UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
Commission file number 0-24566
AVONDALE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
36-3895923
(I.R.S. Employer Identification No.)
20 NORTH CLARK STREET, CHICAGO, ILLINOIS 60602
(Address of principal executive offices)
Registrant's Telephone number, including area code: (312) 782-6200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES: XXX NO: _____
---
The aggregate market value of the voting shares held by nonaffiliates of
the Registrant was $32,643,000 as of February 1, 1999. Solely for the purpose of
this computation, it has been assumed that executive officers and directors of
the Registrant are "affiliates".
There were issued and outstanding 2,898,262 common shares of the Registrant's
Common Stock as of February 1, 1999.
INDEX
Page
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PART I
Item 1 Business......................................................................... 3
Item 2 Properties....................................................................... 11
Item 3 Legal Proceedings................................................................ 11
Item 4 Submission of Matters to a Vote of Security Holders.............................. 11
PART II
Item 5 Market for Registrant's Common Stock and Related Stockholder Matters............. 12
Item 6 Earnings Summary and Selected Financial Data..................................... 13
Item 7 Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 15
Item 8 Financial Statements and Supplementary Data...................................... 36
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure....................................................................... 73
PART III
Item 10 Directors and Executive Officers of the Registrant............................... 73
Item 11 Executive Compensation........................................................... 75
Item 12 Security Ownership of Certain Beneficial Owners and Management................... 77
Item 13 Certain Relationships and Related Transactions................................... 78
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.................. 79
Signatures....................................................................... 81
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PART I
ITEM 1. BUSINESS
General
Avondale Financial Corp. (the "Company"), a Delaware corporation, was
organized for the purpose of becoming the savings and loan holding company for
Avondale Federal Savings Bank ("Avondale" or the "Bank"). The Company owns
all of the outstanding stock of the Bank issued on April 3, 1995 in connection
with the completion of the Bank's conversion from the mutual to stock form of
organization (the "Conversion"). At December 31, 1998 the Company had
approximately 1,300 shareholders of record, 2,904,762 shares of common stock
outstanding and total consolidated assets of approximately $499 million.
Subsequent Events
On October 13, 1998 the Company and Coal City Corporation ("Coal City"),
the holding company for Manufacturers Bank, announced they had entered into a
definitive agreement in connection with a merger of equals. The combined company
will be called MB Financial, Inc. ("MB Financial") and have assets of
approximately $1.4 billion. Coal City is a privately held bank holding company
headquartered in Chicago whose principal subsidiary, Manufacturers Bank,
operates eight banking offices in the Chicago metropolitan area. At December 31,
1998, Coal City had consolidated assets of $872 million and total shareholders
equity of $47 million.
Under the terms of the agreement, Coal City will be merged into the Company
and the Company will be renamed MB Financial, Inc. (the "Merger"). Immediately
following the Merger, the Bank's five retail branches will be merged into
Manufacturers Bank. Each share of Coal City common stock will be converted into
83.5 shares of MB Financial common stock while each share of Avondale will be
converted into 1 share of MB Financial. On a pro forma basis, the total number
of shares outstanding will be approximately 7.0 million shares. Shareholders of
Coal City will own approximately 58.5% of the combined company, while
stockholders of the Company will own approximately 41.5%.
In connection with the agreement, the Company and Coal City granted each
other an option to acquire up to 19.9% of the outstanding common stock of the
other upon the occurrence of certain events. A restructuring charge for
severance payments, facilities writedowns and other merger-related costs could
be approximately $10 million pre-tax. The transaction is expected to close on
February 28, 1999 and will be accounted for as a purchase of the Company by Coal
City. The transaction has been granted regulatory approval and was approved by
stockholders of Avondale and Coal City in February 1999. Additional information
related to the Merger are included in the Company's Proxy Statement dated
January 8, 1999 for the Special Meeting of Stockholders held on February 10,
1999.
On February 17, 1999, the Company completed the sale of the assets of its
national mortgage origination operation to New South Federal Savings Bank ("New
South") of Birmingham, Alabama. Pursuant to the agreement, New South purchased
certain assets and assumed certain liabilities of the Company. The Company
accepted a promissory note for the purchase price of approximately $2.0 million
that will be due in five years from the date of purchase.
Services
Avondale maintains three offices in the north and northwest areas in the
city of Chicago, as well as one in downtown Chicago. In addition, there is one
Chicago suburban office in Niles, Illinois. Avondale currently emphasizes
providing its retail deposit products and services to the neighborhoods
surrounding its offices. These services include checking, savings, NOW and money
market deposit accounts. Automated Teller Machines (ATMs), which provide 24-hour
banking services, are installed at each branch location. Customers are also able
to access their accounts at any time through Avondale's automated phone banking.
Avondale also offers its customers a debit card, which can be used anywhere
MasterCard is accepted. The Bank established Avondale Community
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Development Corporation (the "Community Development Subsidiary" or "CDC"), to
engage in community lending and equity investments to facilitate the
construction and rehabilitation of housing in low and moderate neighborhoods in
the Bank's market area. The Bank's lending products consist primarily of
mortgages, including home equity lines of credit, on owner-occupied and non-
owner occupied and one to four family residences. The Bank has expanded its
wholesale distribution channels through third party brokers and other financial
institutions to offer equity lines of credit in thirty-seven different states.
To a lesser extent, Avondale also originates multi-family construction loans.
The Bank also offers investment products and insurance through its wholly-owned
subsidiary, Avondale Financial Services, Inc. (''AFS''). Revenues are
principally derived from interest on loans, gains on sale resulting from
securitizations of home equity loans, income from investment securities and fee
income.
Lending Activities
General. The Company has emphasized the origination of revolving,
adjustable-rate equity lines of credit primarily secured by first and second
liens on residential real estate. The Company also offers mortgages consisting
of one to four family residential fixed-rate and adjustable-rate (''ARM'')
loans.
Equity Lines of Credit. During 1998, the Company continued to originate
home equity lines of credit. Avondale primarily originates home equity lines of
credit using independent mortgage brokers. The Company is able to utilize an
automated delivery system in conjunction with credit scoring in originating
these loans. This process allows the Company to make quick approval decisions in
regions throughout the country. During 1998 the Company successfully completed
securitization and sales of approximately $100 million of home equity lines of
credit in order to fund continued growth in this portfolio. The Company retained
the servicing on the loans that were sold. As of December 31, 1998 equity lines
of credit included in the Company's statement of financial condition totaled
$62.0 million or 30.5% of Avondale's gross loan portfolio. At December 31, 1998
the home equity lines of credit under management totaled $293.3 million, or
67.5% of the total loan portfolio under management compared to $341.3 million or
72.3% as of December 31, 1997.
The Company's equity lines of credit consist primarily of first and second
mortgage liens on both owner-occupied and non-owner-occupied properties. The
lines generally have interest tied to the prime rate, mature between five to ten
years and require interest-only monthly payments until maturity when the
outstanding amount is due in full. At December 31, 1998, $46.0 million or
74.2%, of the Company's equity lines of credit were secured by second mortgage
liens, $11.7 million or 18.8% were secured by first mortgages and $4.3 million
or 7.0% were secured by third mortgages. The equity lines of credit are granted
under credit scoring models using risk-based pricing, whereby the interest rate
of the loan is determined by both the borrower's credit score and the ratio of
all outstanding loans to the appraised value of the property. These equity lines
of credit are written so that the total commitment amount (including any unused
portion of the equity line), when combined with the balance of the first
mortgage loan, if any, can be granted up to 100% of the appraised value of the
property. For the year ended December 31, 1998, $98.0 million equity lines of
credit were originated, which was 80.0% of total loans originated for the
period.
One-to-Four Family Residential Real Estate Lending. The Company originates
permanent loans, both fixed and adjustable rate, secured by one-to-four family
residences, which at December 31, 1998 totaled $80.2 million, or 39.5% of the
Company's gross portfolio.
At December 31, 1998, approximately $10.7 million, or 13.4% of the
Company's one-to-four family residential real estate loan portfolio, are
adjustable rate mortgages (ARM) tied to the prime rate of interest and have rate
adjustment limitations. These loans have contractual maturities of 30 years,
require interest-only payments for the first five years and amortize ratably
over the last 25 years of the loan.
The Company also originates one-to-four family residential adjustable rate
mortgages, which are fully amortizing loans with contractual maturities of up to
30 years. The interest rates on substantially all of the ARMs originated by the
Company adjust annually. The Company's ARM products generally carry interest
rates that reset to a stated margin over an independent index. Increases or
decreases in the interest rate of the Company's ARMs are generally limited to 2%
at any adjustment date and 6% over the life of the loan. Certain ARMs are
convertible into
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fixed rate loans between the 13th and 60th months. The Company's ARMs are not
subject to prepayment penalties. Additionally, the Company does not have any
negative amortization ARMs. At December 31, 1998, the total balance of one-to-
four family one-year ARMs was $14.9 million, or 18.6% of the Company's total
one-to-four family residential loan portfolio.
The Company originates residential first mortgage loans with loan-to-value
ratios up to 95%. On mortgage loans exceeding an 80% loan-to-value ratio at the
time of origination, the Company generally requires private mortgage insurance
that reduces the Company's exposure to 80% or less of the appraised value of the
underlying collateral. The Company also originates fixed-rate residential
mortgage loans. These loans generally are underwritten under guidelines which
would allow them to be sold in the secondary market.
Multi-Family Real Estate and Commercial Lending. To a lesser extent, the
Company also originates and purchases permanent multi-family real estate and
commercial loans. At December 31, 1998, the Company's multi-family real estate
and commercial loan portfolio totaled $38.9 million, or 19.2% of the Company's
gross loan portfolio. At December 31, 1998, there were 9 multi-family real
estate loans with net book values above $500,000.
Avondale's multi-family real estate loan portfolio includes loans secured
by apartments, the majority of which are located within the north and northwest
Chicago area. Multi-family properties generally consist of 5 to 24 units. The
Company primarily originates multi-family real estate loans with loan-to-value
ratios up to 80%.
Construction and Development Lending. The Company has made a limited number
of construction loans to individuals for the construction of their residences as
well as to builders and developers for the construction of one to four family
residences, the development of one to four family lots and commercial real
estate. Included in this category are loans for the construction of low and
moderate income rental apartment buildings for senior citizens. Each of these
loans represents approximately 10% of the project's total cost with the balance
of the funds subsidized by various entities, including governmental agencies. At
December 31, 1998, the Company had construction loans outstanding with aggregate
principal balance of $2.4 million, representing 1.2 % of the Company's gross
loan portfolio.
Consumer Lending. As a result of the growth and opportunities in the
Company's home equity and first and second mortgage lending business, the
Company did not originate consumer loans in 1998. Prior to 1998, the Company
originated mobile home loans through a third party broker. These loans are
secured by the mobile home and are written so that collection of delinquent
payments and risk of loss are the responsibility of the broker. The third party
broker maintains cash reserve accounts for these loans at the Bank. As of
December 31, 1998 the Company had $16.7 million of outstanding mobile home loans
with associated reserves for credit losses of $3.7 million.
Foreign Operations
The Company does not engage in any operations in foreign countries.
Employees
At December 31, 1998, the Company and its subsidiary had approximately 168
employees. The Company's employees are not represented by any collective
bargaining group. Management considers its relations with its employees to be
good.
Competition
The Company faces strong competition, both in originating real estate loans
and in attracting deposits. Competition in originating real estate loans comes
primarily from other savings institutions, commercial banks, credit unions,
other consumer finance companies and mortgage bankers making loans secured by
real estate. Other savings institutions, commercial banks and credit unions
compete for customer deposits. Avondale also competes
5
with money funds and other non-banking organizations for deposit funds.
Avondale's share of the deposit market in Cook County, Illinois is less than 1%.
Supervision and Regulation
General. The Company is subject to broad federal regulation and oversight
extending to all its operations. Avondale is a member of the Federal Home Loan
Bank ("FHLB") of Chicago and is subject to certain limited regulation by the
Federal Reserve Board. The Bank is a member of the Savings Association Insurance
Fund ("SAIF") and the deposits of Avondale are insured by the Federal Deposit
Insurance Corporation ("FDIC"). As a result, the FDIC has certain regulatory and
examination authority over the Bank.
Federal Regulation of Savings Association. The Office of Thrift Supervision
("OTS") has extensive authority over the operations of savings associations.
As part of this authority, Avondale is required to file periodic reports with
the OTS and is subject to periodic examinations by the OTS and the FDIC. The
last regular safety and soundness OTS examination of the Company and the Bank
was as of January 5, 1998. In addition, the OTS conducts examinations to review
compliance with the Community Reinvestment Act ("CRA").
The OTS also has extensive enforcement authority over savings institutions
and their holding companies. This enforcement authority includes, among other
things, the ability to assess civil monetary penalties, to issue cease and
desist or removal orders and to initiate injunctive actions. In general, these
enforcement actions may be initiated for violations of laws and regulations and
unsafe or unsound practices. In addition, federal laws and regulations govern
Avondale's investment, lending and branch expansion activity.
The Bank's legal lending limit for loans-to-one-borrower is equal to the
greater of $500,000 or 15% of unimpaired capital and surplus (except for loans
fully secured by certain readily marketable collateral, in which case this limit
is increased to 25% of unimpaired capital and surplus). At December 31, 1998,
Avondale's lending limit under this restriction was $5.9 million. The Bank is in
compliance with its legal lending limit.
The OTS and other federal banking agencies have adopted guidelines
establishing safety and soundness standards on matters such as loan underwriting
and documentation, internal controls and audit systems, interest rate risk
exposure and compensation and other employee benefits. Any institution which
fails to comply with these standards must submit a compliance plan. The failure
to submit a plan or to comply with an approved plan will subject the institution
to further enforcement action.
Insurance of Accounts and Regulation by the FDIC. Avondale is a member of
the SAIF, which is administered by the FDIC. The FDIC may prohibit any FDIC-
insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the FDIC. The FDIC also has the
authority to initiate enforcement actions against savings associations, after
giving the OTS an opportunity to take such action, and may terminate the deposit
insurance if it determines that the institution has engaged or is engaging in
unsafe or unsound practices, or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are based upon a risk-based deposit
insurance assessment system. Under the system, all insured depository
institutions are placed into one of nine categories and assessed insurance
premiums based upon their level of capital and supervisory evaluation.
Institutions classified as well capitalized (i.e., a core capital ratio of at
least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1
risk-based capital") of at least 6% and a risk-based capital ratio of at least
10%) and considered healthy would pay the lowest premium while institutions that
are less than adequately capitalized (i.e., core and Tier 1 risk-based capital
ratios of less than 4% or a risk-based capital ratio of less than 8%) and
considered of substantial supervisory concern would pay the highest premium.
Risk classification of all insured institutions will be made by the FDIC for
each semi-annual assessment period. The Bank is a Tier 1 organization.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if
it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such
6
higher reserve ratio as established by the FDIC. The FDIC may also impose
special assessments on SAIF members to repay amounts borrowed from the United
States Treasury or for any other reason deemed necessary by the FDIC. During
1998, the FDIC insurance charge on SAIF assessable deposits was approximately
6.1 basis points.
Regulatory Capital Requirements. Federally insured savings associations,
such as Avondale, are required to maintain a minimum level of regulatory
capital. The OTS has established capital standards, including a tangible capital
requirement, a leverage ratio (or core capital) requirement and a risk-based
capital requirement applicable to such savings associations. These capital
requirements must be generally as stringent as the comparable capital
requirements for national banks. The capital regulations require tangible
capital of at least 1.5% of adjusted total assets (as defined by regulation). At
December 31, 1998, Avondale had tangible capital of $34.7 million, or 6.97% of
adjusted total assets, which is $27.2 million above the minimum leverage ratio
requirement of 1.5% in effect on that date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. At December 31, 1998, Avondale
had risk-based capital of $38.5 million and risk-weighted assets of
approximately $286.8 million; or capital of 13.41% of risk-weighted assets.
The OTS has adopted a final rule that requires every savings association
with more than normal interest rate risk to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings association, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
based upon the present value of expected cash flows from balance sheet assets,
and liabilities and off-balance sheet contracts. The rule provides for a two
quarter lag between calculating interest rate risk and recognizing any deduction
from capital.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against associations that fail to meet their
capital requirements.
Limitations on Dividends and Other Capital Distributions. OTS regulations
impose various restrictions or requirements on associations with respect to
their ability to pay dividends or make other distributions of capital. OTS
regulations prohibit an association from declaring or paying any dividends or
from repurchasing any of its stock if, as a result, the regulatory capital of
the association would be reduced below the amount required to be maintained for
the liquidation account established in connection with its mutual to stock
conversion.
The OTS utilizes a three-tiered approach to permit associations, based on
their capital level and supervisory condition, to make capital distributions
which include dividends, stock redemptions or repurchases, cash-out mergers and
other transactions charged to the capital account.
Generally, Tier 1 associations such as Avondale, which are associations
that before and after the proposed distribution meet their fully phased-in
capital requirements, may make capital distributions during any calendar year
equal to the greater of 100% of net income for the year-to-date plus 50% of the
amount by which the lesser of the association's tangible, core or risk-based
capital exceeds its capital requirement for such capital component, as measured
at the beginning of the calendar year, or 75% of the association's net income
for the most recent four quarter period.
Tier 1 associations proposing to make a capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. As a
subsidiary of the Company, the Bank is also required to give the OTS 30 days
notice prior to declaring any dividend on its stock. The OTS may object to the
distribution during that 30-day period based on safety and soundness concerns.
Federal Deposit Insurance Corporation Improvement Act ("FDICIA"). On
December 19, 1991, FDICIA was enacted into law. FDICIA contains, among other
things: (I) truth-in-savings legislation that requires financial institutions to
disclose terms, conditions, fees and yields on deposit accounts in a uniform
manner; (ii) provisions
7
that impose audit requirements and expand the role of the independent auditor;
(iii) provisions that require regulatory agencies to examine financial
institutions more frequently than was required in the past; (iv) provisions that
require the expedited resolution of undercapitalized financial institutions;
(vi) provisions that require regulatory agencies to develop a method for
financial institutions to provide information concerning the estimated fair
market value of assets and liabilities as supplemental disclosures to the
financial statements filed with the regulatory agencies; (vii) provisions that
require the regulatory agencies to adopt regulations that facilitate cross-
industry transactions, and provide for the acquisition of banks by thrift
institutions.
FDICIA provides the federal banking regulators with broad power to take
prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "well capitalized," "adequately capitalized," or
"undercapitalized." Depending upon the capital category to which an
institution is assigned, the regulators' corrective powers include: requiring
the submission of a capital restoration plan; placing limits on asset growth and
restrictions on activities; requiring the institution to issue additional
capital stock (including additional voting stock) or to be acquired; restricting
transactions with affiliates; restricting the interest rate the institution may
pay on deposits; ordering a new election of directors of the institution;
requiring that senior executive officers or directors be dismissed; prohibiting
the institution from accepting deposits from correspondent banks; requiring the
institution to divest certain subsidiaries; prohibiting the payment of principal
or interest on subordinated debt; and ultimately, appointing a receiver for the
institution.
Truth-In-Savings Act. FDICIA requires the Federal Reserve Board to adopt
regulations implementing the Truth-in-Savings regulations. The Federal Reserve
Board's Truth-in-Savings regulations contain, as key elements: (i) a requirement
that institutions disclose yields, fees, penalties and costs for all interest-
bearing accounts; (ii) a requirement that institutions use the term "annual
percentage yield" in advertisements; (iii) a requirement that institutions
provide 30 days notice prior to reducing rates on most accounts; and (iv) a
requirement that interest be paid on entire balances rather than investable
funds.
Community Reinvestment. Under the CRA, as implemented by OTS regulations, a
savings institution has a continuing and affirmative obligation, consistent with
its safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the OTS to assess the institution's
record of meeting the credit needs of its community and to take such record into
account in determining whether to grant approval of applications for, among
other things, branches and other deposit facilities, mergers and holding company
acquisitions. An applicant's performance under the CRA may be the basis for the
regulators to deny such applications. Federal law requires public disclosure of
an institution's CRA rating and that the OTS provide a written evaluation of an
institution's CRA performance utilizing a four-tiered description rating system.
Liquidity. All savings associations are required to maintain an average
daily balance of liquid assets equal to a certain percentage of the sum of its
average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. This liquid asset ratio requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the minimum liquid asset
ratio is 5%. In addition, short-term liquid assets (e.g. cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's average
daily balance of net withdrawable deposit accounts and current borrowings.
Penalties may be imposed upon associations for violations of either liquid asset
ratio requirement. At December 31, 1998, Avondale was in compliance with both
requirements.
Accounting. An OTS policy statement applicable to all savings associations
requires that the investment activities of a savings association must be in
compliance with approved and documented investment polices and strategies and
that an institution must support its classification of and accounting for loans
and securities (i.e., whether held for investment, sale or trading) with
appropriate documentation. Avondale is in compliance with these rules.
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Qualified Thrift Lender Test. All savings associations are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (which consists of total assets less intangibles, properties
used to conduct the savings association's business and liquid assets not
exceeding 20% of total assets) in qualified thrift investments on a monthly
average for nine out of every twelve months on a rolling basis. Such investments
primarily consist of residential housing related loans and investments. At
December 31, 1998, the Bank was in compliance with this test.
Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions are restricted to a percentage of the
association's capital. Affiliates of Avondale include the Company. In addition,
a savings association may not lend to any affiliate engaged in activities not
permissible for a bank holding company or acquire the securities of most
affiliates. The Bank's subsidiaries are not deemed affiliates; however, the OTS
has the discretion to treat subsidiaries of savings associations as affiliates
on a case-by-case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation. The Company is a unitary savings and loan
holding company subject to regulatory oversight by the OTS. As such, the Company
is required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over the Company and its non-savings association subsidiaries which
also permits the OTS to restrict or prohibit activities that are determined to
be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than Avondale or any other SAIF-insured savings association)
would become subject to such restrictions unless such other associations each
qualify as a QTL and were acquired in a supervisory acquisition.
Federal Securities Law. The Common Stock of the Company is registered with
the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). The Company is subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the SEC under the Exchange Act.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At December 31, 1998, Avondale was in compliance with these
reserve requirements.
Savings associations are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require associations
to exhaust other reasonable alternative sources of funds, including FHLB
borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System. Avondale is a member of the FHLB of Chicago,
which is one of 12 regional FHLBs, that administers the home financing credit
function of savings associations. Each FHLB serves as a reserve or central bank
for its members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB system. It makes
loans to members (i.e. advances) in accordance with policies and procedures
established by the board of directors of the FHLB. These policies and procedures
are subject to the regulation and oversight of the Federal Housing Finance
Board. All advances from the FHLB must be fully secured by sufficient collateral
as determined by the FHLB. In addition, all long-term advances are required to
provide funds for residential home financing.
9
As a member of the FHLB of Chicago, Avondale is required to purchase and
maintain stock in the FHLB of Chicago. At December 31, 1998, the Bank owned $5.3
million in FHLB stock and was in compliance with this requirement.
Government Monetary Policies and Economic Controls
The earnings and growth of the savings and loan industry are affected by
the credit policies of monetary authorities, including the Federal Reserve
System. An important function of the Federal Reserve System is to regulate the
national supply of financial institution credit in order to combat recession and
curb inflationary pressures. Among the instruments of monetary policy used by
the Federal Reserve to implement these objectives are open market operations in
U.S. government securities, changes in reserve requirements against member
institutions deposits and changes in the Federal Reserve discount rate. These
means are used in varying combinations to influence overall growth of loans,
investments and deposits, and may also affect interest rates charged on loans or
paid for deposits. The monetary policies of the Federal Reserve authorities have
had a significant effect on the operating results of savings banks in the past
and are expected to continue to have such an effect in the future.
In view of changing conditions in the national economy and in the money
markets, as well as the effect of credit policies by monetary and fiscal
authorities, including the Federal Reserve System, no prediction can be made as
to possible future changes in interest rates, deposit levels and loan demand, or
their effect on the business and earnings of the Company.
