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 operating
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 in this document.
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,
2003, First Federal operated 13 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 Minneapolis Tribune, 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, 2003, was 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, 2003, 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 OTHER DATA FOR FSF FINANCIAL CORP.
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Financial Condition (DOLLARS IN THOUSANDS)
Year Ended September 30, 2003 2002 2001 2000 1999
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Total assets $ 541,152 $ 532,160 $ 473,631 $ 466,515 $ 418,094
Loans held-for-sale 17,122 29,242 12,082 3,191 5,334
Loans receivable, net 358,708 382,690 340,484 341,813 278,290
Mortgage-backed securities held-to-maturity - 20,679 25,731 26,986 27,587
Mortgage-backed securities available-for-sale 29,923 29,196 27,481 15,369 15,979
Debt securities held-to-maturity - 12,447 12,420 18,393 19,937
Debt securities available-for-sale 12,178 - 3,055 12,728 12,794
Equity securities available-for-sale 12,009 12,046 12,021 12,321 12,909
Cash and cash equivalents (1) 80,601 14,615 12,594 8,482 19,265
Savings deposits 391,015 381,924 312,541 294,823 231,651
Other borrowings 93,000 98,000 113,500 127,500 140,967
Stockholders' equity 51,187 45,881 41,941 39,765 42,325
Summary of Operations (DOLLARS IN THOUSANDS)
Year Ended September 30, 2003 2002 2001 2000 1999
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Interest income $ 33,518 $ 35,174 $ 35,310 $ 32,877 $ 29,420
Interest expense 14,686 17,248 21,900 19,753 18,198
Net interest income 18,832 17,926 13,410 13,124 11,222
Provision for loan losses 1,228 811 1,077 216 456
Noninterest income 10,799 8,975 6,599 4,825 5,259
Noninterest expense 18,627 16,131 12,815 11,979 11,826
Net income 6,089 6,032 3,733 3,504 2,505
Other Selected Data
Year Ended September 30, 2003 2002 2001 2000 1999
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Return on average assets 1.12% 1.18% 0.80% 0.81% 0.59%
Return on average equity 12.49% 13.69% 9.09% 8.54% 5.74%
Average equity to average assets 8.96% 8.62% 8.86% 9.49% 10.26%
Net interest rate spread (2) 3.50% 3.53% 2.77% 2.93% 2.39%
Nonperforming assets to total assets 1.33% 0.94% 0.65% 0.28% 0.13%
Allowance for loan losses to net loans 0.45% 0.41% 0.44% 0.44% 0.48%
Basic earnings per share $ 2.70 $ 2.77 $ 1.68 $ 1.46 $ 0.94
Diluted earnings per share $ 2.55 $ 2.63 $ 1.61 $ 1.43 $ 0.90
Cash dividends declared per share $ 1.20 $ 1.00 $ 0.60 $ 0.50 $ 0.50
Dividend payout ratio 43.70% 36.02% 34.90% 34.40% 53.10%
<FN>
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.
</FN>
2
TO OUR SHAREHOLDERS:
This annual report includes information on the financial performance for FSF
Financial Corp., and we would like to take this opportunity to provide you with
some of the significant accomplishments and highlights.
Net income of $6.1 million was a new record for the Corporation. Even though net
income increased over the level of one year ago, earnings per share decreased
slightly due to an increase in the number of shares outstanding. We view the
increase in the number of shares outstanding as a positive event, even though it
resulted in a reduction in earnings per share. A number of individuals exercised
stock options and are holding the shares for investment purposes. Their
confidence in the performance of the Corporation is rewarding.
We continue to focus on residential construction lending. During the last year,
we originated almost $220 million of residential construction loans, the
majority of which were made to the owner-occupant of the home. The loans are
short-term (maturing in one year or less); provide interest earnings at rates
that are generally above market rates; and when the construction is completed,
the majority of the loans are modified and sold into the secondary market. The
risk profile associated with construction loans is generally higher than other
residential lending and is the main reason for earnings that are greater than
current market rates. As we have experienced losses within our residential
construction portfolio, we have tightened our credit standards, strengthened our
reserves, resolved various nonperforming loans, and implemented fraud detection
software. During a year when refinance activity contributed heavily to
noninterest income for many financial institutions, we experienced a diminished
impact. In fiscal 2002, we had total gains from the sale of mortgages of $4.3
million, and $1.5 million of that total was attributable to residential
construction loans. In fiscal 2003, the gains from the sale of mortgages
increased to $5.0 million, and $3.0 million of that amount came from residential
construction loans. We believe that this market segment provides a sustainable
source of future income, both interest income during the construction phase and
noninterest income when the mortgage is sold, that may not be as sensitive to
interest rate changes as other types of lending.
During the last year, we introduced our on-line banking product. We are excited
about the usage and acceptance of this additional delivery vehicle. The
electronic banking segment (on-line banking, bill payment, telephone banking,
and ACH activity) accounts for more than 50% of our banking transactions. We are
pleased that we are able to provide a variety of delivery systems that are
cost-effective to our customers and shareholders alike.
We achieved a return on assets ("ROA") of 1.12% and a Return on Equity ("ROE")
of 12.49% for the year ended September 30, 2003. We believe that these measures
compare favorably to statistics compiled by the FDIC for all savings
institutions with total assets of $500 million to $1 billion. There are 140 such
institutions and through June 30, 2003, the latest reported period, the
institutions achieved an average ROA of 0.98% and an ROE of 9.43%.
Book value of the Corporation increased from $20.79 at September 30, 2002 to
$22.30 this year. In October 2002, your Board of Directors announced an increase
in the quarterly dividend of $0.05 to $0.30, providing a dividend yield in
excess of 3%.
We are also encouraged by the movement in our stock price during the last year.
At September 30, 2002, the common stock of FSF Financial Corp. closed at $19.80,
and at September 30, 2003, the closing price was $30.82.
Insurance Planners, Homeowners Mortgage Corporation, and Firstate Investments,
FSF Financial Corp.'s family of companies, continue to provide high-quality
products and services that complement and supplement the offerings of the Bank
and contribute to the continued profitability of our Corporation.
Thank you for your confidence and investment in FSF Financial Corp. We hope that
you are using some of our many products and services. If not, please consider
doing so. Our best sales people are our satisfied customers.
Sincerely,
/s/ Donald A. Glas /s/ George B. Loban
Donald A. Glas George B. Loban
Co-Chairman/Chief Executive Officer Co-Chairman/President
3
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," and "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 affect 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 that
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 level of
construction loans outstanding has impacted the Bank's interest income. The Bank
originates construction loans, and all construction loans are closed in the
Bank's name and administered and monitored by the Bank's 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.
