1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended December 31, 1998 Commission File Number 0-22224
- --------------------------------------------------------------------------------
HALLMARK CAPITAL CORP.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1762467
(State of Incorporation) (I.R.S. Employer Identification No.)
7401 West Greenfield Avenue
West Allis, Wisconsin 53214
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (414) 317-7100
Indicate by check mark whether the registrant (1) has filed all reports
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 filing requirements for the past 90 days.
(1) Yes [X] No [ ]
(2) Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock, par value $1.00
per share, was 2,880,332 at February 11, 1999, the latest practicable date.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
FORM 10-Q
Part I. Financial Information
Item 1. Financial Statements (unaudited):
Consolidated Statements of Financial Condition
as of December 31, 1998 (unaudited) and June 30, 1998................................ 1
Consolidated Statements of Income for the Three and Six Months
ended December 31, 1998 and 1997 (unaudited)......................................... 2
Consolidated Statements of Shareholders' Equity for the Six
Months Ended December 31, 1998 and 1997 (unaudited)..................................... 3
Consolidated Statements of Cash Flows for the Six Months
ended December 31, 1998 and 1997 (unaudited)......................................... 4
Notes to Consolidated Financial Statements (unaudited).................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................ 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk............................... 29
Part II. Other Information
Item 1. Legal Proceedings....................................................................... 30
Item 2. Changes in Securities and Use of Proceeds............................................... 30
Item 3. Defaults Upon Senior Securities......................................................... 30
Item 4. Submission of Matters to a Vote of Security Holders..................................... 30
Item 5. Other Information....................................................................... 30
Item 6. Exhibits and Reports on Form 8-K........................................................ 31
Signature Page.......................................................................... 32
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands)
DECEMBER 31, JUNE 30,
1998 1998
-------------- -----------
ASSETS (Unaudited)
Cash and non-interest bearing deposits ......................... $ 1,528 $ 1,998
Interest-bearing deposits ...................................... 12,573 6,186
--------- ---------
Cash and cash equivalents ...................................... 14,101 8,184
Securities available-for-sale (at fair value):
Investment securities ........................................ 24,355 8,896
Mortgage-backed and related securities ....................... 81,320 57,549
Securities held-to-maturity:
Investment securities (fair value - $388 at June 30, 1998) ... -- 388
Mortgage-backed and related securities (fair value -
$56,221 at December 31, 1998; $66,185 at June 30, 1998) .... 55,665 65,282
Loans receivable, net .......................................... 286,390 280,889
Loans held for sale, at lower of cost or market ................ 2,849 2,056
Investment in Federal Home Loan Bank stock, at cost ............ 6,681 5,932
Foreclosed properties, net ..................................... 11 11
Office properties and equipment ................................ 5,783 5,653
Prepaid expenses and other assets .............................. 4,326 3,534
--------- ---------
Total assets ......................................... $ 481,481 $ 438,374
========= =========
LIABILITIES AND SHaREHOLDERS' EQUITY
Liabilities:
Deposits ..................................................... $ 304,464 $ 271,619
Notes payable to Federal Home Loan Bank ...................... 130,059 117,059
Securities sold under agreements to repurchase ............... 4,875 --
Payable for investments purchased ............................ 3,585 9,858
Advance payments by borrowers for taxes and insurance ........ 166 3,163
Accrued interest on deposit accounts and other borrowings .... 1,776 1,455
Accrued expenses and other liabilities ....................... 2,090 1,767
--------- ---------
Total liabilities .................................... $ 447,015 $ 404,921
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 2,880,332 shares at
December 31, 1998 and 2,933,608 shares at June 30, 1998 .... 3,162 3,162
Additional paid-in capital ................................... 9,694 9,512
Unearned ESOP compensation ................................... (478) (532)
Unearned restricted stock award .............................. (82) (124)
Net unrealized depreciation on securities available for sale . (5) (27)
Treasury stock, at cost: 282,168 shares at December 31, 1998
and 228,892 shares at June 30, 1998 ........................ (2,144) (1,385)
Retained earnings, substantially restricted .................. 24,319 22,947
--------- ---------
Total shareholders' equity ........................... $ 34,466 $ 33,453
--------- ---------
Total liabilities and shareholders' equity ........... $ 481,481 $ 438,374
========= =========
See accompanying Notes to Consolidated Financial Statements
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except for per share data)
(Unaudited)
Three Months Ended Six Months Ended
December 31, December 31,
-------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
INTEREST INCOME:
Loans receivable ...................................... $ 5,970 $ 6,034 $ 11,871 $ 11,893
Mortgage-backed and related securities ................ 2,112 1,571 4,179 3,204
Securities and interest-bearing deposits .............. 803 557 1,195 1,069
-------- -------- -------- --------
Total interest income ....................... 8,885 8,162 17,245 16,166
INTEREST EXPENSE:
Deposits .............................................. 4,018 3,757 7,716 7,662
Advance payments by borrowers for taxes and insurance . 29 32 55 61
Notes payable and other borrowings .................... 1,937 1,696 3,776 3,196
-------- -------- -------- --------
Total interest expense ...................... 5,984 5,485 11,547 10,919
-------- -------- -------- --------
Net interest income ................................... 2,901 2,677 5,698 5,247
Provision for losses on loans ......................... 210 240 340 440
-------- -------- -------- --------
Net interest income after provision for losses on loans 2,691 2,437 5,358 4,807
NON-INTEREST INCOME:
Service charges on loans .............................. 57 90 135 135
Service charges on deposit accounts ................... 121 109 234 223
Loan servicing fees, net .............................. (1) 19 13 40
Insurance commissions ................................. 10 4 29 8
Gain on sale of securities and
mortgage-backed and related securities, net ....... 35 9 35 (8)
Gain on sale of loans ................................. 438 2 652 23
Other income .......................................... 46 3 88 15
-------- -------- -------- --------
Total non-interest income ................... 706 236 1,186 436
NON-INTEREST EXPENSE:
Compensation and benefits ............................. 1,283 929 2,522 1,886
Marketing ............................................. 98 103 164 154
Occupancy and equipment ............................... 384 252 793 495
Deposit insurance premiums ............................ 40 45 82 88
Other non-interest expense ............................ 386 247 704 533
-------- -------- -------- --------
Total non-interest expense .................. 2,191 1,576 4,265 3,156
-------- -------- -------- --------
Income before income taxes ............................ 1,206 1,097 2,279 2,087
Income taxes .......................................... 417 383 772 728
-------- -------- -------- --------
Net income ....................................... $ 789 $ 714 $ 1,507 $ 1,359
======== ======== ======== ========
Earnings per share - (basic) ..................... $ 0.28 $ 0.26 $ 0.54 $ 0.50
======== ======== ======== ========
Earnings per share - (diluted) ................... $ 0.27 $ 0.25 $ 0.52 $ 0.48
======== ======== ======== ========
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
Additional Unearned Unearned Unrealized
Common Paid-In ESOP Restricted Gains Treasury Retained
Stock Capital Compensation Stock (Losses) Stock Earnings
----- ------- ------------ ----- -------- ----- --------
SIX MONTHS ENDED DECEMBER 31, 1998
Balance at June 30, 1998 ...................... $ 3,162 $ 9,512 ($532) ($124) ($27) ($ 1,385) $ 22,847
Net income .................................... -- -- -- -- -- -- 1,507
Amortization of unearned ESOP and
restricted stock award compensation ......... -- 138 54 42 -- -- --
Purchase of treasury stock (66,900 shares) .... -- -- -- -- -- (855) --
Exercise of stock options (13,624 shares) ..... -- 44 -- -- -- 96 (35)
Realized gain on sale of securities
available-for-sale .......................... -- -- -- -- (35) -- --
Related tax benefit on sale of securities
available-for-sale .......................... -- -- -- -- 14 -- --
Unrealized appreciation on securities
available for sale, net of tax benefit ...... -- -- -- -- 43 -- --
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1998 .................. $ 3,162 $ 9,694 ($478) ($82) ($5) ($ 2,144) $ 24,319
======== ======== ======== ======== ======== ======== ========
THREE MONTHS ENDED DECEMBER 31, 1997
Balance at June 30, 1997 ...................... $ 3,162 $ 9,022 ($ 632) ($ 208) ($ 225) ($ 1,592) $ 20,145
Net income .................................... -- -- -- -- -- -- 1,359
Amortization of unearned ESOP and
restricted stock award compensation ......... -- 120 54 42 -- -- --
Exercise of stock options (47,708 shares issued
In connection with 55,340 options issued) ... -- -- -- -- -- 207 (96)
Realized loss on sale of securities
available-for-sale .......................... -- -- -- -- 8 -- --
Related tax benefit on sale of securities
available-for-sale .......................... -- -- -- -- (3) -- --
Unrealized appreciation on securities
available for sale, net of tax benefit ...... -- -- -- -- 162 -- --
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997 .................. $ 3,162 $ 9,142 ($ 578) ($ 166) ($ 58) ($ 1,385) $ 21,408
