EXHIBIT 13
FSF FINANCIAL CORP.
1996 ANNUAL REPORT
TABLE OF CONTENTS
- -----------------
CORPORATE PROFILE AND STOCK MARKET INFORMATION.............................. 1
SELECTED FINANCIAL AND OTHER DATA........................................... 3
LETTER TO STOCKHOLDERS...................................................... 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................. 5
INDEPENDENT AUDITOR'S REPORT................................................ 16
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION.............................. 17
CONSOLIDATED STATEMENTS OF INCOME........................................... 18
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY.................. 19
CONSOLIDATED STATEMENTS OF CASH FLOWS....................................... 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.................................. 22
SELECTED QUARTERLY FINANCIAL DATA........................................... 39
OFFICE LOCATIONS............................................................ 40
CORPORATE INFORMATION....................................................... 41
FSF FINANCIAL CORP.
Corporate Profile and Related Information
FSF Financial Corp. (the "Corporation") is a Minnesota corporation organized in
1994 at the direction of First Federal fsb (the "Bank") to acquire all of the
capital stock of the Bank upon its conversion from the mutual to stock form of
ownership. The Bank resulted from the merger of First Federal Savings and Loan
Association of Hastings, Hastings, Minnesota, with and into First State Federal
Savings and Loan Association, Hutchinson, Minnesota, on September 30, 1994. On
October 6, 1994, the Bank completed its mutual-to-stock conversion
("Conversion") and is currently chartered by the Office of Thrift Supervision
("OTS") as a federally-chartered stock savings bank. The Corporation is a
unitary savings and loan holding company which, under existing laws, generally
is not restricted in the types of business activities in which it may engage
provided that the Bank retains a specified amount of its assets in
housing-related investments.
The Corporation purchased all of the capital stock of the Bank with one-half of
the net proceeds from the Conversion. The Corporation also provided a loan to
the Bank's Employee Stock Ownership Plan ("ESOP") to enable the ESOP to purchase
shares of the Corporation's common stock in the initial public offering. The
note bears an interest rate and has terms and conditions which prevailed in the
marketplace at the time it was originated. The Corporation has not engaged in
any business activities to date other than the loan to the ESOP.
The Bank conducts its business from its main office in Hutchinson, Minnesota,
and ten additional full service offices located in the Minnesota counties of
McLeod, Dakota, Meeker, Sibley, Carver, Stearns and Wright. The Bank also
operates ten automated teller machines ("ATMs"). The Bank's deposits have been
federally insured since 1934 and are currently insured up to the maximum
allowable by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is
a community oriented savings institution offering a variety of financial
services to meet the needs of the communities it serves.
The Bank attracts deposits from the general public and uses such deposits,
together with borrowings and other funds, primarily to originate and purchase
loans secured by first mortgages on owner-occupied, one-to-four family
residences located in its market area and to invest in mortgage-backed and
investment securities. The Bank also originates commercial real estate and
multi-family loans, construction loans and consumer loans.
Stock Market Information
Since its issuance in October 1994, the Corporation's common stock has been
traded on the NASDAQ National Market. The daily stock quotation for FSF
Financial Corp. is listed in the NASDAQ National Market published in The Wall
Street Journal, the St Paul Pioneer Press and Dispatch, and other leading
newspapers under the trading symbol "FFHH". The following table reflects the
stock price as published by the NASDAQ statistical report.
High Low
-------------- -------------
First Quarter - December 31, 1994 $10.50 $ 7.50
Second Quarter - March 31, 1995 $10.75 $ 9.00
Third Quarter - June 30, 1995 $12.00 $10.00
Fourth Quarter - September 30, 1995 $13.13 $11.13
First Quarter - December 31, 1995 $13.50 $12.38
Second Quarter - March 31, 1996 $13.50 $12.38
Third Quarter - June 30, 1996 $13.00 $11.50
Fourth Quarter - September 30, 1996 $13.25 $11.38
1
The number of stockholders of record of common stock as of the record date of
December 11, 1996, was approximately 650. This does not reflect the number of
persons or entities who held stock in nominee or "street" name through various
brokerage firms. At December 11, 1996, there were 3,304,310 issued and
outstanding.
The following table sets forth the Corporation's net income and the dividends
declared on the common stock:
Net Dividends
Income Declared
-------------- -------------
(Dollars in thousand,
except per share amounts)
Quarter ended December 31, 1994
Total $1,069
Per common share outstanding 0 N/A
Quarter ended March 31, 1995
Total 565
Per common share outstanding 0.14 $0.125
Quarter ended June 30, 1995
Total 531
Per common share outstanding 0.14 0.125
Quarter ended September 30, 1995
Total 460
Per common share outstanding 0.12 0.125
Quarter ended December 31, 1995
Total 421
Per common share outstanding 0.11 0.125
Quarter ended March 31, 1996
Total 460
Per common share outstanding 0.13 0.125
Quarter ended June 30, 1996
Total 684
Per common share outstanding 0.11 0.125
Quarter ended September 30, 1996
Total 103
Per common share outstanding 0.03 0.125
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.
2
FSF FINANCIAL CORP.
- -------------------------------------------------------------------------------
SELECTED FINANCIAL AND OTHER DATA (1)
Financial Condition (Dollars in Thousands)
- ----------------------------------------------------------------------------------------------------------------------------
September 30, 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $ 354,636 $ 304,605 $ 281,467 $ 217,672 $ 190,146
Loans held for sale 443 230 729 21,576 17,572
Loans receivable, net 216,727 170,921 116,591 99,370 105,355
Mortgage-backed securities 38,557 37,110 33,267 30,702 25,785
Mortgage-backed securities available for sale 16,336 16,141 16,338 16,979 -
Debt securities 44,349 41,914 22,897 28,175 22,868
Equity securities available for sale 18,231 16,165 14,172 - -
Investment securities held for trading - - - - 2,950
Cash and cash equivalents (2) 11,756 14,855 69,991 14,666 12,189
Savings deposits 189,074 171,516 156,479 164,827 163,664
Other borrowings 114,693 73,807 37,688 30,472 6,100
Stockholders' equity 47,649 57,351 20,508 19,873 17,447
Summary of Operations (Dollars in Thousands) (3)
- ----------------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------
Interest income $ 23,244 $ 19,079 $ 15,320 $ 14,728 $ 15,050
Interest expense 13,609 9,472 7,544 7,282 8,479
Net interest income 9,635 9,607 7,776 7,446 6,571
Provision for loan losses 42 24 33 47 412
Non-interest income 1,354 1,127 184 1,684 2,507
Non-interest expense (4) 8,178 6,966 5,964 5,339 5,165
Income before cummulative effect
of change in accounting principle 1,668 2,243 1,135 2,464 2,375
Net income 1,668 2,625 1,135 2,464 2,241
Other Selected Data
- ----------------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------
Return on average assets before cum. eff. 0.69% 0.82% 0.50% 1.27% 0.62%
Return on average assets after cum. eff. 0.69% 0.95% 0.50% 1.27% 0.59%
Return on average equity before cum. eff. 4.25% 3.83% 5.58% 7.56% 1.66%
Return on average equity after cum. eff. 4.25% 4.48% 5.58% 14.78% 7.13%
Average equity to average assets 15.93% 21.31% 8.96% 8.57% 8.17%
Net interest rate spread (5) 2.36% 2.78% 3.41% 3.73% 3.07%
Non-performing assets to total assets 0.06% 0.12% 0.20% 0.38% 0.51%
Allowance for loan losses to total loans 0.36% 0.41% 0.61% 0.57% 0.58%
Earnings per share before cum. eff. $ 0.48 $ 0.57 N/A N/A N/A
Earnings per share after cum. eff. 0.48 $ 0.67 N/A N/A N/A
Cash dividends declared per share $ 0.50 $ 0.375 N/A N/A N/A
- ----------------------------------------------------
(1) The financial statements and other selected data as of and for the periods
ended September 30, 1993, and 1992 have been restated to reflect First
State Federal's merger with First Federal of Hastings, which was accounted
for as a pooling-of-interests.
(2) Consists of cash due from banks, interest-bearing deposits, and other
investments with original maturities of less than three months.
(3) The cumulative effect of the change in accounting for debt securities as a
pro-forma adjustment to prior years operations would result in an increase
in non-interest income for fiscal 1994 by $681 and net income would
increase by $382.
(4) Includes a one-time special assessment of $1,030,000 to recapitalize the
SAIF for the year ended September 30, 1996.
(5) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities
3
To Our Stockholders:
The year ended September 30, 1996, provided many challenges, which were met, and
many opportunities, which were capitalized on. The Savings Association Insurance
Fund special assessment cost the Corporation more than $1 million, but the move
toward deposit insurance parity and the reduction in ongoing premiums should
enhance future earnings. The relatively low interest rate environment during the
first half of the year gave way to slightly higher interest rates and a steeper
yield curve, which helped to increase net interest margin. Lending continues to
be diversified, with a greater emphasis on adjustable-rate and "prime-based"
products, while not compromising our credit risk standards.
Earnings per share were $0.48 for the fiscal year compared with $0.57 for the
1995 fiscal year, before the cumulative effect of change in accounting
principle, and $.67 after the cumulative effect. Without the SAIF special
assessment, earnings per share would have been $0.66. Stockholders' equity, as a
percentage of total assets, decreased to 13.4% at September 30, 1996, from 18.8%
at September 30, 1995. This was accomplished by stock repurchases completed
during the year that totaled 802,485 shares. Another 5% repurchase was completed
during October, 1996, and we have received approval from the Office of Thrift
Supervision to repurchase another 10% of the outstanding stock over a 12 month
period. These repurchases have the effect of decreasing stockholders' equity
while increasing earnings per share for you, our stockholders.
Fiscal year 1996 saw mortgage originations and purchases exceed $87 million,
land and commercial real estate originations were $3.5 million, and consumer
originations totaled more than $27 million. This activity led to an increase in
our loan portfolio of more than $44.6 million and an increase in total assets of
more than 20%. Mortgage lending will continue to be an important part of our
asset generation and will be supplemented with a continued increase in consumer
and other prime-based lending.
Our emphasis continues to be customer service and increased customer
relationships. The introduction of our "Master Money" check card has provided
customers with increased access to funds. We recently provided customers with
telephonic access to all of their account information, while still continuing to
provide excellent face-to-face customer service at no charge.
FSF Financial Corp. is positioned to meet tomorrow's challenges and
opportunities. Quality financial services and products, along with dedicated
staff, management, and directors who recognize the importance of customer and
stockholder satisfaction, will be the key ingredients to our growth and
profitability.
Thank you for your confidence and support in our future success.
Sincerely,
/s/ Donald A. Glas /s/ George B. Loban
Donald A. Glas George B. Loban
Co-Chair/Chief Executive Officer Co-Chair/President
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
General
The Corporation does not engage in any active business. In connection with the
Conversion from the mutual to stock form of ownership, the Corporation made a
loan to the Bank's employee stock ownership plan, from which it receives
interest income. The Corporation also receives interest income on its
investments.
The earnings of the Corporation depend primarily on the Bank's net interest
income. 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 average rates of
interest earned on earning assets and the average rates paid on interest bearing
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.
In addition, the Bank receives income from service charges and other fees and
occasionally from sales of loans and real estate owned. 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.
Interest Rate Sensitivity Analysis
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 long-term loans secured by one- to
four-family residences, the majority of which have a repricing term which is
substantially shorter than their amortization term, and the source of funds has
been deposits and borrowings. Having interest-earning assets that reprice more
frequently than interest-bearing liabilities is generally beneficial to net
interest income during periods of increasing interest rates, such an
asset/liability mismatch is generally detrimental during periods of declining
interest rates.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. Management meets at least quarterly to
review the interest rate risk position and projected profitability of the Bank.