10
ITEM 2. PROPERTIES
The Company conducts its business at its corporate office and four other
retail branch locations in its primary market area. All of the branches have
ATM's. The Company also has a loan production and servicing office and a loan
sales office. The following table sets forth information relating to each of
the Company's offices as of December 31, 1998. The total net book value of
Avondale's premises and equipment (including land, building and leasehold
improvements and furniture, fixtures and equipment) at December 31, 1998 was
$4.5 million.
CORPORATE OFFICE:
20 North Clark Street
Chicago, Illinois
BRANCH OFFICES:
20 North Clark Street 6443 N. Sheridan Road
Chicago, Illinois Chicago, Illinois
2965 North Milwaukee Avenue 8300 W. Belmont Avenue
Chicago, Illinois Chicago, Illinois
7557 West Oakton
Niles, Illinois
LOAN PRODUCTION AND SERVICING OFFICE: LOAN SALES OFFICE:
900 Frontage Road 23422 Mill Creek Drive
Woodridge, Illinois Laguna Hills, California
The Company maintains the depositor and borrower customer records, as well
as the Company's general ledger, with two outside service bureaus. The net book
value of the Company's data processing and computer equipment included in fixed
assets at December 31, 1998 was $1.7 million.
ITEM 3. LEGAL PROCEEDINGS
The Company, the Bank and its subsidiaries are involved from time to time
as plaintiff or defendant in various legal actions arising in the normal course
of their businesses. While the ultimate outcome of pending proceedings cannot be
predicted with certainty, it is the opinion of management, after consultation
with counsel representing the Company, the Bank or its subsidiaries in the
proceedings, that the resolution of these proceedings should not have a material
effect on the Company's consolidated financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
1998.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "AVND." The approximate number of shareholders of record of Common
Stock as of December 31, 1998 was 1,300. Certain of the Company's shares are
held in "nominee" or "street" name and accordingly, the number of beneficial
owners of such shares are not known or included in the foregoing number. Such
shares are not separated to count actual beneficial owners. As of December 31,
1998 there were 2,904,762 common shares outstanding.
MARKET INFORMATION
Market Price
Range
----------------------------
Dividends
1998 Paid Book Value High Low
---- ------------- ------------- ------------- -------------
Quarter ended December 31.................. -- $13.31 $16.00 $ 8.38
Quarter ended September 30................. -- 13.14 17.88 11.13
Quarter ended June 30...................... -- 14.21 18.19 15.75
Quarter ended March 31..................... -- 13.88 16.75 14.88
1997
----
Quarter ended December 31.................. -- $13.83 $18.88 $15.63
Quarter ended September 30................. -- 13.18 17.56 13.63
Quarter ended June 30...................... -- 15.85 17.50 12.75
Quarter ended March 31..................... -- 14.88 18.50 16.00
12
ITEM 6. EARNINGS SUMARY AND SELECTED FINANCIAL DATA
The following table sets forth certain consolidated financial and other
data of the Company at the dates and for the periods indicated (in
thousands). The information is derived in part from and should be read in
conjunction with the Company's consolidated financial statements and notes
thereto.
SELECTED FINANCIAL DATA
FOR THE FOR THE FOR THE FOR THE NINE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED MONTHS ENDED YEAR ENDED
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 DEC. 31, 1995 MAR. 31, 1995
-------------- -------------- ------------- ------------- --------------
INCOME STATEMENT DATA:
Interest income.......................... $40,148 $ 54,008 $45,881 $32,238 $32,745
Interest expense......................... 23,340 28,327 25,917 18,941 17,832
------- -------- ------- ------- -------
Net interest income.................... 16,808 25,681 19,964 13,297 14,913
Provision for loan losses................ 4,727 26,527 4,293 1,150 610
------- -------- ------- ------- -------
Net interest income after provision
for loan losses...................... 12,081 (846) 15,671 12,147 14,303
Noninterest income....................... 5,341 3,908 10,403 1,637 (5,176)
Noninterest expense...................... 19,375 22,739 19,506 9,223 11,443
------- -------- ------- ------- -------
Income before income taxes............... (1,953) (19,677) 6,568 4,561 (2,316)
Provision (benefit) for income taxes..... (706) (7,195) 2,352 1,784 (896)
Net income (loss)........................ $(1,247) $(12,482) $ 4,216 $ 2,777 $(1,420)
======= ======== ======= ======= =======
AT AT AT AT AT
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 DEC. 31, 1995 MAR. 31, 1995
------------- ------------- ------------- ------------- -------------
BALANCE SHEET DATA:
Cash and cash equivalents...................... $ 76,529 $ 67,521 $ 9,074 $ 6,342 $ 35,642
Trading securities............................. 2,139 -- -- -- --
Securities available-for-sale.................. 86,081 46,373 35,901 77,879 54,068
Securities held-to-maturity.................... -- -- 6,498 6,880 10,364
Mortgage-backed securities available for sale.. 50,668 80,621 136,418 219,121 73,600
Mortgage-backed securities held-to-maturity.... 43,007 53,719 61,438 64,734 165,719
Loans, net..................................... 195,876 239,942 317,300 218,467 181,349
Federal Home Loan Bank stock................... 5,290 4,540 4,790 4,415 3,915
All other assets............................... 39,340 48,742 24,152 12,699 15,046
-------- -------- -------- -------- --------
Total assets................................... $498,930 $541,458 $595,571 $610,537 $539,703
======== ======== ======== ======== ========
Deposits....................................... $349,737 $397,110 $330,655 $335,861 $347,096
FHLB advances.................................. 105,803 90,803 90,803 78,303 63,303
Securities sold under repurchase agreements.... -- -- 69,146 76,792 21,398
Other borrowings............................... -- -- 32,000 41,500 --
All other liabilities.......................... 5,304 7,582 12,078 11,166 84,336
Stockholders' equity........................... 38,086 45,963 60,889 66,915 23,570
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity..... $498,930 $541,458 $595,571 $610,537 $539,703
======== ======== ======== ======== ========
13
AT OR FOR THE AT OR FOR THE AT OR FOR THE AT OR FOR THE AT OR FOR THE
YEAR YEAR YEAR NINE MONTHS YEAR
ENDED ENDED ENDED ENDED ENDED
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 DEC. 31, 1995 MAR. 31, 1995
-------------- -------------- -------------- -------------- --------------
SELECTED FINANCIAL RATIOS: (1)
Performance Ratios:
Return on average assets.................. (0.23)% (2.03)% 0.71% 0.65% (0.29)%
Return on average equity.................. (2.92) (22.60) 6.87 5.86 (6.22)
Net interest rate spread.................. 3.39 4.22 3.00 2.62 2.99
Net interest margin....................... 3.46 4.50 3.48 3.19 3.20
Other expense to average assets........... 3.62 3.71 3.27 2.15 2.36
Average interest-earning assets to
average interest-bearing liabilities.... 101.57 105.80 110.77 112.66 105.47
Net interest income to other expense...... 86.75 112.10 102.35 144.17 130.32
Asset Quality Ratios:
Non-performing loans to total loans....... 3.15% 2.50% 1.63% 1.98% 2.23%
Non-performing assets to total assets..... 1.38 1.35 0.93 0.86 0.82
Allowance for loan losses to total Loans.. 3.32 2.56 2.22 1.56 1.52
Allowance for loan losses to non-
performing loans........................ 105.17 101.74 136.15 78.85 67.93
Capital Ratios:
Average equity to average assets.......... 7.97% 9.01% 10.28% 11.02% 4.71%
Equity to total assets.................... 7.63 8.49 10.22 10.96 4.37
Tangible and Core capital................. 6.97 8.33 9.90 9.82 4.45
Risk-based capital........................ 13.41 16.89 18.99 23.29 13.21
(1) Performance ratios have been annualized for the nine month period ended
December 31, 1995.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1998 Three Months Ended 1997 Three Months Ended
------------------------ ------------------------
In thousands, except per
share data Dec. Sept. June March Dec. Sept. June March
------- --------- ------- -------- -------- --------- -------- ---------
Interest income........... $8,856 $10,140 $9,965 $11,186 $11,919 $ 13,522 $14,883 $ 13,684
Interest expense.......... 5,147 5,541 6,039 6,613 6,946 7,159 7,365 6,857
------ ------- ------ ------- ------- -------- ------- --------
Net interest income....... 3,709 4,599 3,926 4,573 4,973 6,363 7,518 6,827
Provision for loan losses. 2,075 1,062 764 826 1,945 6,523 3,545 14,514
------ ------- ------ ------- ------- -------- ------- --------
Net interest income after
provision for loan
losses................. 1,634 3,537 3,162 3,747 3,028 (160) 3,973 (7,687)
Noninterest income........ 2,111 (3,826) 4,915 2,141 4,824 (8,635) 6,103 1,616
Noninterest expense....... 3,639 4,891 5,287 5,558 4,545 5,865 6,553 5,776
------ ------- ------ ------- ------- -------- ------- --------
Income (loss) before
income taxes............ 106 (5,180) 2,790 330 3,307 (14,660) 3,523 (11,847)
Provision (benefit) for
income taxes............ 88 (1,943) 1,024 124 1,177 (5,342) 1,238 (4,268)
------ ------- ------ ------- ------- -------- ------- --------
Net income (loss)......... $ 18 $(3,237) $1,766 $ 206 $ 2,130 $ (9,318) $ 2,285 $ (7,579)
====== ======= ====== ======= ======= ======== ======= ========
Basic earnings per share.. $ .01 $ (1.09) $ 0.55 $ .06 $ 0.62 $ (2.67) $ 0.65 $ (2.15)
====== ======= ====== ======= ======= ======== ======= ========
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The following is a discussion and analysis of Avondale Financial Corp.'s
financial position and results of operations and should be read in conjunction
with the financial statements and notes thereto appearing elsewhere in this
report. The Company became the holding company for Avondale Federal Savings Bank
as of April 3, 1995. The conversion, whereby the Bank converted from a Federally
chartered mutual savings bank to a Federally chartered stock savings bank, and
the establishment of the Holding Company (the ''Conversion'') were accounted for
in a manner similar to a pooling of interests, and, as a result, the Company's
financial statements include the consolidated amounts of the Bank. 1996 was the
Company's first full year as a public company.
The Company has engaged primarily in mortgage banking activities.
Management oversees the Company's business along the lines of loan originations,
loan servicing, retail banking and all other activities. See Note 14 of Notes to
Consolidated Financial Statements for additional information. The Company's
results of operations are dependent upon its net interest income, which is the
difference between interest income on its interest-earnings assets and interest
expense on its interest-bearing liabilities. The Company's results of operations
are also affected by the provision for loan losses and the level of noninterest
income and expense. Noninterest income had historically consisted primarily of
service charges and other fees. Beginning in 1996 the Company began securitizing
and selling loans, thereby increasing noninterest income as a result of gains on
sales and servicing the securitized loans. Noninterest income also includes
realized gains on sales of securities. Noninterest expense includes salaries and
employee benefits, foreclosed real estate expenses, occupancy of premises,
federal deposit insurance premiums, data processing expenses and other operating
expenses.
The operating results of the Company are also affected by general economic
conditions, the monetary and fiscal policies of federal agencies and the
policies of agencies that regulate financial institutions. Avondale's cost of
funds is influenced by interest rates on competing investments and general
market rates of interest. Lending activities are influenced by the demand for
real estate loans and other types of loans, which is in turn affected by the
interest rates at which such loans are made, general economic conditions
affecting loan demand and the availability of funds for lending activities.
15
TABLE 1--AVERAGE BALANCES, INTEREST RATES AND YIELDS
(IN THOUSANDS)
The following table presents for the periods indicated the total dollar amount
of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
and the resultant costs, expressed both in dollars and rates. No tax equivalent
adjustments were made. To the extent received, interest on non-accruing loans
has been included in the table.
For the Year Ended For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997 December 31, 1996
---------------------------- ---------------------------- ----------------------------
Average Annual Yield/ Average Annual Yield/ Average Annual Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
--------- -------- ------- --------- -------- ------- --------- -------- -------
Assets:
Interest earning assets:
Loans.............................. $220,572 $23,007 10.43% $344,706 $39,234 11.38% $265,803 $24,842 9.35%
Securities available-for-sale...... 148,581 9,187 6.18 39,758 2,582 6.49 48,376 3,522 7.28
Securities held-to-maturity........ -- -- -- 10,959 933 8.51 12,885 995 7.72
Mortgage-backed securities
available-for-sale................ 67,726 5,629 8.31 117,127 7,354 6.28 182,713 11,982 6.56
Mortgage-backed securities held-to-
Maturity.......................... 48,592 2,325 4.79 57,837 3,905 6.75 63,208 4,540 7.18
-------- ------- -------- ------- -------- -------
Total interest-earning assets.... 485,471 40,148 8.27 570,387 54,008 9.47 572,985 45,881 8.01
------- ------- -------
Non interest-earning assets......... 49,837 43,012 23,761
-------- -------- --------
Total assets..................... $535,308 $613,399 $596,746
======== ======== ========
Liabilities and Retained Earnings:
Interest-bearing liabilities:
Deposits:
NOW accounts...................... $ 7,955 156 1.96 $ 9,376 184 1.96 $ 8,618 189 2.19
Money market accounts............. 39,116 1,412 3.61 47,516 1,948 4.10 65,769 2,554 3.88
Passbook and statement savings.... 87,740 3,080 3.51 77,097 2,813 3.65 69,146 2,135 3.09
Certificate accounts.............. 226,034 12,872 5.70 237,507 13,831 5.82 173,398 9,717 5.60
-------- ------- -------- ------- -------- -------
Total deposits................... 360,845 17,520 4.86 371,496 18,776 5.05 316,931 14,595 4.61
Advances from Federal Home Loan
Bank............................. 117,112 5,818 4.97 90,557 5,269 5.82 90,653 5,236 5.78
Securities sold under repurchase
Agreements....................... -- -- -- 51,553 2,880 5.59 80,558 4,541 5.64
Other borrowings.................. 15 2 13.33 25,512 1,402 5.50 29,131 1,545 5.30
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities..................... 477,972 23,340 4.88 539,118 28,327 5.25 517,273 25,917 5.01
------- ------- -------
Non-interest bearing deposits....... 8,742 6,144 6,545
Other liabilities................... 5,921 12,896 11,601
-------- -------- --------
Total liabilities................ 492,635 558,158 535,419
Stockholders' Equity................ 42,673 55,241 61,327
-------- -------- --------
Total liabilities and
stockholders' Equity............ $535,308 $613,399 $596,746
======== ======== ========
Net interest income/Interest rate $16,808 3.39% $25,681 4.22% $19,964 3.00%
spread............................. ======= ===== ======= ===== ======= ====
Net interest-earning assets/net
interest margin.................... $ 7,499 3.46% $ 31,269 4.50% $ 55,712 3.48%
======== ===== ======== ===== ======== ====
Ratio of interest-earning assets to
interest bearing liabilities....... 101.57% 105.80% 110.77%
======== ======== ========
16
Net Interest Income
Table 1 presents a comparison of net interest income and average volumes,
together with effective yields earned and rates paid on such funds. Net interest
income is the difference between interest income earned on interest-earning
assets, such as loans and investments, and interest expense on average interest-
bearing liabilities, such as deposits and other borrowings. The results shown
reflect the excess of interest earned on assets over the interest paid for
funds.
Net interest income is the primary source of revenue for the Company. It
comprised 75.9% of the Company's total revenues for the year ended December 31,
1998, 86.8% of the Company's total revenues for the year ended December 31, 1997
and 65.7% for the year ended December 31, 1996.
For the year ended December 31, 1998, net interest income decreased 34.6%, to
$16.8 million. The decrease resulted from lower levels of higher earning loans
and lower interest rates in 1998 compared to 1997. Average loan balances were
$220.6 million with an average yield of 10.43% compared to $344.7 million and
11.38%, respectively, for the year-ago period. Average earnings assets were
$485.5 million in 1998 compared to $570.4 million for the year-ago period. The
net interest margin for 1998 was 3.46%, versus 4.50% for 1997 due to a change in
the Company's asset mix and lower loan originations.
For the year ended December 31, 1997 compared to 1996, net interest income
increased 28.6%, to $25.7 million. The increase resulted from increased levels
of higher earning loans and higher interest rates in 1997 compared to 1996.
Average loan balances were $265.8 million with an average yield of 9.35% during
1996 while average earnings assets were $573.0 million. The net interest margin
for 1996 was 3.48%.
Several other factors affect net interest income including average earning
assets compared to average costing liabilities. The ratio of average earning
assets to average costing liabilities was 101.57% in 1998. For the year ended
December 31, 1997 this ratio was 105.8%, compared to the year ended December 31,
1996 when this ratio was 110.8%. The decrease from 1997 to 1998 was primarily
the result of lower receivable balances resulting primarily from 1997 and 1998
securitizations. The decrease from 1996 to 1997 was primarily the result of an
increase in average deposit balances and Company stock repurchases, somewhat
mitigated by lower average repurchase agreement borrowings.
The net interest spread decreased from 4.2% for the year ended December 31,
1997 to 3.4% for the year ended December 31, 1998. The decrease was primarily
the result of lower earning investments replacing higher yielding home equity
and consumer loans in the Company's balance sheet. Receivable balances
decreased as the result of 1997 and 1998 loan securitizations and the sale of
substantially all of the Company's private label credit card portfolio during
the third quarter of 1997. As a percentage of total interest earning assets,
loans decreased to 45.4% of total interest earning assets in 1998 from 60.4% for
the year ended December 31, 1997. Average interest bearing borrowings were
$117.1 and $167.6 million in 1998 and 1997, respectively. The decrease in 1998
was due mainly to the funding provided by loan securitizations and lower overall
funding needs as a result of lower loan originations.
The net interest spread increased from 3.0% for the year ended December 31,
1996 to 4.2% for the year ended December 31, 1997. The main reason for the
increase in net interest spread in 1997 was a continuing change in the asset mix
due to the Company's ability to originate consumer loans. In addition, net
interest spread benefited from higher yielding consumer loans. Although the
Company securitized and sold $170.3 million in home equity lines of credit in
1997, average loan balances increased $78.9 million. As a percentage of total
interest earning assets, loans increased to 60.4% of total interest earning
assets in 1997 from 46.4% for the year ended December 31, 1996. The resultant
interest income increase was partially offset by higher costing interest-bearing
deposits due primarily to the change in the mix of the deposit portfolio.
Average interest bearing borrowings were $167.6 and $200.3 million in 1997 and
1996, respectively. The 1997 decrease was due mainly to the funding provided by
loan securitizations. In addition, 1997 borrowings were higher due to stock
repurchases by the Company.
17
Through 1998, the Company focused its loan origination efforts to higher
yielding home equity line of credit loans tied to the prime rate. The average
prime rate for the years ended December 31, 1998 and 1997 was 8.4% compared to
the year ended December 31, 1996 when the average prime rate was 8.3%. The
average yield on loans decreased 1.0% and 2.0%, respectively, for 1998 and 1997
primarily as a result of lower consumer loans that had higher interest rates.
The average balance of lower yielding investments increased $39.2 million from
the year ended December 31, 1997 to the year ended December 31, 1998 and
decreased $81.5 million for the year ended December 31, 1997 from the year ended
December 31, 1996. The yield on investments was essentially flat at 6.5% for the
years ended December 31, 1998 and 1997. The yield on investments decreased 30
basis points from 6.8% for the year ended December 31, 1996 to 6.5% for the year
ended December 31, 1997.
Average borrowings decreased from $167.6 million for the period ended
December 31, 1997 to $117.1 million for the year ended December 31, 1998 as a
result of alternative funding provided by loan securitizations. During 1997,
average borrowings decreased $32.7 million from 1996 also due primarily to the
funding provided by securitizations completed during the year. Total average
assets increased from $596.7 million in 1996 to $613.4 million in 1997 and
decreased to $535.3 million in 1998. Rates on borrowings decreased from 5.7% for
the years ended December 31, 1996 and 1997 to 5.0% for the year ended December
31, 1998 due to reduced use of reverse repurchase agreements and other
borrowings.
Many factors beyond Management's control can have a significant impact on
changes in net interest income from one period to another. Such factors include:
(1) credit demands by customers; (2) fiscal and debt management policy of
federal and state governments; (3) monetary policy of the Federal Reserve Board;
and (4) changes in regulations.
18
TABLE 2--RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
The following table presents the extent to which changes in interest rates and
changes in the volume of interest earning assets and interest bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated (in thousands). Information is provided in each
category with respect to changes attributable to changes in volume, changes
attributable to changes in rate and the total changes. The changes attributable
to the combined impact of volume and rate have been allocated to the changes due
to volume.
Year Ended December 31, 1998 Year Ended December 31, 1997
Vs Year Ended December 31, 1997 Vs Year Ended December 31, 1996
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------- ----------------------------------
Volume Rate Net Volume Rate Net
---------- ---------- ---------- ---------- ---------- ----------
Interest Income:
Loans receivable $(14,129) $(2,098) $(16,227) $ 8,982 $5,410 $14,392
Securities available-for-sale 7,067 (462) 6,605 (560) (380) (940)
Securities held-to-maturity (933) -- (933) (164) 102 (62)
Mortgage-backed securities available- for-sale (3,102) 1,377 (1,725) (4,118) (510) (4,628)
Mortgage-backed securities held- to-maturity (624) (956) (1,580) (363) 272 (635)
-------- ------- -------- ------- ------ -------
Total interest income (11,721) (2,139) (13,860) 3,777 4,350 8,127
-------- ------- -------- ------- ------ -------
Interest Expense:
Deposits (538) (718) (1,256) (2,758) 1,424 4,181
Advances from the Federal Home Loan Bank 1,545 (996) 549 (5) 38 33
Securities sold under agreements to repurchase (2,880) -- (2,880) (1,620) (41) (1,661)
Other borrowed money (1,400) -- (1,400) (199) 56 (143)
-------- ------- -------- ------- ------ -------
Total interest expense (3,273) (1,714) (4,987) 934 1,477 2,410
-------- ------- -------- ------- ------ -------
Net interest income $ (8,448) $ (425) $ (8,873) $ 2,844 $2,873 $ 5,717
======== ======= ======== ======= ====== =======
19
TABLE 3--INVESTMENT SECURITIES
The following table sets forth information regarding amortized cost and
estimated fair value of the Company's securities (in thousands):
At December 31, 1998 At December 31, 1997
-------------------------------------- --------------------------------------
Amortized % of Fair Amortized % of Fair
Cost Total Value Cost Total Value
----------- ------------ ----------- ----------- ------------ -----------
Securities available-for-sale:
U.S. Government agency securities........... $46,421 54.30% $46,609 $46,251 100.00% $46,373
Trust Preferred securities.................. 39,070 45.70 39,472 -- -- --
------- ------ ------- ------- ------ -------
Total.................................. $85,491 100.00% $86,081 $46,251 100.00% $46,373
======= ====== ======= ======= ====== =======
Mortgage-backed securities
available-for sale:
Collateralized Mortgage Obligations (CMO)
Government and Agency..................... $13,891 27.30% $13,676 $ 5,546 6.89% $ 5,459
Private Issuer............................ 12,453 24.47 12,468 17,951 22.31 17,836
GNMA Certificates........................... 21,161 41.58 21,106 51,874 64.45 52,334
FHLMC Certificates.......................... 1,481 2.91 1,489 2,960 3.68 2,859
FNMA Certificates........................... 1,901 3.74 1,929 2,150 2.67 2,133
------- ------ ------- ------- ------ -------
Total.................................. $50,887 100.00% $50,668 $80,481 100.00% $80,621
======= ====== ======= ======= ====== =======
Mortgage-backed securities
held-to-maturity:
Private Issuer Collateralized Mortgage
Obligations................................ $29,000 67.43% $29,574 $36,313 67.60% $35,945
GNMA Certificates........................... 1,727 4.02 1,790 2,393 4.45 2,506
FHLMC Certificates.......................... 610 1.42 628 835 1.56 855
FNMA Certificates........................... 11,670 27.13 11,795 14,178 26.39 14,153
------- ------ ------- ------- ------ -------
Total.................................. $43,007 100.00% $43,787 $53,719 100.00% $53,459
======= ====== ======= ======= ====== =======
Securities
The Company must maintain minimum levels of securities and other assets that
qualify as liquid assets under OTS regulations. Historically, the Company has
maintained liquid assets at levels above the minimum requirements imposed by the
OTS regulations. Federally chartered savings institutions have the authority to
invest in various types of liquid assets. Generally, the investment policy of
the Company is to invest funds among categories of investments and maturities
based upon the Company's asset/liability management policies, investment
quality, liquidity needs and performance objectives. The Company's investment
policy also considers the inherent prepayment risk of mortgage-backed securities
and call features of investment securities.