======== ======== ======== ======== ======== ======== ========
Total Other
Shareholders' Comprehensive
Equity Income
------ ------
SIX MONTHS ENDED DECEMBER 31, 1998
Balance at June 30, 1998 ...................... $ 33,453 $ --
Net income .................................... 1,507 1,507
Amortization of unearned ESOP and
restricted stock award compensation ......... 234 --
Purchase of treasury stock (66,900 shares) .... (855) --
Exercise of stock options (13,624 shares) ..... 105 --
Realized gain on sale of securities
available-for-sale .......................... (35) (35)
Related tax benefit on sale of securities
available-for-sale .......................... 14 14
Unrealized appreciation on securities
available for sale, net of tax benefit ...... 43 43
-------- --------
Balance at December 31, 1998 .................. $ 34,466 $ 1,529
======== ========
THREE MONTHS ENDED DECEMBER 31, 1997
Balance at June 30, 1997 ...................... $ 29,672 $ --
Net income .................................... 1,359 1,359
Amortization of unearned ESOP and
restricted stock award compensation ......... 216 --
Exercise of stock options (47,708 shares issued
In connection with 55,340 options issued) ... 111 --
Realized loss on sale of securities
available-for-sale .......................... 8 8
Related tax benefit on sale of securities
available-for-sale .......................... (3) (3)
Unrealized appreciation on securities
available for sale, net of tax benefit ...... 162 162
-------- --------
Balance at December 31, 1997 .................. $ 31,525 $ 1,526
======== ========
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
DECEMBER 31,
--------------------------
1998 1997
----------- ------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net Income ....................................................... $ 1,507 $ 1,359
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Provision for losses on loans and real estate .................. 340 440
Provision for depreciation and amortization .................... 211 148
Net (gain) loss on sales of investments and
mortgage-backed and related securities ....................... (35) 8
Net gain on sale of loans ...................................... (652) (23)
Amortization of unearned ESOP and restricted stock awards ...... 234 216
Loans originated for sale ...................................... (36,797) (4,434)
Sales of loans originated for sale ............................. 36,004 4,434
Decrease (increase) in prepaid expenses and other assets ....... (768) 271
Decrease in payables for investments purchased ................. (6,273) --
Increase in accrued expenses and other liabilities ............. 299 21
Other adjustments .............................................. 346 (139)
-------- --------
Net cash provided by (used in) operating activities .............. (5,584) 2,301
-------- --------
INVESTING ACTIVITIES
Proceeds from the sale of securities available-for-sale .......... 5,535 18,100
Proceeds from the maturity of securities available-for-sale ...... 6,090 3,000
Purchases of securities available-for-sale ....................... (85,389) (14,867)
Proceeds from sale of investment securities held-to-maturity ..... -- --
Proceeds from maturities of investment securities held-to-maturity 572 --
Purchases of mortgage-backed and related securities .............. (8,116) (352)
Principal collected on mortgage-backed and related securities .... 52,306 10,229
Net increase in loans receivable ................................. (5,189) (13,806)
Proceeds from sales of foreclosed properties ..................... -- 273
Purchase of Federal Home Loan Bank stock ......................... (749) (730)
Purchases of office properties and equipment, net ................ (341) 2,677)
-------- --------
Net cash used in investing activities ............................ (35,472) (830)
-------- --------
FINANCING ACTIVITIES
Net increase (decrease) in deposits .............................. 32,845 (18,399)
Proceeds from long-term notes payable to Federal Home Loan Bank .. 20,000 30,000
Net increase (decrease) in short-term notes payable to
Federal Home Loan Bank ......................................... 1,000 500
Net decrease in long-term notes payable to Federal Home Loan Bank (8,000) (7,000)
Net increase in securities sold under agreements to repurchase ... 4,875 --
Exercise of stock options ........................................ 105 111
Purchase of treasury stock ....................................... (855) --
Net decrease in advance payments by borrowers for
taxes and insurance ............................................ (2,997) (3,226)
-------- --------
Net cash provided by financing activities ........................ 46,973 1,986
-------- --------
Increase in cash and cash equivalents ............................ 5,917 3,457
Cash and cash equivalents at beginning of period ................. 8,184 8,755
-------- --------
Cash and cash equivalents at end of period ....................... $ 14,101 $ 12,212
======== ========
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
DECEMBER 31,
------------------------------
1998 1996
-------------- ------------
(IN THOUSANDS)
Supplemental disclosures of cash flow information:
Interest paid (including amounts credited to deposit accounts) .............. $11,234 $11,004
Income taxes paid ........................................................... $844 $945
Non-cash transactions:
Loans transferred to foreclosed properties .................................. - $267
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles (GAAP) for interim
financial information and in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of the results for the interim
periods have been included.
The results of operations and other data for the three and six months ended
December 31, 1998 are not necessarily indicative of results that may be expected
for the entire fiscal year ending June 30, 1999.
The unaudited consolidated financial statements include the accounts of Hallmark
Capital Corp. (the "Company") and its wholly-owned subsidiary, West Allis
Savings Bank and subsidiaries (the "Bank") as of and for the three and six
months ended December 31, 1998. All material intercompany accounts and
transactions have been eliminated in consolidation.
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income, was adopted July 1, 1998. Previous periods have been reclassified for
comparative purposes. Adoption has no effect on financial condition or results
of operations.
(2) STOCK BENEFITS AND INCENTIVE PLANS
At December 31, 1998, the Company has reserved 423,312 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 following is a
summary of stock option activity for the six months ended December 31, 1998:
SHARES UNDER OPTION PRICE
OPTION PER SHARE
------ ---------
Outstanding and exercisable at June 30, 1998............................. 321,274 $4.00 - $7.625
Exercised............................................................ (13,624) $4.00 - $7.375
-------- --------------
Outstanding and exercisable at December 31, 1998......................... 307,650 $4.00 - $7.625
(3) EARNINGS PER SHARE
Basic earnings per share of common stock for the three and six months ended
December 31, 1998 have been computed by dividing net income for the period 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 earnings per share is as follows:
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(3) EARNINGS PER SHARE(CONT.)
For the Three Months For the Three Months
Ended December 31, 1998 Ended December 31, 1997
----------------------- -----------------------
Basic Diluted Basic Diluted
----- ------- ----- -------
Weighted average common shares outstanding.. 2,903,558 2,903,558 2,919,690 2,919,690
Ungranted restricted stock ................. (18,462) (18,462) (18,462) (18,462)
Uncommitted ESOP shares .................... (126,500) (126,500) (151,800) (151,800)
Common stock equivalents due to
dilutive effect of stock options ........ -- 101,616 -- 148,559
----------- ----------- ----------- -----------
Total weighted average common shares
and equivalents outstanding ........ 2,758,596 2,860,212 2,749,428 2,897,986
=========== =========== =========== ===========
Net income for period .............. $ 789,000 $ 789,000 $ 714,000 $ 714,000
Earnings per share ................. $ 0.28 $ 0.27 $ 0.26 $ 0.25
=========== =========== ============ ===========
For the Six Months For the Six Months
Ended December 31, 1998 Ended December 31, 1997
----------------------- -----------------------
Basic Diluted Basic Diluted
----- ------- ----- -------
Weighted average common shares outstanding.. 2,919,724 2,919,724 2,902,795 2,902,795
Ungranted restricted stock ................. (18,462) (18,462) (18,462) (18,462)
Uncommitted ESOP shares .................... (126,500) (126,500) (151,800) (151,800)
Common stock equivalents due to
dilutive effect of stock options ........ -- 106,303 -- 140,423
----------- ----------- ----------- -----------
Total weighted average common shares
and equivalents outstanding ............. 2,774,762 2,881,065 2,732,533 2,872,956
=========== =========== =========== ===========
Net income for period ................... $ 1,507,000 $ 1,507,000 $ 1,359,000 $ 1,359,000
Earnings per share ...................... $ 0.54 $ 0.52 $ 0.50 $ 0.48
=========== =========== =========== ===========
(4) COMMITMENTS AND CONTINGENCIES
Commitments to originate mortgage loans of $3.2 million at December 31, 1998
represent amounts which the Bank expects to fund during the quarter ending March
31, 1999. There were no commitments to sell fixed-rate mortgage loans at
December 31, 1998. The Bank had unissued credit under existing home equity
line-of-credit loans and credit card lines of $12.3 million and $8.6 million,
respectively, as of December 31, 1998. Also, the Bank had unused credit under
existing commercial line-of-credit loans of $7.1 million at December 31, 1998.
The Bank had commitments to purchase fixed-rate mortgage related securities of
$3.6 million as of December 31, 1997.
(5) REGULATORY CAPITAL ANALYSIS
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
also are 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 December 31, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
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(5) REGULATORY CAPItAL ANALYSIS (CONT.)
