UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-20956
HFB FINANCIAL CORPORATION
A Tennessee Corporation I.R.S. Employer
Identification
No. 61-1228266
Address Telephone Number
- ------- ----------------
1602 Cumberland Avenue (606) 248-1095
Middlesboro, Kentucky 40965
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the
preceding twelve 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 .
-- __
The number of shares of the registrant's $1 par value common stock outstanding
at March 31, 1999 was 1,100,151.
There are a total of 16 pages filed in this document.
HFB FINANCIAL CORPORATION
I N D E X
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PAGE NO
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet 3
Consolidated Statement of Income 4
Consolidated Statement of Stockholders' Equity 5
Consolidated Statement of Cash Flows 6
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-13
Item 3. Asset/liability Management - Qualitative and
Quantitative Disclosures about Market Risk. 14
PART II - OTHER INFORMATION 15
SIGNATURES 16
2
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
(Unaudited)
March 31, June 30,
1999 1998
Assets
Cash and cash equivalents $ 9,358,367 $ 6,947,148
Trading securities 944,062 835,307
Investment securities
Available for sale 33,100,005 26,904,517
Held to maturity 22,105,849 20,546,634
---------------- ----------------
Total investment securities 55,205,854 47,451,151
Loans 122,442,164 117,143,613
Allowance for loan losses (1,186,325) (972,859)
---------------- ----------------
Net loans 121,255,839 116,170,754
Premises and equipment 2,421,786 2,220,548
Federal Home Loan Bank stock 1,301,300 1,255,900
Interest receivable 1,450,916 1,407,901
Other Assets 282,597 148,077
---------------- ----------------
Total assets 192,220,721 176,436,786
================ ================
Liabilities
Deposits
Interest bearing $151,970,730 $144,622,466
Non-interest bearing 1,688,603 258,952
---------------- ----------------
Totals 153,659,333 144,881,418
Short term borrowings 7,500,000 6,500,000
Long term debt 10,614,010 5,661,598
Interest payable 1,357,168 580,621
Other liabilities 1,218,595 825,950
---------------- ----------------
Total liabilities $174,349,106 $158,449,587
---------------- ----------------
Stockholders' Equity
Issued and outstanding - 1,302,197 and 1,291,694 shares 1,302,197 1,291,694
Additional paid-in capital 6,248,463 6,195,948
Less: Common stock acquired by ESOP -- (41,545)
Common stock acquired by Rabbi trusts for deferred
Compensation plans (686,845) (313,059)
Treasury stock, at cost, 202,046 shares (2,030,955) (2,030,955)
Retained earnings 13,065,376 12,754,183
Accumulated other comprehensive income, net unrealized
gain on securities available for sale (26,621) 130,933
---------------- ----------------
Total stockholders' equity 17,871,615 17,987,199
---------------- ----------------
Total liabilities and stockholders' equity $192,220,721 $176,436,786
================ ================
See notes to consolidated financial statements.
3
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statement of Income
(Unaudited)
Three-Months Ended Nine Months Ended
March 31, March 31,
1999 1998 1999 1998
Interest Income
Loans receivable $2,418,541 $2,529,504 $7,513,849 $7,310,287
Investment securities 825,890 694,295 2,326,618 2,122,847
Other dividend income 29,523 33,149 85,570 76,266
Deposits with financial institutions 80,811 59,548 151,393 144,568
--------------- ---------------- --------------- ----------------
Total interest income 3,354,765 3,316,496 10,077,430 9,653,968
--------------- ---------------- --------------- ----------------
Interest Expense
Deposits 1,794,189 1,679,414 5,434,428 4,934,133
Short term borrowings 93,227 144,674 282,947 376,119
Long term debt 126,489 13,721 295,123 42,055
--------------- ---------------- --------------- ----------------
Total interest expense 2,013,905 1,837,809 6,012,498 5,352,307
--------------- ---------------- --------------- ----------------
