SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For Annual and Transition Reports Pursuant to Sections 13
or 15(d) of the Securities Exchange Act of 1934
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2001
--------------------------------------------
- or -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period __________________ to ____________________
Commission Number: 0-24648
FSF FINANCIAL CORP.
(Exact name of Registrant as specified in its Charter)
Minnesota 41-1783064
(State or other jurisdiction of incorporation (I.R.S. Employer)
or organization) Identification No.)
201 Main Street South, Hutchinson, Minnesota 55350-2573
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (320) 234-4500
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 $0.10 per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filling requirements for the past 90 days. X YES 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 stock held by non-affiliates of
the Registrant, based on the average bid and asked price of the Registrant's
Common Stock as quoted on the National Association of Securities Dealers, Inc.,
Automated Quotations National Market on November 30, 2001, was $ 27,871,698
(1,597,232 shares at $ 17.45 per share). ------------
-------
As of November 30, 2001 there were issued and outstanding 2,306,714
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year Ended
September 30, 2001. (Parts I,II and IV)
2. Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held January 15, 2002. (Part III)
PART I
FSF Financial Corp. (the "Corporation") may from time to time make written or
oral "forward-looking statements", including statements contained in the
Corporation's filings with the Securities and Exchange Commission (including
this annual report on Form 10-K and the exhibits thereto), in its reports to
stockholders and in other communications by the Corporation, which are made in
good faith by the Corporation pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such as
statements of the Corporation's plans, objectives, expectations, estimates and
intentions, that are subject to change based on various important factors (some
of which are beyond the Corporation's control). The following factors, among
others, could cause the Corporation's financial performance to differ materially
from the plans, objectives, expectations, estimates and intentions expressed in
such forward-looking statements: The strength of the United States economy in
general and the strength of the local economies in which the Corporation
conducts operations; the effects of, and changes in, trade, monetary and fiscal
policies and laws, including interest rate policies of the board of governors of
the federal reserve system, inflation, interest rates, market and monetary
fluctuations; the timely development of and acceptance of new products and
services of the Corporation and the perceived overall value of these products
and services by users, including the features, pricing and quality compared to
competitors' products and services; the willingness of users to substitute
competitors' products and services for the Corporation's products and services;
the success of the Corporation in gaining regulatory approval of its products
and services, when required; the impact of changes in financial services' laws
and regulations (including laws concerning taxes, banking, securities and
insurance); technological changes; acquisitions; changes in consumer spending
and saving habits and the success of the Corporation at managing the risks
resulting from these factors.
The Corporation cautions that the factors listed above are not exclusive. The
Corporation does not undertake to update any forward-looking statement, whether
written or oral, that may be made from time to time by or on behalf of the
Corporation.
ITEM 1. BUSINESS
General
FSF Financial Corp. is a Minnesota corporation organized in May, 1994, and as of
October 6, 1994, became the holding company for First Federal fsb ("First
Federal" or the "Bank"). First Federal is the resulting institution of the
merger between First State Federal Savings and Loan Association, Hutchinson,
Minnesota and First Federal Savings and Loan Association of Hastings, Hastings,
Minnesota. The Corporation operates two wholly owned subsidiaries: Insurance
Planners and the Bank. Insurance Planners (the "Agency") is an independent
property and casualty insurance agency located in Hutchinson, Minnesota. The
Corporation acquired the Agency on June 1, 1998. On November 17, 1998, the
Corporation acquired Homeowners Mortgage Corporation ("HMC"), a mortgage banking
company located in Vadnais Heights, Minnesota. As of June 1, 2000, HMC became an
operating subsidiary of the bank following regulatory approval. See "Subsidiary
Activity".
First Federal's business consists primarily of attracting deposits from the
general public and using such deposits, together with borrowings and other
funds, to make mortgage loans secured by residential real estate located in
Minnesota. At September 30, 2001, First Federal operated 11 retail-banking
offices in Minnesota. On November 9, 2001, First Federal completed its
acquisition of the ING Bank branch facility in the St. Cloud and Minneapolis
area. See "Item 2- Properties".
First Federal is regulated by the Office of Thrift Supervision ("OTS") and by
the Federal Deposit Insurance Corporation ("FDIC") which, through the Savings
Association Insurance Fund ("SAIF"), insures up to certain legal limits, the
deposit accounts of institutions such as First Federal fsb. First Federal fsb is
also a member of the Federal Home Loan Bank ("FHLB") of Des Moines, which is one
of the twelve regional banks for federally insured savings institutions and
certain other residential lending entities comprising the Federal Home Loan Bank
System.
1
Competition
The Corporation is one of many financial institutions serving its market area
that consists of the ten Minnesota counties of Benton, Carver, Dakota, McLeod,
Meeker, Sherburne, Sibley, Stearns, Washington and Wright. The competition for
deposit products comes from other insured financial institutions such as
commercial banks, thrift institutions, credit unions and multi-state regional
banks in the Corporation's market area. Deposit competition also includes a
number of insurance products sold by local agents and investment products such
as mutual funds and other securities sold by local and regional brokers. Loan
competition varies depending upon market conditions and comes from other insured
financial institutions such as commercial banks, thrift institutions, credit
unions, multi-state regional banks and mortgage bankers.
2
Lending Activities
The following table sets forth the composition of the loan portfolio in dollars
and in percentages of total loans at the dates indicated:
At September 30,
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2001 2000 1999 1998 1997
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Amount % Amount % Amount % Amount % Amount %
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Residential
real estate:
One to four
family (1) $ 81,790 19.1 $101,034 26.3 $120,884 38.8 $157,340 52.2 $170,422 60.3
Residential
construction 142,035 33.2 82,408 21.5 42,937 13.8 21,960 7.3 20,796 7.4
Multi-family 5,922 1.4 4,737 1.2 5,635 1.8 2,975 1.0 3,370 1.2
----------------------------------------------------------------------------------------------------------
229,747 53.7 188,179 49.0 169,456 54.4 182,275 60.4 194,588 68.9
Agricultural loans 49,935 11.7 43,829 11.4 33,384 10.7 22,959 7.6 - -
Land and commercial
real estate 55,220 12.9 50,970 13.3 36,429 11.7 34,399 11.4 38,582 13.7
Commercial business 23,908 5.6 29,831 7.8 29,767 9.6 21,095 7.0 8,114 2.9
----------------------------------------------------------------------------------------------------------
129,063 30.1 124,630 32.4 99,580 32.0 78,453 26.0 46,696 16.5
Consumer:
Home equity and
second mortgage 29,991 7.0 28,106 7.3 24,312 7.8 23,606 7.8 20,812 7.4
Automobile loans 13,023 3.0 13,255 3.5 7,428 2.4 9,670 3.2 11,596 4.1
Other 26,292 6.1 29,943 7.8 10,898 3.5 7,605 2.5 8,821 3.1
----------------------------------------------------------------------------------------------------------
Total consumer loans 69,306 16.2 71,304 18.6 42,638 13.7 40,881 13.6 41,229 14.6
----------------------------------------------------------------------------------------------------------
Total loans 428,116 100.0 384,113 100.0 311,674 100.0 301,609 100.0 282,513 100.0
========= ========= ========= ========= =========
Less:
Loans in process (73,235) (36,864) (26,156) (16,658) (20,364)
Deferred fees (774) (711) (507) (641) (703)
Allowance for loan
losses (1,541) (1,534) (1,387) (1,035) (852)
--------- ------------- ------------- ------------- -------------
Total loans,
net $352,566 $345,004 $283,624 $283,275 $260,594
========= ============= ============= ============= =============
(1) Includes loans held for sale in the amount of $12.1 million, $3.2 million,
$5.3 million, $2.7 million and $204,000 as of September 30, 2001, 2000,
1999, 1998 and 1997, respectively.
