1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
-- EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: JUNE 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-- SECURITIES EXCHANGE ACT OF 1934
Commission File No.: 0-27940
HARRINGTON FINANCIAL GROUP, INC.
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(Exact name of registrant as specified in its charter)
Indiana 48-1050267
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
722 East Main Street, P. O. Box 968
Richmond, Indiana 47375
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (765) 962-8531
Securities registered pursuant to Section 12(b) of the Act:
NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK (PAR VALUE $0.125 PER SHARE)
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
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As of September 20, 2001, the aggregate value of the 930,700 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
2,089,070 shares held by all directors and executive officers of the Registrant
as a group, was approximately $11.2 million. This figure is based on the last
known trade price of $12.00 per share of the Registrant's Common Stock on
September 20, 2001.
Number of shares of Common Stock outstanding as of September 20, 2001:
3,137,670.
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PART I.
ITEM 1. BUSINESS
GENERAL
Harrington Financial Group, Inc. (the "Company") is an
Indiana-chartered, registered thrift holding company for Harrington Bank, FSB
(the "Bank"). The Bank is a federally chartered savings bank that conducts
business through seven full-service offices located in Carmel, Fishers,
Noblesville, Indianapolis, and Richmond, Indiana; Mission, Kansas and Chapel
Hill, North Carolina.
The Company was incorporated on March 3, 1988 to acquire and hold all
of the outstanding common stock of the Bank. The Bank was originally organized
in 1889 as an Indiana-chartered savings association under the name "The Peoples
Home and Savings Association of Richmond, Indiana." In 1936, the Bank obtained
federal insurance and in 1984 adopted a federal charter and changed its name to
"Peoples Federal Savings Association." In 1985, the Bank converted from mutual
to stock form and, in March 1994, changed its name to "Harrington Bank, FSB." On
May 6, 1996, the Company sold 1,265,000 shares of common stock at $10.00 per
share to investors in an initial public offering resulting in gross proceeds of
$12,650,000 to the Company. Net proceeds to the Company after offering expenses
were $11,437,000. At June 30, 2001, the Company had total consolidated assets of
$408.0 million, total consolidated borrowings of $59.7 million, total
consolidated deposits of $323.3 million, and total consolidated stockholders'
equity of $18.7 million.
The Company was organized by certain principals of Smith Breeden
Associates, Inc. ("Smith Breeden") for the sole purpose of acquiring the Bank.
This investor group purchased the Bank with the intention of expanding the
Bank's community banking and investment operations, and improving the Bank's
return on equity. The Company has contracted with Smith Breeden to provide
investment advisory services and interest rate risk analysis. Certain
stockholders and directors of the Company are also principals of Smith Breeden.
Smith Breeden has a commercial loan outstanding with the Bank at June 30, 2001.
On May 30, 2001, the Company announced that it had reached a definitive
agreement to merge with Hasten Bancshares after the sale of both its banking
operations in North Carolina and Kansas and its 51% interest in Harrington
Wealth Management Company to third parties. The total consideration to be paid
by Hasten for all the outstanding and issued shares and options of the Company
is $40 million or $12.4916 per share. The merger is expected to be completed in
late December, 2001 or early January, 2002.
Harrington's business strategy focuses on achieving attractive returns
consistent with prudent risk management. Harrington has sought to implement this
strategy by: (1) expanding its banking locations and product offerings in order
to build a strong community banking franchise; (2) controlling interest rate
risk by matching the interest rate sensitivity of its assets to that of its
liabilities; (3) controlling credit risk by originating well-collateralized
loans and by applying conservative underwriting standards and credit risk
monitoring; and (4) utilizing excess capital balances through the management of
a hedged investment portfolio.
Highlights of the principal elements of the Company's business strategy are as
follows:
- Expand Banking Locations and Product Offerings. An integral part of the
Company's strategy has been to expand opportunistically the products,
services, and banking locations for business and retail customers in
markets where the Company's management and directors have market
knowledge and customer relationship potential. A total of eight new
banking locations have been opened since May 1994, and the Company's
commercial loan division was developed in the spring of 1998. With the
primary expansion complete, the Company is focused on efficiency and
revenue enhancement to improve profitability.