As of December 31, 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 December 31, 1998:
Tier I Capital Leverage (to Average Assets):
Consolidated .......................... $34,451 7.49% $14,561 3.00% $24,269 5.00%
West Allis Savings Bank ............... 30,471 6.30 14,513 3.00 24,188 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated .......................... 34,451 12.40 11,112 4.00 16,668 6.00
West Allis Savings Bank ............... 30,471 10.98 11,100 4.00 16,649 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated .......................... 37,086 13.35 22,224 8.00 27,780 10.00
West Allis Savings Bank ............... 33,106 11.93 22,199 8.00 27,749 10.00
As a state-chartered savings bank, the Bank also is subject to a minimum
regulatory capital requirement of the State of Wisconsin. At December 31, 1998,
on a fully-phased-in basis of 6.0%, the Bank had actual capital of $33,122,000
with a required amount of $28,898,000, for excess capital of $4,224,000.
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(6) LOANS RECEIVABLE
Loans receivable are summarized as follows:
DECEMBER 31, JUNE 30,
1998 1998
-------------------- --------------------
(IN THOUSANDS)
Increase
Amount Percent Amount Percent (Decrease)
------ ------- ------ ------- ----------
Real estate mortgage loans:
Residential one-to-four family................... $153,915 51.2% $155,082 53.7% $(1,167)
Home equity...................................... 21,936 7.3% 25,079 8.7% (3,143)
Residential multi-family......................... 35,013 11.6% 33,513 11.6% 1,500
Commercial real estate........................... 39,270 13.0% 34,610 12.0% 4,660
Residential construction......................... 5,540 1.8% 6,838 2.4% (1,298)
Other construction and land...................... 23,938 8.0% 13,874 4.8% 10,064
-------- ----- -------- ------ -------
Total real estate mortgage loans............ 279,612 92.9% 268,996 93.2% 10,616
Consumer-related loans:
Automobile...................................... 532 0.2% 755 0.3% (223)
Credit card...................................... 2,712 0.9% 2,777 1.0% (65)
Other consumer loans............................. 1,151 0.4% 1,476 0.4% (325)
-------- ----- -------- ------ -------
Total consumer-related loans................ 4,395 1.5% 5,008 1.7% (613)
-------- ----- -------- ------ --------
Commercial loans..................................... 16,920 5.6% 14,646 5.1% 2,274
-------- ------ -------- ------ -------
Gross loans................................. 300,927 100.0% 288,650 100.0% 12,277
Accrued interest receivable.......................... 1,753 1,764
Less:
Undisbursed portion of loan proceeds............. (13,177) (6,848)
Deferred loan fees............................... (474) (319)
Unearned interest................................ (4) (29)
Allowances for loan losses....................... (2,635) (2,329)
-------- --------
$286,390 $280,889
======== ========
Loans serviced for investors totaled $27.0 million and $25.7 million at December
31, 1998 and June 30, 1998, respectively.
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(7) NOTES PAYABLE AND OTHER BORROWINGS
Notes payable and other borrowings are summarized as follows (dollars in
thousands):
DECEMBER 31, 1998 JUNE 30, 1998
---------------------------- ---------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
MATURITY AMOUNT RATE AMOUNT RATE
-------- ------ ---- ------ ----
Advances from
Federal Home Loan Bank 1998 $ - - $8,000 5.51%
1999 22,000 6.55% 21,000 6.62
2000 22,007 6.23 22,007 6.24
2001 3,000 5.91 3,000 5.91
2002 28,500 5.61 28,500 5.61
2003 8,052 5.13 3,052 5.60
2004 5,000 6.32 5,000 6.32
2005 5,000 5.33 - -
2007 6,500 6.52 6,500 6.52
2008 30,000 4.88 20,000 4.95
---- ------ ---- -------- ----
$130,059 5.74% $117,059 5.87%
======== ==== ======== ====
Securities sold under
agreements to repurchase 1999 $ 4,875 5.45% - -
FHLB advances totaled $130.1 million or 96.4% and $117.1 million or 100.0% of
total borrowings at December 31, 1998 and June 30, 1998, respectively. The
Company is required to maintain as collateral unencumbered one-to-four family
mortgage loans in its portfolio such that the outstanding balance of FHLB
advances does not exceed 60% of the book value of this collateral. The Company
had delivered mortgage-backed securities with a carrying value of $56.9 million
and $30.7 million at December 31, 1998 and June 30, 1998, respectively. In
addition, all FHLB advances are collateralized by all Federal Home Loan Bank
stock and are subject to prepayment penalties. The Company's unused advance line
with the Federal Home Loan Bank was $11.0 million at December 31, 1998. FHLB
variable rate term borrowings consist of $5.0 million tied to the one-month
LIBOR, and $3.0 million tied to the six-month LIBOR index.
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 December 31, 1998
agreements to repurchase identical securities totaled $4.9 million. There were
no liabilities recorded under agreements to repurchase substantially identical
securities at December 31, 1998.
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Quarterly Report on Form 10-Q or future filings with the
Securities and Exchange Commission, in annual 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 rates, (ii) general economic
conditions, (iii) legislative/regulatory changes, (iv) monetary and fiscal
policies of the U.S. Treasury and Federal Reserve, (v) changes in the quality or
composition of the Company's loan and investment portfolios, (vi) demand for
loan products, (vii) deposit flows, (viii) competition, (ix) demand for
financial services in the Company's markets, and (x) changes in accounting
principles, policies or guidelines.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect the occurrence of anticipated
or unanticipated events or circumstances after the date of such statements.
GENERAL
In order to maximize shareholder value, the Company continues to pursue a
strategy of effectively utilizing the capital acquired in the Bank's conversion
from mutual to stock form and the Company's initial public offering consummated
in December 1993 (the "Conversion"). 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 will continue in fiscal
1999, 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.
Commencing in fiscal 1994 and continuing through the first half of fiscal 1997,
the Company implemented stage one of it's strategic plan 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.
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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 and commercial real estate loans or participation
interests in such loans secured by properties 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 opportunities to originate higher-yielding loans by
establishing a new 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 mortgage-backed and related securities, retail deposits and FHLB
advances.
In fiscal 1999, the Company intends to continue the implementation of the second
stage of its strategic plan by slowing the rate of growth of its asset base and
continuing to focus on asset portfolio diversification.* This will continue to
be accomplished by increasing the origination and purchase of multi-family real
estate, commercial real estate and commercial/industrial business loans,
combined with the growth of the commercial lending division.* The Company also
intends to begin to increase sales of one-to-four family mortgage loans in the
secondary market, including selling seasoned and recently originated one-to-four
family mortgage loans in order to provide liquidity for the funding of
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 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.* Loans purchased, or participation interests purchased, which relate to
properties located outside of the Company's primary lending area will consist
primarily of multi-family, commercial real estate, multi-family construction and
commercial real estate construction loans.* In deciding whether or not to
purchase a loan or participation interest in a loan originated outside of the
Company's primary lending area, management of the Company has applied, and
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
by 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
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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 December 31, 1998, commercial deposits
totaled $27.0 million or 8.9% of the Company's 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 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
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Company longer term, and should contribute to a long-term improvement in the
Company's net income and return on equity.*
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 the fiscal years 1997 and 1998,
prepayments increased as interest rates decreased in the second half of the
fiscal year. Also, during the six months ended December 31, 1998 prepayments
continued to increase as interest rates continued to decline.
The primary investing activity of the Company is the origination and purchase of
loans and the purchase of mortgage-backed and related securities. For the six
months ended December 31, 1998, the Company originated and purchased loans
totaling $106.2 million and $5.0 million, respectively, as compared to the six
months ended December 31, 1997 when originated and purchased loans totaled $60.2
million and $2.6 million, respectively. Purchases of mortgage-backed and related
securities held-to-maturity for the six months ended December 31, 1998 and 1997
totaled $8.1 million and $352,000, respectively. There were no purchases of
investment securities held-to-maturity for the six months ended December 31,
1998 and 1997. For the six months ended December 31, 1998 and 1997, these
activities were funded primarily by principal repayments on loans of $68.4
million and $59.4 million, respectively; principal repayments on mortgage-backed
and related securities of $52.3 million and $10.2 million, respectively;
proceeds from the sale of mortgage loans of $36.0 million and $4.4 million,
respectively; net proceeds from notes payable to the FHLB-Chicago of $13.0
million and $23.5 million, respectively; and a net increase in deposits and
securities sold under agreements to repurchase of $32.8 million and $4.9
million, respectively, during the 1998 period. Purchases of securities
available-for-sale totaled $85.4 million and sales were $5.5 for the six months
ended December 31, 1998, compared to purchases of $14.9 million and sales of
$18.1 million for the three months ended December 31, 1997.
The Company is required to maintain minimum levels of liquid assets under the
regulations of the Wisconsin Department of Financial Institutions, Division of
Savings and Loan for state-chartered stock 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%. The
Company's liquidity ratio was 30.9% at December 31, 1998. 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. At December 31, 1998 and June 30, 1998, cash
and cash equivalents were $14.1 million and $8.2 million, respectively. The
increase in cash and cash equivalents was due to an increase in wholesale
brokered deposits and advance borrowings from the FHLB-Chicago.