In addition, management reviews the Bank's portfolio, formulates investment
strategies and oversees the timing and implementation of transactions to assure
attainment of the Bank's objectives in the most effective manner. The Board of
Directors reviews on a quarterly basis the Bank's asset/liability position,
including simulations of the effect on the Bank's capital of various interest
rate scenarios.
Depending on the relationship between long-term and short-term interest rates,
market conditions and consumer preferences, the Bank, at times, may place more
emphasis on managing net interest margin than on better 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 assets 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 and has taken a
number of steps to restructure its assets and liabilities. The Bank sells all
fixed rate mortgages with contractual terms of greater than 20 years and has
primarily focused its residential lending programs on loans with either
adjustable interest rates or balloon provisions. These loans provide the Bank
with a repricing time frame which is substantially shorter than the contractual
term. During the 1996 fiscal year, the Bank originated $21.2 million of single
family mortgage loans which have initial fixed rates for terms of one to ten
years and then adjust annually off a treasury index thereafter. The Bank also
originated $6.7 million of single family mortgage loans that have a balloon
payment due in three to seven years. Originations of construction and land
development loans, which generally have a contractual maturity of two years or
less, totaled $27.9 million. At September 30, 1996, $126.0 million of real
estate mortgages were adjustable rate mortgages, balloon mortgages, or
construction and land development loans, representing 71% of total mortgages and
35.5% of total assets.
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of rate-sensitive assets and rate-sensitive liabilities. These
differences, or interest rate repricing "GAP," provide an indication of the
extent to which the
5
Bank's net interest income is affected by future changes in interest rates. A
GAP is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A GAP is considered
negative when the amount of interest rate sensitive liabilities exceeds interest
rate sensitive assets. During a period of falling interest rates, a negative GAP
would tend to result in an increase in net interest income, while a positive GAP
would tend to affect net interest income adversely. Conversely, during a period
of rising interest rates, a negative GAP would tend to result in a decrease in
net interest income, while a positive GAP would tend to result in an increase in
net interest income.
The table that follows sets forth the amounts of interest-earning assets and
interest-bearing liabilities at September 30, 1996, which are expected to
reprice or mature in each of the future time periods shown.
Analysis of Repricing Mechanisms
Over One Over Five
Within to Five to Ten Over Ten
One Year Years Years Years Total
-------------- ------------- --------------- ------------- --------------
Interest-earning assets: (Dollars in Thousands)
Mortgage loans $ 86,502 $ 55,817 $ 25,599 $ 9,937 $ 177,855
Other loans 28,752 9,015 2,324 - 40,091
Investment securities 67,237 12,166 - 47,462 126,865
-------------- ------------- --------------- ------------- --------------
Total interest-earning assets 182,491 76,998 27,923 57,399 344,811
-------------- ------------- --------------- ------------- --------------
Interest-bearing liabilities:
Noninterest bearing deposits - -
NOW and Super now accounts 6,530 1,760 3,168 12,674 24,132
Savings accounts 12,955 3,538 6,367 25,474 48,334
Money market deposit accounts 940 253 455 1,821 3,469
Certificates 84,776 26,972 1,391 - 113,139
Other borrowed money 32,100 82,593 - - 114,693
-------------- ------------- --------------- ------------- --------------
Total interest-bearing liabilities 137,301 115,116 11,381 39,969 303,767
-------------- ------------- --------------- ------------- --------------
Interest sensitivity gap $ 45,190 $ (38,118) $ 16,542 $ 17,430 $ 41,044
============== ============= =============== ============= ==============
Cumulative interest sensitivity
gap $ 45,190 $ 7,072 $ 23,614 $ 41,044
============== ============= =============== =============
Cumulative ratio of interest-
earning-assets to interest-
bearing liabilities 1.33% 1.03% 1.09% 1.14%
============== ============= =============== =============
Cumulative ratio of cumulative
interest sensitivity gap to
total assets. 12.74% 2.00% 6.67% 11.57%
============== ============= =============== =============
The table above indicates the time periods in which interest-earning
assets and interest-bearing liabilities will mature or reprice in
accordance with their contractual terms. The following assumptions have
been used in calculating the values in the table: Adjustable-rate and
balloon loans have a constant prepayment rate of 6%; mortgages held for
sale are all set to reprice in three years or less; remaining mortgages
have prepayment rates ranging from 4% to 10%; consumer loans have a
prepayment rate that is constant over time at 19%; NOW checking, core
savings deposits, and money market deposits have an increasing decay
ranging from 6.0% to 30.0%. Management utilizes its own assumptions,
and feels that these assumptions provide a reasonable estimate of
actual experience.
Certain shortcomings are inherent in the method of analysis presented
in the previous table. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they
may react in different degrees to changes in market interest rates.
Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Additionally, certain assets, such as adjustable-rate mortgage loans,
have features which restrict changes in interest rates on a short-term
basis over the life of the assets. Further, in the event of a
6
change in interest rate, prepayment levels and decay rates on core
deposits may deviate significantly from those assumed in calculating
the table.
Net Portfolio Analysis
Due to the shortcomings of the GAP analysis presented above, the Bank also
utilizes a Net Portfolio Value ("NPV") analysis to assist management in dealing
with the potential impact of changes in interest rates. NPV is the difference
between incoming and outgoing discounted cash flows from assets, liabilities,
and off-balance sheet contracts. In applying this methodology, instantaneous
changes in interest rates are applied to all assets, liabilities, and
off-balance sheet contracts in 100 basis point (one basis point equals .01%)
increments.
The OTS adopted a final rule in August, 1993, incorporating an interest rate
risk ("IRR") component into the risk-based capital rules. Although the
implementation of the new rule has been delayed, the Bank and the OTS have used
a NPV approach to interest rate risk. When the IRR component is applied, a
dollar amount will be deducted from total capital for the purpose of calculating
an institution's risk-based capital requirement based on changes in NPV. An
institution's IRR is measured as the change to its NPV as a result of a
hypothetical 200 basis point change in market interest rates. A resulting change
in NPV of more than 2% of the estimated market value of its assets will require
the institution to deduct from its capital 50% of that excess change. When the
rule is implemented, the OTS will calculate the IRR component quarterly for each
institution. The following table presents the Bank's NPV as of September 30,
1996, based on information Management believes is consistent with OTS
methodology.
Changes in Interest
Rates in Basis Net Portfolio Change NPV as % of Assets
-------------------------------------------------------- -----------------------------------------
Points (Rate Shock) $ Amount $ Change Change % NPV Ratio Change
----------------- --------------- ----------------- ---------------- ---------------------
(Dollars in thousands)
+400 bp $ 125,882 6,227 5.20 % 31.64 266 bp
+300 bp 124,441 4,786 4.00 31.01 203 bp
+200 bp 122,925 3,270 2.73 30.36 137 bp
+100 bp 121,331 1,676 1.40 29.68 70 bp
0 bp 119,655 - - 28.99 -
-100 bp 117,898 (1,757) (1.47) 28.27 (72) bp
-200 bp 116,057 (3,598) (3.01) 27.52 (146) bp
-300 bp 114,133 (5,522) (4.61) 26.76 (222) bp
-400 bp 112,128 (7,527) (6.29) 25.98 (301) bp
As the table shows, increases in interest rates would result in net increases in
the Bank's NPV, while decreases in interest rates will result in net decreases
in the Bank's NPV. Based upon the above calculations as of September 30, 1996,
the Bank would not be required to deduct any amount from total capital for
purposes of calculating the Bank's risk-based capital requirement. (Bank's NPV,
as a percent of assets, decreases by 1.46% if interest rates decrease by 200
basis points.) Certain shortcomings are inherent in the methodology used in the
above table. Modeling changes in NPV requires the making of certain assumptions
that may tend to oversimplify the manner in which actual yields and costs
respond to changes in market interest rates. First, the models assume that the
composition of the Bank's interest sensitive assets and liabilities existing at
the beginning of a period remains constant over the period being measured.
Second, the models assume that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities. Accordingly, although
the NPV measurements do provide an indication of the Bank's interest rate risk
exposure at a particular point in time, such measurements are not intended to
provide a precise forecast of the effect of changes in market interest rates on
the Bank's net interest income.
7
Average Balances
The following table sets forth information relating to the Corporation's average
balance sheet and reflects the 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 or
interest-bearing liabilities, respectively, for the periods indicated. Average
balances are derived from month-end balances. Management does not believe that
the use of month-end balances has caused any material difference in the
information presented.
Years Ended September 30,
------------------------------------------------------------------------
1996 1995
-------------------------------------------------------------------------
Average Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost
-------------------------------------------------------------------------
Interest-Earning Assets (in thousands) (in thousands)
Loans receivable (1) $193,202 $ 16,077 8.32% $ 142,711 $11,221 7.86%
Mortgage-backed securities 54,208 3,270 6.03% 51,984 3,504 6.74%
Investment securities (2) 69,676 3,897 5.59% 70,762 4,354 6.15%
----------------------- -------------------------
Total interest-earning assets $317,086 23,244 7.33% $ 265,457 19,079 7.19%
----------------------- -------------------------
Interest-Bearing Liabilities
NOW and money market accounts $25,697 443 2.41% 27,923 673 2.41%
Passbook savings 49,120 1,576 3.52% 47,519 1,669 3.52%
Certificates of deposit 108,665 6,243 5.75% 86,518 4,411 5.10%
----------------------- -------------------------
Total deposits 183,482 8,262 4.50% 161,960 6,753 4.17%
FHLB advances 90,408 5,347 5.91% 52,688 2,719 5.16%
----------------------- -------------------------
Total interest-bearing liabilities 273,890 13,609 4.97% 214,648 9,472 4.41%
----------------------- -------------------------
Net Interest Income $ 9,635 $ 9,607
============ =============
Net Interest Rate Spread (3) 2.36% 2.78%
Net Interest Rate Margin (4) 3.04% 3.62%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.16x 1.24x
=========== ============
Years Ended September 30,
------------------------------------
1994
------------------------------------
Average
Average Income/ Yield/
Balance Expense Cost
------------------------------------
Interest-Earning Assets (In thousands)
Loans receivable (1) $ 119,133 $ 9,996 8.39%
Mortgage-backed securities 49,623 2,696 5.43%
Investment securities (2) 40,429 2,628 6.50%
------------------------
Total interest-earning assets $ 209,185 15,320 7.32%
------------------------
Interest-Bearing Liabilities
NOW and money market accounts $ 33,192 796 2.40%
Passbook savings 48,899 1,496 3.06%
Certificates of deposit 76,563 3,810 4.98%
------------------------
Total deposits 158,654 6,102 3.85%
FHLB advances
34,080 1,442 4.23%
------------------------
Total interest-bearing liabilities 192,734 7,544 3.91%
------------------------
Net Interest Income $ 7,776
============
Net Interest Rate Spread (3) 3.41%
Net Interest Rate Margin (4) 3.72%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.07X
============
- ------------------------------
(1) Average balances include non-accrual loans and loans held for sale.
(2) Includes interest-bearing deposits in other financial institutions.
(3) Net interest rate spread represents the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities.
