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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, 1998 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.)
7401 West Greenfield Avenue
West Allis, Wisconsin 53214
(Address and Zip Code of principal executive offices)
Registrant's telephone number: (414) 317-7100
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.
-----------------------------------------
(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 September 8, 1998, there were issued and outstanding 3,152,500 and
2,938,608 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 8, 1998, was $34.5 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 1998 Annual Meeting
of Shareholders are incorporated by reference into Part III hereof.
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FORM 10 - K TABLE OF CONTENTS
Page
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Part I
Item 1 - Business ................................................................ 1
Item 2 - Properties .............................................................. 46
Item 3 - Legal Proceedings ....................................................... 47
Item 4 - Submission of Matters to a Vote of Security Holders ..................... 48
Part II
Item 5 - Market for the Registrant's Common Stock and Related Security
Holder Matters .......................................................... 49
Item 6 - Selected Consolidated Financial and Other Data .......................... 50
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations .................................................... 52
Item 7A - Quantitative and Qualitative Disclosures About Market Risk ............... 71
Item 8 - Financial Statements and Supplementary Data .............................. 72
Item 9 - Changes in and Disagreements with Accountants and Financial Disclosure ... 101
Part III
Item 10 - Directors and Executive Officers of the Registrant ....................... 101
Item 11 - Executive Compensation ................................................... 101
Item 12 - Security Ownership of Certain Beneficial Owners and Management ........... 101
Item 13 - Certain Relationships and Related Transactions ........................... 101
Part IV
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8 - K ........ 102
Signatures ......................................................................... 104
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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," "intends to" 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") was formed for the purpose of owning
all of the outstanding stock of West Allis Savings Bank (the "Bank") issued in
the mutual to stock conversion of the Bank (the "Conversion"). The Company
acquired all of the outstanding common stock of the Bank on December 30, 1993.
The Bank is a Wisconsin state-chartered stock savings bank headquartered in
Milwaukee, Wisconsin.
In order to maximize shareholder value, the Company continues to pursue a
strategy of effectively utilizing the capital acquired in the Bank's Conversion
and the Company's initial public offering consummated in December 1993. The
Company believes that its effective utilization of capital is best achieved
through the growth of the Company's business. Pursuant to the Company's
post-Conversion strategic plan, this growth is to be achieved through the
expansion of the Company's asset base and diversification of the Company's
portfolio into higher yielding assets, and is to be implemented in two stages.
In stage one, implemented in fiscal 1994 through the first half of fiscal 1997,
management focused on achieving a target asset size for the Company established
by the Board of Directors. In stage two, which commenced in the second half of
fiscal 1996 and continued in fiscal 1998, management focused, and intends to
continue to focus, on portfolio diversification coupled with a moderate increase
in the rate of growth of the Company's asset base. The Company intends to
continue its asset portfolio diversification strategy in fiscal 1999.*
Commencing in fiscal 1994 and continuing through the first half of fiscal
1997, the Company implemented the first stage of the strategy by leveraging its
capital base to achieve asset growth. The objective of the first stage of the
strategy was to reach a targeted asset size for the Company established by the
Board of Directors within a three-to-five year period following the Conversion.
The Company increased its asset size from $179.6 million at June 30, 1994 to
$409.8 million at June 30, 1997. The Bank's principal investment focus during
the four-year post-Conversion period was to originate and purchase mortgage
loans (principally loans secured by one-to-four family owner-occupied homes) and
purchase mortgage-backed securities. The asset growth was funded through
significant increases in Federal Home Loan Bank ("FHLB") advances and other
borrowings and increases in deposits, primarily brokered and non-brokered
wholesale deposits. Pursuit of the foregoing strategy resulted in increases in
the Company's net income, earnings per share, return on average equity ("ROAE")
and return on average assets ("ROAA") in fiscal 1994, 1995 and 1996. Excluding
the impact of the one-time industry-wide SAIF assessment in fiscal 1997, pursuit
of the strategy also resulted in increases in the Company's net income, earnings
per share, ROAE and ROAA for fiscal 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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Starting in the latter half of fiscal 1996 and continuing in fiscal 1998,
the Company implemented the second stage of its post-Conversion plan in order to
continue to increase net income, earnings per share, ROAE and ROAA. This
strategy involved shifting the focus from asset growth to asset portfolio
diversification, while maintaining prudent capital and liquidity levels. This
was, and continues to be achieved by altering the composition of loans and
securities originated, purchased, sold and held in the total asset portfolio. In
particular, the Company focused and will focus on originating and purchasing
higher-yielding 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), which will either replace or supplement the
lower-yielding one-to-four family mortgage loans and principal run-off from the
mortgage securities portfolio.* The Company also evaluated opportunities to
purchase multi-family, commercial real estate, and commercial business loans or
participation interests in such loans secured by properties or business assets
located outside the Company's primary lending area. In fiscal 1998, the Company
purchased an aggregate of $25.5 million, or 8.9% of gross loans at June 30,
1998, of loans and participation interests in loans originated by other lenders
and secured by properties located outside of the Company's primary lending area
(as defined herein). These loans and participation interests consisted primarily
of commercial real estate and commercial real estate construction loans. The
Company also expanded its origination of higher-yielding loans through its
commercial lending division, which offers commercial/industrial real estate term
loans, equipment leasing, inventory/equipment/receivables financing, lines of
credit, letters of credit and SBA loan programs. The Company originated and
purchased $35.6 million in various commercial business loans, either unsecured
or secured by commercial business assets as of June 30, 1998, of which $6.28
million were secured by business assets located outside of the Company's
primary lending area. Asset portfolio diversification in fiscal 1998 was funded
through principal repayment cash flows from existing assets, wholesale brokered
and non-brokered deposits, the sale of one-to-four family mortgage loans in the
secondary market, the maturity and sale of mortgage-backed and related
securities, retail deposits and FHLB advances.
In fiscal 1999, the Company intends to continue the implementation of the
second phase of its business plan with a moderate rate of growth of its asset
base.* The Company's business strategy is to continue its focus on increasing
net interest income and generating additional non-interest income from existing
and new revenue sources.* In order to increase net interest income, the Company
intends to continue to utilize its asset portfolio diversification strategy of
selling lower-yielding assets such as securities and one-to-four family mortgage
loans in the secondary market in order to provide liquidity to fund
higher-yielding loan originations and purchases, increase non-interest income
and maintain adequate levels of capital.* The Company anticipates that increased
sales of one-to-four family mortgage loans will decrease the proportion of the
gross loan portfolio represented by such loans, will increase non-interest
income as a result of increased gains on the sales of such loans, and will
further lessen the Company's negative gap position as such loans are replaced by
higher-yielding, adjustable rate assets, including multi-family, commercial real
estate and commercial loans.* Portfolio diversification in fiscal 1999 also will
include continued purchases of loans or participation interests in loans
originated by other lenders both within and outside of its primary lending
area as well as originations outside of the primary lending area.* Loans
purchased, or participation interests purchased, which relate to properties or
business assets located outside of the Company's primary lending area will
consist primarily of multi-family, commercial real estate, multi-family
construction, commercial real estate construction loans and commercial business
loans.* In deciding whether or not to originate or 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 continues to apply,
underwriting guidelines which are at least as strict as those applicable to the
origination of similar loans within its primary lending area.
The Company intends to fund its asset portfolio diversification in fiscal
1999 through a combination of retail deposits, brokered deposits, borrowings,
the sale of one-to-four family mortgage loans in the secondary market, the
maturity and sale of mortgage-backed and related securities, and FHLB advances.*
In addition, in fiscal 1999, the Company intends to continue increasing the
activities of its commercial lending division as another element of the overall
portfolio diversification strategy.* The focus of the Company's commercial
lending operation will be small business loans and leases. Management currently
anticipates that the commercial lending division will generate approximately $40
million in new commercial loans/leases during fiscal 1999.* Management believes
that the commercial lending component of its operations will benefit the Company
longer term, and should contribute to a long-term increase in net income and
return on equity.* The commercial lending division also has enhanced the
Company's core deposit base, through the establishment of new deposit
relationships with the commercial lending division's customers. As of June 30,
1998, commercial deposits totaled $5.9 million or 2.16% of the Company's core
deposit base.
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The Company also intends to increase non-interest income and net interest
income in fiscal 1999 by exploring ways to expand its lending activities into
higher credit risk financial services (also known as subprime lending).* The
subprime lending market includes manufactured housing, automobile, credit card,
business, and residential first and second mortgage financing. The subprime
mortgage market for first and second mortgage loans, on which the Company
currently intends to focus, represents loans that do not conform to Federal Home
Loan Mortgage Corporation ("FHLMC") and Fannie Mae guidelines. The borrowers on
such loans typically have credit deficiencies on their credit history, such as
late payments on their mortgage loan, low credit scores, foreclosures or
bankruptcies. Other non-conforming reasons which classify loans as subprime
include higher debt-to-income ratios, no down payment, limited documentation,
high cash-out refinances or no verification of the borrower's income. A
secondary market of private investors and mortgage bankers provides a mechanism
for the underwriting, sale and servicing of subprime loans. Due to the higher
degree of credit risk inherent in this type of lending, subprime residential
mortgage loan rates generally are higher yielding compared to conventional
one-to-four family mortgage rates. In addition, if sold in the secondary market,
a higher origination fee and yield spread premium are paid on such loans.* The
Company presently is involved in the exploratory phase of assessing the subprime
market. If the Company decides to proceed in the development of a subprime
program, the Board of Directors and management intend to establish parameters in
the areas of total portfolio size, underwriting guidelines, approval process,
underlying collateral type and location. In addition, in establishing such
parameters, the Board of Directors of the Company intends to evaluate the impact
of such a program on the Company's allowance and provision for loan loss as well
as the overall financial impact on the Company.
In fiscal 1999, the Company also intends to explore alternative methods of
reducing net interest expense, such as offering deposit products on the
Company's Website, evaluating potential acquisitions of retail branch networks
in market areas demonstrating a lower cost of funds demand for deposit products
and by actively seeking lower cost funding in the wholesale financial markets.*
During fiscal 1999, the Company also intends to increase its non-interest
income by expanding the following three fee income producing divisions:
Residential Lending, Hallmark Planning Services and Commercial Banking.* The
Company also intends to evaluate the feasibility and profitability of opening
satellite lending facilities in communities outside of the Company's primary
lending area to help increase originations of one-to-four family first mortgage
loans, which are sold in the secondary market to generate fee income.* The
Company's insurance subsidiary Hallmark Planning Services, Inc. continues to
grow as the Company seeks to generate fee income from investment product and
annuity sales. The Company also has begun to develop a program for mortgage
contract cash processing within the commercial lending division, a service
intended to generate fee income.* Pursuant to such program, the Bank would act
as a partial sub-servicer performing a cash/processing function for
nationally-originated commercial real estate loans.*
The increase in the level of the allowance for losses on loans during
fiscal 1998 was primarily the result of increases in the commercial, home equity
and commercial real estate loan portfolios. Loans secured by multi-family and
commercial real estate and commercial business assets 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
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.
Management anticipates that as the Company's volume of multi-family and
commercial/nonresidential real estate and commercial business 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, which
will have a negative effect on the Company's net income in the short-term.*
However, the Company believes that building the higher yielding multi-family and
commercial/nonresidential real estate components of its gross loan portfolio
will benefit the Company longer term, and should contribute to a long-term
improvement in the Company's net income and return on equity.*
Under regulations established for state savings banks by the Wisconsin
Department of Financial Institutions, Division of Savings Institutions ("DSI"),
as implemented by the Administrator of the DSI, the Bank is limited in the
amount of commercial real estate and commercial business loans it can hold in
its loan portfolio. This limit is currently 20% of the Bank's total assets and
may be increased with the approval of the DSI. At June 30, 1998, the Bank had
$63.1 million of such loans in its portfolio with a current limit based on the
Bank's asset base of $88.0 million. Management anticipates that as the Bank's
commercial real estate and commercial business loan origination and purchase
activity increases in fiscal 1999, the Bank will be required to apply to the DSI
to increase the limit to an amount in excess of 20% of the Bank's asset base.*
While management believes it will be able to obtain such DSI approval, there can
be no assurances that if requested, the DSI will approve an increase in such
lending limit for the Bank, or at what lending limit level such approval will be
granted.
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MARKET AREA
The Bank offers a variety of retail deposit products and services primarily
in Milwaukee and Waukesha counties, Wisconsin. Of the Bank's total deposits at
June 30, 1998, 54.2% represented retail or core deposits and 45.8% represented
non-core wholesale brokered and non-brokered deposits. The Bank also offers a
variety of mortgage loan 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").
During fiscal 1996 and continuing in fiscal 1998, under authority granted
by the Board of Directors, management began to evaluate lending opportunities on
a national basis. Loans originated or purchased and participation interests
purchased in loans secured by collateral outside of the Bank's primary lending
area, in fiscal 1998, did not exceed 10% of the entire portfolio and primarily
consisted of commercial real estate and commercial real estate construction
loans. In fiscal 1999, management intends to continue to evaluate lending
opportunities on a national basis, and management will evaluate opportunities to
originate and purchase one-to-four family, multi-family, commercial real estate
construction loans, or participation interests in such loans originated by other
lenders and secured by properties located outside of the Company's primary
lending area.* Management also intends to actively pursue opportunities to
originate and purchase commercial real estate and commercial business loans both
within and outside its primary lending area as part of its ongoing asset
portfolio diversification strategy. These commercial-related loans are either
secured by real estate, collateralized by other business assets or are
unsecured.
The Bank'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 Bank has three
full-service branches located in West Allis, New Berlin and Greenfield, which
are suburbs of Waukesha and Milwaukee counties, respectively, and together
account for approximately 50.5% of the Bank's total deposits. The Bank also
operates a limited-service office inside of a senior community residence in West
Allis. All of the Bank's locations are in areas generally characterized as
residential neighborhoods.
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 1970'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
$288.7 million at June 30, 1998, was first mortgage loans secured by
owner-occupied one-to-four family residences. At June 30, 1998, one-to-four
family owner-occupied mortgage loans totaled $134.9 million or 46.7% of gross
loans. Of the total one-to-four family mortgage loans, $49.9 million or 44.4%
were ARM loans. Of the remaining gross loans held at June 30, 1998, 12.0% were
commercial real estate loans, 11.6% were multi-family mortgage loans, 8.7% were
home equity loans, 7.0% were one-to-four family non-owner occupied mortgage
loans, 5.1% were commercial business loans, 4.8% were commercial construction
and lot loans, 1.7% were in various consumer loans, 1.3% were one-to-four family
construction loans and 1.1% were multi-family construction loans. 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, some of which are sold to secondary market
investors within guidelines established by the Asset/Liability Committee. The
Bank's total loan portfolio increased for the year ended June 30, 1998,
primarily because the Bank retained more originated loans, since such loans
currently carry a higher yield than comparable mortgage-backed and related
securities. During the fiscal year ended June 30, 1998, approximately $39.4
million of fixed-rate one-to-four family mortgage loans were originated and
purchased as
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compared to $18.1 million during fiscal year ended June 30, 1997. The total
amount of fixed-rate loans originated was $39.4 million for fiscal 1998; and
$15.6 million for fiscal year 1997. There were no one-to-four family fixed-rate
loans purchased in fiscal 1998. While the level of originations of one-to-four
family mortgage loans increased in fiscal 1998 compared to fiscal 1997,
purchases of one-to-four family mortgage loans (including one-to-four family
construction loans) decreased from $14.7 million in fiscal 1997 to $2.1 million
in fiscal 1998. The reason for the increase in one-to-four family originations
was due primarily to a lower level of long-term interest rates in fiscal 1998
that increased the amount of loans refinanced. In particular, in lieu of
purchasing additional one-to-four family and multi-family mortgage loans, the
Company focused on the origination of a larger percentage of higher-yielding
home equity, commercial/non-residential, commercial real estate construction and
commercial business loans.
In fiscal 1999, the Company's business objectives are to profitably utilize
the Company's shareholders' equity and leverage the capital position of the
Company by continuing to implement a strategy of moderate asset growth, similar
to fiscal 1998.* One of the Company's primary goals is to increase the
percentage size of its gross loan portfolio as compared to the percentage size
of its mortgage-backed and related investment securities portfolio, and within
the gross loan portfolio, to increase the percentage size of higher-yielding
loans secured by multi-family and commercial real estate (both within and
outside the Bank's primary lending area), and commercial business assets (both
within and outside the Bank's primary lending area), as compared to loans
secured by owner-occupied one-to-four family residences, both within and outside
of the Bank's primary lending area.* In fiscal 1999, the Company also intends to
manage its capital and liquidity position and improve profitability by selling a
larger percentage of newly-originated one-to-four family mortgage loans in the
secondary market.* The Company expects the number of loans originated to
increase through the development of a higher credit risk financial services
program (also known as subprime lending) and satellite lending offices outside
the Company's primary lending area.* The subprime lending market includes
manufactured housing, automobile, credit card, business, and residential first
and second mortgage financing, as discussed herein in detail. See "Business -
General."
In fiscal 1999, the Company also intends to explore alternative methods of
reducing net interest expense, such as offering deposit products on the
Company's Website, evaluating potential acquisitions of retail branch networks
in market areas demonstrating a lower cost of funds demand for deposit products
and by actively seeking lower cost funding in the wholesale financial markets.*
The Bank will continue to promote its home equity line of credit product, the
"flexLOAN" to increase the size of its home equity loan portfolio.* Management
of the Company believes the Company's return on equity will continue to improve
through moderate asset growth and through an increase in the volume of
higher-yielding multi-family and commercial real estate loans and commercial
non-real estate loans, through the sale of one-to-four family mortgage loans in
the secondary market, and through the implementation of subprime mortgage
originations and servicing.*
Under regulations established for state savings banks by the DSI as
implemented by the Administrator of the DSI, the Bank is limited in the amount
of commercial real estate and commercial business loans it can hold in its loan
portfolio. This limit is currently 20% of the Bank's total assets and may be
increased with the approval of the DSI. At June 30, 1998, the Bank had $63.1
million of such loans in its portfolio with a current limit based on the Bank's
asset base of $88.0 million. Management anticipates that as the Bank's
commercial real estate and commercial business loan origination and purchase
activity increases in fiscal 1999, the Bank will be required to apply to the DSI
to increase the limit to an amount in excess of 20% of the Bank's asset base.*
While management believes it will be able to obtain such DSI approval, there can
be no assurances that if requested, the DSI will approve an increase in such
lending limit for the Bank, or at what lending limit level such approval will be
granted.
While the Company intends to continue to focus its efforts on originations
within its primary lending area, the Company will continue lending on
credit-worthy opportunities on a national basis.* In fiscal 1999, the Company's
management will continue to evaluate and implement opportunities to originate
and purchase, and may in fact purchase, one-to-four family, multi-family,
commercial real estate loans, commercial real estate construction loans,
commercial business loans, or participation interests in such loans, originated
by other lenders outside the Company's primary lending area.* Management
believes opportunities exist in the national market for the selective
acquisition of quality assets which meet the Bank's asset portfolio
diversification strategy and credit quality guidelines. In deciding whether or
not to originate or 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. However, management of the Company intends to continue
to be cautious with loans secured by multi-family, commercial real estate, and
commercial business loans, as these types of loans generally involve a greater
degree of
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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. 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. The Bank and the Board of Directors have taken precautions to reduce such
risk by establishing prudent loan underwriting guidelines and loan-to-value
ratios. The cash flows, both historical and future projections, of the business
and the value of the collateral are analyzed to provide assurances to the Bank
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. The above credit risks may be
increased with respect to loans secured by properties or business assets located
outside the Company's primary lending area due to the increased difficulty of
monitoring such loans.
Despite the risks inherent in commercial real estate and business lending,
the Bank's delinquent commercial real estate and business loans as a percentage
of gross loans has been minimal. Total non-performing loans to gross loans
receivable was .50% at June 30, 1998 compared to .22% at June 30, 1997. The
primary reason for the increase in total non-performing loans relates to the
default of a commercial real estate loan during fiscal 1998 that is located in
the Bank's primary market with a balance of $683,000. Management believes that
the specific loan loss reserve established on this loan is adequate to absorb a
potential loss related to its resolution.
As the Company's volume of 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
multi-family, commercial real estate and commercial business components of its
gross loan portfolio will benefit the Company longer term, and should contribute
to a long-term improvement in 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 and allowance for losses) as of
the dates indicated.
AT JUNE 30,
-----------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ------------------ ------------------ ----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------- -------- -------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
REAL ESTATE LOANS:
One-to-four family:
Owner-occupied ................ $134,877 46.7% $153,618 53.6% $146,022 58.7% $101,008 66.2% $72,411 65.8%
Non-owner occupied ............ 20,205 7.0 13,893 4.9 7,667 3.1 5,633 3.7 5,429 5.0
Home equity........................ 25,079 8.7 25,297 8.8 19,349 7.8 11,888 7.8 9,810 8.9
Multi-family ...................... 33,513 11.6 27,616 9.7 19,788 8.0 3,755 2.5 2,538 2.3
Commercial/nonresidential ......... 34,610 12.0 21,693 7.6 5,488 2.2 1,297 0.8 1,675 1.5
One-to-four family construction ... 3,718 1.3 17,382 6.1 23,885 9.6 12,796 8.4 7,017 6.6
Multi-family construction ......... 3,120 1.1 9,621 3.4 13,131 5.3 2,556 1.7 -- 0.0
Other construction and land ....... 13,874 4.8 7,385 2.6 6,491 2.6 3,858 2.5 1,478 1.3
-------- ------- -------- -------- -------- -------- -------- ------- -------- ------
Total real estate loans ....... 268,996 93.2 276,505 96.7 241,821 97.3 142,791 93.6 100,358 91.2
CONSUMER AND OTHER LOANS:
Automobile ........................ 755 0.2 1,195 0.7 1,774 0.7 2,327 1.5 2,250 2.1
Student ........................... -- 0.0 -- 0.0 -- 0.0 1,974 1.3 1,681 1.5
Credit card ....................... 2,777 1.0 2,730 1.0 2,585 1.0 2,796 1.8 2,990 2.7
Other consumer loans .............. 1,476 0.5 1,950 1.0 2,372 1.0 2,684 1.8 2,730 2.5
-------- ------- -------- -------- -------- -------- -------- ------- -------- ------
Total consumer loans .......... 5,008 1.7 5,875 2.1 6,731 2.7 9,781 6.4 9,651 8.8
Commercial loans................... 14,646 5.1 3,471 1.2 - 0.0 - 0.0 - 0.0
Gross loans receivable ............ 288,650 100.0% 285,851 100.0% 248,552 100.0% 152,572 100.0% 110,009 100.0%
-------- ------- -------- -------- -------- -------- -------- ------- -------- ------
ADD:
Accrued interest, net ............ 1,764 1,694 1,287 784 523
LESS:
Loans in process ................. (6,848) (11,998) (23,770) (10,099) (4,618)
Deferred fees and discounts ...... (319) (197) (18) 28 (64)
Allowance for loan losses ........ (2,329) (1,762) (1,234) (953) (769)
Allowance for uncollected interest (29) (32) (10) (11) (13)
-------- -------- -------- -------- --------
Total additions/deductions ... (7,762) (12,295) (23,745) (10,251) (4,941)
-------- -------- -------- -------- --------
Loans receivable, net ...... $280,889 $273,556 $224,807 $142,321 $105,068
======== ======== ======== ======== ========
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LOAN MATURITY
The following table shows the contractual maturity of the Bank's loan and
mortgage-backed and related securities portfolio at June 30, 1998. 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 $140.2 million, $70.1 million
and $38.7 million for the years ended June 30, 1998, 1997 and 1996,
respectively. Management anticipates that as the Bank continues to originate
and purchase multi-family, commercial real estate loans 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, 1998
------------------------------------------------------------------------------------------
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 ..................... $ 194 $ 212 $ 359 $ -- $ -- $ 337 $ 1,920
After one year:
One to three years ................ 280 -- 983 494 1,000 7,246 4,500
Three to five years ............... 884 -- 523 1,831 -- 10,675 500
Five to ten years ................. 10,467 -- 22,171 5,588 500 14,060 4,012
Ten to 20 years ................... 46,069 -- 1,043 2,334 500 1,390 2,942
Over 20 years ..................... 97,188 3,506 -- 23,266 1,120 902 --
--------- --------- --------- -------- -------- --------- ----------
Total due after one year ....... 154,888 3,506 24,720 33,513 3,120 34,273 11,954
--------- --------- --------- -------- -------- --------- ----------
Total amounts due .............. 155,082 3,718 25,079 33,513 3,120 34,610 13,874
LESS:
Loans in process .................... (256) (2,152) -- -- (95) -- (4,345)
Deferred fees and discounts ......... (38) -- -- -- -- -- --
Allowance for loan losses/
Unrealized depreciation on
securities available-for-sale ....... (585) (11) (342) (242) (23) (600) (181)
--------- --------- --------- -------- -------- --------- ----------
Loans receivable and mortgage-
backed and related securities, net .. $ 154,203 $ 1,555 $ 24,737 $ 33,271 $ 3,002 $ 34,010 $ 9,348
========= ========= ========= ======== ======== ========= ==========
AT JUNE 30, 1998
-------------------------------------------------
TOTAL
MORTGAGE-
BACKED
AND
RELATED
SECURITIES CONSUMER COMMERCIAL TOTAL
---------- ---------- ----------- -------
AMOUNTS DUE:
Within one year ..................... $ 291 $ 3,016 $ 6,330 $ 12,659
After one year:
One to three years ................ 2,024 535 778 17,840
Three to five years ............... 278 367 4,652 19,710
Five to ten years ................. 4,270 458 2,886 64,412
Ten to 20 years ................... 17,659 632 -- 72,569
Over 20 years ..................... 98,009 -- -- 223,991
--------- -------- -------- ---------
Total due after one year ....... 122,240 1,992 8,316 398,522
--------- -------- -------- ---------
Total amounts due .............. 122,531 5,008 14,646 411,181
LESS:
Loans in process .................... -- -- -- (6,848)
Deferred fees and discounts ......... 305 -- (281) (14)
Allowance for loan losses/
Unrealized depreciation on
securities available-for-sale ....... (5) (160) (185) (2,334)
--------- ------- -------- ---------
Loans receivable and mortgage-
backed and related securities, net .. $ 122,831 $4,848 $14,180 $401,985
========= ======= ======== =========
The following table sets forth at June 30, 1998, the dollar amount of all
loans and mortgage-backed and related securities due after June 30, 1999, and
whether such loans have fixed interest rates or adjustable interest rates.
