SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended June 30, 1996
Securities and Exchange Commission File Number 0-25722
HF BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0576146
(State or other jurisdiction (I.R.S. Employer I.D. No.)
of incorporation or organization)
445 E. Florida Avenue, Hemet, California 92543
(Address of principal executive offices)
Registrant's telephone number, including area code: (909) 658-4411
Securities registered pursuant to Section 12(b) of the Act: Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share Nasdaq Stock Market
(Title of Class) (Name of exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The number of shares outstanding for each of the registrant's classes of
common stock issued and outstanding as of September 10, 1996 was 6,281,875.
The aggregate market value of the voting stock held by "non-affiliates" of
the registrant (i.e., persons other than the directors and executive officers of
the registrant) was $55,543,854 based upon the last sales price as quoted on The
NASDAQ Stock Market for September 10, 1996.
HF BANCORP, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
----
Item 1. Description of Business ............................................................... 3
General ........................................................................... 3
Market Area and Competition ....................................................... 4
Weakness in the Regional Economy .................................................. 5
Lending Activities ................................................................ 5
Investment Activities ............................................................. 24
Sources of Funds .................................................................. 32
Borrowings ........................................................................ 36
Subsidiary Activities ............................................................. 38
Personnel ......................................................................... 39
Regulation and Supervision ........................................................ 39
Federal and State Taxation ........................................................ 48
Item 2. Properties ............................................................................ 52
Item 3. Legal Proceedings ..................................................................... 53
Item 4. Submission of Matters to a Vote of Security Holders ................................... 53
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters ....................................................... 53
Item 6. Selected Financial Data ............................................................... 54
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition ............................................................... 56
Item 8. Financial Statements and Supplementary Data ........................................... 71
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .............................................................. 122
PART III
Item 10. Directors and Executive Officers of the Registrant .................................... 122
Item 11. Executive Compensation ................................................................ 122
Item 12. Security Ownership of Certain Beneficial Owners and Management ........................ 122
Item 13. Certain Relationships and Related Transactions ........................................ 122
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ....................... 123
PART I
Item 1. Description of Business
General
HF Bancorp, Inc. (the Company) is a savings and loan holding company
incorporated in the State of Delaware that was organized for the purpose of
acquiring all of the capital stock of Hemet Federal Savings and Loan Association
(the Association) upon its conversion from a federally chartered mutual savings
association to a federally chartered stock savings association. On June 30,
1995, HF Bancorp, Inc. completed its sale of 6,612,500 shares of its common
stock through subscription and community offerings to the Association's
depositors, Board of Directors, management, employees and the public and used
approximately 50% of the net proceeds from such sales to purchase all of the
Association's common stock issued in the Association's conversion to stock form.
Such business combination was accounted for at historical cost in a manner
similar to a pooling of interests. At June 30, 1996, the Company had
consolidated total assets of $826.9 million and total equity of $81.1 million.
The Company was incorporated under Delaware law. The Company is a savings and
loan holding company and is subject to regulation by the Office of Thrift
Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the
Securities and Exchange Commission ("SEC"). Currently, the Company does not
transact any material business other than through its subsidiary, the
Association except for its investments in mortgage backed securities.
Operational activity of the Savings and Loan Association will hereafter be
referred to as "Association", where applicable. Headquartered in Hemet,
California, the Association conducts business from its main office and three
branch offices located in Hemet, California, and from its other eleven branch
offices located in Riverside, Sun City, San Jacinto, Canyon Lake, Idyllwild,
Murrieta, Vista, Oceanside and Rancho Bernardo, California. The Association is
regulated by the OTS and the FDIC and its deposits are insured up to the
applicable limits under the Savings Association Insurance Fund ("SAIF") of the
FDIC. The Association is also a member of the Federal Home Loan Bank of San
Francisco ("FHLB"). At June 30, 1996, the Association had total assets of $810.4
million, total deposits of $670.0 million and total stockholders' equity of
$60.7 million and exceeded all of its regulatory capital requirements with
tangible, core and risk-based capital ratios of 6.66%, 6.66% and 24.27%,
respectively.
The Association is primarily engaged in the business of attracting funds in
the form of deposits and supplementing such deposits with FHLB and other
borrowings, and investing such funds in loans secured by real estate, primarily
one- to four-family residential mortgage loans. Additionally, the Association
invests in mortgage-backed and related securities, including collateralized
mortgage obligations ("CMOs") that generally are either guaranteed by a Federal
agency or are private issuer securities that have an investment grade rating of
AAA. To a lesser extent, the Association invests in multi-family mortgage loans,
commercial real estate loans, construction loans, acquisition, development and
land loans and consumer loans. At June 30, 1996, $299.4 million, or 36.2% of the
Company's assets were invested in mortgage-backed and related securities
compared to $225.2 million, or 27.2% invested in real estate and consumer loans.
Of the Company's $299.4 million in mortgage-backed and related securities,
$145.1 million were fixed-rate and $154.3 million were adjustable rate mortgage-
backed and related securities at June 30, 1996. Management believes that its
investment in mortgage-backed and related securities enable the Company to
maintain adequate liquidity levels, maintain a balance of high quality,
diversified investments, provide collateral for short- and long-term borrowings,
provide low administrative cost, manage interest rate risk and lessen the
exposure to credit risk.
3
The Association's revenues are derived principally from interest on its
mortgage loan and mortgage-backed securities portfolio and interest and
dividends on its investment securities. The Association's primary sources of
funds are deposits and principal and interest payments on loans and mortgage-
backed securities and, to a lesser extent, FHLB advances, and other borrowings.
Through its second-tier subsidiary, First Hemet Corporation ("First Hemet"), the
Association also engages in residential real estate development and receives
commissions from the sale of mortgage life insurance, fire insurance, annuities
commissions and derives income from trustee services.
Market Area and Competition
The Association has been, and continues to be, a community banking
institution offering a variety of financial services to address the needs of the
diverse communities it serves. Twelve of the Association's fifteen branches,
including the Main Office, are located in the western portion of Riverside
County. The Main Office is located in the City of Hemet, about one-hundred miles
east-southeast of Los Angeles and ninety miles north of San Diego. In addition
to the Main Office, the Association operates three additional branches in Hemet
and three offices in the City of Riverside, as well as single branches in the
Riverside County communities of San Jacinto, Sun City, Canyon Lake, Idyllwild
and Murrieta. The remaining three branches were recently purchased (June 21,
1996) from Hawthorne Savings Bank, FSB, and are located in the northern portion
of San Diego County - in the communities of Vista, Oceanside and Rancho
Bernardo.
Hemet Federal recently entered the Northern San Diego County market through
the purchase of branch offices and assumption of deposit liabilities totalling
$185.2 million from Hawthorne Savings Bank. The acquisition was consummated on
June 21, 1996 and resulted in the Association expanding its branch network by an
additional three branch offices, all located in Northern San Diego County. The
Association paid a premium of $6.3 million, or 3.671% of the core deposits
assumed.
In addition, on May 9, 1996, the Association entered into a definitive
agreement with Palm Springs Savings Bank, F.S.B. ("Palm Springs") pursuant to
which Palm Springs will be merged with the Association. The Association agreed
to pay $14.375 per share in cash for each outstanding share of Common Stock. The
acquisition will cost a total of $16.3 million. Following consummation of the
acquisition of Palm Springs, which is currently expected to occur on September
27, 1996, the Association intends to operate Palm Springs' four branch offices
as a division of the Association under the name "Palm Springs Savings," a
division of Hemet Federal. Mr. Stephen Hoffman, the current president of Palm
Springs will become the President and a director of the Association upon
consummation of the acquisition of Palm Springs. Mr. Eichinger will continue as
the Chairman of the Board and Chief Executive Officer of the Association and a
Chairman of the Board, President and Chief Executive Officer of the Company
following the acquisition of Palm Springs.
Throughout its market areas, the Association operates in a very competitive
environment, with virtually every major state-wide financial institution
headquartered in California. Competition is provided primarily by other savings
institutions, commercial banks and credit unions. Non-traditional investments
such as stocks, mutual funds and insurance annuities have also become a serious
competitive factor in recent years. The Association faces keen competition not
only in numbers of competitors and their size, but also in terms of interest
rates paid. While paying competitive rates, the Association does not attempt to
match the very highest rates offered - because to do so would result in growth,
but growth at the expense of profitability and capital strength. For the fiscal
year ended June 30, 1996, the Associations total deposits net of interest
credited and net of the deposits acquired via the Hawthorne branches purchased
($185.2 million) declined $13.0 million compared to the fiscal year ended June
30, 1995 where
4
deposits declined $26.1 million, net of interest credited. Included in the $13.0
million net outflow was $10.0 million of a matured broker savings deposit
account. The lessening of the outflow for fiscal 1996 over fiscal 1995 is
primarily due to the Association offering deposit rates that were more
competitive in its market area, initiating improved procedures used in its
telemarketing efforts to retain maturing deposit accounts and the Association
enhanced its marketing capability by establishing a relationship with a leading
Southern California advertising agency that is a member of the American
Association of Advertising Agencies.
The Association's competition on the lending side comes primarily from
savings institutions, commercial banks and mortgage brokers. The recessionary
California economy of the past several years has resulted in higher unemployment
rates and significantly lower real estate values, both factors having a
dampening effect on mortgage loan originations in our market area. For the
fiscal years ended June 30, 1996, the Association funded mortgage loans of $50.6
million compared to the fiscal year ended June 30, 1995, where mortgage loan
fundings were $17.3 million. The primary reason for the increase in mortgage
loan fundings was attributed to the purchase of whole loans in the secondary
market of $13.8 million, more competitive loan pricing and a trend of lower
mortgage rates for most of the fiscal year ended June 30, 1996.
Weakness in the Regional Economy
Southern California, including the Association's market area, has
experienced reduced employment and recessionary economic conditions in recent
years as a result of downsizing of the defense and construction industries and
corporate relocations. Additionally, the area has experienced a general
weakening of real estate values and a slow down of home sales and construction.
As a result, loan repayment delinquencies have increased and the underlying
values of properties securing nonperforming loans made by lending institutions
have declined, and in some cases, have resulted in substantial losses to some
institutions. Losses from real estate operations, net, totalled $1.6 million,
$747,000, and $498,000 for the fiscal years ended June 30, 1994, 1995 and 1996,
respectively. Total nonperforming assets peaked at a high of $9.1 million at
June 30, 1993 and totalled $2.8 million at June 30, 1996. At June 30, 1996, the
Association's ratios of nonperforming loans to gross loans and nonperforming
assets to total assets of the Company were .56% and .33% respectively. There can
be no assurance that the Southern California economy and real estate market will
not deteriorate further or that such deterioration, if it occurs, will not have
an adverse impact on the Association's financial condition or results of
operations.
Lending Activities
Loan Portfolio Composition
--------------------------
The Association's loan portfolio composition consists primarily of
conventional first mortgage loans secured by one-to-four-family residences and,
to a lesser extent, commercial real estate loans, construction loans,
acquisition, development and land loans, multi-family loans and consumer loans.
At June 30, 1996, the Association had total one-to-four-family first and second
residential mortgage loans outstanding of $162.7 million, or 68.8% of the
Association's total loan portfolio. At that same date, commercial real estate
loans totalled $46.2 million, or 19.6% of total loans, construction loans
totalled $9.5 million, or 4.0% of total loans, acquisition, development and land
loans totalled $7.4 million, or 3.1% of total loans and multi-family residential
mortgage loans totalled $5.6 million, or 2.4% of total loans. Consumer loans in
the Association's portfolio principally consisted of mobile home loans,
automobile loans, boat loans, recreational vehicle loans, savings account loans
and line of credit loans, totalling $5.1 million, or 2.1% of total loans at June
30, 1996. The Association, as part of its strategy to reduce its
5
exposure to interest rate risk, has in recent years sought to increase its
originations of ARM loans; however, as a result of the low interest rate
environment that prevailed in the early 1990s, the Association's borrowers
refinanced some of their loans at lower interest rates and the Association
experienced an increase in fixed-rate loan originations, compared to ARM loans.
Therefore to offset the interest rate risk of our borrower's preference for
fixed rate loans, the Association has increased its investment in short-term or
adjustable rate mortgage backed securities and related securities. At June 30,
1996, $107.7 million of the Association's gross loans receivable or, 45.6% of
total loans had adjustable interest rates.
6
The following table sets forth the composition of the Association's loans
in dollar amounts and in percentages at the dates indicated.
At June 30,
--------------------------------------------------------------------------
1992 1993 1994
---------------------- ----------------------- ------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in thousands)
Mortgage loans:
One-to four-family................................... $142,032 58.60% $149,349 61.81% $134,475 62.36%
Multi-family loans................................... 5,580 2.30 5,352 2.21 5,498 2.55
Commercial real estate loans......................... 54,543 22.50 55,488 22.97 51,685 23.97
Construction loans................................... 14,790 6.10 11,446 4.74 8,616 3.99
Acquisition, development and land loans.............. 10,866 4.49 8,723 3.61 6,860 3.18
Second mortgage residential loans ................... 5,751 2.37 3,675 1.52 1,984 .92
------- ------- ------- ------- ------- ------
Total real estate loans........................... 233,562 96.36 234,033 96.86 209,118 96.97
Consumer loans:
Mobile home loans.................................... 6,429 2.66 5,998 2.48 5,409 2.51
Loans on deposit accounts............................ 914 .38 792 .33 725 .34
Other consumer loans................................. 1,461 .60 795 .33 393 .18
------- ------- ------- ------- ------- ------
Total consumer loans.............................. 8,804 3.64 7,585 3.14 6,527 3.03
------- ------- ------- ------- ------- ------
Total loans....................................... 242,366 100.00% 241,618 100.00% 215,645 100.00%
------- ======= ------- ======= ------- ======
Less:
Undisbursed loan funds............................... 4,254 5,126 4,106
Unamortized yield adjustments........................ 2,414 2,562 2,487
Allowance for estimated losses....................... 1,339 3,157 2,682
8,007 10,845 9,275
Total loans receivable, net....................... $ 234,359 $ 230,773 $ 206,370
======= ======= =======
------------------------------------------------
1995 1996
---------------------- ------------------------
Percent Percent
Amount of Total Amount of Total
------ -------- ------ --------
(Dollars in thousands)
Mortgage loans:
One-to four-family........................................................... $136,418 64.72% $161,448 68.30%
Multi-family loans........................................................... 5,434 2.58 5,564 2.36
Commercial real estate loans................................................. 49,020 23.26 46,222 19.55
Construction loans........................................................... 5,920 2.81 9,459 4.00
Acquisition, development and land loans...................................... 6,527 3.10 7,355 3.11
Second mortgage residential loans ........................................... 1,656 .79 1,282 .54
------- ------- ------- -------
Total real estate loans................................................... 204,975 97.24 231,330 97.86
Consumer loans:
Mobile home loans............................................................ 4,779 2.27 4,158 1.76
Loans on deposit accounts.................................................... 764 .36 746 0.32
Other consumer loans......................................................... 273 .13 149 .06
------- ------- ------- -------
Total consumer loans...................................................... 5,816 2.76 5,053 2.14
------- ------- ------- -------
Total loans............................................................... 210,791 100.00% 236,383 100.00%
------- ======= ------- =======
Less:
Undisbursed loan funds....................................................... 3,281 5,584
Unamortized yield adjustments................................................ 2,419 2,570
Allowance for estimated losses............................................... 2,694 3,068
------- -------
8,394 11,222
------- -------
Total loans receivable, net............................................... $ 202,397 $ 225,161
======== =========
7
Loan Maturity
-------------
The following table shows the maturity of the Association's loans at June
30, 1996. The table does not include prepayments or scheduled principal
amortization. Prepayments and scheduled principal amortization on total loans
totalled $51.6 million, $22.4 million and $25.2 million for the fiscal years
ended June 30, 1994, 1995 and 1996.
At June 30, 1996
------------------------------------------------------------------------------------------------
One-to Acquisition, Total
Four- Multi- Commercial Development Loans
Family(1) Family Real Estate Construction(2) and Land Consumer Receivable
--------- ------ ----------- --------------- -------- -------- ----------
Amounts due: (In thousands)
Within one year.................... $ 113 $ 0 $ 2,975 $ 519 $ 1,124 $ 778 $ 5,509
After one year:
One to three years................ 2,023 192 12,480 0 644 19 15,358
Three to five years............... 1,192 1,940 11,202 0 121 128 14,583
Five to 10 years.................. 8,466 609 18,326 0 1,200 396 28,997
10 to 20 years.................... 36,427 484 1,239 607 4,266 3,732 46,755
Over 20 years..................... 114,509 2,339 0 8,333 0 0 125,181
------- ------ ------- ------ ------ ------ -------
Total due after one year.......... 162,617 5,564 43,247 8,940 6,231 4,275 230,874
------- ------ ------- ------ ------ ------ -------
Total amounts due................. 162,730 5,564 46,222 9,459 7,355 5,053 236,383
Less:
Undisbursed loan funds............. 106 0 0 5,478 0 0 5,584
Unamortized yield adjustments...... 1,967 21 259 174 90 59 2,570
Allowance for estimated loan losses 969 37 1,248 19 566 229 3,068
------- ------ ------- ------ ------ ------ -------
Loans, net....................... $159,688 $ 5,506 $ 44,715 $ 3,788 $ 6,699 $ 4,765 $225,161
======= ====== ======= ====== ====== ====== =======
- ---------------------------------------------------
(1) Includes second mortgage loans on residential one- to four-family loans.
(2) Includes loans that are interest only for the initial construction phase,
generally not in excess of nine months, that convert to permanent loans.
At June 30, 1996, $8.9 million of the construction loans will become
permanent loans once a notice of completion of construction on those
properties has been received by the Association.
8
The following table sets forth at June 30, 1996, the dollar amount of gross
loans receivable, contractually due after June 30, 1997, and whether such loans
have fixed interest rates or adjustable interest rates.
Fixed Adjustable Total
----- ---------- -----
(In thousands)
Mortgage loans(1):
One-to four-family............................ $ 109,526 $53,091 $162,617
Multi-family.................................. 827 4,737 5,564
Commercial real estate........................ 2,889 40,358 43,247
Construction.................................. 8,502 438 8,940
Acquisition, development and land............. 1,086 5,145 6,231
Consumer loans(1).................................. 3,494 781 4,275
------- ------- -------
Total loans............................... $126,324 $104,550 $230,874
======= ======= =======
- --------------------------------------
(1) Includes nonperforming loans.
9
The following table sets forth the Association's loan originations,
purchases, sales and principal repayments for the periods indicated:
For the Fiscal Year Ended June 30,
-------------------------------------------------
1994 1995 1996
---- ---- ----
(In thousands)
Mortgage loans (gross):
At beginning of period............................................ $234,033 $209,118 $204,975
Mortgage loans originated:
One- to four-family(1)...................................... 25,824 7,373 23,152
Multi-family................................................ 551 -- 70
Commercial real estate...................................... 1,678 2,151 96
Acquisition, development and land........................... 970 1,695 2,199
Construction................................................ 9,100 6,040 11,285
------- ------- -------
Total mortgage loans originated........................... 38,123 17,259 36,802
Mortgage loans purchased...................................... 513 207 13,892
------- ------- -------
Total mortgage loans originated and purchased............. 38,636 17,466 50,694
Transfer of mortgage loans to real estate
acquired through foreclosure.............................. (5,374) (1,815) (1,810)
Principal repayments.......................................... (48,388) (19,794) (22,529)
Sale of mortgage loans........................................ (9,789) -- --
------- ------- -------
Balance of mortgage loans at end of period........................ $209,118 $204,975 $231,330
======= ======= =======
Consumer loans (gross):
At beginning of period............................................ 7,585 6,527 5,816
Loans originated.............................................. 2,317 2,062 2,018
Principal repayments.......................................... (3,167) (2,642) (2,660)
Loans acquired through foreclosure............................ (208) (131) (121)
------- ------- -------
Balance of consumer loans at end of period.................... $ 6,527 $ 5,816 $ 5,053
======= ======= =======
- --------------------------------------------
(1) Includes second mortgage residential loans.
10
One-to-Four-Family Mortgage Lending
-----------------------------------
The Association offers both fixed-rate and ARM loans secured by one- to
four-family residences, including condominium and town house units, located in
the Association's primary market area. The majority of such loans, are held in
portfolio and are secured by property located in the cities of Hemet, Riverside,
Temecula and Murrieta and surrounding areas, primarily in western Riverside
County and typically serve as the primary residence of the owner.
The Association generally originates one-to-four-family residential
mortgage loans, including loans secured by condominium and town house units in
amounts up to 80% of the lower of the appraised value or selling price of the
property securing the loan. One-to-four-family mortgage loans may be originated
in amounts up to 95% of the lower of the appraised value or selling price of the
mortgaged property, provided that the property is owner-occupied and private
mortgage insurance ("PMI") is provided on the amount in excess of 80% of the
appraised or selling value. The Association currently has a limited amount of
residential loans secured by condominiums and town homes. Mortgage loans
originated by the Association generally include due-on-sale clauses which
provide the Association with the contractual right to deem the loan immediately
due and payable in the event that the borrower transfers ownership of the
property without the Association's consent. Due-on-sale clauses are an important
means of adjusting the rates on the Association's fixed-rate mortgage loan
portfolio and the Association has generally exercised its rights under these
clauses.
The Association currently offers ARM loans which adjust every six months.
The Association's ARM loans typically carry an initial interest rate below the
fully-indexed rate for the loan. The Association, however, qualifies borrowers
based upon the fully indexed rate. The initial discounted rate is determined by
the Association in accordance with market and competitive factors and, as of
June 30, 1996, the rate offered by the Association on these loans was 227 basis
points below the fully-indexed rate based on the Eleventh District Cost of Funds
Index ("COFI"), which was 4.82% as of such date. The COFI is a lagging market
index and therefore may adjust more slowly than the cost of the Association's
interest-bearing liabilities. Currently, the Association's ARM loans adjust by a
maximum of 1.0% every six months, with a lifetime adjustment cap of 6.00%. The
Association currently charges origination fees up to 1.0% for its one- to four-
family ARM loans. It is possible that given the interest rate caps on the
Association's ARM loans, market rates could exceed the maximum rates on the
Association's ARM loans.
The volume and types of ARM loans originated by the Association have been
affected by such market factors as the level of interest rates, competition and
consumer preferences. During fiscal 1996, demand for loans, particularly ARM
loans, was weak. Accordingly, although the Association will continue to offer
ARM loans, there can be no assurance that in the future the Association will be
able to originate a sufficient volume of ARM loans to increase or maintain the
proportion that these loans bear to total loans. The Association has re-entered
the secondary market for the purpose of increasing its adjustable rate mortgage
portfolio and is actively purchasing adjustable rate mortgage whole loans that
meet the Association's conservative underwriting standards.
The retention of ARM loans, as opposed to fixed-rate residential mortgage
loans, in the Association's loan portfolio helps reduce the Association's
exposure to increases in interest rates. However, ARM loans generally pose
credit risks different from the risks inherent in fixed-rate loans, primarily
because as interest rates rise, the underlying payments of the borrower rise,
thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected. In order to
minimize risks, borrowers of six month ARM loans are qualified at the fully
indexed
11
rate. The Association has not in the past, nor does it currently originate ARM
loans which provide for negative amortization.
The Association offers fixed-rate mortgage loans with terms of 15 to 30
years, which are payable either monthly or bi-weekly. Interest rates charged on
fixed-rate mortgage loans are competitively priced based on market conditions
and the Association's cost of funds. Origination fees for fixed-rate loans were
1.5% at June 30, 1996. Generally, the Association's standard underwriting
guidelines conform to the federal agency guidelines. The Association also offers
a two-step loan that has a fixed-rate for an initial five or seven year period
then converts to a six month adjustable rate mortgage loan tied to the COFI.
On occasion, the Association has sold a portion of its conforming fixed-
rate mortgage loans in the secondary market to federal agencies while retaining
the servicing rights on all such loans sold. As of June 30, 1996, the
Association's portfolio of loans serviced for others totalled approximately
$21.2 million.
The Association makes loans secured by second trust deeds on single-family
owner-occupied property. The maximum loan-to-value ratios on such loans may not
exceed 80% of the appraised value for both the first and second trust deeds.
Loans secured by second trust deeds may be fixed or ARMs for a period of up to
15 years. At June 30, 1996, the Association had $1.3 million outstanding in
second trust deeds.
Multi-Family Lending
--------------------
The Association originates ARM multi-family loans that are indexed to the
COFI generally with contractual terms of 15 years, with amortization over
periods of up to 30 years. These loans are generally secured by apartment
buildings and are made in amounts of up to 80% of the appraised value of the
property. In making such loans, the Association bases its underwriting decision
primarily on the net operating income generated by the real estate to support
the debt service, the financial resources and the income level of the borrower,
the borrower's experience in owning or managing similar property, the
marketability of the property and the Association's lending experience with the
borrower. The Association generally requires a debt service coverage ratio of
1.10x or better and in certain circumstances requires personal guarantees from
borrowers or the principals of the borrowing entity. The Association's largest
multi-family loan, at June 30, 1996, had an outstanding balance of $1.4 million
and is secured by a 54 unit senior citizen apartment complex. This loan has been
current since its origination in 1990.
Commercial Real Estate Lending
------------------------------
The Association originates commercial real estate loans that are generally
secured by properties used exclusively for business purposes such as retail
stores, mini-warehouse units, light industrial and small office buildings,
health care facilities and churches located primarily in the Association's
market area. The Association's commercial real estate loans are generally made
in amounts up to 80% of the appraised value of the property. These loans are
generally made with terms up to ten years, with amortization over periods up to
30 years. Generally, all commercial real estate loans are one-year ARMs that are
indexed to the COFI and adjust a maximum of 2% per year, with a 6% lifetime cap.
In making such loans, the Association considers the net operating income of the
property and the borrower's expertise, credit history and profitability. The
Association generally requires that the properties securing commercial real
estate loans have debt service coverage ratios of not less than 1.10x and in
certain circumstances requires personal guarantees and other credit enhancements
from the borrowers or the principals of the borrowing entity. Updated financial
information is obtained annually. The largest commercial real estate loan in the
Association's portfolio was originated in 1988 and is secured by a 150
12
bed convalescent hospital, which, had an outstanding balance at June 30, 1996 of
approximately $4.5 million. This loan is currently performing in accordance with
its contractual terms. At June 30, 1996, $14.9 million of the Association's
commercial real estate loans were secured by mini-warehouse units, which were
performing in accordance with their terms at June 30, 1996; however, increased
competition in the mini-warehouse unit market could result in borrowers' profit
margins narrowing, which could result in increased delinquencies. The
Association monitors these loans on a regular basis.
Construction Loans
------------------
The Association's construction loans primarily have been made to finance
the construction of one-to four-family owner occupied residential properties
and, to a lesser extent, multi-family and commercial real estate properties. The
Association offers construction loans in amounts up to a maximum of 90% with
mortgage insurance, of the appraised value of the property securing the loan.
Loan proceeds are disbursed in increments as construction progresses and as
inspections performed by Hemet Federal personnel warrant. Owner occupied single-
family residential loans are structured to allow the borrower to pay interest
only on the funds advanced during the first nine months of the loan. Thereafter,
construction loans are structured to be converted to permanent fixed or ARM
loans. One- to four-family speculative construction loans are originated for up
to one year with the borrower paying interest only based on the prime rate plus
1.5%, during the construction period. Multi-family and commercial real estate
construction loans are originated for up to one year with the borrower paying
interest only based on the prime rate plus 1.5% during the construction period;
thereafter such loans convert to a one-year ARM loan on the same terms as the
one-to four-family loan index. At June 30, 1996, the largest construction loan
had an outstanding balance of $620,000, is secured by a single-family residence
and was current at June 30, 1996.
Acquisition, Development and Land Loans
---------------------------------------
The Association originates loans for the acquisition and development of
property to contractors and individuals. Land development loans typically are
short-term loans. At June 30, 1996, the Association had $7.4 million, or 3.1% of
the Association's total loan portfolio invested in acquisition, development and
land loans, most of which were lot loans, which the Association offers on a
selective basis with loan amounts up to $150,000 with maximum loan to value
ratios of 70% of the appraised value of the property. Such loans are originated
as an ARM loan with a fully amortizing term of up to 15 years. The Association
offers other acquisition, development and land loans in amounts up to 75% of the
appraised value of the property securing the loan. Such loans are originated for
up to two years with the borrower paying interest only, based on the prime rate
plus 1.5% during the construction period, with the principal due at the end of
the term. Loan proceeds are disbursed in increments as construction progresses
and as inspections warrant. Such loans generally are made to customers of the
Association and developers and contractors with whom the Association has had
prior lending experience. At June 30, 1995, the Association's largest land,
acquisition and development loan was a land loan in Hemet, California. This loan
was originated in 1991, has been extended to 2006 and had an outstanding balance
of $763,000 at June 30, 1996. This loan was converted to an amortizing basis
beginning April 1996 and has been paid current since it's inception.
Diversified Lending Risks
-------------------------
Commercial real estate and multi-family loans are generally considered to
involve a higher degree of credit risk than one-to-four-family residential
mortgage loans. In particular, commercial real estate and multi-family lending
typically involve higher principal loan amounts and the repayment of such loans
13
generally depends on the income produced by the property being sufficient to
cover operating expenses and debt service. Due to circumstances outside the
borrower's control, such as economic events or regulatory changes, income from
the property as well as its market value could be adversely affected.
Additionally, the decline in real estate values experienced in the Association's
lending area has been more pronounced with respect to commercial real estate and
multi-family properties than one- to four-family properties. The Association has
experienced decreased delinquencies and charge-offs in the commercial real
estate category, and no significant delinquencies or losses have occurred on the
Association's multi-family loan portfolio in recent periods. The Association has
a large concentration of commercial real estate loans secured by mini-warehouse
units located in its local market area. At June 30, 1996, the Association had
loans on eleven properties with an aggregate balance of approximately $14.9
million secured by mini-warehouses, which were performing in accordance with
their terms. The Association has not experienced significant increased
delinquencies in the commercial real estate and multi-family loan categories in
recent periods, but there can be no assurance that delinquencies will not
increase given the decline in real estate values for multi-family units that has
occurred recently in the Association's market area.
Construction and land loans often involve the disbursement of substantial
funds with repayment dependent, in part, on the success of the ultimate project
rather than the ability of the borrower or guarantor to repay principal and
interest. If the Association is forced to foreclose on a project prior to or at
completion due to a default, there can be no assurance that the Association will
be able to recover all of the unpaid balance of, and accrued interest on, the
loan as well as related foreclosure and holding costs. In addition, the
Association may be required to fund additional amounts to complete the project
and may have to hold the property for an unspecified period of time. Such loans
may also be affected by the current weak economy in Southern California.
Consumer Loans
--------------
The Association also offers loans on deposit accounts and line of credit
loans that are 100% secured by the borrower's savings account. In the past, the
Association made loans on mobile homes, automobiles, boats and recreational
vehicles; however, the Association has ceased making such loans, for its
portfolio. The Association continues to offer such loans on behalf of other
consumer lenders, thereby generating fee income from such relationships. Mobile
home loans were originated for up to the lesser of 75% of the appraised value or
cost of the mobile home for a maximum of $100,000, with a term of up to 20
years. Mobile home loans were originated on either a fixed-rate or ARM basis. At
June 30, 1996, $5.1 million, or 2.1% of the Association's total loan portfolio
consisted of consumer loans and of that amount, $4.2 million were secured by
mobile homes. The Association also offers savings account loans and line of
credit loans.
Loan Approval Procedures and Authority
--------------------------------------
All loans over Federal Home Loan Mortgage Corporation ("FHLMC") and Federal
National Mortgage Association ("FNMA") conforming limits of $207,000 must be
approved by one or more members of the Association's Real Estate Loan Committee
or the Board of Directors, depending on the amount and type of loan. The Real
Estate Loan Committee is comprised of the President and Chief Executive Officer,
the Senior Vice-President/Chief Loan Officer, who acts as chairman of the
Committee, the Executive Vice President/Chief Operating Officer, the Vice
President/Wholesale Loan Manager and the Vice President/Construction Loan
Manager.
