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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For Fiscal Year Ended June 30, 2000 Commission File Number 0-22224
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HALLMARK CAPITAL CORP.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1762467
(State of Incorporation) (IRS Employer Identification No.)
5555 N. Port Washington Road
Glendale, Wisconsin 53217
(Address and Zip Code of principal executive offices)
Registrant's telephone number: (414) 290-7900
Securities Registered Pursuant to Section 12(b) of the Act: None.
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $1.00 per share.
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such 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 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. YES [ ] NO [X]
As of August 31, 2000, there were issued and outstanding 3,162,500 and 2,563,241
shares of the Registrant's Common Stock, respectively. The aggregate market
value of the voting stock held by non-affiliates of the Registrant, computed by
reference to the average of the bid and asked price of such stock as of
September 5, 2000, was $26.6 million. Solely for purposes of this calculation,
all executive officers and directors of the Registrant are considered to be
affiliates; also included as "affiliate shares" are certain shares held by
various employee benefit plans where the trustees are directors of the
Registrant or are required to vote a portion of unallocated shares at the
direction of executive officers or directors of the Registrant. The exclusion
from such amount of the market value of the shares owned by any person shall not
be deemed an admission by the Registrant that such person is an affiliate of the
Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K: Portions of the Proxy Statement for 2000 Annual Meeting
of Shareholders are incorporated by reference into Part III hereof.
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FORM 10-K TABLE OF CONTENTS
Page
Part I
Item 1 - Business................................................................................ 1
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 Stock and Related Security
Holder Matters.......................................................................... 54
Item 6 - Selected Consolidated Financial and Other Data.......................................... 55
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................... 57
Item 7a - Quantitative and Qualitative Disclosures About Market Risk.............................. 76
Item 8 - Financial Statements and Supplementary Data............................................. 77
Item 9 - Changes in and Disagreements with Accountants and Financial Disclosure.................. 107
Part III
Item 10 - Directors and Executive Officers of the Registrant...................................... 107
Item 11 - Executive Compensation.................................................................. 107
Item 12 - Security Ownership of Certain Beneficial Owners and Management.......................... 107
Item 13 - Certain Relationships and Related Transactions.......................................... 107
Part IV
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 108
Signatures............................................................................................ 110
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PART I.
FORWARD-LOOKING STATEMENTS
When used in this Annual Report on Form 10-K or future filings with the
Securities and Exchange Commission, in quarterly reports or press releases or
other public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, various words or phrases are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include words and phrases such as "will likely result," "are expected
to," "will continue," "is anticipated," "estimate," "project," "intend" or
similar expressions and various other statements indicated herein with an
asterisk after such statements. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors could affect the
Company's financial performance and could cause actual results for future
periods to differ materially from those anticipated or projected. Such factors
include, but are not limited to: (i) general market interest rates, (ii) general
economic conditions, (iii) legislative/regulatory changes, (iv) monetary and
fiscal policies of the U.S. Treasury and Federal Reserve, (v) changes in the
quality or composition of the Company's loan and investment portfolios, (vi)
demand for loan products, (vii) deposit flows, (viii) competition, (ix) demand
for financial services in the Company's markets, and (x) changes in accounting
principles, policies or guidelines.
The Company does not undertake and specifically disclaims any
obligation to update any forward-looking statements to reflect the occurrence of
anticipated or unanticipated events or circumstances after the date of such
statements.
ITEM 1. BUSINESS
GENERAL
Hallmark Capital Corp. (the "Company") is a holding company
incorporated under the laws of the State of Wisconsin and is engaged in the
financial services business through its wholly-owned subsidiary, West Allis
Savings Bank (the "Bank"), a Wisconsin state-chartered stock savings bank
headquartered in Milwaukee, Wisconsin. The Company's initial public offering was
consummated in December 1993, and the Company acquired all of the outstanding
common stock of the Bank issued in the mutual to stock conversion of the Bank
(the "Conversion") on December 30, 1993.
The Company's primary strategy since the Conversion through fiscal 2000
has been to focus on effectively utilizing the capital acquired in the
Conversion to fund asset growth and asset portfolio diversification into
higher-yielding assets. This strategy resulted in an increase in the Company's
asset size from $179.6 million at June 30, 1994 to $519.6 million at June 30,
2000. The Company's asset growth has come primarily through (i) the origination
and purchase of mortgage loans (principally loans secured by one-to-four family
owner-occupied homes) within and outside of the Company's primary lending area,
(ii) the purchase of mortgage-backed and related securities, and (iii) the
origination and purchase of commercial real-estate and business loans within and
outside of the Company's primary lending area. This asset growth was funded
through significant increases in Federal Home Loan Bank ("FHLB") advances and
other borrowings, and increases in deposits consisting primarily of brokered and
non-brokered wholesale deposits.
The Company's asset portfolio diversification has been achieved by
altering the composition of loans and securities originated, purchased, sold and
held in the total asset portfolio. In particular, the Company has focused on
originating and purchasing higher-yielding non-conforming one-to-four family,
multi-family, commercial real estate and commercial business loans secured by
properties or assets located within the Company's primary lending area (as
defined herein) and outside of the Company's primary lending area, to either
replace or supplement lower-yielding one-to-four family mortgage loans and
principal run-off from the mortgage securities portfolio. In fiscal 2000, the
Company originated and purchased loans or participation interests (loan
production) totaling $140.4 million and $118.9 million, respectively, (total
loan production of $259.3 million) as compared to fiscal 1999 when originated
and purchased loans and participation interests totaled $202.1 million and $56.9
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million, respectively (total loan production of $259.0 million). Approximately
$132.4 million and $47.1 million of the Company's total loan production related
to properties or business assets located outside of the Company's primary
lending area in fiscal 2000 and 1999, respectively (representing 32.09% and
15.76% of gross loans at June 30, 2000 and 1999, respectively). A significant
portion of the Company's loan production in 2000 related to multi-family and
construction loans, commercial real estate loans, commercial construction and
land loans and commercial business loans.
The Company has substantially completed its strategy of utilizing the
capital acquired in the Conversion to fund asset growth and asset portfolio
diversification into higher-yielding assets. In fiscal 2001, the Company does
not intend to significantly grow in asset size from its current level of $519.6
million.* Under FDIC regulatory capital adequacy guidelines, the Bank must
maintain certain amounts and ratios of total and Tier 1 capital (as defined in
the regulations) to risk-weighted assets (as defined in the regulations) in
order to maintain its status as a well-capitalized institution. As of June 30,
2000, the Bank was fully-leveraged from a risk-based capital standpoint, with a
ratio of total capital to risk-weighted assets of 10.34% (with a required ratio
of 10%). See Note 9 to the Company's Notes to Consolidated Financial Statements.
Therefore, in fiscal 2001, in order to maintain its well-capitalized status, the
Bank will only be able to increase its asset base to the extent of net retained
earnings.
The Company intends to continue to maximize the yield on its loan
portfolio in fiscal 2001 by maintaining the portfolio percentage composition of
higher-yielding non-conforming one-to-four family, multi-family, commercial real
estate and commercial business loans and selling substantially all of its
current year lower-yielding one-to-four family mortgage loans originated.* The
Company projects that total loan production will be approximately $200 million
in fiscal 2001 compared to $259.3 million in fiscal 2000*. The Company
anticipates that approximately half of its total loan production in fiscal 2001
will be generated from the purchase of loans secured by properties located
outside of its primary market area.* A significant portion of out-of-market
purchases are expected to relate to non-conforming one-to-four family mortgage
loans, multi-family and commercial real-estate loans.*
The Company intends to evaluate the benefits of converting the Bank
from a state thrift charter to a state bank charter in 2001.* Under regulations
established for state savings banks by the Wisconsin Department of Financial
Institutions ("DFI"), the Bank is limited in the amount of commercial real
estate and commercial business loans it can hold in its loan portfolio. The DFI
approved limit for the Bank was 30% of the Bank's total asset base at June 30,
2000 and June 30, 1999. At June 30, 2000, the Bank had $138.3 million of such
loans in its portfolio, representing 26.6% of the Bank's total asset base of
$520.0 million. At June 30, 1999, the Bank had $77.7 million of such loans in
its portfolio, representing 16.5% of the Bank's asset base of $469.6 million.
The Company projects that the percentage of total assets represented by
commercial real estate and commercial business loans will not increase
significantly in fiscal 2001 as a substantial portion of these new originations
and purchases are expected to be sold in the secondary market. Thus, while
management believes that this current regulatory limit is currently sufficient
to meet the Bank's business strategy in fiscal 2001, the Company intends to
evaluate whether a state bank charter would provide more lending flexibility.*
The Company intends to begin the process of increasing the level of
core retail deposits relative to brokered and non-brokered wholesale deposits
which is expected to reduce the overall cost of liabilities for the Company.*
This process will begin in fiscal 2001 through the use of several different
strategies, including changing the bank name from West Allis Savings Bank to
Ledger Bank, S.S.B., opening a new full-service banking center in Glendale,
Wisconsin, implementing a proactive internal sales culture, and by offering an
internet-only deposit product.*
The Company intends to enhance its presence in the marketplace by
changing its bank name from West Allis Savings Bank to Ledger Bank, S.S.B.
during the second quarter of fiscal 2001.* The new name, Ledger Bank, S.S.B.,
was strategically selected to pay tribute to the Bank's 81-year old heritage as
a trustworthy, solid community bank and to act as a vehicle to demonstrate the
Bank's commitment to future growth.* The Company believes the new name will
enable it to create a differentiated, customer-focused, financial services brand
in the market.* The new name will become official on October 26, 2000, the day
following the Company's annual meeting of shareholders, with a local media and
promotional campaign. The Company believes the new name
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will help enhance the Bank's growth plans to increase its market share around
each current branch office, opening a new full-service banking center as well as
the ongoing sales efforts of its residential lending officers and business loan
officers throughout southeastern Wisconsin.* The Company intends to support the
new name and enhanced brand identity through increased marketing expenditures in
fiscal 2001.*
A new full-service banking center in Glendale, Wisconsin is expected to
be operating during the third quarter of fiscal 2001.* This north shore location
currently serves as the executive and administrative headquarters for the
Company and Bank. Location-specific market research was conducted during fiscal
2000 by a third party company, placing this site as one of the top five
locations for attracting core deposit balances in Milwaukee County. The
full-service banking center will offer traditional deposit products and
services, discount brokerage services, and mortgage, consumer and commercial
business lending services.* The Company expects to incur significant
non-interest expenses in connection with opening the new banking center.*
During fiscal 2001, the Company also intends to generate additional
non-interest income from existing and new revenue sources.* This is expected to
be accomplished by (i) continuing to generate commercial lending and deposit
activities through the commercial lending division, (ii) increasing fee income
opportunities within the residential mortgage lending division through the sale
of one-to-four family mortgage loans and referral of subprime mortgage loans,
(iii) increasing fees from its insurance subsidiary, Hallmark Planning Services,
Inc., and (iv) expanding commercial mortgage banking activities during fiscal
2001.*
In fiscal 2001, the Company intends to continue pursuing commercial
lending activities through its commercial banking division as another source of
additional fee income and higher-yielding assets.* The focus of the Company's
commercial division will be the origination and purchase of small business loans
and leases, as well as the acquisition of business deposits.* During fiscal
2000, the Company originated and purchased $158.2 million of multi-family,
commercial real estate, multi-family construction, commercial construction and
commercial business loans, lines of credit and leases, of which $80.9 million
were purchases and $77.3 were originations. Management currently projects that
the commercial lending division will significantly decrease its origination and
purchase activity (by approximately 50%) during fiscal 2001 in order to maintain
a minimal growth rate in the Company's asset base.* The Company also expects
increased fee income from the commercial banking division resulting from a
growth in business deposit relationships.* The Company also has recently
implemented a program for mortgage contract cash processing within the
commercial lending division, a service which generates fee income. Through the
program, the Bank acts as a partial sub-servicer, providing a cash/processing
function for nationally originated commercial real estate loans.
During fiscal 2001, the Company also intends to increase its
non-interest income by expanding the secondary marketing activities of its
residential mortgage division, generating additional fee income through the sale
of mortgage credit and life insurance, and through the referral of subprime
mortgage loans to a third party lender.* The Company expects one-to-four family
mortgage loan originations to increase despite the generally higher level of
market interest rates due to increased marketing activities and expansion of our
retail banking centers.* It is currently anticipated that substantially all of
the 30-year fixed rate conforming one-to-four family mortgage loans originated
in fiscal 2001 will be sold in the secondary market resulting in income from
gains on loans sold.*
During the fourth quarter of fiscal 2000, the Company discontinued its
lending activities involving higher credit risk financial services (also known
as subprime lending) through Hallmark Financial, Inc. (d/b/a Major Finance).
Major Finance was formed to broker subprime loans primarily secured by
one-to-four family mortgage and commercial real estate within and outside the
Company's primary lending area. Management discontinued the operations of Major
Finance due to the lack of loan production to cover the costs of engaging in
this lending activity. No loans originated by Major Finance are currently in the
Bank's portfolio. It is anticipated that the Company's subprime lending
activities in fiscal 2001 will be limited to referring subprime loan prospects
to third-party lenders through the residential mortgage lending division and
generating referral fee income from such activity.*
The Company expects its insurance subsidiary, Hallmark Planning
Services, Inc., to generate additional fee income in fiscal 2001 from the sale
of securities, mutual funds, annuities and life insurance products by
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licensed investment brokers. The Company attributes the projected growth in fee
income to the overall business strategy of adding a new retail banking center
and the implementation of a proactive sales culture in fiscal 2001.*
During fiscal 2001, the Company also intends to generate non-interest
income by leveraging its existing commercial lending capabilities through the
origination, selling and servicing of commercial real estate mortgages on a
national basis, with primary concentration in the southwest and western regions
of the country.* While the Company primarily expects to originate and purchase
commercial real estate mortgages on a national basis, it also may originate and
purchase loans or participation interests in loans secured by multi-family real
estate and commercial business assets.* The new commercial mortgage banking
operation, Hallmark Financial, Inc. ("HFI"), will be a wholly-owned subsidiary
of the Company. HFI will originate loans from a third party commercial
real-estate broker on a non-exclusive basis and act as the lender of record
until the loan is sold without recourse, generally within 45 days of the loan
closing.* HFI will retain the servicing rights to these loans and receive a
servicing fee.* The Company estimates that during fiscal 2001 HFI will
originate, sell and service approximately $50 - $100 million of commercial real
estate mortgage loans on a national basis, with primary concentration in the
southwest and western regions of the country.* HFI revenues, generated primarily
through the collection of originating and servicing fees, are projected to be
approximately $150,000 - $300,000 in fiscal 2001.* The primary benefit of the
expansion of the Bank's commercial lending activities is to gain economies of
scale through the ability to leverage existing staff, expertise level, overhead
and infrastructure in order to increase fee income without a significant
incremental increase in expenses.*
The Company expects to incur significant increases in non-interest
expense as a result of implementing its strategic business plan in fiscal 2001.*
In addition, the Company's negative interest rate gap position (41.1% at June
30, 2000) will likely reduce net income in the event of an increase in market
interest rates.* To mitigate the Company's exposure to rising interest rate
levels, the Company intends to decrease its negative interest rate gap position
by lengthening the maturities of its wholesale funding sources (wholesale
brokered CDs and FHLB advances). The Company also may implement hedging
strategies involving derivative financial instruments such as options and
interest rate swaps during fiscal 2001.* See "Management's Discussion and
Analysis of Financial Condition - Asset/Liability Management." As a result of
the projected expense increases and narrowing of interest margin due to the gap
position and the generally higher level of interest rates, the Company expects
net income in fiscal 2001 to fall below reported net income for 2000.* Despite
the projected decline in net income, the Company believes the strategic benefits
of the expanded sales and branch activities will have a long-term positive
impact on the Company's results of operations and franchise value.
MARKET AREA
The Company offers a variety of retail deposits and services primarily
in the metropolitan Milwaukee area. The Company also offers a variety of
mortgage, consumer and commercial lending products in the southern Wisconsin
counties of Milwaukee, Waukesha, Racine, Kenosha, Ozaukee, Washington,
Sheboygan, Fond du Lac, Dodge, Jefferson, Dane, Rock and Walworth ("primary
lending area"). In addition, management evaluates lending opportunities on a
national basis, and also will evaluate opportunities to originate and purchase
one-to-four family, multi-family, multi-family construction, commercial real
estate, commercial construction and commercial business loans, or participation
interests in such loans originated by other lenders and secured by properties
located outside of the Company's primary lending area.
The Company's administrative office is located at 5555 N. Port
Washington Road, Glendale, Wisconsin. The city of Glendale is immediately north
of the city of Milwaukee, which is located on the western shore of Lake
Michigan, approximately 90 miles north of Chicago, Illinois. The Company has
three full-service branches located in West Allis, Greenfield and New Berlin,
which are suburbs in Milwaukee and Waukesha counties, respectively. The Company
also operates a limited-services office inside of a senior community residence
in West Allis. All of the Company's locations are in areas generally
characterized as residential neighborhoods.
During fiscal 2000, the Company intends to open a new retail office in
the building currently housing the administrative office in Glendale,
Wisconsin.* Like the Company's other locations, the new location is located in a
primarily residential neighborhood, but management anticipates opportunity for
commercial loan origination and deposit acquisition.* See "Item I. Business -
General."
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The City of Milwaukee is the largest city in Wisconsin, and the
Milwaukee metropolitan statistical area ("MSA") which includes Milwaukee,
Waukesha, Ozaukee and Washington counties, is the largest MSA within the State
of Wisconsin. The MSA includes a diverse economic base, including business,
industry and agriculture. Major employers include Johnson Controls, Inc.,
Harnischfeger Industries, Inc., Briggs and Stratton Corp., Harley-Davidson,
Inc., A.O. Smith Corp., Rockwell Allen-Bradley and Northwestern Mutual Life
Insurance Co., and the home offices of numerous other insurance companies and
financial institutions. Although the local economy was adversely impacted by the
reduction in the number of jobs in heavy industry in the late 1920's and early
1980's, the addition of many service industry and small manufacturing jobs has
had a favorable impact upon the area's economy. The MSA has eleven colleges and
universities each with enrollments exceeding 1,000 students, including Marquette
University, the Milwaukee campus of the University of Wisconsin and Concordia
University.
LENDING ACTIVITIES
GENERAL
The largest component of the Bank's gross loan portfolio, which totaled
$412.6 million at June 30, 2000, was first mortgage loans secured by
owner-occupied one-to-four family residences. At June 30, 2000, one-to-four
family owner-occupied mortgage loans totaled $169.0 million or 41.0% of gross
loans. Of the remaining gross loans held at June 30, 2000, 21.0% were commercial
real estate loans, 10.1% were multi-family mortgage loans, 5.2% were home equity
loans, 4.2% were one-to-four family non-owner-occupied mortgage loans, 6.0% were
commercial business loans, 6.6% were commercial construction and lot loans, 2.9%
were multi-family construction loans, 2.2% were one-to-four family construction
loans and 0.8% were in various consumer loans. As part of its strategy to manage
interest rate risk, the Bank originates primarily ARM loans or fixed-rate loans
which have short- and intermediate-term maturities for its own loan portfolio.
The Bank also offers longer-term fixed-rate loans, of which substantially all
are sold to secondary market investors within guidelines established by the
Asset/Liability Committee.
Since fiscal 1996, the Bank has been actively diversifying its loan
portfolio from lower-yielding one-to-four family mortgage loans into
higher-yielding non-conforming 1-4 family, multi-family, commercial real estate
and commercial business loans while increasing the total asset size of the Bank.
At June 30, 2000, total gross loans receivable grew 38.0% to $412.6 million from
$298.9 million at June 30, 1999. During the same period, higher-yielding
non-conforming 1-4 family, multi-family, commercial real estate, commercial
construction/land and commercial business loans increased proportionately higher
than lower-yielding one-to-four family conforming mortgage loans. Commercial
real estate loans grew by 104.2% to $86.5 million at June 30, 2000 from $42.4
million at June 30, 1999, commercial construction and land loans grew by 59.4%
to $27.2 million at June 30, 2000 from $17.1 million at June 30, 1999 and
commercial business loans grew by 34.7% to $24.6 million from $18.3 million
during the same period. Multi-family real estate and construction loans grew by
19.0% to $53.6 million at June 30, 2000 from $45.1 million at June 30, 1999.
One-to-four family mortgage and construction loans increased by 28.8% to $195.7
million at June 30, 2000 from $151.9 million at June 30, 1999. The increase in
one-to-four family mortgage loans was primarily due to the Bank's purchase of
higher-yielding non-conforming one-to-four family mortgage loans that were
secured by properties located outside of the Company's primary lending area and
totaled $37.0 million at June 30, 2000. During periods of lower interest rates,
customers generally prefer long-term fixed rate mortgages, which the Bank
originates and typically sells in the secondary market based on its
asset/liability management strategy. Substantially all of the 30-year fixed rate
conforming one-to-four family mortgage loans originated in fiscal 2000 were sold
in the secondary market on a service-released basis in lieu of being retained in
the Bank's portfolio.
The Company intends to maintain a higher-yielding asset portfolio
composition in fiscal 2001 by originating and purchasing loans or participation
interests both within and outside the Company's primary lending area.* The
Company's management will continue to evaluate and implement opportunities to
originate and purchase multi-family, commercial real estate loans, multi-family
and commercial construction loans, commercial business loans or participation
interests in such loans originated by other lenders on a national basis. In
fiscal 2000, approximately 32.09% (or $132.4 million) of the Company's gross
loan portfolio related to properties or business assets located outside of the
Company's primary lending area, compared to approximately 15.75% (or $47.1
million) in fiscal 1999.
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In terms of geographic distribution of loans, no single state (other than
Wisconsin) represented in excess of 10% of the Company's gross loan portfolio at
June 30, 2000. However the Company did have loan balances secured by properties
located in California, Minnesota, Illinois, New York and Michigan which
represented 5.4%, 4.7%, 3.8%, 2.4% and 2.1% of the Company's gross loan
portfolio at June 30, 2000, respectively.
In deciding whether or not to purchase a loan or participation interest
in a loan originated outside of the Company's primary lending area, management
of the Company has applied, and intends to continue to apply underwriting
guidelines at least as strict as those applicable to the origination of
comparable loans within its market area. Management of the Company intends to
continue to closely monitor the performance of such loans secured by
multi-family and commercial real estate as well as business assets, as these
types of loans generally involve a greater degree of credit risk than
one-to-four family loans and carry larger balances. The increased credit risk is
the result of several factors, including the concentration of principal in a
limited number of loans and borrowers, the effect of general economic conditions
on income producing properties, and the increased difficulty of evaluating and
monitoring these types of loans. These risks may be increased with respect to
loans secured by properties located outside the Company's primary lending area
due to the increased difficulty of monitoring such loans. Due to the risks
associated with this type of lending, the Company uses a separate risk
monitoring and analysis process for its portfolio of purchased loans both within
and outside of its primary lending area.
The Company also applies a stringent underwriting review process before
purchasing one-to-four family non-conforming loans that involve higher
loan-to-value and debt-to-income ratios both within and outside of its primary
lending area. Additional procedures have been implemented relative to
non-conforming one-to-four family mortgage loans originated by the Company for
its own portfolio which include a secondary review process in the areas of
underwriting, risk and yield analysis. A monthly review of the portfolio is
conducted by the Company's Asset Quality Committee.
As the Company's volume of non-conforming one-to-four family,
multi-family, commercial real estate and commercial business lending activity
has increased, the Company has built a higher level of allowance for loan
losses, established through a provision for loan losses, which has had a
negative effect on the Company's net income in the short term. However, the
Company believes that building the higher-yielding non-conforming one-to-four
family, multi-family, commercial real estate and commercial business components
of its gross loan portfolio will produce higher net interest margin after loan
losses than the current loan portfolio mix and will benefit the Shareholders
longer term by improving the Company's return on equity.*
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COMPOSITION OF LOAN PORTFOLIO
The following table presents information concerning the composition of
the Bank's loan portfolio in dollar amounts and in percentages (before deduction
for loans in process, deferred fees and discounts, allowance for loan losses and
allowance for uncollected interest) as of the dates indicated.
AT JUNE 30,
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2000 1999 1998
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AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
REAL ESTATE LOANS:
One-to-four family:
Owner-occupied........................ $169,028 41.0% $132,924 44.5% $134,877 46.7%
Non-owner occupied.................... 17,248 4.2 15,036 5.0 20,205 7.0
Home equity........................... 21,758 5.2 20,457 6.8 25,079 8.7
Multi-family............................. 41,751 10.1 36,320 12.1 33,513 11.6
Commercial/nonresidential................ 86,521 21.0 42,366 14.2 34,610 12.0
One-to-four family construction.......... 9,414 2.2 3,933 1.3 3,718 1.3
Multi-family construction................ 11,870 2.9 8,740 2.9 3,120 1.1
Other construction and land.............. 27,179 6.6 17,056 5.7 13,874 4.8
-------- ------ -------- ----- -------- -----
Total real estate loans............... 384,769 93.2 276,832 92.6 268,996 93.2
CONSUMER AND OTHER LOANS:
Automobile............................... 262 0.1 444 0.1 755 0.3
Credit card.............................. 2,112 0.5 2,372 0.8 2,777 1.0
Other consumer loans..................... 853 0.2 1,030 0.4 1,476 0.5
-------- ------ -------- ----- -------- -----
Total consumer loans.................. 3,227 0.8 3,846 1.3 5,008 1.8
Commercial loans......................... 24,589 6.0 18,254 6.1 14,646 5.1
Gross loans receivable................... 412,585 100.0% 298,932 100.0% 288,650 100.0%
-------- ------ -------- ----- -------- -----
ADD:
Accrued interest, net.................... 2,031 1,664 1,764
LESS:
Loans in process......................... (18,589) (16,279) (6,848)
Deferred fees and discounts.............. (630) (490) (319)
Allowance for loan losses ............... (3,201) (2,648) (2,329)
Allowance for uncollected interest....... (432) (59) (29)
-------- -------- --------
Total additions/deductions........... (22,852) (19,476) (7,762)
-------- -------- --------
Loans receivable, net............ $391,764 $281,120 $280,889
======== ======== ========
AT JUNE 30,
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1997 1996
------------------------------------------
AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ -------
REAL ESTATE LOANS:
One-to-four family:
Owner-occupied........................ $153,618 53.6% $146,022 58.7%
Non-owner occupied.................... 13,893 4.9 7,667 3.1
Home equity........................... 25,297 8.8 19,349 7.8
Multi-family............................. 27,616 9.7 19,788 8.0
Commercial/nonresidential................ 21,693 7.6 5,488 2.2
One-to-four family construction.......... 17,382 6.1 23,885 9.6
Multi-family construction................ 9,621 3.4 13,131 5.3
Other construction and land.............. 7,385 2.6 6,491 2.6
-------- ----- -------- -----
Total real estate loans............... 276,505 96.7 241,821 97.3
CONSUMER AND OTHER LOANS:
Automobile............................... 1,195 0.4 1,774 0.7
Credit card.............................. 2,730 1.0 2,585 1.0
Other consumer loans..................... 1,950 0.7 2,372 1.0
-------- ----- -------- -----
Total consumer loans.................. 5,875 2.1 6,731 2.7
Commercial loans......................... 3,471 1.2 - 0.0
Gross loans receivable................... 285,851 100.0% 248,552 100.0%
-------- ----- -------- -----
ADD:
Accrued interest, net.................... 1,694 1,287
LESS:
Loans in process......................... (11,998) (23,770)
Deferred fees and discounts.............. (197) (18)
Allowance for loan losses ............... (1,762) (1,234)
Allowance for uncollected interest....... (32) (10)
-------- --------
Total additions/deductions........... (12,295) (23,745)
-------- --------
Loans receivable, net............ $273,566 $224,807
======== ========
11
LOAN MATURITY
The following table shows the contractual maturity of the Bank's loan
and mortgage-backed and related securities portfolio at June 30, 2000. Loans
that have adjustable rates are shown as being due in the period during which the
last payment is due. Demand loans that have no schedule for repayment and no
stated maturity are reported as due in one year or less. The table does not
include estimated prepayments or scheduled principal amortization. Prepayments
and scheduled principal amortization on loans totaled $110.3 million, $199.7
million and $140.2 million for the years ended June 30, 2000, 1999 and 1998,
respectively. Management anticipates that if and when the Bank purchases
multi-family, one-to-four family, commercial real estate and commercial business
loans, or participation interests in such loans, there will not be a material
impact on the contractual maturities of the Bank's loan portfolio.*
AT JUNE 30, 2000
------------------------------------------------------------------------------------------
ONE-TO-
ONE-TO- FOUR MULTI- COMMERCIAL/ OTHER
FOUR FAMILY HOME MULTI- FAMILY NON- CONSTRUCTION/
FAMILY CONSTRUCTION EQUITY FAMILY CONSTRUCTION RESIDENTIAL LAND
------ ------------ ------ ------ ------------ ----------- ----
(IN THOUSANDS)
AMOUNTS DUE:
Within one year..................... $ 72 $ 612 $ 262 $ 968 $ 7,620 $ 8,447 $ 5,758
After one year:
One to three years................ 1,096 200 309 8,001 -- 8,460 6,500
Three to five years............... 2,955 -- 919 13,736 1,500 29,649 4,491
Five to ten years................. 16,309 1,000 19,410 5,153 1,600 25,737 8,205
Ten to 20 years................... 79,678 -- 858 3,090 1,150 14,228 2,225
Over 20 years..................... 86,166 7,602 -- 10,803 -- -- --
--------- ---------- ---------- ---------- ---------- ---------- ----------
Total due after one year........ 186,204 8,802 21,496 40,783 4,250 78,074 21,421
--------- ---------- ---------- ---------- ---------- ---------- ----------
Total amounts due............... 186,276 9,414 21,758 41,751 11,870 86,521 27,179
LESS:
Loans in process.................... (105) (4,155) -- -- (4,272) -- (10,057)
Deferred fees and discounts......... (371) -- -- -- -- (259) --
Allowance for loan losses........... (719) (13) (243) (331) (57) (1,125) (214)
Unrealized loss on
securities available-for-sale....... -- -- -- -- -- -- --
--------- ---------- ---------- ---------- ---------- ---------- ----------
Loans receivable and mortgage-
backed and related securities, net.. $ 185,081 $ 5,246 $ 21,515 $ 41,420 $ 7,541 $ 85,137 $ 16,908
========= ========== ========== ========== =========== ========== ==========
AT JUNE 30, 2000
-------------------------------------------------
TOTAL
MORTGAGE-
BACKED
AND
RELATED
SECURITIES CONSUMER COMMERCIAL TOTAL
---------- -------- ---------- -----
(IN THOUSANDS)
AMOUNTS DUE:
Within one year..................... $ 889 $ 2,200 $ 12,559 $ 39,387
After one year:
One to three years................ 110 249 4,372 29,297
Three to five years............... 817 118 4,522 58,707
Five to ten years................. 269 445 3,136 81,264
Ten to 20 years................... 10,195 215 -- 111,639
Over 20 years..................... 39,214 -- -- 143,785
--------- --------- --------- ---------
Total due after one year........ 50,605 1,027 12,030 424,692
--------- --------- --------- ---------
Total amounts due............... 51,494 3,227 24,589 464,079
LESS:
Loans in process.................... -- -- -- (18,589)
Deferred fees and discounts......... 41 -- -- (589)
Allowance for loan losses........... -- (148) (351) (3,201)
Unrealized loss on
securities available-for-sale....... (574) -- -- (574)
--------- --------- --------- ---------
Loans receivable and mortgage-
backed and related securities, net.. $ 50,961 $ 3,079 $ 24,238 $ 441,126
========= ========= ========= =========
The following table sets forth at June 30, 2000, the dollar amount of
all loans and mortgage-backed and related securities due after June 30, 2001,
and whether such loans have fixed interest rates or adjustable interest rates.
DUE AFTER JUNE 30, 2001
------------------------------------------
FIXED ADJUSTABLE TOTAL
----- ---------- -----
(IN THOUSANDS)
Mortgage loans:
One-to-four family......................................... $144,268 $ 41,936 $186,204
One-to-four family construction............................ 1,200 7,602 8,802
Home equity................................................ 2,542 18,954 21,496
Multi-family............................................... 28,865 11,918 40,783
Multi-family construction.................................. 4,250 -- 4,250
Commercial/nonresidential.................................. 65,415 12,659 78,074
Other construction and land................................ 4,551 16,870 21,421
Consumer loans ....................................................... 1,027 -- 1,027
Commercial loans....................................................... 11,747 283 12,030
-------- -------- --------
Gross loans receivable................................... 263,865 110,222 374,087
Mortgage-backed and related securities................................. 29,262 21,343 50,605
-------- -------- --------
Gross loans receivable and
mortgage-backed and related securities................. $293,127 $131,565 $424,692
======== ======== ========
-8-
12
ONE-TO-FOUR FAMILY MORTGAGE LENDING
The majority of the Bank's historical lending activity has been the
origination of first mortgage loans secured by one-to-four family owner-occupied
residences located within the Bank's primary lending area. In fiscal 2000, the
Bank primarily originated one-to-four family real estate loans secured by
properties located within the Bank's primary lending area and purchased
one-to-four family real estate loans secured by properties located outside the
Bank's primary lending area. At June 30, 2000, the Bank's one-to-four family
mortgage loan portfolio was $186.3 million (representing 45.2% of gross loans)
compared to $148.0 million (representing 49.5% of gross loans) at June 30, 1999.
Due to the higher level of interest rates and lower level of refinancing
activity, the Bank's originations of one-to-four family loans decreased by 61.7%
to $34.2 million at June 30, 2000 from $89.3 million at June 30, 1999. The Bank
purchased $38.0 million in non-conforming one-to-four family mortgage loans
during fiscal 2000 all of which were secured by properties located outside of
the primary lending area, compared to $7.0 million in one-to-four family
non-conforming loan purchases during fiscal 1999. All one-to-four family
mortgage loans purchased in fiscal 2000 were retained in the Bank's loan
portfolio. The purchased loans either were underwritten in accordance with the
Bank's underwriting guidelines or if the Bank's underwriting guidelines were not
met, other credit enhancements or rate adjustments were obtained.
The Bank offers conventional fixed-rate mortgage loans and ARM loans
with maturity dates that typically range from 15 to 30 years. During fiscal
2000, substantially all of the ARM loans were originated for the Bank's own loan
portfolio. The Bank also originates 15-year fixed-rate loans that primarily have
been retained in the Bank's portfolio in recent fiscal years but which the Bank
may sell in the future.* During the fiscal year ended June 30, 2000, the Bank
originated and purchased $7 million in fixed-rate one-to-four family mortgage
loans. The Bank sold $11.5 million in fixed-rate one-to-four family mortgage
loans in fiscal 2000 of which substantially all were 30-year fixed-rate mortgage
loans. The Bank had sold primarily all of its 30-year fixed-rate loans in prior
years. In fiscal 2001, the Bank intends to continue to sell a larger percentage
of one-to-four family conforming mortgage loans in the secondary market as part
of its strategy to generate gains from the sale of such loans and to not
significantly grow the asset base.* Certain fixed-rate loans made under special
loan terms or programs, principally originated for purposes of compliance with
the Community Reinvestment Act are retained in the Bank's portfolio. The Bank
follows Freddie Mac and Fannie Mae underwriting guidelines for its conforming
one-to-four family mortgage loans.
Due to the highly competitive banking environment in its primary
lending area, the Bank offers a variety of rates, fees, origination terms and
mortgage products. While the interest rate on a mortgage loan is a function of
the origination points charged, the Bank has originated and intends to continue
to originate loans that are for sale in the secondary market and primarily
without points.*
In fiscal 2001, the Bank intends to continue from time to time
purchasing higher-yielding one-to-four family non-conforming mortgage loans
secured by properties located both within and outside of the Company's primary
lending area.* One-to four family non-conforming portfolio loans are defined as
loans that do not meet Freddie Mac or Fannie Mae underwriting guidelines
generally due to reasons such as alternative or limited documentation, higher
loan-to-value ratios, higher debt-to-income ratios, consolidation of unseasoned
debt, 100% combined loan-to-value ratios or no private mortgage insurance. With
respect to these loans made at higher loan-to-value ratios, other underwriting
criteria such as debt-to-income ratios and credit history are given greater
emphasis than loans involving lower loan-to-value ratios and conforming
underwriting guidelines. Credit and payment histories are current and generally
considered acceptable by federal secondary market agency standards. Due to the
higher loan-to-value or debt-to-income ratios, these loans may present a higher
level of risk of default and are accordingly made at higher interest rates than
one-to-four family conforming loans. Because the Bank is not involved in the
lending origination process, the Bank takes efforts to mitigate the additional
risk by reviewing the historical payment and credit history of the borrower, and
the collateral quality prior to purchase of the loans. The Bank expects the
servicing of these non-conforming portfolio loans to be retained by the
originating lender.*
The Bank also originates mortgage loans secured by one-to-four family
properties located within its primary lending area for retention in its own
portfolio which do not conform to Freddie Mac and Fannie Mae underwriting
guidelines, typically due to higher loan-to-value ratios, source of down payment
or lower credit scores. The Company estimates that approximately 25% of its
total one-to-four family originations in fiscal 2000
-9-
13
(or approximately $7 million) were comprised of one-to-four family
non-conforming mortgage loans secured by properties within the Company's primary
lending area. Management anticipates that origination levels of one-to-four
family non-conforming mortgage loans in fiscal 2001 will remain approximately
the same.* To compensate for the non-conforming characteristics which increase
the risk on these loans, the Bank receives a higher interest rate or fees.
Additional procedures have been implemented relative to non-conforming
one-to-four family mortgage loans originated by the Company for its own
portfolio which include a secondary review process in the areas of underwriting,
risk and yield analysis. A monthly review of the portfolio is conducted by the
Company's Asset Quality Committee.
Upon receipt of a completed mortgage application from a prospective
borrower, a credit report is ordered, an appraisal from an independent
third-party is obtained, income and other deposit information is verified, and,
as necessary, additional financial information is requested. The Bank requires
title insurance on all first mortgage loans. Borrowers must present evidence of
appropriate hazard insurance and flood insurance (if applicable) prior to the
closing. Borrowers are generally required to advance funds on a monthly basis,
together with payments of principal and interest, to a mortgage escrow account
from which the Bank makes disbursements for items such as real estate taxes,
hazard insurance, and in some cases, flood insurance. For loans with lower
loan-to-value ratios, escrow requirements may be waived for an additional fee.
The lending policy of the Bank for its one-to-four family mortgage loans meeting
federal secondary market guidelines restricts mortgage loan amounts to 80% of
the lesser of the appraised value or purchase price of the real estate to be
mortgaged to the Bank. The Bank makes mortgage loans in amounts up to 95% of the
lesser of the appraised value or purchase price, subject to the availability of
private mortgage insurance insuring the amount in excess of 80% of the appraised
value or purchase price. One-to-four family non-conforming mortgage loans
purchased by the Company typically do not have private mortgage insurance.
Another exception to this policy is for ARM loans in which case the Bank loans
up to 95% of the appraised value or purchase price with the appropriate private
mortgage insurance. The Bank's underwriting department reviews all the pertinent
information and makes a credit decision for approval or denial within
established Bank policy guidelines. Utilizing the Bank's current underwriting
guidelines, a portion of one-to-four family loans were outsourced to a contract
underwriter, then reviewed by the Bank's internal underwriter during fiscal
2000. The use of outsourcing of one-to-four family loans to a contract
underwriter is consistent with the strategy to contain the Bank's variable per
loan origination costs. Recommendations to deny applications based on
underwriting considerations are reviewed by the Bank's underwriter prior to a
final loan denial and secondarily reviewed by the department manager. Summaries
of all one-to-four family mortgage loan applications are reviewed on a monthly
basis by the Board of Directors and the Loan Committee. Mortgage loans held in
the Bank's loan portfolio generally include due-on-sale clauses, which provide
the Bank with the contractual right to deem the loan immediately due and payable
in the event the borrower transfers the ownership of the property without the
Bank's prior consent. The Bank enforces the due-on-sale clauses of its mortgage
loans.
The Bank makes loans under various governmental programs including the
Wisconsin Housing Economic Development Authority ("WHEDA"), the Federal Veterans
Administration ("Fed VA"), the State Department of Veterans Affairs ("State VA")
and utilizing whenever possible other grant programs offered through various
local and state programs. The WHEDA and State VA programs generally have lower
down payment requirements, lower interest rates and less restrictive
qualification ratios. The WHEDA and State VA loans are originated for the
agencies, underwritten and serviced by them. The Fed VA loans are originated for
wholesale investors and underwritten by the agency to remove any risk to the
Bank.
One-year ARM loans currently adjust a maximum of 2 percentage points
per year with a lifetime interest rate cap of 6.0% above the original note rate.
Monthly payments of principal and interest are adjusted when the interest rate
adjusts to maintain full amortization of the mortgage loan within the remaining
term. The Bank also offers one- and three-year ARM loans, which adjust annually
after the initial one- and three-year terms, and provide for an option to
convert the ARM loan to a fixed-rate loan at certain intervals upon the payment
of a fee. The initial rates offered on ARM loans fluctuate with general interest
rate changes and are determined by competitive conditions and the Bank's yield
requirements. The Bank primarily uses the one-year Constant Maturity United
States Treasury index to determine the interest rate payable upon the adjustment
date of outstanding ARM loans. Substantially all of the ARM loans that contain a
fixed-rate conversion feature permitting conversion to a fixed-rate for up to
five years after origination are sold in the secondary market. Substantially all
-10-
14
ARM loans that are originated for the Bank's own portfolio are non-convertible
to a fixed rate. Conversion terms are established at origination to permit the
Bank to sell the ARM loan to secondary market investors immediately upon
conversion to a fixed rate. From time to time, the Bank offers initial interest
rates on the ARM loans it originates below the fully indexed rate (i.e.,
"teasers"). To minimize the associated risk with ARM loans, borrowers are
qualified at the higher of the initial offering rate or the fully indexed rate.
ARM loans generally pose different risks than fixed-rate loans. In a rising
interest rate environment, the underlying ARM loan payment rises, increasing the
potential for default, and the marketability of the underlying property may be
adversely affected. In a decreasing interest rate environment, mortgagors tend
to refinance to fixed-rate loans. The Bank's delinquency experience on its ARM
loans has been minimal.
Prior to the mid-1980s, the Bank originated ARM loans which carried
interest rates that were subject to annual adjustment by the Bank on a
discretionary basis ("non-index ARMs"). At June 30, 2000, the Bank had $3.0
million of non-index ARMs outstanding.
