CMOs and REMICs
backed by federal agency collateral. At such date, the mortgage-backed
securities portfolio had a weighted average interest rate of 6.5%
Delinquencies and Classified Assets
Delinquent Loans. The Association sends a notice to the borrower when a
loan is 20 days past due. When the loan is less than one year old, a letter is
also sent at that time. On all loans, a late notice is also sent after payment
is 30 days past due. If payment is not received, an additional late notice is
sent by both certified and regular mail after payment is 60 days past due. In
the event that payment is not received, additional letters may be sent and/or
phone calls made to the borrower. When contact is made with the borrower at any
time prior to foreclosure, the Association will attempt to obtain full payment
or work out a repayment schedule with the borrower. Once a loan is 90 days past
due, and if a repayment plan has not been established, a foreclosure notice is
sent to the borrower. Property acquired by the Association as a result of a
foreclosure on a mortgage loan is classified as real estate owned. Interest
income is reduced by the full amount of accrued and uncollected interest on all
loans once they become 90 days delinquent.
9
Classified Assets. Federal regulations and the Association's
Classification of Assets Policy provide for the classification of loans and
other assets such as debt and equity securities considered by the OTS to be of
lesser quality as "substandard", "doubtful" or "loss" assets. An asset is
considered "substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "doubtful" have all of the weaknesses
inherent in those classified "substandard", with the added characteristic that
the weaknesses present make "collection or liquidation in full", on the basis of
currently existing facts, conditions and values, "highly questionable and
improbable". Assets classified as "loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories, but possess weaknesses
are required to be designated "special mention" by management, including one- to
four-family residences that are delinquent 76 days or more, or other mortgage
loans that are delinquent 45 days or more unless the collateral has been sold
and closing is imminent.
When an insured institution classifies problem assets as either substandard
or doubtful, it is required to establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
problem assets as loss, it is required either to establish a specific allowance
for losses equal to 100% of the amount of the asset so classified or to charge-
off such amount. An institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. In connection with the filing of its periodic reports with the OTS,
the Association regularly reviews the problem loans in its portfolio to
determine whether any loans require classification in accordance with applicable
regulations.
At December 31, 1997, the Association had eight loans classified as special
mention totaling $732,000. Six loans are on a single-family residence with an
average balance of $94,000, one is a land loan with a balance of $143,000 and
one is a loan on commercial property with a balance of $28,000. The Association
also had classified fourteen loans totaling $1.1 million as substandard at
December 31, 1997. Twelve of these loans are on one- to four-family, owner-
occupied residences, with an average balance of $76,000, one is on commercial
property, with a balance of $208,000 and one loan is a home equity loan with a
balance of $8,000. Three are loans of which the borrower is in bankruptcy and
payments are being made by the trustee in bankruptcy and two loans are in
foreclosure, while the borrowers on the remainder of these loans are on
repayment plans. Fourteen of the loans, totaling $1.2 million, are classified
as either special mention or substandard, but do not qualify as non-performing
loans because they are less than 90 days delinquent.
10
At December 31, 1997, 1996 and 1995, delinquencies in the Association's
loan portfolio were as follows:
At December 31, 1997 At December 31, 1996
------------------------------------------------ ----------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
--------- ------------ -------- --------------- ------- ------------ ------------- -----------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
--------- ------------ -------- --------------- ------- ------------ ------------- -----------
(Dollars in Thousands)
One-to four-family.......... 4 $324 7 $643 6 $419 10 $811
Multi-family................ 1 17 -- -- 1 68 -- --
Commercial real estate...... -- -- 1 28 -- -- -- --
Land and Construction....... -- -- -- -- -- -- -- --
-- -- -- -- -- -- -- --
Total loans............. 5 $341 8 $671 7 $487 10 $811
= ==== = ==== = ==== == ====
Delinquent loans to total
loans....................... 0.12% 0.24% 0.20% 0.30%
==== ==== ==== ====
At December 31, 1995
------------------------------------------------------------------------------------------------
60-89 Days 90 Days or More
------------------------------------------------ ----------------------------------------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
--------------------------- -------------------- ------------------------- -------------------
(Dollars in Thousands)
One-to four-family........... 11 $579 8 $696
Multi-family................. 1 20 -- --
Commercial real estate....... -- -- 1 68
Land and Construction........ -- -- -- --
-- --- -- --
Total loans............. 12 $599 9 $764
== ==== = ====
Delinquent loans to total
loans........................ 0.24% 0.30%
==== ====
11
Non-performing Assets. The following table sets forth information
regarding loans which are 90 days or more delinquent. The Association continues
accruing interest on delinquent loans 90 days or more past due, but reserves
100% of the interest due on such loans, thus effecting a non-accrual status. At
December 31, 1997 there were no other known problem assets except as described
above or as included in the table below.
At December 31,
----------------------------------------------------------------------------
1997(1) 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(Dollars in Thousands)
Non-accrual delinquent mortgage loans.......... $671 $811 $764 $589 $568
Total real estate owned, net of related
allowance for losses........................... -- 117 47 136 --
---- ---- ---- ---- ----
Total non-performing assets.................... $671 $928 $811 $725 $568
==== ==== ==== ==== ====
Non-performing loans to total loans............ 0.24% 0.30% 0.30% 0.24% 0.26%
Total non-performing assets to total assets.... 0.18% 0.24% 0.23% 0.21% 0.18%
- -----------------------------
(1) For the year ended December 31, 1997, gross interest income which would
have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to approximately $28,000.
12
Allowance for Loan Losses
The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risk inherent in its loan
portfolio and the general economy. Such evaluation, which includes a review of
all loans on which full collectibility may not be reasonably assured, considers
among other matters, the estimated net realizable value of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss
allowance.
The following table sets forth the Association's allowance for
possible loan losses at the dates indicated.
At December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
----------- ------------ --------- -------- -------
(Dollars in Thousands)
Balance at beginning of period ......................................... $14,613 $ 754 $ 738 $ 708 $ 805
------- ----- ----- ----- -----
Provision for loan losses .............................................. 24 24 16 30 15
Charge-offs net of recoveries (one- to four-family) .................... -- -- -- -- (15)
Charge-offs net of recoveries (multi-family) ........................... -- (27) -- -- (97)
Allowance transferred from (to) real estate owned ..................... -- -- -- -- --
---- ----- ----- ----- -----
Balance at end of year ................................................. $775 $ 751 $ 754 $ 738 $ 708
==== ===== ===== ===== =====
At end of period allocated to:
Mortgage loans(1) ...................................................... $775 $ 751 $ 754 $ 738 $ 708
Ratio of net charge-offs during the period to average loans
outstanding during the period .......................................... --% .01% --% --% .06%
Ratio of allowance for loan losses to net loans receivable at the end
of period .............................................................. 0.29 0.29 0.31 0.31 0.34
Ratio of allowance for loan losses to total non-performing assets at
the end of period ...................................................... 115.50 80.93 92.97 101.79 124.65
Ratio of allowance for loan losses to non-performing loans at the end
of the period .......................................................... 115.50 92.60 98.69 125.30 124.65
- ---------------------------
(1) The total amount of the Association's allowance for possible loan
losses for each of the periods shown was allocated to mortgage loans. At
the end of each reported period, mortgage loans represented in excess of
96% of total loans.
13
Investment Activities
The investment policy of the Company and its subsidiaries, which is
established by the Board of Directors and implemented by the Asset/Liability
Committee, is designed primarily to provide and maintain liquidity, to generate
a favorable return on investments without incurring undue interest rate and
credit risk, and to complement the Association's lending activities. Federally
chartered savings institutions have the authority to invest in various types of
liquid assets, including United States Treasury obligations, securities of
various federal agencies, certain certificates of deposit of insured banks and
savings institutions, certain bankers acceptances, repurchase agreements and
loans on federal funds. Subject to various restrictions, federally chartered
savings institutions may also invest a portion of their assets in commercial
paper, corporate debt securities and asset-backed securities. At December 31,
1997, the Company and its subsidiaries had investment securities in the
aggregate amount of $44.7 million. The investment portfolio is classified as
available for sale.
The following table sets forth certain information regarding the
amortized cost and market, or carrying, values of the Company and its
subsidiaries' investment securities portfolio at the dates indicated.
At December 31,
-------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- ---------------------------
Carrying Carrying Carrying
Amortized (Market) Amortized (Market) Amortized (Market)
Cost Value Cost Value Cost Value
-------------- ------------ -------------- ------------ -------------- ------------
(Dollars In Thousands)
Interest-bearing deposits:
Certificates of deposit .................. $ 195 $ 195 $ 198 $ 198 $ 95 $ 95
FHLB daily investment .................... 6,143 6,143 5,122 5,122 6,767 6,767
Other daily investments .................. 153 153 60 60 712 712
------ ------ ------- ------- ------- -------
Total interest-bearing deposits ........ $6,491 $6,491 $ 5,380 $ 5,380 $ 7,574 $ 7,574
====== ====== ======= ======= ======= =======
Investment securities:
U.S. Government securities and
obligations(1) ........................... $41,410 $41,364 $47,296 $46,591 $42,692 $41,983
Investment in common stock
of various entities ...................... 355 550 485 663 550 641
FHLB-Chicago stock ....................... 2,734 2,734 3,108 3,108 3,319 3,319
ARM portfolio fund ....................... -- -- 6,649 6,631 7,170 7,197
Municipal bonds .......................... 100 100 130 130 160 160
A.I.D. certificates ...................... -- -- 4 4 5 5
------- ------- ------- ------- ------- -------
Total investment securities ............ $44,599 $44,748 $57,672 $57,127 $50,577 $53,305
======= ======= ======= ======= ======= =======
- ---------------
(1) For a complete description, see Note 2 to the "Notes to Consolidated
Financial Statements" contained herein at Item 8.
14
The table below sets forth certain information regarding the
carrying value, weighted average yields and maturities of the Company and its
subsidiaries' investment securities at December 31, 1997.
At December 31, 1997
--------------------------------------------------------------------------------------------
One Year or Less One to Five Years Five to 10 Years
------------------------------ ----------------------------- ------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
U.S. Government securities
and agency obligations............ $12,950 4.59% $16,512 6.01% $11,400 6.39%
Investment in common
stock of various entities......... -- -- -- -- -- --
FHLB-Chicago stock.................. 2,734 7.00 -- -- -- --
ARM portfolio fund.................. -- -- -- -- -- --
Municipal bonds..................... -- -- 100 4.35 -- --
A.I.D. certificates................. -- -- -- -- -- --
------- ------- -------
Total............................. $15,684 5.01 $16,612 6.00 $11,400 6.39
======= ======= =======
At December 31, 1997
----------------------------------------------------------------------------------------
More than 10 Years Total Investment Securities
----------------------- ------------------------------------------------------------
Average
Weighted Remaining Approximate Weighted
Carrying Average Years to Carrying Market Average
Value Yield Maturity Value Value Yield
----- ----- -------- ----- ----- -----
(Dollars in Thousands)
U.S. Government securities
and agency obligations............ $502 6.75% 3.2 $41,364 $41,364 5.68%
Investment in common
stock of various entities......... 550 -- -- 550 550 --
FHLB-Chicago stock.................. -- -- -- 2,734 2,734 7.00
ARM portfolio fund.................. -- -- -- -- -- --
Municipal bonds..................... -- -- 3.0 100 100 4.35
A.I.D. certificates................. -- -- -- -- -- --
------ ------- ------- -----
Total............................. $1,052 3.22 3.2 $44,748 $44,748 5.69
====== ======= =======
There were no investment securities (exclusive of obligations of the
U.S. Government and federal agencies and the ARM portfolio fund) issued by any
one entity with a total carrying value in excess of 10% of stockholders' equity
at December 31, 1997.
15
Sources of Funds
General. Deposits, repayments on loans and mortgage-backed
securities, stockholders' equity and FHLB-Chicago advances are the primary
sources of the Association's funds for use in lending, investing and for other
general purposes.
Deposits. The Association offers a variety of deposit accounts
having a range of interest rates and terms. The Association's deposits consist
of passbook savings, NOW, money market and certificate accounts. The flow of
deposits is influenced significantly by general economic conditions, changes in
money market and prevailing interest rates and competition. The Association's
deposits are obtained primarily from the areas in which its offices are located.
The Association relies primarily on customer service and long-standing
relationships with customers to attract and retain these deposits. Certificate
accounts in excess of $100,000 are not actively solicited by the Association nor
does the Association use brokers to obtain deposits. Management constantly
monitors the Association's deposit accounts and, based on historical experience,
management believes it will retain a large portion of such accounts upon
maturity.
The following table presents the deposit activity of the Association
for the periods indicated.
Year Ended December 31,
-----------------------------------------
1997 1996 1995
----------- ------------- -------------
(Dollars In Thousands)
Deposits........................... $366,819 $379,691 $346,859
Withdrawals........................ 376,020 365,340 337,572
-------- -------- --------
Net deposits (withdrawals)......... (9,201) 14,351 9,287
Interest credited on deposits...... 11,820 10,774 10,342
-------- -------- --------
Total increase in deposits..... $ 2,619 $ 25,125 $ 19,629
======== ======== ========
At December 31, 1997, the Association had outstanding $42.8 million
in deposit accounts in amounts of $100,000 or more maturing as follows:
Maturity Period Amount
------------------------------------------------ -----------------------------
(Dollars In Thousands)
Three months or less............................ $27,546
Over three through six months................... 7,560
Over six through 12 months...................... 2,966
Over 12 months.................................. 4,691
-------
Total....................................... $42,763
=======
16
The following table sets forth the distribution of the Association's
deposit accounts at the dates indicated and the weighted average nominal
interest rates on each category of deposits presented. Management does not
believe that the use of year-end balances instead of average balances resulted
in any material difference in the information presented.
At December 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- ---------------------------- ------------------------------
Weighted Weighted Weighted
Percent of Average Percent of Average Percent of Average
Total Nominal Total Nominal Total Nominal
Amount Deposits Rate Amount Deposits Rate Amount Deposits Rate
------- ---------- --------- -------- ---------- ------- -------- ---------- ---------
(Dollars in Thousands)
Transaction accounts:
NOW........................ $22,410 7.92% 2.81% $ 20,661 7.37% 2.71% $ 22,493 8.81% 2.71%
Money Market............... 39,024 13.79 3.40 39,770 14.18 3.40 40,073 15.70 3.40
-------- ------ -------- ------ -------- ------
Total.................... 61,434 21.71 60,431 21.55 62,566 24.51
-------- ------ -------- ------ -------- ------
Passbook accounts............ 45,923 16.22 3.00 47,317 16.87 3.00 47,295 18.52 3.00
-------- ------ -------- ------ -------- ------
Certificate accounts:
Ninety-one day........... 2,604 0.92 4.88 2,358 0.84 4.86 2,793 1.09 4.96
Six month................ 28,705 10.14 5.33 30,758 10.97 5.20 31,938 12.51 5.47
Eight month.............. 10,958 3.87 5.60 16,125 5.75 5.38 20,438 8.01 5.57
Twelve month............. 33,308 11.77 5.52 33,016 11.77 5.23 32,960 12.91 5.76
Eighteen month........... 52,982 18.72 6.15 44,886 16.01 6.11 13,585 5.32 5.66
Thirty month............. 14,159 5.00 5.62 16,313 5.82 5.76 21,046 8.24 5.21
Thirty-six month......... 22,468 7.94 6.11 19,458 6.94 5.99 9,486 3.72 5.74
Jumbo.................... 10,512 3.71 5.59 9,772 3.48 5.49 13,201 5.17 5.80
-------- ------ -------- ------ -------- ------
Total.................. 175,696 62.07 172,686 61.58 145,447 56.97
-------- ------ -------- ------ -------- ------
Total deposits............. $283,053 100.00% $280,434 100.00% $255,308 100.00%
======== ====== ======== ====== ======== ======
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at December 31, 1997, 1996 and 1995 and the
periods to maturity of the certificate accounts outstanding at December 31,
1997.
Period to Maturity
At December 31, from December 31, 1997
------------------------------------------ ------------------------------------------------------
Within One to
1997 1996 1995 One Year Three Years(1) Total
-------------- ------------- ------------ ----------------- --------------------- --------------
(Dollars in Thousands)
Certificate accounts:
5.99% or less................. $121,934 $122,404 $126,434 $ 97,322 $24,612 $121,934
6.00% to 6.99%............... 53,762 50,282 18,633 37,652 16,110 53,762
7.00% to 7.99%............... -- -- 380 -- -- --
8.00% to 8.99%............... -- -- -- -- -- --
-------- -------- -------- -------- ------- --------
Total..................... $175,696 $172,686 $145,447 $134,974 $40,722 $175,696
======== ======== ======== ======== ======= ========
---------------------------
(1) The Association does not offer certificate accounts with a period to
maturity exceeding three years.
17
Borrowings
Although deposits are the Association's primary source of funds, the
Association's policy has been to utilize borrowings as an alternative source of
funds. The Association obtains advances from the FHLB-Chicago. These advances
are collateralized by the capital stock of the FHLB-Chicago held by Southwest
Federal and certain of the Association's mortgage loans, mortgage-backed
securities and investment securities. See "Regulation and Supervision--Federal
Home Loan Bank System". Such advances are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB-Chicago will advance to member
institutions, including the Association, for purposes other than meeting
withdrawals, fluctuates from time to time in accordance with the policies of the
OTS and the FHLB-Chicago. The maximum amount of FHLB-Chicago advances to a
member institution generally is reduced by borrowings from any other source. In
connection with its initial public offering, the Association established an
Employee Stock Ownership Plan (the "ESOP"). The ESOP was funded by the proceeds
from a $2,240,000 loan from an unaffiliated third-party lender which was
refinanced by the Company on September 30, 1994. The loan carries an interest
rate of one-eighth of one percent under prime rate, and matures in the year
1999. The loan is secured by the shares of the Company purchased with the loan
proceeds. The Association has committed to make contributions to the ESOP
sufficient to allow the ESOP to fund the debt service requirements of the loan.
During 1997, the Company entered into sales of securities under agreements to
repurchase (repurchase agreements). These transactions are accounted for as
financings, and the obligation to repurchase securities sold are reflected as
borrowed money in the consolidated statements of financial condition, while the
securities sold continue to be accounted for as assets. The securities sold
under agreements to repurchase consisted of mortgage-backed securities, and were
held in the Company's account with the broker who arranged the transaction. At
December 31, 1997, the Company's FHLB-Chicago advances totaled $ 33.9 million,
representing 10.4% of total liabilities.
The following tables set forth certain information regarding borrowed funds
for the dates indicated.
At or For the Year Ended December 31,
=======================================================
1997 1996 1995
=========== =========== ===========
(Dollars in Thousands)
FHLB-Chicago advances:
Average balance outstanding............................................ $47,421 $52,162 $47,132
Maximum amount outstanding at any month-end during the period.......... 52,158 59,158 62,375
Balance outstanding at end of period................................... 33,850 54,158 52,658
Weighted average interest rate during the period....................... 6.38% 6.45% 6.35%
Weighted average interest rate at end of period........................ 6.76% 6.37% 6.51%
At or For the Year Ended December 31,
=======================================================
1997 1996 1995
=========== =========== ===========
(Dollars in Thousands)
Repurchase agreements:
Average balance outstanding............................................ $ 142 $ 458 $ --
Maximum amount outstanding at any month-end during the period.......... 1,000 1,000 --
Balance outstanding at end of period................................... -- 1,000 --
Weighted average interest rate during the period....................... 5.62% 5.53% --
Weighted average interest rate at end of period........................ -- 5.70% --
18
Subsidiary Activities
Southwest Service Corporation. Southwest Service Corporation ("SSC") is
primarily engaged in the acquisition of real estate and development into
improved residential lots and lots to be used for the construction of
condominium buildings and townhomes. SSC is a service corporation of the
Association incorporated in Illinois in 1971. At December 31, 1997, SSC was
involved in four active real estate development projects that are located in the
Chicago metropolitan area. At this same date, the Association had an unsecured
loan of $600,000 to SSC which was used to pay income tax liabilities, and which
is eliminated in consolidation in the Association's consolidated financial
statements. SSC also operates as a full service insurance agency that offers a
variety of insurance products and annuities. SSC's income has been a
significant component of the Association's non-interest income and was $710,000
for the period ending December 31, 1997.
Hartz-Southwest Partnership (the "Partnership") is a joint venture
partnership entered into between SSC and Hartz Construction Co., Inc. (the
"Hartz"), a builder/developer with whom SSC has had a successful and long-
standing relationship. The purpose of the partnership is to acquire, develop
and sell real property located in the Association's primary lending area. This
joint venture has been profitable for the past eight years. Each of the
partners makes a 50% capital contribution in the form of cash to acquire and
develop the partnership's properties into sites primarily for single family
residences, including townhomes and condominiums. Upon closing of the sale of a
developed site, SSC receives a 50% share of the development profit and 25% of
the gross profit upon completion of construction of the dwelling by Hartz.
SSC's net investment in this partnership at December 31, 1997 was $3.4 million.
The first project is the Bramblewood Subdivision in Oak Forest, Illinois.
As of December 31, 1997, 76 of the 110 single family lots have been sold and
closed. During 1997, nine contracts were signed at an average selling price of
$247,000 and six purchases closed with an average profit to SSC of $24,000 each.
The Association provided a $500,000 line of credit loan to this project using
five model homes as collateral.
The second project is Timberline Subdivision located in Orland Hills,
Illinois. During 1997, twelve contracts on quad townhomes were signed at an
average selling price of $122,000 and fourteen purchases closed with an average
profit to SSC of $9,000 per unit. At December 31, 1997, one contract was
outstanding. Four contracts on single family lots were signed during the year
at an average selling price of $188,000. SSC expects this project to be
completed in 1998. No financing for this project was provided by the Company or
the Association.
The third project is the Pepperwood Subdivision located in Orland Hills,
Illinois. At year end, 12 of the 66 single family lots located in Phase One
have been sold and closed. During 1997, 34 contracts were signed at an average
selling price of $197,000. There were twelve purchases that closed at an
average profit to SSC of $14,000 per lot. The Association provided a $1.4
million line of credit loan to fund site improvements for this project.
The fourth project is Liberty Square located in Lombard, Illinois. For
this project, 4.4 acres were acquired in October 1996, for the purpose of
constructing 112 condominium units in three elevator buildings. Construction of
the first building should commence in the spring of 1998 and should be completed
in nine months. This project site is adjacent to the Yorktown Shopping Center.
No financing for this project was provided by the Company or the Association.
Southwest Bancshares Development Corporation. Southwest Bancshares
Development Corporation ("SBDC") was incorporated under Illinois law in November
1992 for joint venture real estate development and is involved in three projects
at December 31, 1997. During the year ended December 31, 1997, SBDC contributed
$199,000 to the non-interest income of the Company.
The first project is Bailey Park located in Darien, Illinois. As of
December 31, 1997, 49 of the 65 units have been sold and closed. During 1997,
six contracts were signed at an average selling price of $168,000 and three
purchases closed at an average profit to SBDC of $16,000 per unit. Sixteen
units remain at year end, of which two units were partially complete when the
property was purchased and fourteen are new units. No financing for this
project was provided by the Company or Association.
19
The second project is the Courtyards of Ford City located in southwest
Chicago, with plans to construct 124 condominium units. Construction of the
first 24 unit building was completed during 1996 and the models opened in
October of 1996. As of December 31, 1997, thirteen units were sold at an
average selling price of $118,000 and thirteen purchases were closed with an
average profit of $10,000 to SBDC. The Company originated two line of credit
loans to this project. The first loan for $1.1 million was for site
improvements. The second loan for $1.5 million was for the construction of a 24
unit condominium building. The Company has sold a 50% interest in these loans
to a local area lender.