Net Interest Income 1,340,860 1,478,687 4,064,932 4,301,661
Provision for loan losses 95,384 64,615 229,843 200,542
--------------- ---------------- --------------- ----------------
Net Interest Income After
Provision for Loan Losses 1,245,476 1,414,072 3,835,089 4,101,119
--------------- ---------------- --------------- ----------------
Other Income
Service charges for deposit accounts 98,220 95,567 278,061 299,947
Other customer fees 16,344 41,380 71,368 68,817
Net gain on trading securities (25,554) (1,048) (222,834) 205,314
Net realized gain (loss) on sales of
available for sale securities - 4,737 2,827 13,614
Other income 1,952 2,447 5,244 23,635
--------------- ---------------- --------------- ----------------
Total other income 90,962 143,083 134,666 611,327
--------------- ---------------- --------------- ----------------
Other Expenses
Salaries and employee benefits 460,158 541,841 1,295,484 1,456,808
Net occupancy expenses 46,053 58,181 143,972 164,955
Equipment expenses 57,878 55,105 160,554 171,200
Data processing fees 57,042 83,596 176,271 208,626
Deposit insurance expense 22,238 20,775 64,887 62,848
Legal and professional fees 43,946 37,079 143,604 121,913
Advertising 19,232 36,014 80,565 105,907
State franchise and deposit taxes 37,683 30,112 108,758 92,401
Other expenses 173,231 132,992 525,415 442,607
--------------- ---------------- --------------- ----------------
Total other expenses 917,461 995,695 2,699,510 2,827,265
--------------- ---------------- --------------- ----------------
Income Before Income Tax 418,977 561,460 1,270,245 1,885,181
Income tax expense 171,803 208,340 466,295 742,634
--------------- ---------------- --------------- ----------------
Net Income $ 247,174 $ 353,120 $ 803,950 $1,142,547
=============== ================ =============== ================
Basic Earnings Per Share $0.22 $0.33 $0.73 $1.05
Diluted Earnings Per Share 0.22 0.32 0.72 1.03
See notes to consolidated financial statements.
4
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine-months ended March 31, 1999
(Unaudited)
Additional
Common Paid-in Esop Rabbi Treasury Comprehensive
Stock Capital Debt* Trusts Stock Income
----------------------------------------------------------------------------------
Balances, June 30, 1998 $1,291,694 $6,195,948 ($41,545) ($313,059) ($2,030,955)
Net income $803,950
Other Comprehensive income -
Net change in unrealized gain on securities
Available for sale (157,554)
------------------
Comprehensive Income $646,396
==================
Stock issued upon exercise of 10,503 52,515
Stock options
Dividends declared
Reduction of ESOP debt 41,545
Distribution of rabbi trust shares 40,434
Purchase of rabbi trust shares (39,600)
Net change in fair value of rabbi trust shares (2,805)
Transitional fair value adjustment of
Rabbi trust shares (371,815)
---------------------------------------------------------------
Balances, March 31, 1999 $1,302,197 $6,248,463 -- $(686,845) $(2,030,955)
===============================================================
Accumulated
Other Total
Retained Comprehensive Stockholders'
Earnings Income Equity
---------------------------------------------
Balances, June 30, 1998 $12,754,183 $130,933 $17,987,199
Net income 803,950 803,950
Other Comprehensive income -
Net change in unrealized gain on securities
Available for sale (157,554) (157,554)
Comprehensive Income
Stock issued upon exercise of 63,018
Stock options
Dividends declared (492,757) (492,757)
Reduction of ESOP debt 41,545
Distribution of rabbi trust shares 40,434
Purchase of rabbi trust shares (39,600)
Net change in fair value of rabbi trust shares (2,805)
Transitional fair value adjustment of
Rabbi trust shares (371,815)
------------------------------------------------------------------------
Balances, March 31, 1999 $13,065,376 $(26,621) $17,886,615
=============================================
* Employees Stock Ownership Plan (ESOP) See notes to consolidated financial
statements.