The Bank offers one- to two-year ARM loan programs amortized over a
15-year term for land loans. Under these programs, the interest rate and monthly
payment are fixed for the initial term and, thereafter, adjust annually after
the initial one- and two-year terms.
HOME EQUITY LENDING
The Bank originates closed- and open-ended home equity loans, also
referred to as flexLOANS, secured by one-to-four family residences within its
primary lending area. The closed-end home equity loans have fixed rates for
periods of up to fifteen years. Open-ended home equity loans are granted for up
to a ten-year term, renewable at the sole discretion of the Bank for up to
additional ten-year periods. The minimum periodic payment on open-ended home
equity loans is based on 1.5% for loans with combined loan-to-value ratios up to
100% and interest-only on loans up to 85% combined loan-to-value ratios. After
an initial introductory interest rate which is set below the fully-indexed rate,
open-ended loans have an interest rate adjustable monthly, currently set at the
prime rate plus 2%-3% for loans with combined loan-to-value ratios above 85% and
prime rate for loans with combined loan-to-value ratios up to 85%. Origination
fees are charged on close-ended home equity loans. The Bank reviews completed
loan applications, receives a credit report, verifies income and other financial
data, and either uses the tax assessment of the property as assessed by the
local municipality or obtains a separate appraisal of the property to determine
the maximum amount it will loan on such property. The Bank's delinquency
experience on home equity loans has been minimal. At June 30, 2000, the home
equity loan portfolio was $21.8 million compared to $20.5 million at June 30,
1999. The open-ended home equity product is promoted by loan originators and
offers the Bank an asset that adjusts with current interest rates and is part of
the Bank's asset/liability management strategy. In fiscal 2001, the Bank intends
to increase its home equity business by offering packaged account relationships
to Bank customers.*
RESIDENTIAL CONSTRUCTION LENDING
Construction loans are made to individuals who have signed construction
contracts with a homebuilder and to a lesser extent, directly to a self-builder.
Loan proceeds are disbursed through a title insurance company as residential
construction progresses. These loans have loan-to-value ratios not exceeding
95%. When the loan-to-value ratio exceeds 80%, private mortgage insurance is
required which insures payment of a portion of the principal balance, reducing
the Bank's exposure to 75% loan-to-value or less. 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, the borrower is
required to commence principal and interest payments based on an amortization
schedule of 351-months or fewer. The Bank's single-family residential
construction loan programs are primarily one- or three-year ARM loans which
require interest-only payments during the construction period. To increase the
volume of residential construction loan activity, the Bank offers permanent
financing on residential construction loans which enables borrowers to avoid
duplicate closing costs normally associated with temporary financing during
construction periods and permanent financing upon completion of construction.
-11-
15
For the fiscal year ended June 30, 2000, residential construction loan
originations and purchases totaled $9.1 million compared to $5.1 million at June
30, 1999. In fiscal 2000, all originated one-to-four family construction loans
were secured by properties located within the Bank's primary lending area. A
significant number of the Bank's construction loans result in permanent mortgage
loans. In fiscal 2001, the Bank intends to evaluate opportunities to purchase,
and may in fact purchase, residential construction loans or participation
interests in such loans, originated by other lenders and secured by properties
located outside of the Bank's primary lending area.* Because most residential
construction loans are ARM loans, residential construction loans afford the Bank
the opportunity to increase the repricing frequency of its loan portfolio. The
Bank also receives yields on fixed-rate residential construction loans that are
higher than those obtainable on fixed-rate loans secured by existing residential
properties. While higher risks generally are associated with residential
construction lending because of the uncertainties involved in the construction
process, the Bank has taken precautions to reduce such risks by requiring
private mortgage insurance if the loan-to-value ratio exceeds 80%. All
construction loans originated by the Bank are underwritten according to the
Bank's underwriting guidelines. The Bank originates and purchases construction
loans whereby substantially all are provided permanent financing as a part of
the original loan agreement. The Bank has had minimal delinquent residential
construction loans to date.
SUBPRIME LENDING
During the fourth quarter of fiscal 2000, the Bank discontinued its
lending activities involving higher credit risk financial services (also known
as subprime lending) through Hallmark Financial, Inc. (d/b/a Major Finance).
Major Finance was formed to broker subprime loans primarily secured by
one-to-four family and commercial real estate within and outside the Company's
primary lending area. Management discontinued the operations of Major Finance
due to the lack of loan production to cover the costs of engaging in this
lending activity. No loans originated by Major Finance remain on the Bank's
books at June 30, 2000. It is anticipated the Company's subprime lending
activities in fiscal 2001 will be limited to referring subprime loan prospects
third-party lenders through the residential mortgage lending division and
generating referral fee income from such activity. The Company estimates that it
will collect a minimal level of referral fees from this activity, however, the
Company recognizes value in providing this service to existing customers.*
MULTI-FAMILY LENDING
The Bank originates multi-family loans that it retains in its
portfolio. In the past, the Bank offered both ARM and fixed-rate multi-family
loans. Currently, the Bank offers fixed-rate balloon notes typically with
three-to-five year maturities amortized over 15 to 30 years. Multi-family loans
generally have shorter maturities than one-to-four family mortgage loans. The
rates charged on the Bank's multi-family loans typically are slightly higher
than those charged on loans secured by one-to-four family residential
properties. An origination fee equal to 0.5% to 1.0% of the principal amount is
usually charged on such loans.
Multi-family loans generally are underwritten in amounts of up to 80%
of the lesser of the appraised value or purchase price of the underlying
property. Appraisals on properties which secure multi-family loans are performed
by an independent appraiser designated by the Bank. In addition, the Bank's
underwriting procedures require verification of the borrower's credit history,
an analysis of the borrower's income, personal and business (if applicable)
financial statements and banking relationships and a review of the property,
including cash flow projections and historical operating results. The Bank
evaluates all aspects of multi-family lending to mitigate risk to the extent
possible. The Bank seeks to ensure that the property securing the loans will
generate sufficient cash flow to adequately cover operating expenses and debt
service payments. Individual guarantees for all multi-family loans originated or
purchased is typically required as part of the overall credit analysis. The Bank
applies underwriting guidelines to purchased multi-family loans (both within and
outside of the market area) which are at least as strict to those existing for
multi-family loans originated in the Bank's primary lending area.
The Bank originated $11.6 million and $10.6 million in multi-family
loans secured by properties within its primary lending area in fiscal 2000 and
1999, respectively. In fiscal 2000, the Bank purchased $6.0 million of
multi-family loans, of which $3.5 million were secured by properties located
outside its primary lending area. In fiscal 1999, the Bank purchased $1.0
million in multi-family loans, all of which were secured by properties within
-12-
16
the primary lending area The Bank will continue to explore opportunities to
originate and purchase multi-family loans both within and outside of its primary
lending area in fiscal 2001.*
Loans secured by multi-family real estate generally involve a greater
degree of credit risk than one-to-four family mortgage loans and carry larger
loan balances. This increased credit risk is a result of several factors,
including the concentration of principal in a limited number of loans and
borrowers, the effects of general economic conditions on income-producing
properties and the increased difficulty of evaluating and monitoring these types
of loans. Furthermore, the repayment of loans secured by multi-family real
estate is typically dependent upon the successful operation of the related real
estate project. If the cash flow from the project is reduced, the borrower's
ability to repay the loans may be impaired. The risk may be increased on loans
secured by properties located outside of the Bank's primary market due to the
decreased ability to actively monitor such properties. Despite the risks
inherent in multi-family real estate lending, the Bank's delinquent multi-family
loans as a percentage of gross loans have been minimal. To the extent
multi-family loans outside of the Company's primary lending area are purchased,
management will utilize local servicing of the originating lender to attempt to
mitigate the risks associated with this type of lending activity.
MULTI-FAMILY CONSTRUCTION LENDING
In fiscal 2000, the Bank decreased its multi-family residential
construction lending activities as compared to fiscal 1999. The primary reason
for the decrease in multi-family construction lending was a decrease in the
origination of multi-family construction loans within the Bank's primary lending
area. For the fiscal year ended June 30, 2000, the Bank originated no
multi-family residential construction loans compared to $5.7 million for the
fiscal year ended June 30, 1999. There were $3.1 million in purchases of
multi-family construction loans in fiscal 2000, compared to no purchases in
fiscal 1999. Of the $3.1 million in multi-family construction loans purchased in
fiscal 2000, all related to properties located outside of the Bank's primary
lending area and consisted of two separate transactions, which related to
multi-family real estate located in Minnesota. In fiscal 2001, the Bank intends
to evaluate opportunities to originate and purchase multi-family construction
loans, or participation interests in such loans secured by properties located
both within and outside of the Bank's primary lending area.*
Multi-family construction loans typically offered by the Bank are
balloon loans with three-to-five year terms amortized over 15 to 30 years after
allowing for interest only payments during a twelve-month construction period.
Loan proceeds are disbursed in increments through an insured title company as
construction of the project progresses. The rates charged on the Bank's
multi-family construction loans are typically higher than those charged on loans
secured by one-to-four family residential properties. An origination fee of 0.5%
to 1% of the principal amount is usually charged on such loans.
The loan-to-value on multi-family construction loans does not exceed
80% of the lessor of the appraised value or purchase price of the property.
Appraisals on properties which secure multi-family loans are performed by an
independent appraiser designated by the Bank. In addition, the Bank's
underwriting procedures require verification of the borrower's credit history,
an analysis of the borrower's income, personal and business (if applicable)
financial statements, banking relationships and a review of the property,
including cash flow projections and historical operating results. The Bank
evaluates all aspects of multi-family construction lending to mitigate risk to
the extent possible. The Bank seeks to ensure that the property securing the
loans will generate sufficient cash flow to adequately cover operating expenses
and debt service payments. Individual guarantees for all multi-family loans
originated or purchased are typically required as part of the overall credit
analysis. The Bank originates and purchases construction loans whereby
substantially all are provided permanent financing as a part of the original
loan agreement.
Loans secured by multi-family real estate generally involve a greater
degree of credit risk than one-to-four family loans and carry larger loan
balances. The increased credit risk is the result of several factors, including
the concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income-producing properties and the
increased difficulty of monitoring these types of loans. The risk may be
increased on loans secured by properties located outside of the Bank's primary
lending area due to the decreased ability to actively monitor such properties.
The Bank uses underwriting guidelines for construction loans purchased outside
its primary lending area which are at least as strict as those guidelines for
-13-
17
loans originated within its primary lending area. While higher risks generally
are associated with construction lending because of the uncertainties involved
in the construction process, the Bank has taken precautions to reduce such risks
by requiring the loan-to-value ratio to not exceed 80%. Despite the risks
inherent in multi-family construction real estate lending, the Bank's delinquent
multi-family construction loans as a percentage of gross loans have been
minimal.
COMMERCIAL REAL ESTATE LENDING
Prior to fiscal 1996, the Bank had minimal originations of commercial
real estate loans (i.e., loans secured by non-residential property). The Bank
originated and purchased $11.0 million, $49.8 million and $52.9 million in
commercial real estate loans in fiscal years 1998, 1999 and 2000, respectively.
The increase in originations and purchases in fiscal 2000 is consistent with the
Bank's asset portfolio diversification strategy into higher-yielding assets. In
fiscal 2000, the Bank originated and purchased $52.9 million of commercial real
estate loans, of which $20.2 million, (or 39.1%), were loans originated or
purchased and secured by properties within the Bank's primary lending area, and
$32.7 million were participation interests in loans secured by properties
located outside of the Bank's primary lending area. The $32.7 million of
participation interests purchased outside of the Bank's primary lending area
consisted of 27 separate transactions with the largest transaction aggregating
$3.9 million which is secured by a 148 room hotel located in Key West, Florida.
In fiscal 2001, the Bank intends to continue to originate and purchase of
commercial real estate loans or participation interests in loans secured by
properties located both within and outside of its primary lending area.*
Commercial loans generally will be underwritten in amounts of up to 80%
of the lessor of the appraised value or purchase price of the underlying
property. Appraisals on properties which secure commercial real estate will be
performed by an independent appraiser designated by the lender at the time the
application is submitted. In addition, the Bank's underwriting procedures
require verification of the borrowers' credit history, an analysis of the
borrower's income, credit history, personal and business (if applicable)
financial statements and banking relationships and a review of the property,
including cash flow projections, historical operating results and environmental
concerns. The Bank evaluates all aspects of commercial real estate lending to
mitigate risk to the extent possible. The Bank seeks to ensure that the property
securing the loans will generate sufficient cash flow to adequately cover
operating expenses and debt service payments. The Bank uses underwriting
guidelines for loans purchased outside its primary lending area which are at
least as strict as those guidelines for loans originated within its primary
lending area.
Loans secured by commercial real estate generally involve a greater
degree of credit risk than one-to-four family mortgage loans and carry larger
loan balances. This increased credit risk is a result of several factors,
including the concentration of principal in a limited number of loans and
borrowers, the effects of general economic conditions on income-producing
properties and the increased difficulty of evaluating and monitoring these types
of loans. Furthermore, the repayment of loans secured by commercial real estate
is typically dependent upon the successful operation of the related business
occupant. Payments on loans secured by commercial real estate also are often
susceptible to adverse conditions in the real estate market or the economy. The
risk may be increased on loans secured by properties located outside of the
Bank's primary lending area due to the decreased ability to actively monitor
such properties. To the extent commercial loans are purchased outside of the
Company's primary lending area, management will utilize local servicing of the
originating lender to attempt to mitigate the risks associated with this type of
lending activity. Despite the risks inherent in commercial real estate lending,
the Bank's delinquent commercial real estate loans as a percentage of gross
loans have been minimal.
CONSUMER LENDING
The Bank originates a variety of consumer loans, generally consisting
of automobile, motorcycle, boat, mobile home and credit card. At June 30, 2000,
these consumer loans totaled $3.2 million, or 0.8% of gross loans, compared to
$3.8 million or 1.3% at June 30, 1999. Consumer loans generally have shorter
terms and higher interest rates than mortgage loans but generally involve more
risk than mortgage loans because of the type and nature of the collateral and,
in certain cases, the absence of collateral. Consumer loans generally are
dependent on the borrower's continuing financial stability and thus are more
likely to be affected by adverse
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18
personal circumstances. Often the loans are secured by rapidly depreciable
personal property, such as automobiles. Despite the risks inherent in consumer
lending, the Bank's delinquent consumer loans as a percentage of gross loans has
been minimal.
OTHER CONSTRUCTION/LAND LENDING
In fiscal 2000, the Bank originated and purchased $36.7 million of
commercial real estate construction loans for commercial properties and
residential real estate land loans compared to $28.4 million in fiscal 1999.
These loans consist of adjustable rate mortgage loans originated at prevailing
market rates and participation interests in commercial real estate construction
loans originated by other lenders. Of the $36.7 million originated and purchased
in fiscal 2000, $16.9 million were originated internally, and $10.3 million of
the $16.9 million originated by the Bank consisted of commercial real estate
construction loans and $6.6 million consisted of residential land loans. Of the
$19.8 million of loans purchased, $19.3 million were participation interests in
commercial real estate construction loans originated by other lenders and
$500,000 consisted of land loans. $15.5 million of the $19.3 million of
participation interests in commercial real estate construction loans were
secured by properties located outside the Bank's primary lending area. The $15.5
million of participation interests purchased outside of the Bank's primary
lending area consisted of 12 separate transactions with the largest transaction
aggregating $3.0 million which relates to commercial real estate located in
Missouri. In fiscal 2001, the Bank intends to continue to originate and purchase
such loans secured by properties located both within and outside of its primary
lending area.*
While higher risks generally are associated with commercial real estate
construction lending because of the uncertainties involved in the construction
process and the impact of adverse conditions in the real estate market or the
economy, the Bank has taken precautions to reduce such risks by requiring the
loan-to-value ratio to not exceed 80% of the lesser of the appraised value or
purchase price of the underlying property. The risk may be increased on loans
secured by properties located outside of the Bank's primary market due to the
decreased ability to actively monitor such properties. The Bank evaluates all
aspects of commercial real estate construction lending. Appraisals on properties
which secure commercial loans are performed by an independent appraiser. In
addition, the Bank's underwriting procedures require verification of the
borrower's credit history, an analysis of the borrower's income, personal and
business (if applicable) financial statements and banking relationships, and a
review of the property, including cash flow projections and historical operating
results. The Bank seeks to ensure that the property securing the loans will
generate sufficient cash flow to adequately cover operating expenses and debt
service payments. Individual guarantees for all commercial real estate
construction loans originated or purchased is typically required as part of the
overall credit analysis. The Bank originates and purchases construction loans
whereby substantially all are provided permanent financing as a part of the
original loan agreement. Despite the risks inherent in commercial real estate
construction and land lending, the Bank's delinquencies have been minimal.
COMMERCIAL BUSINESS LENDING
The commercial lending division originated $33.9 million in commercial
business loans during fiscal 2000 compared to $36.8 million in fiscal 1999.
During fiscal 2000, the Bank purchased $14.0 million in commercial business
loans, all of which related to businesses located outside of the Bank's primary
lending area. Aggregate commercial business loans purchased in fiscal 1999 were
$8.6 million. Of the $14.0 million in out-of-market commercial business loan
purchases, the largest single transaction consisted of a $4.0 million loan
secured by business cash flows and the financial strength of the organization
located in Crandon, WI. The commercial lending division will originate loans
collateralized by business equipment, inventory and trade receivables. The
transactions generally will be in the form of loans, leases, lines of credit and
letters of credit. Such transactions typically will be structured as short-term
fixed or adjustable rate loans with three-to-five year maturities.
The focus of the Company's commercial lending operation is to provide
financing options to businesses with revenues up to $10 million by offering
commercial/ industrial real estate term loans, construction loans, equipment
leasing, inventory/equipment/receivables financing, lines of credit, letters of
credit and government loan programs both within and outside of the Bank's
primary lending area. Under regulations established for state savings banks by
the Wisconsin Department of Financial Institutions ("DFI"), the Bank is limited
in the amount of
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commercial real estate and commercial business loans it can hold in its loan
portfolio. The DFI approved limit for the Bank is 30% of the Bank's total asset
base at June 30, 2000 and 1999. At June 30, 2000, the Bank had $138.3 million of
such loans in its portfolio, which represents 26.6% of the Bank's asset base of
$520.0 million. At June 30, 1999, the Bank had $77.7 million of such loans in
its portfolio, which represents 16.5% of the Bank's asset base of $469.6
million. The Company projects that the percentage of total assets represented by
commercial real estate and commercial business loans will not increase
significantly in fiscal 2001 as a substantial portion of these new originations
and purchases are expected to be sold in the secondary market. Management
believes that the regulatory limit will be sufficient to meet the Bank's asset
growth and portfolio diversification objectives in fiscal 2001.*
Loans secured by commercial business assets generally involve a greater
degree of credit risk than one-to-four family mortgage loans and carry larger
loan balances. This increased credit risk is a result of several factors,
including the concentration of principal in a limited number of loans and
borrowers, the effects of the general economic conditions on income producing
business assets and the increased difficulty of evaluating and monitoring these
types of loans. Also, the repayment of loans secured by commercial business
assets is typically dependent upon the successful operation of the business for
which the loan was made. To the extent the Bank originates or purchases
commercial loans for business located outside of its primary lending area, the
risks may be increased due to the decreased ability to monitor these loans. The
Bank and Board of Directors has taken precaution to reduce such risk by
establishing prudent loan underwriting guidelines and loan-to-value ratios. Cash
flows, both historical and future projections, of the business and the value of
the collateral are analyzed to give the Bank assurance that the business will
generate a sufficient level of cash flow to cover ongoing business expenses and
debt service. The loan-to-value ratios vary depending on the type and liquidity
of the collateral; and internal controls and systems have been put in place to
monitor collateral and other financial aspects of these loans. Loans secured by
properties or business assets outside of the Company's primary lending area are
generally serviced by a local financial institution who closely monitors the
performance of the loans and borrowers.
LOAN APPROVAL
The Bank's residential lending underwriters are authorized by the Board
of Directors to approve one-to-four residential real estate secured loans up to
the maximum loan amount of $400,000, home equity loans up to $100,000 and
consumer loans up to $30,000. Authority exceeding the aforementioned limits for
the residential lending division are referred to the Senior Loan Committee and
its limits are $100,000 for consumer loans, $250,000 for home equity installment
and flexloans, and $750,000 for one-to-four family mortgage loans.
A commercial lending policy approved by the Board of Directors has
established three levels of underwriting approval with individual loan officer
authority up to $250,000, Senior Loan Committee up to $1.5 million, and loans in
excess of $1.5 million will require the approval of the Board of Directors.
Loans exceeding the authority limits of the Senior Loan Committee must be
approved by the full Board of Directors. All loans approved pursuant to
designated authority are confirmed monthly by the Loan Committee. One-to-four
family, multi-family and commercial real estate loans purchased or participation
interests in such loans purchased which are secured by properties located
outside of the Bank's primary lending area will be underwritten pursuant to
guidelines at least as strict as those guidelines applicable to internal Bank
loan originations. See also "Lending Activities - One-to-four Family Mortgage
Lending" and "Originations, Purchases and Sales of Loans - Commercial Loan
Originations, Sales and Servicing (Hallmark Financial, Inc.)."
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20
ORIGINATIONS, PURCHASES AND SALES OF LOANS
The following table sets forth the Company's total loan production
(originations and purchases) and gross loan sales for fiscal 2000, 1999 and
1998.
YEAR ENDED JUNE 30,
----------------------------------------------------
2000 1999 1998
-------- --------- --------
(IN THOUSANDS)
Total loan originations.............................. $140,441 $202,098 $135,731
Total loan purchases................................. 118,897 56,862 27,702
-------- -------- --------
Total loan production.............................. $259,338 $258,960 $163,433
======== ======== ========
Total loan sales..................................... $33,932 $48,329 $20,213
The principal sources of revenue from the Company's loan production and
loan sale activities are (i) mortgage loan origination fees, if any, (ii)
interest income earned on mortgage loans pending sale, (iii) mortgage loan
servicing fees, (iv) gains on the sale of mortgage loans and (v) gains on the
sale of mortgage servicing rights. The Company also receives income through
other loan related fees, including late payment charges and miscellaneous
service fees.
The following table sets forth the Bank's loan originations and loan
purchases, sales and principal repayments by loan category for the periods
indicated. Mortgage loans and mortgage-backed and related securities held for
sale are included in the totals.
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FISCAL YEAR ENDED JUNE 30,
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS)
MORTGAGE LOANS (GROSS):
At beginning of period..................................... $276,832 $268,996 $276,505
Mortgage loans originated:
One-to-four family....................................... 34,210 89,265 46,756
One-to-four family construction.......................... 9,082 5,148 3,218
Home equity............................................. 14,259 10,899 16,151
Multi-family............................................. 11,571 10,606 13,301
Multi-family construction................................ -- 5,691 1,720
Commercial/non-residential............................... 14,964 28,833 2,504
Other construction/land.................................. 16,881 9,060 16,034
-------- -------- --------
Total mortgage loans originated........................ 100,967 159,502 99,684
Mortgage loans purchased:
One-to-four family....................................... 37,991 6,951 413
One-to-four family construction.......................... 28 -- 1,688
Multi-family............................................. 6,026 1,000 --
Multi-family construction................................ 3,100 -- 3,917
Commercial/non-residential............................... 37,911 20,936 8,513
Other construction/land.................................. 19,850 19,377 6,540
-------- -------- --------
Total mortgage loans purchased......................... 104,906 48,264 21,071
-------- -------- --------
Total mortgage loans originated and purchased............ 205,873 207,766 120,755
-------- -------- --------
Transfer of mortgage loans to foreclosed
real estate.............................................. (1,473) (682) (267)
Principal repayments....................................... (62,531) (150,919) (107,784)
Sales of fixed-rate loans.................................. (33,932) (48,329) (20,213)
-------- -------- --------
At end of period........................................... $384,769 $276,832 $268,996
======== ======== ========
CONSUMER LOANS:
At beginning of period..................................... $ 3,846 $ 5,008 $ 5,875
Consumer loans originated................................ 5,605 5,768 7,065
Principal repayments....................................... (6,224) (6,930) (7,932)
-------- -------- --------
At end of period........................................... $ 3,227 $ 3,846 $ 5,008
======== ======== ========
COMMERCIAL LOANS:
At beginning of period..................................... $ 18,254 $ 14,646 $ 3,471
Commercial loans originated.............................. 33,869 36,828 28,982
Commercial loans purchased............................... 13,991 8,598 6,631
Principal repayments..................................... (41,525) (41,818) (24,438)
-------- -------- --------
At end of period........................................... $ 24,589 $ 18,254 $ 14,646
======== ======== ========
MORTGAGE-BACKED AND RELATED SECURITIES:
At beginning of period..................................... $110,184 $122,831 $96,811
Mortgage-backed and related
securities purchased..................................... 23,855 83,730 63,753
Sales of mortgage-backed and related
securities............................................... (50,861) (2,503) (8,905)
Amortization and repayments................................ (32,073) (93,577) (28,938)
Market valuation allowance on available-for-sale
mortgage-backed securities................................ (144) (297) 110
-------- -------- --------
At end of period........................................... $ 50,961 $110,184 $122,831
======== ======== ========
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RESIDENTIAL LOAN ORIGINATION, FEES AND SERVICING
Mortgage loans are originated from real estate brokers, builders,
developers, existing or past customers, residents of the local communities
located in the Bank's primary lending areas, and purchased from other lenders
from within and outside of the Bank's primary lending area. While the Company
does not intend to originate mortgage loans outside of its primary lending area
in fiscal 2001, the Company would consider such opportunities if they were to
meet the Company's standard underwriting guidelines. The Bank advertises its
mortgage products in newspapers, through direct mail and other media in addition
to using its loan officers to directly solicit potential borrowers.
In connection with the origination of mortgage loans, the Bank charges
points for origination, commitment and discounts, and fees for processing and
closing in addition to requiring borrower reimbursement for out-of-pocket fees
for costs associated with obtaining independent appraisals, credit reports,
title insurance, private mortgage insurance and other items. Because of the
highly competitive mortgage market in which the Bank originates loans, the point
structure varies considerably, depending upon the type of mortgage loan being
made, its interest rate and other competitive factors. While origination fees
ranging from zero to two points generally have been quoted on mortgage loans in
recent years, most of the Bank's borrowers typically accept a slightly higher
interest rate and pay zero points. Commitment fees are paid by the applicant at
time of loan commitment, whereas the origination and discount fees are paid at
time of closing. Loan origination and commitment fees and certain direct loan
origination costs are deferred and the net amounts amortized as an adjustment of
the related loan's yield in accordance with Statement of Financial Accounting
Standard No. 91. These amounts are amortized to interest income using the level
yield method over the contractual life of the related loans. Unamortized
deferred net loan fees and (costs) totaled $630,000, $490,000 and $319,000 at
June 30, 2000, 1999, and 1998, respectively. The increase in unamortized
deferred loan fees at June 30, 2000, primarily resulted from the originations of
loans with higher fees.
The Bank services residential real estate loans owned by the Bank as
well as for other secondary market purchasers for certain loans sold in the
secondary market. See "-Sale of Residential Loans." Loan servicing includes
collecting and remitting loan payments, accounting for principal and interest,
making advances to cover delinquent payments, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering the loans. The Bank receives fees for servicing residential
mortgage loans to compensate it for the servicing function. These fees generally
range from 0.25% to 0.375% of the declining principal balances of the loans per
annum.
PURCHASES OF RESIDENTIAL LOANS
During the fiscal year ended June 30, 2000, the Bank purchased $38.0
million of one-to-four family mortgage loans as compared to $7.0 million in
fiscal 1999 and $413,000 in fiscal 1998. All of the loans purchased consisted of
non-conforming one-to-four family mortgage loans secured by properties located
outside of the Bank's primary lending area, and were purchased from, and are
serviced by, a third-party bank, which originated the loans. Purchases of
non-conforming one-to-four family mortgage loans both within and outside of the
Company's primary lending area increased significantly during fiscal 2000 as
part of the Company's asset portfolio diversification strategy.
The Bank will continue to evaluate opportunities to purchase
residential loans both within and outside of its primary lending area during
fiscal 2001 due to strong local competition which exerts downward pressure on
interest rates, market demand, availability for internally originated loans and
the Bank's emphasis on various types of loans in order to meet asset portfolio
diversification objectives.* The Company projects total loan purchase volume to
be approximately $100 million in fiscal 2001, of which approximately $10 million
is expected to consist of non-conforming one-to-four family mortgage loans
compared to $38.0 million of non-conforming one-to-four family mortgage loan
purchases in fiscal 2000.* The projected decrease is consistent with the
Company's strategy to not significantly grow its asset base in fiscal 2001.*
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23
SALE OF RESIDENTIAL LOANS
The Bank sells one-to-four family mortgage loans, on a non-recourse
basis, into the secondary market to Freddie Mac, WHEDA, federal and state VA and
other private secondary market purchasers. The amount of loans sold by the Bank
is based upon market conditions and the Bank's asset/liability strategy. The
Bank sold $11.5 million in fixed-rate one-to-four family mortgage loans in
fiscal 2000. Of the $11.5 million, substantially all were 30-year fixed-rate
mortgage loans. The Bank had sold primarily all of its 30-year fixed loans in
prior years. During fiscal 2000, management continued to sell a portion of the
fixed-rate loans originated to provide funds for adding higher yielding loans to
the portfolio. Certain fixed-rate loans made under special loan terms or
programs, principally originated for purposes of compliance with the Community
Reinvestment Act are retained in the Bank's portfolio. The Bank follows Freddie
Mac and Fannie Mae underwriting guidelines for its one-to-four family mortgage
loans, which are sold in the secondary market. In fiscal 2001, management
intends to continue the sale of 30-year fixed-rate mortgage loans to either
Freddie Mac or private secondary market purchasers as part of its strategy of
portfolio diversification and in order to continue to manage interest rate risk
and provide liquidity for the funding of higher-yielding non-conforming
one-to-four family, multi-family, commercial real estate and commercial business
loans.*
For the fiscal years ended June 30, 2000, 1999 and 1998, the Bank's
fixed-rate loan sales to private and governmental investors totaled $33.9
million, $48.3 million and $18.7 million, with associated gross gains of
$224,000, $892,000 and $297,000, respectively.
The Bank virtually always retains servicing on loans sold to Freddie
Mac. The Bank generally releases servicing on loans sold to all other secondary
market purchasers. When loans are sold with servicing rights released to the
secondary market purchaser, the Company recognizes current income from receipt
of servicing release fees in addition to receiving a premium or deducting a
discount based on the market value of the loan (which is dependent upon, among
other factors, the interest rate and market conditions at the time the sale
price is locked in with the purchaser). For fiscal years ended June 30, 2000,
1999, and 1998, the Bank's net service fees on loans sold into the secondary
market totaled $50,000, $21,000 and $61,000, respectively. Sales prices for
loans originated for resale are generally locked in with the secondary market
purchasers at the time of origination in order to minimize the Company's
interest rate risk.
When loans are sold to Freddie Mac with servicing retained, the Company
recognizes additional gains based on the estimated fair value of the servicing
retained. Recognition of such gains creates originated mortgage servicing rights
for the Company, which are capitalized and amortized in proportion to, and over
the period of, the estimated future net servicing income stream of the
underlying mortgage loans. See Note 4 of the Company's Notes to Consolidated
Financial Statements.
The contractual right to service mortgage loans that have been sold has
an economic value that, in accordance with GAAP, is recognized as an asset on
the Bank's balance sheet. During fiscal 1998, mortgage servicing rights on loans
sold, where the servicing was retained by the Bank, to secondary market
investors totaled $66,000 and is included in gains on the sale of loans. There
were no gains on the sales of such servicing rights included in gains on the
sale of loans for fiscal 1999 and 2000. The mortgage servicing asset created
will be amortized against the servicing fee income stream in accordance with
Statement of Financial Accounting Standard No. 125. The value results from the
future income stream of the servicing fees, the availability of the cash
balances associated with escrow funds collected monthly for real estate taxes
and insurance, the availability of the cash from monthly principal and interest
payments from the collection date to the remittance date, and the ability of the
servicer to cross-sell other products and services. The actual value of a
servicing portfolio is dependent upon such factors as the age, maturity and
prepayment rate of the loans in the portfolio, the average dollar balance of the
loans, the location of the collateral property, the average amount of escrow
funds held, the interest rates and delinquency experience of the loans, the
types of loans and other factors.
The Bank also acts as a conduit for loans sold to WHEDA. For those
borrowers who qualify under WHEDA guidelines, the Bank originates the loan for a
fee equal to 1% of the underlying loan amount and sells the loan to WHEDA, on a
non-recourse basis, servicing released.
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24
COMMERCIAL LOAN ORIGINATION, SALES AND SERVICING (HALLMARK FINANCIAL, INC.)
During fiscal 2001, the Company intends to leverage its existing
commercial lending capabilities to include the origination, sale and servicing
of commercial real estate mortgages on a national basis, with primary
concentration in the southwest and western regions of the country. While the
Company primarily expects to originate and purchase commercial real estate
mortgages on a national basis, it also may originate and purchase loans or
participation interests in loans secured by multi-family real estate and
commercial business assets.* The new commercial mortgage banking operation,
Hallmark Financial, Inc. ("HFI"), will be a wholly-owned subsidiary of the
Company. HFI will originate loans from a third party commercial real-estate
broker on a non-exclusive basis and will act as the lender of record until the
loan is sold without recourse, generally within 45 days of the loan closing.*
HFI recognizes that the volume of loans originated, sold and serviced will be
dependent on the level of referrals generated by the third party real estate
broker. HFI intends to expand its referral network of real estate brokers in the
future.* HFI intends to retain the servicing rights to these loans and receive a
servicing fee.* The principal sources of revenue from the commercial mortgage
banking operation are expected to be: (i) mortgage loan origination fees, (ii)
interest income earned on mortgage loans pending sale, (iii) mortgage loan
servicing fees and (iv) underwriting and administrative fees.* The primary
benefit of the expansion of the Bank's commercial mortgage banking activities is
to gain economies of scale through the ability to leverage existing staff,
expertise level, overhead and infrastructure in order to increase fee income
without a significant incremental increase in expenses.*
Commercial loans will be originated through HFI from the referrals of a
third party commercial real-estate broker. HFI will receive all customary and
usual underwriting documentation in order to make an underwriting decision. A
commitment letter will be issued to the borrower, subject to any and all
underwriting conditions. In addition, HFI also will require at the time of
commitment a best-efforts stipulation requiring the sale of the loan upon
closing to a secondary market investor. A senior loan committee has been
established to approve all loans originated by HFI. Loans will be closed in the
name of HFI as the lender of record. The referring real estate broker will
receive a portion of total fee services rendered upon the funding of the loan
and the remaining amount at the time the loan is sold to a secondary market
investor. HFI's maximum funding level for new commercial mortgage loan
originations will be based on the amount of credit made available by a third
party lender which is currently $9.0 million.
The Company projects HFI activities to generate approximately $150,000
- - $300,000 in gross revenues in fiscal 2001.* HFI will collect an underwriting
fee for its credit analysis services on each loan transaction and a servicing
fee on the principal amount of each loan. Loan servicing fees will include
prepayment fees, late charges and other miscellaneous fees. Interest income will
be earned on mortgage loans pending sale to the secondary market investors,
which is typically within 45 days of loan closing. The Company estimates in
order to produce gross revenues of $150,000 - $300,000 in fiscal 2001, it will
purchase, sell and service approximately $50 - $100 million of commercial real
estate mortgage loans on a national basis, with primary concentration in the
southwest and western regions of the country.* The Company anticipates that HFI
will be structured like a conventional mortgage banking operation which uses a
correspondent banking network to generate loans for their own pipeline.* HFI
intends to sell such loans in the secondary market on a servicing-retained
basis.* The Company does not plan to use their own branch network and loan
officers to generate loans for HFI.*
HFI is expected to originate, sell and service primarily construction
only and permanent commercial real estate loans. Construction-only loans are
typically balloon loans with a one-to two-year term with rates generally tied to
a prime rate index, allowing for interest-only payments during the construction
period. Permanent commercial real estate loans are typically balloon loans with
fixed rates for a three-to-five year period amortized over 15 to 20 years. The
rates charged on these loans are typically higher than those charged on loans
secured by one-to-four family residential properties. The average loan amount is
expected to range from $3 million to $7 million.* An origination fee of 1% to 2%
of the principal amount generally will be charged on both construction-only and
commercial real estate mortgage loans. Short-term construction-only and
commercial real estate mortgage loans purchased and sold with servicing rights
retained by HFI are expected to have the same credit quality characteristics as
those originated by internal bank sources.* These loans will be underwritten
using the underwriting guidelines for similar loans originated or purchased by
secondary market investors. Commercial real estate mortgage loans generally will
be underwritten in amounts of up to 80% of the lessor of the appraised value or
purchase price of the underlying
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25
property. Appraisals on properties which secure commercial or multi-family real
estate will be performed by an independent appraiser approved by HFI. In
addition, HFI's underwriting procedures require verification of the borrowers'
credit history, an analysis of the borrower's income, credit history, personal
and business (if applicable) financial statements and banking relationships and
a review of the property, including cash flow projections, historical operating
results and environmental concerns. HFI evaluates all aspects of commercial real
estate lending to mitigate risk to the extent possible. HFI seeks to ensure that
the property securing the loans will generate sufficient cash flow to adequately
cover operating expenses and debt service payments.
In connection with the commercial mortgage loans which are sold on a
non-recourse basis, HFI will make certain representations and warranties
customary in the industry relating to compliance with laws, regulations, program
standards, and accuracy of information.* In the event of a breach of such
representations and warranties, HFI may be required to repurchase such loans
from the secondary market investor.*
The commercial mortgage loans held for sale by HFI will be carried at
the lower of cost or market, and losses, if any, are recorded on the financial
statements of the Company, irrespective of when the asset is ultimately sold.
Gains, if any, are recognized at the time the loan is sold and funded. Gains or
losses on the sale result primarily from two factors. First, HFI may originate a
loan at a price which is higher or lower than HFI would receive because of
changes in interest rates since the initial rate committed to the borrower.
Second, gains and losses result from the actual number of loans closed being
greater or fewer than anticipated. Changes in interest rates also affect the
value of commitments to sell commercial mortgage loans to secondary market
investors.
HFI is subject to interest rate risk on fixed rate loans from the point
in time that the rate is locked with the borrower until the sale and delivery of
the related loan. HFI will mitigate and manage these risks primarily in two
ways. The loans are originated by HFI with a pre-commitment to buy from the
secondary market investor on a non-recourse basis. HFI also manages this risk by
setting a maximum aggregate funding limit of $9 million. Currently, HFI does not
intend to use techniques such as options, swaps or futures contracts to hedge
the potential interest rate risk of this activity.* Management will actively
monitor the pipeline to assess the market value of the loans on an ongoing
basis.
Commercial mortgage loan servicing includes collecting and remitting
loan payments, accounting for principal and interest, administering escrow funds
for payment of mortgage-related expenses such as taxes and insurance, advancing
funds to cover delinquent tax payments, contacting delinquent mortgagors, and
supervising foreclosures and property dispositions in the event of unremedied
defaults. A servicer's obligation to provide mortgage loan servicing and its
right to collect fees are set forth in a servicing contract. Servicing rights
represent a contractual right to fees and not a beneficial ownership in the
underlying mortgage loans. It is anticipated that pursuant to the terms of
purchase contracts with secondary market investors, HFI will not be required to
advance certain principal and interest payments to secondary market investors
prior to collection of such payments from specific mortgagors.*
HFI intends to retain servicing on the commercial mortgage loans sold
to secondary market investors. As compensation for providing servicing, HFI will
receive loan servicing fees, which represent the difference between the interest
rate charged the borrower and the rate at which such loans are sold. The
servicing rate earned by the Company is anticipated to be .25% per annum on the
declining principal balances of the loans. Servicing fees are collected out of
monthly mortgage payments. Other sources of loan servicing revenue include late
charges, miscellaneous and administrative fees. Servicing portfolios are subject
to reduction by normal amortization, by prepayment or by foreclosure of
delinquent loans. The degree of credit risk of a servicing portfolio is limited
when loans are sold on a non-recourse basis.
The contractual right to service mortgage loans that have been sold has
an economic value that, in accordance with GAAP, is generally recognized as an
asset on the Company's balance sheet. The mortgage servicing asset created will
be amortized against the servicing fee income stream in accordance with
Statement of Financial Accounting Standard No. 125. The value results from the
future income stream of the servicing fees, the availability of the cash
balances associated with escrow funds collected monthly for real estate taxes
and insurance, the availability of the cash from monthly principal and interest
payments from the collection date to the
-22-
26
remittance date, and the ability of the servicer to cross-sell other products
and services. The actual value of a servicing portfolio is dependent upon such
factors as the age, maturity and prepayment rate of the loans in the portfolio,
the average dollar balance of the loans, the location of the collateral
property, the average amount of escrow funds held, the interest rates and
delinquency experience of the loans, the types of loans and other factors.
Loans secured by commercial real estate generally involve a greater
degree of credit risk than one-to-four family mortgage loans and carry larger
loan balances. See "Lending Activities" for a discussion on credit risk.
DELINQUENCIES, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS
DELINQUENT LOANS - RESIDENTIAL/CONSUMER LOANS
When a borrower fails to make a required payment by the end of the
month in which the payment is due, the Bank generally initiates collection
procedures. The Bank will send a late notice, and in most cases, delinquencies
are cured promptly; however, if a loan becomes delinquent for more than 60 days,
the Bank contacts the borrower directly, to determine the reason for the
delinquency and to effect a cure, and where it believes appropriate, reviews the
condition of the property and the financial position of the borrower. At that
time, the Bank may: (i) accept a repayment program for the arrearage; (ii) seek
evidence of efforts by the borrower to sell the property; (iii) request a deed
in lieu of foreclosure; or (iv) initiate foreclosure proceedings. When a loan
secured by a mortgage is delinquent for three or more monthly installments, the
Bank generally will initiate foreclosure proceedings. With respect to
delinquencies on VA or other governmental loan program mortgages, the Bank
follows the appropriate notification and foreclosure procedures prescribed by
the respective agencies.
On mortgage loans or loan participations purchased by the Bank, the
Bank receives monthly reports from its loan servicers with which it monitors the
loan portfolio. Based upon servicing agreements with the servicers of the loan,
the Bank relies upon the servicer to contact delinquent borrowers, collect
delinquent amounts and to initiate foreclosure proceedings, when necessary, all
in accordance with applicable laws, regulations and the terms of the servicing
agreements between the Bank and its servicing agents.
DELINQUENT LOANS - COMMERCIAL BUSINESS AND COMMERCIAL REAL ESTATE LOANS
When a borrower fails to make a required payment, the borrower is
typically contacted if the payment is not received within 7 business days of the
due date to collect the payment or determine the reason for the delinquency.
