CORPORATE PROFILE AND STOCK MARKET INFORMATION
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Corporate Profile
FSF Financial Corp. (the "Corporation") is the holding company for First Federal
fsb ("First Federal") and Insurance Planners. Insurance Planners is an
independent property and casualty insurance agency located in Hutchinson,
Minnesota. Additionally, 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 operation
subsidiary of First Federal (the "Bank") following regulatory approval. Since
becoming an operating subsidiary of the Bank, HMC has become an integral part of
the residential construction lending function. The terms "First Federal", "Bank"
and "HMC" are synonymous when used in conjunction with residential lending and
residential construction lending.
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 a variety of loans. The Federal Deposit Insurance Corporation, subject
to applicable limits, insures deposits with First Federal. At September 30,
2002, First Federal operated 12 retail-banking offices in Minnesota.
Stock Market Information
Since its issuance in October 1994, the Corporation's common stock has been
traded on the NASDAQ National Market. The daily stock quotation for FSF
Financial Corp. is listed in the NASDAQ National Market published in The Wall
Street Journal, the St Paul Pioneer Press and Dispatch and other leading
newspapers under the trading symbol of "FFHH". For a listing of the stock price
as published by the NASDAQ statistical report, see "Selected Quarterly Financial
Data."
The number of stockholders of record of common stock as of the record date of
November 30, 2002, were approximately 511. This does not reflect the number of
persons or entities who held stock in nominee or "street" name through various
brokerage firms. At November 29, 2002, there were 2,303,514 shares issued and
outstanding.
The Corporation's ability to pay dividends to stockholders is dependent upon the
dividends it receives from the Bank. The Bank may not declare or pay a cash
dividend on any of its stock if the effect thereof would cause the Bank's
regulatory capital to be reduced below (1) the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock form or (2) the regulatory capital requirements imposed by the
OTS.
1
SELECTED FINANCIAL AND OATHER DATA FOR FSF FINANCIAL CORP.
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Financial Condition (dollars in thousands)
Year Ended September 30, 2002 2001 2000 1999 1998
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Total assets $ 532,160 $ 473,631 $ 466,515 $ 418,094 $ 416,232
Loans held for sale 29,242 12,082 3,191 5,334 2,672
Loans receivable, net 382,690 340,484 341,813 278,290 280,603
Mortgage-backed securities held to maturity 20,679 25,731 26,986 27,587 36,418
Mortgage-backed securities available for sale 29,196 27,481 15,369 15,979 16,574
Debt securities held to maturity 12,447 12,420 18,393 19,937 24,412
Debt securities available for sale - 3,055 12,728 12,794 3,010
Equity securities available for sale 12,046 12,021 12,321 12,909 13,084
Cash and cash equivalents (1) 14,615 12,594 8,482 19,265 22,597
Savings deposits 381,924 312,541 294,823 231,651 226,542
Other borrowings 98,000 113,500 127,500 140,967 144,177
Stockholders' equity 45,881 41,941 39,765 42,325 42,518
Summary of Operations (dollars in thousands)
Year Ended September 30, 2002 2001 2000 1999 1998
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Interest income $ 35,174 $ 35,310 $ 32,877 $ 29,420 $ 29,981
Interest expense 17,248 21,900 19,753 18,198 18,499
Net interest income 17,926 13,410 13,124 11,222 11,482
Provision for loan losses 811 1,077 216 456 302
Non-interest income 8,975 6,599 4,825 5,259 2,269
Non-interest expense 16,131 12,815 11,979 11,826 8,395
Net income 6,032 3,733 3,504 2,505 3,030
Other Selected Data
Year Ended September 30, 2002 2001 2000 1999 1998
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Return on average assets 1.18% 0.80% 0.81% 0.59% 0.74%
Return on average equity 13.69% 9.09% 8.54% 5.74% 6.94%
Average equity to average assets 8.62% 8.86% 9.49% 10.26% 10.70%
Net interest rate spread (2) 3.53% 2.77% 2.93% 2.39% 2.44%
Non-performing assets to total assets 0.94% 0.65% 0.28% 0.13% 0.19%
Allowance for loan losses to net loans 0.41% 0.44% 0.44% 0.48% 0.36%
Basic earnings per share $ 2.77 $ 1.68 $ 1.46 $ 0.94 $ 1.14
Diluted earnings per share $ 2.63 $ 1.61 $ 1.43 $ 0.90 $ 1.05
Cash dividends declared per share $ 1.00 $ 0.60 $ 0.50 $ 0.50 $ 0.50
Dividend payout ratio 36.02% 34.90% 34.40% 53.10% 44.80%
1. Consists of cash due from banks, interest-bearing deposits and other
investments with original maturities of less than three months.
2. Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward looking statements. When used in this discussion,
the words "believes", "anticipates", "contemplates", "expects" and similar
expressions are intended to identify forward looking statements. Such statements
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risks associated with the effect of integrating newly
acquired businesses, the ability to control costs and expenses and general
economic conditions. FSF Financial Corp. undertakes no obligation to publicly
release the results of any revisions to those forward looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
General
The Corporation does not engage in any active business. The earnings of the
Corporation depend primarily on the Bank's net interest income, and to a lesser
extent, income from its wholly owned subsidiary Insurance Planners. Net interest
income is affected by the interest rates that the Bank receives from its loans
and investments and by the interest rates that the Bank must pay for its sources
of funds. The difference between the average rate of interest earned on assets
and the average rate paid on liabilities is the "interest rate spread". When
interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will produce net interest income. The Bank's
interest income has been impacted by the level of construction loans
outstanding. The Bank originates construction loans and all construction loans
are closed in the Bank's name, administered and monitored by Bank personnel.
In addition, the Bank receives income from service charges on deposit accounts,
other service charges and fees, commission income and income from the sale of
loans to the secondary market. When construction loans are complete, a
modification agreement is executed and the loan is sold in the secondary market,
any gain on sale appears on the Bank's income statement. The Bank incurs
expenses in addition to interest expense in the form of salaries and benefits,
deposit insurance, property operations and maintenance, advertising and other
related business expenses.
Earnings of the Bank are significantly affected by economic and competitive
conditions, particularly changes in interest rates, government policies and
regulations of various regulatory authorities.
Asset/Liability Management
The Bank, like other financial institutions, is vulnerable to changes in
interest rates to the extent that interest-bearing liabilities mature
differently than interest-earning assets. The lending activities of the Bank
have emphasized the origination of loans, the majority of which have a repricing
term that is substantially shorter than their amortization term and the source
of funds has been deposits and borrowings. Having interest-earning assets that
reprice more frequently than interest-bearing liabilities is generally
beneficial to net interest income during periods of increasing interest rates,
such an asset/liability mismatch is generally detrimental during periods of
declining interest rates.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. Management meets at least quarterly to
review the interest rate risk position and projected profitability of the Bank.
In addition, management reviews the Bank's portfolio, formulates investment
strategies and oversees the timing and implementation of transactions to assure
attainment of the Bank's objectives in the most effective manner. The Board of
Directors reviews, on a quarterly basis, the Bank's asset/liability position,
including simulations of the effect of various interest rate scenarios on the
Bank's capital.
Depending on the relationship between long-term and short-term interest rates,
market conditions and consumer preferences, the Bank may place more emphasis on
managing net interest margin rather than matching the interest rate sensitivity
of its assets and liabilities in an effort to enhance net interest income.
Management believes that the increased net interest income resulting from a
mismatch in the maturity of its asset and liability portfolios can provide high
enough returns to justify the increased exposure to sudden and unexpected
changes in interest rates.
4
Management attempts to reduce the Bank's interest rate risk by the way it
structures its assets and liabilities. The Bank sells all fixed-rate residential
mortgages and retains for its portfolio residential mortgages with either
adjustable interest rates or balloon provisions. These loans provide the Bank
with a repricing time frame that is substantially shorter than the contractual
term. During the 2002 fiscal year, the Bank originated $370,000 of single family
mortgage loans that have initial fixed rates for terms of one to ten years and
then adjust annually off a treasury index thereafter. The Bank also originated
$570,000 of single family mortgage loans that have a balloon payment due in
three to seven years. Originations of construction and land development loans,
which generally have a contractual maturity of two years or less, totaled $151.0
million. At September 30, 2002, the Bank had outstanding, $180.1 million of real
estate mortgages that were adjustable rate, balloon or construction and land
development loans, representing 47.1% of net loans and 33.8% of total assets.
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of rate sensitive assets and rate sensitive liabilities. These
differences, or interest rate repricing "GAP," provide an indication of the
extent to which the net interest income is affected by future changes in
interest rates. A GAP is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
GAP is considered negative when the amount of interest rate sensitive
liabilities exceeds interest rate sensitive assets. During a period of falling
interest rates, a negative GAP would tend to result in an increase in net
interest income, while a positive GAP would tend to affect net interest income
adversely. Conversely, during a period of rising interest rates, a negative GAP
would tend to result in a decrease in net interest income, while a positive GAP
would tend to result in an increase in net interest income.
The table that follows sets forth the amounts of interest-earning assets and
interest bearing liabilities at September 30, 2002, which are expected to
reprice or mature in each of the future time periods shown.
Analysis of Repricing Mechanisms
Over One Over Five
Within to Five to Ten Over Ten
One Year Years Years Years Total
------------- ------------ ------------- ------------- ------------
(Dollars in Thousands)
Interest-earning assets:
Mortgage loans $209,055 $ 46,567 $ 9,919 $ 14,822 $280,363
Other loans 95,987 32,355 5,325 418 134,085
Investment securities 65,069 4,169 2,009 20,064 91,311
------------- ------------ ------------- ------------- ------------
Total interest-earning assets 370,111 83,091 17,253 35,304 505,759
------------- ------------ ------------- ------------- ------------
Interest bearing liabilities:
Non-interest bearing deposits 26,387 - - - 26,387
NOW and Super NOW accounts 26,083 - - - 26,083
Savings accounts 89,037 - - - 89,037
Money market deposits accounts 10,217 - - - 10,217
Certificates 162,985 60,762 6,453 - 230,200
Other borrowed money 10,000 26,000 62,000 - 98,000
------------- ------------ ------------- ------------- ------------
Total interest-bearing liabilities 324,709 86,762 68,453 - 479,924
------------- ------------ ------------- ------------- ------------
Interest sensitivity gap $ 45,402 $ (3,671) $ (51,200) $ 35,304 $ 25,835
============= ============ ============= ============= ============
Cumulative interest sensitivity gap $ 45,402 $ 41,731 $ (9,469) $ 25,835
============= ============ ============= =============
Cumulative ratio of interest-earning assets
to interest-bearing liabilities 1.14% 1.10% 0.98% 1.05%
============= ============ ============= =============
Cumulative ratio of cumulative interest
sensitivity gap to total assets 8.52% 7.83% -1.78% 4.85%
============= ============ ============= =============
5
The previous table above indicates the time periods in which interest-earning
assets and interest-bearing liabilities will mature or reprice in accordance
with their contractual terms. The following assumptions have been used in
calculating the values in the table: adjustable rate and balloon loans have a
constant prepayment rate of 6.0%, mortgages held for sale are all set to reprice
in three years or less, while remaining mortgages have prepayment rates ranging
from 4.0% to 10.0%. Consumer loans have a prepayment rate that is constant over
time at 19.0%, NOW checking, core savings deposits and money market deposits
have an increasing decay rate ranging from 6.0% to 30.0%. Management utilizes
its own assumptions and feels that these assumptions provide a reasonable
estimate of actual experience.
Certain shortcomings are inherent in the method of analysis presented in the
previous table. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable rate mortgage loans,
have features that restrict changes in interest rates on a short-term basis over
the life of the assets. Further, in the event of a change in interest rates,
prepayment levels and decay rates on core deposits may deviate significantly
from those assumed in calculating the table.
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices
and rates. The Bank's market risk is comprised primarily of interest rate risk
resulting from its core banking activities of lending and deposit taking.
Interest rate risk is the risk that changes in market interest rates might
adversely affect the Bank's net interest income or the economic value of its
portfolio of assets, liabilities and off-balance sheet contracts. Management
continually develops and applies strategies to mitigate this risk. Management
does not believe that the Bank's primary market risk exposures and how those
exposures are managed in fiscal 2002 have changed when compared to fiscal 2001.
Market risk limits have been established by the Board of Directors based on the
Bank's tolerance for risk.
The Bank primarily relies on its Net Portfolio Value Model (the "Model") to
measure its susceptibility to interest rate changes. Net portfolio value ("NPV")
is defined as the present value of expected cash flows from existing assets
minus the present value of expected net cash flows from existing liabilities
plus or minus the present value of net expected cash flows from existing
off-balance sheet contracts. The Bank does not currently own any derivative
financial instruments whose values are determined from underlying instruments or
market indices and whose notional or contractual amounts would not be recognized
in the financial statements. The Model estimates the current economic value of
each type of asset, liability and off-balance sheet contract after various
assumed instantaneous, parallel shifts in the Treasury yield curve both upward
and downward.