4
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 VOLUME TOTAL
-------------- -------------- ---------------
YEAR ENDED SEPTEMBER 30, 2003 VS. 2002: (In Thousands)
Interest income:
Loans receivable $ (2,509) $ 1,545 $ (964)
Mortgage-backed securities (330) (449) (779)
Securities (417) 504 87
-------- -------- --------
Total change in interest income (3,256) 1,600 (1,656)
Interest expense:
Deposit accounts (2,887) 1,009 (1,878)
Federal Home Loan Bank borrowings (286) (398) (684)
-------- -------- --------
Total change in interest expense (3,173) 611 (2,562)
-------- -------- --------
Net change in net interest income $ (83) $ 989 $ 906
======== ======== ========
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RATE VOLUME TOTAL
-------------- -------------- ---------------
YEAR ENDED SEPTEMBER 30, 2002 VS. 2001: (In Thousands)
Interest income:
Loans receivable $ (2,623) $ 3,376 $ 753
Mortgage-backed securities (298) 333 35
Investment securities (874) (50) (924)
-------- -------- --------
Total change in interest income (3,795) 3,659 (136)
Interest expense:
Deposit accounts (5,576) 2,228 (3,348)
Federal Home Loan Bank borrowings (290) (1,014) (1,304)
-------- -------- --------
Total change in interest expense (5,866) 1,214 (4,652)
-------- -------- --------
Net change in net interest income $ 2,071 $ 2,445 $ 4,516
======== ======== ========
5
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,
-----------------------------------------------------------------------------
2003 2002
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AVERAGE AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE COST BALANCE EXPENSE COST
-----------------------------------------------------------------------------
(in thousands) (in thousands)
INTEREST-EARNING ASSETS
Loans receivable (1) $ 403,388 $ 30,425 7.54% $ 383,892 $ 31,389 8.18%
Mortgage-backed securities 41,022 1,651 4.02% 51,415 2,430 4.72%
Securities (2) 70,158 1,442 2.06% 48,519 1,355 2.79%
--------------------------- ----------------------------
Total interest-earning assets 514,568 33,518 6.51% 483,826 35,174 7.27%
--------------------------- ----------------------------
INTEREST-BEARING LIABILITIES
NOW and money market accounts $ 64,959 334 0.51% $ 56,294 411 0.73%
Passbook savings 87,558 1,011 1.15% 92,974 1,585 1.70%
Certificates of deposit 242,015 8,255 3.41% 211,294 9,482 4.49%
--------------------------- ----------------------------
Total deposits 394,532 9,600 2.43% 360,562 11,478 3.18%
FHLB advances and other borrowed funds 93,699 5,086 5.43% 100,871 5,770 5.72%
--------------------------- ----------------------------
Total interest-bearing liabilities 488,231 14,686 3.01% 461,433 17,248 3.74%
--------------------------- ----------------------------
Net Interest Income $ 18,832 $ 17,926
============= ==============
NET INTEREST RATE SPREAD (3) 3.50% 3.53%
NET INTEREST RATE MARGIN (4) 3.66% 3.70%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.05x 1.05x
============== ==============
YEARS ENDED SEPTEMBER 30,
----------------------------------------
2001
----------------------------------------
AVERAGE
AVERAGE INCOME/ YIELD/
BALANCE EXPENSE COST
----------------------------------------
(in thousands)
INTEREST-EARNING ASSETS
Loans receivable (1) $ 344,470 $ 30,636 8.89%
Mortgage-backed securities 44,791 2,395 5.35%
Securities (2) 50,262 2,279 4.53%
----------------------------
Total interest-earning assets 439,523 35,310 8.03%
----------------------------
INTEREST-BEARING LIABILITIES
NOW and money market accounts $ 35,305 266 0.75%
Passbook savings 87,064 3,491 4.01%
Certificates of deposit 176,336 11,069 6.28%
----------------------------
Total deposits 298,705 14,826 4.96%
FHLB advances and other borrowed funds 117,957 7,074 5.99%
----------------------------
Total interest-bearing liabilities 416,662 21,900 5.26%
----------------------------
Net Interest Income $ 13,410
==============
NET INTEREST RATE SPREAD (3) 2.77%
NET INTEREST RATE MARGIN (4) 3.05%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.05x
==============
1. Average balances include nonaccrual 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.
6
CHANGES IN FINANCIAL CONDITION
General
Total assets increased from $532.2 million at September 30, 2002 to $541.2
million at September 30, 2003. This increase of $9.0 million was mainly funded
by deposit growth and resulted in an increase in cash and cash equivalents,
offset by a decrease in loans receivable, loans held-for-sale, and securities.
The Bank has continued to experience good demand for loans and supplemented the
internal loan origination of $572.3 million with purchases of other loans
totaling $4.0 million that met the interest rate risk and credit risk criteria
established by management.
Securities Available-for-Sale
Equity securities decreased by $37,000 due to a decrease in the market value of
fund investments. During the current fiscal year, the Corporation transferred
all its held-to-maturity debt securities and mortgage-backed and related
securities to the available-for-sale category. The fair value of these
securities at the time of transfer was $31.0 million, and the unrealized gain,
net of income taxes, was $561,000. During this fiscal year, $9.0 million of
securities available-for-sale were purchased. The net unrealized losses on
securities available-for-sale increased from $123,000 at September 30, 2002 to
an unrealized gain of $640,000 at September 30, 2003. This change was primarily
due to the transfer of securities from held-to-maturity to available-for-sale
and the market rate of interest decreasing as compared to the contractual rate
of interest on securities held in the portfolio.
Securities Held-to-Maturity
During the current fiscal year, the Bank transferred all the securities
held-to-maturity to available-for-sale.
Loans Held-for-Sale
Net loans held-for-sale decreased from $29.2 million at September 30, 2002 to
$17.1 million at September 30, 2003. The Bank had firm commitments to sell these
loans held-for-sale that were closed by September 30, 2003.
Loans Receivable
Net loans receivable decreased from $382.7 million at September 30, 2002 to
$358.7 million at September 30, 2003. This decrease of $24.0 million was a
result of decreases in other real estate mortgages totaling $24.5 million, an
increase in net construction loans totaling $19.0 million, and agricultural
loans in the amount of $1.1 million, partially offset by a decline in
one-to-four-family loans of $18.1 million.
The composition of the loans originated was indicative of the change in the
Corporation's loan portfolio. During the last five years, one-to-four-family
residential mortgages decreased from 38.8% of all loans to 8.5%. 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 7.54% for the year ended September 30,
2003, as compared to 8.18% in the prior year. While this yield decreased 64
basis points, the cost of funds decreased by 73 basis points. See "Average
Balances" on page 6.
Deposits
Deposits, after interest credited, increased from $381.9 million at September
30, 2002 to $391.0 million at September 30, 2003, an increase of $9.1 million.
Overall cost of funds on deposits during the period decreased 75 basis points
(100 basis points equals 1%) as the Bank attempted to maintain deposit rates
consistent with market place competitors. Demand deposits increased $7.0
million, or 11.2%, from September 30, 2002 to September 30, 2003. Savings
account balances decreased $2.4 million during the same period, while
certificates of deposit increased $4.5 million. The Bank utilized this increase
in deposits to fund the continued loan growth and to reduce Federal Home Loan
Bank ("FHLB") borrowings. Borrowings decreased by $5.0 million during fiscal
2003 due to principal payments. The Bank was able to fund lending and
investments with loan repayments and deposit growth.
Stockholders' Equity
At September 30, 2003, total stockholders' equity increased $5.3 million to
$51.2 million from $45.9 million at September 30, 2002. The increase was
primarily due to net income of $6.1 million during the period coupled with the
exercise of stock options and an increase in accumulated comprehensive income
offset by stock repurchases and dividends paid.
7
Accumulated other comprehensive income increased as a result of changes in the
net unrealized loss on the securities available-for-sale due to fluctuations in
interest rates and the transfer of securities from held-to-maturity. Pursuant to
accounting principles generally accepted in the United States of America,
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, 2003 AND 2002
Net Income
Net income increased to $6.1 million for the year ended September 30, 2003 from
$6.0 million for the year ended September 30, 2002. The increase was primarily
due to an increase in noninterest income of $1.8 million and an increase in net
interest income of $906,000 less an increase in noninterest expense of $2.5
million.
Interest Income
Total interest income decreased to $33.5 million for the year ended September
30, 2003 from $35.2 million for the year ended September 30, 2002. Interest
income on loans decreased by $964,000 from $31.4 million for the year ended
September 30, 2002 to $30.4 million for the year ended September 30, 2003. This
was a result of a $19.5 million increase in the average balance of loans
receivable from $383.8 million at September 30, 2002 to $403.3 million at
September 30, 2003. The average yield decreased from 8.18% at September 30, 2002
to 7.54% at September 30, 2003. Interest income on mortgage-backed securities
decreased $779,000 from September 30, 2002 to September 30, 2003. The average
balance of securities increased by $21.6 million during the fiscal year, and the
yield decreased from 2.79% to 2.06%. The yield on interest-earning assets
decreased from 7.27% at September 30, 2002 to 6.51% at September 30, 2003.
Interest income increased by $1.6 million as a result of increased volume during
the year while the changes in rates caused interest income to decrease by $3.2
million. Details are contained in the tables at pages 5 and 6.
Interest Expense
Total interest expense decreased to $14.7 million for the 2003 fiscal year from
$17.2 million for the 2002 fiscal year, as the average balance of total
interest-bearing liabilities increased $26.8 million and the average cost of
funds decreased 73 basis points. The increased cost of deposits attendant to the
growth of balances was approximately $1.0 million, while the decrease associated
with a change in rate was approximately $2.9 million. The cost associated with
interest-bearing deposits decreased from 3.18% for the year ended September 30,
2002 to 2.43% for the same period ended September 30, 2003. The cost associated
with borrowed funds decreased to 5.43% for fiscal 2003 as compared to 5.72% for
fiscal 2002. Decreased volumes reduced interest expense by $398,000, and
$286,000 of the decrease was rate related. Details are contained in the tables
at pages 5 and 6.
Net Interest Income
Net interest income increased $906,000 during the 2003 fiscal year. Changes in
interest rates caused a decrease in net income of $83,000, while volumes
accounted for an increase in net interest income of $989,000.