14
The Real Estate Loan Committee may specifically designate any loan officer
to approve loans on one-to-four-family residences, not to exceed FHLMC/FNMA
conforming single-family limits, which at June 30, 1996, was $207,000, located
in the Association's lending area. Loans on all properties other than one-to-
four-family residences require the signature of at least one member of the Real
Estate Loan Committee, regardless of the amount. An individual member of the
committee may approve loans not in excess of $300,000 except that loans insured
or guaranteed by the Federal Housing Administration or the Veterans
Administration may be committed to the maximum amounts allowed by such agencies.
Two members of the Committee, one of whom shall be the Committee Chairman or the
President/Chief Executive Officer, or the Executive Vice President, Chief
Operating Officer may approve loans not in excess of $600,000. The Real Estate
Loan Committee may approve loans, by a majority vote, that do not exceed $1
million, except loan requests in the amount of $250,000 or more by a multiple
borrower, whose accumulated loans would amount to $1 million or more must be
approved by the Board of Directors. Loan requests in excess of $1 million must
be submitted to the Board of Directors for approval.
For all loans originated by the Association, upon receipt of a completed
loan application from a prospective borrower, a credit report is ordered and
certain other information is verified by an independent credit agency and, if
necessary, additional financial information is required. An appraisal of the
real estate intended to secure the proposed loan is required, which is performed
by a licensed or certified independent real estate appraiser. The Board annually
approves the independent appraisers used by the Association and approves the
Association's appraisal policy. It is the Association's policy to obtain title
insurance on all real estate loans. Borrowers must also obtain hazard insurance
prior to closing. Borrowers generally are not required to advance funds on a
monthly basis together with each payment of principal and interest to a mortgage
escrow account from which the Association may make disbursements for items such
as real estate taxes or hazard insurance premiums. All loans with loan to value
ratios over 80% require escrow accounts for private mortgage insurance. Taxes
are required to be escrowed on loans in excess of 90% loan to value ratio.
Delinquencies and Classified Assets
-----------------------------------
Delinquent Loans. When a borrower fails to make a required payment on a
loan, the Association takes a number of steps to have the borrower cure the
delinquency and restore the loan to current status. In the case of residential
mortgage loans, the Association generally sends the borrower a written notice of
non-payment after the loan is first past-due. In the event payment is not then
received, additional letters and phone calls are made. If the loan is still not
brought current and it becomes necessary for the Association to take legal
action, the Association will generally commence foreclosure proceedings against
any real property that secures the loan. If a foreclosure action is instituted
and the loan is not brought current, paid in full, or refinanced before the
foreclosure sale, the real property securing the loan is sold at foreclosure by
the trustee named in the deed of trust. Property foreclosed upon is held by the
Association as real estate owned at its fair value less estimated cost to sell.
The Association ceases to accrue interest on all loans 90 days past-due. When a
loan first becomes 90 days past due, all previously accrued but unpaid interest
is deducted from interest income. In the event a non-accrual loan subsequently
becomes current, which would require that the borrower pay all past due
payments, late charges and any other delinquent fees owed, all income is
recognized by the Association and the loan is returned to accrual status.
In the case of consumer loans, the Association generally attempts to
contact the borrower by telephone after any loan payment is ten days past-due
and a senior loan officer reviews all collection efforts made if payment is not
received after the loan is 30 days past due.
15
In the case of commercial real estate loans, construction loans, and land,
acquisition and development loans, the Association generally sends the borrower
a written notice of non-payment upon expiration of the grace period. Decisions
as to when to commence foreclosure actions for commercial real estate loans and
construction loans are made on a case-by-case basis. The Association may
consider loan work-out arrangements with these types of borrowers in certain
circumstances. Upon initiation of foreclosure for loans secured by commercial or
other income producing property, these loans are reviewed to determine the
feasibility of seeking a Receiver to collect the income produced by the
property.
Federal regulations and the Association's Classification of Asset Policy
require that the Association utilize an internal asset classification system as
a means of reporting problem and potential problem assets. The Association has
incorporated the OTS internal asset classifications as a part of its credit
monitoring system. The Association currently classifies problem and potential
problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is
considered "Substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "Doubtful" have all of the weaknesses
inherent in those classified "Substandard" with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "Loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are required to be designated "Special Mention."
When an insured institution classifies one or more assets, or proportions
thereof, as Substandard or Doubtful, it is required to establish a general
valuation allowance for loan losses in an amount deemed prudent by management.
Allowance for Loan and Lease Losses (A.L.L.L.), which is a regulatory term,
represent loss allowances which have been established to recognize the inherent
risk associated with lending activities, but which, unlike specific allowances,
have not been allocated to particular problem assets. When an insured
institution classifies one or more assets, or proportions thereof, as "Loss," it
is required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge-off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions, there has
been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of the examination of
institutions by the OTS and the FDIC. While the Association believes that it has
established an adequate allowance for loan losses, there can be no assurance
that regulators, in reviewing the Association's loan portfolio, will not request
the Association to materially
16
increase at that time its allowance for loan losses, thereby negatively
affecting the Association's financial condition and earnings at that time.
Although management believes that adequate specific and general loan loss
allowances have been established, actual losses are dependent upon future events
and, as such, further additions to the level of specific and general loan loss
allowances may become necessary.
The Association classifies loans in accordance with the guidelines
described above. At June 30, 1996, the Association had $6.1 million in loans
classified as Substandard, and the largest loan so classified had a principal
balance of $878,000, no loans classified as Doubtful and $1.2 million of loans
classified as Loss. As of June 30, 1996, loans designated as Special Mention
include 51 loans totalling $11.1 million. These loans are designated as Special
Mention due to delinquencies or other identifiable weaknesses. At June 30, 1996,
the largest loan designated as Special Mention had a principal balance of $2.0
million and is secured by a mini-warehouse facility. This loan was originated in
1989 and has never been delinquent. The Special Mention classification was used
conservatively due to devaluation of real estate prices in the area. Real Estate
Owned acquired through foreclosure (REO-F) is also classified as substandard.
The Association appraises foreclosed properties at the time foreclosure
proceedings are initiated and on an annual basis thereafter. The Association
generally conducts external inspections on foreclosed properties on at least a
quarterly basis.
17
The following table sets forth delinquencies in the Association's loan
portfolio as of the dates indicated:
At June 30,
---------------------------------------------------------------------------------------
1994 1995
------------------------------------------ ------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
-------------------- ------------------- -------------------- -------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
----- -------- ----- -------- ----- -------- ----- --------
(Dollars in thousands)
One- to four-family(1)....................... 5 $290 12 $ 735 5 $298 23 $1,993
Multi-family................................. -- -- -- -- -- -- -- --
Commercial real estate....................... 1 552 1 1,394 -- -- 1 102
Construction................................. -- -- -- -- -- -- -- --
Acquisition, development and land............ -- -- 4 490 1 55 1 47
Consumer loans............................... 2 59 2 17 1 15 3 139
---- ---- ---- ----- ---- ---- ---- -----
Total.................................... 8 $901 19 $2,636 7 $368 28 $2,281
==== ==== ==== ===== ==== ==== ==== =====
Delinquent loans to gross loans.............. 0.43% 1.25% 0.18% 1.10%
At June 30,
---------------------------------------------
1996
---------------------------------------------
60-89 Days 90 Days or More
--------------------- ----------------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
----- -------- ----- --------
(Dollars in thousands)
One- to four-family(1)....................... 7 $866 11 $ 982
Multi-family................................. -- -- -- --
Commercial real estate....................... -- -- -- --
Construction................................. -- -- -- --
Acquisition, development and land............ 1 93 2 319
Consumer loans............................... -- -- -- --
---- ---- ---- -----
Total.................................... 8 $959 13 $1,301
==== ==== ==== =====
Delinquent loans to gross loans.............. .42% .56%
- ------------------------------
(1) Includes second mortgage residential loans.
18
Non-Accrual Loans and Real Estate Acquired Through Foreclosure. The
following table sets forth information regarding non-accrual loans delinquent 90
days or more, and REO. If all non-accrual loans had been performing in
accordance with their original terms and had been outstanding from the earlier
of the beginning of the period or origination, the Association would have
recorded interest income of $231,000, $177,000, and $124,000 for the fiscal
years ending June 30, 1994, 1995 and 1996, respectively, as opposed to $104,000,
$100,000, and $83,000 which was included in interest income for such periods,
respectively.
At June 30,
--------------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accrual mortgage loans delinquent
more than 90 days......................... $4,005 $7,740 $2,619 $2,141 $1,301
Non-accrual consumer loans delinquent
more than 90 days......................... 29 24 17 140 --
------- ------- ------- ------- -------
Total nonperforming loans.................... 4,034 7,764 2,636 2,281 1,301
Total investment in REO ..................... 1,785 1,324 3,554 1,893 1,460
------- ------- ------- ------- -------
Total nonperforming assets............. $5,819 $9,088 $6,190 $4,174 $2,761
===== ===== ===== ===== =====
Nonperforming loans to gross loans........... 1.69% 3.28% 1.25% 1.10% .56%
Nonperforming assets to total Company
assets.................................... 1.04% 1.69% 1.04% .63% .33%
Allowance for Estimated Loan and Real Estate Losses. The allowance for loan
losses is established through a provision for loan losses based on management's
evaluation of the risks inherent in its loan portfolio and the general economy.
Management reviews the Association's loan loss allowance on a monthly basis. In
determining levels of risk, management considers a variety of factors, including
asset classifications, economic trends, industry experience and trends, industry
and geographic concentrations, estimated collateral values, management's
assessment of the credit risk inherent in the portfolio, historical loan loss
experience, and the Association's underwriting policies ("Potential Risk
Factors"). In the past, these estimates have resulted in either additions to or
recaptures of the monthly provision, based upon management's current evaluation
of the loan and real estate portfolios. Accordingly, the amounts of such loan
and real estate loss provisions (credits) varied from period to period. The
allowance for loan losses is maintained at an amount management considers
adequate to cover losses in loans receivable which are deemed probable and
estimable. To determine the overall allowance, management reviews all loans by
loan category (i.e., one- to four-family, commercial real estate, multi-family,
etc.). Management then reviews loans by their loan classifications within each
loan category (i.e., whether loans are classified Pass, Special Mention,
Substandard, Doubtful or Loss). Adjustments to loan loss allowance are made by
the Association on a monthly basis based upon management's analysis of each
category of loans and analysis of Potential Risk Factors within each category.
The provision for loan losses will fluctuate on a monthly basis as changes occur
within the loan categories. Loan loss provisions may fluctuate as a result of
numerous factors, including new loan originations, loan repayments, prepayments
and changes in asset classifications. Loan loss provisions may be recaptured for
a particular loan category if management determines that factors that had
existed the prior month, which required higher provisions, are no longer
present. For loans transferred to REO, the
19
general loan loss provisions that previously had been established for those
loans are reversed. Specific reserves related to such loans are charged-off
through the allowance for loan losses. Conversely, loan loss provisions may be
increased if management becomes aware of factors elevating the risk in a
particular loan category, such as a material decrease in the collateral
underlying loans in a particular loan category. The Association will continue to
monitor and modify its allowances for loan losses as conditions dictate. Various
regulatory agencies, as an integral part of their examination process,
periodically review the Association's valuation allowance. These agencies may
require the Association to establish additional valuation allowances, based on
their judgments of the information available at the time of the examination.
At June 30, 1996, the Association had $1.1 million of REO-F, net of
reserves. If the Association acquires property through foreclosure, it is
initially recorded at the lower of cost or the fair value less estimated costs
to sell, which may require a charge to estimated loan losses. Subsequent
declines in value are charged to operations. It is the policy of the Association
to charge-off consumer loans when it is determined that they are no longer
collectible. The policy for loans secured by real estate, which comprise the
bulk of the Association's portfolio, is to establish loss reserves in accordance
with the Association's asset classification process, based on GAAP. It is the
policy of the Association to obtain an appraisal on all REO at the time of
foreclosure.
The Association had $996,000 of Real Estate held for Investment (REO-I),
net of reserves at June 30, 1996. REI is carried at the lower of cost or net
realizable value. All costs of anticipated disposition are considered in the
determination of net realizable value. Properties acquired for sale or
investment are recorded at cost, not to exceed net realizable value. In recent
years the Association has experienced losses from REO-F and REO-I. Losses from
real estate operations, net totalled $1.6 million ,$747,000, and $498,000
respectively for the fiscal years ended June 30, 1994, 1995 and 1996,
respectively.
Troubled Debt Restructures. At June 30, 1996 the Association had ten loans,
totalling $714,000, classified as troubled debt restructures. These loans are on
condominium units all located in the same complex, with a single borrower who
was the developer of the overall condominium complex. The Association had
previously financed the construction of the condominium project and presently
have a parcel of land, encompassed within this complex, as REO-F, carried on its
books at $100,000. The owner of the ten units was attempting to market them
under a lease with option to buy program, with hopes that the depressed market
would turn around. An agreement was entered into on November 20, 1995 that
temporarily interrupted the monthly principal and interest payments and allows
the borrower to pay interest only payments for a period of two years ending
October 31, 1997; thereafter the balance of payments will be recalculated to
allow full amortization of the outstanding debt by the originally established
maturity of each Note. At June 30, 1996 all loans were considered as performing
and the Association had established a specific loan loss provision aggregating
$198,000 or 27.7%, against the outstanding balance.
On July 1, 1995, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as
amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan-
Income Recognition and Disclosures. SFAS No. 114 generally requires all
creditors to account for impaired loans, except those loans that are accounted
for at fair value or at the lower of cost or fair value, at the present value of
the expected future cash flows discounted at the loan's effective interest rate
or, as a practical expedient, at the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent. SFAS No. 114
indicates that a creditor should evaluate the collectibility of both contractual
interest and contractual principal when assessing the need for a loss accrual.
The adoption of this statement did not have a material impact on the results of
operations or the financial position of the Company, taken as a whole. The
Company considers a loan to be impaired when it is probable that the Company
will be unable to collect all contractual principal and
20
interest payments in accordance with the terms of the original loan agreement.
However, in determining when a loan is impaired, management also considers the
loan documentation, current loan to value ratios, and the borrower's current
financial position. Included as impaired loans are all loans delinquent 90 days
or more and all loans that have a specific loss allowance applied to adjust the
loan to fair value. The accrual of interest on impaired is discontinued after a
90-day delinquent period or when, in management's opinion, the borrower may be
unable to meet payments as they become due. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Interest income is
subsequently recognized to the extent of full cash payments received an
accepted. The Company applies the measurement provision of SFAS No. 114 to all
loans in its portfolio except for single-family residence and installment loans
which are collectively evaluated for impairment. Impairment of loans having
recorded investments of $3.3 million at June 30, 1996 has been recognized in
conformity with SFAS No. 114, as amended by SFAS NO. 118. Recorded investments
in other impaired loans were $5.7 million at June 30, 1996. The average recorded
investment in impaired loans during the year ended June 30, 1996 was $8.3
million. The total allowance for loan losses related to these loans was $1.2
million at June 30, 1996. At June 30, 1996, loans totaling $7.6 million with
specific reserves of $1.0 million that the Company has classified impaired are
performing in accordance with the terms of their collateral agreements. Interest
income on impaired loans of $707,000 was recognized for cash payments received
in 1996.
21
The following table sets forth the Association's allowances for
estimated loan and real estate losses at the dates indicated.
At or For the Year Ended June 30,
------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance for estimated loan losses:
Balance at beginning of period.................... $760 $1,339 $3,157 $2,682 $2,694
Charge-offs:
One- to-four-family............................. -- (10) (36) (46) (320)
Multi-family.................................... -- -- -- -- --
Commercial real estate.......................... -- (56) (1,062) (636) (304)
Construction.................................... -- -- -- -- (10)
Acquisition, development and land............... -- (21) (188) (394) (20)
Consumer........................................ (6) (15) (66) (114) (26)
----- ----- ----- ----- ------
Total charge-offs.................................... (6) (102) (1,352) (1,190) (680)
Provision charged to income.......................... 585 1,920 877 1,202 1,054
----- ----- ----- ----- ------
Balance at end of period............................. $1,339 $3,157 $2,682 $2,694 $3,068
===== ===== ===== ===== ======
Allowance for estimated real estate losses:
Balance at beginning of period....................... $ 102 $121 $798 $1,841 $1,927
Charge-offs.......................................... (70) (240) (228) (547) (274)
Provision charged to income.......................... 89 917 1,271 633 264
----- ----- ----- ----- ------
Balance at end of period............................. $121 $798 $1,841 $1,927 $1,917
===== ===== ===== ===== ======
Ratio of net loan charge-offs during the period to
average loans outstanding during period(1)...... -- % .04% .61% .58% .57%
Ratio of allowance for estimated loan losses to
gross loans at end of period(1)................. .56 1.33 1.27 1.30 1.33
Ratio of allowance for estimated loan losses to
nonperforming loans at end of period............ 33.19 40.66 101.75 118.11 235.75
Ratio of allowance for estimated real estate losses
to total real estate owned(2)................... 1.59 16.39 25.82 33.07 48.03
Ratio of allowances for total estimated losses to
total nonperforming assets at end of period(3).. 25.09 43.52 73.07 110.71 94.18
________________________________
(1) Includes gross loan balances, net of undisbursed loan funds (excludes
loss reserves and unamortized yield adjustments).
(2) Includes only gross real estate owned balances (excludes specific and
general loss allowances).
(3) Nonperforming assets includes gross loan balances and gross real estate
owned balances.
22
The following table sets forth the Association's allowance for
estimated loan losses to total loans in each of the categories listed.
At June 30,
--------------------------------------------------------------------------------------
1992 1993 1994
----------------------------- -------------------------- ---------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans(1) Amount Total Loans(1) Amount Total Loans(1)
------ -------------- ------ -------------- ------ ------------
(Dollars in thousands)
Allocated(2):
Mortgage loans:
One- to four-family(3)................... $ -- 60.97% $ -- 63.33% $ 8 63.28%
Multi-family........................... -- 2.30 -- 2.21 -- 2.55
Commercial real estate................. 81 22.50 538 22.97 897 23.97
Construction........................... -- 4.49 -- 3.61 6 3.99
Acquisition, development and land...... -- 6.10 -- 4.74 48 3.18
Consumer loans............................ 11 3.64 25 3.14 28 3.03
----- ------- ------ ------ ------- ------
Total allocated allowances............. 92 100.00% 563 100.00% 987 100.00%
----- ======= ------ ====== ------- ======
Unallocated(4):
Mortgage loans:
One- to four-family(3)................. 277 60.97 373 63.33 274 63.28
Multi-family........................... 20 2.30 153 2.21 29 2.55
Commercial real estate................. 513 22.50 1,621 22.97 945 23.97
Construction........................... 198 4.49 226 3.61 65 3.99
Acquisition, development and land...... 104 6.10 125 4.74 207 3.18
Consumer loans............................ 135 3.64 96 3.14 175 3.03
----- ------- ------ ------- ------- -------
Total unallocated allowances.............. 1,247 100.00% 2,594 100.00% 1,695 100.00%
----- ======= ------ ======= ------- =======
Total allowances for estimated loan losses $1,339 $ 3,157 $ 2,682
===== ====== =======
At June 30,
-------------------------------------------------------------
1995 1996
------------------------------ ------------------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans(1) Amount Total Loans(1)
------ -------------- ------ --------------
(Dollars in thousands)
Allocated(2):
Mortgage loans:
One- to four-family(3)................ $ 359 65.50% $ 614 68.85%
Multi-family.......................... -- 2.58 4 2.35
Commercial real estate................ 267 23.25 266 19.56
Construction.......................... 202 2.81 -- 4.00
Acquisition, development and land..... 92 3.10 261 3.11
Consumer loans........................ 82 2.76 79 2.13
----- ------- ----- -------
Total allocated allowances......... 1,002 100.00% 1,224 100.00%
----- ======= ----- =======
Unallocated(4):
Mortgage loans:
One- to four-family(3)................ 310 65.50 354 68.85
Multi-family.......................... 27 2.58 33 2.35
Commercial real estate................ 884 23.25 983 19.56
Construction.......................... 35 2.81 19 4.00
Acquisition, development and land..... 254 3.10 305 3.11
Consumer loans........................ 182 2.76 150 2.13
----- ------- ----- -------
Total unallocated allowances............ 1,692 100.00% 1,844 100.00%
----- ======= ----- =======
Total allowances for estimated loan losses $2,694 $ 3,068
===== =====
___________________________________
(1) Percent of loans in category to total loans is based on gross loan
balances.
(2) Allocated allowances represent the estimable loss attributable to specific
loans.
(3) Includes second mortgage residential loans.
(4) Unallocated allowances are not allocated to specific loans and are based
upon management's determination of the following factors: composition of
portfolio and risks inherent in the loan portfolio; economic conditions and
the regulatory environment.
23
Investment Activities
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including U.S.Treasury obligations,
securities of various federal agencies, certain certificates of deposit of
insured banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Association must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations.
Historically, the Association has maintained liquid assets above the minimum OTS
requirements and at a level believed to be adequate to meet its normal daily
activities.
The investment policy of the Company, established by the Board of
Directors and implemented by the Finance Committee, attempts to provide and
maintain liquidity, generate a favorable return on investments without incurring
undue interest rate and credit risk. The Company's policies generally limit
investments to government and federal agency-backed securities and other non-
government guaranteed securities, including certificates of deposits, mortgage-
backed and related securities issued by the FHLMC, FNMA, Government National
Mortgage Association ("GNMA") or private issuers that have an AA credit rating
or higher and are collateralized by loans on residential real estate, corporate
debt obligations, that are marketable and rated in one of the four highest
categories by Moody's or Standard and Poor's and commercial paper rated in
either of the two highest grades by Moody's or Standard and Poor's, or paper
guaranteed by the issuer of securities meeting the rating requirement. Non-
agency issues are limited to 10% of total assets. The Company's policies provide
that all investment purchases be ratified by the Board at monthly Board
meetings. At June 30, 1996, the Company had mortgage-backed and related
securities held to maturity in the aggregate amount of $165.9 million with a
market value of $159.1 million. The held to maturity portfolio is accounted for
on an amortized cost basis. At June 30, 1996, the Company had $133.5 million in
mortgage-backed and related securities available for sale, which are accounted
for at fair value. At June 30, 1996, the Company's investment securities
portfolio included $15.3 million in mutual funds, which were designated as
available for sale securities and were carried at fair market value at that
date. These funds are comprised primary of government guaranteed mortgage-backed
securities.
In November 1995, the FASB issued a Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities: Questions and Answers (the Guide). The Guide allows for a one-time
reassessment of the classification of all securities and, in connection with
such reassessment, permits the reclassification of securities from the held-to-
maturity classification to the available for sale classification as of a single
date no later than December 31, 1995, without calling into question management's
intent to hold to maturity the remaining securities classified as held-to-
maturity. On December 29, 1995, the Association transferred $59.0 million of
investments and $24.3 million of mortgage-backed securities from the held-to-
maturity to the available-for-sale classification to enhance liquidity and
provide more flexibility through a variety of interest rate scenarios. The
transfer resulted in an unrealized gain of $600,000, net of tax, which was
included in the unrealized gains/losses on available-for-sale securities set
forth as a separate component of stockholder's equity.
Mortgage-Backed and Related Securities
--------------------------------------
The Company currently invests in mortgage-backed and related securities
and utilizes such investments to: (i) generate positive interest rate spreads on
large principal balances with minimal administrative expense as compared to the
competitive costs to originate loans; (ii) lower the credit risk
24
of the Company as a result of the guarantees provided by FHLMC, FNMA, and GNMA;
(iii) enable the Company to use these mortgage-backed securities as collateral
for financing in the capital markets; and (iv) increase the Company's liquidity.
In fiscal 1993, the Association established an available for sale category for
mortgage-backed securities, which included all fixed-rate mortgage-backed
securities. Since that time, the mortgage-backed securities are either held to
maturity or available for sale, depending upon the intent of the Association.
Mortgage-backed securities which are categorized as available for sale are
carried at fair value. At June 30, 1996, net mortgage-backed and related
securities totalled $299.4 million, or 36.2% of the Company's total assets. At
June 30, 1996, 51.5% of the mortgage-backed and related securities were
adjustable-rate and 48.5% were fixed-rate. The mortgage-backed and related
securities in these portfolios had coupon rates ranging from 6.0% to 12.5% and
had a weighted average yield of 7.06% at June 30, 1996. The estimated fair value
of the Company's mortgage-backed securities available for sale at June 30, 1996,
was $100.3 million, which is $373,000 greater than its amortized cost of $99.9
million.
Related securities at June 30, 1996, consisted of CMOs, including
REMICs, a type of CMO, which had a net carrying value of $39.9 million at June
30, 1996. A CMO is a special type of pass-through debt in which the stream of
principal and interest payments on the underlying mortgages or mortgage-backed
securities is used to create classes with different maturities and, in some
cases, amortization schedules, as well as a residual interest, with each such
class possessing different risk characteristics. The Association's CMOs are
either guaranteed by the FNMA, FHLMC or the GNMA or are private issuer CMOs that
have the highest credit rating by Moody's or Standard and Poors (i.e., "AAA").
Private issue CMOs held by the Association were structured primarily by the
Resolution Trust Corporation ("RTC") using unsecuritized whole loans. The
underlying collateral carries no guarantee, such as that offered by FNMA, FHLMC
or GNMA; however, these floating rate tranches do have the subordination
protection of other tranches in the pool as well as private insurance
protection, usually amounting to between 5% and 15% of the pool. This type of
support is required to warrant the highest rating by Moody's or Standard and
Poors. Although lower ratings are available in lower tranches, the Association's
investment policies limit the Association's investment to a double A (AA) rating
or better issued by Moody's or Standard & Poors. The Association monitors the
credit ratings on its CMOs on a regular and consistent basis. The ratings issued
by Moody's and Standard and Poors relate solely to credit risk and are not
reflective of interest rate risk that may be incurred.
The Association also has one stripped mortgage-backed security,
interest-only ("IO"), in which the Association receives all, or substantially
all, of the interest payments on an underlying pool of mortgages. The collateral
underlying the IO are 30-year fixed rate FNMA guaranteed mortgage-backed
securities with pass-through coupon rates of 11.50%. The IO was acquired in 1991
with a face amount of $5.2 million and a discounted purchase price of $1.8
million or 35.5% of the face amount. The IO was acquired to provide protection
against rising interest rates. Due to rapid prepayments of the collateral
underlying the IO, which carried coupon rates significantly in excess of
prevailing market rates, and which occurred when interest rates were decreasing
from October 1991 through March 1994, cash flows were significantly reduced. As
a result, the Association had to write-down the IO on a monthly basis. As
interest rates began to rise in the last two quarters of 1994 and into 1995,
required write-downs on the IO have significantly decreased. During the fiscal
year ended June 30, 1996, no write-downs were required. During the fiscal ended
June 30, 1996 the Association received cash flow from this IO totalling
$126,000, of which $57,000 was recognized as income and $69,000 was applied as a
reduction of the outstanding balance. IOs are extremely sensitive to changes in
prepayments and interest rates. Because of the uncertainties of the interest
cash flow, IOs typically are acquired at a substantial discount to their
anticipated cash flow. The Association reviews on a monthly basis the expected
recoverability of its investment in the IO. The OTS' "Statement of Policy on
Securities Activities," set forth in Thrift Bulletin 52 ("Bulletin") requires
depository institutions to establish prudent policies and strategies for
securities
25
transactions, describes securities trading and sales practices that are
unsuitable when conducted in an investment portfolio and sets forth certain
factors that must be considered when evaluating whether the reporting of an
institution's investments is consistent with its intent and ability to hold such
investments. The Bulletin also establishes a framework for identifying when
certain mortgage derivative products are high-risk mortgage securities that must
be reported in a "trading" or "held for sale" account. The Association believes
that it currently holds and reports its securities and loans in a manner
consistent with the Bulletin. Pursuant to the Bulletin, stripped mortgage-backed
securities nearly always are deemed to be high risk. However, IOs may be used
for managing the interest-rate risk inherent in mortgage portfolios, since
prepayments cause the values of an IO strip to move in the opposite direction
from those of mortgages and traditional fixed-income securities. The Association
and Company will not invest in IOs in the future.
At June 30, 1996, CMOs classified as available for sale totalled $33.3
million and mortgage-backed and related securities held to maturity totalled
$165.9 million. At June 30, 1996, mortgage-related securities totalled $39.9
million, or 4.8% of the Company's total assets and had a market value of $39.8
million and a weighted average yield of 6.7%. Approximately 83.4% of the
Association's CMOs at June 30, 1996, had floating rates which adjust on a
monthly or quarterly basis. The Association's floating rate CMOs may be subject
to volatile price movements which typically result from prepayments on the
underlying obligations.
Mortgage-backed securities generally yield less than the loans that
underlie such securities because of the cost of payment guaranties or credit
enhancements that result in nominal credit risk. In addition, mortgage-backed
securities are more liquid than individual mortgage loans and may be used to
collateralize obligations of the Association. In general, mortgage-backed
securities issued or guaranteed by FNMA and FHLMC and certain AA-rated and AAA-
rated mortgage-backed pass-through securities are weighted at no more than 20%
for risk-based capital purposes, and mortgage-backed securities issued or
guaranteed by GNMA are weighted at 0% for risk-based capital purposes, compared
to an assigned risk weighing of 50% to 100% for whole residential mortgage
loans. These types of securities allow the Association to optimize regulatory
capital to a greater extent than non-securitized whole loans.
While mortgage-backed securities carry a reduced credit risk as
compared to whole loans, such securities remain subject to the risk that a
fluctuating interest rate environment, along with other factors such as the
geographic distribution of the underlying mortgage loans, may alter the
prepayment rate of such mortgage loans and so affect both the prepayment speed,
and value, of such securities. Specifically, investments in mortgage-backed and
related securities involve risks that actual prepayments may exceed prepayments
estimated over the life of the security that may result in a loss of any
premiums paid for such instruments thereby reducing the net yield on such
securities. Conversely, if interest rates increase, the market value of such
securities may be adversely affected. In contrast to mortgage-backed securities
in which cash flow is received (and, hence, prepayment risk is shared) pro rata
by all securities holders, the cash flows from the mortgages or mortgage-backed
securities underlying REMICs or CMOs are segmented and paid in accordance with a
predetermined priority to investors holding various tranches of such securities
or obligations. A particular tranche of REMICs or CMOs may therefore carry
prepayment risk that differs from that of both the underlying collateral and
other tranches.
The Company had an amount of mortgage-backed and related securities
issued by the following entities which had a total carrying value in excess of
10% of the Company's equity at June 30, 1996.
26
The following table sets forth the composition of the Association's and
Company's mortgage-backed and related securities in dollar amounts and in
percentages at the dates indicated.
At June 30,
-----------------------------------------------------------------------
1992 1993 1994
----------------------- ----------------------- ---------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in thousands)
Mortgage-backed and related
securities(1):
CMOs - Agency backed(2) ............. $ 39,708 15.88% $ 28,503 11.57% $ 23,664 7.09%
CMOs - Non-agency ................... 28,746 11.49 40,456 16.43 32,189 9.64
FHLMC................................ 29,174 11.67 29,652 12.04 21,539 6.45
FNMA................................. 148,232 59.27 96,697 39.26 155,499 46.59
GNMA................................. 4,237 1.69 50,994 20.70 100,901 30.23
-------- ------ -------- ------ -------- ------
Total mortgage-backed and related
securities........................... $250,097 100.00% $246,302 100.00% $333,792 100.00%
======== ====== ======== ====== ======== ======
At June 30,
------------------------------------------------
1995 1996
------------------------- ---------------------
Percent Percent
Amount of Total Amount of Total
------ -------- ------ --------
(Dollars in thousands)
Mortgage-backed and related
securities(1):
CMOs - Agency backed(2) ............. $ 17,002 5.33% $ 20,184 6.74%
CMOs - Non-agency ................... 23,419 7.34 19,739 6.60
FHLMC ............................... 31,865 9.98 25,527 8.52
FNMA ................................ 146,715 45.98 150,565 50.28
GNMA ................................ 100,113 31.37 83,429 27.86
-------- ------ -------- ------
Total mortgage-backed and related
securities........................... $319,114 100.00% $299,444 100.00%
======== ====== ======== ======
______________________________________
(1) Includes $51.7 million, $133.5 million, $110.6 million, and $133.5 million
mortgage-backed and related securities available for sale at June 30, 1993,
1994, 1995, and 1996 respectively.
