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 March 31, 1999 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
equired 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 2,893,332 at May 14, 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 March 31, 1999 (unaudited) and June 30, 1998................................... 1
Consolidated Statements of Income for the Three and Nine Months
ended March 31, 1999 and 1998 (unaudited)............................................ 2
Consolidated Statements of Shareholders' Equity for the Nine
Months ended March 31, 1999 and 1998 (unaudited)..................................... 3
Consolidated Statements of Cash Flows for the Nine Months
ended March 31, 1999 and 1998 (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)
MARCH 31, JUNE 30,
1999 1998
-------------------- --------------------
ASSETS (Unaudited)
Cash and non-interest bearing deposits..................................... $ 716 $ 1,998
Interest-bearing deposits.................................................. 13,299 6,186
------- --------
Cash and cash equivalents.................................................. 14,015 8,184
Securities available-for-sale (at fair value):
Investment securities.................................................... 32,706 8,896
Mortgage-backed and related securities................................... 70,319 57,549
Securities held-to-maturity:
Investment securities (fair value - $388 at June 30, 1998)............... - 388
Mortgage-backed and related securities (fair value -
$54,162 at March 31, 1999; $66,185 at June 30, 1998)................... 53,816 65,282
Loans receivable, net...................................................... 284,208 280,889
Loans held for sale, at lower of cost or market............................ 4,999 2,056
Investment in Federal Home Loan Bank stock, at cost........................ 6,831 5,932
Foreclosed properties, net................................................. 512 11
Office properties and equipment............................................ 5,764 5,653
Prepaid expenses and other assets.......................................... 4,692 3,534
-------- --------
Total assets..................................................... $477,862 $438,374
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits................................................................. $307,855 $271,619
Notes payable to Federal Home Loan Bank.................................. 129,059 117,059
Securities sold under agreements to repurchase........................... - -
Payable for investments purchased........................................ - 9,858
Advance payments by borrowers for taxes and insurance.................... 1,650 3,163
Accrued interest on deposit accounts and other borrowings................ 2,119 1,455
Accrued expenses and other liabilities................................... 1,919 1,767
-------- --------
Total liabilities................................................ $442,602 $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 2,901,332 shares at
March 31, 1999 and 2,933,608 shares at June 30, 1998................... 3,162 3,162
Additional paid-in capital............................................... 9,831 9,512
Unearned ESOP compensation............................................... (451) (532)
Unearned restricted stock awards......................................... (80) (124)
Net unrealized depreciation on securities available for sale............. (152) (27)
Treasury stock, at cost: 261,168 shares at March 31, 1999
and 228,892 shares at June 30, 1998.................................... (1,998) (1,385)
Retained earnings, substantially restricted.............................. 24,948 22,847
-------- --------
Total shareholders' equity....................................... $ 35,260 $ 33,453
-------- --------
Total liabilities and shareholders' equity....................... $477,862 $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 Nine Months Ended
March 31, March 31,
----------- -----------
1999 1998 1999 1998
---- ---- ---- ----
INTEREST INCOME:
Loans receivable.................................................. $5,954 $ 6,016 $ 17,825 $ 17,909
Mortgage-backed and related securities............................ 1,923 1,533 6,102 4,737
Securities and interest-bearing deposits.......................... 924 394 2,119 1,463
------ ------- -------- --------
Total interest income................................... 8,801 7,943 26,046 24,109
INTEREST EXPENSE:
Deposits.......................................................... 3,970 3,565 11,686 11,227
Advance payments by borrowers for taxes and insurance............. 5 7 60 68
Notes payable and other borrowings................................ 1,874 1,687 5,650 4,883
------ ------- -------- --------
Total interest expense.................................. 5,849 5,259 17,396 16,178
------ ------- -------- --------
Net interest income............................................... 2,952 2,684 8,650 7,931
Provision for losses on loans..................................... 140 200 480 640
------ ------- -------- --------
Net interest income after provision for losses on loans........... 2,812 2,484 8,170 7,291
NON-INTEREST INCOME:
Service charges on loans.......................................... 127 67 262 202
Service charges on deposit accounts............................... 107 100 341 323
Loan servicing fees, net.......................................... 7 18 20 58
Insurance commissions............................................. 31 10 60 18
Gain on sale of securities and
mortgage-backed and related securities, net................... -- -- 35 (8)
Gain on sale of loans............................................. 180 114 832 137
Other income...................................................... 121 56 209 71
------ ------- -------- --------
Total non-interest income............................... 573 365 1,759 801
NON-INTEREST EXPENSE:
Compensation and benefits......................................... 1,363 994 3,885 2,880
Marketing......................................................... 96 120 260 274
Occupancy and equipment........................................... 449 327 1,242 822
Deposit insurance premiums........................................ 45 45 127 133
Other non-interest expense........................................ 374 325 1,078 858
------ ------- -------- --------
Total non-interest expense.............................. 2,327 1,811 6,592 4,967
------ ------- -------- --------
Income before income taxes........................................ 1,058 1,038 3,337 3,125
Income taxes...................................................... 340 359 1,112 1,087
------ ------- -------- --------
Net income................................................... $ 718 $ 679 $ 2,225 $ 2,038
====== ======= ======== ========
Earnings per share - (basic) ................................ $ 0.26 $ 0.24 $ 0.80 $ 0.74
====== ======= ======== ========
Earnings per share - (diluted) .............................. $ 0.25 $ 0.22 $ 0.78 $ 0.68
====== ======= ======== ========
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)
Accumulated
Additional Unearned Unearned Other
Common Paid-In ESOP Restricted Comprehensive Treasury
Stock Capital Compensation Stock Income Stock
----- ---------- ------------ ----- ------ -----
NINE MONTHS ENDED MARCH 31, 1999
Balance at June 30, 1998........................... $3,162 $9,512 ($532) ($124) ($27) ($1,385)
Net income......................................... - - - - - -
Accumulated other comprehensive income:
Unrealized holding loss arising during period.. - - - - (104) -
Re-classification adjustment for gains
realized in income............................ - - - - (35) -
Income tax effect............................. - - - - 14 -
Amortization of unearned ESOP and
restricted stock award compensation.............. - 206 81 44 - -
Purchase of treasury stock (70,900 shares)......... - - - - - (898)
Exercise of stock options (38,624 shares).......... - 113 - - - 285
------ ------ ----- ----- ----- -------
Balance at March 31, 1999.......................... $3,162 $9,831 ($451) ($ 80) ($152) ($1,998)
====== ====== ===== ===== ====== =======
NINE MONTHS ENDED MARCH 31, 1998
Balance at June 30, 1997........................... $3,162 $9,022 ($632) ($208) ($225) ($1,592)
Net income......................................... - - - - - -
Accumulated other comprehensive income:
Unrealized holding loss arising during period.. - - - - 183 -
Re-classification adjustment for gains
realized in income............................ - - - - 8 -
Income tax effect............................. - - - - (3) -
Amortization of unearned ESOP and
restricted stock award compensation.............. - 189 81 63 - -
Exercise of stock options (47,708 shares issued
in connection with 55,340 options issued)........ - - - - 207
------ ------ ----- ----- ------- -------
Balance at March 31, 1998.......................... $3,162 $9,211 ($551) ($145) ($ 37) ($1,385)
====== ====== ===== ===== ====== =======