Provision For Loan Losses
The allowance for losses on loans is maintained at a level that is considered by
management to be appropriate to absorb probable incurred 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.
8
The Bank's loan loss provision increased from $811,000 for the year ended
September 30, 2002 to $1.2 million for the year ended September 30, 2003. The
Bank's allowance for loan losses was $1.7 million at September 30, 2003. The
allowance for loan losses represents 0.45% of net loans outstanding and 23.7% of
total nonperforming 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 that 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.
Noninterest Income
Total noninterest income increased by $1.8 million to $10.8 million for the year
ended September 30, 2003 from $9.0 million for the year ended September 30,
2002. Gains on loans sold increased from $4.3 million for fiscal year 2002 to
$5.0 million for fiscal year 2003 primarily due to an increase in the number of
residential construction loans that were modified and sold in the secondary
market. Other service charges and fees increased from $1.4 million for the year
ended September 20, 2002 to $1.7 million for the year ended September 30, 2003,
primarily due to declining interest rates that helped boost the purchase and
refinance markets. Service charges on deposit accounts increased $729,000 due to
an increase in fees charged on overdrafts.
Noninterest Expense
Total noninterest expense increased from $16.1 million for the year ended
September 30, 2002 to $18.6 million for the year ended September 30, 2003.
Compensation and benefits increased $2.1 million, as a result of higher indirect
administrative costs related to the higher levels of mortgage and construction
lending activities and merit increases and higher ESOP expense due to release of
11,276 extra shares, combined with an increase in the value of the Company's
stock. Occupancy and equipment expense increased $262,000 due to increased
computer and software depreciation.
Income Tax Expense
Income tax expense decreased $240,000 to $3.7 million, which was primarily due
to a decrease of $183,000 in pretax income. A state income tax refund of
approximately $119,000, in addition to a reduction of state income tax for the
current fiscal year, impacted the nominal tax rate for the comparative periods
resulting from an apportionment formula related to the multi-state residential
construction lending.
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 noninterest income of $2.4 million and an increase in net
interest income of $4.5 million less an increase in noninterest 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 $3.7 million as a result of increased volume
during the year, while the changes in rates caused interest income to decrease
by $3.8 million. Details are contained in the tables at pages 5 and 6.
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 $2.2 million, while the decrease
associated with a change in interest rates was approximately $5.6 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. A decrease of $290,000 in the cost of
borrowed funds was the result of decreases in rates, while decreased volumes
reduced interest expense by $1.0 million. Details are contained in the tables at
pages 5 and 6.
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 $2.1 million, while
volumes accounted for an increase in net interest income of $2.4 million.
Provision For Loan Losses
The allowance for losses on loans is maintained at a level that 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. 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 nonperforming 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 that 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.
Noninterest Income
Total noninterest 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.
Noninterest Expense
Total noninterest 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
10
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 pretax income of
$3.8 million.
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 provided cash of $21.0 million during the year ended
September 30, 2003. Operating activities used cash of $8.9 million and $3.1
million during the years ended September 30, 2002 and 2001, respectively. In
fiscal 2003, 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 $43.0 million during the year ended September 30,
2003 and provided $9.4 million and $6.9 million during the years ended September
30, 2002 and 2001. 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, 2003, 2002, and 2001, the
Corporation originated loans in the amount of $572.3 million, $481.0 million,
and $348.0 million. The net loan originations and principal payments on loans
provided $24.8 million in 2003, $4.6 million in 2002, and $25.9 million in 2001.
The purchase of loans used $4.0 million, $19.3 million, and $27.3 million in
fiscal 2003, 2002, and 2001 and was largely comprised of land development and
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 $2.2 million, $5.1 million, and $7.3 million for the
years ended September 30, 2003, 2002, and 2001, respectively. The purchase of
investment securities available-for-sale used $9.0 million, $3.0 million, and
$13.9 million, and maturities or the exercise of call provision by the issuers
of such securities provided $28.0 million, $4.8 million, and $13.3 million for
the years ended September 30, 2003, 2002, and 2001, respectively. Other
investment activities included the purchase of equipment and property
improvements and proceeds from the sale of REO property.
For the year ended September 30, 2003, $9.2 million in cash was provided as a
result of an increase in deposits and net cash of $5.0 million was paid on FHLB
advances. The purchase of treasury stock and dividends on common stock used $1.0
million and $2.7 million, respectively. During the fiscal 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 used $1.5 million and dividends on common stock used $2.2
million during the 2002 fiscal year. Basic and diluted earnings per share for
the year ended September 30, 2003 were $2.70 and $2.55, respectively. A portion
of the earnings per share was a result of the purchase of treasury stock during
the fiscal year. Financing activities provided $2.0 million during the year
ended September 30, 2003 and provided $1.5 million and $327,000 in cash during
the years ended September 30, 2002 and 2001, respectively.
The Bank's liquidity is a measure of its ability to fund loans and 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, 2003, such borrowed funds totaled $93.0 million. While loan
repayments and maturing
11
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, 2004 is approximately $167.4 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, 2003, the Bank had commitments to extend credit of $42.2
million, including unused lines of credit. 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 6.0%, 6.2%,
3.0%, and 2.7%, respectively.
The Bank's risk-based capital increased from $40.5 million to $44 million during
the year ended September 30, 2003. 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
accounting principles generally accepted in the United States of America. 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.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") recently issued two new
accounting standards, Standard 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities" and Statement 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equities",
both of which generally become effective in the quarter beginning July 1, 2002.
Because the Company does not have these instruments or is only nominally
involved in these instruments, management determined that, upon adopting the new
standards, the new accounting standards will not materially affect the Company's
operating results or financial condition.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51". This
Interpretation provides new guidance for the consolidation of variable interest
entities ("VIEs") and requires such entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risk among parties
involved. The Interpretation also adds disclosure requirements for investors
that are involved with unconsolidated VIEs. The consolidation requirements apply
immediately to VIEs created after January 31, 2003 and are effective for the
first fiscal year or interim period beginning after June 15, 2003 for VIEs
acquired before February 1, 2003. The adoption of
12
this interpretation is not expected have a significant impact on the Company's
financial condition of results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 ensure
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.
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. Originations of construction and land development loans, which generally
have a contractual maturity of two years or less, totaled $242.1 million. At
September 30, 2003, the Bank had outstanding, $219.3 million of real estate
mortgages that were adjustable rate, balloon, or construction and land
development loans, representing 58.4% of net loans and 40.6% of total assets.
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 2003 have changed when compared to fiscal 2002.
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.
13
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.
The following table sets forth the present value estimates of the Bank at
September 30, 2003, as calculated by the NPV Model. The table shows the NPV of
the Bank under rate shock scenarios of -200 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 increases and prepayments are
slow. As rates decrease, the market value of mortgage loans and securities
decreases due to prepayment risk, periodic rates 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 $48,544 $ 138 0.29% 9.15% 13 bp
+200 bp 48,502 96 0.20 9.11 9 bp
+100 bp 48,456 50 0.10 9.07 5 bp
0 bp 48,406 - - 9.02 -
-100 bp 48,354 (52) (0.11) 8.98 (4)bp
-200 bp 48,304 (102) (0.21) 8.94 (8)bp
This table shows that the Bank's economic value of equity would increase with
rising interest rates while decreasing with declining 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.
14
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 as of September 30, 2003 and the related
consolidated statements of income, comprehensive income, changes in
stockholders' equity, and cash flows for the year then ended. 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 audit. The accompanying consolidated financial statements of the Corporation
as of September 30, 2002 and for the two years then ended were audited by other
auditors whose report dated October 26, 2002 expressed an unqualified opinion on
those statements.