The NPV Model uses an option based pricing approach to value one-to-four family
mortgages, mortgages serviced by others and firm commitments to buy, sell or
originate mortgages. This approach makes use of an interest rate simulation
program to generate numerous random interest rate paths that, in conjunction
with a prepayment model, are used to estimate mortgage cash flows. Prepayment
options and interest rate caps and floors contained in mortgages and mortgage
related securities introduce significant uncertainty in estimating the timing of
cash flows for these instruments that warrants the use of this sophisticated
methodology. All other financial instruments are valued using a static
discounted cash flow method. Under this approach, the present value is
determined by discounting the cash flows the instrument is expected to generate
by the yields currently available to investors from an instrument of comparable
risk and duration.
6
The following table sets forth the present value estimates of the Bank at
September 30, 2002, as calculated by the NPV Model. The table shows the NPV of
the Bank under rate shock scenarios of -300 to +300 basis points (bp) in
increments of 100. As market rates increase, the market value of the Bank's
large portfolio of mortgage loans and securities declines significantly and
prepayments are slow. As rates decrease, the market value of mortgage loans and
securities increase only modestly due to prepayment risk, periodic rate caps and
other embedded options. Actual changes in market value will differ from
estimated changes set forth in this table due to various risks and
uncertainties.
Changes in Interest Net Portfolio Change NPV as % of Assets
Rates in Basis --------------------------------------- ----------------------
Points (Rate Shock) $ Amount $ Change Change % NPV Ratio Change
------------ ------------ --------- --------- ----------
(Dollars in thousands)
+300 bp $41,269 $ (3,094) (6.97) % 7.74 % (44) bp
+200 bp 42,233 (2,130) (4.80) 7.87 (31) bp
+100 bp 43,261 (1,102) (2.48) 8.02 (16) bp
0 bp 44,363 - - 8.18 - bp
-100 bp 45,548 1,185 2.67 8.35 17 bp
-200 bp 46,826 2,463 5.55 8.53 35 bp
-300 bp 48,212 3,849 8.68 8.73 55 bp
This table shows thk's economic value of equity would decrease with
rising interest rates while increasing with falling interest rates. However,
computations of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan repayments and deposit runoffs and may not be indicative of actual
results. The computations do not reflect any actions the Bank may undertake in
response to changes in interest rates because management cannot always predict
future interest rates or their effect on the Bank. Certain shortcomings are
inherent in the method of analysis presented in the computation of NPV. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react in differing degrees to changes in market
area interest rates. Additionally, certain assets, such as adjustable rate
loans, have features that restrict changes in interest rates during the initial
term and over the remaining life of the asset. Further, in the event of a change
in interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in the table. Finally, the ability of many
borrowers to service their adjustable rate debt may decrease in the event of an
interest rate increase.
7
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest
income and interest expense for the Corporation during the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rates (changes
in rate multiplied by old average volume), (2) changes in volume (changes in
average volume multiplied by old rate) and (3) total changes in rate/volume. The
combined effects of changes in both volume and rate that cannot be separately
identified have been allocated proportionately to the change due to volume and
the change due to rate.
Increase (Decrease) Due To
---------------------------------------
Rate/
Rate Volume Volume Total
------- ------- ------- -------
(In Thousands)
Year Ended September 30, 2002 vs 2001:
Interest income:
Loans Receivable $(2,458) $ 3,492 $ (281) $ 753
Mortgage-backed securities (281) 356 (40) 35
Investment securities (877) (81) 34 (924)
------- ------- ------- -------
Total change in interest income (3,616) 3,767 (287) (136)
Interest expense:
Savings accounts (5,327) 3,058 (1,079) (3,348)
FHLB Borrowings (327) (1,032) 55 (1,304)
------- ------- ------- -------
Total change in interest expense (5,654) 2,026 (1,024) (4,652)
------- ------- ------- -------
Net change in net interest income $ 2,038 $ 1,741 $ 737 $ 4,516
======= ======= ======= =======
---------------------------------------
Rate/
Rate Volume Volume Total
------- ------- ------- -------
(In Thousands)
Year Ended September 30, 2001 vs 2000:
Interest income:
Loans Receivable $ 348 $ 3,147 $ 44 $ 3,539
Mortgage-backed securities (356) 96 (13) (273)
Investment securities (506) (393) 66 (833)
------- ------- ------- -------
Total change in interest income (514) 2,850 97 2,433
Interest expense:
Savings accounts 734 2,312 172 3,218
FHLB Borrowings 134 (1,198) (7) (1,071)
------- ------- ------- -------
Total change in interest expense 868 1,114 165 2,147
------- ------- ------- -------
Net change in net interest income $(1,382) $ 1,736 $ (68) $ 286
======= ======= ======= =======
8
Average Balances
The following table sets forth information relating to the Corporation's average
yield on assets and average cost of liabilities for the periods indicated. The
yields and costs are computed by dividing income or expense by the average
balance of interest-earning assets and interest-bearing liabilities for the
periods indicated. Average balances are derived from daily balances.
Years Ended September 30,
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2002 2001 2000
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Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost Balance Expense Cost
----------------------------------------------------------------------------------------
(in thousands) (in thousands) (In thousands)
Interest Earning Assets
Loans receivable (1) $ 383,892 $ 31,389 8.18% $ 344,470 $ 30,636 8.89% $ 308,721 $ 27,097 8.78%
Mortgage-backed securities 51,415 2,430 4.72% 44,791 2,395 5.35% 43,224 2,668 6.17%
Investment securities (2) 48,519 1,355 2.79% 50,262 2,279 4.53% 57,508 3,112 5.41%
-------------------- -------------------- ---------------------
Total interest earning assets 483,826 35,174 7.27% 439,523 35,310 8.03% 409,453 32,877 8.03%
-------------------- -------------------- ---------------------
Interest Bearing Liabilities
NOW and money market accounts $ 56,294 411 0.73% $ 35,305 266 0.75% $ 33,727 259 0.77%
Passbook savings 92,974 1,585 1.70% 87,064 3,491 4.01% 73,422 3,110 4.24%
Certificates of deposit 211,294 9,482 4.49% 176,336 11,069 6.28% 141,686 8,239 5.81%
-------------------- -------------------- ---------------------
Total deposits 360,562 11,478 3.18% 298,705 14,826 4.96% 248,835 11,608 4.66%
FHLB advances and other borrowed funds 100,871 5,770 5.72% 117,957 7,074 5.99% 138,213 8,145 5.89%
-------------------- -------------------- ---------------------
Total interest bearing liabilities 461,433 17,248 3.74% 416,662 21,900 5.26% 387,048 19,753 5.10%
-------------------- -------------------- ---------------------
Net Interest Income $ 17,926 $ 13,410 $ 13,124
========== ========== ==========
Net Interest Rate Spread (3) 3.53% 2.77% 2.93%
Net Interest Rate Margin (4) 3.70% 3.05% 3.21%
Ratio of average interest earning assets
to average interest bearing liabilities 1.05x 1.05x 1.06x
========== ========== ===========
1. Average balances include non-accrual loans and loans held for sale.
2. Includes interest-bearing deposits in other financial institutions.
3. Net interest rate spread represents the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities.
4. Net interest rate margin represents net interest income as a percentage of
average interest-earning assets.
9
Changes in Financial Condition
General
Total assets increased from $473.6 million at September 30, 2001, to $532.2
million at September 30, 2002. This increase of $58.4 million was mainly the
result of an increase in loans held for sale, an increase in construction loans
outstanding and loans receivable from the ING Bank branch acquisition (see Note
2 of the Notes to audited Consolidated Financial Statements). The Bank has
continued to experience good demand for loans and supplemented the internal loan
origination of $481.0 million with purchases of other loans totaling $19.3
million that met the interest rate risk and credit risk criteria established by
management.
Securities Available for Sale
Equity securities increased by $25,000 due an increase in the market value of
fund investments. Mortgage-backed and related securities available for sale
increased by $1.7 million during the 2002 fiscal year as a result of an
additional security purchased and an increase in market value. Debt securities
available for sale decreased $3.1 million due to maturities. The net unrealized
losses on securities available for sale decreased from $567,000 at September 30,
2001 to $123,000 at September 30, 2002. This decrease was primarily due to the
market rate of interest decreasing as compared to the contractual rate of
interest.
Securities Held to Maturity
Debt securities held to maturity remained the same at $12.4 million.
Mortgage-backed securities held to maturity decreased from $25.7 million to
$20.7 million during fiscal 2002, due to principal repayments. The net
unrealized gain on securities held to maturity was $748,000, at September 30,
2002. At September 30, 2001, held to maturity securities had a net unrealized
loss of $75,000. The improvement was a result of a decline in the market rate of
interest as compared to the contractual rate of interest on the securities.
Loans Held for Sale
Net loans held for sale increased from $12.1 million at September 30, 2001 to
$29.2 million at September 30, 2002. The Bank had firm commitments to sell these
loans held for sale that were closed by September 30, 2002.
Loans Receivable
Net loans receivable increased from $340.5 million at September 30, 2001 to
$382.7 million at September 30, 2002. This increase of $42.2 million was a
result of increases in other real estate mortgages totaling $8.6 million, net
construction loans totaling $68.1 million and agricultural loans in the amount
of $6.2 million, partially offset by a decline in one-to-four family loans of
$27.3 million and consumer and commercial loans of $15.3 million. As part of the
acquisition of the ING branch, the Bank purchased $2.6 million of consumer loans
and $26.2 million in commercial and commercial real estate loans at a premium of
$316,000.
The composition of the loans originated were indicative of the change in the
Corporation's loan portfolio. During the last five years, one-to-four family
residential mortgages decreased from 55.1% of all loans to 11.1%. The interest
rate risk profile of residential mortgages causes the Bank to sell the majority
of such loans in the secondary market. The diversification of the loan portfolio
helped to mitigate the impact of interest rate reductions on the average yield
in the loan portfolio, which decreased to 8.18% for the year ended September 30,
2002, as compared to 8.89% in the prior year. While this yield decreased 71
basis points, the cost of certificates of deposit decreased by 178 basis points,
which may be more indicative of interest rate movements. See "Average Balances"
on page 9.
Deposits
Deposits, after interest credited, excluding the ING branch acquisition,
increased from $312.5 million at September 30, 2001 to $332.2 million at
September 30, 2002, an increase of $19.7 million. Overall cost of funds on
deposits during the period decreased 178 basis points (100 basis points equals
1%) as the Bank attempted to maintain deposit rates consistent with market place
competitors. Demand deposits increased $ 2.7 million or 6.6% from September 30,
2001 to September 30, 2002. Savings account balances decreased $10.6 million
during the same period, while certificates of deposit increased $27.6 million.
As part of the ING branch acquisition, the Bank assumed $19.3 million in demand
deposits, $6.2 million in savings accounts and $24.2 million in certificates of
deposit, at a discount of $416,000. The Bank also recorded $794,000 of core
deposit intangibles in this transaction. The Bank utilized this
10
increase in deposits to fund the continued loan growth and reduce Federal Home
Loan Bank ("FHLB") borrowings. Borrowings decreased by $15.5 million dollars
during fiscal 2002 due to principal payments. The Bank was able to fund lending
and investments with loan repayments and deposit growth.
Stockholders' Equity
At September 30, 2002, total stockholders' equity increased $3.9 million to
$45.9 million from $41.9 million at September 30, 2001. The increase was
primarily due to net income of $6 million during the period coupled with an
increase in accumulated comprehensive income offset by stock repurchases and
dividends paid.
Accumulated other comprehensive income increased as a result of changes in the
net unrealized (loss) on the available for sale securities due to fluctuations
in interest rates. Pursuant to generally accepted accounting principles,
securities available for sale are recorded at current market value and net
unrealized gains or losses on such securities are excluded from current earnings
and reported net of income taxes as part of comprehensive income, until
realized. Because of interest rate volatility, the Corporation's accumulated
other comprehensive income could materially fluctuate for each interim period
and year-end. Unrealized losses on investment securities available for sale will
not affect the Corporation's net income until the securities are sold.
Comparison of Years Ended September 30, 2002 and 2001
Net Income
Net income increased to $6.0 million for the year ended September 30, 2002, from
$3.7 million for the year ended September 30, 2001. The increase was primarily
due to an increase in non-interest income of $2.4 million and an increase in net
interest income of $4.5 million less an increase in non-interest expense of $3.3
million.
Interest Income
Total interest income decreased to $35.2 million for the year ended September
30, 2002, from $35.3 million for the year ended September 30, 2001. Interest
income on loans increased by $753,000 from $30.6 million for the year ended
September 30, 2001, to $31.4 million for the year ended September 30, 2002. This
was a result of a $39.4 million increase in the average balance of loans
receivable from $344.5 million at September 30, 2001, to $383.8 million at
September 30, 2002. The average yield decreased from 8.89% at September 30,
2001, to 8.18% at September 30, 2002. Interest income on mortgage-backed
securities increased $35,000 from September 30, 2001 to September 30, 2002. The
average balance of investment securities decreased by $1.7 million during the
fiscal year and the yield decreased from 4.53% to 2.79%. The yield on
interest-earning assets decreased from 8.03% at September 30, 2001 to 7.27% at
September 30, 2002. Interest income increased by $3.8 million as a result of
increased volume during the year while the changes in rates caused interest
income to decrease by $3.6 million and the rate/volume change decreased interest
income by $287,000. Details are contained in the tables at pages 8 and 9.