Total
Retained Shareholders'
Earnings Equity
-------- ------------
NINE MONTHS ENDED MARCH 31, 1999
Balance at June 30, 1998........................... $22,847 $33,453
Net income......................................... 2,225 2,225
Accumulated other comprehensive income:
Unrealized holding loss arising during period.. - (104)
Re-classification adjustment for gains
realized in income............................ - (35)
Income tax effect............................. - 14
Amortization of unearned ESOP and
restricted stock award compensation.............. - 331
Purchase of treasury stock (70,900 shares)......... - (898)
Exercise of stock options (38,624 shares).......... (124) 274
------- -------
Balance at March 31, 1999.......................... $24,948 $35,260
======= =======
NINE MONTHS ENDED MARCH 31, 1998
Balance at June 30, 1997........................... $20,145 $29,672
Net income......................................... 2,038 2,038
Accumulated other comprehensive income:
Unrealized holding loss arising during period.. - (104)
Re-classification adjustment for gains
realized in income............................ - (35)
Income tax effect............................. - 14
Amortization of unearned ESOP and
restricted stock award compensation.............. - 333
Exercise of stock options (47,708 shares issued
in connection with 55,340 options issued)........ (96) 111
------- -------
Balance at March 31, 1998.......................... $22,087 $32,342
======= =======
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
-------------- ------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net Income.................................................................. $ 2,225 $ 2,038
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Provision for losses on loans and real estate............................. 480 640
Provision for depreciation and amortization............................... 328 234
Net (gain) loss on sales of investments and
mortgage-backed and related securities.................................. (35) 8
Net gain on sale of loans................................................. (832) (137)
Amortization of unearned ESOP and restricted stock awards................. 331 333
Loans originated for sale................................................. (49,319) (10,086)
Sales of loans originated for sale........................................ 46,376 10,086
Decrease (increase) in prepaid expenses and other assets.................. (1,158) 122
Decrease in payables for investments purchased........................... (9,858) --
Increase in accrued expenses and other liabilities........................ 152 --
Other adjustments......................................................... (366) (115)
-------- ---------
Net cash provided by (used in) operating activities......................... (11,676) 3,123
-------- ---------
INVESTING ACTIVITIES
Proceeds from the sale of securities available-for-sale..................... 5,535 20,881
Proceeds from the maturity of securities available-for-sale................. 8,150 4,000
Purchases of securities available-for-sale.................................. (103,130) (28,961)
Proceeds from maturities of investment securities held-to-maturity.......... 572 297
Purchases of mortgage-backed and related securities......................... (10,320) (352)
Principal collected on mortgage-backed and related securities............... 74,895 15,959
Net increase in loans receivable............................................ (2,967) (10,604)
Proceeds from sales of foreclosed properties................................ 11 273
Purchase of Federal Home Loan Bank stock.................................... (899) (754)
Purchases of office properties and equipment, net........................... (439) (2,769)
-------- ---------
Net cash used in investing activities....................................... (28,592) (2,030)
-------- ---------
FINANCING ACTIVITIES
Net increase (decrease) in deposits......................................... 36,236 (5,740)
Proceeds from notes payable to Federal Home Loan Bank....................... 25,000 30,000
Repayment of notes payable to Federal Home Loan Bank........................ (13,000) (14,000)
Exercise of stock options................................................... 274 111
Purchase of treasury stock.................................................. (898) --
Net decrease in advance payments by borrowers for
taxes and insurance....................................................... (1,513) (1,743)
-------- ---------
Net cash provided by financing activities................................... 46,099 8,628
-------- ---------
Increase in cash and cash equivalents....................................... 5,831 9,721
Cash and cash equivalents at beginning of period............................ 8,184 8,755
-------- ---------
Cash and cash equivalents at end of period.................................. $ 14,015 $ 18,476
======== =========
See accompanying Notes to Consolidated Financial Statements (unaudited)
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HALLMARK CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
MARCH 31,
----------------------
1999 1998
-------------- ------------
(IN THOUSANDS)
Supplemental disclosures of cash flow information:
Interest paid (including amounts credited to deposit accounts) .............. $16,748 $16,366
Income taxes paid ........................................................... $1,318 $1,345
Non-cash transactions:
Loans transferred to foreclosed properties .................................. $512 $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 nine months ended
March 31, 1999 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 nine
months ended March 31, 1999. 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 March 31, 1999, the Company has reserved 398,312 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 nine months ended March 31, 1999:
SHARES UNDER OPTION PRICE WEIGHTED
OPTION PER SHARE AVERAGE
------ --------- -------
Outstanding and exercisable at June 30, 1998................. 321,274 $4.00 - $7.625 $5.45
Exercised................................................ (38,624) $4.00 - $7.550 $4.18
------- -------------- -----
Outstanding and exercisable at March 31, 1999................ 282,650 $4.00 - $7.625 $5.64
(3) EARNINGS PER SHARE
Basic earnings per share of common stock for the three and nine months ended
March 31, 1999 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 March 31, 1999 Ended March 31, 1998
-------------------- --------------------
Basic Diluted Basic Diluted
----- ------- ----- -------
Weighted average common shares outstanding........... 2,881,965 2,881,965 2,933,608 2,933,608
Ungranted restricted stock........................... (18,462) (18,462) (18,462) (18,462)
Uncommitted ESOP shares.............................. (120,175) (120,175) (145,475) (145,475)
Common stock equivalents due to
dilutive effect of stock options.................. - 87,692 - 249,382
--------- --------- --------- ---------
Total weighted average common shares
and equivalents outstanding....................... 2,743,328 2,831,020 2,769,671 3,019,053
========= ========= ========= =========
Net income for period........................ $718,000 $718,000 $679,000 $679,000
Earnings per share........................... $0.26 $0.25 $0.24 $0.22
========= ========= ========== =========
For the Nine Months For the Nine Months
Ended March 31, 1999 Ended March 31, 1998
-------------------- --------------------
Basic Diluted Basic Diluted
----- ------- ----- -------
Weighted average common shares outstanding........... 2,907,363 2,907,363 2,912,916 2,912,916
Ungranted restricted stock........................... (18,462) (18,462) (18,462) (18,462)
Uncommitted ESOP shares.............................. (120,175) (120,175) (145,475) (145,475)
Common stock equivalents due to
dilutive effect of stock options..................... - 95,345 - 237,830
---------- ---------- ---------- ---------
Total weighted average common shares
and equivalents outstanding.................. 2,831,020 2,864,071 2,748,979 2,986,809
========= ========= ========== =========
Net income for period........................ $2,225,000 $2,225,000 $2,038,000 $2,038,000
Earnings per share........................... $0.80 $0.78 $0.74 $0.68
========== ========== =========== ==========
(4) COMMITMENTS AND CONTINGENCIES
Commitments to originate mortgage loans of $3.1 million at March 31, 1999
represent amounts which the Bank expects to fund during the quarter ending June
30, 1999. There were no commitments to sell fixed-rate mortgage loans at March
31, 1999. The Bank had unissued credit under existing home equity line-of-credit
loans and credit card lines of $11.8 million and $8.8 million, respectively, as
of March 31, 1999. Also, the Bank had unused credit under existing commercial
line-of-credit loans of $8.3 million at March 31, 1999. The Bank had no
commitments to purchase fixed-rate mortgage related securities as of March 31,
1999.