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
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maintains a $10.0 million backup credit facility for contingency purposes to
replace funds from wholesale brokered deposits should retention of those
deposits diminish due to extraordinary events in the financial markets. The
Company's overall cost of funds has increased in recent years due primarily to a
much greater percentage of the deposits being in certificates, both wholesale
brokered and retail, as opposed to passbooks, money market accounts and checking
accounts. Management believes that a significant portion of its retail deposits
will remain with the Company and, in the case of wholesale brokered deposits,
may be replaced with similar type accounts even should the level of interest
rates change.* However, in the event of a significant increase in market
interest rates, the cost of obtaining replacement brokered deposits would
increase as well.
At December 31, 1998, retail and wholesale certificates of deposit totaled $72.4
million and $143.7 million, respectively. 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
wholesale deposits and FHLB advances would increase as well.
The Bank's Board of Directors has set a maximum limitation of total borrowings
equal to 32% of total assets. This internal limit is 3% below the allowable
borrowing limit (for all borrowings including FHLB advances and reverse
repurchase agreements) of 35% of total assets established by the FHLB-Chicago.
At December 31, 1998, FHLB advances totaled $130.1 million or 27.2% of the
Bank's total assets and securities sold under agreements to repurchase totaled
$4.9 million or 1.0% of the Bank's total assets. At December 31, 1998, the Bank
had unused borrowing authority under the borrowing limitations established by
the Board of Directors of $18.3 million and $32.7 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.*
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 usually are available and
obtainable from the wholesale brokered and non-brokered market as well as the
unused credit line from the FHLB-Chicago, and funds also may be available
through reverse repurchase agreements wherein the Company pledges investment,
mortgage-backed or related securities. The Company maintains a $10.0 million
contingent backup credit facility with a major correspondent bank to replace a
portion of its interest rate sensitive liabilities, such as borrowings and
wholesale brokered and non-brokered deposits should such funding sources become
difficult or impracticable to obtain or retain due to a changing interest rate
environment. The Company also has a federal funds open line of credit in the
amount of $10.0 million with a correspondent bank which does not require the
direct pledging of any assets. 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 ensure sufficient sources
of funds are available to meet the Company's liquidity needs.
The Company has various unfunded commitments at December 31, 1998 which
represent amounts the Company expects to fund during the quarter ended March 31,
1999. For a summary of such commitment see discussion under footnote (4)
"Commitments and Contingencies" contained in the section entitled, "Notes to
Consolidated Financial Statements." 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.
CHANGE IN FINANCIAL CONDITION
Total assets increased $43.1 million, or 9.8%, from $438.4 million at June 30,
1998 to $481.5 million at December 31, 1998. This increase is primarily
reflected in an increase in interest-bearing deposits, securities
available-for-sale and loans receivable, funded primarily by an increase in
deposits, FHLB-
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Chicago advances, securities sold under agreements to repurchase and decreases
in mortgage-backed and related securities held-to-maturity. Cash and cash
equivalents were $14.1 million and $8.2 million at December 31, 1998 and June
30, 1998, respectively. The increase in cash and cash equivalents was due to
management's decision to increase such assets to purchase securities
available-for-sale and to have funding available for unused loan commitments.
Securities available-for-sale increased to $105.7 million at December 31, 1998
compared to $66.4 million at June 30, 1998. Mortgage-backed and related
securities held-to-maturity increased to $81.3 million at December 31, 1998
compared to $57.5 million at June 30, 1998. Investment securities
available-for-sale increased to $24.4 million at December 31, 1998 compared to
$8.9 million at June 30, 1998. The increase in mortgage-backed and related
securities available-for-sale and investment securities available-for-sale was
the result of management's decision to increase such assets to mitigate the
effect of lower than expected loan portfolio balances due to higher than
anticipated levels of mortgage loans refinanced with outside institutions.
Loans receivable increased to $286.4 million at December 31, 1998 compared to
$280.9 million at June 30, 1998. The increase at December 31, 1998 compared to
June 30, 1998 is primarily the result of management's decision to retain its
ARM, intermediate-term (15 year) and loans originated and purchased for the
Company's portfolio, as such loans carried higher yields than comparable
mortgage-backed and related securities during the six months ended December 31,
1998. Total mortgage loans originated and purchased amounted to $99.6 million
($3.5 million of which were purchased mortgage loans) and $62.8 million ($2.6
million of which were purchased mortgage loans) for the six months ended
December 31, 1998 and 1997, respectively, while sales of fixed-rate mortgage
loans totaled $36.8 million and $4.4 million for the six months ended December
31, 1998 and 1997, respectively. Total commercial real estate mortgage loans
originated and purchased totaled $19.3 million and $7.4 million for the six
months ended December 31, 1998 and 1997, respectively.
Deposits increased $32.9 million to $304.5 million at December 31, 1998 from
$271.6 million at June 30, 1998. The increase in deposits was primarily due to
the Company's increase in money market deposit accounts for the six months ended
December 31, 1998. Money market deposit accounts totaled $54.5 million at
December 31, 1998, representing 17.9% of total deposits as compared to $28.0
million, or 10.3% of total deposits at June 30, 1998. Also, the Company
increased its use of wholesale brokered and non-brokered certificates of deposit
for the six months ended December 31, 1998. Brokered certificates of deposit
totaled $96.7 million at December 31, 1998, representing 31.8% of total deposits
as compared to $81.4 million, or 30.0% of total deposits, at June 30, 1998.
Non-brokered wholesale deposits totaled $47.0 million at December 31, 1998,
representing 15.4% of total deposits as compared to $42.9 million, or 15.8% of
total deposits at June 30, 1998. 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 increased to $130.5 million at December 31, 1998 compared
to $117.1 million at June 30, 1998. Also, at December 31, 1998, the Company had
$4.9 million in reverse repurchase agreements. The Company has used FHLB-Chicago
advances and securities sold under agreements to repurchase as a funding source
due to attractive rates offered in relation to deposit funds obtainable in the
Company's local market.
ASSET/LIABILITY MANAGEMENT
The Company closely monitors interest rate risk in an attempt to manage the
extent to which net interest income is significantly affected by changes in
market interest rates. In managing the Company's interest rate risk during the
six months ended December 31, 1998, the Company utilized money market deposit
accounts and FHLB-advances to fund increases in the Company's interest-bearing
assets due primarily to the attractive rates offered on money market deposit
accounts and FHLB advances. At December 31, 1998, the Company's estimated
cumulative one-year gap between assets and liabilities was a negative 10.0% of
total assets as compared to a negative 5.1% at June 30, 1998. The increase in
the Company's negative one-year
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gap reflects the increased use of shorter-term maturity deposits and FHLB
advances to fund a larger portfolio of fixed-rate mortgage, mortgage related
securities and investment securities. During periods of rising interest rates, a
positive interest rate sensitivity gap would tend to positively affect net
interest income, while a negative interest rate sensitivity gap would adversely
affect net income. Although the opposite effect on net income would occur in
periods of falling interest rates, the Company could experience substantial
prepayments of its fixed rate mortgage loans and mortgage-backed and related
securities, which would result in the reinvestment of such proceeds at market
rates which are lower than current rates.*
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ASSET/LIABILITY MANAGEMENT SCHEDULE
The following table sets forth at December 31, 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 MORE THAN
WITHIN FOUR TO ONE YEAR THREE YEARS
THREE TWELVE TO THREE TO FIVE OVER FIVE
MONTHS MONTHS YEARS YEARS YEARS TOTAL
------ ------ ----- ----- ----- -----
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS(1):
Mortgage loans(2):
Fixed rate ................................... $ 12,377 $ 31,915 $ 62,571 $ 28,149 $ 15,673 $ 150,685
Adjustable rate .............................. 29,600 42,973 35,631 3,536 1,671 113,411
Consumer loans (2) ................................ 394 3,191 603 21 -- 4,209
Commercial loans (2) .............................. 7,720 3,595 4,587 435 -- 16,337
Mortgage-backed and related securities:
Fixed rate and securities available-for-sale . 3,421 8,929 16,397 9,489 7,187 45,423
Adjustable rate .............................. 53,104 38,458 -- -- -- 91,562
Investment securities and
securities available-for-sale ................... 20,442 2,640 160 20,367 43,609
--------- --------- --------- --------- --------- ---------
Total interest-earning assets ................ $ 127,058 $ 131,701 $ 119,949 $ 41,630 $ 44,898 $ 465,236
========= ========= ========= ========= ========= =========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts ................................. $ 246 $ 739 $ 1,173 $ 575 $ 552 $ 3,285
Money market deposit accounts ................ 8,173 24,520 18,308 2,929 558 54,489
Passbook savings accounts .................... 1,562 4,686 7,435 3,643 3,500 20,825
Certificates of deposit ...................... 77,589 104,840 30,607 3,136 -- 216,172
Escrow deposits .............................. -- 166 -- -- -- 166
Borrowings(4)
FHLB advances and other borrowings ........... 49,375 35,000 26,007 8,052 16,500 134,934
--------- --------- --------- --------- --------- ---------
Total interest-bearing liabilities ........... $ 136,945 $ 169,951 $ 83,530 $ 18,335 $ 21,110 $ 429,871
========= ========= ========= ========= ========= =========
Excess (deficiency) of interest-earning assets over
interest-bearing liabilities .................... ($ 9,887) ($ 38,250) $ 36,419 $ 23,295 $ 23,788 $ 35,365
========= ========= ========= ========= ========= =========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities ........ ($ 9,887) ($ 48,137) ($ 11,718) $ 11,577 $ 35,365 $ 35,365
========= ========= ========= ========= ========= =========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities
as a percent of total assets .................... (2.1)% (10.0)% (2.4)% 2.4% 7.4% 7.4%
========= ========= ========= ========= ========= =========
- ---------------------------
(1) Adjustable- and floating-rate assets are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due, and fixed-rate assets are included in the periods in
which they are scheduled to be repaid based on scheduled amortization, in
each case adjusted to take into account estimated prepayments utilizing the
Company's historical prepayment statistics modified for forecasted
statistics using annual prepayment rates ranging from 5% to 20%, based on
the loan type.