The third project is the Laraway Ridge Subdivision located in New Lenox,
Illinois. The lift station servicing this site was completed by the Village of
New Lenox during the summer of 1996. At that time, engineering plans were
submitted to the Village of New Lenox for their approval. Engineering and the
offsite improvements on Phase One were completed in 1997. This subdivision will
consist of 317 single family sites, a 7.5 acre commercial site, 17.5 acres of
open land suitable for a park and 11 acres which have been donated for a
proposed school. The Company has a $ 1.1 million loan outstanding on this
project. The proceeds of this loan were used for land acquisition.
Real estate development activities involve risks that could have an adverse
effect on the profitability of the Company. SBDC and SSC generally incur
substantial costs to acquire land, design projects, install site improvements
and engage in marketing activities prior to commencement of construction and
receipt of proceeds from sales. Because such costs generally are not recouped
until sales of a number of the units are closed, there are negative cash flows
in the early stages of the project. During the construction phase, a number of
factors could result in cost overruns, which could decrease or possibly
eliminate the potential profit from the project. In addition, the profit
potential on any given project may cease if the project is not completed, the
underlying value of the project or the general market area declines, the project
is not sold, or is sold over a longer period of time than initially
contemplated, or a combination of these or other factors occurs. All of the
real estate development projects are located in the Chicago metropolitan area.
Accordingly, the ability to generate income from such projects is dependent, in
part, on the economy in that area. Notwithstanding the risks involved, the
Company has recorded positive income from real estate development activities
during each of the past eight years. Depending on economic conditions in its
primary market area, the Company presently intends to continue real estate
development activities at moderate levels consistent with its prior experience.
In attempting to insure that risks are minimized, the Company currently monitors
the activities of its real estate projects closely. Each project site is
visited regularly by an officer. In addition, pro forma operating statements
are prepared on each project and are updated or revised as warranted.
In addition to the risks involved in real estate development activities,
pursuant to the OTS capital regulations, for purposes of determining its capital
requirements, the Association is required to deduct from capital certain
investments in and loans to SSC. See "Regulation and Supervision--Federal
Savings Institution Regulation--Capital Requirements" for a further discussion
of this rule and its effect on the Association.
Competition
The Chicago metropolitan area has a high density of financial institutions,
many of which are significantly larger and have greater financial resources than
the Association, and all of which are competitors of the Association to varying
degrees. The Association's competition for loans comes principally from savings
and loan associations, savings banks, mortgage banking companies, insurance
companies and commercial banks. Its most direct competition for deposits has
historically come from savings and loan associations, savings banks, commercial
banks and credit unions. The Association faces additional competition for
deposits from short-term money market funds and other corporate and government
securities funds. The Association also faces increased competition from other
financial institutions such as brokerage firms and insurance companies for
deposits. Competition may also increase as a result of the lifting of
restrictions on the interstate operations of financial institutions.
The Association is a community-oriented financial institution serving its
market area with a wide selection of residential loans and retail financial
services. Management considers the Association's reputation for financial
strength and customer service as its major competitive advantage in attracting
and retaining customers in its market
20
area. The Association also believes it benefits from its community bank
orientation as well as its relatively high core deposit base.
Personnel
As of December 31, 1997, the Association had 79 full-time employees and 26
part-time employees. The employees are not represented by a collective
bargaining unit, and the Association considers its relationship with its
employees to be excellent.
Year 2000 Compliance
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems and software
include those developed and maintained by the Company's third-party data
processing vendor and purchased software which is run on in-house computer
networks. In 1997 the Company initiated a review and assessment of all hardware
and software to confirm that it will function properly in the year 2000. To
date, those vendors which have been contacted have indicated that their hardware
or software is or will be Year 2000 compliant in time frames that meet
regulatory requirements. The costs associated with the compliance efforts are
not expected to have a significant impact on the Company's ongoing results of
operations.
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Association, are governed by the
HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Association is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Association is a member of the Federal Home Loan Bank
("FHLB") System and its deposit accounts are insured up to applicable limits by
the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The
Association must file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals
prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions. The OTS and/or the FDIC conduct
periodic examinations to test the Association's safety and soundness and
compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory
requirements and policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the Association and their
operations. Certain of the regulatory requirements applicable to the
Association and to the Company are referred to below or elsewhere herein. The
description of statutory provisions and regulations applicable to savings
institutions and their holding companies set forth in this Form 10-K does not
purport to be a complete description of such statutes and regulations and their
effects on the Association and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Association
continues to be a qualified thrift lender ("QTL"). See "Federal Savings
Institution Regulation - QTL Test". Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the QTL test
21
and is deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and certain activities authorized by
OTS regulation, and no multiple savings and loan holding company may acquire
more than 5% of the voting stock of a company engaged in impermissible
activities.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions as described below. The Association must notify the OTS 30
days before declaring any dividend to the Company. In addition, the financial
impact of a holding company on its subsidiary institution is a matter that is
evaluated by the OTS and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio.
In addition, the prompt corrective action standards discussed below also
establish, in effect, a minimum 2% tangible capital standard, a 4% leverage
(core) capital ratio (3% for institutions receiving the highest rating on the
CAMELS financial institution rating system), and, together with the risk-based
capital standard itself, a 4% Tier I risk-based capital standard. Core capital
is defined as common stockholders' equity (including retained earnings), certain
noncumulative perpetual preferred stock and related surplus, and minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain mortgage servicing rights and credit card relationships. The OTS
regulations also require that, in meeting the tangible, leverage (core) and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, as assigned by the OTS capital regulation based on the
risks OTS believes are inherent in the type of asset. The components of Tier I
(core) capital are equivalent to those discussed earlier. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
22
The OTS regulatory capital requirements also incorporate an interest rate
risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. The OTS has deferred indefinitely implementation of
the interest rate risk component. At December 31, 1997, the Association met
each of its capital requirements, in each case on a fully phased-in basis, and
it is anticipated that the Association will not be subject to the interest rate
risk component.
The following table presents the Association's capital position at December
31, 1997.
Capital
===========================
Actual Required Excess Actual Required
Capital Capital Amount Percentage Percentage
=========== =========== ========== ============ =============
(Dollars in thousands)
Tangible..................... $29,282 $ 5,357 $23,925 8.20% 1.50%
Core (Leverage).............. 29,282 10,714 18,568 8.20 3.00
Risk-based................... 30,046 17,391 12,655 13.82 8.00
The following table is an analysis of the Association's estimated interest
rate risk as of December 31, 1997, as measured by changes in Net Portfolio Value
("NPV") for instantaneous and sustained parallel shifts in interest rates, up
and down 400 basis points in 100 point increments.
Interest Rate Sensitivity of Net Portfolio Value (NPV)
Net Portfolio Value
--------------------------------
Assumed Change in Rates $ Amount $ Change % Change
------------------------ -------- -------- --------
(Dollars in Thousands)
+400 bp $ 6,414 $(34,365) (84)%
+300 bp 14,613 (26,166) (64)
+200 bp 23,326 (17,453) (43)
+100 bp 32,288 (8,491) (21)
0 bp 40,779 -- --
-100 bp 48,126 7,348 18
-200 bp 54,605 13,827 34
-300 bp 61,438 20,659 51
-400 bp 69,928 29,149 71
23
At December 31, 1997, 2.0% of the present value of the Association's assets
was approximately $7.4 million, which was less than $17.5 million, the decrease
in NPV resulting from a 200 basis point change in interest rates. As a result,
if the interest rate risk rule were in effect and were applicable, the
Association would have been required to make a $5.1 million deduction from total
capital in calculating its risk-based capital requirement, although the
Association's capital would have remained far in excess of regulatory minimums.
As noted above, the market value of the Association's net assets would be
anticipated to decline significantly in the event of certain designated
increases in interest rates. For instance, in the event of a 200 basis point
increase in interest rates, NPV is anticipated to fall by $17.5 million or 43%.
On the other hand, a decrease in interest rates is anticipated to cause an
increase in NPV.
Certain assumptions related to interest rates, loan prepayment rates,
deposit decay rates and the market value of certain assets under the various
interest rate scenarios, were utilized by the OTS in assessing the interest rate
risk of thrift institutions in preparing the previous table. In the event that
interest rates change to the designated levels, there can be no assurance that
the Association's assets and liabilities would perform as set forth above. In
addition, a change in Treasury rates to the designated levels accompanied by a
change in shape of the Treasury yield curve would cause significantly different
changes to the NPV than indicated above.
During the last several years, the Board of Directors has determined to
reduce the level of tolerated interest rate risk as measured by the
Association's interest rate sensitivity gap and by the changes to its NPV based
upon specified interest rate shocks. The actual and targeted levels of
tolerated interest rate risk are reviewed on a quarterly basis and are subject
to change depending on economic and competitive factors.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of under capitalization. Generally, a savings institution
is considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMELS rating). A savings institution that has
a ratio of total capital to risk-weighted assets of less than 8%, a ratio of
Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized". A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized". Subject to a narrow exception, the banking
regulator is required to appoint a receiver or conservator for an institution
that is "critically undercapitalized". The regulation also provides that a
capital restoration plan must be filed with the OTS within 45 days of the date a
savings institution receives notice that it is "undercapitalized",
"significantly undercapitalized" or "critically undercapitalized". Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Association are presently
insured by the SAIF. On September 30, 1996, the President signed into law the
Deposit Insurance Funds Act of 1996 (the "Funds Act") which, among other things,
imposed a special one-time assessment on SAIF member institutions, including the
Association, to recapitalize the SAIF. The SAIF was undercapitalized due
primarily to a statutory requirement that SAIF members make payments on bonds
issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize
the predecessor to the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF
24
Special Assessment"). The SAIF Special Assessment was recognized by the
Association as an expense in the quarter ended September 30, 1996 and was
generally tax deductible. The SAIF Special Assessment recorded by the
Association amounted to $1.7 million on a pre-tax basis and $1.0 million on an
after-tax basis.
The Funds Act also spread the obligations for payment of the FICO bonds
across all SAIF and Bank Insurance Fund ("BIF") members. The BIF is the fund
which primarily insures commercial bank deposits. Beginning on January 1, 1997,
BIF deposits were assessed for a FICO payment of approximately 1.3 basis points,
while SAIF deposits pay approximately 6.4 basis points. Full pro rata sharing
of the FICO payments between BIF and SAIF members will occur on the earlier of
January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act
specifies that the BIF and SAIF will be merged on January 1, 1999, provided no
savings associations remain as of that time.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. SAIF members will also continue to make the FICO payments
described above. Management cannot predict the level of FDIC insurance
assessments on an on-going basis, whether the savings association charter will
be eliminated or whether the BIF and SAIF will eventually be merged.
The Association's assessment rate for fiscal 1997 ranged from six to seven
basis points and the premium paid for this period was $179,000. A significant
increase in SAIF insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Association.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Association does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. The Funds Act provides that the BIF and
SAIF will merge on January 1, 1999 if there are no more savings associations as
of that date. Various proposals to eliminate the federal thrift charter, create
a uniform financial institutions charter and abolish the OTS have been
introduced in Congress. Some bills would require federal savings institutions
to convert to a national bank or some type of state charter by a specified date,
or they would automatically become national banks. Under some proposals,
converted federal thrifts would generally be required to conform their
activities to those permitted for the charter selected and divestiture of
nonconforming assets would be required over a two year period, subject to two
possible one year extensions. State chartered thrifts would become subject to
the same federal regulation as applies to state commercial banks. A more recent
bill passed by the House Banking Committee would allow federal savings
institutions to continue to exercise activities being conducted when they
convert to a bank regardless of whether a national bank could engage in the
activity. Holding companies for savings institutions would become subject to
the same regulation as holding companies that control commercial banks, with
some limited grandfathering included for savings and loan holding company
activities. The grandfathering would be lost under certain circumstances such
as a change in control of the Company. The Company is unable to predict whether
such legislation would be enacted or the extent to which the legislation would
restrict or disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if such loan is secured by readily-marketable collateral, which is
defined to include certain financial instruments and bullion. At December 31,
1997, the Association's limit on loans to one borrower was $5.0 million. At
December 31, 1997, the Association's largest aggregate outstanding balance of
loans to one borrower was $4.9 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test.
Under the QTL test, a savings and loan association either must qualify as a
"domestic building and loan association" as defined in the Internal Revenue
25
Code or is required to maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed securities)
in at least 9 months out of each 12 month period.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1997, the Association maintained 85.9% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test. Recent
legislation has expanded the extent to which education loans, credit card loans
and small business loans may be considered "qualified thrift investments".
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in
need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a calendar year
equal to the greater of (i) 100% of its net earnings to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (ii) 75% of its net income for the previous
four quarters. Any additional capital distributions would require prior
regulatory approval. In the event the Association's capital fell below its
regulatory requirements or the OTS notified it that it was in need of more than
normal supervision, the Association's ability to make capital distributions
could be restricted. In addition, the OTS could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by the
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice. In December 1994, the OTS proposed amendments to
its capital distribution regulation that would generally authorize the payment
of capital distributions without OTS approval provided that the payment does not
cause the institution to be undercapitalized within the meaning of the prompt
corrective action regulation. However, institutions in a holding company
structure would still have a prior notice requirement. At December 31, 1997,
the Association was a Tier 1 Bank.
Liquidity. The Association is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than a
specified percentage of its net withdrawable deposit accounts plus short-term
borrowings. This liquidity requirement was 5% for fiscal 1997, but is subject
to change from time to time by the OTS to any amount within the range of 4% to
10% depending upon economic conditions and the savings flows of member
institutions. During 1997, OTS regulations also required each savings
institution to maintain an average daily balance of short-term liquid assets of
at least 1% of the total of its net withdrawable deposit accounts and borrowings
payable in one year or less. Monetary penalties may be imposed for failure to
meet these liquidity requirements. The OTS has recently lowered the liquidity
requirement from 5% to 4% and eliminated the 1% short- term liquid asset
requirement. The Association's liquidity ratio for December 31, 1997 was
14.1%, which exceeded the applicable requirements. The Association has never
been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessments, paid on a semi-
annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Association's latest
quarterly thrift financial report. The assessments paid by the Association for
the fiscal year ended December 31, 1997 totaled $90,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Association's authority to engage
in transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the
26
Company and its non-savings institution subsidiaries) is limited by Sections 23A
and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate
amount of covered transactions with any individual affiliate to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in Section 23A and
the purchase of low quality assets from affiliates is generally prohibited.
Section 23B generally provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.
The Association's authority to extend credit to executive officers,
directors and 10% shareholders ("insiders"), as well as entities such persons
control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O
thereunder. Among other things, such loans are required to be made on terms
substantially the same as those offered to unaffiliated individuals and to not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. Regulation O also places
individual and aggregate limits on the amount of loans the Association may make
to insiders based, in part, on the Association's capital position and requires
certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; asset quality; earnings; and
compensation, fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
Guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the FDI
Act. The final rule establishes deadlines for the submission and review of such
safety and soundness compliance plans when such plans are required.
Federal Home Loan Bank System
The Association is a member of the FHLB System, which consists of 12
regional FHLBs. The FHLB provides a central credit facility primarily for
member institutions. The Association, as a member of the FHLB, is required to
acquire and hold shares of capital stock in the FHLB in an amount at least equal
to 1% of the aggregate principal amount of its unpaid residential mortgage loans
and similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Association was in
compliance with this requirement with an investment in FHLB stock at December
31, 1997 of $2.7 million. FHLB advances must be secured by specified types of
collateral and all long-term advances may only be obtained for the purpose of
27
providing funds for residential housing finance. At December 31, 1997, the
Association had $33.9 million in outstanding FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended December 31, 1997, 1996 and
1995, dividends from the FHLB to the Association amounted to $192,000, $206,000
and $218,000, respectively. If dividends were reduced, the Association's net
interest income would likely also be reduced. Further, there can be no
assurance that the impact of recent or future legislation on the FHLBs will not
also cause a decrease in the value of the FHLB stock held by the Association.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally required for most of 1997 that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$49.3 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement was 3%; and for accounts aggregating greater than $49.3
million, the reserve requirement was $1.48 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that portion
of total transaction accounts in excess of $49.3 million. The first $4.4
million of otherwise reservable balances (subject to adjustments by the Federal
Reserve Board) were exempted from the reserve requirements. The Association
maintained compliance with the foregoing requirements. For 1998, the Federal
Reserve Board has decreased from $49.3 to $47.8 million the amount of
transaction accounts subject to the 3% reserve requirement and to increase the
amount of exempt reservable balances from $4.4 million to $4.7 million. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Association report their income on a
consolidated basis using the accrual method of accounting, and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Association's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Association or the Company. The Association has not been
audited by the IRS since 1985, which covered the tax years through 1984. For
its 1997 taxable year, the Association is subject to a maximum federal income
tax rate of 34%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (i.e.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding
28
$500 million in assets) are required to use only the specific charge-off method.
Thus, the PTI Method of accounting for bad debts is no longer available for any
financial institution.
A thrift institution required to change its method of computing reserves
for bad debts will treat such change as a change in method of accounting,
initiated by the taxpayer, and having been made with the consent of the IRS.
Any Section 481(a) adjustment required to be taken into income with respect to
such change generally will be taken into income ratably over a six-taxable year
period, beginning with the first taxable year beginning after 1995, subject to
the residential loan requirement.
Under the residential loan requirement provision, the recapture required by
the 1996 Act will be suspended for each of two successive taxable years,
beginning with the Association's current taxable year, in which the Association
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Association during its six taxable
years preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the
Association is not permitted to make additions to its tax bad debt reserves. In
addition, the Association is required to recapture (i.e., take into income) over
a six year period the excess of the balance of its tax bad debt reserves as of
December 31, 1995 other than its supplemental reserve for losses on loans, if
any, over the balance of such reserves as of December 31, 1987. As a result of
such recapture, the Association will incur an additional tax liability of
approximately $1.3 million which is generally expected to be taken into income
beginning in 1997 over a six-year period.
Distributions. Under the 1996 Act, if the Association makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Association's unrecaptured tax bad debt reserves (including
the balance of its reserves as of December 31, 1987), to the extent thereof, and
then from the Association's supplemental reserve for losses on loans, to the
extent thereof, and an amount based on the amount distributed (but not in excess
of the amount of such reserves) will be included in the Association's income.
Non-dividend distributions include distributions in excess of the Association's
current and accumulated earnings and profits, as calculated for federal income
tax purposes, distributions in redemption of stock, and distributions in partial
or complete liquidation. Dividends paid out of the Association's current or
accumulated earnings and profits will not be so included in the Association's
income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Association makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Association does not intend to pay dividends
that would result in a recapture of any portion of its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7 cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Illinois Taxation. The Association files Illinois income tax returns. For
Illinois income tax purposes, savings institutions are presently taxed at a rate
equal to 7.2% of taxable income. For this purpose, "taxable income" generally
means federal taxable income, subject to certain adjustments (including the
addition of interest income on state and municipal obligations and the exclusion
of interest income on United States Treasury obligations). The exclusion of
income on United States Treasury obligations has the effect of reducing
significantly the Illinois taxable income of savings institutions.
Impact of New Accounting Standards
The following does not constitute a comprehensive summary of all material
changes or developments affecting the manner in which the Association keeps its
books and records and performs its financial accounting
29
responsibilities. It is intended only as a summary of some of the recent
pronouncements made by the Federal Accounting Standards Board (the "FASB") which
are of particular interest to financial institutions.
In December 1996, the FASB issued Statement of Financial Accounting
Standards No. 127 ("SFAS No 127"), "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125". The statement delays for one year the
implementation of SFAS No. 125, as it relates to (1) secured borrowings and
collateral, and (2) for the transfers of financial assets that are part of
repurchase agreement, dollar-roll, securities lending and similar transactions.
The Company has adopted portions of SFAS No. 125 (those not deferred by SFAS No.
127) effective January 1, 1997. Adoption of these portions did not have a
significant effect on the Company's financial condition or results of
operations. Based on its review of SFAS No. 125, management does not believe
that adoption of the portions of SFAS No. 125 which have been deferred by SFAS
No. 127 will have a material effect on the Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains, losses) in a full set of general-purpose
financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The Company has not yet determined the impact of
adopting this statement.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("SFAS No. 131"), "Disclosures about Segments of an Enterprise and
Related Information" which becomes effective for fiscal years beginning after
December 15, 1997. SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments and requires
enterprises to report selected information about operating segments in interim
financial reports. The Company has not yet determined the impact of adopting
this statement.
30
Additional Item. Executive Officers of the Registrant.
- ------------------------------------------------------
The following table sets forth certain information regarding the executive
officers of the Company and the Association who are not also directors.
Age at Position with the Company and Association and Past Five Years
Name 12/31/97 Experience
- ---- -------- -------------------------------------------------------------
Robert J. Eckert 57 Vice President of the Company. Vice President and Chief
Financial Officer of the Association.
Michael J. Gembara 38 Vice President of the Company. Vice President of Subsidiary
Operations of the Association.
Ronald D. Phares 63 Vice President of the Company. Senior Vice President and Chief
Operations Officer of the Association.
Mary A. McNally 40 Corporate Secretary of the Company. Vice President, Secretary
and Chief Lending Officer of the Association.
Robert C. Olson 51 Comptroller of the Company. Treasurer and Controller of the
Association.
Noralee Goossens 40 Assistant Secretary of the Company. Assistant Vice President
and Assistant Secretary of the Association.
Kurt R. Kluever 48 Vice President of Marketing and Security Officer of the
Association.
Elaine P. Mankus 59 Vice President of the Association since 1990.
Item 2. Properties.
- -------------------
The Company is located and conducts its business at the Association's
Hometown office, located at 4062 Southwest Highway in Hometown, Illinois. The
Association conducts its business through its main office facility at 3525 West
63rd Street in Chicago, Illinois. The Association also has branch offices at
5830 W. 35th Street in Cicero, Illinois, at 9640 S. Pulaski Road and 10270 S.
Central Avenue, in Oak Lawn, Illinois and at 9850 W. 159th Street in Orland
Park, Illinois. See Note 9 to the "Notes to Consolidated Financial Statements"
included herein for the net book value of the Association's premises and
equipment and for liability under the lease commitments.
Item 3. Legal Proceedings.
- --------------------------
Neither the Company nor its subsidiaries are involved in any pending legal
proceedings, other than routine legal matters occurring in the ordinary course
of business, which in the aggregate involve amounts which are believed by
management to be immaterial to the consolidated financial condition or results
of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------------------------------------------------------------
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
- ------------------------------------------------------------------------------
Southwest Bancshares, Inc. common stock is traded on the Nasdaq National
Stock Market under the symbol "SWBI". Newspaper stock tables list the Company
as "SwBcsh" or "SwBncsh". The table below shows the reported high and low sale
prices of the common stock for the periods indicated during the fiscal years
ended December 31, 1997 and 1996.
31
1997 1996
--------------------------- --------------------------
High Low High Low
------------- ------------ ------------- ------------
First Quarter.............. $20 1/2 $18 $18 1/2 $17 11/32
Second Quarter............. 21 1/4 18 3/4 18 11/32 17 27/32
Third Quarter.............. 21 3/4 20 18 11/32 17 27/32
Fourth Quarter............. 30 1/4 20 3/4 18 3/4 17 59/64
Item 6. Selected Financial Data.