(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.
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(5) REGULATORY CAPITAL ANALYSIS (CONT.)
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). As of March 31, 1999, Management believes that the Bank
meets all capital adequacy requirements to which it is subject.
As of March 31, 1999, 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 March 31, 1999:
Tier I Capital Leverage (to Average Assets):
Consolidated........................ $35,367 7.14% $14,864 3.00% N/A N/A
West Allis Savings Bank............. 31,242 6.32 14,819 3.00 24,699 5.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated........................ 35,367 12.33 11,473 4.00 N/A N/A
West Allis Savings Bank............. 31,242 10.62 11,768 4.00 17,652 6.00
Total Capital (to Risk-Weighted Assets):
Consolidated........................ 37,890 13.21 22,946 8.00 N/A N/A
West Allis Savings Bank............. 33,765 11.48 23,535 8.00 29,419 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 March 31, 1999, on
a fully-phased-in basis of 6.0%, the Bank had actual capital of $33,658,000 with
a required amount of $28,815,000, for excess capital of $4,843,000.
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(6) LOANS RECEIVABLE
Loans receivable are summarized as follows:
MARCH 31, JUNE 30,
1999 1998
-------------------- --------------------
(IN THOUSANDS)
INCREASE
AMOUNT PERCENT AMOUNT PERCENT (DECREASE)
------ ------- ------ ------- --------
REAL ESTATE MORTGAGE LOANS:
RESIDENTIAL ONE-TO-FOUR FAMILY................... $148,730 50.1% $155,082 53.7% $(6,352)
HOME equity...................................... 21,079 7.1% 25,079 8.7% (4,000)
Residential multi-family......................... 36,598 12.3% 33,513 11.6% 3,085
Commercial real estate........................... 39,671 13.4% 34,610 12.0% 5,061
Residential construction......................... 5,409 1.8% 6,838 2.4% (1,429)
Other construction and land...................... 21,833 7.4% 13,874 4.8% 7,959
-------- ----- -------- ------ -------
Total real estate mortgage loans............ 273,320 92.1% 268,996 93.2% 4,324
Consumer-related loans:
Automobile....................................... 466 0.2% 755 0.3% (289)
Credit card...................................... 2,450 0.8% 2,777 1.0% (327)
Other consumer loans............................. 1,108 0.4% 1,476 0.4% (368)
-------- ----- -------- ------ --------
Total consumer-related loans................ 4,024 1.4% 5,008 1.7% (984)
-------- ----- -------- ------ --------
Commercial loans..................................... 19,183 6.5% 14,646 5.1% 4,537
-------- ----- -------- ------ --------
Gross loans................................. 296,527 100.0% 288,650 100.0% 7,877
Accrued interest receivable.......................... 1,712 1,764
Less:
Undisbursed portion of loan proceeds............. (11,028) (6,848)
Deferred loan fees............................... (474) (319)
Unearned interest................................ (6) (29)
Allowances for loan losses....................... (2,523) (2,329)
-------- --------
$284,208 $280,889
======== ========
Loans serviced for investors totaled $28.2 million and $25.7 million at March
31, 1999 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):
MARCH 31, 1999 JUNE 30, 1998
---------------------------- ----------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
MATURITY AMOUNT RATE AMOUNT RATE
-------- ------ ---- ------ ----
Advances from
Federal Home Loan Bank 1998 $ - - $ 8,000 5.51%
1999 16,000 6.61% 21,000 6.62
2000 27,007 5.98 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 4.77 20,000 4.95
-------- --------
$129,059 5.66% $117,059 5.87%
======== ===== ======== =====
FHLB advances totaled $129.1 million or 100.0% and $117.1 million or 100.0% of
total borrowings at March 31, 1999 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 $50.9 million and $30.7
million at March 31, 1999 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 $900,000 based upon collateral pledged at March 31, 1999. 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. There were no
liabilities recorded under agreements to repurchase substantially identical
securities at March 31, 1999 and June 30, 1998, respectively.
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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 its 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
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1997, pursuit of the strategy also resulted in increases in the Company's net
income, earnings per share, ROAE and ROAA for fiscal 1997.
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.
In fiscal 1998 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 has continued and 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 has been and 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 has included
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.* As of March 31, 1999, the Company purchased an aggregate of
$27.4 million, or 9.1% of gross loans at March 31, 1999, of loans and
participation interests in such loans secured by properties located outside the
Company's primary lending area. These loans and participation interests
consisted primarily of commercial real estate 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.
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The Company has funded and intends to continue 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 has increased and intends to continue
increasing the activities of its commercial lending division as another element
of the overall portfolio diversification strategy.* The focus of the Company's
commercial lending operation will be small business loans and leases. Management
currently anticipates that the commercial lending division will generate
approximately $40 million in new commercial loans/leases during fiscal 1999.*
Management believes that the commercial lending component of its operations will
benefit the Company longer term, and should contribute to a long-term increase
in net income and return on equity.* The commercial lending division also has
enhanced the Company's core deposit base through the establishment of new
deposit relationships with the commercial lending division's customers. As of
March 31, 1999, commercial deposits totaled $5.2 million or 1.7% of the
Company's deposit base.
In April 1999, the Company announced the creation of Hallmark Financial, Inc., a
wholly owned subsidiary of the Bank ("HFI"). HFI's operations will be focused on
lending activities involving 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 limited history
regarding the borrower's income. A secondary market of private investors and
mortgage bankers provides a mechanism for the establishment of underwriting
standards, sale and servicing of subprime loans. HFI intends to sell all
subprime loans originated into the secondary market.* 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 generally paid in connection with
such loans.* These loans generally are sold without recourse as to credit risk;
however, depending upon the contract between HFI and the secondary market
purchaser, HFI may retain some contractual liability in the event of defects or
misrepresentations in the origination process.
HFI intends to originate subprime loans primarily secured by one-to-four family
real estate within the primary lending area of the Bank using underwriting
guidelines established by the secondary market lenders that will purchase such
loans.* The secondary market lenders' underwriting guidelines will be utilized
since HFI intends to receive a commitment from a secondary market lender to
purchase a subprime loan prior to HFI's origination of such loan.* Management
estimates that HFI will originate approximately $5.0 million in subprime loans,
generating approximately $175,000 of fee income on the sale of such subprime
loans during fiscal 2000.* The Company will also evaluate opportunities to
originate subprime loans outside of its primary lending area.* The Company's
competitors in the subprime loan finance market include other banks, consumer
finance companies, mortgage banking companies, commercial banks, credit unions
and subprime loan brokers, many of which are substantially larger and have
considerably greater financial, technical and marketing resources.
Such competitors have both a local or national market presence.
In fiscal 2000, 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
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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 the nine
months ended March 31, 1999 was primarily the result of increases in the
commercial and commercial real estate loan portfolios. Loans secured by
multi-family and commercial real estate and commercial business assets generally
involve a greater degree of credit risk than one-to-four family loans and carry
larger balances. The increased credit risk is the result of several factors,
including concentration of principal in a limited number of loans and borrowers,
the effect of general economic conditions on income-producing properties, and
the increased difficulty of evaluating and monitoring these types of loans.