DUE AFTER JUNE 30, 1999
----------------------------------
FIXED ADJUSTABLE TOTAL
-------- -------------- --------
(IN THOUSANDS)
Mortgage loans:
One-to-four family ........................ $ 106,301 $ 48,587 $ 154,888
One-to-four family construction ........... -- 3,506 3,506
Home equity ............................... 2,833 21,887 24,720
Multi-family .............................. 4,343 29,170 33,513
Multi-family construction ................. 1,500 1,620 3,120
Commercial/nonresidential ................. 16,990 17,283 34,273
Other construction and land ............... 67 11,887 11,954
Consumer loans .................................. 1,992 -- 1,992
Commercial loans ................................ 8,316 -- 8,316
----------- ---------- ----------
Gross loans receivable ................... 142,342 133,940 276,282
Mortgage-backed and related securities .......... 29,921 92,319 122,240
----------- ---------- ----------
Gross loans receivable and
mortgage-backed and related securities .. $ 172,263 $ 226,259 $ 398,522
=========== ========== ==========
-8-
11
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 1998, the
Bank primarily purchased and originated one-to-four family real estate loans
secured by properties located within the Bank's primary lending area. Of the
$46.8 million in one-to-four family originations and $413,000 in purchases
during fiscal 1998, $2.2 million, or 4.8% of gross one-to-four family
originations and purchases, were originated outside of the primary lending area.
The Bank did not purchase any one-to-four family mortgage loans secured by
properties located outside of the primary lending area. One-to-four family loan
purchases decreased from $6.4 million in fiscal 1997 to $413,000 in fiscal 1998.
The decrease of one-to-four family purchased loans in fiscal 1998 was consistent
with the Company's strategic plan to diversify the Bank's asset base into
higher-yielding loans. The one-to-four family mortgage loans purchased in fiscal
1998 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, such as
loan repurchase agreements, were obtained and approved in advance by the Board
of Directors.
The Bank offers conventional fixed-rate mortgage loans and ARM loans with
maturity dates that typically range from 15 to 30 years. Substantially all of
the ARM loans are 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. During the fiscal year ended June 30,
1998, the Bank originated and purchased $39.4 million in fixed-rate one-to-four
family mortgage loans. The Bank sold $18.7 million in fixed-rate one-to-four
family mortgage loans, or 40% of such originated loans, in fiscal 1998. Of the
$18.7 million loans sold, substantially all were 30-year fixed-rate mortgage
loans. During fiscal 1998, management continued its fiscal 1997 strategy of
selling a portion of the fixed-rate loans originated and purchased to provide
funds for adding higher yielding loans to the portfolio. In fiscal 1999, the
Bank intends to sell a larger percentage of one-to-four family mortgage loans in
the secondary market as part of its strategy of asset portfolio diversification,
moderate asset growth, and capital and liquidity management.* 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 Federal Home Loan Mortgage Corporation
("FHLMC") and Fannie Mae underwriting guidelines for its 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 recently has originated loans primarily
without points.
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 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. The lending policy of the Bank
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 exception to this policy is for ARM loans in which case the Bank loans up to
90% 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 majority of one-to-four family loans were outsourced to a contract
underwriter, then reviewed by the Bank's internal underwriter during fiscal
1998. The increase in 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. During fiscal 1998, the Bank began utilizing Desktop
Underwriter (Fannie Mae's automated underwriting system) and Loan Prospector
(FHLB's underwriting system) for the analysis and approval of conforming loans.
This process was initiated in order to streamline the loan underwriting process
and to say up-to-date with advances in mortgage technology. Recommendations to
deny applications based on underwriting considerations are reviewed by the
Bank's senior underwriter prior to a final loan denial. Summaries of all
one-to-four family mortgage loan applications are reviewed on a monthly basis by
the
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12
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 WHEDA
and "First Time Home Buyer" programs offered through the City of Milwaukee and
the City of West Allis. The WHEDA and "First Time Home Buyer" programs generally
have lower down payment and less restrictive qualification ratios. The WHEDA
loans are serviced through WHEDA and originated for them, and the "First Time
Home Buyer" type mortgages generally are held in portfolio.
One-year ARM loans currently adjust a maximum of 2 percentage points per
year with a lifetime interest rate cap of 12.9%. 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 contain a fixed-rate conversion
feature permitting conversion to a fixed rate for up to five years after
origination. 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 or higher. 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, 1998, the Bank had $3.3
million of non-index ARMs outstanding.
The Bank offers one- to three-year balloon payment loan programs for land
loans. Under these programs, the interest rate and monthly payment are fixed for
the initial term and, thereafter, provided certain conditions are met at
maturity, the loan would be either paid off in full or renewed at the
then-current rate.
Historically, the Bank has focused on residential mortgage loan
origination. As a result of mortgage origination emphasis, $29.5 million in
one-to-four family mortgage loans were originated for the fiscal year ended June
30, 1996. For the fiscal years ended June 30, 1997 and 1998, such loan
originations totaled $27.8 million and $46.8 million, respectively. The Bank
experienced a decrease in residential loan origination during fiscal 1997,
compared to fiscal 1996, due to higher interest rate levels. An increase in
originations was experienced in fiscal 1998 as interest rates decreased during
the fiscal year and refinancings increased. Due to the Company's strategy to
increase non-interest income and to provide liquidity for the funding of
higher-yielding multi-family, commercial real estate and commercial business
loans in fiscal 1999, the origination and purchase, and subsequent sale in the
secondary market, of one-to-four family mortgage loans is expected to increase
through the development of a subprime mortgage loan program and satellite
lending offices outside the Company's primary lending area.*
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 market
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 80% combined loan-to-value ratios. After an initial
introductory interest rate which is set below the fully-indexed rate, open-ended
loans have an adjustable interest rate, currently set at the prime rate plus
2%-3% for loans with
-10-
13
combined loan-to-value ratios above 80% and prime plus 1% for loans with
combined loan-to-value ratios up to 80%. Origination fees are charged on closed-
and open-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, 1996 and June 30, 1997, the Bank held $19.3
million and $25.3 million, respectively, in outstanding home equity loans which
represented 7.8% and 8.8%, respectively, of total loans at the end of each
period. At June 30, 1998, home equity loans were $25.1 million, or 8.7% of gross
loans. The Bank intends to continue its effort to increase flexLOAN portfolio
totals in fiscal 1999 as part of its strategy to diversify the loan portfolio
into higher-yielding loans.*
RESIDENTIAL CONSTRUCTION LENDING
The Bank became active in single-family owner-occupied construction loans
in the mid-1980s. Construction loans are made to individuals who have signed
construction contracts with a homebuilder and to a lesser extent, directly to a
home builder. Loan proceeds are disbursed through an insured title 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 and occasionally fixed-rate loans amortized over a
351-month period after a nine-month period during which only interest payments
are required. 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.
For the fiscal years ended June 30, 1996 and 1997, the Bank originated and
purchased $30.5 million and $20.6 million in residential construction loans,
respectively. For the fiscal year ended June 30, 1998, residential construction
loan originations and purchases totaled $4.9 million, of which $1.7 million or
34.4% were purchased loans. The decrease in construction originations and
purchases was consistent with the Company's strategic plan to diversify the
Bank's asset base into higher-yielding loans. In fiscal 1998, all originated and
purchased one-to-four family construction loans were secured by properties
located within the Bank's primary lending area. In fiscal 1999, the Bank intends
to evaluate opportunities to originate residential construction loans secured
by properties located outside of the primary lending area, and 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.
MULTI-FAMILY LENDING
The Bank originates multi-family loans that it retains in its portfolio. In
recent years, the Bank has offered both ARM and fixed-rate multi-family loans
with terms up to 30 years for ARM loans and 15 years for fixed-rate loans. The
rates charged on the Bank's multi-family fixed rate and ARM loans typically are
slightly higher than those charged on loans secured by one-to-four family
residential properties. Multi-family ARM loans typically adjust in a manner
similar to that of the Bank's other ARM loans, although generally at a slightly
higher margin. An origination fee equal to 0.5% to 2.0% of the principal amount
is usually charged on such loans. In fiscal 1998, the Bank evaluated
opportunities to increase its multi-family loan portfolio by originating
multi-family loans within and outside its primary lending area and by purchasing
multi-family loans or participation interests in such loans,
-11-
14
secured by properties located both within and outside of its primary lending
area. However, in fiscal 1998, the Bank did not originate or purchase any
multi-family loans or participation interests in such loans that were secured
by properties located outside of the Bank's primary lending area. In fiscal
1999, the Bank intends to continue to evaluate opportunities to originate and
purchase multi-family loans or participation interests in such loans originated
by other lenders and secured by properties located outside of the Company's
primary lending area.*
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 at the time the application is
submitted. In addition, the Bank's underwriting procedures require verification
of the borrower's credit history, an analysis of the borrower's income, personal
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 part of the overall credit analysis whereby the Bank strives to
obtain such guarantees when possible. 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.
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 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.
The Bank originated $10.5 million, $7.3 million and $13.3 million in
multi-family loans in fiscal years 1996, 1997 and 1998, respectively. In fiscal
1997, the Bank purchased $500,000 of loans secured by multi-family properties,
as compared to $4.5 million in fiscal 1996. The Bank did not purchase any
multi-family loans in fiscal 1998.
MULTI-FAMILY CONSTRUCTION LENDING
In fiscal 1998, the Bank increased its multi-family residential
construction lending activities as compared to fiscal 1997. The primary reason
for the increase in multi-family construction lending was an increase in the
purchase of multi-family construction loans outside of the Bank's primary
lending area. For the fiscal years ended June 30, 1996, 1997 and 1998, the Bank
originated and purchased $8.4 million, $1.8 million and $5.6 million in
multi-family residential construction loans, respectively. Of the $5.6 million
in multi-family construction loans originated and purchased in fiscal 1998, $2.9
million were purchased outside of the Bank's primary lending area. The $2.9
million of purchases outside of the Bank's primary lending area consisted of two
separate transactions, with the largest transaction totaling $2.4 million, and
related to a project located in Fitchburg, Wisconsin. The second transaction of
$500,000 was secured by property located in Minneapolis/St. Paul, Minnesota. In
fiscal 1999, the Bank intends to evaluate opportunities to originate and
purchase multi-family construction loans, or participation interests in such
loans, secured by properties located outside of the Bank's primary lending
area.*
Multi-family construction loans typically offered by the Bank are ARM loans
amortized over 348 months 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 ARM loans are typically
higher than those charged on loans secured by one-to-four family residential
properties. Multi-family ARM loans typically adjust in a manner similar to that
of the Bank's other ARM loans, although generally at a slightly higher margin.
An origination fee of 1% to 2% of the principal amount is usually charged on
such loans.
-12-
15
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 at the time the application is submitted. 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 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 is part of the overall credit analysis whereby the Bank
strives to obtain such guarantees when possible. 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.
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 has 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 $2.6 million, $8.1 million and $15.1 million in
commercial real estate loans in fiscal years 1996, 1997 and 1998, respectively.
In fiscal 1998, the Bank originated and purchased $15.1 million of commercial
real estate loans, of which $8.0 million or 53.0% were loans originated or
purchased and secured by properties within the Bank's primary lending area, and
$7.1 million were participation interests in loans secured by properties located
outside of the Bank's primary lending area. The $7.1 million of participation
interests purchased outside of the Bank's primary lending area, consisted of
seven separate transactions with the largest transaction aggregating $2.7
million and most of the properties securing the loan participations are located
in Minneapolis/St. Paul, Minnesota. In fiscal 1999, the Bank intends to continue
to actively pursue opportunities to originate commercial real estate loans
secured by properties within and outside of its primary lending area, and to
purchase 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 financial statements and banking relationships
and a review of the property, including cash flow projections, historical
operating results, property management experience 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 originated and 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 real estate
project. 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
-13-
16
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 has been minimal.
CONSUMER LENDING
The Bank originates a variety of other consumer loans, generally consisting
of automobile, motorcycle, boat, mobile home and credit card. At June 30, 1996
and June 30, 1997, these other types of loans totaled $6.7 million and $5.9
million, respectively, or 2.7% and 2.1%, respectively, of gross loans at those
dates. The total at June 30, 1998 was $5.0 million, which represented 1.8% of
gross loans. 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 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.
During fiscal 1996, the Bank sold its student loan portfolio and currently
refers student loan applications to external lenders. Management of the Bank
concluded it could employ its capital in higher yielding assets than student
loans.
OTHER CONSTRUCTION/LAND LENDING
In fiscal 1996, 1997 and 1998, respectively, the Bank originated and
purchased $6.4 million, $12.6 million and $18.5 million of commercial real
estate construction loans for commercial properties and residential real estate
land loans. 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 $18.5 million originated
and purchased in fiscal 1998, $11.9 million were originated internally and,
$10.5 million of the $11.9 million originated by the Bank consisted of
commercial real estate construction loans and $1.4 million consisted of
residential land loans. Of the $6.5 million of loans purchased, $6.4 million
were participation interests in commercial real estate construction loans
originated by other lenders and $80,000 consisted of residential land loans. The
$6.4 million of participation interests in commercial real estate construction
loans were secured by properties located outside the Bank's primary lending
area, primarily in Minneapolis/St. Paul, Minnesota. In fiscal 1999, the Bank
intends to continue to pursue opportunities to originate commercial real estate
construction loans secured by properties both within and outside of its primary
lending area and to 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 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 part of the overall credit analysis whereby the
Bank attempts to obtain such guarantees when possible. 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.
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17
COMMERCIAL BUSINESS LENDING
Management believes the operation of the Bank's commercial lending
division, which was established in fiscal 1997, is an effective way to implement
the strategy of asset portfolio diversification resulting in higher-yielding
assets and a higher level of net income. The commercial lending division
originates 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 with three-to-five year maturities and will be fixed or
adjustable rate.
The commercial lending division originated $6.3 million and $28.4 million
in commercial business loans during fiscal years 1997 and 1998, respectively.
All of the commercial business loans originated in fiscal 1997 and 1998 were
collateralized by business assets within the Bank's primary lending area.
However, in fiscal 1999, management intends to evaluate opportunities to
originate commercial business loans secured by business assets located outside
of its primary lending area, or which are unsecured and related to businesses
located outside of its primary lending area.* In addition, during fiscal 1998,
the Bank purchased $6.6 million in commercial business loans for which the
borrowers are businesses located outside of the Bank's primary lending area,
and which consisted of three separate transactions, with the largest
transaction totaling $3.1 million, secured by business assets located in
Arizona. The other two transactions were for loans in the principal amount of
$1.7 million and $1.5 million, and are secured by business assets located in
California and New Mexico, respectively. The business loans purchased outside
of the Bank's primary lending market were short-term participation interests
secured by business assets, and are being serviced by the originating party.
The Company's primary focus has been, and will continue to be, the
origination and purchase of commercial business loans in its primary market.
However, as a recently established division, the Company's commercial lending
unit has experienced, and is expected to continue to experience, competition
from other more seasoned local lenders in its primary market area. In response
to such competition, management has evaluated, and intends to continue to
evaluate, out-of-market commercial loan origination and purchase opportunities
which meet the Company's established loan criteria and underwriting guidelines.
To compensate for the higher levels of risk inherent in such loans, the Bank
receives a higher rate of return and shorter maturity terms. The purchase of the
$6.6 million in out-of-market commercial business loans in fiscal 1998 was
consistent with the Company's strategic plan to diversify the Bank's asset base
into higher-yielding loans, and met the Board mandated loan and underwriting
criteria. The Board of Directors has delegated full credit authority to the
Senior Loan Committee to originate and purchase commercial business loans
within and outside of the Bank's primary lending area that are deemed to be a
short-term asset due to early repayment or near-term resale. All other market
and out-of-market commercial business loan origination and purchases are
approved according to the policy authorized by the Board of Directors, as
discussed herein in detail. See "Loan Approval." In fiscal 1999, the Company
intends to continue to evaluate and implement opportunities to originate and
purchase commercial business loans or participation interests in such loans,
secured or unsecured, both within and outside of its primary lending area.*
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. 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. In addition, an automated tracking and tickler system is in place to
monitor the ongoing financial conditions of the borrowers' businesses,
collateral, insurance coverage, and loan documentation. A 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 requiring the approval of
the Board of Directors.
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18
LOAN APPROVAL
The Bank's 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. Bank underwriters have the authority to approve +5 units
multi-family loans to $250,000, home equity loans up to $100,000 and consumer
loans up to $30,000. Authority exceeding the aforementioned limits are referred
to the Senior Loan Committee and its limits are $100,000 for consumer loans,
$250,000 for home equity loans, $750,000 for one-to-four family loans, and $1.5
million for all multi-family, multi-family construction, commercial real estate,
commercial construction and commercial business loans. A policy approved by the
Board of Directors has established three levels of underwriting approval for
loans secured by real estate or business assets with individual loan officer
authority up to $250,000, Senior Loan Committee authority up to $1.5 million,
and loans in excess of $1.5 million will require the approval of the Board of
Directors. For unsecured commercial business loans, the Board of Directors has
established three levels of underwriting approval with individual loan officer
authority up to $100,000, Senior Loan Committee up to $250,000, and loans in
excess of $250,000 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. The Board of Directors has delegated full credit
authority to the Senior Loan Committee to purchase commercial real estate or
commercial business loans within and outside of the Bank's primary lending area
that are deemed to be a short-term asset due to early repayment or near-term
resale. All other market and out-of-market commercial real estate and business
loan purchases are approved according to the policy authorized by the Board of
Directors. All loans approved pursuant to designated authority are confirmed
monthly by the Loan Committee. One-to-four family, multi-family, commercial real
estate loans and commercial business loans originated and 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.
ORIGINATIONS, PURCHASES AND SALES OF LOANS
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. 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. The
following table sets forth the Bank's loan originations and loan purchases,
sales and principal repayments for the periods indicated. Mortgage loans and
mortgage-backed and related securities held for sale are included in the totals.
In addition, in fiscal 1999, the Company intends to continue to evaluate
opportunities to originate and purchase, and may in fact purchase, one-to-four
family, multi-family, multi-family construction, commercial real estate,
commercial construction, commercial business loans, or participation interests
in such loans, originated by lenders and secured by properties, business assets
or unsecured, located both within and outside of the Company's primary lending
area, due to the higher yields associated with such lending activities.* The
Company also intends to sell a larger percentage of one-to-four family mortgage
loans which may be seasoned or recently originated in the secondary market in
fiscal 1999 to provide liquidity for the funding of higher-yielding
multi-family, commercial real estate and commercial business loans.* The
Company anticipates that increased sales of one-to-four family loans will
decrease the proportion of the gross loan portfolio represented by such loans,
will increase non-interest income as a result of increased gains on the sales
of such loans, and will further lessen the Company's negative gap position as
such loans are replaced by higher-yielding, adjustable rate assets, including
multi-family, commercial real estate and commercial business loans.*
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19
FISCAL YEAR ENDED JUNE 30,
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
MORTGAGE LOANS (GROSS):
At beginning of period ................................................ $ 276,505 $ 241,821 $ 142,791
Mortgage loans originated:
One-to-four family ................................................. 46,756 27,781 29,476
One-to-four family construction .................................... 3,218 12,241 14,883
Home equity...................................................... .. 16,151 18,950 16,658
Multi-family ....................................................... 13,301 7,287 10,488
Multi-family construction .......................................... 1,720 1,810 7,359
Commercial/non-residential ......................................... 2,504 4,826 625
Other construction/land ............................................ 16,034 10,563 2,039
--------- --------- ---------
Total mortgage loans originated .................................. 99,684 83,458 81,528
Mortgage loans purchased:
One-to-four family ................................................. 413 6,368 24,120
One-to-four family construction .................................... 1,688 8,345 15,625
Multi-family ....................................................... -- 500 4,476
Multi-family construction .......................................... 3,917 -- 1,000
Commercial/non-residential ......................................... 8,513 3,250 2,000
Other construction/land ............................................ 6,540 2,029 4,374
--------- --------- ---------
Total mortgage loans purchased ................................... 21,071 20,492 51,595
--------- --------- ---------
Total mortgage loans originated and purchased ...................... 120,755 103,950 133,123
--------- --------- ---------
Transfer of mortgage loans to foreclosed
real estate ........................................................ (267) (54) (126)
Principal repayments .................................................. (107,784) (58,594) (30,452)
Securitization of fixed-rate loans .................................... -- -- (2,512)
Sales of fixed-rate loans ............................................. (20,213) (10,618) (1,003)
--------- --------- ---------
At end of period ...................................................... $ 268,996 $ 276,505 $ 241,821
========= ========= =========
CONSUMER LOANS:
At beginning of period ................................................ $ 5,875 $ 6,731 $ 9,781
Consumer loans originated .......................................... 7,065 7,896 7,190
Principal repayments .................................................. (7,932) (8,752) (8,225)
Sale of student loans ................................................. -- -- (2,015)
--------- --------- ---------
At end of period ...................................................... $ 5,008 $ 5,875 $ 6,731
========= ========= =========
COMMERCIAL LOANS:
At beginning of period ................................................ $ 3,471 $ -- $ --
Commercial loans originated ........................................ 28,982 6,262 --
Commercial loans purchased ......................................... 6,631 -- --
Principal repayments ............................................... (24,438) (2,791) --
--------- --------- ---------
At end of period ...................................................... $ 14,646 $ 3,471 $ --
========= ========= =========
MORTGAGE-BACKED AND RELATED SECURITIES:
At beginning of period ................................................ $ 96,811 $ 115,258 $ 82,447
Mortgage-backed and related
securities purchased ................................................ 63,753 731 69,483
Sales of mortgage-backed and related
securities .......................................................... (8,905) (421) (14,083)
Amortization and repayments ........................................... (28,938) (19,041) (22,120)
Market valuation allowance on available-for-sale
mortgage-backed securities ........................................... 110 284 (469)
--------- --------- ---------
At end of period ...................................................... $ 122,831 $ 96,811 $ 115,258
========= ========= =========
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20
SALE OF MORTGAGE LOANS
The Bank sells one-to-four family mortgage loans, on a non-recourse basis,
into the secondary market to the Federal Home Loan Mortgage Corporation
("FHLMC"), WHEDA 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 $18.7 million in fixed-rate one-to-four
family mortgage loans in fiscal 1998. Of the $18.7 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 1998, management continued to
sell a portion of the fixed-rate loans originated and purchased 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 Federal Home Loan Mortgage Corporation ("FHLMC") and
Fannie Mae underwriting guidelines for its one-to-four family mortgage loans. In
fiscal 1998, management intends to re-activate its seller/servicer agreement
with Fannie Mae and begin selling and servicing conventional and affordable
housing lending programs through Fannie Mae in order to expand the Bank's
lending opportunities. In fiscal 1999, management intends to sell a larger
percentage of 30-year and 15-year fixed-rate mortgage loans to either FHLMC,
Fannie Mae or private secondary market purchasers as part of its strategy of
portfolio diversification and in order to continue to manage interest rate risk,
control asset growth and provide liquidity for the funding of higher-yielding
multi-family, commercial real estate and commercial business loans.*
For the fiscal years ended June 30, 1998, 1997 and 1996, the Bank's
fixed-rate loan sales to private and governmental investors totaled $18.7
million, $10.6 million and $1.0 million, with associated gains of $297,000,
$95,000 and $75,000, respectively.
All mortgage loans are made and underwritten pursuant to the requirements
of and with commitments from secondary market investors. The Bank retains
servicing on loans sold to FHLMC, receiving a servicing fee, which represents
the difference between the contract rate on the loans sold and the yield at
which such loans are sold. The servicing spread earned by the Bank is typically
.25%. The Bank releases servicing on loans sold to private secondary market
purchasers. For the fiscal years ended June 30, 1998, 1997 and 1996, the Bank's
net service fees on loans sold into the secondary market totaled $61,000,
$86,000 and $103,000, respectively.
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.
PURCHASED LOANS
During the fiscal year ended June 30, 1998, the Bank purchased $21.1
million of mortgage loans compared to $20.5 million in fiscal 1997 and $51.6
million in fiscal 1996. Of the $21.1 million of mortgage loans purchased during
fiscal 1998, $19.0 million or 90.0% consisted of participation interests,
primarily in commercial construction, commercial real estate and multi-family
loans, and $2.1 million or 10.0% consisted of whole loans, primarily in
one-to-four family and one-to-four family construction mortgage loans, which
were serviced either by the Bank or others; furthermore, $18.1 million, or 85.8%
of the mortgage loans purchased during fiscal 1998, were secured by properties
located outside of the Bank's primary lending area, compared to $5.3 million or
25.9% of mortgage loans purchased during fiscal 1997.
The purchase of mortgage loans increased during fiscal 1998, primarily in
the multi-family construction, commercial construction and commercial real
estate categories due to the availability of purchase opportunities and a less
competitive environment outside of the Bank's primary lending area, and
continued to decrease in the one-to-four family purchase and construction loan
categories. This decrease is due to the Company's strategy of capital and
liquidity management, and asset portfolio diversification which shifts the
emphasis from the origination and purchase of lower-yielding one-to-four family
mortgage loans to multi-family, commercial real estate and business loans. In
fiscal 1999, the Bank intends to continue to purchase mortgage loans or
participation interests in loans originated by other lenders and secured by
properties located within and outside its primary lending area at levels
consistent with its strategy of asset portfolio diversification and capital
management.* 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 has applied, and continues to apply, underwriting guidelines which
are at least as strict as those applicable to the origination of similar loans
within its primary lending area.