(2) Balances have been reduced for undisbursed loan proceeds, unearned credit
insurance premiums, deferred loan fees, purchased loan discounts and the
allowance for loan losses, which aggregated $16.3 million at December 31,
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 $86.8 million or 18.1% of total assets.
(4) Adjustable- and floating-rate borrowings are included in the period in
which their interest rates are next scheduled to adjust rather than in the
period in which they are due.
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ASSET QUALITY
The Company and the Bank regularly review assets to determine proper valuation.
The review consists of an update of the historical loss experience, valuation of
the underlying collateral and the outlook for the economy in general as well as
the regulatory environment.
The following table sets forth information regarding the Bank's non-accrual
loans and foreclosed properties at the dates indicated:
THREE MONTHS ENDED
--------------------------------------------------
DEC 31 SEP 30 JUN 30 MAR 31 DEC 31
1998 1998 1998 1998 1997
---- ---- ---- ---- ----
Non-accrual mortgage loans ........ $3,238 $1,674 $1,338 $1,028 $ 337
Non-accrual consumer loans ........ 136 45 52 24 29
------ ------ ------ ------ ------
Total non-accrual loans ........... $3,374 $1,719 $1,390 $1,052 $ 366
====== ====== ====== ====== ======
Loans 90 days or more
delinquent and still accruing ... 52 32 20 61 60
------ ------ ------ ------ ------
Total non-performing loans ........ $3,426 $1,751 $1,424 $1,113 $ 426
====== ====== ====== ====== ======
Non-accrual investment securities . 233 -- -- -- --
Total foreclosed real estate net of
related allowance for losses .... 11 11 11 11 11
------ ------ ------ ------ ------
Total non-performing assets ....... $3,670 $1,762 $1,435 $1,124 $ 437
====== ====== ====== ====== ======
Non-performing loans to
gross loans receivable .......... 1.14% 0.60% 0.50% 0.38% 0.14%
====== ====== ====== ====== ======
Non-performing assets to
total assets .................... 0.76% 0.38% 0.33% 0.27% 0.11%
====== ====== ====== ====== ======
At December 31, 1998, non-performing loans increased to $3.4 million from $1.4
million at June 30, 1998. The increase primarily relates to the default on a
commercial real estate loan located in the Bank's primary market with a balance
of $1.1 million. The remaining portion of the increase relates to several
one-to-four family real estate loans also located in the Bank's primary market.
Management believes that these loans are adequately collateralized and/or have
specific loan loss reserves established which are adequate to absorb potential
losses related to resolution.
19
22
ALLOWANCE FOR LOAN LOSSES
The following table sets forth an analysis of the Bank's allowance for loan
losses:
SIX MONTHS YEAR SIX MONTHS
ENDED ENDED ENDED
DEC. 31, 1998 JUNE 30, 1998 DEC. 31, 1997
------------- ------------- -------------
(DOLLARS IN THOUSANDS)
Balance at beginning of period .......... $ 2,329 $ 1,762 $ 1,762
Additions charged to operations:
One- to four-family ................... -- -- --
Multi-family and commercial real estate 230 512 242
Consumer .............................. 50 163 103
Commercial ............................ 60 125 95
------- ------- -------
340 800 440
Recoveries:
One- to four-family .................. -- -- --
Consumer ............................. 6 31 15
------- ------- -------
6 31 1
Charge-offs:
One- to four-family .................. (11) (69) (69)
Consumer ............................. (29) (195) (86)
------- ------- -------
(40) (264) (155)
------- ------- -------
Net charge-offs ......................... (34) (233) (140)
------- ------- -------
Balance at end of period ................ $ 2,635 $ 2,329 $ 2,062
======= ======= =======
Allowance for loan losses to
non-performing loans at end
of the period ......................... 76.91% 163.55% 484.04%
======= ======= =======
Allowance for loan losses to
total loans at end of the period ...... 0.88% 0.81% 0.69%
======= ======= =======
The level of allowance for loan losses at December 31, 1998, reflects the
continued low level of charged off loans. Management believes that the allowance
for loan losses is adequate as of December 31, 1998.
20
23
RESULTS OF OPERATIONS -
COMPARISON OF THE THREE MONTHS ENDED DECEMBER 31, 1998
AND 1997
GENERAL
Net income for the three months ended December 31, 1998 increased to $789,000
from $714,000 for the comparable 1997 period. The increase in net income was
primarily due to an increase in non-interest income and net interest income.
Return on average equity decreased to 9.17% for the three months ended December
31, 1998 from 9.19% for the comparable 1997 period. Return on average assets
decreased to 0.66% for the three months ended December 31, 1998 from 0.68% for
the comparable 1997 period.
NET INTEREST INCOME
The following table presents certain information related to average
interest-earning assets and liabilities, net interest rate spread and net
interest margin:
FOR THE THREE MONTHS ENDED DECEMBER 31,
----------------------------------------------------------------------
1 9 9 8 1 9 9 7
----------------------------- ----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
------- ---- ---- ------- ---- ----
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans ......................... $264,591 $ 5,492 8.30% $271,023 $ 5,698 8.41%
Consumer loans ......................... 4,257 139 13.06 5,350 175 13.08
Commercial loans ....................... 14,135 339 9.59 6,208 161 10.37
-------- -------- -------- --------
Total loans ......................... 282,983 5,970 8.44 282,581 6,034 8.54
Securities held-to-maturity:
Mortgage-backed securities ........... 16,460 256 6.22 42,438 751 7.08
Mortgage related securities .......... 40,684 751 7.38 37,806 650 6.88
-------- -------- -------- --------
Total mortgage-backed
and related securities ............ 57,144 1,007 7.05 80,244 1,401 6.98
Investment and other securities ........ 28,442 384 5.40 13,925 227 6.52
Securities available-for-sale .......... 91,003 1,413 6.21 24,915 401 6.44
Federal Home Loan Bank stock ........... 6,619 111 6.70 5,614 99 7.05
-------- -------- -------- --------
Total interest-earning assets ........ 466,191 8,885 7.62 407,279 8,162 8.02
Non-interest earning assets .............. 9,074 11,238
-------- --------
Total assets ......................... $475,265 $418,517
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
NOW accounts ........................... $ 2,834 12 1.69% $ 2,623 11 1.68%
Money market deposit accounts .......... 41,175 528 5.13 24,205 315 5.21
Passbook accounts ...................... 21,294 156 2.93 21,207 159 3.00
Certificates of deposit ................ 228,555 3,322 5.81 215,161 3,272 6.08
-------- -------- -------- --------
Total deposits ....................... 293,858 4,018 5.47 263,196 3,757 5.71
Advance payments by borrowers
for taxes and insurance ................ 3,868 29 3.00 4,197 32 3.05
Borrowings ............................... 131,527 1,937 5.89 108,572 1,696 6.25
-------- -------- -------- --------
Total interest-bearing liabilities ... 429,253 5,984 5.58 375,965 5,485 5.84
Non-interest bearing deposits
and liabilities ........................ 11,607 11,469
Shareholders' equity ..................... 34,405 31,083
-------- --------
Total liabilities and
shareholders' equity ............... $475,265 $418,517
======== ========
Net interest income/interest rate spread . $ 2,901 2.04% $ 2,677 2.18%
======== ==== ======== ====
Net earning assets/net interest margin ... $ 36,938 2.49% $ 31,314 2.63%
======== ==== ======== ====
21
24
Net interest income before provision for losses on loans increased $224,000 or
8.4%, to $2.9 million for the three months ended December 31, 1998 from $2.7
million for the comparable 1997 period. Interest income increased $723,000 for
the three months ended December 31, 1998, partially offset by an increase in
interest expense of $499,000. The level of net interest income primarily
reflects an 6.2% increase in average interest-earning assets to $466.2 million
for the three months ended December 31, 1998 from $407.3 million for the
comparable 1997 period, a 18.0% increase in the excess of the Company's average
interest-earning assets over average interest-bearing liabilities to $36.9
million for the three months ended December 31, 1998 from $31.3 million for the
comparable 1997 period, offset by a decrease in interest rate spread to 2.04%
for the three months ended December 31, 1998 from 2.18% for the comparable 1997
period. The decrease in interest rate spread was primarily due to the increased
proportion of interest earning assets invested in investment securities that
carry lower yields than loans.