3
The following table sets forth the loan originations, loan sales and principal
payments for the periods indicated:
Years Ended September 30,
-----------------------------------------------------------------------
2001 2000 1999 1998 1997
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(In Thousands)
Total gross loans receivable at
end of period $ 428,116 $ 384,113 $ 311,674 $ 301,609 $ 282,513
Loans originated:
Residential real estate:
One to four family 99,017 56,400 130,461 56,768 55,144
Residential construction 150,254 94,929 55,700 23,007 12,968
Multi-family - - - 240 190
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Total residential real estate 249,271 151,329 186,161 80,015 68,302
Land 14,258 7,189 5,900 4,960 20,077
Commercial business 12,912 16,149 13,033 9,801 2,402
Agricultural 42,040 38,204 28,081 27,049 -
Consumer 29,471 49,804 27,503 25,740 28,465
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Total loans originated 347,952 262,675 260,678 147,565 119,246
Purchase of loans 27,337 32,417 40,883 10,832 8,528
Sale of loan participation (1,600) (851) (3,000) - -
Sale of loans (129,245) (54,364) (128,925) (24,953) (6,661)
Principal repayments (235,841) (166,921) (169,131) (112,284) (72,035)
Other (net) 35,400 (517) 9,560 (2,064) 1,331
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Net loan activity $ 44,003 $ 72,439 $ 10,065 $ 19,096 $ 50,409
=======================================================================
Maturity of Loans
The following table sets forth the maturity of the Bank's loans at September 30,
2001. The table does not include prepayments or scheduled principal repayments.
Prepayments and scheduled principal repayments on loans totaled $203.4 million
for the year ended September 30, 2001. Adjustable rate mortgage loans are shown
as maturing based on contractual maturities.
One to Four Land, Commercial
Family Multi-Family Business,
Real Estate and Commercial Agriculture and
Mortgages Real Estate Construction Consumer Total
-----------------------------------------------------------------------------------
(In Thousands)
Amounts Due:
Within 3 months $ 12,733 $ 19,403 $ 65,417 $ 51,843 $ 149,396
3 months to 1 year 35,306 6,781 76,618 37,676 156,381
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Total due before one year 48,039 26,184 142,035 89,519 305,777
-----------------------------------------------------------------------------------
After 1 year:
1 to 3 years 12,124 25,913 - 30,231 68,268
3 to 5 years 5,826 3,751 - 20,417 29,994
5 to 10 years 911 2,751 - 2,564 6,226
10 to 20 years 7,485 2,543 - 418 10,446
Over 20 years 7,405 - - - 7,405
-----------------------------------------------------------------------------------
Total due after one year 33,751 34,958 - 53,630 122,339
-----------------------------------------------------------------------------------
Total amount due $ 81,790 $ 61,142 $ 142,035 $ 143,149 $ 428,116
===================================================================================
4
The following table sets forth, as of September 30, 2001, the dollar amount of
all loans due after September 30, 2002, based upon fixed rates of interest,
balloon rates or adjustable rates.
Fixed- Balloon Adjustable
Rates Rates Rates Total
------------- -------------- -------------- -------------
(In Thousands)
One to four family real estate and construction $ 8,775 $ 5,400 $ 19,576 $ 33,751
Land, multi-family and commercial real estate 29,016 2,130 3,812 34,958
Commercial business, agricultural and consumer 23,061 - 30,569 53,630
------------- -------------- -------------- -------------
Total $ 60,852 $ 7,530 $ 53,957 $122,339
============= ============== ============== =============
One- to-Four Family Mortgage Loans
The largest portion of mortgage loans are made for the purpose of enabling
borrowers to purchase one- to-four family residences secured by first liens on
the properties. The Bank and HMC originate balloon, adjustable rate mortgage
loans ("ARM") and fixed rate mortgage loans secured by one-to-four family
residences with terms of up to 30 years. FHA and VA loans are also offered and
then sold, servicing released in the secondary market. Borrower demand for ARM
loans versus fixed rate mortgage loans depends on various factors, including,
but not limited to, interest rates offered, the expectations of changes in the
short and long term levels of interest rates and loan fees charged. The relative
amount of fixed rate, balloon and ARM loans that can be originated at any time
is largely determined by the demand for each in a competitive environment. All
fixed rate loans are sold in the secondary market, some with servicing released
and some servicing retained, which are sold to the Federal Home Loan Mortgage
Corporation ("FHLMC").
The Bank originates three, five and seven year balloon mortgage loans, the
majority of which are the three year. These mortgages contain no contractual
assurances that the loan will be renewed. At maturity, the loan is generally
re-written and re-recorded. If the borrower's loan payment history is
satisfactory, a new appraisal is not required. Management believes that balloon
loans have a pricing characteristic that helps offset the detrimental effect
that rising rates could have on net interest income because the balloon loans do
not contain interest rate adjustment caps. At September 30, 2001, balloon
mortgages were $15.0 million, or 4.3% of the Bank's loan portfolio.
The Bank offers ARM loans that adjust every year, with the initial adjustment
coming one, three, five, seven or ten years after origination. The loans have
terms from 10 to 30 years and the interest rates on these loans are generally
based on Treasury bill indices. The annual interest rate cap (the maximum amount
which the interest rate may increase in a year) on the Bank's ARM loans is
generally 2.0% and the lifetime cap is generally 6.0% over the initial rate of
the loan. The Bank considers market factors and competitive rates on loans, as
well as its own cost of funds when determining the rates on the loans it offers.
The Bank does not originate loans with negative amortization.
Residential Construction Lending.
The Bank and HMC originate residential construction loans to qualified borrowers
for construction of one- to-four family residential properties primarily located
in the Bank's market area. Construction loans are made to builders on a
pre-sold, speculative and model home basis and primarily to owners for
construction of their primary residence on a construction/permanent basis. Such
loans generally have terms from six to nine months. Loans for speculative
housing construction are made to area builders only after a thorough background
check, which includes an analysis of the builder's financial statements, credit
reports and reference checks with sub-contractors and suppliers, has been made.
The Bank usually will have no more than two speculative or model home
construction loans outstanding at any one time to any single builder. Loan
proceeds are disbursed in increments as construction progresses and only after a
physical inspection of the project has been made. Accrued interest on loan
disbursements is paid monthly.
Loans involving construction financing present a greater level of risk than
loans for the purchase of existing homes because collateral value and
construction costs can only be estimated at the time the loan is approved. The
Bank and HMC have sought to minimize the risk by limiting construction lending
to qualified borrowers primarily in the Bank's market area, limiting the number
of construction loans for speculative purposes outstanding at any one time and
by installing a system to inspect the property and to monitor loan
disbursements.
5
Land Acquisition and Development Loans, Commercial Real Estate and Multi-Family
Lending The Bank originates land loans on residential properties located in the
Bank's primary market area. Land lending generally involves additional risks to
the lender as compared with residential mortgage lending. This risk is
attributable to the fact that loan funds are advanced upon the security of land
under development and predicated on the future value of the property upon
completion of development. Loans on undeveloped land may run the risk of adverse
zoning changes and environmental or other restrictions on future use. Because of
these factors, the analysis of land loans requires an expertise that is
different in significant respects from that which is required for residential
lending.
Commercial real estate loans are permanent loans secured by improved property
such as office buildings, retail or wholesale facilities, industrial buildings
and other non-residential buildings. Commercial real estate loans may be
originated in amounts up to 80% of the appraised value of the mortgaged property
as determined by a certified or licensed independent appraiser.
Multi-family residential real estate loans are permanent loans secured by
apartment buildings. Of primary concern in multi-family residential real estate
lending is the borrower's creditworthiness, feasibility and cash flow potential
of the project. Loans secured by income properties generally are larger and
involve greater risks than residential mortgage loans because payments on loans
secured by income properties are often dependent on the successful operation or
management of the properties. As a result, repayment of such loans may be
subject to, more than residential real estate loans, adverse conditions in the
real estate market or the economy. In order to monitor cash flows on income
properties, the Bank requires borrowers and loan guarantors, if any, to provide
annual financial statements and rent rolls on multi-family loans. At September
30, 2001, the five largest land acquisition and development, commercial real
estate and multi-family loans ranged from $2.3 million to $6.9 million with an
average committed outstanding balance of $3.9 million. All such loans were
current and have performed in accordance with their terms.
Commercial Business Lending
The Bank's commercial business loans are for a variety of purposes; including
working capital, accounts receivable, inventory, equipment and acquisitions. The
Bank has no energy or foreign loans.