Unless previous arrangements have been made, the Bank will review all necessary
steps or actions to protect its lien or collateral position if two payments are
due and owing. The steps may include, but not be limited to, loan forbearance,
assignment of any rents, enforcement of any loan guarantees, liquidation of any
business collateral, and/or foreclosure of any real estate collateral.
NON-PERFORMING ASSETS
Loans are placed on non-accrual status when, in the judgment of Bank
management, the probability of collection of principal or interest is deemed
insufficient to warrant further accrual of interest. The Bank discontinues the
accrual of interest on loans when the borrower is delinquent as to a
contractually due principal or interest payment by 90 days or more. When a loan
is placed on non-accrual status, all of the accrued interest on that loan is
reversed by way of a charge to interest income. Accrual of interest on a
non-accrual loan is resumed when all contractually past due payments are current
and when management believes the outstanding loan principal and contractually
due interest is no longer doubtful of collection. The Bank discontinues the
accrual of interest on loans more than 90 days past due, at which time all
accrued but uncollected interest is reversed by way of a charge to interest
income. Uncollected interest on credit card loans, however, continues to accrue
after 90 days of delinquency but is capitalized to the loan balance monthly and
reserved for in the Bank's allowance for loan losses. The non-performing credit
card loans are typically charged off at 120 to 150 days past due.
Property acquired by the Bank as a result of a foreclosure is
classified as foreclosed properties. Foreclosed properties are recorded at the
lower of the unpaid principal balance of the related loan or fair value, less
estimated costs to sell. The amount by which the recorded loan balance exceeds
the fair value at the time a
-23-
27
property is classified a foreclosed property is charged against the allowance
for loan losses. Any subsequent reduction in the fair value of a foreclosed
property, along with expenses incurred to maintain or dispose of a foreclosed
property, is charged against current earnings. The Bank had two one-to-four
family mortgage loans totaling $357,000 and one commercial real estate loan with
a net balance of $756,000 in foreclosed properties at June 30, 2000, compared to
one commercial real estate loan with a net balance of $621,000 in foreclosed
properties at June 30, 1999.
The decrease in the non-accrual mortgage loans 90 days or more past due
primarily relates to the decrease in the principal balance of non-accrual
commercial real estate loans and one-to-four family participations. The
properties are located in the Bank's primary lending area. The decrease in the
loans 90 days past due and still accruing is due primarily to the decrease in
credit card loans 90 days past due. The increase in the real estate owned and in
judgment relates to the default of two one-to four family mortgage loans in
fiscal 1999 which were acquired by the Bank during fiscal 2000. The properties
are located in the Bank's primary lending area.
Non-performing loans include loans placed on non-accrual status and
troubled debt restructuring. Non-performing assets include non-performing loans,
foreclosed properties and investment securities. The following table sets forth
non-performing loans and assets:
AT JUNE 30,
---------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Non-accrual mortgage loans 90 days or more past due............. $1,798 $2,118 $1,338 $ 572 $ 64
Non-accrual consumer loans 90 days or more past due............. 54 88 52 20 21
Loans 90 days or more past due and still accruing(1)............ 18 219 34 31 22
Troubled debt restructuring..................................... -- -- -- -- --
------ ------ ------ ----- -----
Total non-performing loans.................................... 1,870 2,425 1,424 623 107
------ ------ ------ ----- -----
Total real estate owned and in judgment, net of
related allowance for losses................................ 1,114 621 11 20 --
------ ------ ------ ----- -----
Total investment securities, net of related discount............ -- 235 -- -- --
------ ------ ------ ----- -----
Total non-performing assets..................................... $2,984 $3,281 $1,435 $ 643 $ 107
====== ====== ====== ===== =====
Total non-performing loans to gross loans receivable............ 0.45% 0.81% 0.50% 0.22% 0.04%
====== ====== ====== ===== =====
Total non-performing assets to total assets..................... 0.57% 0.70% 0.32% 0.16% 0.03%
====== ====== ====== ===== =====
- ----------------
(1) The Bank discontinues the accrual of interest on loans more than 90 days
past due, at which time all accrued but uncollected interest is reversed by
way of a charge to interest income. Uncollected interest on credit card
loans, however, continues to accrue after 90 days of delinquency but is
capitalized to the loan balance monthly, and reserved for in the Bank's
allowance for loan losses.
POTENTIAL PROBLEM LOANS
Potential problem loans are loans where known information about
possible credit problems of borrowers causes management to have doubts as to the
ability of such borrowers to comply with the present loan repayment terms. The
decision by management to categorize a loan as a potential problem loan does not
necessarily indicate that the Company expects losses to occur, but that
management recognizes there is a higher degree of risk associated with these
performing loans. At June 30, 2000, the Bank had a potential problem loan with a
balance of $1.2 million secured by 9 first-lien one-to-four family mortgages
held in trust for the benefit of the Bank and a secondary payee under the loan
obligation. The original balance of the loan was $4.1 million. At June 30, 2000,
the loan was current as to payment of principal and interest. Proceeds from
payments made to the trustee from potential homeowners (occupying the properties
under 2-year leases with an option to purchase at a agreed upon price upon
expiration of the lease-term), or from any other eventual sale of the
one-to-four family residences securing the obligation, are to be applied by the
trustee first to the repayment of the total of all principal and interest due
the Bank, with any excess over such amounts becoming due to the secondary payee.
The Bank assumed responsibility for receipt and servicing of payments from the
potential homeowners upon the secondary payee's filing of bankruptcy in June
1999. The Bank also removed a third party bank as the bond trustee and has
appointed itself as trustee in December 1999. The one-to-four family properties
securing the obligation are located in the Bank's primary lending area and
management believes the underlying value of the properties and the Bank's first
lien status are sufficient to prevent any significant loss from this credit.
-24-
28
CLASSIFICATION OF ASSETS
The FDIC requires each federally insured bank to classify its assets on
a regular basis in accordance with the guidelines set forth in the FDIC Manual
of Examination Policies. In addition, in connection with examinations of insured
banks by the FDIC, FDIC examiners have authority to identify problem assets as
Substandard, Doubtful or Loss. Substandard assets have one or more well-defined
weaknesses that jeopardize the liquidation of the debt and are characterized by
the distinct possibility that the bank will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets, with the additional characteristics that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, highly questionable and improbable. An asset classified
as Loss is considered uncollectible and of such little value that continuance as
an asset of the bank is not warranted. At June 30, 2000, the Bank had assets
classified as Substandard of $3,840,000, $55,000 as Doubtful, and none as Loss.
The increase in Substandard classified assets and non-accrual mortgage loans is
due primarily to the addition of a $1.2 million loan secured by 9 first-lien
one-to-four family mortgages to the substandard classification during fiscal
2000, the properties are located in the Bank's primary lending area. In
addition, substandard one-to-four family mortgage loans increased during the
year. Management believes that the loan loss reserves established on these loans
is adequate to absorb any probable loss related to its resolution. Assets which
are classified as Loss are charged off. The FDIC examination policies include a
Special Mention category, consisting of assets which currently do not expose the
Bank to a sufficient degree of risk to warrant adverse classification, but do
possess credit deficiencies deserving management's close attention. At June 30,
2000, none of the Bank's assets were classified as Special Mention.
ALLOWANCE FOR LOAN LOSSES
Under federal regulations, when an insured institution classifies
problem assets as either Substandard or Doubtful, it is required to establish a
general allowance for loan losses in an amount deemed prudent by management. In
addition to general valuation allowances, the Bank may establish specific loss
allowances against specific assets in which a loss may be realized. General
allowances represent loss allowances which have been established to recognize
the inherent risks associated with lending activities, but which, unlike
specific allowances, have not been allocated to recognize probable losses on
particular problem assets. The Bank's determination as to its classification of
assets and the amount of its specific and general valuation allowances are
subject to review by the Commissioner and the FDIC, either one of which can
order the establishment of additional general or specific loss allowances.
The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risk inherent in its loan
portfolio and the general economy. Such evaluation, which includes a review of
all loans on which full collectibility may not be reasonably assured, considers,
among other matters, the estimated net realizable value of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss
allowance. Also, management continues to evaluate the allowance for losses on
loans as established by industry peers. During fiscal 2000, the increase in the
level of allowance for losses on loans was primarily the result of the increase
in multi-family, multi-family construction, commercial real estate and
commercial business loan portfolios which carry a greater degree of inherent
credit risk as compared to one-to-four family lending. It is anticipated that in
fiscal 2001, additions charged to expense may approximate the amount charged in
fiscal 2000 due to increased emphasis on, and increased risks associated with,
non-conforming one-to-four family, multi-family, commercial real estate lending
and commercial business lending and overall loan portfolio growth. Despite the
significant growth the Company anticipates in loan purchases of higher-yielding
non-conforming one-to-four family, multi-family, commercial real estate and
commercial business loans during fiscal 2000, management believes that it
continues to have a sufficient allowance for loan losses. The Board of Directors
of the Company and the Asset Quality Committee actively monitor the Bank's
general and specific levels of loan loss reserves based on performance of its
own portfolio and the industry standard.
-25-
29
The following table sets forth activity in the Bank's allowance for loan
losses during the fiscal years indicated.
AT JUNE 30,
---------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Balance at beginning of period ..................... $ 2,648 $ 2,329 $ 1,762 $ 1,234 $ 953
Additions charged to expense:
One-to-four family ............................ -- -- -- 295 172
Multi-family and commercial real estate ....... 499 310 512 181 80
Consumer ...................................... 143 120 163 114 115
Commercial .................................... 229 50 125 60 --
-------- -------- -------- -------- ---------
871 480 800 650 367
-------- -------- -------- -------- ---------
Recoveries:
One-to-four family ............................ -- -- -- 1 8
Consumer ...................................... 22 15 -- 5 9
Commercial .................................... -- 31 -- --
-------- -------- -------- -------- ---------
22 15 31 6 17
-------- -------- -------- -------- ---------
Charge-Offs:
One-to-four family ............................ (43) (11) (69) (11) (15)
Multi Family and commercial real estate ....... (5) (34) -- -- --
Consumer ...................................... (178) (131) (195) (117) (88)
Commercial .............................. (114) -- -- -- --
-------- -------- -------- -------- ---------
(340) (176) (264) (128) (103)
-------- -------- -------- -------- ---------
Net charge-offs .................................... (318) (161) (233) (122) (86)
-------- -------- -------- -------- ---------
Balance at end of period ........................... $ 3,201 $ 2,648 $ 2,329 $ 1,762 $ 1,234
======== ======== ======== ======== =========
Percentage of loans to gross loans receivable:
Mortgage loans ................................ 93.26% 92.61% 93.19% 96.73% 97.29%
Consumer loans ................................ 0.78 1.29 1.73 2.06 2.71
Commercial loans .............................. 5.96 6.11 5.08 1.21 --
Ratio of allowance for loan losses to gross loans
receivable at the end of period ............... 0.78 0.89 0.81 0.62 0.50
Ratio of allowance for losses on loans to non-
performing loans at the end of period ......... 171.26 109.19 166.36 282.37 1,153.27
Ratio of net charge-offs to average gross loans
during period ................................. 0.08 0.05 0.08 0.04 0.05
Average gross loans outstanding .................... $376,575 $297,899 $280,204 $274,056 $ 187,969
Gross loans receivable at end of period ............ $412,585 $298,932 $288,650 $285,851 $ 248,552
-26-
30
At June 30, 2000, 1999, and 1998, delinquencies in the Bank's loan
portfolio were as follows:
AT JUNE 30, 2000 AT JUNE 30, 1999
----------------------------------------- -----------------------------------------
60-89 90 DAYS 60-89 90 DAYS
DAYS OR MORE(1) DAYS OR MORE(1)
------------------- ------------------- ------------------- -------------------
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)
MORTGAGE LOANS:
One-to-four family ........ 3 $ 462 26 $1,071 6 $ 284 17 $1,125
Residential construction .. ------ ------ ------ ------ ------ ------ ------ ------
Home equity ............... 1 20 11 318 9 209 8 80
Commercial ................ 1 470 2 409 1 688 1 1,072
------ ------ ------ ------ ------ ------ ------ ------
Total mortgage loans... 5 952 39 1,798 16 1,181 26 2,277
CONSUMER LOANS .............. 2 3 10 72 9 16 26 148
------ ------ ------ ------ ------ ------ ------ ------
TOTAL .................... 7 $ 955 49 $1,870 25 $1,197 52 $2,425
====== ====== ====== ====== ====== ====== ====== ======
DELINQUENT LOANS TO GROSS
LOANS .................... 0.23% 0.45% 0.40% 0.81%
====== ====== ====== ======
AT JUNE 30, 1998
-------------------------------------------
60-89 90 DAYS
DAYS OR MORE(1)
-------------------- -------------------
NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS
----- -------- ----- --------
(DOLLARS IN THOUSANDS)
MORTGAGE LOANS:
One-to-four family ........ 6 $ 350 8 $ 533
Residential construction .. ------ ------ ------ ------
Home equity ............... 5 95 9 122
Commercial ................ -- -- 1 683
------ ------ ------ ------
Total mortgage loans... 11 445 18 1,338
CONSUMER LOANS .............. 10 28 23 86
------ ------ ------ ------
TOTAL .................... 21 $ 473 41 $1,424
====== ====== ====== ======
DELINQUENT LOANS TO GROSS
LOANS .................... 0.17% 0.50%
====== ======
- ----------------
(1) The Bank discontinues the accrual of interest on loans when the borrower is
delinquent as to a contractually due principal or interest payment by more
than 90 days.
31
The following table shows the Bank's allowance for loan losses and the
allocation to the various categories of loans held for investment at the dates
indicated. Allocations to a particular category do not restrict the Bank's
ability to use such allowance in any other category.
AT JUNE 30,
-------------------------------------------------------------------------------------------
2000 1999 1998
------------------------------- ------------------------------ --------------------------
% OF % OF % OF
% OF LOANS IN % OF LOANS IN % OF LOANS IN
TOTAL CATEGORY TOTAL CATEGORY TOTAL CATEGORY
LOANS TO TOTAL LOANS TO TOTAL LOANS TO TOTAL
BY OUTSTANDING BY OUTSTANDING BY OUTSTANDING
AMOUNT CATEGORY LOANS AMOUNT CATEGORY LOANS AMOUNT CATEGORY LOANS
------ -------- ----- ------ -------- ----- ------ -------- -----
(DOLLARS IN THOUSANDS)
Breakdown of Allowance:
Mortgage loans:
One-to-four family ............... $ 719 0.39% 45.15% $ 613 0.42% 49.50% $ 585 0.38% 53.73%
Home equity ...................... 243 1.12 5.27 240 1.15 6.84 342 1.36 8.69
Multi-family ..................... 331 0.79 10.12 296 0.82 12.15 242 0.72 11.61
Commercial/nonresidential ........ 1,125 1.30 20.97 935 1.93 14.17 600 1.73 11.99
One-to-four family
construction .................... 13 0.13 2.28 13 0.33 1.32 11 0.30 1.29
Multi-family construction ........ 57 0.48 2.88 17 0.82 2.92 23 0.74 1.08
Other construction and land ...... 214 0.79 6.59 135 1.36 5.71 181 1.30 4.81
------ ------ ------ ------ ------ ------
Total mortgage loans............ 2,702 93.26 2,249 92.61 1,984 93.20
------ ------ ------ ------ ------ ------
Consumer loans..................... 148 4.60 0.78 164 4.28 1.29 160 3.19 1.73
------ ------ ------ ------ ------ ------
Commercial loans................... 351 1.43 5.96 235 1.29 6.10 185 1.26 5.07
------ ------ ------ ------ ------ ------
Total allowance for loan
losses....................... $3,201 100.00% $2,648 100.00% $2,329 100.00%
====== ====== ====== ====== ====== ======
AT JUNE 30,
----------------------------------------------------------------
1997 1996
----------------------------------- ---------------------------
% OF % OF
% OF LOANS IN % OF LOANS IN
TOTAL CATEGORY TOTAL CATEGORY
LOANS TO TOTAL LOANS TO TOTAL
BY OUTSTANDING BY OUTSTANDING
AMOUNT CATEGORY LOANS AMOUNT CATEGORY LOANS
------ -------- ----- ------ -------- -----
(DOLLARS IN THOUSANDS)
Breakdown of Allowance:
Mortgage loans:
One-to-four family...................... $ 685 0.41% 58.60% $488 0.32% 61.82%
Home equity............................. 253 1.00 8.85 194 1.00 7.78
Multi-family............................ 190 0.69 9.66 198 1.00 7.96
Commercial/nonresidential............... 198 0.91 7.59 44 0.80 2.21
One-to-four-family construction......... 69 0.40 6.08 40 0.17 9.61
Multi-family construction............... 72 0.75 3.37 46 0.35 5.28
Other construction and land............. 74 1.00 2.58 65 1.00 2.60
------ ------ ------ ------
Total mortgage loans.................. 1,541 96.73 1,075 97.26
------ ------ ------ ------
Consumer loans............................ 161 2.74 2.06 159 2.34 2.74
------ ------ ------ ------
Commercial loans.......................... 60 1.73 1.21 -- --
------ ------ ------ ------
Total allowance for loan losses......... $1,762 100.00% $1,234 100.00%
====== ====== ====== ======
-28-
32
INVESTMENT ACTIVITIES
GENERAL
The investment policy of the Bank, which is established by the Board of
Directors and implemented by the Bank's President/Chief Executive Officer,
Executive Vice President and Senior Vice President-Finance, is designed to
provide a required level of liquidity and minimize potential losses due to
interest rate fluctuations without incurring undue credit risk. The Bank is
authorized by regulation to invest in various types of liquid assets, including
United States Treasury obligations, securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB-Chicago,
certain certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds. The Bank also invests in mortgage-backed
and related securities, securities that are either of investment grade or issued
or guaranteed by FHLMC, Fannie Mae or the Government National Mortgage
Association ("GNMA"), investment grade corporate debt, non-rated trust preferred
securities issued by other financial institutions and mortgage mutual funds.
The Bank categorizes the securities it purchases into a
"Held-To-Maturity," "Trading Account" or "Available-For-Sale" portfolio as
follows:
1. Securities Held-to-Maturity. The Company has the positive
ability and intent to hold these assets to maturity. Upon
acquisition, securities are classified as to the Bank's intent
and only under remote situations could a sale from this
portfolio be effected. The held-to-maturity portfolio is not
used for speculative purposes and is carried at amortized
cost. Should the intent change these assets would be
classified as available-for-sale.
2. Trading Securities. This portfolio includes securities
acquired to make a profit from short-term movements in market
prices. Securities purchased for trading purposes are carried
at fair value, with unrelated holding gains and losses
included in earnings.
3. Securities Available-for-Sale. This is a portfolio for
securities not classified as either Held-to-Maturity or
Trading. This portion of the securities portfolio is designed
to meet anticipated loan demand and deposit runoff. Securities
classified as available-for-sale are carried at fair value,
with unrealized holding gains and losses reported as a
separate component of shareholders' equity and are not
reported in earnings until a decline in fair value below cost
is deemed to be other-than-temporary.
The investment activities of the Bank consist primarily of investments
in mortgage-backed and related securities and other investment securities,
consisting primarily of securities issued or guaranteed by the United States
Government or agencies thereof and corporate obligations. Typical investments
include federally sponsored agency mortgage pass-through, private issue and
senior-subordinated pass-through, and federally sponsored agency and
mortgage-related securities. Investment and aggregate investment limitations and
credit quality parameters of each class of investment are prescribed in the
Bank's investment policy. The Bank performs analyses on mortgage related
securities prior to purchase and on an ongoing basis to determine the impact on
earnings and market value under various interest rate and prepayment conditions.
INVESTMENT SECURITIES
The Bank invests in various types of liquid assets that are permissible
investments for state-chartered savings banks, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of federally insured banks and savings institutions and federal funds.
The Bank also invests its assets in commercial paper and mutual funds, the
assets of which conform to the investments that a Wisconsin-chartered savings
association is otherwise authorized to make directly. The Bank also invests in
trust preferred securities issued by other financial institutions. Trust
preferred securities are a form of preferred stock issued to increase the Tier I
capital of the issuing financial institution. The Bank generally purchases up to
$500,000 with any one issuer that is considered, at minimum, "well capitalized"
by the FDIC. The Bank's current investment policy permits purchases only of
investments rated investment grade by a nationally recognized rating agency and
-29-
33
does not permit purchases of securities of non-investment grade quality;
provided however, the investment policy does permit purchases of investments in
non-rated trust preferred securities up to 15% of the Bank's equity capital.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent a participation interest in a pool
of single-family or multi-family mortgages, the principal and interest payments
on which are passed from the mortgage originators through intermediaries
(federal-government sponsored enterprises or private entities) that pool and
repackage the participation interest in the form of securities to investors such
as the Bank. The underlying pool of mortgages can be composed of either
fixed-rate mortgages or ARM loans. Mortgage-backed securities commonly are
referred to as mortgage participation certificates or pass-through certificates.
As a result, the interest rate risk characteristics of the underlying pool of
mortgages, i.e., fixed rate or adjustable rate, as well as the prepayment risk,
are passed on to the certificate holder.
When the intermediary is a quasi-governmental agency such as FHLMC,
Fannie Mae and GNMA, timely payment of principal and interest is guaranteed to
investors by such agency and the loans that back such securities are conforming
loans (meaning they are underwritten to certain standards and are subject to
certain size limitations). When the intermediary is a private entity, neither
the principal nor the interest on such securities is guaranteed. In addition,
the loans that back private mortgage-backed securities generally are
non-conforming loans and consequently have a greater amount of credit risk.
Mortgage-backed securities issued by quasi-governmental agencies generally
increase the quality of the Bank's assets by virtue of the guarantees that back
them. In addition, mortgage-backed securities generally are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations of the Bank.
The life of a mortgage-backed pass-through security is equal to the
life of the underlying mortgages. The actual maturity of a mortgage-backed
security varies, however, depending on when the mortgagors prepay or repay the
underlying mortgages. Prepayments of the underlying mortgages may shorten the
life of the investment, thereby adversely affecting its yield to maturity and
the related market value of the mortgage-backed security. The yield is based
upon the interest income and the amortization of the premium or accretion of the
discount related to the mortgage-backed security. Premiums and discounts on
mortgage-backed securities are amortized or accreted over the estimated term of
the securities using a level yield method. The prepayment assumptions used to
determine the amortization period for premiums and discounts can significantly
affect the yield of the mortgage-backed security and these assumptions are
reviewed periodically to reflect the actual prepayment. The actual prepayments
of the underlying mortgages depend on many factors, including type of mortgages,
the coupon rate, the age of the mortgages, the geographical location of the real
estate collateralizing the mortgages and general levels of market interest
rates. The difference between the interest rates on the underlying mortgages and
the prevailing mortgage interest rates is an important determinant in the rate
of prepayments. During periods of falling mortgage interest rates, prepayments
generally increase. If the coupon rate of the underlying mortgages significantly
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages. Prepayment experience is more difficult to estimate for adjustable
rate mortgage-backed securities.
A senior-subordinated structure often is used with mortgage-backed
securities to provide credit enhancement for pass-through securities when the
underlying collateral is not guaranteed by an agency of the U.S. Government.
These structures divide mortgage pools into two risk classes: a senior class and
one or more subordinated classes. The subordinated classes provide protection to
the senior classes. When cash flow is impaired, debt service goes first to the
holders of senior class securities. In addition, incoming cash flows also may go
into a reserve fund to meet any future shortfalls of cash flow to senior
noteholders. The subordinated noteholder may not receive any funds until the
senior note holders have been paid and, when appropriate, until a specified
level of funds has been contributed to the reserve fund. It is the policy of the
Bank to purchase only investment grade non-agency backed mortgage-backed
securities.
-30-
34
MORTGAGE RELATED SECURITIES
REMICs and CMOs are typically issued by a special purpose entity, which
may be organized in a variety of legal forms, such as a trust, a corporation or
a partnership. The entity aggregates pools of pass-through securities, which are
used to collateralize the mortgage related securities. Once combined, the cash
flows can be divided into "tranches" or "classes" of individual securities,
thereby creating more predictable average lives for each security than the
underlying pass-through pools. Accordingly, under this security structure all
principal paydowns from the various mortgage pools are allocated to a mortgage
related securities class or classes structured to have priority until it has
been paid off. Thus, these securities are intended to address the reinvestment
concerns associated with mortgage-backed security pass-through, namely that they
tend to pay off when interest rates fall. Bank management believes these
securities represent attractive alternatives relative to other investments due
to the wide variety of maturity and repayment options available through such
investments and due to the limited prepayment risk associated with such
investments. The Bank has not purchased and does not intend to purchase higher
risk CMO residuals or stripped mortgage securities for its investment securities
portfolio. The Bank's investment in REMICs/CMOs is primarily in floating-rate or
short- and intermediate-term (1-5 years) fixed-rate tranche securities.
The Bank has experienced a decrease in the level of principal
repayments on mortgage-backed securities and mortgage related securities to
$32.0 million during the fiscal year ended June 30, 2000, from $93.4 million in
fiscal year 1999. The decrease in principal repayments during fiscal 2000 is
primarily related to the increase in interest rates and decrease in refinancing.
The decrease in the balance of mortgage-backed and related securities portfolio
is part of the Company's strategy to increase and diversify its loan portfolio.
COMPOSITION OF SECURITIES HELD-TO-MATURITY
Mortgage-Backed and Related Securities. At June 30, 2000, the Company
held $15.0 million in its mortgage-backed and related securities portfolio as
compared to $54.6 million and $65.2 million at June 30, 1999 and 1998,
respectively. Of this amount, fixed-rate securities and adjustable-rate
securities were $15.0 million and $0.0 million; $11.4 million and $43.2 million;
and $8.1 million and $57.2 million at June 30, 2000, 1999 and 1998,
respectively. The decrease in fiscal 2000 is primarily due to the decision of
the Company to transfer $37.9 million in held-to-maturity securities to the
trading and available-for-sale portfolios. At the time of transfer there was an
unrealized gain on the trading securities of $16,000 and an unrealized gain on
the securities available-for-sale of $60,000. The unrealized gains are included
in the gain on sale of securities and mortgage-backed and related securities in
the Consolidated Statements of Income for the trading securities and in Other
Comprehensive Income-Unrealized Holding Loss for the year ended June 30, 2000
and are not presented as a cumulative effect of an accounting change due to
their immateriality to net income and comprehensive income for the period. The
estimated market value of these securities at June 30, 2000 was $14.7 million as
compared to $54.9 million and $66.2 million at June 30, 1999 and 1998,
respectively. At June 30, 2000, the mortgage-backed and related securities
portfolio represented 2.9% of the Company's total assets as compared to 11.6%
and 14.9% at June 30, 1999 and 1998, respectively. Included in the
mortgage-backed and related securities portfolio were federal agency backed and
private-issue pass-through securities totaling $4.3 million and $10.7 million;
$9.2 million and $2.1 million; $14.7 million and $16.8 million at June 30, 2000,
1999 and 1998, respectively. Of the $10.7 million in private-issue securities at
June 30, 2000, all were fixed rate securities and carried a minimum credit
rating of AA at the time of purchase and such ratings have not been downgraded
since the time of purchase.
Mortgage-related securities, which primarily consisted of real estate
mortgage investment conduit securities ("REMICs"), totaled $13.6 million, $43.4
million and $33.8 million at June 30, 2000, 1999 and 1998, respectively.
Other Investment Securities. Other investments consisted primarily of
overnight deposits, certificates of deposit and bankers' acceptances which
totaled $13.8 million, $5.0 million and $6.6 million at June 30, 2000, 1999 and
1998, respectively. The market value of these securities were $13.8 million,
$5.0 million and $6.6 million at June 30, 2000, 1999 and 1998, respectively.
-31-
35
COMPOSITION OF SECURITIES AVAILABLE-FOR-SALE
Mortgage-Backed Securities and Related Securities. At June 30, 2000,
the Company held mortgage-backed and related securities available-for-sale with
a carrying and market value of $35.9 million as compared to $55.6 million and
$57.5 million at June 30, 1999 and 1998, respectively. Of this amount at June
30, 2000, $12.7 million of the securities are mortgage-backed securities and
$23.2 million REMIC securities. Included in the mortgage-backed and related
securities were federal agency backed and private-issue securities totaling
$11.2 million and $24.7 million, respectively. Of the $35.9 million in
mortgage-backed and related securities available-for-sale at June 30, 2000,
fixed-rate securities and adjustable-rate securities were $14.8 million and
$21.1 million, respectively. The Company carries such investments at fair value.
Other Investment Securities. The Company's other investment securities
available-for-sale include U.S. Government and agency obligations and ARM Mutual
Funds totaling $32.8 million and $1.0 million; $38.7 million and $1.0 million;
and $5.0 million and $1.0 million at June 30, 2000, 1999 and 1998, respectively.
Also at June 30, 2000, the Company had trust preferred securities and municipal
bonds with a carrying and market value of $4.3 million and $274,000,
respectively. The Company carries such investments at fair value.
-32-
36
The tables below sets forth certain information regarding the carrying
value, composition and market value of the Company's available-for-sale and
held-to-maturity securities at June 30, 2000, 1999 and 1998.
JUNE 30, 2000
--------------------------------------
CARRYING % OF MARKET
VALUE TOTAL VALUE
---------- --------- -------
(DOLLARS IN THOUSANDS)
SECURITIES AVAILABLE-FOR-SALE:
U.S. government securities........................................ $ 32,758 44.11% $ 32,758
Mortgage-backed securities........................................ 12,706 17.11 12,706
Mortgage-related securities (REMICs).............................. 23,238 31.29 23,238
ARM loan mutual funds............................................. 958 1.29 958
Trust preferred securities........................................ 4,325 5.82 4,325
Municipal bonds/other............................................. 274 .38 274
-------- ------ --------
Total securities available-for-sale............................. $ 74,259 100.00% $ 74,259
======== ====== ========
SECURITIES HELD-TO-MATURITY:
Demand deposits in other financial institutions................... $ 13,777 100.00 $ 13,777
-------- ------ --------
Total securities held-to-maturity............................. $ 13,777 100.00% $ 13,777
======== ====== ========
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY:
GNMA.............................................................. $ -- 0.00% $ --
FHLMC............................................................. 405 29.14 400
FNMA.............................................................. 985 70.86 963
Other participation certificates.................................. -- -- --
-------- ------ --------
Total mortgage-backed securities held-to-maturity............... $ 1,390 100.00 $ 1,363
======== ====== ========
MORTGAGE-RELATED SECURITIES HELD-TO-MATURITY:
CMOs.............................................................. -- -- --
REMICs............................................................ 13,627 100.00 13,322
-------- ------ --------
Total mortgage-related securities held-to-maturity.................. $ 13,627 100.00% $ 13,322
======== ====== ========
JUNE 30, 1999
--------------------------------------
CARRYING % OF MARKET
VALUE TOTAL VALUE
---------- --------- -------
(DOLLARS IN THOUSANDS)
SECURITIES AVAILABLE-FOR-SALE:
U.S. government securities........................................ $ 38,702 38.52% $ 38,702
Mortgage-backed securities........................................ 16,943 16.86 16,943
Mortgage-related securities (REMICs).............................. 38,623 38.44 38,623
ARM loan mutual funds............................................. 964 .96 964
Trust preferred securities........................................ 4,797 4.78 4,797
Municipal bonds/other............................................. 439 .44 439
-------- ------ --------
Total securities available-for-sale............................. $100,468 100.00% $100,468
======== ====== ========
SECURITIES HELD-TO-MATURITY:
Demand deposits in other financial institutions................. 5,017 100.00 5,017
-------- ------ --------
Total securities held-to-maturity............................... $ 5,017 100.00% $ 5,017
======== ====== ========
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY:
GNMA.............................................................. $ 571 5.07% $ 595
FHLMC............................................................. 2,302 20.45 2,311
FNMA.............................................................. 6,292 55.88 6,301
Other participation certificates.................................. 2,094 18.60 2,090
-------- ------ --------
Total mortgage-backed securities held-to-maturity............... $ 11,259 100.00% $ 11,297
======== ====== ========
MORTGAGE-RELATED SECURITIES HELD-TO-MATURITY:
CMOs.............................................................. -- -- --
REMICs............................................................ 43,359 100.00 43,359
-------- ------ --------
Total mortgage-related securities held-to-maturity............. $ 43,359 100.00% $ 43,359
======== ====== ========
-33-
37
JUNE 30, 1998
--------------------------------------
CARRYING % OF MARKET
VALUE TOTAL VALUE
---------- --------- -------
(DOLLARS IN THOUSANDS)
SECURITIES AVAILABLE-FOR-SALE:
U.S. government securities........................................ $ 4,992 7.51% $ 4,992
Mortgage-backed securities........................................ 39,150 58.92 39,150
Mortgage-related securities (REMICs).............................. 18,399 27.69 18,399
ARM loan mutual funds............................................. 969 1.46 969
Trust preferred securities........................................ 2,500 3.76 2,500
Municipal bonds................................................... 435 .66 435
-------- ------ --------
Total securities available-for-sale............................. $ 66,445 100.00% $ 66,445
======== ====== ========
SECURITIES HELD-TO-MATURITY:
Demand deposits in other financial institutions................... $ 6,186 94.10% $ 6,186
Time deposits in other financial institutions..................... 388 5.90 388
-------- ------ --------
Total securities held-to-maturity............................... $ 6,574 100.00% $ 6,574
======== ====== ========
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY:
GNMA.............................................................. $ 720 2.29% $ 758
FHLMC............................................................. 2,986 9.49 3,038
FNMA.............................................................. 10,256 32.58 10,514
Other participation certificates.................................. 17,518 55.64 17,434
-------- ------ --------
Total mortgage-backed securities held-to-maturity................... $ 31,480 100.00% $ 31,744
======== ====== ========
MORTGAGE-RELATED SECURITIES HELD-TO-MATURITY:
CMOs.............................................................. -- -- --
REMICs............................................................ 33,802 100.00 34,441
-------- ------ --------
Total mortgage-related securities held-to-maturity............. $ 33,802 100.00% $ 34,441
======== ====== ========
The composition and contractual maturities of securities
held-to-maturity, excluding FHLB-Chicago stock, is indicated in the following
table.
AT JUNE 30, 2000
TOTAL
LESS THAN 1 TO 10 OVER 10 INVESTMENT
1 YEAR YEARS YEARS SECURITIES
------------ ----------- ----------- ------------
(DOLLARS IN THOUSANDS)
Securities held-to-maturity:
Demand deposits in other financial institutions............. $13,777 - - $13,777
------- -------
Total securities held-to-maturity....................... $13,777 - - $13,777
======= ======== ======== =======
Weighted average yield........................................ 6.50% -% -% 6.50%
======= ======== ======== =======
-34-
38
The following table shows the maturity or period to repricing of the Company's
securities available-for-sale at June 30, 2000.
AT JUNE 30, 2000
-----------------------------------------------------------------------------------
FIXED-RATE FIXED-RATE ADJUSTABLE-RATE FIXED-RATE
U.S. GOVERNMENT MORTGAGE-BACKED MORTGAGE-BACKED CMOS AND
SECURITIES SECURITIES SECURITIES REMICS
-------------------- ----------------- --------------------- -----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
----- ----- ----- ----- ----- ----- ----- -----
(IN THOUSANDS)
AMOUNTS DUE OR REPRICING:
Within one year ............................. $ -- -- $ 429 5.10 $ 4,664 6.74% $ -- --
AFTER ONE YEAR:
One to three years .......................... -- -- -- -- -- -- -- --
Three to five years ......................... 9,634 6.04 -- -- -- -- -- --
Five to ten years ........................... 1,878 6.50 51 8.00 -- 457 7.51
Ten to 20 years ............................. 21,246 6.94 4,207 6.26 -- -- 833 8.36
Over 20 years ............................... -- -- 3,355 7.52 -- -- 5,448 6.72
------- ----- ------- ------ ------- ------ ------- ----
Total due or repricing after one year ..... 32,758 6.66 7,613 6.83 -- 6,738 6.97
------- ----- ------- ------ ------- ------ ------- ----
Total amount due or repricing.............. 32,758 6.66% 8,042 6.72% 4,664 6.74% 6,738 6.97%
Less unearned discounts and premiums, net.. -- -- -- --
Mortgage-backed and related securities..... $32,758 $ 8,042 $ 4,664 $6,738
======= ======= ======= ======
Average remaining years to maturity ............ 10.8 19.8 21.2 25.1
AT JUNE 30, 2000
----------------------------------------------------------------------------------
TRUST PREFERRED SEC/ FIXED-RATE
ADJUSTABLE-RATE ADJUSTABLE-RATE MUNICIPAL
REMICS MUTUAL FUNDS BONDS TOTAL
--------------------- ------------------- ----------------------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
----- ----- ----- ----- ----- ----- ----- -----
(IN THOUSANDS)
AMOUNTS DUE OR REPRICING:
Within one year ............................. $16,500 7.11% $1,408 6.85% $ -- $23,001 6.98%
AFTER ONE YEAR:
One to three years .......................... -- -- -- -- -- -- -- --
Three to five years ......................... -- -- -- -- -- -- 9,634 6.04
Five to ten years ........................... -- -- -- -- 274 5.33 2,660 6.58
Ten to 20 years ............................. -- -- -- -- -- -- 26,286 6.88
Over 20 years ............................... -- -- 3,875 9.22 -- -- 12,678 7.70
------- ----- ------- ---- --- ---- ------ ----
Total due or repricing after one year ..... -- 3,875 9.22 274 5.33 51,258 6.91
------- ----- ------- ---- --- ---- ------ ----
Total amount due or repricing.............. 16,500 7.11% 5,283 8.62% 274 5.33% 74,259 6.93%
Less unearned discounts and premiums, net.. -- -- -- --
Mortgage-backed and related securities..... $16,500 $5,283 $274 $74,259
======= ====== ==== =======
Average remaining years to maturity ............ 24.9 0.0 5.6 17.3
The following table shows the maturity or period to repricing of the Company's
mortgage-backed and related securities portfolio held-to-maturity at June 30,
2000.
AT JUNE 30, 2000
----------------------------------------------------------------------------
FIXED-RATE FIXED-RATE
MORTGAGE-BACKED CMOS AND
SECURITIES REMICS TOTAL
-------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
----------- -------- ---------- ----------- ---------- -----------
(IN THOUSANDS)
AMOUNTS DUE OR REPRICING:
Within one year............................. $ 452 6.00% $ -- --% $ 452 6.00%
AFTER ONE YEAR:
One to three years.......................... 110 8.00 -- -- 110 8.00
Three to five years......................... 818 5.89 -- -- 818 5.89
Five to ten years........................... 218 5.49 218 5.49
Ten to 20 years............................. -- -- 1,847 6.75 1,847 6.75
Over 20 years............................... 11,613 6.80 11,613 6.80
------- ------ ------- ------ -------- ------
Total due or repricing after one year..... 928 6.14 13,678 6.77 14,606 6.73
------- ------ ------- ------ -------- ------
Total amounts due or repricing............ 1,380 6.09% 13,678 6.77% 15,058 6.71%
Less unearned discounts and premiums, net...... 10 (51) (41)
------- ------- --------
Mortgage-backed and related securities, net.... $1,390 $13,627 $ 15,017
======= ======= ========
Average remaining years to maturity............ 2.3 24.1 22.0
-35-
39
SOURCES OF FUNDS
GENERAL
The Company's primary sources of funds for use in lending, investing
and for other general purposes are deposits, proceeds from principal and
interest payments on loans, mortgage-backed and related securities and
investment securities, FHLB advances and reverse repurchase agreements.
Contractual loan payments are a relatively stable source of funds, while deposit
inflows and outflows and loan prepayments are significantly influenced by
general market interest rates and economic conditions. Borrowings are used to
support expanded lending or investment activities. The Company utilizes advances
from the FHLB-Chicago and reverse repurchase agreements as sources for its
borrowings. At June 30, 2000, the Company had advances from the FHLB-Chicago
totaling $112.5 million or 21.7% of total assets as compared to $120.0 million
or 25.6% of total assets and $117.1 million or 26.7% of total assets as of June
30, 1999 and 1998, respectively. At June 30, 2000, the Company had $18.5 million
in reverse repurchase agreements as compared to $9.5 million at June 30, 1999.
The Company had no reverse repurchase agreements at June 30, 1998. The Bank has
continued to use FHLB-Chicago advances as a funding source due to the attractive
rates offered on advances in relation to deposit funds obtainable in the
Company's local market. Also see, "Borrowings and Other Financing Transactions."
Of the Company's outstanding FHLB-Chicago advances at June 30, 2000, $8.0
million will mature before June 30, 2001. In June of 2000, the Company obtained
a line of credit facility with a third-party bank for the primary purpose of
funding the Company's commercial mortgage banking activities and for providing
capital investment into the Bank from the Company. The third-party line of
credit facility totals $10.0 million and had an outstanding balance of $1.0
million at June 30, 2000. For a further discussion of the Company's funding
strategy, see Part II, Item 7 of the Company's Annual Report on Form 10-K,
"Financial Condition," "Liquidity and Capital Resources" and "Asset/Liability
Management."
DEPOSITS
The Company offers a variety of deposit accounts having a range of
interest rates and terms. The Company's deposits principally consist of
non-interest bearing checking, NOW, money market deposit and passbook accounts
and certificates of deposit. The flow of deposits is influenced significantly by
general economic conditions, changes in prevailing interest rates and
competition. The Company's deposits are obtained from the areas in which its
branches are located, and more recently from national wholesale certificate of
deposit sources. Various types of advertising and promotion to attract and
retain deposit accounts also are used. Management monitors the Bank's
certificates of deposit and, based on historical experience, management believes
it will retain a large portion of such accounts upon maturity. Management
considers Company profitability, the matching of term lengths with assets, the
attractiveness to customers and rates offered by competitors in considering its
deposit offerings and promotions. The Company believes it has been competitive
in the types of accounts and interest rates it has offered on its deposit
products. The Company intends to continue its efforts to attract deposits as a
primary source of funds for supporting its lending and investing activities.*
The Company has maintained competitive rates on its deposit accounts over the
last year as higher market interest rates prevailed.
The following table presents the deposit activity of the Company for
the periods indicated.