(4) Net interest rate margin represents net interest income as a percentage of
average interest-earning assets
8
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in volume
(changes in average volume multiplied by old rate); (2) changes in rates
(changes in rate multiplied by old average volume); (3) total changes in
rate-volume. The combined effects of changes in both volume and rate which
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 Rate/Volume Total
-------------- ------------- --------------- -------------
Year Ended September 30, 1996 vs 1995: (In Thousands)
Interest income:
Loans Receivable $ 656 $ 3,968 $ 232 $4,856
Mortgage-backed securities (369) 150 (15) (234)
Investment securities (396) (67) 5 (458)
------ ------ ------ -----
Total change in interest income (109) 4,051 222 4,164
Interest expense:
Savings accounts 534 897 78 1,509
Other liabilities 395 1,947 286 2,628
------ ------ ------ -----
Total change in interest expense 929 2,844 364 4,137
------ ------ ------ -----
Net change in net interest income $(1,038) $ 1,207 $(142) $ 27
====== ====== ====== =====
Year Ended September 30, 1995 vs 1994:
Interest income:
Loans Receivable $ (631) $ 1,978 $(122) $1,225
Mortgage-backed securities 650 128 30 808
Investment securities (142) 1,972 (104) 1,726
------ ------ ------ -----
Other interest-earning assets (123) 4,078 (196) 3,759
Total change in interest income
Interest expense:
Savings accounts 349 131 171 651
Other liabilities 375 755 147 1,277
------ ------ ------ -----
Total change in interest expense 724 886 318 1,928
------ ------ ------ -----
Net change in net interest income $ (847) $ 3,192 $(514) $1,831
====== ====== ====== =====
9
Changes in Financial Condition
General. Total assets increased from $304.6 million at September
30, 1995, to $354.6 million at September 30, 1996, an increase of $50 million or
16.4%. The Bank continues to experience good demand for loans and supplemented
the internal loan originations ($97.6 million) with purchases of other loans
($17.4 million) that meet the interest rate risk and credit risk criteria
established by management.
Securities Available for Sale. Equity securities available for sale
increased by $2.0 million during the 1996 fiscal year as a result of the
purchase of additional stock in the Federal Home Loan Bank of Des Moines (FHLB).
The additional stock purchase was required as FHLB borrowings increased.
Securities Held to Maturity. Debt securities held to maturity
increased from $41.9 million to $44.3 million and mortgage-backed securities
held to maturity increased from $37.1 million to $38.6 million during fiscal
1996 as a result of purchases of securities that management made in an effort to
enhance net interest income.
Loans Held for Sale. Loans held for sale increased from $230,000
at September 30, 1995, to $443,000 at September 30, 1996. The Bank has firm
commitments to sell $316,000 of the loans held for sale that were closed
in September, 1996.
Loans Receivable. Loans receivable increased from $170.9 million at
September 30, 1995, to $216.7 million at September 30, 1996, an increase of
$45.8 million or 26.8%. The increase was primarily comprised of increases in
adjustable rate mortgages (ARMs), balloon mortgages, loans with short
contractual maturities and/or interest rates that adjusts to the prime rate as
published in the Wall Street Journal, i.e. consumer loans, land development
loans, and Home Equity Lines of Credit (HELOCs).
Deposits. Total deposits increased by $17.6 million, or 10.3%
during the 1996 fiscal year. The increase in deposits can be almost solely
attributable to an increase in certificates of deposit. The increase in total
deposits was accompanied by an increase in the weighted average cost of funds
from 4.17% to 4.50% for the years ended September 30, 1995 and 1996,
respectively. The increase in cost is primarily attributable to the increase in
short-term interest rates during the periods compared.
Borrowings. With an increase of $17.6 million in deposits,
additional borrowings of $40.9 million were needed in order to fund the growth
in assets. Management utilizes a least cost, at the margin, approach to fund
assets. As a result, borrowings will be utilized as a funding source when it
provides the least cost, at the margin. FHLB advances are used to fund lending
and investment activities, withdrawls from deposit accounts and other ordinary
business activity.
Stockholders' Equity. Stockholders' equity decreased from $57.4
million at September 30, 1995, to $47.6 million at September 30, 1996, a
decrease of $9.8 million. The Corporation repurchased 802,485 shares of its
common stock during the year at an average price of $13.16, thereby reducing
stockholders' equity. The repurchase of shares also reduced the total number of
shareholders and even though total stockholders' equity decreased during the
1996 fiscal year, book value per share increased from $15.07 at September 30,
1995, to $15.50 at September 30, 1996.
Comparison of Years Ended September 30, 1996 and 1995
Net Income. Net income decreased by $957,000 to $1.7 million for
the year ended September 30, 1996, from $2.6 million for the year ended
September 30, 1995. The decrease was primarily due to the Savings Association
Insurance Fund (SAIF) special assessment of $1,030,000 which was accrued for as
of September 30, 1996. Without the special assessment, net income for the year
ended September 30, 1996, would have been $2.3 million, a decrease of $344,000
compared to the year ended September 30, 1995.
Interest Income. Total interest income increased $4.1 million to
$23.2 million for the year ended September 30, 1996, from $19.1 million for the
year ended September 30, 1995. Interest income on loans increased by $4.9
million from $11.2 million for the year ended September 30, 1995, to $16.1
million for the year ended September 30, 1996, as a result of a $50.5 million
increase in the average balance of loans receivable from $142.7 million at
September 30, 1995, to $193.2 million at September 30, 1996. Furthermore, the
average yield increased from 7.86% at September 30, 1995, to 8.32% at September
30, 1996. Interest income on mortgage-backed securities decreased from $3.5
million for the year ended September 30, 1995, to $3.3 million for the year
ended September 30, 1996. The income decrease was the result of a decrease in
average rate from 6.74% for the 1995 fiscal year to 6.03% for the 1996 fiscal
year. The average balance
10
of investment securities decreased by $1.1 million during the fiscal year and
the yield decreased from 6.15% to 5.59%. The decline in yields for both mortgage
backed securities and investment securities was primarily impacted by the
relatively low interest rate environment and the flat yield curve that existed
during the first six months of the fiscal year. The yield on interest-earning
assets increased from 7.19% for the year ended September 30, 1995, to 7.33% for
the year ended September 30, 1996. Interest income increased by $4.1 million as
a result of increased volume during the year while the changes in rates caused
interest income to decrease by $109,000 and the rate/volume change increased
interest income by $222,000.
Interest Expense. Total interest expense increased to $13.6 million
for 1996 from $9.5 million for 1995 as both the average balance of total
interest bearing liabilities and the average cost of funds increased. The
increased cost of deposits attendant to the growth of balances was approximately
$897,000 while the increase associated with a change in interest rates was
approximately $534,000. The cost associated with interest bearing deposits
increased from 4.17% for the year ended September 30, 1995, to 4.50% for the
same period ended September 30, 1996. The cost associated with borrowed funds
increased to 5.91% for fiscal 1996 compared to 5.16% for fiscal 1995. $395,000
of the increase in the cost of borrowed funds was a result of increases in
rates, $1.9 million of the increase was attributable to the increased volumes
and $286,000 was rate/volume related.
Net Interest Income. Net interest income remained unchanged at $9.6
million. Changes in interest rates caused a decrease in net interest income of
$1.0 million, volumes accounted for an increase in net interest income of $1.2
million and rate/volume differences were slightly less than $200,000.
Provision For Loan Losses. The allowance for losses on loans is
maintained at a level which is considered by management to be adequate to absorb
probable losses on existing loans that may become uncollectible based on an
evaluation of the collectibility, prior loss experience and market conditions.
The evaluation takes into consideration such factors as changes in the nature
and volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect the borrower's
ability to pay. The allowance for loan losses is established through a provision
for loan losses charged to expense.
The Bank's loan loss provision increased from $24,000 for the year ended
September 30, 1995, to $42,000 for the year ended September 30, 1996. The Bank's
allowance for loan losses was $776,000 at September 30, 1996. The allowance for
loan losses represents .36% of total loans outstanding and 354.3% of total
non-performing assets. While the Bank maintains its allowance for loan losses at
a level which it considers to be adequate, there can be no assurance that
further additions will not be made to the loss allowances or that such losses
will not exceed the estimated amounts.
Non-interest Income. Total non-interest income increased by
$227,000 to $1.4 million for the year ended September 30, 1996, from $1.1
million for the year ended September 30, 1995. Gains on loans sold increased
from $6,000 in the 1995 fiscal year to $38,000 in the 1996 fiscal year. The
gains are a result of long-term fixed-rate mortgages (with an amortization of
greater than 20 years) that are sold in the secondary market because they do not
fit the interest rate risk profile of the Bank. Other service charges and fees
increased from $117,000 for the year ended September 30, 1995 to $226,000 for
the year ended September 30, 1996. Service charges on deposit accounts increased
$87,000 during the periods compared as a result of an increase in the number of
accounts affected and to a lesser degree by an increase in the fees associated
with deposit accounts.
Non-interest Expense. Total non-interest expense increased to $8.2
million for the year ended September 30, 1996, from $7.0 million for the year
ended September 30, 1995, or 17.4%. Without the impact of the SAIF special
assessment, non-interest expense increased by $181,000 or 2.6% during the
period. Compensation and benefits increased from $4.2 million to $4.4 million or
4.8%, primarily due to merit increases. Occupancy and equipment expense
increased 11.3% between September 30, 1995, and September 30, 1996, with the
majority of the increase due to the opening of the Bank's eleventh location in
Waite Park, Minnesota. Data processing decreased from $567,000 for the year
ended September 30, 1995, to $379,000 for the year ended September 30, 1996, as
a result of cost savings realized through the integration of processing systems
subsequent to the merger.
Recent legislation required all qualifying members of the SAIF (including the
Bank) to recapitalize the SAIF by paying a one-time special assessment equal to
.65% of the Bank's deposits as of March 31, 1995. This assessment, expensed
during the fourth quarter of fiscal 1996, cost the Bank approximately $1,030,000
prior to any tax benefit. Due to the special assessment, it is anticipated that
future SAIF premiums will be lowered from levels paid during fiscal 1996.
11
Income Tax Expense. Income tax expense decreased to $1.1 million
for the year ended September 30, 1996, from $1.5 million for the year ended
September 30, 1995, or 26.6%. The decrease was primarily due to a decrease in
pre-tax income of slightly less than $1 million.
Comparison of Years Ended September 30, 1995 and 1994
Net Income. Net income increased by $1.5 million to $2.6 million
for the year ended September 30, 1995, from $1.1 million for the year ended
September 30, 1994. The increase was primarily due to an increase in net
interest income from increased interest-earning assets, net proceeds of the
Conversion and the Bank's continued growth. An increase in non-interest expense
was almost offset by an increase in non-interest income. The results of
operations for 1995 included $382,000 as a result of the implementation of SFAS
No. 115 as described in Note 1 to the Notes to Consolidated Financial
Statements.
Interest Income. Total interest income increased $3.8 million to
$19.1 million for the year ended September 30,1995, from $15.3 million for the
year ended September 30, 1994. Interest income on loans increased by $1.2
million from $10.0 million for the year ended September 30, 1994, to $11.2
million for the year ended September 30, 1995, as a result of a $23.6 million
increase in the average balance of loans receivable from $119.1 million at
September 30, 1994, to $142.7 million at September 30, 1995. Although the
average balance on loans increased, the average yield declined from 8.39% at
September 30, 1994, to 7.86% at September 30, 1995. Interest income on
mortgage-backed securities increased from $2.7 million for the year ended
September 30, 1994, to $3.5 million for the year ended September 30, 1995. The
income growth was a combined result of an increase in average balance from $49.6
million to $52.0 million and an increase in yield from 5.43% to 6.74% during the
1995 fiscal year. Investment securities increased by $30.3 million or 75.0%
during the fiscal year. While the average balance increased, the yield decreased
from 6.50% to 6.15%. Interest on investment securities increased by $1.7 million
as a result of the changes in average balance and yield. The yield on
interest-earning assets declined from 7.32% for the year ended September 30,
1994, to 7.19% for the year ended September 30, 1995. The decrease in yield
reduced interest income by $123,000 for the year while the increase in average
balance provided $4.1 million in additional interest income and the rate/volume
change reduced interest income by $196,000.
Interest Expense. Total interest expense increased to $9.5 million
for 1995 from $7.5 million for 1994 as both the average balance of total
interest bearing liabilities and the average cost of funds increased. The
increased cost of deposits attendant to the growth of balances was approximately
$886,000 while the increase associated with a change in interest rates was
approximately $724,000. The cost associated with interest bearing deposits
increased from 3.85% for the year ended September 30, 1994, to 4.17% for the
same period ended September 30, 1995. The cost associated with borrowed funds
increased to 5.16% for fiscal 1995 compared to 4.23% for fiscal 1994. The
increase is consistent with the increase in short-term interest rates and the
overall flattening of the treasury yield curve.