(2) Includes an interest-only stripped mortgage-backed security with a book
value of $1.6 million, $880,000, $561,000, $395,000 and $325,000 at June 30,
1992, 1993, 1994, 1995 and 1996, respectively.
27
The following tables set forth certain information regarding carrying
and market values and percentage of total carrying values of the Association's
and Company's mortgage-backed and related securities portfolio.
At June 30,
-------------------------------------------------------------------
1994 1995
--------------------------------- ------------------------------
Carrying Market Carrying Market
Value % of Total Value Value % of Total Value
-------- ---------- ------ -------- ---------- ------
(Dollars in thousands)
Held to maturity:
Mortgage-backed securities:
GNMA........................................... $100,901 30.23% $ 98,197 $100,113 31.37% $101,016
FHLMC.......................................... 8,425 2.53 8,740 21,238 6.66 21,902
FNMA........................................... 90,370 27.07 81,207 86,739 27.18 83,893
------- ----- ------- ------- ----- -------
Total mortgage-backed securities............. 199,696 59.83 188,144 208,090 65.21 206,811
------- ----- ------- ------- ----- -------
Mortgage-related securities:
CMOs - Agency backed(1)........................ 607 0.18 532 432 .13 411
CMOs - Non-agency.............................. -- -- -- -- -- --
------- ----- ------- ------- ----- -------
Total mortgage-related securities............ 607 0.18 532 432 .13 411
------- ----- ------- ------- ----- -------
Total mortgage-backed and related
securities.................................. $200,303 60.01 $188,676 $208,522 65.34 $207,222
======= ===== ======= ======= ===== =======
Available for sale:
Mortgage-backed securities:
GNMA........................................... $ -- --% $ -- $ -- --% $ --
FHLMC.......................................... 13,114 3.93 13,114 10,627 3.33 10,627
FNMA........................................... 65,129 19.51 65,129 59,976 18.80 59,976
------- ----- ------- ------- ----- -------
Total mortgage-backed securities............. 78,243 23.44 78,243 70,603 22.13 70,603
------- ----- ------- ------- ----- -------
Mortgage-related securities:
CMOs - Agency backed........................... 23,057 6.91 23,057 16,570 5.19 16,570
CMOs - Non-agency.............................. 32,189 9.64 32,189 23,419 7.34 23,419
------- ----- ------- ------- ----- -------
Total mortgage-related securities............ 55,246 16.55 55,246 39,989 12.53 39,989
------- ----- ------- ------- ----- -------
Total available for sale securities.......... 133,489 39.99 133,489 110,592 34.66 110,592
------- ----- ------- ------- ----- -------
Total mortgage-backed and related securities...... $333,792 100.00% $322,165 $319,114 100.00% $317,814
======= ======= ======= ======= ======= =======
At June 30,
--------------------------------
1996
--------------------------------
Carrying Market
Value % of Total Value
--------- ---------- ------
(Dollars in thousands)
Held to maturity:
Mortgage-backed securities:
GNMA........................................... $67,293 22.47% $67,119
FHLMC.......................................... 10,454 3.49 10,717
FNMA........................................... 81,515 27.22 74,685
------- ----- -------
Total mortgage-backed securities............. 159,262 53.18 152,521
------- ----- -------
Mortgage-related securities:
CMOs - Agency backed(1)........................ 6,666 2.23 6,563
CMOs - Non-agency.............................. -- -- --
------- ----- -------
Total mortgage-related securities............ 6,666 2.23 6,563
------- ----- -------
Total mortgage-backed and related
securities.................................. $165,928 55.41% $159,084
======= ===== =======
Available for sale:
Mortgage-backed securities:
GNMA........................................... $ 16,136 5.39% $ 16,136
FHLMC.......................................... 15,073 5.03 15,073
FNMA........................................... 69,050 23.06 69,050
------- ----- -------
Total mortgage-backed securities............. 100,259 33.48 100,259
------- ----- -------
Mortgage-related securities:
CMOs - Agency backed........................... 13,518 4.51 13,518
CMOs - Non-agency.............................. 19,739 6.60 19,739
------- ----- -------
Total mortgage-related securities............ 33,257 11.11 33,257
------- ----- -------
Total available for sale securities.......... 133,516 44.59 133,516
------- ----- -------
Total mortgage-backed and related securities...... $299,444 100.00% $292,600
======= ====== =======
- ----------------------------------
(1) Includes interest-only stripped mortgage-backed security with a book value
of $561,000, $395,000, and $325,000 at June 30, 1994, 1995 and 1996,
respectively.
28
The following table shows the maturity or period to repricing of the
Association and the Company's mortgage-backed and related securities portfolio
at June 30, 1996. At June 30, 1996, the weighted average maturity of the
Association's and Company's mortgage-backed securities portfolio was 24.4 years.
At June 30, 1996
-------------------------------------------------------------------------------------------------
Fixed Rate ARM Total
Mortgage-Backed Mortgage-Backed Fixed-Rate Mortgage-Backed and
Securities Securities CMOs ARM CMOs Related Securities (1)
--------------- --------------- ---------- -------- ----------------------
(In thousands)
Amounts due:
Within one year...................... $ 2,062 $ 118,930 $ -- $ 32,550 $34,612
After one year:
One to three years .................. 242 -- -- -- 242
Three to five years ................. 10,949 -- -- -- 10,949
Five to 10 years .................... 7,507 -- -- -- 7,507
10 to 20 years ..................... 2,469 -- 6,808 -- 11,409
Over 20 years ..................... 115,557 -- -- -- 232,355
------- ------- ----- ------ -------
Total due or repricing
after one year..................... 136,724 118,930 6,808 -- 262,462
------- ------- ----- ------ -------
Total amounts due or repricing..... 138,786 118,930 6,808 32,550 297,074
------- ------- ----- ------ -------
Adjusted for:
Unamortized yield adjustments........ (76) 1,508 (177) 367 1,622
Unrealized gain/loss................... (217) 590 -- 375 748
------- ------- ----- ------ -------
Total mortgage-backed
and related securities............. $138,493 $121,028 $ 6,631 $ 33,292 $299,444
======= ======= ===== ====== =======
__________________________________
(1) Includes $133.5 million of mortgage-backed and related securities
available for sale at June 30, 1996.
The following table sets forth the activity in the Association's and
the Company's mortgage-backed and related securities during the periods
indicated.
For the Years Ended June 30,
---------------------------------------------
1994 1995 1996
---- ---- ----
(In thousands)
Mortgage-backed and related securities:
At beginning of period................. $246,302 $333,792 $319,114
Mortgage-backed securities purchased. 157,049 23,124 21,272
Mortgage-backed securities sold...... (19,487) -- --
CMOs purchased....................... -- -- 6,804
CMOs sold and matured................ -- (6,349) --
Amortization and repayments.......... (50,169) (32,868) (46,985)
Change in unrealized gain (loss)....... 97 1,415 (761)
------- ------- ---------
Balance of mortgage-backed and related
securities at end of period(1)..... $333,792 $319,114 $299,444
======= ======= =======
_____________________________________________
(1) Includes $133.5 million of mortgage-backed and related securities available
for sale at June 30, 1996.
29
The table below sets forth certain information regarding the carrying
value, weighted average yields and maturities of the Association and the
Company's mortgage-backed and related securities at June 30, 1996.
At June 30, 1996
---------------------------------------------------------------------------------------
Over One to Over Five to
One Year or Less Five Years Ten Years Over Ten Years
------------------- ------------------- -------------------- -----------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- ------- -------- -------- -------- ------- -------- --------
(Dollars in thousands)
Held to maturity:
FNMA........................ $ -- --% $ -- --% $ 58 8.75% $ 81,457 6.67%
FHLMC....................... 2,029 8.31 4,620 7.53 1,152 8.37 2,653 10.16
GNMA........................ -- -- -- -- 53 6.50 67,240 7.08
CMOs(1)..................... -- -- -- -- 325 11.50 6,341 5.84
--- ---- --- --- ---- ------ ------ -----
Total mortgage-backed and related
securities held to maturity 2,029 8.31 4,620 7.53 1,588 8.96 157,691 6.87
----- ----- ----- ---- ----- ---- ------- ----
Available for sale:
FNMA........................ -- -- -- -- 6,137 6.73 62,913 7.66
FHLMC....................... -- -- 6,646 7.56 -- -- 8,427 7.79
GNMA........................ -- -- -- -- -- -- 16,136 7.07
CMOs........................ -- -- -- -- -- -- 33,257 6.97
---- ---- ---- ---- ---- ---- ------ ----
Total mortgage-backed and related
securities available for sale -- -- 6,646 7.56 6,137 6.73 120,733 7.40
---- ---- ------ ----- ------ ----- ------- ----
Total mortgage-backed and related
securities.................. $ 2,029 8.46% $11,266 7.50% $7,725 7.23% $278,424 7.02%
======= ===== ======= ==== ====== ==== ======== ====
At June 30, 1996
------------------------------------------------------
Mortgage-Backed and Related Securities Totals
----------------------------------------------------
Weighted
Average
Remaining Estimated Weighte
Years to Carrying Market Average
Maturity Value Value Yield(2)
-------- -------- --------- --------
(Dollars in thousands)
Held to maturity:
FNMA........................... 28 $81,515 $74,685 6.59%
FHLMC.......................... 6 10,454 10,717 8.44
GNMA........................... 26 67,293 67,119 7.00
CMOs(1)........................ 13 6,666 6,563 6.26
--- ------- ------- -----
Total mortgage-backed and related
securities held to maturity.. 25 165,928 159,084 6.86
--- ------- ------- -----
Available for sale:
FNMA........................... 24 69,050 69,050 7.54
FHLMC.......................... 14 15,073 15,073 7.58
GNMA........................... 26 16,136 16,136 7.00
CMOs........................... 25 33,257 33,257 6.81
--- ------- ------- -----
Total mortgage-backed and related
securities available for sale.. 23 133,516 133,516 7.30
--- ------- ------- -----
Total mortgage-backed and related
securities..................... 24 $299,444 $292,600 7.06%
=== ======== ======== =====
_____________________________
(1) Includes an interest-only stripped mortgage-backed security with a carrying
value of $325,000 at June 30, 1996.
(2) Weighted average yield is calculated based on the average historical
amortized cost balance.
30
The following table sets forth certain information regarding the
carrying and market values of the Association's and Company's other investment
securities and interest-earning assets at the dates indicated:
At June 30,
-----------------------------------------------------------------------
1994 1995 1996
-------------------- --------------------- ------------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
--------- --------- --------- ---------- ----------- ----------
(In thousands)
Investment securities:
U.S. government and
federal agencies.................... $ -- $ -- $ 19,032 $ 19,160 $152,631 $151,910
Repurchase agreement................... -- -- -- -- 4,075 4,075
Federal funds sold..................... 13,625 13,625 75,275 75,275 88,460 88,460
FHLB deposits.......................... 1,590 1,590 6,767 6,767 5,245 5,245
------ ------ ------- ------- ------- -------
Subtotal............................ 15,215 15,215 101,074 101,202 250,411 249,690
FHLB stock............................... 4,045 4,045 4,319 4,319 4,436 4,436
Mutual funds(1) 15,097 15,097 15,408 15,408 15,283 15,283
------- ------- ------- ------- ------- -------
Total............................... $ 34,357 $ 34,357 $120,801 $120,929 $270,130 $269,409
====== ====== ======= ======= ======= =======
____________________________________________
(1) Mutual funds (which are issued by Smith Breeden) are designated as
available for sale securities and are carried at fair value.
31
Sources of Funds
General
-------
Deposits are a major source of the Association's funds for lending and
other investment activities and general business purposes. In addition to
deposits, the Association derives funds from principal and interest payments on
loans, proceeds from sales of mortgage-backed securities, maturities of
investment securities, advances from the FHLB, dollar reverse repurchase and
reverse repurchase agreements and other borrowings. Although loan repayments are
a relatively stable source of funds, deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions. Borrowings may be used on a short-term basis to compensate
for reductions in the availability of funds from other sources. They may also be
used on a longer term basis for general business purposes.
Deposits
--------
The Association offers a variety of deposit accounts having a range of
interest rates and terms. The Association's deposits principally consist of
fixed-term certificates, regular passbook accounts, non-interest-bearing
checking, NOW accounts, money market and deposit accounts. Of the deposit
accounts, approximately $60.4 million, or 9.0% consist of individual retirement
accounts ("IRA") or Keogh retirement accounts. The flow of deposits is
influenced significantly by general economic conditions, changes in money market
and prevailing interest rates and competition. The Association's deposits are
obtained primarily from the areas surrounding its offices. The Association
relies primarily on customer service and long-standing relationships with
customers and media advertising of certain competitively priced products, such
as off-term certificates of deposit with terms of 7 days and 8, 15, 21 or 30
months, for example, to attract and retain deposits. Certificate accounts in
excess of $100,000 are offered by the Association to the general public. The
Association has used brokers to obtain deposits in the past; however, the
Association has not used brokers since 1988, and as of June 30, 1996 had no
broker accounts outstanding, since the last broker account matured in June 1996
at $10.0 million.
The following table presents the deposit activity of the Association
for the periods indicated.
For the Fiscal Year Ended June 30,
--------------------------------------------
1994 1995 1996
---- ---- ----
(In thousands)
Branch Deposits Purchased(1)......................... -- -- $ 185,189
Deposits............................................. $580,871 $642,649 569,642
Withdrawals.......................................... 585,993 668,776 582,597
Withdrawals in excess of deposits.................... (5,122) (26,127) (12,955)
Interest credited on deposits........................ 15,632 17,505 25,154
------- ------ -------
Net increase (decrease) in deposits.................. $ 10,510 $ (8,622) $ 197,388
====== ======= =========
(1) Branch deposits were acquired on June 21, 1996 from Hawthorne Savings Bank.
See Description of Business - Market Area and Competition.
32
At June 30, 1996, the Association had outstanding $82.6 million in
certificate of deposit accounts in amounts of $100,000 or more, maturing as
follows:
Weighted
Amount Average Rate
------ ------------
(In thousands)
Maturity Period:
Three months or less................................... $ 26,245 5.48%
Over three through six months.......................... 16,981 5.53
Over six through 12 months............................. 23,638 5.56
Over 12 months......................................... 15,734 6.14
------- -----
Total............................................... $82,598 5.64%
======= =====
33
The following table sets forth the distribution of the Association's
deposit accounts for the periods indicated and the weighted average nominal
interest rates on each category of deposits presented.
For the Year Ended June 30,
-------------------------------------------------------------------------
1994 1995
------------------------------------- -------------------------------
Weighted Weighted
Percent Average Percent Average
Average of Total Nominal Average of Total Nominal
Balance Deposits Rate Balance Deposits Rate
------- -------- -------- ------- -------- --------
(Dollars in thousands)
Passbook accounts........................... $ 67,107 14.07% 2.13% $ 58,469 12.32% 2.07%
NOW accounts................................ 34,565 7.25 1.37 31,801 6.70 1.09
Non-interest-bearing accounts............... 2,275 0.48 -- 3,959 0.83 --
------- ----- ------ ------ ----- -----
Total deposit accounts................. 103,947 21.80 1.83 94,229 19.85 1.65
------- ----- ------ ------ ----- -----
Money market investment accounts............ 43,972 9.22 2.36 35,622 7.50 2.65
------- ----- ------ ------ ----- -----
Certificate accounts:
7-day..................................... -- -- -- -- -- --
3-6 month ................................ 20,309 4.26 3.09 13,319 2.80 3.58
6-12 month................................ 87,341 18.31 3.46 81,143 17.08 4.50
1 - 2 year................................ 48,910 10.25 3.59 63,250 13.32 4.67
2 - 3 year................................ 35,954 7.54 4.62 49,802 10.49 4.94
3 - 5 year................................ 22,846 4.79 6.00 20,781 4.37 5.39
5 - 7 year................................ 24,745 5.19 6.77 26,467 5.57 6.52
7 - 10 year............................... 16,222 3.40 7.59 16,440 3.46 5.41
I.R.A. - Keogh accounts................... 45,092 9.45 5.92 46,142 9.71 5.98
Jumbo accounts(1)......................... 27,727 5.81 4.86 27,752 5.84 5.38
------- ----- ------ ------ ----- -----
Total Certificate Accounts............. 329,146 68.98 4.67 345,096 72.65 5.17
------- ----- ------ ------- ----- -----
Total deposits......................... $477,065 100.00% 3.84% $474,947 100.00% 4.29%
======= ====== ==== ======== ====== ====
For the Year Ended June 30,
---------------------------------
1996
---------------------------------
Weighted
Percent Average
Average of Total Nominal
Balance Deposits Rate
------- -------- --------
(Dollars in thousands)
Passbook accounts.......................... $58,169 12.05% 2.56%
NOW accounts............................... 29,780 6.17 1.18
Non-interest-bearing accounts.............. 5,520 1.14 --
------- ----- -----
Total deposit accounts................ 93,469 19.36 1.97
------- ----- -----
Money market investment accounts........... 26,951 5.58 3.27
------- ----- -----
Certificate accounts:
7-day.................................... 336 0.07 4.57
3-6 month ............................... 10,658 2.21 4.73
6-12 month............................... 114,268 23.67 5.38
1 - 2 year............................... 61,182 12.67 5.78
2 - 3 year............................... 47,254 9.79 5.52
3 - 5 year............................... 13,848 2.87 5.23
5 - 7 year............................... 24,025 4.98 6.33
7 - 10 year.............................. 14,576 3.02 7.24
I.R.A. - Keogh accounts.................. 46,574 9.65 6.10
Jumbo accounts(1)........................ 29,579 6.13 5.53
------- ----- -----
Total Certificate Accounts............ 362,300 75.06 5.69
------- ----- -----
Total deposits........................ $482,720 100.00% 4.84%
======= ====== ====
- -----------------------------------
(1) Includes $5.0 million of broker deposit funds for the fiscal years ended
June 30, 1994, and 1995.
34
The following table presents, by various rate categories, the amount of
the Association's certificate accounts outstanding at the dates indicated and
the periods to maturity of the certificate accounts outstanding at June 30,
1996.
At June 30, Period to Maturity from June 30, 1996
-------------------------------------------- -------------------------------------------------------
1993 1994 1995 1996 Within 1 Year 1 to 3 Years Thereafter Total
---- ---- ---- ---- ------------ ------------ ---------- -----
(In thousands)
Certificate accounts:
3.99% or less........ $ 173,877 $167,992 $2,823 $ 477 $ 415 $ 62 $ -- $ 477
4.00% to 4.99%....... 28,152 61,291 72,754 71,280 69,126 2,077 77 71,280
5.00% to 5.99%....... 33,349 44,893 149,024 359,282 295,563 57,695 6,024 359,282
6.00% to 6.99%....... 29,255 25,130 92,718 80,196 56,581 16,924 6,691 80,196
7.00% to 7.99%....... 23,392 18,813 17,468 12,350 6,735 4,691 924 12,350
8.00% to 8.99%....... 27,101 19,684 15,348 5,083 447 4,034 602 5,083
9.00% to 9.99%....... 2,062 953 238 172 35 137 -- 172
10.00% and over...... 606 953 -- -- -- -- -- --
--------- ------- ------ ------- --------- ------- ------ -------
Total.......... $317,794 $339,019 $350,373 $528,840 $428,902 $85,620 $14,318 $528,840
======= ======= ======= ======= ======= ====== ====== =======
35
Borrowings
From time to time, the Association obtains advances from the FHLB which
are secured by a pledge of certain mortgage loans and mortgage-backed
securities. Such advances are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. The
maximum amount that the FHLB will advance to member institutions, including the
Association, for purposes other than meeting withdrawals, fluctuates from time
to time in accordance with the policies of the OTS and the FHLB. In fiscal 1994
the Association increased its average balance of FHLB advances by $50 million,
which funds were borrowed for a five year term at a weighted average cost of
4.97% and invested by the Association in mortgage-backed securities insured by
the FNMA with a 6.50% coupon rate and weighted average yield of 6.27%. This
limited arbitrage has enabled the Association to realize income equal to the
spread between the cost of the borrowed funds and the yield on the mortgage-
backed securities while incurring limited credit risk. In October 1995 the
Association borrowed an additional $50 million from the FHLB for a one year term
at 5.70%. Proceeds were used to purchase a FHLB Note, 7.25%, 12 year, callable
in 12 months (Oct '96). In June 1996, the note was prepaid utilizing proceeds
obtained in the purchase of three branches from Hawthorne Savings F.S.B. Such
proceeds were received in the assumption of savings deposit liabilities with a
nominal interest cost of 5.18%, thus widening the spread on the investment to
207 basis points. At June 30, 1996, the Association had $70.0 million of FHLB
advances outstanding.
The Association also entered into a Reverse Repurchase Agreement in
November 1995 for $49.4 million to facilitate the purchase of a $50.0 million
FHLB Note, 7.35%, 10 year, callable in 3 months (Feb '96). The initial rate on
the borrowing was 5.74%. The Note was called on February 28, 1996. On March 7,
1996 the transaction was repeated whereby a $50.0 million FHLB Note, 7.42%, 15
years, callable in 3 months (June '96) was purchased; the Reverse Repurchase
Agreement of $49.4 million had a rate of 5.21%. This Note was not called in June
therefore the Reverse Repurchase Agreement was renewed for 17 days to June 24,
1996 at a rate of 5.33%. The borrowing was paid-off at maturity utilizing
proceeds obtained in the purchase of three branches from Hawthorne Savings,
F.S.B. The Association currently recognizes an interest spread of 224 basis
points on this investment. At June 30, 1996 the Association had no outstanding
Reverse Repurchase Agreement borrowings.
In addition, the Association, from time to time, enters into dollar
reverse repurchase agreements with nationally recognized primary securities
dealers and financial institutions, which are similar to reverse repurchase
agreements, whereby mortgage-backed securities are used as collateral for short-
term borrowing (usually 30-60 days) as a means to enhance interest rate yield on
the Association's mortgage-backed securities portfolio. The Association's
borrowing policy sets forth various terms and limitations with respect to dollar
reverse repurchase agreements, including acceptable types and maturities of
collateral securities and the maximum amount of borrowings from any one approved
broker. Current market rates are used to price the transaction and the
Association invests such funds in either Federal Funds, FHLB certificates of
deposit or AA rated corporate notes for an exact matching term. The
Association's borrowing policy prohibits the Association from entering into a
dollar reverse repurchase agreement that would earn the Association a spread of
less than 1%. Current market conditions have made dollar reverse repurchase
agreements less attractive due to the lack of market demand and the low spreads
offered, and, as such, the Association has not entered into a dollar reverse
repurchase agreement since May, 1994. The Association does not use such
borrowings as a means to fund its normal operations; however, the Association
anticipates that it will use such borrowings as a source of funds in the
foreseeable future if market conditions make such borrowings attractive.
36
The following table sets forth certain information regarding the
Association's borrowed funds at or for the periods ended on the dates indicated:
At or For the Year Ended June
----------------------------------------------
1994 1995 1996
---- ---- ----
(Dollars in thousands)
FHLB - Advances:
Average balance outstanding during period............. $54,615 $70,000 $103,333
Maximum amount outstanding at any month-end
during period...................................... 70,000 70,000 120,000
Balance outstanding at end of period.................. 70,000 70,000 70,000
Weighted average interest rate during period.......... 5.06% 5.20% 5.36%
Weighted average interest rate at end of period....... 5.20 5.20 5.20
Other Borrowings:
Average balance outstanding during period............. $16,215 $ -- 24,719
Maximum amount outstanding at any month-end
during period...................................... 84,423 -- 49,438
Balance outstanding at end of period.................. -- -- --
Weighted average interest rate during period.......... 2.01% -- 5.48
Weighted average interest rate at end of period....... -- -- --
Total Borrowings:
Average balance outstanding during period............. $70,830 $70,000 $128,052
Maximum amount outstanding at any month-end
during period...................................... 154,423 70,000 169,438
Balance outstanding at end of period.................. 70,000 70,000 70,000
Weighted average interest rate during period.......... 4.36% 5.20% 5.38%
Weighted average interest rate at end of period....... 5.20 5.20 5.20
37
Subsidiary Activities
First Hemet Corporation is a wholly owned subsidiary of HF Financial
Corporation, a wholly owned subsidiary of the Association that was incorporated
January 10, 1973. First Hemet provides trustee services for the Association, is
engaged in real estate development, and receives commissions from the sale of
mortgage life insurance, fire insurance and annuities. For the fiscal years
ended June 30, 1994, 1995, and 1996, First Hemet had approximately $3.1 million,
$3.2 million, and $2.5 million in total assets, respectively, and a pre-tax loss
of approximately $188,000, $467,000, and $77,000 respectively.
Currently, First Hemet is involved in the following real estate
developments:
Vista Bonita I - First Hemet acquired title to a 112-lot residential
subdivision in 1989 and retained a general contractor under a management
agreement to develop the off-site improvements and construct 112 homes. The
subdivision is located in Hemet and, as of June 30, 1996, 96 homes have been
sold. New homes were constructed based on sales of existing inventory, which was
limited to 3 unsold homes at a time. The projected completion date for this
project is mid 1998. During the 1996 fiscal year, the project recognized pre-tax
loss of $14,000 on the sale of two units plus an additional $182,000 of loss
provision. At June 30, 1996, First Hemet's net investment in Vista Bonita I was
$433,000 representing the fair value of one completed home and 15 developed
residential lots. The one remaining home is in escrow and expected to close in
July 1996. The remaining 15 developed lots are listed for bulk sale, as the
corporation does not plan on building out the remaining units in this
development.
Vista Bonita II - A 56 residential lot subdivision, which is adjacent
to the subdivision discussed above. First Hemet has obtained a final subdivision
map on this project and is seeking to sell the property on a bulk sale basis.
During the fiscal year the project recognized pre-tax loss of $12,000 before
additional loss provisions of $69,000. At June 30, 1996, First Hemet's net
investment in this property was $208,000.
Concordia's Festival - A 22 residential lot subdivision for
moderately priced ($106,000 to $129,000) single-family homes, which was acquired
by the Association through foreclosure. At June 30, 1996 all 22 units were
completely built and 20 units were sold. One unit is in escrow, leaving 1 unit
completed but unsold. During the fiscal year, First Hemet recognized a pre-tax
loss of $8,000 on the sale of 9 units before the recapture of loss provisions of
$112,000. At June 30, 1996, First Hemet's net investment in this project was
$190,000.
Mayberry Estates - In May 1992, First Hemet acquired 9 fully
developed residential lots and in June 1992, entered into an agreement with a
general contractor to construct 9 upscale homes. As of June 30, 1996, three
homes had been built and sold, leaving 6 remaining undeveloped lots. During the
fiscal year management recognized $1,000 of additional loss provisions in
addition to $37,000 in pre-tax loss on the sale of the last completed unit. At
June 30, 1996, First Hemet's net investment in this project was $165,000.
Management is planning on selling this property on a bulk sale basis by June
1997.
Because of First Hemet's real estate development activities, OTS
regulations require the Association to deduct from capital its investment in
First Hemet. At June 30, 1996, the Association was required to deduct $2.5
million from regulatory capital to account for its investment in First Hemet.
38
Personnel
As of June 30, 1996, the Company had 123 full-time employees and 58
part-time employees. The employees are not represented by a collective
bargaining unit and, the Company considers its relationship with its employees
to be good.
Regulation and Supervision
General
-------
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Association, are governed by the
HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Association is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Association is a member of the Federal Home Loan Bank
("FHLB") and its deposit accounts are insured up to applicable limits by the
Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Association
must file reports with the OTS and the FDIC concerning its activities and
financial condition in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other savings institutions. The OTS and/or the FDIC conduct periodic
examinations to test the Association's compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulatory requirements and policies, whether by the OTS, the
FDIC or the Congress could have a material adverse impact on the Company, the
Association and their operations. Certain of the regulatory requirements
applicable to the Association and to the Company are referred to below or
elsewhere herein. The description of statutory provisions and regulations
applicable to savings institutions and their holding companies set forth in this
Form 10-K does not purport to be a complete description of such statutes and
regulations and their effects on the Association and the Company.
Holding Company Regulation
--------------------------
The Company is a non-diversified unitary savings and loan holding
company within the meaning of the HOLA. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the
Association continues to be a qualified thrift lender ("QTL"). Upon any non-
supervisory acquisition by the Company of another savings institution or savings
bank that meets the QTL test and is deemed to be a savings institution by the
OTS, the Company would become a multiple savings and loan holding company (if
the acquired institution is held as a separate subsidiary) and would be subject
to extensive limitations on the types of business activities in which it could
engage. The HOLA limits the activities of a multiple savings and loan holding
company and its non-insured institution subsidiaries primarily to activities
permissible for bank holding companies under Section 4(c)(8) of the Bank Holding
Company Act ("BHC Act"), subject to the prior approval of the OTS, and
activities authorized by OTS regulation.
39
Recently proposed legislation could restrict the activities of unitary savings
and loan holding companies to those permissible for multiple savings and loan
holding companies.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a non-subsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Association must notify the OTS 30
days before declaring any dividend to the Company. In addition, the financial
impact of a holding company on its subsidiary institution is a matter that is
evaluated by the OTS and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the institution.
Federal Savings Institution Regulation
--------------------------------------
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core capital) ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMEL financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier I risk-based capital standard. Core capital is defined as
common stockholder's equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
purchased mortgage servicing rights and credit card relationships. The OTS
regulations also require that, in meeting the leverage ratio, tangible and risk-
based capital standards, institutions must generally deduct investments in and
loans to subsidiaries engaged in activities not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as
assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently
40
include cumulative preferred stock, long-term perpetual preferred stock,
mandatory convertible securities, subordinated debt and intermediate preferred
stock and the allowance for loan and lease losses limited to a maximum of 1.25%
of risk-weighted assets. Overall, the amount of supplementary capital included
as part of total capital cannot exceed 100% of core capital.
The OTS regulatory capital requirements also incorporate an interest
rate risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At June 30, 1996, the
Association met each of its capital requirements, in each case on a fully
phased-in basis.
Capital(1)
Excess ---------------------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
----------- ----------- ------------ ----------- ------------
(Dollars in thousands)
Tangible............ $53,363 $ 12,023 $41,340 6.66% 1.50%
Core (Leverage)..... 53,363 24,046 29,317 6.66 3.00
Risk-based:
Tier I (core)... 53,363 9,098 44,265 23.46 4.00
Total............ 55,207 18,196 37,011 24.27 8.00
- -----------------------
(1) Although the OTS capital regulations require savings institutions to meet
a 1.5% tangible capital ratio and a 3% leverage (core) capital ratio, the
prompt corrective action standards discussed below also establish, in
effect, a minimum 2% tangible capital standard, a 4% leverage (core)
capital ratio (3% for institutions receiving the highest rating on the
CAMEL financial institution rating system), and, together with the risk-
based capital standard itself, a 4% Tier I risk-based capital standard.
41
A reconciliation between regulatory capital and the Association's GAAP
capital at June 30, 1996 included in Note 2 to the accompanying consolidated
financial statements is presented below:
Total
Tangible Core Risk-based
Capital Capital Capital
-------------- ----------------- ---------------
(In thousands)
Association' s GAAP capital-originally
reported to regulatory authorities
and included in Note 2 to the
accompanying consolidated $60,666 $60,666 $60,666
financial statements.............................