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21
LOAN ORIGINATION, SERVICING AND OTHER FEES
In addition to interest earned on loans, the Bank receives income through
fees in connection with loan originations, loan sales, loan modifications, late
payments and for miscellaneous services related to its loans, including loan
servicing. Income from these activities varies from period to period with the
volume and type of loans originated.
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 $319,000, $197,000 and $18,000 at
June 30, 1998, 1997, and 1996, respectively. The increase in unamortized
deferred loan fees at June 30, 1998, primarily resulted from the originations of
loans with higher fees.
For loans sold to FHLMC, the Bank virtually always retains the
responsibility for servicing such loans. At June 30, 1998, the Bank serviced
$25.7 million of loans for others and received fee income of $61,000 for the
fiscal year ended June 30, 1998 in connection with loans serviced for others.
The contractual right to service mortgage loans that have been sold has an
economic value that, in accordance with GAAP, was generally not 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. The
mortgage servicing asset created will be amortized against the servicing fee
income stream in accordance with Financial Accounting Standards 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.
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 FHA, 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
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22
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 10 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.
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 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. At June 30, 1998, the
Bank had one property in foreclosure.
Non-performing loans include loans placed on non-accrual status and
troubled debt restructuring. Non-performing assets include non-performing loans
and foreclosed properties. The following table sets forth non-performing loans
and assets:
AT JUNE 30,
-------------------------------------------
1998 1997 1996 1995 1994
------ -------- -------- -------- -----
(DOLLARS IN THOUSANDS)
Non-accrual mortgage loans 90 days or more past due ....... $ 1,338 $ 572 $ 64 $ 117 $ --
Non-accrual consumer loans 90 days or more past due ....... 52 20 -- -- --
Loans 90 days or more past due and still accruing(1) ...... 34 31 26 26 217
Troubled debt restructuring ............................... -- -- -- -- --
-------- -------- -------- -------- -------
Total non-performing loans ............................... 1,424 623 143 143 217
-------- -------- -------- -------- -------
Total real estate owned and in judgment, net of
related allowance for losses ............................ 11 20 24 24 26
-------- -------- -------- -------- -------
Total non-performing assets ............................... $ 1,435 $ 643 $ 167 $ 167 $ 243
======== ======== ======== ======== =======
Total non-performing loans to gross loans receivable ...... 0.50% 0.22% 0.09% 0.09% 0.20%
======== ======== ======== ======== =======
Total non-performing assets to total assets ............... 0.33% 0.16% 0.06% 0.06% 0.14%
======== ======== ======== ======== =======
- -------------------------------------
(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. At June 30, 1998, total loans 90 days or more
past due and still accruing consisted of credit card loans in the amount of
$34,000.
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23
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, 1998, the Bank had assets
classified as Substandard of $1,049,000, $192,000 as Doubtful, and none as Loss.
The increase in substandard and classified assets and non-accrual mortgage loans
relates to the default of a commercial real-estate loan during fiscal 1998 that
is located in the Bank's primary market with a balance of $683,000. Management
believes that the specific loan loss reserve established on this loan is
adequate to absorb a potential 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,
1998, 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, which reduces net interest income, 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. During fiscal 1998, the increase in the level
of allowance for losses on loans was primarily the result of the increase in
multi-family, multi-family construction, home equity, commercial real estate and
commercial business loan portfolios which carry a greater degree of credit risk
as compared to one-to-four family lending. It is anticipated that in fiscal
1999, additions charged to operations will increase due to increased emphasis
on, and increased risks associated with, multi-family, commercial real estate
lending and commercial business lending and overall loan portfolio growth.
-21-
24
The following table sets forth activity in the Bank's allowance for loan
losses during the fiscal years indicated.
AT JUNE 30,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Balance at beginning of period .................. $ 1,762 $ 1,234 $ 953 $ 769 $ 652
Additions charged to expense:
One-to-four family .......................... -- 295 172 114 129
Multi-family and commercial real estate ..... 512 181 80 57 --
Consumer .................................... 163 114 115 77 100
Commercial .................................. 125 60 -- -- --
-------- -------- -------- -------- --------
800 650 367 248 229
-------- -------- -------- -------- --------
Recoveries:
One-to-four family .......................... -- 1 8 -- --
Consumer .................................... 31 5 9 7 15
-------- -------- -------- -------- --------
31 6 17 7 15
-------- -------- -------- -------- --------
Charge-Offs:
One-to-four family .......................... (69) (11) (15) (13) (47)
Consumer .................................... (195) (117) (88) (58) (80)
-------- -------- -------- -------- --------
(264) (128) (103) (71) (127)
-------- -------- -------- -------- --------
Net charge-offs ................................. (233) (122) (86) (64) (112)
-------- -------- -------- -------- --------
Balance at end of period ........................ $ 2,329 $ 1,762 $ 1,234 $ 953 $ 769
======== ======== ======== ======== ========
Percentage of loans to gross loans receivable:
Mortgage loans .............................. 93.19% 96.73% 93.59% 93.59% 91.23%
Consumer loans .............................. 1.73 2.06 6.41 6.41 8.77
Commercial loans ............................ 5.08 1.21 -- -- --
Ratio of allowance for loan losses to gross loans
receivable at the end of period ............. 0.81 0.62 0.62 0.62 0.70
Ratio of allowance for losses on loans to non-
performing loans at the end of period ....... 166.36 282.37 666.43 666.43 354.38
Ratio of allowance for losses on loans to non-
performing assets at the end of period ...... 165.06 273.60 570.66 570.66 316.47
Ratio of net charge-offs to average gross loans
during period ............................... 0.08 0.04 0.05 0.05 0.12
Average gross loans outstanding ................. $280,204 $274,056 $187,969 $134,152 $ 94,428
Gross loans receivable at end of period ......... $288,650 $285,851 $248,552 $152,572 $110,009
-22-
25
At June 30, 1998, 1997, and 1996, delinquencies in the Bank's loan
portfolio were as follows:
AT JUNE 30, 1998 AT JUNE 30, 1997
------------------------------------ -------------------------------------------
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 ........ 6 $350 8 $533 -- $-- 8 $573
Residential construction .. -- -- -- -- 1 12 -- --
Home equity ............... 5 95 9 122 -- -- -- --
Multi-family .............. -- -- -- -- -- -- -- --
Commercial ................ -- -- 1 683 -- -- -- --
------ --------- ------ --------- ------ ----------- ----------- ---------
Total mortgage loans .. 11 445 18 1,338 1 12 8 573
CONSUMER LOANS ............... 10 28 23 86 2 5 18 51
------ --------- ------ --------- ------ ----------- ----------- ---------
TOTAL ..................... 21 $473 41 $1,424 3 $17 26 $624
====== ========= ====== ========= ====== =========== =========== =========
DELINQUENT LOANS TO GROSS
LOANS(2)................. 0.17% 0.50% 0.01% 0.22%
========= ========= =========== =========
AT JUNE 30, 1996
------------------------------------
60-89 90 DAYS
DAYS OR MORE(1)
----------------- -----------------
NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS
------ --------- ------ ---------
MORTGAGE LOANS:
One-to-four family ........ 1 $ 10 4 $ 64
Residential construction .. -- -- -- --
Home equity ............... -- -- -- --
Multi-family .............. -- -- -- --
Commercial ................ -- -- -- --
------ --------- ------ ---------
Total mortgage loans .. 1 64 4 64
CONSUMER LOANS ............... 19 48 13 43
------ --------- ------ ---------
TOTAL ..................... 20 $ 58 17 $ 107
====== ========= ====== ==========
DELINQUENT LOANS TO GROSS
LOANS(2)................. 0.02% 0.04%
======== =========
- --------------------------------
(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.
(2) Excluding mortgage-backed and related securities.
-23-
26
The following tables shows the Bank's allowance for loan losses and the
allocation to the various categories of loans held for investments 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,
------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- ---------------------------- --------------------------
% 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 ........... $585 0.38% 53.73% $685 0.41% 58.60% $488 0.32% 61.82%
Home equity .................. 342 1.36 8.69 253 1.00 8.85 194 1.00 7.78
Multi-family ................. 242 0.72 11.61 190 0.69 9.66 198 1.00 7.96
Commercial/nonresidential .... 600 1.73 11.99 198 0.91 7.59 44 0.80 2.21
One-to-four family
construction ................ 11 0.30 1.29 69 0.40 6.08 40 0.17 9.61
Multi-family construction .... 23 0.74 1.08 72 0.75 3.37 46 0.35 5.28
Other construction and land .. 181 1.30 4.81 74 1.00 2.58 65 1.00 2.60
------ -------- -------- -------- ------ --------
Total mortgage loans ........ 1,984 93.20 1,541 96.73 1,075 97.26
------ -------- -------- -------- ------ --------
Consumer loans ................ 160 3.19 1.73 161 2.74 2.06 206 2.34 2.74
------ -------- -------- -------- ------ --------
Commercial loans .............. 185 1.26 5.07 60 1.73 1.21 --
------ -------- -------- -------- ------
Total allowance for loan
losses ..................... $2,329 100.00% $1,762 100.00% $1,234 100.00%
====== ======== ======== ======== ====== ========
AT JUNE 30,
-----------------------------------------------------------------
1995 1994
----------------------------- ----------------------------------
% 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 ................ $471 0.44% 69.90% $386 0.50% 70.76%
Multi-family ...................... 119 1.00 7.23 25 0.99 2.31
Home equity ....................... 37 0.98 2.46 99 1.01 8.92
Commercial/nonresidential ......... 13 1.00 0.85 17 1.01 1.52
One-to-four-family construction ... 51 0.40 8.39 35 0.50 6.38
Other construction and land ....... 64 1.01 4.20 15 1.01 1.34
---- ------- ----- -------
Total mortgage loans ............. 755 93.03 577 91.23
---- ------- ----- -------
Consumer loans ..................... 198 2.02 6.97 192 1.99 8.77
---- ------- ----- -------
Total allowance for loan losses .. $953 100.00% $769 100.00%
==== ======= ===== =======
-24-
27
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, the Federal National
Mortgage Association ("FNMA") or the Government National Mortgage Association
("GNMA"), investment grade corporate debt 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's current
investment policy permits purchases only of investments rated investment grade
by a nationally recognized rating agency and does not permit purchases of
securities of non-investment grade quality.
-25-
28
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, FNMA
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 noteholders 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.
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
that 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
-26-
29
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 an increase in the level of principal repayments
on mortgage-backed securities and mortgage related securities to $28.8 million
during the fiscal year ended June 30, 1998, from $19.0 million in fiscal year
1997. The increase in principal repayments during fiscal 1998 is primarily
related to the decrease in interest rates and increase 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, 1998, the Company
held $65.3 million in its mortgage-backed and related securities portfolio as
compared to $85.4 million and $97.3 million at June 30, 1997 and 1996,
respectively. Of this amount, fixed-rate securities and adjustable-rate
securities were $8.1 million and $57.2 million; $13.4 million and $72.0
million; and $16.7 million and $80.6 million at June 30, 1998, 1997 and 1996,
respectively. The decrease in fiscal 1998 is attributable to the decision of
the Company to use the principal repayments on mortgage-backed and related
securities to fund the increase in loans receivable and mortgage-backed and
related securities available-for-sale. The estimated market value of these
securities at June 30, 1998 was $66.2 million as compared to $86.1 million and
$97.2 million at June 30, 1997 and 1996, respectively. At June 30, 1998, the
mortgage-backed and related securities portfolio represented 14.9% of the
Company's total assets as compared to 20.8% and 25.8% at June 30, 1997 and
1996, respectively. Included in the mortgage-backed securities portfolio were
federal agency backed and private-issue pass-through securities totaling $14.7
million and $16.8 million; $21.0 million and $25.1 million; $27.0 million and
$28.8 million at June 30, 1998, 1997 and 1996, respectively. Of the $16.8
million in private-issue securities at June 30, 1998, all were adjustable 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 $33.8 million, $39.4
million and $41.5 million at June 30, 1998, 1997 and 1996, respectively.
Other Investment Securities. Other investments consisted primarily of
overnight deposits, certificates of deposit and bankers' acceptances which
totaled $6.6 million, $5.7 million and $3.7 million at June 30, 1998, 1997 and
1996, respectively. The market value of these securities were $6.6 million,
$5.7 million and $3.7 million at June 30, 1998, 1997 and 1996, respectively.
COMPOSITION OF SECURITIES AVAILABLE-FOR-SALE
Mortgage-Backed Securities and Related Securities. At June 30, 1998, the
Company held mortgage-backed and related securities available-for-sale with a
carrying and market value of $57.5 million as compared to $11.4 million and
$17.9 million at June 30, 1997 and 1996, respectively. Of this amount at June
30, 1998, $41.4 million of the securities are mortgage-backed securities and
$16.1 million REMIC securities. Included in the mortgage-backed and related
securities were federal agency backed and private-issue securities totaling
$6.6 million and $50.9 million, respectively, and all were fixed-rate
securities. 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, ARM Mutual
totaling $5.0 million and $1.0 million; $16.7 million and $1.0 million; and
$17.9 million and $1.4 million at June 30, 1998, 1997 and 1996, respectively.
Also at June 30, 1998, the Company had trust preferred securities and municipal
bonds with a carrying and market value of $2.5 million and $410,000,
respectively. The Company carries such investments at fair value.
-27-
30
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, 1998, 1997 and 1996.
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/other ............................ 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
======== ======== ========
JUNE 30, 1997
----------------------------
CARRYING % OF MARKET
VALUE TOTAL VALUE
-------- -------- --------
(DOLLARS IN THOUSANDS)
SECURITIES AVAILABLE-FOR-SALE:
U.S. government securities ......................... $16,748 56.74% $16,748
Mortgage-backed securities ......................... 3,695 12.52 3,695
Mortgage-related securities (REMICs) ............... 7,686 26.04 7,686
ARM loan mutual funds .............................. 978 3.31 978
Municipal bonds .................................... 411 1.39 411
-------- -------- --------
Total securities available-for-sale .............. $29,518 100.00% $29,518
======== ======== ========
SECURITIES HELD-TO-MATURITY:
Demand deposits in other financial institutions .... $ 4,896 86.26% $ 4,896
Time deposits in other financial institutions ...... 780 13.74 780
-------- -------- --------
Total securities held-to-maturity ................ $ 5,676 100.00% $ 5,676
======== ======== ========
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY:
GNMA .............................................. $ 934 2.03% $ 979
FHLMC ............................................. 4,823 10.47 4,893
FNMA .............................................. 15,171 32.94 15,359
Other participation certificates .................. 25,132 54.56 25,101
-------- -------- --------
Total mortgage-backed securities
held-to-maturity ............................. $46,060 100.00% $46,332
======== ======== ========
MORTGAGE-RELATED SECURITIES HELD-TO-MATURITY:
CMOs ............................................... -- -- --
REMICs ............................................. 39,370 100.00 39,370
-------- -------- --------
Total mortgage-related securities
held-to-maturity ............................... $39,370 100.00% $39,370
======== ======== ========
-28-
31
JUNE 30, 1996
----------------------------
CARRYING % OF MARKET
VALUE TOTAL VALUE
-------- -------- --------
(DOLLARS IN THOUSANDS)
SECURITIES AVAILABLE-FOR-SALE:
U.S. government securities ......................... $17,932 48.10% $17,932
Mortgage-backed securities ......................... 8,775 23.53 8,775
Mortgage-backed securities (REMICs) ................ 9,151 24.54 9,151
ARM loan mutual funds .............................. 1,426 3.83 1,426
-------- -------- --------
Total securities available-for-sale .............. $37,284 100.00% $37,284
======== ======== ========
SECURITIES HELD-TO-MATURITY:
Demand deposits in other financial institutions .... $ 2,689 73.33% $ 2,689
Time deposits in other financial institutions ...... 978 26.67 978
------- -------- --------
Total securities held-to-maturity ................ $3,667 100.00% $3,667
======== ======== ========
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY:
GNMA ............................................... $ 1,379 2.47% $ 1,433
FHLMC .............................................. 6,484 11.62 6,509
FNMA ............................................... 19,127 34.28 19,157
Other participation certificates ................... 28,801 51.63 28,524
------- -------- --------
Total mortgage-backed securities
held-to-maturity ............................... $55,791 100.00% $55,623
======== ======== ========
MORTGAGE-RELATED SECURITIES HELD-TO-MATURITY:
CMOs ............................................... -- -- --
REMICs ............................................. 41,541 100.00 41,616
-------- -------- --------
Total mortgage-related securities
held-to-maturity .............................. $41,541 100.00% $41,616
======== ======== ========
The composition and contractual maturities of securities held-to-maturity,
excluding FHLB-Chicago stock, is indicated in the following table.
AT JUNE 30, 1998
-----------------------------------------------
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 .. $6,186 - - $6,186
Time deposits in other financial institutions .... 388 - - 388
------ ------- ------- ------
Total securities held-to-maturity .............. $6,574 - - $6,574
====== ======= ======= ======
Weighted average yield ........................... 5.59% -% -% 5.59%
====== ======= ======= ======
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32
The following table shows the maturity or period to repricing of the
Company's securities available-for-sale at June 30, 1998.
AT JUNE 30, 1998
----------------------------------------------------------------------------------
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 .............................. $ -- -- $ 289 5.00% $ 31,486 7.25% $ -- --
AFTER ONE YEAR:
One to three years ........................... 4,992 6.00 615 5.50 -- -- -- --
Three to five years .......................... -- -- -- -- -- -- -- --
Five to ten years ............................ -- -- -- -- -- -- -- --
Ten to 20 years .............................. -- -- -- -- -- -- 8,007 7.31
Over 20 years ................................ -- -- 6,760 7.77 -- -- 6,623 7.52
-------- -------- --------- --------- --------- --------- -------- ------
Total due or repricing after one year ...... 4,992 6.00 7,375 7.58 -- -- 14,630 7.41
-------- -------- --------- --------- --------- --------- -------- ------
Total amount due or repricing .............. 4,992 6.00% 7,664 7.48% 31,486 7.25% 14,630 7.41%
Less unearned discounts and premiums, net .. -- -- -- --
Mortgage-backed and related securities ..... $ 4,992 $ 7,664 $ 31,486 $ 14,630
======== ========= ========= ========
Average remaining years to maturity ............ 2.7 24.9 25.0 19.9
AT JUNE 30, 1998
--------------------------------------------------------------------------------
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 .............................. $ 3,769 7.71% $ 969 5.46% $ -- --% $36,513 7.23%
AFTER ONE YEAR:
One to three years ........................... -- -- -- -- 160 5.00 5,767 5.92
Three to five years .......................... -- -- -- -- -- -- -- --
Five to ten years ............................ -- -- -- -- 275 5.33 275 5.33
Ten to 20 years .............................. -- -- -- -- -- -- 8,007 7.31
Over 20 years ................................ -- -- 2,500 8.60 -- -- 15,883 7.80
-------- -------- -------- -------- --------- --------- --------- ------
Total due or repricing after one year ...... -- 2,500 8.60 435 5.21 29,932 7.28
-------- -------- -------- -------- --------- --------- --------- ------
Total amount due or repricing .............. 3,769 7.71% 3,469 7.72% 435 5.21% 66,445 7.25%
Less unearned discounts and premiums, net .. -- -- -- --
Mortgage-backed and related securities ..... $ 3,769 $3,469 $ 435 $66,445
======== ======== ========= =========
Average remaining years to maturity ............ 26.2 0.0 6.3 22.0
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, 1998.
AT JUNE 30, 1998
------------------------------------------------------------------------
FIXED-RATE ADJUSTABLE-RATE FIXED-RATE
MORTGAGE-BACKED MORTGAGE-BACKED CMOS AND
SECURITIES SECURITIES REMICS
------------------ ----------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
AMOUNTS DUE OR REPRICING:
Within one year ............................ $ -- --% $27,587 7.20% $ -- --%
AFTER ONE YEAR:
One to three years ......................... 1,317 6.76 -- -- 87 6.60
Three to five years ........................ -- -- -- -- -- --
Five to ten years .......................... 2,139 6.23 -- -- 409 5.45
Ten to 20 years ............................ 252 8.88 -- -- 802 7.58
Over 20 years .............................. 65 9.50 -- -- 2,990 7.24
-------- -------- ----------- ----------- ----------- -----------
Total due or repricing after one year .... 3,773 6.64 -- -- 4,288 6.78
-------- -------- ----------- ----------- ----------- -----------
Total amounts due or repricing ........... 3,773 6.54% 27,587 7.20% 4,288 6.78%
Less unearned discounts and premiums, net .... 33 87 (122)
-------- ----------- -----------
Mortgage-backed and related securities, net .. $3,806 $27,674 $4,266
======== =========== ===========
Average remaining years to maturity .......... 5.4 23.8 19.5
AT JUNE 30, 1998
----------------------------------------------------
ADJUSTABLE-RATE
REMICS TOTAL
-------------------------- ------------------------
WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD
----------- ----------- ----------- -----------
AMOUNTS DUE OR REPRICING:
Within one year ............................ $29,741 6.80% $ 57,328 6.99%
AFTER ONE YEAR:
One to three years ......................... -- -- 1,404 6.75
Three to five years ........................ -- -- -- --
Five to ten years .......................... -- -- 2,548 6.10
Ten to 20 years ............................ -- -- 1,054 7.89
Over 20 years .............................. -- -- 3,055 7.29
----------- ----------- ----------- -----------
Total due or repricing after one year .... -- -- 8,061 6.71
----------- ----------- ----------- -----------
Total amounts due or repricing ........... 29,741 6.80% 65,389 6.95%
Less unearned discounts and premiums, net .... (205) (107)
----------- -----------
Mortgage-backed and related securities, net .. $29,536 $ 65,282
=========== ===========
Average remaining years to maturity .......... 22.4 21.8
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33
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, 1998, the Company had advances from the FHLB-Chicago totaling
$117.1 million or 26.7% of total assets as compared to $92.1 million or 22.5%
of total assets and $102.4 million or 27.1% of total assets as of June 30, 1997
and 1996, respectively. At June 30, 1998 and 1997, the Company had no reverse
repurchase agreements At June 30, 1996, the Company had $11.6 million in
reverse repurchase agreements. 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, 1998, $23.0 million will mature before 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."
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,
----------------------------------
1998 1997 1996
-------- -------------- --------
(IN THOUSANDS)
Deposits ............................... $449,609 $432,876 $424,023
Withdrawals ............................ 466,515 387,593 352,357
-------- -------- --------
Net deposits/withdrawals ............... (16,906) 45,283 71,666
Interest credited on deposits .......... 7,013 6,554 5,842
-------- -------- --------
Total increase (decrease) in deposits .. $(9,893) $51,837 $77,508
======== ======== ========
The Company attributes the decrease in deposits before interest credited
during fiscal 1998 primarily to the planned run-off of certificates of deposit
locally and on a wholesale basis nationally. The decreased deposit funding
source was replaced with an increase in FHLB advances in fiscal 1998.
Management believes 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. Brokered deposits totaled $81.4 million at June 30, 1998,
as compared to $92.2 million at June 30, 1997. The average maturity of brokered
deposits at June 30, 1998 was eight months as compared to eleven months at June
30, 1997. The average rate paid on brokered deposits for the fiscal year ended
June 30, 1998 was 6.13% as compared to 5.98% for the fiscal year ended June 30,
1997. The Company's demand deposits have decreased in recent fiscal years,
primarily due to the decline in
-31-
34
passbook savings accounts; however, increases in certificates of deposit and
money market deposit accounts have offset this growth. Management believes that
this pattern is a result of the lower interest rate environment.
At June 30, 1998, the Company had outstanding $56.0 million in
certificates of deposit in amounts of $100,000 or more maturing as follows:
AMOUNT AT
JUNE 30, 1998
--------------
(IN THOUSANDS)
Three months or less ............ $19,887
Over three through six months ... 16,525
Over six through twelve months .. 9,763
Over twelve months .............. 9,874
---------
Total .......................... $56,049
=========
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35
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 $81.4 million of brokered certificates of
deposit at June 30, 1998, which represent all of the Company's brokered deposits
at June 30, 1998.
AT JUNE 30,
--------------------------------------------------------------------------------------------
1998 1997
-------------------------------------- ---------------------------------------------
WEIGHTED WEIGHTED
PERCENT OF AVERAGE PERCENT OF AVERAGE
TOTAL NOMINAL TOTAL NOMINAL
AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE
------ -------- ---- ------- -------- -----
(DOLLARS IN THOUSANDS)
DEMAND DEPOSITS:
Non-interest-bearing..... $ 7,738 2.85% --% $ 7,105 2.52% --%
NOW...................... 2,701 0.99 1.75 2,594 0.92 1.75
Money market............. 27,995 10.31 5.10 20,730 7.37 5.20
Passbook................. 21,158 7.79 2.93 21,952 7.80 2.98
-------- --------- -------- ----------
Total................... 59,592 21.94 3.52 52,381 18.61 3.40
CERTIFICATE ACCOUNTS (TERM):
One to nine months....... 68,050 25.09 5.79 12,650 4.49 5.37
12 to 20 months.......... 14,290 5.26 5.77 40,309 14.32 5.90
24 to 36 months.......... 2,662 0.98 5.83 15,555 5.53 5.73
38 to 60 months.......... 2,685 0.99 6.02 19,439 6.90 5.96
66 to 96 months.......... -- 0.00 -- 157 0.06 7.96
Wholesale(1)............. 124,340 45.74 6.07 141,021 50.09 6.15
-------- --------- -------- ----------
Total certificates...... 212,027 78.06 5.95 229,131 81.39 6.02
-------- --------- -------- ----------
Total deposits............ $271,619 100.00% 5.42% $281,512 100.00% 5.53%
======== ========= ======== ==========
AT JUNE 30,
-----------------------------------------
1996
-----------------------------------------
WEIGHTED
PERCENT OF AVERAGE
TOTAL NOMINAL
AMOUNT DEPOSITS RATE
---------- ---------- ----
DEMAND DEPOSITS:
Non-interest-bearing..... $ 7,215 3.14% --%
NOW...................... 2,517 1.10 1.75
Money market............. 7,678 3.34 5.21
Passbook................. 24,342 10.60 2.99
---------- ----------
Total................... 41,752 18.18 2.79
CERTIFICATE ACCOUNTS (TERM):
One to nine months....... 21,999 9.58 5.37
12 to 20 months.......... 24,482 10.66 5.49
24 to 36 months.......... 17,688 7.70 5.94
38 to 60 months.......... 15,586 6.79 6.08
66 to 96 months.......... 172 0.07 7.93
Wholesale(1)............. 107,996 47.02 6.22
---------- ----------
Total certificates...... 187,923 81.82 5.99
---------- ----------
Total deposits............ $229,675 100.00% 5.41%
========== ==========
(1) Wholesale certificates of deposit have an average maturity of 8.0 months,
11.6 months and 8.2 months at June 30, 1998, 1997 and 1996, respectively.