- --------------------------------
At December 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands, Except Per Share Data)
Selected Financial Data:
Total assets............................... $368,283 $382,361 $359,483 $350,400 $322,548
Loans receivable, net...................... 270,592 262,431 242,859 238,103 207,627
Investment securities...................... 44,748 57,127 53,305 55,619 55,596
Mortgage-backed securities, net............ 20,913 32,840 31,268 32,626 30,962
Trading account securities................. -- -- -- -- 7,519
Interest-bearing deposits.................. 6,491 5,380 7,574 1,535 1,541
Deposits................................... 283,053 280,434 255,308 235,679 240,845
Borrowed funds............................. 33,850 55,158 52,658 60,375 26,300
Stockholders' equity (1)................... 44,030 39,859 45,820 48,409 49,477
Book value per share (actual shares
outstanding) (2).......................... 16.22 15.11 15.31 14.03 13.55
32
At December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ----------- ------------ ---------- -----------
(Dollars in Thousands, Except Per Share Data)
Selected Operating Data:
Interest income........................................... $28,003 $27,230 $26,870 $24,589 $24,204
Interest expense.......................................... 16,050 15,277 14,391 10,045 8,835
------- ------- ------- ------- -------
Net interest income..................................... 11,953 11,953 12,479 14,544 15,369
Less provision for loan losses............................ 24 24 16 30 15
------- ------- ------- ------- -------
Net interest income after provision for loan losses..... 11,929 11,929 12,463 14,514 15,354
------- ------- ------- ------- -------
Non-interest income:
Gain on sale of investment securities,
mortgage-backed securities, and loans
receivable............................................ 175 4 129 422 165
Insurance commissions................................... 191 148 140 145 215
Income from joint ventures.............................. 593 675 477 455 355
Fees and service charges................................ 141 179 181 247 522
Other................................................... 368 301 340 268 487
------- ------- ------- ------- -------
Total non-interest income........................... 1,468 1,307 1,267 1,537 1,744
------- ------- ------- ------- -------
Non-interest expense:
Compensation and benefits................................. 4,190 4,320 3,928 3,811 4,142
Office occupancy and equipment expenses................... 1,206 1,208 1,042 892 844
Insurance premiums........................................ 437 827 841 881 806
SAIF special assessment................................... -- 1,698 -- -- --
Data processing........................................... 256 262 243 225 215
Other..................................................... 1,202 1,087 970 946 1,021
------- ------- ------- ------- -------
Total non-interest expense.......................... 7,291 9,402 7,024 6,755 7,028
------- ------- ------- ------- -------
Income before income taxes................................ 6,106 3,834 6,706 9,296 10,070
Income tax expense........................................ 1,995 1,206 2,174 3,229 3,668
------- ------- ------- ------- -------
Net income.......................................... $4,111 $ 2,628 $ 4,532 $ 6,067 $ 6,402
====== ======= ======= ======= =======
Basic earnings per share (2).............................. $1.55 $ 0.91 $ 1.31 $ 1.61 $ 1.59
Diluted earnings per share (2)............................ 1.49 0.91 1.30 1.61 1.59
Dividends declared per common share (2)................... 0.77 0.73 0.68 0.17 0.80
- ---------------
(1) The Association may not pay dividends to the Company on its stock if its
regulatory capital would thereby be reduced below (i) the aggregate amount
then required for the liquidation account, or (ii) the amount of its
regulatory capital requirements.
(2) All share-related information has been restated to reflect the effect of the
3-for-2 stock split paid on November 13, 1996, including earnings per share
data.
33
At or for the Year Ended December 31,
---------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ----------- ------------
(Dollars In Thousands, Except Per Share Data)
Selected Financial Ratios and Other Data:
Return on average assets (1)......................... 1.09% 0.72% 1.26% 1.80% 2.03%
Return on average stockholders' equity (2)........... 9.94 6.30 9.26 12.12 12.49
Average stockholders' equity to average assets....... 10.97 11.45 13.67 14.84 16.23
Stockholders' equity to total assets................. 11.96 10.42 12.75 13.82 15.34
Interest rate spread during period................... 3.02 3.08 3.15 4.17 4.74
Net interest margin (3).............................. 3.39 3.47 3.68 4.60 5.18
Operating expenses to average assets (4)............. 1.93 2.57 1.96 2.00 2.23
Non-performing loans to total loans (5).............. 0.24 0.30 0.30 0.24 0.26
Non-performing assets to total assets (6)............ 0.18 0.24 0.23 0.21 0.18
Allowance for loan losses to non-performing loans.... 115.50 92.60 98.69 125.30 124.65
Allowance for loan losses to non-performing assets... 115.50 80.93 92.97 101.79 124.65
Net interest income to operating expenses............ 1.64x 1.27x 1.78x 2.15x 2.19x
Average interest-earning assets to average
interest-bearing liabilities......................... 1.08 1.09 1.12 1.14 1.15
Loan originations.................................... $55,092 $66,603 $50,630 $67,116 $74,133
Number of deposit accounts........................... 22,473 22,402 21,080 19,282 19,184
Number of offices.................................... 6 6 5 5 5
- ---------------
(1) Return on average assets was calculated on an annualized basis. The 1996
ratio would have been 1.00% without the one-time SAIF assessment.
(2) Return on average stockholders' equity for 1996 would have been 8.74%
without the one-time SAIF assessment.
(3) Calculation is based upon net interest income before provision for loan
losses divided by interest-earning assets.
(4) For purposes of calculating these ratios, operating expenses equal
non-interest expense less amortization of excess of cost over net assets
acquired.
(5) Non-performing loans consist of loans 90 days or more delinquent.
(6) Non-performing assets consist of non-performing loans and real estate
owned.
34
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations.
- ----------------------
General
Southwest Bancshares, Inc. (the "Company") was organized on February 11,
1992 as the holding company of Southwest Federal Savings and Loan Association of
Chicago (the "Association") in connection with the Association's conversion from
a federally chartered mutual to a stock savings association.
The Company's business currently consists of the business of the
Association, Southwest Bancshares Development Corporation and Southwest Service
Corporation. The Association's results of operations are dependent primarily on
net interest income, which is the difference between the interest income earned
on its loan and investment portfolios and its cost of funds, which is the
interest paid on its deposits and borrowings. The Association's operating
expenses principally consist of employee compensation, office occupancy
expenses, federal insurance premiums and other general and administrative
expenses. The Association's results of operations are also significantly
affected by general economic and competitive conditions, particularly changes in
market interest rates, government policies and actions of regulatory
authorities. The Association is subject to regulation by the OTS and the FDIC.
Southwest Service Corporation (the "SSC") is a wholly-owned subsidiary of
the Association engaged in real estate development activities and the operation
of a general insurance agency.
Southwest Bancshares Development Corporation (the "SBDC"), an Illinois
corporation, was formed November 19, 1992 as a wholly-owned subsidiary of the
Company to also engage in real estate development activities.
The Company authorized a 3-for-2 stock split in the form of a 50% stock
dividend distributed November 13, 1996 to stockholders of record on October 22,
1996. Accordingly, stockholders of record received one additional share for
each two shares owned as of October 22, 1996. All prior share related
information has been restated to reflect the stock split effect, including
earnings per share data.
Management Strategy
The Association was originally organized in 1883 and has operated as a
traditional thrift institution seeking to attract deposits from the general
public and investing those deposits, together with funds generated from
operations, primarily in loans on one- to four-family, owner-occupied residences
and mortgage-backed securities. The Association's strategy has been to maintain
profitability and a strong capital position. This strategy has been implemented
by maintaining a stable core of low cost transaction accounts in its deposit
base and managing growth while continuing to serve its depositor and borrower
customers.
Over the past five years, the Company's return on average assets has
averaged 1.38%. The Company's interest rate margin during this five year period
ranges from 3.39% to 5.18%, with an average of 4.06%.
Highlights of the key components of the Association's strategy are as
follows:
Stable Deposit Base. The Association seeks to maintain a stable core deposit
base by providing quality service to its customers without significantly
increasing its cost of funds or operating expense ratios. The core deposit
base, passbook and NOW accounts, totalled $68.3 million, or 24.14% of total
deposits and had a weighted average nominal rate of 2.94% on such deposits at
December 31, 1997.
High Asset Quality. Management seeks to maintain high asset quality in its loan
portfolio by applying the Association's underwriting standards which it utilizes
for all originated mortgage loans and by purchasing mortgage-backed securities
guaranteed by government sponsored agencies. As a result, the Association's
35
ratio of non-performing loans to total loans was .24% at December 31, 1997 and
has not exceeded .30% in the last five years.
Managed Deposit Growth. The Association has managed its deposit growth
primarily through the selected pricing of its deposit products. This has enabled
the Association to maintain a strong stockholders' equity to total assets ratio,
as well as to invest its funds on a selective basis. Between December 31, 1993
and December 31, 1997, the Association's deposits have increased by $42.2
million, or 17.52%. Total assets increased during this same time period by $45.7
million, or 14.18%.
Fixed-Rate Mortgage Investing. The Chicago-area mortgage market is highly
competitive, with ARM loans being particularly difficult to originate on terms
attractive to the lender. Management believes that investment in fixed-rate
mortgage loans improves net interest income as such loans generally are higher
yielding compared to ARMs, which in order to be competitively priced to home
buyers, often carry lower interest rates in the early years of the loan and have
limits on interest rate increases. While management's strategy to invest
primarily in fixed-rate mortgages has maintained profitability, the
Association's investment in fixed-rate mortgage loans has had a negative effect
on the Association's interest rate gap position. As part of its strategy to
reduce interest rate risk, the Association initiated marketing an ARM product in
the second quarter of 1997 and also markets a seven year term adjustable rate
home equity line-of-credit loan. In addition, the Association has invested in
guaranteed CMOs, FHLMC PCs, FNMA PCs and REMICs backed by ARM loans.
Income From Subsidiary Operations. The Association has received significant
non-interest income from its subsidiary, SSC, whose operations include real
estate development and insurance activities. SSC's insurance business is fully
operational and earnings are expected to be relatively stable. SBDC was formed
November 19, 1992 and is currently involved in three joint venture developments.
In 1997, the income from all subsidiary operations provided over 53% of all non-
interest income for the Company and should continue to provide income in 1998.
Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are interest rate sensitive and by
monitoring an institution's interest rate sensitivity gap. An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of interest-
earning assets maturing or repricing within a specific time period and the
amount of interest-bearing liabilities maturing or repricing within that time
period. A gap is considered positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities. A gap is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. During a period of rising
interest rates, a negative gap would tend to adversely affect net interest
income while a positive gap would tend to result in an increase in net interest
income. During a period of falling interest rates, a negative gap would tend to
result in an increase in net interest income while a positive gap would tend to
adversely affect net interest income.
At December 31, 1997, total interest-bearing liabilities maturing or
repricing within one year exceeded total interest-earning assets maturing or
repricing in the same time period by $69.1 million, representing a negative
cumulative one year gap ratio of 18.77%. Thus, during periods of rising
interest rates, it is expected that the cost of the Association's interest-
bearing liabilities would rise more quickly than the yield on its interest-
earning assets, which would adversely affect net interest income. Although in
periods of falling interest rates the opposite effect on net interest income is
expected, the Association could experience substantial prepayments of its fixed-
rate mortgage loans which may result in the reinvestment of such proceeds at
market rates which may be lower than current rates. Management currently
believes the risk of prepayments is limited due to the fact that the yield on
the loan portfolio approximates current market rates. In addition, a seven year
term home equity line-of-credit loan was introduced in September 1995 and an ARM
product was introduced in the second quarter of 1997. Management believes that
given the level of
36
capital of the Association and the substantial excess of interest-earning assets
over interest-bearing liabilities, the increased net income resulting from a
mismatch in the maturity of its asset and liability portfolios provides
sufficient returns during periods of declining or stable interest rates to
justify the increased vulnerability to sudden and unexpected increases in
interest rates. The Association has taken the above steps to more closely
monitor its interest rate risk as such risk relates to management's strategy.
The Association's Board of Directors has established an Asset/Liability
Committee which is responsible for reviewing the Association's asset and
liability policies, including interest rate risk. The Committee meets monthly
and reports quarterly to the Board of Directors on interest rate risk and
trends, as well as liquidity and capital ratios and requirements.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1997 which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of term to repricing or the
contractual terms of the asset or liability. The Association has assumed that
its passbook savings, NOW and money market accounts, which totalled $107.4
million at December 31, 1997, are withdrawn at the annual percentage rates of
6%, 38% and 15%, respectively. These withdrawal rates are based on the
Association's historical experience regarding deposit withdrawals. Loan
prepayments are based on assumptions provided by the OTS.
Certain shortcomings are inherent in the method of analysis presented in
the table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Additionally, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Furthermore, certain assets, such as ARM loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table.
In this current environment of narrowing interest margins, management
continues to attempt to decrease the interest rate sensitivity by extending
liability maturities and shortening the investment portfolio by laddering
maturities.
37
- ------------------------------------------------------------------------------------------------------
MORE THAN MORE THAN
0-3 4-12 ONE YEAR TO THREE YEARS
MONTHS MONTHS THREE YEARS TO FIVE YEARS
- ------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Mortgage loans (1)........................... $ 18,843 28,002 55,795 40,712
Other loans (1).............................. 8,715 -- 144 --
Interest-bearing deposits.................... 6,296 195 -- --
Mortgage-backed securities................... 17,596 308 680 521
Investment securities........................ 13,487 10,500 9,100 1,500
- ------------------------------------------------------------------------------------------------------
Total interest-earning assets................ 64,937 39,005 65,719 42,733
- ------------------------------------------------------------------------------------------------------
LESS:
Unearned discount and deferred fees.......... (214) (318) (633) (462)
- ------------------------------------------------------------------------------------------------------
Net interest-earning assets.................. $ 64,723 38,687 65,086 42,271
======================================================================================================
INTEREST-BEARING LIABILITIES:
Passbook accounts............................ $ 711 2,091 2,691 2,523
NOW accounts................................. 2,445 6,059 7,492 2,001
Money market accounts........................ 1,569 4,475 5,383 4,589
Certificate accounts......................... 69,732 65,242 40,722 --
Borrowed funds............................... -- 20,200 12,450 1,200
- ------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities........... $ 74,457 98,067 68,738 10,313
======================================================================================================
Interest sensitivity gap..................... $ (9,734) (59,380) (3,652) 31,958
Cumulative interest sensitivity gap.......... $ (9,734) (69,114) (72,766) (40,808)
Cumulative interest sensitivity gap as a
percentage of total assets............. (2.64)% (18.77) (19.76) (11.08)
Cumulative net interest-earning
assets as a percentage of
interest-sensitive liabilities......... 86.93% 59.94 69.84 83.78
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
MORE THAN MORE THAN
FIVE YEARS 10 YEARS MORE THAN
TO 10 YEARS TO 20 YEARS 20 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Mortgage loans (1)........................... $ 63,493 49,886 8,093 264,824
Other loans (1).............................. -- -- -- 8,859
Interest-bearing deposits.................... -- -- -- 6,491
Mortgage-backed securities................... 853 747 268 20,973
Investment securities........................ 10,000 -- -- 44,587
- ------------------------------------------------------------------------------------------------------
Total interest-earning assets................ 74,346 50,633 8,361 345,734
- ------------------------------------------------------------------------------------------------------
LESS:
Unearned discount and deferred fees.......... (720) (566) (90) (3,003)
- ------------------------------------------------------------------------------------------------------
Net interest-earning assets.................. $ 73,626 50,067 8,271 342,731
======================================================================================================
INTEREST-BEARING LIABILITIES:
Passbook accounts............................ $ 2,365 2,218 33,324 45,923
NOW accounts................................. 2,686 1,472 255 22,410
Money market accounts........................ 3,913 3,336 15,759 39,024
Certificate accounts......................... -- -- -- 175,696
Borrowed funds............................... -- -- -- 33,850
- ------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities........... 8,964 7,026 49,338 316,903
======================================================================================================
Interest sensitivity gap..................... $ 64,662 43,041 (41,067) 25,828
Cumulative interest sensitivity gap.......... $ 23,854 66,895 25,828
Cumulative interest sensitivity gap as a
percentage of total assets............. 6.48% 18.16 7.01
Cumulative net interest-earning
assets as a percentage of
interest-sensitive liabilities......... 109.16% 125.00 108.15
- ------------------------------------------------------------------------------------------------------
(1) For purposes of the gap analysis, mortgage and other loans are reduced for
non-performing loans and undisbursed loan proceeds but are not reduced by
the allowance for loan losses. At December 31, 1997, non-performing loans
and undisbursed loan proceeds totalled $671,000 and $5.5 million,
respectively.
38
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected the Association's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate), (ii) changes attributable to changes in the
rate (changes in rate multiplied by prior volume), and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
COMPARED TO COMPARED TO
YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------ ----------------------------
INCREASE(DECREASE) INCREASE(DECREASE)
IN NET INTEREST INCOME IN NET INTEREST INCOME
------------------------------------ ----------------------------
DUE TO DUE TO
------------------------- ----------------
VOLUME RATE NET VOLUME RATE NET
------------------------------------ ----------------------------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Mortgage loans, net............................ $ 1,092 (227) 865 708 (316) 392
Other loans.................................... 336 8 344 276 (16) 260
Mortgage-backed securities..................... (209) 19 (190) (69) (36) (105)
Interest-earning deposits...................... (104) (51) (155) 88 67 155
Investment securities.......................... (189) 98 (91) (371) 29 (342)
Trading account securities..................... --- --- --- --- --- ---
- --------------------------------------------------------------------------------------------------------------------------------
Total..................................... $ 926 (153) 773 632 (272) 360
- --------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Deposits....................................... $ 699 430 1,129 416 76 492
Borrowed funds................................. (324) (32) 356 351 43 394
- --------------------------------------------------------------------------------------------------------------------------------
Total..................................... $ 375 398 773 767 119 886
- --------------------------------------------------------------------------------------------------------------------------------
Net change in net interest income......... $ 551 (551) 0 (135) (391) (526)
================================================================================================================================
YEAR ENDED
DECEMBER 31, 1994
COMPARED TO
YEAR ENDED
DECEMBER 31, 1995
------------------------------------
INCREASE(DECREASE)
IN NET INTEREST INCOME
------------------------------------
DUE TO
-------------------------
VOLUME RATE NET
------------------------------------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Mortgage loans, net............................ 1,632 292 1,924
Other loans.................................... 58 16 74
Mortgage-backed securities..................... (127) 195 68
Interest-earning deposits...................... 75 (3) 72
Investment securities.......................... 341 (94) 247
Trading account securities..................... (104) --- (104)
- --------------------------------------------------------------------------------------------
Total..................................... 1,875 406 2,281
- --------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Deposits....................................... 2,738 481 3,219
Borrowed funds................................. 1,048 79 1,127
- --------------------------------------------------------------------------------------------
Total..................................... 3,786 560 4,346
- --------------------------------------------------------------------------------------------
Net change in net interest income......... (1,911) (154) (2,065)
============================================================================================
39
Average Balance Sheet
The following table sets forth certain information relating to the Company's
consolidated statement of financial condition at December 31, 1997, and
consolidated statements of financial condition and the consolidated statements
of earnings for the years ended December 31, 1997, 1996 and 1995 and reflects
the average yield on assets and average cost of liabilities for the periods
indicated. Such yields and costs are derived by dividing income or expenses by
the average balance of assets or liabilities, respectively, for the periods
shown. Average balances are derived from average monthly balances. Management
does not believe that the use of month-end balances instead of average daily
balances has caused any material differences in the information presented. The
yields and costs include fees which are considered adjustments to yields.
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans, net ................................. $261,639 $ 22,176 8.48% 248,717 21,311 8.57
Other loans ......................................... 8,026 707 8.81 4,199 363 8.64
Mortgage-backed securities .......................... 28,790 1,920 6.67 31,939 2,110 6.61
Interest-bearing deposits ........................... 4,245 250 5.89 5,929 405 6.83
Investment securities ............................... 50,086 2,950 5.89 53,319 3,041 5.70
====================================================================================================================================
Total interest-earning assets ................. 352,786 28,003 7.94 344,103 27,230 7.91
Non-interest earning assets ............................. 24,124 -- -- 20,274 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets .................................. $376,910 -- -- 364,377 -- --
====================================================================================================================================
LIABILITIES AND RETAINED EARNINGS:
Interest-bearing liabilities:
Deposits:
Passbook ........................................... $ 46,725 $ 1,425 3.05% 47,124 1,441 3.06
Certificate ........................................ 171,910 9,758 5.68 155,745 8,630 5.54
NOW and money market accounts ...................... 59,922 1,834 3.06 60,549 1,817 3.00
Borrowed funds:
FHLB advances and other ............................ 47,574 3,033 6.38 52,620 3,389 6.44
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities ............ 326,131 16,050 4.92 316,038 15,277 4.83
Other liabilities ....................................... 9,157 -- -- 6,615 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities ............................. 335,288 -- -- 322,653 -- --
Stockholders' equity .................................... 41,622 -- -- 41,724 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity .... $376,910 -- -- 364,377 -- --
====================================================================================================================================
Net interest income/interest rate spread (1) ............ -- $ 11,953 3.02% -- 11,953 3.08
Net earning assets/net interest margin (2) .............. $ 26,655 -- 3.39% 28,065 -- 3.47
====================================================================================================================================
Ratio of interest-earning assets to interest-bearing
liabilities ........................................ 1.08x -- -- 1.09x -- --
====================================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, AT DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------
1995 1997
- ---------------------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE YIELD/COST
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans, net .................................. 240,500 20,919 8.70 261,733 8.05
Other loans .......................................... 1,025 103 10.05 8,859 8.84
Mortgage-backed securities ........................... 32,977 2,215 6.72 20,957 6.42
Interest-bearing deposits ............................ 4,518 250 5.53 6,491 5.25
Investment securities ................................ 59,847 3,383 5.65 44,587 5.74
=====================================================================================================================
Total interest-earning assets .................. 338,867 26,870 7.93 342,627 7.62
Non-interest earning assets ............................. 19,458 -- -- 25,656 --
- ---------------------------------------------------------------------------------------------------------------------
Total assets ................................... 358,325 -- -- 368,283 --
=====================================================================================================================
LIABILITIES AND RETAINED EARNINGS:
Interest-bearing liabilities:
Deposits:
Passbook ........................................... 48,072 1,466 3.05 45,923 3.01
Certificate ........................................ 144,268 8,037 5.57 175,696 5.76
NOW and money market accounts ...................... 61,759 1,893 3.07 61,434 3.05
Borrowed funds:
FHLB advances and other ............................ 47,132 2,995 6.35 33,850 6.67
- ---------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities ............... 301,231 14,391 4.78 316,903 4.93
Other liabilities ....................................... 8,128 -- -- 7,350 --
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities ................................ 309,359 -- -- 324,253 --
Stockholders' equity .................................... 48,966 -- -- 44,030 --
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ....... 358,325 -- -- 368,283 --
=====================================================================================================================
Net interest income/interest rate spread (1) ............ -- 12,479 3.15 -- 2.69
Net earning assets/net interest margin (2) .............. 37,636 -- 3.68 -- 3.05
=====================================================================================================================
Ratio of interest-earning assets to interest-bearing
liabilities ........................................... 1.12 -- -- 1.08x --
=====================================================================================================================
(1) Interest rate spread represents the difference between the average rate on
interest-earning assets and the average cost of interest-bearing
liabilities.
(2) Net interest margin represents net interest income before the provision for
loan losses divided by average interest-earning assets.