Residential mortgage loans are generally made on the basis of the borrower's
ability to make repayments from his or her employment income and also other
income sources. These residential mortgage loans are secured by real property
with a value that tends to be more easily ascertainable. Commercial business
loans are generally made on the basis of the borrower's ability to make
repayment from the cash flow of the borrower's business. As a result, the
availability of funds for the repayment of commercial business loans may be
substantially dependent on the success of the business itself (which is likely
to be dependent upon the general economic environment.) Business assets, such as
accounts receivable, equipment and inventory, as well as real estate sometimes,
but not always, secure the Bank's commercial business loans. However, the
collateral securing these loans may depreciate over time, may be difficult to
appraise or may fluctuate in value based on the success of the business.
The Bank recognizes the general increased risk associated with commercial
business lending. The Bank's commercial business lending policy emphasizes (1)
credit file documentation, (2) analysis of the borrower's character, (3)
analysis of the borrower's capacity to repay the loan, (4) adequacy of the
borrower's capital and collateral and (5) evaluation of the industry conditions
affecting the borrower. Analysis of the borrower's past, present and future cash
flows is also an important aspect of the Bank's credit analysis. The Bank plans
to continue to expand its commercial business lending, subject to market
conditions.
The Bank generally obtains annual financial statements from borrowers for
commercial business loans. These statements are analyzed to monitor the quality
of the loan. As of September 30, 2001, the five largest commercial business
loans ranged from $2.0 million to $6.1 million, with an average committed
balance outstanding of $3.5 million. All such loans are current and have
performed in accordance with their terms.
6
Agricultural Lending
The Bank originates loans to finance the purchase of farmland, livestock, farm
machinery and equipment, seed, fertilizer and for other farm related products.
Agricultural operating loans are originated at either an adjustable or fixed
rate of interest for up to a one year term or, in the case of livestock, upon
sale. Most agricultural operating loans have terms of one year or less. Such
loans provide for payments of principal and interest at least annually, or a
lump sum payment upon maturity if the original term is less than one year. Loans
secured by agricultural machinery are generally originated as fixed rate loans
with terms of up to five years.
Agricultural real estate loans are frequently originated with adjustable rates
of interest. Generally, such loans provide for a fixed rate of interest for the
first three years, adjusting annually thereafter. In addition, such loans
generally provide for a ten year term based on a 20 year amortization schedule.
Adjustable rate agricultural real estate loans are generally limited to 80% of
the value of the property securing the loan.
Agricultural lending affords the Bank the opportunity to earn yields higher than
those obtainable on one-to-four family residential lending. Nevertheless,
agricultural lending involves a greater degree of risk than one-to-four family
residential mortgage loans because of the typically larger loan amount. In
addition, payments on loans are dependent on the successful operation or
management of the farm property securing the loan or for which an operating loan
is utilized. The success of the loan may also be affected by many factors
outside the control of the farm borrower.
Weather presents one of the greatest risks as hail, drought, floods or other
conditions can severely limit crop yields and thus impair loan repayments and
the value of the underlying collateral. This risk can be reduced with
multi-peril crop insurance, which can guarantee set yields to provide certainty
of repayment. Unless the circumstances of the borrower merit otherwise, the Bank
generally does not require its borrowers to procure multi-peril crop or hail
insurance. However, recent changes in government support programs generally
require that farmers procure multi-peril crop insurance to be eligible to
participate in such programs.
Grain and livestock prices also present a risk as prices may decline prior to
sale resulting in a failure to cover production costs. The farmer with the use
of futures contracts or options to provide a "floor" below which prices will not
fall may reduce these risks. The Bank does not monitor or require the use by
borrowers of future contracts or options.
Another risk is the uncertainty of government programs and other regulations.
Some farmers rely on the income from government programs to make loan payments
and if these programs are discontinued or significantly changed, cash flow
problems or defaults could result.
Finally, many farms are dependent on a limited number of key individuals whose
injury or death may result in an inability to successfully operate the farm. At
September 30, 2001, the five largest agricultural loans ranged from $1.2 million
to $2.8 million, with an average committed outstanding balance of $1.7 million.
All such loans are in the Bank's market area, are current and have performed in
accordance with their terms.
Consumer and Other Loans
The Bank offers consumer and other loans in the form of home equity and second
mortgages, automobile and loans for other purposes. Federal regulations permit
federally chartered thrift institutions to make secured and unsecured consumer
loans up to 35% of an institution's assets. The Bank originates consumer loans
in order to provide a wide range of financial services to its customers and
because the shorter terms and normally higher interest rates help maintain a
profitable spread between its average loan yield and the Bank's cost of funds.
In connection with consumer loan applications, the Bank verifies the borrower's
income and reviews credit bureau reports. In addition, the relationship of the
loan to the value of the collateral is considered. Consumer loans entail greater
risks than one-to-four family residential mortgage loans, particularly because
consumer loans are secured by rapidly depreciable assets such as automobiles or
loans that are unsecured. In such cases, any repossessed collateral for a
defaulted loan may not provide an adequate source of repayment of the
outstanding loan balance, since there is a greater likelihood of damage, loss or
depreciation of the underlying collateral. Further, consumer loan collections
are dependent on the
7
borrower's continuing financial stability, and therefore are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default.
Loan Approval Authority and Underwriting
The primary source of mortgage loan applications is referrals from existing or
past customers. Applications are also solicited from real estate brokers,
contractors, call-ins and walk-ins to the offices.
Upon receipt of any loan application from a prospective borrower, a credit
report is ordered and verifications of specific information relating to the loan
applicant's employment, income and credit standing are requested. An appraisal
or valuation determination, subject to regulatory requirements, of the real
estate intended to secure the proposed loan is undertaken. Licensed independent
appraisers and two authorized appraisers on staff at the Bank are utilized in
determining the value of property. In connection with the loan approval process,
underwriters analyze the loan applications and the property involved. All
residential, home equity, multi-family, construction and commercial real estate
loans are underwritten, subject to the loan underwriting policies as approved by
the Board of Directors. In general, the Board of Directors must approve loans in
excess of $1.0 million.
Loan applicants are promptly notified of the decision by a letter setting forth
the terms and conditions of the decision. If approved, these terms and
conditions include the amount of the loan, interest rate basis, amortization
term, a brief description of real estate to be mortgaged and the notice of
requirement of insurance coverage to be maintained. Title insurance or a title
opinion are required on first mortgage loans, as well as fire and casualty
insurance on all properties securing loans. Insurance must be maintained during
the entire term of the loan. Flood insurance is also required, if appropriate.
Loans to One Borrower
Under federal law, federally chartered savings banks have, subject to certain
exemptions, aggregate lending limits to one borrower equal to 15.0% of the
institution's unimpaired capital and surplus. As of September 30, 2001, First
Federal's five largest lending relationships included a $4.3 million commercial
line of credit, a $6.1 million line of credit to an unaffiliated mortgage
banking company, $7.2 million in construction and development loans to a local
developer, a $3.5 million commercial real estate loan and $6.9 million in land
development loans to a local developer. This is approximately 6.5% of the total
loans. At September 30, 2001, all of these loans were within the loans to one
borrower limitations, performing in accordance with their terms, and at market
rates of interest.
Loan Servicing
The Bank services substantially all of the loans that it retains in its
portfolio. However, HMC does not engage in any loan servicing. Loan servicing
includes collecting and remitting loan payments, accounting for principal and
interest, making advances to cover delinquent payments, making inspections of
mortgaged premises (as required), contacting delinquent mortgagors, supervising
foreclosures and property dispositions in the event of unremedied defaults and
generally administering the loans. Funds that have been escrowed by borrowers
for the payment of mortgage related expenses, such as property taxes and hazard
and mortgage insurance premiums, are maintained in non-interest bearing accounts
at the Bank. At September 30, 2001, the Bank had $298,000 deposited in escrow
accounts for its loans serviced for others.
The following table presents information regarding the loans serviced by the
Bank for others at the dates indicated:
September 30,
----------------------------------------------------
2001 2000 1999
----------------------------------------------------
(In Thousands)
Mortgage loan portfolios serviced for:
FHLMC $ 42,736 $ 45,002 $ 48,219
Other Investors 10,232 7,126 7,269
----------------------------------------------------
$ 52,968 $ 52,128 $ 55,488
====================================================
8
The Bank receives fees for servicing mortgage loans, which generally amounts to
0.25% per annum on the declining balance of mortgage loans. Such fees serve to
compensate the Bank for the cost of performing the servicing functions. Another
source of loan servicing revenues is late fees. For the years ended September
30, 2001, 2000 and 1999, the Bank earned gross fees of $276,000, $247,000 and
$236,000, respectively from loan servicing. The Bank retains a portion of funds
received from borrowers on the loans it services for others in payment of its
servicing fees received on loans serviced for others.