5
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statement of Cash Flows
Nine-months Ended
March 31,
1999 1998
Operating Activities
Net cash provided by operating activities $1,953,354 $1,842,591
----------------- ------------------
Investing Activities
Purchases of securities available for sale (14,521,635) (8,151,194)
Proceeds from maturities of securities available for sale 7,528,873 4,176,672
Purchases of securities held to maturity (6,497,692) (5,897,077)
Proceeds from sales of securities available for sale 520,648 1,784,398
Proceeds from maturities of securities held to maturity 4,956,266 5,817,628
Net change in loans (5,298,550) (8,402,833)
Purchases of premises and equipment (486,355) (167,124)
Proceeds from sale of fixed assets 13,000 --
----------------- ------------------
Net cash used by investing activities (13,811,445) (10,839,530)
----------------- ------------------
Financing Activities
Net change in
Non interest-bearing, interest-bearing
and saving deposits (227,824) 759,194
Certificates of deposit 9,005,739 7,521,993
Short term borrowings 1,000,000 1,000,000
Proceeds of long-term debt 5,000,000
Repayment of long-term debt (47,588) 4,956,082
Cash dividends (492,757) (466,405)
Proceeds from exercise of options on common stock 63,018 12,126
Common stock acquired by Rabbi trusts (31,278) (11,151)
----------------- ------------------
Net cash provided by financing activities 14,269,310 13,771,839
----------------- ------------------
Net Change in Cash and Cash Equivalents 2,411,219 4,774,901
Cash and Cash Equivalents, Beginning of Period 6,947,148 3,794,637
----------------- ------------------
Cash and Cash Equivalents, End of Period $9,358,367 $8,569,538
================= ==================
Additional Cash Flows Information
Interest paid $4,657,881 $4,791,713
Income tax paid 320,864 740,196
See notes to consolidated financial statements.
6
HFB FINANCIAL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The unaudited consolidated financial information for the three and
nine-month periods ended March 31, 1999 and 1998 includes the results
of operations of HFB Financial Corporation (the "Company") and its
wholly owned subsidiary Home Federal Bank, Federal Savings Bank ("Home
Federal" or the "Bank"). The accompanying unaudited financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial statements and with the
instructions to Form 10-Q. These statements and notes should be read in
conjunction with the financial statements and notes thereto included in
the Company's annual report for the year ended June 30, 1998 on Form
10-K filed with the Securities and Exchange Commission.
In the opinion of management, the financial information reflects all
adjustments (consisting only of normal recurring adjustments) which are
necessary for a fair presentation of the results of operations for such
periods but should not be considered as indicative of results for a
full year.
2. Accounting Pronouncements
The Financial Accounting Standards Board has issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging activities", which
requires companies to record derivatives on the balance sheet at their
fair value. Statement No. 133 will be effective for the Company
beginning in fiscal 2000 and is not expected to have a material impact
on the Company's financial position or results of operations.
3. Nonperforming Loans and Problem Assets
The following sets forth the activity in the Bank's allowance for loan
losses for the nine-months ended March 31, 1999 and 1998:
(Dollars in thousands)
1999 1998
----- ----
Balance July 1 $ 973 $710
Charge offs (16) (10)
Provision for loan losses 229 201
--- ---
Balance March 31 $1,186 $901
7
Information on impaired loans is summarized below
At March 31 1999
----
Impaired loans with an allowance $1,705
Allowance for impaired loans (included in the Company's $949
Allowance for loan losses)
Nine-months Ended March 31 1999
----
Average balance of impaired loans $1,427
Interest income recognized on impaired loans --
Cash-basis interest received --
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Statements
Certain matters discussed in this Quarterly Report on Form 10-Q are
"forward-looking statements" intended to qualify for the safe harbors from
liability established by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes",
"anticipates", "expects", "estimates" or words of similar import. Similarly,
statements that describe the Company's future plans, objectives or goals are
also forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties which are described in close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this report. Shareholders, potential investors and
other readers are urged to consider these factors in evaluating the
forward-looking statements and are cautioned not to place undue reliance on such
forward-looking statements. The forward-looking statements included herein are
only made as of the date of this report and the Company undertakes no obligation
to publicly update such forward-looking statements to reflect subsequent events
or circumstances.
General:
HFB Financial Corporation, a Tennessee Corporation, was formed in September 1992
at the direction of Home Federal Bank, Federal Savings Bank for the purpose of
becoming a holding company for the Bank as part of its conversion from mutual to
stock form. The Corporation's primary operation is its' investment in the common
stock of the Bank.