Interest Expense
Total interest expense decreased to $17.2 million for the 2002 fiscal year from
$21.9 million for the 2001 fiscal year, as the average balance of total
interest-bearing liabilities increased $61.9 million and the average cost of
funds decreased 178 basis points. The increased cost of deposits attendant to
the growth of balances was approximately $3.1 million, while the decrease
associated with a change in interest rates was approximately $5.3 million. The
cost associated with interest-bearing deposits decreased from 4.96% for the year
ended September 30, 2001 to 3.18% for the same period ended September 30, 2002.
The cost associated with borrowed funds decreased to 5.72% for fiscal 2002 as
compared to 5.99% for fiscal 2001. $327,000 of the decrease in the cost of
borrowed funds was a result of decreases in rates, while decreased volumes
reduced interest expense by $1.0 million and $55,000 of the increase was
rate/volume related. Details are contained in the tables at pages 8 and 9.
Net Interest Income
Net interest income increased $4.5 million during the 2002 fiscal year. Changes
in interest rates caused an increase in net income of $2.0 million, volumes
accounted for an increase in net interest income of $1.7 million and rate/volume
differences increased $737,000.
11
Provision For Loan Losses
The allowance for losses on loans is maintained at a level which is considered
by management to be adequate to absorb inherent losses on existing loans that
may become uncollectible based on an evaluation of the collectibility, prior
loss experience and market conditions. The evaluation takes into consideration
such factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans and current economic
conditions that may affect the borrower's ability to pay. The allowance for loan
losses is established through a provision for loan losses charged to expense.
The Bank's loan loss provision decreased from $1.1 million for the year ended
September 30, 2001 to $811,000 for the year ended September 30, 2002. Included
in the Bank's loan loss provision for September 30, 2001 was a $716,000 charge
in regard to an agricultural loan. See- "Comparison of the years ended September
30, 2001 and 2000, Provision for Loan Losses". The Bank's allowance for loan
losses was $1.7 million at September 30, 2002. The allowance for loan losses
represents 0.41% of net loans outstanding and 33.8% of total non-performing
assets.
A loan is impaired when, based on current information and events, the Bank will
be unable to collect all amounts contractually due under a loan agreement. When
a loan is determined to be impaired, a valuation allowance is established based
upon the difference between investment in the loan and the fair value of the
collateral securing the loan. While the Bank maintains its allowance for loan
losses at a level which it considers to be adequate, there can be no assurance
that further additions will not be made to the loss allowances or that such
losses will not exceed the estimated amounts.
Non-interest Income
Total non-interest income increased by $2.4 million to $9.0 million for the year
ended September 30, 2002 from $6.6 million for the year ended September 30,
2001. Gains on loans sold increased from $2.5 million for fiscal year 2001 to
$4.3 million for fiscal year 2002 and other service charges and fees increased
from $979,000 for the year ended September 20, 2001 to $1.4 million for the year
ended September 30, 2002, primarily due to declining interest rates that helped
boost the purchase and refinance markets. Service charges on deposit accounts
increased $216,000 due to a combination of an increase in the number of accounts
and an increase in fees.
Non-interest Expense
Total non-interest expense increased from $12.8 million for the year ended
September 30, 2001 to $16.1 million for the year ended September 30, 2002.
Compensation and benefits increased $1.8 million, as a result of the acquisition
of the St. Cloud office and higher indirect administrative costs related to the
higher levels of construction lending activities and merit increases. Occupancy
and equipment expense decreased $8,000 while deposit insurance premiums
increased $4,000. Professional fees increased from $401,000 for fiscal year 2001
to $524,000 for fiscal year 2002. The increase is due to expenses incurred
relating to evaluations required with the St. Cloud acquisition, an increased
reliance on consultants, where appropriate, and general increases. Data
processing increased $147,000 to $901,000 for the period ended September 30,
2002, partially due to the St. Cloud acquisition and partially due to the
delivery of additional data processing related services to our customer base.
Other operating expenses increased as a result of goodwill and core deposit
intangibles associated with the ING acquisition, increased indirect expenses
related to the higher levels of construction lending activities and
communication and other costs associated with the integration of an additional
branch location.
Income Tax Expense
Income tax expense increased $1.5 million for the year ended September 30, 2002
to $3.9 million. This increase was primarily due to a gain in pre-tax income of
$3.8 million.
Comparison of Years Ended September 30, 2001 and 2000
Net Income
Net income increased to $3.7 million for the year ended September 30, 2001, from
$3.5 million for the year ended September 30, 2000. The increase was primarily
due to an increase in non-interest income of $1.8 million.
Interest Income
Total interest income increased $2.4 million to $35.3 million for the year ended
September 30, 2001, from $32.9 million for the year ended September 30, 2000.
Interest income on loans increased by $3.5 million
12
from $27.1 million for the year ended September 30, 2000, to $30.6 million for
the year ended September 30, 2001. This was a result of a $35.7 million increase
in the average balance of loans receivable from $308.7 million at September 30,
2000, to $344.4 million at September 30, 2001. Furthermore, the average yield
increased from 8.78% at September 30, 2000, to 8.89% at September 30, 2001.
Interest income on mortgage-backed securities decreased from $2.7 million for
the year ended September 30, 2000, to $2.4 million for the year ended September
30, 2001. The decrease was primarily the result of a decrease in average rate
from 6.17% for the 2000 fiscal year to 5.35% for the 2001 fiscal year. The
average balance of investment securities decreased by $7.2 million during the
fiscal year and the yield decreased from 5.41% to 4.53%. The yield on
interest-earning assets remained the same at 8.03% for the years compared.
Interest income increased by $2.9 million as a result of increased volume during
the year while the changes in rates caused interest income to decrease by
$514,000 and the rate/volume change increased interest income by $97,000.
Details are contained in the tables at pages 8 and 9.
Interest Expense
Total interest expense increased to $21.9 million for the 2001 fiscal year from
$19.8 million for the 2000 fiscal year, as the average balance of total
interest-bearing liabilities and the average cost of funds increased. The
increased cost of deposits attendant to the growth of balances was approximately
$2.3 million, while the increase associated with a change in interest rates was
approximately $734,000. The cost associated with interest-bearing deposits
increased from 4.66% for the year ended September 30, 2000 to 4.96% for the same
period ended September 30, 2001. The cost associated with borrowed funds
increased to 5.99% for fiscal 2001 as compared to 5.89% for fiscal 2000.
$134,000 of the increase in the cost of borrowed funds was a result of increases
in rates, while decreased volumes reduced interest expense by $1.2 million and
$7,000 of the decrease was rate/volume related. Details are contained in the
tables at pages 8 and 9.
Net Interest Income
Net interest income increased $286,000 during the 2001 fiscal year. Changes in
interest rates caused a decrease in net interest income of $1.4 million, volumes
accounted for an increase in net interest income of $1.7 million and rate/volume
differences decreased net interest income $68,000.
Provision For Loan Losses
The allowance for losses on loans is maintained at a level which is considered
by management to be adequate to absorb inherent losses on existing loans that
may become uncollectible based on an evaluation of the collectibility, prior
loss experience and market conditions. The evaluation takes into consideration
such factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans and current economic
conditions that may affect the borrower's ability to pay. The allowance for loan
losses is established through a provision for loan losses charged to expense.
The Bank's loan loss provision increased from $216,000 for the year ended
September 30, 2000 to $1.1 million for the year ended September 30, 2001. The
Bank's allowance for loan losses was $1.5 million at September 30, 2001. The
allowance for loan losses represents 0.44% of net loans outstanding and 50.0% of
total non-performing assets. During the fiscal year ended September 30, 2001, an
agricultural loan in the Bank's loan portfolio experienced deterioration. A
large portion of the loan was collateralized by stored corn, which due to the
weather conditions caused spoilage to the corn. Management determined that the
loan was impaired and recognized a $716,000 charge to earnings.
A loan is impaired when, based on current information and events, the Bank will
be unable to collect all amounts contractually due under a loan agreement. When
a loan is determined to be impaired, a valuation allowance is established based
upon the difference between investment in the loan and the fair value of the
collateral securing the loan. While the Bank maintains its allowance for loan
losses at a level which it considers to be adequate, there can be no assurance
that further additions will not be made to the loss allowances or that such
losses will not exceed the estimated amounts.
Non-interest Income
Total non-interest income increased by $1.8 million to $6.6 million for the year
ended September 30, 2001 from $4.8 million for the year ended September 30,
2000. Gains on loans sold increased from $1.2 million for fiscal year 2000 to
$2.5 million for fiscal year 2001. Other service charges and fees increased from
$765,000 for the year ended September 20, 2000 to $979,000 for the year ended
September 30, 2001, primarily due to declining interest rates that helped boost
the purchase and refinance markets. Service charges on deposit accounts
increased $289,000 during the periods compared due to a combination of
13
an increase in the number of accounts affected and an increase in the fees
associated with deposit accounts.
Non-interest Expense
Total non-interest expense increased 6.7% to $12.8 million for the year ended
September 30, 2001, from $12.0 million for the year ended September 30, 2000.
Compensation and benefits increased $473,000 from $7.2 million for fiscal 2000
to $7.7 million for fiscal 2001. Occupancy and equipment expense increased
$109,000, while deposit insurance premiums decreased $14,000. Professional fees
increased from $378,000 for fiscal year 2000 to $401,000 for fiscal year 2001.
Data processing increased $65,000 to $754,000 for the period ended September 30,
2001.
Income Tax Expense
Income tax expense increased $134,000 for the year ended September 30, 2001 to
$2.4 million for the year ended September 30, 2000. The increase was primarily
due to a gain in pre-tax income of $363,000.
Liquidity and Capital Resources
The liquidity of a Corporation reflects its ability to provide funds to meet
loan requests, accommodate possible outflows in deposits and take advantage of
interest rate market opportunities. Funding of loan requests, providing for
liability outflows and management of interest rate fluctuations require a
continuous analysis in order to match the maturities of specific categories of
short term loans and investments with specific types of deposits and borrowings.
The Corporation's liquidity, represented by cash and cash equivalents, is a
product of its operating, investing and financing activities. The primary
sources of cash were net income and cash derived from investing activities.
Operating activities used cash of $8.6 million during the year ended September
30, 2002. Operating activities used cash of $3.0 million and provided cash of
$6.9 million during the years ended September 30, 2001 and 2000, respectively.
In fiscal 2002, the cash flow in operating activities was influenced primarily
by the change in loans held for sale and other assets and liabilities.
Investing activities provided $9.4 million during the year ended September 30,
2002 and provided $6.9 million and used $61.0 million during the years ended
September 30, 2001 and 2000. The primary activity of the Bank is originating and
purchasing loans and purchasing investment and mortgage-backed securities. The
primary activity of HMC is originating and selling loans in the secondary
mortgage market. During the years ended September 30, 2002, 2001 and 2000, the
Corporation originated loans in the amount of $481.0 million, $348.0 million and
$262.7 million. The net loan originations and principal payments on loans
provided $4.6 million in 2002 and provided $25.9 million in 2001 and used $32.3
million in 2002 and 2000, respectively. The purchase of loans used $19.3
million, $27.3 million and $32.4 million in fiscal 2002, 2001 and 2000 and was
largely comprised of commercial business loans that represented participation
interests with other financial institutions. The Bank also sold a participation
in a development loan in fiscal year 2001 for $1.6 million. Maturities,
principal payments or the exercise of call provisions by the issuers of
mortgage-backed securities held to maturity provided $5.1 million, $7.3 million
and $2.2 million for the years ended September 30, 2002, 2001 and 2000. The
purchase of investment securities available for sale used $3.0 million, $13.9
million and $50,000 and maturities or the exercise of call provision by the
issuers of such securities provided $4.8 million, $13.3 million and $0 for the
years ended September 30, 2002, 2001 and 2000. Other investment activities
included the purchase of equipment and property improvements and the net cash
received in the acquisition of the ING branch.
For the year ended September 30, 2002, $19.9 million in cash was provided as a
result of an increase in deposits and net cash of $15.5 million was paid on FHLB
advances. The purchase of treasury stock and dividends on common stock used $1.5
million and $2.2 million, respectively. During the fiscal year ended September
30, 2001, $17.7 million in cash was provided as a result of an increase in
deposits and net cash of $14.0 million was paid on FHLB advances. The purchase
of treasury stock used $2.5 million and dividends on common stock used $1.3
million during the 2001 fiscal year. Basic and diluted earnings per share for
the year ended September 30, 2002, were $2.77 and $2.63, correspondingly. A
portion of the earnings per share was a result of the purchase of treasury stock
during the fiscal year. Financing activities provided $1.3 million during the
year ended September 30, 2002 and provided $207,000 and $43.4 million in cash
during the years ended September 30, 2001 and 2000.