INTEREST INCOME
Interest income increased 8.9% to $8.9 million for the three months ended
December 31, 1998 from $8.2 million for the comparable 1997 period. The increase
in interest income was the result of an increase in average interest-earning
assets of 14.5% to $466.2 million for the three months ended December 31, 1998
from $407.3 million for the comparable 1997 period, offset by a decrease of 40
basis points in the yield on interest-earning assets to 7.62% for the three
months ended December 31, 1998 from 8.02% for the comparable 1997 period.
Interest income on loans decreased 1.1% to $5.970 million for the three months
ended December 31, 1998, from $6.034 million for the comparable 1997 period. The
decrease was the result of a decrease in average yield to 8.44% for the three
months ended December 31, 1998 from 8.54% for the comparable 1997 period, offset
by a rise in the Company's average gross loans of 0.1% to $283.0 million for the
three months ended December 31, 1998 from $282.6 million for the comparable 1997
period. Gross loans increased primarily as a result of the Company retaining
substantially all of its adjustable and short-term fixed rate loan originations
and purchasing more loans in the secondary market. The decrease in yield is
attributable to the increase in loans refinanced at lower interest rates during
the 1998 period. At December 31, 1998 the multifamily and commercial components
of the Company's loan portfolio totaled $113.5 million, or 37.7% of the total
loan portfolio, compared to $90.7 million, or 30.5% of the total loan portfolio
at December 31, 1997. Interest income on mortgage-backed securities decreased
65.9% to $256,000 for the three months ended December 31, 1998 from $751,000 for
the comparable 1997 period. The decrease was primarily due to a decrease in
average balances to $16.5 million for the three months ended December 31, 1998
from $42.4 million for the comparable 1997 period and a decrease in average
yield to 6.22% for the 1998 period from 7.08% for the 1997 period. The decrease
in average yield on mortgage-backed securities was primarily due to the downward
rate adjustment in the adjustable rate securities portion of this portfolio
which decreased due to the lower interest rate environment in the 1998 period
and the accelerated amortization of purchase premiums on mortgage-backed
securities due to faster that projected principal repayments in the 1998 period.
Interest income on mortgage-related securities increased 15.5% to $751,000 for
the three months ended December 31, 1998 from $650,000 for the comparable 1997
period. The increase was primarily due to an increase in average balances to
$40.7 million for the three months ended December 31, 1998 from $37.8 million
for the comparable 1997 period, and by an increase in average yield to 7.38% for
the three months ended December 31, 1998 from 6.88% for the comparable 1997
period. The increase in average yield on mortgage-related securities was
primarily due to accelerated amortization of purchase discounts on mortgage
related securities due to faster than projected principal repayments during the
1998 period. The decline in average balances of mortgage-backed and related
securities is due to management's decision to increase the securities
available-for-sale portfolio. Interest income on investment securities and
securities available-for-sale and investment and other securities increased
186.1% to $1.8 million for the three months ended December 31, 1998 from
$628,000 for the comparable 1997 period. The increase was primarily due to an
increase in average balance to $119.4 million for the three months ended
December 31, 1998 from $38.8 million for the 1997 period, offset by a decrease
in average yield to 6.02% for the three months ended December 31, 1998 from
6.47% for the comparable 1997 period. The increase in securities
available-for-sale was due to management's decision to have the ability to sell
securities to meet future loan demand. The lower average yield was primarily
attributable to the lower interest rate environment during the 1998 period as
compared to the 1997 period.
22
25
INTEREST EXPENSE
Interest expense increased 9.1% to $6.0 million for the three months ended
December 31, 1998 from $5.5 million for the comparable 1997 period. The increase
was the result of an 14.2% increase in the average amount of interest-bearing
liabilities to $429.3 million for the three months ended December 31, 1998
compared to $376.0 million for the comparable 1997 period, offset by a decrease
in the average rate paid on interest-bearing liabilities to 5.58% for the 1998
period from 5.84% for the 1997 period. The increased balances of certificates of
deposit (including brokered deposits), money market deposit accounts, NOW
accounts and borrowings at lower average interest rates was the primary reason
for the decrease in the average rate paid on the interest-bearing liabilities
for the three months ended December 31, 1998 as compared to the comparable 1997
period. Interest expense on deposits increased 6.9% to $4.0 million for the
three months ended December 31, 1998 from $3.8 million for the comparable 1997
period. The increase was the result of an increase in average balances of 11.6%
to $293.9 million for the three months ended December 31, 1998 from $263.2
million for the comparable 1997 period, partially offset by a decrease in the
average rate paid to 5.47% for the 1998 period from 5.71% for the 1997 period.
The increase in deposits was primarily due to an increase of 70.1% in money
market deposit accounts to $41.2 million for the three months ended December 31,
1998 from $24.2 million for the comparable 1997, with a decrease in the average
rate paid on such accounts to 5.13% for the 1998 period from 5.21% for the 1997
period. Money market deposit accounts increased primarily due to aggressive
marketing and a competitive rate offered during the three months ended December
31, 1998. Certificate of deposit accounts (including brokered deposits)
increased 6.2% to $228.6 million for the three months ended December 31, 1998
from $215.2 million for the 1997 period, with a decrease in the average rate to
5.81% for the 1998 period from 6.08% for the 1997 period. NOW accounts increased
8.0% to $2.8 million for the three months ended December 31, 1998 from $2.6
million for the comparable 1997 period, with an increase in average rate paid to
1.69% for the 1998 period from 1.68% for the 1997 period. The Company's increase
in certificates of deposit was the result of aggressive marketing and pricing
and the use of brokered certificates of deposit. Of the $228.6 million in the
average balance of certificates of deposit for the three months ended December
31, 1998, $98.0 million, or 42.9%, represented brokered certificates of deposit
compared to $80.7, million or 37.5%, for the 1997 period. The average rate paid
on brokered certificates of deposit decreased to 5.73% for the three months
ended December 31, 1998 from 6.17% for the comparable 1997 period. The decrease
was primarily due to the lower interest rate environment during the 1998 period
as compared to the 1997 period. Interest on borrowings (FHLB advances and
reverse repurchase agreements) increased 14.2% to $1.9 million for the three
months ended December 31, 1998 from $1.7 million for the comparable 1997 period.
The increase was primarily due to the increase in average balances of FHLB
advances and reverse repurchase agreements of 21.1% to $131.5 million for the
three months ended December 31, 1998 from $108.6 million for the comparable 1997
period, with a decrease in the average rate paid to 5.89% for the 1998 period
from 6.25% for the 1997 period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans decreased 12.5% to $210,000 for the three
months ended December 31, 1998 from $240,000 for the comparable 1997 period. 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.
Management anticipates that as the Company's volume of multi-family and
commercial/non-residential real estate lending activity continues to increase,
the Company will need to build a higher level of allowance for loan losses
established through a provision for loan losses.* Based on management's
evaluation of the loan portfolio and the increase in gross loans during the
three months ended December 31, 1998, the allowance for losses on loans
increased 27.8% to $2.6 million at December 31, 1998 compared to $2.1 million at
December 31, 1997. This increase was primarily the result of the increase in
multi-family, multi-family construction, home equity, commercial real estate and
commercial loan components of the gross loan portfolio which carry a greater
degree of credit risk as compared to one-to-four family mortgage lending. The
ratio of allowance for loan losses to gross loans increased to 0.88% at December
31, 1998 from 0.69% at December 31, 1997, reflecting the continued low level of
loans charged off loans. The amount of non-performing loans at December 31, 1998
was $3.4 million, or 1.2% of gross loans, compared to $1.4, or 0.50% of gross
loans, at June 30, 1998 and $349,000 or 0.12% of gross loans at December 31,
1997.
23
26
NON-INTEREST INCOME
Non-interest income increased 199.2% to $706,000 for the three months ended
December 31, 1998 from $236,000 for the comparable 1997 period. The largest
components of the increase were an increase in gains on the sale of loans to
$438,000 for the three months ended December 31, 1998 compared to $2,000 for the
comparable 1997 period, an increase in service charges on deposit accounts to
$121,000 for the three months ended December 31, 1998 from $109,000 for the
comparable 1997 period, an increase in gains on the sale of securities and
mortgage-backed and related securities to $35,000 for the three months ended
December 31, 1998 from $9,000 for the 1997 period, an increase in other income
to $46,000 for the three months ended December 31, 1998 from $3,000 for the 1997
period and an increase in insurance commissions to $10,000 for the three months
ended December 31, 1998 from $4,000 for the 1997 period. The increase in gains
on the sale of loans reflects the increase in long-term fixed rate loans sold
into the secondary market during the 1998 period as compared to the 1997 period.