Net Interest Income. Net interest income increased $1.8 million or
23.5% for the year ended September 30,1995, from $7.8 million for the year ended
September 30, 1994. This increase is primarily attributed to the average
balances of interest earning assets increasing faster than the average balance
of interest bearing liabilities. The net changes in the amount of interest
earning assets and interest bearing liabilities accounted for a $3.2 million
increase in net interest income, while the change in interest rates had a
negative impact on net interest income of $847,000, and the combination of
rate/volume changes reduced net interest income by $514,000.
Provision For Loan Losses. The Bank's loan loss provision decreased
from $33,000 for the year ended September 30, 1994, to $24,000 for the year
ended September 30, 1995. The Bank's allowance for loan losses was $764,000 at
September 30, 1995. The allowance for loan losses represents .45% of total loans
outstanding and 201.1% of total non-performing assets. While the Bank maintains
its allowance for loan losses at a level which it considers to be adequate,
there can be no assurance that further additions will not be made to the loss
allowances or that such losses will not exceed the estimated amounts. See also
"Comparison of Years Ended September 30, 1996, and 1995 - Provision for Loan
Losses."
12
Non-interest Income. Total non-interest income increased by
$943,000 to $1.1 million for the year ended September 30, 1995, from $184,000
for the year ended September 30, 1994, due primarily to the absence of losses
associated with the sale of loans and market value losses in securities that
were held for sale. Prior to the adoption of SFAS No. 115, the Bank held
mortgage-backed securities that were classified as held for sale. These
securities were reported in the balance sheet at the lower of cost or market,
with the changes reported in the income statement. Following the adoption of
SFAS No. 115, the same securities were designated available for sale and are
reported in the balance sheet at fair value with the changes reported as a
separate component of equity. The cumulative effect of the adjustments due to
the adoption of SFAS No. 115 are non-recurring and will not have an effect on
non-interest income in future periods.
Non-interest Expense. Total non-interest expense increased to $7.0
million for the year ended September 30, 1995, from $6.0 million for the year
ended September 30, 1994, or 16.8%. Compensation and benefits increased from
$3.2 million to $4.2 million or 31.0%, due to the implementation of benefit
programs instituted subsequent to the Conversion and approved by stockholders,
and to a lesser extent merit increases. Data processing decreased from $762,000
for the year ended September 30, 1994, to $567,000 for the year ended September
30, 1995, as a result of cost savings realized from the integration of
processing systems in February, 1995. Professional expense increased $82,000
during the 1995 fiscal year and was a direct result of the cost associated with
being a public company.
Income Tax Expense. Income tax expense increased to $1.5 million
for the year ended September 30, 1995, from $828,000 for the year ended
September 30, 1994, or 81.3%. The increase was primarily due to an increase in
pre-tax income of $1.8 million.
Liquidity and Capital Resources
The liquidity of a banking institution 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 Bank'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 $3.0 million, $3.6 million and $3.6
million during the years ended September 30, 1996, 1995, and 1994, respectively.
In fiscal 1996, the cash flow in operating activities was primarily influenced
by the increase in accrued liabilities associated with the accrual of the SAIF
special assessment. Flows for fiscal 1995 and 1994 have been primarily related
to increases or decreases in loans and investments held for sale.
Investing activities used $52.2 million, $79.5 million, and $11.5 million during
the years ended September 30, 1996, 1995, and 1994, respectively. During fiscal
1996 and fiscal 1995, the cash used in investing activities was primarily due to
the origination and purchase of loans and to a less extent was the result of the
purchase of securities held to maturity and mortgage-backed securities held to
maturity. During fiscal 1994, the cash used in investing activities was the
result of the purchase of securities held to maturity and mortgage-backed
securities held to maturity. The use of cash in all periods was offset in part
by maturities of investments.
The primary activity of the Bank is originating and purchasing loans, and
purchasing investment and mortgage-backed securities. During the years ended
September 30, 1996, 1995, and 1994, the Bank originated loans in the amounts of
$97.6 million, $94.7 million and $62.8 million, respectively. The Bank also
purchases loans, investment and mortgage-backed securities to manage liquidity
and interest rate risk, to supplement local loan demand and to diversify its
loan portfolio. Purchases of loans were $17.4 million and $21.0 million for the
1996 and 1995 fiscal years, respectively. Purchases of investment and
mortgage-backed securities held to maturity totaled $21.0 million, $26.0
million, and $27.5 million, and securities available for sale totaled $2.0
million, $1.9 million and $0.0 million during the years ended September 30,
1996, 1995, and 1994, respectively. Other investment activities included
investments in U. S. Government and federal agency obligations, and FHLB of Des
Moines stock.
Changes in cash flows from financing activities covered by the Consolidated
Statements of Cash Flows in fiscal 1994 were primarily the result of
subscriptions to purchase Common Stock of the Corporation as part of the
Conversion. In addition, short-term borrowings provided $7.2 million and
decreases in deposits used $4.3 million in cash during fiscal 1994. For the year
ended September 30, 1995, $15.0 million in cash was provided as a result of an
increase in deposits and $36.1 million in cash was provided as a result of an
increase in borrowings. Expenses related to the Conversion, purchase of
13
treasury stock, refunds of oversubscriptions and dividends on common stock used
$1.5 million, $2.6 million, $23.0 million and $1.5 million, respectively. During
the fiscal year ended September 30, 1996, $17.6 million in cash was provided as
a result of an increase in deposits and $40.9 million was provided as a result
of an increase in borrowings. The purchase of treasury stock used $10.6 million
and dividends on Common Stock used $1.8 million during the 1996 fiscal year.
Earnings per share for the year ended September 30, 1996, were $0.48. A portion
of the earnings per share was a result of the purchase of treasury stock during
the fiscal year. Earnings per share for the fiscal year would have been $0.42,
if the same weighted average shares would have been outstanding during fiscal
1996 as were outstanding in fiscal 1995. Financing activities provided $46.2
million, $20.7 million, and $63.2 million in cash during the years ended
September 30, 1996, 1995 and 1994, respectively. Financing activities in the
foreseeable future are expected to primarily include changes in deposits and
advances from FHLB of Des Moines. See Consolidated Statements of Cash Flow for
FSF Financial Corp. and Subsidiary.
The Bank's liquidity is a measure of its ability to fund loans, pay withdrawals
of deposits, and other cash outflows in an efficient, cost effective manner. The
Bank's primary source of funds are deposits and 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, 1996, such
borrowed funds totaled $114.7 million. While loan repayments and maturing
investments and mortgage-backed securities are relatively predictable sources of
funds, deposit flows and loan and mortgage-backed security prepayments are
greatly influenced by general interest rates, economic conditions and
competition.
The Bank is required under federal regulations to maintain certain specified
levels of "liquid investments," which include certain United States government
obligations and other approved investments. Current regulations require the Bank
to maintain liquid assets of not less than 5% of its net withdrawable accounts
plus short term borrowings. Short term liquid assets must consist of not less
than 1% of such accounts and borrowings, which amount is also included within
the 5% requirement. These levels may change from time to time by the regulators
to reflect the current economic conditions. The Bank has generally maintained
liquidity far in excess of regulatory requirements. The Bank's regulatory
liquidity was 6.08%, 11.05% and 19.04% at September 30, 1996, 1995, and 1993,
respectively, and its short-term liquidity was 6.08%, 11.05%, and 19.03%, at
such dates, respectively.
The amount of certificate accounts which are scheduled to mature during the
twelve months ending September 30, 1997, is approximately $80.7 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, FHLB advances or outside borrowings. It has been the Bank's
experience that a substantial portion of such maturing deposits remain at the
Bank.
At September 30, 1996, the Bank had commitments to extend credit of $17.9
million and forward commitments to purchase mortgages of $1.5 million. Funds
required to fill these commitments are derived primarily from FHLB borrowings,
current excess liquidity, deposit inflows, or loan and security repayments.
OTS regulations require the Bank to maintain core capital of 3% of assets, of
which 1.5% must be tangible capital, excluding goodwill. The Bank is also
required to maintain risk-based capital equal to 8% of total risk-based assets.
The OTS has proposed amending its regulations in a manner that would increase
the core capital requirements for most thrifts from 3% to 4% or 5%, depending
upon the institution's financial condition and other factors. Although the final
form of the regulation cannot be foreseen, if adopted as proposed, the Bank
would expect its core capital requirement to remain at 3%.
The Bank's compliance with regulatory capital requirements are presented in Note
12 to the Notes to Consolidated Financial Statements.
Management believes that under current regulations, the Bank will continue to
meet 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.
14
Impact of Inflation and Changing Prices
The financial statements and related data have been prepared in accordance with
Generally Accepted Accounting Principles (GAAP) which 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 of a financial institution's performance than general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the price of goods and services, since
goods and services are affected by inflation. In the current interest rate
environment, liquidity and the maturity structure of the Bank's assets and
liabilities are critical to the maintenance of acceptable performance levels.
15
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
FSF Financial Corp. and Subsidiary
Hutchinson, MN 55350
We have audited the accompanying consolidated statements of financial condition
of FSF Financial Corp. and Subsidiary (the Corporation) as of September 30,
1996, and 1995, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three fiscal years in the
period ended September 30, 1996. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FSF Financial
Corp. and Subsidiary as of September 30, 1996, and 1995, and the consolidated
results of their operations and their cash flows for each of the three fiscal
years in the period ended September 30, 1996, in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the financial statements, the Corporation changed its
method of accounting for certain investments in debt and equity securities as of
October 1, 1994.