-33-
36
The following table presents, by various rate categories, the amount of
certificates of deposit outstanding at June 30, 1998, 1997 and 1996, and the
periods to maturity of the certificate accounts outstanding at June 30, 1998.
At June 30, 1998, brokered certificates of deposit totaled $81.4 million with
an average rate of 6.04%.
AT JUNE 30, PERIOD TO MATURITY FROM JUNE 30, 1997
------------------------------------ ----------------------------------------------------
WITHIN ONE TO
ONE THREE
1998 1997 1996 YEAR YEARS THEREAFTER TOTAL
-------- -------- -------- -------- ------- ---------- --------
(IN THOUSANDS)
CERTIFICATES OF DEPOSIT:
4.99% and less.......... $ 1,033 $ 1,579 $ 10,044 $ 1,026 $ 7 $ -- $ 1,033
5.00% to 5.99%.......... 118,081 89,991 141,411 92,147 25,934 -- 118,081
6.00% to 6.99%.......... 92,344 136,808 34,359 71,755 19,530 1,059 92,344
7.00% to 7.99%.......... 430 619 1,977 110 320 -- 430
8.00% to 8.99%.......... 139 134 132 -- 9 130 139
9.00% to 9.99%.......... -- -- -- -- -- -- --
10.00% to 10.99%......... -- -- -- -- -- -- --
-------- -------- -------- -------- ------- ------ --------
Total.................. $212,027 $229,131 $187,923 $165,038 $45,800 $1,189 $212,027
======== ======== ======== ======== ======= ====== ========
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, 1998, the
Bank's FHLB-Chicago advances totaled $117.1 million, representing 28.9% of
total liabilities, an increase from the $92.1 million outstanding at June 30,
1997. 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, 1996, there were $11.6 million in repurchase agreements. At June 30,
1998 and 1997, the Company had no reverse repurchase agreements outstanding.
The Bank has continued to use FHLB-Chicago advances and decreased its use of
reverse repurchase agreements as a funding source because of the attractive
long-term interest rates offered on FHLB advances.
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.*
-34-
37
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,
----------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(DOLLARS IN THOUSANDS)
FHLB-CHICAGO ADVANCES:
Average balance outstanding........................... $107,378 $100,384 $75,097
Maximum amount outstanding at any month-end during
the period........................................... 115,573 106,086 102,386
Balance outstanding at end of period.................. 117,059 92,073 102,386
Weighted average interest rate during the period (1).. 6.10% 5.98% 5.25%
Weighted average interest rate at end of period....... 5.87 6.01 5.82
REVERSE REPURCHASE AGREEMENTS:
Average balance outstanding........................... $ -- $ 3,717 $12,433
Maximum amount outstanding at any month-end during
the period........................................... -- 11,652 13,926
Balance outstanding at end of period.................. -- -- 11,568
Weighted average interest rate during the period (1).. --% 5.96% 6.27%
Weighted average interest rate at end of period....... -- -- 5.61
TOTAL ADVANCES AND REVERSE REPURCHASE AGREEMENTS:
Average balance outstanding........................... $107,378 $104,101 $87,529
Maximum amount outstanding at any month-end during
the period........................................... 115,573 111,233 113,954
Balance outstanding at end of period.................. 117,059 92,073 113,954
Weighted average interest rate during the period (1).. 6.10% 5.98% 5.40%
Weighted average interest rate at end of period....... 5.87 6.01 5.80
- ---------------
(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. 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 brokerage firms and
insurance companies. The Bank is also 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. (the
"HPS," formerly West Allis Insurance, Inc.), was organized as a Wisconsin
corporation in 1978. During the fiscal year ended June 30, 1997, 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 income (loss) for HPS was ($8,124) and $28,117 for the fiscal years
ended June 30, 1998 and 1997, respectively.
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.
-35-
38
PERSONNEL
At June 30, 1998, the Bank had 81 full-time employees and 9 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,
1998, 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 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.
-36-
39
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.
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.
-37-
40
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 DSI, 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 Wisconsin Department of Financial Institutions, Division of
Savings Institutions ("DSI") and the Securities and Exchange Commission
("SEC").
WISCONSIN SAVINGS BANK REGULATION
Regulations adopted by the DSI govern various aspects of the activities
and the 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 DSI. Savings banks are required to pay examination
fees and annual assessments to fund the supervisory operations of the DSI.
Based on the assessment rates published by the DSI and the Bank's total assets
of approximately $414.6 million at December 31, 1997, the Bank paid $21,839 in
assessments in the fiscal year ended June 30, 1998.
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 do not exceed 10% of the Bank's total
assets, unless the DSI 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 DSI and
implemented by the Administrator of the DSI, the Bank is limited in the amount
of commercial real estate and commercial business loans it can hold in its loan
portfolio. This limit is currently 20% of the Bank's total assets and may be
increased with the approval of the DSI. At June 30, 1998, the Bank had $63.1
million of such loans in its portfolio with a current limit based on the Bank's
asset base of $88.0 million. Management anticipates that as the Bank's
commercial real estate and commercial business loan origination and purchase
activity increases in fiscal 1999, the Bank will be required to apply to the
DSI to increase the limit to an amount in excess of 20% of the Bank's asset
base.* While management believes it will be able to obtain DSI approval, there
can be no assurances the DSI will approve an increase in such lending limit for
the Bank, or at what lending limit such approval will be granted.
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 the prior approval of the DSI, compliance with capital
requirements and certain other restrictions, savings banks may invest in
residential housing development projects. Savings banks may invest in service
corporations or subsidiaries with the prior approval of the DSI, subject to
certain restrictions. The lending and investment powers of Wisconsin savings
banks also are limited by FDIC regulations and other federal laws and
regulations.
The Bank's subsidiary operations also are regulated by the FDIC and the
FRB. See "-Federal Deposit Insurance Corporation Improvement Act" and "-Holding
Company Regulation." At June 30, 1997, the Bank's subsidiary operations were
not under any DSI, FRB or FDIC order to divest or terminate any activity. The
lending and investment powers of Wisconsin savings banks also are limited by
FDIC regulations and other federal law and regulations. See "Federal Deposit
Insurance Corporation Improvement Act of 1991 - Restrictions on State-Chartered
Banks."
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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, 1998, 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. At June 30, 1998, the Bank
maintained 78.30% 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 DSI 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 DSI'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 is defined as primarily short-term
liquid assets and U.S. government and U.S. government agency securities. At
June 30, 1998, the Bank's daily liquidity ratio was 25.95%.
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, DSI 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 on terms which would be available to members of
the general public for similar credit extensions.
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 DSI may, for safety and
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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 DSI 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. The matrix so created 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 6.4 cents per $100 of deposits. The Bank's expense related to FDIC premiums
was $173,713 and $347,650 for the fiscal year ended June 30, 1998 and 1997.
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 in order 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.
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.
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PROMPT CORRECTIVE REGULATORY ACTION
Federal bank regulators are required to take certain supervisory actions
with respect to undercapitalized institutions, the severity of which depends
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, 1998,
the Bank had $81.4 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, 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.
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.
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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 the FDIC's prior 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 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 of a type 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, 1998, the Bank's ratio of Tier 1 capital to
total assets was 7.05%, or 4.05 percentage points in excess of the minimum
leverage capital requirement, the Bank's Tier 1 capital to risk-weighted assets
was 11.75%, or 7.75 percentage points in excess of the FDIC requirement, and
the Bank's total capital to risk-weighted assets was 12.67%, or 4.67 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
DSI determines that the financial condition, history, management or earning
prospects of a savings bank are not adequate, the DSI may require a higher
minimum capital level for the savings bank. If a savings bank's capital ratio
falls below the required level, the DSI may direct the savings bank to adhere
to a specific written plan established by the DSI 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, 1998, the Bank's total capital, as calculated under Wisconsin law, was
$32.2 million, or 7.29% of total assets, which was 1.29% in excess of the
required amount.
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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 July 10, 1995, 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
implementation of 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, 1998, 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, 1998.
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.
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 $5.9 million at June
30, 1998.
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, 1998, the Bank had
$117.1 million in advances from the FHLB-Chicago.
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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, or substantially all the assets
of a bank located outside the State of Wisconsin 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.
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 DSI. The DSI 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,
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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 may 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 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 amount of the assessment to the Bank was $877,000. The special
assessment was recorded on September 30, 1996 and had the effect of reducing
the Bank's earnings and capital by the after-tax amount of the assessment as of
the date of enactment, which was $533,000 or $0.19 per share. As described
below, with the recapitalization of the SAIF, BIF and SAIF regular premiums
will be comparable and, therefore, FDIC premium expense is expected to be
reduced in future periods.
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-
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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 curing 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. This
obligation had previously been the sole responsibility of SAIF-insured
institutions and had been funded through SAIF assessments. The DIF Act
eliminated the statutory link between FICO's assessments and amounts authorized
to be assessed by the SAIF, effective January 1, 1997, all insured institutions
will pay an annual assessment to fund interest payments on the FICO bonds.
BIF-member institutions will pay one-fifth the rate to be paid by SAIF members,
for the first three years. The annual FICO assessment is 1.3 and 6.5 basis
points of deposits for BIF and SAIF members, respectively. After January 1,
2000, BIF and SAIF members will share the FICO payments on a pro-rata basis,
which is assessed at 2.4 basis points, until the bonds mature in 2017.
In addition, the DIF Act provides for the merger of BIF and SAIF into a
single Deposit Insurance Fund. This provision will be effective January 1,
1999, assuming that no insured depository institution is a savings association
on that date. This legislation contemplates that the savings association
charter will be phased out over that period of time.
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 will analyze additional
limited-service office opportunities in the future.
In December 1997, the Bank purchased a former Security Bank, S.S.B.
facility in Glendale, Wisconsin for $2.5 million. The Bank intends to open a
full-service banking facility at the Glendale location during the quarter
ending December 31, 1999.* 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 full-service
offices is as follows:
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NET BOOK VALUE
OF PROPERTIES AND
YEAR IMPROVEMENTS AT
OFFICE LOCATION OPENED JUNE 30, 1998
- --------------------------- ------ -----------------
West Allis/Home Office 1919 $262,000
7401 West Greenfield Avenue
West Allis, WI 53214
New Berlin Office 1989 980,000
15600 West Cleveland Avenue
New Berlin, WI 53151
Greenfield Office 1988 1,026,000
5101 South 27th Street
Greenfield, WI 53221
Glendale Office 1998 2,526,000
5555 N. Port Washington Road
Glendale, WI 53217
----------
Net Book Value: $4,794,000
==========
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 July 1993, the Circuit Court for Milwaukee County denied the Bank's
request for specific performance of the purchase contract and found the
purchase contract unenforceable based upon the Bank's right in its sole
discretion to void the purchase contract. The Bank appealed the decision but
the Wisconsin Court of Appeals affirmed the Circuit Court.
The Bank continues to have some interest in the property as a prospective
branch office location. As of June 30, 1998, the Bank has advanced $117,000 in
real estate taxes to avoid a foreclosure suit resulting from a default in
payment of property taxes and has taken a real estate mortgage on the property
to secure repayment of such amounts.
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. The Bank does not intend
to acquire the property without the clean-up having been completed nor does it
intend to participate in the costs of the clean-up. 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.
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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, 1998.
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 60, 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 50, 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 38, 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.
NANCY S. HOELTER, age 52, is Vice President of the Company and has been
Senior Vice President of the Bank since March 1993. Ms. Hoelter joined the Bank
in 1986, served as an Administrative Assistant from 1987 to 1989, as Human
Resources Coordinator from 1989 to 1992 and as Vice President from 1992 to
March 1993. Ms. Hoelter also is a director, Secretary and Treasurer of the West
Allis Savings Bank Foundation.
ELIZABETH S. BORST, age 36, 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 31, 1998, there were 343 holders of record and an estimated
1,100 beneficial holders owning a total of 2,938,608 voting shares. On October
30, 1997, the Company declared a two-for-one stock split in the form of a 100%
stock dividend. Shareholders of the Company received one additional share of
the Company's common stock for each share of common stock owned as of the
record date, November 10, 1997. As a result of the stock split, the number of
shares of the Company's common stock outstanding increased to 2,933,608 from
1,442,950 on November 24, 1997.
The Board of Directors of the Company does not presently anticipate the
declaration or payment of a dividend. Future payments of dividends will be
subject to determination and declaration by the Company's Board of Directors,
which will take into account the Company's financial condition, results of
operations, tax considerations, industry standards, economic conditions and
other factors, including regulatory restrictions which affect the payment of
dividends by the Bank to the Company. There can be no assurance that dividends
will in fact be paid on the Common Stock or that, if paid, such dividends will
not be reduced or eliminated in future periods.
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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,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS)
SELECTED FINANCIAL CONDITION DATA:
Total assets ....................................... $438,374 $409,820 $377,157 $259,477 $179,642
Loans receivable, net .............................. 280,889 273,556 224,807 142,321 105,068
Cash and cash equivalents .......................... 8,184 8,755 4,825 6,820 8,429
Securities held for sale/available-for-sale ........ 66,445 29,518 37,284 33,108 22,224
Investment securities and certificates of deposit .. 388 780 978 590 1,783
Mortgage-backed and related securities ............. 65,282 85,430 97,332 66,781 35,511
Deposits ........................................... 271,619 281,512 229,675 152,167 115,036
FHLB advances and other borrowings ................. 117,059 92,073 113,954 76,779 35,998
Shareholders' equity ............................... 33,453 29,672 27,011 25,260 24,294
FISCAL YEAR ENDED JUNE 30,
-------------------------------------------------------
1998 1997 1996 1995 1994
------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SELECTED OPERATIONS DATA:
Total interest income ................................. $32,227 $29,823 $22,894 $14,560 $11,258
Total interest expense ................................ 21,586 20,210 15,348 8,743 6,333
------- ---------- ---------- ---------- ----------
Net interest income .................................. 10,641 9,613 7,546 5,817 4,925
Provision for loan losses ............................. 800 650 367 248 229
------- ---------- ---------- ---------- ----------
Net interest income after provision for loan losses .. 9,841 8,963 7,179 5,569 4,696
Non-interest income:
Loan servicing and loan-related fees ................. 349 251 233 238 202
Depository fees and service charges .................. 429 478 494 464 491
Gain on sale of loans ................................ 297 95 75 23 193
Gain (loss) on sale of securities and
mortgage-backed and related securities, net ......... (8) 7 72 (102) (103)
Other non-interest income ............................ 141 197 388 375 186
------- ---------- ---------- ---------- ----------
Total non-interest income ............................. 1,208 1,028 1,262 998 969
Total non-interest expense ............................ 6,847 7,046 5,554 4,785 4,635
------- ---------- ---------- ---------- ----------
Income before income tax expense ...................... 4,202 2,945 2,887 1,782 1,030
Income tax expense .................................... 1,403 1,026 1,009 708 437
------- ---------- ---------- ---------- ----------
Net income .......................................... $ 2,799 $ 1,919 $ 1,878 $ 1,074 $ 593
======= ========== ========== ========== ==========
Earnings per share (basic) .......................... $ 1.01 $ 0.71 $ 0.70 $ 0.38 $ 0.11
======= ========== ========== ========== ==========
Earnings per share (diluted) ........................ $ 0.97 $ 0.68 $ 0.68 $ 0.37 $ 0.11
======= ========== ========== ========== ==========
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53
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
AT OR FOR THE FISCAL YEAR ENDED JUNE 30,
------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SELECTED FINANCIAL RATIOS AND OTHER DATA:
PERFORMANCE RATIOS
Return on average assets ............................... 0.67% 0.48% 0.60% 0.51% 0.35%
Return on average equity ............................... 8.89 6.83 7.17 4.39 2.91
Interest rate spread during period(1) .................. 2.22 2.06 1.97 2.34 2.57
Net interest margin(1) ................................. 2.63 2.48 2.45 2.89 3.06
Non-interest expense to average assets ................. 1.64 1.77 1.76 2.29 2.74
Non-interest income to average assets .................. 0.29 0.26 0.40 0.48 0.57
Average interest-earning assets to
average interest-bearing liabilities .................. 1.08x 1.08x 1.10x 1.13x 1.12x
ASSET QUALITY RATIOS
Non-performing loans to gross loans(2) ................. 0.49% 0.22% 0.04% 0.09% 0.20%
Non-performing assets to total assets(2) ............... 0.32 0.16 0.03 0.06 0.14
Allowance for loan losses to non-performing loans ...... 166.36 282.37 1,153.27 666.43 354.38
Ratio of allowance for loan losses to gross loans ...... 0.81 0.62 0.50 0.62 0.70
Net charge-offs to average gross loans ................. 0.08 0.04 0.05 0.05 0.12
CAPITAL RATIOS(3)
Average shareholders' equity to average assets ......... 7.54 7.07 8.30 11.70 12.03
Shareholders' equity to total assets at end of period .. 7.63 7.24 7.16 9.73 13.52
OTHER DATA
Number of deposit accounts ............................. 16,054 18,064 18,070 19,285 18,487
Number of real estate loans outstanding ................ 3,620 3,824 3,654 2,922 2,334
Number of real estate loans serviced ................... 4,063 4,360 4,111 3,419 2,893
Number of consumer loans outstanding ................... 3,229 3,310 3,705 5,322 5,671
Number of commercial loans outstanding ................. 90 32 -- -- --
Loan originations/purchases ............................ $162,637 $118,108 $140,313 $70,175 $72,900
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
GENERAL
In order to maximize shareholder value, the Company continues to pursue a
strategy of effectively utilizing the capital acquired in the Bank's Conversion
and the Company's initial public offering consummated in December 1993. The
Company believes that its effective utilization of capital is best achieved
through the growth of the Company's business. Pursuant to the Company's
post-Conversion strategic plan, this growth is to be achieved through the
expansion of the Company's asset base and diversification of the Company's
portfolio into higher yielding assets, and is to be implemented in two stages.
In stage one, implemented in fiscal 1994 through the first half of fiscal 1997,
management focused on achieving a target asset size for the Company established
by the Board of Directors. In stage two, which commenced in the second half of
fiscal 1996 and continued in fiscal 1998, management focused, and intends to
continue to focus, on portfolio diversification coupled with a moderate
increase in the rate of growth of the Company's asset base. The Company intends
to continue its asset portfolio diversification strategy in fiscal 1999.*
Commencing in fiscal 1994 and continuing through the first half of fiscal
1997, the Company implemented the first stage of the strategy by leveraging its
capital base to achieve asset growth. The objective of the first stage of the
strategy was to reach a targeted asset size for the Company established by the
Board of Directors within a three-to-five year period following the Conversion.
The Company increased its asset size from $179.6 million at June 30, 1994 to
$409.8 million at June 30, 1997. The Bank's principal investment focus during
the four-year post-Conversion period was to originate and purchase mortgage
loans (principally loans secured by one-to-four family owner-occupied homes)
and purchase mortgage-backed securities. The asset growth was funded through
significant increases in Federal Home Loan Bank ("FHLB") advances and other
borrowings and increases in deposits, primarily brokered and non-brokered
wholesale deposits. Pursuit of the foregoing strategy resulted in increases in
the Company's net income, earnings per share, return on average equity ("ROAE")
and return on average assets ("ROAA") in fiscal 1994, 1995 and 1996. Excluding
the impact of the one-time industry-wide SAIF assessment in fiscal 1997,
pursuit of the strategy also resulted in increases in the Company's net income,
earnings per share, ROAE and ROAA for fiscal 1997. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Starting in the latter half of fiscal 1996 and continuing in fiscal 1998,
the Company implemented the second stage of its post-Conversion plan in order
to continue to increase net income, earnings per share, ROAE and ROAA. This
strategy involved shifting the focus from asset growth to asset portfolio
diversification, while maintaining prudent capital and liquidity levels. This
was, and continues to be achieved by altering the composition of loans and
securities originated, purchased, sold and held in the total asset portfolio.
In particular, the Company focused and will focus on originating and purchasing
higher-yielding 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), which will either replace or supplement the
lower-yielding one-to-four family mortgage loans and principal run-off from the
mortgage securities portfolio.* The Company also evaluated opportunities to
purchase multi-family, commercial real estate, and commercial business loans or
participation interests in such loans secured by properties or business assets
located outside the Company's primary lending area. In fiscal 1998, the Company
purchased an aggregate of $25.5 million, or 8.9% of gross loans at June 30,
1998, of loans and participation interests in loans originated by other lenders
and secured by properties located outside of the Company's primary lending area
(as defined herein). These loans and participation interests consisted
primarily of commercial real estate and commercial real estate construction
loans. The Company also expanded its origination of higher-yielding loans
through its commercial lending division, which offers commercial/industrial
real estate term loans, equipment leasing, inventory/equipment/receivables
financing, lines of credit, letters of credit and SBA loan programs. The
Company originated and purchased $35.6 million in various commercial business
loans, either unsecured or secured by commercial business assets located as of
June 30, 1998, of which $6.28 million were secured by business assets located
outside of the Company's primary lending area. Asset portfolio diversification
in fiscal 1998 was funded through principal repayment cash flows from existing
assets, wholesale brokered and non-brokered deposits, the sale of one-to-four
family mortgage loans in the secondary market, the maturity and sale of
mortgage-backed and related securities, retail deposits and FHLB advances.
In fiscal 1999, the Company intends to continue the implementation of the
second phase of its business plan with a moderate rate of growth of its asset
base.* The Company's business strategy is to continue its focus on
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55
increasing net interest income and generating additional non-interest income
from existing and new revenue sources.* In order to increase net interest
income, the Company intends to continue to utilize its asset portfolio
diversification strategy of selling lower-yielding assets such as securities and
one-to-four family mortgage loans in the secondary market in order to provide
liquidity to fund higher-yielding loan originations and purchases, increase
non-interest income and maintain adequate levels of capital.* The Company
anticipates that increased sales of one-to-four family mortgage loans will
decrease the proportion of the gross loan portfolio represented by such loans,
will increase non-interest income as a result of increased gains on the sales of
such loans, and will further lessen the Company's negative gap position as such
loans are replaced by higher-yielding, adjustable rate assets, including
multi-family, commercial real estate and commercial loans.* Portfolio
diversification in fiscal 1999 also will include continued purchases of loans or
participation interests in loans originated by other lenders both within and
outside of its primary lending area as well as originators outside of the
primary lending area.* Loans purchased, or participation interests purchased,
which relate to properties or business assets located outside of the Company's
primary lending area will consist primarily of multi-family, commercial real
estate, multi-family construction, commercial real estate construction loans
and commercial business loans.* In deciding whether or not to originate or
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
continues to apply, underwriting guidelines which are at least as strict as
those applicable to the origination of similar loans within its primary lending
area.
The Company intends to fund its asset portfolio diversification in fiscal
1999 through a combination of retail deposits, brokered deposits, borrowings,
the sale of one-to-four family mortgage loans in the secondary market, the
maturity and sale of mortgage-backed and related securities, and FHLB
advances.*
In addition, in fiscal 1999, the Company intends to continue increasing
the activities of its commercial lending division as another element of the
overall portfolio diversification strategy.* The focus of the Company's
commercial lending operation will be small business loans and leases.
Management currently anticipates that the commercial lending division will
generate approximately $40 million in new commercial loans/leases during fiscal
1999.* Management believes that the commercial lending component of its
operations will benefit the Company longer term, and should contribute to a
long-term increase in net income and return on equity.* The commercial lending
division also has enhanced the Company's core deposit base, through the
establishment of new deposit relationships with the commercial lending
division's customers. As of June 30, 1998, commercial deposits totaled $5.9
million or 2.16% of the Company's core deposit base.
The Company also intends to increase non-interest income and net interest
income in fiscal 1999 by exploring ways to expand its lending activities into
higher credit risk financial services (also known as subprime lending).* The
subprime lending market includes manufactured housing, automobile, credit card,
business, and residential first and second mortgage financing. The subprime
mortgage market for first and second mortgage loans, on which the Company
currently intends to ?, represents loans that do not conform to Federal Home
Loan Mortgage Corporation ("FHLMC") and Fannie Mae guidelines. The borrowers on
such loans typically have credit deficiencies on their credit history, such as
late payments on their mortgage loan, low credit scores, foreclosures or
bankruptcies. Other non-conforming reasons which classify loans as subprime
include higher debt-to-income ratios, no down payment, limited documentation,
high cash-out refinances or no verification of the borrower's income. A
secondary market of private investors and mortgage bankers provides a mechanism
for the underwriting, sale and servicing of subprime loans. Due to the higher
degree of credit risk inherent in this type of lending, subprime residential
mortgage loan rates generally are higher yielding compared to conventional
one-to-four family mortgage rates. In addition, if sold in the secondary
market, a higher origination fee and yield spread premium are paid on such
loans.* The Company presently is involved in the exploratory phase of assessing
the subprime market. If the Company decides to proceed in the development of a
subprime program, the Board of Directors and management intend to establish
parameters in the areas of total portfolio size, underwriting guidelines,
approval process, underlying collateral type and location. In addition, in
establishing such parameters, the Board of Directors of the Company intends to
evaluate the impact of such a program on the Company's allowance and provision
for loan loss as well as the overall financial impact on the Company.