40
Financial Condition
Total consolidated assets of the Company at December 31, 1997 decreased
$14.1 million, or 3.68%, to $368.3 million from $382.4 million at December 31,
1996. The decrease in assets primarily resulted from a $5.2 million decrease in
U.S. Government and agency obligations, available for sale, an $11.9 million
decrease in mortgage-backed securities, available for sale, and a $6.8 million
decrease in other investments, available for sale, all partially offset by the
$8.2 million increase in net loans receivable and a $2.2 million increase in
cash and interest-bearing deposits.
Total cash and interest-bearing deposits increased $2.2 million, or 18.92%,
to $13.9 million at December 31, 1997 from $11.7 million at December 31, 1996.
This increase is the result of the proceeds from matured or called securities in
December 1997 not being reinvested.
U.S. Government and agency obligations, available for sale, at December 31,
1997 of $41.4 million, decreased $5.2 million, or 11.22%, from $46.6 million at
December 31, 1996 as a result of maturing and called securities of $10.9 million
exceeding purchases of new securities of $5.0 million along with current market
value adjustments. Mortgage-backed securities, available for sale, decreased
$11.9 million, or 36.32%, to $20.9 million at December 31, 1997 from $32.8
million at December 31, 1996. This resulted from the sale of $9.8 million of
securities along with principal reduction of $2.7 million partially offset by
current market value adjustments.
Loans receivable increased $8.2 million, or 3.11%, to $270.6 million at
December 31, 1997 from $262.4 million at December 31, 1996. The loan portfolio
represents 73.47% of total assets at December 31, 1997. The Company had no
foreclosed real estate at December 31, 1997 as compared to $117,000 at December
31, 1996.
Stock in the Federal Home Loan Bank of Chicago decreased $374,000, or
12.05%, to $2.7 million at December 31, 1997 from $3.1 million at December 31,
1996.
Other investments, available for sale, decreased $6.8 million, or 91.24%,
to $650,000 at December 31, 1997 from $7.4 million at December 31, 1996,
primarily the result of the sale of an ARM loan mutual fund.
Investment in joint ventures increased $542,000, or 7.68%, to $7.6 million
at December 31, 1997 from $7.1 million at December 31, 1996, as a result of the
retention of annual income in the partnerships.
Office properties and equipment decreased $173,000, or 5.63%, to $2.9
million at December 31, 1997 from $3.1 million at December 31, 1996, as a result
of annual depreciation. Prepaid expenses and other assets decreased $311,000,
or 5.43%, to $5.4 million at December 31, 1997 from $5.7 million at December 31,
1996. The decrease primarily resulted from decreased deferred tax benefits
offset by increases in prepaid pension costs and cash surrender value of key
person insurance policies.
Deposits increased $2.7 million, or 0.93%, to $283.1 million at December
31, 1997 from $280.4 million at December 31, 1996. The Association promoted a
special rate eighteen month CD during the year and certificate balances
increased $3.0 million while balances in passbook, NOW and money market accounts
decreased $300,000 at year end 1997 from the previous year. Borrowed money,
including FHLB advances and other borrowed money, decreased $21.3 million, or
38.63%, to $33.9 million at December 31, 1997 from $55.2 million at December 31,
1996, as a result of borrowed money being repaid. Advance payments by borrowers
for taxes and insurance were increased by $348,000, or 14.95%, at December 31,
1997 to $2.7 million from $2.3 million the previous year. This resulted
primarily from the increase in the mortgage loan portfolio.
41
Total stockholders' equity increased by $4.2 million, or 10.46%, to $44.0
million at December 31, 1997 from $39.9 million at December 31, 1996. This
increase in stockholders' equity reflects the $4.1 million net income recorded
in 1997.
Comparison of Operating Results for the Years Ended December 31, 1997 and
December 31, 1996.
General
Net income for the year ended December 31, 1997 increased by $1.5 million,
or 56.42%, to $4.1 million from $2.6 million for the year ended December 31,
1996. This increase is the result of the decrease in non-interest expense of
$2.1 million and an increase in non-interest income of $161,000, partially
offset by the $790,000 increase in the federal and state tax provision. The
reduction in non-interest expense is primarily attributable to the FDIC special
assessment to recapitalize the SAIF paid in the third quarter of 1996, and the
reduction in FDIC premiums paid in 1997.
Interest Income
Interest income for the year ended December 31, 1997 was $28.0 million
compared to $27.2 million the previous year, an increase of $773,000, or 2.84%.
This increase was a result of the average balance of interest-earning assets
increasing by $8.7 million, to $352.8 million in 1997 from $344.1 million in
1996, a 2.52% increase, along with an increase in the average yield on interest-
earning assets of 0.03% to 7.94% from 7.91% the previous year. The increase in
loan interest of $1.2 million, or 5.58%, to $22.9 million for the year ended
December 31, 1997 from $21.7 million the previous year was the result of the
increase in the average loan portfolio of $16.7 million to $269.7 million in
1997 as compared to $252.9 million in 1996, a 6.62% increase. Yields decreased
to 8.49% in 1997 from 8.57% in 1996. Interest income on mortgage-backed
securities decreased $190,000, or 9.00%, to $1.9 million for the year ended
December 31, 1997 from $2.1 million the prior year. The average balance of
mortgage-backed securities declined $3.1 million, or 9.86%, to $28.8 million in
1997 from $31.9 million in 1996, while the average yield on the mortgage-backed
securities portfolio increased to 6.67% for 1997 from 6.61% the previous year,
an increase of 0.06%. Total interest earned on investment securities, other
financial assets, trading account securities and dividends on FHLB stock of $3.2
million for the year ended December 31, 1997 decreased $246,000, or 7.14%, from
the $3.4 million the previous year. The average balance of the time deposit and
securities portfolios decreased $4.9 million to $54.3 million for 1997 from
$59.2 million in 1996, an 8.30% decrease. This average balance decrease of the
time deposit and securities portfolio is the result of the proceeds of
maturities of U.S. Government securities being invested in other interest-
earning assets.
Interest Expense
Deposit interest expense for the year ended December 31, 1997 of $13.0
million increased by $1.1 million, or 9.51% from the same period in 1996,
primarily as a result of the 0.16% increase in the cost of savings. The average
certificate deposit base increased in 1997 to $171.9 million from $155.7 million
in 1996 as the Association promoted a special rate eighteen month CD in the
fourth quarter of 1997. Interest expense on borrowed funds decreased $356,000,
or 10.52%, to $3.0 million for the year ended December 31, 1997 from $3.4
million the previous year. The average balance of total borrowings decreased
$5.0 million to $47.6 million for the year ended December 31, 1997, a 9.59%
decrease from $52.6 million for the year ended December 31, 1996. This decrease
was due to the repayment of borrowings from the proceeds of sold and maturing
securities. The average balance of total interest-bearing liabilities increased
for the year ended December 31, 1997 by $10.1 million, or 3.19%, to $326.1
million from $316.0 million the previous year, while total interest expense
increased by $774,000, or 5.07%, to $16.1 million from $15.3 million the
previous year. The overall increase of 0.09% in the average cost of funds is
attributable to the increase in CD interest rates during the period.
42
Net Interest Income Before Provision For Loan Losses
Net interest income before provision for loan losses remained at $12.0
million for both the years ended December 31, 1997 and 1996. The average net
interest rate spread for the year ended December 31, 1997 of 3.02% decreased
from the 3.08% level for the year ended December 31, 1996. The average cost of
deposits and borrowed funds increased to 4.92% for 1997 from 4.83% the previous
year combined with the slight increase in the yield on interest-earning assets
to 7.94% for 1997 from 7.91% the previous year reflect the narrowing interest
spread created by general market interest rates experienced in 1997.
Provision For Loan Losses
The provision for loan losses of $24,000 for the year ended December 31,
1997 is equal to the provision of $24,000 for the previous year. The cumulative
allowance for loan losses at year end is $775,000 with the allowance for loan
losses to non-performing loans being 115.50% on December 31, 1997, as compared
to 92.60% at December 31, 1996. No loan losses were charged off in 1997. Non-
performing loans totalled $671,000, or .24% of total loans receivable at
December 31, 1997 as compared to $811,000, or .30% of total loans receivable at
December 31, 1996. The provision reflects management's policy to maintain a loan
loss allowance based on its evaluation of the risks inherent in the loan
portfolio and the general economy. Although the Association believes its
allowance for losses is at a level which it considers to be adequate to provide
for losses, there can be no assurance that such losses will not exceed the
estimated amounts.
Non-Interest Income
Non-interest income for the year ended December 31, 1997 increased by
$161,000, or 12.32%, to $1.5 million from $1.3 million for the year ended
December 31, 1996. Increases of $43,000, $171,000 and $83,000 in insurance
commissions, gain on sale of securities, available for sale and miscellaneous
income, respectively, were partially offset by decreases of $38,000, $82,000 and
$17,000 in fees and service charges, income from joint ventures and loss on sale
of REO, respectively.
Non-Interest Expense
Non-interest expense for the year ended December 31, 1997 decreased $2.1
million, or 22.46%, to $7.3 million from $9.4 million for the year ended
December 31, 1996. The major factor for the large decrease in non-interest
expense is the decrease in insurance premium expense as the special FDIC
assessment was paid in the third quarter of 1996. Slight increases in legal,
audit and examination services and other operating expenses of $66,000 and
$80,000, respectively, were partially offset by modest decreases in compensation
and advertising expenses of $130,000 and $31,000, respectively. Occupancy and
equipment expense and data processing expense remained stable for both years.
Income Tax Expense
Income tax for the year ended December 31, 1997 increased $790,000, or
65.48%, to $2.0 million from $1.2 million in 1996, as a result of the increase
in pre-tax earnings.
Comparison of Operating Results for the Years Ended December 31, 1996 and
December 31, 1995.
General
Net income for the year ended December 31, 1996 decreased by $1.9 million,
or 42.01%, to $2.6 million from $4.5 million for the year ended December 31,
1995. This decrease is primarily attributable to the FDIC special assessment to
recapitalize the SAIF paid in the third quarter of 1996, as well as an increase
in other non-interest expense.
43
Interest Income
Interest income for the year ended December 31, 1996 was $27.2 million
compared to $26.9 million the previous year, an increase of $360,000, or 1.34%.
This increase was a result of the average balance of interest-earning assets
increasing by $5.2 million, to $344.1 million in 1996 from $338.9 million in
1995, a 1.55% increase. This was partially offset by the average yield on
interest-earning assets decreasing 0.02% to 7.91% from 7.93% the previous year.
The slight increase in mortgage loan interest to $21.3 million for the year
ended December 31, 1996 from $21.0 million the previous year was the result of
the increase in the average mortgage loan portfolio of $8.2 million to $248.7
million in 1996 as compared to $240.5 million in 1995, a 3.42% increase. Yields
decreased to 8.57% in 1996 from 8.70% in 1995. Interest income on mortgage-
backed securities decreased $105,000, or 4.73%, to $2.1 million for the year
ended December 31, 1996 from $2.2 million of the prior year. The average
balance of mortgage-backed securities declined $1.0 million, or 3.15%, to $31.9
million in 1996 from $33.0 million in 1995, while the average yield on the
mortgage-backed securities portfolio decreased to 6.61% for 1996 from 6.72% the
previous year, a decrease of 0.11%. Total interest earned on investment
securities, other financial assets, trading account securities and dividends on
FHLB stock of $3.4 million for the year ended December 31, 1996 decreased
$187,000, or 5.15%, from the $3.6 million the previous year. The average
balance of the time deposit and securities portfolios decreased $5.1 million to
$59.2 million for 1996 from $64.4 million in 1995, a 7.95% decrease. This
average balance decrease of the time deposit and securities portfolio is the
result of the proceeds of maturities of U.S. Government securities being
invested in other interest-earning assets.
Interest Expense
Deposit interest expense for the year ended December 31, 1996 of $11.9
million increased by $492,000, or 4.32% from the same period in 1995, primarily
as a result of the $9.3 million increase in the average balance of deposit
accounts and the 0.03% increase in the cost of savings. The average certificate
deposit base increased $11.5 million in 1996 to $155.7 million from $144.3
million in 1995 as the Association promoted special rate eighteen and 36 month
CDs during 1996. Interest expense on borrowed funds increased $394,000, or
13.16%, to $3.4 million for the year ended December 31, 1996 from $3.0 million
the previous year. The average balance of total borrowings increased $5.5
million to $52.6 million for the year ended December 31, 1996, an 11.64%
increase from $47.1 million for the year ended December 31, 1995. This increase
was due to funding requirements for new mortgage loans and normal operating
liquidity. The average balance of total interest-bearing liabilities increased
for the year ended December 31, 1996 by $14.8 million, or 4.92%, to $316.0
million from $301.2 million the previous year, while total interest expense
increased by $886,000, or 6.16%, to $15.3 million from $14.4 million. The
overall increase of 0.05% in the average cost of funds is attributed to the
slight increase in overall market interest rates in general during the period.
Net Interest Income Before Provision For Loan Losses
Net interest income before provision for loan losses decreased $526,000 to
$12.0 million, or 4.22%, for the year ended December 31, 1996 from $12.5 million
for the year ended December 31, 1995. The average net interest rate spread for
the year ended December 31, 1996 of 3.08% decreased from the 3.15% level for the
year ended December 31, 1995. The average yield on interest-earning assets
decreased to 7.91% for the year ended December 31, 1996 from 7.93% the previous
year combined with the increase in the average cost of deposits and borrowed
funds to 4.83% for 1996 from 4.78% the previous year to reflect the narrowing
spread created by the overall general market increase in interest rates
experienced during 1996.
Provision For Loan Losses
The provision for loan losses of $24,000 for the year ended December 31,
1996 is an increase from a provision of $16,000 for the previous year. The
cumulative allowance for loan losses at year end is
44
$751,000 with the allowance for loan losses to non-performing loans being 92.60%
on December 31, 1996, as compared to 98.69% at December 31, 1995. The
Association charged off $26,000 of loan losses in 1996. Non-performing loans
totalled $811,000, or .30% of total loans receivable at December 31, 1996 as
compared to $764,000, or .30% of total loans receivable at December 31, 1995.
The provision reflects management's policy to maintain a loan loss allowance
based on its evaluation of the risks inherent in the loan portfolio and the
general economy. Although the Association believes its allowance for losses is
at a level which it considers to be adequate to provide for losses, there can be
no assurance that such losses will not exceed the estimated amounts.
Non-Interest Income
Non-interest income for the year ended December 31, 1996 increased
slightly, by $40,000, or 3.15%, to $1.31 million from $1.27 million for the year
ended December 31, 1995. The increase in joint venture income of $198,000 was
partially offset by the $110,000 decrease in gain on sale of securities,
available for sale, and the $48,000 decrease in miscellaneous income.
Non-Interest Expense
Non-interest expense for the year ended December 31, 1996 increased $2.4
million, or 33.85%, from the previous year. The major factor for the large
increase in non-interest expense is insurance premium expense for the special
FDIC assessment of $1.7 million. The $392,000, or 10.00%, increase in
compensation and benefit expenses from the previous year resulted from salary
adjustments in 1996 which produced modest benefit cost increases along with an
adjustment increasing the SERP funding. Advertising and promotion expenses
increased $84,000, or 106.48%, which relates to the promotion of the Orland Park
office and special rate CDs in 1996. Slight increases in data processing of
$20,000 and other operating expenses of $31,000 relate to the increased
operational costs of the expanded office network.
Income Tax Expense
Income tax for the year ended December 31, 1996 decreased $1.0 million, or
44.54%, to $1.2 million from $2.2 million in 1995, as a result of a decrease in
pre-tax earnings.
Liquidity And Capital Resources
The Company's primary sources of funds are the Association's deposits and
proceeds from principal and interest payments on loans and mortgage-backed
securities, advances from the FHLB-Chicago and proceeds from the maturity of
investments. While maturities and scheduled amortization of loans and mortgage-
backed securities are predictable sources of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition. As of December 31, 1997, the Association had
outstanding loan commitments of $8.4 million, of which the majority were fixed-
rate loans with an average interest rate of 7.90%. Management anticipates that
it will have sufficient funds available to meet its current loan commitments.
Certificates of deposit which are scheduled to mature in one year or less from
December 31, 1997 totalled $135.0 million. Based upon the Association's
experience, management believes that a significant portion of such deposits will
remain with the Association.
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities and financing
activities. Cash flows from operating activities were $5.2 million for the year
ended December 31, 1997 as compared to $4.8 million for the same period in 1996.
Net cash provided from investing activities was $17.0 million for the year ended
December 31, 1997 as compared to $27.4 million provided for investing activities
in the comparable period in 1996. Net cash provided for financing activities
was $20.0 million for the year ended December 31, 1997 as compared to $18.5
million provided by financing activities for the year ended December 31, 1996.
45
The primary investment activity of the Association is the origination of
mortgage loans and the purchase of mortgage-backed and mortgage-related
securities. The Association originated $55.1 million in loans for the year
ended December 31, 1997 as compared to $66.6 million for the same period of
1996. Other investing activities include primarily investing in U.S. Government
and agency obligations which totalled $5.0 million and $21.3 million for the
years ended December 31, 1997 and 1996, respectively.
The Association is required to maintain minimum levels of liquid assets as
defined by OTS regulations. This requirement, which may be varied at the
direction of the OTS depending upon economic conditions and deposit flows, is
based upon a percentage of deposits and short-term borrowings. The required
ratio is currently 4%. The Association's liquidity ratio was 14.10% at December
31, 1997.
The Association's most liquid assets are cash and cash equivalents, which
include investments in highly liquid, short-term investments. The levels of
these assets are dependent on the Association's operating, financing, lending
and investing activities during any given period. At December 31, 1997, cash
and cash equivalents totalled $13.9 million.
The OTS capital regulations require savings institutions to meet three
capital standards: a 1.5% tangible capital standard; a 3% leverage (core
capital) ratio; and an 8% risk-based capital standard. Core capital is defined
as common stockholders' equity (including retained earnings), noncumulative
perpetual preferred stock and related surplus, minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
qualifying supervisory goodwill and certain purchased mortgage servicing rights.
The core capital requirement was effectively increased to 4% since OTS
regulations stipulate that an institution with less than 4% core capital will be
deemed to be "undercapitalized". As of December 31, 1997, the Association's
actual capital percentages for tangible capital of 8.20%, core capital of 8.20%,
and current risk-based capital of 13.82% significantly exceed the regulatory
requirement for each category. In addition, under the OTS's prompt corrective
action regulations, the Association is considered a "well capitalized"
institution.
On August 23, 1993, the OTS issued a final rule which sets forth the
methodology for calculating an interest rate risk component that would be
incorporated into the OTS risk-based regulatory capital rule effective January
1, 1994. However, the effective date has been delayed by the OTS. This
regulation is not expected to have a material impact on the financial condition
of the Association.
Dividends
The declaration of dividends by the Board of Directors will depend upon a
number of factors including; investment opportunities available to the Company
or the Association, capital requirements, regulatory limitations, the Company's
and the Association's results of operations and financial condition, tax
considerations and general economic conditions. The Association is not
permitted to pay dividends on its capital stock if its stockholders' equity
would be reduced below the amount required for the liquidation account or
applicable regulatory capital requirements. The Board of Directors initiated a
program of quarterly dividends in November, 1994 and declared a quarterly cash
dividend of 16 1/2 cents per share. This amount was paid for the fourth quarter
1994 and the first, second and third quarters of 1995. The dividend for the
fourth quarter of 1995 was increased to 18 cents per share and was paid in
December, 1995, and the first, second and third quarters of 1996. A dividend of
19 cents per share was declared and paid in the fourth quarter of 1996 and the
first, second and third quarters of 1997. A dividend of 20 cents per share was
declared and paid in the fourth quarter of 1997. Although the Board expects to
declare regular quarterly dividends in the future, no assurance can be given,
however, that any dividends will continue to be paid.
The Company continued its stock repurchase program by purchasing 6,024
shares of its common stock during 1997.
46
Proposed Merger
On December 16, 1997, the Board of Directors approved a definitive
agreement to merge with Alliance Bancorp of Hinsdale, Illinois. Pursuant to the
merger agreement, which is subject to shareholder and regulatory approval, each
common share of Southwest Bancshares, Inc. common stock will be exchanged for
1.1981 shares of Alliance Bancorp common stock, subject to adjustment based on
the current value of Alliance Bancorp common stock at the effective date.
Concurrent with the execution of the definitive agreement, the Company has
granted Alliance Bancorp an option to purchase an amount of shares equal to 9.9%
of its outstanding common stock, which option is exercisable in certain
circumstances. The transaction is expected to close prior to June 30, 1998.
Impact Of Inflation And Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with Generally Accepted Accounting
Principles (the "GAAP"), which require the measurement of financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The impact
of inflation is reflected in the increased cost of the Company's operations.
Unlike most industrial companies, nearly all of the assets and liabilities of
the Company are monetary in nature. As a result, interest rates have a greater
impact on the Company's performance than do the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the price of goods and services.
Stock Data
Southwest Bancshares, Inc.'s common stock is listed under the trading
symbol "SWBI" and is traded on the Nasdaq National Market. As of February 25,
1998, the Company had 366 stockholders of record (not including the number of
persons or entities holding stock in nominee or street name through various
brokerage firms) and 2,720,285 outstanding shares of common stock (excluding
treasury shares).
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. 1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR.
------------------------------------------- -------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income ......................... $ 7,055 7,016 7,056 6,876 6,659 6,629 6,840 7,102
Interest expense ........................ 4,012 4,007 4,058 3,973 3,640 3,595 3,904 4,138
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income before provision
for loan losses ...................... 3,043 3,009 2,998 2,903 3,019 3,034 2,936 2,964
Provision for loan losses ............... 6 6 6 6 6 6 6 6
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses ...................... 3,037 3,003 2,992 2,897 3,013 3,028 2,930 2,958
Gain on sale of assets .................. 15 78 81 1 -- -- -- 4
Income (loss) from real estate operations (4) -- -- (7) -- 6 -- --
Other income ............................ 271 277 289 467 268 392 366 271
Non-interest expense .................... 1,802 1,805 1,736 1,948 1,962 1,936 3,636 1,868
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax expense.. 1,517 1,553 1,626 1,410 1,319 1,490 (340) 1,365
Income tax expense ...................... 521 542 567 365 444 503 (196) 455
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) ....................... $ 996 1,011 1,059 1,045 875 987 (144) 910
====================================================================================================================================
Basic earnings (loss) per share ......... $ 0.38 0.38 0.40 0.39 0.30 0.34 (0.05) 0.34
Diluted earnings (loss) per share ....... 0.36 0.37 0.38 0.38 0.29 0.34 (0.05) 0.33
Dividends declared per common share ..... 0.19 0.19 0.19 0.20 0.18 0.18 0.18 0.19
====================================================================================================================================
47
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
---------------------------------------------------------------------
Disclosure related to market risk is included in "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
contained at Item 7 of this Form 10-K.
Item 8. Financial Statements and Supplementary Data.
- ----------------------------------------------------
48
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Bancshares, Inc.
Hometown, Illinois
We have audited the consolidated statements of financial condition of
Southwest Bancshares, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of earnings, changes in stockholders'
equity, and cash flows for each of the three years in the period ending December
31, 1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatements. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southwest
Bancshares, Inc. and its subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ending December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ Cobitz, Vandenberg & Fennessy
January 23, 1998
Palos Hills, Illinois
-49-
SOUTHWEST BANCSHARES, INC.