Bertram Cooper & Co., LLP
Waseca, Minnesota
October 25, 1996
16
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
----------------------
1996 1995
----------------------
(In thousands)
ASSETS
Cash and cash equivalents:
Interest bearing $ 9,392 $ 12,448
Non-interest bearing 2,364 2,407
Securities available for sale, at fair value:
Equity securities 18,231 16,165
Mortgage-backed and related securities 16,336 16,141
Securities held to maturity, at amortized cost:
Debt securities 44,349 41,914
Mortgage-backed and related securities 38,557 37,110
Loans held for sale 443 230
Loan receivable, net 216,727 170,921
Accrued interest receivable 2,325 2,097
Premises and equipment 3,728 3,758
Other assets 2,184 1,414
----------------------
Total Assets $ 354,636 $304,605
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Demand deposits $ 27,601 $ 27,338
Savings accounts 48,334 48,027
Certificates of deposit 113,139 96,151
----------------------
Total deposits 189,074 171,516
Federal Home Loan Bank borrowings 114,693 73,807
Other liabilities 3,220 1,931
----------------------
Total liabilities 306,987 247,254
----------------------
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 4,499,905 shares issued 450 450
Additional paid in capital 43,150 43,069
Retained earnings, substantially 22,068 22,158
restricted
Treasury stock at cost (1,023,083 and (13,095) (2,589)
224,825 shares)
Unearned ESOP shares at cost (271,850 and
310,259 shares) (2,719) (3,103)
Unearned MSP stock grants at cost
(131,946 and 159,322 shares) (1,398) (1,688)
Unrealized (loss) on securities available
for sale (807) (946)
----------------------
Total stockholders' equity 47,649 57,351
----------------------
Total Liabilities and Stockholders'
Equity $ 354,636 $304,605
======================
17
The accompanying notes are an integral part of these statements
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended
September 30,
------------------------------
1996 1995 1994
------------------------------
(In thousands)
Interest income:
Loans receivable $ 16,077 $ 11,221 $ 9,996
Mortgage-backed and related securities 3,270 3,504 2,696
Investment securities 3,897 4,354 2,628
----------------------------
Total interest income 23,244 19,079 15,320
----------------------------
Interest expense:
Deposits 8,262 6,753 6,102
Borrowed funds 5,347 2,719 1,442
----------------------------
Total interest expense 13,609 9,472 7,544
----------------------------
Net interest income 9,635 9,607 7,776
Provision for loan losses 42 24 33
----------------------------
Net interest income after provision for
loan losses 9,593 9,583 7,743
----------------------------
Non-interest income:
Gain (loss) on loans - net 38 6 (842)
Other service charges and fees 226 117 90
Service charges on deposit accounts 744 657 562
Commission income 231 161 166
Other 115 186 208
----------------------------
Total non-interest income 1,354 1,127 184
----------------------------
Non-interest expense:
Compensation and benefits 4,404 4,212 3,214
Occupancy and equipment 797 716 748
Deposit insurance premiums 406 357 381
SAIF special assessment 1,030 -- --
Data processing 379 567 762
Professional fees 249 242 160
Other 913 872 699
----------------------------
Total non-interest expense 8,178 6,966 5,964
----------------------------
Income before provision for income taxes
and cumulative effect of change in
accounting principle 2,769 3,744 1,963
Income tax expense 1,101 1,501 828
----------------------------
Income before cumulative effect of change
in accounting principle 1,668 2,243 1,135
Cumulative effect of change in accounting for
securities available for sale -- 382 --
----------------------------
Net income $ 1,668 $ 2,625 $ 1,135
============================
Earnings per common and common equivalent shares:
Income before cumulative effect of change
in accounting principle $ 0.48 $ 0.57 N/A
Cumulative effect of change in accounting
principle -- 0.10 N/A
Net income $ 0.48 $ 0.67 N/A
18
The accompany notes are an integral part of these statements
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Retained Unallocated Unrealized
Earnings Common Unearned (Loss) on
Additional Substan- Stock Stock Securities
Common Paid-in tially Held by Acquired by Treasury Available
Stock Capital Restricted ESOP MSP Stock For Sale Total
------------------------------------------------------------------------------
Balance, September 30, 1993 $ - $ - $ 19,911 $ - $ - $ - $ (38) $ 19,873
Net earnings for
the year ended
September 30, 1994 - - 1,135 - - - - 1,135
Change in
unrealized
loss on equity
securities - - - - - - (500) (500)
-----------------------------------------------------------------------------
Balance, September 30, 1994 - - 21,046 - - - (538) 20,508
Net earnings for
the year ended
September 30, 1995 - - 2,625 - - - - 2,625
Issuance of common stock
net of stock acquired
by the ESOP and MSP 450 43,020 - (3,597) (1,905) - - 37,968
Cost of shares
reacquired for
treasury - - - - - (2,589) - (2,589)
Cash dividends
declared on
common stock at
$0.375 per share - - (1,513) - - - - (1,513)
Allocated/earned
ESOP & MSP shares - 17 - 494 217 - - 728
Stock issued for
options
exercised - 32 - - - - - 32
Cumulative effect
of change in
accounting for
securities - - - - - - (382) (382)
Net changes in
unrealized loss on
securities
available for
sale, net of tax - - - - - - (26) (26)
--------------------------------------------------------------------
Balance September 30, 1995 450 43,069 22,158 (3,103) (1,688) (2,589) (946) 57,351
Net earnings for
the year ended
September 30, 1996 - - 1,668 - - - - 1,668
Cost of shares
reacquired for
treasury - - - - - (10,560) - (10,560)
Treasury stock
issued for
stock options - (7) - - - 54 - 47
Cash dividends
declared on
common stock at
$0.50 per share - - (1,758) - - - - (1,758)
Allocated/earned
ESOP & MSP shares - 75 - 384 290 - - 749
Stock issued for
options exercised - 13 - - - - - 13
Net changes in
unrealized loss on
securities
available for
sale, net of tax - - - - - - 139 139
------------------------------------------------------------------------------
Balance September 30, 1996 $ 450 $ 43,150 $ 22,068 $ (2,719) $(1,398) $(13,095) $ (807) $ 47,649
==============================================================================
The accompany notes are an integral part of these statements
19
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30,
----------------------------
1996 1995 1994
----------------------------
Cash flows from operating activities: (In thousands)
Net income $ 1,668 $ 2,625 $ 1,135
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 340 330 297
Net amortization of discounts and
premiums on securities held to maturity (36) (55) (6)
Provision for loan losses 42 24 33
Net market value adjustment on ESOP shares 89 18 -
Amortization of ESOP and MRP
stock compensation 674 712 -
Net gain on sale of fixed assets (2) (12) -
Net gain on real estate sold (3) (44) (13)
Federal Home Loan Bank stock dividends (81) - -
Change in accounting for securities
available for sale - (382) -
Net decrease in market value of
securities available for sale - - 641
Net loan fees deferred and amortized 283 225 234
(Increase) decrease in:
Loans held for sale (213) 499 2,367
Accrued interest receivable (228) (741) (136)
Income taxes receivable - - (309)
Other assets (72) 547 (575)
Increase (decrease) in:
Net deferred tax liability (676) (237) 58
Accrued interest payable (16) (87) 62
Accrued income tax (26) 411 (149)
Accrued liabilities 1,111 (416) (101)
Deferred compensation payable 106 203 71
---------- ---------- --------
Net cash provided by operating activities 2,960 3,620 3,609
---------- ---------- --------
Cash flows from investing activities:
Loan originations and principal
payments on loans, net (28,770) (33,767) 991
Purchase of loans (17,447) (20,993) -
Principal payments on securities held
to maturity 49 84 13,503
Purchase of mortgage-related securities
held to maturity (1,494) (3,924) (16,044)
Purchase of securities available
for sale (1,963) (1,900) -
Purchase of securities held to maturity (19,552) (22,063) (11,411)
Proceeds from maturities of securities
held to maturity 17,150 3,100 2,000
Investment in foreclosed real estate (21) (35) (24)
Proceeds from sale of foreclosed real
estate 112 502 233
Proceeds from sale of fixed assets 2 16 -
Purchase of single premium insurance
policies - - (605)
Purchase of equipment and property
improvements (311) (481) (145)
---------- ---------- --------
Net cash (used in) investing activities $(52,245) $(79,461) $(11,502)
---------- ---------- --------
The accompanying notes are an integral part of these statements
20
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended September 30,
----------------------------
1996 1995 1994
----------------------------
Cash flows from financing activities: (In thousands)
Net increase (decrease) in deposits, $ 17,558 $ 15,036 $ (4,286)
Net increase in short-term borrowings 40,886 36,119 7,216
Net increase (decrease) in mortgage
escrow funds 6 53 (51)
Expenses related to stock offering - (1,496) -
Treasury stock purchased (10,559) (2,589) -
Proceeds from stock offering - - 60,339
Refund of proceeds from stock offering - (23,032) -
Dividends on common stock (1,758) (1,513) -
Purchase of stock for MSP - (1,905) -
Proceeds from exercise of stock options 53 32 -
----------------------------
Net cash provided by financing activities 46,186 20,705 63,218
----------------------------
Net increase in cash and cash equivalents (3,099) (55,136) 55,325
Cash and cash equivalents:
Beginning of year 14,855 69,991 14,666
----------------------------
End of year $ 11,756 $14,855 $69,991
============================
Supplemental disclosures of cash flow information:
Cash payments for:
Interest on advances and other
borrowed money $ 5,368 $ 2,834 $ 1,442
Interest on deposits 8,258 6,725 6,102
Income taxes 1,656 1,338 1,159
Supplemental schedule of noncash investing
and financing activities:
Federal Home Loan Bank stock dividends $ 81 $ - $ -
Reinvested amounts of capital gains and
dividends from mutual fund investments 163 607 -
Refinancings of sales of real estate owned - 436 113
Transfer of loans for sale to loans held for
investment - - 18,480
Transfer of deposits to stock subscriptions - - 4,061
The accompanying notes are an integral part of these statements
21
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(1) Summary of Significant Accounting Policies
The following comprise the significant accounting policies FSF Financial Corp.
(the Corporation) follows in preparing and presenting its consolidated financial
statements:
Principles of Consolidation
The consolidated financial statements include the accounts of FSF Financial
Corp. and its wholly owned subsidiary, First Federal fsb (the Bank), and its
wholly owned subsidiary, Firstate Services Inc., which markets insurance and
investment products. Significant intercompany accounts and transactions are
eliminated in consolidation. Certain amounts in the financial statements for the
prior years have been reclassified to conform to current financial statement
presentation.
Organization
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 (the Conversion) via the issuance of common stock. The Bank
received $64.4 million in subscriptions for common stock in the Corporation and
an order for 359,720 shares of common stock from the Employee Stock Ownership
Plan (the ESOP). In conjunction with the Conversion, the Corporation sold
4,496,500 shares of common stock which, after giving effect to offering expenses
of $1.5 million, resulted in net proceeds of $44.0 million and refunds of $23.0
million of the stock subscription proceeds held at September 30, 1994. Pursuant
to the Conversion, the Bank transferred all of its outstanding shares to a newly
organized holding company, FSF Financial Corp., in exchange for 50% of the net
proceeds.
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.
The Bank resulted from the merger of First Federal Savings and Loan Association
of Hastings, Minnesota and First State Federal Savings and Loan Association of
Hutchinson, Minnesota . The merger was consummated on September 30, 1994, and
was accounted for as a pooling of interests. Accordingly, the assets,
liabilities and retained earnings of the respective Associations were combined
as of that date and recorded at historical cost. All financial information for
the year ended September 30, 1994, contained herein relates solely to the Bank
and its subsidiary.
Nature of Business
The Corporation is a unitary thrift holding company whose subsidiary provides
financial services. The Bank's business is that of a financial intermediary and
consists primarily of attracting deposits from the general public and using such
deposits, together with borrowings and other funds, to make mortgage loans
secured by residential real estate located primarily in Minnesota. At September
30, 1996, the Bank operated 11 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 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 Equivalents
For purposes of the consolidated statements of cash flows, the Corporation
considers all highly liquid debt instruments with original maturities of three
months or less and money market funds to be cash equivalents. The Corporation
held cash equivalents of $3,341 and, $9,865 at September 30, 1996, and 1995,
respectively.
22
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Debt and Equity Securities
The Corporation classifies its investments, including marketable equity
securities, mortgage-backed securities, and mortgage-related securities, in one
of three categories:
Trading Account Securities
Securities held principally for resale in the near term, are classified as
trading account securities and recorded at their fair values. Unrealized
gains and losses on trading account securities are included in other income.
The Corporation did not hold any trading securities at September 30, 1996 or
1995.
Securities Held to Maturity
Debt securities which the Corporation has the positive intent and ability to
hold to maturity are reported at cost, adjusted for premiums and discounts
that are recognized in interest income using the interest method over the
period to maturity. Unrealized losses on held to maturity securities
reflecting a decline in value judged to be other than temporary are charged
to income.
Securities Available for Sale
Available for sale securities consist of equity securities and certain debt
securities not classified as trading securities nor as held to maturity
securities. Unrealized holding gains and losses, net of income taxes, on
available for sale securities are reported as a net amount in a separate
component of shareholders' equity until realized. Gains and losses on the
sale of available for sale securities are determined using the specific
identification method. Any decision to sell available for sale securities
would be based on various factors, including movements in interest rates,
changes in the maturity mix of the Corporation's assets and liabilities,
liquidity demands, regulatory capital considerations, and other similar
factors. Premiums and discounts are recognized in interest income using the
interest method over the period to maturity. Unrealized losses on available
for sale securities reflecting a decline in value judged to be other than
temporary are charged to income.