We conducted our audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the 2003 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of FSF
Financial Corp. and Subsidiaries as of September 30, 2003 and the results of
their operations and their cash flows for the year then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Oak Brook, Illinois
October 31, 2003
15
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
- --------------------------------------------------------------------------------
September 30,
-----------------------------
2003 2002
-----------------------------
(In thousands)
ASSETS
------
Cash and cash equivalents:
Cash $ 3,556 $ 3,597
Interest-bearing deposits 77,045 11,018
-----------------------------
Total cash and cash equivalents 80,601 14,615
Securities available-for-sale, at fair value:
Equity securities 12,009 12,046
Mortgage-backed and related securities 29,923 29,196
Debt securities 12,178 -
Securities held-to-maturity, at amortized cost:
Debt securities (fair value of $13,150) - 12,447
Mortgage-backed and related securities (fair value of $20,724) - 20,679
Restricted stock 4,797 5,925
Loans held-for-sale 17,122 29,242
Loans receivable, net 358,708 382,690
Foreclosed real estate 1,152 122
Accrued interest receivable 3,960 4,436
Premises and equipment 6,331 6,005
Goodwill 3,883 3,883
Identifiable intangibles 1,014 1,184
Investment in life insurance 8,388 7,982
Other assets 1,086 1,708
-----------------------------
Total assets $ 541,152 $ 532,160
=============================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Demand deposits $ 69,684 $ 62,687
Savings accounts 86,666 89,037
Certificates of deposit 234,665 230,200
-----------------------------
Total deposits 391,015 381,924
FHLB borrowings 93,000 98,000
Advances from borrowers for taxes and insurance 233 352
Other liabilities 5,717 6,003
-----------------------------
Total liabilities 489,965 486,279
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 43,925 43,101
Retained earnings, substantially restricted 38,643 35,214
Treasury stock at cost (2,156,540 and 2,197,763 shares) (31,444) (31,621)
Unearned ESOP shares at cost (7,643 and 54,891 shares) (76) (549)
Unearned MSP stock grants at cost (41,764 and 42,164 shares) (484) (448)
Accumulated other comprehensive (loss) 173 (266)
-----------------------------
Total stockholders' equity 51,187 45,881
-----------------------------
Total liabilities and stockholders' equity $ 541,152 $ 532,160
==============================
The accompanying notes are an integral part of these statements.
16
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts)
- --------------------------------------------------------------------------------
Years Ended September 30,
----------------------------------------------
2003 2002 2001
----------------------------------------------
(In thousands)
Interest income:
Loans receivable $ 30,425 $ 31,389 $ 30,636
Mortgage-backed and related securities 1,651 2,430 2,395
Investment securities 1,442 1,355 2,279
----------------------------------------------
Total interest income 33,518 35,174 35,310
----------------------------------------------
Interest expense:
Deposits 9,600 11,478 14,826
Borrowed funds 5,086 5,770 7,074
----------------------------------------------
Total interest expense 14,686 17,248 21,900
----------------------------------------------
Net interest income 18,832 17,926 13,410
Provision for loan losses 1,228 811 1,077
----------------------------------------------
Net interest income after provision for loan losses 17,604 17,115 12,333
----------------------------------------------
Noninterest income:
Gain (loss) on sale of loans - net 5,044 4,273 2,499
Other service charges and fees 1,657 1,384 979
Service charges on deposit accounts 2,496 1,767 1,551
Commission income 1,243 1,126 1,145
Other 359 425 425
----------------------------------------------
Total noninterest income 10,799 8,975 6,599
----------------------------------------------
Noninterest expense:
Compensation and benefits 11,655 9,533 7,705
Occupancy and equipment 1,769 1,507 1,515
Data processing 1,002 901 754
Professional fees 627 524 401
Other 3,574 3,666 2,440
----------------------------------------------
Total noninterest expense 18,627 16,131 12,815
----------------------------------------------
Income before provision for income taxes 9,776 9,959 6,117
Income tax expense 3,687 3,927 2,384
----------------------------------------------
Net income $ 6,089 $ 6,032 $ 3,733
==============================================
Basic earnings per share $ 2.70 $ 2.77 $ 1.68
Diluted earnings per share $ 2.55 $ 2.63 $ 1.61
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands)
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 6,089 $ 6,032 $ 3,733
Other comprehensive income
Unrealized holding gains on securities transferred from held to
maturity,
net of taxes 561 - -
Unrealized holding gains (losses) arising during period (180) 444 1,966
Tax benefit (expense) 58 (170) (735)
-----------------------------------------------
Other comprehensive income (loss) after tax 439 274 1,231
-----------------------------------------------
Comprehensive income $ 6,528 $ 6,306 $ 4,964
===============================================
The accompanying notes are an integral part of these statements.
17
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands, except per share amounts)
- ---------------------------------------------------------------------------------------------------------------------------------
Unallocated
Retained Common Unearned
Additional Earnings Stock Stock
Common Paid-in Substantially Held by Acquired by
Stock Capital Restricted ESOP MSP
------------------------------------------------------------------------------
Balance, September 30, 2000 $ 450 $ 43,391 $ 28,925 $ (1,268) $ (458)
Net earnings - - 3,733 - -
Treasury stock acquired - - - - -
Stock issued for options and compensation - (330) - - -
Amortization of MSP shares - 5 - - 5
Common stock dividends
($0.60 per share) - - (1,303) - -
Allocated ESOP shares - 118 - 359 -
Other comprehensive loss - - - - -
------------------------------------------------------------------------------
Balance September 30, 2001 450 43,184 31,355 (909) (453)
Net earnings - - 6,032 - -
Treasury stock acquired - - - - -
Stock issued for options and compensation - (246) - - -
Amortization of MSP shares - - - - 5
Common stock dividends
($1.00 per share) - - (2,173) - -
Allocated ESOP shares - 163 - 360 -
Other comprehensive income - - - - -
------------------------------------------------------------------------------
Balance September 30, 2002 450 43,101 35,214 (549) (448)
Net earnings - - 6,089 - -
Treasury stock acquired - - - - -
Stock issued for options and compensation - 282 - - (41)
Amortization of MSP shares - - - - 5
Common stock dividends
($1.20 per share) - - (2,660) - -
Allocated ESOP shares - 542 - 473 -
Other comprehensive income - - - - -
------------------------------------------------------------------------------
Balance September 30, 2003 $ 450 $ 43,925 $ 38,643 $ (76) $ (484)
==============================================================================
Accumulated
Other
Comprehensive
Treasury Income
Stock (Loss) Total
---------------------------------------------
Balance, September 30, 2000 $ (29,504) $ (1,771) $ 39,765
Net earnings - - 3,733
Treasury stock acquired (2,488) - (2,488)
Stock issued for options and compensation 846 - 516
Amortization of MSP shares - - 10
Common stock dividends
($0.60 per share) - - (1,303)
Allocated ESOP shares - - 477
Other comprehensive loss - 1,231 1,231
---------------------------------------------
Balance September 30, 2001 (31,146) (540) 41,941
Net earnings - - 6,032
Treasury stock acquired (1,496) - (1,496)
Stock issued for options and compensation 1,021 - 775
Amortization of MSP shares - - 5
Common stock dividends
($1.00 per share) - - (2,173)
Allocated ESOP shares - - 523
Other comprehensive income - 274 274
---------------------------------------------
Balance September 30, 2002 (31,621) (266) 45,881
Net earnings - - 6,089
Treasury stock acquired (1,016) - (1,016)
Stock issued for options and compensation 1,193 - 1,434
Amortization of MSP shares - - 5
Common stock dividends
($1.20 per share) - - (2,660)
Allocated ESOP shares - - 1,015
Other comprehensive income - 439 439
---------------------------------------------
Balance September 30, 2003 $ (31,444) $ 173 $ 51,187
=============================================
The accompanying notes are an integral part of these statements.
18
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
- --------------------------------------------------------------------------------
Years Ended September 30,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
Cash flows from operating activities:
Net income $ 6,089 $ 6,032 $ 3,733
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 927 730 658
Net amortization of discounts and premiums (120) (186) (39)
Provision for loan losses 1,228 811 1,077
Net market value adjustment on ESOP shares 542 163 117
Amortization of ESOP and MSP stock compensation 246 211 325
Amortization of intangibles 170 444 118
Net gain on sale of assets - - (30)
Net loan fees deferred and amortized (323) 91 64
Loans originated for sale (342,977) (225,532) (138,136)
Loans sold 355,097 208,371 129,245
(Increase) decrease in: Accrued interest receivable 476 434 (345)
Life insurance (406) (411) (372)
Other assets 542 (267) (277)
Deferred taxes (244) (276) (678)
Other liabilities (286) 518 1,402
-----------------------------------------------
Net cash provided by (used in) operating activities 20,961 (8,867) (3,138)
-----------------------------------------------
Cash flows from investing activities:
Loan originations and principal payments on loans, net 24,759 4,599 25,925
Purchase of loans (4,000) (19,298) (27,337)
Loan participations sold - - 1,600
Principal payments on mortgage-related securities held-to-maturity 2,178 5,085 1,260
Purchase of securities available-for-sale (9,030) (2,992) (13,938)
Proceeds from FHLB stock redeemed 1,128 - 450
Principal repayments and proceeds from maturities of securities
available-for-sale 28,003 4,753 13,321
Proceeds from maturities of securities held-to-maturity - - 6,000
Investment in foreclosed real estate (163) (21) (6)
Proceeds from sale of REO 1,357 175 231
Purchase of ING Branch, net of deposits assumed - 17,589 -
Purchase of equipment and property improvements (1,253) (530) (583)
-----------------------------------------------
Net cash provided by investing activities $ 42,979 $ 9,360 $ 6,923
-----------------------------------------------
The accompanying notes are an integral part of these statements.