Regulatory capital adjustments:
Investment in Non-includable Subsidiaries........ (2,469) (2,469) (2,469)
Adjustment for net unrealized losses on
certain available for sale securities............ 1,879 1,879 1,879
General valuation allowances..................... - - 1,844
Non qualifying Intangible Assets................. $ (6,713) $ (6,713) $ (6,713)
------- -------- -------
Regulatory Capital............................. $53,363 $53,363 $55,207
======= ======== =======
42
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to average assets is at least
5%, and it is not subject to any order or directive by the OTS to meet a
specific capital level. A savings institution generally is considered
"adequately capitalized" if its ratio of total capital to risk-weighted assets
is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at
least 4%, and its ratio of core capital to average assets is at least 4% (3% if
the institution receives the highest CAMEL rating). A savings institution that
has a ratio of total capital to weighted assets of less of than 8%, a ratio of
Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the banking regulator is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Association are
presently insured by the SAIF. Both the SAIF and the Bank Insurance Fund
("BIF"), the deposit insurance fund that covers most commercial bank deposits,
are statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying average
deposit insurance premiums of between 24 and 25 basis points. The BIF presently
meets the required reserve ratio, whereas the SAIF is not expected to meet or
exceed the required level until 2002 at the earliest. This situation is
primarily due to the statutory requirement that SAIF members make payments on
bonds issued in the late 1980s by the Financing Corporation ("FICO") to
recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC adopted a new
assessment rate schedule of 4 to 31 basis points for BIF members for the second
half of 1995. Under that schedule, approximately 91% of BIF members paid the
lowest assessment rate of 4 basis points. Most recently, the FDIC has voted to
reduce the BIF assessment schedule further for the first half of 1996 so that
most BIF members will pay the statutory minimum semiannual assessment of $1,000.
With respect to SAIF member institutions, the FDIC adopted a final rule
retaining the existing 23 to 31 basis point assessment rate applicable to SAIF
member institutions. As long as the premium differential continues, it may have
adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as the Association could be placed at a substantial competitive
disadvantage to BIF members with respect to pricing of loans and deposits and
the ability to achieve lower operating costs.
43
Legislation has been proposed in Congress to mitigate the effect of the
BIF/SAIF premium disparity. Under the legislation a special assessment would be
imposed on the amount of deposits held by SAIF-member institutions, including
the Association, to recapitalize the SAIF fund. The amount of the special
assessment would be left to the discretion of the FDIC but is generally
estimated at between 65 to 70 basis points of insured deposits. The legislation
would also require that the BIF and the SAIF be merged by January 1, 1998,
provided that subsequent legislation is enacted requiring savings associations
to become banks, and that the FICO payments be spread across all BIF and SAIF
members. The payment of the special assessment would have the effect of
immediately reducing the capital of SAIF-member institutions, net of any tax
effect; however, it would not affect the Association's compliance with its
regulatory capital requirements. Management cannot predict whether legislation
imposing such a fee will be enacted, or, if enacted, the amount of any special
assessment or when and whether ongoing SAIF premiums will be reduced to a level
equal to that of BIF premiums. Management can also not predict whether or when
the BIF and SAIF will merge.
The Association's assessment rate for fiscal 1996 was 23 basis points
and the premium paid for this period was $1.2 million. A significant increase in
SAIF insurance premiums or a significant special assessment to recapitalize the
SAIF would likely have an adverse effect on the operating expenses and results
of operations of the Association. Based on the Association's deposit insurance
assessment base as of June 30, 1996, an 65 to 70 basis point fee to recapitalize
the SAIF would result in a $2.4 million to $2.6 million payment on an after-tax
basis. If the Association had been required to pay a special assessment of 70
basis points on June 30, 1996, the Association would have reported a net loss of
$608,000 for the year ended June 30, 1996.
Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Association does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. Bills have been introduced into
Congress which would eliminate the federal thrift charter. These bills would
require that all federal savings associations convert to national banks or state
banks by no later than January 1, 1998 and would treat all state savings
associations as state banks as of that date. All savings and loan holding
companies would become bank holding companies under the legislative proposals
and would be subject to the activities restrictions (with some activities
grandfathered) applicable to bank holding companies. The legislative proposals
would also abolish the OTS; savings associations would be regulated by the bank
regulators depending upon the type of bank charter selected. The Board of
Governors of the Federal Reserve System would be responsible for the regulation
of savings and loan holding companies. Management cannot predict whether or when
this legislation will be enacted. However, any such future legislation could
eliminate the institution's ability to engage in certain activities and
otherwise disrupt operations.
Loans to One Borrower. Under the HOLA, savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. Generally, savings institutions may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital
and surplus. An additional amount may be lent, equal to 10% of unimpaired
capital and surplus, if such loan is secured by readily-marketable collateral,
which is defined to include certain financial instruments and bullion. At June
30, 1996, the Association's limit on loans to one borrower was $8.7 million. At
June 30, 1996, the Association's largest aggregate outstanding balance of loans
to one borrower was $4.5 million. This loan has been current since its
inception.
44
QTL Test. The HOLA requires savings institutions to meet a QTL test.
Under the QTL test, a savings and loan association is required to maintain at
least 65% of its "portfolio assets" (total assets less (i) specified liquid
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business) in certain "qualified
thrift investments" (primarily residential mortgages and related investments,
including certain mortgage-backed securities) in at least 9 months out of each
12 month period.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
June 30, 1996, the Association maintained 72.4% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Association") and has not been advised by the OTS that it
is in need of more than normal supervision, could, after prior notice but
without obtaining approval of the OTS, make capital distributions during a
calendar year equal to the greater of (i) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year or (ii) 75% of its net
income for the previous four quarters. Any additional capital distributions
would require prior regulatory approval. In the event the Association's capital
fell below its regulatory requirements or the OTS notified it that it was in
need of more than normal supervision, the Association's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice. In December 1994, the OTS proposed
amendments to its capital distribution regulation that would generally authorize
the payment of capital distributions without OTS approval provided the payment
does not make the institution undercapitalized within the meaning of the prompt
corrective action regulation. However, institutions in a holding company
structure would still have a prior notice requirement. At June 30, 1996, the
Association was a Tier 1 association.
Liquidity. The Association is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than a
specified percentage of its net withdrawable deposit accounts plus short-term
borrowings. This liquidity requirement is currently 5% but may be changed from
time to time by the OTS to any amount within the range of 4% to 10% depending
upon economic conditions and the savings flows of member institutions. OTS
regulations also require each member savings institution to maintain an average
daily balance of short-term liquid assets at a specified percentage (currently
1%) of the total of its net withdrawable deposit accounts and borrowings payable
in one year or less. Monetary penalties may be imposed for failure to meet these
liquidity requirements. The Association's liquidity and short-term liquidity
ratios for June 30, 1996 were 12.0% and 10.5% respectively, which exceeded the
then applicable requirements. The Association has never been subject to monetary
penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessment, paid on a semi-
annual basis, is computed upon the savings institution's total assets, including
consolidated subsidiaries, as reported in the Association's latest
45
quarterly thrift financial report. The assessments paid by the Association for
the fiscal year ended June 30, 1996 totalled $133,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Association's authority to
engage in transactions with related parties or "affiliates" (e.g.., any company
that controls or is under common control with an institution, including the
Company and its non-savings institution subsidiaries) is limited by Sections 23A
and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate
amount of covered transactions with any individual affiliate to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in Section 23A and
the purchase of low quality assets from affiliates is generally prohibited.
Section 23B generally provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.
The Association's authority to extend credit to executive officers,
directors and 10% shareholders, as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Regulation O also places individual and
aggregate limits on the amount of loans the Association may make to such persons
based, in part, on the Association's capital position and requires certain board
approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all "institution-affiliated parties," including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and an
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
46
interest rate risk exposure; asset growth; and compensation, fees and benefits.
The agencies are expected to adopt a proposed rule that proposes asset quality
and earnings standards which, if adopted in final, would be added to the
Guidelines. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final rule
establishes deadlines for the submission and review of such safety and soundness
compliance plans when such plans are required.
Federal Home Loan Bank System
-----------------------------
The Association is a member of the FHLB System, which consists of 12
regional FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Association, as a member of the FHLB-San Francisco, is
required to acquire and hold shares of capital stock in that FHLB in an amount
at least equal to the greater of: (a) 1% of the aggregate principal amount of
its unpaid residential mortgage loans and similar obligations at the beginning
of each year, (b) 5% of its advances (borrowings) from the FHLB-San Francisco,
or (c) 3% of total assets. The Association was in compliance with this
requirement, with an investment in FHLB-San Francisco stock at June 30, 1996, of
$4.4 million. During fiscal year 1996, the Association borrowed $50 million for
a one year term which required the purchase of $1.6 million of FHLB stock,
however after the borrowing was prepaid in June 1996 the Association redeemed
$1.8 million of stock that was considered excess. FHLB advances must be secured
by specified types of collateral and may be obtained primarily for the purpose
of providing funds for residential housing finance.
The FHLBs are required to provide funds to cover certain obligations on
bonds issued to fund the resolution of insolvent thrifts and to contribute funds
for affordable housing programs. These requirements could reduce the amount of
dividends that the FHLBs pay to their members and could also result in the FHLBs
imposing a higher rate of interest on advances to their members. For the years
ended June 30, 1994, 1995, and 1996, dividends from the FHLB-San Francisco to
the Association amounted to $162,000, $219,000, and $299,000 respectively. If
dividends were reduced, or interest on future FHLB advances increased, the
Association's net interest income might also be reduced.
Federal Reserve System
----------------------
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally require that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $52.0 million or less
(subject to adjustment by the Federal Reserve Board) the reserve requirement is
3%; and for accounts greater than $52.0 million, the reserve requirement is $1.6
million plus 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) against that portion of total transaction accounts in excess of $52.0
million. The first $4.3 million of otherwise reservable balances (subject to
adjustments by the Federal Reserve Board) are exempted from the reserve
requirements. The Association is in compliance with the foregoing requirements.
The balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
47
Federal Securities Laws
-----------------------
The Company's Common Stock is registered with the SEC under Section
12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
The Company is subject to the periodic reporting requirements, proxy
solicitation rules, insider trading restrictions, tender offer rules and other
requirements under the Exchange Act.
The registration under the Securities Act of 1933 (the "Securities
Act") of shares of the Common Stock that were issued in the Association's
conversion from mutual to stock form does not cover the resale of such shares.
Shares of the Common Stock purchased by persons who are not affiliates of the
Company may be resold without registration. Shares purchased by an affiliate of
the Company will be subject to the resale restrictions of Rule 144 under the
Securities Act. If the Company meets the current public information requirements
of Rule 144 under the Securities Act, each affiliate of the Company who complies
with the other conditions of Rule 144 (including those that require the
affiliate's sale to be aggregated with those of certain other persons) would be
able to sell in the public market, without registration, a number of shares not
to exceed, in any three-month period, the greater of (i) 1% of the outstanding
shares of the Company or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks. Shares acquired through the
Company's option plans have been registered under the Securities Act and,
therefore, are not subject to resale restrictions.
Federal and State Taxation
Federal Taxation
----------------
General. The Company and the Association will report their income on a
fiscal year basis using the accrual method of accounting and will be subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Association's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Association or the Company. The Association has not been
audited by the IRS during the last five years.
Tax Bad Debt Reserves. Savings institutions such as the Association
which meet certain definitional tests primarily relating to their assets and the
nature of their business ("qualifying thrifts") are permitted to establish a
reserve for bad debts and to make annual additions thereto, which additions may,
within specified formula limits, be deducted in arriving at their taxable
income. The Association's deduction with respect to "qualifying loans," which
are generally loans secured by certain interests in real property, may be
computed using an amount based on the Association's actual loss experience, or a
percentage equal to 8% of the Association's taxable income, computed with
certain modifications and reduced by the amount of any permitted addition to the
non-qualifying reserve. The Association's deduction with respect to non-
qualifying loans must be computed under the experience method which essentially
allows a deduction based on the Association's actual loss experience over a
period of several years. Each year the Association selects the most favorable
way to calculate the deduction attributable to an addition to the tax bad debt
reserve.
The Association presently satisfies the qualifying thrift definitional
tests. If the Association failed to satisfy such tests in any taxable year, it
would be unable to make additions to its bad debt reserve. Instead, the
Association would be required to deduct bad debts as they occur and would
additionally be required to recapture its bad debt reserve deductions ratably
over a multi-year period. Among other things, the qualifying thrift definitional
tests require the Association to hold at least 60% of its assets as
48
"qualifying assets." Qualifying assets generally include cash, obligations of
the United States or any agency or instrumentality thereof, certain obligations
of a state or political subdivision thereof, loans secured by interests in
improved residential real property or by savings accounts, student loans and
property used by the Association in the conduct of its banking business. The
Association's ratio of qualifying assets to total assets exceeded 60% through
June 30, 1996. Although there can be no assurance that the Association will
satisfy the 60% test in the future, management believes that this level of
qualifying assets can be maintained by the Association.
The amount of the addition to the reserve for losses on qualifying real
property loans under the percentage of taxable income method cannot exceed the
amount necessary to increase the balance of the reserve for losses on qualifying
real property loans at the close of the taxable year to 6 percent of the balance
of the qualifying real property loans outstanding at the end of the taxable
year. Currently, the Association's total reserve for bad debts on qualifying
real property loans is approximately $13.6 million, less than 6 percent of its
qualifying real property loans outstanding. Also, if the qualifying thrift uses
the percentage of taxable income method, then the qualifying thrift's aggregate
addition to its reserve for losses on qualifying real property loans cannot,
when added to the addition to the reserve for losses on non-qualifying loans,
exceed the amount by which: (i) 12 percent of the amount that the total
deposits or withdrawable accounts of depositors of the qualifying thrift at the
close of the taxable year exceeds (ii) the sum of the qualifying thrift's
surplus, undivided profits and reserves at the beginning of such year. As of
June 30, 1996, this overall limitation would not have restricted the
Association's deduction for additions to its bad debt reserve. At June 30, 1996,
the Association's total bad debt reserve for tax purposes was approximately
$13.6 million.
Distributions. To the extent that the Association makes "non-dividend
distributions" to the Company that are considered as made: (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method; or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Association's taxable income. Non-dividend distributions include
distributions in excess of the Association's current and accumulated earnings
and profits, distributions in redemption of stock, and distributions in partial
or complete liquidation. However, dividends paid out of the Association's
current or accumulated earnings and profits, as calculated for federal income
tax purposes, will not be considered to result in a distribution from the
Association's bad debt reserve. Thus, any dividends to the Company that would
reduce amounts appropriated to the Association's bad debt reserve and deducted
for federal income tax purposes would create a tax liability for the
Association. The amount of additional taxable income created from an Excess
Distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, if the Association
makes a "non-dividend distribution," then approximately one and one-half times
the amount so used would be includable in gross income for federal income tax
purposes, assuming a 35% corporate income tax rate (exclusive of state and local
taxes). The Association does not intend to pay dividends that would result in a
recapture of any portion of its tax bad debt reserve.
Legislation was recently signed into law that repeals the tax rules
applicable to bad debt reserves of thrift institutions for taxable years
beginning after December 31, 1995. The Association will, as a result, be
required to change its method of accounting starting with their taxable year
beginning July 1, 1996 from the previously discussed reserve method to the
specific charge off method. Under the specific charge off method. Under the
specific charge off method tax deductions may be taken for bad debts only to the
extent they become wholly or partially worthless. The newly passed legislation
will require thrift institutions to recapture that portion of their existing bad
debt reserve to the extent it exceeds the balance of their bad debt reserve as
of the last taxable beginning before 1988, with some adjustments. The
49
Association's existing bad debt reserve does not exceed the pre 1988 balance and
they will not be subject to recapture under the new provisions. The previous
discussion regarding distributions and their impact on the allowable bad debt
reserve will not materially change under the new provisions.
Corporate Alternative Minimum Tax. The Internal Revenue Code (the
"Code") imposes a tax on alternative minimum taxable income ("AMTI") at a rate
of 20%. The excess of the tax bad debt reserve deduction using the percentage of
taxable income method over the deduction that would have been allowable under
the experience method is treated as a preference item for purposes of computing
the AMTI. Only 90% of AMTI can be offset by net operating loss carryovers of
which the Company currently has none. AMTI is increased by an amount equal to
75% of the amount by which the Company's adjusted current earnings exceeds its
AMTI (determined without regard to this preference and prior to reduction for
net operating losses). In addition, for taxable years beginning after December
31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess
of AMTI (with certain modifications) over $2.0 million is imposed on
corporations, including the Company, whether or not an Alternative Minimum Tax
("AMT") is paid. The Company does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Association as a member of
the same affiliated group of corporations. The corporate dividends received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Association will not file a
consolidated tax return, except that if the Company or the Association owns more
than 20% of the stock of a corporation distributing a dividend, then 80% of any
dividends received may be deducted.
50
State and Local Taxation
------------------------
State of California. The California franchise tax rate applicable to
the Association equals the franchise tax rate applicable to corporations
generally, plus an "in lieu" rate approximately equal to personal property taxes
and business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Association); however, the total tax
rate cannot exceed 11.3%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Company and its subsidiaries file
California state franchise tax returns on a combined basis.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
51
Item 2. Properties
The following table sets forth information relating to each of the
Company's offices as of June 30, 1996.
Net Book Value
of Property or
Original Date Leasehold
Leased or Leased or Date of Lease Improvements at
Location Description Owned Acquired Expiration June 30, 1996
- -------- ----------- ----- -------- ---------- -------------
445 E Florida Avenue Main Office Owned 1963 -- $1,284,271
Hemet, CA
3600 Tyler St. Tyler Branch Leased 1996 2011 49,333
Riverside, CA
28031 Bradley Road Sun City Office Owned 1973 -- 304,942
Sun City, CA
1479 S San Jacinto Avenue San Jacinto Branch Leased 1986 1998 2,300
San Jacinto, CA
5395 Canyon Crest Drive Canyon Crest Branch Owned 1978 -- 566,611
Riverside, CA
1111 S State Street Diamond Valley Leased 1978 1999 37,386
Hemet, CA
3013 W Florida Avenue Hemet West Branch Leased 1979 2007 52,240
Hemet, CA
41815 E Florida Avenue Hemet East Branch Leased 1980 1997 34,771
Hemet, CA
5242 Arlington Avenue Hardman Center Branch Leased 1981 1997 11,663
Riverside, CA
31740 Railroad Canyon Road Canyon Lake Branch Leased 1982 1998 19,608
Canyon Lake, CA
54245 North Circle Drive Idyllwild Branch Owned 1984 -- 314,977
Idyllwild, CA
40461 Murrieta Hot Springs Road Murrieta Branch Leased 1990 2000 85,342
Murrieta, CA
916 S Santa Fe Ave. Vista Branch Owned 1996 -- 495,051
Vista, Ca
810 Mission Ave. Oceanside Branch Leased 1996 1996 --
Oceanside, Ca
15703 Bernardo Height Pkway Rancho Bernardo Br Owned 1996 -- 1,005,000
San Diego, Ca
800 S Sanderson Ave. Future Loan Center Owned 1996 -- 576,918
Hemet, Ca
130 S Buena Vista Street Office Services Owned 1983 -- 241,453
Hemet, CA Support Center -----------
Total $5,081,866
===========
52
Item 3. Legal Proceedings
The Company is not involved in any material pending legal proceedings
other than routine legal proceedings occurring in the ordinary course of
business. Such other routine legal proceedings in the aggregate are believed by
management to be immaterial to the Company's financial condition or results of
operations. All executive officers of the Company had the same position with
respect to the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Common Stock and Related Stockholder Matters
The Common Stock of HF Bancorp, Inc. is traded over-the-counter on the
NASDAQ Stock Market under the new symbol "HEMT". The stock began trading on June
30, 1995. The stock has traded in the high and low range of $10.25 and $8.1875,
respectively, during the fiscal year ended June 30, 1996. On September 3, 1996,
the closing price of the Common Stock was $9.375. To date, the Company has not
paid a dividend to its shareholders. In the future, the Board of Directors may
consider a policy of paying cash dividends on the Common Stock. On February 8,
1996 the OTS approved a five percent repurchase program authorized by the Board
of Directors of the Company. A total of 330,625 shares were repurchased at an
average of $10.125. The repurchase was completed on May 28, 1996. As of
September 3, 1996, there were 767 holders of the Common Stock of the Company,
which includes the approximate number of shares held in street name and
6,281,875 shares outstanding (excluding Treasury shares). Additional information
relating to the payment of dividends by the Registrant appears in Note 17 to the
Notes to Consolidated Financial Statements included herein on page 117.
53
Item 6. Selected Consolidated Financial and Other Data of the Company
Set forth below are selected consolidated financial and other data of
the Company for the periods and at the dates indicated. This financial data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements and related Notes of the Company presented elsewhere
herein.
At June 30,
----------------------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(In thousands)
Selected Financial Condition Data:
Total assets.......................... $558,756 $538,475 $597,452 $666,062 $826,916
Loans receivable, net................. 234,359 230,773 206,370 202,397 225,161
CMOs available for sale, net(1)....... -- -- 55,246 39,989 33,257
CMOs held to maturity, net(1)(2)...... 68,454 68,959 607 432 6,666
mutual funds available for sale..... -- -- 15,097 15,408 15,283
Other investment securities
and interest-earning assets(1)(3)... 43,194 32,822 15,215 101,074 270,130
Mortgage-backed securities
available for sale, net(1).......... -- 51,725 78,243 70,603 100,259
Mortgage-backed securities held
to maturity, net(1)................. 181,643 125,618 199,696 208,090 159,262
Real estate acquired through
foreclosure, net.................... 1,706 1,092 2,877 1,361 1,079
Real estate acquired for sale
or investment, net.................. 5,772 2,978 2,411 2,539 996
Deposit accounts...................... 490,280 470,449 480,959 472,337 669,725
Advances from the FHLB................ 20,000 20,000 70,000 70,000 70,000
Total equity/stockholders' equity..... 38,523 40,841 39,640 87,146 81,071
Fiscal Year Ended June 30,
--------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(In thousands)
Selected Operating Data:
Interest income.................................................. $51,255 $41,606 $38,084 $40,424 $50,355
Interest expense(4) ............................................. 38,382 28,515 26,451 28,795 34,059
------ ------ ------ ------ ------
Net interest income before
provision for estimated loan losses......................... 12,873 13,091 11,633 11,629 16,296
Provision for estimated loan losses.............................. 585 1,920 877 1,202 1,054
Net interest income after provision
for estimated loan losses................................... 12,288 11,171 10,756 10,427 15,242
Other income (expense)(1)(5)..................................... 3,521 4,242 (5,778) 176 765
General and administrative expenses.............................. 11,881 12,205 12,255 11,649 12,931
------ ------ ------ ------ ------
Earnings (loss) before income tax expense (benefit) 3,928 3,208 (7,277) (1,046) 3,076
Income tax expense (benefit)..................................... 1,900 1,338 (2,704) (353) 1,129
------ ------ ------ ------ ------
Net earnings (loss) before cumulative effect
of change in method of accounting for
income taxes and cumulative effect of
change in method of accounting for securities 2,028 1,870 (4,573) (693) 1,947
Cumulative effect of change in method
of accounting for income taxes.............................. -- 448 -- -- --
Cumulative effect of change in method
of accounting for securities (net of
income tax effect of $2,432)(1)(5).......................... -- -- 3,435 -- --
------ ------ ------ ------ ------
Net earnings (loss)....................................... $ 2,028 $ 2,318 $ (1,138) $ (693) $ 1,947
====== ====== ====== ====== ======
(footnotes on page 55)
54
At or For the Fiscal Year Ended June 30,
---------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Selected Financial Ratios and Other Data:
Performance ratios(6):
Return on average assets(7)............ .34% .41% (.19)% (.12)% .27%
Return on average equity(8)........... 5.44 5.96 (2.83) (1.63) 2.24
Average equity to average assets...... 6.18 6.91 6.77 7.14 12.14
Equity to total assets at end of period 6.89 7.58 6.63 13.08 9.80
Interest rate spread during the period(9) 2.07 2.19 1.86 1.75 1.74
Net interest margin(10)(14)........... 2.25 2.44 2.05 2.02 2.37
Average interest-earning assets to
average interest-bearing liabilities 1.03x 1.05x 1.04x 1.06x 1.13x
General and administrative expenses
to average assets................... 1.97% 2.17% 2.07% 1.95% 1.81%
Regulatory Capital Ratios(6)(11):
Tangible capital...................... 6.53 7.29 6.39 9.02 6.66
Core capital.......................... 6.53 7.29 6.39 9.02 6.66
Risk-based capital.................... 14.92 18.29 19.27 29.24 24.27
Asset quality ratios(6):
Nonperforming loans as a percent of
gross loans receivable (12)......... 1.69 3.28 1.25 1.10 0.56
Nonperforming assets as a percent of
total assets(13).................... 1.04 1.69 1.04 0.63 0.33
Net loan charge-offs as a percent of
average loans....................... -- .04 .61 0.58 0.57
Allowance for estimated loan losses as a
percent of gross loans receivable(12) .56 1.33 1.27 1.30 1.33
Allowances for total estimated losses as a
percent of nonperforming assets..... 25.09 43.52 73.07 110.71 94.18
Allowance for estimated loan losses as a
percent of nonperforming loans...... 33.19 40.66 101.75 118.11 235.75
Other Data:
Number of mortgage loans.............. 3,696 3,399 2,985 2,855 2,924
Number of deposit accounts............ 41,969 40,723 39,311 38,572 45,822
Full service offices.................. 12 12 12 12 15
_____________________________________
(1) The Association analyzed its portfolio and made a final classification of
its investment and mortgage-backed securities as "held to maturity" or
"available for sale" when the Association adopted the Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," effective June 30, 1994.
(2) Includes an interest-only stripped mortgage-backed security.
(3) Includes U.S. Government and agency notes, federal funds sold and interest-
earning accounts at the FHLB, which are included in cash and cash
equivalents.
(4) Includes net hedging expense of $4.8 million, $5.1 million, $4.7 million,
$4.5 million and $3.2 million, for the fiscal years ended June 30, 1992,
1993, 1994, 1995 and 1996, respectively.
(5) Other expense of $5.8 million reported for the fiscal year ended 1994 was
primarily due to a net loss from real estate operations of $1.6 million and
the lower of cost or market adjustment for securities available for sale of
$5.9 million. Upon the adoption of SFAS No. 115, the Association
reclassified certain mortgage-backed securities previously classified as
available for sale to a held to maturity classification. As a result, the
cumulative effect of the accounting change as of June 30, 1994, was to
reverse the previously recorded unrealized holding gains and losses on these
securities, net of a tax effect of $2.4 million, of $3.4 million. See Note 1
of the Notes to Consolidated Financial Statements.
(6) Asset quality ratios and regulatory capital ratios are end of period ratios.
With the exception of end of period ratios, all ratios are based on average
monthly balances during the indicated periods and are annualized where
appropriate.
(7) Return on average assets is net earnings (loss) divided by average total
assets.
(8) Return on average equity is net earnings (loss) divided by average equity.
(9) The interest rate spread represents the differences between the average rate
on interest-earning assets and the average rate on interest-bearing
liabilities.
(10)Represents net interest income before provision for estimated loan losses as
a percentage of average interest-earning assets.
(11)For definitions and further information relating to the Association's
regulatory capital requirements, see "Regulation - Federal Savings
Institution Regulation - Capital Requirements."
(12)Includes all non-accrual loans, and loans delinquent 90 days or more, net of
undisbursed loan funds.
(13)Nonperforming assets consist of nonperforming loans and REO.
(14)Reflects yield on mortgage backed and related securities and other
investment securities calculated on the historical amortized cost balances.
55
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
-------
The Company was formed for the purpose of acquiring the Association in
connection with the Association's conversion from mutual to stock form. The
Company was incorporated in Delaware and is headquartered in Hemet, California.
Its principal business currently consists of the operation of its wholly owned
subsidiary Hemet Federal Savings and Loan Association. The Company has signed a
definitive merger agreement to acquire Palm Springs Savings Bank which is
expected to be completed on September, 27, 1996. The Company had no operations
prior to June 30, 1995 and, accordingly, the results of operations prior to such
date reflect only those of the Association and its subsidiaries.
The Company's principal business is attracting retail deposits from the
general public and investing those deposits, together with funds from
operations, and borrowings, primarily in one- to four-family residential
mortgage loans. The Company's current strategic plan is to maintain the
Association's well-capitalized position to take advantage of future expansion or
growth opportunities, while managing growth, maintaining asset quality,
controlling expenses and reducing exposure to credit and interest rate risk.
Management seeks to accomplish these goals by: (i)continuing to emphasize its
community banking services through its network of retail branches, which
includes the origination of one- to four-family residential loans in the
communities it serves as market conditions permit; (ii)placing greater emphasis
on the origination of ARM loans when market conditions permit; (iii)enhancing
earnings and offsetting the effects of the competition for mortgage lending in
the Association's market area through the purchase of adjustable rate and short
term fixed rate mortgage-backed and related securities, which provide a source
of liquidity, low credit risk and low administrative cost as well as helping to
manage interest rate risk; and (iv) continuing to monitor interest rate risk,
while de-emphasizing off-balance sheet hedging activities, which the Association
initiated in 1987 to reduce the interest rate risk associated with its interest
rate sensitive assets and liabilities; at that time, the Association's interest
rate sensitive liabilities exceeded its interest rate sensitive assets creating
a negative "gap" position.
The Association intends to continue to seek opportunities to originate
for its portfolio one- to four-family residential mortgage loans in its primary
market area of Riverside and San Diego County, California. The Association's
total net loan portfolio has decreased as a percent of the Company's total
assets since 1990 primarily because of intense competition in the Association's
market area for loan originations and, as interest rates decreased in the early
1990s, there was less demand for ARM loans than 30-year fixed-rate loans.
Additionally, as interest rates decreased, higher levels of prepayments were
experienced in the loan portfolio as borrowers refinanced their loans at lower
interest rates, primarily 30-year fixed-rate loans. While continuing to offer
loans in its community, management has sought to manage interest rate risk and
enhance earnings by investing in adjustable and fixed-rate mortgage-backed and
related securities as well as certain investment securities. At June 30, 1996,
the Company had $259.5 million, or 31.4% of the Company's total assets in
mortgage-backed securities and $207.8 million or 25.1% of the Company's total
assets in investment securities.
The Company's results of operations are dependent primarily on the
difference between income on interest-earning assets, such as loans and
investments, and the interest expense on its interest-bearing liabilities, such
as deposits and borrowings. The Company's operating results are also affected by
its net hedging expense and the amount of its general and administrative
expenses, which consist principally of employment compensation, occupancy
expenses and federal deposit insurance premiums. The Company's operating results
are affected to a lesser extent by the amount of its other operating income,
including loan servicing, origination and commitment fees, as well as
transactional and other fee income. Additionally,
56
net earnings may be affected by gains or losses on the sale of investment
securities and mortgage-backed and related securities.
Total assets of the Company increased $160.9 million, or 24.2% for the
fiscal year ended June 30, 1996, primarily as a result of the acquisition by the
Association of three branches from Hawthorne Savings, F.S.B. on June 21, 1996,
which increased cash by $177.9 million, premises and equipment by $1.5 million
and other assets (core deposits premium) by $6.6 million. A significant portion
of the cash received was used to pay off $50 million in FHLB borrowings and a
$49.4 million reverse repurchase agreement borrowed in the current year to fund
the purchase of $100 million in FHLB callable notes. The ratio of equity to
total assets has decreased from 13.1% at June 30, 1995 to 9.8% at June 30, 1996.