The Corporation adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" as of October 1, 1994. Prior to the adoption of SFAS No. 115, the
Corporation classified and accounted for its held to maturity debt securities
using the same criteria required by SFAS No. 115. Held for sale debt securities
were carried at the lower of cost or market with unrealized losses thereon
included in the determination of net income. Marketable equity securities were
recorded at the lower of cost or market with unrealized losses recorded as a
reduction in retained earnings. Upon adoption of SFAS No. 115, held for sale
debt securities were reclassified as available for sale. The cumulative effect
of the change in accounting method for debt securities is reported, net of
income tax, in the consolidated statements of income and the consolidated
statements of changes in stockholders' equity. If SFAS No. 115 had been applied
earlier, the pro-forma effect on fiscal 1994 would have been an increase in net
income in an amount equal to the amount of the cumulative effect on fiscal 1995.
The Bank, as a member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the Federal Home Loan Bank of Des
Moines (FHLB) in varying amounts based on balances of outstanding home loans and
on amounts borrowed from the FHLB. Because no ready market exists for this
stock, and it has no quoted market value, the Bank's investment in this stock is
carried at cost.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income.
Loans Receivable
Loans receivable for which management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
unpaid balances reduced by any charge-offs or specific valuation accounts and
net of any deferred fees or costs on originated loans, or unamortized premiums
or discounts on purchased loans.
Discounts on first mortgage loans are amortized to income using the interest
method over the remaining period to contractual maturity, adjusted for
anticipated prepayments. Discounts on consumer loans are recognized over the
lives of the loans using the interest method.
The Bank adopted SFAS No. 114, "Accounting for Creditors for Impairment of a
Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -
Income Recognition and Disclosures," on October 1, 1995. These two
pronouncements require measurement of impairment based on the present value of
expected future cash flows discounted at the loan's effective interest rate or
the fair value of the collateral if the loan is collateral dependent. Regardless
of the measurement method, impairment is based on the fair value of the
collateral when the Bank determines that foreclosure is probable. The adoption
of these statements did not impact the Bank's results of operations for fiscal
1996 or any prior period.
23
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
Uncollectible interest on loans that are contractually past due for three months
is charged off or an allowance is established, based on management's periodic
evaluation. The allowance is established by a charge to interest income equal to
all interest previously accrued, and income is subsequently recognized only to
the extent cash payments are received until, in management's judgment, the
borrower's ability to make periodic interest and principal payments returns to
normal, in which case the loan is returned to accrual status.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment to the yield of the related loan.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure establishing a new
cost basis. After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of (1) cost or (2) fair
value minus estimated costs to sell. Revenue and expenses from operations and
changes to the valuation allowance are included in operations.
Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to future years
to differences between the financial statements carrying amounts and the tax
bases of existing assets and liabilities. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date. The measurement of deferred tax assets is reduced, if necessary,
by the amount of any tax benefits that, based on available evidence, are not
expected to be realized. The effect of a change in the beginning-of-the-year
balance of a valuation allowance that results from a change in judgment about
the realizability of deferred tax assets is included in income.
Premises and Equipment
Land, buildings, leasehold improvements and equipment are carried at cost, less
accumulated depreciation and amortization. Buildings and equipment are
depreciated using the straight-line method over the estimated useful lives of
the assets. The cost of leasehold improvements is being amortized using the
straight-line method over the terms of the related leases. Net gains and losses
on disposal or retirement of premises and equipment are included in other
income.
Mortgage Loan-Servicing Rights
The Bank adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights - An
Amendment of SFAS No. 65," prospectively as of October 1, 1995. Issued in May
1995, SFAS No. 122 amends certain provisions of SFAS No. 65 to eliminate the
accounting distinction between rights to service mortgage loans for others that
are acquired through loan origination activities and rights acquired through
purchase transactions. The statement requires a mortgage banking enterprise,
which sells or securitizes loans and retains the related mortgage servicing
rights, to allocate the total cost of the mortgage loans to the mortgage
servicing rights and the loans (without the mortgage servicing rights) based on
their relative fair values. The effect of adopting SFAS No. 122 did not have a
material impact of the Bank's financial condition or the results of its
operations.
The cost of mortgage servicing rights is amortized in proportion to, and over
the period of, estimated net servicing revenues. Impairment of mortgage
servicing rights is assessed based on the fair value of those rights. Fair
values are estimated using discounted cash flows based on a current market
interest rate. The Bank evaluates the mortgage servicing rights strata for
impairment by estimating the fair value based on anticipated future net cash
flows, taking into consideration prepayment predictions. The predominant
characteristics used as the basis for stratifying are loan types, period of
origination, and interest rates. The amount of impairment recognized is the
amount by which the capitalized mortgage servicing rights for a stratum exceed
their fair value.
Prior to SFAS No. 122, when participating interests in loans sold having average
contractual interest rate, adjusted for normal servicing fees, that differed
from the agreed yield to the purchaser, gains or losses were recognized equal to
the present value of such differential over the estimated remaining life of such
loans. The resulting "excess servicing receivable" or "deferred servicing
revenue" is amortized over the estimated life using the interest method.
Quoted market prices are not available for the excess servicing receivables.
Thus, the excess servicing receivables and the amortization thereon are
periodically evaluated in relation to estimated future servicing revenues,
taking into consideration changes in interest rates, current prepayment rates,
and expected future cash flows. The Bank evaluates the carrying value
24
of the excess servicing receivables by estimating the future servicing income of
the excess servicing receivables based on management's best estimate of
remaining loan lives and discounted at the original discount rate.
Long-Lived Assets
The Corporation adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of," in fiscal year
1996. This statement requires impairment losses to be recorded on long-lived
assets used in operations when indicators of impairment are present. Impairment
would be considered when the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount. Implementation of
this statement had no effect on the consolidated financial statements.
Earnings Per Share
Earnings per share of common stock for the years ended September 30, 1996 and
1995, has been determined by dividing the income before cumulative effect of
change in accounting principle and net income by the weighted average number of
shares of common stock and common stock equivalents outstanding during the year
of 3,384,930 and 3,931,000, respectively. Stock options are regarded as common
stock equivalents computed using the treasury stock method. Shares acquired by
the employee stock benefit plans are not considered in the weighted average
shares outstanding until shares are committed to be released to an employee's
individual account or have been earned. The difference between primary and fully
diluted earnings per share is not material.
Earnings per share has not been presented for the year ended September 30, 1994,
because the Bank was a mutual savings and loan association for that period.
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 excess proceeds credited to additional paid-in capital.
Treasury stock is available for general corporate purposes.
Fair Values of Financial Instruments
The following methods and assumptions were used by the Corporation in estimating
fair values of financial instruments as disclosed herein:
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.
Loansreceivable - For variable-rate loans, loans with balloon maturities,
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 fair values.
Accrued interest - The carrying amounts of accrued interest receivable
approximate their fair values
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 for 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.
Short-term borrowings - The carrying amounts of advances from the Federal
Home Loan Bank (FHLB) of Des Moines maturing within 90 days
approximate their fair values.
Long-term borrowings - The carrying amounts of 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.
25
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(2) Debt and Equity Securities (in thousands)
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at September 30 are presented as follows:
September 30, 1996
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ------- -------- --------
Available for sale securities:
Equity securities:
Fund Investments $12,522 $ - $ 426 $12,096
Stock in FHLB 5,736 - - 5,736
Preferred Stock 398 1 - 399
-------- ------- -------- --------
Total 18,656 $ 1 $ 426 $18,231
======== ======= ======== ========
Mortgage backed securities:
REMICs $16,980 $ - $ 644 16,336
======== ======= ======== =========
Held to maturity securities:
Debt securities:
U. S. Government and
Agency $44,349 $ 30 $2,753 41,626
-------- ------- -------- --------
Total $44,349 $ 30 $2,753 $41,626
======== ======= ======== ========
Mortgage backed securities:
REMICs $38,468 $ 46 1,693 $36,821
GNMA certificates 80 4 - 84
FHLMC certificates 9 1 - 10
-------- ------- -------- --------
Total $38,557 $ 51 $1,693 $36,915
======== ======= ======== ========
The amortized cost of debt and mortgage-backed securities at September 30, 1996,
included unamortized premiums of $255 and unaccreted discounts of $462,
respectively.
26
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
September 30, 1995
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ------- -------- --------
Available for sale securities:
Equity securities:
Fund Investments $12,522 $ - $ 451 $12,071
Stock in FHLB 3,692 - - 3,692
Preferred Stock 396 6 - 402
-------- ------- - ------- --------
Total $16,610 $ 6 $ 451 $16,165
======== ======= = ======= ========
Mortgage backed securities:
REMICs $16,979 $ - $ 838 16,141
======== ======= = ======= ========
Held to maturity securities:
Debt securities:
U. S. Government and
Agency $40,914 $ 215 $ 2,027 39,102
Corporate debt
securities 1,000 - 5 995
-------- ------- - ------- --------
Total $41,914 $ 215 $ 2,032 $40,097
======== ====== = ======= ========
Mortgage backed securities:
REMICs $36,986 $ 14 $ 2,013 $34,987
CMOs 24 - - 24
GNMA certificates 88 1 - 89
FHLMC certificates 12 - - 12
-------- ------- -------- --------
Total $37,110 $ 15 $ 2,013 $35,112
======== ======= ======== ========
The amortized cost of debt and mortgage backed securities at September 30, 1995,
includes unamortized premiums of $276 and unaccreted discounts of $494,
respectively.
There were no sales of securities during the three years ended September 30,
1996.
The scheduled maturities of securities held-to-maturity and securities (other
than equity securities) available-for-sale at September 30, 1996, were as
follows:
Held-to-Maturity Available-for-Sale
Securities Securities
------------------- --------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------- ------- -------- --------
Due in one year or less $ 2,496 $ 2,506 $ - $ -
Due from one to five years 12,571 12,271 - -
Due from five to ten years 15,118 13,599 - -
Due after ten years 52,721 50,165 16,980 16,336
-------- ------- -------- --------
Total $82,906 $78,541 $16,980 $16,336
======== ======= ======== ========
For purposes of the maturity table, mortgage-backed securities, which are not
due at a single maturity date, have been allocated over maturity groupings based
on the weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
Securities carried at approximately $26.9 million at September 30, 1996 and
$13.2 million at September 30, 1995, were pledged to secure public deposits and
for other purposes required or permitted by law.
27
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(3) Loans Receivable (in thousands)
Loans receivable are summarized as follows:
September 30,
---------------------
1996 1995
-------- --------
First mortgage loans:
Secured by one-to-four
family residences $149,659 $120,894
Secured by other properties 14,996 8,332
Construction and land
development loans 27,070 30,425
-------- --------
191,725 159,651
Less:
Undisbursed portion of construction and
land development loans (13,401) (15,010)
Unearned discounts (23) (25)
Net deferred loan
origination fees (889) (691)
-------- --------
Sub-total
first mortgage loans 177,412 143,925
-------- --------
Consumer and other loans:
Consumer loans 17,709 16,144
Home equity and second
mortgages 15,430 8,282
Commercial 6,234 2,715
Secured by savings 563 516
-------- --------
39,936 27,657
Add: net deferred loan origination costs 155 103
-------- --------
Sub-total consumer and
other loans 40,091 27,760
-------- --------
Sub-total all loans 217,503 171,685
Less: allowance for loan losses (776) (764)
-------- --------
Total $216,727 $170,921
======== ========
A summary of the activity in the allowance for loan losses is as follows:
Years Ended September 30,
-------------------------
1996 1995 1994
------- -------- --------
Balance, beginning of period $ 764 $ 748 $ 721
Provision for losses 42 24 33
Charge-offs (34) (20) (6)
Recoveries 4 12 -
------ ------- -------
Balance, end of period $ 776 $ 764 $ 748
======= ======== ========
Recorded investments in impaired loans were $74 at September 30, 1996, and $89,
at September 30, 1995. The average recorded investment in impaired loans during
1996 and 1995 was $46 and $111, respectively. The total allowance for loan
losses related to these loans was $7 and $9, on September 30, 1996, and 1995,
respectively. No interest income on these loans was recognized or received in
1996 and 1995.