The increase in service charges on deposit accounts reflects an increase in the
level of fees charged to deposit customers in the 1998 period as compared to the
1997 period. The increase in gains on the sale of securities and mortgage-backed
and related securities relates to management's decision to sell securities that
have a high probability of early repayment of principal. Partially, offsetting
the increases in non-interest income was a decrease in service charges on loans
to $57,000 for the three months ended December 31, 1998 from $90,000 for the
comparable 1997 period and a decrease in loan servicing fees to a loss of $1,000
for the three months ended December 31, 1998 from $19,000 for the comparable
1997 period.
NON-INTEREST EXPENSE
Non-interest expense increased 39.0% to $2.2 million for the three months ended
December 31, 1998 from $1.6 million for the comparable 1997 period. The increase
was primarily due to an increase in compensation and benefits expense of
$354,000 to $1.3 million for the three months ended December 31,1998 from
$929,000 for the comparable 1997 period, an increase in occupancy and equipment
expense of $132,000 to $384,000 for the three months ended December 31, 1998
from $252,000 for the comparable 1997 period and an increase in other
non-interest expense of $139,000 to $386,000 for the three months ended December
31, 1998 from $247,000 for the comparable 1997 period. The increase in
compensation and benefits expense primarily relates to higher salary levels, an
increase in the number of full time equivalent employees and an increase in
incentive compensation related to the increased volume of loans sold into the
secondary market. The increase in occupancy and equipment primarily relates to
the addition of an administrative facility and increased purchases of bank
equipment. The increase in other non-interest expense is primarily due to
increases in printing, office supplies, organization dues, legal and other
miscellaneous expenses.
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 is substantially complete and is projected
to be completed by March 31, 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
24
27
inability to process transactions, and to provide 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, and
for the six months ended December 31, 1998 for the Year 2000 project totaled
$5,000 and $30,000, respectively. It is estimated that completion of the project
will result in additional expenditures of approximately $75,000.* 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 prior to
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.
The Company also is in the process of making inquiries and reviewing plans of
certain third parties, such as commercial loan customers, where Year 2000
failures could result in significant adverse impact on the Company. It is
expected that such inquiries and review will be completed and documented and
contingency plans, if any are necessary, will be formulated by March 31, 1999.
The Board of Directors of the Company receives written status reports on the
Year 2000 project and meets with project leaders quarterly.
25
28
RESULTS OF OPERATIONS - COMPARISON OF THE SIX MONTHS ENDED DECEMBER 31, 1998 AND
1997
GENERAL
Net income for the six months ended December 31, 1998 increased to $1.5 million
from $1.4 million for the comparable 1997 period. The increase in net income was
primarily due to an increase in non-interest income and net interest income.
Return on average equity decreased to 8.83% for the six months ended December
31, 1998 from 8.88% for the comparable 1997 period. Return on average assets
increased to 0.66% for the six months ended December 31, 1998 from 0.65% for the
comparable 1997 period.
NET INTEREST INCOME
The following table presents certain information related to average
interest-earning assets and liabilities, net interest rate spread and net
interest margin:
FOR THE SIX MONTHS ENDED DECEMBER 31,
-------------------------------------
1 9 9 8 1 9 9 7
-------------------------------- --------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
------- ---- ---- ------- ---- ----
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans ........................................ $263,579 $10,955 8.31% $268,940 $11,258 8.37%
Consumer loans ........................................ 4,429 294 13.28 5,483 368 13.42
Commercial loans ...................................... 13,480 622 9.23 5,534 267 9.65
-------- -------- -------- --------
Total loans ........................................ 281,488 11,871 8.43 279,857 11,893 8.50
Securities held-to-maturity:
Mortgage-backed securities .......................... 18,716 630 6.73 43,661 1,561 7.15
Mortgage related securities ......................... 41,735 1,509 7.23 38,344 1,314 6.85
-------- -------- -------- --------
Total mortgage-backed
and related securities ........................... 60,451 2,139 7.08 82,005 2,875 7.01
Investment and other securities ....................... 18,332 512 5.59 11,603 382 6.58
Securities available-for-sale ......................... 77,632 2,507 6.46 25,783 827 6.42
Federal Home Loan Bank stock .......................... 6,416 216 6.73 5,471 189 6.91
-------- -------- -------- --------
Total interest-earning assets ....................... 444,319 17,245 7.76 404,819 16,166 7.99
Non-interest earning assets ............................. 13,697 11,668
-------- --------
Total assets ........................................ $458,016 $416,487
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
NOW accounts .......................................... $ 2,746 24 1.75% $ 2,608 22 1.69%
Money market deposit accounts ......................... 35,081 897 5.11 22,877 597 5.22
Passbook accounts ..................................... 21,309 311 2.92 21,405 321 3.00
Certificates of deposit ............................... 222,240 6,484 5.84 220,399 6,722 6.10
-------- -------- -------- --------
Total deposits ...................................... 281,376 7,716 5.48 267,289 7,662 5.73
Advance payments by borrowers
for taxes and insurance ............................... 3,897 55 2.82 4,129 61 2.95
Borrowings .............................................. 127,043 3,776 5.94 103,358 3,196 6.18
-------- -------- -------- --------
Total interest-bearing liabilities .................. 412,316 11,547 5.60 374,776 10,919 5.83
Non-interest bearing deposits
and liabilities ....................................... 11,581 11,108
Shareholders' equity .................................... 34,119 30,603
-------- --------
Total liabilities and
shareholders' equity .............................. $458,016 $416,487
======== ========
Net interest income/interest rate spread ................ $ 5,698 2.16% $ 5,247 2.16%
======== ==== ======== ====
Net earning assets/net interest margin .................. $ 32,003 2.56% $ 30,043 2.59%
======== ==== ======== ====
26
29
Net interest income before provision for losses on loans increased $451,000 or
8.6% to $5.7 million for the six months ended December 31, 1998 from $5.2
million for the comparable 1997 period. Interest income increased $1.1 for the
six months ended December 31, 1998, partially offset by an increase in interest
expense of $628,000. The level of net interest income primarily reflects a 9.8%
increase in average interest-earning assets to $444.3 million for the six months
ended December 31, 1998 from $404.8 million for the comparable 1997 period and a
6.5% increase in the excess of the Company's average interest-earning assets
over average interest-bearing liabilities to $32.0 million for the six months
ended December 31, 1998 from $30.0 million for the comparable 1997 period.
INTEREST INCOME
Interest income increased 6.7% to $17.2 million for the six months ended
December 31, 1998 from $16.2 million for the comparable 1997 period. The
increase in interest income was the result of an increase in average
interest-earning assets of 9.8% to $444.3 million for the six months ended
December 31, 1998 from $404.8 million for the comparable 1997 period, partially
offset by a decrease of 23 basis points in the yield on interest-earning assets
to 7.76% for the six months ended December 31, 1998 from 7.99% for the
comparable 1997 period. Interest income on loans decreased 1.8% to $11.871
million for the six months ended December 31, 1998 from $11.893 million for the
comparable 1997 period. The decrease was the result of a decrease in average
yield to 8.43% fir the six months ended December 31, 1998 from 8.50% for the
comparable 1997 period, partially offset by an increase in average gross loans
of 5.8% to $281.5 million for the six months ended December 31, 1998 from $279.9
million for the comparable 1997 period. Gross loans increased primarily as a
result of the Company retaining substantially all of its adjustable and
short-term fixed rate loan originations and purchasing more loans in the
secondary market. The decrease in yield is attributable to the increase in loans
refinanced at lower interest rates. Interest income on mortgage-backed
securities decreased 59.6% to $630,000 for the six months ended December 31,
1998 from $1.6 million for the comparable 1997 period. The decrease was
primarily due to a decrease in average balances to $18.7 million for the six
months ended December 31, 1998 from $43.7 million for the comparable 1997 and a
decrease in average yield to 6.73% for the 1998 period from 7.15% for the 1997
period. Interest income on mortgage-related securities increased 14.8% to $1.5
million for the six months ended December 31, 1998 from $1.3 million for the
comparable 1997 period. The increase was primarily due to an increase in average
balances to $41.7 million for the six months ended December 31, 1998 from $38.3
million for the comparable 1997 period and an increase in average yield to 7.23%
for the six months ended December 31, 1998 from 6.85% for the comparable 1997
period. The decrease in average yield on mortgage-backed securities was
primarily due to the adjustment in the adjustable rate securities portion of
this portfolio which decreased due to lower interest rates and the accelerated
amortization of purchase premiums on mortgage-backed securities due to faster
than projected principal repayments during the 1998 period. The increase in
average yield on mortgage related securities was primarily due to the
accelerated amortization of purchase discounts due to faster than projected
principal repayments during the 1998 period. The decline in average balances of
mortgage-backed securities and is due to management's decision to increase the
securities available-for-sale portfolio. Interest income on investment
securities and securities available-for-sale increased 149.7% to $3.0 million
for the six months ended December 31, 1998 from $1.2 million for the comparable
1997 period. The increase was primarily due to an increase in average balance to
$96.0 million for the six months ended December 31, 1998 from $37.4 million for
the 1997 period, offset by a decrease in average yield to 6.29% for the 1998
period from 6.47% for the 1997 period. The lower average yield was primarily
attributable to the lower interest rate environment during the 1998 period as
compared to the 1997 period and the short-term maturity of the securities in
this portfolio.