The book value per share issued and outstanding has decreased from $13.17 at
June 30, 1995 to $12.91 at June 30, 1996. Loans receivable increased from $202.4
million at June 30, 1995 to $225.2 million at June 30, 1996, an increase of
11.2% due primarily to a significant increase in loan originations and a whole
loan purchase of adjustable rate residential loans, indexed to the FHLB 11th
District Cost of Funds (COFI), from a local Savings Bank in the amount of $12.4
million. For the year ended June 30, 1996, the amount of loan fundings was over
double that for the year ended June 30, 1995, where $50.6 million was funded for
the fiscal year ended June 30, 1996 compared to $17.6 million funded for the
year ended June 30, 1995. Investment securities increased $133.0 million, from
$74.9 million at June 30, 1995 to $207.8 million at June 30, 1996 due primarily
to the purchase of $100 million in FHLB callable notes which are classified as
investment securities available for sale. Mortgage-backed securities decreased
$19.2 million, from $278.7 million at June 30, 1995 to $259.5 million at June
30, 1996 due to repayments during the period. Deposit account balances increased
$197.4 million, or 41.8%, from $472.3 million at June 30, 1995, to $669.7
million at June 30, 1996, due primarily to the acquisition of $185.2 million in
deposits from Hawthorne Savings, F.S.B. on June 21, 1996. Cash and cash
equivalents increased from $88.6 million at June 30, 1995 to $100.6 million at
June 30, 1996 primarily due to cash received upon the acquisition of the three
Hawthorne Savings, F.S.B. branches. Other assets increased from $5.3 million at
June 30, 1995 to $14.4 million at June 30, 1996 primarily due to the $6.6
million in core deposit premium booked upon the acquisition of the three
Hawthorne Savings, F.S.B. branches. Accounts payable and other liabilities
decreased from $34.8 million at June 30, 1995 to $5.3 million at June 30, 1996
primarily due to the refund in July 1995 of $26.5 million in over-subscriptions
for stock purchased by potential investors during the initial public offering in
June 1995. Total equity decreased from $87.1 million at June 30, 1995 to $81.1
million at June 30, 1996 primarily due to repurchase of 330,625 shares of common
stock of the Company for $3.3 million, the purchase of 198,375 shares of common
stock of the Company by the Association for future distribution under the Stock
Compensation Plan which is included as a contra equity account for $2.0 million
at June 30, 1996 and the decrease in the net unrealized gain on securities
available for sale from a net unrealized gain of $769,000 at June 30, 1995 to a
$2.3 million net unrealized loss at June 30, 1996. The primary reason for the
negative effect on equity resulting from marking the available for sale
investments to market was the decline in the Treasury yield curve of
approximately 50 basis points in the 5 and 10 year note range and the fact that
the Association transferred $83.6 million of investments from the held to
maturity classification to available for sale. The available for sale portfolio
increased from $126.0 million at June 30, 1995 to $273.4 million at June 30,
1996, or 117.0%.
57
Managing Interest Rate Risk and Hedging Activities
--------------------------------------------------
In an effort to manage the Company's vulnerability to interest rate
changes, management closely monitors interest rate risk on an ongoing basis.
The Association has limited its exposure to interest rate risk, in
part, through the origination of ARM loans and shorter-term fixed-rate loans. At
June 30, 1996, 46.5% of the Association's gross loans were ARM loans. Management
believes that, although investment in ARM loans may reduce short-term earnings
below amounts obtainable through investments in fixed-rate mortgage loans, an
ARM loan portfolio reduces the Association's exposure to adverse interest rate
fluctuations and enhances longer term profitability. In recent periods, overall
loan originations have decreased in the Association's market area, therefore the
Association has sought to purchase adjustable rate whole loans in the secondary
market and invest in adjustable rate and short term fixed rate mortgage-backed
and related securities to shorten the duration of its asset mix. There can be no
assurance that any substantial amount of ARM loans meeting the Association's
underwriting standards will be available for origination in the future; however,
the current increasing interest rate environment should facilitate the
Association's ability to originate ARMs.
As loan balances as a percentage of assets have decreased, the Company
has increased its investments in adjustable rate mortgage-backed and mortgage-
related securities, and other investment securities with short and intermediate
average lives. The investment policy of the Company is designed to manage the
interest rate sensitivity of its overall assets and liabilities, to generate a
favorable return without incurring undue interest rate risk, to supplement the
Association's lending activities, and to provide and maintain liquidity. At June
30, 1996, the Company's mortgage-backed and mortgage-related securities
portfolio, including those available for sale consisted of $145.1 million with
fixed-rates and $154.3 million with adjustable-rates. Included in this total
were $39.9 million of CMOs, of which 83.4% had adjustable-rates. Most CMOs are
private issue CMOs securitized by whole loans and carry an AAA rating, while
others are insured or guaranteed by the FHLMC, FNMA or GNMA. At June 30, 1996,
the Company's investment securities and other interest-earning assets included
$117.4 million of assets maturing and repricing in one year or less and $7.0
million of assets maturing and repricing between one and five years or less.
These investments are consistent with the Company's objective of controlling
interest rate risk through investments in instruments with shorter terms to
maturity or average lives to better match the repricing of liabilities.
The Association has utilized a variety of financial instruments and
strategies to manage the interest rate risk associated with its interest rate
sensitive assets and liabilities, including off-balance sheet transactions, such
as interest rate agreements, including swaps, caps and floors, which the
Association originally entered into to synthetically adjust the duration of the
Association's liabilities to more closely match that of its assets. At June 30,
1996, the Association had two interest rate swap agreements with an aggregate
notional amount of $35million. The Association also purchased in 1991 a
stripped mortgage-backed security, interest-only ("IO") to help protect the
Association from increases in interest rates much the way an interest rate swap
would.
For the fiscal years ended June 30, 1992, 1993, 1994, 1995 and 1996,
the Association incurred net interest expense on interest rate exchange
agreement activity of approximately $4.8 million, $5.1 million, $4.7 million,
$4.5 million and $3.2 million, respectively. The off-balance sheet net
unrealized market value loss associated with the interest rate swaps was $2.1
million at June 30, 1996. See Notes to Notes to Consolidated Financial
Statements. Interest rate swaps fluctuate in market price based on the movement
of interest rates. The Association's interest rate swaps are "short swaps"
whereby the Association pays a predetermined fixed rate and receives a variable
rate tied to the 3-month LIBOR, on
58
a specified notional amount. The exchange of payments is done on a quarterly
basis. Since the interest rate swap agreements were first entered into in 1987,
the 3-month LIBOR initially ranged from between 8-10%, then decreased to a low
of 3.25% in early 1993 and was 5.6% at June 30, 1996. The swaps were entered
into by the Association to help protect it from rising rates and became
disadvantageous when rates began to decline significantly, beginning in the
first quarter of 1989 and continuing through the fourth quarter of 1993. At June
30, 1993, when the 3-month LIBOR was 3.25%, the Association had an unrealized
loss of $22.5 million on an outstanding notional amount of swaps of $156.0
million. By June 30, 1994, the notional amount of swaps outstanding had
decreased to $150 million due to scheduled maturities, and the 3-month LIBOR had
increased to 4.87%. At June 30, 1996, the notional amount of swaps outstanding
decreased further to $35 million and the 3-month LIBOR was 5.6%. The decreases
in the notional amount of swaps outstanding coupled with the increases in the 3-
month LIBOR resulted in the amount of the unrealized market loss decreasing to
$2.1 million as of June 30, 1996. Further decreases in the unrealized market
loss on the swaps could be expected if the 3-month LIBOR rises. However, during
the first quarter of fiscal 1996, the 3-month LIBOR began to decrease, therefore
increasing the cost associated with the swaps. As a result, in July 1995
management decided to terminate its interest in interest rate swaps with
outstanding notional balances of $60.0 million. The termination of the swaps
resulted in the Association realizing a fixed loss of $4.9 million, which will
be amortized in accordance with when the swaps expire. For the fiscal year
ending June 30, 1996 the Association recognized $2.0 million as amortized
expense of the deferred loss on terminated swaps. The budget on terminated swaps
for the fiscal years ending 1997, 1998 and 1999 will recognize amortization of
$1.8 million, $798,000, and $272,000, respectively. The last swap in the group
will expire in November, 1998. In the event market conditions change and
interest rates begin declining further, particularly the 3-month LIBOR,
management may sell the remaining interest rate swaps or a portion thereof to
which it is a party to avoid incurring the significant expenses associated with
those agreements in a decreasing interest rate environment. The Association has
de-emphasized off-balance sheet hedging activities as part of its strategic plan
to manage interest-rate risk and instead has emphasized the origination of ARM
loans and the purchase of adjustable and short term fixed-rate mortgage-backed
and related securities; however, management may engage in hedging activities on
a selective basis as management deems necessary and appropriate given market
conditions and the composition of the Company's asset and liability portfolios.
Interest Rate Sensitivity Analysis
----------------------------------
The matching of the repricing characteristics of assets and liabilities
may be analyzed by examining the extent to which such assets and liabilities are
"interest rate sensitive" and by monitoring an institution's interest rate
sensitivity "gap." An asset or liability is said to be interest rate sensitive
within a specific time period if it matures or re-prices within that time
period. The interest rate sensitivity gap is defined as the difference between
the amount of interest-earning assets anticipated, based upon certain
assumptions, to mature or re-price within a specific time period and the amount
of interest-bearing liabilities anticipated, based upon certain assumptions, to
mature or re-price within that time period. A gap is considered positive when
the amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities maturing or re-pricing within a specific time frame. A gap
is considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets maturing or re-pricing
within that same time frame. Accordingly, in a rising interest rate environment,
an institution with a positive gap would be in a better position to invest in
higher yielding assets, which would result in the yield on its assets increasing
at a pace closer to the cost of its interest-bearing liabilities, than would be
the case if it had a negative gap. During a period of falling interest rates, an
institution with a positive gap would tend to have its assets repricing at a
faster rate than an institution with a negative gap, which would tend to
restrain the growth of its net interest income.
59
The Association maintains a high level of short-term savings deposits,
including passbook savings, negotiable order of withdrawal ("NOW") checking
accounts and money market investment accounts and short-term certificates of
deposit. These accounts typically react more quickly to changes in market
interest rates than the Company's investments in mortgage-backed and related
securities and mortgage loans because of the shorter maturity and re-pricing
characteristics of deposits. As a result, generally, sharp increases in interest
rates may adversely affect earnings while decreases in interest rates may
beneficially affect earnings.
In managing its interest rate risk the Association makes every effort
to provide a more equal match between the maturity of its liabilities and the
maturity or repricing of its investments. In monitoring this process the
Association regularly conducts a comprehensive analysis of the interest rate
risk profile and inherent profitability of it's balance sheet. The Association
utilizes an option adjusted spread analysis including Monte Carlo simulation in
arriving at a mark-to-market comparison of assets and liabilities to book values
and in calculating the net present value of the Association's equity position.
The primary focus is on managing market value and total return. The Association
also makes use of the quarterly OTS Interest Rate Risk Exposure Report, which
has numerous similarities to the Association's internal system. In addition, but
to a much lesser degree, the Company will review its asset-liability gap
position as an indication of how it is faring on matching its asset/liability
maturity - repricing profile.
The following table sets forth the amount of interest-earning assets
and interest-bearing liabilities outstanding at June 30, 1996, that are expected
to reprice or mature in each of the future time periods shown, based on certain
assumptions. Except as stated below, the assets, liabilities, and hedges shown
that reprice or mature during a particular period were determined in accordance
with the earlier of term to repricing or the contractual terms of the asset,
liability, or hedge. All mortgage-backed securities are assumed to prepay at a
constant prepayment rate of 15%, which was chosen based upon a consensus of
prepayment rates that apply to various weighted average coupons over various
weighted average maturities and which are published by the larger brokerage
houses who deal in mortgage-backed and related securities; while CMO's are
assumed to prepay at 14%. Mortgage loans are assumed to prepay at 4.5% which
parallels the Association's experience on originated loans held in portfolio.
Additionally, all variable rate deposit accounts, which include passbook, NOW,
Super NOW, and money market accounts, are assumed to run-off at a rate of 7.49%
for up to 3 months, 8.10% from 3 months to 6 months, 17.80% from over 6 months
to 1 year, 4.90% from over 1 year to 3 years, 4.62% from over 3 years to 5
years, 10.47% from over 5 years to 10 years, 17.61% from over 10 to 20 years,
and 100% for over 20 years. The liability assumptions for variable rate deposit
accounts were derived partly from industry methodology standards of valuing core
deposits and a blend of the Association's own historical experience. The
outstanding hedges at June 30, 1996 were for the purpose of synthetically
extending the duration of all short-term deposit accounts with maturities or
repricings of one year or less. Management believes that all of the above
assumptions are reasonable.
60
The following table sets forth the amounts of the Company's interest-
earning assets and interest-bearing liabilities outstanding at June 30, 1996,
based on the information and assumptions set forth in the notes below.
At June 30, 1996
----------------------------------------------------------------------------------
Three Four Months One to Three to
Months or Less to One Year Three Years Five Years
-------------- ----------- ----------- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage loans(1)............................ $ 41,629 $ 67,407 $ 18,295 $ 15,426
Consumer loans(1)............................ 937 923 583 549
CMOs(2)...................................... 32,870 886 1,890 1,349
Mortgage-backed securities(3)................ 51,412 90,774 34,306 22,359
FHLB Stock................................... 4,436 -- -- --
Other investment securities and interest-
earning assets(4).......................... 110,441 7,000 -- 7,000
---------- --------- --------- ---------
Total interest-earning assets.............. 241,725 166,990 55,074 46,683
Adjusted for:
Unamortized yield adjustments............ (270) (89) 43 (27)
Net interest-earning assets................ 241,455 166,901 55,117 46,656
---------- --------- --------- ---------
Interest-bearing liabilities:
Passbook accounts............................ 4,813 14,539 2,200 1,973
NOW accounts(5).............................. 2,656 8,020 1,214 1,088
Money market investment accounts............. 2,503 7,565 1,145 1,027
Certificate of deposit accounts.............. 152,396 276,506 85,620 12,550
FHLB borrowings.............................. -- 20,000 50,000 --
---------- --------- --------- ---------
Total interest-bearing liabilities......... 162,368 326,630 140,179 16,638
Impact of hedging activities(6).............. (35,000) -- 35,000 --
---------- --------- --------- ---------
Interest-bearing liabilities adjusted for
hedging.................................... 127,368 326,630 175,179 16,638
---------- --------- --------- ---------
Interest-rate hedged sensitivity gap......... $114,087 $ (159,729) $(120,062) $ 30,018
========== ========= ========= =========
Cumulative interest rate hedged sensitivity
gap........................................ $114,087 $ (45,642) $(165,704) $(135,686)
========== ========= ========= =========
Cumulative interest rate hedged sensitivity
gap as a percentage of total assets........ 13.80% -5.52% -20.04% -16.41%
Cumulative interest rate sensitivity gap as a
percentage of total assets pre-hedging 9.56% -9.75% -20.04% -16.41%
Cumulative net interest-earning assets as
a percentage of interest-bearing liabilities 148.71% 83.51% 73.66% 78.99%
At June 30, 1996
---------------------------------------------------------------
Five to More Than
Ten Years Ten Years Total
--------- --------- -----
(Dollars in thousands)
Interest-earning assets:
Mortgage loans(1)............................ $31,320 $ 50,368 $224,445
Consumer loans(1)............................ 1,186 875 5,053
CMOs(2)...................................... 1,864 498 39,357
Mortgage-backed securities(3)................ 30,249 28,617 257,717
FHLB Stock................................... -- -- 4,436
Other investment securities and interest-
earning assets(4).......................... 26,000 117,000 267,441
--------- --------- ---------
Total interest-earning assets.............. 90,619 197,358 798,449
Adjusted for:
Unamortized yield adjustments............ (139) (461) (943)
--------- --------- ---------
Net interest-earning assets................ 90,480 196,897 797,506
--------- --------- ---------
Interest-bearing liabilities:
Passbook accounts............................ 4,265 36,467 64,257
NOW accounts(5).............................. 2,353 20,117 35,448
Money market investment accounts............. 2,219 18,975 33,434
Certificate of deposit accounts.............. 1,768 -- 528,840
FHLB borrowings.............................. -- -- 70,000
--------- --------- ---------
Total interest-bearing liabilities......... 10,605 75,559 731,979
Impact of hedging activities(6).............. -- -- --
--------- --------- ---------
Interest-bearing liabilities adjusted for
hedging 10,605 75,559 731,979
--------- --------- ---------
Interest-rate hedged sensitivity gap......... $79,875 $121,338 $ 65,527
========= ========= =========
Cumulative interest rate hedged sensitivity gap $(55,811) $ 65,527
========= =========
Cumulative interest rate hedged sensitivity gap
as a percentage of total assets............ -6.75% 7.92%
Cumulative interest rate sensitivity gap as a
percentage of total assets pre-hedging -6.75% 7.92%
Cumulative net interest-earning assets as
a percentage of interest-bearing liabilities 91.50% 108.95%
- ----------------------------------------
(1) For purposes of the gap analysis, mortgage and consumer loans are reduced
for non-performing loans but are not reduced for the allowance for
estimated loan losses.
(2) Includes CMOs available for sale and held to maturity including an
interest-only stripped mortgage-backed security with a book value of
$325,000.
(3) Includes mortgage-backed securities available for sale and held to
maturity.
(4) Includes federal funds sold, interest-earning accounts at the FHLB and
FHLB Stock.
(5) Excludes non-interest-bearing checking accounts of $7.7 million.
(6) Represents the impact of off-balance sheet interest rate swaps and caps.
61
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to 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 ARM loans, have features
which restrict changes in interest rates on a short-term basis and over the life
of the asset. Further, in the event of a change in interest rates, prepayment
and early withdrawal levels would likely deviate significantly from those
assumed in calculating the table. Finally, the ability of many borrowers to
service their ARM loans may decrease in the event of an interest rate increase.
Analysis of Net Interest Income
-------------------------------
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income depends upon the volume of interest-earning assets and interest-
bearing liabilities and the interest rate earned or paid on them.
62
Average Balance Sheet
---------------------
The following table sets forth certain information relating to the
Company for the fiscal years ended June 30, 1994, 1995, and 1996. The yields and
costs are derived by dividing income or expense by the average balance of assets
or liabilities, respectively, for the periods shown except where noted
otherwise. Average balances are derived from average month-end balances.
Management does not believe that the use of average monthly balances instead of
average daily balances has caused any material differences in the information
presented. The yields and costs include fees which are considered adjustments to
yields.
Year Ended June 30,
----------------------------------------
1994
----------------------------------------
Average
Average Yield/
Balance Interest Cost
------------ ------------ ------------
(Dollars in thousands)
ASSETS:
Interest-earning assets:
Real estate loans, net(1)........................................ $211,759 $17,586 8.30%
Consumer loans, net(1)........................................... 6,785 704 10.38
Mortgage-backed securities(2)(9)................................. 232,399 14,542 6.26
CMOs(3)(9)....................................................... 62,594 2,998 4.79
Other investment securities and interest-earning assets(4)(9).... 51,019 2,092 4.10
FHLB stock....................................................... 3,932 162 4.12
-------- -------
Total interest-earning assets.................................. 568,488 38,084 6.70
Non-interest-earning assets........................................ 24,572
Total assets................................................... $593,060
========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposit accounts................................................. $477,065 $18,520 3.88
Borrowings(5).................................................... 69,344 3,245 4.68
Net hedging expense(6)........................................... 4,686
Capitalized interest............................................. -- --
Total interest-bearing liabilities............................. 546,409 26,451 4.84
-------- -------
Non-interest-bearing liabilities................................... 6,475
--------
Total liabilities.............................................. 552,884
Equity............................................................. 40,176
--------
Total liabilities and equity................................... $593,060
========
Net interest income/interest rate spread(7)........................ $11,633 1.86%
======= =======
Net interest-earning assets/net interest margin(8)................. $ 22,079 2.05%
======== =======
Ratio of interest-earning assets to interest-bearing liabilities... 1.04x
=======
Year Ended June 30,
----------------------------------------
1995
----------------------------------------
Average
Average Yield/
Balance Interest Cost
------------ ------------ ------------
(Dollars in thousands)
Assets:
Interest-earning assets:
Real estate loans, net(1)........................................ $198,546 $15,755 7.94%
Consumer loans, net(1)........................................... 5,745 590 10.27
Mortgage-backed securities(2)(9)................................. 277,232 18,191 6.56
CMOs(3)(9)....................................................... 48,495 3,217 6.63
Other investment securities and interest-earning assets(4)(9).... 40,856 2,452 6.00
FHLB stock....................................................... 4,152 219 5.27
-------- -------
Total interest-earning assets.................................. 575,026 40,424 7.03
-------
Non-interest-earning assets........................................ 22,204
--------
Total assets................................................... $597,230
========
Liabilities and Equity:
Interest-bearing liabilities:
Deposit accounts................................................. $474,947 20,628 4.34
Borrowings(5).................................................... 70,000 3,641 5.20
Net hedging expense(6)........................................... 4,526
Capitalized interest............................................. --
-------- -------
Total interest-bearing liabilities............................. 544,947 28,795 5.28
-------- -------
Non-interest-bearing liabilities................................... 9,638
--------
Total liabilities.............................................. 554,585
Equity............................................................. 42,645
--------
Total liabilities and equity................................... $597,230
========
Net interest income/interest rate spread(7)........................ $11,629 1.75%
======= =======
Net interest-earning assets/net interest margin(8)................. $ 30,079 2.02%
======== =======
Ratio of interest-earning assets to interest-bearing liabilities... 1.06x
=======
Year Ended June 30,
----------------------------------------
1996
----------------------------------------
Average
Average Yield/
Balance Interest Cost
------------ ------------ ------------
(Dollars in thousands)
Assets:
Interest-earning assets:
Real estate loans, net(1)........................................ $206,361 $17,111 8.29%
Consumer loans, net(1)........................................... 5,001 537 10.74
Mortgage-backed securities(2)(9)................................. 274,617 19,113 6.96
CMOs(3)(9)....................................................... 43,075 2,905 6.74
Other investment securities and interest-earning assets(4)(9).... 153,744 10,390 6.76
FHLB stock....................................................... 5,394 299 5.54
--------- -------
Total interest-earning assets.................................. 688,192 50,355 7.32
-------
Non-interest-earning assets........................................ 26,970
---------
Total assets................................................... $715,162
=========
Liabilities and Equity:
Interest-bearing liabilities:
Deposit accounts................................................. 487,040 23,781 4.88
Borrowings(5).................................................... 123,587 7,086 5.73
Net hedging expense(6)........................................... 3,192
Capitalized interest............................................. --
-------
Total interest-bearing liabilities............................. 610,627 34,059 5.58
--------- -------
Non-interest-bearing liabilities................................... 17,732
Total liabilities.............................................. 628,359
Equity............................................................. 86,803
---------
Total liabilities and equity................................... $715,162
=========
Net interest income/interest rate spread(7)........................ $16,296 1.74%
======= =======
Net interest-earning assets/net interest margin(8)................. $ 77,565 2.37%
========= =======
Ratio of interest-earning assets to interest-bearing liabilities 1.13x
=======
- ---------------------------------------
(1) In computing the average balance of loans, non-accrual loans have been
included.
(2) Includes both mortgage-backed securities available for sale and held to
maturity.
(3) Includes both CMOs available for sale and held to maturity, including an
interest-only stripped mortgage-backed security.
(4) Includes federal funds sold, banker's acceptances, commercial paper,
interest-earning accounts at the FHLB and U.S. government and agency
obligations.
(5) Includes advances from the FHLB and dollar reverse repurchase agreements.
(6) Represents the net interest expense of hedging activities from interest
rate swaps, caps, and floors.
(7) Interest rate spread represents the difference between the average rate on
interest-earning assets and the average rate on interest-bearing
liabilities.
(8) Net interest margin equals the net interest income before provision for
estimated loan losses divided by average interest-earning assets.
(9) Average balance of mortgage-backed and related securities and other
investment securities and interest earning assets classified as available
for sale are based on the average of historical amortized cost.
63
Rate/Volume Analysis
--------------------
The following table presents the extent to which changes in interest
rates and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume); and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
Year Ended June 30, 1994 Year Ended June 30, 1995
Compared to Compared to
Year Ended June 30, 1993 Year Ended June 30, 1994
------------------------------- ---------------------------------
Increase (Decrease) Increase (Decrease)
------------------------------- ---------------------------------
Due to Due to
------------------------------- ---------------------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(In thousands)
INTEREST INCOME:
Real estate loans, net................. $(1,088) $(2,105) $(3,193) $(1,080) $(751) $(1,831)
Consumer loans, net.................... (128) (25) (153) (107) (7) (114)
Mortgage-backed securities, net(1) 10,270 (10,877) (607) 2,923 726 3,649
CMOs(2)................................ 20 (308) (288) (310) 529 219
Other investment securities and
interest-earning assets.............. 435 177 612 (272) 632 360
FHLB stock(3).......................... --- 107 107 10 47 57
------ ------ ------ ------ ------ ------
Total interest income.............. 9,509 (13,031) (3,522) 1,164 1,176 2,340
------ ------ ------ ------ ------ ------
INTEREST EXPENSE:
Deposit accounts....................... (501) (2,766) (3,267) (82) 2,190 2,108
Advances from the FHLB and
other borrowings..................... (1,871) (323) 1,548 31 365 396
Net hedging expense.................... -- (405) (405) -- (160) (160)
Capitalized interest................... 60 -- 60 -- -- --
------ ------ ------ ------ ------ ------
Total interest expense............. 1,430 (3,494) (2,064) (51) 2,395 2,344
------ ------ ------ ------ ------ ------
Net change in net interest income........ $ 8,079 $ (9,537) $ (1,458) $ 1,215 $(1,219) $ (4)
====== ====== ====== ====== ====== ======
Year Ended June 30, 1996
Compared to
Year Ended June 30, 1995
--------------------------------
Increase (Decrease)
--------------------------------
Due to
--------------------------------
Volume Rate Net
------ ---- ---
(In thousands)
Interest Income:
Real estate loans, net................. $ 621 $ 734 $1,355
Consumer loans, net.................... (76) 23 (53)
Mortgage-backed securities, net(1) (172) 1,095 923
CMOs(2)................................ (359) 47 (312)
Other investment securities and
interest-earning assets.............. 6,773 1,165 7,938
FHLB stock(3).......................... 65 15 80
------ ------ ------
Total interest income.............. 6,852 3,079 9,931
------ ------ ------
Interest Expense:
Deposit accounts....................... 525 2,628 3,153
Advances from the FHLB and
other borrowings..................... 2,787 658 3,445
Net hedging expense.................... -- (1,334) (1,334)
Capitalized interest................... -- -- --
------ ------ ------
Total interest expense............. 3,312 1,952 5,264
------ ------ ------
Net change in net interest income........ $ 3,540 $ 1,127 $ 4,667
====== ====== ======
- ---------------------------------------
(1) Includes both mortgage-backed securities available for sale and held to
maturity.
(2) Includes both CMOs available for sale and CMOs held to maturity, including
an interest-only stripped mortgage-backed security.
(3) Income amounts represent stock dividends paid on FHLB stock.
64
Comparison of Operating Results for the Fiscal Years Ended June 30,
-------------------------------------------------------------------
1996 and 1995
-------------
General. The Company reported net income of $1.9 million for the
fiscal year ended June 30, 1996 compared to a net loss of $693,000 for the
fiscal year ended June 30, 1995. Net interest income increased $4.7 million or
40.1% from $11.6 million for the year ended June 30, 1995 to $16.3 million for
the year ended June 30, 1996, primarily due to several factors, including:
interest earned on investment of the IPO proceeds; a lower net interest expense
from hedging transactions; leveraging transactions in which $100 million of
borrowings funded investment securities with a combined net interest margin of
1.80%; a higher volume of real estate loans originated; and a significant
reduction in non performing assets. Future results of operations could be
adversely affected if the proposals various regulators have made to Congress
that a special one time assessment of between 65-70 basis points be adopted to
recapitalize the SAIF fund, which would allow the adoption of an ongoing
assessment schedule similar to that applicable to BIF members is actually
adopted. If adopted, based upon deposits held by the Association at June 30,
1996, the Association would have to pay between approximately $4.1 million to
$4.4 million in insurance premiums to satisfy the special assessment.
Interest Income. Interest income increased by $9.9 million, or 24.6%
from $40.4 million for fiscal 1995 to $50.4 for fiscal 1996. The increase
primarily resulted from a $7.7 million increase in interest and dividends on
investment securities due to the additional funds invested from the proceeds of
the June 30, 1995 initial public offering and the added interest income from the
$100 million invested in FHLB callable notes, previously discussed. Interest
income from loans increased $1.3 million from $16.3 million from the year ended
June 30, 1995 to $17.6 million for the year ended June 30, 1996, primarily due
to an increase in the average balance of real estate loans outstanding of $7.8
million and a increase in the average yield of 35 basis points, from 7.94% on an
average outstanding balance of $198.6 to 8.29% on an average outstanding balance
of $206.4 million. The increase in the outstanding balance of real estate loans
was primarily due to an increase in loan originations and a $12.4 million whole
loan purchase. Interest income on mortgage-backed securities increased by
$922,000, or 5% from $18.2 million for the fiscal year ended June 30, 1995 to
$19.1 million for the fiscal year ended June 30, 1996. The increase resulted
primarily from an increase in the average yield of 40 basis points from 6.56% on
an average outstanding balance of $277.2 million to 6.96% on an average
outstanding balance of $274.6 million.
Interest Expense. Interest expense increased by $5.3 million, or
18.3%, from $28.8 million for fiscal 1995 to $34.1 million for fiscal 1996. The
increase in interest expense was due primarily to an increase in the average
cost on average interest bearing liabilities by 30 basis points, from 5.28% in
fiscal 1995 to 5.58% in fiscal 1996, and an increase in average interest bearing
liabilities by $65.7 million from $544.9 million to $610.6 million. Interest on
deposits which accounts for 69.8% of total interest expense for fiscal 1996,
increased from $20.6 million for fiscal 1995 to $23.8 million for fiscal 1996
due to an increase in the average cost on deposit accounts by 54 basis points,
from 4.34% in fiscal 1995 to 4.88% in fiscal 1996, and an increase in the
average outstanding balance on deposit accounts from $475.0 million in 1995 to
$487.0 million in 1996. Competition for savings deposits continued to increase
with the wide array of competitive products on the market. The Association
strives to offer competitive deposit rates in its marketplace relative to thrift
and bank competition in transaction and term accounts and has offered its
deposit products at negative spreads to Treasury rates. Net expenses for hedging
activities decreased by $1.3 million or 29.5% from $4.5 million for fiscal 1995
to $3.2 million for fiscal 1996 due to a decrease in interest expense on
interest rate swaps from $4.5 million for fiscal 1995 to $3.2 million for fiscal
1996 of which $2.0 million related to the terminated swaps previously discussed.
The interest on the swaps decreased primarily due to the termination of swaps
with notional balances of $60 million in July, 1995 as previously discussed.
Associated with the termination, $2.0 million of the related deferred loss of
$4.9 million was amortized offsetting the decrease in interest expense.
65
Provision for Estimated Loan Losses. The provision for estimated loan
losses decreased by $148,000, or 12.3% from $1.2 million in fiscal 1995 to $1.1
million in fiscal 1996. However, the allowance for estimated loan losses
increased from $2.7 million at June 30, 1995 to $3.1 million at June 30, 1996.
Such allowances include valuation reserves provided for specifically identified
loan losses as well as general valuation allowances for loan losses. Total non-
performing loans decreased $980,000 from $2.3 million in 1995 to $1.3 million in
fiscal 1996. The ratio of non-performing loans to gross loans decreased from
1.10% in fiscal 1995 to .56% in fiscal 1996 and the ratio of allowance for
estimated loan losses to non performing loans increased from 118.11% at June 30,
1995 to 235.75% at June 30, 1996.
While management uses all information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Company's control.
Other Income and Expenses. Other income increased from $176,000 in
fiscal 1995 to $765,000 in fiscal 1996. The increase is primarily due to an
income tax refund of $373,000 from the California Franchise Tax Board for the
fiscal year 1979 and a decrease of $401,000 in the loss provision for real
estate owned for investment from $542,000 for fiscal 1995 to $141,000 for fiscal
1996. The decrease can be attributed to the continued divestiture of the real
estate portfolio from $2.5 million at June 30, 1995 to $1.0 million at June 30,
1996. While management believes it has adequately provided for losses on its
real estate operations there can be no assurance that actual losses will not
exceed the estimated amounts.
General and Administrative Expenses. General and administrative
expenses increased by $1.3 million or 11.0%, from $11.6 million in fiscal 1995
to $12.9 million in fiscal 1996. The increase is primarily attributable to the
increase in salaries and employee benefits from $5.8 million for fiscal 1995 to
$6.8 million for fiscal 1996 due to additional expenses associated with the
Employee Stock Ownership Plan, the Stock Compensation Plan and the addition of a
new corporate position of Executive Vice President - Chief Operating Officer.