The Bank is principally engaged in the business of accepting deposits from the
general public and originating permanent loans which are secured by one-to-four
family residential properties located in its market area. The Bank also
originates consumer loans and commercial real estate loans, and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities.
The operations of Home Federal, and savings institutions generally, are
significantly influenced by general economic conditions and the monetary and
fiscal policies of government regulatory agencies. Deposit flows and costs of
funds are influenced by interest rates on competing investments and prevailing
market rates of interest. Lending activities are affected by the demand for
financing real estate and other types of loans, which in turn are influenced by
the interest rates at which such financing may be offered and other factors
related to loan demand and the availability of funds. Just as the Bank's
operations are influenced by regulatory authorities, so are its liquidity levels
and capital resources.
8
Financial Condition
The Company's assets increased by 8.95% to $192.2 million at March 31, 1999
compared to $176.4 million at June 30, 1998. The majority of this increase is
reflected in increases in cash and cash equivalents, investment securities and
loans. These increases were funded by increases in deposits, short-term
borrowings and long term debt.
Cash and cash equivalents increased by $2.4 million to $9.3 million at March 31,
1999 from $6.9 million at June 30, 1998. This increase was established to fund
several March, 1999 purchases of investment securities which settled shortly
after March 31, 1999.
The Company maintains a portfolio of trading account securities which is
comprised of common stock of other financial institutions. The balance of the
portfolio was $944,000 at March 31, 1999 compared to $835,000 at June 30, 1998.
Most of this increase was attributable to increased investment activity in the
portfolio.
The loan portfolio increased by $5.3 million to $122.4 million at March 31, 1999
from $117.1 million at June 30, 1998 due to lower interest rates and a strong
loan demand. In the current interest rate environment, a substantial portion of
loans originated are adjustable-rate residential mortgages. During the
nine-months ended March 31, 1999, the Bank originated $32.4 million in
mortgages.
At March 31, 1999, the allowance for loan losses was $1.186 million or .97% of
loans receivable compared to $973,000 or .83% of loans receivable at June 30,
1998. During the nine-months ended March 31, 1999, the provision for loan losses
was $214,000. Total non-performing assets were $2.1million or 1.73% of total
loans at March 31, 1999 as compared to $717,000 or .62% of total loans at June
30, 1998. Most of the increase in non-performing loans was due to several
problem real estate loans to one borrower that total $1.2 million. The
commercial properties securing these loans are not generating sufficient cash
flow to fund debt service payments. Management has aggressively worked with the
borrower to secure refinancing from another lender, but only with limited
success. Foreclosure proceedings were initiated in December 1998 and
subsequently postponed in January due to the receipt of $346,000 in payment. The
source of the payment was from another lender. Since that time, foreclosure
proceedings were resumed due to a breakdown in negotiations with the other
lender, but were halted because of the borrower filing for bankruptcy.
Management has continually evaluated the collectability of these loans and
believes that its risk of loss is mitigated to some extent by collateral
estimated at $2.3 million.
The Company augments its lending activities and increases its asset yields by
investing in mortgage-backed securities "MBSs" and U.S. Government securities.
During the nine-months ended March 31, 1999, management purchased $21.0 million
in investment securities and MBSs. These purchases were primarily funded by
proceeds from called and maturing investment securities, principal collected on
MBSs and investments, the sale of investment securities and a $5.0 million
advance from the Federal Home Loan Bank. At March 31, 1999, the Bank held $33.1
million in investment securities, available for sale with a net unrealized loss
of $26,000, net of tax. The book value and the fair market value of investment
securities held to maturity were both $22.1 million at March 31, 1999.
Total deposits increased by $8.8 million to $153.7 million at March 31, 1999
from $144.9 million at June 30, 1998. During the nine-months ended March 31,
1999, certificates of deposit increased $9.0 million. NOW accounts and savings
deposits decreased $200,000.
Short- term borrowings increased $1.0 million to $7.5 million at March 31, 1999
from $6.5 million at June 30, 1998 as a means to fund short term liquidity
needs. Long term debt increased $5.0 million to $10.6 million at March 31, 1999
from $5.6 million at June 30, 1998 as the result of a growth strategy to
increase net interest income.