In fiscal 1999, the Company also intends to explore alternative methods of
reducing net interest expense, such as offering deposit products on the
Company's Website, evaluating potential acquisitions of retail branch networks
in market areas demonstrating a lower cost of funds demand for deposit products
and by actively seeking lower cost funding in the wholesale financial markets.*
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56
During fiscal 1999, the Company also intends to increase its non-interest
income by expanding the following three fee income producing divisions:
Residential Lending, Hallmark Planning Services and Commercial Banking.* The
Company also intends to evaluate the feasibility and profitability of opening
satellite lending facilities in communities outside of the Company's primary
lending area to help increase originations of one-to-four family first mortgage
loans, which are sold in the secondary market to generate fee income.* The
Company's insurance subsidiary Hallmark Planning Services, Inc. continues to
grow as the Company seeks to generate fee income from investment product and
annuity sales. The Company also has begun to develop a program for mortgage
contract cash processing within the commercial lending division, a service
intended to generate fee income.* Pursuant to such program, the Bank would act
as a partial sub-servicer performing a cash/processing function for
nationally-originated commercial real estate loans.
The increase in the level of the allowance for losses on loans during
fiscal 1998 was primarily the result of increases in the commercial, home
equity and commercial real estate loan portfolios. Loans secured by
multi-family and commercial real estate and commercial business assets
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 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. 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. Management anticipates that as the Company's volume of
multi-family and commercial/nonresidential real estate and commercial business
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, which will have a negative effect on the Company's net income in the
short-term.* However, the Company believes that building the higher yielding
multi-family and commercial/nonresidential real estate components of its gross
loan portfolio will benefit the Company longer term, and should contribute to a
long-term improvement in the Company's net income and return on equity.*
Under regulations established for state savings banks by the Wisconsin
Department of Financial Institutions, Division of Savings Institutions ("DSI"),
as implemented by the Administrator of the DSI, the Bank is limited in the
amount of commercial real estate and commercial business loans it can hold in
its loan portfolio. This limit is currently 20% of the Bank's total assets and
may be increased with the approval of the DSI. At June 30, 1998, the Bank had
$63.1 million of such loans in its portfolio with a current limit based on the
Bank's asset base of $88.0 million. Management anticipates that as the Bank's
commercial real estate and commercial business loan origination and purchase
activity increases in fiscal 1999, the Bank will be required to apply to the
DSI to increase the limit to an amount in excess of 20% of the Bank's asset
base.* While management believes it will be able to obtain such DSI approval,
there can be no assurances that if requested, the DSI will approve an increase
in such lending limit for the Bank, or at what lending limit level such
approval will be granted.
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COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED JUNE 30, 1998 AND
1997
GENERAL
Net income for the fiscal year ended June 30, 1998 increased 45.9% to $2.8
million from $1.9 million for fiscal 1997. The increase in net income was
primarily attributable to an increase in net interest income. Net interest
income before the provision for losses on loans increased to $10.6 million for
the fiscal year ended June 30, 1998 from $9.6 million for fiscal 1997,
primarily as a result of higher average interest-earning assets during fiscal
1998 as compared to fiscal 1997. Non-interest income increased by $180,000 to
$1.2 million for the fiscal year ended June 30, 1998 from $1.0 million for
fiscal 1997. The increase in non-interest income was primarily due to an
increase in gain on the sale of loans of $202,000 to $297,000 for the fiscal
year ended June 30, 1998 from $95,000 for fiscal 1997, and an increase in
service charges on loans of $123,000 to $288,000 for the fiscal year ended June
30, 1998 from $165,000 for fiscal 1997. Also, other non-interest income
increased $5,000 to $92,000 for the fiscal year ended June 30, 1998 from
$87,000 for fiscal 1997. The increases were offset by a decrease in service
charges on deposit accounts of $49,000 to $429,000 for the fiscal year ended
June 30, 1998 from $478,000 for fiscal 1997, a decrease in insurance
commissions of $61,000 to $49,000 for the fiscal year ended June 30, 1998 from
$110,000 for fiscal 1997, and a decrease in loan servicing fees of $25,000 to
$61,000 for the fiscal year ended June 30, 1998 from $86,000 for fiscal 1997.
Also, gains on the sale of securities and mortgage-backed and related
securities decreased $15,000 to a loss of $8,000 for the fiscal year ended June
30, 1998 from a gain of $7,000 for fiscal 1997. Non-interest expense decreased
$200,000 to $6.8 million for the fiscal year ended June 30, 1998 from $7.0
million for fiscal 1997, primarily as a result of a one-time industry-wide FDIC
special assessment charge of $877,000, partially offset by a refund credit of
$137,000, for the fiscal year ended June 30, 1997, and a decrease in deposit
insurance premiums of $174,000 to $174,000 for the fiscal year ended June 30,
1998 from $348,000 for fiscal 1997. The decreases were offset by an increase in
compensation and benefits expense of $464,000 to $4.0 million for the fiscal
year ended June 30, 1998 from $3.5 million for fiscal 1997, an increase in
occupancy and equipment expense of $195,000 to $1.2 million for the fiscal year
ended June 30, 1998 from $1.0 million for fiscal 1997, and an increase in
marketing expense of $52,000 to $380,000 for the fiscal year ended June 30,
1998 from $328,000 for fiscal 1997. Net income also was reduced by an increase
in the provision for losses on loans to $800,000 for fiscal 1998 from $650,000
for fiscal 1997.
Return on average equity increased to 8.89% for the fiscal year ended June
30, 1998 from 6.83% for fiscal 1997. Return on average assets increased to .67%
for the fiscal year ended June 30, 1998 from .48% for fiscal 1997. The
increases in return on average equity and average assets resulted primarily
from a one-time after-tax charge in fiscal 1997 of $533,000 to recapitalize the
SAIF, the FDIC insurance fund which insures deposits of savings associations,
partially offset by an after-tax FDIC credit refund of $83,000. Excluding the
effects of the FDIC assessment and credit, return on average equity and return
on average assets for fiscal 1997 would have been 8.43% and .60%, respectively.
The Company's principal investment focus during the fiscal year ended June 30,
1998 was the origination and purchase of mortgage and commercial loans both
within and outside of the Company's primary lending area. In addition, in
fiscal 1999, the Company intends to continue increasing the activities of its
commercial lending division as another element of the overall portfolio
diversification strategy.* The focus of the Company's commercial lending
operation will be small business loans and leases. Management currently
anticipates that the commercial lending division will generate approximately
$40 million in new commercial loans/leases during fiscal 1999.* Management
believes that the commercial lending component of its operations will benefit
the Company longer term, and should contribute to a long-term increase in net
income and return on equity.* The commercial lending division also has enhanced
the Company's core deposit base, through the establishment of new deposit
relationships with the commercial lending division's customers. As of June 30,
1998, commercial deposits totaled $5.9 million or 2.16% of the Company's core
deposit base. The asset growth primarily was funded through increases in FHLB
advances and money market deposits and sales of loans in the secondary market.
NET INTEREST INCOME
Net interest income increased 10.7% to $10.6 million for fiscal 1998 from
$9.6 million for fiscal 1997. Interest income increased $2.4 million in fiscal
1998, while interest expense increased $1.4 million. The level of net interest
income primarily reflects a 4.2% increase in average interest-earning assets
during fiscal 1998, a 1.2% increase in the excess of the Company's average
interest-earning assets over average interest-bearing liabilities to $29.0
million for fiscal 1998 from $28.7 million for fiscal 1997, and an increased
interest rate spread to 2.22% for fiscal 1998 from 2.06% for fiscal 1997. The
increased interest rate spread for fiscal 1998 is a result of the
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Company's origination and purchase of multi-family, commercial real estate and
commercial business loans that carry higher interest rates than one-to-four
family loans and mortgage-backed and related securities.
INTEREST INCOME
Interest income increased 8.1% to $32.2 million for fiscal 1998 from $29.8
million for fiscal 1997. The increase in interest income was the result of an
increase in average interest-earning assets of 4.2% to $404.3 million for
fiscal 1998 compared to $388.1 million for fiscal 1997 and an increase of 29
basis points in the yield on interest-earning assets to 7.97% for fiscal 1998
from 7.68% for fiscal 1997. Interest income on loans increased 14.7% to $23.8
million for fiscal 1998 from $20.7 million for fiscal 1997. The increase was
the result of an increase in the Company's average gross loans of 10.3% to
$280.2 million for fiscal 1998 from $254.1 million for fiscal 1997 and an
increase in average yield to 8.49% for fiscal 1998 from 8.16% for fiscal 1997.
Gross loans increased in fiscal 1998 compared to fiscal 1997 primarily as a
result of the Company retaining all of its originated adjustable rate loans and
purchasing loans from outside of its primary market. The increase in yield is
primarily attributable to the retention of higher rate adjustable-rate loans,
and to the higher yields paid on the multi-family and commercial components of
the loan portfolio. Interest income on mortgage-backed securities decreased
20.5% to $2.8 million for fiscal 1998 from $3.6 million for fiscal 1997. The
decrease was primarily due to a decrease in average balances to $40.0 million
for fiscal 1998 from $50.4 million for fiscal 1997, partially offset by an
increase in average yield to 7.06% for fiscal 1998 from 7.05% for fiscal 1997.
The decrease in mortgage-backed securities is expected to continue in fiscal
1999 as the Company will use the principal prepayments to fund the Company's
continued asset portfolio diversification.* Interest income on mortgage-related
securities decreased 5.5% to $2.5 million for fiscal 1998 from $2.7 million for
fiscal 1997. The decrease was primarily due to a decrease in average balances
to $37.2 million for fiscal 1998 from $40.5 million for fiscal 1997, partially
offset by a increase in average yield to 6.84% for fiscal 1998 from 6.65% for
fiscal 1997. Interest income on investment securities and securities
available-for-sale increased 8.3% to $2.7 million for fiscal 1998 from $2.5
million for fiscal 1997. The increase was primarily due to a increase in
average balances to $41.2 million for fiscal 1998 from $37.9 million for fiscal
1997, partially offset by a decrease in yield to 6.51% for fiscal 1998 from
6.54% for fiscal 1997. The lower average yield was primarily attributable to a
larger portion of the average balances maintained in shorter-term investments
that carry lower yields. The interest rate environment for fiscal 1998 was
marked by decreasing interest rates, especially longer-term interest rates. The
lower longer-term interest rates also resulted in increased refinancing of
one-to-four family mortgage loans and mortgage-backed and related securities.
INTEREST EXPENSE
Interest expense increased 6.8% to $21.6 million for fiscal 1998 from
$20.2 million for fiscal 1997. The increase was the result of a 4.4% increase
in the average amount of interest-bearing liabilities to $375.3 million for
fiscal 1998 compared to $359.4 million for fiscal 1997 and an increase in the
average rate paid on interest-bearing liabilities to 5.75% for fiscal 1998 from
5.62% for fiscal 1997. The increased average balances of certificates of
deposit (including brokered and non-brokered wholesale deposits), money market
deposits and borrowings, offset by decreases in lower cost NOW accounts and
passbook deposits, was the primary reason for the increase in the average rate
paid in fiscal 1998 as compared to fiscal 1997. Interest expense on deposits
increased 7.7% to $15.0 million for fiscal 1998 from $13.9 million for fiscal
1997. The increase was the result of an increase in average balances of 5.1% to
$264.8 million for fiscal 1998 from $251.8 million for fiscal 1997 and an
increase in the average rate paid on deposits to 5.65% for fiscal 1998 from
5.52% for fiscal 1997. The increase in deposits was primarily due to an
increase of 2.2% in the average outstanding balance of certificates of deposit
to $215.7 million for fiscal 1998 compared to $211.0 million in fiscal 1997 and
an increase in average rate paid on certificates of deposit to 6.01% for fiscal
1998 from 5.86% for fiscal 1997. Average money market deposits increased 63.4%
to $25.2 million for fiscal 1998 compared to $15.4 million in fiscal 1997 and
the average rate paid on such deposits increased to 5.23% for fiscal 1998 from
5.21% for fiscal 1997. Also, NOW accounts increased 10.9% to $2.6 million for
fiscal 1998 compared to $2.4 million for fiscal 1997 and the average rate paid
on such accounts decreased to 1.71% for fiscal 1998 from 1.73% for fiscal 1997.
These increases were partially offset by a decline of 7.9% in passbook accounts
to $21.2 million for fiscal 1998 compared to $23.0 million for fiscal 1997 and
a decrease in average rate paid to 2.95% for fiscal 1998 from 3.00% for fiscal
1997. Money market deposits increased due to aggressive marketing and an
attractive interest rate paid within the Bank's local market area. 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
$215.7 million in the average balance of certificates of deposit for fiscal
1998, $81.4
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million, or 37.8%, represented brokered certificates of deposit compared to
$87.1 million, or 41.3%, for fiscal 1997. The average rate paid on brokered
certificates of deposit increased to 6.13% for fiscal 1998 from 6.11% for fiscal
1997. Interest on borrowings (FHLB advances and reverse repurchase agreements)
increased 5.2% to $6.5 million for fiscal 1998 from $6.2 million for fiscal
1997. The increase in borrowings was primarily due to growth in the average
balance of FHLB advances of 3.2% to $107.4 million for fiscal 1998 compared to
$104.1 million for fiscal 1997. The increase in interest on borrowings also was
due to an increase in the average rate paid to 6.10% for fiscal 1998 from 5.98%
for fiscal 1997, as the Company increased it's use of longer-term fixed-rate
advances. FHLB advances will continue to be utilized as the Company continues
the implementation of the second phase of its strategic plan by slowing the rate
of growth of its asset base and continuing to focus on asset portfolio
diversification in fiscal 1999.*
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans increased by 23.1% to $800,000 for
fiscal 1998 from $650,000 for fiscal 1997. 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 existing and
anticipated general economic conditions. Based on management's evaluation of
the loan portfolio and the increase in gross loans during fiscal 1998, the
allowance for losses on loans increased 32.2% to $2.3 million at June 30 1998
compared to $1.8 million at June 30, 1997. The increase in the level of
allowance for losses on loans was primarily the result of the increases in
commercial, home equity and commercial real estate loan portfolios which carry
a greater degree of credit risk. The ratio of allowance for loan losses to
gross loans increased to 0.81% at June 30, 1998 from 0.62% at June 30, 1997.
The amount of non-performing loans at June 30, 1998 was $1.4 million or 0.50%
of gross loans compared to $624,000 or 0.22% of gross loans at June 30, 1997.
NON-INTEREST INCOME
Non-interest income increased 17.5% to $1.2 million for fiscal 1998 from
$1.0 million for fiscal 1997. The largest components of the increase was an
increase in gain on the sale of loans to $297,000 for fiscal 1998 compared to
$95,000 for fiscal 1997, an increase in service charges on loans to $288,000
for fiscal 1998 compared to $165,000 for fiscal 1997, and an increase in other
non-interest income to $92,000 for fiscal 1998 compared to $87,000 for fiscal
1997. Partially offsetting the increases in non-interest income were decreases
in insurance commissions to $49,000 for fiscal 1998 compared to $110,000 for
fiscal 1997, a decrease in service charges on deposit accounts to $429,000 for
fiscal 1998 compared to $478,000 for fiscal 1997, a decrease in loan servicing
fees to $61,000 for fiscal 1998 compared to $86,000 for fiscal 1997 and a
decrease in gains on the sale of securities and mortgage-backed and related
securities to a loss of $8,000 for fiscal 1998 from a gain of $7,000 for fiscal
1997. The increase in gain on sale of loans reflects the increased volume of
loans sold in fiscal year 1998 due to a higher level of refinanced loans.
Service charges on loans increased due to the increased loan volume and higher
charges associated with commercial type loans. The decrease in insurance
commissions reflects the sale of the property and casualty policies of the
Company's insurance subsidiary during fiscal 1996. The decrease in gains on the
sale of securities and mortgage-backed and related securities reflects
management's decision to sell more higher-yielding available-for-sale
securities in the 1997 period. The decrease in loan servicing fees reflects
decreases in the average balance of the Company's sold loan serviced portfolio.
NON-INTEREST EXPENSE
Non-interest expense decreased 2.8% to $6.8 million for fiscal 1998 from
$7.0 million for fiscal 1997. The decrease was primarily due to an
industry-wide special assessment charge in fiscal 1997 of $877,000 for an
amount to recapitalize the SAIF, partially offset by a refund credit of
$137,000 and a decrease in FDIC deposit insurance premiums of $174,000 to
$174,000 for fiscal 1998 from $348,000 for fiscal 1997. Compensation and
benefits expense increased $464,000 to $4.0 million for fiscal 1998 from $3.5
million for fiscal 1997, which primarily relates to higher salary, loan
commissions and incentive compensation and an increase in full-time equivalent
employees. Occupancy and equipment expense increased $195,000 to $1.2 million
for fiscal 1998 from $1.0 million for fiscal 1997, due to additional building
and bank equipment purchases. Marketing expense increased $52,000 to $380,000
for fiscal 1998 from $328,000 for fiscal 1997. Other non-interest expense
increased $4,000 to $1.177 million for fiscal 1998 from $1.173 million for
fiscal 1997, due to increases in loan, printing, office supplies, organization
dues, legal and other miscellaneous expenses.
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INCOME TAX EXPENSE
Income tax expense increased to $1.4 million for fiscal 1998 from $1.0
million for fiscal 1997. The increase was primarily a result of higher income
before income taxes. However, the effective tax rate decreased from 34.8% for
fiscal 1997 to 33.4% for fiscal 1998 resulting from 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, 1997 AND
1996
GENERAL
Net income for the fiscal year ended June 30, 1997 increased 2.2% to
$1.919 million from $1.878 million for fiscal 1996. The increase in net income
was primarily attributable to an increase in net interest income. Net interest
income before the provision for losses on loans increased to $9.6 million for
the fiscal year ended June 30, 1997 from $7.5 million for fiscal 1996,
primarily as a result of higher average interest-earning assets during fiscal
1997 as compared to fiscal 1996. Non-interest income decreased by $234,000 to
$1.0 million for the fiscal year ended June 30, 1997 from $1.3 million for
fiscal 1996. The decrease in non-interest income was primarily due to a
decrease in other non-interest income which decreased $174,000 to $87,000 for
the fiscal year ended June 30, 1997 from $261,000 for fiscal 1996 and a
decrease in gains on the sale of investments and mortgage-backed and related
securities of $65,000 to $7,000 for fiscal year ended June 30, 1997 from
$72,000 for fiscal 1996. Also, insurance commissions decreased $17,000 to
$110,000 for the fiscal year ended June 30, 1997 from $127,000 for fiscal 1996,
loan servicing fees decreased $17,000 to $86,000 for the fiscal year ended June
30, 1997 from $103,000 for fiscal 1996, and service charges on deposit accounts
decreased $16,000 to $478,000 for the fiscal year ended June 30, 1997 from
$494,000 for fiscal 1996. The decrease in non-interest income was partially
offset by an increase in service charges on loans of $35,000. Non-interest
expense increased $1.4 million to $7.0 million for the fiscal year ended June
30, 1997 from $5.6 million for fiscal 1996, primarily as a result of a one-time
industry-wide FDIC special assessment charge of $877,000, partially offset by a
refund credit of $137,000, an increase of $454,000 in compensation and
benefits, an increase of $182,000 in other non-interest expense, an increase of
$114,000 in occupancy and equipment expense and an increase of $47,000 in
marketing expense. Net income also was reduced by an increase in the provision
for losses on loans to $650,000 for fiscal 1997 from $367,000 for fiscal 1996.
Return on average equity decreased to 6.83% for the fiscal year ended June
30, 1997 from 7.17% for fiscal 1996. Return on average assets decreased to .48%
for the fiscal year ended June 30, 1997 from .60% for fiscal 1996. The
decreases in return on average equity and average assets resulted primarily
from a one-time after-tax charge of $533,000 to recapitalize the SAIF, the FDIC
insurance fund which insures deposits of savings associations, partially offset
by an after-tax FDIC credit refund of $83,000. Excluding the effects of the
FDIC assessment and credit, return on average equity and return on average
assets would have been 8.43% and .60%, respectively. The Company's principal
investment focus during the fiscal year ended June 30, 1997 was the origination
and purchase of mortgage and commercial loans. The asset growth primarily was
funded through increases in deposits, primarily brokered and non-brokered
wholesale certificates of deposit, money market deposits, retail certificates
of deposit and sales of loans in the secondary market.
NET INTEREST INCOME
Net interest income increased 27.4% to $9.6 million for fiscal 1997 from
$7.5 million for fiscal 1996. Interest income increased $6.9 million in fiscal
1997, while interest expense increased $4.9 million. The level of net interest
income primarily reflects a 26.3% increase in average interest-earning assets
during fiscal 1997 and a 4.7% increase in the excess of the Company's average
interest-earning assets over average interest-bearing liabilities to $28.7
million for fiscal 1997 from $27.4 million for fiscal 1996, and by an increased
interest rate spread to 2.06% for fiscal 1997 from 1.97% for fiscal 1996. The
increased interest rate spread for fiscal 1997 is a result of the Company's
origination and purchase of loans with variable rates at higher interest rates,
partially offset by higher funding costs.
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INTEREST INCOME
Interest income increased 30.3% to $29.8 million for fiscal 1997 from
$22.9 million for fiscal 1996. The increase in interest income was the result
of an increase in average interest-earning assets of 26.3% to $388.1 million
for fiscal 1997 compared to $307.4 million for fiscal 1996 and an increase of
23 basis points in the yield on interest-earning assets to 7.68% for fiscal
1997 from 7.45% for fiscal 1996. The rate of asset growth experienced during
fiscal year 1997 is not expected to continue as the Company had substantially
completed the leveraging of its assets during the first half of fiscal 1997 and
continues to implement the second phase of its strategic plan by slowing its
assets growth and focusing on asset portfolio diversification in fiscal 1998.
Interest income on loans increased 52.7% to $20.7 million for fiscal 1997 from
$13.6 million for fiscal 1996. The increase was the result of an increase in
the Company's average gross loans of 47.0% to $254.1 million for fiscal 1997
from $172.9 million for fiscal 1996 and an increase in average yield to 8.16%
for fiscal 1997 from 7.86% for fiscal 1996. While total mortgage loans
originated and purchased decreased in fiscal 1997 compared to fiscal 1996 as
the Company focused on portfolio diversification, gross loans increased
primarily as a result of the Company retaining all of its originated adjustable
rate loans. The increase in yield is primarily attributable to the retention of
higher rate adjustable-rate loans, and to the higher yields paid on the
multi-family and commercial components of the loan portfolio. Interest income
on mortgage-backed securities decreased 6.8% to $3.5 million for fiscal 1997
from $3.8 million for fiscal 1996. The decrease was primarily due to a decrease
in average balances to $50.4 million for fiscal 1997 from $55.2 million for
fiscal 1996 offset by an increase in average yield to 7.05% for fiscal 1997
from 6.90% for fiscal 1996. The decrease in mortgage-backed securities is
expected to continue in fiscal 1998 as the Company continues to use the
principal prepayments to fund the asset portfolio diversification. Interest
income on mortgage-related securities increased 2.1% to $2.7 million for fiscal
1997 from $2.6 million for fiscal 1996. The increase was primarily due to an
increase in average balances to $40.5 million for fiscal 1997 from $37.3
million for fiscal 1996, offset by a decrease in average yield to 6.65% for
fiscal 1997 from 7.06% for fiscal 1996. Interest income on investment
securities and securities available-for-sale decreased 4.3% to $2.5 million for
fiscal 1997 from $2.6 million for fiscal 1996. The decrease was primarily due
to a decrease in average yield to 6.54% for fiscal 1997 from 6.83% for fiscal
1996. The lower average yield was primarily attributable to the falling
interest rate environment during the last half of fiscal 1997. The interest
rate environment for fiscal 1997 was marked by increasing interest rates for
the first half before falling in the last half as compared to a rising interest
rate environment throughout fiscal 1996. The lower interest rates of the last
half of fiscal 1997 also resulted in lower average yields on the Bank's fixed
and adjustable rate loans and related securities portfolios.