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In March 2000, the Company reached a definitive agreement to sell the
Bank's two southern Indianapolis branches. The Company determined that
the branches did not strategically fit with its market development on the
north side of Indianapolis in Hamilton County. On September 8, 2000, the
Company sold deposits and certain assets of the two branch banking
locations. The Company sold $43.5 million of deposits, $0.4 million of
office properties and equipment, and paid approximately $41.7 million.
The sale resulted in a pre-tax gain of approximately $1.4 million.
The Company's lending emphasis is on the origination of loans secured by
first and second liens on single-family (one to four units) residences
and commercial real estate, equipment, inventory, and receivables lending
through its commercial loan division. In fiscal year 2001, the Company
originated $22.8 million in single family related loans, $29.2 million in
consumer related loans, and $86.4 million in commercial related loans.
Total loans have increased to $329.2 million at June 30, 2001 from $94.0
million at June 30, 1997.
The Company believes that retail deposits are a cost-effective source of
funds, provide an additional source of fee income, and also permit the
further cross selling of additional products and services. Consequently,
the Company is focusing on increasing its retail deposit base while
controlling deposit cost. Core deposits (total consolidated deposits less
public funds deposits and brokered deposits) were $287.0 million at June
30, 2001 and have increased from $123.5 million at June 30, 1997.
The Company also formed Harrington Wealth Management Company ("HWM") in
February 1999. HWM is a strategic alliance between the Bank (51% owner)
and Los Padres Bank (49% owner), a federally chartered savings bank
located in California. HWM provides trust, investment management, and
custody services for individuals and institutions.
- Control Interest Rate Risk. The Company attempts to manage its assets and
liabilities in order to maintain a portfolio that produces positive
returns in either an increasing or decreasing interest rate environment.
The Company has sought to control interest rate risk both internally
through the management of the composition of its assets and liabilities
and externally through the utilization of interest rate contracts.
Interest rate contracts are purchased with the intention of protecting
the market value of the Bank's portfolio and net interest income.
- Control Credit Risk. In order to limit the Company's credit exposure, the
Company originates and adds to its portfolio well-secured residential and
commercial loans and maintains strict underwriting standards. As such,
non-performing loans have remained relatively low, with only $2,346,000
or 0.71% of total loans at June 30, 2001.
- Utilize Excess Capital Balances. The Company utilizes excess capital
balances through the management of a hedged investment portfolio
primarily consisting of mortgage-backed securities and corporate bonds.
Although these securities often carry lower yields than traditional
loans, such securities generally increase the quality of the Company's
assets, are more liquid than individual loans, and may be used to
collateralize borrowings or other obligations of the Company. The funds
invested in the securities portfolio can be quickly redeployed to pursue
community bank expansion opportunities as they arise.
During fiscal year 2001, the Company marked almost all of its
investment securities and related interest rate contracts to market either in
earnings (trading portfolio) or in equity (available for sale portfolio). This
method of accounting was consistent with the Company's strategy of active
portfolio management and provided the Company with the flexibility to quickly
adjust the mix of its interest earning assets in response to changing market
conditions or to take advantage of community banking growth opportunities. With
the growth in the core retail and commercial banking business, the level of
assets subject to mark-to market accounting has declined.
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In summary, the Company continues to operate a community-oriented
banking operation in order to sustain loan originations and deposit growth,
benefit from economies of scale, and generate additional fee and net interest
income. Management's primary goal is to increase stockholders' value as measured
on a risk-adjusted total return basis.