The Bank's regulatory liquidity ratio was 35.9% at March 31, 1999 as compared to
26.2% at June 30, 1998. At March 31, 1999 the Bank met all the fully phased-in
regulatory capital requirements under FIRREA. Tangible, core and risk-based
capital ratios were 8.7%, 8.7% and 19.8% respectively at March 31, 1999 as
compared to 9.1%, 9.1% and 22.5% respectively, at June 30, 1998.
9
Results of Operations for the Three-months Ended March 31, 1999 and 1998
Net income decreased by $106,000 to $247,000 for the three-month period ended
March 31, 1999 from $353,000 for the three-month period ended March 31, 1998.
The primary reasons for the decrease were a $138,000 decrease in net interest
income, a $31,000 increase in provision for loan losses, a decrease of $52,000
in noninterest income, a decrease of $78,000 in noninterest expense, and a
$37,000 decrease in income tax expense.
Net interest income decreased by $138,000 for the three-month period ended
March 31, 1999 as compared to the three-month period ended March 31, 1998, as
the result of a lower net interest margin and the write off of interest on loans
placed on nonaccrual status.
Interest on loans decreased by $111,000 to $2.419 million for the three-month
period ended March 31, 1999 as compared to $2.530 million for the three-month
period ended March 31, 1998. This decrease is mainly attributable to lower
interest rates and an adjustment to write off $125,000 of accrued interest on
nonaccrual loans. This interest was accrued in prior periods and determined to
be uncollectable during the period ended March 31, 1999.
Interest on investment securities increased by $132,000 to $826,000 for the
three-month period ended March 31, 1999 from $694,000 for the three-month period
ended March 31, 1998. This increase is primarily the result of higher average
balances during the period.
Interest on deposits with other financial institutions increased by $21,000 to
$81,000 for the three-month period ended March 31, 1999 from $60,000 for the
three-month period ended March 31, 1998 primarily due to a higher level of
interest-bearing cash balances.
Interest on deposits increased by $115,000 to $1.794 million for the three-month
period ended March 31, 1999 from $1.679 million for the three-month period ended
March 31, 1998 as a result of higher balances and a change in the overall
deposit mix. Lower rate savings accounts declined, while more costly
certificates of deposit increased.
Interest on short term borrowings and long term debt increased by $62,000 to
$220,000 for the three-month period ended March 31, 1999 from $158,000 for the
three-month period ended March 31, 1998 due to higher levels of borrowing.
The provision for loan losses increased $31,000 for the three-month period ended
March 31, 1999 as compared to the same period in 1998. The provision was the
result of Management's evaluation of the adequacy of the allowance for loan
losses including consideration of recoveries of loans previously charged off,
the perceived risk exposure among loan types, actual loss experience,
delinquency rates, and current economic conditions. The Bank's allowance for
loan losses as a percent of total loans at March 31, 1999 was .97%.
The Bank's non-interest income decreased by $52,000 to $91,000 for the
three-month period ended March 31, 1999 as compared to $143,000 for the same
period in 1998. The decrease was primarily attributable to trading account
realized and unrealized losses of $25,000 and a decrease of $22,000 in customer
fees and service charges.
Non-interest expense decreased by $78,000 to $917,000 for the three-month period
ended March 31, 1999 as compared to $995,000 for the same period in 1998.
Compensation and benefits decreased by $82,000 to $460,000 for the three-month
period ended March 31, 1999 as compared to $541,000 for the same period in 1998.
This decrease is primarily attributable to a change in presentation of the
portion of salaries and wages that are being deferred as loan origination costs,
a reduction in ESOP expense and a decrease in employee education expense.
Occupancy expense decreased by $12,000 to $46,000 for the three-month period
ended March 31, 1999 compared to $58,000 for the same period in 1998 due to
lower depreciation and amortization expense.
Equipment expense increased by $3,000 to $58,000 for the three-month period
ended March 31, 1999 from $55,000 for the three-month period ended March 31,
1998. The decrease was primarily due to higher maintenance expense.
Data processing fees decreased by $27,000 to $57,000 for the three-month period
ended March 31, 1999 from $84,000 for the three-month period ended March 31,
1998, primarily due to conversion expenses incurred during
10
the quarter ended March 31, 1998. Management believes the Bank's change in data
processing services has also created greater efficiencies.