YEAR ENDED JUNE 30,
---------------------------------
2000 1999 1998
--------- --------- ---------
(IN THOUSANDS)
Deposits ............................ $ 875,389 $ 691,858 $ 449,609
Withdrawals ......................... 829,164 682,088 466,515
--------- --------- ---------
Net deposits/withdrawals ............ 46,225 9,770 (16,906)
Interest credited on deposits ....... 10,379 7,325 7,013
--------- --------- ---------
Total increase (decrease) in deposits $ 56,604 $ 17,095 $ (9,893)
========= ========= =========
The Company attributes the increase in deposits before interest
credited on deposits during fiscal 2000 primarily to the increase in wholesale
brokered and non-brokered certificates of deposit. Management believes the
likelihood for retention of brokered certificates of deposit is more a function
of the rate paid on such accounts as
-36-
40
compared to retail deposits which may be established due to Bank location or
other intangible reasons. Brokered deposits totaled $216.2 million at June 30,
2000 (or approximately 62.6% of total deposits at June 30, 2000), as compared to
$101.2 million at June 30, 1999 (or 35.1% of total deposits at June 30, 1999).
The significant increase in brokered deposits is due to attractive rates offered
on the brokered deposits and the Company's highly competitive local market for
retail deposits resulting in increasing reliance on brokered deposits as a
funding source. The average maturity of brokered deposits at June 30, 2000 and
1999 was four months. The average rate paid on brokered deposits for the fiscal
year ended June 30, 2000 was 6.03% as compared to 5.63% for the fiscal year
ended June 30, 1999.
At June 30, 2000, the Company had outstanding $212.5 million in
certificates of deposit in amounts of $100,000 or more maturing as follows:
AMOUNT AT
JUNE 30, 2000
-------------
(IN THOUSANDS)
Three months or less....................................................... $ 101,592
Over three through six months.............................................. 61,163
Over six through twelve months............................................. 47,165
Over twelve months......................................................... 2,533
----------
Total.................................................................. $ 212,453
==========
-37-
41
The following table sets forth the distribution of the Company's demand
deposits and certificate accounts at the dates indicated and the weighted
average nominal interest rates on each category of deposits presented.
Management does not believe that the use of year end balances instead of average
balances in calculating weighted average nominal interest rates resulted in any
material difference in the information presented. The jumbo certificates of
deposit in the following table contain $216.2 million of brokered certificates
of deposit at June 30, 2000, which represent all of the Company's brokered
deposits at June 30, 2000.
AT JUNE 30,
-----------------------------------------------------------------------------------------------------------
2000 1999 1998
----------------------------- --------------------------------- --------------------------------------
WEIGHTED WEIGHTED WEIGHTED
PERCENT AVERAGE PERCENT AVERAGE PERCENT OF AVERAGE
OF TOTAL NOMINAL OF TOTAL NOMINAL TOTAL NOMINAL
AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE
------ -------- ---- ------ -------- ---- ------ -------- ----
(DOLLARS IN THOUSANDS)
DEMAND DEPOSITS:
Non-interest-bearing.. $ 8,400 2.43% --% $ 9,006 3.12% --% $ 7,738 2.85% --%
NOW................... 3,147 0.91 0.76 2,789 0.97 1.75 2,701 0.99 1.75
Money market.......... 27,398 7.94 4.95 35,495 12.29 4.37 27,995 10.31 5.10
Passbook.............. 18,373 5.32 2.92 20,962 7.26 2.92 21,158 7.79 2.93
Total............... 57,318 16.60 3.34 68,252 23.64 3.24 59,592 21.94 3.52
CERTIFICATE ACCOUNTS
(TERM):
One to nine months.... 42,420 12.28 5.53 51,931 17.98 5.06 68,050 25.09 5.79
12 to 20 months....... 10,159 2.94 5.88 7,759 2.69 5.08 14,290 5.26 5.77
24 to 36 months....... 2,999 0.87 5.93 1,522 0.53 5.55 2,662 0.98 5.83
38 to 60 months....... 1,935 0.56 5.38 2,868 0.99 5.62 2,685 0.99 6.02
66 to 96 months....... -- 0.00 -- -- 0.00 -- -- 0.00 --
Wholesale(1).......... 230,487 66.75 6.46 156,382 54.17 5.32 124,340 45.74 6.07
Total certificates.. 288,000 83.40 6.29 220,462 76.36 5.26 212,027 78.06 5.95
Total deposits........... $345,318 100.00% 5.80% $288,714 100.00% 4.78% $271,619 100.00% 5.42%
- -------------
(1) Wholesale certificates of deposit have an average maturity of 4.3 months,
4.3 months and 8.0 months at June 30, 2000, 1999 and 1998, respectively.
-38-
42
The following table presents, by various rate categories, the amount of
certificates of deposit outstanding at June 30, 2000, 1999 and 1998, and the
periods to maturity of the certificate accounts outstanding at June 30, 2000. At
June 30, 2000, brokered certificates of deposit totaled $216.2 million with an
average rate of 6.45%.
AT JUNE 30, PERIOD TO MATURITY FROM JUNE 30, 2000
----------------------------- -------------------------------------------
WITHIN ONE TO
ONE THREE
2000 1999 1998 YEAR YEARS THEREAFTER TOTAL
----- ----- ----- ---- ----- ---------- -----
(IN THOUSANDS)
CERTIFICATES OF DEPOSIT:
4.99% and less................. $ 14,244 $ 36,190 $ 1,033 $ 12,255 $ 1,351 $ 638 $ 14,244
5.00% to 5.99%................. 42,276 162,753 118,081 34,782 6,531 963 42,276
6.00% to 6.99%................. 194,518 21,057 92,344 187,570 6,676 272 194,518
7.00% to 7.99%................. 36,813 314 430 35,391 1,360 62 36,813
8.00% to 8.99%................. 149 148 139 -- 149 -- 149
-------- -------- -------- --------- -------- ------- --------
Total....................... $288,000 $220,462 $212,027 $ 269,998 $ 16,067 $ 1,935 $288,000
======== ======== ======== ========= ======== ======= ========
BORROWINGS AND OTHER FINANCING TRANSACTIONS
Although deposits are the Company's primary source of funds, the
Company's policy has been to utilize borrowings as an alternative or less costly
source of funds. The Company utilizes borrowings as part of its asset/liability
management strategy. Borrowings are secured when management believes it can
profitably re-invest those funds for the benefit of the Company. The Company's
primary form of borrowing consists of advances from the FHLB-Chicago. These
advances are collateralized by the capital stock of the FHLB-Chicago held by the
Company and certain of its mortgage loans and mortgage-backed and related
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 the FHLB-Chicago will advance to member institutions, including
the Company, for purposes other than meeting withdrawals fluctuates from time to
time in accordance with policies of the FHLB-Chicago. At June 30, 2000, the
Bank's FHLB-Chicago advances totaled $112.5 million, representing 23.1% of total
liabilities, an increase from the $120.0 million outstanding at June 30, 1999.
For a further discussion of the Company's funding strategy, see Part II, Item 7
of the Company's Annual Report on Form 10-K, "Financial Condition," "Liquidity
and Capital Resources" and "Asset/Liability Management."
The Company's borrowings from time to time include reverse repurchase
agreements. The form of reverse repurchase agreement used by the Company
involves the sale of securities owned by the Company with a commitment to
repurchase the same or substantially the same securities at a predetermined
price at a future date, typically within 30 days to six months. These
transactions are treated as borrowings collateralized by the securities sold and
are therefore included as other borrowings in the Company's Consolidated
Financial Statements. These transactions are authorized by the Company's
Investment Policy and are governed by agreements with primary government dealers
under Public Securities Association Master Repurchase Agreements. At June 30,
2000, reverse repurchase agreements totaled $18.5 million, representing 3.8% of
total liabilities, an increase from the $9.5 million outstanding at June 30,
1999. At June 30, 1998 the Company had no reverse repurchase agreements
outstanding. The Bank has increased its use of reverse repurchase agreements as
a funding source because of the attractive short-term interest rates offered on
reverse repurchase agreements relative to FHLB advances.
In June of fiscal year 2000 the Company obtained a line of credit
facility with a third-party bank for the primary purpose of funding the
Company's commercial mortgage banking activities and for providing capital
investment into the Bank from the Holding Company. The third-party line of
credit facility is secured by the Holding Company's investment in the Bank. The
Company's commercial mortgage banking subsidiary will utilize the line of credit
facility from time to time to fund its pipeline of commercial real estate loans
that are pre-committed for sale. Also, the line of credit facility can be used
by the Holding Company to increase its investment in the Bank. The line of
credit facility totals $10.0 million and has an outstanding balance at June 30,
2000 of $1.0 million. The line of credit facility has an adjustable interest
rate that resets off of the Federal Funds Rate and has a term of one year.
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While increases in borrowings and changes in the collateralization
levels due to market interest rate changes could require the Bank to add
collateral to secure its borrowings, the Company does not anticipate having a
shortage of qualified collateral to pledge against its borrowings.* The
following table sets forth certain information regarding the Bank's FHLB-Chicago
advances, borrowed funds and reverse repurchase agreements at or for the periods
ended on the dates indicated.
AT OR FOR THE FISCAL YEAR ENDED JUNE 30,
---------------------------------------
2000 1999 1998
--------- --------- ----------
(DOLLARS IN THOUSANDS)
FHLB-CHICAGO ADVANCES:
Average balance outstanding........................................ $ 133,519 $ 126,518 $107,378
Maximum amount outstanding at any month-end during the period...... 148,244 132,059 115,573
Balance outstanding at end of period............................... 112,530 120,044 117,059
Weighted average interest rate during the period (1)............... 5.76% 5.81% 6.10%
Weighted average interest rate at end of period.................... 5.84 5.59 5.87
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS:
Average balance outstanding........................................ $ 22,539 $ 4,414 $ --
Maximum amount outstanding at any month-end during the period...... 28,350 18,289 --
Balance outstanding at end of period............................... 19,510 9,475 --
Weighted average interest rate during the period (1)............... 5.69% 5.12% --%
Weighted average interest rate at end of period.................... 6.32 5.25 --%
TOTAL ADVANCES REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS:
Average balance outstanding........................................ $ 156,058 $130,932 $107,378
Maximum amount outstanding at any month-end during the period...... 150,348 150,348 115,573
Balance outstanding at end of period............................... 132,040 129,519 117,059
Weighted average interest rate during the period (1)............... 5.75% 5.78% 6.10%
Weighted average interest rate at end of period.................... 5.90 5.51 5.87
- ------------
(1) Computed on the basis of average monthly balances.
COMPETITION
The Bank has significant competition in its mortgage, consumer and
commercial lending business, as well as in attracting deposits. The Bank's
primary competitors for loans are savings banks, thrifts, mortgage banking
companies, insurance companies and commercial banks on a local and national
basis. Its most direct competition for deposits are savings banks, thrifts,
commercial banks and credit unions. Because of the large industrial base in West
Allis and surrounding areas, credit unions, formerly affiliated with industry,
present formidable competition. These credit unions have obtained community
charters, enabling them to attract business from the community at large, rather
than just the associated industry. Additionally, these credit unions have
certain tax advantages, and, consequently, are able to offer competitive rates.
The Bank faces additional competition for funds from a number of institutions,
including short-term money market funds and other corporate and government
securities funds offered by other financial service companies, such as
securities brokerage firms and insurance companies. The Bank also is
experiencing increased competition from national and regional banks and savings
banks as well as national credit card companies as it focuses on obtaining
wholesale funding from sources beyond its primary market area.
SUBSIDIARY ACTIVITIES
The Bank's wholly-owned subsidiary, Hallmark Planning Service, Inc.
("HPS," formerly West Allis Insurance, Inc.), was organized as a Wisconsin
corporation in 1978. During the fiscal year ended June 30, 2000, HPS was engaged
primarily in the sale of annuity and mutual fund products. The Bank has a
management agreement with HPS whereby HPS reimburses the Bank for certain
services it performs and pays rent for occupancy in the West Allis branch
office. Net loss for HPS was ($3,238) and ($6,313) for the fiscal years ended
June 30, 2000 and 1999, respectively.
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The Bank organized a wholly-owned subsidiary located in Nevada in
September 1994 named Hallmark Investment Corp. The purpose of this subsidiary is
to manage a portion of the Bank's investment portfolio.
The Bank established a wholly-owned subsidiary, Hallmark Financial,
Inc. (d/b/a Major Finance) during fiscal 1999 to provide subprime lending
activities. During the fourth quarter of fiscal 2000, the Company discontinued
its subprime lending activities through Major Finance. Management discontinued
the operations of Major Finance due to the lack of loan production to cover the
costs of engaging in this lending activity. For a further discussion of the
Bank's subprime lending activities, see "Lending Activities - Subprime Lending."
PERSONNEL
At June 30, 2000, the Bank had 78 full-time employees and 17 part-time
employees. The employees of the Bank are not represented by a collective
bargaining unit and the Bank believes its relationship with its employees to be
good.
LEGAL PROCEEDINGS
The Bank is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business or which
in the aggregate involve amounts that are believed by management to be
immaterial to the financial condition of the Bank.
FEDERAL TAXATION
GENERAL
The following discussion of tax matters is intended to be a summary of
the material tax rules applicable to the Bank and does not purport to be a
comprehensive description of all applicable tax rules.
For federal income tax purposes, the Bank reported its income and
expenses primarily on the hybrid method of accounting (i.e., a method that
incorporated more than one type of accounting method in determining taxable
income) and filed its consolidated federal income tax returns on this basis
through June 30, 1987. Beginning with its taxable year ended June 30, 1988, the
Bank has adopted an accrual method of accounting. Both before and after the
Conversion, the Bank, as a general matter, is and will be subject to the rules
of federal income taxation applicable to corporations. Generally, the Internal
Revenue Code requires that all corporations, including the Bank, compute taxable
income under the accrual method of accounting. For its taxable year ended June
30, 2000, the Bank was subject to a maximum federal income tax rate of 34%.
BAD DEBT RESERVES
Savings banks, such as the Bank, which meet certain definitional tests
primarily relating to their assets and the nature of their business ("qualifying
thrifts"), were permitted for tax years beginning prior to December 31, 1995 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. Such additions were computed using one of two allowable methods.
Each year, the Bank has used the method that allows the largest addition, and
thus, the greater deduction for tax purposes.
The Small Business Job Protection Act of 1996 ("the Act") repealed the
reserve method of accounting for bad debts by thrift institutions, effective for
taxable years beginning after December 31, 1995. Thrift institutions such as the
Bank with less than $500 million in assets are now required to use the
experience method. The Act also grants partial relief from the bad debt reserve
"recapture" which occurs in connection with the change in method of accounting.
The pre-1988 reserves are not required to be included in income in connection
with the change in method of accounting. In addition, the Act suspends recapture
of post-1987 reserves for a period of two years, conditioned on the
institution's compliance with certain residential loan requirements.
Institutions can meet this residential loan requirement if the principal amount
of residential loans made during a taxable year was not less than
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the "base amount" for such year. The base amount is determined on an
institution-by-institution basis, and constitutes the average of the principal
amounts of residential loans made by an institution during the six most recent
taxable years. Notwithstanding the foregoing, institutions will be required to
pay for recaptured post-1987 bad debt reserves ratably over a six-year period
starting in 1998. Since provisions for deferred income tax have been provided
for on post-1987 bad debt reserves, there will not be any additional income tax
expense to the Bank on recapture.
Earnings appropriated for bad debt reserves and deducted for federal
income tax purposes cannot be used by the Bank to pay cash dividends or
distributions to the Holding Company without the Bank including the amount in
taxable income, together with an amount deemed necessary to pay the resulting
income tax. Thus, any dividends to the Holding Company that would reduce amounts
appropriated to the Bank's bad debt reserves and deducted for federal income tax
purposes could create a tax liability for the Bank. The Bank does not intend to
pay dividends that would result in a recapture of its bad debt reserves.
CORPORATE ALTERNATIVE MINIMUM TAX
For taxable years beginning after December 31, 1986, the Internal
Revenue Code imposes an alternative minimum tax ("AMT") of 20% on alternative
minimum taxable income ("AMTI"). Only 90% of AMTI can be offset by net operating
losses. For taxable years beginning after December 31, 1989, the adjustment to
AMTI based on book income will be an amount equal to 75% of the amount by which
a corporation's adjusted current earnings exceeds its AMTI (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 0.12% of
the excess of AMTI (with certain modifications) over $2.0 million was imposed on
corporations, including the Bank, whether or not AMT is paid. The Bank does not
expect to be subject to AMT in the future, although no assurance can be made
that it will not.
DISTRIBUTIONS
To the extent that the Bank makes "non-dividend distributions" to
shareholders that are considered to result in distributions from (i) the Bank's
reserve for losses on qualifying real property loans that exceeds the amount
that would have been allowed under an experience method or (ii) the supplemental
reserve for losses on loans ("Excess Distributions"), then an amount equal to
such Excess Distributions must be included in the Bank's taxable income.
Non-dividend distributions include distributions in excess of the Bank's current
and accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. In contrast, distributions
made from the Bank's current or accumulated earnings and profits, as calculated
for federal income tax purposes, rather than the Bank's bad debt reserves are
generally considered dividends for federal income tax purposes and therefore
would not be included in the Bank's taxable income. Further, under certain
circumstances, such as tax-free reorganizations, non-dividend distributions may
not be required to be included in the Bank's taxable income.
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 after the
Conversion, certain portions of the Bank's accumulated tax bad debt reserve are
used for any purpose other than to absorb qualified bad debt loans, such as for
the payment of dividends or other distributions with respect to the Bank's
capital stock (including distributions upon redemption or liquidation) and such
payment or other distribution is not otherwise excluded from the provisions
generally applicable to Excess Distributions, approximately one and one-half
times the amount so used would be includable in gross income for federal income
tax purposes, assuming a 34% corporate income tax rate (exclusive of state
taxes). See "Regulation" and "Dividend Policy" for limits on the payment of
dividends of the Bank.
Under provisions of the Revenue Reconciliation Act of 1993 ("RRA"),
enacted on August 10, 1993, the maximum federal corporate income tax rate was
increased from 34% to 35% for taxable income over $10.0 million, with a 3%
surtax imposed on taxable income over $15.0 million.
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STATE TAXATION
The State of Wisconsin imposes a tax on the Wisconsin taxable income of
corporations, including savings banks, at the rate of 7.9%. Wisconsin taxable
income is generally similar to federal taxable income except that interest from
state and municipal obligations is taxable, no deduction is allowed for state
income taxes and net operating losses may be carried forward but not back.
Wisconsin law does not provide for filing of consolidated state income tax
returns. In fiscal 1998, the Bank received refunds from the Wisconsin Department
of Revenue totaling $177,000 related to audit assessments which had previously
been taken into account in calculating tax expense.
REGULATION
The following discussion is intended to be a summary of regulatory
issues and not a comprehensive description of all applicable regulations.
The Bank is a Wisconsin-chartered stock savings bank and its deposit
accounts are insured up to applicable limits by the Federal Deposit Insurance
Corporation ("FDIC") under the Savings Association Insurance Fund ("SAIF"). The
Bank is subject to extensive regulation by the Wisconsin Department of Financial
Institutions, Division of Savings Institutions ("DFI"), as its chartering
agency, and by the FDIC, as its deposit insurer and principal federal regulator.
The lending and investment authority of the Bank is prescribed by Wisconsin law
and regulations, as well as applicable federal law and regulations, and the Bank
is prohibited from engaging in any activities not permitted by such law and
regulations. The Company is a unitary bank holding company subject to regulatory
oversight by the Board of Governors of the Federal Reserve System (the "FRB"),
the DFI and the Securities and Exchange Commission ("SEC").
WISCONSIN SAVINGS BANK REGULATION
Regulations adopted by the DFI govern various aspects of the activities
and operation of Wisconsin-chartered savings banks.
EXAMINATIONS AND ASSESSMENTS
The Bank is required to file periodic reports with and is subject to
periodic examinations by the DFI. Savings banks are required to pay examination
fees and annual assessments to fund the supervisory operations of the DFI. Based
on the assessment rates published by the DFI and the Bank's total assets of
approximately $519.3 million at December 31, 1999, the Bank paid $16,099 in
assessments in the fiscal year ended June 30, 2000.
LOANS AND INVESTMENTS
The Bank is authorized to make, invest in, sell, purchase, participate
or otherwise deal in mortgage loans or interests in mortgage loans without
geographic restriction, including loans made on the security of residential and
commercial property. Savings banks also may lend funds on a secured or unsecured
basis for business, corporate commercial or agricultural purposes provided the
total of all such loans does not exceed 10% of the Bank's total assets, unless
the DFI authorizes a greater amount. Loans are subject to certain limitations,
including percentage restrictions based on the Bank's total assets.
Under regulations established for state savings banks by the DFI and
implemented by the Administrator of the DFI, the Bank is limited in the amount
of commercial real estate and commercial business loans it can hold in its loan
portfolio. The DFI approved limit for the Bank was 30% of the Bank's total asset
base at June 30, 2000 and June 30, 1999. At June 30, 2000, the Bank had $138.3
million of such loans in its portfolio, which represents 26.6% of the Bank's
asset base of $520.0 million. Management believes this expanded regulatory limit
will be sufficient to meet the Bank's asset growth and portfolio diversification
objectives in fiscal 2000.*
Savings banks may invest funds in certain types of debt and equity
securities, including obligations of federal, state and local governments and
agencies. Subject to prior approval of the DFI, compliance with capital
requirements and certain other restrictions, savings banks may invest in
residential housing development projects.
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Savings banks may invest in service corporations or subsidiaries with the prior
approval of the DFI, subject to certain restrictions.
The lending and investment powers of Wisconsin savings banks also are
limited by FDIC regulations and other federal law and regulations. Operations
and investments of the Company are regulated by the FRB. See "Holding Company
Regulation." At June 30, 2000 neither the Bank or Company were under any DFI,
FRB or FDIC order to divest or terminate any investment or activity.
LOANS TO ONE BORROWER
Savings banks may make loans and extensions of credit, both direct and
indirect, to one borrower in amounts up to 15% of capital plus an additional 10%
for loans fully secured by readily marketable collateral. In addition, savings
banks may make loans to one borrower for any purpose in an amount not to exceed
$500,000, or to develop domestic residential housing units in an amount not to
exceed the lesser of $30 million or 30% of capital, subject to certain
conditions. At June 30, 2000, the Bank did not have any loans which exceeded the
loans-to-one borrower limitations.
QUALIFIED THRIFT LENDER REQUIREMENT
The Bank must qualify for and maintain a level of qualified thrift
investments equal to 60% of its assets as prescribed in Section 7701(a)(19) of
the Internal Revenue Code of 1986, as amended. A savings bank that fails to meet
the qualified thrift lender test becomes subject to certain operating
restrictions otherwise applicable only to commercial banks. At June 30, 2000,
the Bank maintained 60.98% of its assets in qualified thrift investments and
therefore met the qualified thrift lender requirement.
DIVIDEND LIMITATIONS
A savings bank which meets its regulatory capital requirement may
declare dividends on capital stock based upon net profits, provided that its
paid-in surplus equals its capital stock. If the paid-in surplus of the savings
bank does not equal its capital stock, the board of directors may not declare a
dividend unless at least 10% of the net profits of the preceding half year in
the case of quarterly or semi-annual dividends, or 10% of the net profits of the
preceding year in case of annual dividends, has been transferred to paid-in
surplus. In addition, prior approval of the DFI is required before dividends
exceeding 50% of profits for any calendar year may be declared and before a
dividend may be declared out of retained earnings. Under the DFI's regulations,
a savings bank which has converted from mutual to stock form also would be
prohibited from paying a dividend on its capital stock if the effect thereof
would cause the regulatory capital of the savings bank to be reduced below the
amount required for its liquidation account.
LIQUIDITY
Savings banks are required to maintain an average daily balance of
liquid assets of not less than 8% of its average daily balance of net
withdrawable accounts plus its short-term borrowings. Also required is a
"primary liquid assets" ratio of at least 4% of average daily withdrawable
accounts and short-term borrowings. Primary liquid assets are defined as
primarily short-term liquid assets and U.S. government and U.S. government
agency securities. At June 30, 2000, the Bank's daily liquidity ratio was
10.29%.
RESTRICTIONS ON LOANS TO AND TRANSACTIONS WITH INSIDERS AND AFFILIATES
FRB regulations limit the total amount a savings bank may lend to its
executive officers, directors, principal shareholders, and their related
interests. Generally, an affiliated person may borrow an aggregate amount not
exceeding 15% of a savings bank's unimpaired capital and unimpaired surplus on
an unsecured basis and an additional 10% on a secured basis. The regulations
limit, with certain exceptions, the aggregate amount a depository institution
may lend to affiliated persons as a class to an amount not exceeding the
institution's unimpaired capital and unimpaired surplus.
In addition, FRB regulations provide certain restrictions and limits on
loans and other transactions with the Bank's affiliated persons to ensure that
such loans and transactions are (i) on terms which would be available to
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members of the general public for similar credit extensions, or (ii) only under
the terms of a benefit or compensation plan which is generally available to
employees of the Bank and its affiliates and does not give preference to or
otherwise distinguish between such employees.
The Bank also must comply with Sections 23A and 23B of the Federal
Reserve Act relative to transactions with affiliates in the same manner and to
the same extent as if the Bank were a Federal Reserve member bank. Generally,
Sections 23A and 23B limit the extent to which an insured institution or its
subsidiaries may engage in certain covered transactions with an affiliate to an
amount equal to 10% of such institution's capital and surplus, plus an aggregate
limit on all such transactions with affiliates to an amount equal to 20% of such
capital and surplus, and require that all transactions be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, the purchase of assets, issuance of a guaranty and similar other types
of transactions. The DFI may, for safety and soundness reasons, impose more
stringent restrictions on savings banks but may not exempt transactions from or
otherwise abridge Sections 23A and 23B.
Unless prior approval of the DFI is obtained, a savings bank may not
purchase, lease or acquire a site for an office building or an interest in real
estate from an affiliated person, including a stockholder owning more than 10%
of its capital stock, or from any firm, corporation, entity or family in which
an affiliated person or 10% stockholder has a direct or indirect interest.
The Bank has not been significantly affected by the applicable
restrictions on loans to and transactions with affiliates.
INSURANCE OF DEPOSITS
The Bank's deposits are insured to applicable limits under the Savings
Association Insurance Fund ("SAIF") of the FDIC. The FDIC regulations assign
institutions to a particular capital group based on the level of an
institution's capital -- "well capitalized," "adequately capitalized," and
"undercapitalized." These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern. This matrix results in nine assessment risk
classifications, with reduced insurance rates paid by well-capitalized,
financially sound institutions and higher rates paid by undercapitalized
institutions that pose a substantial risk of loss to the insurance fund unless
effective corrective action is taken.
Deposit insurance premiums for the Bank are currently assessed at the
rate of 2.1 cents per $100 of deposits. The Bank's expense related to FDIC
premiums was $121,890, $172,355 and $173,713 for the fiscal years ended June 30,
2000, 1999 and 1998, respectively. Deposit premium levels are set in order to
permit the SAIF to achieve a ratio of reserves to insured deposits of 1.25%, and
the FDIC may adjust assessment rates to maintain the target ratio. In addition,
the FDIC imposed a one-time, industry-wide, special assessment, which resulted
in a premium charge of $739,997 for the Bank's fiscal year ended June 30, 1997.
While an increase in premiums for the Bank could have an adverse effect on
earnings, a decrease in premiums could have a positive impact on earnings. The
Bank does not expect any increase in the insurance premium in the foreseeable
future.
The FDIC insures commercial bank deposits through a separate fund, the
Bank Insurance Fund ("BIF"). During 1995, BIF assessment rates were reduced and
as a result, BIF member institutions were paying lower deposit insurance
premiums than SAIF-member institutions. Legislation passed during 1996 addressed
the BIF/SAIF premium disparity and other matters related to deposit insurance
obligations. See "Regulatory Legislation Affecting Deposit Insurance."
Under the FDIC 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.
Management of the Company does not know of any practice, condition or violation
that might lead to the termination of deposit insurance for the Bank.
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CERTAIN FEDERAL REGULATIONS
Provisions of federal law address risk reduction and the promotion of
standards of safety and soundness for insured depository institutions.
EXAMINATIONS AND AUDITS
Federal regulations require annual on-site examinations for all
depository institutions except those well-capitalized institutions with assets
of less than $100 million; annual audits by independent public accountants for
all insured institutions with assets in excess of $500 million; the formation of
independent audit committees of the boards of directors of insured depository
institutions for institutions with assets equal to or in excess of $500 million;
and management of depository institutions to prepare certain financial reports
annually and to establish internal compliance procedures.
PROMPT CORRECTIVE REGULATORY ACTION
Federal bank regulators are required to take certain supervisory
actions with respect to undercapitalized institutions, the severity of which
depend upon the institution's degree of capitalization. The regulations provide
that an insured institution that has a ratio of total capital to risk-based
assets of less than 8.0%, core capital to risk-based assets of less than 4.0% or
a leverage ratio that is less than 4.0%, would be considered "undercapitalized."
An insured institution that has a ratio of total capital to risk-based assets of
less than 6.0%, core capital to risk-based assets of less than 3.0% or a
leverage ratio that is less than 3.0%, would be considered "significantly
undercapitalized" and an insured institution that has tangible capital to assets
ratio equal to or less than 2.0% would be deemed "critically undercapitalized."
Subject to limited exceptions, insured institutions in any of the
undercapitalized categories are prohibited from declaring dividends, making any
other capital distribution or paying a management fee to a controlling person or
entity. Undercapitalized and significantly undercapitalized institutions face
more severe restrictions. The Bank currently exceeds all applicable regulatory
capital requirements and, therefore, is not subject to prompt correctional
action.
BROKERED DEPOSITS
FDIC regulations govern the acceptance of brokered deposits by insured
depository institutions. The capital position of an institution determines
whether and with what limitations an institution may accept brokered deposits. A
"well-capitalized" institution (one that significantly exceeds specified capital
ratios) may accept brokered deposits without restriction. "Undercapitalized"
institutions (those that fail to meet minimum regulatory capital requirements)
may not accept brokered deposits and "adequately capitalized" institutions
(those that are not "well-capitalized" or "undercapitalized") may only accept
such deposits with the consent of the FDIC. (The definitions of
"well-capitalized", "adequately capitalized" and "undercapitalized" governing
the acceptance of brokered deposits conform to the definitions used in the
regulations implementing the prompt corrective action provisions of the FDICIA.)
The Bank is a "well-capitalized" institution and therefore may accept brokered
deposits without restriction. At June 30, 2000, the Bank had $216.2 million in
brokered deposits.
UNIFORM LENDING STANDARDS
Savings institutions must adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit that are
secured by liens or interests in real estate or are made for the purpose of
financing permanent improvements to real estate. These policies must establish
loan portfolio diversification standards, prudent underwriting standards
(including loan-to-value limits) that are clear and measurable, as well as loan
administration procedures and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies that have been adopted
by federal bank regulators. The Bank has adopted and maintains such policies.
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50
STANDARDS FOR SAFETY AND SOUNDNESS
On July 10, 1995, federal bank regulators adopted Interagency
Guidelines Establishing Standards for Safety and Soundness (the "Guidelines")
and also adopted a final rule establishing deadlines for submission and review
of safety and soundness compliance plans and operational and managerial
standards for all insured depository institutions relating to internal controls,
information systems and audit systems; loan documentation; credit underwriting;
interest rate risk exposure; asset growth; and compensation fees and benefits.
The compensation standards prohibit employment contracts, compensation or
benefit arrangements, stock option plans, fee arrangements or other compensatory
arrangements that would provide excessive compensation, fees or benefits or
could lead to material financial loss. Federal bank regulators are authorized,
but not required, to request a compliance plan for failure to satisfy the safety
and soundness standards set out in the Guidelines.
The Bank believes that its operational and managerial standards
substantially comply with the standards set forth in the Guidelines and that
compliance with the Guidelines will therefore not impose a significant burden on
Bank operations.
RESTRICTIONS UPON STATE-CHARTERED BANKS
FDIC regulations governing the equity investments of the Bank prohibit
certain equity investments and generally limit equity investments to those
permissible for federally-chartered banks and their subsidiaries. Banks holding
impermissible equity investments that do not receive FDIC approval must submit
to the FDIC a plan for divesting such investments. The Bank does not hold any
impermissible equity investments.
Under FDIC regulations, the Bank must obtain prior FDIC approval before
directly, or indirectly through a majority-owned subsidiary, engaging "as
principal" in any activity that is not permissible for a national bank unless
certain exceptions apply. The activity regulations provide that state banks
which meet applicable minimum capital requirements would be permitted to engage
in certain activities that are not permissible for national banks, including
guaranteeing obligations of others, activities which the FRB has found to be
closely related to banking and certain securities activities conducted through
subsidiaries. The FDIC will not approve an activity that it determines presents
a significant risk to the FDIC insurance funds. As a SAIF-insured,
state-chartered savings bank which was formerly a state-chartered savings
association, the Bank continues to be subject to certain restrictions which are
imposed by federal law on state-chartered savings associations. The activities
of the Bank and its subsidiary are permissible under applicable federal
regulations.
CAPITAL MAINTENANCE
FDIC REGULATION
FDIC-insured institutions are required to follow certain capital
adequacy guidelines which prescribe minimum levels of capital and require that
institutions meet certain risk-based capital requirements. The Bank is required
to meet the following capital standards to remain adequately capitalized and not
be subject to corrective action: (i) "Tier 1 capital" in an amount not less than
3% of total assets; (ii) "Tier 1 capital" in an amount not less than 4% of
risk-weighted assets; and (iii) "total capital" in an amount not less than 8% of
risk-weighted assets.
FDIC-insured institutions in the strongest financial and managerial
condition (with a composite rating of "1" under the Uniform Financial
Institutions Rating System established by the Federal Financial Institutions
Examination Council) are also required to maintain "Tier 1 capital" equal to at
least 3% of total assets (the "leverage capital" requirement). Tier 1 capital is
defined to include the sum of common shareholders' equity, noncumulative
perpetual preferred stock (including any related surplus), and minority
interests in consolidated subsidiaries, minus all intangible assets (with
certain exceptions), identified losses, and qualifying investments in securities
subsidiaries. An institution that fails to meet the minimum leverage limit
requirement must file a capital restoration plan with the appropriate FDIC
regional director. At June 30, 2000, the Bank's ratio of Tier 1 capital to total
average assets was 6.65%, or 3.65 percentage points in excess of the minimum
leverage capital requirement, the Bank's Tier 1 capital
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51
to risk-weighted assets was 9.46%, or 5.46 percentage points in excess of the
FDIC requirement, and the Bank's total capital to risk-weighted assets was
10.34%, or 2.34 percentage points in excess of the FDIC requirement.
WISCONSIN REGULATION
Wisconsin-chartered savings banks are required to maintain a minimum
capital to assets ratio of 6% and must maintain total capital necessary to
ensure the continuation of insurance of deposit accounts by the FDIC. If the DFI
determines that the financial condition, history, management or earning
prospects of a savings bank are not adequate, the DFI may require a higher
minimum capital level for the savings bank. If a savings bank's capital ratio
falls below the required level, the DFI may direct the savings bank to adhere to
a specific written plan established by the DFI to correct the savings bank's
capital deficiency, as well as a number of other restrictions on the savings
bank's operations, including a prohibition on the declaration of dividends. At
June 30, 2000, the Bank's total capital, as calculated under Wisconsin law, was
$36.3 million, or 6.93% of total assets, which was 0.91% in excess of the
required amount.
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act of 1977, as amended (the "CRA"),
as implemented by FDIC regulations, the Bank has a continuing and affirmative
obligation consistent with its safe and sound operation to help meet the credit
needs of its entire community, including low and moderate income neighborhoods.
The CRA does not establish specific lending requirements or programs for
financial institutions nor does it limit an institution's discretion to develop
the types of products and services it believes are best suited to its particular
community. The CRA requires the FDIC, in connection with its examination of a
bank, to assess the institution's record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
applications by such institution. The law requires public disclosure of an
institution's CRA rating and also requires the primary regulator to provide a
written evaluation of an institution's CRA performance. The Bank's latest CRA
rating, received on February 23, 1999, was "satisfactory."
On May 4, 1995, the federal banking regulators adopted uniform final
rules governing the compliance with the CRA by financial institutions. Although
the new rules modify the standards used to assess CRA performance, the Bank does
not anticipate that its CRA rating will be negatively affected by the new rules.
FEDERAL RESERVE SYSTEM
Regulation D, promulgated by the FRB, imposes reserve requirements on
all depository institutions which maintain transaction accounts or non-personal
time deposits. Checking accounts, NOW accounts and certain other types of
accounts that permit payments or transfers to third parties fall within the
definition of transaction accounts and are subject to Regulation D reserve
requirements, as are any non-personal time deposits (including certain money
market deposit accounts) at a savings institution. For 1997, a depository
institution must maintain average daily reserves equal to 3% on the first $49.3
million of transaction accounts and an initial reserve of $1.5 million, plus 10%
of that portion of total transaction accounts in excess of $49.3 million. The
first $4.4 million of otherwise reservable balances (subject to adjustment by
the FRB) are exempt from the reserve requirements. These percentages and
threshold limits are subject to adjustment by the FRB. As of June 30, 2000, the
Bank met its Regulation D reserve requirements.
Thrift institutions also have authority to borrow from the Federal
Reserve Bank "discount window," but FRB policy generally requires thrift
institutions to exhaust all FHLB sources before borrowing from the Federal
Reserve System. The Bank had no discount window borrowings as of June 30, 2000.
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Bank System, consisting of twelve FHLBs, is under
the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated
duties of the FHFB are to supervise the FHLBs; ensure that the FHLBs carry out
their housing finance mission; ensure that the FHLBs remain adequately
capitalized and able to raise funds in the capital markets; and ensure that the
FHLBs operate in a safe and sound manner.
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The Bank, as a member of the FHLB-Chicago, is required to acquire and
hold shares of capital stock in the FHLB-Chicago in an amount equal to the
greater of (i) 1% of the aggregate outstanding principal amount of residential
mortgage loans, home purchase contracts and similar obligations at the beginning
of each year, or (ii) 0.3% of total assets. The Bank is in compliance with this
requirement with an investment in FHLB-Chicago stock of $7.8 million at June 30,
2000.
Among other benefits, the FHLBs provide a central credit facility
primarily for member institutions. It is funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB System. It makes advances
to members in accordance with policies and procedures established by the FHFB
and the Board of Directors of the FHLB-Chicago. At June 30, 2000, the Bank had
$112.5 million in advances from the FHLB-Chicago.
HOLDING COMPANY REGULATION
FEDERAL REGULATION
The Company is a registered bank holding company pursuant to the Bank
Holding Company Act of 1956, as amended (the "BHCA"). As such, the Company is
subject to examination, regulation and periodic reporting under the BHCA, as
administered by the FRB. The FRB has adopted capital adequacy guidelines for
bank holding companies (on a consolidated basis) substantially similar to those
of the FDIC for the Bank. Failure to meet the capital adequacy requirements may
result in supervisory or enforcement action by the FRB. The Company's pro forma
total and Tier 1 capital significantly exceed such capital adequacy
requirements.
The Company is required to obtain the prior approval of the FRB to
acquire all, or substantially all, of the assets of any bank or bank holding
company. Prior FRB approval is required for the Company to acquire direct or
indirect ownership or control of any voting securities of any bank or bank
holding company if, after giving effect to such acquisition, it would, directly
or indirectly, own or control more than 5% of any class of voting shares of such
bank or bank holding company. The BHCA also prohibits the acquisition by the
Company of more than 5% of the voting shares of a bank located outside the State
of Wisconsin or of substantially all of the assets of such a bank, unless such
an acquisition is specifically authorized by the laws of the state in which such
bank is located.
FRB regulations govern a variety of bank holding company matters,
including redemption of outstanding equity securities and a bank holding company
engaging in non-banking activities. Pursuant to FRB policy, dividends should be
paid only out of current earnings and only if the prospective rate of earnings
retention by the bank holding company appears consistent with its capital needs,
asset quality and overall financial condition. The FRB policy also requires that
a bank holding company serve as a source of financial strength to its subsidiary
banks by standing ready to use available resources to provide adequate capital
funds to those banks during periods of financial stress or adversity. These
policies could affect the ability of the Holding Company to pay cash dividends.
Subsidiary banks of a bank holding company are subject to certain
quantitative and qualitative restrictions imposed by the Federal Reserve Act on
any extension of credit to, or purchase of assets from, or letter of credit on
behalf of, the bank holding company or its subsidiaries, and on the investment
in or acceptance of stocks or securities of such holding company or its
subsidiaries as collateral for loans. In addition, provisions of the Federal
Reserve Act and FRB regulations limit the amounts of, and establish required
procedures and credit standards with respect to, loans and other extensions of
credit to officers, directors and principal shareholders of the Bank, the
Company, any subsidiary of the Company and related interests of such persons.
See " -Restrictions on Loans to and Transactions with Affiliates." Moreover,
subsidiaries of bank holding companies are prohibited from engaging in certain
tie-in arrangements (with the Company or any of its subsidiaries) in connection
with any extension of credit, lease or sale of property or furnishing of
services.
The Company and its subsidiary, the Bank, are affected by the monetary
and fiscal policies of various agencies of the United States Government,
including the Federal Reserve System. In view of changing conditions in the
national economy and in the money markets, it is impossible for management of
the Company to accurately predict future changes in monetary policy or the
effect of such changes on the business or financial condition of the Company.
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53
STATE SAVINGS BANK HOLDING COMPANY REGULATION
In addition to the FRB bank holding company regulations, a bank holding
company that owns or controls, directly or indirectly, more than 25% of the
voting securities of a state savings bank also is subject to regulation as a
savings bank holding company by the DFI. The DFI has not yet issued proposed
regulations governing savings bank holding companies.
ACQUISITION OF THE COMPANY
Under the federal Change in Bank Control Act of 1978, as amended (the
"CBCA"), a notice must be submitted to the FRB if any person (including a
company), or group acting in concert, seeks to acquire 10% or more of the
Company's shares of Common Stock outstanding, unless the FRB has found that the
acquisition will not result in a change in control of the Company. Under the
CBCA, the FRB has 60 days within which to act on such notices, taking into
consideration certain factors, including the financial and managerial resources
of the acquirer, the convenience and needs of the communities served by the
Company and the Bank, and the anti-trust effects of the acquisition. Under the
BHCA, any company would be required to obtain prior approval from the FRB before
it could obtain "control" of the Company within the meaning of the BHCA. Control
is generally defined to mean ownership or power to vote 25 percent or more of
any class of voting securities of the Company or the ability to control in any
manner the election of a majority of the Company's directors. In addition, the
BHCA prohibits the acquisition of the Company by a bank holding company located
outside the State of Wisconsin, unless such acquisition is specifically
authorized by Wisconsin law. See "Holding Company Regulation."