Non-Performing and Problem Assets
Loan Collections and Delinquent Loans
The Bank's collection procedures provide that when a loan is 30 days or more
delinquent, the borrower is contacted by mail and telephone and payment is
requested. If the delinquency continues, subsequent efforts will be made to
contact the borrower. In certain instances, the Bank may modify the loan or
grant a limited moratorium on loan payments to enable the borrower to reorganize
his financial affairs. Once a loan delinquency exceeds 60 days, it is classified
as special mention and the Bank attempts to work with the borrower to establish
a repayment schedule to cure the delinquency. If the borrower is unable to cure
the delinquency, the Bank will institute foreclosure actions. If a foreclosure
action is taken and the loan is not reinstated, paid in full or refinanced, the
property is sold at a judicial sale at which the Bank may be the buyer if there
are no offers to satisfy the debt. Any property acquired as the result of a
foreclosure or by deed in lieu of foreclosure is classified as foreclosed real
estate until such time as it is sold or otherwise disposed of by the Bank. At
September 30, 2001, the Bank had $126,000 of foreclosed real estate, consisting
of a one-to-four family residential loan. When foreclosed real estate is
acquired, it is recorded at the lower of the unpaid principal balance of the
related loan or its fair market value less related disposition costs. Any write
down of the property is charged to the allowance for losses.
Non-performing Assets
Loans are reviewed on a regular basis and are placed on non-accrual status when,
in the opinion of management, the collection of additional interest is doubtful.
Residential mortgage loans are generally placed on non-accrual status when
either principal or interest is 90 days or more past due. Consumer loans are
generally charged off when the loan becomes over 90 days delinquent. Commercial
business and real estate loans are generally placed on non-accrual status when
the loan is 90 days or more past due. Interest accrued and unpaid at the time a
loan is placed on non-accrual status is charged against interest income.
Subsequent payments are either applied to the outstanding principal balance or
recorded as interest income, depending on the assessment of the ultimate
collectibility of the loan. At September 30, 2001, there were no accruing loans
that were contractually past due 90 days or more.
9
The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated. During the periods indicated,
the Bank had no restructured loans within the meaning of Statement of Financial
Accounting Standards (SFAS) No. 15 and there were no impaired loans within the
meaning of SFAS 114, as amended by SFAS 118.
At September 30,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------------
(Dollars in Thousands)
Loans accounted for on a non-accrual basis:
Mortgage loans:
Residential construction loans $ 1,043 $ 323 $ - $ - $ 393
Permanent loans secured by one to
four family units 78 55 205 240 25
Non-mortgage loans:
Commercial and agricultural 1,195 452 - - -
Consumer 637 159 22 69 82
-----------------------------------------------------------------
Total non-accrual loans 2,953 989 227 309 500
Foreclosed real estate and real estate
held for investment 126 321 323 502 72
-----------------------------------------------------------------
Total non-performing assets $ 3,079 $ 1,310 $ 550 $ 811 $ 572
=================================================================
Total non-performing loans to net loans 0.84% 0.29% 0.08% 0.11% 0.19%
=================================================================
Total non-performing loans to total assets 0.62% 0.21% 0.05% 0.07% 0.13%
=================================================================
Total non-performing assets to total assets 0.65% 0.28% 0.13% 0.19% 0.15%
=================================================================
There were eight residential construction loans accounted for on a non-accrual
basis. One loan with a balance of $251,000 was paid in full subsequent to
September 30, 2001. Two loans totaling $245,000 are in the process of
foreclosure. The homes are about 90% complete and the loan-to-value ratio on the
homes is approximately 65%. The five remaining loans have balances ranging from
$100,000 to $138,000 and should be resolved in a satisfactory manner. There were
two loans secured by one to four family residential units accounted for on a
non-accrual basis. The commercial and agricultural loans were comprised of two
agricultural loans totaling $252,000 that were paid-in-full subsequent to
September 30, three loans totaling $382,000 that are in the process of being
liquidated, one operating loan for $406,000, insured by the US Department of
Agriculture, that is being liquidated and two loans, totaling $155,000 that have
repayment schedules in place. There are 33 consumer loans that were in a
non-accrual status at September 30, 2001 that had balances ranging from $279 to
$89,000. The majority of the loans have payment schedules established that are
closely monitored, and some of the loans are in the liquidation process. Loans
that are in the liquidation process are evaluated for impairment and the
balances are adjusted, if necessary, in accordance with SFAS 114.
Interest income that would have been recorded on loans accounted for on a
non-accrual basis under the original terms of such loans was approximately
$178,000 for the year ended September 30, 2001.
Classified Assets
Management, in compliance with regulatory guidelines, has instituted an internal
loan review program, whereby loans are classified as special mention,
substandard, doubtful or loss. When a loan is classified as substandard or
doubtful, management is required to establish a general valuation reserve for
loan losses in an amount that is deemed prudent. General allowances represent
those that have been established to recognize inherent risk associated with
lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When management classifies a loan as
loss, a reserve equal to 100% of the loan balance may be established or the loan
is charged off.
An asset is considered substandard if the paying capacity and net worth of the
obligor or the collateral inadequately protects it. Substandard assets include
those characterized by the distinct possibility that the 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, highly questionable and improbable, on the
10
basis of currently existing facts, conditions and values. 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 a
sufficient degree of risk and are not classified in one of the aforementioned
categories but possess credit deficiencies or potential weaknesses, including
all loans over 60 days delinquent, are required to be designated special mention
by management. The OTS has promulgated regulations that discontinue the
classification of assets as special mention. However, the Bank continues to
utilize this category.
Management's evaluation of the classification of assets and the adequacy of the
reserve for loan losses is reviewed by regulatory agencies as part of their
periodic examinations. At September 30, 2001 the Bank had total classified
assets of $4.8 million of which $1.2 million were considered substandard and no
assets were classified as doubtful or loss. Special mention assets totaled $3.6
million at September 30, 2001.
Allowance for Loan and Lease Losses and Foreclosed Real Estate
In making loans, the Bank recognizes that credit losses will be experienced and
that the risk of loss will vary with, among other things, the type of loan being
made, the creditworthiness of the borrower over the term of the loan and in the
case of a secured loan, the quality of the collateral for the loan. The Bank's
management evaluates the need to establish reserves against losses on loans and
other assets each quarter based on estimated losses on specific loans and on any
real estate held for sale or investment when a finding is made that a loss is
estimable and probable. Such evaluation includes a review of all loans for which
full collectibility may not be reasonably assured and considers, among other
matters, the estimated market value of the underlying collateral of problem
loans, prior loss experience, economic conditions and overall portfolio quality.
While management recognizes and charges against the allowance for loan losses
accounts that are determined to be uncollectible, experience indicates that at
any point in time, possible losses may exist in the loan portfolio which are not
specifically identifiable. Therefore, based upon management's best estimate,
each year an amount may be charged to earnings to maintain the allowance for
loan losses at a level sufficient to recognize potential risk.
Impaired loans, including all loans that are in a troubled debt restructuring
involving a modification of terms, are measured at the present value of expected
future cash flows discounted at the loan's initial effective interest rate. The
fair value of the collateral of an impaired collateral dependent loan or an
observable market price, if one exists, may be used as an alternative to
discounting. If the measure of the impaired loan is less than the recorded
investment in the loan, impairment is recognized through the allowance for loan
losses. A loan is considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect all amounts due
according to the contractual terms of the loan agreement.
The Bank believes it has established its existing allowance for loan losses in
accordance with GAAP. However, there can be no assurance that banking
regulators, in reviewing the Bank's loan portfolio, will not request First
Federal to significantly increase its allowance for loan losses or that a
deteriorating real estate market or other unforeseen economic changes may cause
a significant increase in allowance for loan losses. This may negatively affect
the Bank's financial condition and earnings.