INVESTMENT ADVISOR
Smith Breeden is a money management and consulting firm providing
investment management services to taxable and tax-exempt clients such as
corporate, state and municipal pension funds, university endowments and mutual
fund investors and consulting and investment advisory services to taxable
financial institutions. Smith Breeden specializes in mortgage-backed and related
securities, interest rate risk management, and the application of option pricing
to loans and investments. Smith Breeden currently advises, or manages on a
discretionary or advisory basis, assets totaling over $22 billion. Over the past
19 years, the firm has acted as a consultant to banks, thrifts and governmental
agencies charged with the regulation of financial institutions and the
resolution of troubled thrifts.
Smith Breeden was co-founded in 1982 by Douglas T. Breeden and Gregory
Smith, who retired in 1988. Dr. Breeden is Chairman of the Board of the Company.
He is the dean of Duke University's Fuqua School of Business. He has served on
business school faculties at the University of Chicago, Stanford University
(where he obtained a Ph.D. in Finance), Duke University's Fuqua School of
Business, and as Dalton McMichael Professor of Finance at the University of
Northern Carolina. He is the founding editor of the JOURNAL OF FIXED INCOME.
Since 1988, Smith Breeden and certain of its principals have made
equity investments in financial institutions that apply the firm's approach to
banking and investment management. Certain of the principals of Smith Breeden
are investors in a number of banks and thrift institutions. Smith Breeden is
based in Chapel Hill, North Carolina, and employs approximately 60 people in its
main office and its office in Boulder, Colorado.
LENDING ACTIVITIES
GENERAL. At June 30, 2001, the Bank's net loan portfolio totaled $329.2
million, representing approximately 80.7% of the Company's $408.0 million of
total assets at that date. In addition to utilizing option-adjusted pricing
analyses in order to manage the Company's investment portfolio, the Company also
uses such analyses to price its loan originations and ascertain the net spread
expected to be earned with respect to the Bank's loan portfolio. The Bank
continues to directly originate and service single-family residential mortgage
loans. Since fiscal 1995, the Bank has also been active in originating whole
residential mortgage loans through correspondents that meet its pricing and
credit quality objectives. In the latter part of fiscal year 1998, the Company
initiated the development of a commercial loan division. The Company's
origination of commercial mortgage and commercial and industrial loans provides
further diversification of business lines and fulfills a critical component of
the Company's community banking strategy.
The risks associated with residential mortgage lending are well defined
and controllable. Credit risk is controlled through the adherence, with few
exceptions, to secondary market underwriting guidelines. In addition, the
commercial real estate loans and collateralized commercial loans are
underwritten to comply with stringent internal guidelines. A strong internal
loan review program monitors compliance with the Bank's underwriting standards,
which is reflected by the low level of non-performing assets. See - "Asset
Quality - Non-Performing Assets." Market risk is controlled by a disciplined
approach to pricing and by regular monitoring and hedging of the institution's
overall sensitivity to interest rate changes.
As a federally chartered savings institution, the Bank has general
authority to originate and purchase loans secured by real estate located
throughout the United States. Notwithstanding this nationwide lending authority,
the Company estimates that at June 30, 2001, approximately 88% of the loans in
the Bank's portfolio are to customers
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located in the immediate market areas of its offices in Richmond and
Indianapolis, Indiana as well as Mission, Kansas and Chapel Hill, North
Carolina.
Although the Bank has historically originated loans with lesser dollar
balances than the maximum permitted by federal regulations, current loans-to-one
borrower limitations may restrict its ability to do business with certain
customers. A savings institution generally may not make loans to any one
borrower and related entities in an amount that exceeds 15% of its unimpaired
capital and surplus, although loans in an amount equal to an additional 10% of
unimpaired capital and surplus may be made to a borrower if the loans are fully
secured by readily marketable securities. At June 30, 2001, the Bank's
regulatory limit on loans-to-one borrower was $4.3 million and its five largest
loans or groups of loans-to-one borrower, including related entities, aggregated
$3.2 million, $3.1 million, $2.8 million, $2.8 million and $2.8 million. All
five of the Bank's largest loans or groups of loans are secured primarily by
commercial real estate or commercial business assets and were performing in
accordance with their terms at June 30, 2001.