FEDERAL SECURITIES LAWS
The Company filed with the Commission a registration statement under
the Securities Act of 1933, as amended (the "Securities Act"), for the
registration of the Common Stock issued pursuant to the Conversion. Upon
completion of the Conversion, the Company's Common Stock was registered with the
Commission under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). The Company is subject to the information, proxy solicitation, insider
trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of the shares of the Common
Stock does not cover the resale of such shares. Shares of Common Stock purchased
by persons who are not affiliates of the Company may be resold without
registration. Shares purchased by an affiliate of the Holding 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. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances.
REGULATORY LEGISLATION AFFECTING DEPOSIT INSURANCE
Deposits of the Bank currently are insured to applicable limits by the
FDIC under the Savings Associations Insurance Fund ("SAIF"). The FDIC also
insures commercial bank deposits under the Bank Insurance Fund ("BIF"). Premium
levels are set in order to permit the funds to be capitalized at a level equal
to 1.25% of total fund deposits. Assessment rate changes made in 1995 created a
deposit insurance premium disparity between the two funds; while most BIF
members were paying only a nominal $2,000 annual premium, SAIF members were
paying average rates of 23.4 basis points of deposits.
On September 30, 1996, Congress passed legislation to address the
deposit insurance premium disparity. The "Deposit Insurance Funds Act of 1996"
(the "DIF Act"), included as part of an Omnibus Appropriations Bill, directed
the FDIC to impose a special assessment on SAIF-assessable deposits at a rate
that would cause the SAIF to achieve its designated reserve ratio of 1.25% of
SAIF-insured deposits as of October 1, 1996. The DIF Act required
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54
that the special assessment be applied against the SAIF-assessable deposits held
by institutions as of March 31, 1995. Pursuant to a final rule issued by the
FDIC on October 16, 1996, the special assessment rate was determined to be 65.7
basis points. This one-time special assessment fully capitalized the SAIF and
was collected on November 27, 1996.
The FDIC published a final rule on December 24, 1996, establishing a
permanent base assessment schedule for the SAIF and setting assessment rates at
a range of 4 to 31 basis points. The rule provides for an adjusted assessment
schedule reducing these rates by 4 basis points to reflect current conditions,
producing an effective SAIF assessment range of 0 to 27 basis points beginning
October 1, 1996. This assessment range, which applies to all SAIF institutions
other than SAIF member savings associations, is comparable to the current
schedule for BIF-institutions. A special interim rate schedule ranging from 16
to 27 basis points applied to SAIF-member savings associations for the last
quarter of 1996, reflecting the fact that assessments related to certain bond
obligations of the Financial Corporation ("FICO"), which were issued to resolve
the savings and loan crisis in the 1980's, will be included in the SAIF rates
for these institutions during that period. Because the Bank is a "Sasser bank"
(a bank that converted its charter from a savings association to a state savings
bank charter, yet remains a SAIF member in accordance with the so-called "Sasser
Amendment"), it was not assessed this interim rate and received a credit in
January 1997 for its entire FDIC premium for the quarter ended December 31,
1996.
The DIF Act addressed other matters which will affect the Bank. Certain
bond obligations of the Financial Corporation ("FICO"), which were issued to
resolve the savings and loan crisis in the 1980's, are being shared by all
insured depository institutions beginning after December 31, 1996. While BIF and
SAIF members have previously paid different annual assessments to fund repayment
of the FICO bonds, after January 1, 2000, they share the FICO payments on a
pro-rata basis, which is assessed at 2.4 basis points until the bonds mature in
2017.
The DIF Act provided for the merger of BIF and SAIF into a single
Deposit Insurance Fund, which was to be effective January 1, 1999, if no insured
depository institution was a savings association on that date. While this
legislation contemplated that the savings association charter would be phased
out over that period of time, that has not occurred and both BIF and SAIF
continue in existence.
GRAMM-LEACH-BLILEY ACT
The laws and regulations to which the Bank and Company are subject are
under constant review by Congress, state legislatures, and state and federal
regulators. On November 12, 1999, comprehensive federal legislation, referred to
as the Gramm-Leach-Bliley Act (the "GLBA"), was signed into law eliminating many
of the Depression-era restrictions on affiliations between banks, securities
firms, insurance companies, and other financial services organizations. The GLBA
provides for a new type of "financial holding company" structure under which
affiliations among these entities may occur, subject to regulation of financial
holding companies by the Federal Reserve Board and of their affiliates by the
appropriate functional regulator, including the Securities and Exchange
Commission and state insurance regulators. In addition, the GLBA permits certain
non-banking financial and financially related activities to be conducted by
operating subsidiaries of a national bank. Under the GLBA, a bank holding
company may become certified as a financial holding company by filing a notice
with the Federal Reserve Board, together with a certification that the bank
holding company meets certain criteria, including capital, management and
Community Reinvestment Act requirements. The GLBA contains a number provisions
allocating regulatory authority among the Federal Reserve Board, other banking
regulators, the Securities and Exchange Commission and state insurance
regulators. In addition, the GLBA imposes strict new privacy disclosure and
"opt-out" requirements regarding the ability of financial institutions to share
personal non-public customer information with third parties.
Other important provisions of the GLBA permit merchant banking and
venture capital activities, and insurance underwriting, to be conducted by a
subsidiary of a financial holding company, and municipal securities underwriting
activities to be conducted directly by a national bank or its subsidiary. Under
the GLBA, a financial holding company may engage in a broad list of "financial
activities", as well as in any non-financial activity that the Federal Reserve
Board determines is "complimentary" to a financial activity and poses no
substantial risk to the safety and soundness of depository institutions or the
financial system.
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While certain provisions of the GLBA became effective on November 12,
1999, other provisions are subject to delayed effective dates and, in some
cases, will be implemented only upon adoption by federal regulatory agencies of
rules prescribed by the GLBA. Certain of the authorities provided under the GLBA
may require action by the DFI or Wisconsin legislature before becoming available
to Wisconsin-chartered insured institutions such as the Bank.
ITEM 2. PROPERTIES
The Bank conducts its business through three full-service office
locations. In May 1996, the Bank opened a limited-service office inside of a new
senior community residence in West Allis. Library Square, the senior community,
is located at 1820 South 75th Street and contains 118 apartments for independent
living. The Bank conducts business at Library Square two days a week. Two of the
full-service branch offices are located in Milwaukee county and one in Waukesha
County. The Bank owns all of the properties on which its full-service offices
are located. Management believes the Bank's current facilities are adequate to
meet present and immediately foreseeable needs of the Bank and the Holding
Company.
The Bank intends to open a new full-service banking facility at the
Glendale, Wisconsin location in fiscal 2000.* The Bank currently leases a
portion of the Glendale facility to various tenants and operates certain
administrative functions out of the remaining portion of such facility.
A list of the Bank's administrative and full-service offices is as follows:
NET BOOK VALUE
OF PROPERTIES AND
YEAR IMPROVEMENTS AT
OFFICE LOCATION OPENED JUNE 30, 2000
- --------------- ------ -------------
West Allis/Home Office 1919 $ 241,000
7401 West Greenfield Avenue
West Allis, WI 53214
New Berlin Office 1989 927,000
15600 West Cleveland Avenue
New Berlin, WI 53151
Greenfield Office 1988 976,000
5101 South 27th Street
Greenfield, WI 53221
Glendale Office 1998 2,530,000
5555 N. Port Washington Road
Glendale, WI 53217
----------
Net Book Value: $4,674,000
==========
In addition to the properties described above, in January, 1991, the
Bank entered into a purchase contract with two companies (the "Sellers") for the
purchase of certain real estate located in Wauwatosa, Wisconsin. The Bank sought
to acquire the real estate as a location for a Wauwatosa branch office. The
purchase contract required the Sellers, at their cost and expense, to take all
steps necessary to remove all hazardous substances and underground storage
tanks, pipes, and related appurtenances from the property. As a result of
Sellers' failure to remove the hazardous substances from the property, the Bank
instituted suit in August 1992 for specific performance of the purchase
contract, alleging Sellers' failure to clean up the property and the Bank's
entitlement to have the purchase contract enforced by requiring the Sellers to
complete the agreed-upon clean-up of the property.
In March 1993, the Bank recognized losses of $250,000 to provide an
allowance for capitalized real estate taxes, legal fees and other expenses
related to the attempted acquisition of the property. During fiscal 1999,
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Milwaukee County foreclosed on the property, which terminated the Bank's
interest in the property, if any. The Bank believes its current position does
not expose it to liability in connection with clean-up expenses or other
expenses related to the property, including without limitation liabilities
arising under the Comprehensive Environmental Response, Compensation and
Liability Act.*
ITEM 3. LEGAL PROCEEDINGS
The Company is involved as a plaintiff or defendant in various legal
actions arising in the normal course of its business. While the ultimate outcome
of these various legal proceedings cannot be predicted with certainty, it is the
opinion of management that the resolution of these legal actions should not have
a material effect on the Company's consolidated financial condition or results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 2000.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information as to the business experience is supplied
with respect to executive officers of the Company who, with the exception of
Messrs. James D. Smessaert and Peter A. Gilbert, do not serve on the Company's
Board of Directors. There are no arrangements or understandings between the
persons named and any one person pursuant to which such officers were selected,
nor are there any family relationships among them.
JAMES D. SMESSAERT, age 62, is President, Chief Executive Officer and
Chairman of the Board of the Company, has been President, Chief Executive
Officer and a director of the Bank since 1983, and became Chairman of the Board
effective July 1, 1993. Prior to joining the Bank, Mr. Smessaert was Executive
Vice President of Advantage Bank, formerly Kenosha Savings and Loan Association.
Mr. Smessaert is past President of the Milwaukee Council of the Wisconsin League
of Financial Institutions. He currently serves as Secretary and as a member of
the Legislative and Executive Committees of the Wisconsin League of Financial
Institutions. Mr. Smessaert also is immediate past Chairman of the West Allis
Chamber of Commerce and past Chairman of the West Allis Business Expo.
PETER A. GILBERT, age 52, is Corporate Secretary and Executive Vice
President, Chief Operating Officer and a director of the Bank effective August
1, 1995, and a director of the Company effective August 22, 1995. Prior to
joining the Bank, Mr. Gilbert was President and CEO of Valley Real Estate
Services Corp., a mortgage banking subsidiary of Valley Bancorporation located
in Sheboygan, Wisconsin, from 1992 to 1994, and Managing Director of Gilbert and
Associates, a financial services consulting firm located in Encinitas,
California, from 1988 to 1992.
ARTHUR E. THOMPSON, age 40, is Chief Financial Officer and Treasurer of
the Company and has been Senior Vice President of the Bank since March 1993. Mr.
Thompson joined the Bank in 1985 as the Controller and served as Vice President
and Treasurer from 1987 to March 1993. Mr. Thompson also is a director of the
Bank's subsidiary, Hallmark Investment Corp. Prior to joining the Bank, Mr.
Thompson was an accountant at Hopkins Savings & Loan Association from 1984 to
1985 and Assistant Controller at West Bend Savings & Loan Association from 1983
to 1984. Mr. Thompson is a Certified Public Accountant.
ELIZABETH S. BORST, age 38, is Senior Vice President of the Company and
has been Senior Vice President of Sales and Marketing of the Bank since November
1995. Ms. Borst served as Vice President-Marketing from 1993 to 1995. Ms. Borst
also is a director of the Bank's subsidiary, Hallmark Planning Services, Inc.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
SHAREHOLDERS/SHARES OUTSTANDING
The Company's common stock is currently being traded on the National
Association of Securities Dealers Automated Quotation (NASDAQ) National Market
System over-the-counter exchange under the symbol of HALL. Information required
by this item is incorporated by reference to the table "Market Information" as
part of the "Quarterly Financial Information (Unaudited)" shown in Note 16 to
Notes to Consolidated Financial Statements and the "Earnings Per Share" Note 1
to Notes to Consolidated Financial Statements included under Item 8 of this
Annual Report on Form 10-K.
As of August 24, 2000, there were 293 holders of record and an
estimated 800 beneficial holders owning a total of 2,563,241 voting shares.
Payment of future dividends is within the discretion of the
Corporation's Board of Directors and will depend among other factors, on
earnings, capital requirements, and the operating and financial condition of the
Corporation. At the present time, the Corporation expects that dividends will
continue to be paid in the future. See Item 6 of this document for information
on dividends.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (Five-Year Summary)
Set forth below are selected consolidated financial and other data of the
Company. The financial data is derived in part from, and should be read in
conjunction with, the Consolidated Financial Statements of the Company and Notes
thereto presented elsewhere in this report.
AT JUNE 30,
-------------------------------------------------------------
2000 1999 1998 1997 1996
-------- ---------- ---------- ---------- --------
(IN THOUSANDS)
SELECTED FINANCIAL CONDITION DATA:
Total assets......................................... $519,584 $469,659 $438,374 $409,820 $377,157
Loans receivable, net................................ 391,764 281,120 280,889 273,556 224,807
Cash and cash equivalents............................ 16,559 8,599 8,184 8,755 4,825
Securities available-for-sale........................ 74,259 100,468 66,445 29,518 37,284
Investment securities and certificates of deposit.... -- -- 388 780 978
Mortgage-backed and related securities............... 15,017 54,618 65,282 85,430 97,332
Deposits............................................. 345,318 288,714 271,619 281,512 229,675
FHLB advances and other borrowings................... 132,040 129,519 117,059 92,073 113,954
Shareholders' equity................................. 33,355 34,496 33,453 29,672 27,011
FISCAL YEAR ENDED JUNE 30,
---------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SELECTED OPERATIONS DATA:
Total interest income................................ $ 38,439 $ 34,29 $ 32,227 $ 29,823 $ 22,894
Total interest expense............................... 26,023 22,814 21,586 20,210 15,348
--------- --------- --------- --------- ---------
Net interest income................................ 12,416 11,484 10,641 9,613 7,546
Provision for loan losses............................ 871 480 800 650 367
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 11,545 11,004 9,841 8,963 7,179
Non-interest income:
Loan servicing and loan-related fees............... 350 355 349 251 233
Depository fees and service charges................ 457 451 429 478 494
Gain on sale of loans.............................. 9 892 297 95 75
Gain (loss) on sale of securities and
mortgage-backed and related securities, net...... 48 68 (8) 7 72
Other non-interest income.......................... 367 316 141 197 388
--------- --------- --------- --------- ---------
Total non-interest income............................ 1,231 2,082 1,208 1,028 1,262
Total non-interest expense........................... 8,391 8,451 6,847 7,046 5,554
--------- --------- --------- --------- ---------
Income before income tax expense..................... 4,385 4,635 4,202 2,945 2,887
Income tax expense................................... 1,381 1,505 1,403 1,026 1,009
--------- --------- --------- --------- ---------
Net income....................................... $ 3,004 $ 3,130 $ 2,799 $ 1,919 $ 1,878
========= ========= ========= ========= =========
Earnings per share (basic)....................... $ 1.17 $ 1.13 $ 1.01 $ 0.71 $ 0.70
========= ========= ========= ========= =========
Earnings per share (diluted)..................... $ 1.14 $ 1.10 $ 0.97 $ 0.68 $ 0.68
========= ========= ========= ========= =========
Cash dividends per share......................... $ 0.15 $ 0.00 $ 0.00 $ 0.00 $ 0.00
========= ========= ========= ========= =========
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59
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
AT OR FOR THE FISCAL YEAR ENDED JUNE 30,
--------------------------------------------------------
2000 1999 1998 1997 1996
------ ------ ------ ------ -------
(DOLLARS IN THOUSANDS)
SELECTED FINANCIAL RATIOS AND OTHER DATA:
PERFORMANCE RATIOS
Return on average assets................................... 0.58% 0.67% 0.67% 0.48% 0.60%
Return on average equity................................... 8.93 9.08 8.89 6.83 7.17
Interest rate spread during period(1)...................... 2.20 2.18 2.22 2.06 1.97
Net interest margin(1)..................................... 2.50 2.54 2.63 2.48 2.45
Non-interest expense to average assets..................... 1.62 1.81 1.64 1.77 1.76
Non-interest income to average assets...................... 0.24 0.44 0.29 0.26 0.40
Average interest-earning assets to
average interest-bearing liabilities...................... 1.06x 1.07x 1.08x 1.08x 1.10x
ASSET QUALITY RATIOS
Non-performing loans to gross loans(2)..................... 0.45% 0.81% 0.49% 0.22% 0.04%
Non-performing assets to total assets(2)................... 0.57 0.70 0.32 0.16 0.03
Allowance for loan losses to non-performing loans.......... 171.26 109.19 166.36 282.37 1,153.27
Ratio of allowance for loan losses to gross loans.......... 0.78 0.89 0.81 0.62 0.50
Net charge-offs to average gross loans..................... 0.08 0.05 0.08 0.04 0.05
CAPITAL RATIOS(3)
Average shareholders' equity to average assets............. 6.51 7.36 7.54 7.07 8.30
Shareholders' equity to total assets at end of period...... 6.42 7.34 7.63 7.24 7.16
OTHER DATA
Number of deposit accounts................................. 14,102 15,441 16,054 18,064 18,070
Number of real estate loans outstanding.................... 2,852 3,306 3,620 3,824 3,654
Number of real estate loans serviced....................... 3,219 3,687 4,063 4,360 4,111
Number of consumer loans outstanding....................... 3,535 3,011 3,229 3,310 3,705
Number of commercial loans outstanding..................... 110 129 90 32 --
Loan originations/purchases................................ $259,338 $258,960 $163,433 $118,108 $140,313
Full-service facilities.................................... 3 3 3 3 3
- --------------------
(1) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities. Net interest margin represents net interest income as a
percentage of average interest-earning assets.
(2) Non-performing loans consist of non-accrual loans, accruing loans 90 days or
more past due and troubled debt restructurings. Non-performing assets
consist of non-performing loans and foreclosed properties, which consist of
real estate acquired by foreclosure or deed-in-lieu thereof, real estate in
judgment and loans which are deemed in-substance foreclosed.
(3) For a discussion of the Bank's regulatory capital ratios, see Note 9 of
Notes to Consolidated Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
When used in this Annual Report on Form 10-K or future filings with the
Securities and Exchange Commission, in quarterly reports or press releases or
other public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, various words or phrases are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include words and phrases such as "will likely result," "are expected
to," "will continue," "is anticipated," "estimate," "project," "intend" or
similar expressions and various other statements indicated herein with an
asterisk after such statements. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors could affect the
Company's financial performance and could cause actual results for future
periods to differ materially from those anticipated or projected. Such factors
include, but are not limited to: (i) general market interest rates, (ii) general
economic conditions, (iii) legislative/regulatory changes, (iv) monetary and
fiscal policies of the U.S. Treasury and Federal Reserve, (v) changes in the
quality or composition of the Company's loan and investment portfolios, (vi)
demand for loan products, (vii) deposit flows, (viii) competition, (ix) demand
for financial services in the Company's markets, and (x) changes in accounting
principles, policies or guidelines.
The Company does not undertake and specifically disclaims any
obligation to update any forward-looking statements to reflect the occurrence of
anticipated or unanticipated events or circumstances after the date of such
statements.
GENERAL
Hallmark Capital Corp. (the "Company") is a holding company
incorporated under the laws of the State of Wisconsin and is engaged in the
financial services business through its wholly-owned subsidiary, West Allis
Savings Bank (the "Bank"), a Wisconsin state-chartered stock savings bank
headquartered in Milwaukee, Wisconsin. The Company's initial public offering was
consummated in December 1993, and the Company acquired all of the outstanding
common stock of the Bank issued in the mutual to stock conversion of the Bank
(the "Conversion") on December 30, 1993.
The Company's primary strategy since the Conversion through fiscal 2000
has been to focus on effectively utilizing the capital acquired in the
Conversion to fund asset growth and asset portfolio diversification into
higher-yielding assets. This strategy resulted in an increase in the Company's
asset size from $179.6 million at June 30, 1994 to $519.6 million at June 30,
2000. The Company's asset growth has come primarily through (i) the origination
and purchase of mortgage loans (principally loans secured by one-to-four family
owner-occupied homes) within and outside of the Company's primary lending area,
(ii) the purchase of mortgage-backed and related securities, and (iii) the
origination and purchase of commercial real-estate and business loans within and
outside of the Company's primary lending area. This asset growth was funded
through significant increases in Federal Home Loan Bank ("FHLB") advances and
other borrowings, and increases in deposits consisting primarily of brokered and
non-brokered wholesale deposits.
The Company's asset portfolio diversification has been achieved by
altering the composition of loans and securities originated, purchased, sold and
held in the total asset portfolio. In particular, the Company has focused on
originating and purchasing higher-yielding non-conforming one-to-four family,
multi-family, commercial real estate and commercial business loans secured by
properties or assets located within the Company's primary lending area (as
defined herein) and outside of the Company's primary lending area, to either
replace or supplement lower-yielding one-to-four family mortgage loans and
principal run-off from the mortgage securities portfolio. In fiscal 2000, the
Company originated and purchased loans or participation interests (loan
production) totaling $140.4 million and $118.9 million, respectively, (total
loan production of $259.3 million) as compared to fiscal 1999 when originated
and purchased loans and participation interests totaled $202.1 million and $56.9
million, respectively (total loan production of $259.0 million). Approximately
$132.4 million and $47.1 million of the Company's total loan production related
to properties or business assets located outside of the Company's
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primary lending area in fiscal 2000 and 1999, respectively (representing 32.09%
and 15.76% of gross loans at June 30, 2000 and 1999, respectively). A
significant portion of the Company's loan production in 2000 related to
multi-family and construction loans, commercial real estate loans, commercial
construction and land loans and commercial business loans.
The Company has substantially completed its strategy of utilizing the
capital acquired in the Conversion to fund asset growth and asset portfolio
diversification into higher-yielding assets. In fiscal 2001, the Company does
not intend to significantly grow in asset size from its current level of $519.6
million.* Under FDIC regulatory capital adequacy guidelines, the Bank must
maintain certain amounts and ratios of total and Tier 1 capital (as defined in
the regulations) to risk-weighted assets (as defined in the regulations) in
order to maintain its status as a well-capitalized institution. As of June 30,
2000, the Bank was fully-leveraged from a risk-based capital standpoint, with a
ratio of total capital to risk-weighted assets of 10.34% (with a required ratio
of 10%). See Note 9 to the Company's Notes to Consolidated Financial Statements.
Therefore, in fiscal 2001, in order to maintain its well-capitalized status, the
Bank will only be able to increase its asset base to the extent of net retained
earnings.
The Company intends to continue to maximize the yield on its loan
portfolio in fiscal 2001 by maintaining the portfolio percentage composition of
higher-yielding non-conforming one-to-four family, multi-family, commercial real
estate and commercial business loans and selling substantially all of its
current year lower-yielding one-to-four family mortgage loans originated.* The
Company projects that total loan production will be approximately $200 million
in fiscal 2001 compared to $259.3 million in fiscal 2000*. The Company
anticipates that approximately half of its total loan production in fiscal 2001
will be generated from the purchase of loans secured by properties located
outside of its primary market area.* A significant portion of out-of-market
purchases are expected to relate to non-conforming one-to-four family mortgage
loans, multi-family and commercial real-estate loans.*
The Company intends to evaluate the benefits of converting the Bank
from a state thrift charter to a state bank charter in 2001.* Under regulations
established for state savings banks by the Wisconsin Department of Financial
Institutions ("DFI"), the Bank is limited in the amount of commercial real
estate and commercial business loans it can hold in its loan portfolio. The DFI
approved limit for the Bank was 30% of the Bank's total asset base at June 30,
2000 and June 30, 1999. At June 30, 2000, the Bank had $138.3 million of such
loans in its portfolio, representing 26.6% of the Bank's total asset base of
$520.0 million. At June 30, 1999, the Bank had $77.7 million of such loans in
its portfolio, representing 16.5% of the Bank's asset base of $469.6 million.
The Company projects that the percentage of total assets represented by
commercial real estate and commercial business loans will not increase
significantly in fiscal 2001 as a substantial portion of these new originations
and purchases are expected to be sold in the secondary market. Thus, while
management believes that this current regulatory limit is currently sufficient
to meet the Bank's business strategy in fiscal 2001, the Company intends to
evaluate whether a state bank charter would provide more lending flexibility.*
The Company intends to begin the process of increasing the level of
core retail deposits relative to brokered and non-brokered wholesale deposits
which is expected to reduce the overall cost of liabilities for the Company.*
This process will begin in fiscal 2001 through the use of several different
strategies, including changing the bank name from West Allis Savings Bank to
Ledger Bank, S.S.B., opening a new full-service banking center in Glendale,
Wisconsin, implementing a proactive internal sales culture, and by offering an
internet-only deposit product.*
The Company intends to enhance its presence in the marketplace by
changing its bank name from West Allis Savings Bank to Ledger Bank, S.S.B.
during the second quarter of fiscal 2001.* The new name, Ledger Bank, S.S.B.,
was strategically selected to pay tribute to the Bank's 81-year old heritage as
a trustworthy, solid community bank and to act as a vehicle to demonstrate the
Bank's commitment to future growth.* The Company believes the new name will
enable it to create a differentiated, customer-focused, financial services brand
in the market.* The new name will become official on October 26, 2000, the day
following the Company's annual meeting of shareholders, with a local media and
promotional campaign. The Company believes the new name will help enhance the
Bank's growth plans to increase its market share around each current branch
office, opening a new full-service banking center as well as the ongoing sales
efforts of its residential lending officers and
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business loan officers throughout southeastern Wisconsin.* The Company intends
to support the new name and enhanced brand identity through increased marketing
expenditures in fiscal 2001.*
A new full-service banking center in Glendale, Wisconsin is expected to
be operating during the third quarter of fiscal 2001.* This north shore location
currently serves as the executive and administrative headquarters for the
Company and Bank. Location-specific market research was conducted during fiscal
2000 by a third party company, placing this site as one of the top five
locations for attracting core deposit balances in Milwaukee County. The
full-service banking center will offer traditional deposit products and
services, discount brokerage services, and mortgage, consumer and commercial
business lending services.* The Company expects to incur significant
non-interest expenses in connection with opening the new banking center.*
During fiscal 2001, the Company also intends to generate additional
non-interest income from existing and new revenue sources.* This is expected to
be accomplished by (i) continuing to generate commercial lending and deposit
activities through the commercial lending division, (ii) increasing fee income
opportunities within the residential mortgage lending division through the sale
of one-to-four family mortgage loans and referral of subprime mortgage loans,
(iii) increasing fees from its insurance subsidiary, Hallmark Planning Services,
Inc., and (iv) expanding commercial mortgage banking activities during fiscal
2001.*
In fiscal 2001, the Company intends to continue pursuing commercial
lending activities through its commercial banking division as another source of
additional fee income and higher-yielding assets.* The focus of the Company's
commercial division will be the origination and purchase of small business loans
and leases, as well as the acquisition of business deposits.* During fiscal
2000, the Company originated and purchased $158.2 million of multi-family,
commercial real estate, multi-family construction, commercial construction and
commercial business loans, lines of credit and leases, of which $80.9 million
were purchases and $77.3 were originations. Management currently projects that
the commercial lending division will significantly decrease its origination and
purchase activity (by approximately 50%) during fiscal 2001 in order to maintain
a minimal growth rate in the Company's asset base.* The Company also expects
increased fee income from the commercial banking division resulting from a
growth in business deposit relationships.* The Company also has recently
implemented a program for mortgage contract cash processing within the
commercial lending division, a service which generates fee income. Through the
program, the Bank acts as a partial sub-servicer, providing a cash/processing
function for nationally originated commercial real estate loans.
During fiscal 2001, the Company also intends to increase its
non-interest income by expanding the secondary marketing activities of its
residential mortgage division, generating additional fee income through the sale
of mortgage credit and life insurance, and through the referral of subprime
mortgage loans to a third party lender.* The Company expects one-to-four family
mortgage loan originations to increase despite the generally higher level of
market interest rates due to increased marketing activities and expansion of our
retail banking centers.* It is currently anticipated that substantially all of
the 30-year fixed rate conforming one-to-four family mortgage loans originated
in fiscal 2001 will be sold in the secondary market resulting in income from
gains on loans sold.*
During the fourth quarter of fiscal 2000, the Company discontinued its
lending activities involving higher credit risk financial services (also known
as subprime lending) through Hallmark Financial, Inc. (d/b/a Major Finance).
Major Finance was formed to broker subprime loans primarily secured by
one-to-four family mortgage and commercial real estate within and outside the
Company's primary lending area. Management discontinued the operations of Major
Finance due to the lack of loan production to cover the costs of engaging in
this lending activity. No loans originated by Major Finance are currently in the
Bank's portfolio. It is anticipated that the Company's subprime lending
activities in fiscal 2001 will be limited to referring subprime loan prospects
to third-party lenders through the residential mortgage lending division and
generating referral fee income from such activity.*
The Company expects its insurance subsidiary, Hallmark Planning
Services, Inc., to generate additional fee income in fiscal 2001 from the sale
of securities, mutual funds, annuities and life insurance products by licensed
investment brokers. The Company attributes the projected growth in fee income to
the overall business strategy of adding a new retail banking center and the
implementation of a proactive sales culture in fiscal 2001.*
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During fiscal 2001, the Company also intends to generate non-interest
income by leveraging its existing commercial lending capabilities through the
origination, selling and servicing of commercial real estate mortgages on a
national basis, with primary concentration in the southwest and western regions
of the country.* While the Company primarily expects to originate and purchase
commercial real estate mortgages on a national basis, it also may originate and
purchase loans or participation interests in loans secured by multi-family real
estate and commercial business assets.* The new commercial mortgage banking
operation, Hallmark Financial, Inc. ("HFI"), will be a wholly-owned subsidiary
of the Company. HFI will originate loans from a third party commercial
real-estate broker on a non-exclusive basis and act as the lender of record
until the loan is sold without recourse, generally within 45 days of the loan
closing.* HFI will retain the servicing rights to these loans and receive a
servicing fee.* The Company estimates that during fiscal 2001 HFI will
originate, sell and service approximately $50 - $100 million of commercial real
estate mortgage loans on a national basis, with primary concentration in the
southwest and western regions of the country.* HFI revenues, generated primarily
through the collection of originating and servicing fees, are projected to be
approximately $150,000 - $300,000 in fiscal 2001.* The primary benefit of the
expansion of the Bank's commercial lending activities is to gain economies of
scale through the ability to leverage existing staff, expertise level, overhead
and infrastructure in order to increase fee income without a significant
incremental increase in expenses.*
The Company expects to incur significant increases in non-interest
expense as a result of implementing its strategic business plan in fiscal 2001.*
In addition, the Company's negative interest rate gap position (41.1% at June
30, 2000) will likely reduce net income in the event of an increase in market
interest rates.* To mitigate the Company's exposure to rising interest rate
levels, the Company intends to decrease its negative interest rate gap position
by lengthening the maturities of its wholesale funding sources (wholesale
brokered CDs and FHLB advances). The Company also may implement hedging
strategies involving derivative financial instruments such as options and
interest rate swaps during fiscal 2001.* See "Management's Discussion and
Analysis of Financial Condition - Asset/Liability Management." As a result of
the projected expense increases and narrowing of interest margin due to the gap
position and the generally higher level of interest rates, the Company expects
net income in fiscal 2001 to fall below reported net income for 2000.* Despite
the projected decline in net income, the Company believes the strategic benefits
of the expanded sales and branch activities will have a long-term positive
impact on the Company's results of operations and franchise value.
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED JUNE 30, 2000 AND
1999
GENERAL
Net income for the fiscal year ended June 30, 2000 decreased 4.0% to
$3.0 million from $3.1 million for fiscal 1999. The decrease in net income was
primarily attributable to a decrease in non-interest income and an increase in
the provision for losses on loans. Net interest income before the provision for
losses on loans increased to $12.4 million for the fiscal year ended June 30,
2000 from $11.5 million for fiscal 1999, primarily as a result of higher average
interest-earning assets during fiscal 2000 as compared to fiscal 1999.
Non-interest income decreased by $851,000 to $1.2 million for the fiscal year
ended June 30, 2000 from $2.1 million for fiscal 1999. The decrease in
non-interest income was primarily due to a decrease in gain on the sale of loans
which decreased $883,000 to $9,000 for the fiscal year ended June 30, 2000 from
$892,000 for fiscal 1999, a decrease in service charges on loans of $34,000 to
$300,000 for the fiscal year ended June 30, 2000 from $334,000 for fiscal 1999
and a decrease in gains on the sale of securities available-for-sale and
mortgage-backed and related securities available-for-sale of $20,000 to $48,000
for the fiscal year ended June 30, 2000 from $68,000 for fiscal 1999. The
decreases were partially offset by an increase in insurance commissions of
$35,000 to $125,000 for the fiscal year ended June 30, 2000 from $90,000 for
fiscal 1999, an increase in service charges on deposit accounts of $6,000 to
$457,000 for the fiscal year ended June 30, 2000 from $451,000 for fiscal 1999,
an increase in loan servicing fees of $29,000 to $50,000 for the fiscal year
ended June 30, 2000 from $21,000 for fiscal 1999 and an increase in other
non-interest income of $16,000 to $242,000 for the fiscal year ended June 30,
2000 from $226,000 for fiscal 1999. Non-interest expense decreased $60,000 to
$8.4 million for the fiscal year ended June 30, 2000 from $8.5 million for
fiscal 1999, primarily as a result of a decrease in compensation and benefits
expense of $160,000 to $4.9 million for the fiscal year ended June 30, 2000 from
$5.0 million for fiscal 1999, a decrease in occupancy and equipment of $132,000
to $1.5 million for the fiscal year ended June 30, 2000 from $1.6 million for
fiscal 1999 and a decrease in deposit insurance expense of $51,000 to $122,000
for the fiscal year
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ended June 30, 2000 from $173,000 for fiscal 1999. The decrease in non-interest
expense was partially offset by an increase in marketing expense of $14,000 to
$366,000 for the fiscal year ended June 30, 2000 from $352,000 for fiscal 1999
and an increase in other non-interest expense of $269,000 to $1.6 million for
the fiscal year ended June 30, 2000 from $1.3 million for fiscal 1999. Net
income also was decreased by an increase in the provision for losses on loans of
$391,000 to $871,000 for fiscal 2000 from $480,000 for fiscal 1999.
Return on average equity decreased to 8.93% for the fiscal year ended
June 30, 2000 from 9.08% for fiscal 1999. Return on average assets decreased to
.58% for the fiscal year ended June 30, 2000 from .67% for the fiscal year ended
1999. The decrease in return on average equity was primarily due to the decrease
in gains on the sale of loans and increase in the provision for losses on loans.
The Company's principal investment focus during the fiscal year ended June 30,
2000 was the origination and purchase of mortgage and commercial loans. The
asset growth primarily was funded through increases in brokered certificates of
deposit and securities sold under agreements to repurchase.
NET INTEREST INCOME
Net interest income increased 8.1% to $12.4 million for fiscal 2000
from $11.5 million for fiscal 1999. Interest income increased $4.1 million in
fiscal 2000, while interest expense increased $3.2 million. The level of net
interest income primarily reflects a 10.0% increase in average interest-earning
assets during fiscal 2000 and a increase in interest rate spread to 2.20% for
fiscal 2000 from 2.18% for fiscal 1999, partially offset by a 11.3% decrease in
the excess of the Company's average interest-earning assets over average
interest-bearing liabilities to $27.1 million for fiscal 2000 from $30.5 million
for fiscal 1999. The increased interest rate spread for fiscal 2000 is primarily
a result of the Company's reallocation to higher yielding loans and a decreased
level of lower yielding investment securities.
INTEREST INCOME
Interest income increased 12.1% to $38.4 million for fiscal year 2000
from $34.3 million for fiscal 1999. The increase in interest income was the
result of an increase in average interest-earning assets of 10.0% to $497.2
million for fiscal 2000 from $452.0 million for fiscal 1999 and by an increase
of 14 basis points in the yield on interest-earning assets to 7.73% for fiscal
2000 from 7.59% for fiscal 1999. Interest income on loans increased 22.4% to
$28.8 million for fiscal 2000 from $23.5 million for fiscal 1999. The increase
was the result of an increase in average gross loans of 23.9% to $352.7 million
for fiscal 2000 from $284.7 million for fiscal 1999, partially offset by a
decrease in average yield to 8.17% for fiscal 2000 from 8.27% for fiscal 1999.
Gross loans increased primarily as a result of the Company purchasing more loans
in the secondary market, retaining substantially all of its adjustable and
short-term fixed rate loan originations and increases in multi-family and
commercial components of the portfolio. The decrease in yield is attributable to
the increase in loans originated and purchased at lower interest rates in the
first half of fiscal year 2000. Interest income on mortgage-backed securities
decreased 66.8% to $343,000 for fiscal 2000 from $1.0 million for the comparable
1999 period. The decrease was primarily due to a decrease in average balances to
$5.5 million for fiscal 2000 from $14.6 million for fiscal 1999 and by a
decrease in average yield to 6.23% for the 2000 period from 7.08% for the 1999
period. Interest income on mortgage-related securities decreased 32.3% to $1.9
million for fiscal 2000 from $2.8 million for fiscal 1999. The decrease was
primarily due to a decrease in average balances to $29.2 million for fiscal 2000
from $43.0 million for fiscal 1999 and by a decrease in average yield to 6.57%
for the 2000 period from 6.59% for the 1999 period. The decrease in average
yield on mortgage-backed and related securities was primarily due to the higher
level of repayments on the higher coupon rate securities portion of this
portfolio. The decline in average balances of mortgage-backed and related
securities and is due to management's decision to transfer $37.9 million in
securities from this portfolio to the trading and available-for-sale portfolio
during fiscal year 2000. Interest income on investment securities and securities
available-for-sale increased 5.9% to $6.8 million for fiscal 2000 from $6.5
million for fiscal 1999. The increase was primarily due to an increase in
average yield to 6.68% for the 2000 period from 6.25% for the 1999 period,
offset by a decrease in average balances to $102.4 million for fiscal 2000 from
$103.2 million for fiscal 1999. The higher average yield was primarily
attributable to the increasing interest rate environment during the 2000 period
as compared to the 1999 period.
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INTEREST EXPENSE
Interest expense increased 14.1% to $26.0 million for fiscal 2000 from
$22.8 million for fiscal 1999. The increase was primarily the result of an 11.6%
increase in the average amount of interest-bearing liabilities to $470.2 million
for fiscal 2000 compared to $421.5 million for fiscal 1999 and by an increase in
the average rate paid on interest-bearing liabilities to 5.53% for the 2000
period from 5.41% for the 1999 period. The increased balances of certificates of
deposit (including brokered deposits) and borrowings at higher average interest
rates was the primary reason for the increase in the average rate paid on the
interest-bearing liabilities for fiscal 2000 as compared to fiscal 1999.
Interest expense on deposits increased 12.0% to $17.0 million for fiscal 2000
from $15.2 million for the comparable 1999 period. The increase was the result
of an increase in average balances of 8.2% to $311.0 million for fiscal 2000
from $287.4 million for the comparable 1999 period and by an increase in the
average rate paid to 5.46% for the 2000 period from 5.28% for the 1999 period.
The increase in deposits was primarily due to an increase of 12.7% in
certificates of deposit (including brokered deposits) to $257.0 million for
fiscal 2000 from $228.0 million for the 1999 period and an increase in the
average rate paid on such deposits to 5.82% for the 2000 period from 5.60% for
the 1999 period. NOW accounts increased 3.5% to $2.9 million for fiscal 2000
from $2.8 million for the comparable 1999 period, offset by a decrease in
average rate paid to 1.65% for the 2000 period from 1.74% for the 1999 period.
Offsetting the increase in deposits was a decrease in money market deposit
accounts of 12.3% to $31.2 million for fiscal 2000 from $35.6 million for the
comparable 1999 period, with a decrease in the average rate paid on such
deposits to 4.52% for the 2000 period from 4.88% for the 1999 period. Money
market deposit accounts decreased primarily due to aggressive competitive rates
offered in the Bank's market during fiscal 2000. The Company's increase in
certificates of deposit was the result of aggressively marketing and pricing and
the use of brokered certificates of deposit. Of the $257.0 million in the
average balance of certificates of deposit for fiscal 2000, $166.7 million, or
64.9%, represented brokered certificates of deposit compared to $101.5 million,
or 44.5%, for the 1999 period. The average rate paid on brokered certificates of
deposit increased to 6.03% for fiscal 2000 from 5.63% for the comparable 1999
period. The increase was primarily due to the increasing interest rate
environment during the 2000 period as compared to the 1999 period. Interest on
borrowings (FHLB advances and reverse repurchase agreements) increased 18.4% to
$9.0 million for fiscal 2000 from $7.6 million for the comparable 1999 period.
The increase was primarily due to the increase in average balance to $156.1
million for fiscal 2000 from $131.2 million for the comparable 1999 period,
partially offset by a decrease in average rate paid to 5.75% for fiscal 2000
from 5.78% for the 1999 period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans increased to $871,000 for fiscal 2000
from $480,000 for fiscal 1999. The provision for losses on loans increased as a
result of growth in the loan portfolio and higher net charge-offs in fiscal
2000. The level of allowance for losses on loans generally is determined by the
Bank's historical loan loss experience, the condition and composition of the
Bank's loan portfolio and general economic conditions. Management anticipates
that as the Company's volume of multi-family and commercial/non-residential real
estate lending activity continues to increase, the Company will need to build a
higher level of allowance for loan losses established through a provision for
loan losses.* Based on management's evaluation of the loan portfolio and the
increase in gross loans during fiscal 2000, the allowance for losses on loans
increased 20.9% to $3.2 million at June 30, 2000 compared to $2.6 million at
June 30, 1999. This increase was primarily the result of the increase in the
multi-family, multi-family construction, commercial real estate and commercial
loan components of the gross loan portfolio which carry a greater degree of
inherent credit risk as compared to one-to-four family mortgage lending. The
ratio of allowance for loan losses to gross loans decreased to 0.78% at June 30,
2000 from 0.89% at June 30, 1999. The amount of non-performing loans at June 30,
2000 was $1.9 million or 0.45% of gross loans, compared to $2.4 million or 0.81%
of gross loans at June 30, 1999.