11
The following table sets forth information with respect to the Bank's allowance
for loan losses at the dates indicated:
At September 30,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------------
(Dollars in Thousands)
Average loans outstanding $344,470 $308,721 $274,676 $276,730 $237,475
=================================================================
Allowance balance (beginning of period) $ 1,534 $ 1,387 $ 1,035 $ 852 $ 776
-----------------------------------------------------------------
Provision (credit):
Residential and construction 85 - - - -
Land and Commercial real estate 30 60 20 2 40
Commercial/agricultural business 772 156 418 293 -
Consumer 190 - 18 7 80
-----------------------------------------------------------------
Total provision 1,077 216 456 302 120
Charge off:
Residential and construction - - - 45 13
Commercial real estate 756 - - - -
Consumer 371 98 142 87 37
-----------------------------------------------------------------
Total charge offs 1,127 98 142 132 50
Recoveries:
Residential and construction - - - - -
Commercial real estate 35 - - - -
Consumer 22 29 38 13 6
-----------------------------------------------------------------
Total recoveries 57 29 38 13 6
-----------------------------------------------------------------
Net charge offs 1,070 69 104 119 44
-----------------------------------------------------------------
Allowance balance (at end of period) $ 1,541 $ 1,534 $ 1,387 $ 1,035 $ 852
=================================================================
Allowance as percent of net loans 0.44% 0.44% 0.48% 0.36% 0.33%
Net loans charged off as a percent of
average loans 0.31% 0.02% 0.04% 0.04% 0.02%
To further monitor and assess the risk characteristics of the loan portfolio,
loan delinquencies are reviewed to consider any developing loan problems. Based
upon the procedures in place, the Bank's experience regarding charge-offs and
recoveries and the current risk elements in the portfolio, management believes
the allowance for loan losses at September 30, 2001 is adequate. However,
assessment of the adequacy of the allowance for loan losses involves subjective
judgments regarding future events and thus there can be no assurance that
additional provisions for loan losses will not be required in future periods.
The following table sets forth the breakdown by loan category of the allowance
for loan losses:
September 30,
------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------------------------------------------------------------------------------------------
(Dollars in Thousands)
Real Estate:
One-to-four family $ 49 19.1% $ 59 26.3% $ 73 38.8% $ 94 52.2% $ 103 60.3%
Residential construction 117 33.2% 59 21.5% 25 13.8% 11 7.3% 5 7.4%
Multi-family 48 1.4% 47 1.2% 56 1.8% 30 1.0% 34 1.2%
Land and commercial real estate 390 12.9% 473 13.2% 486 11.7% 347 11.4% 380 13.7%
Agricultural loans 318 11.7% 245 11.4% 200 10.7% 138 7.6% - 0.0%
Commercial business 239 5.6% 298 7.8% 297 9.6% 211 7.0% 124 2.9%
Consumer loans 380 16.0% 353 18.6% 250 13.6% 204 13.5% 206 14.5%
------------------------------------------------------------------------------------------
$1,541 100.0% $1,534 100.0% $1,387 100.0% $1,035 100.0% $ 852 100.0%
12
Investment and Mortgage-Backed Securities Activities
General
Federally chartered thrift 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. To supplement lending activities, subject to various
restrictions, the Bank invests a portion of its assets in commercial paper,
corporate debt securities and asset backed securities (e.g., mortgage-backed
securities). A significant portion of the Bank's income during recent years has
been attributable to interest income on such securities. The Corporation does
not have the same investment limitations as the Bank.
Mortgage-Backed and Related Securities
First Federal invests in residential mortgage-backed securities guaranteed by
participation certificate issues by the FHLMC, the Federal National Mortgage
Association ("FNMA") and the Government National Mortgage Association ("GNMA").
The mortgage-backed securities portfolio as of September 30, 2001 consisted of
$42.0 million in Real Estate Mortgage Investment Conduits ("REMICs"), $5.7
million in a FNMA certificate and $5.5 million in FHLMC certificates.
Mortgage-backed securities represent a participation interest in a pool of
single family or multi-family mortgages. The principal and interest payments are
passed from the mortgage originators, through intermediaries (generally
quasi-governmental agencies) that pool and repackage the participation interest
in the form of securities to investors such as the Bank. Such quasi-governmental
agencies, which guarantee the payment of principal and interest to investors,
primarily include FHLMC, FNMA and GNMA.
Mortgage-backed securities typically are issued with stated principal amounts
and pools of mortgages that have loans with interest rates that are within a
range and have varying maturities back the securities. The underlying pool of
mortgages is primarily composed of either fixed rate mortgages or ARM loans.
Mortgage-backed securities are generally referred to as mortgage participation
certificates or pass-through certificates. As a result, the interest rate risk
characteristics of the underlying pool of mortgages, (i.e. fixed rate or
adjustable rate) as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed, pass-through security is equal to the
life of the underlying mortgages. Mortgage-backed securities issued by FHLMC,
FNMA and GNMA make up a majority of the pass-through market.
Mortgage-backed securities provide for monthly payments of principal and
interest and generally have contractual maturities ranging from five to thirty
years. In periods of declining interest rates, payments on many mortgages are
received faster than the contractual amount required, causing the estimated
lives of mortgage related securities to be significantly shorter than expected.
REMICs are typically issued by a special purpose entity ("issuer"), which may be
organized in a variety of legal forms, such as a trust, a corporation or a
partnership. The entity aggregates pools of pass-through securities, which are
used to collateralize the mortgage-related securities. Once combined, the cash
flows can be divided into tranches or classes of individual securities, thereby
creating more predictable average duration for each security than the underlying
pass-through pools. Accordingly, under this security structure all principal pay
downs from the various mortgage pools are allocated to a mortgage related class
or classes structured to have priority until it has been paid off. Thus, these
securities are intended to address the reinvestment concerns associated with
mortgage-backed securities pass-through, namely that (i) they tend to pay off
when interest rates fall, thereby taking their relatively high coupon with them
and (ii) their expected average life may vary significantly among the different
tranches.
Some REMIC instruments are more like traditional debt instruments because they
have stated principal amounts and traditionally defined interest rate terms.
Purchasers of certain other REMIC securities are entitled to the excess, if any,
of the issuer's cash inflows, including reinvestment earnings, over the cash
outflows for debt service and administrative expenses. These mortgage related
instruments may include instruments designated as residual interests and are
riskier in that they could result in the loss of a portion of the original
investment. Cash flows from residual interests are very sensitive to
prepayments, and thus, contain a high degree of interest rate risk. Residual
interest represents an ownership interest in the underlying collateral, subject
to the first lien of the REMICs investors.
13
The REMICs held by the Bank at September 30, 2001 consisted of floating rate
tranches. The interest rate of all of the Bank's floating rate securities
adjusts monthly and provides the institution with net interest margin protection
in an increasing market rate environment. The securities are backed by mortgages
on one to four family residential real estate and have contractual maturities up
to 30 years. None of the securities are deemed to be "high risk" according to
OTS guidelines. The securities are primarily companion tranches to "PACs" and
"TACs". PACs and TACs (Planned and Targeted Amortization Classes) are designed
to provide a specific principal and interest cash flow. Principal payments that
are received in excess of the amount needed for the PACs and TACs are allocated
to the companion tranches. When the PACs and TACs are repaid in full, all
principal is then used to pay the companion tranches. Although the timing of
principal payments may be impacted by the amount of prepayments (the higher the
level of prepayments, the sooner the principal will be received), all of the
principal and interest payments are guaranteed.
Investment Securities
The Bank is required under federal regulation, to maintain a sufficient level of
liquid assets which may be invested in specified short-term securities and
certain other investments. However, the OTS does not prescribe by regulation to
a minimum amount or percentage of liquid assets. Liquidity levels may be
increased or decreased, depending upon the yields on investment alternatives and
upon management's judgement as to the attractiveness of the yields then
available in relationship to other opportunities. Also its expectations of
future yield levels, as well as management's projections as to the short-term
demand for funds, are used in the Bank's loan originating and other activities.
These securities consist mainly of U.S. Government Securities and U.S.
Government Agency obligations. The Bank also invests in debt and equity
securities.
The Board of Directors establishes the investment policy of the Bank. It is
designed to provide and maintain liquidity, to generate a favorable return on
investments without incurring undue interest rate and credit risk and to
compliment the Bank's lending activity. The policy currently provides for
investments held to maturity and investments available for sale.
The amount of short-term securities reflects management's strategy to provide
interest rate adjustments for securities that are shorter than their maturity.