The determination to classify a security as held-to-maturity is made in
consideration of the asset/liability and capital structure of the Company. To
meet the requirements, the Company must have the intent and ability to hold the
security to maturity. The held-to-maturity portfolio must make economic sense
from a risk return perspective throughout the expected life of the asset. While
the held-to-maturity portfolio is not subject to mark-to-market accounting, it
is subject to interest rate risk. To minimize this risk, the held-to-maturity
portfolio must be funded by liabilities whose changes in costs are likely to
correlate with changes in rates on the held-to-maturity assets. The Company's
held-to-maturity portfolio exists to produce current income based upon a yield
to maturity over expected costs of deposit liabilities not used to fund loans.
The Company's liquidity needs are partly satisfied through the available-for-
sale portfolio. The securities in the available-for-sale portfolio are viewed as
residual balances from other operations, temporarily using other sources of
funds while being flexible enough to meet any contingent funding needs.
Generally, new securities purchased are held in the available-for-sale
portfolio. This classification allows the Company maximum flexibility to respond
to changing economic and business conditions. As of December 31 1998, 75.2% of
the Company's investments were available-for-sale, 23.7% were held-to-maturity
and
20
1.1% were classified as held for trading. At December 31, 1997, 70.3% of the
Company's investments were classified as available-for-sale and 29.7% was
classified as held-to-maturity. The Company has $2.1 million of trading
investments at December 31, 1998. All trading investments were liquidated in
January 1999.
As a result of lower loan originations and the Company's attempt to invest all
available capital, there has been a change in the Company's asset mix to
securities from higher yielding loans. For the year ended December 31, 1998,
average securities increased to $264.9 million from $225.7 million at December
31, 1997.
During the year ended 1998, the company sold $27.1 million of its available-
for-sale securities. Net gains on these securities sales totaled $307 thousand.
During the year ended December 31, 1997, the Company sold available-for-sale
securities with an amortized cost of $80.6 million, realizing gains on such
sales of $1.2 million. The Company sells securities to maximize the total return
of the available-for-sale portfolio and in response to changing market spreads
and funding availability.
TABLE 4--INVESTMENT SECURITIES MATURITY SCHEDULE AND YIELDS
(IN THOUSANDS)
The following table presents the maturity distribution and average yields of
the securities portfolio at December 31, 1998.
One to Over Five to
Five Years Ten Years Over Ten Years Total
-------------------- -------------------- -------------------- --------------------
Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- --------- --------- --------- --------- --------- --------- ---------
Securities available-for-sale:
U.S. Government Agencies.............. $33,228 6.09% $13,193 6.34% $ -- --% $46,421 6.16%
Trust Preferred securities............ -- -- 2,709 11.91 36,361 7.82 39,070 8.10
------- ---- ------- ----- ------- ----- ------- -----
Total........................... $33,228 6.09% $15,902 7.29% $36,361 7.82% $85,491 7.05%
======= ==== ======= ===== ======= ===== ======= =====
Mortgage-backed securities
held-to-maturity:
Privately Issued Collateralized
Mortgage Obligation (CMO).......... $ -- --% $ -- --% $29,000 7.03% $29,000 7.03%
GNMA certificates..................... 71 7.74 1,656 7.84 -- -- 1,727 7.84
FHLMC certificates.................... -- -- 7 7.33 603 7.40 610 7.40
FNMA certificates..................... 1,977 5.61 1,218 7.70 8,475 6.19 11,670 6.25
------- ---- ------- ----- ------- ----- ------- -----
Total........................... $ 2,048 5.68% $ 2,881 7.78% $38,078 6.85% $43,007 6.86%
======= ==== ======= ===== ======= ===== ======= =====
Mortgage-backed securities
available-for-sale:
Privately Issued Collateralized
Mortgage Obligation (CMO).......... $ -- --% $ 1,293 4.88% $11,160 5.93% $12,453 5.82%
Government and Agency CMO............. 7,985 6.15 2,978 4.07 2,928 4.10 13,891 5.27
GNMA certificates..................... -- -- -- -- 21,161 5.60 21,161 5.60
FHLMC certificates.................... 1,481 5.82 -- -- -- -- 1,481 5.82
FNMA certificates..................... -- -- -- -- 1,901 6.29 1,901 6.29
------- ---- ------- ----- ------- ----- ------- -----
Total........................... $ 9,466 6.10% $ 4,271 4.32% $37,150 5.62% $50,887 5.60%
======= ==== ======= ===== ======= ===== ======= =====
21
Loans
TABLE 5--LOAN PORTFOLIO
The following table sets forth the composition of the Company's loan portfolio
in dollar amounts (in thousands) and percentages of the respective portfolios at
the dates indicated.
December 31, 1998 December 31, 1997 December 31, 1996 December 31, 1995
-------------------- -------------------- -------------------- ---------------------
Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total
--------- --------- --------- --------- --------- --------- ---------- ---------
Mortgage loans:
Home Equity lines of credit....... $ 61,959 30.54% $116,587 47.10% $120,371 36.94% $ 79,842 36.29%
One-to-four family................ 80,204 39.53 82,610 33.37 101,066 31.03 107,294 48.76
Multi-family...................... 18,766 9.24 22,709 9.17 23,765 7.29 28,556 12.98
Commercial........................ 20,120 9.91 - - - - 307 0.14
Construction or development....... 2,407 1.19 1,076 0.43 2,191 0.67 2,737 1.24
-------- ------ -------- ------ -------- ------ -------- ------
Total Mortgage loans.............. 183,456 90.41 222,982 90.07 247,393 75.93 218,736 99.41
Consumer loans 19,452 9.59 24,546 9.93 78,434 24.07 1,296 0.59
-------- ------ -------- ------ -------- ------ -------- ------
Gross loans....................... $202,908 100.00% $247,528 100.00% 325,827 100.00% 220,032 100.00%
====== ====== ====== ======
Unearned discounts on loans
Purchased........................ - 9 19 36
Deferred loan fees (costs)........ 315 1,274 1,300 (1,931)
Allowance for possible loan losses 6,717 6,303 7,208 3,460
-------- -------- -------- --------
Loans, net........................ $195,876 $239,942 $317,300 $218,467
======== ======== ======== ========
March 31, 1995
--------------------
Percent
Amount of Total
--------- ---------
Mortgage loans:
Home Equity lines of credit....... $ 66,058 35.77%
One-to-four family................ 86,247 46.70
Multi-family...................... 28,994 15.70
Commercial........................ 337 0.18
Construction or development....... 2,979 1.61
-------- ------
Total Mortgage loans.............. 184,615 99.96
Consumer loans 75 0.04
-------- ------
Gross loans....................... 184,690 100.00%
======
Unearned discounts on loans
Purchased........................ 54
Deferred loan fees (costs)........ 491
Allowance for possible loan losses 2,796
--------
Loans, net........................ $181,349
========
During 1998 and 1997, the Company has focused its efforts on originating
equity lines of credit. The Company utilizes a credit scoring model whereby the
equity lines of credit are priced according to the credit worthiness of the
customer as well as the loan to value ratio of the loan. As a result, the
Company believes its loans are priced relative to the risks associated with the
credits. The Company originates these loans up to 100% equity in the property.
In substantially all cases, broker relationships are used to originate loans.
The Company originates equity lines of credit in thirty-seven states. The
Company is utilizing its advances in technology to reduce the time and cost to
originate and close loans and to gain access to customers throughout the
country.
Between 1997 and 1998 the gross loan portfolio decreased $44.6 million to
$202.9 million at December 31, 1998 due primarily to the securitization of
$100.0 million of home equity lines of credit and lower home equity line of
credit originations.
The Company's other mortgage loans have increased to $121.5 million at
December 31, 1998 from $106.4 million at December 31, 1997. The Company began to
market first and second mortgage products more aggressively during the second
half of 1998 and purchased $20.1 million of commercial loans during 1998.
Consumer loans were $19.5 million at December 31, 1998 compared to $24.5 million
at December 31, 1997. The decrease of $5.0 million is due to runoff in the
mobile home loan and private label credit card portfolios. The Company does not
expect further growth in these portfolios.
In February 1999, the Company entered into a transaction to sell its national
mortgage origination business. However, the Company will retain its existing
loan portfolio. See Subsequent Events on page 3 for additional information.
22
TABLE 6--LOAN MATURITY SCHEDULE
(IN THOUSANDS)
The following schedule sets forth the contractual maturities of the Company's
loan portfolio at December 31, 1998. This schedule does not reflect the effects
of possible prepayments or enforcement of due on sale clauses.
Period Which Loans are Due to Mature:
------------------------------------
Less than 1 year Over 1 to 3 years Over 3 to 5 years Over 5 to 10 years
------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
-------- --------- -------- --------- -------- --------- -------- ---------
Mortgage loans:
Equity lines of credit $ 6,641 9.64% $ 3,715 9.67% $ 2 15.00% $51,574 13.20
One-to-four family 34,580 8.86 18,125 8.74 12,489 9.04% 13,678 9.90
Multi-family 1,632 9.99 17 9.00 1,024 8.02% 2,459 9.15
Commercial 1,596 7.28 16,241 7.01 2,283 6.76 - -
Construction or
Development 2,407 8.44 - - - - - -
Consumer Loans 3,233 17.19 4,221 16.20 2,705 10.24 4,732 10.23
------- ----- ------- ----- ------- ----- ------- -----
Total Loans $50,089 9.47% $42,319 8.90% $18,503 8.88% $72,443 12.25%
======= ===== ======= ===== ======= ===== ======= =====
Period Which Loans are Due to Mature:
------------------------------------
Over 10 to 20 years Over 20 years Total
-------------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
--------- --------- ------- --------- --------- ---------
Mortgage loans:
Equity lines of credit $ 4 11.25% $ 23 13.50% $ 61,959 12.61%
One-to-four family - - 1,332 8.25 80,204 9.03
Multi-family 9,132 8.78 4,502 8.26 18,766 8.77
Commercial - - - - 20,120 7.00
Construction or
Development - - - - 2,407 8.44
Consumer Loans 4,561 10.04 - - 19,452 12.64
------- ----- ------ ----- -------- -----
Total Loans $13,697 9.20% $5,857 8.28% $202,908 10.24%
======= ===== ====== ===== ======== =====
Non-Performing Assets
Non-performing assets consist of non-performing loans and other real estate
owned. The Company's management policy is to place all loans on non-accrual
status when the collection of principal and/or interest has become more than 90
days past due or upon bankruptcy of the borrower. As shown in Table 7, the
balance of non-accrual loans at December 31, 1998 and 1997 was $6.4 and $6.2
million, respectively. Interest income which would have been recognized had
these loans been current throughout the period approximated $585, $617 and $264
thousand for the years ended December 31, 1998, 1997 and 1996, respectively.
The amount that was included in interest income on such loans for the years
ended December 31, 1998, 1997 and 1996, was $149, $242 and $389 thousand,
respectively.
Other real estate owned includes assets acquired through loan foreclosure and
repossession. The carrying value of other real estate owned is reviewed by
management on a monthly basis to ensure the recoverability of its carrying
value, which is the lower of cost or fair value less estimated selling costs.
Non-performing loans as a percentage of gross loans were 3.15% as of December
31, 1998 and 2.50% as of December 31, 1997. The year to year increase is a
result of the Company's approach to credit cycle management and was in line with
management's expectations as the home equity portfolio continues to season and
the Company continues to originate higher risk equity lines of credit. The
Company's pricing policies for these products takes into account this increased
risk. Management actively attempts to resolve non-performing loans, and will
continue its emphasis on the collection of the loans on non-accrual, including
collection of unpaid interest.
Management continues to emphasize the early identification of loan related
problems. Management is not currently aware of any significant loan, groups of
loans, or segment of the loan portfolio as to which there are serious doubts as
to the ability of the borrower(s) to comply with the present loan payment terms.
23
TABLE 7--NON-PERFORMING ASSETS
(IN THOUSANDS)
At At At At At
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1997 1996 1995 1995
------------- ------------- ------------- ------------- ----------
Non-accruing loans:
Equity lines of credit......................... $4,347 $5,159 $2,150 $2,505 $3,942
One to four family loans....................... 1,261 207 1,523 1,495 173
Multi-family................................... 215 47 365 388 --
Consumer loans................................. 564 782 1,256 -- --
------------- ------------ ------------- ------------- ----------
Total non-performing loans....................... $6,387 $6,195 $5,294 $4,388 $4,115
============= ============ ============= ============= ----------
Total non-performing loans to total loans........ 3.15% 2.50% 1.63% 1.98% 2.23%
============= ============ ============= ============= ----------
Real estate owned:
One to four family loans....................... $ 329 $ 545 $ 270 $ 837 $ 316
Consumer loans................................. 175 560 -- -- --
------------- ------------ ------------- ------------- ----------
Total.......................................... $ 504 $1,105 $ 270 $ 837 $ 316
============= ============ ============= ============= ==========
Total non-performing loans and real estate
owned to total assets.......................... 1.38% 1.35% 0.93% 0.86% 0.82%
============= ============ ============= ============= ==========
Provision for Loan Losses
The provision for loan losses includes current period loan losses and an
amount which, in the judgment of management, is sufficient to maintain reserves
for loan losses at a level that reflects known and inherent losses in the
portfolio. The adequacy of the loan loss allowance is analyzed on a monthly
basis. Factors considered in assessing the adequacy of the allowance include:
changes in the type and volume of the loan portfolio; review of specific
delinquent loans; historical loss experience; current economic trends and
conditions; loan growth and other factors management deems appropriate.
Management allocates the allowance for credit losses to various loan categories
based on historical losses and trends by portfolio. In addition, management
maintains a small unallocated allowance based on judgement, economic factors and
growth in the portfolio. Although management allocates the allowance to the
various components of the portfolio, management considers the entire reserve
when assessing its adequacy.
During the years ended December 31, 1998 and 1997, the Company increased the
level of its allowance for loan losses due to higher inherent risks, continued
seasoning and growth in the home equity line of business. For the year ended
December 31, 1998 the loan loss provision was $4.7 million. The $21.8 million
decrease from the year ended December 31, 1997 provision for loan losses of
$26.5 million was due to the absence of loss provisions related to the Company's
private label credit card portfolio, which was sold in 1997. The provision for
loan losses for the year ended December 31, 1996 was $4.3 million. The
allowance for loan losses as a percentage of non-performing loans was 105.2% for
the year ended December 31, 1998, compared to 101.7% as of December 31, 1997.
The allowance for loan losses as a percentage of gross loans increased from
2.55% as of December 31, 1997 to 3.32% as of December 31, 1998.
The increase in non-performing loans from $6.2 million as of December 31, 1997
to $6.4 million as of December 31, 1998 was in line with management's
expectations and was primarily the result of the continued seasoning of the home
equity portfolio and the Company's credit cycle management policies whereby the
Company originates loans with higher credit risk in exchange for higher interest
rates.
Because management is not certain as to the full collectibility of non-
performing loans, potential loss exposure has been provided for in the Company's
allocation of the allowance for loan losses. The allocation of the allowance to
equity lines of credit has increased due to the seasoning of the portfolio.
24
Management believes the allowance for loan losses at December 31, 1998 is
adequate to cover known and inherent loan losses in the loan portfolio.
TABLE 8--ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
At Dec. 31, At Dec. 31, At Dec. 31, At Dec. 31, At Mar. 31,
1998 1997 1996 1995 1995
----------- ----------- ----------- ----------- -----------
Balance at beginning of period............................... $ 6,303 $ 7,208 $ 3,460 $2,796 $2,809
Charge-offs:
Equity lines of credit..................................... (3,774) (2,768) (691) (290) (400)
One-to-four-family loans................................... (30) (397) -- -- (170)
Multi-family............................................... -- -- (63) (212) (56)
Consumer loans............................................. (1,015) (24,781) -- -- --
--------- ---------- --------- -------- --------
(4,819) (27,946) (754) (502) 626)
--------- ---------- --------- -------- --------
Recoveries:
Equity lines of credit............................... 445 312 209 -- --
Consumer loans............................................. 61 1,387 -- 16 3
--------- ---------- --------- -------- --------
Net charge-offs.............................................. (4,313) (26,247) (545) (486) (623)
Provision for loan losses.................................... 4,727 26,527 4,293 1,150 610
--------- ---------- --------- -------- --------
Reserves on loans sold....................................... -- (774) -- -- --
Other, net................................................... -- (411) -- -- --
--------- ---------- --------- -------- --------
Balance at end of period..................................... $ 6,717 $ 6,303 $ 7,208 $3,460 $2,796
========= ========== ========= ======== ========
Ratio of net charge-offs during the period to average loans
Outstanding during the period (1)......................... 1.96% 0.98% 0.20% 0.25% 0.35%
========= ========== ========= ======== ========
Ratio of net charge-offs during the period to average non-
Performing assets during the period (1)................... 63.04% 55.65% 12.14% 12.35% 12.15%
========= ========== ========= ======== ========
Ratio of allowance for loan losses to non-performing loans... 105.17% 101.74% 136.05% 78.85% 67.93%
========= ========== ========= ======== ========
(1) Excludes charge-offs related to the private label credit card portfolio in
1997. Including these charge-offs, the 1997 ratios would be 7.61% and 230.83%
for net charge-offs to average loans outstanding and for net charge-offs to
average non-performing assets during the period, respectively.
TABLE 9--ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
At December 31, At December 31, At December 31, At December 31, At March 31,
1998 1997 1996 1995 1995
------------------- ------------------ ----------------- ----------------- -----------------
Percent of Percent of Percent of Percent of Percent of
Loans In Loans In Loans In Loans In Loans In
Each Each Each Each Each
Category Category Category Category Category
To Total To Total To Total To Total To Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ -------- ------ --------- ------ ---------
Mortgage loans:
One-to-four family..... $ 424 39.53% $ 212 33.37% $ 513 31.03% $ 301 48.76% $ 190 46.70%
Multi-family........... 90 9.24 82 9.17 179 7.29 150 12.98 21 15.70
Construction &
development......... -- 1.19 -- 0.43 -- -- -- 1.24 -- 1.61
Commercial............. -- 9.91 -- -- -- 0.67 1 0.14 5 0.18
Home equity line of
credit.............. 3,992 30.54 4,830 47.10 2,539 36.94 1,125 36.29 1,063 35.77
Consumer................ 314 9.59 486 9.93 1,035 24.07 9 0.59 7 0.04
Unallocated............. 1,897 N/A 693 N/A 2,942 N/A 1,874 N/A 1,510 N/A
------ ------ ------ ------ ------ ------ ------ ------ ------
Total............... $6,717 100.00% $6,303 100.00% $7,208 100.00% $3,460 100.00% $2,796 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== =======
25
Noninterest Income
Noninterest income was $5.3, $3.9 and $10.4 million for the years ended
December 31, 1998, 1997 and 1996, respectively. The increase from 1997 to 1998
was primarily due to the absence of the loss on the sale of substantially all of
the private label credit card portfolio in 1997. Without the 1997 loss,
noninterest income decreased between 1998 and 1997. The decrease in 1997 from
1996 was primarily due to the loss on the sale and disposition of the private
label credit card portfolio, somewhat mitigated by increased gains on the
securitization and sale of loans and increased loan fees. Additionally,
noninterest income in 1996 included a $2.9 million gain on the sale of the
Company's Lake Forest Branch
Securities gains were $307 thousand, $1.2 and $2.3 million for the years ended
December 31, 1998, 1997 and 1996, respectively. The Company continued to take
advantage of market opportunities in managing its securities portfolio on a
total return basis while reducing the portfolio's size to accommodate the rising
loan portfolio. The Company adjusts the portfolio depending on changing market
spreads and funding availability. The changes result in higher credit quality
and a greater emphasis on variable-rate securities.
Securitization income decreased to $727 thousand in 1998 from $8.8 million in
1997 and $3.3 million in 1996. The decrease was a result of lower gains on
securitizations due to market conditions and lower levels of assets sold and a
1998 charge for writing down the value of interest-only securities. In addition
to the initial net gain on sale, securitization income includes loan servicing
fees and any fair value adjustment of the I/O strip recorded as a result of the
securitization of loans. During 1998, the Company took a $6.1 million charge to
write-down the value of its interest-only securities. On a quarterly basis, the
Company performs a review to determine the fair value of its interest-only
strips. As part of this review, the Company reviews its assumptions of
prepayment speeds, discount rates and loan losses. In the third quarter of 1998,
the Company revised its discount rate to reflect reduced liquidity and higher
risk premiums being required by capital markets, adjusted prepayments to be in
line with both historical experience and expectations for the future, and
utilized loan losses consistent with the Company's non-judgmental models. The
analysis was based upon net CPR speeds ranging from approximately 30% to 45%,
historical and forecasted losses discounted at the risk-free rate and an overall
discount rate of 12%. The revision of the foregoing assumptions resulted in a
pretax charge to the interest-only securities of $6.1 million. The Company will
continue to review its assumptions quarterly and revise them when circumstances
dictate. Also during 1998, the Company completed a home equity loan
securitization totaling $100.0 million that resulted in a net gain on sale of
$4.5 million. The gains on sale assumptions were consistent with those used to
revalue the interest-only securities in the third quarter of 1998. During 1997
the Company completed two home equity loan securitizations totaling $170.3
million resulting in net gains on sale of $7.9 million. During 1997 the Company
recorded a $500 thousand write-down of the value of the I/O strip that resulted
from the 1996 securitization. In 1996 the Company securitized and sold $74.8
million of loans with a net gain on the sale of $3.3 million. The Company
retained the servicing of these portfolios.
The $11.9 million loss on the sale of loans during 1997 was the result of the
sale and disposition of substantially all of the Company's private label credit
card portfolio. The Company decided to exit this line of business during 1997.
Loan fees were $3.0 million in the year ended December 31, 1998 compared to
$4.7 million in the year ended December 31, 1997 and to $751 thousand for the
year ended December 31, 1996. Late fees, which are recorded in income when
received, were $772 thousand, $2.0 million and $276 thousand for the years ended
December 31, 1998, 1997 and 1996, respectively. Additionally, $401 thousand and
$1.1 million of home equity line of credit fees were recorded in 1998 and 1997,
respectively. During 1997, other fees recorded in this caption also include
interim subservicing fees for one private label credit card portfolio of $329
thousand and annual fees and merchant fees of $183 thousand and $1.0 million,
respectively, from the exited PLCS business.
Other noninterest income of $627, $596 and $526 thousand for the years ended
December 31, 1998, 1997 and 1996, respectively, consists primarily of
commissions on annuity sales. These commissions totaled $606, $550 and $524
thousand for the years ended December 31, 1998, 1997 and 1996, respectively.
26
Noninterest Expense
Noninterest expense was $19.4, $22.7 and $19.5 million for the years ended
December 31, 1998, 1997 and 1996, respectively.
Salaries and employee benefits decreased to $9.2 million for the year ended
December 31, 1998 from $9.4 million for the year ended December 31, 1997 and
increased from $8.2 million for the year ended December 31, 1996. The decrease
in 1998 from 1997 was due to fewer employees and lower incentive compensation
expense. The increase from 1996 to 1997 was primarily due to increased staffing
in order to service higher levels of home equity line of credit and consumer
loan volume.
Occupancy expense was $2.8, $2.1 and $1.4 million for the years ended December
31, 1998, 1997 and 1996, respectively. The increase of $755 thousand from 1997
to 1998 was primarily due to rent increases and higher depreciation and
amortization expense. The increase in occupancy expense during 1997 from 1996
was primarily due to larger space requirements needed to support additional
loan-related business.