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LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition of
the Bank's loan portfolio by type of loan at the dates indicated.
JUNE 30,
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2001 2000 1999
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AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
(DOLLARS IN THOUSANDS)
Single-family residential (1) $178,907 54.2 % $181,414 66.7 % $216,511 83.5 %
Commercial real estate (2) 25,695 7.8 16,098 5.9 16,707 6.4
-------- ----- -------- ----- -------- -----
Total real estate loans 204,602 62.0 197,512 72.6 233,218 89.9
Collateralized commercial loans 89,409 27.1 57,063 21.0 17,071 6.6
Consumer loans:
Deposit secured 342 0.1 364 0.1 426 0.2
Home improvement/equity 32,385 9.8 14,248 5.3 5,443 2.1
Automobile 3,134 0.9 2,371 0.9 2,811 1.1
Other 300 0.1 373 0.1 369 0.1
-------- ----- -------- ----- -------- -----
Total consumer loans 36,161 10.9 17,356 6.4 9,049 3.5
-------- ----- -------- ----- -------- -----
Total loans 330,172 100.0 % 271,931 100.0 % 259,338 100.0 %
======== ===== ======== ===== ======== =====
Less:
Deferred loan origination costs,
and other (3)(4) 1,190 447 1,204
Allowance for loan losses (2,140) (1,408) (868)
-------- -------- --------
Net loans $329,222 $270,970 $259,674
======== ======== ========
JUNE 30,
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1998 1997
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AMOUNT PERCENT AMOUNT PERCENT
(DOLLARS IN THOUSANDS)
Single-family residential (1) $154,336 94.6 % $91,140 97.2 %
Commercial real estate (2) 3,522 2.2 258 0.3
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Total real estate loans 157,858 96.8 91,398 97.5
Collateralized commercial loans 1,201 0.7 - -
Consumer loans:
Deposit secured 221 0.1 252 0.2
Home improvement/equity 3,536 2.2 2,136 2.3
Automobile 13 - - -
Other 240 0.2 - -
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Total consumer loans 4,010 2.5 2,388 2.5
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Total loans 163,069 100.0 % 93,786 100.0 %
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Less:
Deferred loan origination costs,
and other (3)(4) 837 385
Allowance for loan losses (360) (213)
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Net loans $163,546 $93,958
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(1) Includes single-family residential construction loans. At June 30, 2001,
the Bank had $986,000 in single-family residential.
(2) Includes $0, $0, $63,000, $224,000 and $258,000 of mortgage revenue bonds
secured by commercial real estate at each of the respective dates, and
$12.0 million in commercial real estate construction loans in process.
(3) Reflects the balance of the fair value adjustments made on the loan
portfolio as a result of the completion in September 1988 of the
Company's acquisition of the Bank, which was accounted for under the
purchase method of accounting.
(4) Includes undisbursed funds relating to construction loans.
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CONTRACTUAL PRINCIPAL REPAYMENTS AND INTEREST RATES. The following table sets
forth certain information at June 30, 2001 regarding the dollar amount of loans
maturing in the Bank's total loan portfolio, based on the contractual terms to
maturity, before giving effect to net items.
DUE AFTER DUE AFTER
DUE IN ONE ONE TO FIVE FIVE OR MORE
YEAR OR LESS YEARS YEARS TOTAL
(DOLLARS IN THOUSANDS)
Single-family residential $ 9,733 $20,865 $148,309 $178,907
Commercial 62,043 12,556 40,505 115,104
Consumer 17,325 7,478 11,358 36,161
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Total $89,101 $40,899 $200,172 $330,172
========== ========== ============ ==========
The following table sets forth the dollar amount of all loans, before
net items, due after one year from June 30, 2001, which have fixed interest
rates or which have floating or adjustable interest rates.