INTEREST EXPENSE
Interest expense increased 31.7% to $20.2 million for fiscal 1997 from
$15.3 million for fiscal 1996. The increase was the result of a 28.4% increase
in the average amount of interest-bearing liabilities to $359.4 million for
fiscal 1997 compared to $280.0 million for fiscal 1996 and an increase in the
average rate paid on interest-bearing liabilities to 5.62% for fiscal 1997 from
5.48% for fiscal 1996. The increased balances of certificates of deposit
(including brokered and non-brokered wholesale deposits), money market deposits
and borrowings, offset by decreases in lower cost NOW accounts and passbook
deposits, was the primary reason for the increase in the average rate paid in
fiscal 1997 as compared to fiscal 1996. Interest expense on deposits increased
36.9% to $13.9 million for fiscal 1997 from $10.1 million for fiscal 1996. The
increase was the result of an increase in average balances of 33.0% to $251.8
million for fiscal 1997 from $189.4 million for fiscal 1996 and an increase in
the average rate paid on deposits to 5.52% for fiscal 1997 from 5.36% for
fiscal 1996. The increase in deposits was primarily due to an increase of 35.1%
in certificates of deposit to $211.0 million for fiscal 1997 compared to $156.2
million in fiscal 1996 and an increase in average rate paid on certificates of
deposit to 5.86% for fiscal 1997 from 5.81% for fiscal 1996. Also, money market
deposits increased 148.8% to $15.4 million for fiscal 1997 compared to $6.2
million in fiscal 1996 and the average rate paid on such deposits increased to
5.21% for fiscal 1997 from 4.78% for fiscal 1996. These increases were
partially offset by a decline of 5.9% in passbook accounts to $23.0 million for
fiscal 1997 compared to $24.4 million for fiscal 1996 and a decline of 7.5% in
NOW accounts to $2.4 million for fiscal 1997 compared to $2.6 million for
fiscal 1996. Money market deposits increased due to aggressive marketing and an
attractive interest rate paid within the Bank's local market area. 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
$211.1 million in the average balance of certificates of deposit for fiscal
1997, $87.1 million or 41.3% represented brokered certificates of deposit
compared to $52.5 million or 33.6% for fiscal 1996. The average rate paid on
brokered certificates of deposit increased to 6.11% for fiscal 1997 from 5.81%
for fiscal 1996. The rate of brokered
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certificate of deposit growth experienced in fiscal 1997 is not expected to
continue as the Company continues to implement the second phase of its strategic
plan by slowing the rate of growth of its asset base and focusing on asset
portfolio diversification in fiscal 1998. Interest on borrowings (FHLB advances
and reverse repurchase agreements) increased 21.6% to $6.2 million for fiscal
1997 from $5.1 million for fiscal 1996. The increase in borrowings was primarily
due to growth in the average balance of FHLB advances of 33.7% to $100.4 million
for fiscal 1997 compared to $75.1 million for fiscal 1996. The increase in
interest on borrowings also was due to an increase in average rate paid to 5.98%
for fiscal 1997 from 5.85% for fiscal 1996, as interest rates on the
adjustable-rate and short-term fixed-rate maturity borrowings increased as
interest rates in general increased in the first half of fiscal 1997. FHLB
advances will continue to be utilized as the Company continues the
implementation of the second phase of its strategic plan by slowing the rate of
growth of its asset base and focusing on asset portfolio diversification in
fiscal 1998.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans increased by 77.1% to $650,000 for
fiscal 1997 from $367,000 for fiscal 1996. 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 existing and
anticipated general economic conditions. Based on management's evaluation of
the loan portfolio and the increase in gross loans during fiscal 1997, the
allowance for losses on loans increased 42.8% to $1.8 million at June 30 1997
compared to $1.2 million at June 30, 1996. The increase in the level of
allowance for losses on loans was primarily the result of the increases in
commercial, home equity and commercial real estate loan portfolios which carry
a greater degree of credit risk. The ratio of allowance for loan losses to
gross loans increased to 0.62% at June 30, 1997 from 0.50% at June 30, 1996.
The amount of non-performing loans at June 30, 1997 was $624,000 or 0.22% of
gross loans compared to $107,000 or 0.04% of gross loans at June 30, 1996.
NON-INTEREST INCOME
Non-interest income decreased 18.5% to $1.0 million for fiscal 1997 from
$1.3 million for fiscal 1996. The largest components of the decrease were a
decrease in other income to $87,000 for fiscal 1997 compared to $261,000 for
fiscal 1996, a decrease in gains on the sale of securities and mortgage-backed
and related securities to $7,000 for fiscal 1997 compared to $72,000 for fiscal
1996, a decrease in insurance commissions to $110,000 for fiscal 1997 compared
to $127,000 for fiscal 1996, a decrease in loan servicing fees to $86,000 for
fiscal 1997 compared to $103,000 for fiscal 1996, and a decrease in service
charges on deposit accounts to $478,000 for fiscal 1997 compared to $494,000
for fiscal 1996. The decreases in non-interest income were offset by an
increase in gains on the sales of loans to $95,000 for fiscal 1997 compared to
$75,000 for fiscal 1996. The decrease in other income and insurance commissions
reflects the sale of the property and casualty policies of the Company's
insurance subsidiary for a one-time gain of $100,000 during fiscal 1996. The
decrease in gains on the sale of securities and mortgage-backed and related
securities reflects management's decision to sell more higher-yielding
available-for-sale securities in the 1996 period. The increase in gains on the
sale of loans reflects the gains on the sale of an increased volume of mortgage
loans in the 1997 period. The decrease in loan servicing fees reflects
decreases in the average balance of the Company's sold loan serviced portfolio.
Service charges on loans increased $35,000 to $165,000 for fiscal 1997 from
$130,000 for fiscal 1996, primarily reflecting the increased fees charged on
commercial loan volume.
NON-INTEREST EXPENSE
Non-interest expense increased 26.9% to $7.0 million for fiscal 1997 from
$5.6 million for fiscal 1996. The increase was primarily due to an increase in
FDIC deposit insurance premiums of $695,000 to $1.1 million for fiscal 1997
from $393,000 for fiscal 1996. The increase in FDIC deposit insurance premiums
was primarily a result of an industry-wide special assessment charge of
$877,000 for an amount to recapitalize the SAIF during the 1997 period,
partially offset by a refund credit of $137,000. See "Recent Regulatory
Developments." Compensation and benefits expense increased $454,000 to $3.5
million for fiscal 1997 from $3.0 million for fiscal 1996, which primarily
relates to higher salary, loan commissions and incentive compensation and an
increase in full-time equivalent employees. Occupancy and equipment expense
increased $114,000 to $963,000 for fiscal 1997 from $849,000 for fiscal 1996,
due to additional bank equipment purchases. Other non-interest expense
increased $182,000 to $1.2 million for fiscal 1997 from $1.0 million for fiscal
1996, due to increases in loan, printing, office supplies, organization dues,
legal and other miscellaneous expenses. Marketing expense increased $47,000 to
$328,000 for fiscal 1997 from $281,000 for fiscal 1996.
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INCOME TAX EXPENSE
Income tax expense increased to $1.026 million for fiscal 1997 from $1.009
million for fiscal 1996. 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,
1998, 1997 and 1996, 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 $169,000, $4,000 and $(4,000) for the fiscal years ended June 30,
1998, 1997 and 1996, respectively. The increase in the amount of loan fees
recognized in interest income for 1998 as compared to 1997 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,
--------------------------------------------------------
1998 1997
------------------------------ ------------------------
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 ......................................................... $267,549 $22,390 8.37% $246,744 $19,849 8.04%
Consumer loans ......................................................... 5,280 704 13.33 6,015 776 12.90
Commercial loans ....................................................... 7,375 700 9.49 1,387 124 8.94
-------- -------- -------- -------
Total loans ........................................................... 280,204 23,794 8.49 254,146 20,749 8.16
Mortgage-backed securities ............................................. 40,007 2,825 7.06 50,367 3,552 7.05
Mortgage derivative securities ......................................... 37,205 2,543 6.84 40,494 2,691 6.65
-------- -------- -------- -------
Total loans and related securities .................................... 77,212 5,368 6.95 90,861 6,243 6.87
Investment and other securities ........................................ 10,678 711 6.66 4,980 294 5.90
Securities available for sale .......................................... 30,524 1,972 6.46 32,887 2,184 6.64
Federal Home Loan Bank stock ........................................... 5,661 382 6.75 5,217 354 6.79
-------- -------- -------- -------
Total interest-earning assets(1) ...................................... 404,279 32,227 7.97 388,091 29,824 7.68
-------- ------- ------- -------
Non-interest earning assets ............................................. 13,315 9,456
-------- --------
Total assets .......................................................... $417,594 $397,547
======== ========
LIABILITIES AND RETAINED EARNINGS:
Deposits:
NOW accounts ........................................................... $ 2,628 45 1.71 $ 2,370 41 1.73
Money market deposit accounts .......................................... 25,230 1,319 5.23 15,444 804 5.21
Passbook ............................................................... 21,194 625 2.95 23,001 691 3.00
Certificates of deposit ................................................ 215,701 12,967 6.01 211,010 12,357 5.86
-------- -------- -------- -------
Total deposits ........................................................ 264,753 14,956 5.65 251,825 13,893 5.52
Advance payments by borrowers for taxes and insurance ................... 3,139 84 2.68 3,486 94 2.66
Borrowings .............................................................. 107,378 6,546 6.10 104,101 6,224 5.98
-------- -------- -------- -------
Total interest-bearing liabilities .................................... 375,270 21,586 5.75 359,412 20,211 5.62
-------- ------- ------- -------
Other liabilities (Incl. non-interest bearing demand deposits) .......... 10,848 10,031
Retained earnings ....................................................... 31,476 28,104
-------- --------
Total liabilities and retained earnings ............................... $417,594 $397,547
======== ========
Net interest income/interest rate spread(2) .............................. $10,641 2.22% $9,613 2.06%
======== ======= ======= =======
Net earning assets/net interest margin(3) ................................ $ 29,009 2.63% $28,679 2.48%
======== ======= ======== =======
Average interest-earning assets to average interest-bearing liabilities .. 1.08x 1.08x
======== =======
CONSOLIDATED AVERAGE BALANCE SHEETS
FISCAL YEAR ENDED JUNE 30,
------------------------------------
1996
------------------------------------
AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
----------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans ......................................................... $164,565 $12,617 7.67%
Consumer loans ......................................................... 8,339 968 11.61
Commercial loans ....................................................... -- -- --
----------- --------
Total loans ........................................................... 172,904 13,585 7.86
Mortgage-backed securities ............................................. 55,218 3,810 6.90
Mortgage derivative securities ......................................... 37,320 2,636 7.06
----------- --------
Total loans and related securities .................................... 92,538 6,446 6.97
Investment and other securities ........................................ 4,378 268 6.12
Securities available for sale .......................................... 33,523 2,322 6.93
Federal Home Loan Bank stock ........................................... 4,036 273 6.76
----------- --------
Total interest-earning assets(1) ...................................... 307,379 22,894 7.45
-------- -------
Non-interest earning assets ............................................. 7,966
-----------
Total assets .......................................................... $315,345
===========
LIABILITIES AND RETAINED EARNINGS:
Deposits:
NOW accounts ........................................................... $ 2,562 42 1.64
Money market deposit accounts .......................................... 6,207 297 4.78
Passbook ............................................................... 24,446 734 3.00
Certificates of deposit ................................................ 156,161 9,072 5.81
----------- --------
Total deposits ........................................................ 189,376 10,145 5.36
Advance payments by borrowers for taxes and insurance ................... 3,089 85 2.71
Borrowings .............................................................. 87,529 5,118 5.85
----------- --------
Total interest-bearing liabilities .................................... 279,994 15,348 5.48
-------- -------
Other liabilities (Incl. non-interest bearing demand deposits) .......... 9,163
Retained earnings ....................................................... 26,188
-----------
Total liabilities and retained earnings ............................... $315,345
===========
Net interest income/interest rate spread(2) .............................. $ 7,546 1.97%
======== =======
Net earning assets/net interest margin(3) ................................ $ 27,385 2.45%
=========== =======
Average interest-earning assets to average interest-bearing liabilities .. 1.10x
========
- ------------------
(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, 1998 FISCAL YEAR ENDED JUNE 30, 1997
COMPARED TO COMPARED TO
FISCAL YEAR ENDED JUNE 30, 1997 FISCAL YEAR ENDED JUNE 30, 1996
-------------------------------------- --------------------------------------
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 ................... $800 $1,674 $ 67 $2,541 $621 $6,301 $301 $7,232
Consumer loans ................... 26 (95) (3) (72) 108 (270) (30) (192)
Commercial loans ................. 8 535 33 576 -- 124 -- 124
Mortgage-backed securities ....... 5 (731) (1) (727) 84 (335) (7) (258)
Mortgage-derivative securities ... 77 (219) (6) (148) (156) 224 (13) 55
Investment and other securities .. 38 336 43 417 (10) 37 (1) 26
Securities available for sale .... (59) (157) 4 (212) (96) (44) 2 (138)
Federal Home Loan Bank stock ..... (2) 30 -- 28 1 80 -- 81
-------- -------- -------- -------- -------- -------- -------- --------
Total .......................... 893 1,373 137 2,403 552 5,993 385 6,930
-------- -------- -------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
NOW accounts ..................... -- 4 -- 4 2 (3) -- (1)
Money market demand accounts ..... 3 509 2 514 26 442 39 507
Passbook accounts ................ (13) (54) 1 (66) -- (43) -- (43)
Certificates of deposit .......... 328 275 7 610 73 3,186 26 3,285
Advance payments by borrowers
for taxes and insurance .......... (1) (9) -- (10) (2) 11 -- 9
Borrowings ....................... 122 196 4 322 115 969 22 1,106
-------- -------- -------- -------- -------- -------- -------- --------
Total .......................... 439 921 14 1,374 214 4,562 87 4,863
-------- -------- -------- -------- -------- -------- -------- --------
Net change in net interest income .. $454 $ 452 $123 $1,029 $338 $1,431 $298 $2,067
======== ======== ======== ======== ======== ======== ======== ========
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FINANCIAL CONDITION
Total assets increased $28.6 million or 7.0%, from $409.8 million at June
30, 1997 to $438.4 million at June 30, 1998. This increase is primarily
reflected in increases in loans receivable and mortgage-backed and related
securities available-for-sale, consistent with the Company's strategy of
moderate asset growth and asset portfolio diversification. The increase was
funded primarily by an increase in FHLB-Chicago advances and money market
deposits.
Starting in the later half of fiscal 1996 and continuing in fiscal 1998,
the Company implemented the second stage of its post-Conversion strategy by
shifting its focus from asset growth to asset portfolio diversification. While
the Company intends to continue to originate and purchase one-to-four family
mortgage loans, the Company's long-term objective is to increase net income by
increasing the proportion of higher yielding assets in its loan portfolio. The
Company began to implement this strategy in the second half of fiscal 1996 by
increasing the multi-family real estate, multi-family construction and
commercial/nonresidential real estate components of its loan portfolio. In the
second half of fiscal 1997, a commercial lending division began operations to
continue the asset portfolio diversification. The moderate asset growth and
portfolio diversification in fiscal 1998 was funded primarily through increases
in FHLB-Chicago advances, money market deposits and sales of loans in the
secondary market. The Company intends to fund its asset portfolio
diversification in fiscal 1999 through increases in retail deposits, brokered
and non-brokered wholesale deposits, principal repayment cash flows from
existing assets, modest increases in FHLB advances (subject to Board-imposed
and regulatory limitations discussed herein), the liquidation of a portion of
its available-for-sale portfolio, the maturity and sale of mortgage-backed and
related securities, and loan sales in the secondary market.*
Cash and cash equivalents decreased 6.5% to $8.2 million at June 30, 1998
compared to $8.8 million at June 30, 1998. The decrease is largely attributable
to the increase in loans receivable and mortgage-backed and related securities
available-for sale.
Investment securities decreased to $388,000 at June 30, 1998 compared to
$780,000 at June 30, 1997. The change was primarily the result of management's
decision to decrease its portfolio of investment securities, which consist
primarily of certificates of deposits in other financial institutions, due to
the competitive yields on loans in fiscal 1998 and loan portfolio
diversification.
Securities available-for-sale increased to $66.4 million at June 30, 1998
compared to $29.5 million at June 30, 1997. The increase is the result of
management's decision to increase its investment in mortgage-backed and related
securities available-for-sale due to favorable competitive yields on such
securities and the increased level of repayments received on the loan
portfolio. At June 30, 1998, the securities available-for-sale portfolio
contained $5.0 million of fixed-rate U.S. government agency securities, $6.2
million of agency and private-issue fixed-rate mortgage-backed securities with
a minimum investment rating of AA, $35.1 million of private-issue
adjustable-rate mortgage-backed securities with a minimum investment rating of
AA, $14.7 million of fixed-rate intermediate-term tranche CMOs with a minimum
investment rating of AAA, $1.5 million of floating-rate tranche CMOs with a
minimum investment rating of AA, $2.5 million in trust preferred securities,
$1.0 million of adjustable-rate mortgage mutual funds and $410,000 of municipal
bonds.
Mortgage-backed and related securities held-for-investment decreased to
$65.3 million at June 30, 1998 compared to $85.4 million at June 30, 1997. The
decrease is attributable to management's decision to decrease its investment in
mortgage-backed and related securities to provide funding for the loan
portfolio growth and diversification and increased investment in
mortgage-backed and related securities available-for-sale. Of the $65.3 million
in mortgage-backed and related securities at June 30, 1998, $57.2 million were
adjustable rate and $8.1 million were fixed rate, compared to a total of $85.4
million at June 30, 1997, of which $72.0 million were adjustable rate and $13.4
million were fixed rate. The decrease in mortgage-backed and related securities
was primarily attributable to the principal repayments of adjustable-rate
mortgage-backed securities and CMOs in fiscal 1998. At June 30, 1998, $19.2
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, 1998.
Loans receivable increased to $280.9 million at June 30, 1998 compared to
$273.6 million at June 30, 1997. The increase at June 30, 1998 compared to the
prior fiscal year end is primarily the result of management's decision to
retain more ARM loans originated and purchased for the Company's portfolio, as
such loans carried higher yields than comparable mortgage-backed and related
securities in fiscal 1998. Total mortgage loans originated and purchased
amounted to $120.8 million and $104.0 million for the fiscal years ended June
30, 1998 and 1997, respectively, while sales of fixed-rate mortgage loans
totaled $20.2 million and $10.6 million for the fiscal years ended June 30,
1998 and 1997, respectively. The increase in
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fixed-rate mortgage loan sales is primarily attributable to the Company's
decision to create liquidity to fund commercial loan originations. During fiscal
1998, the Company originated and purchased loans totaling $135.7 million and
$27.7 million, respectively. Of the $27.7 million in purchased loans, the
Company purchased $25.6 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 decreased $9.9 million to $271.6 million at June 30, 1998 from
$281.5 million at June 30, 1997. The decrease in deposits was primarily due to
the Company's decreased use of brokers to attract certificates of deposit with
the Company. Brokered deposits totaled $81.4 million at June 30, 1998,
representing 30.0% of total deposits, as compared to $92.2 million, or 32.8% of
total deposits, at June 30, 1997. The average maturity of brokered deposits was
eight months at June 30, 1998, compared to eleven months at June 30, 1997.
Non-brokered wholesale deposits totaled $42.9 million at June 30, 1998,
representing 15.8% of total deposits as compared to $48.8 million, or 17.3% of
total deposits, at June 30, 1997. Deposits are the Company's 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 $117.1 million at
June 30, 1998 compared to $92.1 million at June 30, 1997. At June 30, 1998,
FHLB advances were 28.9% of total liabilities compared to 24.2% of total
liabilities at June 30, 1997. There were no borrowings under reverse
repurchase agreements at June 30, 1998 and 1997. 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.
Mortgage loans and mortgage securities prepayments increased in fiscal 1996 as
interest rates declined for the first half of the fiscal year before increasing
in the last half of the fiscal year. During fiscal year 1997 and 1998,
prepayments increased as interest rates decreased in the second half of the
fiscal year.
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 1998, the Company originated and purchased loans totaling $134.9
million and $27.7 million, respectively, as compared to fiscal 1997 when
originated and purchased loans totaled $97.6 million and $20.5 million,
respectively. The Company did not purchase mortgage-backed and related
securities in fiscal 1998 and 1997. The Company also purchased investment
securities in the amount of $352,000 and $0 during fiscal 1998 and 1997,
respectively. For fiscal 1998 and 1997, these activities were funded primarily
by principal repayments on loans of $144.7 million and $70.1 million,
respectively; principal repayments on mortgage-backed and related securities of
$28.8 million and $19.0 million, respectively; proceeds from the sale of
mortgage loans of $20.2 million and $10.6 million, respectively; proceeds from
maturity of investment securities of $392,000 and $198,000, respectively;
proceeds from long-term notes payable to the FHLB-Chicago of $50.0 million and
$35.0 million, respectively; and a net increase in deposits of $51.8 million in
fiscal 1997. Purchases of securities available-for-sale totaled $69.9 million
and sales were $20.9 million for fiscal 1998, compared to purchases of $2.0
million and sales of $2.3 million for fiscal 1997.
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 FHLB-Chicago advances and 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. The Company maintains a $15.0
million backup credit facility for contingency purposes to replace funds from
wholesale brokered deposits should retention of
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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.
During fiscal 1998, the Company found the use of FHLB-Chicago advances
more attractive as a funding source than wholesale brokered and non-brokered
deposits. 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, 1998, FHLB advances totaled $117.1 million, or 26.7%
of the Bank's total assets. At June 30, 1998, the Bank had unused borrowing
authority under the borrowing limitations established by the Board of Directors
of $23.2 million and $36.3 million under the FHLB total asset limitation. The
Bank intends to fund asset portfolio diversification in fiscal 1999 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 1998, management shortened the maturities of both its
wholesale brokered certificates of deposits and the FHLB borrowings to reduce
short-term liquidity risks. As of June 30, 1998, the average maturity of the
wholesale brokered certificates of deposit was eight months compared to eleven
months in fiscal 1997 and compared to a nine month maturity for retail
certificates of deposits as of June 30, 1998.
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 26.5% and
19.83% at June 30, 1998 and 1997, 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
$8.2 million and $8.8 million at June 30, 1998 and 1997, respectively. The
decrease in cash and cash equivalents in fiscal 1998 resulted primarily from
the cash used to purchase securities available-for-sale and to fund the
increase in loans receivable.
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
$15.0 million contingent backup credit facility 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. The Company also has a federal funds open line of credit in
the amount of $5.0 million with a correspondent bank which does not require the
direct pledging of any assets. 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, 1998, the Company had outstanding loan commitments of $4.1
million. The Company had $9.9 million in commitments to purchase
mortgage-backed and related securities at June 30, 1998. The Company
anticipates it will have sufficient funds available to meet its current loan
commitments, including loan applications received and in process to the
issuance of firm commitments. Certificates of deposit scheduled to mature in
one year or less at June 30, 1998 totaled $165.0 million.
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IMPACT OF YEAR 2000
The Company is currently in the process of addressing a potential problem
that faces all users of automated systems including information systems. Many
computer systems process transactions based on two digits representing the year
of transaction, rather than four digits. These computer systems may not operate
properly when the last two digits become "00", as will occur on January 1,
2000. The problem could affect a wide variety of automated information systems,
such as mainframe applications, personal computers, communication systems,
environmental systems and other information systems.
The Company has identified areas of operations critical for the delivery
of its loan and deposit products. The majority of the Company's applications
used in operations are purchased from outside vendors. The vendors providing
the software are responsible for maintenance of the systems and modifications
to enable uninterrupted usage after December 31, 1999. The Company's plan
includes obtaining certification of compliance from third parties and testing
all of the impacted applications (both internally developed and third party
provided). The Company's goal is to have conversion activities and testing
fully compliant by June 30, 1999. Testing of the system will occur during
fiscal year 1999. Contingency plans are in the process of development to
address potential problems discovered during testing. The Company's plan also
includes reviewing any potential risks associated with loan and deposit data
base information due to the Year 2000 issue. Potential risks could include, but
are not limited to, system failure or miscalculations causing disruptions of
operations which may include the temporary inability to process transactions,
and sending accurate customer loan payment or deposit receipt information.
Based on currently available information, management does not anticipate
that the cost to address the Year 2000 issues will have a material adverse
impact on the Company's financial position. Direct expenditures in fiscal year
1998 for the Year 2000 project totaled $5,000, and it is estimated that
completion of the project will result in additional expenditures of
approximately $110,000. 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. Currently, the Company is utilizing
internal staff to coordinate the Year 2000 project, which may delay new product
implementation through fiscal 1999. The Company does not plan to engage
consultants to complete the Year 2000 project unless the aforementioned
conversion and testing cannot be completed by the end of fiscal 1999. There can
be no guarantee, that the systems of other parties on which the Company's
systems rely will be timely converted and not have an adverse impact on the
Company's systems.
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.
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.
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The Company utilizes basic strategies in managing its assets and
liabilities by managing or maximizing the net interest income under various
interest rate scenarios. Certain techniques such as hedging through the use of
options, financial futures, and interest rate swaps historically have not been
utilized by the Company. Management does not intend to use such sophisticated
techniques in the near future. 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 1996 and 1997 as a result of favorable advance and wholesale rates in
relation to those obtainable on retail deposits.
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; and (v) the Bank utilizes longer-term borrowings from the
FHLB-Chicago to manage its assets and liabilities and enhance earnings. At June
30, 1998, 1997 and 1996, total FHLB-Chicago advances were $117.1 million or
26.7% of total assets, $92.1 million or 22.5% of total assets, and $102.4
million or 27.1% of total assets, respectively.
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, 1998, the average maturity was eight months. Liquidity is another
factor in asset/liability management. As of June 30, 1998, the Company had $8.2
million in cash or demand deposits and $66.4 million in its available-for-sale
investment securities portfolio, of which $35.5 million is due or will be
repriced within one year. The composition of the held-to-maturity investment
securities portfolio as of June 30, 1998 was $65.3 million, of which $57.2
million will be due or repriced within one year. The held-to-maturity
investment securities due to be repriced within one year consist of
mortgage-backed and related securities.
By primarily originating or purchasing ARM and intermediate fixed-rate
loans during fiscal 1998, the Company has been able to reduce interest rate
risk by more closely matching the terms and repricing characteristics of its
assets by extending the maturities of its liabilities to reduce interest rate
risk. However, during fiscal 1998, the Company originated for portfolio $16.3
million in 30-year fixed-rate mortgage loans as compared to $13.0 million for
fiscal 1997. The increase was due to the decreasing interest rate environment
during the second half of fiscal 1998. In addition, 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 interest 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, 1998 and 1997, total interest-bearing liabilities repricing
within one year exceeded total interest-bearing assets repricing in the same
period by $22.3 million and $17.7 million, respectively, representing a
negative cumulative one-year interest rate sensitivity gap equal to 5.1% and
4.3%, respectively, of total assets. The increase in the Company's negative
one-year gap reflects the increased use of shorter-term maturity deposits and
FHLB advances to fund adjustable rate mortgage loans, intermediate fixed-rate
loans and mortgage-backed and related securities. During periods of rising
interest
-68-
71
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 monthly. 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 1999, the Company intends to maintain the weighted average
maturity level of its fixed-rate liabilities, including FHLB borrowings and
certificates of deposit, to fund the asset portfolio diversification.*
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. 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.