14
The Bank's liquidity is a measure of its ability to fund loans, pay withdrawals
of deposits and other cash outflows in an efficient and cost effective manner.
The Bank's primary sources of funds are deposits and the scheduled amortization
and prepayments of loan and mortgage-backed security principal. During the past
several years the Bank has used such funds primarily to fund maturing time
deposits, pay savings withdrawals, fund lending commitments, purchase new
investments and increase liquidity. The Bank funds its operations internally and
as needed with borrowed funds from the FHLB. As of September 30, 2002, such
borrowed funds totaled $98.0 million. While loan repayments and maturing
investments and mortgage-backed securities are relatively predictable sources of
funds, deposit flows and loan and mortgage-backed security prepayments are
greatly influenced by general interest rates, economic conditions and
competition.
The amount of certificate accounts that are scheduled to mature during the
twelve months ending September 30, 2003 is approximately $163.0 million. To the
extent that these deposits do not remain at the Bank upon maturity, the Bank
believes that it can replace these funds with deposits, current excess liquidity
and FHLB advances or outside borrowings. It has been the Bank's experience that
substantial portions of such maturing deposits remain at the Bank.
At September 30, 2002, the Bank had commitments to extend credit of $63.9
million. Funds required to fill these commitments are derived primarily from
FHLB borrowings, current excess liquidity, deposit inflows, loan sales and loan
and security repayments.
OTS regulations require the Bank to maintain core capital of 4.0% of assets, of
which 2.0% must be tangible equity capital, excluding goodwill. The Bank is also
required to maintain risk-based capital equal to 8.0% of total risk-based
assets. The Bank's regulatory capital exceeded its tangible equity, tier 1
(risk-based), tier 1 (core) and risk-based capital requirements by 5.9%, 3.4%,
6.8% and 3.3%, respectively.
The Bank's risk-based capital increased from $37.2 million to $40.5 million
during the year ended September 30, 2002. This was primarily due to the Bank's
net earnings less the amount of a dividend paid by the Bank to the Corporation.
Management believes that under current regulations, the Bank will continue to
meets its minimum capital requirements in the foreseeable future. Events beyond
the control of the Bank, such as increased interest rates or a downturn in the
economy in areas in which the Bank operates could adversely affect future
earnings and as a result, the ability of the Bank to meet its future minimum
capital requirements.
Impact of Inflation and Changing Prices
The financial statements and related data have been prepared in accordance with
generally accepted accounting principles. These require the measurement of
financial position and operating results in terms of historical dollars, without
consideration for changes in the relative purchasing power of money over time
caused by inflation.
Unlike industrial companies, nearly all of the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates have a
more significant impact on a financial institution's performance than general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the price of goods and services, since
goods and services are affected by inflation. In the current interest rate
environment, liquidity and the maturity structure of the Bank's assets and
liabilities are critical to the maintenance of acceptable performance levels.
15
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
To the Board of Directors and Stockholders
FSF Financial Corp. and Subsidiaries
Hutchinson, MN
We have audited the accompanying consolidated statements of financial condition
of FSF Financial Corp. and Subsidiaries (the Corporation) as of September 30,
2002 and 2001 and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity and cash flows for each of the three
fiscal years in the period ended September 30, 2002. These financial statements
are the responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FSF Financial
Corp. and Subsidiaries as of September 30, 2002 and 2001 and the consolidated
results of their operations and their cash flows for each of the fiscal years in
the three-year period ended September 30, 2002, in conformity with accounting
principles generally accepted in the United States of America.
/s/Larson, Allen, Weishair & Co., LLP
Larson, Allen, Weishair & Co., LLP
Austin, Minnesota
October 26, 2002
16
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS, except shares)
- --------------------------------------------------------------------------------
September 30,
-------------------------
2002 2001
--------- ---------
(In thousands)
ASSETS
------
Cash and cash equivalents $ 14,615 $ 12,594
Securities available for sale, at fair value:
Equity securities 12,046 12,021
Mortgage-backed and related securities 29,196 27,481
Debt securities -- 3,055
Securities held to maturity, at amortized cost:
Debt securities (Fair value of $13,150 and $12,490) 12,447 12,420
Mortgage-backed and related securities
(Fair value of $20,724 and $25,586) 20,679 25,731
Restricted Stock 5,925 5,925
Loans held for sale 29,242 12,082
Loans receivable, net 382,690 340,484
Foreclosed real estate 122 126
Accrued interest receivable 4,436 4,777
Premises and equipment 6,005 5,439
Other assets 9,690 8,901
Goodwill 4,451 2,595
Core deposit intangible 616 --
--------- ---------
Total assets $ 532,160 $ 473,631
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Demand deposits $ 62,687 $ 40,721
Savings accounts 89,037 93,428
Certificates of deposit 230,200 178,392
--------- ---------
Total deposits 381,924 312,541
Federal Home Loan Bank borrowings 98,000 113,500
Advances from borrowers for taxes and insurance 352 497
Other liabilities 6,003 5,152
--------- ---------
Total liabilities 486,279 431,690
Stockholders' equity:
Serial preferred stock, no par value 5,000,000 shares
authorized, no shares issued -- --
Common stock, $.10 par value 10,000,000 shares authorized,
4,501,277 and 4,501,277 shares issued 450 450
Additional paid in capital 43,101 43,184
Retained earnings, substantially restricted 35,214 31,355
Treasury stock at cost (2,197,763 and 2,194,803 shares) (31,621) (31,146)
Unearned ESOP shares at cost (54,891 and 90,863 shares) (549) (909)
Unearned MSP stock grants at cost (42,164 and 42,564 shares) (448) (453)
Accumulated other comprehensive (loss) (266) (540)
--------- ---------
Total stockholders' equity 45,881 41,941
--------- ---------
Total liabilities and stockholders' equity $ 532,160 $ 473,631
========= =========
The accompanying notes are an integral part of these statements.
17
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, except per share amounts)
- --------------------------------------------------------------------------------
Years Ended September 30,
--------------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Interest income:
Loans receivable $ 31,389 $ 30,636 $ 27,097
Mortgage-backed and related securities 2,430 2,395 2,668
Investment securities 1,355 2,279 3,112
-------- -------- --------
Total interest income 35,174 35,310 32,877
-------- -------- --------
Interest expense:
Deposits 11,478 14,826 11,608
Borrowed funds 5,770 7,074 8,145
-------- -------- --------
Total interest expense 17,248 21,900 19,753
-------- -------- --------
Net interest income 17,926 13,410 13,124
Provision for loan losses 811 1,077 216
-------- -------- --------
Net interest income after provision for loan losses 17,115 12,333 12,908
-------- -------- --------
Non-interest income:
Gain (loss) on loans- net 4,273 2,499 1,197
Other service charges and fees 1,384 979 765
Service charges on deposit accounts 1,767 1,551 1,262
Commission income 1,126 1,145 1,108
Other 425 425 493
-------- -------- --------
Total non-interest income 8,975 6,599 4,825
-------- -------- --------
Non-interest expense:
Compensation and benefits 9,533 7,705 7,232
Occupancy and equipment 1,507 1,515 1,406
Deposit insurance premiums 61 57 71
Data processing 901 754 689
Professional fees 524 401 378
Other 3,605 2,383 2,203
-------- -------- --------
Total non-interest expense 16,131 12,815 11,979
-------- -------- --------
Income before provision for income taxes 9,959 6,117 5,754
Income tax expense 3,927 2,384 2,250
-------- -------- --------
Net income 6,032 3,733 3,504
======== ======== ========
Basic earnings per share $ 2.77 $ 1.68 $ 1.46
Diluted earnings per share $ 2.63 $ 1.61 $ 1.43
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (IN THOUSANDS)
- --------------------------------------------------------------------------------
Net Income $ 6,032 $ 3,733 $ 3,504
Other comprehensive income
Unrealized gains (losses) on securities
Unrealized holding gains (losses) arising during period 444 1,966 (736)
Tax benefit (expense) (170) (735) 278
-------- -------- --------
Other comprehensive income (loss) after tax 274 1,231 (458)
-------- -------- --------
Comprehensive income $ 6,306 $ 4,964 $ 3,046
======== ======== ========
The accompanying notes are an integral part of these statements.
18
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS, except per share amounts)
- -------------------------------------------------------------------------------------------------------------------
Unallocated Unearned Accumulated
Retained Common Stock Other
Additional Earnings Stock Acquired Comprehensive
Common Paid-in Substantially Held by by Treasury Income
Stock Capital Restricted ESOP MSP Stock (Loss) Total
-----------------------------------------------------------------------------------------------------
Balance, September 30, 1999 $ 450 $ 43,292 $ 26,627 $ (1,628) $ (528) $(24,575) $ (1,313) $42,325
Net earnings - - 3,504 - - - - 3,504
Treasury stock acquired - - - - - (4,947) - (4,947)
Stock issued for options
and compensation - - - - - 18 - 18
Amortization of and tax
on MSP shares - 18 - - 70 - - 88
Common stock dividends
($0.50 per share) - - (1,206) - - - - (1,206)
Allocated ESOP shares - 81 - 360 - - - 441
Other comprehensive loss - - - - - - (458) (458)
-----------------------------------------------------------------------------------------------------
Balance September 30, 2000 450 43,391 28,925 (1,268) (458) (29,504) (1,771) 39,765
Net earnings - - 3,733 - - - - 3,733
Treasury stock acquired - - - - - (2,488) - (2,488)
Stock issued for options
and compensation - (330) - - - 846 - 516
Amortization of and tax
on MSP shares - 5 - - 5 - - 10
Common stock dividends
($0.60 per share) - - (1,303) - - - - (1,303)
Allocated ESOP shares - 118 - 359 - - - 477
Other comprehensive income - - - - - - 1,231 1,231
-----------------------------------------------------------------------------------------------------
Balance September 30, 2001 450 43,184 31,355 (909) (453) (31,146) (540) 41,941
Net earnings - - 6,032 - - - - 6,032
Treasury stock acquired - - - - - (1,496) - (1,496)
Stock issued for options
and compensation - (246) - - - 1,021 - 775
Amortization of and tax
on MSP shares - - - - 5 - - 5
Common stock dividends
($1.00 per share) - - (2,173) - - - - (2,173)
Allocated ESOP shares - 163 - 360 - - - 523
Other comprehensive income - - - - - - 274 274
-----------------------------------------------------------------------------------------------------
Balance September 30, 2002 $ 450 $ 43,101 $ 35,214 $ (549) $ (448) $(31,621) $ (266) $45,881
=====================================================================================================
The accompanying notes are an integral part of these statements.
19
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
- --------------------------------------------------------------------------------
Years Ended September 30,
-----------------------------------
2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net income $ 6,032 $ 3,733 $ 3,504
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation 730 658 603
Net amortization of discounts and premiums on securities
held to maturity (186) (39) (40)
Provision for loan losses 811 1,077 216
Net market value adjustment on ESOP shares 163 117 71
Amortization of ESOP and MSP stock compensation 460 445 451
Amortization of intangibles 444 118 118
Net gain on sale of assets -- (30) (126)
Net loan fees deferred and amortized 91 64 (203)
Loans originated for sale (225,532) (138,136) (52,221)
Loans sold 208,371 129,245 54,364
(Increase) decrease in:
Accrued interest receivable 434 (345) (1,104)
Other assets (678) (649) (435)
Increase (decrease) other liabilities 242 724 1,699
--------- --------- ---------
Net cash provided (used) by operating activities (8,618) (3,018) 6,897
--------- --------- ---------
Cash flows from investing activities:
Loan originations and principal payments on loans, net 4,599 25,925 (32,349)
Purchase of loans (19,298) (27,337) (32,417)
Loan participations sold -- 1,600 851
Principal payments on securities held to maturity 5,085 1,260 604
Purchase of securities available for sale (2,992) (13,938) (50)
Proceeds from FHLB stock redeemed -- 450 1,038
Proceeds from maturities of securities available for sale 4,753 13,321 --
Proceeds from maturities of securities held to maturity -- 6,000 1,570
Investment in foreclosed real estate (21) (6) (7)
Proceeds from sale of REO 175 231 428
Proceeds from sale of fixed assets -- -- 157
Purchase of ING Branch, net of deposits assumed 17,589 -- --
Purchase of equipment and property improvements (530) (583) (872)
--------- --------- ---------
Net cash provided (used) by investing activities $ 9,360 $ 6,923 $ (61,047)
--------- --------- ---------
The accompanying notes are an integral part of these statements.