AND SUBSIDIARIES
----------------
Consolidated Statements of Financial Condition
December 31,
----------------------------
1997 1996
-------------- ------------
Assets
- ------
Cash and amounts due from
depository institutions $ 7,399,412 6,299,645
Interest-bearing deposits 6,490,520 5,379,942
------------ -----------
Total cash and cash equivalents 13,889,932 11,679,587
U.S. Government and agency obligations,
available for sale, at fair value (note 2) 41,363,703 46,591,063
Mortgage-backed securities, available for sale,
at fair value (note 3) 20,912,539 32,840,347
Loans receivable (net of allowance for loan
losses:
1997 - $775,443; 1996 - $751,443) (note 4) 270,592,293 262,430,839
Foreclosed real estate - 117,258
Stock in Federal Home Loan Bank of Chicago 2,733,500 3,108,000
Other investments, available for sale,
at fair value (note 6) 650,384 7,427,738
Investment in joint ventures (note 7) 7,614,721 7,071,757
Accrued interest receivable (note 8) 2,190,208 2,274,205
Office properties and equipment - net (note 9) 2,906,602 3,079,874
Prepaid expenses and other assets (note 10) 5,428,869 5,740,370
------------ -----------
Total assets 368,282,751 382,361,038
============ ===========
Liabilities and Stockholders' Equity
- ------------------------------------
Liabilities
- -----------
Deposits (note 11) 283,053,058 280,433,964
Federal Home Loan Bank advances (note 12) 33,850,000 54,158,265
Other borrowed money (note 13) - 1,000,000
Advance payments by borrowers for taxes
and insurance 2,683,898 2,334,913
Other liabilities (note 14) 4,666,185 4,575,098
------------ -----------
Total liabilities 324,253,141 342,502,240
------------ -----------
Stockholders' Equity
- --------------------
Preferred stock, $.01 par value; authorized
1,000,000 shares; none outstanding - -
Common stock, $.01 par value; authorized
5,000,000 shares; 4,463,358 shares issued and
2,714,655 shares outstanding at December 31,
1997 and 4,437,720 shares issued and 2,637,461
shares outstanding at December 31, 1996 44,634 44,377
Additional paid-in capital 29,800,520 29,140,212
Retained earnings, substantially restricted 41,779,746 40,256,461
Unrealized gain (loss) on securities available
for sale, net of income taxes 130,119 (637,191)
Treasury stock, at cost (1,748,703 and 1,800,259
shares at December 31, 1997 and 1996) (27,405,409) (28,182,790)
Common stock acquired by Employee Stock
Ownership Plan (320,000) (640,000)
Common stock awarded by Association Recognition
and Retention Plan - (122,271)
------------ -----------
Total stockholders' equity (notes 19 and 20) 44,029,610 39,858,798
------------ -----------
Commitments and contingencies (notes 21 and 22)
Total liabilities and stockholders' equity $368,282,751 382,361,038
============ ===========
See accompanying notes to consolidated financial statements.
-50-
SOUTHWEST BANCSHARES, INC.
AND SUBSIDIARIES
----------------
Consolidated Statements of Earnings
Years Ended December 31,
------------------------------------
1997 1996 1995
---- ---- ----
Interest income:
Loans $22,885,004 21,674,082 21,022,304
Mortgage-backed securities 1,920,041 2,110,016 2,214,700
Investment securities 2,757,099 2,835,102 3,163,818
Other financial assets 249,382 404,476 250,731
Dividends on FHLB stock 191,741 206,091 218,386
----------- ---------- ----------
Total interest income 28,003,267 27,229,767 26,869,939
----------- ---------- ----------
Interest expense:
Deposits 13,017,750 11,887,516 11,395,669
Borrowings 3,032,554 3,388,984 2,994,820
----------- ---------- ----------
Total interest expense 16,050,304 15,276,500 14,390,489
----------- ---------- ----------
Net interest income before
provision for loan losses 11,952,963 11,953,267 12,479,450
Provision for loan losses 24,000 24,000 16,000
----------- ---------- ----------
Net interest income after
provision for loan losses 11,928,963 11,929,267 12,463,450
----------- ---------- ----------
Non-interest income:
Fees and service charges 141,192 179,243 181,760
Insurance commissions 191,244 147,759 139,549
Income from joint ventures (note 7) 592,964 675,114 477,447
Gain on sale of loans, held for sale
(note 5) - - 13,689
Loss on sale of mortgage-backed
securities, available for sale (47,131) - -
Gain on sale of investment
securities, available for sale 222,834 4,313 114,744
Gain (loss) on sale of foreclosed
real estate - net (10,773) 6,021 (2,691)
Miscellaneous income 377,750 294,644 342,625
----------- ---------- ----------
Total non-interest income 1,468,080 1,307,094 1,267,123
----------- ---------- ----------
Non-interest expense:
Compensation, employee benefits and
related expenses (notes 15, 16 and
17) 4,190,311 4,320,335 3,927,849
Advertising and promotion 131,620 163,069 78,976
Occupancy and equipment expense
(note 9) 1,206,449 1,208,062 1,042,449
Data processing 256,327 262,471 242,553
Insurance expense 257,845 265,311 267,238
Federal deposit insurance premiums
(note 23) 178,855 561,133 573,692
SAIF special assessment (note 23) - 1,698,492 -
Legal, audit and examination services 253,089 187,105 186,162
Other operating expenses 816,569 736,711 705,753
----------- ---------- ----------
Total non-interest expense 7,291,065 9,402,689 7,024,672
----------- ---------- ----------
Net income before income taxes 6,105,978 3,833,672 6,705,901
Provision for federal and state
income taxes (note 18) 1,995,352 1,205,811 2,174,336
----------- ---------- ----------
Net income $ 4,110,626 2,627,861 4,531,565
=========== ========== ==========
Earnings per share - basic $1.55 .96 1.37
---- ---- ----
Earnings per share - diluted 1.49 .91 1.31
---- ---- ----
Dividends declared per common share $.77 .73 .68
--- ---- ----
See accompanying notes to consolidated financial statements.
-51-
SOUTHWEST BANCSHARES, INC.
AND SUBSIDIARIES
----------------
Consolidated Statements of Changes in Stockholders' Equity
Three years ended December 31, 1997
-----------------------------------
Unrealized
Gain (Loss) on Common Common
Additional Securities Stock Stock
Common Paid-In Retained Available Treasury Acquired Awarded
Stock Capital Earnings for Sale Stock by ESOP by RRP Total
------ ---------- -------- -------------- -------- -------- ------- -----
Balance at December 31, 1994 $ 43,098 27,783,017 37,409,484 (3,725,164) (11,209,563) (1,280,000) (611,357) 48,409,515
Additions (deductions)
for the year ended
December 31, 1995:
Net income 4,531,565 4,531,565
Adjustment of
securities to fair value,
net of tax effect 3,299,677 3,299,677
SFAS 87 adjustment of
non-qualified pension
plan, net of tax effect (201,991) (201,991)
Exercise of stock options 373 248,627 249,000
Tax benefit related to
employee stock plans 151,320 151,320
Purchase of treasury
stock (495,367 shares) (8,962,285) (8,962,285)
Amortization of award
of RRP stock 244,543 244,543
Contribution to fund ESOP loan 320,000 320,000
Payment of dividends (2,221,158) (2,221,158)
------ ---------- ---------- -------- ----------- -------- -------- ----------
Balance at December 31, 1995 43,471 28,182,964 39,517,900 (425,487) (20,171,848) (960,000) (366,814) 45,820,186
Additions (deductions)
for the year ended
December 31, 1996:
Net income 2,627,861 2,627,861
Adjustment of
securities to fair value,
net of tax effect (211,704) (211,704)
SFAS 87 adjustment of
non-qualified pension
plan, net of tax effect 107,510 107,510
Exercise of stock options 906 602,867 603,773
Tax benefit related to
employee stock plans 354,381 354,381
Purchase of treasury
stock (446,117 shares) (8,010,942) (8,010,942)
Amortization of award
of RRP stock 244,543 244,543
Contribution to fund ESOP loan 320,000 320,000
Payment of dividends (1,995,943) (1,995,943)
3 for 2 stock split related
to fractional shares (867) (867)
------ ---------- ---------- -------- ----------- -------- -------- ----------
Balance at December 31, 1996 44,377 29,140,212 40,256,461 (637,191) (28,182,790) (640,000) (122,271) 39,858,798
Additions (deductions)
for the year ended
December 31, 1997:
Net income 4,110,626 4,110,626
Adjustment of
securities to fair value,
net of tax effect 767,310 767,310
SFAS 87 adjustment of
non-qualified pension
plan, net of tax effect (27,496) (27,496)
Exercise of stock options 257 170,749 (518,220) 902,278 555,064
Tax benefit related to
employee stock plans 489,559 489,559
Purchase of treasury
stock (6,024 shares) (124,897) (124,897)
Amortization of award
of RRP stock 122,271 122,271
Contribution to fund ESOP loan 320,000 320,000
Payment of dividends (2,041,625) (2,041,625)
------ ---------- ---------- ------- ----------- -------- -------- ----------
Balance at December 31, 1997 $ 44,634 29,800,520 41,779,746 130,119 (27,405,409) (320,000) - 44,029,610
====== ========== ========== ======= =========== ======== ======== ==========
See accompanying notes to consolidated financial statements.
-52-
SOUTHWEST BANCSHARES, INC.
AND SUBSIDIARIES
----------------
Consolidated Statements of Cash Flows
Years Ended December 31,
--------------------------------------------
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income $ 4,110,626 2,627,861 4,531,565
Adjustments to reconcile net income
to net cash from operating activities:
Depreciation 374,878 388,966 300,571
Amortization of cost of stock
benefit plans 442,271 564,543 564,543
Net loss on sale of mortgage-
backed securities, available
for sale 47,131 - -
Net gain on sale of investment
securities, available for sale (222,834) (4,313) (114,744)
Net gain on sale of loans, held
for sale - - (13,689)
Net (gain) loss on sale of
foreclosed real estate 10,773 (6,021) 2,691
Provision for loan losses 24,000 24,000 16,000
Decrease in prepaid and deferred
federal and state income taxes 389,081 352,071 457,283
(Increase) decrease in accrued
interest receivable 83,997 (109,610) 132,467
Increase (decrease) in accrued
interest payable (84,266) (15,776) 56,187
Federal Home Loan Bank stock dividend - - (49,900)
Increase in other assets (117,732) (273,368) (404,902)
Increase in other liabilities 144,354 1,229,387 181,723
------------- ----------- -----------
Net cash provided by operating activities 5,202,279 4,777,740 5,659,795
------------- ----------- -----------
Cash flows from investing activities:
Purchase of mortgage-backed securities,
available for sale - (4,969,275) -
Purchase of investment securities,
available for sale (4,996,563) (21,314,377) (7,213,279)
Purchase of stock in Federal Home Loan
Bank of Chicago (170,500) (476,000) (100,000)
Proceeds from sale of mortgage-backed
securities, available for sale 9,796,533 - -
Proceeds from maturities of
mortgage-backed securities - - 728,867
Proceeds from maturities of mortgage-
backed securities, available for sale 2,691,336 2,992,376 1,852,007
Proceeds from sale of investment
securities, available for sale 7,001,388 4,065,375 3,782,625
Proceeds from maturities of investment
securities, available for sale 10,916,055 13,266,627 10,377,440
Proceeds from Federal Home Loan Bank
of Chicago stock redemption 545,000 686,700 -
Proceeds from sale of loans, held
for sale - - 3,182,400
Loan disbursements (56,786,926) (66,239,478) (49,912,726)
Loan repayments 49,038,850 50,498,285 40,205,529
Participation loans purchased (3,958,339) (6,006,504) -
Participation loans sold 3,431,587 2,008,115 1,610,958
Property and equipment expenditures (201,606) (646,712) (1,620,558)
Proceeds from sale of foreclosed
real estate 195,859 79,678 241,789
Investment in joint ventures (542,964) (1,378,202) 84,527
------------- ----------- -----------
Net cash provided by (for) investing
activities 16,959,710 (27,433,392) 3,219,579
------------- ----------- -----------
Cash flows from financing activities:
Proceeds from exercise of stock
options 555,064 603,773 249,000
Deposit receipts 366,818,990 379,691,186 346,859,169
Deposit withdrawals (376,020,245) (365,339,561) (337,572,123)
Interest credited to deposit
accounts 11,820,349 10,773,965 10,342,591
Proceeds of borrowed money 31,000,000 20,500,000 72,758,265
Repayment of borrowed money (52,308,265) (18,000,000) (80,475,000)
Increase (decrease) in advance
payments by borrowers for taxes
and insurance 348,985 245,731 (821,040)
Purchase of treasury stock (124,897) (8,010,942) (8,962,285)
Dividends paid on common stock (2,041,625) (1,996,810) (2,221,158)
------------- ----------- -----------
Net cash provided by (for) financing
activities (19,951,644) 18,467,342 157,419
------------- ----------- -----------
Increase (decrease) in cash and cash
equivalents 2,210,345 (4,188,310) 9,036,793
Cash and cash equivalents at beginning
of year 11,679,587 15,867,897 6,831,104
------------- ----------- -----------
Cash and cash equivalents at end of
year $ 13,889,932 11,679,587 15,867,897
============= =========== ===========
Cash paid during the year for:
Interest $ 16,134,570 15,292,276 14,334,302
Income taxes 1,642,380 853,736 1,717,461
Non-cash investing activities:
Transfer of loans to
foreclosed real estate $ 102,607 134,356 155,505
============= =========== ===========
See accompanying notes to consolidated financial statements.
-53-
SOUTHWEST BANCSHARES, INC.
AND SUBSIDIARIES
----------------
Notes to Consolidated Financial Statements
1) Summary of Significant Accounting Policies:
-------------------------------------------
Southwest Bancshares, Inc. (the "Company") is a Delaware corporation
incorporated on February 11, 1992 for the purpose of becoming the savings
and loan holding company for Southwest Federal Savings and Loan Association
of Chicago (the "Association"). On June 23, 1992, the Association
converted from a mutual to a stock form of ownership, and the Company
completed its initial public offering, and, with a portion of the net
proceeds acquired all of the issued and outstanding capital stock of the
Association.
The accounting and reporting policies of the Company and its subsidiaries
conform to generally accepted accounting principles and to general practice
within the thrift industry. The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The following is a description
of the more significant policies which the Company follows in preparing and
presenting its consolidated financial statements.
Principles of Consolidation
---------------------------
The accompanying consolidated financial statements consist of the accounts
of the Company, and its wholly-owned subsidiaries, Southwest Bancshares
Development Corporation and Southwest Federal Savings and Loan Association
of Chicago, and the Association's wholly-owned subsidiary, Southwest
Service Corporation. Significant intercompany balances and transactions
have been eliminated in consolidation.
Investment Securities, Available for Sale
-----------------------------------------
Investment securities available for sale are recorded in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting
for Certain Investments in Debt and Equity Securities". SFAS 115 requires
the use of fair value accounting for securities available for sale or
trading and retains the use of the amortized cost method for investments
the Company has the positive intent and ability to hold to maturity.
SFAS 115 requires the classification of debt and equity securities into one
of three categories: held to maturity, available for sale, or trading.
Held to maturity securities are measured at amortized cost. Unrealized
gains and losses on trading securities are included in income. Unrealized
gains and losses on available for sale securities are excluded from income
and reported net of taxes as a separate component of stockholders' equity.
The Company has designated its investments in U.S. Government and agency
obligations, mortgage-backed securities, and equity securities as available
for sale, and has recorded these investments at their current fair values.
Unrealized gains and losses are recorded in a valuation account which is
included, net of income taxes, as a separate component of stockholders'
equity. Gains and losses on the sale of available for sale securities are
determined using the specific identification method and are reflected in
earnings when realized.
-54-
1) Summary of Significant Accounting Policies (continued)
------------------------------------------------------
Loans Receivable and Related Fees
---------------------------------
Loans are stated at the principal amount outstanding, net of loans in
process, deferred fees and the allowance for losses. Interest on loans is
credited to income as earned and accrued only if deemed collectible. Loans
are placed on nonaccrual status when, in the opinion of management, the
full timely collection of principal or interest is in doubt. As a general
rule, the accrual of interest is discontinued when principal or interest
payments become 90 days past due or earlier if conditions warrant. When a
loan is placed on nonaccrual status, previously accrued but unpaid interest
is charged against current income.
Loan origination fees are being deferred in accordance with SFAS No. 91
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases". This statement
requires that loan origination fees and direct loan origination costs for a
completed loan be netted and then deferred and amortized into interest
income as an adjustment of yield.
The Company has adopted the provisions of SFAS No. 114 "Accounting by
Creditors for Impairment of a Loan" and SFAS No. 118 "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures".
These statements apply to all loans that are identified for evaluation
except for large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment. These loans include, but are not
limited to, credit card, residential mortgage and consumer installment
loans.
Under these statements, of the remaining loans which are evaluated for
impairment (a loan is considered impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement), there were no material amounts of loans which met the
definition of an impaired loan during the year ended December 31, 1997 and
no loans to be evaluated for impairment at December 31, 1997.
Allowance for Loan Losses
-------------------------
The determination of the allowance for loan losses involves material
estimates that are susceptible to significant change in the near term. The
allowance for loan losses is maintained at a level adequate to provide for
losses through charges to operating expense. The allowance is based upon
past loss experience and other factors which, in management's judgement,
deserve current recognition in estimating losses. Such other factors
considered by management include growth and composition of the loan
portfolio, the relationship of the allowance for losses to outstanding
loans, and economic conditions.
Management believes that the allowance is adequate. While management uses
available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for
losses. Such agencies may require the Company to recognize additions to
the allowance based on their judgements about information available to them
at the time of their examination.
Loans Receivable, Held for Sale
-------------------------------
That portion of loans receivable designated as held for sale are recorded
at the lower of cost or fair value in accordance with SFAS No. 65
"Accounting for Certain Mortgage Banking Activities". Unrealized declines
in fair value are reflected as a component of current earnings.
Foreclosed Real Estate
----------------------
Real estate acquired through foreclosure or deed in lieu of foreclosure is
carried at the lower of fair value minus estimated costs to sell or the
acquisition cost. Valuations are periodically performed by management and
an allowance for loss is established by a charge to operations if the
carrying value of a property exceeds its fair value minus estimated costs
to sell.
-55-
1) Summary of Significant Accounting Policies (continued)
------------------------------------------------------
Depreciation
------------
The office buildings are being depreciated on a straight-line basis. All
other items are being depreciated on either a straight-line or accelerated
basis depending on the nature of the items.
Income Taxes
------------
The Company files a consolidated federal income tax return with its
subsidiaries. The provision for federal and state taxes on income is based
on earnings reported in the financial statements. Deferred income taxes
arise from the recognition of certain items of income and expense for tax
purposes in years different from those in which they are recognized in the
consolidated financial statements. Deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amount of existing
assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates in effect for the year
in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
Consolidated Statements of Cash Flows
-------------------------------------
For the purpose of reporting cash flows, the Company has defined cash and
cash equivalents to include cash on hand, amounts due from depository
institutions, and interest-bearing deposits in other financial
institutions.
Earnings per Share
------------------
The Company computes its earnings per share (EPS) in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings
per Share". This statement simplifies the standards for computing EPS
previously found in Accounting Principles Board Opinion No. 5, "Earnings
per Share" and makes them comparable to international EPS standards. It
replaces the presentation of primary EPS with a presentation of basic EPS
and fully diluted EPS with diluted EPS.
Basic EPS, unlike primary EPS, excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings
of the entity.
The following presentation illustrates basic and diluted EPS in accordance
with the provisions of SFAS 128:
Years Ended December 31,
-------------------------------------
1997 1996 1995
---- ---- ----
Weighted average number of
common shares outstanding used
in basic EPS calculation 2,651,108 2,751,498 3,292,944
Add common stock equivalents
for shares issuable under
Stock Option Plans 96,361 121,360 177,414
--------- --------- ---------
Weighted average number of shares
outstanding adjusted for common
stock equivalents 2,747,469 2,872,858 3,470,358
========= ========= =========
Net income $4,110,626 2,627,861 4,531,565
Basic earnings per share $ 1.55 .96 1.37
Diluted earnings per share $ 1.49 .91 1.31
EPS for prior periods has been restated to comply with the provisions of
SFAS 128.
-56-
2) United States Government and Agency Obligations, Available for Sale
-------------------------------------------------------------------
Securities available for sale are recorded at fair value in accordance with
SFAS 115. This portfolio is summarized as follows:
December 31, 1997
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Description Cost Gains Losses Value
----------- ------------ ---------- ---------- ------------
U.S. Treasury Notes $ 1,998,340 21,660 - 2,020,000
FHLB Notes 39,411,741 54,604 122,642 39,343,703
---------- ------- ------- ----------
$ 41,410,081 76,264 122,642 41,363,703
========== ======= ======= ==========
Weighted average interest rate 5.68%
====
December 31, 1996
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Description Cost Gains Losses Value
----------- ------------ ---------- ---------- -----------
FHLB Notes $ 47,295,638 26,027 730,602 46,591,063
========== ======= ======= ==========
Weighted average interest rate 5.83%
====
During the years ended December 31, 1997 and 1996, the Company sold no
securities from this portfolio. During the year ended December 31, 1995,
the Company sold securities realizing gross proceeds of $3,003,750, and
profits of $3,750. In addition, during the current period, the decrease in
net unrealized losses of $658,197, net of the tax effect of $269,861,
resulted in a $388,336 credit to stockholders' equity.
The contractual maturity of the above investments are summarized as
follows:
December 31, 1997 December 31, 1996
------------------------ ----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ---------- ---------- ----------
Term to Maturity
----------------
Due in one year or less $ 12,997,723 12,950,156 999,599 1,005,625
Due after one year
through five years 16,497,741 16,511,719 32,883,750 32,429,594
Due after five years
through ten years 11,416,923 11,400,109 12,914,761 12,655,219
Due after ten years
through twenty years 497,694 501,719 497,528 500,625
-------- ------- ---------- ----------
$ 41,410,081 41,363,703 47,295,638 46,591,063
========== ========== ========== ==========
-57-
3) Mortgage-Backed Securities, Available for Sale
----------------------------------------------
Mortgage-backed securities available for sale are recorded at fair value in
accordance with SFAS 115. This portfolio is summarized as follows:
December 31, 1997
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Description Cost Gains Losses Value
- ----------- ------------ ---------- ---------- ---------
FHLMC participation
certificates - fixed rate $ 885,454 116,023 - 1,001,477
GNMA participation
certificates - fixed rate 2,497,306 76,529 - 2,573,835
FHLMC participation
certificates - adjustable rate 1,759,116 2,311 10,968 1,750,459
FNMA participation
certificates - adjustable rate 6,724,687 127,692 5,772 6,846,607
CMOs - adjustable rate 992,603 4,368 - 996,971
REMICs - adjustable rate 7,981,591 - 238,401 7,743,190
------------ ------- ------- ----------
$ 20,840,757 326,923 255,141 20,912,539
============ ======= ======= ==========
Weighted average interest rate 6.47%
====
December 31, 1997
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Description Cost Gains Losses Value
- ----------- ------------ ---------- ---------- ---------
FHLMC participation
certificates - fixed rate $ 2,674,560 116,848 37,381 2,754,027
GNMA participation
certificates - fixed rate 11,895,149 67,395 296,789 11,665,755
FHLMC participation
certificates - adjustable rate 1,929,507 128 32,597 1,897,038
FNMA participation
certificates - adjustable rate 7,679,426 75,433 13,190 7,741,669
CMOs - adjustable rate 1,218,251 - 30,456 1,187,795
REMICs - adjustable rate 7,978,864 - 384,801 7,594,063
------------ ------- ------- ----------
$ 33,375,757 259,804 795,214 32,840,347
============ ======= ======= ==========
Weighted average interest rate 6.61%
====
During the current year, the Company sold mortgage-backed securities realizing
gross proceeds of $9,796,533, and profits of $5,940 offset by losses of $53,071.