Federal Deposit Insurance expense for the twelve months ended December 31,
1998, 1997 and 1996 was $238 thousand, $238 thousand and $2.9 million,
respectively. The decrease in 1997 from 1996 was partially the result of a
premium reduction to approximately 6.3 cents per $100 of deposits in 1997 from
23 cents per $100 dollars of deposits during 1996. In addition, the 1996
expense includes a one time assessment of $2.3 million to recapitalize the
Savings Association Insurance Fund.
Advertising and public relations expense was $495 thousand during the year
ended December 31, 1998 compared to $519 thousand in the year ended December 31,
1997 and $701 thousand for the year ended December 31, 1996. This expense
varies from period to period based upon the number and extent of advertising
campaigns undertaken to promote the Company's deposit and lending products.
Data processing expense decreased to $2.0 million for the year ended December
31, 1998 from $2.9 million for the year ended December 31, 1997 and from $1.6
million for the year ended December 31, 1996. The decrease in 1998 from 1997 was
due to lower third party service bureau charges and lower maintenance, equipment
and programming expenses related to the exited private label credit card
business. The increase in 1997 from 1996 was partially the result of higher
charges from the Company's outside service bureau, which was due to an increase
in the number of loan accounts. Additionally, higher depreciation of the
Company's data processing equipment as well as programming enhancements
contributed to the 1997 increase.
Legal and professional fees were $2.1 million, $1.9 million and $531 thousand
for the years ended December 31, 1998, 1997 and, 1996, respectively. While
total legal fees were substantially the same in 1998 and 1997, the increase in
1997 from 1996 was primarily due to increased collection agency and legal fees
related to the private label credit card portfolio.
Other operating costs were $2.7, $6.0 and $4.1 million for the years ended
December 31, 1998, 1997 and 1996, respectively. The decrease from 1997 to 1998
was partially due to the reversal of a portion of the Company's previously
established restructuring reserves. The $1.2 million reversal resulted from an
assessment of the Company's restructuring reserves in light of current and
anticipated circumstances relating to leases on certain facilities. In addition,
lower temporary help expense, personnel hiring costs and supplies and telephone
expense resulted in the decrease. These costs were lower due to lower loan
volume in 1998 compared to 1997. The increase in 1997 from 1996 was primarily
the result of increased loan-related expenses associated with higher home equity
line of credit volume and the exited private label credit card business. These
costs include postage, supplies, telephone and temporary help expenses.
27
Income Taxes
The Company realized an income tax benefit of $706 thousand and $7.2 million
for the years ended December 31, 1998 and 1997, respectively. Income tax
expense for the year ended December 31, 1996 was $2.4 million. The Company's
effective tax rate (income tax expense/benefit divided by income before taxes)
was 36.2, 36.6% and 35.8% for the years ended December 31, 1998, 1997 and 1996,
respectively.
Liquidity and Interest Rate Sensitivity Analysis
The primary functions of asset/liability management are to assure adequate
liquidity and to maintain an appropriate balance between interest earning assets
and interest bearing liabilities. The matching of assets and liabilities is
accomplished by analyzing the extent to which such assets and liabilities are
''interest rate sensitive'' and by monitoring an institution's interest rate
sensitivity ''gap.'' An asset or liability is said to be interest rate sensitive
within a specific time period if it will mature or reprice within that time
period. The interest rate sensitivity gap is the difference between the amount
of interest earning assets maturing or repricing within a specific time period
and the amount of interest bearing liabilities maturing or repricing within the
same time period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets.
During a period of rising rates, a negative gap would tend to adversely affect
net interest income while a positive gap would tend to result in an increase in
net interest income. During a period of falling interest rates, a negative gap
would tend to result in an increase in net interest income while a positive gap
would tend to adversely affect net interest income.
The Company's gap position is illustrated in table 10. Loans that have
adjustable rates of interest are shown as being due in the period that the rates
are next subject to change. Fixed-rate loans and mortgage-backed securities are
shown using the assumption that there will be no prepayment for maturities under
five years, and those with maturities in excess of five years will prepay at
annual rates ranging from 13% to 37%, depending on the stated rates of the
underlying assets. The Company has assumed that passbook accounts will be
withdrawn (decay) at annual rates of 17% of the cumulative declining balance for
the first three years, 16% for the fourth and fifth years and 14% thereafter.
NOW accounts will decay at an annual rate of 37% for the first year, 32% for the
second and third years and 17% thereafter. Money Market accounts will decay at
an annual rate of 79% for the first year and 31% thereafter. Certificates are
assumed to remain outstanding through maturity. The prepayment rates for loans
and mortgage-backed securities, along with the decay rates for passbook, NOW and
money market accounts are based on assumptions prepared by the OTS. Such
assumptions are reasonably indicative of the Company's experience over recent
periods.
Liquidity management involves the ability to meet the cash flow requirements
of depositors wanting to withdraw funds or borrowers seeking funds to meet their
credit needs. All savings institutions are required to maintain an average
daily balance of liquid assets equal to a certain percentage of its average
daily balance of net withdrawable deposit accounts and borrowings payable in one
year or less. At the present time, the minimum liquid asset ratio is 5%. At
December 31, 1998, Avondale was in compliance with the regulatory liquidity
requirement, with an overall liquid asset ratio of 58.36%.
In addition to cash and due from banks, marketable securities, particularly
those with shorter maturities, have periodically been used as a source of asset
liquidity. At December 31, 1998 and 1997, the Company held no securities that
mature in one year or less. Also at December 31, 1998, securities with a book
value of $41.2 million were callable at the option of the issuer within one
year.
Rate sensitivity varies for different types of interest earning assets and
interest bearing liabilities. For example, rate sensitivity for Federal Funds
purchased with varying daily rates or for loans indexed to the prime rate
differs considerably from sensitivity for long-term securities or fixed rate
loans. Time deposits over $100,000 exhibit more
28
rate sensitivity than savings accounts. Table 11 illustrates the maturity
schedule as of December 31, 1998 of time deposits $100,000 and greater. As
indicated in the table, 30.0% of the deposits mature within six months. This
percentage was 40.1% as of December 31, 1997.
At December 31, 1998, deposits maturing within one year decreased $112.9
million to $151.4 million from $264.3 million at December 31, 1997. Term
borrowings decreased $90.0 million over this same time period, to $0 at December
31, 1998 from $90.0 million at December 31, 1997.
With approximately 53.8% of the Company's loan portfolio maturing or repricing
within three months at December 31, 1998, there is an immediate effect on
interest income when rates rise or fall. In a changing interest rate
environment, interest expense changes more slowly primarily due to the longer-
term maturities of certificates of deposits. As a result, the net interest
margin on lower cost funding increases in a period of rising rates or,
conversely, the net interest margin decreases in a falling rate environment.
As illustrated in table 10, the Company is asset sensitive through the five
year time horizon, with a cumulative five year sensitivity gap of 7.0% of total
interest-earning assets. The Company attempts to control its interest rate risk
by originating primarily adjustable-rate mortgage loans, including equity lines
of credit, for its portfolio. The Company also controls interest rate risk with
purchases of adjustable rate and short term securities and through the use of
short term borrowings. The Company continuously monitors and manages its
interest rate sensitivity position.
29
TABLE 10-MATURITY OR REPRICING OF ASSETS AND LIABILITIES
(IN THOUSANDS)
The following table sets forth the interest rate sensitivity of the Bank's
assets and liabilities at December 31,1998 on the basis of the factors and
assumptions set forth above.
More than More than More than More than
3 Months 3 months 1 Year 3 Years 5 Years
Or less to 1 year 3 Years to 5 Years to 10 Years
------------ ------------ ------------ ------------- -------------
Interest-earning assets:
Loans receivable:
Fixed rate loans $ 4,391 $ 10,031 $ 22,363 $16,218 $ 28,604
Adjustable rate loans 104,681 11,196 - - -
-------- -------- -------- ------- --------
Total loans receivable 109,072 21,227 22,363 16,218 28,604
Mortgage backed securities held-to-maturity 1,629 4,343 12,246 5,571 6,648
Mortgage backed securities available for sale 2,112 5,631 16,756 9,491 14,733
Investment securities available for sale 19,421 23,960 5,200 3,000 34,500
Interest bearing deposits and Federal Funds sold 66,566 - - - -
-------- -------- -------- ------- --------
Total investments 89,728 33,934 34,202 18,062 55,881
-------- -------- -------- ------- --------
Total earning assets 198,800 55,161 56,565 34,280 84,485
Interest-bearing liabilities:
Passbook and statement accounts 4,132 11,301 23,395 15,184 19,397
NOW accounts 1,994 5,218 6,190 1,656 2,223
Money market accounts 11,169 16,144 3,804 1,811 1,388
Certificate accounts 32,926 68,518 89,692 14,663 -
Advances from the Federal Home Loan Bank - - 5,000 803 100,000
-------- -------- -------- ------- --------
Total interest-bearing liabilities 50,221 101,181 128,081 34,117 123,008
-------- -------- -------- ------- --------
Interest sensitivity gap per period $148,579 $(46,020) $(71,516) $ 163 $(38,523)
======== ======== ======== ======= ========
Cumulative interest sensitivity gap $148,579 $102,559 $ 31,043 $31,206 $ (7,317)
======== ======== ======== ======= ========
Cumulative interest sensitivity gap as a
Percentage of total interest-earning assets 33.07% 22.83% 6.91% 6.95% (1.63)%
======== ======== ======== ======= ========
Cumulative net interest-earning assets as a
Percentage of net interest-bearing liabilities 395.85% 167.74% 111.11% 109.95% 98.32%
======== ======== ======== ======= ========
More than
10 Years More than
to 20 Years 20 Years Total
------------- ----------- ----------
Interest-earning assets:
Loans receivable:
Fixed rate loans $ 4,350 $ 1,074 $ 87,031
Adjustable rate loans - - 115,877
-------- ------- --------
Total loans receivable 4,350 1,074 202,908
Mortgage backed securities held-to-maturity 2,883 9,688 43,008
Mortgage backed securities available for sale 1,945 - 50,668
Investment securities available for sale - - 86,081
Interest bearing deposits and Federal Funds sold - - 66,566
-------- ------- --------
Total investments 4,828 9,688 246,323
-------- ------- --------
Total earning assets 9,178 10,762 449,231
Interest-bearing liabilities:
Passbook and statement accounts 13,417 3,814 90,640
NOW accounts 1,220 224 18,725
Money market accounts 251 6 34,573
Certificate accounts - - 205,799
Advances from the Federal Home Loan Bank - - 105,803
-------- ------- --------
Total interest-bearing liabilities 14,888 4,044 455,540
-------- ------- --------
Interest sensitivity gap per period $ (5,710) $ 6,718 $ (6,309)
======== ======= ========
Cumulative interest sensitivity gap $(13,027) $(6,309) $ (6,309)
======== ======= ========
Cumulative interest sensitivity gap as a
Percentage of total interest-earning assets (2.90)% (1.40)% (1.40)%
======== ======= ========
Cumulative net interest-earning assets as a
Percentage of net interest-bearing liabilities 97.11% 98.62% 98.62%
======== ======= ========
TABLE 11--TIME DEPOSITS $100,000 AND OVER MATURITY SCHEDULE
Maturity Period At December 31, 1998 Amount
------------------------------------ --------------
(In thousands)
Three months or less.................................... $ 2,531
More than three months through six months............... 4,838
More than six months through twelve months.............. 1,719
More than twelve months................................. 15,460
-------
Total certificate accounts in excess of $100,000........ $24,548
=======
30
Borrowed Funds
The Company has historically borrowed funds in the form of advances from
the FHLB of Chicago, securities sold under agreements to repurchase and other
term borrowings.
At December 31, 1998, the Company's borrowings consisted of FHLB advances
of $5.0 million with a rate of 5.22% maturing in the year 2000, $.8 million of
advances with a rate of 2.5% maturing in 2003 and $100.0 million of advances
with an average rate of 4.69% maturing in 2008.
At December 31, 1997, the Company had outstanding FHLB advances of $90.0
million with an average rate of 5.84% maturing within one year and advances of
$.8 million with a rate of 2.5% maturing in the year 2003. These advances were
the Company's only borrowings as of December 31, 1997.
TABLE 12--BORROWED FUNDS
For the Year Ended December 31
---------------------------------------------------
1998 1997 1996
---- ---- ----
(In thousands)
ADVANCES FROM THE FEDERAL HOME LOAN BANK:
Average balance outstanding.................................. $117,112 $ 90,557 $ 90,653
Maximum outstanding at any month-end during the period....... 160,803 90,803 95,803
Balance outstanding at end of period......................... 105,803 90,803 90,803
Weighted average interest rate during the period............. 4.97% 5.82% 5.78%
Weighted average interest rate at end of period.............. 4.70% 5.81% 5.93%
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
Average balance outstanding.................................. $ - $ 51,553 $ 80,558
Maximum outstanding at any month-end during the period....... - 96,311 116,447
Balance outstanding at end of period......................... - - 69,147
Weighted average interest rate during the period............. - 5.59% 5.64%
Weighted average interest rate at end of period.............. - - 5.59%
OTHER BORROWINGS:
Average balance outstanding.................................. $ 15 $ 25,512 $ 29,131
Maximum outstanding at any month-end during the period....... - 36,500 40,000
Balance outstanding at end of period......................... - - 32,000
Weighted average interest rate during the period............. 13.33% 5.50% 5.31%
Weighted average interest rate at end of period.............. - - 7.00%
TOTAL BORROWINGS:
Average balance outstanding.................................. $117,127 $167,622 $200,342
Maximum outstanding at any month-end during the period....... 160,803 217,114 196,595
Balance outstanding at end of period......................... 105,803 90,803 191,950
Weighted average interest rate during the period............. 4.98% 5.70% 5.66%
Weighted average interest rate at end of period.............. 4.70% 5.81% 5.99%
31
Capital Resources
Federally insured savings associations, such as Avondale, are required to
maintain minimum levels of regulatory capital. The OTS has established capital
standards, including a tangible capital requirement, a leverage ratio (or core
capital) requirement and a risk-based capital requirement applicable to such
savings associations. See Item 1. Business, Supervision and Regulation
Regulatory Capital Requirements and Limitations on Dividends and Other Capital
Distributions for additional information. The capital regulations require
tangible capital of at least 1.5% of adjusted total assets (as defined by
regulation). As shown in table 13, at December 31, 1998, Avondale had tangible
capital of $34.7 million, or 6.97% of adjusted total assets, which is $27.2
million above the minimum leverage ratio requirement of 1.5% in effect on that
date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. At December 31, 1998, Avondale
had risk-based capital of $38.5 million and risk-weighted assets of
approximately $286.8 million; or capital of 13.41% of risk-weighted assets.
TABLE 13--CAPITAL STANDARDS
At December 31, 1998
---------------------------
Amount Percentage
------------ -------------
(In thousands)
Tangible capital:
Capital level $34,713 6.97%
Requirement 7,468 1.50
------- -----
Excess $27,245 5.47%
======= =====
Core capital:
Capital level $34,713 6.97%
Requirement 19,914 4.00
------- -----
Excess $14,799 3.11%
======= =====
Risk-based capital:
Capital level $38,472 13.41%
Requirement 22,946 8.00
------- -----
Excess $15,526 5.54%
======= =====
Capital Ratios
--------------
Well Adequately Under-
Avondale Capitalized Capitalized Capitalized
------------ ------------- ------------- -------------
Core capital.................... 6.97% * = 5.0% * = 4.0% ** 4.0%
Tier 1 risk-based capital....... 12.10 * = 6.0 * = 4.0 ** 4.0
Total risk-based capital........ 13.41 * = 10.0 * = 8.0 ** 8.0
* More Than
** Less Than
32
Cash Flows
During the year ended December 31, 1998, the Company continued to utilize
loan securitizations as an efficient source of funding its loan growth. A
securitization in the amount of $100.0 million was completed during 1998. As a
result of the securitization and lower loan originations, the Company's gross
loans included in its statement of financial condition decreased from $247.5
million at December 31, 1997 to $202.9 million at December 31, 1998. The Company
manages an additional $231.3 million of securitized home equity lines of credit
which are not included in its statement of financial condition. Total assets
decreased to $498.9 million at December 31, 1998 from $538.9 million at December
31, 1997. In addition to the loan securitizations, sales of securities reduced
the Company's total assets and provided cash and liquidity. The increase in FHLB
advances of $15.0 million from December 31, 1997 to December 31, 1998 provided
additional funds, while the decrease in deposit liabilities of $47.4 million
from December 31, 1997 to December 31, 1998 used the Company's funds.
During the year ended December 31, 1997, two securitizations totaling
$170.3 million were completed. As a result of the securitizations, the Company's
gross loans included in its statement of financial condition decreased from
$324.5 million at December 31, 1996 to $246.2 million at December 31, 1997. The
Company managed an additional $224.7 million of securitized home equity lines of
at December 31, 1997. Total assets decreased to $541.5 million at December 31,
1997 from $595.6 million at December 31, 1996. The increase in deposit
liabilities of $66.4 million from December 31, 1996 to December 31, 1997
provided funds, while the repayment of $101.1 million of repurchase agreements
and other borrowings during 1997 used the Company's funds.
The Company does not anticipate any significant capital expenditure that
would require funding outside of the Company's normal operations.
Recent Accounting Pronouncements and Regulatory Issues
In June 1997, the FASB adopted Statement of Financial Accounting Standard
No. 131 ("SFAS 131"), Disclosures About Segments of an Enterprise and Related
Information. This Statement supersedes SFAS No. 14, Financial Reporting for
Segments of a Business Enterprise, and utilizes the "management approach" for
segment reporting. The management approach is based on the way that the chief
operating decision maker organizes segments within a company for making
operating decisions and assessing performance. Reportable segments are based on
any manner in which management disaggregates its company such as by products and
services, geography, legal structure and management structure. SFAS 131 requires
disclosures for each segment that are similar to those required under current
standards with the addition of quarterly disclosure requirements and more
specific and detailed geographic disclosures. This Statement also requires
descriptive information about the way the operating segments were determined.
The Company has presented the required disclosures pursuant to this statement in
its consolidated financial statements.
In June 1998, the FASB adopted Statement of Financial Accounting Standard
No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging
Activities. SFAS 133 establishes accounting and reporting standards requiring
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an asset
or liability measured at its fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. SFAS 133 is effective for fiscal years beginning after June
15, 1999. SFAS 133 may be implemented as of the beginning of any fiscal quarter
after June 30, 1998 but cannot be applied retroactively. SFAS 133 must be
applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997. The Company has not yet quantified the impacts
of adopting SFAS 133 on its financial statements and has not determined the
timing of or method of its adoption of SFAS 133. However, SFAS 133 could
increase volatility in earnings and other comprehensive income.
33
In October 1998, the FASB adopted Statement of Financial Accounting
Standard No. 134 ("SFAS 134"), Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise. This Statement amends SFAS No. 65, Accounting for Certain
Mortgage Banking Activities, and requires that after the securitization of
mortgage loans held for sale, an entity engaged in mortgage banking activities
classify the resulting mortgage-backed securities or other retained interests
based on its ability and intent to sell or hold those investments. The
provisions of SFAS 134 are effective for the first fiscal quarter beginning
after December 15, 1998, with earlier application permitted. The Company adopted
the provisions of this statement, the effect of which had the Company reclassify
its retained interest-only securities as available for sale from trading, in the
fourth quarter of 1998.
There are no regulatory issues outstanding.
Year 2000 Compliance
A significant issue has emerged in the banking industry and for the economy
overall regarding how existing application software programs and operating
systems can accommodate the date value for the year 2000. Among the risks to
the Company of not becoming year 2000 compliant are the loss of financial and
non-financial data, defection of customers and direct and indirect financial
loss. To address these risks, the Company has developed a plan for itself and
its third party service providers to ensure year 2000 compliance. As part of
this plan, the Company has created a committee of specialists to ensure that the
Company and its vendors will be prepared for the year 2000. The committee has
determined the Company's and its vendor's critical processes that must be made
year 2000 compliant. On a regular basis, the committee evaluates and tests the
Company's and its third party vendor's readiness for the year 2000. The Company
has tested the majority of its internal systems and has determined them to be
year 2000 compliant. The Company has been working with its third party vendors
to determine their level of compliance and is currently awaiting results of the
vendors' testing. To date, the financial impact to the Company of such
compliance has not been, and is not anticipated by management to be, material to
the financial position, results of operations or cash flow of the Company. In
conjunction with the Company's previously announced merger, the Company will
convert to Coal City's computer systems. If the merger is not completed as
anticipated, management will be required to assess alternative contingency plans
to ensure that the Company and its vendors will become year 2000 compliant.
34
Market Risk
The Company's market risk is primarily due to interest rate risk. The
following table provides information about the Company's financial instruments
that are subject to interest rate risk. For loans, securities and liabilities
with contractual maturities, the table presents principal cash flows and
weighted-average rates by contractual maturities as well as the Company's
historical experience of the impact of interest rate fluctuations on the
prepayment of loans and mortgage-backed securities. For core deposits that have
no contractual maturity, the table presents principal cash flows and weighted-
average rates based on historical experience of balance attrition.
FINANCIAL INSTRUMENTS SUBJECT TO INTEREST RATE RISK PRINCIPAL MATURITIES
(Dollars in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Principal Amount Maturing in:
-----------------------------------------------------------------------------
Dec. 31, 1998
Year ending December 31 1999 2000 2001 2002 2003 Thereafter Total Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
Rate sensitive assets:
Fixed interest rate loans $ 14,422 $11,816 $10,548 $ 9,076 $ 7,142 $ 34,027 $ 87,031 $ 86,109
Average interest rate 8.25% 8.27% 8.10% 8.30% 8.35% 8.25% 8.25%
Adjustable rate loans $ 32,357 $23,297 $16,774 $12,078 $ 8,696 $ 22,360 $115,562 $111,768
Average interest rate 12.65% 12.60% 12.65% 12.70% 12.68% 12.75% 12.67%
Fixed interest rate securities $ 50,913 $11,329 $ 2,679 $ 4,790 $ 1,174 $ 41,677 $112,562 $114,401
Average interest rate 6.10% 6.46% 6.22% 5.96% 6.36% 7.75% 6.75%
Adjustable rate securities $ 8,450 $ 5,665 $10,024 $ 8,355 $ 7,769 $ 25,999 $ 66,262 $ 66,135
Average interest rate 6.83% 6.31% 5.66% 6.19% 6.32% 6.66% 6.40%
- ------------------------------------------------------------------------------------------------------------------------------------
Rate sensitive liabilities:
Non-interest bearing deposits $ 3,212 $ 1,470 $ 1,430 $ 433 $ 393 $ 1,743 $ 8,681 $ 8,681
Average interest rate -- -- -- -- -- -- --
Passbook, NOW and money markets $ 46,296 $15,249 $15,288 $ 8,893 $ 8,933 $ 40,598 $135,257 $134,855
Average interest rate 2.07% 2.25% 2.24% 2.34% 2.33% 2.25% 2.23%
Certificate accounts $101,444 $87,729 $ 1,963 $11,053 $3,3610 $ -- $205,799 $207,594
Average interest rate 4.64% 5.75% 5.80% 6.33% 6.75% -- 5.25%
Fixed rate FHLB advances $ -- $ -- $ -- $ -- $ 803 $100,000 $100,803 $ 90,477
Average interest rate -- -- -- -- 2.50% 4.69% 4.67%
Adjustable rate FHLB advances $ -- $ 5,000 $ -- $ -- $ -- $ -- $ 5,000 $ 5,000
Average interest rate -- 5.22% -- -- -- -- 5.22%
- ------------------------------------------------------------------------------------------------------------------------------------
35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AVONDALE FINANCIAL CORP.
1998 CONSOLIDATED FINANCIAL STATEMENTS
36
AVONDALE FINANCIAL CORP.