Management anticipates that as the Company's volume of multi-family and
commercial/nonresidential real estate and commercial business lending activity
continues to increase, the Company will need to build a higher level of
allowance for loan losses established through a provision for loan losses, which
will have a negative effect on the Company's net income in the short-term.*
However, the Company believes that building the higher yielding multi-family and
commercial/nonresidential real estate components of its gross loan portfolio
will benefit the Company longer term, and should contribute to a long-term
improvement in the Company's net income and return on equity.*
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
predicable 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 nine months ended March 31, 1999 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 nine
months ended March 31, 1999, the Company originated and purchased loans totaling
$161.2 million and $29.9 million, respectively, as compared to the nine months
ended March 31, 1998 when originated and purchased loans totaled $104.7 million
and $13.5 million, respectively. Purchases of mortgage-backed and related
securities held-to-maturity for the nine months ended March 31, 1999 and 1998
totaled $10.3 million and $352,000, respectively. There were no purchases of
investment securities held-to-maturity for the nine months ended March 31, 1999
and 1998. For the nine months ended March 31, 1999 and 1998, these activities
were funded primarily by principal repayments on loans of $145.1 million and
$98.4 million, respectively; principal repayments on mortgage-backed and related
securities of $74.9 million and $16.0 million, respectively; proceeds from the
sale of mortgage loans of $45.6 million and $10.1 million, respectively; net
proceeds from notes payable to the FHLB-Chicago of $12.0 million and $16.0
million, respectively; and a net increase in deposits of $36.2 million during
the 1999 period. Purchases of securities available-for-sale totaled $103.1
million and sales were $5.5 for the nine months ended March 31, 1999, compared
to purchases of $29.0 million and sales of $20.9 million for the nine months
ended March 31, 1998.
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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 31.3% at March 31, 1999. 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 March 31, 1999 and June 30, 1998, cash
and cash equivalents were $14.0 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 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 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 March 31, 1999, retail and wholesale certificates of deposit totaled $67.6
million and $173.9 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 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 March 31, 1999, FHLB advances totaled $129.1 million or 27.1% of the Bank's
total assets. There were no securities sold under agreements to repurchase at
March 31, 1999. At March 31, 1999, the Bank had unused borrowing authority under
the borrowing limitations established by the Board of Directors of $23.3 million
and $37.6 million under the FHLB total asset limitation. The Bank has and
intends to continue 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
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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 March 31, 1999 which represent
amounts the Company expects to fund during the quarter ended June 30, 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 $39.5 million, or 9.0%, from $438.4 million at June 30,
1998 to $477.9 million at March 31, 1999. 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-Chicago
advances and decreases in mortgage-backed and related securities
held-to-maturity. Cash and cash equivalents were $14.0 million and $8.2 million
at March 31, 1999 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 $103.0 million at March 31, 1999
compared to $66.4 million at June 30, 1998. Mortgage-backed and related
securities available-for-sale increased to $70.3 million at March 31, 1999
compared to $57.5 million at June 30, 1998. Investment securities
available-for-sale increased to $32.7 million at March 31, 1999 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 $284.2 million at March 31, 1999 compared to
$280.9 million at June 30, 1998. The increase at March 31, 1999 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 nine months ended March 31, 1999. Total
mortgage loans originated and purchased amounted to $148.5 million ($3.5 million
of which were purchased mortgage loans) and $90.9 million ($10.4 million of
which were purchased mortgage loans) for the nine months ended March 31, 1999
and 1998, respectively, while sales of fixed-rate mortgage loans totaled $49.3
million and $10.1 million for the nine months ended March 31, 1999 and 1998,
respectively. Total commercial real estate mortgage loans originated and
purchased totaled $33.2 million and $8.7 million for the nine months ended March
31, 1999 and 1998, respectively.
Deposits increased $36.2 million to $307.9 million at March 31, 1999 from $271.6
million at June 30, 1998. The increase in deposits was primarily due to the
Company's increase in wholesale brokered and non-brokered deposits. Brokered
certificates of deposit totaled $120.5 million at March 31, 1999, representing
39.1% of total deposits as compared to $81.4 million, or 30.0% of total
deposits, at June 30, 1998. Non-brokered wholesale deposits totaled $53.4
million at March 31, 1999, representing 17.4% of total deposits as
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compared to $42.9 million, or 15.8% of total deposits at June 30, 1998. Also,
the Company increased its use of money market deposit accounts for the nine
months ended March 31, 1999. Money market deposit accounts totaled $34.5 million
at March 31, 1999, representing 11.2% of total deposits as compared to $28.0
million, or 10.3% of total deposits as of 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 $129.1 million at March 31, 1999 compared to
$117.1 million at June 30, 1998. At March 31, 1999, the Company had no 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
nine months ended March 31, 1999, the Company utilized wholesale brokered and
non-brokered deposits, 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 wholesale deposits, money market deposit accounts
and FHLB advances. At March 31, 1999, the Company's estimated cumulative
one-year gap between assets and liabilities was a negative 17.5% of total assets
as compared to a negative 5.1% at June 30, 1998. The increase in the Company's
negative one-year 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 March 31, 1999 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....................................$ 11,349 $ 32,103 $ 58,917 $32,461 $25,227 $160,057
Adjustable rate............................... 25,707 45,893 27,741 3,505 1,253 104,099
Consumer loans (2)................................. 386 2,980 524 - - 3,890
Commercial loans (2)............................... 7,766 4,625 6,292 - - 18,683
Mortgage-backed and related securities:
Fixed rate and securities available-for-sale.. 2,856 7,521 14,153 8,526 7,499 40,555
Adjustable rate............................... 54,304 29,276 - - - 83,580
Investment securities and
securities available-for-sale ................... 21,277 2,375 160 4,974 24,049 52,835
-------- -------- -------- ------- ------- --------
Total interest-earning assets.................$123,645 $124,773 $107,787 $49,466 $58,028 $463,699
======== ======== ======== ======= ======= ========
INTEREST-BEARING LIABILITIES:
Deposits(3):
NOW accounts..................................$ 206 $ 618 $ 981 $ 481 $ 462 $ 2,748
Money market deposit accounts................. 5,174 15,521 11,588 1,854 353 34,490
Passbook savings accounts..................... 1,594 4,781 7,586 3,717 3,571 21,249
Certificates of deposit....................... 112,155 103,884 22,344 3,159 - 241,542
Escrow deposits............................... - 1,650 - - - 1,650
Borrowings(4)
FHLB advances and other borrowings............ 68,500 18,000 23,007 3,052 16,500 129,059
-------- -------- -------- ------- -------- --------
Total interest-bearing liabilities............$187,629 $144,454 $ 65,506 $12,263 $ 20,886 $430,738
======== ======== ======== ======= ======== ========
Excess (deficiency) of interest-earning assets over
interest-bearing liabilities.....................($63,984) ($19,681) $42,281 $37,203 $37,142 $ 32,961
======== ======== ======= ======= ======= ========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities.........($63,984) ($83,665) ($41,384) ($ 4,181) $32,961 $ 32,961
======== ======= ======= ======== ======= ========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities
as a percent of total assets..................... (13.4)% (17.5)% (8.7)% (0.9)% 6.9% 6.9%
======== ======= ======= ======== ======= ========
(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 $14.1 million at March
31, 1999.