NON-INTEREST INCOME
Non-interest income decreased 40.9% to $1.2 million for fiscal 2000
from $2.1 million for the comparable 1999 period. The largest components of the
decrease were a decrease in gains on the sale of loans of $883,000 to $9,000 for
fiscal 2000 from $892,000 for the comparable 1999 period, a decrease in service
charges on loans of $34,000 to $300,000 for fiscal 2000 from $334,000 for the
comparable 1999 period and a decrease in gains on the sale of securities and
mortgage-backed and related securities of $20,000 to $48,000 for fiscal 2000
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from $68,000 for the comparable 1999 period. The decreases were partially offset
by an increase in insurance commissions of $35,000 to $125,000 for fiscal 2000
from $90,000 for the comparable 1999 period, an increase in service charges on
deposit accounts of $6,000 to $457,000 for fiscal 2000 from $451,000 for the
comparable 1999 period, an increase in loan servicing fees of $29,000 to $50,000
for fiscal 2000 from $21,000 for the comparable 1999 period and an increase in
other non-interest income of $16,000 to $242,000 for fiscal 2000 from $226,000
for the comparable 1999 period. The decrease in gains on the sale of loans
reflects the increase in interest rates during fiscal year 2000 that decreased
the level of refinanced loans. Also, the decrease in gains on the sale of loans
reflects the write-down to market value of certain loans held-for-sale. Such
write-downs are due to increasing interest rates on similar loans.
NON-INTEREST EXPENSE
Non-interest expense decreased 0.7% to $8.4 million for fiscal 2000
from $8.5 million for the comparable 1999 period. The decrease was primarily due
to a decrease in compensation and benefits expense of $160,000 to $4.9 million
for fiscal 2000 from $5.0 million for the comparable 1999 period, a decrease in
occupancy and equipment expense of $132,000 to $1.5 million for fiscal 2000 from
$1.6 million for the comparable 1999 period and a decrease in deposit insurance
premiums of $51,000 to $122,000 for fiscal 2000 from $173,000 for the comparable
1999 period. The decrease in non-interest expense was partially offset by an
increase in marketing expense of $14,000 to $366,000 for fiscal 2000 from
$352,000 for the comparable 1999 period and by an increase in other non-interest
expense of $269,000 to $1.6 million for fiscal 2000 from $1.3 million for the
comparable 1999 period. The decrease in compensation and benefits expense
primarily relates to a decrease in the accrual for incentive compensation and a
lower average number of full-time equivalent employees. The decrease in
occupancy and equipment expense primarily relates to a refund credit received on
telecommunications equipment and a lower level of general equipment expenditures
in the 2000 period. The increase in other non-interest expense is primarily due
to the write-off of an equity investment in a low income housing partnership and
to general increases in printing, office supplies, organization dues, legal and
other miscellaneous expenses.
INCOME TAX EXPENSE
Income tax expense decreased to $1.4 million for fiscal 2000 from $1.5
million for fiscal 1999. The decrease was primarily a result of lower income
before income taxes and lower state income taxes due to an increase in the
amount of interest income not subject to state income taxes.
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED JUNE 30, 1999 AND
1998
GENERAL
Net income for the fiscal year ended June 30, 1999 increased 11.8% to
$3.1 million from $2.8 million for fiscal 1998. The increase in net income was
primarily attributable to an increase in net interest income and non-interest
income. Net interest income before the provision for losses on loans increased
to $11.5 million for the fiscal year ended June 30, 1999 from $10.6 million for
fiscal 1998, primarily as a result of higher average interest-earning assets
during fiscal 1999 as compared to fiscal 1998. Non-interest income increased by
$874,000 to $2.1 million for the fiscal year ended June 30, 1999 from $1.2
million for fiscal 1998. The increase in non-interest income was primarily due
to a increase in gain on the sale of loans which increased $595,000 to $892,000
for the fiscal year ended June 30, 1999 from $297,000 for fiscal 1998, an
increase in other non-interest income of $134,000 to $226,000 for the fiscal
year ended June 30, 1999 from $92,000 for fiscal 1998, an increase in gains on
the sale of securities available-for-sale and mortgage-backed and related
securities available-for-sale to $68,000 for the fiscal year ended June 30, 1999
from a loss of $8,000 for fiscal 1998, an increase in insurance commissions of
$41,000 to $90,000 for the fiscal year ended June 30, 1999 from $49,000 for
fiscal 1998 and an increase in service charges on deposit accounts of $22,000 to
$451,000 for the fiscal year ended June 30, 1999 from $429,000 for fiscal 1998.
The increases were partially offset by a decrease in loan servicing fees of
$40,000 to $21,000 for the fiscal year ended June 30, 1999 from $61,000 for
fiscal 1998. Non-interest expense increased $1.7 million to $8.5 million for the
fiscal year ended June 30, 1999 from $6.8 million for fiscal 1998, primarily as
a result of an increase in compensation and benefits expense of $1.0 million to
$5.0 million for the fiscal year
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ended June 30, 1999 from $4.0 million for fiscal 1998, an increase in occupancy
and equipment of $447,000 to $1.6 million for the fiscal year ended June 30,
1999 from $1.2 million for fiscal 1998 and an increase other non-interest
expense of $123,000 to $1.3 million for the fiscal year ended June 30, 1999 from
$1.2 million for fiscal 1998. The increase in non-interest expense was partially
offset by a decrease in marketing expense of $28,000 to $352,000 for the fiscal
year ended June 30, 1999 from $380,000 for fiscal 1998. Net income also was
increased by a decrease in the provision for losses on loans to $480,000 for
fiscal 1999 from $800,000 for fiscal 1998.
Return on average equity increased to 9.08% for the fiscal year ended
June 30, 1999 from 8.89% for fiscal 1998. Return on average assets was .67% for
the fiscal year ended June 30, 1999 and 1998. The increase in return on average
equity was primarily due to the increases in net income and treasury stock. The
Company's principal investment focus during the fiscal year ended June 30, 1999
was the origination and purchase of mortgage and commercial loans. The asset
growth primarily was funded through increases in FHLB advances, securities sold
under agreements to repurchase, wholesale certificates of deposit, money market
deposits and sales of loans in the secondary market.
NET INTEREST INCOME
Net interest income increased 7.9% to $11.5 million for fiscal 1999
from $10.6 million for fiscal 1998. Interest income increased $2.1 million in
fiscal 1999, while interest expense increased $1.2 million. The level of net
interest income primarily reflects a 11.8% increase in average interest-earning
assets during fiscal 1999 and a 5.1% increase in the excess of the Company's
average interest-earning assets over average interest-bearing liabilities to
$30.5 million for fiscal 1999 from $29.0 million for fiscal 1998, partially
offset by a decrease in interest rate spread to 2.18% for fiscal 1999 from 2.22%
for fiscal 1998. The decreased interest rate spread for fiscal 1999 is primarily
a result of the Company's refinancing of loans that carry lower interest rates.
INTEREST INCOME
Interest income increased 6.4% to $34.3 million for fiscal year 1999
from $32.2 million for fiscal 1998. The increase in interest income was the
result of an increase in average interest-earning assets of 11.8% to $452.0
million for fiscal 1999 from $404.3 million for fiscal 1998, partially offset by
a decrease of 38 basis points in the yield on interest-earning assets to 7.59%
for fiscal 1999 from 7.97% for fiscal 1998. Interest income on loans decreased
1.0% to $23.5 million for fiscal 1999 from $23.8 million for fiscal 1998. The
decrease was the result of a decrease in average yield to 8.27% for fiscal 1999
from 8.49% for fiscal 1998, partially offset by an increase in average gross
loans of 1.6% to $284.7 million for fiscal 1999 from $280.2 million for fiscal
1998. Gross loans increased primarily as a result of the Company retaining
substantially all of its adjustable and short-term fixed rate loan originations,
purchasing more loans in the secondary market and increases in multi-family and
commercial components of the portfolio. The decrease in yield is attributable to
the increase in loans refinanced at lower interest rates. Interest income on
mortgage-backed securities decreased 63.4% to $1.0 million for fiscal 1999 from
$2.8 million for the comparable 1998 period. The decrease was primarily due to a
decrease in average balances to $14.6 million for fiscal 1999 from $40.0 million
for fiscal 1998, partially offset by an increase in average yield to 7.08% for
the 1999 period from 7.06% for the 1998 period. Interest income on
mortgage-related securities increased 11.5% to $2.8 million for fiscal 1999 from
$2.5 million for fiscal 1998. The increase was primarily due to an increase in
average balances to $43.0 million for fiscal 1999 from $37.2 million for fiscal
1998, partially offset by a decrease in average yield to 6.59% for the 1999
period from 6.84% for the 1998 period. The increase in average yield on
mortgage-backed securities was primarily due to the higher level of repayments
on the adjustable rate securities portion of this portfolio which carry lower
interest rates. The decrease in average yield on mortgage related securities was
primarily due to the accelerated amortization of purchase premiums due to faster
than projected principal repayments during fiscal 1999. The decline in average
balances of mortgage-backed securities and is due to management's decision to
increase the securities available-for-sale portfolio. Interest income on
investment securities and securities available-for-sale increased 140.6% to $6.5
million for fiscal 1999 from $2.7 million for fiscal 1998. The increase was
primarily due to an increase in average balance to $103.2 million for fiscal
1999 from $41.2 million for fiscal 1998, partially offset by a decrease in
average yield to 6.25% for the 1999 period from 6.51% for the 1998 period. The
lower average yield was primarily attributable to the lower interest rate
environment during the 1999 period as compared to the 1998 period and the
short-term maturity of the securities in this portfolio.
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INTEREST EXPENSE
Interest expense increased 5.7% to $22.8 million for fiscal 1999 from
$21.6 million for fiscal 1998. The increase was primarily the result of an 12.3%
increase in the average amount of interest-bearing liabilities to $421.5 million
for fiscal 1999 compared to $375.3 million for fiscal 1998, partially offset by
a decrease in the average rate paid on interest-bearing liabilities to 5.41% for
the 1999 period from 5.75% for the 1998 period. The increased balances of
certificates of deposit (including brokered deposits), money market deposit
accounts, NOW accounts and borrowings at lower average interest rates was the
primary reason for the decrease in the average rate paid on the interest-bearing
liabilities for fiscal 1999 as compared to fiscal 1998. Interest expense on
deposits increased 1.4% to $15.2 million for fiscal 1999 from $15.0 million for
the comparable 1998 period. The increase was the result of an increase in
average balances of 8.6% to $287.4 million for fiscal 1999 from $264.8 million
for the comparable 1998 period, partially offset by a decrease in the average
rate paid to 5.28% for the 1999 period from 5.65% for the 1998 period. The
increase in deposits was primarily due to an increase of 5.7% in certificates of
deposit (including brokered deposits) to $228.0 million for fiscal 1999 from
$215.7 million for the 1998 period, with a decrease in the average rate paid on
such deposits to 5.60% for the 1999 period from 6.01% for the 1998 period. Money
market deposit accounts increased 41.0% to $35.6 million for fiscal 1999 from
$25.2 million for the comparable 1998 period, with a decrease in the average
rate paid on such deposits to 4.88% for the 1999 period from 5.23% for the 1998
period. Money market deposit accounts increased primarily due to aggressive
marketing and a competitive rate offered during fiscal 1999. NOW accounts
increased 4.9% to $2.8 million for fiscal 1999 from $2.6 million for the
comparable 1998 period, with an increase in average rate paid to 1.74% for the
1999 period from 1.71% for the 1998 period. The Company's increase in
certificates of deposit was the result of aggressive marketing and pricing and
the use of brokered certificates of deposit. Of the $228.0 million in the
average balance of certificates of deposit for fiscal 1999, $101.5 million, or
44.5%, represented brokered certificates of deposit compared to $81.4 million,
or 37.8%, for the 1998 period. The average rate paid on brokered certificates of
deposit decreased to 5.63% for fiscal 1999 from 6.13% for the comparable 1998
period. The decrease was primarily due to the lower interest rate environment
during the 1999 period as compared to the 1998 period. Interest on borrowings
(FHLB advances and reverse repurchase agreements) increased 15.7% to $7.6
million for fiscal 1999 from $6.5 million for the comparable 1998 period. The
increase was primarily due to the increase in average balance to $131.2 for
fiscal 1999 from $107.4 for the comparable 1998 period, partially offset by a
decrease in average rate paid to 5.78% for fiscal 1999 from 6.10% for the 1998
period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans decreased to $480,000 for fiscal 1999
from $800,000 for fiscal 1998. The higher provision for losses on loans in
fiscal 1998 was due in part to higher charge-offs in 1998. The level of
allowance for losses on loans generally is determined by the Bank's historical
loan loss experience, the condition and composition of the Bank's loan portfolio
and general economic conditions. Management anticipates that as the Company's
volume of multi-family and commercial/non-residential real estate lending
activity continues to increase, the Company will need to build a higher level of
allowance for loan losses established through a provision for loan losses.*
Based on management's evaluation of the loan portfolio and the increase in gross
loans during fiscal 1999, the allowance for losses on loans increased 13.7% to
$2.6 million at June 30, 1999 compared to $2.3 million at June 30, 1998. This
increase was primarily the result of the increase in the multi-family,
multi-family construction, commercial real estate and commercial loan components
of the gross loan portfolio which carry a greater degree of inherent credit risk
as compared to one-to-four family mortgage lending and also due to an increase
in non-performing loans. The ratio of allowance for loan losses to gross loans
increased to 0.89% at June 30, 1999 from 0.81% at June 30, 1998. The amount of
non-performing loans at June 30, 1999 was $2.4 million or 0.81% of gross loans,
compared to $1.4 million or 0.50% of gross loans at June 30, 1998. The increase
in non-performing loans during fiscal 1999 primarily relates to the default of a
commercial real-estate loan located in the Bank's primary lending area with a
balance of $1.1 million.
NON-INTEREST INCOME
Non-interest income increased 72.4% to $2.1 million for fiscal 1999
from $1.2 million for the comparable 1998 period. The largest components of the
increase were an increase in gains on the sale of loans to $892,000 for fiscal
1999 from $297,000 for the comparable 1998 period, an increase in service
charges on loans
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to $334,000 for fiscal 1999 from $288,000 for the comparable 1998 period, an
increase in service charges on deposit accounts to $451,000 for fiscal 1999 from
$429,000 for the comparable 1998 period, an increase in gains on the sale of
securities and mortgage-backed and related securities to $68,000 for fiscal 1999
from a loss of $8,000 for the comparable 1998 period, an increase in insurance
commissions to $90,000 for fiscal 1999 from $49,000 for the comparable 1998
period and an increase in other non-interest income to $226,000 for fiscal 1999
from $92,000 for the comparable 1998 period. The increase in gains on the sale
of loans reflects the increase in long-term fixed rate loans sold into the
secondary market during the 1999 period as compared to the 1998 period due to a
higher level of refinanced loans. Partially offsetting the increases in
non-interest income was a decrease in loan servicing fees to $21,000 for fiscal
1999 from $61,000 for the comparable 1998 period. The decrease in loan servicing
fees was due to a decrease in the loans serviced due to an increase in
prepayments on the serviced loans as well as accelerated amortization of the
mortgage servicing right asset based on the decreasing balance of the underlying
assets.
NON-INTEREST EXPENSE
Non-interest expense increased 23.4% to $8.5 million for fiscal 1999
from $6.8 million for the comparable 1998 period. The increase was primarily due
to an increase in compensation and benefits expense of $1.0 million to $5.0
million for fiscal 1999 from $4.0 million for the comparable 1998 period, an
increase in occupancy and equipment expense of $447,000 to $1.6 million for
fiscal 1999 from $1.2 million for the comparable 1998 period and an increase in
other non-interest expense of $123,000 to $1.3 million for fiscal 1999 from $1.2
million for the comparable 1998 period. The increase in non-interest expense was
partially offset by a decrease in marketing expense of $28,000 to $352,000 for
fiscal 1999 from $380,000 for the comparable 1998 period. The increase in
compensation and benefits expense primarily relates to higher salary levels, an
increase in the number of full time equivalent employees and an increase in
incentive compensation related to the increased volume of loans sold into the
secondary market. The increase in occupancy and equipment expense primarily
relates to the addition of an administrative facility and increased purchases of
bank equipment. The increase in other non-interest income is primarily due to
increases in printing, office supplies, organization dues, legal and other
miscellaneous expenses.
INCOME TAX EXPENSE
Income tax expense increased to $1.5 million for fiscal 1999 from $1.4
million for fiscal 1998. The increase was primarily a result of higher income
before income taxes, partially offset by lower state income taxes due to an
increase in the amount of interest income not subject to state income taxes.
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the
Company's consolidated average statements of financial condition and the
consolidated statements of income at and for the fiscal years ended June 30,
2000, 1999 and 1998, and reflects the average yields on interest-earning assets
and average rates on interest-bearing liabilities for the periods indicated.
Such yields and rates are derived by dividing income or expense by the average
balance of interest-earning assets or interest-bearing liabilities,
respectively, for the periods shown. Average balances are derived principally
from average monthly balances and include non-accruing loans. The average yields
and rates include loan fees which are considered adjustments to loan yield. The
amount of interest income resulting from the recognition of loan fees was
$328,000, $312,000 and $169,000 for the fiscal years ended June 30, 2000, 1999
and 1998, respectively. The increase in the amount of loan fees recognized in
interest income for 1999 as compared to 1998 primarily resulted from the
originations of loans with higher fees and the increased refinancing of the loan
portfolio. Interest income on non-accrual loans is reflected in the period it is
collected and not in the period it is earned. Such amounts are not material to
net interest income or net change in net interest income in any period.
Non-accruing loans are included in the average balances and do not have a
material effect on the average yield.
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CONSOLIDATED AVERAGE BALANCE SHEETS
FISCAL YEAR ENDED JUNE 30,
-----------------------------------------------------------------------
2000 1999
-------------------------------------- -------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
------- ---- ----- -------- ---- -----
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans......................................... $ 327,445 $ 26,088 7.97% $ 265,438 $ 21,607 8.14%
Consumer loans......................................... 3,405 461 13.54 4,157 572 13.76
Commercial loans....................................... 21,881 2,264 10.35 15,081 1,368 9.07
--------- -------- ---------- ---------
Total loans.......................................... 352,731 28,813 8.17 284,676 23,547 8.27
Mortgage-backed securities............................. 5,509 343 6.23 14,603 1,034 7.08
Mortgage derivative securities......................... 29,217 1,920 6.57 43,009 2,835 6.59
--------- -------- ---------- ---------
Total mortgage-backed and related securities......... 34,726 2,263 6.52 57,612 3,869 6.72
Investment and other securities........................ 9,163 521 5.69 14,550 775 5.33
Securities available for sale.......................... 93,258 6,317 6.77 88,650 5,680 6.41
Federal Home Loan Bank stock........................... 7,371 525 7.12 6,505 427 6.56
--------- -------- ---------- ---------
Total interest-earning assets(1)..................... 497,249 38,439 7.73 451,993 34,298 7.59
-------- ----- --------- -----
Non-interest earning assets.............................. 19,589 16,126
--------- ----------
Total assets......................................... $ 516,838 $ 468,119
========= ==========
LIABILITIES AND RETAINED EARNINGS:
Deposits:
NOW accounts........................................... $ 2,854 47 1.65 $ 2,757 48 1.74
Money market deposit accounts.......................... 31,205 1,409 4.52 35,563 1,736 4.88
Passbook............................................... 19,857 580 2.92 21,107 613 2.90
Certificates of deposit................................ 257,043 14,948 5.82 227,979 12,766 5.60
--------- -------- ---------- ---------
Total deposits....................................... 310,959 16,984 5.46 287,406 15,163 5.28
Advance payments by borrowers for taxes and insurance.... 3,169 71 2.24 2,927 75 2.56
Borrowings............................................... 156,058 8,968 5.75 131,164 7,576 5.78
--------- -------- ---------- ---------
Total interest-bearing liabilities................... 470,186 26,023 5.53 421,497 22,814 5.41
-------- ----- --------- -----
Other liabilities (Incl. non-interest bearing demand
deposits) 12,995 12,167
Retained earnings........................................ 33,657 34,455
--------- ----------
Total liabilities and retained earnings.............. $516,838 $ 468,119
========= ==========
Net interest income/interest rate spread(2)................ $ 12,416 2.20% $ 11,484 2.18%
======== ===== ========= =====
Net earning assets/net interest margin(3).................. $ 27,063 2.50% $ 30,496 2.54%
========= ===== ========== =====
Average interest-earning assets to average interest-bearing
liabilities 1.06x 1.07x
===== =====
CONSOLIDATED AVERAGE BALANCE SHEETS
FISCAL YEAR ENDED JUNE 30,
----------------------------------
1998
----------------------------------
AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
------------- -------- ---------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans......................................... $ 267,549 $22,390 8.37%
Consumer loans......................................... 5,280 704 13.33
Commercial loans....................................... 7,375 700 9.49
---------- -------
Total loans.......................................... 280,204 23,794 8.49
Mortgage-backed securities............................. 40,007 2,825 7.06
Mortgage derivative securities......................... 37,205 2,543 6.84
---------- -------
Total mortgage-backed and related securities......... 77,212 5,368 6.95
Investment and other securities........................ 10,678 711 6.66
Securities available for sale.......................... 30,524 1,972 6.46
Federal Home Loan Bank stock........................... 5,661 382 6.75
---------- -------
Total interest-earning assets(1)..................... 404,279 32,227 7.97
------- -----
Non-interest earning assets.............................. 13,315
----------
Total assets......................................... $ 417,594
==========
LIABILITIES AND RETAINED EARNINGS:
Deposits:
NOW accounts........................................... $ 2,628 45 1.71
Money market deposit accounts.......................... 25,230 1,319 5.23
Passbook............................................... 21,194 625 2.95
Certificates of deposit................................ 215,701 12,967 6.01
---------- -------
Total deposits....................................... 264,753 14,956 5.65
Advance payments by borrowers for taxes and insurance.... 3,139 84 2.68
Borrowings............................................... 107,378 6,546 6.10
---------- -------
Total interest-bearing liabilities................... 375,270 21,586 5.75
------- -----
Other liabilities (Incl. non-interest bearing demand
deposits) 10,848
Retained earnings........................................ 31,476
----------
Total liabilities and retained earnings.............. $ 417,594
==========
Net interest income/interest rate spread(2)................ $10,641 2.22%
======= =====
Net earning assets/net interest margin(3).................. $ 29,009 2.63%
========== =====
Average interest-earning assets to average interest-bearing
liabilities 1.08x
=====
(1) Calculated net of deferred loans fees, loan discounts, loans in process and
allowance for loan losses.
(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average rate on interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
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RATE/VOLUME ANALYSIS
The most significant impact on the Company's net interest income
between periods is derived from the interaction of changes in the volume of, and
rates earned or paid on, interest-earning assets and interest-bearing
liabilities. The volume of earning dollars in loans and investments, compared to
the volume of interest-bearing liabilities represented by deposits and
borrowings, combined with the spread, produces the changes in net interest
income between periods. The following table shows the interest income for
periods indicated. Information is provided with respect to (i) effects on
interest income attributable to changes in rate (changes in rate multiplied by
prior volume), (ii) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate), and (iii) changes in rate/volume
(changes in rate multiplied by changes in volume).
FISCAL YEAR ENDED JUNE 30, 2000 FISCAL YEAR ENDED JUNE 30, 1999
COMPARED TO COMPARED TO
FISCAL YEAR ENDED JUNE 30, 1999 FISCAL YEAR ENDED JUNE 30, 1998
-------------------------------------- --------------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
-------------------------------------- --------------------------------------
(IN THOUSANDS)
RATE/ RATE/
RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
---- ------ ------ --- ---- ------ ------ ---
Interest-earning assets:
Mortgage loans .................. ($ 459) $ 5,047 ($107) $ 4,481 ($611) ($177) $ 5 ($783)
Consumer loans .................. (9) (103) 1 (111) 23 (150) (5) (132)
Commercial loans ................ 192 617 87 896 (31) 731 (32) 668
Mortgage-backed securities ...... (125) (644) 78 (691) 8 (1,794) (5) (1,791)
Mortgage-derivative securities... (9) (909) 3 (915) (91) 397 (14) 292
Investment and other securities.. 52 (287) (19) (254) (142) 258 (52) 64
Securities available for sale.... 325 295 17 637 (16) 3,755 (31) 3,708
Federal Home Loan Bank stock .... 36 57 5 98 (10) 57 (2) 45
------- ------- ------- ------- ------- ------- ------- -------
Total ........................ 3 4,073 65 4,141 (870) 3,077 (136) 2,071
------- ------- ------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
NOW accounts .................... (3) 2 -- (1) 1 2 -- 3
Money market demand accounts .... (130) (213) 16 (327) (87) 540 (36) 417
Passbook accounts ............... 4 (36) (1) (33) (9) (3) -- (12)
Certificates of deposit ......... 492 1,627 63 2,182 (889) 738 (50) (201)
Advance payments by borrowers
for taxes and insurance ......... (9) 6 (1) (4) (4) (6) 1 (9)
Borrowings ...................... (39) 1,438 (7) 1,392 (344) 1,451 (77) 1,030
------- ------- ------- ------- ------- ------- ------- -------
Total ........................ 315 2,824 70 3,209 (1,332) 2,722 (162) 1,228
------- ------- ------- ------- ------- ------- ------- -------
Net change in net interest income.. ($312) $ 1,249 ($5) $ 932 $ 462 $ 355 $ 26 $ 843
======= ======= ======= ======= ======= ======= ======= =======
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FINANCIAL CONDITION
Total assets increased $49.9 million or 10.6%, from $469.7 million at
June 30, 1999 to $519.6 million at June 30, 2000. This increase is primarily
reflected in increases in loans receivable and interest-bearing deposits
consistent with the Company's strategy of moderate asset growth and asset
portfolio diversification. The increase was funded primarily by an increase in
wholesale brokered deposits, securities sold under agreements to repurchase and
decreases in securities held-to-maturity and securities available-for-sale.
Cash and cash equivalents increased 92.6% to $16.6 million at June 30,
2000 compared to $8.6 million at June 30, 1999. The increase is largely
attributable to the increase in wholesale brokered deposits and decreases in
securities held-to-maturity and securities available-for-sale.
Securities available-for-sale decreased to $74.3 million at June 30,
2000 compared to $100.5 million at June 30, 1999. The decrease is the result of
management's decision to sell securities available-for-sale and increase its
investment into higher yielding loans. At June 30, 2000, the securities
available-for-sale portfolio contained $32.8 million of fixed-rate U.S.
government agency securities, $8.0 million of agency and private-issue
fixed-rate mortgage-backed securities with a minimum investment rating of AA,
$4.7 million of private-issue adjustable-rate mortgage-backed securities with a
minimum investment rating of AA, $6.7 million of fixed-rate intermediate-term
tranche CMOs with a minimum investment rating of AAA, $16.5 million of
floating-rate tranche CMOs with a minimum investment rating of AA, $4.3 million
in trust preferred securities, $1.0 million of adjustable-rate mortgage mutual
funds and $274,000 of municipal bonds.
Mortgage-backed and related securities held-for-investment decreased to
$15.0 million at June 30, 2000 compared to $54.6 million at June 30, 1999. The
decrease is the result of management's decision to decrease its investment in
mortgage-backed and related securities to provide funding for the loan portfolio
growth and diversification. Of the $15.0 million in mortgage-backed and related
securities at June 30, 2000, all were fixed rate, compared to a total of $54.6
million at June 30, 1999, of which $43.2 million were adjustable rate and $11.4
million were fixed rate. At June 30, 2000, $10.7 million of the mortgage-backed
and related securities portfolio consisted of private-issue mortgage-backed and
related securities, each issue of which carried a minimum investment rating of
AA at the time of purchase and at June 30, 2000. The decrease in mortgage-backed
and related securities was primarily attributable to the transfer of $37.9
million to trading and securities available-for-sale of which $25.5 million was
sold to fund higher yielding loans.
Loans receivable increased to $391.8 million at June 30, 2000 compared
to $281.1 million at June 30, 1999. The increase at June 30, 2000 compared to
the prior fiscal year end is primarily the result of management's decision to
retain more fixed-rate loans originated and purchased for the Company's
portfolio, as such loans carried higher yields than comparable mortgage-backed
and related securities in fiscal 1999. Total mortgage loans originated and
purchased amounted to $205.9 million and $207.8 million for the fiscal years
ended June 30, 2000 and 1999, respectively, while sales of fixed-rate mortgage
loans totaled $33.9 million and $48.3 million for the fiscal years ended June
30, 2000 and 1999, respectively. The decrease in fixed-rate mortgage loan sales
is primarily attributable to the increased interest rate environment during
fiscal 2000 that decreased the level of loans refinanced. During fiscal 2000,
the Company originated and purchased loans totaling $140.4 million and $118.9
million, respectively. Of the $118.9 million in purchased loans, the Company
purchased $62.3 million outside of its primary lending area, whereby management
of the Company has applied underwriting guidelines which are at least as strict
as those applicable to the origination of similar loans within its primary
lending area.
Deposits increased $56.6 million to $345.3 million at June 30, 2000
from $288.7 million at June 30, 1999. The increase in deposits was primarily due
to the Company's use of brokers and marketing efforts to increase the
certificates of deposit with the Company. Brokered deposits totaled $216.2
million at June 30, 2000, representing 62.6% of total deposits as compared to
$101.2 million, or 35.1% of total deposits, at June 30, 1999. The significant
increase in brokered deposits is due to attractive rates offered on the brokered
deposits and the Company's highly competitive local market for retail deposits
resulting in increasing reliance on brokered deposits as a funding source. The
average maturity of brokered deposits was four months at June 30, 2000 and June
30, 1999. Non-brokered wholesale deposits totaled $14.2 million at June 30,
2000, representing 4.1% of total deposits, as compared to $55.2 million, or
19.1% of total deposits, at June 30, 1999. Deposits are the Company's
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73
primary source of externally generated funds. The level of deposits is heavily
influenced by such factors as the general level of short and long-term interest
rates as well as alternative yields that investors may obtain on competing
investment securities such as money market mutual funds.
FHLB-Chicago advances and other borrowings increased to $132.0 million
at June 30, 2000 compared to $129.5 million at June 30, 1999. At June 30, 2000,
FHLB advances were $112.5 million, or 23.1% of total liabilities, compared to
$120.0 million, or 27.6% of total liabilities at June 30, 1999. Borrowings under
reverse repurchase agreements increased to $18.5 million at June 30, 2000
compared to $9.5 million at June 30, 1999. The Company has increasingly used
FHLB-Chicago advances and securities sold under agreements to repurchase as a
funding source due to attractive rates offered on advances in relation to
deposit funds obtainable in the Company's local market. The Company uses
borrowings from the FHLB-Chicago and securities sold under agreements to
repurchase to manage the total asset/liability portfolio of the Company. For a
further discussion of FHLB borrowings and securities sold under agreements to
repurchase, see Note 8 to Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are retail and wholesale
brokered deposits, proceeds from principal and interest payments on loans,
principal and interest payments on mortgage-backed and related securities and
FHLB-Chicago advances. Alternative funding sources are evaluated and utilized
based upon factors such as interest rates, availability, maturity,
administrative costs and retention capability. Although maturity and scheduled
amortization of loans are predictable sources of funds, deposit flows, mortgage
prepayments and prepayments on mortgage-backed and related securities are
influenced significantly by general interest rates, economic conditions and
competition. During fiscal 2000 mortgage loans and mortgage securities
prepayments decreased as interest rates increased as compared to fiscal 1999 and
1998 when mortgage loans and mortgage securities prepayments increased as
interest rates declined.
The primary investing activity of the Company is the origination and
purchase of loans and the purchase of mortgage-backed and related securities.
For fiscal 2000, the Company originated and purchased loans totaling $140.4
million and $118.9 million, respectively, as compared to fiscal 1999 when
originated and purchased loans totaled $202.1 million and $56.9 million,
respectively. The Company purchased mortgage-backed and related securities in
the amount of $8.1 million and $12.3 million in fiscal 2000 and 1999,
respectively. The Company also purchased investment securities in the amount of
$0 and $184,000 during fiscal 2000 and 1999, respectively. For fiscal 2000 and
1999, these activities were funded primarily by principal repayments on loans of
$110.3 million and $199.7 million, respectively; principal repayments on
mortgage-backed and related securities of $32.0 million and $93.4 million,
respectively; proceeds from the sale of mortgage loans of $33.1 million and
$50.1 million, respectively; proceeds from maturity of investment securities of
$0 and $572,000, respectively; proceeds from notes payable to the FHLB-Chicago
of $104.0 million and $35.5 million, respectively; and a net increase in
deposits of $56.6 million and $17.1 million, respectively. Purchases of
securities available-for-sale totaled $34.7 million and sales were $45.2 million
for fiscal 2000, compared to purchases of $125.3 million and sales of $10.6
million for fiscal 1999.
During fiscal 2000, the Company has found wholesale brokered and
non-brokered deposits to be an efficient source and a cost-effective method,
relative to local retail market deposits, of meeting the Bank's funding needs.
In fiscal 2000, pricing of wholesale brokered deposits ranged from 50 to 75
basis points above comparable term U.S. Treasury securities. At June 30, 2000,
the average rate of the wholesale brokered deposits accepted by the Company was
6.03% compared to an average rate paid for retail certificates of deposit of
4.96%. Management believes that the strategy of leveraging the capital acquired
in the Conversion to achieve the targeted asset size established by the Board of
Directors within a three-to-five year period following the Conversion, could not
have been achieved solely through the use of retail deposits from the local
market. Management also believes that the costs, overhead and interest expense
of achieving comparable retail deposit growth would have exceeded the costs
related to the use of wholesale brokered deposits as a funding source. However,
management recognizes that the likelihood for retention of brokered certificates
of deposit is more a function of the rate paid on such accounts as compared to
retail deposits which may be established due to Bank location or other
intangible reasons. During fiscal 2000, the Company maintained a total of $20.0
million in federal fund lines with two large correspondent banks. These lines
are to be used as backup credit facilities for contingency purposes to replace
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funds from wholesale brokered deposits should retention of those deposits
diminish due to extraordinary events in the financial markets. The Company's
overall cost of funds has increased in recent years due primarily to a much
greater percentage of the deposits being in certificates, both wholesale
brokered and retail, as opposed to passbooks, money market accounts and checking
accounts. Management believes that a significant portion of its retail deposits
will remain with the Company and, in the case of wholesale brokered deposits,
may be replaced with similar type accounts even should the level of interest
rates change. However, in the event of a significant increase in market interest
rates, the cost of obtaining replacement brokered deposits would increase as
well.
The Bank's Board of Directors has set a maximum limitation of total
borrowings equal to 32% of total assets. This internal limit is 3% below the
allowable borrowing limit (for all borrowings including FHLB advances and
reverse repurchase agreements) of 35% of total assets established by the
FHLB-Chicago. At June 30, 2000, FHLB advances and borrowings under reverse
repurchase agreements totaled $132.0 million, or 25.4% of the Bank's total
assets. At June 30, 2000, the Bank had unused borrowing authority under the
borrowing limitations established by the Board of Directors of $34.2 million and
$49.8 million under the FHLB total asset limitation. The Bank intends to fund
asset growth in fiscal 2001 through modest increases in FHLB advances, and to
maintain the 3% excess borrowing capacity with the FHLB as a contingent source
of funds to meet liquidity needs as deemed necessary by the Board of Directors
of the Bank.*
During fiscal 2000, management maintained the maturities of both its
wholesale brokered certificates of deposits and the FHLB borrowings to increase
net interest income. As of June 30, 2000, the average maturity of the wholesale
brokered certificates of deposit was four months compared to five months in
fiscal 1999 and compared to a ten month maturity for retail certificates of
deposits as of June 30, 2000.
The Company is required to maintain minimum levels of liquid assets
under the regulations of the Department of Financial Institutions, Division of
Savings and Loan for state-chartered savings banks. Savings banks are required
to maintain an average daily balance of liquid assets (including cash, certain
time deposits, certain bankers acceptances, certain corporate debt securities,
securities of certain mutual funds and specified United States government, state
or federal agency obligations) of not less than 8.0% since April 1, 1996 and
5.0% prior to that date. The Company's liquidity ratios were 10.29% and 17.65%
at June 30, 2000 and 1999, respectively. The Company adjusts its liquidity
levels to meet various funding needs and to meet its asset and liability
management objectives.
The Company's most liquid assets are cash and cash equivalents, which
include investments in highly liquid, short-term investments. The levels of
these assets are dependent on the Company's operating, financing, lending and
investing activities during any given period. Cash and cash equivalents were
$16.6 million and $8.6 million at June 30, 2000 and 1999, respectively. The
increase in cash and cash equivalents in fiscal 2000 resulted primarily from an
increase in deposits.
Liquidity management for the Company is both an ongoing and long-term
function of the Company's asset/liability management strategy. Excess funds
generally are invested in short-term investments such as federal funds or
overnight deposits at the FHLB-Chicago. Whenever the Company requires funds
beyond its ability to generate them internally, additional sources of funds are
available and obtained from the wholesale brokered and non-brokered market as
well as the unused credit line from the FHLB-Chicago (subject to the
Board-imposed and regulatory limitations discussed herein), and funds also may
be available through reverse repurchase agreements wherein the Company pledges
investment, mortgage-backed or related securities. The Company maintains a
federal funds open line of credit in the amount of $10.0 million with a
correspondent bank which does not require the direct pledging of any assets and
could be used to replace a portion of its interest rate sensitive liabilities
such as borrowings and deposits should such funding sources become difficult to
obtain or retain due to an adverse interest rate environment. In addition, the
Company maintains a relatively high level of liquid assets, such as investment
securities and mortgage-backed and related securities available-for-sale, in
order to insure sufficient sources of funds are available to meet the Company's
liquidity needs.
At June 30, 2000, the Company had outstanding loan commitments of $1.0
million. The Company had no commitments to purchase securities and
mortgage-backed and related securities at June 30, 2000. The Company anticipates
it will have sufficient funds available to meet its current loan commitments,
including loan applications
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received and in process to the issuance of firm commitments. Certificates of
deposit scheduled to mature in one year or less at June 30, 2000 totaled $270.0
million.
IMPACT OF YEAR 2000
The Company believes it has adequately addressed the Year 2000 issue.
The Company identified areas of computer and other operations critical for the
delivery of its loan and deposit products. The majority of the Company's
applications used in operations were purchased from outside vendors. The vendors
providing the software were responsible for maintenance of the systems and
modifications to enable uninterrupted usage after December 31, 1999. The
Company's plan included obtaining certification of compliance from third parties
and testing all of the impacted applications (both internally developed and
third party provided). Testing of the system and conversion activities were
completed as of June 30, 1999. There are no mission critical systems which are
non-compliant. The Company developed and finalized contingency plans for any
adverse situations that may have arisen related to Year 2000. The Company's plan
also included reviewing any potential risks associated with loan and deposit
data base information due to the Year 2000 issue.
Subsequent to January 1, 2000, all computer systems continue to
function as expected and have not affected the ability of the Company to deliver
its products and services to date. Management will continue to monitor computer
systems for problems and errors associated with their operation. Based on
currently available information, management does not anticipate that the cost to
address the Year 2000 issues did not have a material adverse impact on the
Company's financial position.* Direct expenditures for the twelve months ended
June 30, 2000 and June 30, 1999 totaled $13,100 and $37,800, respectively.
Direct expenditures include capital expenditures for compliant equipment and
software, write-offs of non-compliant equipment and software upgrades. The
expenditures will be funded by increases in the Company's non-interest expense
budget.
The Company also made inquiries and reviewed plans of certain third
parties, such as commercial loan customers, where Year 2000 failures could have
resulted in significant adverse impact on the Company. The Company had completed
the inquiry and review process and was satisfied the Bank would not be subject
to significant adverse impact.* Based on information available, the Bank has not
experienced any difficulties with third parties related to the Year 2000 issue.
IMPACT OF INFLATION AND CHANGING PRICES
The Company's Consolidated Financial Statements and Notes thereto have
been prepared in accordance with GAAP, which requires 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 most 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.
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ASSET/LIABILITY MANAGEMENT
The Company's profitability, like that of most financial institutions,
depends to a large extent upon its net interest income, which is the difference
between interest earned on interest-earning assets, such as loans and
investments, and interest paid on interest-bearing liabilities, such as deposits
and borrowings. Net interest income is significantly affected by changes in
market interest rates. During periods of rising interest rates, the Company is
required to pay higher rates to attract deposits which can result in a decline
in net interest income if the Company is unable to increase the yield on its
interest-earning assets sufficiently to compensate for the increase in its cost
of funds.
In an attempt to manage vulnerability to interest rate changes,
management closely monitors the Company's interest rate risk. The Company has
established its investment strategies through an Asset/Liability Committee. The
Committee consists of James Smessaert, President/CEO, Peter Gilbert, Executive
Vice President/COO, Arthur Thompson, Senior Vice President-Finance/CFO, and
Elizabeth Borst, Senior Vice President-Sales & Marketing. The Committee
generally meets weekly and reviews the Company's interest rate risk position,
maturing securities and borrowings, interest rates and programs for increasing
retail and brokered and non-brokered wholesale deposits and originating and
purchasing loans, and develops strategies regarding such issues. In addition,
the Committee closely monitors the Company's growth, profitability, liquidity
and capital adequacy ratios. Minutes of these meetings are prepared and given to
the Board of Directors for their review as well as formal quarterly
asset/liability management and investment strategy reports.
The Company utilizes basic strategies in managing its assets and
liabilities by managing or maximizing the net interest income under various
interest rate scenarios. In addition to monitoring interest rate risk on a
weekly basis, the Company reviews loan and deposit rates weekly. The emphasis
has been on prudent pricing as opposed to increasing local retail market share,
and the Company has significantly supplemented and substituted retail deposits
using FHLB-Chicago advances and wholesale brokered and non-brokered deposits in
fiscal 1999 and 2000 as a result of favorable advance and wholesale rates in
relation to those obtainable on retail deposits Also, during fiscal 2000 hedging
techniques through the use of interest rate caps were utilized by management
with the approval of the Board of Directors to manage the interest rate risk on
the Company's short-term wholesale certificates of deposit.
Generally, the Company utilizes the following strategies to manage its
interest rate risk: (i) the Company maintains a relatively high level of liquid
assets, such as investment securities and mortgage-backed and related securities
available-for-sale; (ii) the Company seeks to primarily originate and retain
mortgage loans and mortgage-backed and related securities with short-to
medium-term periods to re-pricing; (iii) the Company attempts to extend the
maturities of retail deposits when deemed cost effective through the pricing and
promotion of certificates of deposit with longer terms, and periodically
utilizes deposit marketing programs offering maturity and repricing terms
structured to complement the repricing and maturity characteristics of the
existing asset/liability mix; (iv) the Company also attempts to extend the
maturities of wholesale brokered deposits when deemed cost effective; (v) the
Bank utilizes longer-term borrowings from the FHLB-Chicago and reverse
repurchase agreements to manage its assets and liabilities and enhance earnings.
At June 30, 2000, 1999 and 1998, total FHLB-Chicago advances and borrowings
under reverse repurchase agreements were $132.0 million or 25.4% of total
assets, $129.5 million or 27.6% of total assets, and $117.1 million or 26.7% of
total assets, respectively; and (vi) the Company also periodically reviews the
pricing of hedging strategies such as options and interest rate swaps as a way
to manage it's interest rate risk exposure.