There were no sales from this portfolio during the years ended December 31, 1996
and 1995.
In addition, during the current period, the increase in net unrealized gains of
$607,192, net of the tax effect of $248,949, resulted in a $358,243 credit to
stockholders' equity.
-58-
4) Loans Receivable
----------------
Loans receivable are summarized as follows:
December 31,
--------------------------
1997 1996
------------- -----------
Mortgage loans:
One-to-four family $176,007,428 167,303,458
Multi-family 51,248,448 50,504,361
Commercial 28,956,543 26,533,773
Construction and land acquisition
and improvement projects 14,746,040 21,966,870
------------ -----------
Total mortgage loans 270,958,459 266,308,462
------------ -----------
Other loans:
Secured lines of credit 8,798,198 7,215,168
Loans on deposits 144,406 112,799
------------ -----------
Total other loans 8,942,604 7,327,967
------------ -----------
Total loans receivable 279,901,063 273,636,429
------------ -----------
Less:
Loans in process 5,493,174 7,187,535
Deferred loan fees and discounts 3,040,153 3,266,612
Allowance for loan losses 775,443 751,443
------------ -----------
Loans receivable, net $270,592,293 262,430,839
============ ===========
Weighted average interest rate 8.11% 8.14%
==== ====
There were eight loans delinquent three months or more and non-accruing totaling
$670,859, .2% of total loans in force as of December 31, 1997. Comparable
figures for 1996 were ten loans totaling $811,463, .3% of total loans. The
Association has established a general loan loss reserve of $775,443 as required
by its internal policies.
For the years ended December 31, 1997 and 1996, gross interest income which
would have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to approximately $28,000 and $18,600,
respectively.
A summary of changes in the allowance for losses on loans is as follows:
Years Ended December 31,
---------------------------
1997 1996 1995
---- ---- ----
Balance, beginning of year $751,443 753,797 737,797
Provision for loan losses 24,000 24,000 16,000
Charge-offs - (26,354) -
-------- ------- -------
Balance, end of year $775,443 751,443 753,797
======== ======= =======
The Association is required to maintain qualifying collateral for the Federal
Home Loan Bank of Chicago (the "Bank") representing approximately 170 percent of
current Bank credit. At December 31, 1997, the Association met this requirement.
Qualifying collateral is defined as fully disbursed, whole first mortgage loans
on improved residential property. The mortgages must not be past due more than
90 days. They must not be otherwise pledged or encumbered as security for other
indebtedness, and the documents must be in the physical possession or control of
the Association. The documents that govern the determination of the qualifying
mortgage collateral are the (a) Federal Home Loan Bank of Chicago's Credit
Policy Statement, dated February 1, 1993, and (b) the Advances, Collateral
Pledge and Security Agreement between the Association and the Federal Home Loan
Bank of Chicago.
-59-
5) Loans Receivable, Held for Sale
-------------------------------
During the year ended December 31, 1995, the Association entered into
agreements to sell 100% interests in approximately $3,000,000 in fixed rate
mortgage loans to the Federal Home Loan Mortgage Corporation, with the
Association retaining servicing for such loans. The Association realized
profits of $13,689 on these transactions. No such activity took place
during the years ended December 31, 1997 and 1996. Loans serviced for
others totaled approximately $6,644,500, $7,559,200 and $10,473,900 at
December 31, 1997, 1996 and 1995 respectively.
6) Other Investments, Available for Sale
-------------------------------------
These investments have been designated as available for sale and are
recorded at fair value in accordance with SFAS 115. This portfolio is
summarized as follows:
December 31, 1997 December 31, 1996
-------------------- --------------------
Amortized Fair Amortized Fair
Description Cost Value Cost Value
----------- --------- ------- --------- -------
Investment in common stock
of various entities $ 355,247 550,384 485,006 662,629
Municipal bonds 100,000 100,000 130,000 130,000
Agency for International
Development certificates - - 3,934 3,934
Adjustable Rate Mortgage
Portfolio Fund - - 6,648,796 6,631,175
--------- --------- --------- ---------
$ 455,247 650,384 7,267,736 7,427,738
========= ========= ========= =========
During the current period, the Company sold securities realizing gross
proceeds of $7,001,388, and profits of $222,834. During the year ended
December 31, 1996, the Company sold securities realizing gross proceeds of
$4,065,375, and profits of $4,313. During the year ended December 31,
1995, the Company sold securities realizing gross proceeds of $778,875, and
profits of $113,694 offset by losses of $2,700. In addition, the increase
in net unrealized gains of $35,135, net of the tax effect of $14,404,
resulted in a $20,731 credit to stockholders' equity.
-60-
7) Investment in Joint Ventures
----------------------------
The Company's subsidiaries participate in unconsolidated joint ventures
with third parties engaged primarily in the purchase of undeveloped land
for improvement, and construction of residential or low-income housing
properties for sale or investment. The investments in unconsolidated joint
ventures are accounted for using the equity method. These ventures are
summarized as follows:
December 31,
------------------------
1997 1996
---- ----
HSW Partners, L.P. $ 2,598,984 2,450,342
Hartz-Southwest Partnership 3,426,363 2,907,538
Churchview Limited Partnership 615,285 694,788
Kedzie Limited Partnership 974,089 1,019,089
--------- ---------
$ 7,614,721 7,071,757
========= =========
The Company's subsidiaries have realized net profits from joint ventures of
$592,964, $675,114 and $477,447 for the years ended December 31, 1997, 1996
and 1995 respectively. Such profits are credited to the partners based
upon the various joint venture agreements, and generally range from 18% to
28% of gross profits.
Combined statements of financial condition and earnings of the
unconsolidated joint ventures as of December 31, 1997 follow:
Combined Statement of Financial Condition
-----------------------------------------
Assets:
-------
Cash....................................................... $ 1,485,611
Receivables................................................ 6,243,085
Land and development costs................................. 27,947,944
Other assets............................................... 961,282
----------
Total assets................................................. 36,637,922
==========
Liabilities:
------------
Borrowings................................................. 17,298,520
Other liabilities.......................................... 698,645
----------
Total liabilities............................................ 17,997,165
----------
Partners' capital:
------------------
Company's subsidiaries..................................... 7,614,721
Coventurer................................................. 11,026,036
----------
Total partners' capital...................................... 18,640,757
----------
Total liabilities and partners' capital...................... $ 36,637,922
==========
Combined Statement of Earnings
------------------------------
Sales of real estate..........................................$ 2,680,905
Cost of sales................................................ 1,273,245
----------
Gross profit................................................. 1,407,660
Other income................................................. 427,268
Other expense................................................ 867,935
----------
Net income................................................... $ 966,993
==========
-61-
8) Accrued Interest Receivable
---------------------------
Accrued interest receivable is summarized as follows:
December 31,
------------------------
1997 1996
---- ----
U.S. Government and agency obligations $ 625,290 689,794
Mortgage-backed securities 112,264 185,900
Loans receivable 1,477,499 1,412,091
Other investments 3,179 5,069
Allowance for uncollected interest (28,024) (18,649)
--------- ---------
$ 2,190,208 2,274,205
========= =========
9) Office Properties and Equipment
-------------------------------
Office properties and equipment are summarized as follows:
December 31,
------------------------
1997 1996
---- ----
Land $ 1,215,336 1,215,336
Buildings 1,340,063 1,355,092
Parking lot improvements 37,198 12,165
Leasehold improvements 961,418 963,577
Furniture, fixtures, and equipment 1,190,738 1,086,002
Automobiles 84,554 73,545
--------- ---------
4,829,307 4,705,717
Less accumulated depreciation 1,922,705 1,625,843
--------- ---------
$ 2,906,602 3,079,874
========= =========
Depreciation of office properties and equipment for the years ended
December 31, 1997, 1996 and 1995 amounted to $374,878, $388,966 and
$300,571 respectively.
At December 31, 1997, the minimum rental commitments under the current
leases for office space at the Hometown and Oak Lawn branch locations are
approximately as follows:
1998 $ 298,603
1999 307,561
2000 316,788
Thereafter through 2006 2,110,589
---------
$ 3,033,541
=========
The above amounts are exclusive of future escalation charges for real
estate taxes, insurance, and other costs of occupancy relating to common
areas shared with other tenants.
Rent expense, including real estate taxes, insurance and other costs of
occupancy, for the years ended December 31, 1997, 1996 and 1995 totaled
$304,376, $312,058 and $304,062 respectively.
-62-
10) Prepaid Expenses and Other Assets
---------------------------------
Prepaid expenses and other assets consist of the following:
December 31,
------------------------
1997 1996
---- ----
Prepaid pension costs $ 693,299 597,558
Current federal and state income tax
overpayment - net 235,600 137,276
Deferred federal and state income tax
benefit - net (a) 319,058 831,010
Other prepaid expenses 150,230 140,591
Deferred premium on sale of loans 28,942 37,303
Cash surrender value of corporate-owned
Key Person recovery insurance 3,723,160 3,618,179
Accounts receivable and other assets 278,580 378,453
---------- ---------
$ 5,428,869 5,740,370
========= =========
(a) The approximate tax effect of temporary differences that give rise to
the Company's net deferred tax asset at December 31, 1997 and 1996
under SFAS 109 is as follows:
December 31, 1997 Assets Liabilities Net
- ----------------- ------ ----------- ---
Loan fees deferred for financial
reporting purposes $ 757,381 - 757,381
Bad debt reserves established for
financial reporting purposes 374,740 - 374,740
Increases to tax bad debt
reserves since January 1, 1988 - 1,312,617 (1,312,617)
Non-qualified pension plan expense 920,058 - 920,058
Prepaid pension contribution - 209,185 (209,185)
Accelerated depreciation
for tax purposes - 115,977 (115,977)
Unrealized gain on securities
available for sale - 95,342 (95,342)
--------- --------- ---------
$ 2,052,179 1,733,121 319,058
========= ========= =========
December 31, 1996 Assets Liabilities Net
- ----------------- ------ ----------- ---
Loan fees deferred for financial
reporting purposes $ 900,971 - 900,971
Bad debt reserves established for
financial reporting purposes 364,900 - 364,900
Increases to tax bad debt
reserves since January 1, 1988 - 1,575,140 (1,575,140)
Non-qualified pension plan expense 906,875 - 906,875
Nondeductible incentive plan expense 66,052 - 66,052
Deferred compensation 2,863 - 2,863
Prepaid pension contribution - 163,533 (163,533)
Accelerated depreciation
for tax purposes - 97,933 (97,933)
Unrealized loss on securities
available for sale 442,792 - 442,792
Other items - 16,837 (16,837)
--------- --------- ---------
$ 2,684,453 1,853,443 831,010
========= ========= =========
-63-
11) Deposits
--------
Deposit accounts are summarized as follows:
December 31,
--------------------------
1997 1996
---- ----
Passbooks $ 45,923,002 47,317,170
Certificates 175,696,377 172,686,390
NOW and money market accounts 61,433,679 60,430,404
----------- -----------
Total $ 283,053,058 280,433,964
=========== ===========
The composition of deposit accounts by interest rate is as follows:
December 31,
--------------------------
1997 1996
---- ----
Non-interest bearing $ 2,747,131 2,128,609
2.00 - 3.99% 104,609,550 105,618,965
4.00 - 4.99 4,204,422 3,739,345
5.00 - 5.99 117,730,267 118,665,425
6.00 - 6.99 53,761,688 50,281,620
----------- -----------
Total $ 283,053,058 280,433,964
=========== ===========
The weighted average interest rate on deposit accounts at December 31,
1997 and 1996 was 4.71% and 4.62% respectively.
A summary of certificates of deposit that mature during the twelve-month
periods indicated is as follows:
December 31,
--------------------------
1997 1996
---- ----
Twelve month period ended December 31, 1997 $ - 114,038,513
Twelve month period ended December 31, 1998 134,973,856 45,714,995
Twelve month period ended December 31, 1999 27,680,918 12,932,882
Twelve month period ended December 31, 2000 13,041,603 -
----------- -----------
Total $ 175,696,377 172,686,390
=========== ===========
Interest expense on deposits consists of the following:
Years Ended December 31,
---------------------------------
1997 1996 1995
---- ---- ----
Passbooks $ 1,425,180 1,440,999 1,466,245
Certificates 9,742,534 8,583,706 8,036,392
NOW and money market accounts 1,850,036 1,862,811 1,893,032
---------- --------- ----------
Total $ 13,017,750 11,887,516 11,395,669
========== ========== ==========
The aggregate amount of deposit accounts with a balance of $100,000 or
greater was approximately $42,800,000 and $36,600,000 at December 31, 1997
and 1996, respectively. Deposits in excess of $100,000 are not insured by
the Federal Deposit Insurance Corporation.
-64-
12) Federal Home Loan Bank Advances
-------------------------------
Advances consist of the following:
December 31,
Interest --------------------------
Maturity Date Rate 1997 1996
------------- -------- ---- ----
1/03/97 5.55% $ - 2,000,000
2/10/97 4.80 (a) - 1,408,265
2/11/97 4.80 (a) - 3,000,000
3/01/97 6.97 (a) - 2,300,000
4/18/97 6.57 (a) - 2,300,000
5/02/97 6.75 (a) - 1,300,000
5/10/97 6.39 - 3,000,000
6/02/97 5.77 - 3,000,000
11/21/97 5.66 - 4,000,000
5/08/98 6.68 3,000,000 3,000,000
5/27/98 5.74 2,000,000 2,000,000
6/21/98 6.37 (a) 500,000 500,000
9/07/98 6.18 5,000,000 5,000,000
9/29/98 7.32 (a) 3,700,000 3,700,000
11/15/98 5.94 3,000,000 3,000,000
12/01/98 5.60 3,000,000 3,000,000
1/22/99 8.19 3,000,000 3,000,000
9/16/99 7.40 5,000,000 5,000,000
2/21/00 6.08 2,000,000 -
5/16/00 6.76 2,000,000 2,000,000
8/28/00 6.26 (a) 450,000 450,000
9/10/01 7.00 (a) 1,200,000 1,200,000
---------- ----------
$ 33,850,000 54,158,265
========== ==========
Weighted average interest rate 6.76% 6.37%
==== ====
(a) Subject to terms and conditions of the Affordable Housing and Community
Investment Programs.
Interest is accrued on advances and recorded in other liabilities. Interest
expense on advances totaled $3,024,494, $3,363,461 and $2,994,820 for the
years ended December 31, 1997, 1996 and 1995 respectively. See note 4 of
the consolidated financial statements for collateral securing this
indebtedness.
-65-
13) Other Borrowed Money
--------------------
Other borrowed money is summarized as follows:
December 31,
------------------------
Description 1997 1996
----------- ---- ----
Securities sold under agreements
to repurchase; maturing 1/15/97 $ - 1,000,000
========= =========
Weighted average interest rate - % 5.70%
==== ====
During the years ended December 31, 1997 and 1996, the Company entered into
sales of securities under agreements to repurchase (repurchase agreements).
These transactions are accounted for as financings, and the obligation to
repurchase securities sold are reflected as borrowed money in the
consolidated statements of financial condition, while the securities sold
continue to be accounted for as assets. The securities sold under
agreements to repurchase consisted of mortgage-backed securities, and were
held in the Company's account with the broker who arranged the transaction.
Interest expense incurred on this type of transaction amounted to $8,060
and $25,523 for the years ended December 31, 1997 and 1996 respectively.
Activity in repurchase agreements is summarized as follows:
Years Ended December 31,
--------------------------
1997 1996
---- ----
Average balance during the year $ 142,466 458,333
Maximum month-end balance
during the year 1,000,000 1,000,000
Average interest rate
during the year 5.62% 5.53%
Mortgage-backed securities
underlying the agreements at year end:
Amortized cost - 1,100,000
Fair value $ - 1,042,250
In addition, in connection with the Company's initial public offering, the
Association established an Employee Stock Ownership Plan (ESOP). The ESOP
was funded by the proceeds from a $2,240,000 loan from an unaffiliated
third-party lender. During 1994, the Company assumed this loan on
essentially the same terms as the original lender. The loan carries an
interest rate of one-eighth of one percent under prime rate, and matures in
the year 1999. The loan is secured by the shares of the Company purchased
with the loan proceeds. The Association has committed to make contributions
to the ESOP sufficient to allow the ESOP to fund the debt service
requirements of the loan.
-66-
14) Other Liabilities
-----------------
Other liabilities consist of the following:
December 31,
------------------------
1997 1996
---- ----
Accrued interest on deposits $ 124,000 104,000
Accrued interest on borrowed money 195,085 299,351
Accrued real estate taxes 196,000 184,287
Accrued audit fees 37,950 31,250
Accrued cost of non-qualified supplemental
retirement plan 2,427,136 2,410,586
Deferred and accrued compensation - 6,982
Promissory note for capital contribution
due Churchview Limited Partnership 275,000 275,000
Promissory note for capital contribution
due Kedzie Limited Partnership 994,089 994,089
Payments received, not yet remitted, on
loans serviced for others 48,585 57,054
Loan fees paid by borrowers on pending
loan applications 13,940 11,008
Accounts payable - insurance companies 19,112 13,088
Accrued merger expenses 141,804 -
Miscellaneous accounts payable 193,484 188,403
--------- ---------
$ 4,666,185 4,575,098
========= =========
-67-
15) Retirement Plan
---------------
The Association has established a qualified defined benefit pension plan
which covers all full-time employees having a minimum of one year of
service, and who are at least twenty-one years of age. The present funding
policy is to make the maximum annual contribution allowed by applicable
regulations. The plan is currently being funded by the purchase of non-
insurance investments. Contributions to the plan for the years ended
December 31, 1997, 1996 and 1995 amounted to $176,146, $149,394, and
$173,517 respectively. As of December 31, 1997, no unfunded accumulated
benefit obligation exists, and therefore, no additional liability is
required. The following table sets forth the plan's funded status at
December 31:
1997 1996 1995
---- ---- ----
Projected benefit obligation $ 2,513,200 2,933,900 2,768,600
Less plan assets at market value 3,000,500 3,434,400 3,169,300
--------- --------- ---------
Plan assets in excess of
projected benefits 487,300 500,500 400,700
Unrecognized net assets (204,000) (216,700) (229,500)
Unrecognized net loss 226,900 115,100 147,000
---------- -------- ---------
Prepaid pension costs $ 510,200 398,900 318,200
========== ======== =========
Net pension expense for the years ended December 31, 1997, 1996 and 1995 is
being accounted for per Financial Accounting Standards Board Statement No.
87, "Employers' Accounting for Pensions" and includes the following
components:
1997 1996 1995
---- ---- ----
Service cost-benefits earned
during the year $ 146,500 154,000 135,300
Interest cost on projected
benefit obligation 211,700 186,200 165,000
Actual return on plan assets (280,700) (258,700) (210,200)
Net amortization and deferrals (12,700) (12,800) (12,700)
-------- -------- --------
Net periodic pension cost $ 64,800 68,700 77,400
======== ======== ========
The discount rate used in determining the actuarial present value of the
projected benefit obligation at the beginning of the year to determine the
net periodic pension cost and at the end of the year for the present value
of the benefit obligation during 1997, 1996 and 1995 was 7.00%, 7.25% and
6.75% respectively. The expected long-term rate of return on assets was
8.0% during 1997, 1996 and 1995 and the rate of increase in future
compensation was 4.5% in 1997, 1996 and 1995.
-68-
16) Other Employee Benefits
-----------------------
The Association has established a non-qualified supplemental retirement
plan for the benefit of certain key officers. This plan was effective
October 1, 1988, and is being funded through the purchase of life insurance
contracts. The funded status of the Association's non-qualified
supplemental retirement plan is shown below as of December 31:
1997 1996 1995
---- ---- ----
Projected benefit obligation
(actuarial present value of projected
benefits attributed to key officers'
service to date based on future
compensation levels) $ 2,427,136 2,410,586 2,463,541
Plan assets at market value - - -
--------- --------- ---------
Funded status 2,427,136 2,410,586 2,463,541
Unrecognized prior service cost (183,091) (198,696) (261,776)
Unrecognized net loss (206,741) (160,137) (342,358)
--------- --------- ---------
Accrued pension cost 2,037,304 2,051,753 1,859,407
Additional minimum liability 389,832 358,833 604,134
--------- --------- ---------
Minimum liability $ 2,427,136 2,410,586 2,463,541
========= ========= =========
The additional minimum liability required to be recognized currently
exceeds unrecognized net obligation and prior service costs. As a result,
this excess has been charged to retained earnings, net of the applicable
tax benefit.
Included in the projected benefit obligation is an amount called the
accumulated benefit obligation. The accumulated benefit obligation
represents the actuarial present value of benefits attributed to employee
service and compensation levels to date. At December 31, 1997, the
accumulated benefit obligation was $2,427,136. The vested portion was
$2,427,136.
Plan expense for the years ended December 31, 1997, 1996 and 1995 is being
accounted for per Financial Accounting Standards Board Statement No. 87,
"Employers' Accounting for Pensions" and includes the following components:
1997 1996 1995
---- ---- ----
Service cost-benefits earned
during the year $ - - -
Interest cost on projected
benefit obligation 178,138 182,316 155,007
Net amortization and deferrals 15,605 69,931 51,647
------- ------- -------
$ 193,743 252,247 206,654
======= ======= =======
-69-
17) Officer, Director and Employee Plans
------------------------------------
Stock Option Plans In conjunction with the Conversion, the Company adopted
------------------
an incentive stock option plan for the benefit of the officers and
employees of the Company and its affiliates and a director's stock option
plan for the benefit of outside directors of the Company. The number of
options on shares of common stock authorized under the Employees' Plan was
321,600. As of December 31, 1997, 306,600 options had been granted at $6.67
per share. Options granted under the Employees' Plan are exercisable at a
rate of 20% per year commencing June 23, 1993. During 1997, 64,618 options
had been exercised under this Plan. As of December 31, 1997, stock options
to purchase 57,730 shares remain outstanding in the Employees' Plan. The
number of options on shares of common stock authorized under the Directors'
Plan was 98,400. As of December 31, 1997, stock options to purchase 92,400
shares had been granted at a price of $6.67 per share and are exercisable
immediately. During 1997, 18,600 options had been exercised under this
Plan. As of December 31, 1997, stock options to purchase 15,200 shares
remain outstanding in the Directors' Plan. The term of the options issued
under both Plans expires ten years from the date of grant (June 23, 1992),
or one year from the date of death, disability or retirement of the
optionee. The following is an analysis of the stock option activity for
each of the years in the three year period ended December 31, 1997 and the
stock options outstanding at the end of the respective periods.
Exercise Price
----------------------
Options Number of Options Per Share Total
------- ----------------- --------- ----------
Outstanding at January 1, 1995 284,063 $ 6.67 $1,894,280
Granted 0 0
Exercised (37,350) 6.67 (249,000)
------- ------- ---------
Outstanding at December 31, 1995 246,713 6.67 1,645,280
Granted 0
Exercised (90,565) 6.67 (603,773)
------- ------- ---------
Outstanding at December 31, 1996 156,148 6.67 1,041,507
Granted 0
Exercised (83,218) 6.67 (555,064)
------- ------- ---------
Outstanding at December 31, 1997 72,930 $ 6.67 $ 486,443
======= ======= =========
Exercisable at December 31, 1997 72,930 $ 6.67 $ 486,443
======= ======= =========
Options available for future
grants at December 1997 24,360
=======
The Company has elected to follow Accounting Principles Board Opinion No.