(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 $114.3 million or 23.9% 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.
18
21
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
---------------------------------------------------------
MAR 31 DEC 31 SEP 30 JUN 30 MAR 31
1999 1998 1998 1998 1998
------ ------ ------ ------ ------
Non-accrual mortgage loans............................ $2,266 $3,238 $1,674 $1,338 $1,028
Non-accrual consumer loans............................ 129 136 45 52 24
------ ------ ------ ------ ------
Total non-accrual loans............................... $2,395 $3,374 $1,719 $1,390 $1,052
====== ====== ====== ====== ======
Loans 90 days or more
delinquent and still accruing....................... 54 52 32 20 61
------ ------ ------ ------ ------
Total non-performing loans............................ $2,449 $3,426 $1,751 $1,424 $1,113
====== ====== ====== ====== ======
Non-accrual investment securities..................... 233 233 - - -
Total foreclosed real estate net of
related allowance for losses ....................... 512 11 11 11 11
------ ------- ------ ------ ------
Total non-performing assets........................... $3,194 $3,670 $1,762 $1,435 $437
====== ====== ====== ====== ====
Non-performing loans to
gross loans receivable.............................. 0.83% 1.14% 0.60% 0.50% 0.38%
====== ===== ====== ====== ======
Non-performing assets to
total assets ....................................... 0.67% 0.76% 0.38% 0.33% 0.27%
====== ===== ====== ====== ======
At March 31, 1999, non-performing loans increased to $2.4 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.
Impaired loans increased to $1.1 million at March 31, 1999 from $683,000 at June
30, 1998. Impaired loans consist primarily of commercial and commercial real
estate loans which, based on current information and events, it is probable that
the Bank will be unable to collect all amounts due according to the contractual
terms of the loan agreement. 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:
NINE MONTHS YEAR NINE MONTHS
ENDED ENDED ENDED
MAR. 31, 1999 JUNE 30, 1998 MAR. 31, 1998
------------- ------------- -------------
(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.......... 340 512 412
Consumer......................................... 80 163 133
Commercial....................................... 60 125 95
-------- -------- ----------
480 800 640
Recoveries:
ONE- TO FOUR-FAMILY............................. - - -
Consumer........................................ 9 31 26
-------- -------- ----------
9 31 26
Charge-offs:
One- to four-family............................. (11) (69) (69)
Multi-family & commercial real estate........... (171) (69) -
Consumer.................................. (113) (195) (142)
--------- -------- ----------
(295) (264) (211)
---------- -------- ----------
Net charge-offs.................................... (286) (233) (185)
--------- -------- ----------
Balance at end of period........................... $ 2,523 $ 2,329 $ 2,217
========= ======== ==========
Allowance for loan losses to
non-performing loans at end
of the period.................................... 103.02% 163.55% 188.97%
======== ======= ========
Allowance for loan losses to
total loans at end of the period................. 0.85% 0.81% 0.75%
======== ======= ========
The level of allowance for loan losses at March 31, 1999, reflects the continued
low level of charged off loans. Management believes that the allowance for loan
losses is adequate as of March 31, 1999.
20
23
RESULTS OF OPERATIONS - COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 AND
1998
GENERAL
Net income for the three months ended March 31, 1999 increased to $718,000 from
$679,000 for the comparable 1998 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 8.25% for the three months ended March 31,
1999 from 8.51% for the comparable 1998 period. Return on average assets
decreased to 0.59% for the three months ended March 31, 1999 from 0.66% for the
comparable 1998 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 MARCH 31,
1 9 9 9 1 9 9 8
-------------------------------------------------------------------------
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.......................... $268,089 $5,430 8.10% $270,602 $5,648 8.35%
Consumer loans.......................... 3,970 144 14.51 5,244 174 13.27
Commercial loans........................ 16,603 381 9.18 7,751 194 10.01
--------- -------- --------- ------
Total loans.......................... 288,662 5,955 8.25 283,597 6,016 8.49
Securities held-to-maturity:
Mortgage-backed securities............ 13,000 204 6.28 39,035 689 7.06
Mortgage related securities........... 41,608 671 6.45 37,011 633 6.84
--------- -------- --------- ------
Total mortgage-backed
and related securities............. 54,608 875 6.41 76,046 1,322 6.95
Investment and other securities......... 21,275 280 5.26 11,251 168 5.97
Securities available-for-sale........... 104,007 1,586 6.10 21,031 338 6.43
Federal Home Loan Bank stock............ 6,793 105 6.18 6,027 99 6.57
--------- -------- --------- ------
Total interest-earning assets......... 475,345 8,801 7.41 397,952 7,943 7.98
Non-interest earning assets............... 12,780 14,896
--------- ---------
Total assets.......................... $488,125 $412,848
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
NOW accounts............................ $ 2,805 12 1.71% $ 2,653 11 1.66%
Money market deposit accounts........... 40,639 464 4.57 26,351 339 5.15
Passbook accounts....................... 20,765 149 2.87 20,629 149 2.89
Certificates of deposit................. 243,370 3,345 5.50 207,340 3,066 5.91
--------- ------- -------- ------
Total deposits........................ 307,579 3,970 5.16 256,973 3,565 5.55
Advance payments by borrowers
for taxes and insurance................ 908 5 2.20 1,028 7 2.72
Borrowings................................ 131,746 1,874 5.69 112,448 1,687 6.00
--------- ------- -------- ------
Total interest-bearing liabilities.... 440,233 5,849 5.31 370,449 5,259 5.68
Non-interest bearing deposits
and liabilities......................... 13,081 10,478
Shareholders' equity...................... 34,811 31,921
---------- --------
Total liabilities and
shareholders' equity................ $488,125 $412,848
======== ========
Net interest income/interest rate spread.. $2,952 2.10% $2,684 2.30%
====== ===== ====== =====
Net earning assets/net interest margin.... $35,112 2.48% $27,503 2.70%
========= ===== ======== =====
21
24
Net interest income before provision for losses on loans increased $268,000, or
10.0%, to $3.0 million for the three months ended March 31, 1999 from $2.7
million for the comparable 1998 period. Interest income increased $858,000 for
the three months ended March 31, 1999, partially offset by an increase in
interest expense of $590,000. The level of net interest income primarily
reflects a 19.2% increase in average interest-earning assets to $474.2 million
for the three months ended March 31, 1999 from $398.0 million for the comparable
1998 period, a 27.6% increase in the excess of the Company's average
interest-earning assets over average interest-bearing liabilities to $35.1
million for the three months ended March 31, 1999 from $27.5 million for the
comparable 1998 period, offset by a decrease in interest rate spread to 2.10%
for the three months ended March 31, 1999 from 2.30% for the comparable 1998
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 10.8% to $8.8 million for the three months ended March
31, 1999 from $7.9 million for the comparable 1998 period. The increase in
interest income was the result of an increase in average interest-earning assets
of 19.2% to $474.2 million for the three months ended March 31, 1999 from $398.0
million for the comparable 1998 period, offset by a decrease of 57 basis points
in the yield on interest-earning assets to 7.41% for the three months ended
March 31, 1999 from 7.98% for the comparable 1998 period. Interest income on
loans decreased 1.0% to $5.9 million for the three months ended March 31, 1999,
from $6.0 million for the comparable 1998 period. The decrease was the result of
a decrease in average yield to 8.25% for the three months ended March 31, 1999
from 8.49% for the comparable 1998 period, partially offset by a rise in the
Company's average gross loans of 1.8% to $288.7 million for the three months
ended March 31, 1999 from $283.6 million for the comparable 1998 period. Gross
loans increased primarily as a result of the Company retaining substantially all
of its adjustable and short-term fixed rate loan originations, purchasing more
loans in the secondary market and increases in multi-family and commercial
components of the portfolio. The decrease in yield is attributable to the
increase in loans refinanced at lower interest rates during the 1999 period. At
March 31, 1999, the multifamily and commercial components of the Company's loan
portfolio totaled $119.7 million, or 39.8% of the total loan portfolio, compared
to $96.8 million, or 32.8% of the total loan portfolio at March 31, 1998.