Prior to January 1, 1996, most of the Company's wholesale brokered and
non-brokered certificates of deposits had 90 day initial maturities and, as of
June 30, 2000, the average maturity was four months. During the fiscal year
ended June 30, 2000, management maintained the maturity level fixed-rate term
advances from the FHLB-Chicago to between one to five years. Liquidity is
another factor in asset/liability management. As of June 30, 2000, the Company
had $16.6 million in cash or demand deposits and $74.3 million in its
available-for-sale portfolio, of which $21.6 million is due or will be repriced
within one year. The amount of the held-to-maturity portfolio as of June 30,
2000 was $15.0 million, of which $400,000 will be due or repriced within one
year.
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77
During fiscal 2000, the Company increased its interest rate risk by
funding fixed rate loan assets with shorter-term wholesale deposits and
borrowings. The increase was due to the increase in fixed-rate lending combined
with an interest rate environment during fiscal 2000 that led to a decrease in
the early repayment of fixed-rate loans. However, because of the relative
liquidity of mortgage-backed and related securities, the Company can restructure
its interest-earning asset portfolios more quickly and effectively in a changing
interest rate environment. The Company's ARM loans and ARM mortgage-backed and
related securities typically have annual and lifetime interest rate caps which
reduce their ability to protect the Company against a prolonged and significant
increase in interest rates. Mortgage-backed and related securities are subject
to reinvestment risk. For example, during periods of falling interest rates,
mortgage-backed and related securities are more likely to prepay, and the
Company may not be able to reinvest the proceeds from prepayments in securities
or other assets with yields similar to those of the prepaying mortgage-backed
and related securities.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are rate sensitive and by monitoring
an institution's interest rate sensitivity. An asset or liability is said to be
interest rate sensitive within a specific time period if it matures or reprices
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 reprice within a specific time period and the
amount of interest-bearing liabilities anticipated, based upon certain
assumptions, to mature or reprice within that same time period. An interest rate
sensitivity gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities that
mature or reprice within a specified time period. An interest rate sensitivity
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets that mature or
reprice within a specified time period.
At June 30, 2000 and 1999, total interest-bearing liabilities repricing
within one year exceeded total interest-bearing assets repricing in the same
period by $213.7 million and $120.0 million, respectively, representing a
negative cumulative one-year interest rate sensitivity gap equal to 41.1% and
25.6%, respectively, of total assets. The increase in the Company's negative
one-year gap reflects the increased use of shorter-term maturity wholesale
deposits and borrowings to fund fixed rate mortgage loans. During periods of
rising interest rates, a positive interest rate sensitivity gap would tend to
positively affect net interest income while a negative interest rate sensitivity
gap would tend to adversely affect net interest income. In addition to the
potentially adverse effect on net interest income resulting from increasing
interest rates due to the Company's one-year gap position, the Company could
experience a substantial decrease in prepayments of its fixed-rate mortgage
loans with rising interest rates, which may result in a lower level of proceeds
available for reinvestment.
In addition to measuring the interest rate risk as a static gap
measurement, the Company also measures the impact on interest income with an
instantaneous increase or decrease of interest rates of 100, 200, 300 and 400
basis points. This shock analysis is performed quarterly. A third measurement is
used whereby interest rates are ramped over a one-year time frame with increases
and decreases of 100, 200, 300 and 400 basis points. Management continues to
upgrade its modeling techniques related to asset/liability modeling. Results of
the gap, shock and ramped interest risk analysis are reviewed by the Board of
Directors.
In fiscal 2001, the Company intends to extend the weighted average
maturity level of its fixed-rate liabilities, including FHLB borrowings and
certificates of deposit, to decrease its exposure to rising interest rates.*
Management anticipates that the effect of funding the origination and purchase
of an increasing portfolio of multi-family real estate, multi-family
construction and commercial/nonresidential loans with such liabilities will be
to lessen the Company's negative gap position.* Also, the origination and
purchase of such assets normally carry more desirable interest rate repricing
features as compared to the Company's experience with one-to-four family
mortgage lending.
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. 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 and mortgage-backed and
related securities, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset.
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In addition, the proportion of ARM loans and mortgage-backed and related
securities in the Company's portfolios could decrease in future periods if
market interest rates remain at or decrease below current levels due to
refinance activity. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in the table. Finally, the ability of many borrowers to service
their adjustable-rate debt may decrease in the event of an interest rate
increase.
ASSET/LIABILITY MANAGEMENT SCHEDULE
The following table sets forth at June 30, 2000 the amounts of
interest-earning assets and interest-bearing liabilities maturing or repricing
within the time periods indicated, based on the information and assumptions set
forth in the notes thereto.
AMOUNT MATURING OR REPRICING
--------------------------------------------------------------------------------------------------
MORE THAN MORE THAN
WITHIN FOUR TO ONE YEAR TO THREE YEARS TO
THREE MONTHS TWELVE MONTHS THREE YEARS FIVE YEARS OVER FIVE YEARS
-------------------------------------- ---------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE
--------- ------- ------ ------- ------ ------- ------- ------- ------ -------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS(1):
Mortgage loans(2):
Fixed rate..................... $ 18,865 7.93% $30,000 7.98% $ 69,630 7.79% $70,316 7.95 $ 64,615 7.78%
Adjustable rate................ 33,080 9.75 36,415 7.96 33,866 8.05 5,550 8.82 883 9.33
Consumer loans (2)............... 118 10.94 2,332 13.63 464 10.70 165 11.17 -
Commercial loans (2)............. 9,867 10.71 5,528 9.55 6,570 9.34 1,902 8.66 -
Mortgage-backed and related
securities:
Fixed rate and securities
available-for-sale 1,502 6.80 4,102 6.79 8,520 6.79 5,994 6.78 9,680 6.75
Adjustable rate................ 12,734 6.98 8,430 7.05 - - -
Investment securities and
securities available-for-sale 21,767 6.76 727 5.39 - 9,634 6.03 27,723 7.26
-------- ------- -------- -------- --------
Total interest-earning assets.. $ 97,933 8.43 $87,534 8.05 $119,050 7.89 $93,561 7.75 $102,901 7.56
======== ======= ======== ======== ========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts................... $ 236 1.75 $ 708 1.75 $ 1,123 1.75 $ 551 1.75 $ 529 1.75
Money market deposit accounts.. 4,111 4.95 12,334 4.95 9,209 4.95 1,474 4.95 281 4.95
Passbook savings accounts...... 1,378 2.91 4,134 2.91 6,559 2.91 3,214 2.91 3,087 2.91
Certificates of deposit........ 125,442 6.23 144,556 6.55 16,067 6.01 1,935 5.37 -
Escrow deposits................ - 3,724 2.50 - - -
Borrowings(4)
FHLB advances and other
borrowings.................... 44,510 6.00 58,000 5.89 13,030 5.44 5,000 6.32 11,500 6.00
-------- -------- -------- ------- --------
Total interest-bearing
liabilities................... $175,677 6.11% $223,456 6.14% $ 45,988 5.09% $12,174 4.90% $ 15,397 5.22%
======== ======== ======== ======= ========
Excess (deficiency) of
interest-earning assets over
interest-bearing liabilities... ($77,744) ($135,922) $73,062 $ 81,387 $ 87,504
======== ========= ======= ======== ========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities... ($77,744) ($213,666) ($140,604) ($59,217) $ 28,287
======== ========= ========= ======== ========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as
a percent of total assets...... (15.0)% (41.1)% (27.1)% (11.4)% 5.4%
===== ===== ===== ===== ===
AMOUNT MATURING OR REPRICING
----------------------------
TOTAL
----------------------------
AVERAGE
AMOUNT RATE
------ -------
INTEREST-EARNING ASSETS(1):
Mortgage loans(2):
Fixed rate..................... $253,426 7.87%
Adjustable rate................ 109,794 8.58
Consumer loans (2)............... 3,079 12.95
Commercial loans (2)............. 23,867 9.90
Mortgage-backed and related
securities:
Fixed rate and securities
available-for-sale........... 29,798 6.77
Adjustable rate................ 21,164 7.01
Investment securities and
securities available-for-sale 59,851 6.86
--------
Total interest-earning assets.. $500,979 7.93
========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts................... $ 3,147 1.75
Money market deposit accounts.. 27,409 4.95
Passbook savings accounts...... 18,372 2.91
Certificates of deposit........ 288,000 6.37
Escrow deposits................ 3,724 2.50
Borrowings(4)
FHLB advances and other
borrowings.................... 132,040 5.89
--------
Total interest-bearing
liabilities................... $472,692 5.96%
========
Excess (deficiency) of
interest-earning assets over
interest-bearing liabilities... $ 28,287
========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities... $ 28,287
========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as
a percent of total assets...... 5.4%
===
(1) Adjustable- and floating-rate assets are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due, and fixed-rate assets are included in the periods in
which they are scheduled to be repaid based on scheduled amortization, in
each case adjusted to take into account estimated prepayments utilizing the
Company's historical prepayment statistics modified for forecasted
statistics using annual prepayment rates ranging from 8% to 20%, based on
the loan type.
(2) Balances have been reduced for undisbursed loan proceeds, unearned credit
insurance premiums, deferred loan fees, purchased loan discounts and the
allowance for loan losses, which aggregated $22.4 million at June 30, 2000.
(3) Although the Company's negotiable order of withdrawal ("NOW") accounts,
passbook savings accounts and money market deposit accounts generally are
subject to immediate withdrawal, management considers a certain historical
amount of such accounts to be core deposits having significantly longer
effective maturities and times to repricing based on the Company's
historical retention of such deposits in changing interest rate
environments. NOW accounts, passbook savings accounts and money market
deposit accounts are assumed to be withdrawn at annual rates of 30%, 30%
and 60%, respectively, of the declining balance of such accounts during the
period shown. The withdrawal rates used are higher than the Company's
historical rates but are considered by management to be more indicative of
expected withdrawal rates currently. If all of the Company's NOW accounts,
passbook savings accounts and money market deposit accounts had been
assumed to be subject to repricing within one year, the one-year cumulative
deficiency of interest-earning assets over interest-bearing liabilities
would have been $239.7 million or 46.1% of total assets.
(4) Adjustable- and floating-rate borrowings are included in the period in
which their interest rates are next scheduled to adjust rather than in the
period in which they are due.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A derivative financial instrument includes futures, forwards, interest
rate swaps, option contracts and other financial instruments with similar
characteristics. The Company generally has not entered into futures, forwards,
swaps or options but has decided to purchase interest rate caps to manage the
interest rate risk on the Company's short-term wholesale certificates of
deposit. The Company is party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments consist primarily of commitments to
extend credit. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the consolidated
balance sheets. Commitments to extend credit 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 and may require
collateral from the borrower if deemed necessary by the Company.
Additional information required herein pursuant to Item 305 of
Regulation S-K is incorporated by reference in sections entitled "Liquidity and
Capital Resources" from pages 70 to 72 and "Asset/Liability Management" from
pages 73 to 75 hereof.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Hallmark Capital Corp.:
We have audited the accompanying consolidated statements of financial condition
of Hallmark Capital Corp. and subsidiary (the "Company") as of June 30, 2000 and
1999, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the years in the three-year period ended June 30,
2000. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hallmark Capital
Corp. and subsidiary as of June 30, 2000 and 1999 and the results of their
operations and their cash flows for each of the years in the three-year period
ended June 30, 2000, in conformity with accounting principles generally accepted
in the United States of America.
KPMG LLP
Milwaukee, Wisconsin
July 28, 2000
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
AT JUNE 30,
---------------------
2000 1999
------ -------
ASSETS
Cash and non-interest bearing deposits ................................... $ 2,782 $ 3,582
Interest-bearing deposits ................................................ 13,777 5,017
--------- ---------
Cash and cash equivalents ................................................ 16,559 8,599
Securities available-for-sale (at fair value):
Investment securities .................................................. 38,315 44,902
Mortgage-backed and related securities ................................. 35,944 55,566
Securities held-to-maturity:
Mortgage-backed and related securities (fair value -
$14,685 at June 30, 2000 $54,854 at June 30, 1999) ................... 15,017 54,618
Loans held for sale, at lower of cost or market .......................... 1,122 6,437
Loans receivable, net .................................................... 391,764 281,120
Investment in Federal Home Loan Bank stock, at cost ...................... 7,760 6,527
Foreclosed properties, net ............................................... 1,114 621
Office properties and equipment .......................................... 5,461 5,771
Prepaid expenses and other assets ........................................ 6,528 5,498
--------- ---------
Total assets ................................................... $ 519,584 $ 469,659
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits ............................................................... $ 345,318 $ 288,714
Notes payable and other borrowings ..................................... 132,040 129,519
Advance payments by borrowers for taxes and insurance .................. 3,724 3,225
Accrued interest on deposit accounts and borrowings .................... 3,421 2,006
Accrued expenses and other liabilities ................................. 1,726 11,699
--------- ---------
Total liabilities .............................................. $ 486,229 $ 435,163
Shareholders' Equity:
Preferred stock, $1.00 par value; authorized 2,000,000 shares;
none outstanding ..................................................... -- --
Common stock, $1.00 par value; authorized 6,000,000 shares;
issued 3,162,500 shares; outstanding 2,563,241 shares at June 30, 2000
and 2,839,941 at June 30, 1999 ....................................... 3,162 3,162
Additional paid-in capital ............................................. 10,075 9,937
Unearned ESOP compensation ............................................. (311) (405)
Unearned restricted stock award ........................................ (74) (78)
Retained earnings, substantially restricted ............................ 28,386 25,765
Accumulated other comprehensive loss, net of tax ....................... (2,059) (1,089)
Treasury stock, at cost: 599,259 shares at June 30, 2000
and 322,559 shares at June 30, 1999 ................................. (5,824) (2,796)
--------- ---------
Total shareholders' equity ..................................... $ 33,355 $ 34,496
--------- ---------
Total liabilities and shareholders' equity ..................... $ 519,584 $ 469,659
========= =========
See accompanying Notes to Consolidated Financial Statements
-78-
82
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
FOR THE YEARS ENDED
JUNE 30,
-----------------------------------------
2000 1999 1998
---------- ----------- ----------
INTEREST INCOME:
Loans receivable.................................................. $ 28,813 $ 23,547 $ 23,794
Securities and interest-bearing deposits.......................... 5,416 2,938 1,858
Mortgage-backed and related securities............................ 4,210 7,813 6,575
---------- ----------- ----------
Total interest income......................................... 38,439 34,298 32,227
INTEREST EXPENSE:
Deposits.......................................................... 16,984 15,163 14,956
Advance payments by borrowers for taxes and insurance............. 71 75 84
Notes payable and other borrowings................................ 8,968 7,576 6,546
---------- ----------- ----------
Total interest expense........................................ 26,023 22,814 21,586
---------- ----------- ----------
Net interest income.................................................... 12,416 11,484 10,641
Provision for losses on loans.......................................... 871 480 800
---------- ----------- ----------
Net interest income after provision for losses on loans................ 11,545 11,004 9,841
NON-INTEREST INCOME:
Service charges on loans.......................................... 300 334 288
Service charges on deposit accounts............................... 457 451 429
Loan servicing fees, net.......................................... 50 21 61
Insurance commissions............................................. 125 90 49
Gain (loss) on sale of securities and
mortgage-backed and related securities, net..................... 48 68 (8)
Gain on sale of loans ............................................ 9 892 297
Other income...................................................... 242 226 92
---------- ----------- ----------
Total non-interest income..................................... 1,231 2,082 1,208
NON-INTEREST EXPENSE:
Compensation and benefits......................................... 4,861 5,021 3,958
Marketing......................................................... 366 352 380
Occupancy and equipment........................................... 1,473 1,605 1,158
Deposit insurance premiums........................................ 122 173 174
Other non-interest expense ....................................... 1,569 1,300 1,177
---------- ----------- ----------
Total non-interest expense.................................... 8,391 8,451 6,847
---------- ----------- ----------
Income before income taxes............................................. 4,385 4,635 4,202
Income taxes.......................................................... 1,381 1,505 1,403
---------- ----------- ----------
Net income........................................................ $ 3,004 $ 3,130 $ 2,799
========== =========== ==========
Earnings per share (basic)........................................ $ 1.17 $ 1.13 $ 1.01
========== =========== ==========
Earnings per share (diluted)...................................... $ 1.14 $ 1.10 $ 0.97
========== =========== ==========
Dividends per share............................................... $ 0.15 $ 0.00 $ 0.00
========== =========== ==========
See accompanying Notes to Consolidated Financial Statement
-79-
83
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
ADDITIONAL UNEARNED UNEARNED
COMMON PAID-IN ESOP RESTRICTED
STOCK CAPITAL COMPENSATION STOCK
------- --------- ------------ -----------
Balance at June 30, 1997................................ $3,162 $9,022 ($632) ($208)
Net income.............................................. -- -- -- --
Other comprehensive income
Unrealized holding gain arising during period......... -- -- -- --
Re-classification adjustment for losses realized in
income.............................................. -- -- -- --
Income tax effect..................................... -- -- -- --
Comprehensive Income.................................... -- -- -- --
Amortization of unearned ESOP and
restricted stock award compensation................... -- 270 100 84
Exercise of stock options (47,708 shares issued
in connection with 55,340 options exercised).......... -- 220 -- --
-------- --------- ------ -----
Balance at June 30, 1998................................ $3,162 $9,512 ($532) ($124)
Net income.............................................. -- -- -- --
Other comprehensive income
Unrealized holding loss arising during period......... -- -- -- --
Re-classification adjustment for gains realized in
income............................................... -- -- -- --
Income tax effect..................................... -- -- -- --
Comprehensive Income.................................... -- -- -- --
Amortization of unearned ESOP and
restricted stock award compensation................... -- 248 127 46
Purchase of 146,900 shares for treasury stock .......... -- -- -- --
Exercise of stock options (53,233 shares issued
in connection with 61,294 options exercised).......... -- 177 -- --
-------- -------- ------ ------
Balance at June 30, 1999................................ $3,162 $9,937 ($405) ($78)
Net income.............................................. -- -- -- --
Other comprehensive income
Unrealized holding loss arising during period......... -- -- -- --
Re-classification adjustment for gains realized in
income.............................................. -- -- -- --
Income tax effect..................................... -- -- -- --
Comprehensive Income.................................... -- -- -- --
Cash dividends paid ($.15 per share).................... -- -- -- --
Amortization of unearned ESOP and
restricted stock award compensation................... -- 138 94 4
Purchase of 276,700 shares for treasury stock .......... -- -- -- --
-------- --------- ------ ------
Balance at June 30, 2000................................ $3,162 $10,075 ($311) ($74)
======== ========= ====== ======
ACCUMULATED
OTHER TOTAL
RETAINED TREASURY COMPREHENSIVE SHAREHOLDERS'
EARNINGS STOCK LOSS, NET OF TAX EQUITY
---------- ------- ---------------- ---------
Balance at June 30, 1997................................ $20,145 ($1,592) ($225) $29,672
Net income.............................................. 2,799 -- -- 2,799
Other comprehensive income
Unrealized holding gain arising during period......... -- -- 318 318
Re-classification adjustment for losses realized in
income.............................................. -- -- 8 8
Income tax effect..................................... -- -- (128) (128)
-------
Comprehensive Income.................................... -- -- -- 2,997
Amortization of unearned ESOP and
restricted stock award compensation................... -- -- -- 454
Exercise of stock options (47,708 shares issued
in connection with 55,340 options exercised).......... (97) 207 -- 330
--------- --------- --------- -------
Balance at June 30, 1998................................ $22,847 ($1,385) ($27) $33,453
Net income.............................................. 3,130 -- -- 3,130
Other comprehensive income
Unrealized holding loss arising during period......... -- -- (1,720) (1,720)
Re-classification adjustment for gains realized in
income............................................... -- -- (68) (68)
Income tax effect..................................... -- -- 726 726
-------
Comprehensive Income.................................... -- -- -- 2,068
Amortization of unearned ESOP and
restricted stock award compensation................... -- -- -- 421
Purchase of 146,900 shares for treasury stock .......... -- (1,784) -- (1,784)
Exercise of stock options (53,233 shares issued
in connection with 61,294 options exercised).......... (212) 373 -- 338
--------- --------- --------- -------
Balance at June 30, 1999................................ $25,765 ($2,796) ($1,089) $34,496
Net income.............................................. 3,004 -- -- 3,004
Other comprehensive income
Unrealized holding loss arising during period......... -- -- (1,534) (1,534)
Re-classification adjustment for gains realized in
income.............................................. -- -- (48) (48)
Income tax effect..................................... -- -- 612 612
-------
Comprehensive Income.................................... -- -- -- (970)
Cash dividends paid ($.15 per share).................... (383) -- -- (383)
Amortization of unearned ESOP and
restricted stock award compensation................... -- -- -- 236
Purchase of 276,700 shares for treasury stock .......... -- (3,028) -- (3,028)
--------- -------- ------- -------
Balance at June 30, 2000................................ $28,386 ($5,824) ($2,059) $33,355
========= ======== ======= =======
See accompanying Notes to Consolidated Financial Statements
-80-
84
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED
JUNE 30,
---------------------------------------
2000 1999 1998
--------- ---------- ----------
OPERATING ACTIVITIES
Net income ........................................................... $ 3,004 $ 3,130 $ 2,799
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Provision for losses on loans ...................................... 871 480 800
Provision for depreciation and amortization ........................ 618 394 321
Deferred income taxes .............................................. (399) (246) (288)
Net (gain) loss on sales of investments and
mortgage-backed and related securities ........................... (48) (68) 8
Proceeds from sale of trading securities ........................... 25,499 -- --
Net gain on sale of loans .......................................... (9) (892) (297)
Amortization of unearned ESOP and restricted stock awards .......... 236 421 454
Loans originated for sale .......................................... (34,008) (54,499) (20,213)
Sales of loans originated for sale ................................. 33,112 50,118 18,157
(Increase) decrease in prepaid expenses and other assets ........... (19) (1,964) 143
Increase (decrease) in other liabilities ........................... (8,558) 74 10,125
Other adjustments .................................................. -- 1,637 (153)
--------- --------- ---------
Net cash provided by (used in) operating activities .................. 20,299 (1,415) 11,856
--------- --------- ---------
INVESTING ACTIVITIES
Proceeds from the sale of securities available-for-sale .............. 45,209 10,641 20,881
Proceeds from the maturity of securities available-for-sale .......... 4,160 8,365 4,000
Purchases of securities available-for-sale ........................... (34,737) (125,264) (69,928)
Purchases of investment securities held-to-maturity .................. -- (184) (352)
Proceeds from maturities of investments held-to-maturity ............. -- 572 392
Purchases of mortgage-backed and related securities .................. (8,096) (12,314) --
Principal collected on mortgage-backed and related securities ........ 32,031 93,379 28,845
Net change in loans receivable ....................................... (106,768) (440) (8,103)
Proceeds from sales of foreclosed properties ......................... 980 11 273
Purchase of Federal Home Loan Bank stock ............................. (1,233) (595) (653)
Purchases of office properties and equipment, net .................... (98) (512) (2,883)
--------- --------- ---------
Net cash used in investing activities ................................ (68,552) (26,341) (27,528)
--------- --------- ---------
FINANCING ACTIVITIES
Net increase (decrease) in deposits .................................. 56,604 17,095 (9,893)
Proceeds from long-term notes payable to Federal Home Loan Bank ...... 95,000 25,000 50,000
Net increase (decrease) in short-term notes payable and other
borrowings ......................................................... 9,035 10,475 --
Repayment of long-term notes payable to Federal Home Loan Bank ....... (101,514) (23,015) (25,014)
Net increase (decrease) in advance payments by borrowers for taxes
and insurance ...................................................... 499 62 (322)
Purchase of treasury stock ........................................... (3,028) (1,784) --
Cash dividends ....................................................... (383) -- --
Stock option transactions ............................................ -- 338 330
--------- --------- ---------
Net cash provided by financing activities ............................ 56,213 28,171 15,101
--------- --------- ---------
Increase (decrease) in cash and cash equivalents ..................... 7,960 415 (571)
Cash and cash equivalents at beginning of year ....................... 8,599 8,184 8,755
--------- --------- ---------
Cash and cash equivalents at end of year ............................. $ 16,559 $ 8,599 $ 8,184
========= ========= =========
See accompanying Notes to Consolidated Financial Statements
-81-
85
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED
JUNE 30,
--------------------------------
2000 1999 1998
-------- -------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid (including amounts credited to deposit accounts)... $24,629 $22,265 $21,714
Income taxes paid ............................................... $ 1,505 $ 1,724 $ 1,737
Non-cash transactions:
Loans transferred to foreclosed properties ...................... $ 1,473 $ 682 $ 267
Loans-held-for-sale transferred to loan portfolio ............... $12,355 $ -- $ --
Securities and mortgage-backed securities reclassified to
trading and securities available-for-sale ....................... $37,879 $ -- $ --
See accompanying Notes to Consolidated Financial Statements
-82-
86
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Hallmark Capital Corp. (the "Company") is the holding company for West Allis
Savings Bank (the "Bank"), a Wisconsin state-chartered savings bank. The Company
provides a wide range of financial services including real-estate mortgage,
commercial and consumer loans and transaction and time deposit accounts and the
sale of certain non-deposit financial products to individual and corporate
customers through the Bank with locations in the counties of Milwaukee and
Waukesha, Wisconsin. The Bank is subject to the regulations of certain federal
and state agencies and undergoes periodic examinations by those regulatory
authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in accordance with
United States generally accepted accounting principles ("GAAP") and include the
accounts of the Company and its wholly-owned subsidiary, West Allis Savings
Bank, and its subsidiaries, for the entire period presented. Significant
intercompany accounts and transactions have been eliminated. In preparing
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ significantly from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for losses on loans and the valuation of real
estate acquired in connection with foreclosure or in satisfaction of loans. In
connection with the determination of the allowance for loan losses and
foreclosed assets, management obtains independent appraisals for significant
properties.
STATEMENTS OF CASH FLOWS
For the purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash on hand and interest-bearing deposits with the FHLB and
other financial institutions. The Company considers interest-bearing deposits
having a maturity of three months or less when purchased to be cash equivalents.
SECURITIES
Management determines the appropriate classification of debt and equity
securities at the time of purchase and reevaluates such designation as of each
financial statement reporting date. Debt securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
the securities to maturity. Held-to-maturity securities are stated at amortized
cost. Trading account securities are carried at fair value. Gains and losses on
sales and changes in market value are included in non-interest income. Debt
securities not classified as trading or held-to-maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity for the periods presented. The amortized cost of debt
securities classified as held-to-maturity or available-for-sale is adjusted for
the amortization of premiums and accretion of discounts to maturity, or in the
case of mortgage-backed and related securities, over the estimated life of the
security. Such amortization or accretion is included in interest income from the
related security. Interest and dividends are included in interest income from
the related securities. Realized gains and losses and declines in value judged
to be other-than-temporary are included in gain (loss) on sale of securities and
mortgage-backed and related securities, net. The cost of securities sold is
based on the specific identification method.
LOANS HELD FOR SALE
Loans held for sale are recorded at the lower of aggregate cost or market value
and generally consist of certain fixed-rate first mortgage loans which are
expected to be sold in the foreseeable future. Fees received from the borrower
and direct costs to originate the loans are deferred and recorded as an
adjustment of the sales price. Loans transferred from the held-for-sale category
to the loan portfolio are valued at the lower of cost or market value at the
time of transfer. Any unrealized loss at the time of transfer is accounted for
as a discount and is amortized to interest income using a yield method.
-83-
87
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS RECEIVABLE AND INTEREST ON LOANS AND LOAN FEES
Loans receivable which are originated or purchased with the intent and ability
to hold to maturity or for the foreseeable future are carried at their unpaid
principal balances. Interest on loans is recorded as income in the period
earned. An allowance for interest is established for uncollected interest on
loans when any payments are 91 days or more past due and on loans which are
impaired. Impaired loans are defined as all non-accrual loans except for
one-to-four family residential real estate loans and consumer loans. Loan
origination and commitment fees and certain direct loan origination costs are
deferred and the net amounts are amortized as an adjustment to the related
loan's yield. The Bank is amortizing these amounts using the level-yield method
over the contractual life of the related loans.
Impaired loans are measured at the present value of 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. Interest income is not recognized on these loans
until the principal balance has been reduced sufficiently to ensure future
collections and then generally on a cash basis only.
Mortgage servicing rights associated with loans originated and sold, where
servicing is retained, are capitalized and included in other assets in the
balance sheet. The value of these capitalized servicing rights is amortized in
relation to the servicing revenue expected to be earned. Impairment of mortgage
servicing rights is assessed based on the fair value of those rights. The
Company periodically evaluates the carrying value and remaining amortization
periods for impairment. For purposes of measuring impairment, the rights are
stratified into certain risk characteristics including underlying loan type,
note rate, prepayment trends and external market factors. The amortization of
servicing rights is netted against loan servicing fees.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision charged to
expense and is maintained at a level believed adequate by management to absorb
probable losses in the loan portfolio. Management's determination of the
adequacy of the allowance is based on an evaluation of the portfolio and, among
other things, the borrowers' ability to repay, estimated collateral values,
prior loss experience, and growth and composition of the portfolio; however,
future additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies periodically review the
allowance for loan losses. These agencies may require the Bank to make additions
to the allowance for loan losses based on information available to them at the
time of their examination.
INVESTMENT IN FEDERAL HOME LOAN BANK STOCK
The Company's investment in Federal Home Loan Bank stock is held as required by
current regulation and is carried at cost which is the amount at which it can be
redeemed and which approximates fair value since the market for this stock is
limited. Dividends are received from the Federal Home Loan Bank stock and are
included in interest income on securities.
FORECLOSED PROPERTIES
Foreclosed properties (which were acquired by foreclosure or by deed in lieu of
foreclosure) are initially recorded at the lower of cost or fair value minus
estimated costs to sell at the date of foreclosure and any loss at that time is
charged to the allowance for loan losses. Costs related to the development and
improvement of property are capitalized, whereas costs related to holding the
property are expensed. Valuations are periodically performed by management and
independent third parties, any future adjustments to the value of the foreclosed
property are recorded through the income statement. An allowance for losses is
established by a charge to expense if the carrying value of a property exceeds
its fair value minus estimated costs to sell.
-84-
88
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OFFICE PROPERTIES AND EQUIPMENT
Premises and equipment are recorded at cost less accumulated depreciation and
amortization. Depreciation and amortization expense are provided on a
straight-line basis over the estimated useful lives of the assets. The cost of
leasehold improvements is amortized on the straight-line basis over the lesser
of the term of the respective lease or the estimated economic life of the
improvements. Expenditures for normal repairs and maintenance are charged to
expense as incurred. When properties are retired or otherwise disposed of, the
related cost and accumulated depreciation are removed from the respective
accounts and the resulting gain or loss is recorded in income.
INCOME TAXES
The Company accounts for income taxes using the liability method. Under this
method deferred tax assets and liabilities are determined based on the temporary
difference between financial reporting and the tax basis of assets and
liabilities and are measured using the enacted tax rates and laws in effect.
Deferred tax assets are reduced by a valuation allowance when in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
EARNINGS PER SHARE
Basic earnings per share is derived by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding and
does not include the impact of any potentially dilutive common stock
equivalents. The diluted earnings per share calculation is derived by dividing
net income by the weighted-average number of shares outstanding, adjusted for
the dilutive effect of stock options.
REPORTING COMPREHENSIVE INCOME
All items that are required to be recognized under accounting standards as
components of comprehensive income are to be reported in a financial statement
that is displayed with the same prominence as other financial statements.
Accounting standards require that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in-capital in the equity section of the balance
sheet. The Company's other comprehensive income comprises unrealized gains and
losses on available for sale securities and the related deferred tax impact.
SEGMENTS AND RELATED INFORMATION
The Company through the branch network of its subsidiaries provides a broad
range of financial services to individuals and companies in southeastern
Wisconsin. These services include demand, time and savings deposits; the sale of
certain non-deposit financial products; and commercial and retail lending. While
the Company's chief decision-maker monitors the revenue streams of the various
products and services, operations are managed and financial performance is
evaluated on a corporate-wide basis. Accordingly, all of the Company's
operations are considered by management to be aggregated in one reportable
operating segment.
-85-
89
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
On January 1, 2000, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
("Statement 133"). Statement 133 standardizes the accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts. Under the standard, entities are required to carry all derivative
instruments in the statement of financial position at fair value. The accounting
for changes in the fair value (i.e. gains or losses) of a derivative instrument
depends on whether it has been designed and qualifies as part of a hedging
relationship and, if so, on the reason for holding it. If certain conditions are
met, entities may elect to designate a derivative instrument as a hedge of
exposures to changes in fair values, cash flows, or foreign currencies. If the
hedged exposure is a fair value exposure, the gain or loss on the derivative
instrument is recognized in earnings in the period of change together with the
offsetting loss or gain on the hedged item attributable to the risk being
hedged. If the hedged exposure is a cash flow exposure, the effective portion of
the gain or loss on the derivative instrument is reported initially as a
component of other comprehensive income (outside earnings) and subsequently
reclassified into earnings when the forecasted transaction affects earnings. Any
amounts excluded from the assessment of hedge effectiveness as well as the
ineffective portion of the gain or loss is reported in earnings immediately.
Accounting for foreign currency hedges is similar to the accounting for fair
value and cash flow hedges. If the derivative instrument is not designed as a
hedge, the gain or loss is recognized in earnings in the period of change.
The Company formally documents all relationships between hedging instruments and
hedged items as well as its risk-management objective and strategy for
undertaking the hedge transaction. This process includes linking derivatives
that are designated as fair value or cash flow hedges to specific recorded
assets or liabilities or to firm commitments on forecasted transactions.
The Company formally assesses at inception and on an ongoing basis, whether
derivatives that are used in hedging transactions have been highly effective in
offsetting fair values or cash flows of hedged items and whether they are
expected to continue to be highly effective in the future.
If at any time the Company determined that the hedge was no longer effective, or
if the hedged forecasted transactions were not executed, hedge accounting would
be discontinued and the derivative instrument would continue to be marked to its
fair value with gains or losses recognized in non-interest income. The change in
fair value of derivative instruments designated as cash flow hedges will be
recognized in other comprehensive income in future periods and the changes in
the fair value of derivative instruments designated as fair value hedges will be
recognized in non-interest income or expense.
At June 30, 2000, the interest rate caps are the only derivative instruments
used by the Company to manage interest rate risk. The Company's derivative
activities are monitored by its Asset Liability Committee as part of that
Committee's oversight of risk management and asset/liability functions.
On July 1, 2000, the Company adopted Statement of Financial Accounting Standards
No. 138, Accounting for Certain Derivative Instruments and Hedging Activities.
This Statement modifies certain provisions of Statement of Financial Accounting
Standards No. 133. Adoption will have no impact on the Company's Statement of
Financial Condition or its results of operations.
-86-
90
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income for the years
ended June 30, 2000, 1999 and 1998 by the weighted average number of shares of
common stock reduced by ungranted restricted stock and uncommitted ESOP shares.
Diluted earnings per share is calculated by dividing net income by the sum of
the weighted average shares used in the basic earnings per share calculation
plus the effect of dilutive stock options. The effect of dilutive stock options
is calculated using the treasury stock method.
The computation of net income per common share is as follows:
FOR THE YEAR ENDED JUNE 30, 2000 BASIC DILUTED
- -------------------------------- ----- -------
Weighted average common shares outstanding............................... 2,670,519 2,670,519
Ungranted restricted stock............................................... (18,462) (18,462)
Uncommitted ESOP shares.................................................. (90,658) (90,658)
Common stock equivalents due to dilutive effect of stock options......... -- 73,872
----------- -----------
Total weighted average common shares and equivalents outstanding......... 2,561,399 2,635,271
=========== ===========
Net income for period.................................................... $ 3,004,000 $3,004,000
Earnings per share....................................................... $ 1.17 $ 1.14
=========== ===========
FOR THE YEAR ENDED JUNE 30, 1999 BASIC DILUTED
- -------------------------------- ----- -------
Weighted average common shares outstanding............................... 2,898,004 2,898,004
Ungranted restricted stock............................................... (18,462) (18,462)
Uncommitted ESOP shares.................................................. (113,850) (113,850)
Common stock equivalents due to dilutive effect of stock options......... -- 85,942
----------- -----------
Total weighted average common shares and equivalents outstanding......... 2,765,692 2,851,634
=========== ===========
Net income for period.................................................... $ 3,130,000 $ 3,130,000
Earnings per share....................................................... $ 1.13 $ 1.10
=========== ===========
FOR THE YEAR ENDED JUNE 30, 1998 BASIC DILUTED
- -------------------------------- ----- -------
Weighted average common shares outstanding............................... 2,918,075 2,918,075
Ungranted restricted stock............................................... (18,462) (18,462)
Uncommitted ESOP shares.................................................. (139,150) (139,150)
Common stock equivalents due to dilutive effect of stock options......... -- 121,306
----------- -----------
Total weighted average common shares and equivalents outstanding......... 2,760,463 2,881,769
=========== ===========
Net income for period.................................................... $ 2,799,000 $ 2,799,000
Earnings per share....................................................... $ 1.01 $ 0.97
=========== ===========
RECLASSIFICATIONS
Certain amounts in the 1998 and 1999 financial statements have been reclassified
to conform with the 2000 presentation.
-87-
91
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SECURITIES
The following is a summary of available-for-sale securities and held-to-maturity
securities.
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
(IN THOUSANDS)
At June 30, 2000:
Available-For-Sale:
U.S. Government and federal agency obligations......... $ 34,905 $ -- $ 2,147 $ 32,758
Adjustable-rate mortgage mutual funds.................. 1,000 -- 42 958
Trust preferred stock.................................. 4,975 -- 650 4,325
Municipal Bonds/other.................................. 275 -- 1 274
--------- ---------- --------- ------------
$ 41,155 $ -- $ 2,840 $ 38,315
========= ========== ========= ============
At June 30, 1999:
Available-For-Sale:
U.S. Government and federal agency obligations.......... $ 39,914 $ -- $ 1,212 $ 38,702
Adjustable-rate mortgage mutual funds .................. 1,000 -- 36 964
Trust preferred stock................................... 4,991 25 219 4,797
Municipal Bonds......................................... 435 4 -- 439
--------- ---------- --------- ------------
$ 46,340 $ 29 $ 1,467 $ 44,902
========= ========== ========= ============
The amortized cost and estimated fair value of investment securities at June 30,
2000 by contractual maturity, are shown below.
AVAILABLE- AVAILABLE-
FOR-SALE FOR-SALE
AMORTIZED ESTIMATED
COST FAIR VALUE
------------ --------------
(IN THOUSANDS)
Due in one year or less....................................... $ -- $ --
Due after one year through five years......................... 10,000 9,634
Due after five years through ten years........................ 2,275 2,152
Due after ten years........................................... 28,880 26,529
------------ --------------
$ 41,155 $ 38,315
============ ==============
Proceeds from the sale of securities available-for-sale were $45,209,000,
$10,641,000 and $20,881,000 during the years ended June 30, 2000, 1999 and 1998,
respectively. The gross realized losses on such sales totaled $51,000 in 2000,
$2,000 in 1999 and $74,000 in 1998. The gross realized gains on such sales
totaled $115,000 in 2000, $70,000 in 1999 and $66,000 in 1998. There were no
sales of held-to-maturity securities during 2000, 1999 and 1998. Proceeds from
the sale of trading securities were $25,499,000 during the year ended June 30,
2000. The gross realized losses on such sales totaled $297,000 in 2000. The
gross realized gains on such sales totaled $281,000 in 2000. There were no sales
of trading securities during 1999 and 1998.
-88-
92
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. MORTGAGE-BACKED AND RELATED SECURITIES
The following is a summary of available-for-sale and held-to-maturity
mortgage-backed and related securities.
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ -------------- ------------ -------------
(IN THOUSANDS)
At June 30, 2000:
Available-For-Sale:
Mortgage-backed securities
Adjustable-rate ................. $ 4,655 $ 40 $ 31 $ 4,664
Fixed-rate ...................... 8,328 1 287 8,042
Collateralized mortgage obligations
Adjustable-rate ................ 16,675 13 188 16,500
Fixed-rate ..................... 6,860 8 130 6,738
------- ------- ------- -------
$36,518 $ 62 $ 636 $35,944
======= ======= ======= =======
Held-To-Maturity:
Mortgage-backed securities
Fixed-rate ....................... $ 1,390 $ 1 $ 28 $ 1,363
Collateralized mortgage obligations:
Adjustable-rate .................. -- -- -- --
Fixed-rate ....................... 13,627 -- 305 13,322
------- ------- ------- -------
$15,017 $ 1 $ 333 $14,685
======= ======= ======= =======
At June 30, 1999:
Available-For-Sale:
Mortgage-backed securities
Adjustable-rate .................. $ 2,788 $ 10 $ 4 $ 2,794
Fixed-rate ....................... 14,291 -- 142 14,149
Collateralized mortgage obligations
Adjustable-rate .................. 25,868 10 153 25,725
Fixed-rate ....................... 13,013 1 116 12,898
------- ------- ------- -------
$55,960 $ 21 $ 415 $55,566
======= ======= ======= =======
Held-To-Maturity:
Mortgage-backed securities
Adjustable-rate .................. $ 8,840 $ 76 $ 38 $ 8,878
Fixed-rate ....................... 2,419 24 24 2,419
Collateralized mortgage obligations:
Adjustable-rate .................. 34,338 366 150 34,554
Fixed-rate ....................... 9,021 22 40 9,003
------- ------- ------- -------
$54,618 $ 488 $ 252 $54,854
======= ======= ======= =======
-89-
93
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. MORTGAGE-BACKED AND RELATED SECURITIES (CONTINUED)
The following table is a summary of aggregate mortgage-backed and related
securities by issuer.
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----------
(IN THOUSANDS)
At June 30, 2000:
Federal Home Loan Mortgage Corporation (FHLMC) .................... $ 8,976 $ 5 $ 322 $ 8,659
Federal National Mortgage Association (FNMA) ...................... 6,770 31 104 6,697
Government National Mortgage Association (GNMA) ................... 78 2 -- 80
Private issuers ................................................... 35,711 25 543 35,193
--------- ---------- ---------- -----------
$ 51,535 $ 63 $ 969 $ 50,629
========= ========== ========== ===========
At June 30, 1999:
FHLMC ............................................................. $ 21,858 $ 249 $ 172 $ 21,935
FNMA .............................................................. 24,304 199 126 24,377
GNMA .............................................................. 5,481 23 -- 5,504
Private issuers ................................................... 58,935 38 369 58,604
--------- ---------- ---------- -----------
$ 110,578 $ 509 $ 667 $ 110,420
========= ========== ========== ===========
There were no sales of mortgage-backed and related securities held-to-maturity
for the years ended June 30, 2000, 1999 and 1998.