Income Taxes. The Company's income tax expense increased from a fiscal
1995 benefit of $353,000 to a fiscal 1996 expense of $1.1 million primarily due
to the Company improving from a $1.1 million pre-tax loss in fiscal 1995 to a
$3.1 million pre-tax income in fiscal 1996.
Comparison of Operating Results for the Fiscal Years Ended June 30,
-------------------------------------------------------------------
1995 and 1994
-------------
General. The Association's net results for the fiscal year ended June
30, 1995 was a loss of $693,000 compared to the loss for the fiscal year ended
June 30, 1994 of $1.1 million, an improvement of 39.1%. The primary reason for
the improvement was the decrease in general and administrative expense of
$606,000, or 4.9% from $12.3 million for the fiscal year ended June 30, 1994 to
$11.6 million for the fiscal year ended June 30, 1995. Net interest income
before provision for estimated loan losses was virtually unchanged at $11.6
million for the fiscal years ended June 30, 1994 and 1995. During fiscal 1995
the following-interest rate swap contracts matured: (1) an interest rate swap,
with a notional amount of $40 million, (October 1994), (2) an interest rate cap
with a notional amount of $55 million (January 1995) and (3) an interest rate
floor with the notional amount of $75 million (July 1994). Future results of
operations could be adversely affected if the proposals various regulators have
made to Congress that a special one time assessment of between 85-90 basis
points be adopted to recapitalize the SAIF fund, which would allow the adoption
of an ongoing assessment schedule similar to that applicable to BIF members is
actually adopted. If adopted, based upon deposits held by the Association at
June 30, 1995,
66
the Association would have to pay between approximately $4.0 million to $4.5
million in insurance premiums to satisfy the special assessment.
Interest Income. Interest income increased by $2.3 million, or 6.1%,
from $38.1 million for fiscal 1994 to $40.4 million for fiscal 1995. The
increase primarily resulted from a 33 basis point increase in the weighted
average yield on interest earning assets from 6.70% for fiscal 1994 to 7.03% for
fiscal 1995 and an increase in the balance of interest earning assets. Average
interest earning assets increased to $575.0 million for fiscal 1995, from $568.5
million for fiscal 1994, or 1.2 %. Interest income from real estate loans, which
accounted for 46.2% of total interest income for the fiscal year ended June 30,
1994, decreased by $1.8 million, or 10.4%, primarily due to a decrease in the
average balance of real estate loans outstanding of $13.2 million and a decrease
in the average yield of 36 basis points, from 8.30% on an average outstanding
balance of $211.8 million to 7.94% on an average outstanding balance of $198.6
million. The decrease in the outstanding balance of real estate loans was
primarily due to higher yielding loans being prepaid or refinanced and the
effect of the lagging interest rates on certain of the Association's ARM loans.
Interest income on mortgage- backed and related securities increased by $3.9
million, or 22.1% from $17.5 million for the fiscal year ended June 30, 1994 to
$21.4 million for the fiscal year ended June 30, 1995. Average outstanding
balances on this category increased $30.7 millon, or 10.4%, from $295.0 million
to $325.7 million for the comparable periods. Interest income on mortgage-backed
and related securities accounted for 53.0% of total interest income for fiscal
1995. The average weighted yield on this category increased from 5.95% to 6.57%,
or 62 basis points.
Interest Expense. Interest expense increased by $2.3 million, or 8.9%,
from $26.5 million for fiscal 1994 to $28.8 million for fiscal 1995. The
increase in interest expense was due primarily to an increase in the average
cost on average interest bearing liabilities by 44 basis points, from 4.84% in
fiscal 1994 to 5.28% in fiscal 1995, the effect of which was partially offset by
a decline in average interest bearing liabilities by $1.5 million or 27% for
fiscal 1995. Interest on deposit accounts, which accounts for 71.6% of total
interest expense, increased by 46 basis points, from 3.88% to 4.34%, whereas the
average outstanding balance on deposit accounts decreased by $2.1 million, or
.44%, from $477.1 million in 1994 to $475.0 million in 1995. The increase in
interest expense on deposit accounts is directly related to the Federal
Reserve's Board's action to raise short term interest rates throughout fiscal
1995. Competition for savings deposits continued to increase with the wide array
of competitive products on the market. The Association strives to offer
competitive deposit rates in its marketplace relative to thrift and bank
competition in transaction and term accounts and has offered its deposit
products at negative spreads to Treasury rates. Although average balances
outstanding on borrowings reflected little change, the interest expense
increased by $396,000, primarily resulting from the change in activity of using
dollar repurchase agreements in fiscal 1994 as compared to fiscal 1995. This
financing activity for short term periods has the effect of lowering the average
cost since break-even financing rates are so low. The Association had no dollar
repurchase activity in the fiscal year ended June 30, 1995, whereas the
Association utilized an average of $16.2 million of such borrowings during the
fiscal year ended June 30, 1994. Net expenses for hedging activities decreased
by $160,000, or 3.4% from $4.7 million for fiscal 1994 to $4.5 million for
fiscal 1995.
Provision for Estimated Loan Losses. The provision for estimated loan
losses increased by $325,000, or 37.1 % from $877,000 in fiscal 1994 to $1.2
million in fiscal 1995. The Association's allowance for estimated loan losses
was virtually unchanged at $2.7 million at June 30, 1994 and 1995, respectively.
Such allowances include valuation reserves provided for specifically identified
loan losses as well as general valuation allowances for loan losses. General
valuation allowances were virtually unchanged from $1.7 million at both June 30,
1994 and June 30, 1995, while total non-performing loans decreased $355,000 from
$2.6 million in 1994 to $2.3 million in fiscal 1995. The ratio of delinquent
67
loans to gross loans decreased from 1.25% in fiscal 1994 to 1.10% in fiscal 1995
and the rates of allowance for estimated loan losses to non performing loans
increased from 101.75% at June 30, 1994 to 118.11% at June 30, 1995.
While management uses all information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Association's control.
Other Income and Expenses. Other income increased from an expense of
$5.8 million in fiscal 1994 to an income amount of $176,000 in fiscal 1995. The
negative positions in fiscal 1994 were primarily the result of a $5.9 million
lower of cost or market adjustment for securities available for sale during the
period, that was ultimately reversed at the end of the period when the
Association adopted SFAS No. 115. See Note 1 to the Notes to Consolidated
Financial Statements included elsewhere herein. Apart from this adjustment,
there was an increase from $89,000 in fiscal 1994 to $176,000 in fiscal 1995.
The primary cause of the increase was a decrease of $814,000 in losses from real
estate operations, from a loss of $1.6 million in fiscal 1994 to a loss of
$747,000 in fiscal 1995. Gains on sales of mortgage-backed and related
securities decreased from net gains of $781,000 in fiscal 1994 to a loss of
$13,000 in fiscal 1995 and gains on sales of loans were zero (0) for fiscal 1995
compared to $259,000 in fiscal 1994. The Association also experienced a greater
negative equity position relating to its operating subsidiaries, reflecting an
increase in loss from $128,000 for fiscal 1994 to a loss of $308,000 for fiscal
1995. Other income increased from $392,000 in fiscal 1994 to $737,000 in fiscal
1995, which was primarily attributable to a one-time expense of $562,000
recognized by the Association in fiscal 1994 relating to costs that had been
capitalized in the process of the Association's initial plan to convert from
mutual to stock form that was begun in June 1993 and later postponed. The
provision for estimated real estate losses and direct charge-offs decreased
$814,000, or 52.1% from $1.6 million in fiscal 1994 to $747,000 in fiscal 1995.
The loss from real estate operations decreased $707,000, or 48.4%, from $1.6
million in fiscal 1994 to $797,000 in fiscal 1995. At June 30, 1995, the
allowance for estimated real estate losses was $1.9 million compared to $1.8
million at June 30, 1994. While management believes it has adequately provided
for losses on its real estate operations there can be no assurance that actual
losses will not exceed the estimated amounts.
General and Administrative Expenses. General and administrative
expenses decreased by $606,000, or 4.94%, from $12.3 million in fiscal 1994 to
$11.6 million in fiscal 1995, reflecting management's emphasis on controlling
costs. Salaries and employee benefits decreased by $385,000, or 6.2% from $6.2
million in fiscal 1994 to $5.8 million in fiscal 1995, due primarily to the
reduction of full time employees from 158 in fiscal 1994 to 151 in fiscal 1995.
The Association has had an 8.5% reduction in staff over the past two years.
Premiums paid for FDIC deposit insurance decreased by $123,000, or 9.0% from
$1.4 million in fiscal 1994 to $1.2 million in fiscal 1995, due to a decrease in
outstanding deposit accounts from $481.0 million at June 30, l994 to $472.3
million at June 30, 1995.
Income Taxes. The Association income tax benefit declined from a fiscal
1994 benefit of $2.7 million to a fiscal 1995 benefit of $353,000, a benefit
decrease of $2.4 million, due primarily to a decrease in pre-tax loss, before
cumulative effect of change of accounting for securities, of $6.2 million, from
a pre-tax loss of $7.3 million in fiscal 1994 to a pre-tax loss of $1.0 million
in fiscal 1995.
68
Liquidity and Capital Resources
-------------------------------
The Company's primary sources of funds are deposits, principal and
interest payments on loans, mortgage-backed and related securities, retained
earnings and, to a lesser extent, FHLB advances and other borrowings. While
maturities and scheduled amortization of loans are predictable sources of funds,
deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions, and competition. The Association has
continued to maintain the required minimum levels of liquid assets as defined by
OTS regulations. This requirement, which may be varied at the direction of the
OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required ratio is
currently 5%. The Association's liquidity ratios were 13.9%, 8.6%, 8.4%, 16.6%
and 12.0% for the fiscal years ended June 30, 1992, 1993, 1994, 1995, and 1996
respectively. The Association previously maintained a liquidity ratio
substantially above the regulatory requirement, however, management currently
attempts to maintain a liquidity ratio as close to the minimum as possible. For
the fiscal years ending June 30, 1995 and 1996 the liquidity ratios appear high
primarily due to the receipt of the IPO proceeds being recognized on the last
day of fiscal June 30, 1995 and the receipt of the proceeds from the purchase of
three branches of Hawthorne Savings FSB which closed in the last week of fiscal
June 30, 1996, thereby inflating cash balances prior to more permanently
investing the funds.
At June 30, 1996, the Association exceeded all of its regulatory
capital requirements with a tangible capital level of $53.4 million, or 6.66% of
total adjusted assets, which is above the required level of $12.0 million, or
1.5%; core capital of $53.4 million, or 6.66% of total adjusted assets, which is
above the required level of $24.0 million, or 3.0%, and risk-based capital of
$55.2 million, or 24.3% of risk-weighted assets, which is above the required
level of $18.2 million, or 8.0%.
The Company will continue to be affected by general changes in levels
of interest rates and other economic factors beyond its control. At June 30,
1996, the Company's total net interest-bearing liabilities, adjusted for
hedging, maturing or repricing during that period exceeded interest earning
assets maturing or repricing within one year by $45.6 million representing a
one-year interest sensitivity gap as a percentage of total assets of a negative
5.52%. Management anticipates that substantially all of the liabilities will be
retained by the Company upon maturity. The Company's cash flows are comprised of
three primary classifications: cash flows from operating activities, investing
activities and financing activities. See Statements of Cash Flows in the
Consolidated Financial Statements included herein.
The Company's most liquid assets are cash and short-term investments.
The levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At June 30, 1996, the
Company's cash and cash equivalents totalled $100.6 million.
The Company has other sources of liquidity if a need for additional
funds arises including FHLB advances and other collateralized borrowings. At
June 30, 1996, the Association had $70.0 million in advances outstanding from
the FHLB. Another source of liquidity includes investment securities maturing
within one year.
At June 30, 1996, the Association had outstanding loan commitments of
$4.1 million. The Association anticipates that it will have sufficient funds
available to meet its current loan origination commitments. Certificates of
deposit which are scheduled to mature in one year or less from June 30, 1996,
totalled $428.9 million.
69
Impact of Inflation And Changing Prices
---------------------------------------
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with GAAP, which require the measurement
of financial position and operating results in terms of historical dollars
without considering the changes in the relative purchasing power of money over
time due to inflation. The impact of inflation is reflected in the increased
cost of the Company's operations. Unlike industrial companies, nearly all of the
assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the price of goods and services.
Impact of New Accounting Standards
----------------------------------
The Financial Accounting Standards Board (FASB) has issued SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of and SFAS No. 122, Accounting for Mortgage Servicing
Rights, which the Company adopted effective July 1, 1996. There was no material
impact on the Company's financial condition and results of operations upon
adoption of these statements.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-
Based Compensation. SFAS No. 123 establishes financial accounting and reporting
standards for stock-based employee compensation plans. This statement
establishes a fair value based method of accounting for stock-based compensation
plans. It encourages, but does not require, 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 or
the employer incurs liabilities to employees in amounts based on the price of
its stock. SFAS No. 123 also applies to transactions in which an entity issues
its equity instruments to acquire goods and services for non-employees. Those
transactions must be accounted for based on the fair value of the consideration
received or the fair value of the equity instruments issued, whichever is more
reliably measurable.
The Company has elected to continue to apply the accounting provisions
of APB No. 25 to its stock-based compensation awards to employees and, in the
future, will disclose the pro forma effect on net earnings and earnings per
share as if the fair value based method of accounting defined in SFAS No. 123
had been applied.
The accounting requirements of SFAS No. 123 are effective for
transactions entered into in fiscal years that begin after December 15, 1995.
Management does not believe that the adoption of SFAS No. 123 will have a
significant impact on its stock-based arrangements with non-employees.
The disclosure requirements of SFAS No. 123 are effective for financial
statements for fiscal years beginning after December 15, 1995.
70
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Independent Auditors' Report................................................................ 72
Consolidated Statements of Financial Condition as of June 30, 1995 and 1996................. 73
Consolidated Statements of Operations for the
Fiscal Years Ended June 30, 1994, 1995 and 1996........................................ 75
Consolidated Statements of Stockholders' Equity............................................. 77
Consolidated Statements of Cash Flows for the
Fiscal Years Ended June 30, 1994, 1995 and 1996........................................ 78
Notes to Consolidated Financial Statements.................................................. 81
71
INDEPENDENT AUDITORS' REPORT
The Board of Directors
HF Bancorp, Inc.
Hemet, California
We have audited the accompanying consolidated statements of financial condition
of HF Bancorp, Inc. and subsidiary (the Company) as of June 30, 1996 and 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended June 30, 1996. These
consolidated financial statements are the responsibility of the Company'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, such consolidated financial statements present fairly, in all
material respects, the financial position of HF Bancorp, Inc. and subsidiary as
of June 30, 1996 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended June 30, 1996 in
conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements as of June 30,
1994, the Company changed its method of accounting for securities to conform
with Statement of Financial Accounting Standards No.115.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
August 9, 1996
72
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
June 30,
------------------
1996 1995
(in thousands)
ASSETS
Cash and cash equivalents $100,633 $ 88,642
Investment securities held to maturity (estimated fair
value of $33,842 and $19,571 at June 30, 1996 and 1995)
(Notes 3 and 11) 34,666 19,464
Investment securities available for sale (amortized cost of
$177,487 and $55,704 at June 30, 1996 and 1995)(Notes 3
and 11) 173,171 55,397
Loans receivable (net of allowance for estimated loan losses
of $3,068 and $2,694 at June 30, 1996, and 1995)(Notes 4, 5
and 10) 225,161 202,397
Mortgage-backed securities held to maturity (estimated fair
value of $152,521 and $206,811 at June 30, 1996 and 1995)
(Notes 5, 10 and 11) 159,262 208,090
Mortgage-backed securities available for sale (amortized
cost of $99,888 and $68,977 at June 30, 1996 and 1995)
(Notes 5, 10 and 11) 100,259 70,603
Accrued interest receivable (Note 6) 6,260 3,320
Investment in capital stock of the Federal Home Loan
Bank, at cost (Notes 5 and 10) 4,436 4,319
Premises and equipment, net (Note 7) 6,578 4,668
Real estate owned, net (Note 8):
Acquired through foreclosure 1,079 1,361
Acquired for sale or investment 996 2,539
Other assets (Notes 9 and 12) 14,415 5,262
-------- --------
Total assets $826,916 $666,062
======== ========
See notes to consolidated financial statements.
73
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Continued)
- --------------------------------------------------------------------------------
June 30,
-----------------------
1996 1995
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts (Note 9) $ 669,725 $ 472,337
Advances from the Federal Home Loan Bank (Note 10) 70,000 70,000
Accounts payable and other liabilities (Notes 13 and 17) 5,278 34,758
Income taxes (Note 12) 842 1,821
--------- ---------
Total liabilities 745,845 578,916
Commitments and contingencies (Notes 13, 14 and 15)
Stockholders' equity (Notes 1, 2, 13 and 17):
Preferred stock, $.01 par value; 2,000,000 shares authorized;
none issued
Common stock, $.01 par value; 15,000,000 shares authorized;
6,612,500 issued (1996 and 1995); and 6,281,875 (1996) and
6,612,500 (1995) outstanding 66 66
Additional paid-in capital 51,113 51,004
Retained earnings, substantially restricted 40,957 39,010
Net unrealized gain (loss) on securities available for sale, net of taxes (2,309) 769
Deferred stock compensation (5,408) (3,703)
Treasury stock, 330,625 shares (3,348)
--------- ---------
Total stockholders' equity 81,071 87,146
--------- ---------
Total liabilities and stockholders' equity $ 826,916 $ 666,062
========= =========
74
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
Year ended June 30,
---------------------------------
1996 1995 1994
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
INTEREST INCOME:
Interest on loans $ 17,648 $ 16,345 $ 18,290
Interest on mortgage-backed securities 19,113 18,191 14,542
Interest and dividends on investment securities 13,594 5,888 5,252
-------- -------- --------
Total interest income 50,355 40,424 38,084
INTEREST EXPENSE:
Interest on deposit accounts (Note 9) 23,781 20,628 18,520
Interest on advances from the Federal Home Loan Bank
and other borrowings (Notes 10 and 11) 7,086 3,641 3,245
Net interest expense of hedging transactions (Note 15) 3,192 4,526 4,686
-------- -------- --------
Total interest expense 34,059 28,795 26,451
-------- -------- --------
NET INTEREST INCOME BEFORE PROVISION FOR
ESTIMATED LOAN LOSSES 16,296 11,629 11,633
PROVISION FOR ESTIMATED LOAN LOSSES (Note 4) 1,054 1,202 877
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR
ESTIMATED LOAN LOSSES 15,242 10,427 10,756
OTHER INCOME (EXPENSE):
Loan and other fees 193 199 218
Loss on sale of investment securities available for sale (Note 3) (13)
Gain on sales of mortgage-backed securities (Note 5) 781
Gain on sales of loans 259
Loss from real estate operations, net (Note 8) (498) (747) (1,561)
Lower of cost or market adjustment for securities
available for sale (Note 1) (5,867)
Other income 1,070 737 392
-------- -------- --------
Total other income (expense) 765 176 (5,778)
See notes to consolidated financial statements.
75
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
- -------------------------------------------------------------------------------
YEAR ENDED JUNE 30,
-----------------------------------
1996 1995 1994
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits (Note 13) $ 6,790 $ 5,803 $ 6,188
Occupancy and equipment expense (Note 14) 2,023 2,020 2,127
FDIC insurance and other assessments 1,322 1,239 1,362
Legal and professional services 489 378 338
Data processing service costs 832 794 780
Other 1,475 1,415 1,460
---------- -------- --------
Total general and administrative expenses 12,931 11,649 12,255
---------- -------- --------
EARNINGS (LOSS) BEFORE INCOME TAX
EXPENSE (BENEFIT) 3,076 (1,046) (7,277)
INCOME TAX EXPENSE (BENEFIT) (Notes 1 and 12) 1,129 (353) (2,704)
---------- -------- --------
NET EARNINGS (LOSS) BEFORE CUMULATIVE
EFFECT OF CHANGE IN METHOD OF ACCOUNTING
FOR SECURITIES 1,947 (693) (4,573)
CUMULATIVE EFFECT OF CHANGE IN METHOD OF
ACCOUNTING FOR SECURITIES, net of income tax
effect of $2,432 (Note 1) 3,435
--------
NET EARNINGS (LOSS) $ 1,947 $ (693) $ (1,138)
========== ======== ========
EARNINGS PER SHARE $ 0.33 N/A N/A
========== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 5,953,823 N/A N/A
========== ======== ========
See notes to consolidated financial statements.
76
Preferred stock Common stock Additional
---------------------- -------------------- paid in Retained
Shares Amount Shares Amount capital earnings
BALANCE, July 1, 1993 - $ - $ - $ - $ - $ 40,841
Net loss (1,138)
Change in net unrealized gain (loss) on
securities available for sale, net of taxes
---------- ---------- -------- ---- -------- --------
BALANCE, June 30, 1994 39,703
Net loss (693)
Change in net unrealized gain (loss) on
securities available for sale, net of taxes
Issuance of common stock, net of
underwriting expenses 6,613 66 51,004
Common stock acquired by ESOP
---------- ---------- -------- ---- -------- --------
BALANCE, June 30, 1995 6,613 66 51,004 39,010
Net earnings 1,947
Change in net unrealized gain (loss) on
securities available for sale, net of taxes
Purchase of common stock for deferred
stock compensation plans
Amortization of deferred stock compensation 109
Acquisition of treasury stock
---------- ---------- -------- ---- -------- --------
BALANCE, June 30, 1996 - $ - 6,613 $ 66 $ 51,113 $ 40,957
========== ========== ======= ==== ======== ========
Net unrealized gain
(loss) on securities Deferred Total
available for sale, stock Treasury stockholders'
net of taxes compensation stock equity
BALANCE, July 1, 1993 $ - $ - $ - $ 40,841
Net loss (1,138)
Change in net unrealized gain (loss) on
securities available for sale, net of taxes (63) (63)
--------- --------- --------- ---------
BALANCE, June 30, 1994 (63) 39,640
Net loss (693)
Change in net unrealized gain (loss) on
securities available for sale, net of taxes 832 832
Issuance of common stock, net of
underwriting expenses 51,070
Common stock acquired by ESOP (3,703) (3,703)
--------- --------- --------- ---------
BALANCE, June 30, 1995 769 (3,703) 87,146
Net earnings 1,947
Change in net unrealized gain (loss) on
securities available for sale, net of taxes (3,078) (3,078)
Purchase of common stock for deferred
stock compensation plans (2,260) (2,260)
Amortization of deferred stock compensation 555 664
Acquisition of treasury stock (3,348) (3,348)
--------- --------- --------- ---------
BALANCE, June 30, 1996 $ (2,309) $ (5,408) $ (3,348) $ 81,071
========= ========= ========= =========
77
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
YEAR ENDED JUNE 30,
----------------------------------
1996 1995 1994
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 1,947 $ (693) $ (1,138)
Adjustments to reconcile net earnings (loss)
to net cash (used in) provided by operating activities:
Provisions for estimated loan and real estate losses 1,318 1,835 2,148
Cumulative effect of change in method of accounting for securities,
net (3,435)
Lower of cost or market adjustment for securities available for sale
Write-down of stripped mortgage-backed security - interest only 8 85
Direct write-offs from real estate operations 142 121 190
Depreciation and amortization 777 820 857
Amortization of deferred loan fees (383) (331) (678)
Amortization (accretion) of premiums (discounts) on loans and
investment and mortgage-backed securities 147 (155) 470
Amortization of cost of interest rate caps and floors 111 864
Federal Home Loan Bank stock dividend (299) (219) (162)
Dividends from investments in mutual funds (311) (290)
Loss on sale of investment securities available for sale 13
Gain on sales of mortgage-backed securities (781)
Proceeds from sales of loans 10,048
Gain on sales of loans (259)
Gain on sales of real estate (200) (182) (132)
Gain on sales of premises and equipment (10)
Deferred income taxes 302 219 (1,194)
(Increase) decrease in accrued interest receivable (2,940) 599 155
(Decrease) increase in accounts payable and other liabilities (29,480) 27,679 269
(Increase) decrease in other assets (9,153) (1,829) 885
Other, net 1,335 758 (1,840)
--------- -------- ---------
Net cash (used in) provided by operating activities (36,497) 28,443 11,929
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans receivable (24,634) 3,017 9,018
Purchases of mortgage-backed securities held to maturity (23,124) (157,049)
Purchases of mortgage-backed securities available for sale (21,272)
Principal repayments on mortgage-backed securities held to maturity 24,429 14,627 13,751
Principal repayments on mortgage-backed securities available for sale 14,701 8,867 23,581
Proceeds from sales of mortgage-backed securities available for sale 20,268
Purchases of investment securities held to maturity (90,804) (19,052)
Proceeds from maturities and calls of investment securities held to
maturity 16,000
Principal repayments on investment securities held to maturity 595 168 7,947
Purchases of investment securities available for sale (122,000) (15,000)
See notes to consolidated financial statements.
78
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
- --------------------------------------------------------------------------------
YEAR ENDED JUNE 30,
------------------------------------
1996 1995 1994
(IN THOUSANDS)
Proceeds from maturities and calls of investment securities available
for sale $ 52,000 $ 2,020 $ -
Principal repayments on investment securities available for sale 7,134 9,353 4,335
Proceeds from sales of investment securities available for sale 4,329
Proceeds from sales of real estate owned 2,900 3,012 3,543
Additions to real estate owned (123) (2,203) (815)
Proceeds from sale of premises and equipment 17 1,487
Additions to premises and equipment (2,694) (222) (421)
Redemption of Federal Home Loan Bank stock 1,800
Purchase of Federal Home Loan Bank stock (1,618) (55) (14)
--------- -------- ---------
Net cash (used in) provided by investing activities (143,569) 2,224 (90,856)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of deposit accounts 185,189
Net increase (decrease) in deposit accounts 12,199 (8,622) 10,510
Advances from the Federal Home Loan Bank 50,000 50,000
Repayment of advances from the Federal Home Loan Bank (50,000)
Proceeds from other borrowings 98,875 177,000
Repayment of other borrowings (98,875) (177,000)
Issuance of common stock, net of underwriting expenses and
excluding common stock acquired by ESOP 47,367
Payments to acquire common stock for deferred stock
compensation plans (1,983)
Payments to acquire treasury stock (3,348)
--------- -------- ---------
Net cash provided by financing activities 192,057 38,745 60,510
--------- -------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 11,991 69,412 (18,417)
CASH AND CASH EQUIVALENTS, beginning of year 88,642 19,230 37,647
--------- -------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 100,633 $ 88,642 $ 19,230
========= ======== =========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid during the year for:
Interest on deposit accounts and other borrowings $ 9,840 $ 11,222 $ 14,795
========= ======== =========
Income taxes $ 1,420 $ 475 $ 358
========= ======== =========
See notes to consolidated financial statements.
79
HF BANCORP, INC. AND SUBSIDARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
- -------------------------------------------------------------------------------
YEAR ENDED JUNE 30,
--------------------------
1996 1995 1994
(IN THOUSANDS)
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Real estate acquired through foreclosure $ 1,931 $1,946 $ 5,582
======= ====== =======
Loans to facilitate sale of real estate acquired through foreclosure $ 732 $1,860 $ 185
======= ====== =======
Transfer of mortgage-backed securities held to maturity to
available for sale classification $24,321 $ - $ -
======= ====== =======
Transfer of investment securities held to maturity to available for
sale classification $59,022 $ - $59,655
======= ====== =======
Transfer of mortgage-backed securities available for sale to held
to maturity classification $ - $ - $58,935
======= ====== =======
Common stock acquired by ESOP $ - $3,703 $ -
======= ====== =======
See notes to consolidated financial statements.
80
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis for Presentation - HF Bancorp, Inc. is a savings and loan holding
company incorporated in the State of Delaware that was organized for the
purpose of acquiring all of the capital stock of Hemet Federal Savings
and Loan Association (the Association) upon its conversion from a
federally chartered mutual savings association to a federally chartered
stock savings association. On June 30, 1995, HF Bancorp, Inc. completed
its sale of 6,612,500 shares of its common stock through subscription
and community offerings to the Association's depositors, Board of
Directors, management, employees and the public and used approximately
50% of the net proceeds from such sales to purchase all of the
Association's common stock issued in the Association's conversion to
stock form. Such business combination was accounted for at historical
cost in a manner similar to a pooling of interests.
Description of Business - The business of HF Bancorp, Inc. consists
principally of the business of the Association; however, it does have
investments in mortgage-backed securities from which interest income is
earned (Note 18). Headquartered in Hemet, California, the Association
conducts business from its main office and three branch offices located
in Hemet, California and from its other eleven branch offices located in
the Riverside and San Diego counties of California. The Association is
regulated by the Office of Thrift Supervision (OTS) and the Federal
Deposit Insurance Corporation (FDIC), and its deposits are insured up to
the applicable limits under the Savings Association Insurance Fund
(SAIF) of the FDIC.
The Association is primarily engaged in the business of attracting funds
in the form of deposits and supplementing such deposits with FHLB and
other borrowings, and investing such funds in loans secured by real
estate, primarily one- to four-family residential mortgage loans.
Additionally, the Association has invested in U.S. agency-backed
investment securities and mortgage-backed and related securities,
including collateralized mortgage obligations. To a lesser extent, the
Association invests in multi-family mortgage loans, commercial real
estate loans, construction loans, acquisition, development and land
loans, and consumer loans. The Association's revenues are derived
principally from interest on its mortgage loan and mortgage-backed
securities portfolio and interest and dividends on its investment
securities. The Association's primary sources of funds are deposits,
principal and interest payments on loans and mortgage-backed securities,
FHLB advances and other borrowings.
Principles of Consolidation - The consolidated financial statements
include the accounts of HF Bancorp, Inc. and its wholly-owned subsidiary
Hemet Federal Savings and Loan Association and its wholly-owned
subsidiary, HF Financial Corporation, and its subsidiary, First Hemet
Corporation (collectively, the Company). First Hemet Corporation
provides trustee services for the Association, is engaged in real estate
development, and receives commissions from the sale of mortgage life
insurance, fire insurance and annuities. All material intercompany
transactions, profits and balances have been eliminated.
81
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Investment Securities Held to Maturity - Investment securities held to
maturity are recorded at cost with any discount accreted or premium
amortized over the life of the security using the interest method. The
Company has the positive intent and ability to hold these securities to
maturity. The Company designates investment securities as held to
maturity or available for sale upon acquisition.
Investment Securities Available for Sale - Investment securities to be
held for indefinite periods of time, including securities that
management intends to use as part of its asset/liability strategy that
may be sold in response to changes in interest rates, prepayments or
other factors, are classified as available for sale and carried at
estimated fair value. Gains or losses on sales of investment securities
are determined on the specific identification method. Discounts and
premiums are accreted or amortized over the life of the security using
the interest method. Unrealized holding gains or losses for securities
available for sale are excluded from earnings and reported as a net
amount in a separate component of stockholders' equity, net of taxes.
Loans Receivable - Interest on loans is credited to income as earned and
is accrued only if deemed collectible. Generally, interest is not
accrued on loans delinquent three payments or more. Discounts (for loans
that are probable of collection) or premiums on loans are included in
loans receivable and credited or charged to income on the interest
method over the term of the loan.
Loan origination and commitment fees and certain incremental direct loan
origination costs are deferred, and the net fee or cost is amortized
into interest income over the contractual lives of the related loans.
During the period of origination, loans are designated as either held
for investment or held for sale. Loans receivable held for investment
are carried at amortized cost. Loans receivable held for sale are
carried at the lower of aggregate cost or market. At June 30, 1996 and
1995, there were no loans receivable held for sale.
On July 1, 1995, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a
Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment
of a Loan - Income Recognition and Disclosures. SFAS No. 114 generally
requires all creditors to account for impaired loans, except those loans
that are accounted for at fair value or at the lower of cost or fair
value, at the present value of the expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, at
the loan's observable market price or the fair value of the collateral
if the loan is collateral dependent. SFAS No. 114 indicates that a
creditor should evaluate the collectibility of both contractual interest
and contractual principal when assessing the need for a loss accrual.