It is the intention of management to maintain a repricing structure in the
Bank's investment portfolio that better matches the interest rate sensitivities
of its assets and liabilities. However, during periods of rapidly declining
interest rates, such investments also decline at a faster rate than the yields
on fixed rate investments. Investment decisions are made within policy
guidelines established by the Board of Directors. Unless loan demand increases,
the Bank intends to maintain its investments at current levels.
Investment Activities
Current regulatory and accounting guidelines regarding investment securities
(including mortgage-backed securities) require the Corporation to categorize
securities as held to maturity, available for sale or trading. As of September
30, 2001, the Corporation had securities classified as held to maturity and
available for sale in the amounts of $38.2 million and $48.5 million. There were
no securities classified as trading. Securities classified as available for sale
are reported for financial purposes at the fair market value with net changes in
the market value from period to period included as a separate component of
stockholders' equity, net of income taxes. At September 30, 2001, the
Corporation's securities available for sale had an amortized cost of $49.0
million and a market value of $48.5 million (unrealized loss, net of tax of
$541,000). Changes in the market value of securities available for sale do not
affect the Corporation's income. In addition, changes in the market value of
securities available for sale do not affect the Bank's regulatory capital
requirements or its loan to one borrower limit.
14
Investment and Mortgage-Backed Securities Portfolio
The following table sets forth the carrying value of First Federal's investment
securities portfolio, short-term investments, FHLB stock and mortgage-backed and
related securities at the dates indicated:
September 30,
------------------------------
2001 2000 1999
-------- -------- --------
(In Thousands)
Investment securities:
Debt securities $ 12,420 $ 18,393 $ 19,937
Debt securities available for sale 3,055 12,728 12,794
FHLB Stock 5,925 6,375 7,363
Equity securities available for sale 12,021 11,871 11,921
-------- -------- --------
Total investment securities 33,421 49,367 52,015
Interest bearing deposits 9,767 5,552 16,020
Mortgage-backed and related securities:
Mortgage-backed and related securities 25,731 26,986 27,587
Mortgage-backed and related securities
available for sale 27,481 15,369 15,979
-------- -------- --------
Total mortgage-backed and related securities 53,212 42,355 43,566
-------- -------- --------
Total investments $ 96,400 $ 97,274 $111,601
======== ======== ========
15
The following table sets forth certain information regarding the carrying
values, weighted average yields and maturities of the Bank's investment
portfolio at September 30, 2001:
Adjustable One Year or Less One to Five Years Five to Ten Years More than Ten Total Investment
Years Securities
----------------- ----------------- ----------------- ------------------ ------------------- ----------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
U. S.
Government
and Federal
Agency
Obligations
held to
maturity $ - - % $ - - % $ 9,221 3.82 % $ 2,000 3.19 % $ 1,199 7.13 % $12,420 4.03% $12,490
Federal Agency
Obligations
available
for sale - - - - 3,055 5.28 - - - - $ 3,055 5.28 3,055
Equity
Securities
available
for sale 12,021 4.98 - - - - - - - - $12,021 4.98 12,021
FHLB Stock N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 5,925 4.08 5,925
Mortgage-
backed
and related
securities
held to
maturity 24,970 4.76 - - 10 7.59 10 15.68 741 7.04 $25,731 4.83 25,586
Mortgage-
backed
and related
securities
available
for sale 16,698 4.69 - - - - - - 10,783 5.99 $27,481 5.20 27,481
Interest-
bearing
deposits 9,767 1.98 - - - - - - - - $ 9,767 1.98 9,767
------- ----- ------- ------- ------- ------- ------
Total $63,456 4.35 % $ - - % $12,286 4.18 % $ 2,010 3.23 % $12,723 6.15 % $96,400 4.53% $96,325
======= ===== ======= ======= ======= ======= =======
16
Deposits and Other Sources of Funds
General
Deposits are a major source of funds for the Bank's lending and other investment
purposes. In addition to deposits, the Bank derives funds from loan and
mortgage-backed securities principal payments, interest on investment
securities, proceeds from the maturity of mortgage-backed securities and
investment securities and borrowings. Loan and mortgage-backed securities
payments are a relatively stable source of funds, while general interest rates
and money market conditions significantly influence deposit inflows. Borrowings
may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources. They may also be used on a longer-term
basis for general business purposes.
Deposits
First Federal offers a wide variety of deposit accounts. It constantly strives
to meet consumer's needs by offering new products. This, in addition to interest
rate risk management and asset/liability ratios, is taken into consideration
prior to offering new products. Deposit account terms vary, primarily as to the
required minimum balance amount, the amount of time that the funds must remain
on deposit and the applicable interest rate.
The Bank's current deposit products include regular savings, demand deposits,
NOW, money market and certificate of deposit accounts ranging in terms from 91
days to 5 years including certificates of deposit with negotiable interest rates
and balances in excess of $100,000 (jumbo certificates) and Individual
Retirement Accounts (IRAs). All checking and savings accounts are eligible for
an Express Teller ATM card. This card can be used at any Express Teller,
Fastbank, or Instant Cash ATM in Minnesota and surrounding states. With the
addition of the Plus and Cirrus network automated banking system, First
Federal's Express Teller ATM card can be used at thousands of ATM locations
throughout the United States and the world.
Deposits are obtained primarily from residents in the Minnesota counties of
McLeod, Dakota, Meeker, Sibley, Carver, Wright, Benton, Sherburne, Stearns and
Washington. First Federal attracts deposit accounts by offering a wide variety
of products, competitive interest rates, convenient locations and service hours.
The Bank uses traditional methods of advertising to attract new customers and
deposits, including radio and print media advertising.
The Bank pays interest on its deposits that are competitive in the marketplace.
Interest rates on deposits are set weekly, based on a number of factors,
including: (1) the previous week's deposit flow, (2) a current survey of a
selected group of competitor's rates for similar products, (3) external data
which may influence interest rates, (4) investment opportunities and loan demand
and (5) scheduled maturities.
The following table indicates the amount of the Bank's certificates of deposit
of $100,000 or more by time remaining until maturity as of September 30, 2001:
Certificates
Maturity Period of Deposit
-----------------
(In Thousands)
Within three months $ 14,863
Three through six months 5,636
Six through twelve months 32,804
Over twelve months 10,934
----------------
$ 64,237
================
Borrowings.
Savings deposits are the primary source of funds for First Federal's lending and
investment activities and also for its general business purposes. The Bank, if
the need arises, may rely upon advances from the FHLB of Des Moines to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB of Des Moines are typically secured by
First Federal's stock in the FHLB and a portion of First Federal's residential
mortgage loans and other assets (principally securities which are obligations of
or guaranteed by the U.S. Government).
17
Advances have been utilized when adequate spreads can be obtained and the risk
(credit risk, interest rate risk and market risk) in the transaction has been
minimized. Advances have been used to purchase mortgage-backed and related
securities and to purchase single family residential mortgages originated by
other financial institutions within the State of Minnesota.
The following table sets forth certain information as to the Bank's FHLB
advances at the date indicated:
As of and for the Years Ended
September 30,
------------------------------------------
2001 2000 1999
------------------------------------------
(Dollars in Thousands)
Maximum balance $ 127,500 $ 140,967 $ 144,177
Average balance 117,957 138,213 143,123
Balance at end of period 113,500 127,500 140,967
Weighted average rate:
at end of period 5.87% 5.89% 5.39%
during the period 5.99% 5.89% 5.47%
It is First Federal's policy to fund loan demand and investment opportunities
out of current loan and mortgage-backed securities repayments, investment
maturities and new deposits. However, the Bank has utilized FHLB advances to
supplement these sources. This policy may change in the future as investment
opportunities are presented or loan demand increases.
Subsidiary Activity
As of September 30, 2001, the Corporation had two directly owned subsidiaries:
the Bank and the Agency.
The Bank is permitted to invest up to 2% of its assets in the capital stock of
subsidiary corporations in the form of secured or unsecured loans. An additional
investment of 1% of assets is permitted when such investments are utilized
primarily for community development purposes. As of September 30, 2001, the Bank
was authorized to invest up to approximately $9.4 million in the stock of
service corporations (based upon the 2% limitation). The Bank has two wholly
owned subsidiaries, Firstate Services, Inc. ("FSI") and Homeowners Mortgage
Corporation ("HMC"). FSI was incorporated in the State of Minnesota in August
1983 and is engaged in the sale, on an agency basis, of mutual funds, annuities
and life, credit life and disability insurance products. HMC was incorporated in
the State of Minnesota in 1988 and originates residential mortgage loans from
two locations in Minnesota. As of September 30, 2001, the net book value of
First Federal's investment in stock, unsecured loans and conforming loans in FSI
was $105,000 and HMC was $2.8 million. For the fiscal year ended September 30,
2001, FSI had net income of $15,587 and HMC had net loss of $111,552.