As permitted by the adoption of Financial Accounting Standards Board Statement
No. 133 Accounting for Derivative Instruments and Hedging Activities, the
Company transferred held-to-maturity mortgage-backed and related securities with
a carrying value of $37,803,000 to trading securities ($24,320,000) and to
securities available-for-sale ($13,483,000). At the time of transfer there was
an unrealized gain on the trading securities of $16,000 and an unrealized gain
on the securities available-for-sale of $60,000. The unrealized gains are
included in the gain on sale of securities and mortgage-backed and related
securities in the Consolidated Statements of Income for the trading securities
and in Other Comprehensive Income-Unrealized Holding Loss for the year ended
June 30, 2000 and are not presented as a cumulative effect of an accounting
change due to their immateriality to net income and comprehensive income for the
period.
-90-
94
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS RECEIVABLE
Loans receivable are summarized as follows:
AT JUNE 30,
--------------------------------------------
2000 1999
-------------------- ---------------------
(IN THOUSANDS)
Real estate mortgage loans:
Residential one-to-four family......................................... $ 186,276 $ 147,960
Residential multi-family............................................... 41,751 36,320
Commercial real estate................................................. 86,521 42,366
Home equity............................................................ 21,758 20,457
Residential construction............................................... 21,284 12,673
Other construction and land............................................ 27,179 17,056
------------------ -------------------
Total real estate mortgage loans.................................. 384,769 276,832
Consumer and other loans:
Automobile............................................................. 262 444
Credit card............................................................ 2,112 2,372
Other.................................................................. 853 1,030
------------------ ------------------
Total consumer and other loans.................................... 3,227 3,846
Commercial loans........................................................... 24,589 18,254
------------------ ------------------
Gross loans....................................................... 412,585 298,932
Accrued interest receivable................................................ 2,031 1,664
Less:
Undisbursed portion of loan proceeds................................... (18,589) (16,279)
Deferred loan fees..................................................... (630) (490)
Deferred interest on sale of REO....................................... (61) --
Deferred gain on sale of REO........................................... (58) --
Unearned interest...................................................... (313) (59)
Allowance for loan losses.............................................. (3,201) (2,648)
------------------ ------------------
$ 391,764 $ 281,120
================== ==================
Activity in the allowance for loan losses is summarized as follows:
FOR THE YEARS ENDED
JUNE 30,
--------------------------------------
2000 1999 1998
------------ ------------ ------------
(IN THOUSANDS)
Balance at beginning of year............................................... $ 2,648 $ 2,329 $ 1,762
Provisions charged to expense.............................................. 871 480 800
Charge-offs................................................................ (340) (176) (264)
Recoveries................................................................. 22 15 31
-------- -------- --------
Balance at end of year..................................................... $ 3,201 $ 2,648 $ 2,329
======== ======== ========
Non-accrual loans for which interest is recognized only when received, totaled
approximately $1,852,000 and $2,206,000 at June 30, 2000 and 1999, respectively.
-91-
95
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS RECEIVABLE (CONTINUED)
Non-performing loans include troubled debt restructuring and loans on which
accrual of interest, amortization of deferred net fees or costs and accretion of
discount has ceased. Non-performing loans totaled $1,870,000, $2,425,000 and
$1,400,000 at June 30, 2000, 1999 and 1998, respectively. The effect of
non-performing loans on interest income is as follows:
FOR THE YEARS ENDED JUNE 30,
------------------------------------------
2000 1999 1998
-------- ---------- ---------
(IN THOUSANDS)
Interest at original contract rate................... $ 351 $ 368 $ 178
Interest collected................................... 124 108 93
-------- ---------- --------
Net reduction of interest income..................... $ 227 $ 260 $ 85
======== ========== ========
At June 30, 2000 the Company has identified three loans with an aggregate
balance of $880,000 as being impaired. These loans have $67,000 in allocated
loan loss reserves. During the fiscal year ended June 30, 2000, 1999 and 1998
the average balance of impaired loans was $384,000, $1,113,000 and $342,000,
respectively. Interest income of $51,000, $8,000 and $22,000 was recorded on
such loans in the fiscal year ending June 30, 2000, 1999 and 1998, respectively.
Loans serviced for investors were $48,575,000 and $29,175,000 at June 30, 2000
and 1999, respectively. Custodial escrow balances maintained in connection with
the foregoing serviced loans and included in liabilities were $895,000 and
$675,000 at June 30, 2000 and 1999, respectively. Serviced loans are not
reflected in the accompanying consolidated statements of financial condition.
The fair value of capitalized mortgage servicing rights exceeded the carrying
value at June 30, 2000 and 1999. Changes in capitalized mortgage servicing
rights is summarized as follows:
AT JUNE 30,
------------------------------
2000 1999
-------------- -------------
(IN THOUSANDS)
Balance beginning of year.................................................. $ 106 $ 94
Originated servicing rights capitalized.................................... 1 71
Amortization of servicing rights........................................... (22) (59)
------------ -------------
Balance end of year........................................................ $ 85 $ 106
============ =============
The Bank originates mortgage loans, which, depending upon whether the loans meet
the Bank's investment objectives, may be sold in the secondary market or to
other private investors. All loans are sold on a nonrecourse basis and the
servicing of these loans may or may not be retained by the Bank. Direct
origination and servicing costs for mortgage banking activities cannot be
presented as these operations are integrated with and not separable from the
origination and servicing of portfolio loans, and, as a result, cannot be
accurately estimated.
-92-
96
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable on securities and interest bearing deposits is
summarized as follows:
AT JUNE 30,
-------------------------------
2000 1999
-------------- --------------
(IN THOUSANDS)
Interest-bearing deposits.................................................. $ 4 $ 4
Investment securities...................................................... 684 673
Mortgage-backed and related securities..................................... 322 645
------------- ------------
$ 1,010 $ 1,322
============= ============
6. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows:
AT JUNE 30,
-------------------------------
2000 1999
-------------- --------------
(IN THOUSANDS)
Land.......................................................................$ 1,572 $ 1,572
Office buildings and improvements.......................................... 4,463 4,418
Furniture and equipment.................................................... 2,408 2,381
-------------- --------------
8,443 8,371
Less:
Accumulated depreciation................................................... 2,982 2,600
-------------- --------------
$ 5,461 $ 5,771
============== ==============
-93-
97
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEPOSITS
Deposits are summarized as follows:
AT JUNE 30,
---------------------------------------------------------------
2000 1999
----------------------------- --------------------------------
WEIGHTED WEIGHTED
PERCENT AVERAGE PERCENT AVERAGE
OF TOTAL NOMINAL OF TOTAL NOMINAL
AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE
------ -------- ---- ------ -------- ----
(DOLLARS IN THOUSANDS)
DEMAND DEPOSITS:
Non-interest bearing..................... $8,400 2.43% --% $9,006 3.12% --%
NOW...................................... 3,147 0.91 0.76 2,789 0.97 1.75
Money market............................. 27,398 7.94 4.95 35,495 12.29 4.37
Passbook................................. 18,373 5.32 2.92 20,962 7.26 2.92
-------- ------ -------- ------
Total................................. 57,318 16.60 3.34 68,252 23.64 3.24
CERTIFICATES OF DEPOSIT:
One to 12 months......................... $42,420 12.28 5.53 $51,931 17.98 5.06
12 to 24 months.......................... 10,159 2.94 5.88 7,759 2.69 5.08
24 to 36 months.......................... 2,999 0.87 5.93 1,522 0.53 5.55
36 to 60 months.......................... 1,935 0.56 5.38 2,868 0.99 5.62
Wholesale................................ 230,487 66.75 6.46 156,382 54.17 5.32
-------- ------ -------- ------
Total................................. 288,000 83.40 6.29 220,462 76.36 5.26
-------- ------ -------- ------
Total deposits.............................. $345,318 100.00% 5.80% $288,714 100.00% 4.78%
======== ====== ======== ======
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $212,453,000 and $97,836,000 at June 30, 2000 and
1999, respectively, which also includes brokered deposit accounts. The average
maturity of wholesale certificates of deposit was four months at both June 30,
2000 and 1999, respectively.
Aggregate annual maturities of certificate accounts at June 30, 2000 are as
follows:
MATURES DURING
YEAR ENDED
JUNE 30 AMOUNT
-------------- --------------
(IN THOUSANDS)
2001 $ 269,998
2002 12,770
2003 3,297
2004 939
Thereafter 996
----------
$ 288,000
==========
Interest expense on deposits consists of the following:
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------
2000 1999 1998
----------- ------------ ----------------
(IN THOUSANDS)
NOW accounts........................ $ 48 $ 48 45
Money market accounts............... 1,409 1,736 1,319
Passbook accounts................... 580 613 625
Certificate accounts................ 14,947 12,766 12,967
-------- ----------- ------------
$ 16,984 $ 15,163 $ 14,956
======== =========== ============
-94-
98
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. NOTES PAYABLE AND OTHER BORROWINGS
Notes payable and other borrowings are summarized as follows:
AT JUNE 30, 2000 AT JUNE 30, 1999
----------------------------- --------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
MATURITY AMOUNT RATE AMOUNT RATE
-------- ------ ---- ------ ----
(DOLLARS IN THOUSANDS)
Advances from
Federal Home Loan Bank 1999 $ -- -- $ 7,000 6.55%
2000 5,000 6.60 27,002 5.98
2001 3,000 5.91 3,000 5.91
2002 5,000 6.43 28,500 5.61
2003 3,030 5.59 8,042 5.13
2004 50,000 5.63 5,000 6.32
2005 35,000 6.03 5,000 5.33
2007 6,500 6.52 6,500 6.52
2008 5,000 4.35 30,000 4.79
-------- --------
$112,530 5.83% $120,044 5.59%
==== ====
Open line of credit
With Wells Fargo Bank 2001 $ 1,000 7.88% $ -- --
====
Securities sold under
Agreements to repurchase 2000 $ 18,510 6.24% $ 9,475 5.25%
-------- ==== -------- ====
$132,040 $129,519
======== ========
The Company is required to maintain as collateral unencumbered one-to-four
family mortgage loans such that the outstanding balance of FHLB advances does
not exceed 60% of the book value of this collateral. Certain advances are
callable by the FHLB, advances callable within one year amount to $70 million
and $50.5 million at June 30, 2000 and 1999, respectively. At June 30, 2000, the
Bank had delivered mortgage-backed securities with a carrying value of $38.7
million to the Federal Home Loan Bank as additional collateral for the advances.
In addition, advances are collateralized by all Federal Home Loan Bank stock.
Variable rate term borrowings consist of $5.0 million tied to the one-month
LIBOR. FHLB advances are subject to a prepayment penalty if they are repaid
prior to maturity.
The Company enters into sales of mortgage-backed securities with agreements to
repurchase identical securities (reverse repurchase agreements) and
substantially identical securities (dollar reverse repurchase agreements). These
transactions are treated as financings with the obligations to repurchase
securities reflected as a liability. The dollar amount of securities underlying
the agreements remains in the asset accounts. The securities underlying the
agreements are delivered to the counterparty's account. Securities sold under
agreements to repurchase were $18,510,000, $9,475,000 and $0 at June 30, 2000,
1999 and 1998, respectively.
Securities sold under agreements to repurchase averaged $22,462,000 and
$4,414,000 for the year ended June 30, 2000 and 1999, respectively. The average
is computed using daily balances for the respective fiscal year. The maximum
outstanding at any month-end during the year ended June 30, 2000 and 1999 was
$28,350,000 and $18,289,000, respectively. The Company retains securities under
its control.
-95-
99
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. NOTES PAYABLE AND OTHER BORROWINGS (CONTINUED)
The Company has a line of credit facility with a third party lender that was
originated in fiscal 2000. The line of credit provides the holding company with
a source of funding to acquire commercial real estate loans and to make further
capital investment in the Bank. The line of credit has a variable rate tied to
the Fed Funds rate.
9. SHAREHOLDERS' EQUITY
The Bank 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
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt and corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 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). Management believes, as of June 30, 2000, that the Bank
meets all capital adequacy requirements to which it is subject.
As of June 30, 2000, the most recent notification from the Bank's regulators
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table below. There are no conditions or events since that
notification that management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios are presented in the tables below.
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------- ----------------- ---------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- -------- ------- ------------ -----------
(DOLLARS IN THOUSANDS)
As of June 30, 2000:
Tier I Capital Leverage (to Average Assets):
Consolidated............................. $34,713 6.69% $15,569 3.00% N/A N/A
West Allis Savings Bank.................. 34,448 6.65 15,548 3.00 25,913 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated............................. 34,713 9.57 14,508 4.00 N/A N/A
West Allis Savings Bank.................. 34,448 9.46 14,564 4.00 21,846 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated............................. 37,914 10.45 29,016 8.00 N/A N/A
West Allis Savings Bank.................. 37,649 10.34 29,128 8.00 36,410 10.00
-96-
100
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. SHAREHOLDERS' EQUITY (CONTINUED)
The Bank's actual capital amounts and ratios are presented in the tables below.
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------- ------------------- ----------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- -------- -------- -------------- -----------
(DOLLARS IN THOUSANDS)
As of June 30, 1999:
Tier I Capital Leverage (to Average Assets):
Consolidated............................. $35,243 7.52% $14,064 3.00% N/A N/A
West Allis Savings Bank.................. 32,056 6.86 14,018 3.00 23,364 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated............................. 35,243 12.34 11,426 4.00 N/A N/A
West Allis Savings Bank.................. 32,056 11.60 11,056 4.00 16,584 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated............................. 37,891 13.26 22,852 8.00 N/A N/A
West Allis Savings Bank.................. 34,704 12.56 22,111 8.00 27,639 10.00
As a state-charted savings bank, the Bank is also subject to a minimum
regulatory capital requirement of the State of Wisconsin. At June 30, 2000, on a
fully-phased-in basis of 6.0%, the Bank had actual capital of $36,250,000 with a
required amount of $31,390,000, for excess capital of $4,860,000.
At the time of conversion, the Bank established a liquidation account in the
amount of $14.9 million which was equal to its retained earnings as of the
latest practicable date prior to the conversion. The liquidation account is
established to provide a limited priority claim to the assets of the Bank to
qualified depositors (Eligible Account Holders) at December 30, 1993 who
continue to maintain those deposits at the Bank after conversion. As the
deposits are withdrawn, the liquidation account decreases. In the unlikely event
of a complete liquidation of the Bank, and only in such event, each Eligible
Account Holder would receive from the liquidation account a liquidation
distribution based on his or her proportionate share of the then remaining
qualifying deposits.
The Company has a shareholders' rights plan (the "Rights Plan"). Under the terms
of the Rights Plan, shareholders hold one preferred share purchase right on each
outstanding share of common stock of the Company. Upon becoming exercisable,
each right entitles shareholders to buy one one-hundredth of a share of the
Company's preferred stock at a price of $100.00, subject to adjustment as
provided in the Rights Plan (the "Exercise Price"). Rights do not become
exercisable until eleven business days after any person or group has acquired,
commenced or announced its intention to commence a tender or exchange offer to
acquire 20% or more of the Company's common stock, or in the event a person or
group owning 15% or more of the Company's common stock is deemed to be "adverse"
to the Company. If the rights become exercisable, holders of each right other
than the acquirer, upon payment of the Exercise Price, will have the right to
purchase the Company's common stock (in lieu of preferred stock) having a value
equal to two times the Exercise Price. If the Company is acquired in a merger,
share exchange or other business combination or 50% or more of its consolidated
assets or earning power are sold, rights holders, other than the acquiring or
adverse person or group, will be entitled to purchase the acquirer's shares at a
similar discount. If the rights become exercisable, the Company may also
exchange rights, other than those held by the acquiring or adverse person or
group, in whole or in part, at an exchange rate of one share of the Company's
common stock per right held. Rights are redeemable by the Company at any time
until they are exercisable at the exchange rate of $.01 per right. The rights
have no immediate dilutive effect currently, and therefore do not effect
reported earnings per share, are not taxable to the Company or its shareholders,
and have no effect on the way in which the Company's shares are traded. The
rights expire in ten years from the plan's adoption.
-97-
101
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. EMPLOYEE BENEFIT PLANS
The Bank has a qualified defined-contribution plan covering substantially all
full-time employees who have completed one year of service and are at least 21
years old. Employees may contribute up to 15% of their compensation to the Plan,
and employee contributions up to 4% are matched 25% by the Bank. In addition,
the Bank may make a profit-sharing contribution to the Plan at its discretion.
Retirement plan expense recorded in connection with the Plan was $20,000,
$19,000 and $14,000 during 2000, 1999 and 1998, respectively.
The Company has an Employee Stock Ownership Plan ("ESOP") for substantially all
of its full-time employees. The cost of unearned ESOP shares is shown as a
reduction of shareholders' equity. ESOP expense for the years ended June 30,
2000, 1999 and 1998 totaled $248,000, $375,000 and $362,000, respectively. The
expense was determined using the fair value of shares committed to be released
during the year. As shares are committed, the reduction in shareholders' equity
decreases by the cost of those shares. The difference between the cost and fair
value of the shares committed is a charge or credit to additional
paid-in-capital. The fair value of the unearned ESOP shares totaled $709,000 at
June 30, 2000.
The Company has agreements with two executive officers of the Company to provide
certain deferred payments upon retirement and certain payments to their
beneficiaries in the event of their deaths. The expense related to these
agreements was $219,000 in 2000, $214,000 in 1999 and $43,000 in 1998.
The Bank has Management Recognition and Retention Plans ("MRPs") for officers
and directors. As of June 30, 2000, 18,462 shares remain reserved for future
grants. The shares awarded to directors vest at a rate of 33.33% per year
commencing December 30, 1994, while officers' shares vest at a rate of 20% per
year commencing one year from the date of grant of the award. The aggregate cost
of these shares is amortized to compensation expense as the participants become
vested. The unamortized cost is reflected as a reduction of shareholders' equity
as unearned restricted stock. All shares awarded have vested and the cost of
awarded shares has been fully amortized at June 30, 2000. Compensation expense
of $4,000, $46,000 and $84,000 was recognized for the years ended June 30, 2000,
1999 and 1998.
For the purposes of providing the pro-forma disclosures required under SFAS No.
123 "Accounting for Stock Based Compensation," the fair value of stock options
granted was estimated using a binomial pricing model for stock options granted
in fiscal year 1999 and the Black-Scholes option pricing model for stock options
granted in prior fiscal years. The per share weighted-average fair value of
stock options granted during fiscal 1999 was $3.06, on the date of grant with
the following variable assumptions - the Company did not pay a dividend in
fiscal year 1999, return on equity of 8.79%, an expected life of ten years and
expected volatility of 32.4%. The per share weighted-average fair value of stock
options was not calculated for fiscal 2000 since there were no options granted
during the period.
The Company applies APB Opinion No. 25 in accounting for stock options and,
accordingly, compensation cost based on the fair value at grant date has not
been recognized for stock option grants in the consolidated financial statements
for the fiscal years ended June 30, 2000, 1999 and 1998.
Had compensation cost of the Company's stock-based plans been determined in
accordance with SFAS No. 123, net income would have been $2,985,000, $3,118,000
and $2,794,000 for fiscal 2000, 1999 and 1998, respectively. Diluted earnings
per share would have been $1.13, $1.09 and $.97, respectively for fiscal 2000,
1999 and 1998.
The Company has reserved 375,642 shares of common stock for its non-qualified
stock option plan for employees and directors. With respect to options which
have not been granted, the option exercise price cannot be less than the fair
market value of the underlying common stock as of the date of option grant, and
the maximum term cannot exceed ten years. There were no options granted,
exercised or forfeited during the fiscal year ended June 30, 2000.
-98-
102
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. EMPLOYEE BENEFIT PLANS (CONTINUED)
The following is a summary of stock option activity:
SHARES OPTION
UNDER PRICE PER
OPTION SHARE
------ -----
Outstanding at June 30, 1996............................................. 330,614 $ 4.00 - $ 7.63
Granted.............................................................. 16,000 $ 7.38
-------- ----------------
Outstanding at June 30, 1997............................................. 346,614 $ 4.00 - $ 7.63
Granted.............................................................. 30,000 $14.63
Exercised............................................................ (55,340) $ 4.00
--------- ----------------
Outstanding at June 30, 1998............................................. 321,274 $ 4.00 - $14.63
Granted.............................................................. 21,500 $ 10.00 - $11.38
Exercised............................................................ (61,294) $ 4.00 - $ 7.38
Forfeited............................................................ (2,000) $ 4.00 - $ 7.38
--------- ----------------
Outstanding at June 30, 1999............................................. 279,480 $ 4.00 - $14.63
--------- ----------------
Outstanding at June 30, 2000............................................. 279,480 $ 4.00 - $14.63
The range of options outstanding at June 30, 2000 were:
WEIGHTED-
AVERAGE
WEIGHTED-AVERAGE REMAINING
NUMBER OF SHARES EXERCISE PRICE CONTRACTUAL
---------------------------------------------------------------- LIFE
PRICE OUTSTANDING EXERCISABLE OUTSTANDING EXERCISABLE (IN YEARS)
RANGE ----------- ----------- ----------- ----------- -----------
- -----
$4 - 7.63 227,980 219,580 $4.61 $4.50 3.9
10 - 11.38 21,500 4,300 11.12 11.12 8.7
14.63 30,000 12,000 14.63 14.63 8.0
------- ------- ----- ----- ---
279,480 235,880 $6.18 $5.14 4.7
======= ======= ===== ===== ===
11. FINANCIAL INSTRUMENTS
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments consist of commitments to extend credit. Commitments to
extend credit involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the statement of financial condition.
The contract amount reflects the extent of involvement the Company has in this
particular class of financial instrument.
Commitments to extend credit 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 generally
require payment of a fee.
-99-
103
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. FINANCIAL INSTRUMENTS (CONTINUED)
As some commitments expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. The Company
evaluates the creditworthiness of each customer on a case-by-case basis. The
Company generally extends credit on a secured basis. Collateral obtained varies,
but consists primarily of one-to four-family residences located in the counties
of Milwaukee and Waukesha, Wisconsin.
Commitments to sell mortgage loans represent commitments to sell mortgage loans
to other entities at a future date and at a specified price. Commitments to sell
mortgage loans and commitments to extend credit are generally exercised and
fulfilled within ninety days. The fair value of mortgage loans held for sale
plus the commitments to extend credit generally offset the commitments to sell
mortgage loans. Both the commitments to extend credit and the commitments to
sell mortgage loans are at current market interest rates.
Off-Balance sheet financial instruments whose contract amounts represent a
potential credit risk are as follows:
FOR THE YEARS ENDED
JUNE 30,
---------------------------
2000 1999
---------- ----------
(IN THOUSANDS)
Commitments to extend credit:
Fixed-rate mortgage loans (8.125% - 9.25% at June 30, 2000)....... $ 381 $1,157
Adjustable rate mortgage loans.................................... 623 723
Unused lines of credit:
Credit cards...................................................... 6,179 8,203
Home equity....................................................... 12,782 11,578
Commercial........................................................ 8,985 12,914
Stand-by letters of credit........................................ 3,239 3,259
During the year ended June 30, 2000, the Company entered into interest rate caps
with a notional amount of $75.0 million with maturity dates ranging from June
14, 2001 to January 3, 2002. The interest rate caps are carried at fair market
value of $166,000 in the Consolidated Statement of Financial Condition at June
30, 2000. The difference between the cost of the caps of $340,000 and the fair
market value is included in expense for the year. At March 31, 2000, the Company
designated these caps as a cash flow hedge of the interest rate risk on
short-term wholesale certificates of deposit which renew every 90 days and are
indexed to the 3-month LIBOR. The caps are tied to the 3-month LIBOR interest
rate with a 7% strike rate. Cash payments will be received by the Company if the
3-month LIBOR exceeds 7%.
12. LITIGATION
The Company and its subsidiary are involved in certain lawsuits in the course of
its general lending business and other operations. The Company believes that
there are sound defenses against the claims asserted therein and is vigorously
defending these actions. Management, after review with its legal counsel, is of
the opinion that the ultimate disposition of its litigation will not have a
material effect on the Company's financial condition.
-100-
104
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. PARENT COMPANY ONLY FINANCIAL INFORMATION AT JUNE 30,
------------------------
2000 1999
--------- ---------
(IN THOUSANDS)
STATEMENT OF CONDITION
Assets:
Cash and cash equivalents......................................... $ 283 $ 1,256
Securities available-for-sale..................................... 649 1,294
Investment in bank subsidiary..................................... 33,529 31,761
Other assets...................................................... 50 245
------- -------
$34,511 $34,556
======= =======
Liabilities and Shareholders' Equity:
Borrowings........................................................ $ 1,000 --
Other liabilities................................................. 156 $ 60
Total shareholders' equity........................................ 33,355 34,496
------- -------
$34,511 $34,556
======= =======
FOR THE YEARS ENDED JUNE 30,
----------------------------------------
2000 1999 1998
--------- --------- ---------
(IN THOUSANDS)
STATEMENT OF INCOME
Interest and dividend income........................................ $ 147 $ 243 $ 177
Dividend income from subsidiary..................................... 1,500 1,300 --
Gain (loss) on sale of investment securities........................ (3) 28 --
Equity in undistributed net income of subsidiary.................... 1,534 1,740 2,764
-------- -------- --------
Total income................................................... 3,178 3,311 2,941
Other expense....................................................... 189 136 130
-------- -------- --------
Income before provision for income taxes............................ 2,989 3,175 2,811
Provision for income taxes (benefits)............................... (15) 45 12
-------- -------- --------
Net income..................................................... $ 3,004 $ 3,130 $ 2,799
======== ======== ========
STATEMENT OF CASH FLOWS
Operating activities:
Net income........................................................ $ 3,004 $ 3,130 $ 2,799
Adjustments to reconcile net income
to net cash provided by (used in) operating activities:
Equity in undistributed net income of subsidiary............... (1,534) (1,740) (2,764)
Loss on sale of investment securities.......................... (3) -- --
Decrease (increase) in other assets............................ 195 (185) (33)
Increase (decrease) in other liabilities....................... 96 (2) --
Other.......................................................... 23 187 (119)
-------- -------- --------
Net Cash Provided By (Used In) Operating Activities............... 1,781 1,390 (117)
Investment activities:
Sales and maturities of investment securities..................... 657 528 --
Purchase of investment securities................................. -- -- (1,498)
Investment in Bank subsidiary..................................... (1,000) -- --
-------- -------- --------
Net Cash Provided By (Used In) Investing Activities............... (343) 528 (1,498)
Financing activities:
Increase in borrowings............................................ 1,000 -- --
Purchase of common stock of subsidiary............................ (3,028) (1,785) --
Dividends paid.................................................... (383) -- --
Proceeds from exercise of stock options........................... -- 273 330
-------- -------- --------
Net Cash Provided by (Used In) Financing Activities.............. (2,411) (1,512) 330
-------- -------- --------
Net increase (decrease) in cash..................................... (973) 406 (1,285)
Cash and cash equivalents at beginning of year...................... 1,256 850 2,135
-------- -------- --------
Cash and cash equivalents at end of year............................ $ 283 $ 1,256 $ 850
======== ======== ========
-101-
105
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the balance sheet, for which it is practicable to estimate that
value. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair market value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. SFAS 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not necessarily represent the underlying value of the
Company. The Company does not routinely measure the market value of financial
instruments because such measurements represent point-in-time estimates of
value. It is generally not the intent of the Company to liquidate and therefore
realize the difference between market value and carrying value and even if it
were, there is no assurance that the estimated market values could be realized.
Thus, the information presented is not particularly relevant to predicting the
Company's future earnings or cash flows.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount reported in the statement of financial condition for cash
and cash equivalents approximates those assets' fair values.
INVESTMENT AND MORTGAGE-BACKED AND RELATED SECURITIES
Fair values for investment and mortgage-backed and related securities are based
on quoted market prices.
DERIVATIVE INVESTMENT SECURITIES
Fair values for derivative investment securities are based on quoted market
prices.
FEDERAL HOME LOAN BANK STOCK
Federal Home Loan Bank stock is carried at cost, which is its redeemable value,
since the market for this stock is limited.
LOANS RECEIVABLE
The fair value of one-to-four family fixed-rate mortgage loans is determined
based on the current market price for securities collateralized by similar
loans. For variable rate one-to-four family mortgage, consumer and other loans
that reprice frequently and with no significant change in credit risk, carrying
values approximate fair values. The fair value for fixed-rate consumer and other
loans is estimated by discounting cash flows at market interest rates. The fair
value of commercial loans was calculated by discounting cash flows using an
estimated rate that reflects the type of loan and the credit risk inherent in
the loan category. The carrying value of accrued interest receivable
approximates fair value.
DEPOSITS
The fair values disclosed for demand deposits are equal to the amounts payable
on demand at the reporting date. Fair values for fixed-rate certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently offered on certificates to a schedule of aggregated
expected monthly maturities on such deposits. The carrying value of accrued
interest payable approximates fair value.
NOTES PAYABLE TO THE FEDERAL HOME LOAN BANK
The fair values of long-term notes payable to the Federal Home Loan Bank are
estimated using discounted cash flow analysis, based on current borrowing rates
for similar types of borrowing arrangements. The carrying value for variable
rate notes payable to the Federal Home Loan Bank approximates fair value.
-102-
106
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
ACCRUED INTEREST RECEIVABLE AND ACCRUED INTEREST PAYABLE
The carrying amounts reported in the statement of financial condition for
accrued interest receivable and accrued interest payable approximate fair value.
OFF- BALANCE SHEET ITEMS
The fair value of commitments to extend credit is not material and is therefore
not shown.
The carrying amounts and fair values of the Company's financial instruments
consisted of the following:
AT JUNE 30,
-------------------------------------------------
2000 1999
----------------------- -----------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
(In thousands)
Cash and cash equivalents..................................... $ 16,559 $ 16,599 $ 8,599 $ 8,599
Investment securities available-for-sale...................... 38,315 38,315 44,902 44,902
Mortgage-backed and related
securities available-for-sale............................... 35,944 35,944 55,566 55,566
Mortgage-backed and related
securities held-to-maturity................................. 15,017 14,685 54,618 54,854
Derivative investment securities.............................. 166 166 -- --
Federal Home Loan Bank stock.................................. 7,760 7,760 6,527 6,527
Loans receivable:
Real estate (including home equity)......................... 362,848 360,192 258,124 256,293
Credit card and other consumer.............................. 3,079 3,079 3,683 3,683
Commercial.................................................. 24,238 24,238 17,709 17,709
---------- ---------- --------- ---------
$ 390,165 $ 387,509 $ 279,516 $ 277,685
========== ========== ========= =========
Accrued interest receivable................................... $ 3,041 $ 3,041 $ 2,986 $ 2,986
Deposits:
NOW......................................................... 11,547 11,547 11,215 11,215
Money market................................................ 27,398 27,398 36,075 36,075
Passbooks................................................... 18,373 18,373 20,962 20,962
Certificates................................................ 288,000 288,115 220,462 220,726
---------- ---------- --------- ---------
$ 345,318 $ 345,433 $ 288,714 $ 288,978
========== ========== ========= =========
Borrowings:
Notes payable and other borrowings.......................... $ 132,040 $ 130,629 $ 129,519 $ 128,887
Accrued interest payable...................................... $ 3,421 $ 3,421 $ 2,006 $ 2,006
-103-
107
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. INCOME TAXES
Income tax expense (benefit) in the consolidated statements of income consists
of the following:
CURRENT DEFERRED TOTAL
------- -------- -----
(In thousands)
Year ended June 30, 2000:
Federal.......................................... $ 1,743 ($304) $ 1,439
State............................................ 37 (95) (58)
------- ------ --------
$ 1,780 ($399) $ 1,381
======= ====== ========
Year ended June 30, 1999:
Federal.......................................... $ 1,705 ($213) $ 1,492
State............................................ 46 (33) 13
------- ------ --------
$ 1,751 ($246) $ 1,505
======= ====== ========
Year ended June 30, 1998:
Federal.......................................... $ 1,551 ($250) $ 1,301
State............................................ 140 (38) 102
------- ------ --------
$ 1,691 ($288) $ 1,403
======= ====== ========
Income tax expense attributable to income from operations was $1,381,000,
$1,505,000 and $1,403,000 for the years ended June 30, 2000, 1999 and 1998,
respectively, and differed from the amounts computed by applying the Federal
income tax rate of 34 percent to pre-tax income from continuing operations as a
result of the following:
YEARS ENDED JUNE 30,
-------------------------------------------
2000 1999 1998
------- ---- -------
(In thousands)
Computed "expected" tax expense...................... $1,491 $1,576 $1,429
State income taxes, net of
federal income tax benefit....................... (38) 9 67
Utilization of Low Income Housing Credits.......... (5) (20) (29)
Net (increase)/decrease in the cash
surrender value of life insurance
net of premiums paid ............................ (14) 15 (15)
(53) (75) (49)
------- ------ ------
Other................................................ $1,381 $1,505 $1,403
======= ====== ======
-104-
108
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
AT JUNE 30,
------------------------
2000 1999
------- -------
(IN THOUSANDS)
Deferred Tax Assets:
Deferred compensation.............................. $ 370 $ 299
Allowances for loan losses......................... 1,274 1,013
Deferred loan fees................................. -- 39
Unrealized depreciation on securities
available for sale............................... 1,333 718
Other, net....................................... 294 61
------ ------
Gross deferred tax assets............................ 3,271 2,130
Deferred Tax Liabilities:
Depreciation....................................... 163 157
Mortgage servicing rights.......................... 34 42
FHLB stock......................................... 174 --
Other.............................................. 82 127
------ ------
Gross deferred tax liabilities..................... 453 326
------ ------
Net deferred tax assets............................ $2,818 $1,804
====== ======
The net deferred tax asset increased by $1,014,000 in 2000 and $949,000 in 1999.
The difference between the increase and the deferred portion of tax expense is
primarily attributable to the tax effect on the unrealized depreciation on
securities available-for-sale which does not have an income statement impact in
2000 and 1999.
-105-
109
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FOR THE THREE MONTHS ENDED,
-----------------------------------------------------------------------------------------
JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30,
2000 2000 1999 1999 1999 1999 1998 1998
------------ ---------- --------- ---------- --------- -------- -------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest and dividend income........ $9,978 $10,016 $9,694 $8,751 $8,252 $8,801 $8,885 $8,360
Interest expense.................... 6,954 6,889 6,418 5,762 5,418 5,849 5,984 5,563
------ ------- ------ ------ ------ ------ ------ ------
Net interest income................. 3,024 3,127 3,276 2,989 2,834 2,952 2,901 2,797
Provision for loan losses........... 244 337 170 120 -- 140 210 130
------ ------- ------ ------ ------ ------ ------ ------
Net interest income after
provision for loan losses......... 2,780 2,790 3,106 2,869 2,834 2,812 2,691 2,667
Gain (loss) on sales of
investments and mortgage-backed
and related securities............ -- (15) 9 54 33 -- 35 --
Gain (loss) on sale of loans, net... 45 (189) 57 96 60 180 438 214
Other non-interest income........... 303 292 322 257 230 393 233 266
------ ------- ------ ------ ------ ------ ------ ------
Total non-interest income........... 348 88 388 407 323 573 706 480
Total non-interest expense.......... 2,023 2,045 2,163 2,160 1,859 2,327 2,191 2,074
------ ------- ------ ------ ------ ------ ------ ------
Income before income taxes.......... 1,105 833 1,331 1,116 1,298 1,058 1,206 1,073
Income tax expense ................. 371 229 420 361 393 340 417 355
------ ------- ------ ------ ------ ------ ------ ------
Net income ......................... $ 734 $ 604 $ 911 $ 755 $ 905 $ 718 $ 789 $ 718
====== ======= ====== ====== ====== ====== ====== ======
Earnings per share (basic).......... $0.30 $0.24 $0.35 $0.28 $0.33 $0.26 $0.28 $0.26
Earnings per share (diluted)........ $0.29 $0.23 $0.34 $0.28 $0.32 $0.25 $0.28 $0.25
Cash dividends per share............ $0.05 $0.05 $0.05 -- -- -- -- --
Market Information
Trading range - high.............. 11.25 10.50 11.25 12.31 12.13 11.75 13.50 16.25
low............... 8.13 8.50 8.94 10.00 10.00 9.75 9.25 10.63
close............. 9.13 9.38 9.00 10.97 11.63 10.63 11.00 11.50
No dividends were declared on the shares of Common Stock during the quarter
ended September 30, 1999 and the fiscal year ended June 30, 1999.
-106-
110
PART II
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item with respect to directors is included
under the heading "Election of Directors" in the Company's definitive Proxy
Statement dated September 22, 2000, relating to the 2000 Annual Meeting of
Shareholders currently scheduled for October 25, 2000, which section is hereby
incorporated herein by reference. Information concerning executive officers who
are not directors, with the exception of Messrs. James D. Smessaert and Peter A.
Gilbert, is contained in Part I of this Form 10-K pursuant to paragraph (b) of
Item 401 of Regulation S-K in reliance on Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the heading
"Compensation of Executive Officers and Directors" in the Company's definitive
Proxy Statement dated September 22, 2000, relating to the 2000 Annual Meeting of
Shareholders currently scheduled for October 25, 2000, which section is hereby
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is included under the heading "Stock
Ownership of Certain Beneficial Owners" in the Company's definitive Proxy
Statement dated September 22, 2000, relating to the 2000 Annual Meeting of
Shareholders currently scheduled for October 25, 2000, which section is hereby
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading
"Indebtedness of Management and Certain Transactions" in the Company's
definitive Proxy Statement dated September 22, 2000, relating to the 2000 Annual
Meeting of Shareholders currently scheduled for October 25, 2000, which section
is hereby incorporated herein by reference.
-107-
111
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
The following financial statements and financial statement schedules
are included under a separate caption "Financial Statements and Supplementary
Data" in Part II, Item 8 hereof and are incorporated herein by reference.
Independent Auditor's Report
Consolidated Statements of Financial Condition at June 30, 2000 and
1999
Consolidated Statements of Income for Years Ended June 30, 2000, 1999
and 1998
Consolidated Statements of Shareholders' Equity for Years Ended June
30, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for Years Ended June 30, 2000,
1999 and 1998
Notes to Consolidated Financial Statements
-108-
112
(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted as the required
information is inapplicable or has been included in the Consolidated Financial
Statements.
SEQUENTIAL
(A)(3) EXHIBITS PAGE NUMBER
-------- -----------
3.1 Amended Articles of Incorporation of Registrant (1)
3.2 Amended By-laws of Registrant (2)
3.3 Stock Charter of West Allis Savings Bank (1)
3.4 By-laws of West Allis Savings Bank (1)
10.1 West Allis Savings Bank 401(k) Savings Plan (1)
10.2 West Allis Savings Bank Employee Stock Ownership Plan (1)
10.3 Credit Agreement by and between West Allis Savings Bank,
Employee Stock Ownership Trust and Company (1)
10.4 West Allis Savings Bank Management Recognition and Retention Plan (1)
10.5 Hallmark Capital Corp. 1993 Incentive Stock Option Plan as amended (3)
10.6 Hallmark Capital Corp. 1993 Stock Option Plan for Outside Directors, as
amended (3)
10.7 Employment Agreement - James D. Smessaert (1)
10.8 Employment Agreement - Peter A. Gilbert (2)
10.9 Executive Employee Supplemental Compensation Agreement - James D.
Smessaert (4)
10.10 Executive Employee Supplemental Compensation Agreement - Peter A.
Gilbert (4)
10.11 West Allis Savings Bank Employment Agreement (2000) - James D.
Smessaert (5)
10.12 West Allis Savings Bank Employment Agreement (2000) - Peter A.
Gilbert (5)
10.13 Hallmark Capital Corp. Employment Agreement (2000) - James D.
Smessaert (5)
10.14 Hallmark Capital Corp. Employment Agreement (2000) - Peter A.
Gilbert (5)
12.1 Statement regarding computation of per share earnings - See Footnote
(1) in Part II, Item 8
13.1 2000 Summary Annual Report to Shareholders (6)
21.1 Subsidiaries of the Registrant - See "Subsidiaries Activities" in
Part I, Item 1
23.1 Consent of KPMG LLP (7) 111
24.1 Powers of Attorney for certain officers and directors (1)
99.1 Proxy Statement for 2000 Annual Meeting of Shareholders (7) Attached
- -------------
(1) Incorporated by reference to exhibits filed with Company's Form S-1
Registration Statement declared effective on November 4, 1993
(Registration Number 33-67184).
(2) Incorporated by reference to exhibits filed with the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 1995.
(3) Incorporated by reference to exhibits filed with the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 1997.
(4) Incorporated by reference to exhibits filed with the Company's Report
on Form 10-Q for the quarter Ended December 31, 1998.
(5) Incorporated by reference to exhibits filed with the Company's
Quarterly Report on Form 10-Q for the quarter Ended March 31, 2000.
(6) Filed in paper format with the SEC pursuant to Rule 101 of Regulation S-T.
(7) Filed herein.
(b) Reports on Form 8-K
None.
(c) Exhibits
Reference is made to the exhibit index set forth above at (a)(3).
(d) Financial Statement Schedules
Reference is made to the disclosure set forth above at (a)(1 and 2).
-109-
113
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
HALLMARK CAPITAL CORP.
/s/ James D. Smessaert
-------------------------------------------
James D. Smessaert, Chairman,
President and Chief Executive Officer
Date: September 15, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ Martin Hedrich, Jr. /s/ Reginald M. Hislop, III
- ---------------------------------------------- -----------------------------------------------
Martin Hedrich Jr., Director Reginald M. Hislop, III, Director
Date: September 15, 2000 Date: September 15, 2000
/s/ Peter A. Gilbert /s/ Charles E. Rickheim
- ---------------------------------------------- -----------------------------------------------
Peter A. Gilbert, Executive Vice President, Charles E. Rickheim, Director
Corporate Secretary and Director
Date: September 15, 2000 Date: September 15, 2000
/s/ James D. Smessaert /s/ Arthur E. Thompson
- ---------------------------------------------- -----------------------------------------------
James D. Smessaert, Chairman, Arthur E. Thompson
President and Chief Executive Officer Chief Financial Officer and Corporate Treasurer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
Date: September 15, 2000 Date: September 15, 2000
/s/ Donald A. Zellmer
- ----------------------------------------------
Donald A. Zellmer, Director
Date: September 15, 2000
-110-