The adoption of this statement did not have a material impact on the
results of operations or the financial position of the Company, taken as
a whole.
82
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
The Company considers a loan to be impaired when it is probable that the
Company will be unable to collect all contractual principal and interest
payments in accordance with the terms of the original loan agreement.
However, in determining when a loan is impaired, management also
considers the loan documentation, current loan to value ratios, and the
borrower's current financial position. Included as impaired loans are
all loans delinquent 90 days or more and all loans that have a specific
loss allowance applied to adjust the loan to fair value. The accrual of
interest on impaired loans is discontinued after a 90-day delinquent
period or when, in management's opinion, the borrower may be unable to
meet payments as they become due. When interest accrual is discontinued,
all unpaid accrued interest is reversed. Interest income is subsequently
recognized to the extent of full cash payments received and accepted.
The Company applies the measurement provision of SFAS No. 114 to all
loans in its portfolio except for single-family residence and
installment loans which are collectively evaluated for impairment.
Mortgage-Backed Securities Held to Maturity - Mortgage-backed securities
held to maturity represent participating interests in pools of long-term
first mortgage loans originated and serviced by the issuers of the
securities. These securities are recorded at cost with any discounts
accreted or premiums amortized over the term of the mortgage-backed
security using the interest method. The Company has the positive intent
and ability to hold these securities to maturity. The Company designates
mortgage-backed securities as held to maturity or available for sale
upon acquisition.
Mortgage-Backed Securities Available for Sale - Mortgage-backed
securities to be held for indefinite periods of time, including
securities that management intends to use as part of its asset/liability
strategy or that may be sold in response to changes in interest rates,
prepayments or other factors, are classified as available for sale and
carried at estimated fair value. Gains or losses on sales of mortgage-
backed securities are determined on the specific identification method.
Discounts and premiums are accreted or amortized over the term of
mortgage-backed security using the interest method. Unrealized holding
gains or losses for securities available for sale are excluded from
earnings and reported as a net amount in a separate component of
stockholders' equity, net of taxes.
Reclassification of Securities - In November 1995, the Financial
Accounting Standards Board (FASB) issued a Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities: Questions and Answers (the Guide). The Guide allows for a
one-time reassessment of the classification of all securities and, in
connection with such reassessment, permits the reclassification of
securities from the held to maturity classification to the available for
sale classification as of a single date no later than December 31, 1995,
without calling into question management's intent to hold to maturity
the remaining securities classified as held to maturity. On December 29,
1995, the Company transferred $59.0 million of investments and $24.3
million of mortgage-backed securities from the held to maturity to the
available for sale classification to enhance liquidity and provide more
flexibility through a variety of interest rate scenarios. The transfer
resulted in an unrealized gain of approximately $600,000, net of tax,
which was included in the unrealized gains/losses on available for sale
securities as of such date set forth as a separate component of
stockholders' equity.
83
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Derivative Financial Instruments - The Company has entered into various
interest rate exchange agreements as part of its asset and liability
management strategy. These exchange agreements consist of interest rate
swaps, caps and floors. Swap income and expense are recorded using the
accrual method and are classified as income or expense, net in the
consolidated statements of operations. The cost of the interest rate
floor and cap agreements has been capitalized and is being amortized to
interest expense over the terms of the agreements.
Real Estate Owned - Properties acquired through foreclosure are
initially recorded at the lower of cost or fair value less estimated
costs to sell through a charge to the allowance for estimated loan
losses. Subsequent declines in value are charged to operations.
Properties acquired for sale or investment are recorded at cost not to
exceed net realizable value.
Costs incurred that are directly related to the development of real
estate are capitalized. Costs of holding real estate under development
(principally interest and real estate taxes) are also capitalized.
Provisions for estimated losses are charged to current operations.
Recognition of gains on the sale of real estate is dependent on the
transaction meeting certain criteria relating to the nature of the
property sold and the terms of sale. Under certain circumstances, the
gain, or a portion thereof, may be deferred until the criteria are met.
Losses on disposition of real estate, including expenses incurred in
connection with the disposition, are charged to operations.
Allowances for Estimated Loan and Real Estate Losses - Valuation
allowances for estimated loan and real estate losses are provided when
any significant decline in value is deemed to have occurred. Specific
loss allowances are established for loans that are deemed to be
impaired, if the fair value of the loan or the collateral is estimated
to be less than the gross carrying value of the loan. In estimating
losses, management considers the estimated sales price, cost of
refurbishment, payment of delinquent taxes, cost of holding the property
(if an extended period is anticipated) and cost of disposal.
Additionally, general valuation allowances for loan and real estate
losses have been established. The estimates for these allowances are
normally influenced by current economic conditions, actual loss
experience, industry trends and other factors such as the current
adverse economic conditions experienced (including declining real estate
values) in the area in which the Company's lending and real estate
activities are based. These estimates may result in either additions to
or recaptures of the current provision, based on management's current
evaluation of the loan and real estate portfolios. Accordingly, the
amounts of such loan and real estate loss provisions (credits) can vary
from period to period.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Association's allowance for
loan losses. Such agencies may require the Association to recognize
additions to the allowance based on judgments different from those of
management.
84
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
While management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond
the Company's control.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization
are computed principally on the straight-line method over the estimated
useful lives of the various assets.
Depreciable lives used for the principal classes of assets are as
follows:
Furniture, fixtures and equipment 3 to 10 years
Buildings and leasehold improvements 5 to 40 years
Stockholders' Equity - The Association's financial statement equity
includes tax bad debt deductions for which no provision for federal
income taxes has been made. If distributions to shareholders are made in
excess of current or accumulated earnings and profits or if stock of the
Association is partially redeemed, this tax bad debt reserve, which
approximates $13,600,000 at June 30, 1996, will be recaptured into
income at the then prevailing federal income tax rate. The related
unrecognized deferred tax liability is approximately $4,760,000. It is
not contemplated that the Association will make any disqualifying
distributions that would result in the recapture of these reserves.
During 1996, the Company acquired 330,625 shares of treasury stock for
$3,348,000. Retained earnings are restricted for dividends in the amount
of $3,348,000, the cost of the treasury stock acquired.
Earnings per share for the year ended June 30, 1996 are based on
weighted average common shares outstanding of 5,953,823. The total
issued shares of 6,612,500 have been adjusted for the weighted average
of: unallocated shares under the Employee Stock Ownership Plan (ESOP) of
424,069, reduction of outstanding shares purchased for the stock
compensation plan of 198,375 and acquisition of shares of treasury stock
of 36,233.
Earnings per share are not presented for periods prior to conversion to
stock form, as the Association was a mutual savings and loan association
and no stock was outstanding.
Federal and State Income Taxes - The Company accounts for income taxes
under SFAS No. 109, Accounting for Income Taxes. Under this standard,
deferred tax assets and liabilities represent the tax effects of the
temporary differences in the basis of certain assets and liabilities for
tax and financial statement purposes, calculated at currently effective
tax rates, of future deductible or taxable amounts attributable to
events that have been recognized on a cumulative basis in the financial
statements.
85
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Change in Method of Accounting for Securities - In May 1993, the FASB
issued SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities. SFAS No. 115 requires that investments in equity
securities that have readily determinable fair values and all
investments in debt securities be carried at fair value unless they meet
the criteria to be classified as held to maturity. Securities are
classified as held to maturity and carried at amortized cost only if the
Company has the positive intent and ability to hold those securities to
maturity. If not classified as held to maturity, such securities are
classified as trading securities or securities available for sale.
Unrealized holding gains or losses for securities available for sale are
excluded from earnings and reported as a net amount in a separate
component of stockholders' equity. Management of the Company designates
securities as held to maturity or available for sale upon acquisition.
The Company adopted the new standard as of June 30, 1994. Upon the
adoption of SFAS No. 115, the Company reclassified certain mortgage-
backed securities which were previously classified as available for sale
to a held to maturity classification. As a result, the cumulative effect
of the accounting change as of June 30, 1994 was to reverse the
previously recorded unrealized holding gains and losses on these
mortgage-backed securities, net of taxes, of $3,435,000. These
unrealized holding gains and losses had previously been recorded in
results of operations as a net unrealized loss resulting from a lower of
cost or market adjustment.
Use of Estimates in the Preparation of Consolidated Financial
Statements - The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting years. Actual
results could differ from those estimates.
Presentation of Cash Flows - All highly-liquid instruments with original
maturities of three months or less are considered to be cash
equivalents. At June 30, 1996, cash equivalents consisted of federal
funds sold of $88,460,000 and a repurchase agreement of $4,075,000. At
June 30, 1995, cash equivalents consisted of federal funds sold of
$75,275,000.
Recent Accounting Developments - The FASB has issued SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of and SFAS No. 122, Accounting for Mortgage
Servicing Rights, which the Company adopted effective July 1, 1996.
There was no material impact on the Company's financial condition and
results of operations upon adoption of these statements.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-
Based Compensation. SFAS No. 123 establishes financial accounting and
reporting standards for stock-based employee compensation plans. This
statement establishes a fair value based method of accounting for stock-
based compensation plans. It encourages, but does not require, 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
86
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
instruments of the employer or the employer incurs liabilities to
employees in amounts based on the price of its stock. SFAS No. 123 also
applies to transactions in which an entity issues its equity instruments
to acquire goods or services from nonemployees. Those transactions must
be accounted for based on the fair value of the consideration received
or the fair value of the equity instruments issued, whichever is more
reliably measurable.
The Company has elected to continue to apply the accounting provisions
of APB No. 25 to its stock-based compensation awards to employees and,
in the future, will disclose the pro forma effect on net earnings and
earnings per share as if the fair value based method of accounting
defined in SFAS No. 123 had been applied.
The accounting requirements of SFAS No. 123 are effective for
transactions entered into in fiscal years that begin after December 15,
1995. Management does not believe that the adoption of SFAS No. 123 will
have a significant impact on its stock-based arrangements with
nonemployees.
The disclosure requirements of SFAS No. 123 are effective for financial
statements for fiscal years beginning after December 15, 1995.
Reclassifications - Certain reclassifications have been made to the 1995
and 1994 financial statements to conform them to the 1996 presentation.
2. REGULATORY COMPLIANCE
The Association is subject to various regulatory capital requirements
administered by the federal banking agencies. 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 Association's financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Association must meet
specific capital guidelines that involve quantitative measures of the
Association's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Association's
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors. Management believes, as of June 30, 1996, that the Association
meets all capital adequacy requirements to which it is subject.
Quantitative measures established by regulation to ensure capital
adequacy require the Association to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier I capital (as defined
in the regulations) to risk-weighted assets (as defined), and of Tier I
capital (as defined) to average assets (as defined).
87
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
As of June 30, 1996, the most recent notification from the OTS
categorized the Association as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized, the Association must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the table.
There are no conditions or events since that notification that
management believes have changed the Association's category.
The Association's actual capital amounts and ratios are also presented
in the table.
TO BE WELL
CAPITALIZED UNDER
PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS:
------------------ --------------------
AMOUNT RATIO AMOUNT RATIO
(DOLLARS IN THOUSANDS)
As of June 30, 1996:
Total Capital (to Risk Weighted Assets) $55,207 24.27% $22,744 10.0%
Tier I Capital (to Risk Weighted Assets) 53,363 23.46 13,647 6.0
Tier I Capital (to Average Assets) 53,363 7.46 35,758 5.0
As of June 30, 1995:
Total Capital (to Risk Weighted Assets) $59,383 29.24% $20,310 10.0%
Tier I Capital (to Risk Weighted Assets) 57,691 28.40 12,186 6.0
Tier I Capital (to Average Assets) 57,691 9.66 29,862 5.0
Additionally, in accordance with the Financial Institutions Reform,
Recovery and Enforcement Act (FIRREA), the OTS established regulations
requiring the Association to maintain (i) core capital equal to 3% of
adjusted total assets, (ii) tangible capital equal to 1.5% of adjusted
total assets, and (iii) total capital equal to 8% of risk-weighted
assets.
The following table summarizes the OTS regulatory capital requirements
under FIRREA for the Association at June 30, 1996. As indicated in the
tables, the Association's capital levels exceed all three of the
currently applicable minimum capital requirements.
88
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
June 30, 1996
--------------------------------------------------------
Current
Tangible capital Core capital risk-based capital
------------------ ---------------- --------------------
Amount % Amount % Amount %
(dollars in thousands)
Stockholder's equity
per Association
financial statements $60,666 $60,666 $60,666
Adjustments:
Net unrealized loss
on debt securities
available for sale 1,879 1,879 1,879
Nonincludable
subsidiaries (2,469) (2,469) (2,469)
Nonqualifying
intangible assets (6,713) (6,713) (6,713)
Qualifying general
valuation allowance 1,844
------- ---- ------- ----- ------- ------
Regulatory capital 53,363 6.66% 53,363 6.66% 55,207 24.27%
Minimum capital
requirement 12,023 1.50% 24,046 3.00% 18,196 8.00%
------- ---- ------- ----- ------- ------
Excess regulatory
capital $41,340 5.16% $29,317 3.66% $37,011 16.27%
======= ==== ======= ===== ======= ======
The OTS issued final regulations which set forth the methodology for
calculating an interest rate risk component that is being incorporated
into the OTS regulatory capital rules. Under the new regulations, only
savings institutions with above normal interest rate risk exposure are
required to maintain additional capital. This additional capital would
increase the amount of a savings institution's otherwise required risk-
based capital requirement. The final rule became effective January 1,
1994 and implementation will not begin until the Association has been
notified by the OTS.
Management believes that under the current regulations the Association
will continue to meet its minimum capital requirements in the coming
year. However, events beyond the control of the Association, such as
changing interest rates or a further downturn in the economy in the
areas where the Association has most of its loans and real estate
projects, could adversely affect future earnings and, consequently, the
ability of the Association to meet its future minimum capital
requirements.
89
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
OTS regulatory capital regulations require that all equity investments
in equity securities and real property (except real property used as
offices for the conduct of the business and certain real estate owned)
be deducted from total capital for purposes of the risk-based capital
standard. At June 30, 1996, the Association's equity investments in real
property and subsidiary subject to this deduction amounted to
$2,469,000.
At periodic intervals, both the OTS and the FDIC routinely examine the
Association's consolidated financial statements as part of their legally
prescribed oversight of the savings and loan industry. Based on these
examinations, the regulators can direct that the Association's financial
statements be adjusted in accordance with their findings.
The OTS conducted an examination of the Association which concluded in
January 1996. Examination results have been reflected in the
consolidated financial statements presented herein. Future examinations
by the OTS or the FDIC could include a review of certain transactions or
other amounts reported in the Association's consolidated financial
statements. Adjustments, if any, cannot presently be determined.
The FDIC insures deposits of account holders up to $100,000 per insured
depositor. To provide for this insurance, the Association must pay an
annual premium.
As of June 30, 1996, there is legislation pending in Congress that would
impose a one-time assessment expected to be between 65 and 70 basis
points on the amount of deposits as of a date to be determined, held by
Savings Associations Insurance Fund (SAIF) member institutions to
recapitalize the SAIF fund. Based on the level of the Association's
deposit accounts at June 30, 1996, management estimates that the one-
time insurance assessment would approximate $4,100,000 to $4,400,000
excluding any tax effects. Management believes that the Association's
capital would continue to exceed regulatory capital requirements for a
well capitalized institution. It is anticipated by management that if
the one-time insurance assessment is levied, the annual deposit
insurance premiums in future periods would decrease. In addition, other
pending legislation includes the requirement that federal chartered
thrifts convert to national banks or state-chartered institutions and
that the Bank Insurance Fund (BIF) and SAIF insurance funds would merge.
No assurances can be given as to whether the legislation discussed above
will be enacted or, if enacted, what the terms of such legislation would
be. Management cannot predict the ultimate impact the final legislation
and regulatory actions will have on the Association and its operations.
90
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (CONTINUED)
- -------------------------------------------------------------------------------
3. INVESTMENT SECURITIES
Investment securities are summarized as follows:
JUNE 30, 1996
-------------------------------------------------
GROSS GROSS ESTO,ATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
HELD TO MATURITY:
Stripped mortgage-backed security -
interest only $ 325 $10 $ - $ 335
Collateralized mortgage obligations -
Agency 6,341 113 6,228
Federal agencies bonds/notes 28,000 721 27,279
------ --- ---- -------
$34,666 $10 $834 $33,842
======= === ==== =======
JUNE 30, 1996
----------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
Available for Sale:
Collateralized mortgage obligations:
Agency $ 13,385 $138 $ 5 $ 13,518
Non-agency 19,495 244 19,739
Investments in mutual funds 15,601 318 15,283
Federal agencies bonds/notes 129,006 26 4,401 124,631
-------- ---- ------ --------
$177,487 $408 $4,724 $173,171
======== ==== ====== ========
91
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
JUNE 30, 1995
----------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
HELD TO MATURITY:
Stripped mortgage-backed security -
interest only $ 395 $ - $ 21 $ 374
Collateralized mortgage obligations -
Agency 37 37
Federal agencies bonds 19,032 128 19,160
------- ---- ---- -------
$19,464 $128 $ 21 $19,571
======= ==== ==== =======
JUNE 30, 1995
----------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
AVAILABLE FOR SALE:
Collateralized mortgage obligations:
Agency $16,535 $ 35 $ - $16,570
Non-agency 23,568 146 295 23,419
Investments in mutual funds 15,601 193 15,408
------- ---- ---- -------
$55,704 $181 $488 $55,397
======= ==== ==== =======
JUNE 30,
--------------
1996 1995
Weighted average interest rate at end of period:
Investment securities held to maturity 7.04 % 7.12 %
==== ====
Investment securities available for sale 7.21 % 7.17 %
==== ====
There were no sales of investment securities during the years ended June 30,
1996 and 1994. Gross realized losses from sales of investment securities
available for sale were $13,000 for the year ended June 30, 1995. The Company
recorded no gross realized gains from sales of investment securities available
for sale during the year ended June 30, 1995.
92
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
The Company's collateralized mortgage obligations are in the form of
nonequity debt instruments with stated principal amounts and stated
interest rate terms. On a monthly basis, the Company reviews the
expected recoverability of its investment in the interest-only stripped
mortgage-backed security.
At June 30, 1996, $34,629,000 of investment securities held to maturity
have fixed interest rates and $37,000 have adjustable interest rates. At
June 30, 1996, $124,631,000 of investment securities available for sale
have fixed interest rates and $48,540,000 have adjustable interest
rates.
The scheduled maturities of investment securities held to maturity and
investment securities (other than equity securities) available for sale
at June 30, 1996 were as follows:
HELD TO MATURITY AVAILABLE FOR SALE
SECURITIES SECURITIES
------------------------ --------------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------------------ --------------------------
(IN THOUSANDS)
Due in one year or less $ - $ - $ 7,006 $ 7,032
Due from one to five years 7,000 6,911 5,000 4,953
Due from five to ten years 16,000 15,560 5,000 4,801
Due after ten years 5,000 4,808 112,000 107,845
------- ------- -------- --------
$28,000 $27,279 $129,006 $124,631
======= ======= ======== ========
Collateralized mortgage obligations and the interest only mortgage-
backed security have been excluded from the above table as they are not
due at a single maturity date.
93
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
4. LOANS RECEIVABLE
Loans receivable are summarized as follows:
JUNE 30,
--------------------------
1996 1995
(IN THOUSANDS)
Real estate loans - collateralized by trust deeds:
One- to four-family $ 161,448 $ 136,418
Multifamily 5,564 5,434
Commercial 46,222 49,020
Construction 9,459 5,920
Acquisition, development and land 7,355 6,527
Second mortgage residential loans 1,282 1,656
------- -------
231,330 204,975
Less:
Undisbursed loan funds (5,584) (3,281)
Unamortized yield adjustments (2,512) (2,350)
Allowance for estimated loan losses (2,839) (2,430)
------- -------
(10,935) (8,061)
------- -------
Real estate loans, net 220,395 196,914
94
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
JUNE 30,
---------------------------
1996 1995
(IN THOUSANDS)
Consumer loans:
Mobile home loans $ 4,158 $ 4,779
Loans on deposit accounts 746 764
Other consumer loans 149 273
--------- ---------
5,053 5,816
Less:
Unamortized yield adjustments (58) (69)
Allowance for estimated loan losses (229) (264)
--------- ---------
(287) (333)
--------- ---------
Consumer loans, net 4,766 5,483
--------- ---------
$ 225,161 $ 202,397
========= =========
Weighted average interest rate at end
of period 8.09% 7.82%
==== ====
The Company serviced loans for others in the amount of $21,175,000,
$24,770,000 and $28,085,000 as of June 30, 1996, 1995 and 1994,
respectively.
As of June 30, 1996, included in loans receivable are adjustable rate
loans with principal balances of $107,696,000. Adjustable rate loans are
indexed primarily to the Federal Home Loan Bank's Eleventh District cost
of funds.
Activity in the allowance for estimated loan losses is summarized as
follows:
YEAR ENDED JUNE 30,
------------------------------------
1996 1995 1994
(IN THOUSANDS)
Balance, beginning of year $ 2,694 $ 2,682 $ 3,157
Provision for estimated loan losses 1,054 1,202 877
Charge-offs (680) (1,190) (1,352)
------- ------- -------
Balance, end of year $ 3,068 $ 2,694 $ 2,682
======= ======= =======
95
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
A summary of loan activities of executive officers and directors is as
follows:
YEAR ENDED JUNE 30,
-------------------------
1996 1995 1994
(IN THOUSANDS)
Balance, beginning of year $455 $510 $811
New loans 116 72 70
Repayments, including payoffs (88) (127) (371)
---- ---- ----
Balance, end of year $483 $455 $510
==== ==== ====
Under FIRREA, the Association may not make loans to one borrower in
excess of 15% of its unimpaired capital and surplus, except for loans
not to exceed $500,000. This 15% limitation results in a dollar
limitation of approximately $8,651,000 at June 30, 1996. Because the
Association meets the fully phased-in capital requirements at June 30,
1996, it would be able to increase the limitation to 30%, providing
certain notifications are given to the OTS.
The majority of the Company's loans are collateralized by real estate in
Southern California. Included in commercial loans at June 30, 1996 and
1995 are $14,876,000 and $14,893,000, respectively, of loans
collateralized by mini-warehouse units.
Impairment of loans having recorded investments of $3,268,000 at
June 30, 1996 have been recognized in conformity with SFAS No. 114, as
amended by SFAS No. 118. Recorded investments in other impaired loans
were $5,667,000 at June 30, 1996. The average recorded investment in
impaired loans during the year ended June 30, 1996 was $8,257,000. The
total allowance for loan losses related to these loans was $1,224,000 at
June 30, 1996. At June 30, 1996, loans totaling $7,634,000, with
specific reserves of $1,038,000 that the Company has classified as
impaired, are performing in accordance with the terms of their
contractual agreements. Interest income on impaired loans of $707,000
was recognized for cash payments received in the year ended June 30,
1996.
Nonaccrual loans totaled $1,301,000, $2,281,000 and $2,636,000 as of
June 30, 1996, 1995 and 1994, respectively. If nonaccrual loans had been
performing in accordance with their original terms, the Company would
have recorded interest income of $124,000, $177,000 and $231,000,
respectively, instead of interest income actually recognized of $83,000,
$100,000 and $104,000, respectively, for the years ended June 30, 1996,
1995 and 1994, respectively.
At June 30, 1996, the Company had ten loans, totaling $714,000,
classified as troubled debt restructures. At June 30, 1996, all loans
were considered as performing, and the Company had established a
specific loan loss provision aggregating $198,000.
96
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are summarized as follows:
JUNE 30, 1996
----------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
HELD TO MATURITY:
Federal National Mortgage Association $ 81,515 $ 29 $ 6,859 $ 74,685
Federal Home Loan Mortgage Corporation 10,454 263 10,717
Government National Mortgage Association 67,293 431 605 67,119
-------- ------ -------- --------
$159,262 $ 723 $ 7,464 $152,521
======== ====== ======== ========
JUNE 30, 1996
---------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
AVAILABLE FOR SALE:
Federal National Mortgage Association $ 69,149 $ 804 $ 903 $ 69,050
Federal Home Loan Mortgage Corporation 14,953 167 47 15,073
Government National Mortgage Association 15,786 350 16,136
------- ------ -------- --------
$99,888 $1,321 $ 950 $100,259
======= ====== ======== ========
JUNE 30, 1995
----------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
HELD TO MATURITY:
Federal National Mortgage Association $ 86,739 $ 37 $ 2,883 $ 83,893
Federal Home Loan Mortgage Corporation 21,238 664 21,902
Government National Mortgage Association 100,113 1,390 487 101,016
-------- ------ -------- --------
$208,090 $2,091 $ 3,370 $206,811
======== ====== ======== ========
97
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR
EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
JUNE 30, 1995
------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
AVAILABLE FOR SALE:
Federal National Mortgage Association $ 58,413 $1,587 $ 24 $ 59,976
Federal Home Loan Mortgage Corporation 10,564 68 5 10,627
-------- ------ ------- --------
$ 68,977 $1,655 $ 29 $ 70,603
======== ====== ======= ========
The weighted average interest rate on mortgage-backed securities held to
maturity was 6.81% and 6.64% at June 30, 1996 and 1995, respectively.
The weighted average interest rate on mortgage-backed securities
available for sale was 7.46% and 7.54% at June 30, 1996 and 1995,
respectively.
There were no sales of mortgage-backed securities during the years ended
June 30, 1996 and 1995. Gross realized gains from sales of mortgage-
backed securities were $781,000 for the year ended June 30, 1994. The
Company recorded no gross realized losses from sales of mortgage-backed
securities during the year ended June 30, 1994.
The related tax effects of gains on sales of mortgage-backed securities
were $290,000 for the year ended June 30, 1994.
As of June 30, 1996, the Company has pledged $211,154,000 of real estate
loans, mortgage-backed securities and its investment in the capital
stock of the Federal Home Loan Bank (FHLB) of San Francisco in
conjunction with certain interest rate swap transactions and advances
from the FHLB (Note 10). Additionally, the Company has pledged
$8,346,000 of mortgage-backed securities in conjunction with interest
rate swap transactions with other brokerage agencies (Note 15).
98
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Consolidated)
- --------------------------------------------------------------------------------
6. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
JUNE 30,
-------------------
1996 1995
(IN THOUSANDS)
Investment securities held to maturity $ 510 $ 135
Investment securities available for sale 2,722 361
Loans receivable 1,364 1,123
Mortgage-backed securities held to maturity 944 1,195
Mortgage-backed securities available for sale 682 495
Other 38 11
------ ------
$6,260 $3,320
====== ======
7. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
JUNE 30,
-------------------
1996 1995
(IN THOUSANDS)
Land $ 1,729 $ 803
Buildings 4,870 3,655
Leasehold improvements 1,164 1,115
Furniture, fixtures and equipment 4,443 4,376
Automobiles 86 78
-------- --------
12,292 10,027
Less accumulated depreciation and amortization (5,714) (5,359)
-------- --------
$ 6,578 $ 4,668
======== ========
99
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- -------------------------------------------------------------------------------
8. REAL ESTATE OWNED
Real estate owned is summarized as follows:
JUNE 30,
---------------------
1996 1995
(IN THOUSANDS)
Real estate acquired through foreclosure $ 1,460 $ 1,893
Real estate acquired for sale or investment 2,532 3,934
------- -------
3,992 5,827
Less allowance for estimated real estate losses (1,917) (1,927)
------- -------
$ 2,075 $ 3,900
======= =======
Activity in the allowance for estimated real estate losses is summarized
as follows:
YEAR ENDED JUNE 30,
------------------------------
1996 1995 1994
(IN THOUSANDS)
Balance, beginning of year $ 1,927 $ 1,841 $ 798
Provision for estimated real estate losses 264 633 1,271
Charge-offs (274) (547) (228)
------- ------- -------
Balance, end of year $ 1,917 $ 1,927 $ 1,841
======= ======= =======
Loss from real estate operations, net is summarized as follows:
YEAR ENDED JUNE 30,
------------------------------
1996 1995 1994
(IN THOUSANDS)
Gain on sales of real estate $ 200 $ 182 $ 132
Net loss related to holding real estate (292) (175) (232)
Provision for estimated real estate losses (264) (633) (1,271)
Direct write-offs (142) (121) (190)
----- ------- -------
$(498) $ (747) $(1,561)
===== ======= =======
100
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
9. DEPOSIT ACCOUNTS
Deposit accounts are summarized as follows:
JUNE 30,
---------------------------------------------------------------
1996 1995
------------------------------- ------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
BALANCE INTEREST BALANCE INTEREST
(IN THOUSANDS) RATE (IN THOUSANDS) RATE
NOW accounts $ 35,448 1.19% $ 30,141 1.18%
Passbook accounts 64,257 2.76% 57,408 2.32%
Money market investment accounts 33,434 3.28% 29,244 3.20%
Noninterest-bearing accounts 7,746 5,171
Certificate accounts*:
$100 minimum 501,702 5.69% 323,664 5.91%
$100,000 minimum 27,138 5.54% 26,709 6.24%
---------- ---------
$669,725 $472,337
========== =========
Weighted average interest rate at
period-end 4.98% 4.95%
===== =====
* At June 30, 1996, included in certificate accounts are 724
aaccounts totaling $82,598,000 with balances of $100,000 or more.
Interest expense on deposit accounts is summarized as follows:
YEAR ENDED JUNE 30,
-----------------------------------------------------
1996 1995 1994
(IN THOUSANDS)
NOW accounts $ 357 $ 395 $ 480
Passbook accounts 1,499 1,269 1,371
Money market investment accounts 879 935 1,044
Certificate accounts 21,046 18,029 15,625
------------ ------------ ------------
$ 23,781 $ 20,628 $ 18,520
============ ============ ============
101
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- -----------------------------------------------------------------------------
Certificate accounts are scheduled to mature as follows:
JUNE 30,
-------------------------
1996 1995
(IN THOUSANDS)
Within one year $ 428,902 $ 230,430
Within two years 64,333 68,041
Within three years 21,287 29,082
Within four years 7,685 12,911
Within five years 4,865 6,426
Thereafter 1,768 3,483
--------- ---------
$ 528,840 $ 350,373
========= =========
During June 1996, the Company acquired deposit accounts totaling
approximately $185,189,000 and certain other assets of three branches in
San Diego County. A premium of approximately $6,642,000 was paid, all of
which was allocated to core deposit intangible to be amortized, on a
straight-line basis, over seven years. Such amount is included in other
assets in the accompanying consolidated statements of financial
condition.
10. ADVANCES FROM THE FEDERAL HOME LOAN BANK
At June 30, 1996, advances from the FHLB are scheduled to mature in
1998.
At June 30, 1996 and 1995, the weighted average interest rate on
advances from the FHLB was 5.20% and 5.20%, respectively. The advances
which have fixed rates and certain interest rate swap transactions (Note
15) were collateralized at June 30, 1996 by real estate loans, mortgage-
backed securities, and its investment in the capital stock of the FHLB
of San Francisco with balances of approximately $211,154,000.
The following summarizes activities in advances from the FHLB:
YEAR ENDED JUNE 30,
---------------------------------
1996 1995 1994
(DOLLARS IN THOUSANDS)
Average amount outstanding during
the period $ 103,333 $ 70,000 $ 54,615
========= ======== ========
Maximum amount outstanding at any
month-end during the period $ 120,000 $ 70,000 $ 70,000
========= ======== ========
Weighted average interest rate
during the period 5.36% 5.20% 5.06%
==== ==== ====
102
HF BANCORP, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- ---------------------------------------------------------------------------
11. OTHER BORROWINGS
From time to time, the Company enters into reverse repurchase and dollar
reverse repurchase agreements on investment and mortgage-backed
securities.