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72
ASSET/LIABILITY MANAGEMENT SCHEDULE
The following table sets forth at June 30, 1998 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
WITHIN FOUR TO ONE YEAR TO
THREE MONTHS TWELVE MONTHS THREE YEARS
----------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
------ ---- ------ ---- ------ ----
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS(1):
Mortgage loans(2):
Fixed rate ..................................... $ 7,140 7.89% $ 18,720 7.97% $ 42,404 8.12%
Adjustable rate ................................ 24,896 9.15 48,104 8.06 53,848 8.31
Consumer loans (2) .............................. 414 10.51 3,246 13.40 868 10.64
Commercial loans (2) ............................ 1,625 9.34 6,302 7.98 3,122 8.23
Mortgage-backed and related securities:
Fixed rate and securities available-for-sale.... 1,726 7.01 7,140 7.08 8,591 7.12
Adjustable rate ................................ 55,934 7.03 38,000 7.31 -
Investment securities and
securities available-for-sale .................. 12,360 6.06 727 5.66 5,402 5.92
---------- ---------- ----------
Total interest-earning assets .................. $104,095 7.56 $122,239 7.94 $114,235 8.11
========== ========== ==========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts ................................... $ 203 1.75 $ 608 1.75 $ 964 1.75
Money market deposit accounts .................. 4,199 5.10 12,598 5.10 9,406 5.10
Passbook savings accounts ...................... 1,587 2.91 4,761 2.91 7,553 2.91
Certificates of deposit ........................ 57,174 5.85 107,863 5.97 44,305 6.02
Escrow deposits ................................ - 3,163 2.83 -
Borrowings(4)
FHLB advances and other borrowings ............. 10,000 5.53 46,500 5.57 38,007 6.11
---------- ---------- ----------
Total interest-bearing liabilities ............. $ 73,163 5.69% $175,493 5.65% $100,235 6.11%
========== ========== ==========
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities ....... $ 30,932 ($53,254) $ 14,000
========== ========== ==========
Cumulative excess (deficiency) of interest-
earning assets over interest-bearing liabilities $30,932 ($22,322) ($8,322)
========== ========== ==========
Cumulative excess (deficiency) of interest-
earning assets over interest-bearing
liabilities as a percent of total assets ....... 7.1% (5.1)% (1.9)%
========== ========== ==========
AMOUNT MATURING OR REPRICING
-------------------------------------------------------------
MORE THAN
THREE YEARS TO
FIVE YEARS OVER FIVE YEARS TOTAL
-------------------- ------------------ -----------------
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
------ ---- ------ ---- ------ ----
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS(1):
Mortgage loans(2):
Fixed rate ..................................... $32,900 8.05 $28,650 7.62% $129,814 7.96%
Adjustable rate ................................ 2,011 8.56 1,453 8.94 130,312 8.39
Consumer loans (2) .............................. 310 10.85 - 4,838 12.49
Commercial loans (2) ............................ 3,141 7.04 - 14,190 7.98
Mortgage-backed and related securities:
Fixed rate and securities available-for-sale.... 5,249 7.23 6,191 7.38 28,897 7.18
Adjustable rate ................................ - - 93,934 7.14
Investment securities and
securities available-for-sale .................. - 2,913 8.39 21,402 6.32
-------- -------- --------
Total interest-earning assets .................. $43,611 7.99 $39,207 7.73 $423,387 7.88
======== ======== ========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts ................................... $ 472 1.75 $ 454 1.75 $2,701 1.75
Money market deposit accounts .................. 1,505 5.10 287 5.10 27,995 5.10
Passbook savings accounts ...................... 3,701 2.91 3,556 2.91 21,158 2.91
Certificates of deposit ........................ 2,685 6.01 - 212,027 5.95
Escrow deposits ................................ - - 3,163 2.83
Borrowings(4)
FHLB advances and other borrowings ............. 8,052 6.23 14,500 6.26 117,059 5.88
-------- -------- --------
Total interest-bearing liabilities ............. $16,415 5.21% $18,797 5.50% $384,103 5.65%
======== ======== ========
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities ....... $27,196 $20,410 $39,284
======== ======== ========
Cumulative excess (deficiency) of interest-
earning assets over interest-bearing liabilities $18,874 $39,284 $ 39,284
======= ======== ========
Cumulative excess (deficiency) of interest-
earning assets over interest-bearing
liabilities as a percent of total assets ....... 4.3% 9.0% 9.0%
======= ======== ========
- --------------------------
(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 5% to 25%, 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 $9.5 million at June 30, 1998.
(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 $50.2 million or 11.5% 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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73
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 currently does not enter into futures, forwards,
swaps or options. However, 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 65 to 66 and "Asset/Liability Management" from pages 67
to 69 hereof.
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74
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, 1998 and 1997, 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, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatements. 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, 1998 and 1997 and the
results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 1998, in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Milwaukee, Wisconsin
July 31, 1998
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75
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
AT JUNE 30,
------------------
1998 1997
-------- --------
ASSETS
Cash and non-interest bearing deposits ................................. $ 1,998 $ 3,859
Interest-bearing deposits .............................................. 6,186 4,896
-------- --------
Cash and cash equivalents .............................................. 8,184 8,755
Securities available-for-sale (at fair value):
Investment securities ................................................. 8,896 18,137
Mortgage-backed and related securities ................................ 57,549 11,381
Securities held-to-maturity:
Investment securities (fair value - $388 at
June 30, 1998, $780 at June 30, 1997) ................................ 388 780
Mortgage-backed and related securities (fair value -
$66,185 at June 30, 1998; $86,149 at June 30, 1997) .................. 65,282 85,430
Loans receivable, net .................................................. 280,889 273,556
Loans held for sale, at lower of cost or market ........................ 2,056 --
Investment in Federal Home Loan Bank stock, at cost .................... 5,932 5,279
Foreclosed properties, net ............................................. 11 20
Office properties and equipment ........................................ 5,653 3,091
Prepaid expenses and other assets ...................................... 3,534 3,391
-------- --------
Total assets ..................................................... $438,374 $409,820
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits .............................................................. $271,619 $281,512
Notes payable to Federal Home Loan Bank ............................... 117,059 92,073
Payable for investments purchased ..................................... 9,858 --
Advance payments by borrowers for taxes and insurance ................. 3,163 3,485
Accrued interest on deposit accounts and borrowings ................... 1,455 1,578
Accrued expenses and other liabilities ................................ 1,767 1,500
-------- --------
Total liabilities ................................................ $404,921 $380,148
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 2,933,608 shares at June 30, 1998
and 2,885,900 at June 30, 1997 ....................................... 3,162 3,162
Additional paid-in capital ............................................ 9,512 9,022
Unearned ESOP compensation ............................................ (532) (632)
Unearned restricted stock award ....................................... (124) (208)
Net unrealized depreciation on securities available for sale .......... (27) (225)
Treasury stock, at cost: 228,892 shares at June 30, 1998
and 276,600 shares at June 30, 1997 ................................. (1,385) (1,592)
Retained earnings, substantially restricted ........................... 22,847 20,145
-------- --------
Total shareholders' equity ....................................... $ 33,453 $ 29,672
-------- --------
Total liabilities and shareholders' equity ....................... $438,374 $409,820
======== ========
See accompanying Notes to Consolidated Financial Statements
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76
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
FOR THE YEARS ENDED
JUNE 30,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
INTEREST INCOME:
Loans receivable....................................... $23,794 $20,749 $13,585
Securities and interest-bearing deposits............... 1,858 1,829 1,852
Mortgage-backed and related securities................. 6,575 7,245 7,457
------------ ------------ ------------
Total interest income................................ 32,227 29,823 22,894
INTEREST EXPENSE:
Deposits............................................... 14,956 13,893 10,145
Advance payments by borrowers for taxes and insurance.. 84 93 85
Notes payable and other borrowings..................... 6,546 6,224 5,118
------------ ------------ ------------
Total interest expense............................... 21,586 20,210 15,348
------------ ------------ ------------
Net interest income....................................... 10,641 9,613 7,546
Provision for losses on loans............................. 800 650 367
------------ ------------ ------------
Net interest income after provision for losses on loans... 9,841 8,963 7,179
NON-INTEREST INCOME:
Service charges on loans................................ 288 165 130
Service charges on deposit accounts..................... 429 478 494
Loan servicing fees, net................................ 61 86 103
Insurance commissions................................... 49 110 127
Gain (loss) on sale of securities and
mortgage-backed and related securities, net........... (8) 7 72
Gain on sale of loans held for sale..................... 297 95 75
Other income............................................ 92 87 261
------------ ------------ ------------
Total non-interest income............................. 1,208 1,028 1,262
NON-INTEREST EXPENSE:
Compensation and benefits................................. 3,958 3,494 3,040
Marketing................................................. 380 328 281
Occupancy and equipment................................... 1,158 963 849
Deposit insurance premiums................................ 174 348 393
FDIC special assessment, net.............................. - 740 -
Other non-interest expense................................ 1,177 1,173 991
------------ ------------ ------------
Total non-interest expense.............................. 6,847 7,046 5,554
------------ ------------ ------------
Income before income taxes.................................. 4,202 2,945 2,887
Income taxes................................................ 1,403 1,026 1,009
------------ ------------ ------------
Net income................................................ $ 2,799 $ 1,919 $ 1,878
============ ============ ============
Earnings per share (basic)................................ $ 1.01 $ 0.71 $ 0.70
============ ============ ============
Earnings per share (diluted).............................. $ 0.97 $ 0.68 $ 0.68
============ ============ ============
See accompanying Notes to Consolidated Financial Statements
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77
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
ADDITIONAL UNEARNED UNEARNED UNREALIZED
COMMON PAID-IN ESOP RESTRICTED GAINS TREASURY RETAINED
STOCK CAPITAL COMPENSATION STOCK (LOSSES) STOCK EARNINGS TOTAL
------ ---------- ------------ ---------- ---------- -------- -------- -------
Balance at June 30, 1995 ................. $3,162 $8,779 ($861) ($502) ($74) ($1,592) $16,348 $25,260
Net income ............................... -- -- -- -- -- -- 1,878 1,878
Amortization of unearned ESOP and
restricted stock award compensation .... -- 105 121 168 -- -- -- 394
Unrealized depreciation on securities
available for sale, net of tax benefit . -- -- -- -- (521) -- -- (521)
------ ------ ------ ------ ----- -------- ------- -------
Balance at June 30, 1996 ................. $3,162 $8,884 ($740) ($334) ($595) ($1,592) $18,226 $27,011
Net income ............................... -- -- -- -- -- -- 1,919 1,919
Amortization of unearned ESOP and
restricted stock award compensation .... -- 138 108 126 -- -- -- 372
Unrealized appreciation on securities
available for sale, net of tax benefit . -- -- -- -- 370 -- -- 370
------ ------ ------ ------ ----- -------- ------- -------
Balance at June 30, 1997 ................. $3,162 $9,022 ($632) ($208) ($225) ($1,592) $20,145 $29,672
Net income ............................... -- -- -- -- -- -- 2,799 2,799
Amortization of unearned ESOP and
restricted stock award compensation ..... -- 270 100 84 -- -- -- 454
Exercise of stock options (47,708
shares issued in connection with
55,340 options exercised)................ -- 220 -- -- -- 207 (97) 330
Unrealized appreciation on securities
available for sale, net of tax benefit .. -- -- -- -- 198 -- -- 198
------ ------ ------ ------ ----- -------- ------- -------
Balance at June 30, 1998 ................. $3,162 $9,512 ($532) ($124) ($27) ($1,385) $22,847 $33,453
====== ====== ====== ====== ===== ======== ======= =======
Balances above have been restated for the periods presented to account for the
two-for-one stock split effective November 1997.
See accompanying Notes to Consolidated Financial Statements
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78
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED
JUNE 30,
-----------------------------
1998 1997 1996
-------- -------- ---------
OPERATING ACTIVITIES
Net income................................................................... $ 2,799 $ 1,919 $ 1,878
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for losses on loans............................................... 800 650 367
Provision for depreciation and amortization................................. 321 248 227
Deferred income taxes....................................................... (288) (171) (26)
Net (gain) loss on sales of investments and 8 (7) (72)
mortgage-backed and related securities..................................... (297) (95) (75)
Net gain on sale of loans held for sale..................................... 454 372 394
Amortization of unearned ESOP and restricted stock awards................... (20,213) (10,618) (3,515)
Loans originated for sale................................................... 18,157 10,618 5,281
Sales of loans originated for sale.......................................... 143 727 (998)
(Increase) decrease in prepaid expenses and other assets.................... 9,858 -- --
Increase in payables for investments purchased.............................. 267 60 36
Increase in accrued expenses and other liabilities.......................... (153) (148) 613
Other adjustments........................................................... -------- -------- ---------
Net cash provided by operating activities.................................... 11,856 3,555 4,110
-------- -------- ---------
INVESTING ACTIVITIES 20,881 2,268 22,158
Proceeds from the sale of securities available-for-sale...................... 4,000 500 22,552
Proceeds from the maturity of securities available-for-sale.................. (69,928) (1,950) (51,544)
Purchases of securities available-for-sale................................... (352) -- (580)
Purchases of investment securities held-to-maturity.......................... 392 198 192
Proceeds from maturities of investments held-to-maturity..................... -- -- (50,914)
Purchases of mortgage-backed and related securities.......................... -- 435 --
Proceeds from sales of mortgage-backed and related securities................ 28,845 18,995 22,105
Principal collected on mortgage-backed and related securities................ (8,103) (49,413) (82,904)
Net change in loans receivable............................................... 273 15 150
Proceeds from sales of foreclosed properties................................. (653) (160) (1,824)
Purchase of Federal Home Loan Bank stock..................................... (2,883) (400) (409)
Purchases of office properties and equipment, net............................ -------- -------- ---------
Net cash used in investing activities........................................ (27,528) (29,512) (121,018)
-------- -------- ---------
51,837 77,508
FINANCING ACTIVITIES (9,893) 35,000 33,000
Net increase (decrease) in deposits.......................................... 50,000 (39,300) 26,000
Proceeds from long-term notes payable to Federal Home Loan Bank.............. (25,014) (6,013) (20,012)
Net increase (decrease) in short-term notes payable to Federal Home Loan Bank -- (11,568) (1,813)
Repayment of long-term notes payable to Federal Home Loan Bank............... (322) (69) 230
Net decrease in securities sold under agreements to repurchase............... 330 -- --
Net increase (decrease) in advance payments by borrowers for taxes and -------- -------- ---------
insurance................................................................... 15,101 29,887 114,913
Stock option transactions.................................................... -------- -------- ---------
Net cash provided by financing activities.................................... (571) 3,930 (1,995)
Increase (decrease) in cash and cash equivalents............................ 8,755 4,825 6,820
Cash and cash equivalents at beginning of year............................... -------- -------- ---------
Cash and cash equivalents at end of year..................................... $ 8,184 $ 8,755 $ 4,825
======== ======== =========
See accompanying Notes to Consolidated Financial Statements
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79
HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED
JUNE 30,
-------------------------
1998 1997 1996
------- ------- -------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid (including amounts credited to deposit accounts) $21,714 $20,153 $14,836
Income taxes paid............................................. $1,737 $1,208 $950
Non-cash transactions:
Mortgage loans securitized as mortgage-backed securities...... -- -- $2,512
Loans transferred to foreclosed properties.................... $267 $54 $126
Loans made to finance the sale of foreclosed properties....... -- -- $13
See accompanying Notes to Consolidated Financial Statements
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80
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Hallmark Capital Corp. (the "Company") is the holding company for West Allis
Savings Bank (the "Bank"), a Wisconsin state-chartered savings bank. On
December 30, 1993, the Bank completed its conversion from a Wisconsin
state-chartered stock savings bank. On that date, the Company issued and sold
1,581,250 shares of its common stock at $8.00 per share to complete the
conversion. The Company acquired all of the issued and outstanding capital
stock of the Bank using a portion of the net proceeds from the conversion.
BUSINESS
The Company provides a wide range of financial services including real-estate
mortgage, commercial and consumer loans and transaction and time deposit
accounts to individual 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
generally accepted accounting principles ("GAAP") and include the accounts of
the Company and its wholly-owned subsidiary, West Allis Savings Bank, and its
subsidiaries. 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, 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
form 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
are deferred and recorded as an adjustment of the sales price.
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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.
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
serving 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 Company accounts for
mortgage servicing rights under Financial Accounting Standards Board Statement
No. 125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("Statement 125"), which was adopted on January
1, 1997.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by
management to absorb 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.
The Company accounts for impaired loans under Financial Accounting Standards
Board Statement No. 114, Accounting by Creditors for Impairment of a Loan
("Statement 114") and Financial Accounting Standards Board Statement No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures (Statement 118"). Statement No.114 requires that impaired loans be
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. Statement No. 118 eliminates the provisions in Statement
No.114 that describe how a creditor should report interest income on an
impaired loan. Interest income is not recognized on these loans until the
principal balance has been reduced sufficiently to ensure future collections
and the generally on a cash basis only. At June 30, 1998 the Company has
identified one loan with a balance of $683,000 as being impaired. This loan has
$171,000 in allocated loan loss reserves. During the fiscal year ended June 30,
1998 the average balance of impaired loans was $342,000. Interest income of
$22,000 was recorded on such loans in the fiscal year ending June 30, 1998.
Impaired loans were deemed to be immaterial for fiscal years ending June 30,
1997 and 1996.
INVESTMENT IN FEDERAL HOME LOAN BANK STOCK
The Company's investment in Federal Home Loan Bank stock meets the minimum
amount required by current regulation and is carried at cost which is
redeemable (fair) value since the market for this stock is limited.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, and 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.
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 asset and liability method.
Under this method, deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and the
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates in effect for the year in which those temporary differences
are expected to be recovered or settled. Tax benefits to the Company resulting
from the exercise of employee stock options are credited to additional
paid-in-capital.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, Earnings per Share
("Statement 128"), which is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods. Under the
provisions of the statement, primary and fully-diluted earnings per share were
replaced with basic and diluted earnings per share. Basic earnings per share is
arrived at 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 arrived at by dividing net income by the
weighted-average number of shares outstanding, adjusted for the dilutive effect
of stock options. Financial statements for the earlier periods have been
reclassified for comparative purposes.
PENDING ACCOUNTING CHANGES
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income ("Statement 130"). Statement 130
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general
purpose financial statements. 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. Statement 130 requires 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. Statement 130 will be effective for the Company's
fiscal year beginning July 1, 1998. Reclassification of financial statements
for earlier periods provided for comparative purposes is required.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PENDING ACCOUNTING CHANGES (CONT.)
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, Disclosures about Segments of an Enterprise and Related Information
("Statement 131"). Statement 131 will be effective for the Company's fiscal
year beginning July 1, 1998. Statement 131 establishes standards for the way
public business enterprises are to report information about operating segments
in annual financial statements and requires those enterprises to report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Statement
131 supersedes FASB Statement No. 14, Financial Reporting for Segments of a
Business Enterprise ("Statement 14") but retains the requirement to report
information about major customers. It amends FASB Statement No. 94,
Consolidation of All Majority-Owned Subsidiaries, to remove the special
disclosure requirements for previously unconsolidated subsidiaries. The
adoption of Statement 131 will result in additional disclosures in the
Company's financial statements about it's business segments and product lines.
In February 1998, the FASB issued Statement of Financial Accounting Standards
No. 132, Employers' Disclosures about Pensions and Other Post-retirement
Benefits ("Statement 132"). Statement 132 will be effective for the Company's
fiscal year beginning July 1, 1998. Statement 132 amends disclosure
requirements of Statements 87, Employers' Accounting for Pensions, Statement
88, Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination of Benefits, and Statement 106, Employers'
Accounting for Post-retirement Benefits Other Than Pensions. This statement
standardizes the disclosure requirements of Statement 87 and 106 to the extent
practicable and recommends a parallel format for presenting information about
pensions and other post-retirement benefits. Statement 132 is applicable to all
entities and addresses disclosure only.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities ("Statement
133"). Statement 133 will be effective for the Company's fiscal year beginning
July 1,1999. 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 designated 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 is currently evaluating the impact of the
adoption of Statement 133 on the Company's financial statements.
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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, 1998, 1997 and 1996 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, 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
==================================
FOR THE YEAR ENDED JUNE 30, 1997 BASIC DILUTED
- -------------------------------- ---------------- ----------------
Weighted average common shares outstanding ........................ 2,885,900 2,885,900
Ungranted restricted stock ........................................ (18,462) (18,462)
Uncommitted ESOP shares ........................................... (158,292) (158,292)
Common stock equivalents due to dilutive effect of stock options .. -- 103,974
---------------- ----------------
Total weighted average common shares and equivalents outstanding .. 2,709,146 2,813,120
================ ================
Net income for period ............................................. $1,919,000 $1,919,000
Earnings per share ................................................ $0.71 $0.68
================ ================
FOR THE YEAR ENDED JUNE 30, 1996 BASIC DILUTED
- -------------------------------- ---------------- ----------------
Weighted average common shares outstanding ........................ 2,885,900 2,885,900
Ungranted restricted stock ........................................ (18,462) (18,462)
Uncommitted ESOP shares ........................................... (184,990) (184,990)
Common stock equivalents due to dilutive effect of stock options .. -- 87,694
---------------- ----------------
Total weighted average common shares and equivalents outstanding .. 2,682,448 2,770,142
================ ================
Net income for period ............................................. $1,878,000 $1,878,000
Earnings per share ................................................ $0.70 $0.68
================ ================
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform with the 1998 presentation.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. INVESTMENT 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
--------- ---------- ---------- ---------
At June 30, 1998: (IN THOUSANDS)
Available-For-Sale:
U.S. Government and federal agency obligations .. $ 5,000 $-- $ 8 $ 4,992
Adjustable-rate mortgage mutual funds ........... 1,000 -- 31 969
Trust preferred stock ........................... 2,500 -- -- 2,500
Municipal Bonds/other ........................... 435 -- -- 435
--------- ---------- ---------- ---------
$ 8,935 $-- $ 39 $ 8,896
========= ========== ========== =========
Held-To-Maturity:
Certificates of Deposit ......................... $ 388 -- -- $ 388
--------- ---------- ---------- ---------
$ 388 $-- $ -- $ 388
========= ========== ========== =========
At June 30, 1997:
Available-For-Sale:
U.S. Government and federal agency obligations .. $ 16,982 $-- $233 $16,749
Adjustable-rate mortgage mutual funds ............ 1,000 -- 23 977
Municipal Bonds .................................. 410 1 -- 411
--------- ---------- ---------- ---------
$ 18,392 $ 1 $256 $18,137
========= ========== ========== =========
Held-To-Maturity:
Certificates of Deposit ......................... $ 780 -- -- $ 780
--------- ---------- ---------- ---------
$ 780 $-- $ -- $ 780
========= ========== ========== =========
The amortized cost and estimated fair value of investment securities at June
30, 1998 by contractual maturity, are shown below.
AVAILABLE- AVAILABLE- HELD-TO- HELD-TO-
FOR-SALE FOR-SALE MATURITY MATURITY
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- --------- ----------
(IN THOUSANDS)
Due in one year or less ........................... $ -- $ -- $388 $388
Due after one year through five years ............. 5,160 5,152 -- --
Due after five years through ten years ............ 1,275 1,244 -- --
Due after ten years ............................... 2,500 2,500 -- --
---------- ---------- --------- ----------
$8,935 $8,896 $388 $388
========== ========== ========= ==========
Proceeds from the sale of securities available-for-sale were $20,881,000,
$2,268,000 and $22,158,000 during the years ended June 30, 1998, 1997 and 1996,
respectively. The gross realized losses on such sales totaled $74,000 in 1998,
$9,000 in 1997 and $27,000 in 1996. The gross realized gains on such sales
totaled $66,000 in 1998, $1,000 in 1997 and $99,000 in 1996. There were no
sales of held-to-maturity securities during 1998, 1997 and 1996.
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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, 1998:
Available-For-Sale:
Mortgage-backed securities
Adjustable-rate.................... $31,498 $ 25 $ 37 $31,486
Fixed-rate......................... 7,656 15 7 7,664
Collateralized mortgage obligations
Adjustable-rate.................... 3,769 -- -- 3,769
Fixed-rate......................... 14,631 7 8 14,630
--------- ---------- ---------- ---------
$57,554 $ 47 $ 52 $57,549
========= ========== ========== =========
Held-To-Maturity:
Mortgage-backed securities
Adjustable-rate.................... $27,674 $ 242 $ 7 $27,909
Fixed-rate......................... 3,806 45 16 3,835
Collateralized mortgage obligations:
Adjustable-rate.................... 29,536 756 157 30,135
Fixed-rate......................... 4,266 45 5 4,306
--------- ---------- ---------- ---------
$65,282 $1,088 $185 $66,185
========= ========== ========== =========
At June 30, 1997:
Available-For-Sale:
Fixed-rate mortgage-backed securities. $ 3,697 $ 57 $ 59 $ 3,695
Fixed-rate collateralized
mortgage obligations.............. 7,799 - 113 7,686
--------- ---------- ---------- ---------
$11,496 $ 57 $172 $11,381
========= ========== ========== =========
Held-To-Maturity:
Mortgage-backed securities
Adjustable-rate.................... $41,033 $ 365 $ 70 $41,328
Fixed-rate......................... 5,027 51 73 5,005
Collateralized mortgage obligations:
Adjustable-rate.................... 31,009 646 211 31,444
Fixed-rate......................... 8,361 43 32 8,372
--------- ---------- ---------- ---------
$85,430 $1,105 $386 $86,149
========= ========== ========== =========
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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, 1998:
Federal Home Loan Mortgage Corporation (FHLMC)... $ 19,593 $ 541 $ 7 $ 20,127
Federal National Mortgage Association (FNMA)..... 30,700 462 147 31,015
Government National Mortgage Association (GNMA).. 720 38 - 758
Private issuers.................................. 71,823 94 83 71,834
--------- ---------- ---------- ---------
$ 122,836 $ 1,135 $ 237 $ 123,734
========= ========== ========== =========
At June 30, 1997:
FHLMC............................................ $ 24,324 $ 521 $ 70 $ 24,775
FNMA............................................. 31,313 471 259 31,525
GNMA............................................. 934 45 - 979
Private issuers.................................. 40,355 126 230 40,251
--------- ---------- ---------- ---------
$ 96,926 $ 1,163 $ 559 $ 97,530
========= ========== ========== =========
Proceeds from the sale of mortgage-backed and related securities
held-to-maturity were $435,000 during the year ended June 30, 1997. Gross
realized gains from such sales totaled $15,000 for the year ended June 30,
1997. There were no such sales for the years ended June 30, 1998 and 1996.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS RECEIVABLE
Loans receivable are summarized as follows:
AT JUNE 30,
-------------------------
1998 1997
--------- --------
(IN THOUSANDS)
Real estate mortgage loans:
Residential one-to-four family .................................. $155,082 $167,511
Residential multi-family ........................................ 33,513 27,616
Commercial real estate .......................................... 34,610 21,693
Home equity ..................................................... 25,079 25,297
Residential construction ........................................ 6,838 27,003
Other construction and land ..................................... 13,874 7,385
-------- --------
Total real estate mortgage loans ............................. 268,996 276,505
Consumer and other loans:
Automobile ...................................................... 755 1,195
Credit card ..................................................... 2,777 2,730
Other ........................................................... 1,476 1,950
-------- --------
Total consumer and other loans ............................... 5,008 5,875
Commercial loans .................................................. 14,646 3,471
-------- --------
Gross loans .................................................. 288,650 285,851
Accrued interest receivable ....................................... 1,764 1,694
Less:
Undisbursed portion of loan proceeds ............................ (6,848) (11,998)
Deferred loan fees .............................................. (319) (197)
Unearned interest ............................................... (29) (32)
Allowances for loan losses ...................................... (2,329) (1,762)
-------- --------
$280,889 $273,556
======== ========
Activity in the allowance for loan losses is summarized as follows:
FOR THE YEARS ENDED
JUNE 30,
------------------------------
1998 1997 1996
------ -------------- ------
(IN THOUSANDS)
Balance at beginning of year .. $1,762 $1,234 $ 953
Provisions charged to income .. 800 650 367
Charge-offs ................... (264) (128) (103)
Recoveries .................... 31 6 17
------ -------------- ------
Balance at end of year ........ $2,329 $1,762 $1,234
====== ============== ======
Non-accrual loans for which interest is recognized only when received, totaled
approximately $1,314,000 and $575,000 at June 30, 1998 and 1997, respectively.