20
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED (IN THOUSANDS)
- --------------------------------------------------------------------------------
Years Ended September 30,
-----------------------------------
2002 2001 2000
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits $ 19,912 $ 17,718 $ 63,176
FHLB Advances 10,000 26,000 88,000
Payments on FHLB Advances (25,500) (40,000) (101,467)
Net short term borrowings -- -- (200)
Net decrease in mortgage escrow funds (146) (160) (12)
Treasury stock purchased (1,496) (2,488) (4,947)
Dividends on common stock (2,173) (1,303) (1,206)
Proceeds from exercise of stock options 682 440 23
--------- --------- ---------
Net cash provided by financing activities 1,279 207 43,367
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 2,021 4,112 (10,783)
Cash and cash equivalents:
Beginning of year 12,594 8,482 19,265
--------- --------- ---------
End of period $ 14,615 $ 12,594 $ 8,482
========= ========= =========
Supplemental disclosures of cash flow information:
Cash payments for:
Interest on advances and other borrowed money $ 5,770 $ 7,074 $ 8,144
Interest on deposits 12,145 14,044 10,828
Income taxes 3,939 2,830 1,963
Supplemental schedule of non-cash investing and financing activities:
Foreclosed real estate $ 149 $ 339 $ 378
The accompanying notes are an integral part of these statements.
21
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002, 2001 AND 2000
- --------------------------------------------------------------------------------
(1) Description of Business and Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of FSF Financial
Corp. (the "Corporation") and its wholly owned subsidiaries, Insurance Planners
of Hutchinson, Inc. (the "Agency") and First Federal fsb (the "Bank"). Firstate
Services and Homeowners Mortgage Corporation ("HMC") are wholly owned
subsidiaries of the Bank. All significant inter-company accounts and
transactions have been eliminated in consolidated financial statements that have
been prepared in conformity with accounting principles generally accepted in the
United States of America.
Nature of Business
The Corporation is a holding company whose affiliated companies provide
financial services. The Agency is a property and casualty insurance company.
Firstate Services is an investment services company. The Bank is a community
financial institution attracting deposits from the general public and using such
deposits, together with borrowings and other funds, to make mortgage,
construction, consumer, commercial and agricultural loans. HMC, a mortgage
banking entity, has become an integral part of the Bank's lending and fee income
function. At September 30, 2002, the Bank operated 12 retail-banking offices in
Minnesota. The Bank is subject to significant competition from other financial
institutions and is also subject to regulation by certain federal agencies,
therefore undergoing periodic examinations by those regulatory authorities.
Use of Estimates
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the consolidated statements of financial condition
and income and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties. While management uses available
information to recognize losses on loans and foreclosed real estate, future
additions to the allowances may be necessary based on changes in local economic
conditions. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for losses on
loans and foreclosed real estate. Such agencies may require the Bank to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
Cash Equivalents (In thousands)
For purposes of the consolidated statements of cash flows, the Corporation
considers all highly liquid debt instruments with original maturities of three
months or less and money market funds to be cash equivalents. Cash and cash
equivalents include interest-bearing deposits of $11,018 and $9,767 at September
30, 2002 and 2001, respectively.
Debt and Equity Securities
The Corporation classifies its investments, including marketable equity
securities, mortgage-backed securities and mortgage related securities, in one
of three categories:
Trading Account Securities
Securities held principally for resale in the near term are classified
as trading account securities and recorded at their fair values.
Unrealized gains and losses on trading account securities are included
in other income. The Corporation did not hold any trading securities
during the three fiscal years ended September 30, 2002.
Securities Held to Maturity
Debt securities, which the Corporation has the positive intent and
ability to hold to maturity, are reported at cost and adjusted for
premiums and discounts that are recognized in interest income using the
interest method over the period to maturity. Unrealized losses on held
to maturity securities reflecting a decline in value judged to be other
than temporary are charged to income.
22
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Securities Available for Sale
Available for sale securities consist of equity securities and certain
debt securities not classified as trading securities nor as held to
maturity securities. Unrealized holding gains and losses, net of income
taxes on available for sale securities, are reported as a net amount in
a separate component of shareholders' equity until realized. Gains and
losses on the sale of available for sale securities are determined
using the specific identification method. Any decision to sell
available for sale securities would be based on various factors,
including movements in interest rates, changes in the maturity mix of
the Corporation's assets and liabilities, liquidity demands, regulatory
capital considerations and other similar factors. Premiums and
discounts are recognized in interest income using the interest method
over the period to maturity. Unrealized losses on available for sale
securities reflecting a decline in value judged to be other than
temporary are charged to income.
Restricted Stock
The Bank, as a member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the Federal Home Loan Bank of Des
Moines ("FHLB") in varying amounts based on balances of outstanding home loans
and on amounts borrowed from the FHLB. Because no ready market exists for this
stock and it has no quoted market value, the Bank's investment in this stock is
carried at cost.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income.
Loans Receivable
Loans receivable, that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff, are reported at their
outstanding principal adjusted by any charge-off, the allowance for loan losses
and any deferred fees or costs on originated loans and unamortized premiums or
discounts on purchased loans. Discounts and premiums on purchased real estate
loans are amortized to income using the interest method over the remaining
period to contractual maturity, adjusted for anticipated prepayments. Discounts
and premiums on purchased consumer loans are recognized over the expected lives
of the loans using the level yield method.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, estimated value of any underlying collateral
and current economic conditions. Loans are considered impaired if full principal
or interest payments are not anticipated in accordance with the contractual loan
terms. Impaired loans are carried at the present value of expected future cash
flows discounted at the loan's effective interest rate or at the fair value of
the collateral if the loan is collateral dependent. A portion of the allowance
for loan losses is allocated to impaired loans if the value of such loans is
deemed to be less than the unpaid balance. If these allocations cause the
allowance for loan losses to require an increase, such an increase is reported
as a component of the provision for loan losses.
Uncollectible interest on loans that are contractually past due for three months
is charged off or an allowance is established, based on management's periodic
evaluation. The allowance is established by a charge to interest income equal to
all interest previously accrued. Income is subsequently recognized only when
cash payments are received and in management's judgment, the borrower's ability
to make periodic interest and principal payments returns to normal, in which
case the loan is returned to accrual status.
Loan origination fees and certain direct origination costs are capitalized with
the net fee or cost recognized as an adjustment to interest income using the
interest method.
23
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Premises and Equipment
Land is carried at cost. Buildings, leasehold improvements and equipment are
carried at cost, less accumulated depreciation and amortization. Buildings and
equipment are depreciated using the straight-line method over the estimated
useful lives of the assets. The cost of leasehold improvements is being
amortized using the straight-line method over the terms of the related leases.
Net gains and losses on disposal or retirement of premises and equipment are
included in other income.
Mortgage Loan Servicing Rights
The Bank has established accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on the
consistent application of the financial component approach. This approach
requires the recognition of financial assets and servicing assets that are
controlled by the Bank and the de-recognition of financial assets and
liabilities when control is extinguished. Liabilities and derivatives incurred
or obtained in conjunction with the transfer of financial assets are measured at
fair value, if practicable. Servicing assets and other retained interest in
transferred assets are measured by allocating the carrying amount between the
assets sold and the interest retained, based on their relative fair value.
Mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing revenues. Impairment of mortgage servicing rights are
assessed based on the fair value of those rights. Fair values are estimated
using discounted cash flows based on a current market interest rate. The Bank
evaluates the mortgage servicing rights strata for impairment by estimating the
fair value based on anticipated future net cash flows, taking into consideration
prepayment predictions. The predominant characteristics used as the basis for
stratifying are loan types, period of origination and interest rates. The amount
of impairment recognized is the amount by which the capitalized mortgage
servicing rights for a stratum exceed their fair value.
Foreclosed Real Estate
Real estate properties acquired through or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure establishing a new
cost basis. After foreclosure, management periodically performs valuations and
the real estate is carried at the lower of the carrying amount or the fair value
minus the estimated costs to sell. Revenue and expenses from operations and
changes to the valuation allowance are included in operations.
Goodwill
The excess of the purchase price over the fair value of assets acquired
(goodwill) in business combinations accounted for by the purchase method is
amortized using the straight-line method over twenty-five years. Goodwill is
evaluated for impairment based on all operations that it directly benefits using
the undiscounted cash flow method.
Advertising Costs (in thousands)
The Corporation expenses all advertising costs as incurred. Advertising expense
totaled $319, $348 and $268 for the three years ended September 30, 2002, 2001
and 2000, respectively.
Income Taxes
The Corporation calculates income taxes on the liability method. The net
deferred tax asset or liability is determined based on the tax effects of the
differences between the book and tax bases of the various assets and liabilities
of the Corporation giving current recognition to changes in tax rates and laws.
Earnings Per Share
Basic incomes per share amounts are computed by dividing the net income by the
weighted average number of common shares outstanding. Diluted income per share
amounts are computed by dividing net income, adjusted for the effect of assumed
conversions, by the weighted average number of common shares outstanding plus
dilutive potential common shares calculated for stock options outstanding using
the treasury stock method.
Treasury Stock
Treasury stock is recorded at cost. In the event of subsequent reissue, the
treasury stock account will be reduced by the cost of such stock on the average
cost basis with any proceed differences reflected as paid in capital
adjustments. Treasury stock is available for general corporate purposes.
24
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Stock Based Compensation
The Corporation has adopted Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock Based Compensation." As allowed by SFAS No. 123,
the Corporation has elected to continue using the accounting methods prescribed
by the Accounting Principles Board (APB) Opinion No. 25 "Accounting for Stock
Issued to Employees" and related interpretations, which measure compensation
cost using the intrinsic value method. See Note 10 for the impact of the fair
value of employee stock based compensation plans on net income and earnings per
share on a pro-forma basis for awards granted after October 1, 1995.
Comprehensive Income
Comprehensive income consists of net income and other gains and losses affecting
shareholders' equity that, under generally accepted accounting principles, is
excluded from net income. For the Corporation, such items consist of unrealized
gains and losses on securities available for sale.
Fair Values of Financial Instruments
The Corporation in estimating fair values of financial instruments as disclosed
herein used the following methods and assumptions:
Cash and cash equivalents- the carrying value of cash and cash equivalents
approximate fair value.
Debt and equity securities- fair values of debt and equity securities have been
estimated using quoted market prices.
Loans receivable- for variable rate loans and loans with relatively near term
maturities (such as consumer installment loans) carrying values approximate
fair values. The fair value of long term fixed rate loans has been
estimated using present value cash flows, discounted at a rate
approximating current market rates and giving consideration to estimated
prepayment risk and credit loss factors. The estimated fair value of loans
held for sale is based on quoted market prices of similar instruments
trading in the secondary market.
Originated mortgage-servicing rights- the carrying amounts of originated
mortgage servicing rights approximate their fair values.
Accrued interest- the carrying amounts of accrued interest receivable
approximate their fair values.
Life Insurance policies- cash value of the policies approximates fair value.
Deposit liabilities- the fair values of demand
deposits are, by definition, equal to the amount payable on demand at the
reporting date (that is, their carrying amounts). The carrying amounts of
variable rate, fixed term money market accounts and certificates of
deposits approximate their fair values at the reporting date. Fair values
of fixed rate certificates of deposit are estimated using a discounted cash
flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on
time deposits.
Shortterm borrowings- the carrying amounts of advances from the Federal Home
Loan Bank (FHLB) of Des Moines maturing within 90 days approximate their
fair values.
Long term borrowings- the carrying amounts of long term borrowings are estimated
using discounted cash flow analyses based on the Bank's current incremental
borrowing rates for similar types of borrowing arrangements.
Off-balance sheet items- fair value for off-balance sheet lending commitments
are based on fees currently charges to enter into similar agreements,
taking into account the remaining terms of the agreements and the
counterparties credit standings. The carrying value and fair value of
commitments to extend credit are not considered material for disclosure.
Reclassifications
Certain amounts in the prior periods presented have been reclassified to conform
to the current period financial statement presentation. These reclassifications
have no effect on previously reported net income.
25
NOTE 2- BRANCH ACQUISITION (in thousands)
On November 9, 2001, the Bank acquired the St. Cloud, Minnesota branch facility
and related business of ING Bank, fsb. The purchase method transaction involved
the assumption of deposits and acquisitions of assets as follows (in thousands):
Deposits assumed (at fair value) $ 50,083
=========
Assets acquired:
Cash $ 17,589
Loans receivable 28,806
Premises and equipment 765
Other assets 14
Core deposit intangible 794
---------
Sub-total (at fair value) $ 47,968
---------
Cost of unidentifiable intangible asset resulting
from the excess of fair value of deposit
liabilities assumed over the fair value of acquired
identifiable asset (SFAS 72 Goodwill) $ 2,115
=========
The unidentifiable intangible asset is recognized under SFAS No. 72, Accounting
for Certain Acquisitions of Banking and Thrift Institutions and is excluded from
the scope of Statement 142 (See Note 17). Statement 72 intangible asset is
subject to amortization based upon the estimated remaining maturity of the
interest rate sensitive assets acquired (approximately 12 years) and is tax
deductible over a 15-year period. The primary reason for the ING branch
acquisition was to increase the Bank's business and market potential in the St.
Cloud, Minnesota area.
The results of operations for the current fiscal year periods were affected by
less than two cents per share on a pro-forma basis and considered not material
for disclosure. Unidentifiable intangible asset amortization for the current
year was $146.