19
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED (IN THOUSANDS)
- --------------------------------------------------------------------------------
Years Ended September 30,
----------------------------------------------
2003 2002 2001
----------------------------------------------
Cash flows from financing activities:
Net increase in deposits $ 9,175 $ 19,912 $ 17,718
FHLB Advances 5,000 10,000 26,000
Payments on FHLB Advances (10,000) (25,500) (40,000)
Allocated dividends used to retire debt on ESOP 232 249 120
Net decrease in mortgage escrow funds (119) (146) (160)
Treasury stock purchased (1,016) (1,496) (2,488)
Dividends on common stock (2,660) (2,173) (1,303)
Proceeds from exercise of stock options 1,434 682 440
----------------------------------------------
Net cash provided by financing activities 2,046 1,528 327
----------------------------------------------
Net increase in cash and cash equivalents 65,986 2,021 4,112
Cash and cash equivalents:
Beginning of year 14,615 12,594 8,482
----------------------------------------------
End of year $ 80,601 $ 14,615 $ 12,594
==============================================
Supplemental disclosures of cash flow information:
Cash payments for:
Interest on advances and other borrowed money $ 5,086 $ 5,770 $ 7,074
Interest on deposits 10,287 12,145 14,044
Income taxes 3,825 3,939 2,830
Supplemental schedule of non-cash investing and financing activities:
Foreclosed real estate $ 2,224 $ 149 $ 339
Transfer of securities from held-to-maturity to available-for-sale 30,462 - -
Unrealized gain on securities available-for-sale transferred,
net of tax 561 - -
The accompanying notes are an integral part of these statements.
20
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003, 2002, AND 2001
- --------------------------------------------------------------------------------
(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 the consolidated financial statements,
which 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. At September
30, 2003, the Bank operated 13 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, and therefore, undergoes
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 and Cash Equivalents (in thousands)
For purposes of the consolidated statements of cash flows, the Corporation
considers all highly liquid debt instruments and investment certificates of
deposit with original maturities of three months or less and money market funds
to be cash equivalents. At September 30, 2003, interest-bearing deposits
consisted of $19.8 million in overnight funds in other financial institutions,
$44.5 million at the FHLB of Des Moines and $12.7 million in other
interest-bearing accounts. At September 30, 2002, interest-bearing deposits
consisted of $9.8 million at the FHLB and $1.2 million in other interest-bearing
accounts.
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 are 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, 2003.
21
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Securities Held-to-Maturity
Debt securities that 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 securities
held-to-maturity reflecting a decline in value judged to be other than
temporary are charged to income.
Securities Available-for-Sale
Securities available-for-sale consist of equity securities and debt
securities not classified as trading securities or as securities
held-to-maturity. Unrealized holding gains and losses, net of income taxes
on securities available-for-sale, are reported as a net amount in a
separate component of stockholders' equity until realized. Gains and losses
on the sale of securities available-for-sale are determined using the
specific identification method. Any decision to sell securities
available-for-sale 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 securities available-for-sale reflecting a decline in value
judged to be other than temporary are charged to income.
Restricted Stock
The Bank, as a member of the FHLB System, is required to maintain an investment
in capital stock of the 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-offs, 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.
Interest income is reported on the interest method and includes amortization of
net deferred loan fees and costs over the loan term. Interest income on mortgage
and commercial loans is generally discontinued at the time the loan is 90 days
delinquent unless the credit is well secured and in process of collection.
Consumer loans are typically charged off no later than 180 days past due. In all
cases, loans are placed on nonaccrual or charged off at an earlier date if
collection of principal or interest is considered doubtful.
All interest accrued, but not received, for loans placed on nonaccrual is
reversed against interest income. Interest received on such loans is accounted
for on the cash-basis or cost-recovery method until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future payments are
reasonably assured.
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
22
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
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.
Servicing Assets
Servicing assets represent purchased rights and the allocated value of retained
servicing rights on loans sold. Servicing assets are expensed in proportion to,
and over the period of, estimated net servicing revenues. Impairment is
evaluated based on the fair value of the assets, using groupings of the
underlying loans as to interest rates and then, secondarily, as to geographic
and prepayment characteristics. Fair value is determined using prices for
similar assets with similar characteristics, when available, or based upon
discounted cash flows using market-based assumptions. Any impairment of a
grouping is reported as a valuation allowance.
Foreclosed Real Estate
Real estate properties acquired through or in lieu of loan foreclosure are
initially recorded at lower of cost or 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.
Life Insurance
The Corporation has purchased life insurance policies on certain key executives.
Company-owned life insurance is recorded at its cash surrender value or the
amount that can be realized.
Goodwill and Other Intangible Assets
Goodwill results from prior business acquisitions and represents the excess of
the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Upon adopting new accounting
guidance on October 1, 2002, the Corporation ceased amortizing goodwill.
Goodwill is assessed, at least annually, for impairment, and any such impairment
will be recognized in the period identified. The effect on net income of ceasing
goodwill amortization in fiscal 2003 was $267,000.
Other intangible assets consist of core deposit and acquired customer
relationship intangible assets arising from a branch acquisition and acquiring a
property and casualty insurance company. They are initially measured at fair
value and then are amortized on a straight-line method over their estimated
useful lives, which is 15 and 25 years, respectively.
Income Taxes
Income tax expense is the total of the current year income tax due or refundable
and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax amounts for the temporary differences
between carrying amounts and tax bases of assets and liabilities, computed using
enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets
to the amount expected to be realized.
23
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Earnings Per Share
Basic earnings 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.
Derivatives
The Company enters into commitments to make loans whereby the interest rate on
the loan is set prior to funding (rate lock commitments). Rate lock commitments
on mortgage loans that are intended to be sold are considered derivatives. All
derivative instruments are recorded at their fair values. Changes in the fair
value of the rate lock commitments are recorded in gain on sale of loans in the
Statement of Income.
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.
Stock 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.
The exercise price of the employee stock options equals the market price of the
underlying stock on the date of grant, and therefore, no compensation expense is
recognized. 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,
----------------------------------------------------------
2003 2002 2001
------------ ------------ ------------
Net income
As reported $ 6,089 $ 6,032 $ 3,733
Pro forma 6,012 6,008 3,636
Earnings per common share
As reported
Basic $ 2.70 $ 2.77 $ 1.68
Diluted 2.55 2.63 1.61
Pro forma
Basic $ 2.67 $ 2.76 $ 1.64
Diluted 2.51 2.62 1.57
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,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
Risk free interest rate 4.05% 4.63% 4.85%
Expected life 10 years 10 years 10 years
Expected volatility 27.00% 44.00% 27.00%
Expected dividends 5.22% 8.00% 7.00%
Weighted average fair value per share of the option granted $ 4.43 $ 7.20 $ 7.16
24
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed in a separate note.
Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.
Comprehensive Income
Comprehensive income consists of net income and other gains and losses affecting
stockholders' 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.
Newly Effective Accounting Standards
New accounting standards on asset retirement obligations, restructuring
activities and exit costs, operating leases, and early extinguishment of debt,
and financial instruments with characteristics of both liabilities and equity
were issued in fiscal 2003. Because the Company did not have these instruments
or is only nominally involved in these instruments, the new accounting standards
did not materially affect the Company's operating results or financial
condition.
Reclassifications
Certain amounts in the prior periods presented have been reclassified to conform
to the current presentation. These reclassifications have no effect on
previously reported net income.