Insurance Planners (the "Agency") was incorporated in the State of Minnesota in
August 1983 and is engaged in the sale, on an agency basis, of property and
casualty insurance products. As of September 30, 2001, the net book value of the
Corporation's investment in stock, unsecured loans and conforming loans in its
subsidiary was $680,658. For the fiscal year ended September 30, 2001, the
Agency had net income of $47,901.
On November 17, 1998, the Corporation acquired, in a transaction that was a
combination of stock and cash, all of the outstanding shares of Homeowners
Mortgage Corporation ("HMC"). As of June 1, 2000, HMC became an operating
subsidiary of the Bank following regulatory approval. The transfer of HMC was
recorded as a non-cash capital contribution from the Corporation to the Bank.
18
Personnel
As of September 30, 2001, the Bank had 143 full time employees and 53 part time
employees, representing a total of 170.5 full time equivalents. The employees
are not represented by a collective bargaining agreement and the Bank believes
its relationship with their employees is satisfactory.
Regulation
Set forth below is a brief description of certain laws related to the regulation
of the Corporation and the Bank. The description does not purport to be complete
and is qualified in its entirety by reference to applicable laws and
regulations.
Regulation of the Corporation
General
The Corporation is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, the Corporation is required to
register and file reports with the OTS and is subject to regulation and
examination by the OTS. In addition, the OTS has enforcement authority over the
Corporation and its non-savings association subsidiaries, should such
subsidiaries be formed, which also permits the OTS to restrict or prohibit
activities that are determined to be a serious risk to the subsidiary savings
association. This regulation and oversight is intended primarily for the
protection of the depositors of the Bank and not for the benefit of stockholders
of the Corporation.
As a unitary savings and loan holding company, the Corporation generally is not
subject to any restrictions on its business activities. While the
Gramm-Leach-Bliley Act (the "GLB Act"), enacted in November 1999, terminated the
"unitary thrift holding company" exemption from activity restrictions on a
prospective basis, the Corporation enjoys grandfathered status under this
provision of the GLB Act because it acquired the Bank prior to May 4, 1999. As a
result, the GLB Act did not affect the Corporation's freedom from activity
restrictions as a unitary savings and loan holding company. However, if the
Corporation were to acquire control of an additional savings association, its
business activities would be subject to restriction under the Home Owners' Loan
Act. Furthermore, if the Corporation were in the future to sell control of the
Bank to any other company, such company would not succeed to the Corporation's
grandfathered status under the GLB Act and would be subject to the same activity
restrictions. The continuation of the Corporation's exemption from restrictions
on business activities as a unitary savings and loan holding company is also
subject to the Corporations continued compliance with the Qualified Thrift
Lender ("QTL") test. See "-Regulation of the Bank- Qualified Thrift Lender
Test."
Regulation of the Bank
General
Set forth below is a brief description of certain laws that relate to the
regulation of the Bank. The description does not purport to be complete and is
qualified in its entirety be reference to applicable laws and regulations. As a
federally chartered, SAIF-insured savings association, the Bank is subject to
extensive regulation by the OTS and the FDIC. Lending activities and other
investments must comply with various federal statutory and regulatory
requirements. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board.
The OTS, in conjunction with the FDIC, regularly examines the Bank and prepares
reports for the consideration of the Bank's Board of Directors on any
deficiencies that are found in the Bank's operations. The Bank's relationship
with its depositors and borrowers is also regulated, to a great extent by
federal and state law, especially in such matters as the ownership of savings
accounts and the form and content of the Bank's mortgage documents.
The Bank 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. 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 SAIF and depositors. This structure
also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies, including
policies
19
with respect to the classification of assets and the establishment of adequate
loan loss reserves for regulatory purposes.
Insurance of Deposit Accounts
The deposit accounts held by the Bank are insured by the SAIF to a maximum of
$100,000 or each insured member (as defined by law and regulation). 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 institution's primary regulator.
The Bank is required to pay insurance premiums based on a percentage of its
insured deposits to the FDIC for insurance of its deposits by the SAIF. The FDIC
also maintains another insurance fund, the Bank Insurance Fund ("BIF"), which
primarily insures commercial bank deposits. The FDIC has set the deposit
insurance assessment rates for SAIF-member institutions for the first six months
of 2001 at 0% to 0.27% of insured deposits on an annualized basis, with the
assessment rate for most savings institutions set at 0%.
In addition, all FDIC insured institutions are required to pay assessments to
the FDIC at an annual rate of approximately 0.0212% of insured deposits to fund
interest payments on bonds issued by the Financing Corporation ("FICO"), an
agency of the Federal Government established to recapitalize the predecessor to
the SAIF. These assessments will continue until the FICO bonds mature in 2017.
Regulatory Capital Requirements
OTS capital regulations require savings institutions to meet three capital
standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) a
leverage ratio (core capital) equal to at least 3.0% of total adjusted assets
and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted
assets.
Dividend and Other Capital Distribution Limitations
The OTS imposes various restrictions or requirements on the ability of savings
institutions to make capital distributions, including cash dividends.
A savings association that is a subsidiary of a savings and loan holding
company, such as the Bank, must file an application or a notice with the OTS at
least 30 days before making a capital distribution. Savings associations are not
required to file an application for permission to make a capital distribution
and need only file a notice if the following conditions are met: (1) they are
eligible for expedited treatment under OTS regulations, (2) they would remain
adequately capitalized after the distribution, (3) the annual amount of capital
distribution does not exceed net income for that year to date added to retained
net income for the two preceding years and (4) the capital distribution would
not violate any agreements between the OTS and the savings association or any
OTS regulations. Any other situation would require an application to the OTS.
The OTS may disapprove an application or notice if the proposed capital
distribution would: (1) make the savings association undercapitalized,
significantly undercapitalized or critically undercapitalized, (2) raise safety
or soundness concerns or (3) violate a statute, regulation or agreement with the
OTS (or with the FDIC), or a condition imposed in an OTS approved application or
notice. Further, a federal savings association, like the Bank, can not
distribute regulatory capital that is needed for its liquidation account.
Qualified Thrift Lender Test
Federal savings institutions must meet one or two Qualified Thrift Lender
("QTL") tests. To qualify as a QTL, a savings institution must either (1) be
deemed a "domestic building and loan association" under the Internal Revenue
Code by maintaining at least 60% of its total assets in specified types of
assets, including cash, certain government securities, loans secured by and
other assets related to residential real property, educational loans and
investments in premises of the institution or (2) satisfy the statutory QTL test
set forth in the Home Owner's Loan Act by maintaining at least 65% of its
"portfolio assets" in certain "Qualified Thrift Investments" (defined to include
residential mortgages and related equity investments, certain mortgage-related
securities, small business loans, student loans and credit card loans and 50% of
certain community development loans). For purposes of the statutory QTL test,
portfolio assets are defined as total assets minus intangible assets, property
used by the institution in conducting its business and liquid assets equal to
10% of total assets. A savings institution must maintain its status as a QTL on
a monthly basis in at least nine out of every twelve months. A failure to
20
qualify as a QTL results in a number of sanctions, including the imposition of
certain operating restrictions and a restriction on obtaining additional
advances from its FHLB. At September 30, 2001, the Bank was in compliance with
its QTL requirement.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Des Moines, which is one of twelve regional
FHLBs that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB system. It makes loans to
members (i.e. advances) in accordance with policies and procedures established
by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the FHLB of
Des Moines. This amount must be equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW and Super NOW checking accounts) and
non-personal time deposits. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy the
liquidity requirements that are imposed by the OTS. At September 30, 2001, the
Bank was in compliance with these Federal Reserve Board requirements.
21
ITEM 2. PROPERTIES
The Bank operates from its main office located at 201 Main Street South,
Hutchinson, Minnesota. The Bank owns this 20,000 square foot office facility
which it built in 1985/86. The total investment in property and equipment at 201
Main Street South had a net book value of $1.6 million at September 30, 2001.