The Financial Accounting Standards Board (FASB) issued SFAS No. 147, which
amends SFAS No. 72, effective October 1, 2002. The unidentifiable intangible
goodwill recognized pursuant to SFAS 72 (i.e. the unamortized excess of the fair
value of liabilities assumed over the fair value of assets acquired) will be
reclassified as SFAS 141 goodwill as of the date that SFAS 142 is applied. Note
that, as of such date, the carrying amount of core deposit intangible (for which
individual accounting records have been kept) is recorded separately and
continues to be amortized. Reclassified goodwill will be prospectively accounted
for in accordance with SFAS 142, thus effectively, amortization ceases as of
October 1, 2002.
26
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(3) Debt and Equity Securities (in thousands)
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at September 30, are presented as follows:
September 30, 2002
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ------- -------- -------
Available for sale securities:
Equity securities
Fund Investments $12,522 $ -- $ 476 $12,046
======= ======= ======= =======
Mortgage backed securities:
REMICs $28,843 $ 448 $ 95 $29,196
======= ======= ======= =======
Held to maturity securities:
Debt securities:
U.S. Government and Agency $12,447 $ 763 $ 60 $13,150
======= ======= ======= =======
Mortgage backed securities:
REMICs $20,154 $ 136 $ 92 $20,198
FNMA certificates 511 1 -- $ 512
Other certificates 14 -- -- $ 14
------- ------- ------- -------
Total $20,679 $ 137 $ 92 $20,724
======= ======= ======= =======
The amortized cost of debt and mortgage-backed securities at September 30, 2002
included unamortized premiums of $192 and unaccreted discounts of $196,
respectively.
September 30, 2001
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ------- -------- -------
Available for sale securities:
Equity securities
Fund Investments $12,522 $ -- $ 501 $12,021
======= ======= ======= =======
Mortgage backed securities:
REMICs $27,602 $ 162 $ 283 $27,481
======= ======= ======= =======
Debt Securities: $ 3,000 $ 55 $ -- $ 3,055
======= ======= ======= =======
Held to maturity securities:
Debt securities:
U.S. Government and Agency $12,420 $ 298 $ 228 $12,490
======= ======= ======= =======
Mortgage backed securities:
REMICs $24,970 $ 150 $ 320 $24,800
FNMA certificates 741 25 -- $ 766
Other certificates 20 -- -- $ 20
------- ------- ------- -------
Total $25,731 $ 175 $ 320 $25,586
======= ======= ======= =======
27
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
The amortized cost of debt and mortgage backed securities at September 30, 2001
includes unamortized premiums of $201 and unaccreted discounts of $246,
respectively.
There were no sales of securities during the past three years as presented.
The scheduled maturities of securities held to maturity and securities (other
than equity securities) available for sale at September 30, 2002 are as follows:
Held to Maturity Available for Sale
Securities Securities
------------------- -------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ------- --------- -------
Due in one year or less $ 5,092 $ 5,208 $ -- $ --
Due from one to five years 4,169 4,514 -- --
Due from five to ten years 2,009 1,949 -- --
Due after ten years 21,856 22,203 28,843 29,196
------- ------- ------- -------
Total $33,126 $33,874 $28,843 $29,196
======= ======= ======= =======
For purposes of this maturity table, mortgage-backed securities, which are not
due at a single maturity date, have been allocated over maturity groupings based
on the weighted average contractual maturities of underlying collateral.
Mortgage-backed securities may mature earlier than their weighted average
contractual maturities because of principal prepayments. Debt and
mortgage-backed securities carried at approximately $14.6 million at September
30, 2002 and $21.0 million at September 30, 2001 were pledged to secure public
deposits and for other purposes required or permitted by law.
(4) Loans Receivable (in thousands)
Loans receivable are summarized as follows:
September 30,
----------------------
2002 2001
--------- ---------
First mortgage loans:
Secured by 1-4 family residences $ 42,383 $ 69,708
Secured by other properties 52,043 43,395
Land and Land development loans 19,394 17,747
Residential construction loans 239,155 142,035
--------- ---------
352,975 272,885
Less:
Un-disbursed portion of construction
and land development loans (101,854) (73,235)
Net deferred loan origination fees (991) (983)
--------- ---------
Subtotal first mortgage loans 250,130 198,667
Consumer and other loans:
Consumer loans 29,929 39,315
Home equity and second mortgages 27,543 29,991
Commercial 20,484 23,908
Agricultural loans 56,129 49,935
--------- ---------
134,085 143,149
Add:
Net deferred loan origination costs 156 209
--------- ---------
Subtotal consumer and other loans 134,241 143,358
--------- ---------
Subtotal all loans 384,371 342,025
Less:
Allowance for loan losses
(1,681) (1,541)
--------- ---------
Total $ 382,690 $ 340,484
========= =========
28
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Loans receivable on non-accrual status for which interest income has not been
recognized was $4,873 and $2,953 at September 30, 2002 and 2001, respectively.
The interest income not recognized on these loans was $264 and $178,
respectively.
A summary of the allowance for loan losses is as follows:
Years Ended September 30,
-----------------------------
2002 2001 2000
------- ------- -------
Balance, beginning of period $ 1,541 $ 1,534 $ 1,387
ING Branch acquisition 274 -- --
Provision for losses 811 1,077 216
Charge-offs (988) (1,127) (98)
Recoveries 43 57 29
------- ------- -------
Balance, end of period $ 1,681 $ 1,541 $ 1,534
======= ======= =======
Loans, having carrying values of $149 and $339, were transferred to foreclosed
real estate in 2002 and 2001, respectively.
The aggregate amount of loans to executive officers and directors of the
Corporation were $240 and $364 at September 30, 2002 and 2001, respectively.
During 2002, repayments on loans to executive officers and directors amounted to
$259 and $135 was advanced.
(5) Loan Servicing (in thousands)
Loans serviced for others are not included in the accompanying consolidated
statements of financial condition. The unpaid principal balances of these loans
serviced for others were $46,093, $52,968 and $52,127 at September 30, 2002,
2001 and 2000, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing and included in demand deposits were $260 and $298 at September 30,
2002 and 2001, respectively.
Capitalized mortgage servicing rights and excess servicing receivables are
summarized as follows:
Years Ended September 30,
-------------------------
2002 2001 2000
----- ----- -----
Beginning balance, net of accumulated amortization $ 172 $ 207 $ 253
Amounts capitalized 53 36 19
Amortization (88) (71) (65)
Valuation adjustments -- -- --
----- ----- -----
Balance, end of period $ 137 $ 172 $ 207
===== ===== =====
(6) Foreclosed Real Estate (in thousands)
Net gains on foreclosed real estate, including net revenues from operations,
were not material for the three years ended September 30, 2002. The Bank held
foreclosed real estate at September 30, 2002 and 2001, amounting to $122 and
$126.
29
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(7) Premises and Equipment (in thousands)
Premises and equipment are summarized as follows:
September 30,
-----------------
2002 2001
------- -------
Land $ 1,044 $ 728
Buildings, improvements and leasehold improvements 5,186 4,898
Furniture, equipment and automobiles 4,680 4,368
------- -------
Total costs 10,910 9,994
Less accumulated depreciation 4,905 4,555
------- -------
Total $ 6,005 $ 5,439
======= =======
At September 30, 2002, the Corporation was obligated under non-cancelable
operating leases for office space and equipment. Net rental expense under
operating leases, included in occupancy and equipment was $318, $398 and $442
for the years ended September 30, 2002, 2001 and 2000. Projected minimum lease
commitments under the terms of the leases for the five year period ending
September 30, 2007 are $310, $272, $272, $272 and $45, respectively.
(8) Deposits (in thousands)
The aggregate amount of short-term jumbo CDs, each with a minimum denomination
of one hundred thousand dollars was $62,600 and $64,287 in 2002 and 2001,
respectively.
Interest expense is summarized as follows:
September 30,
---------------------------
2002 2001 2000
------- ------- -------
Savings accounts $ 1,585 $ 3,491 $ 3,110
Demand deposits 411 266 259
Certificates of deposit 9,482 11,069 8,239
------- ------- -------
$11,478 $14,826 $11,608
======= ======= =======
Accrued interest payable on total deposits was $2,061 and $2,728 at September
30, 2002 and 2001, respectively.
Non-interest bearing demand deposits amounted to $26,387, $20,797 and $16,124
for the years ended September 30, 2002, 2001 and 2000, respectively.
At September 30, 2002, the scheduled maturities of certificates of deposit are
as follows:
Years Ending September 30,
--------------------------
2003 $ 162,985
2004 33,550
2005 23,561
2006 3,651
2007 and thereafter 6,453
----------
$ 230,200
==========
The Bank held deposits of approximately $548 for related parties at September
30, 2002.
30
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(9) Federal Home Loan Bank Borrowings (in thousands)
Borrowings by the Bank from the Federal Home Loan Bank of Des Moines are
summarized as follows:
September 30,
--------------------------------------------
2002 2001
--------------------- --------------------
Fiscal Year of Maturity - Advances
- ---------------------------------- Weighted Weighted
Amount Rate Amount Rate
---------- -------- --------- -------
2002 - % 25,500 6.41 %
2003 10,000 6.53 10,000 6.53
2004 21,000 5.30 16,000 5.83
2005 - - - -
2006 5,000 4.93 5,000 4.93
2007 and thereafter 62,000 5.55 57,000 5.59
---------- -------- --------- -------
Total $ 98,000 5.56 % $113,500 5.88 %
========== ======== ========= =======
Prepayment penalties will be incurred if the advances are paid prior to their
maturity date.
At September 30, 2002, borrowed funds are collateralized by stock in the FHLB,
loans with carrying value of $69,280 and debt and mortgage-backed securities
with carrying values of $47,389 under a collateral agreement.
(10) Employee and Stock Benefit Plans (in thousands except shares)
Salary Continuation Plans
The Bank has adopted insured salary continuation plans for the benefit of
selected members of management by providing them with retirement and death
benefits. The estimated liability under the agreements is charged to income over
the expected remaining years of employment. The Bank's policy is to fund the
costs accrued with insurance contracts. Salary continuation expense amounted to
$277, $135 and $126 for the three years ended September 30, 2002, respectively.
Deferred Compensation 401(k) Plans
The Corporation provides 401(k) plans that cover substantially all employees
meeting age and length of service requirements. The plan maintained by the Bank
covers employees of both the Bank and the Agency. Employees participating in
this plan are eligible to contribute up to 15% of their annual compensation. The
plan maintained by HMC for the benefit of its employees also provides for
employee contribution up to 15% of their annual compensation. Both plans provide
for discretionary contributions by the employers, which are allocated to the
participants' accounts in proportion to employee contributions. The Corporation
made no discretionary contributions to these plans for the three years ended
September 30, 2002.
Supplemental Life Insurance
In addition to group term insurance benefits provided to substantially all
employees, the Bank maintains investments in insurance policies that provide
either split dollar or survivor benefits for certain key employees.
Self Insurance
The Corporation has a self-insured health plan for all its employees. The
Corporation has purchased stop loss insurance to supplement the health plan,
which will reimburse the Corporation for individual claims in excess of $35,000
annually or aggregate claims exceeding $473,300 annually.
31
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Employee Stock Ownership Plan
The Corporation established an Employee Stock Ownership Plan (ESOP) covering all
employees who are over the age of 21, with at least one year of service and who
work at least 1,000 hours during a plan year. The ESOP borrowed funds from the
Corporation to purchase a total of 359,720 shares of the Corporation's common
stock, with the loan being collateralized by the common stock. Employer
contributions, along with dividends received on unallocated shares, are being
used to repay the loan with shares being released from the Corporation's lien
proportional to the loan repayments. Annually, on September 30, the released
shares are allocated to the participants in the same proportion that their wages
bear to the total compensation of all of the participants. Unreleased ESOP
shares are not considered outstanding in calculating earnings per share.
The Corporation presents these financial statements in accordance with the AICPA
Statement of Position (SOP) No. 93-6, "Employers' Accounting for Employee Stock
Ownership Plans." The price of the shares issued and unreleased is charged to
unearned compensation, a contra-equity account. Shares released are reported as
compensation expense equal to the current market value price of the released
shares. Dividends paid on allocated shares are charged to retained earnings and
those on unallocated shares are charged to expense.
A summary of the ESOP share allocation is as follows:
September 30,
--------------------------------
2002 2001 2000
-------- -------- --------
Shares allocated, beginning of year 268,857 232,885 196,919
Shares allocated during year 35,972 35,972 35,972
Unreleased shares 54,891 90,863 126,829
-------- -------- --------
Total ESOP 359,720 359,720 359,720
Fair value of unreleased shares $ 1,087 $ 1,481 $ 1,585
Amount charged to expense $ 214 $ 406 $ 323
Dividend used for debt reduction $ 340 $ 164 $ 171
Management Stock Plan
The Bank established the Management Stock Plan (MSP) for key officers during the
year ended September 30, 1995. Following shareholder approval of the MSP in
January 1995, the Bank purchased 179,860 shares of the Corporation's common
stock in the open market at $10.59 per share to be awarded to officers in
accordance with the provisions of the MSP. The cost of the shares awarded under
these plans is recorded as unearned compensation, a contra-equity account, and
is recognized as an expense in accordance with the vesting requirements defined
by the MSP. For each of the three fiscal years ended September 30, 2002, 2001
and 2000, the amount included in compensation expense related to the MSP was $5,
$5 and $73, respectively.