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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 $1,400,000, $623,000 and
$107,000 at June 30, 1998, 1997 and 1996, respectively. The effect of
non-performing loans on interest income is as follows:
FOR THE YEARS ENDED JUNE 30,
--------------------------------------
1998 1997 1996
---------- -------------- ----------
(In thousands)
Interest at original contract rate $178 $34 $12
Interest collected................ 93 9 1
---------- -------------- ----------
Net reduction of interest income.. $ 85 $25 $11
========== ============== ==========
Loans serviced for investors were $25,702,000 and $29,998,000 at June 30, 1998
and 1997, respectively. Custodial escrow balances maintained in connection with
the foregoing serviced loans were $683,000 and $819,000 at June 30, 1998 and
1997, respectively. These 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, 1998 and 1997. Changes in capitalized mortgage servicing
rights is summarized as follows:
YEARS ENDING JUNE 30,
------------------------
1998 1997
----------- -----------
(DOLLAR IN THOUSANDS)
Balance beginning of year ................ $74 -
Originated servicing rights capitalized .. 57 $74
Amortization of servicing rights ......... (37) -
----------- -----------
Balance end of year ...................... $94 $74
=========== ===========
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.
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable on investments is summarized as follows:
AT JUNE 30,
---------------------
1998 1997
--------- ---------
(IN THOUSANDS)
Interest-bearing deposits.......................... $ 4 $ 4
Investment securities.............................. 262 445
Mortgage-backed and related securities............. 733 585
---- ------
$999 $1,034
==== ======
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows:
AT JUNE 30,
----------------------------------
1998 1997
----------------------------------
(IN THOUSANDS)
Land ..................................................... $1,572 $ 624
Office buildings and improvements ........................ 4,348 2,726
Furniture and equipment .................................. 1,939 1,665
-------- --------
7,859 5,015
Less:
Accumulated depreciation ................................. 2,206 1,924
-------- --------
$5,653 $3,091
======== ========
7. DEPOSITS
Deposits are summarized as follows:
AT JUNE 30,
------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------
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 ............. $7,738 2.85% --% $7,105 2.52% --%
NOW .............................. 2,701 0.99 1.75 2,594 0.92 1.75
Money market ..................... 27,995 10.31 5.10 20,730 7.37 5.20
Passbook ......................... 21,158 7.79 2.93 21,952 7.80 2.98
---------- ---------- ----------- ----------
Total ........................... 59,592 21.94 3.52 52,381 18.61 3.39
CERTIFICATES OF DEPOSIT:
One to 12 months ................. $68,050 25.09 5.79 $26,992 9.59 5.56
12 to 24 months .................. 14,290 5.26 5.77 32,642 11.60 5.86
24 to 36 months .................. 2,662 0.98 5.83 26,037 9.25 6.05
36 to 60 months .................. 2,685 0.99 6.02 2,317 0.82 5.87
60 and greater ................... -- 0.00 122 0.04 8.00
Wholesale ........................ 124,340 45.74 6.07 141,021 50.09 6.15
---------- ---------- ----------- ----------
Total ........................... 212,027 78.06 5.95 229,131 81.39 6.02
---------- ---------- ----------- ----------
Total deposits .................... $271,619 100.00% 5.42% $281,512 100.00% 5.54%
========== ========== =========== ==========
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $56,049,000 and $50,751,000 at June 30, 1998 and
1997, respectively, which also includes brokered accounts. The average maturity
of wholesale certificates of deposit was eight months and eleven months at June
30, 1998 and 1997, respectively.
-88-
91
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEPOSITS (CONTINUED)
Aggregate annual maturities of certificate accounts at June 30, 1998 are as
follows:
MATURES DURING
YEAR ENDED
JUNE 30 AMOUNT
-------------- ------
(IN THOUSANDS)
1999 $165,038
2000 38,819
2001 5,485
2002 2,685
Thereafter --
--------
$212,027
========
Interest expense on deposits consists of the following:
FOR THE YEARS ENDED JUNE 30,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS)
NOW accounts......... $ 45 $ 41 $ 42
Money market accounts 1,319 804 297
Passbook accounts.... 625 691 734
Certificate accounts. 12,967 12,357 9,072
------- ------- -------
$14,956 $13,893 $10,145
======= ======= =======
-89-
92
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, 1998 AT JUNE 30, 1997
---------------------- ------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
MATURITY AMOUNT RATE AMOUNT RATE
-------- ------- ---- ------ ----
(DOLLARS IN THOUSANDS)
Advances from
Federal Home Loan Bank 1997 $ -- -- $7,000 5.44%
1998 8,000 5.41% 26,000 5.60
1999 21,000 6.62 21,000 6.63
2000 22,007 6.24 17,012 6.24
2001 3,000 5.91 3,000 5.91
2002 28,500 5.61 15,000 5.95
2003 3,052 5.60 3,061 5.60
2004 5,000 6.32 -- --
2007 6,500 6.52 -- --
2008 20,000 4.95 -- --
-------- -------
$117,059 5.87% $92,073 6.01%
======== ==== ======= ====
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. At June 30, 1998, the Bank
had delivered mortgage-backed securities with a carrying value of $30.7 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 $3.0 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. At June 30, 1998 and
1997, there were no liabilities recorded under agreements to repurchase
identical securities or substantially identical securities.
Securities sold under agreements to repurchase averaged $3,716,000 for the year
ended June 30, 1997. The average is computed using month-end balances for the
respective fiscal years. The maximum outstanding at any month-end during the
year ended June 30, 1997 was $11,652,000. There were no securities sold under
agreements to repurchase for the year ended June 30, 1998. The Company retains
securities under its control.
Accrued interest expense on FHLB advances and other borrowings was $563,000 and
$0; and $497,000 and $0 at June 30, 1998 and 1997, respectively.
Interest expense on FHLB advances and other borrowings was $6,546,000 and $0;
$6,003,000 and $221,000; and $4,386,000 and $732,000 for the years ended June
30, 1998, 1997 and 1996, respectively.
-90-
93
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
As of June 30, 1998, the Bank is well capitalized as defined by regulatory
standards. 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, 1998:
Tier I Capital Leverage (to Average Assets):
Consolidated ......................... $33,252 7.81% $12,777 3.00% $21,295 5.00%
West Allis Savings Bank .............. 29,888 7.05 12,725 3.00 21,209 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated ......................... 33,252 13.03 10,207 4.00 15,310 6.00
West Allis Savings Bank .............. 29,888 11.75 10,173 4.00 15,260 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated ......................... 35,581 13.94 20,414 8.00 25,517 10.00
West Allis Savings Bank .............. 32,217 12.67 20,347 8.00 25,433 10.00
As of June 30, 1997:
Tier I Capital Leverage (to Average Assets):
Consolidated ......................... $29,883 7.24% $12,390 3.00% $20,650 5.00%
West Allis Savings Bank .............. 26,664 6.47 12,362 3.00 20,603 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated ......................... 29,883 12.59 9,490 4.00 14,236 6.00
West Allis Savings Bank .............. 26,664 11.24 9,487 4.00 14,231 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated ......................... 31,645 13.34 18,981 8.00 23,726 10.00
West Allis Savings Bank .............. 28,426 11.98 18,974 8.00 23,718 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, 1998, on a
fully-phased-in basis of 6.0%, the Bank had actual capital of $32,198,000 with a
required amount of $26,483,000, for excess capital of $5,715,000.
-91-
94
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. SHAREHOLDERS' EQUITY (CONTINUED)
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 for
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.
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 $14,000,
$13,000 and $12,000 during 1998, 1997 and 1996, 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,
1998, 1997 and 1996 totaled $362,000, $236,000 and $226,000, 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 $1.8 million
at June 30, 1998.
The Bank has Management Recognition and Retention Plans ("MRPs") for officers
and directors. As of June 30, 1998, 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. Compensation expense of $84,000, $126,000 and
$168,000 was recognized for the years ended June 30, 1998, 1997 and 1996.
-92-
95
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. EMPLOYEE BENEFIT PLANS (CONTINUED)
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 the Black-Scholes option pricing model. The per
share weighted-average fair value of stock options granted during fiscal 1998
and 1997 was $1.81 and $2.33, respectively, on the date of grant with the
following variable assumptions: 1998 - The Company did not pay a dividend in
fiscal 1998. Risk-free interest rate of 5.6%, an expected life of ten years and
expected volatility of 32.7%; 1997: The Company did not pay a dividend in fiscal
year 1997. Risk-free interest rate of 7.0%, an expected life of ten years and
expected volatility of 24.9%.
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 its stock options in the consolidated financial statements
for the fiscal years ended June 30, 1998,1997 and 1996.
Had compensation cost of the Company's stock-based plans been determined in
accordance with SFAS No. 123, net income would have been $2,788,000, $1,914,000
and $1,876,000 for fiscal 1998, 1997 and 1996, respectively. Diluted earnings
per share would have been $.97, $.68 and $.68, respectively for fiscal 1998,
1997 and 1996.
The Company has reserved 436,936 shares of common stock for a 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.
The followings is a summary of stock option activity:
SHARES OPTION
UNDER PRICE PER
OPTION SHARE
------ -----
Outstanding and exercisable at June 30, 1995 ........ 314,614 $4.00 - $5.50
Granted ............................................ 16,000 $7.25 - $7.63
-------- --------------
Outstanding and exercisable at June 30, 1996 ........ 330,614 $4.00 - $7.63
Granted ............................................ 16,000 $7.38
-------- --------------
Outstanding and exercisable at June 30, 1997 ........ 346,614 $4.00 - $7.63
Granted ............................................ 30,000 $14.63
Exercised .......................................... (55,340) $4.00
-------- --------------
Outstanding and exercisable at June 30, 1998 ........ 321,274 $4.00 - $14.63
-93-
96
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
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. 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.
Financial instruments whose contract amounts represent a potential credit risk
are as follows:
FOR THE YEARS ENDED
JUNE 30,
----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
Commitments to extend credit:
Fixed-rate mortgage loans (6.875% - 8.625% at June 30, 1998) .. $3,480 $1,192
Adjustable rate mortgage loans ................................ 570 4,207
Unused lines of credit:
Credit cards .................................................. 8,331 6,753
Home equity ................................................... 13,641 14,630
Commercial .................................................... 3,174 1,542
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.
-94-
97
HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. PARENT COMPANY ONLY FINANCIAL INFORMATION
AT JUNE 30,
--------------------
1998 1997
------- -------
(IN THOUSANDS)
STATEMENT OF CONDITION
Assets:
Cash and cash equivalents ................. $ 850 $ 2,135
Investment securities available-for-sale .. 1,909 411
Investment in subsidiary .................. 30,696 27,161
Other assets .............................. 60 27
------- -------
$33,515 $29,734
======= =======
Liabilities and Shareholders' Equity:
Other liabilities ......................... $ 62 $ 62
Total shareholders' equity ................ 33,453 29,672
------- -------
$33,515 $29,734
======= =======
FOR THE YEARS ENDED JUNE 30,
----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
STATEMENT OF INCOME
Interest and dividend income ......................... $ 177 $ 191 $ 389
Equity in undistributed net income of subsidiary ..... 2,764 1,880 1,721
------- ------- -------
Total income ...................................... 2,941 2,071 2,110
Other expense ........................................ 130 159 131
------- ------- -------
Income before provision for income taxes ............. 2,811 1,912 1,979
Provision for income taxes ........................... 12 (7) 101
------- ------- -------
Net income ........................................ $ 2,799 $ 1,919 $ 1,878
======= ======= =======
STATEMENT OF CASH FLOWS
Operating activities:
Net income .......................................... $ 2,799 $ 1,919 $ 1,878
Adjustments to reconcile net income
to net cash used in operating activities:
Equity in undistributed net income of subsidiary .. (2,764) (1,880) (1,721)
Decrease (increase) in other assets ............... (33) 25 29
Increase (decrease) in other liabilities .......... -- 45 (89)
Other ............................................. (119) 102 94
------- ------- -------
Net Cash Provided By (Used In) Operating Activities . (117) 211 191
Investment activities
Sale of investment securities ....................... -- 2,308 500
Purchase of investment securities ................... (1,498) (1,219) --
Investment in Bank subsidiary ....................... -- (2,000) (2,500)
------- ------- -------
Net Cash Used In Investing Activities ............... (1,498) (911) (2,000)
Financing activities:
Stock option transactions .......................... 330 -- --
------- ------- -------
Net Cash Provided by Financing Activities ........... 330 -- --
------- ------- -------
Net decrease in cash and cash equivalents ............ (1,285) (700) (1,809)
Cash and cash equivalents at beginning of year ....... 2,135 2,835 4,644
------- ------- -------
Cash and cash equivalents at end of year ............ $ 850 $ 2,135 $ 2,835
======= ======= =======
-95-
98
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.
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.
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.
-96-
99
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,
----------------------------------------
1998 1997
------------------- -------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- --------- -------- ---------
(In thousands)
Cash and cash equivalents ................. $ 8,184 $ 8,184 $ 8,755 $ 8,755
Investment securities available-for-sale .. 8,896 8,896 18,137 18,137
Investment securities held-to-maturity .... 388 388 780 780
Mortgage-backed and related
securities available-for-sale ............ 57,549 57,549 11,381 11,381
Mortgage-backed and related
securities held-to-maturity .............. 65,282 66,185 85,430 86,149
Federal Home Loan Bank stock .............. 5,932 5,932 5,279 5,279
Loans receivable:
Real estate (including home equity) ...... 260,127 262,045 262,787 265,756
Credit card and other consumer ........... 4,838 4,838 5,714 5,714
Commercial ............................... 14,189 14,189 3,393 3,393
-------- -------- -------- --------
$279,154 $281,072 $271,894 $274,863
======== ======== ======== ========
Accrued interest receivable ............... $ 2,763 $ 2,763 $ 2,728 $ 2,728
Deposits:
NOW ...................................... 10,439 10,439 9,699 9,699
Money market ............................. 27,995 27,995 20,730 20,730
Passbooks ................................ 21,158 21,158 21,952 21,952
Certificates ............................. 212,027 212,740 229,131 229,533
-------- -------- -------- --------
$271,619 $272,332 $281,512 $281,914
======== ======== ======== ========
Borrowings:
Federal Home Loan Bank advances .......... $117,059 $117,370 $ 92,073 $ 91,560
Accrued interest payable .................. $ 1,455 $ 1,455 $ 1,578 $ 1,578
-97-
100
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, 1998:
Federal............................................... $ 1,551 ($250) $ 1,301
State................................................. 140 (38) 102
------- ----- -------
$ 1,691 ($288) $ 1,403
======= ===== =======
Year ended June 30, 1997:
Federal...............................................
State................................................. $ 1,117 ($149) $ 968
80 (22) 58
------- ----- -------
$ 1,197 ($171) $ 1,026
======= ===== =======
Year ended June 30, 1996:
Federal............................................... $ 966 ($ 21) $ 945
State................................................. 69 (5) 64
------- ----- -------
$ 1,035 ($ 26) $ 1,009
======= ===== =======
Income tax expense attributable to income from operations was $1,403,000,
$1,026,000 and $1,009,000 for the years ended June 30, 1998, 1997 and 1996,
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,
-------------------------
1998 1997 1996
------- ------- -------
(In thousands)
Computed "expected" tax expense........................ $1,429 $1,001 $ 982
State income taxes, net of
federal income tax benefit........................... 67 38 42
Change in valuation allowance.......................... -- -- (8)
Utilization of Low Income Housing Credits.............. (29) (16) --
Net increase in the cash surrender value
of life insurance.................................... (15) (14) (14)
Other, net............................................. (49) 17 7
------ ------ ------
$1,403 $1,026 $1,009
====== ====== ======
-98-
101
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,
---------------------
1998 1997
------ ------
(IN THOUSANDS)
Deferred Tax Assets:
Deferred compensation.................. $ 217 $ 168
Allowances for loan losses............. 863 628
Deferred loan fees..................... 30 --
Unrealized depreciation on securities
available for sale.................... 15 146
Amortization of stock benefit plans.... -- 16
Other, net............................. 25 24
----- -----
Gross deferred tax assets............... 1,150 982
Deferred Tax Liabilities:
Deferred loan fees..................... -- 73
Depreciation........................... 146 93
Mortgage servicing rights.............. 37 29
Other.................................. 112 90
----- -----
Gross deferred tax liabilities......... 295 285
----- -----
Net deferred tax assets................ $ 855 $ 697
----- -----
The 1998 net deferred tax asset increased by $158,000. 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 1998 and
1997.
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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,
1998 1998 1997 1997 1997 1997 1996 1996
------ ------ ------ ------- ------ ------ ------ -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest and dividend income........ $8,118 $7,943 $8,162 $ 8,004 $7,844 $7,580 $7,334 $ 7,065
Interest expense.................... 5,408 5,259 5,485 5,434 5,323 5,110 4,996 4,781
------ ------- ------ ------- ------ ------ ------ -------
Net interest income................. 2,710 2,684 2,677 2,570 2,521 2,470 2,338 2,284
Provision for loan losses........... 160 200 240 200 146 150 170 184
------ ------- ------ ------- ------ ------ ------ -------
Net interest income after
provision for loan losses.......... 2,550 2,484 2,437 2,370 2,375 2,320 2,168 2,100
Gain (loss) on sales of investments
and mortgage-backed and
related securities................. -- -- 9 (17) -- -- -- 7
Gain on sale of loans held for sale,
net................................ 160 114 2 21 81 1 5 8
Other non-interest income........... 247 251 225 196 233 236 234 223
------ ------- ------ ------- ------ ------ ------ -------
Total non-interest income........... 407 365 236 200 314 237 239 238
Total non-interest expense.......... 1,880 1,811 1,576 1,580 1,564 1,543 1,513 2,426
------ ------- ------ ------- ------ ------ ------ -------
Income (loss) before income taxes... 1,077 1,038 1,097 990 1,125 1,014 894 (88)
Income tax expense (benefit)........ 316 359 383 345 387 349 321 (31)
------ ------- ------ ------- ------ ------ ------ -------
Net income (loss)................... $ 761 $ 679 $ 714 $ 645 $ 738 $ 665 $ 573 $ (57)
====== ======= ====== ======= ====== ====== ====== =======
Earnings (loss) per share (basic)... $ 0.27 $ 0.24 $ 0.26 $ 0.24 $ 0.27 $ 0.25 $ 0.21 $ (0.02)
Earnings (loss) per share (diluted). $ 0.26 $ 0.23 $ 0.25 $ 0.23 $ 0.26 $ 0.24 $ 0.20 $ (0.02)
Market Information
Trading range - high............... 16.75 17.50 19.00 13.25 11.25 9.69 8.88 8.75
low....................... 14.00 14.75 13.00 10.50 8.75 8.50 8.38 7.25
close..................... 14.00 15.50 17.00 12.88 10.69 9.00 8.88 8.38
No dividends were declared on the shares of Common Stock during the fiscal years
ended June 30, 1998 and 1997.
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103
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 25, 1998, relating to the 1998 Annual Meeting of
Shareholders currently scheduled for October 29, 1998, which has been filed
separately with the Securities and Exchange Commission pursuant to Rule 14a-6
under the Securities Exchange Act of 1934, as amended and in accordance with
General Instruction G(3) to Form 10-K, not later than 120 days after the end of
the Company's fiscal year, and 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 25, 1998, relating to the 1998 Annual Meeting of
Shareholders currently scheduled for October 29, 1998, which has been filed
separately with the Securities and Exchange Commission pursuant to Rule 14a-6
under the Securities Exchange Act of 1934, as amended and in accordance with
General Instruction G(3) to Form 10-K, not later than 120 days after the end of
the Company's fiscal year, and 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 25, 1998, relating to the 1998 Annual Meeting of
Shareholders currently scheduled for October 29, 1998, which has been filed
separately with the Securities and Exchange Commission pursuant to Rule 14a-6
under the Securities Exchange Act of 1934, as amended and in accordance with
General Instruction G(3) to Form 10-K, not later than 120 days after the end of
the Company's fiscal year, and 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 25, 1998, relating to the 1998 Annual
Meeting of Shareholders currently scheduled for October 29, 1998, which has been
filed separately with the Securities and Exchange Commission pursuant to Rule
14a-6 under the Securities Exchange Act of 1934, as amended and in accordance
with General Instruction G(3) to Form 10-K, not later than 120 days after the
end of the Company's fiscal year, and which section is hereby incorporated
herein by reference.
-101-
104
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, 1998 and 1997
Consolidated Statements of Income for Years Ended June 30, 1998, 1997 and
1996
Consolidated Statements of Shareholders' Equity for Years Ended June 30,
1998, 1997 and 1996
Consolidated Statements of Cash Flows for Years Ended June 30, 1998, 1997
and 1996
Notes to Consolidated Financial Statements
-102-
105
(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
3.2 Amended By-laws of Registrant
3.3 Stock Charter of West Allis Savings Bank
3.4 By-laws of West Allis Savings Bank
10.1 West Allis Savings Bank 401(k) Savings Plan
10.2 West Allis Savings Bank Employee Stock Ownership Plan
10.3 Credit Agreement by and between West Allis Savings Bank,
Employee Stock Ownership Trust and Company
10.4 West Allis Savings Bank Management Recognition and Retention Plan
10.5 Hallmark Capital Corp. 1993 Incentive Stock Option Plan, as amended
10.6 Hallmark Capital Corp. 1993 Stock Option Plan for Outside Directors, as amended
10.7 Employment Agreement - James D. Smessaert
10.8 Employment Agreement - Peter A. Gilbert
10.9 Employment Agreement - Arthur E. Thompson
10.1 Executive Employee Salary Continuation Agreement - James D. Smessaert
11.1 Statement regarding computation of per share earnings See Footnote (1) in Part II Item 8
13.1 1998 President's Message (attached) Included herewith
21.1 Subsidiaries of the Registrant See "Subsidiaries" in Part I Item 1
23.1 Consent of KPMG Peat Marwick, LLP Attached
24.1 Powers of Attorney for certain officers and directors
27.0 Financial Data Schedule
99.1 Appraisal Agreement with J.G. Cornwell and Co.
99.2 Appraisal Report of J.G. Cornwell and Co.
99.3 Stock Order Form for Subscription and Community Offerings
99.4 Proxy Statement for Special Meeting of Members of West Allis Savings Bank
99.5 Marketing Materials
99.6 Proxy Statement for 1998 Annual Meeting of Shareholders Attached
- ------------------
A copy of the exhibits listed herein can be obtained by writing to Arthur E.
Thompson, Chief Financial Officer, Hallmark Capital Corp., 5555 N. Port
Washington Road, Glendale, Wisconsin 53217.
(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).
-103-
106
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 16, 1998
------------------------------
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/ Floyd D. Brink /s/ Peter A. Gilbert
- ---------------------------------------- ------------------------------------------------
Floyd D. Brink, Director Peter A. Gilbert, Executive Vice President,
Corporate Secretary and Director
Date: September 16, 1998 Date: September 16, 1998
---------------------------- ----------------------------------
/s/ Reginald M. Hislop, III /s/ Charles E. Rickheim
- ---------------------------------------- ------------------------------------------------
Reginald M. Hislop, III, Director Charles E. Rickheim, Director
Date: September 16, 1998 Date: September 16, 1998
---------------------------- ----------------------------------
/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 16, 1998 Date: September 16, 1998
---------------------------- ----------------------------------
/s/ Donald A. Zellmer
- ----------------------------------------
Donald A. Zellmer, Director
Date: September 16, 1998
----------------------------
-104-
107
EXHIBIT INDEX
-------------
Exhibit No. Description
- ---------- -----------
27 Financial Data Schedule, which is submitted electronically
to the Securities and Exchange Commission for information
only and not filed.