1998 FINANCIAL STATEMENTS
INDEX
Page
------
Independent Auditor's Report--Arthur Andersen LLP...................................................... 38
Statement of Management Responsibility................................................................. 39
Consolidated Balance Sheets as of December 31, 1998 and 1997........................................... 40
Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996................ 41
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1998, 1997
and 1996.............................................................................................. 42
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996............. 43
Notes to the Consolidated Financial Statements......................................................... 45
37
[LOGO OF ARTHUR ANDERSEN LLP]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Board of Directors of
Avondale Financial Corp.:
We have audited the accompanying balance sheets of AVONDALE FINANCIAL CORP. (the
"Company") as of December 31, 1998 and 1997, and the related statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit of obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Avondale Financial Corp. as of
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Chicago, Illinois,
January 29, 1999
38
AVONDALE
FINANCIAL CORP.
STATEMENT OF MANAGEMENT RESPONSIBILITY
Avondale Financial Corp.'s management is responsible for the preparation,
integrity and fair presentation of its published financial statements. The
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and, as such, include amounts based on
judgments and estimates made by management. Management also prepared other
information included in the annual report and is responsible for Its accuracy
and consistency with the financial statements.
The consolidated financial statements have been audited by an independent
accounting firm, Arthur Andersen LLP, which has been given unrestricted access
to all financial records and related data, including minutes of all meetings of
shareholders, the Board of Directors and committees of the Board, Management
believes that representations made to the independent auditors during their
audit were valid and appropriate.
Management maintains a system of internal controls over the preparation of its
published financial statements, which is intended to provide reasonable
assurance to the Company's Board of Directors and officers regarding preparation
of financial statements presented fairly in conformity with generally accepted
accounting principles.
Management has long recognized its responsibility for conducting the Company's
affairs in a manner, which is responsive to the interest of employees,
shareholders, investors and society in general. This responsibility is included
in the statement of policy on ethical standards which provides that the Company
will fully comply with laws, rules and regulations of every community in which
it operates and adhere to the highest ethical standards. Officers, employees and
agents of the Company are expected and directed to manage the business of the
Company with complete honesty, candor and integrity.
Internal auditors monitor the operation of the internal control system, and
actions are taken by management to respond to deficiencies as they are
identified. The Board, operating through its audit committee, which is composed
entirely of directors who are not officers or employees of the Company, provides
oversight to the financial reporting process.
Even effective internal controls, no mater how well designed, have inherent
limitations, such as the possibility of human error or of circumvention or
overriding of controls, and the consideration of cost in relation to benefit of
a control. Further the effectiveness of an internal control can change with
circumstances.
Avondale Financial Corp's management periodically assesses the internal
controls for adequacy. Based upon these assessments, Avondale Financial Corp.'s
management believes that, in all material respects, its internal controls
relating to preparation of consolidated financial statements as of December 31,
1998 functioned effectively during the year ended December, 31 1998.
/s/ Robert S. Engelman /s/ Howard A. Jaffe
Robert S. Engelman, Jr. Howard A. Jaffe
President and Vice President and
Chief Executive Officer Chief Financial Officer
39
AVONDALE FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
At December 31
------------------------------------
1998 1997
-------- --------
(In thousands except per share data)
ASSETS
Cash and due from banks....................................................... $ 9,963 $ 6,630
Interest-bearing deposits..................................................... 66,566 60,891
-------- --------
Total cash and cash equivalents............................................. 76,529 67,521
Trading securities (amortized cost December 31, 1998--$2,000)................ 2,139 --
Securities available-for-sale--At fair value (amortized cost Dec. 31, 1998--
$85,491; Dec. 31, 1997--$46,251)..................................... 86,081 46,373
Mortgage-backed securities available-for-sale--At fair value (amortized cost
Dec. 31, 1998--$50,887; Dec. 31, 1997--$80,481).......................... 50,668 80,621
Mortgage-backed securities held-to-maturity--At amortized cost
(fair value Dec. 31, 1998--$43,787; Dec. 31, 1996--$53,451).............. 43,007 53,719
Loans held for sale--At cost.................................................. 16,741 52,688
Loans......................................................................... 185,852 193,557
Less: Allowance for loan losses............................................... (6,717) (6,303)
-------- --------
Loans, net.................................................................. 195,876 239,942
Federal Home Loan Bank stock--at cost......................................... 5,290 4,540
Office buildings and equipment, net........................................... 4,495 5,264
Other real estate owned, net.................................................. 504 1,105
Accrued interest receivable................................................... 3,767 6,847
Interest-only securities...................................................... 15,362 17,792
Other assets.................................................................. 8,323 5,600
Income taxes receivable....................................................... 406 3,866
Deferred income taxes......................................................... 6,483 5,664
-------- --------
Total assets................................................................ $498,930 $538,854
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits...................................................................... $341,056 $390,539
Non-interest bearing deposits................................................. 8,681 6,571
Advances from Federal Home Loan Bank.......................................... 105,803 90,803
Advance payments by borrowers for taxes and insurance......................... 23 564
Accrued interest payable...................................................... 428 482
Other liabilities............................................................. 4,853 3,932
-------- --------
Total liabilities........................................................... 460,844 492,891
-------- --------
Stockholders' Equity:
Common stock ($.01 par: 10,000,000 shares authorized, 2,904,762 and
3,323,566 shares issued and outstanding, at Dec. 31, 1998 and 1997,
respectively)............................................................... 44 44
Capital surplus............................................................... 43,749 43,536
Retained earnings............................................................. 17,302 18,549
Treasury stock, at cost....................................................... (21,536) (13,988)
Unrealized net gain on securities available-for-sale, net of tax of $81
at Dec. 31, 1998 and $102 at Dec. 31, 1997................................... 135 152
Common stock acquired by ESOP................................................. (847) (1,270)
Unearned portion of restricted stock awards................................... (761) (1,060)
-------- --------
Total stockholders' equity.................................................. 38,086 45,963
-------- --------
Total liabilities and stockholders' equity.................................. $498,930 $538,854
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
40
AVONDALE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
For the Year Ended December 31
--------------------------------------------------
1998 1997 1996
---- ---- ----
(In thousands except per share data)
INTEREST INCOME:
Loans....................................................... $ 23,007 $ 39,234 $ 24,842
Securities.................................................. 7,954 2,649 3,965
Mortgage-backed securities.................................. 4,690 11,259 16,522
Other....................................................... 4,497 866 552
---------- ---------- ----------
Total interest income................................. 40,148 54,008 45,881
INTEREST EXPENSE:
Deposits.................................................... 17,520 18,776 14,595
Advances from the Federal Home Loan Bank.................... 5,818 5,269 5,236
Securities sold under agreements to repurchase.............. -- 2,880 4,541
Other borrowings............................................ 2 1,402 1,545
---------- ---------- ----------
Total interest expense................................ 23,340 28,327 25,917
NET INTEREST INCOME: 16,808 25,681 19,964
Provision for loan losses................................... 4,727 26,527 4,293
---------- ---------- ----------
Net interest income after provision for loan losses......... 12,081 (846) 15,671
NONINTEREST INCOME:
Gains on trading activities, net............................ 139 1 216
Security gains, net......................................... 307 1,199 2,313
Securitization income, net.................................. 727 8,759 3,433
Gains (losses) on sales of loans............................ -- (11,919) 7
Loan fees................................................... 2,956 4,679 625
Fees for customer services.................................. 585 593 361
Gain on sale of branch...................................... -- -- 2,922
Other operating income...................................... 627 596 526
---------- ---------- ----------
Total noninterest income.............................. 5,341 3,908 10,403
NONINTEREST EXPENSE:
Salaries and employee benefits.............................. 9,193 9,368 8,193
Occupancy and equipment, net................................ 2,824 2,069 1,448
Federal deposit insurance premiums.......................... 238 238 2,886
Advertising and public relations............................ 495 519 701
Data processing............................................. 2,014 2,860 1,615
Real estate owned (income) expense, net..................... (137) (202) 35
Legal and professional fees................................. 2,083 1,907 531
Other operating expenses.................................... 2,665 5,980 4,097
---------- ---------- ----------
Total noninterest expense............................. 19,375 22,739 19,506
---------- ---------- ----------
Income (loss) before income taxes........................... (1,953) (19,677) 6,568
Provision (benefit) for income taxes........................ (706) (7,195) 2,352
---------- ---------- ----------
NET INCOME (LOSS)........................................... (1,247) (12,482) 4,216
========== ========== ==========
Other comprehensive income (loss):
Unrealized gains on securities, net of tax.................. 178 868 2,728
Less: Reclassification adjustments for gains included
in net income, net of tax.............................. 195 749 1,446
---------- ---------- ----------
Other comprehensive income (loss)....................... (17) 119 1,280
---------- ---------- ----------
Comprehensive loss.......................................... $ (1,264) $ (12,363) $ 5,498
========== ========== ==========
PER COMMON SHARE:
Basic earnings per common share............................. $ (.40) $ (3.59) $ 1.13
Diluted earnings per common share........................... $ (.40) $ (3.59) $ 1.13
Weighted average common shares outstanding.................. 3,087,168 3,476,332 3,719,272
The accompanying notes are an integral part of these Consolidated Financial
Statements.
41
AVONDALE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Unrealized Net Gain
(loss) on Securities
Common Capital Retained Treasury Available-for-sale
Stock Surplus Earnings Stock Net of tax
----- ------- -------- ----- ----------
(In thousands)
-----------------------------------------------------------------------
Balance at December 31, 1995 $ 44 $43,018 $ 26,815 - $ 1,313
-----------------------------------------------------------------------
Net Income 4,216
Purchase of 700,000 shares of
Treasury Stock (10,496)
Commitment to release 42,320
ESOP shares 181
Net amortization of unearned
Portion of restricted stock
Change in unrealized net gain on securities
Available-for-sale net of tax of $(811) (1,280)
-----------------------------------------------------------------------
Balance at December 31, 1996 44 43,199 31,031 (10,496) 33
-----------------------------------------------------------------------
Net Income (12,482)
Purchase of 230,393 shares of
Treasury Stock (3,492)
Commitment to release 42,320
ESOP shares 337
Net amortization of unearned
Portion of restricted stock
Change in unrealized net gain on securities
Available-for-sale net of tax of $81 119
-----------------------------------------------------------------------
Balance At December 31, 1997 44 43,536 18,549 (13,988) 152
-----------------------------------------------------------------------
Net Loss (1,247)
Purchase of 461,124 shares of
Treasury Stock (7,548)
Commitment to release 42,320
ESOP shares 213
Net amortization of unearned
Portion of restricted stock
Change in unrealized net gain on securities
Available-for-sale net of tax of $81 (17)
-----------------------------------------------------------------------
Balance at December 31, 1998 $ 44 $43,749 $ 17,302 $(21,536) $ 135
-----------------------------------------------------------------------
Unearned Total
Common Stock Restricted Stock Stockholders'
Acquired by ESOP Awards Equity
---------------- ------ ------
---------------------------------------------------------
Balance at December 31, 1995 $ (2,116) $ (2,159) $ 66,915
---------------------------------------------------------
Net Income 4,216
Purchase of 700,000 shares of
Treasury Stock (10,496)
Commitment to release 42,320
ESOP shares 423 604
Net amortization of unearned
Portion of restricted stock 930 930
Change in unrealized net gain on securities
Available-for-sale net of tax of $(811) (1,280)
---------------------------------------------------------
Balance at December 31, 1996 (1,693) (1,229) 60,889
---------------------------------------------------------
Net Income (12,482)
Purchase of 230,393 shares of
Treasury Stock (3,492)
Commitment to release 42,320
ESOP shares 423 760
Net amortization of unearned
Portion of restricted stock 169 169
Change in unrealized net gain on securities
Available-for-sale net of tax of $81 119
---------------------------------------------------------
Balance at December 31, 1997 (1,270) (1,060) 45,963
---------------------------------------------------------
(1,247)
Net Loss
Purchase of 461,124 shares of (7,548)
Treasury Stock
Commitment to release 42,320 423 636
ESOP shares
Net amortization of unearned 299 299
Portion of restricted stock
Change in unrealized net gain on securities
Available-for-sale net of tax of $81 (17)
---------------------------------------------------------
Balance at December 31, 1998 $ (847) $ (761) $ 38,086
---------------------------------------------------------
The accompanying notes are an integral part of these Consolidated Financial
Statements.
42
AVONDALE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31
----------------------------------------------------
1998 1997 1996
---------------- ---------------- -----------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss)....................................................... $ (1,247) $ (12,482) $ 4,216
Adjustments to reconcile net income (loss) to net cash flows
From operating activities:
Depreciation........................................................... 1,608 1,284 997
Amortization (accretion), net.......................................... (838) (477) (3,060)
Unearned restricted stock.............................................. 299 170 930
Provision for loan losses.............................................. 4,727 26,527 4,293
Provision (benefit) for deferred income taxes.......................... (798) (3,044) 415
Net gain on sales of securities available-for-sale and trading......... (446) (1,200) (2,529)
Net gains on sales of loans............................................ (4,451) (7,943) (3,314)
Net gains on sales of other real estate owned.......................... (187) (347) (149)
Net gains on sale of branch............................................ -- -- (2,922)
Net changes in:
Income taxes receivable............................................... 3,439 (3,431) --
Interest-only securities and other assets............................. (293) (2,091) (4,033)
Accrued interest receivable........................................... 3,080 (2,160) (1,464)
Income taxes payable.................................................. -- (452) 417
Accrued interest payable.............................................. (54) 874 1,158
Other liabilities..................................................... 921 (5,432) (543)
-------- --------- ---------
Net cash flows provided by (used in) operating activities............... 5,760 (10,204) (5,588)
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities held-to-maturity................. -- 6,500 400
Purchases of trading securities......................................... (2,000) -- --
Purchases of Federal Home Loan Bank stock............................... (3,500) -- (375)
Proceeds from sales of Federal Home Loan Bank stock..................... 2,750 250 --
Proceeds from maturities of securities available-for-sale............... 43,968 -- 123,120
Proceeds from sales of securities available-for-sale.................... 9,723 7,000 52,750
Proceeds from sales of mortgage-backed securities available-for-sale.... 17,732 63,079 265,850
Purchases of securities available-for-sale.............................. (92,116) (29,545) (134,970)
Purchases of mortgage-backed securities available-for-sale.............. (23,810) (22,373) (207,222)
Purchases of mortgage-backed securities held-to-maturity................ -- -- (4,424)
Principal collected on mortgage-backed securities held-to-maturity...... 13,152 7,718 7,893
Principal collected on mortgage-backed securities available-for-sale.... 33,436 16,541 27,994
Principal collected on securities available-for-sale.................... -- 12,501 465
Proceeds from securitization and sale of loans.......................... 94,518 169,129 73,989
Net increase in loans................................................... (51,828) (123,893) (181,454)
Proceeds from sales of other real estate owned.......................... 1,888 2,027 2,546
Proceeds from sales of office buildings and equipment................... -- -- 3,985
Expenditures for office buildings and equipment......................... (839) (2,673) (2,163)
-------- --------- ---------
Net cash flows provided by (used in) investing activities............... 43,074 106,261 28,384
-------- --------- ---------
43
AVONDALE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS--CONTINUED
For the Year Ended December 31
-----------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
(In thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits.................................... $(47,373) $ 66,455 $ (5,002)
Net decrease in advance payments by borrowers for taxes and
Insurance............................................................. (541) (367) (524)
Net increase (decrease) in securities sold under agreements to
Repurchase............................................................ -- (69,146) (7,646)
Net increase (decrease) in other borrowings............................ -- (32,000) (9,500)
Proceeds from Federal Home Loan Bank advances.......................... 100,000 35,000 62,500
Repayment of Federal Home Loan Bank advances........................... (85,000) (35,000) (50,000)
Capital surplus........................................................ 213 517 181
ESOP committed to be released.......................................... 423 423 423
Purchase of treasury stock............................................. (7,548) (3,492) (10,496)
-------- -------- --------
Net cash flows used in financing activities............................ (39,826) (37,610) (20,064)
-------- -------- --------
INCREASE IN CASH AND CASH EQUIVALENTS.................................. 9,008 58,447 2,732
CASH AND CASH EQUIVALENTS:
Beginning of period.................................................... 67,521 9,074 6,342
-------- -------- --------
Ending of period....................................................... $ 76,529 $ 67,521 $ 9,074
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.......................................................... $ 23,394 $ 27,453 $ 24,760
Income taxes paid...................................................... 79 425 1,935
The accompanying notes are an integral part of these Consolidated Financial
Statements.
44
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1998, 1997 and 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Avondale Financial Corp. (The
"Company") and its wholly-owned subsidiary, Avondale Federal Savings Bank (the
"Bank"), conform with generally accepted accounting principles and to general
industry practice. The following is a description of the more significant
policies that the Company follows in preparing and presenting its consolidated
financial statements.
SUBSEQUENT EVENTS--As discussed in Note 20 to the Consolidated Financial
Statements, the Company and Coal City Corporation ("Coal City"), the holding
company for Manufacturers Bank, have entered into a definitive agreement in
connection with a merger of equals. Under the terms of the agreement, Coal City
will be merged into the Company and the Company will be renamed MB Financial,
Inc. (the "Merger"). Immediately following the Merger, the Bank's five retail
branches will be merged into Manufacturers Bank. Each share of Coal City common
stock will be converted into 83.5 shares of MB Financial common stock while each
share of Avondale will be converted into 1 share of MB Financial. On a pro forma
basis, shareholders of Coal City will own approximately 58.5% of the combined
company, while stockholders of the Company will own approximately 41.5%. See
Note 20 to the Consolidated Financial Statements for additional information.
Also as discussed in Note 20 to the Consolidated Financial Statements, on
February 17, 1999, the Company completed the sale of the assets of its national
mortgage origination operation to New South Federal Savings Bank ("New South").
Pursuant to the agreement, New South purchased certain assets and assumed
certain liabilities of the Company. See Note 20 to the Consolidated Financial
Statements for additional information.
NATURE OF OPERATIONS--The Company's lending products consist primarily of
first and second mortgages including equity lines of credit, on owner-occupied
and non-owner occupied one to four family residences. The Company has expanded
its wholesale distribution channels through third party brokers and other
financial institutions to offer equity lines of credit in thirty-seven states.
To a lesser extent, Avondale also originates multi-family development loans. The
Company also offers investment products and insurance through its wholly-owned
subsidiary, Avondale Financial Services, Inc. ("AFS"). The Company's revenues
are principally derived from interest on loans and investment securities,
securitization income and fee income.
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts and transactions of the Company, the Bank, and the Bank's wholly-
owned subsidiaries, Avondale Financial Services, Avondale Funding Corp. and
Avondale Community Development Corp. All material intercompany balances and
transactions have been eliminated in consolidation.
INVESTMENT AND MORTGAGE-BACKED SECURITIES--Securities are classified into
three categories: trading, held-to-maturity and available-for-sale. Securities
that are bought principally for the purpose of selling them in the near term are
classified as trading securities. Trading account securities are carried at fair
value in the statement of financial condition. Realized and unrealized gains and
losses are included in noninterest income in the statement of income.
Securities for which the Company has the intent and ability to hold until
maturity are classified as held-to-maturity. Held-to-maturity securities are
carried at cost, with premiums amortized and discounts accreted using the level-
yield method, adjusted for actual prepayments and changes in prepayment
assumptions. Realized gains and losses are recorded in the statement of income
on a specific identification basis for held-to-maturity securities.
45
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
All securities not classified as trading or held-to-maturity are classified
as available-for-sale. Available-for-sale securities are carried at fair value
with unrealized gains and losses included, on an after-tax basis, as a separate
component of stockholders' equity. The cost of securities sold by the Company is
determined using specific identification.
INTEREST ON LOANS--Interest on loans is recorded as earned. The accrual of
interest income is generally discontinued on loans which are past due 90 or more
days as to principal or interest payments or when management deems the loans or
interest uncollectible in part or in full. When loans are placed on non-accrual
status, interest previously accrued is charged against interest income. Loans
may be reinstated to accrual status when all payments are brought current and,
in the opinion of management, collection of the remaining balance can be
reasonably expected.
LOANS HELD FOR SALE--Loans held for sale represent receivables currently on
the statement of financial condition that the Company generally intends to
securitize within the next six months. These assets are reported at the lower of
cost or fair market value.
LOAN ORIGINATION FEES, SERVICING FEES, AND PREMIUMS AND DISCOUNTS--Mortgage
loan origination fees and certain related direct mortgage loan origination costs
are deferred and the net amount is recognized over the contractual life of the
loan as an adjustment to yield. Fees for servicing mortgage loan portfolios are
generally recorded on the accrual basis. Premiums and discounts on mortgage
loans purchased are amortized to income over the lives of the loans using the
level yield method.
ALLOWANCE FOR LOAN LOSSES--Provisions for loan losses are charged to
operations based on management's evaluation of inherent losses in the loan
portfolio. The allowance for loan losses is maintained at a level to cover
losses inherent in the portfolio. Among the factors considered in evaluating
inherent losses are historical charge-off experience, delinquency, local and
national economic conditions, the borrower's ability to repay and the value of
any related collateral. Management's estimate of the fair value of collateral
considers the current and anticipated real estate market conditions. As a
result, estimates are susceptible to changes that could result in an adjustment
to future results of operations. Recovery of the carrying value of such loans
and related real estate is dependent on economic, operating and other conditions
that may be beyond the Company's control.
SECURITIZATION INCOME--Certain home equity lines of credit are securitized
and sold to investors with limited recourse. The servicing rights to these loans
have been retained by the Company. Upon sale, the loans are removed from the
statement of financial condition and a gain is recognized for the difference
between the allocated carrying value of the loans and the adjusted sales
proceeds. The adjusted sales proceeds are determined based on a present value
estimate of future cash flows for each loan pool sold. Future cash flows are
based on the "excess spread" between the yield of the underlying loans sold and
the securities issued and reflect estimates of prepayments, servicing fees,
operating expenses and other factors. These cash flows are projected over the
life of the loans sold using assumptions that market participants would use for
similar financial instruments subject to prepayments, credit and interest rate
risk and are discounted at an interest rate that a purchaser unrelated to the
seller of such a financial instrument would demand. The resulting gain is
reduced by applicable costs including unamortized loan origination costs
relating to the pool of loans sold. The gain is further reduced by establishing
a reserve for estimated probable losses under the limited recourse provisions.
This reserve amount is netted against the I/O strip. The I/O strip is amortized
as cash flows are received. The fair value of the I/O strip is evaluated at
least quarterly, and prior to the fourth quarter of 1998, any adjustment was
recognized in earnings immediately. In the fourth quarter of 1998, the Company
reclassified its I/O strips as available-for-sale and any adjustments to the
fair value of the securities are included in comprehensive income unless such
adjustment is considered by management to be other than temporary.
46
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Because of the sensitivity of the value of the I/O strip to market factors
beyond management's control, the actual amounts realized could differ materially
from the carrying value. Net gains on sale, recourse provisions, servicing cash
flows on receivables sold, and any adjustment to fair value of the interest only
strips prior to the fourth quarter of 1998 are reported in the accompanying
consolidated statements of income as securitization income.
OTHER REAL ESTATE OWNED--Other real estate owned represents real estate
acquired by foreclosure or by deed in lieu of foreclosure. At the date of
acquisition, acquired property is recorded at the lower of carrying value or
fair value less estimated costs to sell. Any excess of carrying value over fair
value less estimated costs to sell at the date of acquisition is charged
directly to the allowance for loan losses. Subsequent to acquisition, other real
estate owned is adjusted to the lower of net carrying value or fair value less
estimated costs to sell. Provisions for estimated losses on the basis of
subsequent evaluations, gains or losses on sales and net expenses incurred from
maintaining such properties are included in other expense. THE AMOUNTS THAT
ULTIMATELY COULD BE RECOVERED FROM OTHER REAL ESTATE OWNED COULD DIFFER FROM THE
AMOUNTS USED IN DETERMINING THE NET CARRYING VALUE OF THE ASSETS AS A RESULT OF
MARKET FACTORS BEYOND THE COMPANY'S CONTROL.