The following summarizes the activity in the MSP for the three years ended
September 30, 2002:
Unawarded Awarded
Shares Shares
----------- -------------
At September 30, 1999
42,964 27,380
Vested - (27,380)
Shares Granted (2,000) 2,000
------------ -------------
At September 30, 2000 40,964 2,000
Vested - (400)
------------ -------------
At September 30, 2001 40,964 1,600
Vested - (400)
------------ -------------
At September 30, 2002 40,964 1,200
============ =============
32
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Director's Stock Compensation Plan
In January 1998, the shareholders of the Corporation approved a stock
compensation plan for its non-employee directors. The plan granted 6,000 shares
of common stock issued from treasury that vests over a four-year period, with
1,200 shares awarded in January 1998. The compensation cost associated with this
plan is the fair value of the stock ($19.42/share) on the date that the plan was
approved by shareholders. During the year ended September 30, 2002, 1,200 shares
of the total grant were vested to the plan recipients to complete the plan.
Compensation costs included in the accompanying financial statements for the
fiscal years ended September 30, 2002 was $6 and $23 for September 30, 2000 and
2001.
Stock Option Plans
The Corporation maintains the 1994 stock option plan, approved by the
Corporation's stockholders on January 17, 1995 (the 1994 Plan); and the 1998
stock option plan, approved by the Corporation's stockholders on January 20,
1998 (the 1998 Plan). These plans permit the granting of stock options, with an
exercise price equal to the fair value of the Corporation's stock on the date of
the option grant. All options granted under these plans may be exercised over a
ten-year period beginning on the date the option is granted. Awards made under
the Plans may be incentive stock plans (ISO's) as defined by Section 422 of the
Internal Revenue Code or options that do not qualify. Those options granted that
qualify as ISO's are generally exercisable on the date of the grant while those
not qualifying (non-incentive stock options granted to executives and directors
of the Corporation) vest over 3-5 years. The following summarizes the activity
in the two Plans for the three years ended September 30, 2002:
Shares Available Options Shares Weighted Average
for Grant Outstanding Exercise Price
--------- ----------- --------------
At September 30, 1999 79,894 486,993 $ 13.40
Granted (32,187) 32,187 23.30
Exercised -- (3,600) 19.42
Cancelled 2,995 (2,995) 19.13
-------- -------- ---------
At September 30, 2000 50,702 512,585 13.33
Granted (21,937) 21,937 16.05
Exercised -- (93,087) 15.42
Cancelled 1,550 (1,550) 17.46
-------- -------- ---------
At September 30, 2001 30,315 439,885 13.59
Granted (2,500) 2,500 16.05
Exercised -- (81,375) 18.28
Cancelled 1,944 (1,944) 17.40
-------- -------- ---------
At September 30, 2002 29,759 359,066 $ 14.67
======== ======== =========
Shares available for future grants
1994 Plan 8,987
1998 Plan 20,772
The following table summarizes the information about stock options
outstanding at September 30, 2002:
- --------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------
Weighted average
Exercise Number remaining contractual
Price Outstanding life in years Price Number
- ----------------------------------------------------- ------------------------
$ 9.500 105,694 3.0 $ 9.500 105,694
19.125 98,924 6.3 19.125 98,924
16.050 2,500 9.0 16.050 2,500
19.250 30,000 6.7 19.250 30,000
15.000 37,000 7.2 15.000 27,000
14.750 18,087 7.2 14.750 18,087
12.375 19,237 8.0 12.375 19,237
12.375 20,637 9.0 12.375 20,637
12.125 6,000 9.0 12.125 2,000
16.050 20,987 8.0 16.050 20,987
-------------- ---------------
359,066 345,066
============== ===============
33
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
The Corporation elected to follow APB 25 and related interpretations in
accounting for its employee stock options. The exercise price of the employee
stock options equal the market price of the underlying stock on the date of
grant and, therefore; no compensation expense is recognized under APB 25.
Pro-forma information regarding net income and earnings per share is required by
SFAS No. 123 and has been determined as if the Corporation had accounted for its
employee stock option under the fair value method of that statement. Pro-forma
net income and earnings per share follows:
Years Ended September 30,
--------------------------------
2002 2001 2000
------- ------- --------
Net Income
As reported $ 6,032 $ 3,733 $ 3,504
Pro forma 5,984 3,518 3,371
Earnings per common share
As reported
Basic $ 2.77 $ 1.68 $ 1.46
Diluted 2.63 1.61 1.43
Pro forma
Basic $ 2.75 $ 1.58 $ 1.41
Diluted 2.60 1.52 1.38
The above disclosed pro-forma effect of applying SFAS No. 123 to compensation
costs may not be representative of the effects on reported pro-forma net income
for future years.
The fair value for each option grant is estimated on the date of the grant using
the Black Scholes Model. The Model incorporates the following assumptions for
the grants:
Years Ended September 30,
--------------------------------------
2002 2001 2000
--------------------------------------
Risk free interest rate 4.63% 4.85% 5.45%
Expected life 10 years 10 years 10 years
Expected volatility 44.00% 27.00% 26.00%
Expected dividends 8.00 7.00 4.00
Weighted average fair value per share of the option granted $ 7.20 $ 7.16 $ 7.00
(11) Income Taxes (in thousands)
The Corporation files a consolidated federal income tax return. The Corporation
and its subsidiaries entered into a tax sharing agreement that provides for the
allocation and payment of federal and state income taxes. The provision for
income taxes of each corporation is computed on a separate company basis,
subject to certain adjustments. Income tax expense (benefit) is summarized as
follows:
September 30,
-----------------------------
2002 2001 2000
------- ------- -------
Current
Federal $ 3,176 $ 2,313 $ 1,565
State 1,027 749 509
------- ------- -------
Subtotal 4,203 3,062 2,074
Deferred
Federal (207) (509) 132
State (69) (169) 44
------- ------- -------
Subtotal (276) (678) 176
------- ------- -------
Total income tax provision $ 3,927 $ 2,384 $ 2,250
======= ======= =======
34
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
The State of Minnesota follows the Internal Revenue Code for the determination
of taxable income, in connection with temporary differences. The portion of
deferred tax assets and liabilities attributed to state income taxes is
approximately 25 percent. Temporary differences between the financial statement
carrying amounts and the tax basis of assets and liabilities that can create
deferred tax assets and liabilities are as follows:
September 30,
---------------
2002 2001
------ ------
Deferred tax assets:
Deferred compensation $ 686 $ 573
Deferred net loan fees 166 99
Securities unrealized loss 41 222
Intangible assets 4 --
Section 475 "For Sale Assets" 143 --
Allowance for loan losses 681 666
------ ------
Subtotal 1,721 1,560
Less: Valuation allowance 193 203
------ ------
Total 1,528 1,357
Deferred tax liabilities:
FHLB Stock 193 193
Tax bad debt reserve 85 128
Premises and equipment 571 427
Installment obligation sale of former building 26 26
Mortgage servicing rights 42 49
Discount on loans -- 2
Section 475 "For Sale Assets" -- 27
------ ------
Total 917 852
------ ------
Net deferred tax asset $ 611 $ 505
====== ======
A valuation allowance was established to reduce the deferred tax asset related
to the unrealized loss on equity securities because management is uncertain if
it will be realized. The Corporation has paid sufficient taxes in prior
carryback years, which will enable it to recover the balance of the net deferred
tax assets. Therefore, no additional valuation allowance was required at
September 30, 2002 and 2001.
The actual income tax expense varied from the expected tax expense (computed by
applying the United States Federal Corporate income tax rate of 34 percent to
earnings before income taxes) as follows:
Years Ended September 30,
-----------------------------
2002 2001 2000
------- ------- -------
Computed "expected" tax expense $ 3,386 $ 2,080 $ 1,956
State income taxes, net of federal tax benefit 633 383 365
Other, net (92) (79) (71)
------- ------- -------
Total income tax provision $ 3,927 $ 2,384 $ 2,250
======= ======= =======
Retained earnings at September 30, 2002 include $6,492 of which no deferred
federal income tax liability has been recognized. This amount represents an
allocation of income to bad debt deductions for tax purposes only that arose in
tax years beginning before September 30, 1988, (that is the base year amount).
Reduction of the amount, so allocated for purposes other than tax bad debt
losses or adjustments arising from this carryback of net operating losses, would
create income for tax purposes only. This would be subject to the then current
corporate income tax rate. The unrecorded deferred income tax liability on the
above amount was approximately $2,600 at September 30, 2002.
35
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(12) Earnings per Share
The following table sets forth the computation of basic and diluted earnings per
share:
For the Years ended
September 30,
------------------------------------
2002 2001 2000
------------------------------------
Numerator:
Net income - Numerator for basic earnings
per share and diluted earnings per share--
income available to common stockholders $6,032,000 $3,733,000 $3,504,000
===================================
Denominator:
Denominator for basic earnings per share--
weighted-average shares 2,179,824 2,220,067 2,395,287
Effect of dilutive securities:
Stock - based compensation plans 117,431 96,546 56,224
------------------------------------
Denominator for diluted earnings per share--
adjusted weighted-average shares and
assumed conversions 2,297,255 2,316,613 2,451,511
===================================
Basic earnings per share $ 2.77 $ 1.68 $ 1.46
Diluted earnings per share $ 2.63 $ 1.61 $ 1.43
(13) Commitments and Contingencies
In the ordinary course of business, the Corporation has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements.
(14) Stockholders' Equity and Regulatory Capital (in thousands)
On October 6, 1994, the Bank converted from a federally chartered mutual savings
and loan association to a federally chartered stock savings bank pursuant to a
Plan of Conversion (Conversion) via the issuance of common stock. Upon the
Conversion, the preexisting liquidation rights of the depositors of the Bank
were unchanged. Such rights are accounted for by the Bank for the benefit of
such depositors in proportion to their liquidation interests as of the
Eligibility Record Date or the Supplemental Eligibility Record Date, as defined
in the Conversion.
The Bank is subject to various regulatory capital requirements administered by
the Office of Thrift Supervision (OTS). Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators. If undertaken, these could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
36
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to risk
weighted assets (as defined) and of tangible and Tier 1 capital (as defined) to
adjusted total assets (as defined). Management believes that, as of September
30, 2002, the Bank meets all capital adequacy requirements to which it is
subject.
As of September 30, 2002, the most recent notification from the OTS categorized
the Bank as "well capitalized" under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk based, Tier 1 risk based, and Tier 1 leverage ratios as set
forth in the table below. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual regulatory capital amounts, with reconciliation to the
Corporation's investment in the Bank determined in accordance with U.S.
Generally Accepted Accounting Principles (GAAP), and ratios are also presented
in the table below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ------------------------- -------------------------
GAAP capital, September 30, 2002 $ 43,555
Add: Unrealized gains on debt
securities held for sale (210)
Less: Goodwill (4,499)
--------------
Tangible equity capital and ratio to
adjusted total assets $ 38,846 7.4% $ 7,882 1.5% $ 10,510 2.0%
------------------------ ------------------------- -------------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 38,846 7.4% $ 21,020 4.0% $ 26,275 5.0%
------------------------ ------------------------- -------------------------
Total risk based capital and ratio to
risk weighted assets $ 38,846 10.8% $ 14,365 4.0% $ 21,548 6.0%
---------- ------------------------- -------------------------
Tier 2 risk based capital, net adjustment 1,681
--------------
Total risk based capital and ratio to risk
weighted assets, September 30 , 2002 $ 40,527 11.3% $ 28,730 8.0% $ 35,913 10.0%
======================== ========================= =========================
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ------------------------- -------------------------
GAAP capital, September 30, 2001 $ 39,032
Add: Unrealized losses on debt
securities held for sale 40
Less: Goodwill (2,010)
--------------
Tangible equity capital and ratio to
adjusted total assets $ 37,062 7.9% $ 7,035 1.5% $ 9,380 2.0%
------------------------ ------------------------- -------------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 37,062 7.9% $ 18,761 4.0% $ 23,451 5.0%
------------------------ ------------------------- -------------------------
Total risk based capital and ratio to
risk weighted assets $ 37,062 10.8% $ 13,156 4.0% $ 19,734 6.0%
---------- ------------------------- -------------------------
Tier 2 risk based capital, net adjustment 130
--------------
Total risk based capital and ratio to risk
weighted assets, September 30 , 2001 $ 37,192 10.8% $ 26,312 8.0% $ 32,890 10.0%
======================== ========================= =========================
37
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
The Bank may not declare or pay cash dividends to the Corporation if the effect
would be to reduce GAAP capital below applicable regulatory capital requirements
or if such declaration and payment would otherwise violate regulatory
requirements.