25 "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options equals
the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The Company implemented SFAS No. 123 "Accounting for Stock-Based
Compensation" during 1996. The Company will retain its current accounting
method for its stock-based compensation plans. This statement will only
result in additional disclosures for the Company, and as such, its adoption
did not, nor is it expected to have, a material impact on the Company's
financial condition or its results of operations.
-70-
17) Officer, Director and Employee Plans, (continued)
-------------------------------------------------
Employee Stock Ownership Plan In conjunction with the Conversion, the
-----------------------------
Association formed an Employee Stock Ownership Plan ("ESOP"). The ESOP
covers substantially all employees with more than one year of employment
and who have attained the age of 21. The ESOP borrowed $2,240,000 from an
unaffiliated third-party lender and purchased 336,000 common shares issued
in the Conversion. The debt was assumed by the Company in 1994. The
Association will make scheduled discretionary cash contributions to the
ESOP sufficient to service the amount borrowed. In accordance with
generally accepted accounting principles, the unpaid balance of the ESOP
loan, which is comparable to unearned compensation, is reported as a
reduction of stockholders' equity. Total contributions by the Association
to the ESOP which were used to fund principal and interest payments on the
ESOP debt totaled $289,198, $283,663 and $290,390 for the years ended
December 31, 1997, 1996 and 1995 respectively.
Association Recognition and Retention Plan In conjunction with the
------------------------------------------
Conversion, the Company formed an Association Recognition and Retention
Plan ("RRP"), which was authorized to acquire 4% of the shares of common
stock in the Conversion. The total shares authorized were awarded to
directors and to employees in key management positions in order to provide
them with a proprietary interest in the Company in a manner designed to
encourage such employees to remain with the Company.
Subsequent to the Conversion, the entire balance of shares of common stock
required to fund the RRP (168,000 shares) were purchased by the RRP
trustees in the open market. The RRP trustees completed the purchase of the
shares in the open market at prices ranging from a low of $8.00 to a high
of $8.17 per share.
The $1,353,178 contributed to the RRP is being amortized to compensation
expense as the plan participants become vested in those shares. As of
December 31, 1997, all of the shares had been awarded and vested, and the
entire amount of deferred compensation expense had been recognized. For the
years ended December 31, 1997, 1996 and 1995 respectively, $122,271,
$244,543 and $244,543 had been amortized to expense.
-71-
18) Income Taxes
------------
The Company has adopted Statement of Financial Accounting Standards No. 109
(SFAS 109) which requires a change from the deferred method to the
liability method of accounting for income taxes. Under the liability
method, deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying statutory tax rates applicable to
future years to differences between the financial statement carrying
amounts and tax bases of existing assets and liabilities.
Among the provisions of SFAS 109 which impact the Company is the tax
treatment of bad debt reserves. SFAS 109 provides that a deferred tax asset
is to be recognized for the bad debt reserve established for financial
reporting purposes and requires a deferred tax liability to be recorded for
increases in the tax bad debt reserve since January 1, 1988, the effective
date of certain changes made by the Tax Reform Act of 1986 to the
calculation of savings institutions' bad debt deduction. Accordingly,
retained earnings at December 31, 1997 includes approximately $4,358,000
for which no deferred federal income tax liability has been recognized.
The provision for income taxes consists of the following:
Years Ended December 31,
--------------------------------------------
1997 1996 1995
---- ---- ----
Current $2,002,428 1,098,891 1,937,573
Deferred (benefit) (7,076) 106,920 236,763
--------- --------- ---------
$1,995,352 1,205,811 2,174,336
========= ========= =========
A reconciliation of the statutory federal income tax rate to effective
income tax rate is as follows:
Years Ended December 31,
---------------------------
1997 1996 1995
---- ---- ----
Statutory federal income tax rate 34.0% 34.0 34.0
State income taxes 2.3 2.2 3.4
Tax credits (2.0) (3.2) (1.8)
Other (1.6) (1.5) (3.2)
---- ---- ----
Effective income tax rate 32.7% 31.5 32.4
==== ==== ====
Deferred income tax expense (benefit) consists of the following tax effects
of timing differences:
Years Ended December 31,
-----------------------------------
1997 1996 1995
---- ---- ----
Loan fees $ 143,590 161,452 103,041
Compensation related expenses 120,491 (52,470) (4,836)
Depreciation 18,044 10,083 (17,564)
Book loan loss provision (in
excess of) less than tax deduction (9,840) (9,915) 137,055
Recapture of tax bad debt reserve (262,523) -- --
Other, net (16,838) (2,230) 19,067
-------- ------- -------
$ (7,076) 106,920 236,763
======== ======= =======
-72-
19) Regulatory Capital Requirements
-------------------------------
Capital regulations require the Association to have a minimum regulatory
tangible capital ratio equal to 1.5% of total adjusted assets, a minimum
3.0% core capital ratio, and an 8.0% risk-based capital ratio. In meeting
the core, tangible and risk-based capital ratios, savings institutions must
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank.
In determining compliance with the risk-based capital requirement, the
Association is allowed to use both core capital and supplementary capital
provided the amount of supplementary capital used does not exceed the
Association's core capital. Supplementary capital of Southwest Federal
Savings and Loan Association of Chicago is defined to include all of the
Association's general loss allowances. The risk-based capital requirement
is measured against risk-weighted assets which equals the sum of each asset
and the credit-equivalent amount of each off-balance sheet item after being
multiplied by an assigned risk weight.
At December 31, 1997 and 1996, the Association's regulatory equity capital
was as follows:
Tangible Core Risk-based
Capital Capital Capital
---------- ---------- ----------
December 31, 1997
-----------------
Stockholders' equity $ 32,783,473 32,783,473 32,783,473
Non-includable subsidiary (3,454,059) (3,454,059) (3,466,059)
Unrealized gains on securities
available for sale, net of taxes (46,972) (46,972) (46,972)
General loss allowances - - 775,443
---------- ---------- ----------
Regulatory capital computed 29,282,442 29,282,442 30,045,885
Minimum capital requirement 5,357,000 10,714,000 17,391,000
---------- ---------- ----------
Regulatory capital excess $ 23,925,442 18,568,442 12,654,885
========== ========== ==========
Computed capital ratio 8.20% 8.20% 13.82%
Minimum capital ratio 1.50 3.00 8.00
---- ---- -----
Regulatory capital excess 6.70% 5.20% 5.82%
==== ==== =====
December 31, 1996
-----------------
Stockholders' equity $ 30,715,043 30,715,043 30,715,043
Non-includable subsidiary (3,162,471) (3,162,471) (3,174,471)
Unrealized losses on securities
available for sale, net of taxes 634,089 634,089 634,089
General loss allowances - - 751,443
---------- ---------- ----------
Regulatory capital computed 28,186,661 28,186,661 28,926,104
Minimum capital requirement 5,565,000 11,131,000 14,728,000
---------- ---------- ----------
Regulatory capital excess $ 22,621,661 17,055,661 14,198,104
========== ========== ==========
Computed capital ratio 7.60% 7.60% 15.71%
Minimum capital ratio 1.50 3.00 8.00
---- ---- -----
Regulatory capital excess 6.10% 4.60% 7.71%
==== ==== =====
-73-
20) Stockholders' Equity
--------------------
As part of the Conversion, the Association established a liquidation
account for the benefit of all eligible depositors who continue to
maintain their deposit accounts in the Association after conversion. In
the unlikely event of a complete liquidation of the Association, each
eligible depositor will be entitled to receive a liquidation
distribution from the liquidation account, in the proportionate amount
of the then current adjusted balance for deposit accounts held, before
distribution may be made with respect to the Association's capital
stock. The Association may not declare or pay a cash dividend to the
Company on, or repurchase any of, its capital stock if the effect
thereof would cause the retained earnings of the Association to be
reduced below the amount required for the liquidation account. Except
for such restrictions, the existence of the liquidation account does
not restrict the use or application of retained earnings.
The Association's capital exceeds all of the fully phased-in capital
requirements imposed by FIRREA. OTS regulations generally provide that
an institution that exceeds all fully phased-in capital requirements
before and after a proposed capital distribution could, after prior
notice but without the approval by the OTS, make capital distributions
during the fiscal year of up to 100% of its net income to date during
the fiscal year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in
capital requirements) at the beginning of the fiscal year. Any
additional capital distributions would require prior regulatory
approval.
Unlike the Association, the Company is not subject to these regulatory
restrictions on the payment of dividends to its stockholders. However,
the Company's source of funds for future dividends may depend upon
dividends received by the Company from the Association.
21) Financial Instruments with Off-Balance Sheet Risk
-------------------------------------------------
The Company is a party to various financial instruments with off-balance
sheet risk in the normal course of business. These instruments include
commitments to extend credit, credit enhancement agreements, and letters of
credit. These financial instruments carry varying degrees of credit and
interest-rate risk in excess of amounts recorded in the consolidated
financial statements.
Commitments to originate mortgage loans of $5,450,500 at December 31, 1997
represent amounts which the Association plans to fund within the normal
commitment period of 60 to 90 days. Of this amount, $4,572,500 are in fixed
rate commitments with rates ranging from 6.50% to 8.25%, and $878,000 are
in adjustable rate commitments. In addition, the Association is committed
to fund an additional $2,983,000 in loan participation purchases at
adjustable rates. Because the credit worthiness of each customer is
reviewed prior to extension of the commitment, the Association adequately
controls its credit risk on these commitments, as it does for loans
recorded on the balance sheet. The Association conducts all of its lending
activities in the Chicagoland area in which it serves. Management believes
the Association has a diversified loan portfolio and the concentration of
lending activities in these local communities does not result in an acute
dependency upon economic conditions of the lending region.
The Company and the Association have approved, but unused, equity lines of
credit of approximately $8,470,000 at December 31, 1997. Approval of lines
of credit is based upon underwriting standards and limitations similar to
conventional and construction lending. The Association is also committed to
fund an additional investment of $284,000 in notes secured by adjustable
rate mortgage loans issued by the Community Investment Corporation.
The Association has issued outstanding letters of credit totaling
approximately $3,410,000 to various municipalities regarding incomplete
construction projects on which the Association had originated mortgage
loans, or regarding builders with whom the Association has had long
standing relationships.
The Federal Home Loan Bank of Chicago has issued a standby letter of credit
for $3,000,000 to the State of Illinois on behalf of the Association in
order to secure a deposit of $3,000,000.
-74-
22) Contingencies
-------------
The Association is, from time to time, a party to certain lawsuits arising
in the ordinary course of its business, wherein it enforces its security
interest. Management, based upon discussions with legal counsel, believes
that the Company and the Association are not engaged in any legal
proceedings of a material nature at the present time.
23) SAIF Special Assessment and its Impact on SAIF Insurance Premiums
-----------------------------------------------------------------
The deposits of savings associations, such as Southwest Federal Savings and
Loan Association, are presently insured by the Savings Association
Insurance Fund ("SAIF"), which together with the Bank Insurance Fund
("BIF"), are the two insurance funds administered by the Federal Deposit
Insurance Corporation ("FDIC"). Financial institutions which are members of
the BIF were experiencing substantially lower deposit insurance premiums
because the BIF had achieved its required level of reserves while the SAIF
had not yet achieved its required reserves. In order to help eliminate this
disparity and any competitive disadvantage due to disparate deposit
insurance premium schedules, legislation to recapitalize the SAIF was
enacted in September 1996.
The legislation required a special one-time assessment of 65.7 cents per
$100 of SAIF insured deposits held by the Association at March 31, 1995.
The one-time special assessment resulted in a charge to earnings of
approximately $1,698,000 during the year ended December 31, 1996. The
after-tax effect of this one-time charge to earnings totaled approximately
$1,002,000. The legislation was intended to fully recapitalize the SAIF
fund so that commercial bank and thrift deposits would be charged the same
FDIC premiums beginning January 1, 1997. As of such date, deposit insurance
premiums for highly rated institutions, such as the Association, have been
substantially reduced.
The Association, however, will continue to be subject to an assessment to
fund repayment of the Financing Corporation's ("FICO") obligations. The
FICO assessment for SAIF insured institutions will be 6.48 cents per $100
of deposits while BIF insured institutions will pay 1.52 cents per $100 of
deposits until the year 2000 when the assessment will be imposed at the
same rate on all FDIC insured institutions.
24) Proposed Merger
---------------
On December 16, 1997, the Board of Directors approved a definitive
agreement to merge with Alliance Bancorp of Hinsdale, Illinois. Pursuant to
the merger agreement, which is subject to shareholder and regulatory
approval, each common share of Southwest Bancshares, Inc. common stock will
be exchanged for 1.1981 shares of Alliance Bancorp common stock, subject to
adjustment based on the current value of Alliance Bancorp common stock at
the effective date. Concurrent with the execution of the definitive
agreement, Southwest Bancshares, Inc. has granted Alliance Bancorp an
option to purchase on amount of shares equal to 9.9% of its outstanding
common stock, which option is exercisable in certain circumstances. The
transaction is expected to close prior to June 30, 1998.
-75-
25) Disclosures About the Fair Value of Financial Instruments
---------------------------------------------------------
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value:
Cash and cash equivalents: For cash and interest-bearing deposits, the
carrying amount is a reasonable estimate of fair value.
U.S. Government and agency obligations: Fair values for securities are
based on quoted market prices as published in financial publications.
Mortgage-backed securities: Fair values for mortgage-backed securities are
based on average quotes received from a third-party broker.
Loans receivable: The fair values of fixed-rate one-to-four family
residential mortgage loans are based on quoted market prices of similar
loans sold in conjunction with securitization transactions. The fair values
for other fixed-rate mortgage loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms and collateral to borrowers of similar credit quality. For
adjustable-rate loans which reprice monthly and with no significant change
in credit risk, fair values approximate carrying values.
Other investments: Fair values for other investments are based on quoted
market prices received from third-party sources.
Investment in joint ventures: The Company's subsidiaries are partners in
real estate ventures engaged primarily in the purchase of undeveloped land
for improvement, and construction of residential or low-income housing
properties for sale or investment. There are no quoted market prices for
these venture interests and no stated rate of return. It is not practicable
to estimate the fair value of the investment in these ventures because of
the limited information available to the Company's subsidiaries and because
of the significant cost involved to obtain an outside appraisal. These
investments are being accounted for using the equity method.
Deposit liabilities: The fair value of demand deposits, savings accounts
and money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed maturity certificates of deposit is estimated
by discounting the future cash flows using the rates currently offered for
deposits of similar original maturities.
Borrowed money: Rates currently available to the Company for debt with
similar terms and original maturities are used to estimate fair value of
existing debt.
Financial instruments with off-balance sheet risk: Fair values of the
Company's off-balance sheet financial instruments, which consist of loan
commitments and letters of credit, are based on fees charged to enter into
these agreements. As the Company currently charges no fees on these
instruments, no estimate of fair value has been made.
-76-
25) Disclosures About the Fair Value of Financial Instruments (continued)
---------------------------------------------------------------------
The estimated fair values of the Company's financial instruments as of
December 31, 1997 and 1996 are as follows:
December 31, 1997
---------------------------
Carrying Fair
Amount Value
------------- ----------
Financial assets:
Cash and cash equivalents $ 13,889,932 13,889,932
U.S. Government and agency obligations,
available for sale 41,363,703 41,363,703
Mortgage-backed securities,
available for sale 20,912,539 20,912,539
Loans receivable, gross 279,901,063 283,405,600
Other investments, available for sale 650,384 650,384
Financial liabilities:
Deposits 283,053,058 283,381,700
Borrowed money 33,850,000 34,058,000
December 31, 1996
---------------------------
Carrying Fair
Amount Value
------------- ----------
Financial assets:
Cash and cash equivalents $ 11,679,587 11,679,587
U.S. Government and agency obligations,
available for sale 46,591,063 46,591,063
Mortgage-backed securities,
available for sale 32,840,347 32,840,347
Loans receivable, gross 273,636,429 272,772,800
Other investments, available for sale 7,427,738 7,427,738
Financial liabilities:
Deposits 280,433,964 281,467,600
Borrowed money 55,158,265 55,422,000
-77-
26) Condensed Parent Company Only Financial Statements
--------------------------------------------------
The following condensed statements of financial condition, as of December
31, 1997 and 1996 and condensed statements of earnings and cash flows for
the years ended December 31, 1997, 1996, and 1995 for Southwest Bancshares,
Inc. should be read in conjunction with the consolidated financial
statements and the notes thereto.
Statements of Financial Condition
---------------------------------
December 31,
---------------------------
1997 1996
---- ----
Assets
------
Cash and cash equivalents $ 3,701,994 402,451
Securities available for sale 3,472,174 4,971,446
Loans receivable 3,850,584 4,713,515
Equity investment in subsidiaries 32,483,333 31,704,547
Prepaid expenses and other assets 384,743 76,913
---------- ----------
43,892,828 41,868,872
========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Accrued taxes and other liabilities 200,052 64,378
Borrowed money - 1,000,000
Common stock 44,634 44,377
Additional paid-in capital 29,068,681 28,595,067
Retained earnings 41,901,723 40,350,942
Unrealized gain (loss) on securities,
available for sale 83,147 (3,102)
Treasury stock (27,405,409) (28,182,790)
---------- ----------
$ 43,892,828 41,868,872
========== ==========
Statements of Earnings
----------------------
Years Ended December 31,
---------------------------------
1997 1996 1995
---- ---- ----
Equity in earnings of subsidiaries $ 3,778,787 2,298,262 3,989,933
Interest and dividend income 663,113 802,521 901,223
Interest expense (8,060) (25,523) -
Fees and service charges 15,300 38,650 -
Gain on sale of investment securities
available for sale 210,605 375 113,694
Loss on sale of mortgage-backed
securities available for sale (32,116) - -
Non-interest expense (361,409) (249,209) (197,894)
Provision for federal and state
income taxes (155,594) (237,215) (275,392)
--------- --------- ---------
Net income $ 4,110,626 2,627,861 4,531,564
========= ========= =========
-78-
26) Condensed Parent Company Only Financial Statements (continued)
--------------------------------------------------------------
Statements of Cash Flows
------------------------
Years Ended December 31,
----------------------------------
1997 1996 1995
---- ---- ----
Operating activities:
Net income $ 4,110,626 2,627,861 4,531,564
Equity in earnings of subsidiaries (3,778,787) (2,298,262) (3,989,933)
Gain on sale of investment
securities, available for sale (210,605) (375) (113,694)
Loss on sale of mortgage-backed
securities, available for sale 32,116 - -
(Increase) decrease in accrued
interest receivable (139,042) (22,207) 123,283
(Increase) decrease in prepaid
taxes and other assets 74,142 189,653 65,180
Increase in accrued
taxes and other liabilities 135,674 27,773 23,509
--------- --------- ---------
Net cash provided by
operating activities 224,124 524,443 639,909
--------- --------- ---------
Investing activities:
Proceeds from maturities of
mortgage-backed securities,
available for sale 27,804 165,879 278,113
Proceeds from maturities of
investment securities, available
for sale - - 4,000,000
Proceeds from sales of investment
securities, available for sale 340,364 45,375 778,875
Proceeds from sales of
mortgage-backed securities,
available for sale 1,455,778 - -
Purchase of investment securities,
available for sale - - (250,000)
Loan disbursements (243,343) (1,610,147) (2,543,634)
Loan repayments 1,015,828 1,238,651 320,000
Participation loans sold 90,446 558,115 300,000
--------- --------- ---------
Net cash provided by
investing activities 2,686,877 397,873 2,883,354
--------- --------- ---------
Financing activities:
Proceeds from exercise of
stock options 555,064 603,773 249,000
Proceeds of borrowed money - 1,000,000 -
Repayment of borrowed money (1,000,000) - -
Dividends paid on common stock (2,041,625) (1,995,943) (2,221,158)
Payment in lieu of issuing
fractional shares - (867) -
Dividends received from subsidiary 3,000,000 6,000,000 8,000,000
Purchase of treasury stock (124,897) (8,010,942) (8,962,285)
--------- --------- ---------
Net cash provided by (for)
financing activities 388,542 (2,403,979) (2,934,443)
--------- --------- ---------
Net change in cash and cash
equivalents 3,299,543 (1,481,663) 588,820
Cash and cash equivalents at
beginning of year 402,451 1,884,114 1,295,294
--------- --------- ---------
Cash and cash equivalents at
end of year $ 3,701,994 402,451 1,884,114
========= ========= =========
-79-
Item 9. Change in and Disagreements with Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure.
--------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------------------------------------------------------------
Pursuant to its Bylaws, the number of directors of the Company is set
at seven (7) unless otherwise designated by the Board of Directors. Each of the
seven members of the Board of Directors of the Company also presently serves as
a director of the Association. Directors are elected for staggered terms of
three years each, with a term of office of only one of the three classes of
directors expiring each year. Directors serve until their successors are elected
and qualified.
The following table sets forth, as of February 25, 1998 the names of
the directors and the Named Executive Officers, as defined below, as well as
their ages, a brief description of their recent business experience, including
present occupations and employment, certain directorships held by each, the year
in which each became a director of the Association, and the year in which their
terms (or in the case of nominees, their proposed terms) as director of the
Company expire. This table also sets forth the amount of Common Stock and the
percent thereof beneficially owned by each director and Named Executive Officer
and all directors and executive officers as a group as of February 25, 1998.
Name and Principal Expiration Shares of Common Ownership
Occupation at Present Director of Term as Stock Beneficially as a Percent
and for the Past Five Years Age Since(1) Director Owned(2) of Class
--------------------------- --- -------- ---------- ------------------ ------------
Directors:
Lawrence M. Cox................................... 67 1963 2000 108,131(3) 3.97%
Dr. Cox is Chairman of the Board of Directors of
the Company and the Association. Dr. Cox has
served as a director since 1963 and as Chairman
of the Board of the Association since 1990. Dr.
Cox is a physician in the private practice of
medicine.
Robert E. Lawler.................................. 66 1990 2000 27,201(4) 1.00
Dr. Lawler has his own dental practice and is
the president of a dental corporation.
Richard E. Webber................................. 68 1959 1999 320,822(5)(6) 11.57
Mr. Webber is the President and Chief Financial
Officer of the Company and President and Chief
Executive Officer of the Association. He has
been President of the Association since 1970 and
Chief Executive Officer of the Association since
1959. Mr. Webber also serves as President, and
as a Director of Southwest Service Corporation
and Southwest Bancshares Development Corporation.
James W. Gee, Sr.................................. 80 1953 1999 36,236(4) 1.33
Retired, Mr. Gee was the owner of a lumber and
hardware store.
Joseph A. Herbert................................. 73 1977 1999 44,201 1.62
Mr. Herbert is the owner of a photographic and
electronic supply business.
80
Name and Principal Expiration Shares of Common Ownership
Occupation at Present Director of Term as Stock Beneficially as a Percent
and for the Past Five Years Age Since(1) Director Owned(2) of Class
--------------------------- --- -------- ---------- ------------------ ------------
Frank J. Muriello................................. 69 1988 1998 43,876 1.61%
Mr. Muriello owns his own real estate consulting
and appraisal firm and is Executive Director of
the Housing Authority of the Village of Oak
Park. Mr. Muriello also performs real estate
consulting and quality control appraisal
services for the Association.
Albert Rodrigues.................................. 69 1969 1998 101,920 3.75
Mr. Rodrigues retired as Executive Vice President
of the Association on December 31, 1993 and
remains as consultant to the Association, a
Director of the Company and the Association,
Executive Vice President and Director of Southwest
Service Corporation and Vice President and
Director of Southwest Bancshares Development
Corporation.
Named Executive Officers:
(who are not also directors)
- ----------------------------
Ronald D. Phares.................................. 63 -- -- 42,229(6) 1.55
Mr. Phares has been Senior Vice President and
Chief Operations Officer of the Association
since September 1988. Mr. Phares is also Vice
President and Investor Relations Officer of the
Company.