Interest income on mortgage-backed securities decreased 70.4% to $204,000 for
the three months ended March 31, 1999 from $689,000 for the comparable 1999
period. The decrease was primarily due to a decrease in average balances to
$13.0 million for the three months ended March 31, 1999 from $39.0 million for
the comparable 1998 period and a decrease in average yield to 6.28% for the 1999
period from 7.06% for the 1998 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 1999 period and the accelerated
amortization of purchase premiums on mortgage-backed securities due to faster
that projected principal repayments in the 1999 period. Interest income on
mortgage-related securities increased 6.0% to $671,000 for the three months
ended March 31, 1999 from $633,000 for the comparable 1998 period. The increase
was primarily due to an increase in average balances to $41.6 million for the
three months ended March 31, 1999 from $37.08 million for the comparable 1998
period, partially offset by a decrease in average yield to 6.45% for the three
months ended March 31, 1999 from 6.84% for the comparable 1998 period. The
decrease in average yield on mortgage-related securities was primarily due to
accelerated amortization of purchase premiums on mortgage related securities due
to faster than projected principal repayments during the 1999 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 268.8% to $1.9 million for the three
months ended March 31, 1999 from $506,000 for the comparable 1998 period. The
increase was primarily due to an increase in average balance to $125.3 million
for the three months ended March 31, 1999 from $32.3 million for the 1998
period, offset by a decrease in average yield to 5.96% for the three months
ended March 31, 1999 from 6.27% for the comparable 1998 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
1999 period as compared to the 1998 period.
22
25
INTEREST EXPENSE
Interest expense increased 11.2% to $5.9 million for the three months ended
March 31, 1999 from $5.3 million for the comparable 1998 period. The increase
was the result of an 18.8% increase in the average amount of interest-bearing
liabilities to $440.2 million for the three months ended March 31, 1999 compared
to $370.4 million for the comparable 1998 period, partially offset by a decrease
in the average rate paid on interest-bearing liabilities to 5.31% for the 1999
period from 5.68% for the 1998 period. The increased balances of wholesale
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 March
31, 1999 as compared to the comparable 1998 period. Interest expense on deposits
increased 11.1% to $4.0 million for the three months ended March 31, 1999 from
$3.6 million for the comparable 1998 period. The increase was the result of an
increase in average balances of 19.7% to $307.6 million for the three months
ended March 31, 1999 from $257.0 million for the comparable 1998 period,
partially offset by a decrease in the average rate paid to 5.16% for the 1999
period from 5.55% for the 1998 period. The increase in deposits was primarily
due to an increase of 53.8% in money market deposit accounts to $40.6 million
for the three months ended March 31, 1999 from $26.4 million for the comparable
1998, with a decrease in the average rate paid on such accounts to 4.57% for the
1999 period from 5.15% for the 1998 period. Money market deposit accounts
increased primarily due to aggressive marketing and a competitive rate offered
during the three months ended March 31, 1999. Certificate of deposit accounts
(including brokered deposits) increased 17.4% to $243.4 million for the three
months ended March 31, 1999 from $207.3 million for the 1998 period, with a
decrease in the average rate to 5.50% for the 1999 period from 5.91% for the
1998 period. NOW accounts increased 3.7% to $2.8 million for the three months
ended March 31, 1999 from $2.7 million for the comparable 1998 period, with an
increase in average rate paid to 1.79% for the 1999 period from 1.66% for the
1998 period. The Company's increase in certificates of deposit was the result of
aggressive marketing and pricing and the use of brokered certificates of
deposit. Of the $243.4 million in the average balance of certificates of deposit
for the three months ended March 31, 1999, $117.4 million, or 48.2%, represented
brokered certificates of deposit compared to $73.0 million, or 35.2%, for the
1998 period. The average rate paid on brokered certificates of deposit decreased
to 5.72% for the nine months ended March 31, 1999 from 6.17% for the comparable
1998 period. The decrease was primarily due to the lower interest rate
environment during the 1999 period as compared to the 1998 period. Interest on
borrowings (FHLB advances and reverse repurchase agreements) increased 11.1% to
$1.9 million for the three months ended March 31, 1999 from $1.7 million for the
comparable 1998 period. The increase was primarily due to the increase in
average balances of FHLB advances and reverse repurchase agreements of 17.2% to
$131.7 million for the three months ended March 31, 1999 from $112.4 million for
the comparable 1998 period, with a decrease in the average rate paid to 5.69%
for the 1999 period from 6.00% for the 1998 period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans decreased 30.0% to $140,000 for the three
months ended March 31, 1999 from $200,000 for the comparable 1998 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 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 March 31, 1999, the
allowance for losses on loans increased 8.3% to $2.5 million at March 31, 1999
compared to $2.3 million at March 31, 1998. This increase was primarily the
result of the increase in multi-family, multi-family construction, 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 and also due to an increase in non-performing loans. The ratio of
allowance for loan losses to gross loans increased to 0.85% at March 31, 1999
from 0.75% at March 31, 1998, reflecting the continued low level of loans
charged off loans. The amount of non-performing loans at March 31, 1999 was $2.4
million, or 0.83% of gross loans, compared to $1.4, or 0.50% of gross loans, at
June 30, 1998 and $1.1 million or 0.38% of gross loans at March 31, 1998.
23
26
NON-INTEREST INCOME
Non-interest income increased 57.0% to $573,000 for the three months ended March
31, 1999 from $365,000 for the comparable 1998 period. The largest components of
the increase were an increase in gains on the sale of loans to $180,000 for the
three months ended March 31, 1999 compared to $114,000 for the comparable 1998
period, an increase in service charges on loans to $127,000 for the three months
ended March 31, 1999 from $67,000 for the comparable 1998 period, an increase in
service charges on deposit accounts to $107,000 for the three months ended March
31, 1999 from $100,000 for the comparable 1998 period, an increase in other
income to $121,000 for the three months ended March 31, 1999 from $56,000 for
the 1998 period and an increase in insurance commissions to $31,000 for the
three months ended March 31, 1999 from $10,000 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 1999 period as compared to the
1998 period. The increase in service charges on loans reflects an increase in
the level of fees charged to loan customers in the 1999 period as compared to
the 1998 period. The increase in service charges on deposit accounts reflects an
increase in the level of fees charged to deposit customers in the 1999 period as
compared to the 1998 period. Partially, offsetting the increases in non-interest
income was a decrease in loan servicing fees to $7,000 for the three months
ended March 31, 1999 from $18,000 for the comparable 1998 period.