Loans having carrying values of $73 and $340 were transferred to foreclosed real
estate in 1996 and 1995, respectively.
The Bank is not committed to lend additional funds to debtors whose loans have
been modified.
The aggregate amount of loans to executive officers and directors of the
Corporation were $648, and $637 at September 30, 1996, and 1995, respectively.
During 1996 repayments on loans to executive officers and directors aggregated
$132 and loans originated aggregated $142.
(4) Loan Servicing (in thousands)
Mortgage 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 was $41,133 and $44,452 at September 30, 1996
and 1995, respectively.
28
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were approximately, $235 and $239 at
September 30, 1996 and 1995, respectively.
Mortgage servicing rights of $23 were capitalized in 1996 with a carrying value
of $21 at September 30, 1996. The valuation allowance on September 30, 1996 and
changes in the valuation allowance during this period were not significant.
Capitalized mortgage servicing rights and excess servicing receivables are
summarized as follows:
September 30,
-------------------------
1996 1995 1994
------- -------- --------
Beginning balance, net of
accumulated amortization $ 155 $ 163 $ 132
Amounts capitalized 23 3 55
Amortization (18) (9) (14)
Valuation adjustments (3) (2) (10)
------ ------- -------
Balance, end of period $ 157 $ 155 $ 163
======= ======== ========
(5) Foreclosed Real Estate
Gain on foreclosed real estate, including net revenues from operations, was not
material for the three years ended September 30, 1996. The Bank held no
foreclosed real estate at September 30, 1996 and 1995.
(6) Premises and Equipment (in thousands)
Premises and equipment are summarized as follows:
September 30,
-----------------
1996 1995
-------- --------
Land $ 490 $ 490
Buildings and improvements 3,592 3,514
Furniture, equipment and
automobiles 2,598 2,708
Leasehold improvements 142 26
-------- --------
Total costs 6,822 6,738
Less accumulated depreciation 3,094 2,980
-------- --------
Total $ 3,728 $ 3,758
======== ========
At September 30, 1996, the Bank was obligated under noncancelable operating
leases for office space. Net rental expense under operating leases, included in
occupancy and equipment, was $39, $69, and $76 for the years ended September 30,
1996, 1995, and 1994, respectively.
The projected minimum rental commitments under the terms of the leases at
September 30, 1996, are as follows:
Rental Income Rental Expense
Fiscal as Lessor as Lessor
- ------ --------- ---------
1997 $ 14 $ 34
1998 10 26
------ ------
$ 24 $ 60
======== ========
(7) Deposits (in thousands)
The aggregate amount of short-term jumbo CDs, each with a minimum denomination
of $100,000, was approximately $16,008 and $14,228 in 1996 and 1995
respectively.
29
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Interest expense on deposits is summarized as follows:
September 30,
-------------------------
1996 1995 1994
------- -------- --------
Savings accounts $1,576 $1,669 $1,496
Demand deposits 443 673 796
Certificates of deposit 6,243 4,411 3,810
------- -------- --------
$8,262 $6,753 $6,102
======= ======== ========
At September 30, 1996, the scheduled maturities of certificates of deposit are
as follows:
Years Ending September 30,
--------------------------
1997 $ 80,721
1998 22,438
1999 9,405
2000 -
2001 and thereafter 575
--------
$113,139
========
(8) Borrowed Funds (in thousands)
Borrowings by the Bank from the Federal Home Loan Bank of Des Moines (FHLB) are
summarized as follows:
September 30,
----------------------------------
1996 1995
---------------- -----------------
Fiscal Year of Maturity
Weighted Weighted
Amount Rate Amount Rate
-------- ------- -------- -------
1996 $ - - $12,300 5.96%
1997 22,100 5.74 1,600 6.84
1998 56,900 5.80 40,900 5.90
1999 3,000 6.55 - -
2000 7,693 6.11 8,007 6.16
2001 15,000 6.00 - -
Line of Credit from FHLB 10,000 variable 11,000 variable
-------- ------- -------- --------
$114,693 5.88% $73,807 5.82%
======== ========
At September 30, 1996, borrowed funds are collateralized by stock in the FHLB,
first mortgage loans with carrying value of $147,435 and mortgage-backed
securities with carrying values of $45,250 under a collateral agreement. The
line of credit has a variable rate of interest that is adjusted daily based on
the FHLB's short-term investment return. The interest rate on the line of credit
was 6.18% and 6.02% at September 30, 1996, and 1995, respectively. The total
amount available to the Bank on its line of credit was $15,000 and $14,000 at
September 30, 1996 and 1995, respectively.
(9) Employee and Stock Benefit Plans (in thousands except shares)
Simplified Employee Pension Plan
The Bank has a Simplified Employee Pension Plan (SEPP) covering all qualifying
employees meeting certain eligibility requirements. Contributions are determined
annually by the Board of Directors. The Bank had no expense for the years ended
September 30, 1996 and 1995, and the Bank's expense was $339 for the year ended
September 30, 1994.
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
$134, $141, and $60 for the three years ended September 30, 1996, respectively.
30
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Employee Stock Ownership Plan
At the time of the stock conversion, the Bank established an Employee Stock
Ownership Plan (ESOP) covering all employees, 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, the loan being collateralized by the Common
Stock. Contributions by the Bank, 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 are charged to
unearned compensation, a contra-equity account, and 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. The total amount charged to
expense in the fiscal year ended September 30, 1996 and 1995 was $449 and $525,
respectively.
A summary of the ESOP share allocation is as follows:
September 30,
-----------------
1996 1995
-------- --------
Shares allocated beginning of year 49,461 -
Shares allocated during year 38,409 49,461
Unreleased shares 271,850 310,259
-------- --------
Total ESOP shares 359,720 359,720
======== ========
Fair value of unreleased shares $ 3,466 $ 4,074
======== ========
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 on
January 17, 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 are recorded as unearned compensation, a contra equity account, and
are recognized as an expense in accordance with the vesting requirements under
the plan. For the fiscal year ended September 30, 1996, and 1995, the amount
included in compensation expense was $290 and $218, respectively
Unawarded Awarded
Shares Shares
------- --------
Purchased by Plan 179,860 -
Granted (136,896) 136,896
Vested - -
------- --------
At September 30, 1995 42,964 136,896
------- --------
Granted - -
Vested - 27,379
------- --------
At September 30, 1996 42,964 109,517
======= ========
Stock Option Plan
The Corporation established a stock option plan for directors, officers and
employees. The stock option plan was approved by shareholders on January 17,
1995, and in accordance with the terms of the plan, the exercise price was
established at $9.50 per share, the fair market price on the date of shareholder
approval. Awards made under the plan may be incentive stock options as defined
by Section 422 of the Internal Revenue Code of 1986 or options that do not
qualify. All options expire on January 16, 2005.
31
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The following table summarizes the stock option transactions:
Available Options
for Grant Outstanding
------- --------
At inception 449,650 -
Granted (442,163) 442,163
Exercised - (3,405)
------- --------
At September 30, 1995 7,487 438,758
------- --------
Granted - -
Exercised - (6,000)
------- --------
At September 30, 1996 7,487 432,758
======= ========
(10) Income Taxes (in thousands)
The Corporation and its Subsidiary file consolidated income tax returns. Income
tax expense (benefit) is summarized as follows:
September 30,
-------------------------
1996 1995 1994
------- -------- --------
Current
Federal $1,263 $1,274 $ 583
State 403 424 186
------- -------- --------
Subtotal 1,666 1,698 769
------- -------- --------
Deferred
Federal (423) (148) 45
State (142) (49) 14
------- -------- --------
Subtotal (565) (197) 59
------- -------- --------
Total income tax provision $1,101 $1,501 $ 828
======= ======== ========
The State of Minnesota follows the Internal Revenue Code for the determination
of taxable income, in connection with temporary differences. The State portion
of deferred tax assets and liabilities is approximately 25 percent.
32
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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,
-----------------
1996 1995
-------- --------
Deferred tax assets:
Deferred compensation $ 396 $ 286
Deferred net loan fees 297 238
Deferred SAIF premium 417 -
Securities unrealized loss 423 522
Allowance for loan losses 314 309
-------- --------
Subtotal 1,847 1,355
Less: Valuation allowance 172 183
-------- --------
Total 1,675 1,172
-------- --------
Deferred tax liabilities:
FHLB Stock 241 209
Tax bad debt reserves 252 190
Premises and equipment 273 244
Installment obligation sale
of former building 30 30
Mortgage servicing rights 8 -
Discount of loans 21 39
Section 475 "For Sale Assets" 273 360
-------- --------
Total 1,098 1,072
-------- --------
Net deferred tax asset $ 577 $ 100
======== ========
The valuation allowance was established to reduce the deferred tax asset related
to the unrealized loss on equity securities because management is uncertain that
more likely than not it will be realized. The Bank has paid sufficient taxes in
prior carryback years which will enable it to recover the balance of the net
deferred tax assets, and therefore, no additional valuation allowance was
required at September 30, 1996 and 1995.
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,
-------------------------
1996 1995 1994
------- -------- --------
Computed "expected" tax expense $ 941 $1,273 $ 667
Exempt dividends (20) (5) -
State income taxes, net of
federal tax benefit 173 247 130
Other, net 7 (14) 31
------- -------- --------
Total income tax provision $1,101 $1,501 $ 828
======= ======== ========
If certain conditions are met, savings and loan associations were allowed a
special bad debt deduction in determining income for tax purposes, based on a
specified experience formula or a percentage of taxable income before such
deduction. The Bank used the percentage method in fiscal 1996.
Retained earnings at September 30, 1996, includes $6,492 for 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, which 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, 1996.
On August 31, 1996 legislation was signed into law which repealed the percentage
of taxable income method for tax bad debt deductions. The repeal is effective
for the Bank's taxable year beginning October 1, 1996. In addition, the
legislation requires the Bank to include in taxable income its bad debt reserves
in excess of its base year reserves over a six, seven, or eight year period
depending upon the attainment of certain loan origination levels. Since the
percentage of taxable income method for bad debt deduction and the corresponding
increase in the tax bad debt reserve in excess of the base year have
33
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
been recognized as temporary differences pursuant to SFAS No. 109, this change
in the tax law will not have a material effect on the Corporation's operations
or financial condition.
(11) Contingencies (in thousands)
Loans Sold
During 1982, the Bank sold loans subject to recourse provisions. The balance of
these loans at September 30, 1996, and 1995 was $413 and $465, respectively. The
loans had interest rates ranging from 9.50% to 9.875% with an original balance
of $3,400 and were sold to FHLMC.
(12) Regulatory Capital (in thousands)
The Bank is subject to various regulatory capital requirements administered by
the Office of Thrift Supervision (OTS). Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, 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.
The OTS includes an interest rate risk component in its risk based capital
requirements. Institutions with a greater than normal interest rate risk
exposure (as defined) must take a deduction - from the total capital available
to meet their risk based capital requirement - equal to half the difference
between the institution's actual measured exposure and a defined normal level of
exposure.
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, as of
September 30, 1996, that the Bank meets all capital adequacy requirements to
which it is subject.
As of September 30, 1996, and 1995, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table below. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual regulatory capital amounts, with reconciliation to the
Corporation's investment in the Bank determined in accordance with Generally
Accepted Accounting Principles (GAAP), and ratios as of September 30, 1996, are
also presented in the table below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------- ----------------- -----------------
GAAP capital $38,856
Add: Unrealized losses on debt
securities held for sale 383
-------
Tangible capital and ratio to
adjusted total assets $39,239 11.3% $ 5,218 1.5%
------------------ ---------------
Tier 1 (Core) capital and
ratio to adjusted total assets $39,239 11.3% $10,436 3.0% $17,393 5.0%
------------------ ---------------- -------------------
Tier 1 capital and ratio to
risk-weighted assets $39,239 22.3% $7,023 4.0% $10,534 6.0%
---------- ---------------- -------------------
Tier 2 capital, allowance
for loan losses 776
-------
Total risk-based capital
and ratio to risk-weighted assets $40,015 22.8% $14,046 8.0%% $17,557 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.