State franchise and deposit taxes increased by $8,000 to $38,000 for the quarter
ended March 31, 1999 compared to $30,000 for the quarter ended March 31, 1998
primarily due to a higher level of deposits.
Other expenses increased by $40,000 to $173,000 for the three-month period ended
March 31, 1999 from $133,000 for the three-month period ended March 31, 1998 as
the result of a net increase in various other expense categories. Increases in
postage expense, telephone expense and check imaging services constituted the
majority of the increase.
Income tax expense decreased by $37,000 to $172,000 for the three-month period
ended March 31, 1999 compared to $208,000 for the three-months ended March 31,
1998 due to lower earnings.
Results of Operations for the Nine-months Ended March 31, 1999 and 1998
Net income decreased by $339,000 to $804,000 for the nine-month period ended
March 31, 1999 from $1.143 million for the nine-month period ended March 31,
1998. The primary reasons for the decrease were a $237,000 decrease in net
interest income, a $29,000 increase in provision for loan losses, a $439,000
decrease in net gains on trading account securities and realized and unrealized
gains on investment securities available for sale and a $38,000 decrease in
other income offset by a decrease of $128,000 in noninterest expense and a
$276,000 decrease in income tax expense.
Net interest income decreased by $266,000 for the nine-month period ended March
31, 1999 as compared to the nine-month period ended March 31, 1998, primarily as
the result of a lower net interest margin.
Interest on loans increased by $204,000 to $7.514 million for the nine-month
period ended March 31, 1999 as compared to $7.310 million for the nine-month
period ended March 31, 1998. This increase is mainly attributable to a higher
average balance of loans receivable outstanding.
Interest on investment securities increased by $204,000 to $2.327 million for
the nine-month period ended March 31, 1999 from $2.123 million for the
nine-month period ended March 31, 1998. This increase is primarily the result of
higher average balances during the period.
Interest on deposits with other financial institutions increased by $7,000 to
$151,000 for the nine-month period ended March 31, 1999 from $144,000 for the
nine-month period ended March 31, 1998 primarily due to a higher level of
interest-bearing cash balances.
Other dividend income increased by $9,000 for the nine-months ended March 31,
1999 as compared to the nine-months ended March 31, 1998 primarily due to a
higher level of investment in Federal Home Loan Bank stock.
Interest on deposits increased by $500,000 to $5.434 million for the nine-month
period ended March 31, 1999 from $4.934 million for the nine-month period ended
March 31, 1998 as a result of higher volume and a change in the overall deposit
mix. Lower rate savings accounts declined, while more costly certificates of
deposit increased.
Interest on short term borrowings and long term debt increased by $160,000 to
$578,000 for the nine-month period ended March 31, 1999 from $418,000 for the
nine-month period ended March 31, 1998 due to higher levels of borrowing.
The provision for loan losses increased $29,000 for the nine-month period ended
March 31, 1999 as compared to the same period in 1998. The provision was the
result of Management's evaluation of the adequacy of the allowance for loan
losses including consideration of recoveries of loans previously charged off,
the perceived risk exposure among loan types, actual loss experience,
delinquency rates, and current economic conditions. The Bank's allowance for
loan losses as a percent of total loans, net at March 31, 1999 was .97%.
11
The Banks non-interest income decreased by $477,000 to $134,000 for the
nine-month period ended March 31, 1999 as compared to $611,000 for the same
period in 1998. The decrease was attributable to a net decrease in realized and
unrealized gains (losses) on trading account securities of $428,000, realized
losses on available for sale securities of $11,000, a $19,000 decrease in
customer fees and service charges and a decrease of $18,000 in other income. The
decrease in realized and unrealized gains on trading account securities was
primarily the result of a reduction in the market value of equity securities
included in the trading account portfolio. The trading account portfolio is
comprised of common stocks of other financial institutions, which were adversely
affected by the recent decline in the equities market and have not rebounded as
quickly as the overall market. The decrease in other income was mainly
attributable to a gain on real estate sold in 1998 and the loss of rental income
from properties sold.