(2) SECURITIES (in thousands)
Securities have been classified in the consolidated balance sheets according to
management's intent. During the current fiscal year, the Bank transferred all
securities held-to-maturity to available-for-sale. The carrying amount of
securities and their approximate fair values at September 30 are presented as
follows:
SEPTEMBER 30, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- --------------- --------------- ---------------
Securities available-for-sale:
Equity securities:
Fund Investments $ 12,522 $ - $ 513 $ 12,009
=============== =============== =============== ===============
Debt securities:
U.S. Government and Agency $ 11,362 $ 816 $ - $ 12,178
=============== =============== =============== ===============
Mortgage-backed securities:
REMICs $ 20,294 $ 121 $ 4 $ 20,411
FNMA certificates 5,738 118 - 5,856
Other certificates 3,554 141 39 3,656
--------------- --------------- --------------- ---------------
Total $ 29,586 $ 380 $ 43 $ 29,923
=============== =============== =============== ===============
25
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- --------------- --------------- ---------------
Securities available-for-sale:
Equity securities
Fund Investments $ 12,522 $ - $ 476 $ 12,046
=============== =============== =============== ===============
Mortgage-backed securities:
FNMA certificates 6,797 236 - 7,033
FHLMC certificates 22,046 212 95 22,163
--------------- --------------- --------------- ---------------
Total $ 28,843 $ 448 $ 95 $ 29,196
=============== =============== =============== ===============
Securities held-to-maturity:
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
=============== =============== =============== ===============
There were no sales of securities during the past three years as presented.
The fair values of debt securities at September 30, 2003, by contractual
maturity, were as follows. Securities not due at a single maturity date,
primarily mortgage-backed securities, are shown separately.
Securities
Available
for Sale
---------------------
Fair Value
---------------------
Due in one year or less $ 2,011
Due from one to five years
8,707
Due from five to ten years
-
Due after ten years
1,460
Mortgage-backed
29,923
---------------------
Total $ 42,101
=====================
Debt and mortgage-backed securities with carrying values of approximately $15.7
million at September 30, 2003 and $14.6 million at September 30, 2002 were
pledged to secure public deposits and for other purposes required or permitted
by law.
26
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(3) LOANS RECEIVABLE (in thousands)
Loans receivable are summarized as follows:
September 30,
------------------------------------------
2003 2002
------------------- -------------------
First mortgage loans:
Secured by 1-4 family residences $ 24,293 $ 42,383
Secured by other properties 27,586 52,043
Land and land development loans 20,948 19,394
Residential construction loans 263,227 239,155
------------------- -------------------
336,054 352,975
Less:
Undisbursed portion of construction
and land development loans (110,657) (101,854)
Net deferred loan origination fees (751) (991)
------------------- -------------------
Subtotal first mortgage loans 224,646 250,130
Consumer and other loans:
Consumer loans 32,822 29,929
Home equity and second mortgages 22,482 27,543
Commercial 22,961 20,484
Agricultural loans 57,259 56,129
------------------- -------------------
135,524 134,085
Add:
Net deferred loan origination costs 239 156
------------------- -------------------
Subtotal consumer and other loans 135,763 134,241
------------------- -------------------
Subtotal all loans 360,409 384,371
Less:
Allowance for loan losses (1,701) (1,681)
------------------- -------------------
Total $ 358,708 $ 382,690
=================== ===================
There were no impaired loans at September 30, 2003 and 2002. Loans receivable on
nonaccrual status for which interest income has not been recognized were $6,039
and $4,873 at September 30, 2003 and 2002, respectively. The interest income not
recognized on these loans was $394 and $264, respectively.
A summary of the allowance for loan losses is as follows:
Years Ended September 30,
-----------------------------------------------------------
2003 2002 2001
------------------ ----------------- ------------------
Balance, beginning of year $ 1,681 $ 1,541 $ 1,534
ING Branch acquisition - 274 -
Provision for losses 1,228 811 1,077
Charge-offs (1,293) (988) (1,127)
Recoveries 85 43 57
------------------ ----------------- ------------------
Balance, end of year $ 1,701 $ 1,681 $ 1,541
================== ================= ==================
Loans, having carrying values of $2.2 million and $149 were transferred to
foreclosed real estate in 2003 and 2002, respectively.
The aggregate amount of loans to executive officers and directors of the
Corporation was $313 and $240 at September 30, 2003 and 2002, respectively.
During 2003, repayments on loans to executive officers and directors amounted to
$175, while $248 was advanced.
27
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 $30,118, $46,093, and $52,968 at September 30, 2003,
2002, and 2001, respectively. Custodial escrow balances maintained in connection
with the foregoing loan servicing and included in demand deposits were $101 and
$260 at September 30, 2003 and 2002, respectively. At September 30, 2003 and
2002, the remaining balance of mortgage servicing assets was $128 and $137,
respectively.
(4) PREMISES AND EQUIPMENT (in thousands)
Premises and equipment are summarized as follows:
September 30,
-------------------------------------------
2003 2002
------------------- -------------------
Land $ 979 $ 1,044
Buildings, improvements, and leasehold improvements
5,345 5,186
Furniture, equipment, and automobiles
5,714 4,680
------------------- -------------------
Total costs
12,038 10,910
Less accumulated depreciation
5,707 4,905
------------------- -------------------
Total $ 6,331 $ 6,005
=================== ===================
Depreciation expense was $927, $730, and $658 for the years ended September 30,
2003, 2002, and 2001, respectively.
At September 30, 2003, 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 $370, $318, and $398
for the years ended September 30, 2003, 2002, and 2001, respectively. Rent
commitments under non-cancelable operating leases were as follows, before
considering renewal options that generally are present:
Years Ending September 30,
--------------------------
2004 $ 364
2005 362
2006 334
2007 84
2008 30
-------------
$ 1,174
=============
28
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(5) GOODWILL AND INTANGIBLE ASSETS (in thousands except per share data)
On November 9, 2001, the Bank acquired the St. Cloud, Minnesota branch facility
and related business of ING Bank, fsb. 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 purchase method transaction involved the assumption
of deposits and acquisitions of assets as follows:
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 and other intangibles 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 $ 2,115
===============
Goodwill consists of $1,919 related to the acquisition of HMC and $1,964 related
to the acquisition of ING Bank, fsb. Goodwill is no longer amortized starting in
fiscal year 2003. The effect of not amortizing goodwill (net of tax) is
summarized as follows:
Year Ended September 30,
--------------------------------------------------------
2003 2002 2001
----------------- -------------------------------------
Reported net income $ 6,089 $ 6,032 $ 3,733
Add back: goodwill amortization
- 141 54
----------------- ------------------ -----------------
Adjusted net income $ 6,089 $ 6,173 $ 3,787
================= ================== =================
Basic earnings per share:
Reported net income $ 2.70 $ 2.77 $ 1.68
Goodwill amortization
- 0.06 0.02
----------------- ------------------ -----------------
Adjusted basic earnings per share $ 2.70 $ 2.83 $ 1.70
================= ================== =================
Diluted earnings per share:
Reported net income $ 2.55 $ 2.63 $ 1.61
Goodwill amortization
- 0.06 0.02
----------------- ------------------ -----------------
Adjusted diluted earnings per share $ 2.55 $ 2.69 $ 1.63
================= ================== =================
29
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Acquired identifiable intangible assets were as follows as of fiscal year end:
September 30,
---------------------------------------------------------------------
2003 2002
--------------------------------- ---------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
--------------- ---------------- -------------- -----------------
Amortized intangible assets:
Core deposit intangibles $ 794 $ 320 $ 794 $ 178
Other customer relationship intangibles
687 147 687 119
--------------- ---------------- -------------- -----------------
Total $ 1,481 $ 467 $ 1,481 $ 297
=============== ================ ============== =================
Aggregate amortization expense was $170, $207, and $27 for the three years ended
September 2003, 2002, and 2001, respectively.
Estimated amortization expense for each of the next five years:
Years Ending September 30,
--------------------------
2004 $ 137
2005 111
2006 96
2007 82
2008 69
(6) DEPOSITS (in thousands)
The aggregate amount of short-term jumbo CDs, each with a minimum denomination
of one hundred thousand dollars was $69,263 and $62,600 in 2003 and 2002,
respectively.
Interest expense is summarized as follows:
September 30,
-----------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Savings accounts $ 1,011 $ 1,585 $ 3,491
Demand deposits 334 411 266
Certificates of deposit 8,255 9,482 11,069
----------------- ----------------- -----------------
$ 9,600 $ 11,478 $ 14,826
================= ================= =================
Noninterest-bearing demand deposits amounted to $24,330, $26,387, and $20,797 at
September 30, 2003, 2002, and 2001, respectively.
At September 30, 2003, the scheduled maturities of certificates of deposit are
as follows:
Years Ending September 30,
--------------------------
2004 $ 167,445
2005 47,040
2006 12,471
2007 3,980
2008 and thereafter 3,729
--------------
$ 234,665
==============
30
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Bank held deposits of approximately $2,300 and $548 for related parties at
September 30, 2003 and 2002.