FLOATING OR
FIXED RATES ADJUSTABLE-RATES TOTAL
(DOLLARS IN THOUSANDS)
Single-family residential $146,487 $22,687 $169,174
Commercial 53,061 53,061
Consumer 18,604 232 18,836
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Total $218,152 $22,919 $241,071
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ORIGINATION, PURCHASE AND SALE OF LOANS. The lending activities of the
Bank are subject to the written, non-discriminatory underwriting standards and
loan origination procedures established by the Bank's Board of Directors and
management. Loan originations are obtained by a variety of sources, including
referrals from real estate brokers, builders, existing customers, walk-in
customers, loan officers and advertising. In its marketing, the Bank emphasizes
its community ties, customized personal service, competitive rates, and an
efficient underwriting and approval process. Property valuations are performed
by independent outside appraisers approved by the Bank's Board of Directors. The
Bank requires title, hazard and, to the extent applicable, flood insurance on
all security property.
Mortgage loan applications are reviewed by Bank employees who have
approval authority up to designated limits. All loans in excess of an
individual's designated limits are referred to the Bank's Loan Committee, which
has approval authority for all loans up to $1.0 million. Any loans exceeding
$1.0 million (of which, at June 30, 2001, there was one) must be approved by the
Board of Directors of the Bank. In addition, the Board of Directors of the Bank
ratifies all loans originated and purchased by the Bank.
The single-family residential loans originated by the Bank are
generally made on terms, conditions and documentation which permit the sale to
the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal National
Mortgage Association ("FNMA") and other institutional investors in the secondary
market. From fiscal 1991 to fiscal 1993, the Bank sold substantially all of its
fixed-rate single-family residential loans to FNMA in the secondary market as a
means of generating fee income as well as providing additional funds for
lending, investing and other purposes. Sales of loans were generally under terms
which did not provide any recourse to the Company by the purchaser in the event
of default on the loan by the borrower. With respect to such loan sales, the
Company generally retained responsibility for collecting and remitting loan
payments, inspecting the properties, making
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certain insurance and tax payments on behalf of borrowers and otherwise
servicing the loans it sold, and received a fee for performing these services.
At June 30, 2001, the Company was servicing $21.1 million of loans for others.
During fiscal year 1994, the Bank initiated programs to increase its
portfolio of single-family residential loans in accordance with its community
banking expansion. In addition, during fiscal 1995, the Bank began originating
single-family residential loans through correspondent mortgage banking
companies. The Bank also uses mortgage banking companies located in
Indianapolis, Indiana and Overland Park, Kansas. The Bank requires that all
loans originated through correspondents be underwritten in accordance with its
underwriting guidelines and standards. The Bank reviews the loans for adherence
to its underwriting standards prior to acceptance from the correspondent. Such
loans are obtained with servicing released.
The following table sets forth the loan origination activity of the
Company during the periods indicated.
YEAR ENDED JUNE 30,
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2001 2000 1999
(DOLLARS IN THOUSANDS)
Direct loan originations:
Single-family residential $ 22,839 $10,706 $66,644
Commercial 86,433 53,988 51,585
Consumer 29,233 12,613 9,967
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Total loans originated directly 138,505 77,307 128,196
Originations by correspondents (1) 509 39,523
-------- ------- -------
Total loans originated 138,505 77,816 167,719
Loan principal reductions (80,264) (65,223) (71,450)
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Net increase in loan portfolio $ 58,241 $12,593 $ 96,269
======== ======== ========
(1) Consisted solely of single-family residential loans.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LOANS. Historically, savings
institutions such as the Bank have concentrated their lending activities on the
origination of loans secured primarily by first mortgage liens on existing
single-family residences. At June 30, 2001, $178.9 million or 54.2% of the
Bank's total loan portfolio consisted of single-family residential real estate
loans, substantially all of which are conventional loans.