(15) Concentration of Credit Risk (in thousands)
The Corporation is primarily engaged in originating mortgage, consumer and
business loans in the Minnesota counties of McLeod, Dakota, Meeker, Wright,
Carver, Washington, Benton, Sherburne, Stearns and Sibley. The Bank offers fixed
and adjustable rates of interest on these loans that have amortization terms
ranging up to thirty years. In addition, the Bank has expanded residential
construction lending in recent years and currently does business in 44 states.
The following table indicates the percentage of construction loans outstanding
by state.
% OF TOTAL
STATE OUTSTANDING
--------------------------------------------------------
Minnesota 37.7%
Wisconsin 14.7%
Michigan 6.5%
Colorado 5.0%
40 Other States 5% or less
The Corporation had cash on deposit in a financial institution in excess of
Federal deposit insurance limits of approximately $10,918 at September 30, 2002.
(16) Financial Instruments (in thousands)
The Corporation is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and forward commitments to
purchase securities. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
statement of financial position. The contract or notional amount of those
instruments reflects the extent of the Bank's involvement in particular classes
of financial instruments.
The Bank's exposure to credit loss, in the event of non-performance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit, is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are unused lines of credit and loan commitments
that are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Since some of the commitments may be
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Each customer's creditworthiness
is evaluated on a case by case basis. The amount of collateral obtained, if it
is deemed necessary, upon extension of credit is based on management's credit
evaluation of the counter party. Collateral held varies, but may include,
accounts receivable, inventory, property, plant and equipment and income
producing commercial properties. Standby letters of credit are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Typically, the Bank issues letters of credit to municipalities and generally
does not require collateral for standby letters of credit.
Forward commitments to purchase securities and mortgages involve an agreement
whereby the seller agrees to make delivery at a specified future date of a
specified instrument and at a specified price or yield. Risks arise from the
possible inability of counterparties to meet the terms of their contracts and
from movements in securities values and interest rates.
38
Forward commitments to sell mortgages involve an agreement whereby the Bank
and/or HMC agrees to make delivery at a specified future date of a specified
loan, at a specified price or yield. Risks arise from the possible inability on
counterparties to meet the terms of their contracts and from movements in loan
values and interest rates.
A summary of the notional amounts of the Corporation's financial instruments at
September 30, 2002 follows:
Commitments to extend credit $ 63,889
Standby letters of credit 156
Commitments to sell loans 51,299
The carrying value and fair value of the Corporation's financial assets and
financial liabilities are as follows:
September 30,
2002 2001
----------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------------------------------------------------
Financial Assets:
Cash & cash equivalents $ 14,615 $ 14,615 $ 12,594 $ 12,594
Investment securities 30,418 31,121 33,421 33,491
Mortgage-backed and related securities 49,875 49,920 53,212 53,067
Loans held for sale 29,242 29,242 12,082 12,082
Loans receivable, net 382,690 385,138 340,484 343,404
Accrued interest receivable 4,436 4,436 4,777 4,777
Life Insurance Policies 7,982 7,982 7,581 7,581
Financial Liabilities:
Deposits 381,924 385,529 312,541 309,330
Borrowings 98,000 106,683 113,500 115,134
(17) Effects of New Financial Accounting Standards ( in thousands)
In June 2001, the Financial Accounting Standards Board (FASB) voted to issue
Financial Accounting Standards Statement No. 141, Business Combinations and
Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. Statement 142 changes the accounting for goodwill
from an amortization method to an impairment-only approach. Thus, amortization
of goodwill, including goodwill recorded in past business combinations, will
cease upon adoption of the Statement. The Company must adopt Statement 142
effective for the fiscal year beginning October 1, 2002. Amortization of
goodwill for the years ended September 30, 2002, 2001 and 2000 was $238, $91 and
$91, respectively.
Impairment is the condition that exists when the carrying amount of goodwill
exceeds its implied fair value. In the event of impairment, an impairment loss
would be recognized in an amount equal to that excess. SFAS No. 142 requires a
two step impairment test to identify potential goodwill impairment and measure
the amount of the goodwill impairment loss to be recognized. The two step
impairment test is summarized as follows:
1. Compare the fair value of the reporting unit with its carrying amount
including goodwill. If the fair value of a reporting unit exceeds its
carrying amount, goodwill of the reporting unit is considered not
impaired and no second step is required.
2. To measure the amount of impairment loss, compare the implied fair
value of the reporting unit goodwill with the carrying amount of the
goodwill. The impairment loss shall equal the excess of carrying value
over fair value.
Goodwill was tested for impairment on October 1, 2002 and its fair value
exceeded the carrying value. See also, Note 2 for a discussion of recently
issued SFAS 147.
39
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(18) Parent Only Condensed Financial Information (in thousands)
The information should be read in conjunction with the other Notes to
Consolidated Financial Statements. Stockholder's equity differs from the
consolidated statements by the amount of the ESOP loan.
STATEMENT OF FINANCIAL CONDITION
September 30,
---------------------
2002 2001
------- -------
ASSETS
Cash and cash equivalents $ 1,499 $ 2,188
Investment in subsidiaries 44,303 39,714
Loan to Bank ESOP 549 909
Other assets 116 81
------- -------
Total assets $46,467 $42,892
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 37 $ 42
Stockholders' equity 46,430 42,850
------- -------
Total liabilities & stockholders' equity $46,467 $42,892
======= =======
STATEMENT OF INCOME
Years Ended September 30,
2002 2001 2000
------- ------- -------
Income:
Dividends from Bank Subsidiary $ 2,000 $ 3,000 $ 6,000
Interest From:
Bank's ESOP Plan 37 105 142
Investments 17 69 133
------- ------- -------
2,054 3,174 6,275
Expense:
Non-Interest Expense 473 457 400
------- ------- -------
Income before income taxes and equity in undistributed
net income of subsidiaries 1,581 2,717 5,875
Income tax benefit (140) (114) (47)
------- ------- -------
1,721 2,831 5,922
Equity in undistributed net income of subsidiaries 4,311 902 --
Subsidiaries dividends received in excess of subsidiaries net income -- -- (2,418)
------- ------- -------
Net income $ 6,032 $ 3,733 $ 3,504
======= ======= =======
40
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(18) Parent Only Condensed Financial Information- Continued (in thousands)
STATEMENT OF CASH FLOWS
Years Ended September 30,
2002 2001 2000
------- ------- -------
Cash flows from operating activities:
Net Income $ 6,032 $ 3,733 $ 3,504
Adjustments:
Equity in undistributed net income of subsidiaries (4,311) (902) --
Subsidiaries dividends received in excess
of subsidiaries net income -- -- 2,418
(Increase) decrease in other assets 35 (69) 55
Increase (decrease)in other liabilities (5) (31) 22
Other 187 296 75
------- ------- -------
Net cash provided by operations 1,938 3,027 6,074
------- ------- -------
Cash flows from investing activities:
Proceeds from maturities of investments -- -- 1,570
------- ------- -------
Net cash provided by investing activities -- -- 1,570
------- ------- -------
Cash flows from financing activities:
Payments received on ESOP bank loan 360 360 360
Purchases of treasury stock (1,496) (2,488) (4,947)
Proceeds from exercise of stock options 682 440 23
Payments of cash dividends (2,173) (1,303) (1,206)
------- ------- -------
Net cash used in financing activities (2,627) (2,991) (5,770)
------- ------- -------
Increase (decrease) in cash and cash equivalents (699) 36 1,874
Cash and cash equivalents:
Beginning of year 2,188 2,152 278
------- ------- -------
End of year $ 1,499 $ 2,188 $ 2,152
======= ======= =======
(19) Business Segments
The Corporation's operating segments are business units that offer different
products and services that are marketed through different channels. Firstate
Services, the Agency and FSF Financial Corporation (the "holding company") did
not meet the quantitative thresholds for determining reportable segments and
therefore are included in the "other" category. Management has identified the
Bank's activity and HMC activity as aggregated components of a reportable
business segment.
The accounting policies and the nature of business components are described in
the summary of significant accounting policies (Note 1). Management evaluates
segment performance based on segment profit or loss before income taxes,
nonrecurring gains and losses and returns on average assets and average equity.
Transfers between segments are accounted for at market value.
Due to the integration of HMC lending activity into the Bank during the current
year (the two components have similar qualitative economic characteristics)
results of prior periods have been reclassified to allow for comparability.
41
FSF Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements- Continued
(19) Business Segments- Continued (in thousands)
Consolidated
Banking Other Eliminations Total
-----------------------------------------------
As of and for the year ended September 30, 2002
Interest income from external sources $ 35,157 $ 17 -- $ 35,174
Non-interest income from external sources 8,219 756 -- 8,975
Inter-segment interest income -- 37 (37) --
Interest expense 17,248 -- -- 17,248
Provision for loan loss 811 -- -- 811
Depreciation and Amortization 1,139 36 -- 1,175
Other non-interest expense 13,934 1,060 (38) 14,956
Income tax expense (benefit) 4,001 (74) -- 3,927
Net Income (loss) 6,244 1,788 (2,000) 6,032
Total Assets 530,666 41,479 (39,985) 532,160
As of and for the year ended September 30, 2001
Interest income from external sources $ 35,242 $ 68 -- $ 35,310
Non-interest income from external sources 5,889 710 -- 6,599
Inter-segment interest income -- 174 (106) 68
Interest expense 21,900 -- -- 21,900
Provision for loan loss 1,077 -- -- 1,077
Depreciation and Amortization 734 43 -- 777
Other non-interest expense 11,118 1,026 (106) 12,038
Income tax expense (benefit) 2,447 (63) -- 2,384
Net Income (loss) 3,854 2,879 (3,000) 3,733
Total Assets 471,467 39,676 (37,512) 473,631
As of and for the year ended September 30, 2000
Interest income from external sources $ 32,745 $ 132 -- $ 32,877
Non-interest income from external sources 4,146 982 -- 5,128
Inter-segment interest income -- 143 (143) --
Interest expense 19,753 -- -- 19,753
Provision for loan loss 216 -- -- 216
Depreciation and Amortization 676 45 -- 721
Other non-interest expense 10,437 964 (143) 11,258
Income tax expense (benefit) 2,257 (7) -- 2,250
Net Income (loss) 3,551 5,953 (6,000) 3,504
Total Assets 464,465 38,180 (36,130) 466,515
42
Selected Quarterly Financial Data (Unaudited)
For the Three Years Ended September 30, 2002
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
-----------------------------------------------
Fiscal 2002
Interest income $ 8,825 $ 8,712 $ 8,677 $ 8,960 $35,174
Interest expense 4,873 4,237 4,089 4,049 17,248
-----------------------------------------------
Net Interest Income 3,952 4,475 4,588 4,911 17,926
Provision for loan losses 150 275 203 183 811
Gain on sale of assets 1,348 862 887 1,176 4,273
Net income $ 1,530 $ 1,375 $ 1,426 $ 1,701 $ 6,032
Basic earnings per share 0.70 0.64 0.65 0.77 2.77
Diluted earnings per share 0.67 0.61 0.61 0.74 2.63
Cash dividends declared per share $ 0.250 $ 0.250 $ 0.250 $ 0.250 $ 1.00
Market range:
High bid (1) $ 18.40 $ 19.78 $ 23.21 $ 22.21 $ 23.21
Low bid (1) $ 15.77 $ 16.86 $ 18.94 $ 18.65 $ 15.77
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
-----------------------------------------------
Fiscal 2001
Interest income $ 9,216 $ 9,035 $ 8,482 $ 8,577 $35,310
Interest expense 5,913 5,759 5,186 5,042 21,900
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Net Interest Income 3,303 3,276 3,296 3,535 13,410
Provision for loan losses 90 705 90 192 1,077
Gain on sale of assets 372 575 769 783 2,499
Net income $ 857 $ 577 $ 1,150 $ 1,149 $ 3,733
Basic earnings per share 0.38 0.26 0.52 0.52 1.68
Diluted earnings per share 0.37 0.25 0.50 0.50 1.61
Cash dividends declared per share $ 0.150 $ 0.150 $ 0.150 $ 0.150 $ 0.60
Market range:
High bid (1) $ 15.63 $ 15.38 $ 15.70 $ 17.25 $ 17.25
Low bid (1) $ 12.36 $ 13.85 $ 13.91 $ 14.27 $ 12.36
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
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Fiscal 2000
Interest income $ 7,534 $ 7,797 $ 8,422 $ 9,124 $32,877
Interest expense 4,386 4,626 5,054 5,687 19,753
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Net Interest Income 3,148 3,171 3,368 3,437 13,124
Provision for loan losses 54 54 54 54 216
Gain on sale of assets 346 246 246 359 1,197
Net income $ 821 $ 856 $ 954 $ 873 $ 3,504
Basic earnings per share 0.32 0.35 0.41 0.39 1.46
Diluted earnings per share 0.31 0.35 0.40 0.38 1.43
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market range:
High bid (1) $ 12.38 $ 12.38 $ 13.00 $ 12.63 $ 13.00
Low bid (1) $ 11.81 $ 10.50 $ 10.45 $ 11.88 $ 10.50
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(1) As reported by the Nasdaq Stock Market. Such over the counter quotations do
not reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
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