INTEREST EXPENSE
Interest expense increased 5.8% to $11.5 million for the six months ended
December 31, 1998 from $10.9 million for the comparable 1996 period. The
increase was the result of an 10.1% increase in the average amount of
interest-bearing liabilities to $412.3 million for the six months ended December
31, 1998 compared to $374.8 million for the comparable 1997 period, offset by a
decrease in the average rate paid on interest-bearing liabilities to 5.60% for
the 1998 period from 5.83% for the 1997 period. The increased balances of
certificates of deposit (including brokered deposits), money market deposit
accounts, NOW accounts and borrowings at lower average interest rates was the
primary reason for the decrease in the average rate paid on the interest-bearing
liabilities for the six months ended December 31, 1998 as
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compared to the comparable 1997 period. Interest expense on deposits increased
0.7% to $7.716 million for the six months ended December 31, 1998 from $7.662
million for the comparable 1997 period. The increase was the result of an
increase in average balances of 5.3% to $281.4 million for the six months ended
December 31, 1998 from $267.3 million for the comparable 1997 period, partially
offset by a decrease in the average rate paid to 5.48% for the 1998 period from
5.73% for the 1997 period. The increase in deposits was primarily due to an
increase of 0.8% in certificates of deposit (including brokered deposits) to
$222.2 million for the six months ended December 31, 1998 from $220.4 million
for the 1997 period, with a decrease in the average rate paid on such deposits
to 5.84% for the 1998 period from 6.10% for the 1997 period. Money market
deposit accounts increased 53.3% to $35.1 million for the six months ended
December 31, 1998 from $22.9 million for the comparable 1997 period, with a
decrease in the average rate paid on such deposits to 5.11% for the 1998 period
from 5.22% for the 1997 period. Money market deposit accounts increased
primarily due to aggressive marketing and a competitive rate offered during the
six months ended December 31, 1998. NOW accounts increased 5.3% to $2.7 million
for the six months ended December 31, 1998 from $2.6 million for the comparable
1997 period, with an increase in average rate paid to 1.75% for the 1998 period
from 1.69% for the 1997 period. The Company's increase in certificates of
deposit was the result of aggressive marketing and pricing and the use of
brokered certificates of deposit. Of the $220.4 million in the average balance
of certificates of deposit for the six months ended December 31, 1998, $91.5
million, or 41.2%, represented brokered certificates of deposit compared to
$85.2 million, or 38.7%, for the 1997 period. The average rate paid on brokered
certificates of deposit decreased to 5.85% for the six months ended December 31,
1998 from 6.15% for the comparable 1997 period. The decrease was primarily due
to the lower interest rate environment during the 1998 period as compared to the
1997 period. Interest on borrowings (FHLB advances and reverse repurchase
agreements) increased 18.1% to $3.8 million for the six months ended December
31, 1998 from $3.2 million for the comparable 1997 period. The increase was
primarily due to the increase in average balance to $127.0 for the six months
ended December 31, 1998 from $103.4 for the comparable 1997 period, partially
offset by a decrease in average rate paid to 5.94% for the six months ended
December 31, 1998 from 6.18% for the 1997 period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans decreased 22.7% to $340,000 for the six months
ended December 31, 1998 from $440,000 for the comparable 1997 period. For a
discussion of the factors considered by management in determining the
appropriate level of allowance for losses on loans to be established through a
provision for losses on loans, see comments under "Provision for Losses on
Loans" contained in the section entitled, "Results of Operations - Comparison of
the Three Months Ended December 31, 1998 and 1997."
NON-INTEREST INCOME
Non-interest income increased 172.0% to $1.2 million for the six months ended
December 31, 1998 from $436,000 for the comparable 1997 period. The largest
components of the increase were an increase in gains on the sale of loans to
$652,000 for the six months ended December 31, 1998 from $23,000 for the
comparable 1997 period, an increase in service charges on deposit accounts to
$234,000 for the six months ended December 31, 1998 from $223,000 for the
comparable 1997 period, an increase in gains on the sale of securities and
mortgage-backed and related securities to $35,000 for the six months ended
December 31, 1998 from a loss of $8,000 for the comparable 1997 period, an
increase in insurance commissions to $29,000 for the six months ended December
31, 1998 from $8,000 for the comparable 1997 period and an increase in other
non-interest income to $88,000 for the six months ended December 31, 1998 from
$15,000 for the comparable 1997 period. The increase in gains on the sale of
loans reflects the increase in long-term fixed rate loans sold into the
secondary market during the 1998 period as compared to the 1997 period.
Offsetting the increases in non-interest income was a decrease in loan servicing
fees to $13,000 for the six months ended December 31, 1998 from $40,000 for the
comparable 1997 period.
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NON-INTEREST EXPENSE
Non-interest expense increased 35.1% to $4.3 million for the six months ended
December 31, 1998 from $3.2 million for the comparable 1997 period. The increase
was primarily due to an increase in compensation and benefits expense of
$636,000 to $2.5 million for the six months ended December 31, 1998 from $1.9
million for the comparable 1997 period, an increase in occupancy and equipment
expense of $298,000 to $793,000 for the six months ended December 31, 1998 from
$495,000 for the comparable 1997 period and an increase in other non-interest
expense of $171,000 to $704,000 for the six months ended December 31, 1998 from
$533,000 for the comparable 1997 period. The increase in compensation and
benefits expense primarily relates to higher salary levels, an increase in the
number of full time equivalent employees and an increase in incentive
compensation related to the increased volume of loans sold into the secondary
market. The increase in occupancy and equipment expense primarily relates to the
addition of an administrative facility and increased purchases of bank
equipment. The increase in other non-interest income is primarily due to
increases in printing, office supplies, organization dues, legal and other
miscellaneous expenses.
ITEM 3 - 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.
The information required herein pursuant to Item 305 of Regulation S-K is
incorporated by reference in sections entitled "Liquidity and Capital Resources"
from pages 13 to 14 and "Asset/Liability Management" from pages 15 to 17 hereof
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company and the Bank are parties to legal
proceedings arising out of its lending activities and other operations.
However, there are no pending legal proceedings of which the Company or
the Bank is a party which, if determined adversely to the Company or
the Bank, would have a material adverse effect on the consolidated
financial position of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on October
29, 1998. There were 2,938,608 shares of Common Stock of the Company
entitled to vote at the Annual Meeting, and 2,473,079 shares present at
the meeting by holders thereof in person or by proxy, which constituted
a quorum. The following is a summary of the results of the votes:
NUMBER OF VOTES
----------------------------------------------------
Against or Broker
For Withheld Abstain Non-Votes
--- -------- ------- ---------
Nominees for Director for
Three-Year Term Expiring in 2001
Peter A. Gilbert........................ 2,449,149 23,930 - -
Reginald M. Hislop, III................. 2,449,149 23,930 - -
Charles E. Rickheim..................... 2,449,149 23,930 - -
Ratification of KPMG Peat Marwick LLP
as independent auditors for
fiscal year ending June 30, 1999............... 2,438,063 19,926 15,090 -
The continuing directors of the Company include: James D. Smessaert
and Donald A. Zellmer. Martin Hedrich, Jr. was appointed by the Board
of Directors to serve as a director of the Company to fill the vacancy
on the Company board created by the retirement of Floyd D. Brink. Mr.
Hedrich's term will expire when Mr. Brink's term would have expired in
1999.
ITEM 5. OTHER INFORMATION
On October 21, 1998, the Company announced it had adopted a share
repurchase program for its common stock. The Company plans to purchase
up to 5%, or approximately 150,000 shares, over a six month period
commencing October 21, 1998. The repurchased shares will become
treasury shares and will be used for general corporate purposes. As of
February 11, 1999, the Company had purchased 66,900 shares of common
stock pursuant to the repurchase program.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
10.1 Supplemental Compensation Agreement - James D. Smessaert
10.2 Supplemental Compensation Agreement - Peter A. Gilbert
11 Computation of Earnings per Share - See Note 2 to the
unaudited Consolidated Financial Statements
27 Financial Data Schedule
No reports on Form 8-K were filed during the quarter for which this
report was filed.
* * * * * * * * * * * * * * * * * * * *
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SIGNATURES
Pursuant to the requirement 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.
----------------------
(Registrant)
Date: February 11, 1999 /s/ James D. Smessaert
---------------------------------------------
James D. Smessaert
Chairman of the Board
Chief Executive Officer
Date: February 11, 1999 /s/ Arthur E. Thompson
---------------------------------------------
Arthur E. Thompson
Chief Financial Officer
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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.
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