Mary A. McNally................................... 40 -- -- 45,414(6) 1.67
Ms. McNally is the Corporate Secretary of the
Company, Vice President, Secretary and Chief
Lending Officer of the Association, and
Secretary of Southwest Service Corporation and
Southwest Bancshares Development Corporation.
Michael J. Gembara................................ 38 -- -- 43,669(6) 1.61
Mr. Gembara is Vice President of the Company,
Vice President of Subsidiary Operations of the
Association and Vice President, Treasurer and
Director of Southwest Bancshares Development
Corporation and Vice President and Director of
Southwest Service Corporation.
Stock ownership of all directors and executive
officers of the Company as a group (14 persons). -- -- -- 1,004,885(7)(8) 36.05%
- ----------------------------
(1) Includes years of service as a director of the Company's predecessor, the
Association.
(2) Each person or relative of such person whose shares are included herein
exercises sole (or shared with spouse, relative or affiliate) voting or
dispositive power as to the shares reported.
(3) Includes 6,500 shares subject to options which may be acquired by Dr. Cox
under the Southwest Bancshares, Inc. 1992 Stock Option Plan for Outside
Directors (the" Directors' Option Plan") which are currently exercisable.
(4) Includes 4,100 and 3,000 shares subject to options awarded to outside
directors, Messrs. Lawler and Gee, respectively, which are currently
exercisable under the Directors' Option Plan.
(5) Includes 53,700 shares with respect to Mr. Webber which may be acquired
through the exercise of stock options granted under the Southwest
Bancshares, Inc. 1992 Incentive Stock Option Plan ("Incentive Option Plan").
(6) Includes 23,625, 15,277, 13,131 and 13,926 shares allocated to Messrs.
Webber and Phares, Ms. McNally and Mr. Gembara, respectively, under the
Association's ESOP.
(7) Includes 37,527 shares held by the Association's Retirement Plan over which
Messrs. Eckert and Olson, employees of the Company, as co-trustees, have
shared voting or dispositive power as to the shares reported.
(8) Includes 13,600 shares subject to options under the Directors' Option Plan,
and 105,834 shares allocated to executive officers under the ESOP. Includes
53,700 shares with respect to all executive officers which may be acquired
through the exercise of stock options granted under the Incentive Option
Plan.
81
Meetings of the Board and Committees of the Board
The Board of Directors conducts its business through meetings of the
Board and through activities of its committees. The Board of Directors meets
monthly and may have additional meetings as needed. During fiscal 1997, the
Board of Directors of the Company held twelve regular meetings and five special
meetings. All of the directors of the Company attended at least 75% in the
aggregate of the total number of the Company's board meetings held and committee
meetings on which such directors served during 1997. The Board of Directors of
the Company maintains committees, the nature and composition of which are
described below:
Audit Committee. The Audit Committee of the Company and Association
consists of all outside directors: Messrs. Cox, Gee, Herbert, Lawler, Muriello
and Rodrigues. The purpose of the Audit Committee is to review the Association's
budgets and audit performance and evaluate policies and procedures relating to
the auditing functions and controls. This committee also selects the independent
auditors. The committee met twice in 1997.
Nominating Committee. The Company's Nominating Committee for the 1998
Annual Meeting consists of the Board of Directors. The Nominating Committee
considers and recommends the nominees for director to stand for election at the
Company's Annual Meeting of Stockholders. The Company's Bylaws provide for
stockholder nominations of directors. These provisions require such nominations
to be made pursuant to timely written notice to the Secretary of the Company.
The stockholders' notice of nominations must contain all information relating to
the nominee which is required to be disclosed by the Company's Bylaws and by the
Exchange Act. The Nominating Committee met once in fiscal 1997.
Directors' Compensation
Directors' Fees and Real Estate Consulting Fees. The directors of the
Association receive a retainer of $1,100 per month and $600 for each Association
meeting attended and directors of the Company receive $100 for each Company
meeting attended. The Chairman of the Board receives an additional $300 for each
Association meeting conducted and $50 for each Company meeting conducted.
Directors of SBDC receive $100 for each meeting attended and the directors of
SSC receive $350 per month. Mr. Muriello received $5,200 for real estate
appraisal reviews and consulting services performed during 1997. Mr. Rodrigues
received $24,000 for real estate consulting services for the year ended December
31, 1997.
Directors' Option Plan. Under the Directors' Option Plan, each outside
director was granted, effective June 23, 1992, not accounting for the stock
split, options to purchase 8,400 shares of Common Stock at an exercise price of
$10.00 per share. The Chairman of the Board received, not accounting for the
stock split, options to purchase 28,000 shares of Common Stock. Each person who
is first elected as an outside director subsequent to June 23, 1992 (referred to
herein as a subsequent outside director) will be granted options to purchase
1,500 shares of Common Stock at the fair market value on the date of the grant,
if available. Options granted to outside directors are exercisable immediately.
Association Recognition and Retention Plan and Trust. Under the RRP,
each outside director was awarded, effective June 23, 1992, not accounting for
the stock split, 5,400 shares of Common Stock, except for the Chairman who was
granted 10,800 shares of Common Stock. Each subsequent outside director will be
granted 1,500 shares of Common Stock as of the effective date of such election.
Outside directors will earn shares awarded to them at a rate of 20% per year
commencing one year from the effective date of the grant. In accordance with the
RRP, dividends are paid on shares awarded or held in the RRP. As of December 31,
1997, all shares have been fully earned.
82
Item 11. Executive Compensation.
- --------------------------------
Summary Compensation Table. The following table shows, for the fiscal
years ending December 31, 1997, 1996 and 1995, the cash compensation as well as
certain other compensation paid or accrued for those years, paid by the
Association, to the President and those executive officers of the Company who
received an amount in salary and bonus in excess of $100,000 in 1997 (the "Named
Executive Officers"). The Company does not pay any cash compensation.
Annual Compensation Long-Term Compensation
------------------------------------- ------------------------------------
Awards Payouts
------------------------ --------
Other Restricted Securities All
Annual Stock Underlying LTIP Other
Name and Salary Bonus Compensa- Awards Options/ Payouts Compen-
Principal Position Year ($)(1) ($) tion($)(2) ($)(3) SARs (#)(4) ($)(5) sation($)
- ------------------ ---- ------ ----- ---------- ---------- ----------- ------- ---------
Richard E. Webber 1997 $277,500 $110,417 -- -- -- None $257,257(6)
President, Chief 1996 277,000 110,417 None 67,123
Executive Officer 1995 277,000 104,417 None 70,097
and Director
Ronald D. Phares 1997 100,000 16,167 -- -- -- None 78,178(6)
Senior Vice 1996 100,000 16,167 None 49,168
President 1995 90,500 19,771 None 48,682
Mary A. McNally 1997 81,000 22,875 -- -- -- None 69,537(6)
Vice President and 1996 81,000 22,875 None 43,679
Secretary 1995 72,000 29,000 None 43,971
Michael J. Gembara 1997 83,400 33,050 -- -- -- None 74,238(6)
Vice President 1996 83,400 33,050 None 46,599
1995 71,400 40,750 None 46,462
- ------------------------------------------
(1) Includes directors' fees for Mr. Webber for serving as director of the
Company, Association, SBDC and SSC and for Mr. Gembara for serving as
director of SBDC and SSC.
(2) For 1997, 1996 and 1995, there were no: (a) perquisites over the lesser of
$50,000 or 10% of the individual's total salary and bonus for the year; (b)
payments of above-market or preferential earnings on deferred compensation;
(c) payments of earnings with respect to long-term incentive plans prior to
settlement or maturation; (d) tax payment reimbursements; or (e)
preferential discounts on stock.
(3) At December 31, 1997, Messrs. Webber and Phares, Ms. McNally and Mr. Gembara
had become fully vested in all shares awarded to them pursuant to the RRP.
(4) The Company maintains an Incentive Option Plan. See "Incentive Stock Option
Plan".
(5) For 1997, 1996 and 1995 the Company did not maintain a long-term incentive
plan and, therefore, there were no payments or awards under any long-term
incentive plan.
(6) Includes $109,629, $78,034, $69,347 and $74,048 contributed by the
Association pursuant to the ESOP and allocated respectively for the benefit
of Messrs. Webber and Phares, Ms. McNally and Mr. Gembara for fiscal 1997
including dividends credited to their accounts. Includes $1,026, $144, $190
and $190 attributable to payment of dividends and interest earned on plan
shares under the RRP to Messrs. Webber and Phares, Ms. McNally and Mr.
Gembara, respectively. Includes a distribution to Mr. Webber in the amount
of $146,602 from his Supplemental Executive Retirement Plan paid in fiscal
1997. See "--Supplemental Executive Retirement Plan".
83
Employment Agreement. The Association entered into an employment
agreement with Mr. Webber in 1988, which was amended in 1993. Mr. Webber's
employment agreement with the Association provides for a three-year term. The
Board of Directors reviews the agreement annually and may extend the remaining
term of the agreement for an additional one-year period. The agreement provides
that the base salary for Mr. Webber will be reviewed annually. In 1997, Mr.
Webber's base salary was $250,000 (the "Base Salary").
In addition to the Base Salary, the agreement provides for, among other
things, disability pay and other fringe benefits. The agreement provides for
termination by the Association for cause at any time. In the event the
Association chooses to terminate Mr. Webber's employment for reasons other than
for cause, or in the event of Mr. Webber's resignation from the Association
upon: (i) a material change in Mr. Webber's functions, duties or
responsibilities, or relocation of his principal place of employment; (ii)
liquidation, dissolution, consolidation, reorganization or merger in which the
Association or the Company is not the resulting entity; (iii) failure to reelect
Mr. Webber to his current office or Board duties; or (iv) a breach of the
agreement by the Association or the Company, Mr. Webber, or in the event of
death, his beneficiary, would be entitled to severance pay in an amount equal to
the greater of his remaining salary payments under the agreement or the highest
annual Base Salary, including other cash compensation and bonuses received by
Mr. Webber during the term of the agreement and the amount of any benefits
received pursuant to any employee benefit plans, on behalf of Mr. Webber,
maintained by the Association during the term of the agreement; provided,
however, that if the Association is not in compliance with its minimum capital
requirements or if such payments would cause the Association's capital to be
reduced below its minimum capital requirements, such payments shall be deferred
until such time as the Association is in capital compliance. The Association
would also cause to be continued life, health and disability coverage
substantially identical to the coverage maintained by the Association for Mr.
Webber prior to his termination. Such coverage shall cease upon the expiration
of the remaining term of the agreement. The agreement also provides for certain
benefits to be paid upon disability or retirement, including a severance payment
equal to one-half of Mr. Webber's base salary, bonuses and any other cash
compensation in the event of retirement.
If termination, voluntary or involuntary, follows a change in control
of the Association or the Company, Mr. Webber or, in the event of his subsequent
death, his beneficiary, would be entitled to a severance payment in an amount
equal to the immediately preceding year's base salary plus the compensation that
Mr. Webber would have received during the remaining term of the agreement
subject to the limitation discussed below. The Association and the Company would
also continue Mr. Webber's life, medical and disability coverage substantially
identical to the coverage maintained by the Association for Mr. Webber prior to
his termination. Such coverage shall cease upon the expiration of thirty-six
(36) months. A change in control is generally defined to mean the acquisition by
a person or group of persons having beneficial ownership of 20% or more of the
Association's or the Company's Common Stock during the term of the agreement or
a plan of reorganization, merger, consolidation, sale of all or substantially
all of the assets of the Association or the Company or similar transaction in
which the Association or the Company is not the resulting entity, or contested
election of directors which results in a change of a majority of the Board of
Directors.
The agreement contains a provision to the effect that in the event of a
change in control the aggregate payments under the agreement shall not
constitute an excess parachute payment under Section 280G of the Internal
Revenue Code of 1986, as amended, (the "Code"), which imposes an excise tax on
the recipient and denial of the deduction for such excess amount to the
employer. Such provision provides that the payments under the agreement shall be
reduced to one dollar below the amount which would trigger an excise tax under
Section 280G.
In the event of a change in control, based upon the past fiscal year's
salary and fees, Mr. Webber would receive approximately $1.3 million in
severance payments in addition to other non-cash benefits provided for under the
agreement. In addition, any outstanding options under the Incentive Option Plan
and any awards under the RRP will vest immediately upon a change in control.
The Association has entered into a Supplemental Stock Bonus Retirement
Agreement with Mr. Webber to provide him with stock benefits in the event that
he retires prior to the expiration of the ESOP's term loan. The purpose of the
Agreement is to compensate him for his experience and expertise by providing him
with benefits he
84
would have received under the ESOP had he remained with the Association until
all vested shares held in the ESOP suspense account for his benefit were fully
allocated.
Incentive Stock Option Plan. The Company maintains the Incentive Stock
Option Plan, which provides discretionary awards to officers and key employees
as determined by a committee. The following table shows options exercised by the
Named Executive Officers during 1997, including the aggregate value of gains on
the date of exercise. In addition, the table provides information with respect
to the number of shares of Common Stock represented by outstanding stock options
held by the Named Executive Officers as of December 31, 1997. Also reported are
the values for "in-the-money" options, which represent the positive spread
between the exercise price of any such existing stock options and the year-end
price of the Common Stock.
Aggregate Option/SAR Exercises in Last Fiscal Year
and Fiscal Year-End Option/SAR Value(1)(2)(3)(4)
Shares Number of Securities Underlying Value of Unexercised in-the-money
Acquired on Value Unexercised Options/SARs at Options/SARs at Fiscal Year-
Name Exercise(#) Realized ($)(5) Fiscal Year End(#)(6) End ($)(7)
- --------------------- ------------- --------------- ------------------------------- --------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- -------------- -------------- ---------------
Richard E. Webber.... 15,000 $282,450 53,700 -- $1,239,396 --
Ronald D. Phares..... 1,680 23,654 -- -- -- --
Mary A. McNally...... 1,680 32,474 -- -- -- --
Michael J. Gembara... 3,360 44,579 -- -- -- --
- ------------------------------------
(1) Options granted pursuant to the Incentive Option Plan became exercisable in
equal installments commencing on June 23, 1993 at a rate of 20% of the
original amount awarded per year. The options become exercisable upon a
change in control as defined under the "Employment Agreement". In addition,
vesting of non-statutory options may be accelerated by the committee.
(2) The purchase price may be made in whole or in part through the surrender of
previously held shares of Common Stock at the fair market value of such
shares on the date of surrender.
(3) Under limited circumstances, such as death, disability or normal retirement
of an employee, the employee (or his beneficiary) may request that the
Company, in exchange for the employee's surrender of an option, pay to the
employee (or beneficiary), the amount by which the fair market value of the
common stock exceeds the exercise price of the option on the date of the
employee's termination of employment. It is within the Company's discretion
to accept or reject such a request.
(4) Options are subject to limited (SAR) rights pursuant to which the options
may be exercised in the event of a change in control of the Company. Upon
the exercise of a limited right, the optionee would receive a cash payment
equal to the difference between the exercise price of the related option on
the date of grant and the fair market value of the underlying shares of
Common Stock on the date the limited right is exercised.
(5) Based on the market value of the Common Stock as of the date of exercise,
minus the exercise price.
(6) The options in this table have an exercise price of $6.67.
(7) The price of the Common Stock on December 31, 1997 was $29.75.
Defined Benefit Plan. The Association maintains the Southwest Federal
Savings and Loan Association of Chicago Retirement Plan (the "Retirement Plan"),
for the benefit of eligible employees of the Association. The Retirement Plan is
a noncontributory defined benefit pension plan. The following table sets forth
the estimated annual benefits payable upon retirement at age 65 in calendar year
1997, expressed in the form of a single life annuity, for the final average
salary and benefit service classifications specified.
85
Years of Benefit Service at Retirement (1)(2)
---------------------------------------------
Average Salary 15 20 25 30 35
- ---------------------------------------- --------- -------- -------- -------- --------
$ 25,000 $6,743 $8,990 $11,238 $13,485 $15,733
50,000 13,485 17,980 22,475 26,970 31,465
75,000 20,228 26,970 33,713 40,455 47,198
100,000 26,970 35,960 44,950 53,940 62,930
160,000(3) 43,153 57,537 71,921 86,306 100,690
- --------------------------
(1) The compensation utilized for formula purposes includes the salary reported
in the "Summary Compensation Table".
(2) The benefit amounts shown in this table are on a life only basis and are not
subject to any deductions for social security benefits or other offset
amounts.
(3) Maximum allowable salary in 1997.
The following table sets forth the years of credited service (i.e.,
benefit service) as of December 31, 1997 for each of the individuals named in
the Summary Compensation Table.
Credited Service
----------------
Years
----------------
Richard E. Webber(1) 38
Ronald D. Phares 9
Mary A. McNally 20
Michael J. Gembara 14
- -------------------------
(1) Mr. Webber took an in-service distribution of his retirement benefit in
January 1997.
Supplemental Executive Retirement Plan. In 1988, the Association
entered into a Supplemental Executive Retirement Plan (the "SERP") with Mr.
Webber. The officer becomes vested at a rate equal to 10% for each year of
service, but becomes fully vested upon death, disability or attainment of normal
retirement age. The SERP is an unfunded plan; however, the Association intends
to use a portion of the cash surrender value of the key employee life insurance
policy purchased by the Association to provide payment to Mr. Webber, with
retirement or death benefits payable beginning at his retirement or death with
fixed payments for fifteen years. In the event Mr. Webber terminates employment
prior to retirement, limited benefits will be paid to him. In 1994, the
Association contributed $486,938 for the payment of the premiums on the policy
and no further payments are required. The Association is both the owner and the
beneficiary of such policy.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------------------------------------------------------------------------
The following table sets forth certain information as to those persons
believed by management to be beneficial owners of more than 5% of the
outstanding shares of Common Stock on the Record Date, as disclosed in certain
reports regarding such ownership filed with the Company and with the (SEC), in
accordance with Sections 13(d) or 13(g) of the Securities Exchange Act of 1934,
as amended, (the "Exchange Act") by such persons and groups. Other than those
persons listed below, the Company is not aware of any person or group, as such
term is defined in the Exchange Act, that owns more than 5% of the Common Stock
as of February 25, 1998. Information regarding the share ownership of Directors
and Named Executive Officers is filed as part of this report under Part III,
Item 10.
86
Name and Address of Beneficial Percent
Title of Class Owner Number of Shares of Class
- ------------------- ----------------------------------- ------------------- ----------
Common Stock Southwest Federal Savings and Loan 328,159(1) 12.06%
Employee Stock Ownership Plan
and Trust ("ESOP")
4062 Southwest Highway
Hometown, Illinois 60456
Common Stock Richard E. Webber 320,822(2) 11.57
4062 Southwest Highway
Hometown, IL 60456
- --------------------------------------
(1) The ESOP Committee of the Board of Directors administers the ESOP. The ESOP
Committee may instruct the ESOP Trustee regarding investment of funds
contributed to the ESOP. The ESOP Trustee subject to its fiduciary duty must
vote all allocated shares held in the ESOP in accordance with the
instructions of the participating employees. As of February 25, 1998,
280,159 shares have been allocated to participants' accounts. Under the
ESOP, unallocated shares held in the suspense account will be voted by the
ESOP Trustee in a manner calculated to most accurately reflect the
instructions it has received from participants regarding the allocated stock
so long as such vote is in accordance with the provisions of Employee
Retirement Income Security Act of 1974, as amended (the "ERISA").
(2) Based upon information filed in Amendment No. 5 to Schedule 13D filed by
Richard E. Webber on June 27, 1997 and subsequent transactions through
February 25, 1998.
Item 13. Certain Relationships and Related Transactions.
- --------------------------------------------------------
All loans made by the Association to its executive officers and
directors were made in the ordinary course of business, were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and did
not involve more than the normal risk of collectibility or present other
unfavorable features.
87
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
- -------------------------------------------------------------------------
(a) The following documents are filed as a part of this report:
(1) The following Consolidated Financial Statements of the
Company are filed as part of this report under Part II, Item 8.
Independent Auditors' Report....................................49
Consolidated Statements of Financial
Condition as of December 31, 1997 and 1996......................50
Consolidated Statements of Earnings
for the Years Ended December 31, 1997,
1996 and 1995...................................................51
Consolidated Statements of Changes in
Stockholders' Equity for Three Years Ended
December 31, 1997...............................................52
Consolidated Statements of Cash Flows for
the Years Ended December 31, 1997,
1996 and 1995...................................................53
(2) Notes to Consolidated Financial Statements......................54
(3) All schedules are omitted because they are not required or
applicable, or the required information is shown in the
consolidated financial statements or the notes thereto.
(4) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Amended Certificate of Incorporation of Southwest
Bancshares, Inc.*
3.2 Bylaws of Southwest Bancshares, Inc.*
4.0 Stock Certificate of Southwest Bancshares, Inc.*
10.1 Amended and Restated Employment Agreement between the
Association and Richard E. Webber*
10.2 Supplemental Stock Bonus Retirement Agreement between
the Association and Richard E. Webber and the
Association and Albert Rodrigues*
10.3(a) Form of Recognition and Retention Plan and Trust**
(b) Amendments to Recognition and Retention Plan and
Trust***
10.4 Incentive Stock Option Plan**
10.5 Stock Option Plan for Outside Directors**
21.0 Subsidiary information is incorporated herein by
reference to "Part I - Subsidiary Activities"
23.0 Consent of Cobitz, VandenBerg & Fennessy (filed
herewith)
27.0 Financial Data Schedule (filed herewith)
* Incorporated herein by reference to the Exhibits to Form S-1, Registration
Statement, and Pre-Effective Amendment No. 1, filed on March 13, 1992 and
April 24, 1992, respectively, Registration No. 33-46409.
** Incorporated herein by reference to the Proxy Statement for the Special
Meeting of Stockholders filed on September 11, 1992.
*** Incorporated herein by reference to Exhibit 10.3(b) of Form 10-K for the
year ended December 31, 1994.
88
(b) Reports on Form 8-K
On December 30, 1997, the Company filed a report on Form 8-K,
reporting under Item 5 the entrance into a definitive
Agreement and Plan of Merger between the Company and Alliance
Bancorp. The Agreement and Plan of Merger was filed as an
exhibit at Item 7.
89
SIGNATURES
Pursuant to the requirements of Section 13 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.
SOUTHWEST BANCSHARES, INC.
By: /s/ Richard E. Webber
--------------------------------
Richard E. Webber
DATED: March 26, 1998 President, Chief Financial
Officer and Director
(Principal Executive Officer,
Principal Financial Officer
and Principal Accounting Officer)
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
Name Title Date
---- ----- ----
/s/ Richard E. Webber President, Chief Financial March 26, 1998
- ----------------------------- Officer and Director
Richard E. Webber (Principal Executive Officer,
Principal Financial Officer
and Principal Accounting Officer)
/s/ Lawrence M. Cox Chairman of the Board of March 26, 1998
- ----------------------------- Directors
Lawrence M. Cox
/s/ Albert Rodrigues Director March 26, 1998
- -----------------------------
Albert Rodrigues
/s/ James W. Gee, Sr. Director March 26, 1998
- -----------------------------
James W. Gee, Sr.
/s/ Joseph A. Herbert Director March 26, 1998
- -----------------------------
Joseph A. Herbert
/s/ Robert E. Lawler, D.D.S. Director March 26, 1998
- -----------------------------
Robert E. Lawler, D.D.S.
/s/ Frank J. Muriello Director March 26, 1998
- -----------------------------
Frank J. Muriello
90