OFFICE BUILDINGS AND EQUIPMENT--Office buildings and equipment are stated
at cost less accumulated depreciation and amortization. Depreciation is charged
to operations over the estimated useful lives of the assets using the straight-
line method. The cost of leasehold improvements is amortized using the straight-
line method over the term of the lease. Maintenance, repairs and minor
improvements are charged to operating expense as incurred.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE--The Company enters into
sales of securities under agreements to repurchase generally for periods of less
than ninety days. Fixed coupon agreements are treated as financings and the
obligation to repurchase securities sold is reflected as a liability in the
statement of financial condition. The carrying value of underlying securities
remains in the asset accounts.
OTHER BORROWINGS--Other borrowings consist primarily of Federal funds
purchased usually for periods of one to thirty days.
INCOME TAXES--The Company and its subsidiaries account for income taxes in
accordance with Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes ("SFAS 109"). SFAS 109 requires the use of the liability method
in accounting for income taxes. Deferred tax assets and liabilities are recorded
based on the expected tax effect on future taxable income resulting from
differences between the financial statement and tax bases of assets and
liabilities and the expected tax effect of loss carryforwards.
CASH FLOW REPORTING--The Company uses the indirect method to report cash
flows from operating activities. Net reporting of cash transactions has been
used when balance sheet items consist predominantly of maturities of three
months or less, or where otherwise permitted. Other items are reported on a
gross basis. Cash and cash equivalents consist of cash and due from banks and
interest-bearing deposits.
EARNINGS PER SHARE--Earnings per share computations are in accordance with
Statement of Financial Accounting Standards No. 128, Earnings Per Share and are
based upon the weighted average shares outstanding during the year taking into
account dilutive stock options. In the years ended December 31, 1998, 1997 and
1996, stock options had an anti-dilutive effect, and therefore are not included
in the earnings per share calculation.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified to
conform with the current year's presentation.
47
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS--The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements, as well as the reported
amounts of income and expenses during the reported periods. Actual results could
differ from those estimates.
RECENT ACCOUNTING PRONOUNCEMENTS--In June 1997, the FASB adopted Statement
of Financial Accounting Standard No. 131 ("SFAS 131"), Disclosures About
Segments of an Enterprise and Related Information. This Statement supersedes
SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, and
utilizes the "management approach" for segment reporting. The management
approach is based on the way that the chief operating decision maker organizes
segments within a company for making operating decisions and assessing
performance. Reportable segments are based on any manner in which management
disaggregates its company such as by products and services, geography, legal
structure and management structure. SFAS 131 requires disclosures for each
segment that are similar to those required under current standards with the
addition of quarterly disclosure requirements and more specific and detailed
geographic disclosures. This Statement also requires descriptive information
about the way the operating segments were determined. The Company has presented
the required disclosures pursuant to this statement in the accompanying
consolidated financial statements.
In June 1998, the FASB adopted Statement of Financial Accounting Standard
No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging
Activities. SFAS 133 establishes accounting and reporting standards requiring
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an asset
or liability measured at its fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. SFAS 133 is effective for fiscal years beginning after June
15, 1999. SFAS 133 may be implemented as of the beginning of any fiscal quarter
after June 30, 1998 but cannot be applied retroactively. SFAS 133 must be
applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997. The Company has not yet quantified the impacts
of adopting SFAS 133 on its financial statements and has not determined the
timing of or method of its adoption of SFAS 133. However, SFAS 133 could
increase volatility in earnings and other comprehensive income.
In October 1998, the FASB adopted Statement of Financial Accounting
Standard No. 134 ("SFAS 134"), Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise. This Statement amends SFAS No. 65, Accounting for Certain
Mortgage Banking Activities, and requires that after the securitization of
mortgage loans held for sale, an entity engaged in mortgage banking activities
classify the resulting mortgage-backed securities or other retained interests
based on its ability and intent to sell or hold those investments. The
provisions of SFAS 134 are effective for the first fiscal quarter beginning
after December 15, 1998, with earlier application permitted. The Company adopted
the provisions of this statement, which allow the Company to reclassify its
retained interest-only securities as available for sale from trading, in the
fourth quarter of 1998.
48
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SECURITIES
The amortized cost, gross unrealized gains and losses and fair values of
securities are summarized as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost GAINS LOSSES Value
----------- ---------- ---------- -------
Available-for-sale:
December 31, 1998
-----------------
U.S. Government agency securities.................. $ 46,421 $ 188 $ -- $ 46,609
Trust preferred securities......................... 39,070 872 (470) 39,472
--------- ------- -------- --------
Total............................................. $ 85,491 $ 1,060 $ (470) $ 86,081
========= ======= ======== ========
December 31, 1997
-----------------
U.S. Government agency securities.................. $ 46,251 $ 147 $ (25) $ 46,373
========= ======= ======== ========
The maturity of securities is as follows (in thousands):
At December 31
--------------------------------------------------
1998 1997
---- ----
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ----------- -----------
Available-for-sale:
Term to maturity
----------------
Due after one year through five years....... $ 33,228 $ 33,315 $ 36,262 $ 36,363
Due after five years through ten years...... 52,263 52,766 9,989 10,010
-------- --------- --------- ----------
Total...................................... $ 85,491 $ 86,081 $ 46,251 $ 46,373
======== ========= ========= ==========
Proceeds from the sales of securities available-for-sale were $9.7 million
for the year ended December 31, 1998 and resulted in gross realized gains of
$327 thousand and gross realized losses of $69 thousand. Proceeds from the sales
of securities available-for-sale were $7.0 million for the year ended December
31, 1997 and resulted in gross realized gains of $66 thousand and no realized
losses. Proceeds from the sales of securities available-for-sale were $52.8
million for the year ended December 31, 1996 and resulted in gross realized
gains of $768 thousand and gross realized losses of $8 thousand. There were no
sales of securities held-to-maturity during the years ended December 31, 1998,
1997 or 1996.
49
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 1998 and 1997, the Company held structured notes with an
amortized cost of $8.0 and $16.8 million, respectively, and fair value of $8.0
and $16.8 million, respectively. These securities were issued by the Federal
Home Loan Bank (FHLB). The structured notes are comprised primarily of
securities which have coupon interest rates which ''step up'' periodically
during the term to maturity.
At December 31, 1998, securities with an amortized cost of $28.9 million
and a fair value of $29.1 million were pledged to secure borrowings.
50
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. MORTGAGE-BACKED SECURITIES
The amortized cost, gross unrealized gains and losses and fair values of
mortgage-backed securities are summarized as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -------
Available-for sale:
December 31, 1998:
-----------------
Collateralized Mortgage Obligations:
Government and Agency................................ $ 13,891 $ 9 $ (224) $ 13,676
Private Issuer....................................... 12,453 35 (20) 12,468
GNMA Certificates...................................... 21,161 49 (104) 21,106
FHLMC Certificates..................................... 1,481 8 -- 1,489
FNMA Certificates...................................... 1,901 28 -- 1,929
--------- ------- ---------- ----------
Total.............................................. $ 50,887 $ 129 $ (348) $ 50,668
========= ======= ========== ==========
December 31, 1997:
-----------------
Collateralized Mortgage Obligations:
Government and Agency................................ $ 5,546 $ 17 $ (104) $ 5,459
Private Issuer....................................... 17,951 14 (129) 17,836
GNMA Certificates...................................... 51,874 520 (60) 52,334
FHLMC Certificates..................................... 2,960 ------- (101) 2,859
FNMA Certificates...................................... 2,150 3 (20) 2,133
--------- ------- ---------- ----------
Total.............................................. $ 80,481 $ 554 $ (414) $ 80,621
========= ======= ========== ==========
Held-to-maturity:
December 31, 1998:
-----------------
Private Issuer Collateralized Mortgage
Obligations.......................................... $ 29,000 $ 578 $ (4) $ 29,574
GNMA Certificates...................................... 1,727 63 -- 1,790
FHLMC Certificates..................................... 610 18 -- 628
FNMA Certificates...................................... 11,670 125 -- 11,795
--------- ------- ---------- ----------
Total.............................................. $ 43,007 $ 784 $ (4) $ 43,787
========= ======= ========== ==========
December 31, 1997:
-----------------
Private Issuer Collateralized Mortgage
Obligations.......................................... $ 36,313 $ 110 $ (486) $ 35,937
GNMA Certificates...................................... 2,393 113 -- 2,506
FHLMC Certificates..................................... 835 20 -- 855
FNMA Certificates...................................... 14,178 61 (86) 14,153
--------- ------- ---------- ----------
Total.............................................. $ 53,719 $ 304 $ (572) $ 53,451
========= ======= ========== ==========
51
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Proceeds from the sale of mortgage-backed securities available for sale
were $17.7 million for the year ended December 31, 1998 and resulted in gross
realized gains of $49 thousand and no gross realized losses. Proceeds from the
sale of mortgage-backed securities available for sale were $63.1 million for the
year ended December 31, 1997 and resulted in gross gains of $1.1 million and no
realized losses. Proceeds from the sale of mortgage-backed securities available
for sale were $265.9 million for the year ended December 31, 1996 and resulted
in gross gains of $2.2 million and gross realized losses of $481 thousand. There
were no sales of mortgage-backed securities held-to-maturity during the years
ended December 31, 1998, 1997 or 1996.
At December 31, 1998 mortgage-backed securities with an amortized cost of
$46.9 million and fair value of $46.8 million were pledged to secure borrowings
and mortgage-backed securities with an amortized cost and fair value of $4.2
million were pledged to secure securitization spread accounts.
Mortgage-backed securities are comprised of pass-through certificates
representing interests in pools of fixed and variable interest rate single
family mortgage loans originated for terms of 15, 30, or 40 years. However, very
few of these loans have historically remained outstanding for their entire term
and management anticipates similar prepayments will occur in the future.
Generally, scheduled repayments gradually reduce the outstanding balance until
the underlying property is sold and the loan paid off. Collateralized Mortgage
Obligations consist of AAA, AA, A and BBB rated instruments which are purchased
with initial expected maturities of three to seven years.
As of December 31, 1998 and 1997, the Company had no outstanding
commitments to purchase mortgage-backed securities.
4. LOANS
Loans are summarized as follows (in thousands):
Balance at Percentage Balance at Percentage
December 31, 1998 of Total December 31, 1997 of Total
------------------ -------- ------------------ ----------
Mortgage loans:
Equity lines of credit........................ $ 61,959 30.54% $ 116,587 47.10%
One to four family............................ 80,204 39.53 82,610 33.37
Multi-family.................................. 18,766 9.24 22,709 9.17
Commercial.................................... 20,120 9.91 -- --
Construction or development................... 2,407 1.19 1,076 0.43
------------ ------ ---------- ------
Total mortgage loans.............................. 183,456 90.41 222,982 90.07
Consumer loans.................................... 19,452 9.59 24,546 9.93
------------ ------ ---------- ------
Gross loans....................................... 202,908 100.00% 247,528 100.00%
====== ======
Less:
Unearned discounts on loans purchased......... -- (9)
Deferred loan fees, net....................... (315) (1,274)
Allowance for loan losses..................... (6,717) (6,303)
------------ ----------
Loans, net.................................... $ 195,876 $ 239,942
============ ==========
At December 31, 1998 and 1997, home equity loans held for sale totaled
$16.7 and $52.7 million, respectively.
52
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Equity lines of credit consist of first and second mortgage liens on both
owner occupied and non-owner occupied properties which generally have interest
tied to the prime rate, maturities of 5 to 10 years and require interest-only
monthly payments until maturity. Outstanding equity lines of credit and unused
equity lines of credit are summarized as follows (in thousands):
At December 31
---------------------------------
1998 1997
---- ----
Outstanding lines of credit:
---------------------------
First lien owner occupied................. $ 10,873 $ 15,474
First lien non-owner occupied............. 799 972
--------- ---------
Total first lien..................... 11,672 16,446
--------- ---------
Second lien owner occupied................ 43,666 93,425
Second lien non-owner occupied............ 2,303 531
--------- ---------
Total second lien.................... 45,969 93,956
--------- ---------
Third lien owner occupied................. 4,318 6,185
--------- ---------
Total equity lines of credit..... $ 61,959 $ 116,587
========= =========
Unused lines outstanding:
------------------------
First lien................................ $ 1,172 $ 13,634
Second lien............................... 10,505 40,436
Third lien................................ 867 2,188
--------- ---------
Total unused lines of credit........... $ 12,544 $ 56,258
========= =========
The Company has both adjustable and fixed rate loans. At December 31, 1998,
adjustable interest rate loans totaled $115.9 million and fixed rate loans
totaled $87.0 million. At December 31, 1997, adjustable interest rate loans
totaled $131.5 million and fixed rate loans totaled $95.6 million. All
adjustable interest rate loans reset annually or more frequently. The adjustable
rate loans have interest adjustment caps and are generally indexed to the prime
rate. Market factors may affect the correlation of the interest rate adjustment
with the rates the Company pays on the short-term deposits that have been
primarily utilized to fund these loans.
Loans outstanding to directors and executive officers aggregated $232
thousand at December 31, 1997. Additionally, there were no unused lines of
credit to directors and executive officers at December 31, 1998 or 1997. Such
loans are made on substantially the same terms as those for other customers.
53
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business. These financial instruments include
commitments to extend credit and unused lines of credit. These instruments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the statements of financial condition. The Company's
exposure to credit loss in the event of non-performance by the other party to
the financial instrument for commitments to extend credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for on-balance sheet instruments.
Unless otherwise noted, the Company does not require collateral or other
security to support financial instruments with credit risk.
Financial instruments whose contract amounts represent credit risk are as
follows (in thousands):
At December 31
---------------------------------
1998 1997
---- ----
Unused home equity lines of credit.............. $ 12,544 $ 56,258
Commitments to originate mortgage loans......... 30,058 56,572
----------- -----------
Total........................................ $ 42,602 $ 112,830
=========== ===========
As of December 31, 1998 and 1997, the Company had commitments totaling
$30.0 million and $428 thousand to originate fixed rate mortgage loans.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness and the amount of collateral obtained if deemed necessary by
the Company upon extension of credit, is based upon such evaluation. Collateral
required by the Company generally includes single and multi-family residential
properties and income-producing commercial real estate properties.
Mortgage loans serviced for others are not included in the accompanying
statements of consolidated financial condition. Servicing loans for others
generally consists of collecting mortgage payments, administering escrow
accounts, remitting payments to investors and foreclosure processing. Loan
servicing income is recorded as a component of securitization income on the
accrual basis and includes servicing fees from investors and certain charges
collected from borrowers. These amounts totaled $2.3 million and $817 thousand
for the years ended December 31, 1998 and 1997, respectively. At December 31,
1998 and 1997 the Company serviced loans for the benefit of others with
aggregate unpaid principal balances of $231.3 and $224.7 million, respectively.
54
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. ALLOWANCES FOR LOAN LOSSES
Activity in the allowance for loan losses are summarized as follows (in
thousands):
Year Ended December 31
-------------------------------------------------------
1998 1997 1996
---- ---- ----
Balance, beginning of period......... $ 6,303 $ 7,208 $ 3,460
Provision for loan losses............ 4,727 26,527 4,293
Charge-offs.......................... (4,819) (27,946) (754)
Recoveries........................... 506 1,699 209
Reserves on loans sold............... -- (774) --
Other, net........................... -- (411) --
--------- ---------- --------
Balance, end of period............... $ 6,717 $ 6,303 $ 7,208
========= ========== ========
The balance of non-accrual loans at December 31, 1998 and 1997 was $6.4 and
$6.2 million, respectively. The interest income that would have been recorded
under the original terms of such loans during the years ended December 31, 1998,
1997 and 1996 was $585, $617 and $264 thousand, respectively. During the years
ended December 31, 1998, 1997 and 1996 the amounts that were included in
interest income on such loans were $149, $242 and $389 thousand, respectively.
6. SECURITIZATIONS
During the years ended December 31, 1998 and 1997, the Company securitized and
sold $100.0 million and $170.3 million, respectively, of its home equity lines
of credit to investors with limited recourse, retaining the servicing rights to
the underlying loans. The Company retained a participation interest in the
investor trust, reflecting the excess of the total amount of loans transferred
to the trust over the portion represented by certificates sold to investors.
The initial participation interests retained in the equity line of credit trusts
was $2.0 million for the 1998 securitization and totaled $3.5 million for the
two 1997 securitizations and are included in loans in the Company's statement of
financial condition. Both the 1998 and 1997 transactions were treated as sales
in accordance with SFAS 125. As a result of securitizations, the Company
recorded interest-only strips (I/O strips) of $15.4 million and $17.8 million at
December 31, 1998 and 1997, respectively. The Company also recorded net gains in
1998, 1997 and 1996 of $4.5, $7.9 and $3.3 million, respectively, which
represents the present value of estimated future cash flows reduced by the over-
the-life recourse reserves and other transaction related expenses.
The following table presents information regarding loan sale transactions
for the periods indicated (dollar amounts in thousands):
YEAR ENDED DECEMBER 31
---------------------------------------
1998 1997
---- ----
Home equity lines of credit sold $ 100,000 $ 170,312
Weighted-average coupon 12.47% 13.06%
Weighted-average investor pass-through rate LIBOR + .19% LIBOR + .24%
Net loan sale gains $ 4,451 $ 7,943
55
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables provide certain contractual delinquency information
with the respect to the Company's home equity lines of credit serviced, by year
of origination, as of the dates indicated:
AT DECEMBER 31, 1998
--------------------
Delinquency
-----------------------------------------------------------------------
Year of
Origination Balance 30-59 60-89 90+ Total
----------- ------- ----- ----- ---- -----
1995 $ 14,226 7.61% 1.90% 4.27% 13.78%
1996 58,354 6.67 2.61 5.77 15.05
1997 100,053 4.04 1.66 3.64 9.34
1998 58,660 1.21 0.64 0.50 2.35
-------- ----- ----- ---- -----
Total $231,293 4.21% 1.66% 3.42% 9.29%
======== ===== ===== ==== =====
AT DECEMBER 31, 1998
--------------------
Delinquency
-----------------------------------------------------------------------
Year of
Origination Balance 30-59 60-89 90+ Total
----------- ------- ----- ----- ---- -----
1995 $ 22,735 7.61% 0.76% 2.37% 10.74%
1996 97,368 8.23 1.85 2.85 12.93
1997 104,989 4.02 1.58 0.80 6.40
-------- ----- ----- ---- -----
Total $225,092 6.20% 1.62% 1.84% 9.66%
======== ===== ===== ==== =====
7. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows (in thousands):
At December 31
---------------------------------------
1998 1997
---- ----
Land.................................................. $ 607 $ 607
Buildings............................................. 2,233 2,233
Leasehold improvements................................ 2,442 2,079
Furniture and equipment............................... 6,685 6,226
------- -------
11,967 11,145
Less allowances for depreciation & amortization....... (7,472) (5,881)
------- -------
Total.............................................. $ 4,495 $ 5,264
======= =======
8. OTHER REAL ESTATE OWNED (OREO)
Other real estate owned, which was acquired through foreclosure, was $504
thousand and $1.1 million at December 31, 1998 and 1997, respectively. Real
estate owned consists primarily of one to four family residences.
Real Estate owned income (expense) is summarized as follows (in thousands):
Year Ended December 31
-----------------------------------------------------
1998 1997 1996
---- ---- ----
Gain on sales of OREO................................ $ 240 $ 347 $ 256
Loss on sales of OREO................................ (53) -- (107)
Other expenses....................................... (50) (145) (184)
----- ----- -----
Other real estate owned income (expense), net...... $ 137 $ 202 $ (35)
===== ===== =====
56
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
At December 31
-----------------------------------
1998 1997
---- ----
Loans............................................. $ 1,940 $ 5,407
Securities available-for-sale..................... 1,376 603
Mortgage-backed securities available-for-sale..... 239 414
Mortgage-backed securities held-to-maturity....... 212 423
-------- --------
Total.......................................... $ 3,767 $ 6,847
======== ========
10. DEPOSITS
Deposit accounts are summarized as follows (dollars in thousands):
AT DECEMBER 31, 1998 AT DECEMBER 31, 1997
-------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE PERCENTAGE AVERAGE PERCENTAGE
NOMINAL RATE BALANCE OF TOTAL NOMINAL RATE BALANCE OF TOTAL
------------ ------- ---------- ------------ ------- ----------
Demand accounts:
Non-interest bearing
demand accounts................ 0.00% $ 8,681 2.48% 0.00% $ 6,571 1.65%
NOW accounts..................... 1.17 10,044 2.88 1.97 9,972 2.51
Money market accounts............ 1.97 34,573 9.89 4.12 43,587 10.98
---- -------- ------ ---- -------- ------
Total demand................... 1.55 53,298 15.25 3.31 60,130 15.14
Passbook and statement
Accounts of deposits........... 2.44 90,640 25.92 3.61 82,535 20.78
---- -------- ------ ---- -------- ------
Certificate accounts:
Six months or less............. 4.11 49,324 14.10 5.13 40,297 10.15
Six months to one year......... 4.98 26,968 7.71 6.00 87,060 21.92
One to three years............. 5.65 116,444 33.28 6.11 114,627 28.87
Three to five years............ 6.49 13,063 3.74 6.51 12,461 3.14
---- -------- ------ ---- -------- ------
Total certificates of
Deposit....................... 5.25 205,799 58.83 5.94 254,445 64.07
---- -------- ------ ---- -------- ------
Total Deposits................... 3.96% $349,737 100.00% 5.06% $397,110 100.00%
==== ======== ====== ==== ======== ======
Certificates of deposit in excess of $100,000 at December 31, 1998 and
December 31, 1997 totaled $24.5 and $31.9 million, respectively. Deposits in
excess of $100,000 are not insured by the F.D.I.C.
Maturities of certificate accounts at December 31, 1998 are summarized as
follows (in thousands):
Maturing:
---------
Within 12 months............................... $ 111,570
Beyond 12 months but within 24 months.......... 77,737
Beyond 24 months but within 36 months.......... 4,098
Beyond 36 months............................... 12,394
---------
Total......................................... $ 205,799
=========
57
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Interest expense on deposits consists of the following (in thousands):
YEAR ENDED DECEMBER 31
-----------------------------------------------
1998 1997 1996
---- ---- ----
NOW accounts.................. $ 156 $ 184 $ 189
Money market accounts......... 1,412 1,948 2,554
Passbook accounts............. 3,079 2,813 2,135
Certificate accounts.......... 12,873 13,831 9,717
------- ------- -------
Total...................... $17,520 $18,776 $14,595
======= ======= =======
11. ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of Chicago are summarized as
follows (in thousands):
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE YEAR OF AVERAGE YEAR OF
BALANCE RATE MATURITY BALANCE RATE MATURITY
------- ---- -------- ------- ---- --------
Fixed rate: $ 803 2.50% 2003 $ 803 2.50% 2003
100,000 4.69 2008
Variable rate: 85,000 5.83 1998
5,000 5.22 2000 5,000 6.00 2000
-------- ---- ------- ----
Total $105,803 4.70% $90,803 5.81%
======== ==== ======= ====
The Company has pledged its stock in the Federal Home Loan Bank of Chicago
as collateral for the advances from Federal Home Loan Bank of Chicago. In
addition the Company is required to maintain certain qualifying first mortgage
loans or mortgage-backed securities in an amount equal to at least 170 percent
of the outstanding advances.
58
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(COMBINED)
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments. The estimated fair value
amounts have been determined by the Company using available market information
and appropriate valuation methodologies. However, considerable judgment is
necessarily required to interpret market data in order to develop estimates of
fair value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have an effect on estimated fair value amounts.
At December 31
--------------------------------------------------------
1998 1997
--------------------------- ---------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------- ------------ -------------
(In thousands)
ASSETS:
Cash and due from depository institutions........... $ 9,963 $ 9,963 $ 6,630 $ 6,630
Interest-bearing deposits........................... 66,566 66,566 60,891 60,891
Securities available-for-sale....................... 86,081 86,081 46,373 46,373
Mortgage-backed securities available-for-sale....... 50,668 50,668 80,621 80,621
Mortgage-backed securities held-to-maturity......... 43,007 43,787 53,719 53,451
Loans............................................... 195,876 197,877 239,942 245,346
Interest-only strips................................ 15,362 15,362 17,791 17,791
Federal Home Loan Bank stock........................ 5,290 5,290 4,540 4,540
LIABILITIES:
Deposits............................................ 349,737 351,130 397,110 397,469
Advances from the Federal Home Loan Bank............ 105,803 95,477 90,803 90,670
The fair value of financial instruments was determined as follows:
CASH AND DUE FROM DEPOSITORY INSTITUTIONS, INTEREST-BEARING DEPOSITS AND
FHLB STOCK--For cash and due from depository institutions, interest-bearing
deposits and FHLB stock, the carrying amount approximates fair value due to the
liquid nature of the assets.