The following is a summary of activities in such agreements:
YEAR ENDED JUNE 30,
--------------------------------------
1996 1995 1994
(DOLLARS IN THOUSANDS)
Average amount outstanding during the period $ 24,719 $ - $ 16,215
========== ========== =========
Maximum amount outstanding at any month-end
during the period $ 49,438 $ $ 84,423
========== ========== =========
Weighted average interest rate during the period 5.48% - % 2.01%
==== ==== ====
There were no borrowings under reverse repurchase and dollar reverse
repurchase agreements during the year ended June 30, 1995.
There were no outstanding borrowings under reverse repurchase and dollar
reverse repurchase agreements at June 30, 1996 and June 30, 1994.
The Company enters into reverse repurchase and dollar reverse repurchase
agreements only with primary government securities dealers. The lender
maintains possession of the collateral securing these agreements.
103
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- ------------------------------------------------------------------------------
12. INCOME TAXES
Income taxes are summarized as follows:
YEAR ENDED JUNE 30,
-----------------------------------
(IN THOUSANDS)
Current tax expense (benefit)
Federal $ 825 $ (574) $ (1,191)
State 2 2 (319)
-------- -------- --------
827 (572) (1,510)
Deferred tax expense (benefit):
Federal 302 219 (1,109)
State ( 85)
-------- -------- --------
302 219 (1,194)
-------- -------- --------
$ 1,129 $ (353) $ (2,704)
======== ======== ========
A reconciliation from the statutory federal income tax rate to the
consolidated effective income tax rate follows:
YEAR ENDED JUNE 30,
--------------------------
1996 1995 1994
Statutory federal income tax rate 35.0% (35.0)% (35.0)%
State franchise tax, net of federal
income tax benefit 4.0 0.2 (2.0)
Other (2.3) 1.1 (0.2)
---- ---- ----
36.7% (33.7)% (37.2)%
==== ==== ====
104
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
At June 30, 1996, 1995 and 1994, the deferred components of the
Company's total income tax liabilities (assets) as included in the
consolidated statements of financial condition are summarized as
follows:
YEAR ENDED JUNE 30,
----------------------------------------------
1996 1995 1994
(IN THOUSANDS)
Deferred tax liabilites:
Federal Home Loan Bank stock dividends $ 1,300 $ 1,164 $ 1,065
Depreciation 359 383 385
Prepaid pension, net 136 100 83
Capitalized interest 47 48 49
Net unrealized gains on securities available for sale 548 32
Other 354 145 198
----------- ---------- ---------
Gross deferred tax liabilities 2,196 2,388 1,812
Deferred tax assets:
Net unrealized losses on securities available for sale (1,635)
Bad debt reserve (893) (727) (1,415)
Loan fees (405) (622) (457)
Provision for losses (700) (636) (390)
Premium/discount on loans (104) (104) (104)
Real estate investments (72) (72)
State taxes (29)
California net operating loss (190) (116)
Deferred gain on branch sale (205)
Other (74)
----------- ---------- ---------
Gross deferred tax assets (4,043) (2,351) (2,556)
Valuation allowance 424 268 314
----------- ---------- ---------
Net deferred tax (asset) liability $ (1,423) $ 305 $ (430)
=========== ========== =========
Gross deferred tax assets are primarily expected to be realized in 1997
and 1998.
105
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Valuation allowances under SFAS No. 109 have been provided for state
purposes to the extent uncertainty exists as to the recoverability of
the deferred tax assets. As of June 30, 1996 and 1995, valuation
allowances were provided for a portion of the net deferred state tax
assets. Future reductions in the valuation allowance will be dependent
upon a more likely than not expectation of recovery of tax benefits.
13. BENEFIT PLANS
Defined Benefit Plan - The Association maintains a noncontributory
defined benefit pension plan covering all employees who meet both
minimum age and length of service requirements and an unqualified
benefit plan for its directors. Costs under the pension plan are
calculated and funded under the Projected Unit Credit Actuarial Cost
Method, which includes amortization of past service costs. The
Association's funding policy is to fund pension costs within the
minimum/maximum contribution permitted under ERISA, as calculated by the
actuaries.
Net pension cost consists of the following:
YEAR ENDED JUNE 30,
---------------------------
1996 1995 1994
(IN THOUSANDS)
Service cost benefits earned during the year $348 $387 $379
Interest cost on projected benefit obligations 524 483 454
Actual return on plan assets (971) (817) (84)
Net amortization and deferral 434 456 (248)
---- ---- ----
$335 $509 $501
==== ==== ====
106
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
The following table sets forth the plan's funded status:
YEAR ENDED JUNE 30,
------------------------------
1996 1995 1994
(IN THOUSANDS)
Accumulated benefit obligation:
Vested $(6,608) $(5,772) $(5,165)
Non-vested (323) (328) (374)
------- ------- -------
$(6,931) $(6,100) $(5,539)
======= ======= =======
Projected benefit obligation for service
to June 30 $(8,422) $(7,102) $(6,543)
Plan assets at fair value at June 30
(primarily U.S. government securities
funds) 8,252 7,148 6,004
------- ------- -------
Projected benefit obligation (in excess of)
less than plan assets (170) 46 (539)
Unrecognized net loss 1,382 1,024 1,537
Unrecognized net asset at July 1, 1986 being
recognized over 15 years (89) (106) (124)
Unrecognized prior service cost 113 147 181
------- ------- -------
Prepaid pension cost recognized in consolidated
statements of financial condition $ 1,236 $ 1,111 $ 1,055
======= ======= =======
The weighted average discount rate used in determining the actuarial present
value of the projected benefit obligation was 7.5% in 1996, 1995 and 1994.
The expected long-term rate of return on assets was 8.5% in 1996, 1995 and
1994.
Employee Stock Ownership Plan and Trust - The Company established for
eligible employees an Employee Stock Ownership Plan and Trust (ESOP) which
became effective upon the conversion of the Association from a mutual to a
stock association (the Conversion). Full-time and certain eligible part-time
employees employed with the Association as of January 1, 1994 and full-time
employees of the Company or the Association employed after such date who have
been credited with at least 1,000 hours during a 12-month period and who have
attained age 21 are eligible to participate.
The ESOP subscribed for 7% (or 462,875) of the shares of common stock issued
in the Conversion pursuant to the subscription rights granted under the ESOP
plan. On June 30, 1995, the ESOP borrowed $3,703,000 from the Company in
order to fund the purchase of common stock. The loan to the ESOP will be
repaid principally from the Company's contributions to the ESOP over a period
of
107
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
ten years and the collateral for the loan is the common stock purchased
by the ESOP. The interest rate for the ESOP loan is 9%. At June 30,
1996, the outstanding balance of the loan was $3,332,700 and a total of
46,288 shares of common stock was allocated to employee accounts.
Shares purchased by the ESOP will be held in a suspense account for
allocation among participants as the loan is repaid. Contributions to
the ESOP and shares released from the suspense account in an amount
proportional to the repayment of the ESOP loan will be allocated among
participants on the basis of compensation in the year of allocations.
Benefits generally become 100% vested after five years of credited
service. Prior to the completion of five years of credited service, a
participant who terminates employment for reasons other than death,
retirement or disability will not receive any benefit. Benefits are
payable upon death, retirement or disability.
The expense related to the ESOP for the year ended June 30, 1996 was
approximately $665,000. At June 30, 1996, unearned compensation related
to the ESOP approximated $3,147,000 and is shown as a reduction of
stockholders' equity in the accompanying consolidated statements of
financial condition.
Deferred Compensation Plan - The Association maintains a nonqualified
deferred compensation plan (Deferred Compensation Plan) with certain
directors whereby such directors may defer all or a portion of
compensation otherwise currently payable in exchange for the receipt at
the time they cease to serve as officers of the Association with a
benefit at the time of retirement as provided for in the Plan. Amounts
deferred under this program will earn interest, compounded annually,
based on the highest certificate account rate (excluding accounts
requiring deposits of $100,000 or more) in effect on January 1 of each
year of the deferral or distribution period. Directors may defer
compensation for any number of years, designated in advance. The
Deferred Compensation Plan provides that benefits are to be paid in a
lump sum or annual installments over a period of years determined by the
Association at its discretion. The Deferred Compensation Plan also
provides that directors may elect to have their deferred compensation,
or any portion thereof, invested in stock of the Company. Included in
accounts payable and other liabilities at June 30, 1996 and 1995 are
$524,000 and $439,000, respectively, of deferrals related to the
Deferred Compensation Plan.
Directors' Retirement Plan - The Association and Company maintain a
retirement plan for those directors who have completed ten years of
service or who have both attained the age of 65 and had five years of
consecutive service as a director (Directors' Retirement Plan). The
Directors' Retirement Plan provides that a participant will receive
monthly benefits until death equal to 60% of the basic monthly
director's fee such participant received for the last month in which he
served as director. Upon the retired participant's death, 50% of his/her
benefit shall continue to be paid to his/her surviving spouse for the
balance of his/her life. If the participant dies while still serving as
a director, 50% of the monthly retirement benefit that said participant
would have received had he/she retired the day immediately preceding the
date of his/her death shall be paid to his/her surviving spouse for the
balance of the spouse's life. The Directors' Retirement Plan was
terminated effective March 31, 1995, and consequently, no new directors
will be entitled to benefits under this plan.
108
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Net pension cost for the Director's Retirement Plan consists of the
following:
YEAR ENDED JUNE 30,
------------------------
1996 1995 1994
(IN THOUSANDS)
Service cost benefits earned during the year $ 8 $18 $19
Interest cost on projected benefit obligations 44 46 46
Net amortization and deferral 9 2 (51)
--- --- ---
$61 $66 $14
=== === ===
The following table sets forth the funded status of the Directors'
Retirement Plan:
YEAR ENDED JUNE 30,
-------------------------------
1996 1995 1994
(IN THOUSANDS)
Accumulated benefit obligation:
Vested $(602) $(659) $(614)
Non-vested
----- ----- -----
$(602) $(659) $(614)
===== ===== =====
Projected benefit obligation for service to June 30 $(638) $(659) $(614)
Unrecognized net gain (37) (23) (62)
Unrecognized net obligation at July 1, 1986
being recognized over 15 years 78 93 109
Unrecognized prior service cost (3)
----- ----- -----
Pension liability cost recognized in consolidated
statements of financial condition $(597) $(589) $(570)
===== ===== =====
109
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.5% in 1996 and
1995 and 8% in 1994.
Retirement Restoration Plan - The Association has implemented a non-
qualified retirement plan to provide the Chief Executive Officer with
additional retirement benefits. The benefits provided under such plan
will make up the benefits lost to the participant due to application of
limitations on compensation and maximum benefits applicable to the
Association's tax-qualified plans. Benefits will be provided under the
Retirement Restoration Plan at the same time and in the same form as the
benefits will be provided under the Association's tax-qualified plans.
Net pension cost for the Retirement Restoration Plan consists of the
following for the year ended June 30, 1996:
Immediate recognition of initial liability $87,000
=======
The following table sets forth the funded status of the Retirement
Restoration Plan as of June 30, 1996:
Accumulated benefit obligation: $(87,000)
Vested
Non-vested
--------
$(87,000)
========
Projected benefit obligation for service to June 30 $(87,000)
--------
Pension liability cost recognized in consolidated
statement of financial condition $(87,000)
========
The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.5% in 1996.
Stock Compensation Plan - Effective January 11, 1996, the stockholders
of the Company approved the Hemet Federal Savings and Loan Association
Master Stock Compensation Plan (the Stock Compensation Plan). The Stock
Compensation Plan, which is a nonqualified plan, was authorized to
acquire up to 198,375 shares of Company common stock either directly
from the Company or through purchases in the open market to be used for
the granting of plan share grants, plan share allocations and plan share
awards. The Association contributed funds to the Stock Compensation Plan
to enable
110
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
the Stock Compensation Plan trustees to acquire the necessary shares of
the common stock. On February 28, 1996, 198,375 shares were purchased in
the open market at a price of $10.00 per share. These shares represent
deferred compensation and have been accounted for as a reduction in
stockholders' equity in the accompanying consolidated statement of
financial condition. Such shares are held in trust.
The Stock Compensation Plan allocated 34,700 shares to directors with
the remaining shares allocated to employees as follows: 75% as a base
grant and 25% as a performance grant (provided certain goals are met).
Shares vest in equal annual installments of 20% over a 5-year period.
The expense related to the Stock Compensation Plan for the year ended
June 30, 1996 was approximately $198,000. At June 30, 1996, deferred
compensation related to the Stock Compensation Plan was approximately
$198,000.
Stock Option Plan - Effective January 11, 1996, the stockholders of the
Company approved the HF Bancorp, Inc. 1995 Master Stock Option Plan (the
Stock Option Plan). The Stock Option Plan authorizes the granting of
options equal to 661,250 shares of common stock. All officers and other
employees of the Company and its affiliates, and directors who are not
also serving as employees of the Company or any of its affiliates are
eligible to receive awards under the Stock Option Plan.
Options granted under the Stock Option Plan will be made at an
exercisable price equal to the fair market value on the date of grant.
Options expire 10 years from the date of grant.
Awards granted to employees may include incentive stock options,
nonstatutory stock options and limited rights which are exercisable only
upon a change in control of the Company. Awards granted to nonemployee
directors are nonstatutory options. Options are exercisable in five
equal annual installments of 20% commencing one year from the date of
grant.
The following is a summary of activity in the Stock Option Plan during
1996:
Shares granted (weighted average exercise
price of $10.04) 595,340
=======
Shares outstanding at June 30, 1996 (weighted
average exercise price of $10.04) 595,340
=======
No options were exercised, forfeited or expired during 1996 and none
were exercisable at June 30, 1996.
At June 30, 1996, shares reserved for future grant are 65,910.
111
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
14. COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business in order to meet the financing
needs of its customers. These financial instruments represent
commitments to fund loans. Commitments are issued following the
Company's evaluation of each applicant's creditworthiness on a case-by-
case basis. At June 30, 1996, the Company had outstanding loan funding
commitments of $4,086,000 substantially all of which were adjustable
rate commitments. Commitments to fund loans are agreements to lend to a
customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Also,
external market forces impact the probability of commitments being
exercised; therefore, total commitments outstanding do not necessarily
represent future cash requirements.
As of June 30, 1996, minimum future operating lease commitments of the
Company for real and personal property are as follows:
First year $ 528,000
Second year 500,000
Third year 398,000
Fourth year 361,000
Fifth year 298,000
Thereafter 2,135,000
----------
$4,220,000
==========
Included in general and administrative expenses are rents and other
leasehold expenses which approximated $520,000, $468,000 and $477,000
for the years ended June 30, 1996, 1995 and 1994, respectively.
The Company is involved in litigation concerning various transactions
entered into during the normal course of business. Management does not
believe that settlement of such litigation will have a material effect
on the accompanying consolidated financial statements.
The Company has negotiated an employment agreement with its chief
executive officer. The employment agreement provides for the payment of
up to three years severance benefits upon termination. The agreement
expires on June 30, 1998.
112
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
15. INTEREST RATE RISK MANAGEMENT - OFF-BALANCE SHEET ACTIVITIES
From 1987 to 1993, the Company entered into various interest rate
exchange agreements in order to reduce the interest rate risk associated
with long-term fixed rate mortgages and short-term liabilities. These
agreements were designated as hedges of short-term liabilities,
specifically deposit accounts with no specified maturity date or with
maturity dates of less than one year which were expected to be renewed
or replaced with other deposits upon their maturity.
The Company pays a fixed rate and earns a variable rate, three-month
LIBOR on interest rate swap agreements with notional amounts of
$35,000,000, $110,000,000 and $150,000,000 as of June 30, 1996, 1995 and
1994, respectively. The agreements are due to mature on various dates
through 1999. At June 30, 1996, 1995 and 1994, the weighted average
fixed payment rate and variable payment received rate were 8.72% and
5.49%, 9.17% and 6.15%, and 9.42% and 4.34%, respectively.
The Company purchased interest rate cap agreements which have notional
amounts of $55,000,000 as of June 30, 1994. There were no outstanding
interest rate cap agreements as of June 30, 1996 or 1995.
The Company purchased interest rate floor agreements which have notional
amounts of $75,000,000 as of June 30, 1994. There were no outstanding
interest rate floor agreements as of June 30, 1996 or 1995.
At June 30, 1996, outstanding notional amounts and maturity dates of
interest rate exchange agreements are summarized as follows:
NOTIONAL
AMOUNT
(IN THOUSANDS) MATURITY DATE
Interest rate swaps $20,000 January 6, 1999
15,000 January 30, 1999
-------
$35,000
=======
113
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Net interest expense (income) recorded by the Company on interest rate
swap, cap and floor agreements is summarized as follows:
YEAR ENDED JUNE 30,
---------------------------
1996 1995 1994
(IN THOUSANDS)
Interest rate swaps $1,217 $4,452 $9,034
Interest rate caps 106 232
Interest rate floors,
net of amortization (32) (4,580)
Amortization of deferred
loss on swap termination 1,975
------ ------ ------
$3,192 $4,526 $4,686
====== ====== ======
There are certain risks associated with swaps, floors and caps,
including the risk that the counterparty may default and that there may
not be an exact correlation between the indices on which the interest
rate swap agreements are based and the terms of the hedged liabilities.
In order to offset these risks, the Company generally enters into
interest rate swap, floor and cap agreements only with nationally
recognized securities firms and monitors the credit status of
counterparties, the level of collateral for such swaps and caps, and the
correlation between the hedged liabilities and indices utilized. There
is no assurance that, in the event interest rates change, the swaps,
floors and caps will move on the same basis or in the same amounts as
its cost of funds.
As of June 30, 1996, the Company has pledged $211,154,000 of real estate
loans, mortgage-backed securities and its investment in the capital
stock of the FHLB in conjunction with certain interest rate swap
transactions and advances from the FHLB (Note 10). Additionally, the
Company has pledged $8,346,000 of mortgage-backed securities in
conjunction with interest rate swap transactions with other primary
dealers.
On July 10, 1995, the Company terminated four interest rate swap
agreements with an aggregate outstanding notional amount of $60,000,000.
At June 30, 1995, the weighted average fixed payment rate and variable
payment received rate were 9.53% and 6.11%, respectively. The Company
paid a termination fee of $4,856,000 which has been deferred and is
being amortized over the remaining terms of the respective swap
agreements. Amortization of $1,975,000 for the year ended June 30, 1996
is included in net interest expense of hedging transactions in the
accompanying consolidated statements of operations. Amortization will be
$1,811,000, $798,000 $272,000 for the years ending June 30, 1997, 1998
and 1999, respectively.
114
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments. The estimated
fair value amounts have been determined by the Company using available
market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
JUNE 30, 1996
--------------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
(IN THOUSANDS)
ASSETS:
Cash and cash equivalents $100,633 $100,633
Investment securities held to maturity 34,666 33,842
Investment securities available for sale 173,171 173,171
Loans receivable 223,860 227,894
Mortgage-backed securities held to maturity 159,262 152,521
Mortgage-backed securities available for sale 100,259 100,259
Federal Home Loan Bank stock 4,436 4,436
LIABILITIES:
Term deposit accounts $528,840 $530,453
Other deposit accounts 140,885 140,885
Advances from the Federal Home Loan Bank 70,000 68,066
OFF-BALANCE SHEET UNREALIZED LOSSES:
Commitments $ 9
Interest rate swap agreements (2,063)
115
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
JUNE 30, 1995
---------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
(IN THOUSANDS)
ASSETS:
Cash and cash equivalents $ 88,642 $ 88,642
Investment securities held to maturity 19,464 19,571
Investment securities available for sale 55,397 55,397
Loans receivable 200,116 206,769
Mortgage-backed securities held to maturity 208,090 206,811
Mortgage-backed securities available for sale 70,603 70,603
Federal Home Loan Bank stock 4,319 4,319
LIABILITIES:
Term deposit accounts $350,373 $353,112
Other deposit accounts 121,964 121,964
Advances from the Federal Home Loan Bank 70,000 67,896
OFF-BALANCE SHEET UNREALIZED LOSSES:
Commitments $ (8)
Interest rate swap agreements (8,605)
The estimated fair values of investment securities and mortgage-backed
securities are based on quoted market prices or dealer quotes. If quoted
market prices are not available, estimated fair values are based on
quoted market prices of comparable instruments.
The fair value of loans receivable is estimated by discounting the
future cash flows using the current rates at which similar loans would
be made to borrowers with similar credit ratings and for the same
remaining maturities. The fair value of nonperforming loans with a
principal balance of approximately $1,301,000 and $2,281,000 at June 30,
1996 and 1995, respectively, was not estimated because it is not
practicable to reasonably assess the credit adjustment that would be
applied in the marketplace for such loans. These nonperforming loans,
which are primarily commercial and construction loans, have a weighted
average interest rate of 8.84% and 7.75% as of June 30, 1996 and 1995,
respectively, and are due at various dates through 2022.
The estimated fair value of Federal Home Loan Bank stock is based on its
redemption value.
The fair value of term deposit accounts is estimated using the rates
currently offered for deposits of similar remaining maturities. The
estimated fair value of other deposit accounts is the amount payable on
demand at June 30, 1996 and 1995.
116
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
Rates currently available to the Company for debt with similar terms and
remaining maturities are used to estimate the fair value of advances
from the Federal Home Loan Bank.
The fair value of commitments is estimated using the fees currently
charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of
the counterparties. For fixed-rate loan commitments, the estimated fair
value also considers the difference between current levels of interest
rates and the committed rates.
The fair value of interest rate swap agreements is the estimated amount
that the Company would receive or pay to terminate the interest rate
swap agreements at the reporting date, taking into account current
interest rates and the current creditworthiness of the swap
counterparties.
The fair value estimates presented herein are based on pertinent
information available to management as of June 30, 1996 and 1995.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively re-evaluated for purposes of these consolidated
financial statements since that date, and therefore, current estimates
of fair value may differ significantly from the amounts presented
herein.
17. CONVERSION TO CAPITAL STOCK FORM OF OWNERSHIP
On June 30, 1995, the Association converted from a federally chartered
mutual savings association to a federally chartered stock savings
association. At that time, the Association established a liquidation
account in an amount equal to its equity, as reflected in the latest
statement of financial condition used in the final conversion
prospectus. The liquidation account will be maintained for the benefit
of eligible account holders who continue to maintain their accounts at
the Association after the conversion. The liquidation account will be
reduced annually to the extent that eligible account holders have
reduced their qualifying deposits as of each anniversary date.
Subsequent increases will not restore an eligible account holder's
interest in the liquidation account. In the event of a complete
liquidation of the Association, each eligible account holder will be
entitled to receive a distribution from the liquidation account in an
amount proportionate to the current adjusted qualifying balances for
accounts then held. The liquidation account balance was $18,449,000 at
June 30, 1996.
Subsequent to the conversion, the Association may not declare or pay
cash dividends on, or repurchase, any of its shares of common stock if
the effect thereof would cause equity to be reduced below applicable
regulatory capital maintenance requirements or if such declaration and
payment would otherwise violate regulatory requirements.
At June 30, 1995, included in accounts payable and other liabilities, is
approximately $26,520,000 related to oversubscriptions for stock
purchases by potential investors. Such amounts were refunded during July
1995.
117
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
18. PARENT COMPANY FINANCIAL INFORMATION
The following presents the unconsolidated financial statements of the
parent company only, HF Bancorp, Inc. (Note 1).
HF BANCORP, INC. (PARENT COMPANY ONLY)
STATEMENTS OF FINANCIAL CONDITION
AS OF JUNE 30, 1996 AND 1995
1996 1995
(IN THOUSANDS)
ASSETS:
Cash and cash equivalents $ 4,313 $21,832
Mortgage-backed securities available for sale
(amortized cost of $15,025 at June 30, 1996) 14,608
Accrued interest receivable 93
Investment in subsidiary 58,406 61,611
Receivables from subsidiary 3,483 3,703
Income taxes 168
------- -------
$81,071 $87,146
======= =======
TOTAL STOCKHOLDERS' EQUITY $81,071 $87,146
======= =======
118
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
HF BANCORP, INC. (Parent company only)
STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED JUNE 30, 1996
1996 1995 1994
(IN THOUSANDS)
INTEREST INCOME:
Interest on loans $ 317 $ - $ -
Interest on mortgage-backed securities 946
Interest - Other 468
------ ------ -------
Total interest income 1,731
GENERAL AND ADMINISTRATIVE EXPENSES:
Legal and professional services 76
Salaries and employee benefits 55
Other 320
------ ------ -------
Total general and administrative expenses 451
EQUITY IN NET EARNINGS (LOSS) OF
SUBSIDIARY 1,224 (693) (1,138)
------ ------ -------
EARNINGS (LOSS) BEFORE INCOME TAX EXPENSE 2,504 (693) (1,138)
INCOME TAX EXPENSE 557
------ ------ -------
NET EARNINGS (LOSS) $1,947 $ (693) $(1,138)
====== ====== =======
119
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
HF BANCORP, INC. (Parent company only)
SUMMARY STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED JUNE 30, 1996
1996 1995 1994
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 1,947 $ (693) $(1,138)
Adjustments to reconcile net earnings (loss) to cash
provided by operating activities:
Accretion of discounts on mortgage-backed securities (12)
Increase in accrued interest receivable (93)
Increase in receivables from subsidiary (150)
Increase in income taxes 4
Equity in net (earnings) loss of subsidiary (1,224) 693 1,138
------- ------- -------
Net cash provided by operating activities 472
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage-backed securities available
for sale (16,153)
Principal repayments on mortgage-backed securities
available for sale 1,140
Capital contribution to subsidiary (25,535)
Loan to subsidiary (3,703)
Paydown of loan to subsidiary 370
------- ------- -------
Net cash used in investing activities (14,643) (29,238)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock (3,348)
Net proceeds from issuance of common stock 51,070
------- ------- -------
Net cash (used in) provided by financing activities (3,348) 51,070
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (17,519) 21,832
CASH AND CASH EQUIVALENT,
beginning of year 21,832
------- ------- -------
CASH AND CASH EQUIVALENTS, end of year $ 4,313 $21,832 $ -
======= ======= =======
120
HF BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996 (Continued)
- --------------------------------------------------------------------------------
19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of quarterly results:
FIRST SECOND THIRD FOURTH
(IN THOUSANDS, EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER
1996
Interest income $11,117 $12,473 $13,213 $13,552
Interest expense 7,606 8,415 8,952 9,086
Provision for estimated loan losses 145 58 419 432
Net earnings 214 544 799 390
Earnings per share .03 .09 .13 .07
1995
Interest income $ 9,520 $10,612 $10,041 $10,251
Interest expense 7,449 7,096 6,879 7,371
Provision for estimated loan losses 84 173 538 407
Net earnings (loss) (417) 545 (577) (244)
20. PROPOSED BUSINESS COMBINATION
On May 9, 1996, the Company entered into a definitive agreement to
acquire Palm Springs Savings Bank (Palm Springs). The Company will pay
$14.375 per share for all of the 1,131,279 outstanding shares of common
stock of Palm Springs for a total price of $16,262,000. Palm Springs is
a $187,000,000 four-branch institution located in the Coachella Valley
area of Riverside County. The Company has received regulatory approval
to complete the purchase. On August 23, 1996, the stockholders of Palm
Springs Savings Bank successfully voted to approve the transaction,
which is scheduled to be completed on September 27, 1996.
121
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on October 28, 1996,
on pages 6 and 7.
Officers of the Association who were Executive Officers of the Company as
Defined by Rule 405 of Regulation C of the Securities and Exchange Commission.
Name Age(1) Positions Held With the Association
---- ----- -----------------------------------
Jack A. Sanden 55 Senior Vice President
Letsy J. Glen 50 Senior Vice President
Diane Calderon 45 Senior Vice President
William T Tierney 53 Senior Vice President
leticia J. Arciniega 42 Senior Vice President
(1) As of June 30, 1996
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation is incorporated
herein by reference to the Registrant's Proxy Statement for the Annual Meeting
of Stockholders to be held on October 28, 1996, on pages 10 through 20
(excluding the Report of the Compensation Committee on pages 10 through 12 and
the Stock Performance Graph on page 13).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on October 28,
1996, on page 4 and 6 through 7.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on October 28, 1996,
on page 20.
122
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
These documents are listed in the Index to Consolidated
Financial Statements under Item 8.
2. Financial Statement Schedules
Financial Statement Schedules have been omitted because they are
not applicable or the required information is shown in the
Consolidated Financial Statements or Notes thereto.
(b) Reports on Form 8-K Filed During the Quarter Ended June 30, 1996
Reports on Form 8-K were filed on April 19, 1996 reporting that the
Company had entered into an agreement whereby the Association would
acquire certain assets and liabilities associated with three branch
offices of Hawthorne Savings F.S.B.; on May 20, 1996 announcing that
the Company had entered into an agreement and Plan of Merger whereby
the Company would acquire Palm Springs Savings Bank, F.S.B.; on June
28, 1996 announcing the Association had completed its purchase of
three San Diego County branches of Hawthorne Savings Bank, F.S.B.;
on July 5, 1996 announcing the appointment of a new director; and on
September 4, 1996 announcing the pro forma results of the
Association's acquisition of branch offices from Hawthorne Savings
Bank, F.S.B.
(c) Exhibits Required by Securities and Exchange Commission Regulation
S-K
123
Exhibit Number
- --------------
3.1 Amended Certificate of Incorporation of HF Bancorp, Inc.*
3.2 Bylaws of HF Bancorp, Inc.*
4.0 Stock Certificate of HF Bancorp, Inc.*
10.1 Employment Agreement entered into between the Association and Mr.
Eichinger*
10.2 Employment Agreement entered into between the Company and Mr.
Eichinger*
10.3 Change in Control Agreements entered into between the Association
and certain executive officers*
10.4 Change in Control Agreements entered into between the Company and
certain executive officers*
10.5 Hemet Federal Savings and Loan Association Employee Stock Ownership Plan and Trust*
10.6 Hemet Federal Savings and Loan Association Retirement Restoration
Plan**
10.7 Hemet Federal Savings and Loan Association Directors Deferred Fee
Stock Unit**
10.8 Hemet Federal Savings and Loan Association Management Deferred
Compensation Plan**
10.9 HF Bancorp, Inc. 1995 Master Stock Option Plan***
10.10 Hemet Federal Savings and Loan Association 1995 Master Stock
Compensation Plan***
21 Subsidiaries of HF Bancorp, Inc. See "Part I - Subsidiaries," which information is incorporated
herein by reference
__________________________
* Incorporated herein by reference into this document from the
Exhibits to Form S-1 Registration Statement and any amendments
thereto, filed March 14, 1994, Registration No. 33-90286.
** Incorporated herein by reference into this document form the Form
10-K for the fiscal year ended June 30, 1995 filed with the
Commission on September 27, 1995, file No. 0-27522.
*** Incorporated herein by reference into this document from the Proxy
Statement dated November 28, 1995 filed on December 1, 1995 with
the Commission.
124
SIGNATURE
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HF Bancorp, Inc.
By: /s/ J. Robert Eichinger
---------------------------
J. Robert Eichinger
Dated: September 19, 1996 President and Chief Executive
------------------ Officer
Chairman of the Board
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
Name Title Date
---- ----- ----
/s/ J. Robert Eichinger President and Chief Executive Officer September 19, 1996
- ----------------------------- Chairman of the Board
J. Robert Eichinger (principal executive officer)
/s/ Gerald A. Agnes Executive Vice President September 19, 1996
- -----------------------------
Gerald A. Agnes
/s/ Alex J. Neil Vice President and Chief Financial Officer September 19, 1996
- ------------------------------ (principal financial and accounting officer)
Alex J. Neil
/s/ Norman M. Coulson Director September 19, 1996
- ------------------------------
Norman M. Coulson
/s/ Dr. Robert K. Jabs Director September 19, 1996
- ------------------------------
Dr. Robert K. Jabs
/s/ George W. Fenimore Director September 19, 1996
- ------------------------------
George W. Fenimore
/s/ Patricia A. "Corky" Larson Director September 19, 1996
- ------------------------------
Patricia A. "Corky" Larson
/s/ Harold L. Fuller Director September 19, 1996
- ------------------------------
Harold L. Fuller
/s/ Leonard E. Searl Director September 19, 1996
- ------------------------------
Leonard E. Searl
125