NON-INTEREST EXPENSE
Non-interest expense increased 28.5% to $2.3 million for the three months ended
March 31, 1999 from $1.8 million for the comparable 1997 period. The increase
was primarily due to an increase in compensation and benefits expense of
$369,000 to $1.4 million for the three months ended March 31,1999 from $994,000
for the comparable 1998 period, an increase in occupancy and equipment expense
of $122,000 to $449,000 for the three months ended March 31, 1999 from $327,000
for the comparable 1998 period and an increase in other non-interest expense of
$49,000 to $374,000 for the three months ended March 31, 1999 from $325,000 for
the comparable 1998 period. The increase in compensation and benefits expense
primarily relates to higher salary levels, an increase in the number of full
time equivalent employees and an increase in incentive compensation related to
the increased volume of loans sold into the secondary market. The increase in
occupancy and equipment 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 has been completed by March 31, 1999. There
are no mission critical systems which are non-compliant. Contingency plans are
in the process of development to address potential problems discovered during
testing. The contingency plans are expected to be completed by the fiscal year
end. 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
24
27
include, but are not limited to, system failure or miscalculations causing
disruptions of operations which may include the temporary 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 nine months ended March 31, 1999 for the Year 2000 project totaled
$5,000 and $35,700, 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 made inquiries and reviewed plans of certain third parties,
such as commercial loan customers, where Year 2000 failures could result in
significant adverse impact on the Company. The Company has completed the inquiry
and review process and is satisfied the Bank will not be subject to significant
adverse impact.* 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 NINE MONTHS ENDED MARCH 31, 1999 AND
1998
GENERAL
Net income for the nine months ended March 31, 1999 increased to $2.2 million
from $2.0 million for the comparable 1998 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 8.64% for the nine months ended March 31,
1999 from 8.75% for the comparable 1998 period. Return on average assets
decreased to 0.63% for the nine months ended March 31, 1999 from 0.65% for the
comparable 1998 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 NINE MONTHS ENDED MARCH 31,
---------------------------------------------------------
1 9 9 9 1 9 9 8
------------------------------------------------------------------------
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.......................... $265,383 $16,385 8.23% $269,489 $16,905 8.36%
Consumer loans.......................... 4,273 437 13.64 5,389 543 13.43
Commercial loans........................ 14,588 1,002 9.16 6,037 461 10.18
-------- ------- -------- -------
Total loans.......................... 284,244 17,824 8.36 280,915 17,909 8.50
Securities held-to-maturity:
Mortgage-backed securities............ 15,470 751 6.47 42,098 2,250 7.13
Mortgage related securities........... 43,117 2,263 7.00 37,908 1,947 6.85
-------- ------- -------- -------
Total mortgage-backed
and related securities............. 58,587 3,014 6.86 80,006 4,197 6.99
Investment and other securities......... 19,313 792 5.47 11,545 550 6.35
Securities available-for-sale........... 85,934 4,095 6.35 24,369 1,166 6.38
Federal Home Loan Bank stock............ 6,539 321 6.55 5,639 287 6.79
-------- ------- -------- -------
Total interest-earning assets......... 454,617 26,046 7.64 402,474 24,109 7.99
Non-interest earning assets............... 13,708 12,855
--------- --------
Total assets.......................... $468,325 $415,329
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
NOW accounts............................ $ 2,735 35 1.71% $ 2,618 33 1.68%
Money market deposit accounts........... 35,852 1,361 5.06 24,010 936 5.20
Passbook accounts....................... 21,127 461 2.91 21,180 471 2.97
Certificates of deposit................. 230,526 9,829 5.68 216,628 9,787 6.02
-------- ------- -------- -------
Total deposits........................ 290,240 11,686 5.37 264,436 11,227 5.66
Advance payments by borrowers
for taxes and insurance................ 3,000 60 2.67 3,275 68 2.77
Borrowings................................ 128,134 5,650 5.88 105,773 4,883 6.16
-------- ------- -------- -------
Total interest-bearing liabilities.... 421,374 17,396 5.50 373,484 16,178 5.78
Non-interest bearing deposits
and liabilities......................... 12,615 10,807
Shareholders' equity...................... 34,336 31,038
-------- --------
Total liabilities and
shareholders' equity................ $468,325 $415,329
======== ========
Net interest income/interest rate spread.. $ 8,650 2.12% $ 7,931 2.21%
======= ===== ======= =====
Net earning assets/net interest margin.... $33,243 2.54% $28,990 2.63%
======== ===== ======== =====
26
29
Net interest income before provision for losses on loans increased $719,000, or
9.1%, to $8.7 million for the nine months ended March 31, 1999 from $7.9 million
for the comparable 1998 period. Interest income increased $1.9 for the nine
months ended March 31, 1999, partially offset by an increase in interest expense
of $1.2 million. The level of net interest income primarily reflects a 13.0%
increase in average interest-earning assets to $454.6 million for the nine
months ended March 31, 1999 from $402.5 million for the comparable 1998 period
and a 14.7% increase in the excess of the Company's average interest-earning
assets over average interest-bearing liabilities to $33.2 million for the nine
months ended March 31, 1999 from $29.0 million for the comparable 1998 period.
INTEREST INCOME
Interest income increased 8.0% to $26.0 million for the nine months ended March
31, 1999 from $24.1 million for the comparable 1998 period. The increase in
interest income was the result of an increase in average interest-earning assets
of 13.0% to $454.6 million for the nine months ended March 31, 1999 from $402.5
million for the comparable 1998 period, partially offset by a decrease of 35
basis points in the yield on interest-earning assets to 7.64% for the nine
months ended March 31, 1999 from 7.99% for the comparable 1998 period. Interest
income on loans decreased 0.5% to $17.8 million for the nine months ended March
31, 1999 from $17.9 million for the comparable 1998 period. The decrease was the
result of a decrease in average yield to 8.36% for the nine months ended March
31, 1999 from 8.50% for the comparable 1997 period, partially offset by an
increase in average gross loans of 1.2% to $284.2 million for the nine months
ended March 31, 1999 from $280.9 million for the comparable 1998 period. Gross
loans increased primarily as a result of the Company retaining substantially all
of its adjustable and short-term fixed rate loan originations, purchasing more
loans in the secondary market and increases in multi-family and commercial
components of the portfolio. The decrease in yield is attributable to the
increase in loans refinanced at lower interest rates. Interest income on
mortgage-backed securities decreased 66.6% to $751,000 for the nine months ended
March 31, 1999 from $2.3 million for the comparable 1998 period. The decrease
was primarily due to a decrease in average balances to $15.5 million for the
nine months ended March 31, 1999 from $42.1 million for the comparable 1998 and
a decrease in average yield to 6.86% for the 1999 period from 7.13% for the 1998
period. Interest income on mortgage-related securities increased 16.2% to $2.3
million for the nine months ended March 31, 1999 from $1.9 million for the
comparable 1998 period. The increase was primarily due to an increase in average
balances to $43.1 million for the nine months ended March 31, 1999 from $37.9
million for the comparable 1998 period and an increase in average yield to 7.0%
for nine months ended March 31, 1999 from 6.85% for the comparable 1998 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 1999 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
1999 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 184.8% to $4.9 million for the nine months ended
March 31, 1999 from $1.7 million for the comparable 1998 period. The increase
was primarily due to an increase in average balance to $105.3 million for the
nine months ended March 31, 1999 from $35.9 million for the 1998 period,
partially offset by a decrease in average yield to 6.19% for the 1999 period
from 6.39% for the 1998 period. The lower average yield was primarily
attributable to the lower interest rate environment during the 1999 period as
compared to the 1998 period and the short-term maturity of the securities in
this portfolio.