Non-interest expense decreased by $128,000 to $2.699 million for the nine-month
period ended March 31, 1999 as compared to $2.827 million for the same period in
1998. Compensation and benefits decreased by $161,000 to $1.295 million for the
nine-month period ended March 31, 1999 as compared to $1.457 million for the
same period in 1998. This decrease is primarily attributable to a change in
presentation of the portion of salaries and wages that are being deferred as
loan origination costs, a decrease in ESOP expense and a reduction in employee
education expense.
Occupancy expense decreased by $21,000 to $144,000 for the nine-month period
ended March 31, 1999 compared to $165,000 for the same period in 1998 primarily
due to lower depreciation expense.
Equipment expense decreased by $11,000 to $161,000 for the nine-month period
ended March 31, 1999 from $171,000 for the nine-month period ended March 31,
1998. These decreases were primarily due to lower depreciation expense.
Data processing fees decreased by $32,000 to $176,000 for the nine-month period
ended March 31, 1999 from $209,000 for the nine-month period ended March 31,
1998 primarily due to an increased level of efficiency resulting from a change
in the Bank's core provider of data processing services and additional costs
associated with the Bank's data processing conversion in 1998.
Legal and professional fees increased by $22,000 for the nine-month period ended
March 31, 1999 primarily due to higher consulting fees.
Advertising expense decreased by $25,000 to $81,000 for the quarter ended March
31, 1999 compared to $106,000 for the quarter ended March 31, 1998 primarily due
to a lower level of advertising activity.
State franchise and deposit taxes increased by $16,000 for the nine-month period
ended March 31, 1999 due to a higher level of taxable capital and deposits.
Other expenses increased by $83,000 to $525,000 for the nine-month period ended
March 31, 1999 from $443,000 for the nine-month period ended March 31, 1998
primarily as the result of a $25,000 loss resulting from employee theft. The
remaining increases were comprised of various other expense categories.
Income tax expense decreased by $276,000 to $466,000 for the nine-month period
ended March 31, 1999 compared to $743,000 for the six months ended March 31,
1998 due to a lower level of taxable income.
Year 2000
The Company has completed an assessment of its computer systems, including its
information and non-information systems, and identified those systems that it
believes could be affected by the Year 2000 issue. It has also developed an
implementation plan to address the issue and has tested the majority of its
internal mission critical hardware and software systems to determine if they are
Year 2000 compliant. While the Company has exposure to several risks related to
Year 2000, the primary risk to the Company of not complying with Year 2000 is
the potential inability to correctly process and record customer loan and
deposit transactions.
12
The Company believes that it has met the majority of the requirements that have
been established for the banking industry by the Federal Financial Institution
Examination Council "FFIEC". These standards require that a series of procedures
be performed by financial institutions within established time frames to reduce
the risk of noncompliance with the Year 2000 issue. While the Company believes
that it will meet all of the FFIEC requirements and that its mission critical
systems will be in compliance with Year 2000, it can give no assurance that this
will occur.
The Company is currently developing a business resumption contingency plan that
would take effect if its internal systems, or the systems of those material
vendors on which it is reliant, would not be compliant with Year 2000
requirements.
The Company outsources a significant portion of its data processing to an
outside provider. A worst case scenario for the Company would likely involve
non-compliance with Year 2000 by its primary data processor in such a manner
that would leave the Company in a position where it could not correctly process
and record customer loan and deposit transactions. While the Company has
successfully tested its primary data processing system for compliance with Year
2000, it cannot guarantee that the systems of this and other companies on which
the Company's systems rely will be timely converted and not have a material
effect on the Company. Other parties whose year 2000 compliance may effect the
Company include the Federal Home Loan Bank of Cincinnati, the Federal Reserve
Bank of Cincinnati, vendors who support loan and deposit documentation software,
the operations of the Company's ATM network, and these third parties have
indicated their compliance or intended compliance. Where it is possible to do
so, the Company has scheduled testing with these third parties. Where testing is
not possible, the Company will rely on certifications from vendors and service
providers. A failure to resolve year 2000 issues by governmental agencies,
utilities and telecommunications companies on whom the Company is dependent
could also adversely effect the Company. There can be no assurances that the
Company's year 2000 plan will effectively address the year 2000 issue, that the
impact of any failure of the Company's third-party vendors and service providers
to be year 2000 compliant will not have a material effect on the Company's
business, financial condition or results of operations.