SECURITIES AVAILABLE-FOR-SALE AND SECURITIES HELD-TO-MATURITY--For
securities available-for-sale and securities held-to-maturity, fair values are
based on quoted market prices or dealer quotes. If a quoted price is not
available, fair value is estimated using quoted prices for similar securities.
MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE AND MORTGAGE-BACKED
SECURITIES HELD-TO-MATURITY--For mortgage-backed securities available-for-sale,
fair values are based on quoted prices or dealer quotes. If a quoted price is
not available, fair value is estimated using quoted prices for similar
securities, adjusted for any differences in credit ratings or maturities.
LOANS AND LOANS HELD FOR SALE--For certain homogeneous categories of loans,
such as fixed rate residential mortgages, fair value is estimated by discounting
the future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities. For adjustable rate mortgages, the carrying amount less a reserve
for losses approximates fair value.
59
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INTEREST-ONLY STRIPS--For interest-only strips, cash flows are projected
over the life of the securitized loans using prepayment, delinquency, default
and interest rate assumptions that market participants would use for similar
financial instruments subject to prepayment, credit and interest rate risk.
These cash flows are then discounted using an interest rate that a purchaser
unrelated to the seller of such financial instruments would demand. See Note 6
to the Consolidated Financial Statements Securitizations for additional
information.
DEPOSITS--Fair value of demand deposits, savings accounts, and certain
money market deposits approximates carrying value. The fair value of fixed
maturity certificates of deposits is estimated by discounting future cash flows
using the rates offered for deposits of similar remaining maturities at the
respective valuation dates.
ADVANCES FROM THE FEDERAL HOME LOAN BANK--The fair value of advances from
the Federal Home Loan Bank is based on borrowings with similar terms.
13. COMMITMENTS AND CONTINGENCIES
The Company leases office space for certain of its branch offices. The
future minimum annual rental commitments for these noncancelable leases and
subleases of such space are as follows (in thousands):
Gross Rents Sublease Rents Net
-------------- -------------- --------------
1999..................... $2,622 $ 589 $2,033
2000..................... 2,150 424 1,726
2001..................... 1,156 71 1,085
2002..................... 447 -- 447
2003 and thereafter...... 489 -- 489
------ ------ ------
Total.................. $6,864 $1,084 $5,780
====== ====== ======
Under the terms of these leases, the Company is required to pay its pro
rata share of the cost of maintenance and real estate taxes. Certain of these
leases also provide for increased rental payments based on increases in the
Consumer Price Index.
Gross rental expense for the years ended December 31, 1998, 1997 and 1996
amounted to $2.5, $2.2 and $1.6 million, respectively.
In the ordinary course of business, there are various legal proceedings
pending against the Company. Management believes the aggregate liabilities, if
any, resulting from such actions would not have a material adverse effect on the
financial position of the Company. However, as the ultimate resolution of these
proceedings is influenced by factors outside of the Company's control, it is
reasonably possible that the Company's estimated liability under these
proceedings could change by a material amount. Management believes its reserves
for pending and threatened litigation are adequate as of December 31, 1998.
60
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. SEGMENT REPORTING
The Company adopted Statement of Financial Accounting Standard No. 131
("SFAS 131"), Disclosures About Segments of an Enterprise and Related
Information in 1998. SFAS 131 established standards for reporting information
about operating segments, products and services and geographic areas in annual
and interim financial statements. The Company's reportable operating segments
are managed separately and offer different consumer finance products with
dissimilar delivery channels. All of the Company's assets and operations are
located within the United States.
The Company has three reportable segments: Retail Banking, Loan
Originations and Loan Servicing. Retail Banking includes the Company's five
retail branch locations that primarily engage in attracting deposit accounts.
The Company's Loan Originations segment primarily provides real estate secured
loans to consumers through brokers. These loans are offered with both revolving
and closed-end terms and variable and fixed interest rates. The Loan Servicing
segment collects and applies payments and provides customer service for
borrowers. The Loan Servicing segment is responsible for servicing both loans
owned by the Company and loans owned by other investors that have been
securitized and sold by the Company. The remaining component of the consolidated
totals includes all on balance sheet loan activity, overhead and the since-
exited private label credit card business.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies except that intra
segment transactions have not been eliminated. The Company evaluates
performance and allocates resources based on income from operations after income
taxes. We generally account for transactions between segments as if they were
with third parties.
The primary sources of revenue for the Loan Origination segment are
securitization gains and origination fees. The Loan Servicing segment's primary
sources of income are various loan fees and service fees from securitized loans.
For the Retail Banking segment, transfer pricing interest income is internally
allocated. In addition, interest expense on deposits is charged to the Retail
Banking segment. Segment expenses are generally based on specific
identification. All income and expenses not related to the Loan Origination,
Loan Servicing or Retail Banking segments are recorded in the All Other segment.
Also, writedowns of interest-only securities were charged to the All Other
segment prior to the fourth quarter of 1998.
For the Year Ended December 31, 1998
------------------------------------
Loan Loan Retail All Consolidated
(In thousands) Originations Servicing Banking Other Totals
------------- --------- -------- --------- -------------
Total interest income $ -- $ -- $20,798 $ 19,350 $ 40,148
Total interest expense -- -- 17,520 5,820 23,340
Provision for loan losses -- -- -- 4,727 4,727
Noninterest income 6,162 6,654 1,191 (8,666) 5,341
Noninterest expense 8,489 4,411 4,330 2,145 19,375
Income tax expense (benefit) (756) 729 45 (724) (706)
Segment net income (loss) (1,571) 1,514 94 (1,284) (1,247)
Total segment assets 365 25,271 4,843 468,451 498,930
Expenditures for long-lived
assets 68 285 486 -- 839
61
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Year Ended December 31, 1997
---------------------------------------
Loan Loan Retail All Consolidated
(In thousands) Originations Servicing Banking Other Totals
------------ --------- -------- --------- -------------
Total interest income $ -- $ -- $22,283 $ 31,725 $ 54,008
Total interest expense -- -- 18,776 9,551 28,327
Provision for loan losses -- -- -- 26,527 26,527
Noninterest income 14,492 5,322 963 (16,869) 3,908
Noninterest expense 8,565 3,178 4,403 6,593 22,739
Income tax expense (benefit) 2,199 795 25 (10,214) (7,195)
Segment net income (loss) 3,728 1,349 42 (17,601) (12,482)
Total segment assets 407 23,090 4,496 510,861 538,854
Expenditures for long-lived
assets 217 909 1,547 -- 2,673
For the Year Ended December 31, 1996
---------------------------------------
Loan Loan Retail All Consolidated
(In thousands) Originations Servicing Banking Other Totals
------------ ---------- -------- --------- ------------
Total interest income $ -- $ -- $18,162 $ 27,719 $ 45,881
Total interest expense -- -- 14,595 11,322 25,917
Provision for loan losses -- -- -- 4,293 4,293
Noninterest income 11,545 303 3,806 (5,251) 10,403
Noninterest expense 6,255 1,843 7,136 4,272 19,506
Income tax expense (benefit) 1,894 (551) 85 924 2,352
Segment net income (loss) 3,396 (989) 152 1,657 4,216
Total segment assets 315 10,423 3,032 581,801 595,571
Expenditures for long-lived
assets 176 735 1,252 -- 2,163
62
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. CAPITAL STANDARDS
The Bank is subject to certain regulatory capital requirements administered
by the various federal regulatory agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a material
effect on the Bank's financial position. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities and certain off balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk-weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined) and of Tier 1 capital to average assets (as
defined). Management believes that the Bank meets all capital adequacy
requirements to which it is subject at December 31, 1998 and 1997.
The Bank's regulatory capital at December 31, 1998 and 1997 is presented
below. There were no deductions from capital for interest rate risk.
To be Well Capitalized
Under Prompt
For Capital Corrective Action
(Dollar amounts in thousands) Actual Adequacy Purposes Provisions
---------------- ------------------ -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ --------- ------- ------------ ---------
As of December 31, 1998:
Risk-based capital (to risk-weighted
assets) $38,472 13.41% $22,946 8.00% $28,682 10.00%
Tier 1 capital (to risk-weighted 34,713 12.10 11,473 4.00 17,209 6.00
assets)
Tier 1 capital (to average assets) 34,713 6.97 19,914 4.00 24,893 5.00
As of December 31, 1997:
Risk-based capital (to risk-weighted
assets) $48,767 16.89% $23,104 8.00% $28,881 10.00%
Tier 1 capital (to risk-weighted 45,078 15.61 11,555 4.00 17,329 6.00
assets)
Tier 1 capital (to average assets) 45,078 7.35 24,536 4.00 30,670 5.00
16. EMPLOYEE BENEFIT PLANS
The Bank has a profit-sharing plan that covers substantially all of the
Bank's employees. Prior to January 1, 1995, the plan provided for contributions
by the Bank in amounts as declared by the Board of Directors to a maximum of 15
percent of the participant's compensation and, for voluntary employee
contributions, to a maximum of ten percent of each participant's compensation.
Effective January 1, 1995, the Board of Directors of the Bank adopted a
resolution to amend the profit-sharing plan to incorporate a 401(k) feature,
which includes an employer matching contribution. For 1998, 1997 and 1996 the
Bank contributed 50% of an employee's contribution up to 2% of salary and 25% of
an employee's contributions for the next 4% of salary, with a maximum Bank
contribution of $500. The employer contribution was made for employees and
officers below the title of senior vice president. Compensation expense for the
Bank's contribution was $25 thousand for the year ended December 31, 1998, $61
thousand for the year ended December 31, 1997 and $14 thousand for the year
ended December 31, 1996.
63
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Effective February 1, 1995, the Board of Directors of the Bank adopted a
deferred compensation plan whereby directors and executive officers may elect to
defer receipt of fees and other compensation otherwise payable for services as a
director or executive officer in accordance with the provisions of the plan. As
of December 31, 1998, 1997 and 1996, there were $263 thousand, $348 thousand and
$337 thousand, respectively of fees or compensation deferred in this plan. In
addition, beginning in 1996, Directors are required to receive a portion of
their fee in shares of Avondale Financial Corp. common stock. Stock received
may also be deposited in the deferred compensation plan. As of December 31,
1998 and 1997, 17,874 and 5,796 shares of common stock, respectively, were
deposited into the deferred plan.
1997 OMNIBUS INCENTIVE PLAN
During 1997 the Company's stockholders approved the 1997 Omnibus Incentive
Plan ("Omnibus Plan"). The Omnibus Plan replaces the 1995 Stock Option and
Incentive Plan and the Recognition and Retention Plan and authorizes the
issuance of up to 350,000 shares of the Company's common stock, including the
granting of nonqualified stock options, stock appreciation rights and restricted
stock. Subject to the terms and provisions of the Omnibus Plan, stock-based
awards may be granted to directors or employees as determined by the
Compensation Policy Committee of the Board of Directors ("the Committee"). The
Committee has discretion in determining the number and type of awards granted to
each recipient. Vesting periods for awards are also at the discretion of the
Committee. No compensation expense was recorded upon issuance of the stock
options under the Omnibus Plan, since the exercise option price was equal to or
greater than the market value at the respective dates of the grants. Under the
terms of the Omnibus Plan, upon a change in control of the Company, options
issued under the Omnibus Plan immediately vest to the recipient.
1995 STOCK OPTION AND INCENTIVE PLAN
Prior to adoption of the Omnibus Plan, the Company awarded certain
incentive pay under the terms of the 1995 Stock Option and Incentive Plan (the
"Incentive Plan"). The Incentive Plan authorized the issuance of up to 423,200
shares of the Company's common stock, including the granting of non-qualified
and qualified stock options, stock appreciation rights and limited stock
appreciation rights. Subject to the terms and provisions of the Incentive Plan,
stock options were granted to directors or employees as determined by the
Compensation Policy Committee of the Board of Directors. All options vest over a
five-year period. No compensation expense was recorded upon issuance of the
stock options, since the exercise option price was equal to the market value at
the respective dates of the grants. Under the terms of the Incentive Plan, upon
a change in control of the Company, options issued under the Incentive Plan
immediately vest to the recipient.
The tables on the following page summarize stock-based compensation options
and their related weighted average strike prices for the years ended December
31, 1998 and 1997:
64
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Year Ended December 31
----------------------------------------------------------------------
All stock options: 1998 1997
----------------- ---- ----
Weighted Weighted
Option Average Option Average
Shares Strike Price Shares Strike Price
------ ------------ ------ ------------
Balance, beginning of period 394,036 $ 15.086 354,909 $ 14.345
Granted 147,978 17.794 166,262 16.098
Exercised (2,599) 14.843 (7,903) 14.375
Forfeited (30,669) 15.458 (119,232) 14.291
------- --------
Balance, end of period 508,746 $ 16.051 394,036 $ 15.086
======= ========= ======== =========
Options exercisable 225,962 $ 16.668 98,014 $ 14.498
======= ========= ======== =========
1997 Omnibus 1995 Stock Option and
Incentive Plan Incentive Plan
-------------- --------------
Weighted Weighted
Option Average Option Average
Shares Strike Price Shares Strike Price
------ ------------ ------ ------------
Balance, December 31, 1996 -- -- 354,909 $ 14.345
1997 Activity:
Granted 163,262 $ 16.099 3,000 16.063
Exercised -- -- (7,903) 14.375
Forfeited (7,770) 14.375 (111,462) 14.285
------- --------
Balance, December 31, 1997 155,492 $ 16.186 238,544 $ 14.369
------- --------- -------- ---------
1998 Activity:
Granted 147,978 17.794 -- --
Exercised (649) 16.250 (1,950) 14.375
Forfeited (15,619) 16.549 (15,050) 14.325
------- --------
Balance, December 31, 1998 287,202 $ 17.342 221,544 $ 14.378
======= ========= ======== =========
Options exercisable 95,040 $ 19.827 130,922 $ 14.374
======= ========= ======== =========
At December 31, 1998, the strike price of outstanding options ranged from
$12.63 to $22.28 and the weighted-average remaining contractual term was 5.5
years. For the years ended December 31, 1998 and 1997, the weighted-average fair
value of options granted was $5.13 and $4.72, respectively.
The fair value of options that were granted during 1998 and 1997 was
determined using the Black-Scholes option pricing model. The following weighted-
average assumptions were used in the model:
Variable 1998 Weighted-Average 1997 Weighted-Average
-------- --------------------- --------------------
Risk-free interest rate 5.61% 5.96%
Expected volatility 18.51 25.27
Expected Life 4.47 years 5.09 years
Expected dividends $ -- $ --
65
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The accounting method for stock-based compensation provided in Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), Accounting for Stock-
based Compensation, in particular for stock options, differs from APB Opinion
No. 25, under which most of the accounting requirements for stock-based
compensation were previously contained. The Company has decided not to adopt the
measurement recognition provisions of SFAS 123. An entity that continues to
apply APB Opinion 25 is required to provide pro forma net income and earnings
per share, as if the accounting method in SFAS 123 had been used for stock-based
compensation costs.
Had compensation cost for these plans been determined consistent with SFAS
123, the Company's net income (loss) and earnings per share after the effect of
income taxes would have been reduced to the following pro forma amounts (rounded
to the nearest thousand except per share data):
Year Ended December 31
-------------------------------------------------------------
1998 1997 1996
---- ---- ----
Net income (loss): As reported $ (1,247) $ (12,482) $ 4,216
Pro forma (1,734) (12,808) 3,594
Basic earnings per As reported $ (0.40) $ (3.59) $ 1.13
share: Pro forma (0.56) (3.69) 0.97
RECOGNITION AND RETENTION PLAN
During 1995, the Company's stockholders approved the Recognition and
Retention Plan ("RRP") which authorized the issuance of up to 169,280 shares of
the Company's common stock as restricted stock. Subject to the terms and
provisions of the RRP, restricted stock was granted to employees as determined
by the Compensation Policy Committee of the Board of Directors. Under the terms
of the RRP, recipients have all of the rights of stockholders, except that the
shares cannot be disposed of until certain restrictions have lapsed. On the date
of the grant, the market price of the shares was added to common stock and
capital surplus and an equal amount was deducted from stockholders' equity
(unearned portion of restricted stock awards). The unearned portion is being
amortized to expense over the five-year vesting period using the straight-line
method.
During 1996, under the terms of the RRP, 2,250 shares of stock were
awarded. Also during 1996, 9,000 shares were canceled. During 1997, 7,700
additional shares were granted under the terms of the RRP. Also during 1997,
55,499 shares were canceled. For the year ended December 31, 1998, 4,200 shares
were granted and 3,600 shares were cancelled.
Amortization of the unearned portion of restricted stock awards was $299,
$170 and $930 thousand for the years ending December 31, 1998, 1997 and 1996,
respectively.
66
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
EMPLOYEE STOCK OWNERSHIP PLAN
In conjunction with the Plan of Conversion converting the Bank from a
federally chartered mutual savings bank to a federally chartered stock savings
bank, the Bank established an Employee Stock Ownership Plan ("ESOP") for
eligible employees. The ESOP was established for all employees that are 21 or
older and have completed one year of service with the Company. The ESOP borrowed
approximately $3.0 million from the Company to purchase 296,240 shares of the
common stock of the Company that was issued in the conversion. The loan will be
repaid principally from the Company's discretionary contributions to the ESOP
over a period of seven years. Collateral for the loan is the common stock
purchased for the ESOP. The loan obligation of the ESOP is considered unearned
compensation and, as such, recorded as a reduction of the Company's
stockholders' equity. Both the loan obligation and the unearned compensation are
reduced by the amount of loan repayments made by the ESOP. Shares purchased with
the loan proceeds are held in an account for allocation among participants as
the loan is repaid. Contributions to the ESOP and the shares released are
allocated among participants on the basis of compensation in the year of
allocation. Benefits vest over a five year period.
In conjunction with the Merger discussed in Note 20 to the Consolidated
Financial Statements, the ESOP will be terminated upon consummation of the
Merger. Any assets remaining in the ESOP after repayment of the ESOP loan will
be allocated to participants on the same basis as contributions.
Vesting in the ESOP is accelerated upon retirement, death or disability of
the participant. Forfeitures are returned to the Company or reallocated to other
participants to reduce future funding costs. Benefits may be payable upon
retirement, death, disability, or separation from service. As the Company's
annual contributions are discretionary, benefits payable under the ESOP cannot
be estimated. The Company recorded $703, $670 and $604 thousand of ESOP
compensation expense for the years ended December 31, 1998, 1997 and 1996,
respectively.
17. RESERVE FOR RESTRUCTURING
During 1993, the Company performed a comprehensive analysis of its
operating performance. As a result of this analysis, the Company commenced a
major business restructuring which necessitated a provision to establish a
reserve of $8.5 million to the March 31, 1993 financial statements. This
restructuring focused on three major areas. First, the restructuring of
personnel levels at a cost of approximately $1.3 million was completed during
the fiscal year ended March 31, 1994. Second, the Company restructured the
employee compensation and benefits programs; including a curtailment loss from
the termination of the Company's pension plan of approximately $.7 million which
was paid out during the fiscal year ended March 31, 1994. Third, it was
determined that the Company had significant excess office space. Consequently,
the Company plans to relocate all business functions from its 20 North Clark
Street, Chicago, Illinois location with the exception of the retail banking
space to other facilities. Approximately $6.5 million of the above restructuring
charge represented the cost of this relocation, including $6.0 million write-off
of the estimated value of the leased space to be abandoned and $.5 million
write-off of leasehold improvements, which will not result in any significant
cash expenditures beyond the Company's current lease commitments. The Company
has been relocating business functions as office space becomes subleased.
During 1998, the Company reduced the restructuring reserve by $1.2 million
based upon an assessment of the reserve in light of current and anticipated
circumstances relating to leases on certain facilities.
As of December 31, 1998, 1997 and 1996, $6.3, $5.8 and $4.7 million,
respectively, has been charged to the restructuring accrual.
67
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. INCOME TAXES
The provision for income taxes consists of the following (in thousands):
Year Ended December 31
----------------------------------------------
1998 1997 1996
---- ---- ----
Current.............................................. $ 92 $ (4,151) $ 1,937
Deferred............................................. (798) (3,044) 415
------- --------- --------
Total income tax provision (benefit).............. $ (706) $ (7,195) $ 2,352
======= ========= ========
The difference between recorded income taxes and the amount computed at the
statutory Federal income tax rates are as follows:
Year Ended December 31
--------------------------------------------------------------
1998 1997 1996
---- ---- ----
Statutory rate...................... 34.00% 34.00% 34.00%
State income taxes.................. 1.88 1.88 1.94
Other............................... .27 .69 (0.13)
----- ----- -----
Effective income tax rate......... 36.15% 36.57% 35.81%
===== ===== =====
68
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Deferred income taxes reflect the net effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial purposes
and the amounts used for income tax purposes, and (b) net operating loss and tax
credit carryforwards. The tax effects of items comprising the Company's deferred
tax assets and deferred tax liabilities are as follows (in thousands):
At December 31
----------------------------------------
1998 1997
---- ----
Deferred tax assets:
Allowance for loan losses........................... $ 2,305 $ 2,089
Restructuring....................................... 357 1,061
Securitization gains, net........................... 1,023
Depreciation........................................ 197 193
Federal net operating loss carryforward............. 2,903 4,502
State net operating loss carryforward............... 310 335
Alternative minimum tax carryforward................ 395 --
Other............................................... 249 504
----------- ----------
Total deferred tax assets.......................... 7,739 8,684
----------- ----------
Deferred tax liabilities:
Securitization gains, net........................... -- (2,004)
FHLB stock.......................................... (181) (178)
Accretion on securities............................. (674) (493)
Unrealized gains on securities available-for-sale... (81) (102)
Other............................................... (320) (243)
----------- ----------
Total deferred tax liabilities..................... (1,256) (3,020)
----------- ----------
Net deferred tax assets........................ $ 6,483 $ 5,664
=========== ==========
The Company is permitted under the Internal Revenue Code (the "Code") to
deduct from taxable income a provision for bad debts which differs from the
provisions for such losses recognized in the consolidated statements of
operations. Accordingly, retained earnings at December 31, 1998 included
approximately $5.1 million for which no provision for deferred income taxes has
been provided. If, in the future, this portion of retained earnings is used for
any purpose other than to absorb bad debt losses, Federal income taxes will be
imposed at the then applicable rates.