INTEREST EXPENSE
Interest expense increased 7.5% to $17.4 million for the nine months ended March
31, 1999 from $16.2 million for the comparable 1998 period. The increase was the
result of an 12.8% increase in the average amount of interest-bearing
liabilities to $421.4 million for the nine months ended March 31, 1999 compared
to $373.5 million for the comparable 1998 period, partially offset by a decrease
in the average rate paid on interest-bearing liabilities to 5.50% for the 1999
period from 5.78% for the 1998 period. The increased balances of certificates of
deposit (including brokered deposits), money market deposit accounts, NOW
accounts and
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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
nine months ended March 31, 1999 as compared to the comparable 1998 period.
Interest expense on deposits increased 4.1% to $11.7 million for the nine months
ended March 31, 1999 from $11.2 million for the comparable 1998 period. The
increase was the result of an increase in average balances of 5.3% to $290.2
million for the nine months ended March 31, 1999 from $264.4 million for the
comparable 1998 period, partially offset by a decrease in the average rate paid
to 5.37% for the 1999 period from 5.66% for the 1998 period. The increase in
deposits was primarily due to an increase of 6.41% in certificates of deposit
(including brokered deposits) to $230.5 million for nine months ended March 31,
1999 from $216.6 million for the 1998 period, with a decrease in the average
rate paid on such deposits to 5.68% for the 1999 period from 6.02% for the 1998
period. Money market deposit accounts increased 49.3% to $35.9 million for the
nine months ended March 31, 1999 from $24.0 million for the comparable 1998
period, with a decrease in the average rate paid on such deposits to 5.06% for
the 1999 period from 5.20% for the 1998 period. Money market deposit accounts
increased primarily due to aggressive marketing and a competitive rate offered
during the nine months ended March 31, 1999. NOW accounts increased 4.5% to $2.7
million for the nine months ended March 31, 1999 from $2.6 million for the
comparable 1998 period, with an increase in average rate paid to 1.71% for the
1999 period from 1.68% for the 1998 period. The Company's increase in
certificates of deposit was the result of aggressive marketing and pricing and
the use of brokered certificates of deposit. Of the $230.5 million in the
average balance of certificates of deposit for the nine months ended March 31,
1999, $101.3 million, or 44.0%, represented brokered certificates of deposit
compared to $81.7 million, or 37.7%, for the 1998 period. The average rate paid
on brokered certificates of deposit decreased to 5.72% for the nine months ended
March 31, 1999 from 6.15% for the comparable 1998 period. The decrease was
primarily due to the lower interest rate environment during the 1999 period as
compared to the 1998 period. Interest on borrowings (FHLB advances and reverse
repurchase agreements) increased 15.7% to $5.7 million for the nine months ended
March 31, 1999 from $4.9 million for the comparable 1998 period. The increase
was primarily due to the increase in average balance to $128.1 for the nine
months ended March 31, 1999 from $105.8 for the comparable 1998 period,
partially offset by a decrease in average rate paid to 5.88% for the nine months
ended March 31, 1999 from 6.16% for the 1998 period.
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans decreased 25.0% to $480,000 for nine months
ended March 31, 1999 from $640,000 for the comparable 1998 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 March 31, 1999 and 1998."
NON-INTEREST INCOME
Non-interest income increased 119.6% to $1.8 million for the nine months ended
March 31, 1999 from $801,000 for the comparable 1998 period. The largest
components of the increase were an increase in gains on the sale of loans to
$832,000 for the nine months ended March 31, 1999 from $137,000 for the
comparable 1998 period, an increase in service charges on loans to $262,000 for
the nine months ended March 31, 1999 from $202,000 for the comparable 1998
period, an increase in service charges on deposit accounts to $341,000 for the
nine months ended March 31, 1999 from $323,000 for the comparable 1998 period,
an increase in gains on the sale of securities and mortgage-backed and related
securities to $35,000 for the nine months ended March 31, 1999 from a loss of
$8,000 for the comparable 1998 period, an increase in insurance commissions to
$60,000 for the nine months ended March 31, 1999 from $18,000 for the comparable
1998 period and an increase in other non-interest income to $209,000 for the
nine months ended March 31, 1999 from $71,000 for the comparable 1998 period.
The increase in gains on the sale of loans reflects the increase in long-term
fixed rate loans sold into the secondary market during the 1999 period as
compared to the 1998 period. Offsetting the increases in non-interest income was
a decrease in loan servicing fees to $20,000 for the nine months ended March 31,
1999 from $58,000 for the comparable 1998 period.
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NON-INTEREST EXPENSE
Non-interest expense increased 32.7% to $6.6 million for the nine months ended
March 31, 1999 from $5.0 million for the comparable 1998 period. The increase
was primarily due to an increase in compensation and benefits expense of $1.0
million to $3.9 million for the nine months ended March 31, 1999 from $2.9
million for the comparable 1998 period, an increase in occupancy and equipment
expense of $420,000 to $1.2 million for the nine months ended March 31, 1999
from $822,000 for the comparable 1998 period and an increase in other
non-interest expense of $220,000 to $1.1 million for the nine months ended March
31, 1999 from $858,000 for the comparable 1998 period. The increase in
compensation and benefits expense primarily relates to higher salary levels, an
increase in the number of full time equivalent employees and an increase in
incentive compensation related to the increased volume of loans sold into the
secondary market. The increase in occupancy and equipment expense primarily
relates to the addition of an administrative facility and increased purchases of
bank equipment. The increase in other non-interest income is primarily due to
increases in printing, office supplies, organization dues, legal and other
miscellaneous expenses.
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 14 to 15 and "Asset/Liability Management" from pages 17 to 19 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
There were no matters submitted to Security Holders for vote.
ITEM 5. OTHER INFORMATION
On October 21, 1998, the Company announced it had adopted a share
repurchase program for its common stock to purchase up to 5%, or
approximately 146,900 shares. The repurchase program was to expire on
April 21, 1999. On April 19, 1999, the Company extended the share
repurchase program to expire on May 31, 1999. The repurchased shares
will become treasury shares and will be used for general corporate
purposes. As of May 14, 1999, the Company had purchased 87,900 shares
of common stock pursuant to the repurchase program and has the ability
to repurchase approximately 59,000 additional shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
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: May 14, 1999 /s/ James D. Smessaert
---------------------------------------------
James D. Smessaert
Chairman of the Board
Chief Executive Officer
Date: May 14, 1999 /s/ Arthur E. Thompson
--------------------------------------------
Arthur E. Thompson
Chief Financial Officer
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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: May 14, 1999
--------------------------------------------
James D. Smessaert
Chairman of the Board
Chief Executive Officer
Date: May 14, 1999
---------------------------------------------
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.
33