The Company has, through March 31, 1999, incurred certain costs, not including
salary expense, related to Year 2000. A portion of these costs were incurred in
connection with the recent conversion of the Company's primary data processing
system. Costs incurred through March 31, 1999 total approximately $326,000 and
include $205,000 for equipment, $65,000 for software, $12,000 for de-conversion
fees that were paid to the previous data processing provider, $38,000 for
training and $6,000 for the initial assessment. At March 31, 1999, the Company
expects to incur additional costs associated with testing but does not expect
these costs to be material to the Company's financial condition or results of
operations.
The Company does not have, at March 31, 1999, any material commitments to
purchase new equipment, software or to incur material costs to modify its
existing system for year 2000 compliance and does not believe that any material
amounts of its existing computer hardware or software is impaired. The Company
has assessed the impact of Year 2000 on its commercial-lending customers, and
believes that the impact, in terms of potential credit exposure, is not
material. The majority of the Company's commercial lending portfolio consists of
commercial real estate loans that are made to companies that are not highly
technology intensive.
Asset/Liability Management - Quantitative and Qualitative Disclosures about
Market Risk
Key components of a successful asset/liability strategy are the monitoring and
managing of interest rate sensitivity of both the interest-earning asset and
interest-bearing liability portfolios. Home Federal has employed various
strategies intended to minimize the adverse effect of interest rate risk on
future operations by providing a better match between the interest rate
sensitivity of its assets and liabilities. In particular, the Bank's strategies
are intended to stabilize net interest income for the long-term by protecting
its interest rate spread against increases in interest rates. Such strategies
include the origination of adjustable-rate mortgage loans secured by one-to-four
family residential real estate and the origination of consumer and other loans
with greater interest rate sensitivities than long-term, fixed-rate residential
mortgage loans. Although customers typically prefer fixed-rate mortgage loans in
a low interest rate environment, Home Federal has been successful in originating
adjustable-rate loans in recent years. In addition, the Bank has used excess
funds to invest in various short-term investments including
13
mortgage-backed securities with terms of seven years or less, U.S. Government
Treasury and Agency securities with terms of ten years or less and other short-
term investments.
Asset/liability management in the form of structuring cash instruments provides
greater flexibility to adjust exposure to interest rates. During periods of high
interest rates, management believes it is prudent to offer competitive rates on
short-term deposits and less competitive rates for long-term liabilities. This
posture allows the Bank to benefit quickly from declines in interest rates.
Likewise, offering more competitive rates on long-term deposits during the low
interest rate periods allows the Bank to extend the re-pricing and/or maturity
of its liabilities thus reducing its exposure to rising interest rates.
The Bank does not have a trading account for any class of financial instrument
nor does it engage in hedging activities or purchase high-risk derivative
instruments. Furthermore, the Bank is not subject to foreign currency exchange
rate risk or commodity price risk.
The Bank uses interest rate sensitivity analysis to measure its interest rate by
computing changes in net portfolio value of its cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates. Net portfolio value represents the market
value of portfolio equity and is equal to the market value of assets minus the
market value of liabilities, with adjustments made for off-balance sheet items.
This analysis assesses the risk of loss in market risk sensitive instruments in
the event of a sudden and sustained 100 to 400 basis point increase or decrease
in market interest rates with no effect given to any steps that management might
take to counter the effect of that interest rate movement. Using data compiled
by the OTS, the Bank receives a report that measures interest rate risk by
modeling the change in net portfolio value over a variety of interest rate
scenarios. The most recent interest sensitivity analysis the Bank received from
the OTS measured the Bank's interest risk at December 31, 1998.
14
HFB FINANCIAL CORPORATION
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote
of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
None
b. Reports on Form 8-K
None
15
HFB FINANCIAL CORPORATION
Signatures
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
HFB FINANCIAL CORPORATION
By: /S/ David B. Cook
--------------------------
David B. Cook
President and
Chief Executive Officer
By: /S/ Stanley Alexander, Jr.
--------------------------
Stanley Alexander, Jr.
Chief Financial Officer
Dated: May 12, 1999
16