(7) FEDERAL HOME LOAN BANK BORROWINGS (in thousands)
Borrowings by the Bank from the FHLB of Des Moines are summarized as follows:
September 30,
-----------------------------------------------------------------
2003 2002
------------------------------- -------------------------------
Fiscal Year of Maturity - Advances Weighted Weighted
- ---------------------------------- Amount Rate Amount Rate
-------------- -------------- -------------- ---------------
2003 $ - - % $ 10,000 6.53%
2004 21,000 5.30 21,000 5.30
2006 10,000 3.88 5,000 4.93
2008 and thereafter 62,000 5.55 62,000 5.55
-------------- -------------- -------------- ---------------
Total $ 93,000 5.31% $ 98,000 5.56%
============== ============== ============== ===============
Prepayment penalties will be incurred if the advances are paid prior to their
maturity date. At September 30, 2003, $62 million are callable by the FHLB.
At September 30, 2003, borrowed funds are collateralized by stock in the FHLB,
loans with carrying value of $62,990, debt and mortgage-backed securities with
carrying values of $27,476, and FHLB term certificates of deposit of $22.0
million under a collateral agreement.
(8) 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
$196, $160, and $135 for the three years ended September 30, 2003, 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 contributions 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, 2003.
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
annually or aggregate claims exceeding $558.8 annually.
31
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Employee Stock Ownership Plan ("ESOP")
The Corporation established an 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,
----------------------------------------------------
2003 2002 2001
---------------- ----------------------------------
Shares allocated, beginning of year 304,829 268,857 232,885
Shares allocated during year 47,248 35,972 35,972
Unreleased shares 7,643 54,891 90,863
---------------- ---------------- ----------------
Total ESOP 359,720 359,720 359,720
Fair value of unreleased shares $ 227 $ 1,087 $ 1,481
Amount charged to expense $ 817 $ 214 $ 406
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, 2003, 2002,
and 2001, the amount included in compensation expense related to the MSP was $5,
$5, and $5, respectively.
The following summarizes the activity in the MSP for the three years ended
September 30, 2003:
Un-awarded Awarded
Shares Shares
----------------- -----------------
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
Granted (2,000) 2,000
Vested - (400)
----------------- -----------------
At September 30, 2003 38,964 2,800
================= =================
32
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Directors' Stock Compensation Plan
In January 1998, the stockholders 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 vest 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 per share) on the date that the plan
was approved by the stockholders. 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 and 2001 were $6 and $23,
respectively.
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 options ("ISOs") as defined by Section 422 of
the Internal Revenue Code or options that do not qualify. Those options granted
that qualify as ISOs 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 to 5 years. The following summarizes
the activity in the two plans for the three years ended September 30, 2003:
Shares Available Options Shares Weighted Average
for Grant Outstanding Exercise Price
-------------------- --------------------- ---------------------
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
Granted (21,937) 21,937 23.00
Exercised - (82,196) 14.56
Cancelled 844 (844) 15.00
-------------------- --------------------- ---------------------
At September 30, 2003 8,666 297,963 $ 15.57
==================== ===================== =====================
Shares available for future grants
1994 Plan 7,481
1998 Plan 1,185
The following table summarizes the information about stock options outstanding
at September 30, 2003:
- ------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------------------------------------
Weighted average
Exercise Number remaining contractual
Price Outstanding life in years Price Number
- ----------------------------------------------------------------------- -----------------------------------------
$ 9.68 55,848 1.3 $ 9.68 55,848
19.125 98,530 4.3 19.125 98,530
16.050 2,500 8.1 16.050 2,500
19.250 20,000 4.7 19.250 20,000
15.000 25,000 5.2 15.000 25,000
14.750 17,737 6.2 14.750 17,737
12.375 14,774 5.2 12.375 14,774
12.375 17,000 4.0 12.375 17,000
12.125 6,000 5.0 12.125 6,000
16.050 20,137 5.0 16.050 20,137
23.000 20,437 9.0 23.000 20,437
---------------------- -------------------
297,963 297,963
====================== ===================
33
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(9) 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,
-----------------------------------------------------------
2003 2002 2001
------------------ ----------------- -----------------
Current
Federal $ 3,199 $ 3,176 $ 2,313
State 732 1,027 749
------------------ ----------------- -----------------
Subtotal 3,931 4,203 3,062
Deferred
Federal (164) (207) (509)
State (80) (69) (169)
------------------ ----------------- -----------------
Subtotal (244) (276) (678)
------------------ ----------------- -----------------
Total income tax provision $ 3,687 $ 3,927 $ 2,384
================== ================= =================
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,
------------------------------------------
2003 2002
------------------ -------------------
Deferred tax assets:
Deferred compensation $ 785 $ 686
Deferred net loan fees 56 166
Intangible assets (12) 4
Section 475 "For Sale Assets" 370 143
Allowance for loan losses 689 681
------------------ -------------------
Total 1,888 1,680
Deferred tax liabilities:
FHLB stock 156 193
Tax bad debt reserve 43 85
Premises and equipment 635 571
Installment obligation sale of former building - 26
Mortgage-servicing rights and other 47 42
Securities unrealized gain 467 152
------------------ -------------------
Total 1,348 1,069
------------------ -------------------
Net deferred tax asset $ 540 $ 611
================== ===================
A valuation allowance was established to reduce the deferred tax asset related
to the unrealized loss on equity securities because management is uncertain
whether 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, 2003 and 2002.
34
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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,
-----------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Computed "expected" tax expense $ 3,324 $ 3,386 $ 2,080
State income taxes, net of federal tax benefit 652 633 383
Increase in cash surrender value of life insurance (131) (156) (147)
Other, net (158) 64 68
--------------- -------------- --------------
Total income tax provision $ 3,687 $ 3,927 $ 2,384
=============== ============== ==============
Retained earnings at September 30, 2003 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, 2003.
(10) EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
For the Years Ended September 30,
------------------------------------------------------
2003 2002 2001
------------------------------------------------------
Numerator:
Net income - Numerator for basic earnings
per share and diluted earnings per share--
income available to common stockholders $ 6,089,000 $ 6,032,000 $ 3,733,000
======================================================
Denominator:
Denominator for basic earnings per share--
weighted-average shares
2,252,271 2,179,824 2,220,067
Effect of dilutive securities:
Stock-based compensation plans 140,166 117,431 96,546
------------------------------------------------------
Denominator for diluted earnings per share--
adjusted weighted-average shares and
assumed conversions 2,392,437 2,297,255 2,316,613
======================================================
Basic earnings per share $ 2.70 $ 2.77 $ 1.68
Diluted earnings per share $ 2.55 $ 2.63 $ 1.61
(11) 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.
35
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(12) 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 Office of Thrift Supervision ("OTS") subject to various regulatory capital
requirements administers the Bank. 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.
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, 2003, the Bank meets all of the capital adequacy requirements to which it is
subject.
As of September 30, 2003, 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 and ratios are presented in the
table below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- ---------------------- ---------------------
Tangible equity capital and ratio to
adjusted total assets $ 42,571 8.0% $ 8,073 1.5% $ 10,764 2.0%
--------------------- ---------------------- ---------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 42,571 8.0% $ 21,528 4.0% $ 26,910 5.0%
--------------------- ---------------------- ---------------------
Total risk-based capital and ratio to
risk-weighted assets $ 42,571 12.2% $ 13,939 4.0% $ 20,909 6.0%
-------- ---------------------- ---------------------
Tier 2 risk-based capital, net adjustment 1,701
-------------
Total risk-based capital and ratio to risk-
weighted assets, September 30 , 2003 $ 44,272 12.7% $ 27,878 8.0% $ 34,848 10.0%
===================== ====================== =====================
36
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- ---------------------- ---------------------
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%
===================== ====================== =====================
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.
(13) 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.
STATE % OF TOTAL OUTSTANDING
------------------------- -------------------------------
Minnesota 40.1%
Wisconsin 10.4%
Michigan 6.1%
Colorado 5.9%
40 Other States 5% or less
The Corporation had cash on deposit in other financial institutions in excess of
Federal deposit insurance limits of approximately $76,745 at September 30, 2003.
(14) 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
nonperformance 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.
37
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 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.
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, 2003 and 2002 follows:
2003 2002
----------------------------------
Unused lines of credit $ 36,945 $ 41,832
Standby letters of credit 282 156
Development letters of credit 9,785 4,716
Commitments to sell loans 22,365 51,299
Commitments to extend credit 5,243 22,057
Commitment to purchase securities 2,000 -
Development letters of credit are issued to municipalities to ensure completion
of construction on housing developments. These do not represent additional
commitments to the extent that the development is completed by the borrower with
the use of the amounts included in "Undisbursed portion of construction and land
development loans."