Additional offices, either owned or leased by the Bank and HMC, are set forth
below with information regarding net book value of the premises and equipment at
such facilities at September 30, 2001.
Year
Acquired or Net Book
Date Lease Value at Square
Location Expires September 30, 2000 Footage
- ------------------------------------------- -------------------------------------------------------------------
(Dollars in thousands)
14994 Glazier Avenue
Apple Valley, MN 55124 1989 $274 3,000
305 10th Avenue S
Buffalo, MN 55313 1999 1,050 5,620
1002 Greeley Avenue
Glencoe, MN 55336 2000 438 1,980
1320 South Frontage Road
Hastings, MN 55033 1984 988 15,000
905 Highway 15 South,
Frontage Road
Hutchinson, MN 55350 1980 183 1,400
6505 Cahill Avenue
Inver Grove Heights, MN 55075 1979 251 3,000
501 North Sibley Avenue
Litchfield, MN 55355 1978 156 2,400
200 East Frontage Road,
Highway 5
Waconia, MN 55387 1985 298 2,400
122 East Second Street
Winthrop, MN 55396 2002 (1) 22 950
113 Waite Avenue South
Waite Park, MN 56387 2003 (2) 63 700
135 3rd Avenue SW
Hutchinson, MN 55350 2002 (3) 13 1,200
1001 Labore Industrial Court Suite E
Vadnais Heights, MN 55110 2003 (4) 105 7,748
1113 West Saint Germain Street
Saint Cloud, MN 56302 2001 (5) 440 8,360
1. Lease expires in July 2002 with option to renew for one-year terms. The
Bank expects to renew the lease.
2. Lease expires in September 2003 with an option to renew for an additional
five-year term.
3. Lease expires in March 2002 with an option to renew for one-year terms. The
Company expects to renew the lease.
4. Lease expires in January 2003.
5. Property acquired on November 9, 2001.
22
The Bank leases approximately 3,600 square feet of the property in Hastings,
Minnesota under two, three year operating lease. These leases will expire April
14, 2003, and August 7, 2002, with combined annual rents totaling $22,797 in
addition to their proportionate share of the operating expenses.
The Agency operates from its main office located at 135 3rd Avenue Southeast,
Hutchinson, Minnesota and also has an office within the Bank's building in
Buffalo, Minnesota. Those facilities are covered by a month to month lease under
the terms of an expense sharing agreement.
HMC operates from its main office located at 1001 Labore Industrial Court,
Vadnais Heights, Minnesota and also has an office within the bank's building in
Hastings, Minnesota. These facilities are covered by a month to month lease
under the terms of an expense sharing agreement.
ITEM 3. LEGAL PROCEEDINGS
The Corporation and First Federal, from time to time, is a party to legal
proceedings in the ordinary course of business when it enforces security
interests in loans made by it. The Corporation and First Federal are not engaged
in any legal proceedings of a material nature at the present time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
STOCKHOLDERS MATTERS
For additional information relating to the market for the Corporation's common
equity and related stockholder matters, see "Corporate Profile and Stock Market
Information" in the Registrant's 2001 Annual Report to Stockholders on page 1,
and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The above captioned information appears under "Selected Financial Data" in the
Corporation's 2001 Annual Report to Stockholders on page 2 and is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The above captioned information appears under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Registrant's
2001 Annual Report to stockholders on pages 4 through 15 and is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The above information appears under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Registrant's 2001 Annual
Report to Stockholders on pages 4 through 7 and is incorporated herein by
reference.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Corporation and its subsidiaries,
together with the report thereon by Larson Allen Weishair & Co., LLP appears in
the 2001 Annual Report to Stockholders on pages 16 through 41 and are
incorporated herein by reference.
Quarterly Results of Operations on page 42 of the Annual Report is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES
Effective November 1, 2001, the Corporation's independent public accountants for
the year ended September 30, 2001, Bertram Cooper & Co., LLP merged with the
public accounting firm of Larson Allen Weishair & Co., LLP.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information contained under the sections captioned "Section 16(a) Beneficial
Ownership Reporting Compliance" and "Proposal I--Election of Directors" and
"Biographical Information" in the 2001 Proxy Statement (the "Proxy Statement")
are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the section captioned "Director and Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and
Principal Holders Thereof--Security Ownership of Certain
Beneficial Owners" of the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Voting Securities and
Principal Holders Thereof--Security Ownership of Certain
Beneficial Owners" and "Proposal ! - Election of Directors" of
the Proxy Statement.
(c) Management of the Company knows of no arrangements, including
any pledge by any person of securities of the Company, in
which the operation may, at a subsequent date result in a
change in control of the Corporation.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
section captioned "Certain Relationships and Related Transactions".
24
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 consolidated statements of financial condition of the Corporation
and subsidiaries as of September 30, 2001 and the related consolidated
statements of operations, comprehensive income, changes in
stockholders' equity and cash flows for the year ended September 30,
2001, together with the related notes and the independent auditors'
report of Larson Allen Weishair & Co., LLP independent certified
public accountants are incorporated by reference to pages 16 through
41 of the 2001 Annual Report to Stockholders.
The consolidated statements of financial condition of the Corporation
and subsidiaries as of September 30, 2000 and the related consolidated
statements of operations, comprehensive income, changes in
stockholders' equity and cash flows for each of the years in the two
year period ended September 30, 2000, together with the related notes
were audited by Bertram Cooper & Co., LLP independent certified public
accountants, whose report is presented as exhibit 99.0 of the Form
10-K.
(2) 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.
(3) Exhibits
(a) The following exhibits are files as part of this report.
3.1 Articles of Incorporation of FSF Financial Corporation *
3.2 Bylaws of FSF Financial Corporation *
4.0 Stock Certificate of FSF Financial Corporation *
10.1 Form of Employment Agreement with Donald A. Glas, George B. Loban and
Richard H. Burgart *
10.2 First Federal fsb Management Stock Plan **
10.3 FSF Financial Corporation 1996 Stock Option Plan **
10.4 FSF Financial Corporation 1998 Stock Compensation Plan ***
13.0 2001 Annual Report to Stockholders
21.0 Subsidiary Information (See "Item 1 - Business")
22.0 Consent of Accountant
99.0 Independent accountants report of Bertram Cooper & Co., LLP as of
September 30, 2000 and for the two year period then ended.
(b) On July 26, 2001, the Corporation filed a Form 8-K (Item 7) that
disclosed (1) quarterly dividend; (2) intention to repurchase
110,000 shares of the Corporation's stock; and (3) branch
acquisition agreement.
- --------------------------------------------------------------------------------
* Incorporated herein by reference into this document from the Exhibits to
Form S-1, Registration Statement, initially filed with the Commission, on
June 1, 1994, Registration No. 33-79570.
** Incorporated herein by reference into this document from the Registrant's
Proxy Statement for the Annual Meeting of Stockholders held on January 17,
1996 and filed with the Commission on December 13, 1995.
*** Incorporated herein by reference into this document from the Registrant's
proxy statement for the Annual Meeting of Stockholders held on January 20,
1998 and filed with the Commission on December 10, 1997.
Signatures
Pursuant to the requirements of Section 13 of 15(d) 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.
FSF Financial Corp.
Dated: December 10, 2001 By: /s/ Donald A. Glas
--------------------------------
Donald A. Glas
Co-Chair of the Board and Chief
Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated,
By: /s/ Donald A. Glas By: /s/ Richard H. Burgart
------------------------------------------------- --------------------------------------------
Donald A. Glas Richard H. Burgart
Co-Chair of the Board and Chief Executive Officer Chief Financial Officer and Treasurer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
Director
Date: December 10, 2001 Date: December 10, 2001
By: /s/ George B. Loban By: /s/ Sever B. Knutson
------------------------------------------------- --------------------------------------------
George B. Loban Sever B. Knutson
Co-Chair of the Board and President Director
Date: December 10, 2001 Date: December 10, 2001
By: /s/ Roger R. Stearns By: /s/James J. Caturia
------------------------------------------------- --------------------------------------------
Roger R. Stearns James J. Caturia
Director Director
Date: December 10, 2001 Date: December 10, 2001
By: /s/ Jerome R. Dempsey
-------------------------------------------------
Jerome R. Dempsey
Director
Date: December 10, 2001