34
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(13) Concentration of Credit Risk (in thousands)
The Bank is primarily engaged in originating real estate loans in the Minnesota
counties of McLeod, Dakota, Meeker, Wright, Carver, Washington and Sibley. The
Bank offers fixed and adjustable rates of interest on these loans which have
amortization terms ranging up to thirty years. In addition, the Bank purchases
loans secured by one-to-four family residences located within Minnesota which
have been originated by other financial institutions. The loans are generally
originated on the basis of not more than an 80% loan-to-value ratio, which has
historically provided the Bank with more than adequate collateral coverage in
the event of default. Nevertheless, the Bank, as with any lending institution,
is subject to the risk that real estate values in the primary lending area will
deteriorate, thereby potentially impairing collateral values in the primary
lending area. However, management believes that real estate values are presently
stable in its primary lending area and that loan loss allowances have been
provided for in amounts commensurate with its current perception of the
foregoing risks in the portfolio.
The Corporation had cash on deposit in a financial institution in excess of
Federal deposit insurance limits of approximately $3,463 at September 30, 1996.
(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 reflect 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.
Commitments to extend credit are unused lines of credit and loan commitments
which 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. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment, and income producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Typically, the Bank issues letters of
credit to municipalities and generally does not require collateral for standby
letters of credit.
Forward commitments to purchase securities and mortgages involve an agreement
whereby the seller agrees to make delivery at a specified future date of a
specified instrument, 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
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 Bank's financial instruments
at September 30, 1996 follows:
Commitments to extend credit $17,887
Standby letters of credit 5
Forward commitments to purchase loans 1,494
35
FSF FINANCIAL CORP. AND SUBSIDIARY
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,
----------------------------------
1996 1995
---------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ------- -------- --------
Financial assets:
Cash & cash equivalents $11,756 $11,756 $14,855 $14,855
Investment securities 62,580 59,857 58,079 56,262
Mortgage-backed and related
securities 54,893 53,251 53,251 51,253
Loans held for sale 443 453 230 251
Loans receivable, net 216,727 216,427 170,832 170,767
Accrued interest receivable 2,325 2,325 2,097 2,097
Financial liabilities:
Deposits 189,074 189,300 171,516 171,827
Borrowings 114,693 114,797 73,807 73,587
(15) Effects of New Financial Accounting Standards
SFAS No. 123, "Accounting for Stock-Based Compensation" - issued October, 1995,
establishes a fair value based method of accounting for stock-based compensation
plans. It encourages entities to adopt that method in place of the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees", for all arrangements under which employees receive shares of
stock or other equity instruments of the employer if the employer incurs
liabilities to employees in amounts based on the price of its stock. The
Corporation will continue using the accounting methods prescribed by APB Opinion
No. 25 and beginning in October, 1996, will disclose in the footnotes
information on a fair value basis for its stock-based compensation plans.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" - issued June, 1996, establishes accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on the consistent application of the
financial-components approach. This approach requires the recognition of
financial assets and servicing assets that are controlled by the reporting
entity, and the derecognition of financial assets and liabilities when control
is extinguished. Liabilities and derivatives incurred or obtained by transferors
in conjunction with the transfer of financial assets are required to be measured
at fair value, if practicable. Servicing assets and other retained interest in
transferred assets are required to be measured by allocating the previous
carrying amount between the assets sold, if any and the interest that is
retained, if any, based on the relative fair value of the assets at the date of
transfer. The Corporation will prospectively adopt this statement for
transactions entered into after December 31, 1996.
Management believes adoption of the above-described Statements will not have a
material effect on financial position and the results of operations, nor will
adoption require additional capital resources.
36
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(16) Parent Only Condensed Financial Information (in thousands)
This information should be read in conjunction with the other Notes to
Consolidated Financial Statements. Stockholders' equity differs from the
consolidated statements by the amount of consolidating ESOP adjustments. The
investment in the Bank subsidiary is carried net of the Banks' unrealized loss
on securities available for sale.
STATEMENT OF FINANCIAL CONDITION
September 30,
-----------------
ASSETS 1996 1995
-------- -------
Cash and cash equivalents $3,772 $5,619
Investment securites available for sale 399 402
Investment securities held to maturity 4,560 10,648
Investment in Bank subsidiary 38,856 40,525
Loan to Bank ESOP 2,718 3,103
Other assets 76 171
-------- -------
$50,381 $60,468
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 14 $ 13
Stockholders' equity:
Common stock 450 450
Additional paid-in capital 43,150 43,069
Unrealized gain on securities available for sale 1 4
Treasury stock (13,095) (2,589)
Unearned MSP stock (1,398) (1,688)
Retained earnings 21,259 21,209
-------- -------
Total stockholders' equity 50,367 60,455
-------- -------
$50,381 $60,468
======== =======
STATEMENT OF INCOME
Years Ended September 30,
-------------------------
Income: 1996 1995
-------- -------
Dividends from Bank subsidiary $ 3,500 $ 1,686
Interest from
Bank's ESOP loan 254 306
Investments 641 1,072
-------- -------
4,395 3,064
Expense:
Non-interest expense 474 430
-------- -------
Income before income taxes and equity in undistributed
net income of Bank subsidiary 3,921 2,634
Income tax expense 154 380
-------- -------
3,767 2,254
Equity (loss) in undistributed net
income of Bank subsidiary (2,100) 371
-------- -------
Net income $ 1,667 $ 2,625
======== =======
37
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(16) Parent Only Condensed Financial Information - Continued (In thousands)
STATEMENT OF CASH FLOWS
Years Ended September 30,
-------------------------
1996 1995
-------- -------
Cash flows from operating activities:
Net Income $ 1,667 $ 2,625
Adjustments:
(Equity) loss in undistributed net income of
Bank subsidiary 2,100 (371)
(Increase) decrease in other assets 97 (171)
Increase (decrease) in other liabilities (7) 13
Others 85 -
-------- --------
Net cash provided by operations 3,942 2,096
-------- --------
Cash flows from investing activities:
Proceeds from maturities of investments 8,650 1,000
Purchase of investment securities (2,559) (12,088)
Loan to ESOP - (3,597)
Purchase of subsidiary stock - (21,735)
-------- -------
Net cash provided by (used in) investing activities 6,091 (36,420)
-------- --------
Cash flows from financing activities:
Net proceeds from sale of stock - 43,519
Payments received on ESOP bank loan 385 494
Purchases of treasury stock (10,559) (2,589)
Proceeds from sale of stock 52 32
Payments of cash dividends (1,758) (1,513)
-------- --------
Net cash provided by (used in) financing activities (11,880) 39,943
-------- --------
Increase (decrease) in cash and cash equivalents (1,847) 5,619
Cash and cash equivalents:
Beginning of year 5,619 -
-------- --------
End of year $ 3,772 $ 5,619
======== ========
38
FSF Financial Corp. and Subsidiary
Selected Quarterly Financial Data (Unaudited)
For Three Years Ended September 30, 1996
(In thousands except per share amounts)
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
--------------------------------------------------------
Fiscal 1996
Interest income $ 5,488 $ 5,583 $ 5,898 $ 6,275 $ 23,244
Interest expense 3,219 3,335 3,427 3,628 13,609
--------------------------------------------------------
Net Interest Income 2,269 2,248 2,471 2,647 9,635
Provision for loan losses 6 6 15 15 42
Gain on sale of assets 5 9 3 21 38
Net income $ 421 $ 460 $ 684 103 $ 1,668
Primary earnings per share of common stock:
Net income 0.11 0.13 0.21 0.03 0.48
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market range:
High bid $ 13.50 $ 13.50 $ 13.00 $ 13.25 $ 13.50
Low bid $ 12.38 $ 12.38 $ 11.50 $ 11.38 $ 11.38
Fiscal 1995
Interest income $ 4,451 $ 4,604 $ 4,836 $ 5,188 $ 19,079
Interest expense 1,973 2,149 2,523 2,827 9,472
--------------------------------------------------------
Net Interest Income 2,478 2,455 2,313 2,361 9,607
Provision for loan losses 6 6 6 6 24
Gain on sale of assets 4 - - 2 6
Net income before cumulative effect of change
in accounting principle 687 565 531 460 2,243
Net income $ 1,069 $ 565 $ 531 $ 460 $ 2,625
Primary earnings per share of common stock:
Net income before cumulative effect of
change in accounting for securities $ 0.17 $ 0.14 $ 0.14 $ 0.12 $ 0.57
Net income 0.26 0.14 0.14 0.12 0.67
Cash dividends declared per share N/A $ 0.125 $ 0.125 $ 0.125 $ 0.375
Market range:
High bid $ 10.50 $ 10.75 $ 12.00 $ 13.13 $ 13.13
Low bid $ 7.50 $ 9.00 $ 10.00 $ 11.13 $ 7.50
Fiscal 1994
Interest income $ 3,747 $ 3,669 $ 3,806 $ 4,098 $ 15,320
Interest expense 1,873 1,799 1,857 2,015 7,544
--------------------------------------------------------
Net Interest Income 1,874 1,870 1,949 2,083 7,776
Provision for loan losses 9 12 7 5 33
Gain (loss) on sale of assets 57 83 (402) 174 (88)
Net income $ 391 $ 329 $ 284 $ 131 $ 1,135
Earnings per share N/A N/A N/A N/A N/A
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FSF Financial Corp.
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Corporate Office
201 Main Street South
Hutchinson, MN 55350-2573
(320) 234-4500
FIRST FEDERAL fsb
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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 (612) 437-6169
Hutchinson South Office Apple Valley Office
905 Hwy. 15 South Frontage Road 14994 Glazier Avenue
Hutchinson, MN 55350 Apple Valley, MN 55124-7498
(320) 234-4563 (612) 432-6840
Buffalo Office Glencoe Office
19 Central Avenue, PO Box 338 1002 Greeley Avenue
Buffalo, MN 55313-0338 Glencoe, MN 55336-2128
(320) 682-3035 (320) 864-5541
Inver Grove Heights Office Litchfield Office
6505 Cahill Avenue East 501 North Sibley Avenue, PO Box 577
Inver Grove Heights, MN 55076-2022 Litchfield, MN 55355-0577
(612) 455-1553 (320) 693-2861
Waconia Office Waite Park Office
200 East Frontage Road, Hwy 5, PO Box 287 113 Waite Avenue South, PO Box 641
Waconia, MN 55387-0287 Waite Park, MN
(612) 442-2141 (320) 656-1133
Winthrop Office
122 East Second Street, PO Box 424
Winthrop, MN 55396-0424
(507) 647-5356
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Our Board of Directors and Management Team
Board of Directors of FSF Financial Corp.
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart Carl O. Bretzke
James J. Caturia Maurice P. Zweber
Jerome R. Dempsey Sever B. Knutson
Roger R. Stearns
Board of Directors of First Federal fsb
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart Carl O. Bretzke
James J. Caturia Maurice P. Zweber
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 Arliss M. Haag
Chief Financial Officer Corporate Secretary
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Corporate Counsel Special Counsel
Mackall Crounse & Moore Malizia, Spidi, Sloane & Fisch, P.C.
1400 AT&T Tower One Franklin Square
901 Marquette Avenue 1301 K Street NW, Suite 700 East
Minneapolis, MN 55402 Washington, DC 20005
Independent Auditors Transfer Agent and Registrar
Bertram Cooper & Co., LLP American Securities Transfer, Inc.
110 Second Avenue SE 1825 Lawrence
Waseca, MN 56093 Denver, CO 80202
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