38
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The carrying value and fair value of the Corporation's financial assets and
financial liabilities are as follows:
September 30,
2003 2002
------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------------------------------------------------------
Financial Assets:
Cash and cash equivalents $ 80,601 $ 80,601 $ 14,615 $14,615
Securities 28,984 28,984 30,418 31,121
Mortgage-backed and related securities 29,923 29,923 49,875 49,920
Loans held-for-sale 17,122 17,286 29,242 29,242
Loans receivable, net 358,708 355,058 382,690 385,138
Accrued interest receivable 3,960 3,960 4,436 4,436
Financial Liabilities:
Deposits 391,015 390,095 381,924 385,529
Borrowings 93,000 100,305 98,000 106,683
Advances from borrowers for taxes and
insurance 233 233 352 352
Accrual interest payable 1,458 1,458 2,061 2,061
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.
39
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Borrowings
The carrying amounts of advances from the FHLB of Des Moines maturing within 90
days approximate their fair values. 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
charged 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.
(15) 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.
STATEMENTS OF FINANCIAL CONDITION
September 30,
------------------------------------
2003 2002
---------------- ----------------
ASSETS
Cash and cash equivalents $ 2,731 $ 1,499
Investment in subsidiaries 48,444 44,303
Loan to ESOP 76 549
Other assets 106 116
---------------- ----------------
Total assets $ 51,357 $ 46,467
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 94 $ 37
Stockholders' equity 51,263 46,430
---------------- ----------------
Total liabilities & stockholders' equity $ 51,357 $ 46,467
================ ================
STATEMENTS OF INCOME
Years Ended September 30,
------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Income:
Dividends from Bank Subsidiary $ 3,000 $ 2,000 $ 3,000
Interest from:
Bank's ESOP Plan 16 37 105
Investments 14 17 69
-------------- -------------- --------------
3,030 2,054 3,174
Expense:
Noninterest expense 995 473 457
-------------- -------------- --------------
Income before income taxes and equity in undistributed
net income of subsidiaries 2,035 1,581 2,717
Income tax benefit (358) (140) (114)
-------------- -------------- --------------
2,393 1,721 2,831
Equity in undistributed net income of subsidiaries 3,696 4,311 902
-------------- -------------- --------------
Net income $ 6,089 $ 6,032 $ 3,733
============== ============== ==============
40
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(16) PARENT-ONLY CONDENSED FINANCIAL INFORMATION- CONTINUED (in thousands)
STATEMENTS OF CASH FLOWS
Years Ended September 30,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 6,089 $ 6,032 $ 3,733
Adjustments:
Equity in undistributed net income of subsidiaries (3,696) (4,311) (902)
(Increase) decrease in other assets 10 35 (69)
Increase (decrease) in other liabilities 57 (5) (31)
Other, including ESOP expense 542 187 296
------------ ------------ ------------
Net cash provided by operations 3,002 1,938 3,027
------------ ------------ ------------
Cash flows from investing activities:
Payments received on ESOP bank loan 473 360 360
Cash flows from financing activities:
Purchases of treasury stock (1,016) (1,496) (2,488)
Proceeds from exercise of stock options 1,433 682 440
Payments of cash dividends (2,660) (2,173) (1,303)
------------ ------------ ------------
Net cash used in financing activities (2,243) (2,627) (2,991)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 1,232 (689) 36
Cash and cash equivalents:
Beginning of year 1,499 2,188 2,152
------------ ------------ ------------
End of year $ 2,731 $ 1,499 $ 2,188
============ ============ ============
41
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
FOR THE THREE YEARS ENDED SEPTEMBER 30, 2003
(IN THOUSANDS, EXCEPT MARKET RANGE DATA)
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
----------------------------------------------------------------------------
FISCAL 2003
Interest income $ 8,935 $ 8,557 $ 8,178 $ 7,848 $ 33,518
Interest expense 4,019 3,735 3,549 3,383 14,686
----------------------------------------------------------------------------
Net interest income 4,916 4,822 4,629 4,465 18,832
Provision for loan losses 288 193 305 442 1,228
Gain on sale of loans 1,126 1,306 1,269 1,343 5,044
Net income $ 1,696 $ 1,620 $ 1,626 $ 1,147 $ 6,089
Basic earnings per share 0.77 0.72 0.72 0.50 2.70
Diluted earnings per share 0.73 0.68 0.68 0.47 2.55
Cash dividends declared per share $ 0.30 $ 0.30 $ 0.30 $ 0.30 $ 1.20
Market range:
High bid (1) $ 24.40 $ 24.80 $ 28.88 $ 32.09 $ 32.09
Low bid (1) $ 19.20 $ 22.23 $ 24.07 $ 29.00 $ 19.20
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 loans 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 $ 0.25 $ 0.25 $ 0.25 $ 0.25 $ 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
----------------------------------------------------------------------------
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 loans 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 $ 0.15 $ 0.15 $ 0.15 $ 0.15 $ 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
<FN>
_____________
(1) As reported by the Nasdaq Stock Market. Such over the counter quotations do
not reflect inter-dealer prices without retail mark-up, markdown, or
commission and may not necessarily represent actual transactions.
</FN>
42
FSF FINANCIAL CORP.
CORPORATE OFFICE
201 MAIN STREET SOUTH
HUTCHINSON, MN 55350-2573
(320) 234-4500
FIRST FEDERAL fsb
Office Locations
HUTCHINSON MAIN OFFICE HASTINGS OFFICE
201 Main Street South 1320 South Frontage Road
Hutchinson, MN 55350-2573 Hastings, MN 55033-2426
(320) 234-4500 (651) 437-6169
HUTCHINSON SOUTH OFFICE APPLE VALLEY OFFICE
905 Hwy. 15 South Frontage Road 14994 Glazier Avenue
Hutchinson, MN 55350-2573 Apple Valley, MN 55124-7498
(320) 234-4563 (952) 432-6840
BUFFALO OFFICE GLENCOE OFFICE
305 10th Avenue South 1002 Greeley Avenue
Buffalo, MN 55313-0338 Glencoe, MN 55336-2128
(763) 682-3035 (320) 864-5541
INVER GROVE HEIGHTS OFFICE LITCHFIELD OFFICE
6505 Cahill Avenue East 501 North Sibley Avenue
Inver Grove Heights, MN 55076-2022 Litchfield, MN 55355-0577
(651) 455-1553 (320) 693-2861
WACONIA OFFICE WAITE PARK OFFICE
200 Hwy. 5 East Frontage Road 113 Waite Avenue South
Waconia, MN 55387-0287 Waite Park, MN 56387-0641
(952) 442-2141 (320) 656-1133
WINTHROP OFFICE SAINT CLOUD OFFICE
122 East Second Street 1113 West Saint Germain Street
Winthrop, MN 55396-0424 Saint Cloud, MN 56302
(507) 647-5356 (320) 529-8878
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Insurance Planners
HUTCHINSON OFFICE BUFFALO OFFICE
135 3rd Avenue Southeast 305 10th Avenue South
Hutchinson, MN 55350-2573 Buffalo, MN 55313-0338
(320) 587-2299 (763) 682-3035
- --------------------------------------------------------------------------------
Homeowners Mortgage Corporation
VADNAIS HEIGHTS OFFICE HASTINGS OFFICE
1001 Labore Industrial Court, Suite E 1320 South Frontage Road
Vadnais Heights, MN 55110-5114 Hastings, MN 55033-2426
(651) 415-1020 (651) 437-7791
43
BOARD OF DIRECTORS AND MANAGEMENT TEAM
BOARD OF DIRECTORS OF FSF FINANCIAL CORP. AND FIRST FEDERAL FSB
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart James J. Caturia
Jerome R. Dempsey Sever B. Knutson
Roger R. Stearns
EXECUTIVE OFFICERS OF FSF FINANCIAL CORP.
AND FIRST FEDERAL FSB
Donald A. Glas George B. Loban
Chief Executive Officer President
Richard H. Burgart
Chief Financial Officer
- --------------------------------------------------------------------------------
Corporate Counsel Special Counsel
Mackall, Crounse & Moore Malizia, Spidi & Fisch, PC
1400 AT&T Tower 1100 New York Avenue NW
901 Marquette Avenue Suite 340 West
Minneapolis, MN 55402 Washington, D.C. 20005
Independent Auditors
Crowe Chizek and Company LLC
One Mid America Plaza
P.O. Box 3697 Oak Brook, IL 60522-3697
44