69
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
19. PARENT COMPANY STATEMENTS
Presented below are the condensed statements of financial condition and
statements of income and cash flows for Avondale Financial Corp.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
At December 31
------------------------------------------
1998 1997
---- ----
(In thousands)
Cash and due from banks $ 1,376 $ 50
Investment in subsidiary 34,848 44,354
Prepaid expense & other assets 1,862 1,565
------- -------
Total assets $38,086 $45,969
======= =======
Other liabilities $ -- $ 6
Stockholders' equity 38,086 45,963
------- -------
Total liabilities and equity $38,086 $45,969
======= =======
CONDENSED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31
----------------------------------------
1998 1997
---- ----
(In thousands)
Dividends from bank subsidiary $ 8,700 $ 2,768
Interest income 98 126
------- --------
Total operating income 8,798 2,894
Operating expenses 556 630
------- --------
Income before equity in undistributed loss
of subsidiaries 8,242 2,264
Equity in undistributed loss of subsidiary (9,489) (14,746)
------- --------
Net income (loss) $(1,247) (12,482)
======= ========
70
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31
-----------------------------------------------
1998 1997
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands)
Net income (loss) $(1,247) $(12,482)
Adjustments to reconcile net income (loss) to net cash flows from
operating activities:
Net change in:
Prepaid expenses and other assets (297) (128)
Other liabilities (6) (570)
------- --------
Net cash flows used by operating activities (1,550) (13,180)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Dividends from Avondale Federal Savings Bank 8,700 2,768
Change in equity in Avondale Federal Savings Bank 806 11,859
------- --------
Net cash flows provided by investing activities 9,506 14,627
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Additional paid-in capital 213 337
ESOP common stock committed to be released 423 423
Amortization of unearned restricted stock 299 169
Change in unrealized gains on available-for-sale securities (17) 119
Purchase of treasury stock (7,548) (3,492)
------- --------
Net cash flows used in financing activities (6,630) (2,444)
------- --------
Increase (decrease) in cash and cash equivalents 1,326 (997)
Cash and cash equivalents:
Beginning of period 50 1,047
------- --------
End of period $ 1,376 $ 50
======= ========
71
AVONDALE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
20. SUBSEQUENT EVENTS
On October 13, 1998 the Company and Coal City Corporation ("Coal City"),
the holding company for Manufacturers Bank, announced they had entered into a
definitive agreement in connection with a merger of equals. The combined company
will be called MB Financial, Inc. ("MB Financial") and have assets of
approximately $1.4 billion. Coal City is a privately held bank holding company
headquartered in Chicago whose principal subsidiary, Manufacturers Bank,
operates eight banking offices in the Chicago metropolitan area. At December 31,
1998, Coal City had consolidated assets of $872 million and total shareholders
equity of $47 million.
Under the terms of the agreement, Coal City will be merged into the Company
and the Company will be renamed MB Financial, Inc. (the "Merger"). Immediately
following the Merger, the Bank's five retail branches will be merged into
Manufacturers Bank. Each share of Coal City common stock will be converted into
83.5 shares of MB Financial common stock while each share of Avondale will be
converted into 1 share of MB Financial. On a pro forma basis, the total number
of shares outstanding will be approximately 7.0 million shares. Shareholders of
Coal City will own approximately 58.5% of the combined company, while
stockholders of the Company will own approximately 41.5%.
In connection with the agreement, the Company and Coal City granted each
other an option to acquire up to 19.9% of the outstanding common stock of the
other upon the occurrence of certain events. The transaction is expected to
close on February 28, 1999 and will be accounted for as a purchase of the
Company by Coal City. The transaction has been granted regulatory approval and
was approved by stockholders of Avondale and Coal City in February 1999.
Additional information related to the Merger is included in the Company's Proxy
Statement dated January 8, 1999 for the Special Meeting of Stockholders held on
February 10, 1999 and in Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations.
On February 17, 1999, the Company completed the sale of the assets of its
national mortgage origination operation to New South Federal Savings Bank ("New
South") of Birmingham, Alabama. Pursuant to the agreement, New South purchased
certain assets and assumed certain liabilities of the Company. The Company
accepted a promissory note for the purchase price of approximately $2.0 million,
which approximates the net book value of assets sold, that will be due in five
years from the date of purchase.
72
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Item 10. Directors and Executive Officers of the Registrant
DIRECTORS
The Company's Board of Directors currently consists of eight members, each
of whom is also a director of the Bank. The Board is divided into three classes,
each of which contains approximately one-third of the Board, and approximately
one-third of the directors are elected annually. Directors of the Company are
generally elected to serve for a three-year term or until their respective
successors are elected and qualified.
The following table sets forth certain information, as of December 31,
1998, regarding the Company's Board of Directors, including each director's term
of office.
SHARES OF
COMMON STOCK PERCENT
POSITION(S) HELD DIRECTOR TERM TO BENEFICIALLY OF
NAME AGE IN THE COMPANY SINCE (1) EXPIRE OWNED (2) CLASS
---- ---- -------------- --------- ------ -------- -----
Jameson A. Baxter 55 Director 1993 2001 15,813 0.05%
R. Thomas Eiff 58 Chairman of the Board 1991 1999 17,415 0.06
Robert S. Engelman, Jr. 57 Director, President and 1993 1999 213,689(3) 7.46
Chief Executive Officer
Sandra P. Guthman 54 Director 1995 2001 8,731 0.03
Arthur L. Knight, Jr. 61 Director 1993 1999 19,868 0.07
Peter G. Krivkovich 52 Director 1993 2000 10,568 0.04
Hipolito Roldan 55 Director 1993 2000 6,560 0.02
Robert A. Wislow 54 Director 1993 2001 10,879 0.04
_______
(1) Includes service as a director of the Bank prior to the formation of the
Company.
(2) Includes shares held directly, in retirement accounts, in the deferred
compensation plan, in a fiduciary capacity or by certain affiliated
entities or members of the named individuals' families, with respect to
which shares the named individuals may be deemed to have sole or shared
voting and/or dispositive powers. Excludes 42,320, 13,464, 3,640, and 2,878
shares subject to options granted under the Stock Option Plan to Messrs.
Engelman and Eiff, Knight, and each of the other Directors, respectively,
which options are not exercisable within 60 days of December 31, 1998.
Includes Board of Directors retainer fees deferred in the form of Common
Stock units pursuant to the Deferred Compensation Plan.
(3) Includes 8,567 shares allocated to Mr. Engelman under the ESOP. Excludes
16,928 restricted shares awarded to Mr. Engelman which may not be voted by
him. Includes 133,480 shares subject to options which are exercisable
within 60 days of December 31, 1998.
The business experience for at least the past five years of each Director
is set forth below.
JAMESON A. BAXTER. Ms. Baxter has been President of Baxter Associates,
Inc., a firm providing management and financial services to start-up and
troubled companies in environmentally sensitive and other industries, since
1992. Ms. Baxter is also a Trustee of The Putnam Fund and a Director of The
Banta Corporation. Ms. Baxter served as a Consultant to First Boston Corporation
during 1991 and 1992.
R. THOMAS EIFF. Mr. Eiff is a private investor and was recently the Chief
Operating Officer of Adams Brothers Distribution, an automotive service and
distribution company. Mr. Eiff serves as the Chairman of the Board of the
Company.
73
ROBERT S. ENGELMAN, JR. Mr. Engelman joined the Bank in January 1993 as
President, Chief Executive Officer and Director and has been the Company's
President and Chief Executive Officer since its inception. Prior to joining the
Company, Mr. Engelman was the Chairman of the Board and Chief Executive Officer
of University Financial Corporation and its wholly-owned subsidiary, First
Federal of Elgin, FSA, Elgin, Illinois.
SANDRA P. GUTHMAN. Ms. Guthman has been the President and Chief Executive
Officer of Polk Bros. Foundation, a philanthropic organization for social
service, educational and cultural interests, since 1993. Prior to such time, Ms.
Guthman served IBM Corporation in various marketing capacities. Ms. Guthman also
serves as a Director of MBIA Insurance Corporation of Illinois, as well as other
educational and social organizations.
ARTHUR L. KNIGHT, JR. Mr. Knight is a private investor and business
consultant and was recently President, Chief Executive Officer and Director of
Morgan Products Ltd., a manufacturer and distributor of specialty building
products.
PETER G. KRIVKOVICH. Mr. Krivkovich has been President of Cramer-Krasselt
Company, a marketing communications company, since 1986.
HIPOLITO (PAUL) ROLDAN. Mr. Roldan has been President of the Hispanic
Housing Development Corp., a residential and retail development and property
management company, since 1976. Mr. Roldan serves as a director of the Woodstock
Institute.
ROBERT A. WISLOW. Mr. Wislow is Chairman of U.S. Equities Realty, Inc., a
commercial real estate company.
Executive Officers
The following contains certain information regarding the executive officers
who are not directors of the Company.
HOWARD A. JAFFE. Mr. Jaffe, 45, is Vice President and Chief Financial
Officer of the Company. Mr. Jaffe joined the Company in August 1995. From 1990
through July 1995, Mr. Jaffe was Executive Vice President and Chief Financial
Officer of Northern States Financial Corporation, a multi-bank holding company.
CHARLES W. SEWRIGHT, JR. Mr. Sewright, 52, is Vice President and Chief
Operating Officer of the Company. Mr. Sewright joined the Company in December
1997. From December 1990 through January 1995, Mr. Sewright was President and
Chief Executive Officer of Anchor Mortgage Services, as well as Executive Vice
President of Anchor Savings Bank, fsb. From January 1995 through December 1997,
Mr. Sewright was Chairman, President and Chief Executive Officer of Quest
Advisors, Inc. ("Quest"), a mortgage banking consulting company. Mr. Sewright
continues to serve as Chairman of Quest.
74
Item 11. Executive Compensation
Director Compensation
The Company currently does not compensate its employee directors for their
service in such capacity. For 1998, non-employee directors of the Bank were paid
an annual retainer of $12,000 plus (i) $1,000 per regularly scheduled Board
meeting attended, (ii) $500 per special Board meeting attended via telephone,
(iii) $1,500 per committee membership, (iv) $3,000 for serving as committee
chairman; and (v) $3,500 Chairman of the Board fee. All Board and Committee fees
may be paid in the form of Common Stock, however, at least 50% of the annual
retainer and Board meeting fees must be taken in the form of Common Stock. There
are no extra fees paid for committee meetings. All fees may be deferred pursuant
to the Company's Deferred Compensation Plan for Directors and Executive
Officers. There are eight regularly scheduled Board meetings per year.
Executive Compensation
Executive officers of the Company currently do not receive any remuneration
in their capacity as Company executive officers. The following table sets forth
information concerning the compensation of the Named Officers for services in
all capacities to the Bank for the years ended December 31, 1998, 1997 and 1996.
SUMMARY COMPENSATION TABLE
NAME AND CALENDAR ANNUAL LONG TERM COMPENSATION ALL OTHER
PRINCIPAL POSITION YEAR COMPENSATION AWARDS COMPENSATION
------------------ ---- ------------ ---------------- ------------
RESTRICTED STOCK OPTIONS/
SALARY BONUS AWARDS (2) SARS (3)
------ ----- ---------- --------
Robert S. Engelman, Jr. 1998 $300,000 $210,000 $ -- 35,000 $ 405,415 (4)
President and Chief Executive 1997 300,000 -- -- 35,000 274,498 (5)
Officer 1996 250,000 140,000 -- -- 152,945 (6)
Howard A. Jaffe 1998 155,000 92,000 -- 30,000 34,890 (7)
Vice President 1997 151,196 -- -- 15,187 24,140 (8)
1996 143,750 65,000 -- -- 16,111 (9)
Charles W. Sewright, Jr. 1998 190,000 100,000 -- 20,000 104,521 (10)
Vice President (1) 1997 14,615 -- 315,000 35,000 15,000 (11)
__________
(1) Mr. Sewright was hired in December 1997.
(2) Represents restricted stock issued. Restricted Stock vests between a three
and five year period. Dividends are paid on the restricted shares to the
extent and on the same date as dividends are paid on all other outstanding
shares of the Common Stock. The dividends, however, are held by the Company
for the accounts of Messrs. Engelman, Jaffe and Sewright until the vesting
of the corresponding portion of the award. The shares that have not been
released and the aggregate market value at December 31, 1998 was: Mr.
Engelman--16,928 shares, $262,384; Mr. Jaffe--8,000 shares, $124,000; Mr.
Sewright--20,000 shares, $310,000 at $15.50 the price of the Company's
Common Stock on December 31, 1998.
(3) Represents incentive and non-qualified stock options granted pursuant to
the Company's Stock Option Plans. All options were granted at or above the
market price of the stock on the date of the grant and vest up to five
years.
(4) Includes SERP contribution of $405,000, ESOP contribution of $34,890,
supplemental life insurance premium of $9,910 and an automobile allowance
of $615.
(5) Includes SERP contribution of $240,000, ESOP contribution of $24,140,
supplemental life insurance premium of $9,555 and an automobile allowance
of $803.
(6) Includes SERP contribution of $120,000, ESOP contribution of $22,727,
supplemental life insurance premium of $9,555 and an automobile allowance
of $663.
(7) Includes ESOP contribution of $34,890.
(8) Includes ESOP contribution of $24,140.
(9) Includes ESOP contribution of $16,111.
(10) Includes payment for relocation and sale of residence expenses of $104,521.
(11) Includes payment for relocation of $15,000.
75
STOCK OPTIONS
The following table sets forth certain information with respect to stock
options granted to the Named Officers during 1998.
In addition to providing the number of options granted in the Summary
Compensation Table, the following table discloses the range of potential
realizable values at various assumed appreciation rates. The table discloses for
the Chief Executive Officer and other Named Officers the gain or "spread" that
would be realized at the end of the option term for the options granted during
1998, if the price of the Common Stock appreciates annually by the percentage
levels indicated from the market price on the date of grant.
OPTION GRANTS IN 1998
% of Total
Options
Granted To Potential Realizable Value at
Employees Exercise Assumed Annual Rates of
Options In Fiscal Price Per Expiration Stock Price Appreciation For
Name Granted 1998 Share(1) Date Option Term
---- --------- ------------- ------------ ----------- ------------------------------
5.00% 10.00%
------- --------
Robert S. Engelman, Jr. 35,000 23.65 % $22.28 01/21/04 $ -0- $ 93,905
Howard A. Jaffe 30,000 20.27 % 17.38 07/27/03 58,080 193,590
Charles W. Sewright, Jr. 20,000 13.52 % 17.00 05/12/03 46,220 136,560
The following table sets forth information with respect to shares of the
Common Stock acquired in 1998 through the exercise of stock options, including
the value realized upon the exercise, and the value of all stock options held at
December 31, 1998.
OPTION EXERCISES, HOLDINGS AND VALUES TABLE
Shares Number of Value of Unexercised
Acquired Value Unexercised Options "In-the-money" Options
Name On Exercise Realized At December 31, 1998 At December 31, 1998(1)
----- ------------- --------------- --------------------------- ------------------------------
Exercisable Unexercisable Exercisable Unexercisable
------------ ------------- --------------- -------------
Robert S. Engelman, Jr. -0- -0- 133,480 42,320 $71,415 $47,610
Howard A. Jaffe -0- -0- 12,000 53,187 13,500 9,000
Charles W. Sewright, Jr. -0- -0- 0 55,000 0 -0-
__________
(1) Represents the difference between the closing price of the Common Stock on
December 31, 1998 ($15.50 per share) and the exercise price of the stock
options.
76
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 1998, certain information
as to the beneficial ownership of Avondale Common Stock by: (i) those persons or
entities known by management to beneficially own more than 5% of the outstanding
shares of Avondale Common Stock; (ii) Avondale's executive officers, and (iii)
all directors and executive officers of Avondale as a group.
SHARES
BENEFICIALLY PERCENT
BENEFICIAL OWNER OWNED OF CLASS
---------------- ------------ --------
PRINCIPAL OWNERS
Avondale Financial Corp. (1) 278,264 9.71%
Employee Stock Ownership Plan
20 North Clark Street
Chicago, Illinois 60602
Financial Institutional Partners, L.P. (2) 329,970 11.52
Hovde Capital, Inc.
Steven D. Hovde
Eric D. Hovde
1629 Colonial Parkway
Inverness, IL 60067
Tontine Financial Partners, L.P. (3) 199,000 6.94
Jeffrey Gendell
200 Park Avenue
Suite 3900
New York, New York 02109
EXECUTIVE OFFICERS
Robert S. Engelman, Jr. 213,689 (4) 7.46
President, Chief Executive Officer and Director
of Avondale and the Bank
Howard A. Jaffe 48,368 (4) 1.69
Vice President and Chief Financial Officer
Executive Vice President and Chief Financial
Officer and Director of the Bank
Charles W. Sewright, Jr. 2,090 (4) .07
Vice President and Chief Operating Officer
Executive Vice President and Chief Operating
Officer and Director of the Bank
Directors and executive officers as a group 353,983 (4) 12.35
(10 persons)
__________
(1) The amount reported represents shares held by the Avondale Financial Corp.
Employee Stock Ownership Plan (the "ESOP"), 64,626 shares of which have been
allocated to accounts of participants. First Bankers Trust Co., N.A.,
Quincy, Illinois, the trustee of the ESOP, may be deemed to beneficially own
the shares held by the ESOP which have not been allocated to the accounts of
participants.
(2) A Schedule 13D dated November 30, 1998 states that Financial Institutional
Partners, L.P. (FIP), Hovde Capital, Inc., Steven D. Hovde and Eric D. Hovde
beneficially own 329,970 shares of Avondale Common Stock. FIP reports
shared voting and dispositive power over 329,970 shares; Hovde reports
shared voting and dispositive power over 304,070 and 330,000 shares
respectively; Eric D. Hovde reports sole voting and dispositive power over
7,500 shares and shared voting and dispositive power over 311,570 shares;
and Steven D. Hovde reports sole voting power over 18,400 shares and shared
voting and dispositive power over 322,470 shares.
(3) A Schedule 13D dated July 29, 1998 states that Tontine Financial Partners,
L.P. and Jeffrey Gendell beneficially own 199,000 shares of Avondale Common
Stock. Tontine and Gendell report sole voting and dispositive power over
such shares.
(4) Includes shares held directly, in retirement accounts, in a fiduciary
capacity or by certain affiliated entities or members of the named
individuals' families, with respect to which shares the named individuals
and group may be deemed to have sole or shared voting and/or dispositive
powers. Also includes 8,567 and 3,901 shares allocated to Messrs. Engelman
and Jaffe, respectively, under the ESOP. Excludes (i) 16,928, 8,000, 20,000,
and 44,928 restricted shares of Common Stock awarded to Messrs. Engelman,
Jaffe, and Sewright and all directors and executive officers as a group,
respectively, which may not be voted by such persons, and excludes (ii)
42,320, 53,187, 55,000 and 181,999 shares subject to options granted under
the Company's Stock Option Plans (the "Stock Option Plan") to Messrs.
Engelman, Jaffe, and Sewright and all directors and executive officers as a
group, respectively, which options are not exercisable within 60 days of
December 31, 1998.
77
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Bank has followed a policy of granting consumer loans and loans secured by
the borrower's personal residence to officers, directors and employees. The
loans to executive officers and directors are made in the ordinary course of
business and on the same terms and conditions as those of comparable
transactions prevailing at the time, in accordance with the Bank's underwriting
guidelines, and do not involve more than the normal risk of collectibility or
present other unfavorable features. Loans to executive officers and directors
must be approved by a majority of the disinterested directors and loans to other
officers and employees must be approved by the Bank's loan committee. All loans
by the Bank to its directors and executive officers are subject to OTS
regulations restricting loan and other transactions with affiliated persons of
the Bank. Federal law currently requires that all loans to directors and
executive officers be made on terms and conditions comparable to those for
similar transactions with non-affiliates unless it is made pursuant to a plan
for all employees. As of December 31, 1998, there were no loans or unused lines
of credit to directors and named executive officers. Such loans and lines of
credit, if made, are granted on terms comparable to those for other loan
customers.
78
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements:
See ''Part II--Item 8. Financial Statements and Supplementary Data
(b) Reports on Form 8-K:
None
REFERENCE TO SEQUENTIAL PAGE
PRIOR FILING NUMBER WHERE
REGULATION OR EXHIBIT ATTACHED EXHIBITS
S-K EXHIBIT NUMBER ARE LOCATED IN THIS
NUMBER DOCUMENT ATTACHED HERETO FORM 10-K REPORT
- -------------- ----------------------------------------------------- ------------------- -----------------------
2 Plan of acquisition, reorganization, arrangement,
liquidation or succession ******* Not applicable
3(i) Articles of Incorporation of the Company ****** Not applicable
3(ii) Bylaws of the Company ****** Not applicable
4 Instruments defining the rights of security holders,
including indentures *
9 Voting trust agreement None Not applicable
10 Material contracts:
(a) Employment Agreement with Robert S. Engelman, Jr. ** Not applicable
(b) Severance Pay Agreement with Anthony Pallante II ** Not applicable
(d) Severance Pay Agreement with Howard A. Jaffe ****** Not applicable
(f) 1995 Stock Option and Incentive Plan *** Not applicable
(g) Recognition and Retention Plan **** Not applicable
(h) Unfunded Deferred Compensation Plan for Directors
and Executive Officers ******
(i) Omnibus Plan ****** Not applicable
(j) SERP Agreement ****** Not applicable
11 Statement re: computation of per share earnings See Item 8. Financial Statements and
Supplementary Data Footnote 1
12 Statements re: computation of ratios Not required Not applicable
13 Annual Report to security holders None Not applicable
16 Letter re: change in certifying accountant ***** Not applicable
19 Previously unfiled documents None Not applicable
79
21 Subsidiaries of the registrant 21 83
22 Published report regarding matters submitted to vote None Not applicable
of security holders
23 Consents of experts and counsel None Not applicable
24 Power of Attorney Not required Not applicable
27 Financial data schedule Not required Not applicable
28 Information from reports furnished to state insurance
regulatory authorities Not required Not applicable
99 Additional Exhibits None Not applicable
____________
* Filed as exhibits to the Company's Registration Statement on Form S-1
under the Securities Act of 1933, as amended (the ''Securities Act''),
filed with the Securities and Exchange Commission (the ''SEC'') on June
27, 1994 (Registration No. 33-80774), and incorporated herein by
reference in accordance with Item 601 of Regulation S-K.
** Filed as exhibits to the Company's Form 10-K for the fiscal year ended
March 31, 1995, under the Securities Exchange Act of 1934, filed with
the SEC on June 29, 1995, and incorporated herein by reference in
accordance with Item 601 of Regulation S-K.
*** Filed as exhibit to the Company's Registration Statement on Form S-8
under the Securities Act, filed with the SEC on November 11, 1995
(Registration No. 33-98860), and incorporated herein by reference in
accordance with Item 601 of Regulation S-K.
**** Filed as exhibit to the Company's Registration statement on Form S-8
under the Securities Act, filed with the SEC on November 11, 1995
(Registration No. 33-98862), and incorporated herein by reference in
accordance with Item 601 of Regulation S-K.
***** Incorporated by reference to the Company's Current Report on Form 8-K
filed with the SEC on January 26, 1995, as amended.
****** Incorporated by reference to the Company's Form 10-K for the fiscal year
ended December 31, 1996, under the Securities Exchange Act of 1934,
filed with the SEC on March 27, 1997, and incorporated herein by
reference in accordance with Item 601 of Regulation S-K.
******* Filed as exhibit to the Company's Current Report on Form 8-K under the
Securities Act, filed with the SEC on October 12, 1998, and incorporated
herein by reference in accordance with Item 601 of Regulation S-K.
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned hereunto duly authorized, on this 1st day of
February 1999.
Avondale Financial Corp.
(registrant)
By: /s/ Robert S. Engelman, Jr
---------------------------------------
Robert S. Engelman, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Howard A. Jaffe
---------------------------------
Howard A. Jaffe
Vice President
and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Each director of
the Registrant, whose signature appears below, hereby appoints Robert S.
Engelman, Jr. and Howard A. Jaffe and each of them severally, as his attorney-
in-fact, to sign in his name and on his behalf, as a director of the Registrant,
and to file with the Commission any and all Amendments to this Report on Form
10-K, on this the 1st day of February 1999.
Signature TITLE
--------- -------
/s/ R. Thomas Eiff Director
- --------------------------------------------------
R. Thomas Eiff
/s/ Robert S. Engelman, Jr. Director
- --------------------------------------------------
Robert S. Engelman, Jr.
/s/ Arthur L. Knight, Jr. Director
- --------------------------------------------------
Arthur L. Knight, Jr.
/s/ Jameson A. Baxter Director
- --------------------------------------------------
Jameson A. Baxter
/s/ Sandra P. Guthman Director
- --------------------------------------------------
Sandra P. Guthman
/s/ Peter G. Krivkovich Director
- --------------------------------------------------
Peter G. Krivkovich
/s/ Hipolito Roldan Director
- --------------------------------------------------
Hipolito Roldan
/s/ Robert A. Winslow Director
- --------------------------------------------------
Robert A. Winslow
81
AVONDALE FINANCIAL CORP. AND SUBSIDIARIES
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
EXHIBIT INDEX
Exhibits Page
- -------- ------
21 Subsidiaries of the Registrant 83
82