The Bank offers fixed-rate single family residential loans with terms of
ten to thirty years. Such loans are amortized on a monthly basis with principal
and interest due each month. Generally, the value of fixed-rate loans fluctuates
inversely with changes in interest rates. Consequently, if left unhedged,
long-term fixed-rate single-family residential loans would increase the Bank's
interest rate risk. However, the Bank believes that its sophisticated asset and
liability management techniques provide the Bank with a competitive advantage
and allow for the Bank to continue to offer fixed-rate residential mortgage
loans over a variety of interest rate scenarios.
The Bank also offers adjustable-rate single-family residential mortgage
loans. Such loans generally have up to thirty-year terms and an interest rate
which adjusts after one, three or five years in accordance with a designated
index (the weekly average yield on U.S. Treasury securities adjusted to a
constant comparable maturity of one year, as made available by the Federal
Reserve Board). Such loans currently have a 2% cap on the amount of any increase
or decrease in the interest rate per year, and a 6% limit on the amount by which
the interest rate can increase or decrease over the life of the loan. In
addition, the Bank's adjustable-rate loans are currently not convertible into
fixed-rate loans and do not contain prepayment penalties. Approximately 17.9% of
the single-family residential loans in the Bank's loan portfolio at June 30,
2001 had adjustable interest rates.
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Adjustable-rate mortgage loans decrease but do not eliminate the risks
associated with changes in interest rates. Because periodic and lifetime caps
limit the interest rate adjustments, the value of adjustable-rate mortgage loans
also fluctuates inversely with changes in interest rates. In addition as
interest rates increase, the required payments by the borrower increase, thus
increasing the potential for default.
The demand for adjustable-rate loans in the Bank's primary market area
has been a function of several factors, including the level of interest rates,
the expectations of changes in the level of interest rates and the difference
between the interest rates and loan fees offered for fixed-rate loans and
adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Pursuant to underwriting guidelines adopted by the Board of Directors,
the Bank will generally lend up to 95% of the appraised value of the property
securing a single-family residential loan. However, the Bank generally obtains
private mortgage insurance on the principal amount that exceeds 80% of appraised
value of the security property.
In fiscal year 2001, the Bank implemented a residential construction
lending program. The program was designed to finance the construction of
single-family residential dwellings. The loans are underwritten following
underwriting guidelines that qualify the loans to be sold in the secondary
market, even though the loans may be held in the Bank's loan portfolio. At June
30, 2001, the Bank had $986,000 in single-family residential and $12.0 million
in commercial real estate construction loans in process.
COMMERCIAL REAL ESTATE LOANS. At June 30, 2001, $25.7 million or 7.8% of
the Bank's total loan portfolio consisted of loans secured by commercial real
estate. At June 30, 2001, the Bank's commercial real estate loan portfolio
included term loans secured by commercial buildings located within the Company's
primary market areas.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. During the latter part of the 1998
fiscal year, the Bank developed a commercial lending division by implementing
the necessary policies, operating procedures, loan systems and hiring support
personnel. These loans are made in conformance with strict underwriting
guidelines and adherence to the Bank's policies.
COLLATERALIZED COMMERCIAL LOANS. At June 30, 2001, $89.4 million or 27.1%
of the Bank's total loan portfolio consisted of collateralized commercial loans.
These collateralized loans consist of term loans as well as lines of credit
which are secured by business assets or stock.
As previously mentioned, the Bank's recent development of the commercial
lending division allows for the origination of non-real estate business loans in
strict compliance with the Bank's underwriting standards. Collateralized
commercial lending also entails different and significant risks in relation to
single-family residential lending.
CONSUMER LOANS. The Bank is authorized to make loans for a wide variety
of personal or consumer purposes. The Bank has been originating consumer loans
in recent years in order to provide a wider range of financial services to its
customers and because such loans generally have higher interest spreads than
mortgage loans. The consumer loans offered by the Bank include home equity loans
and lines of credit, home improvement loans and deposit account secured loans.
At June 30, 2001, $36.2 million or 10.9% of the Bank's total loan portfolio
consisted of consumer loans.
Home equity loans and lines of credit are originated by the Bank for up
to 90% of the appraised value, less the amount of any existing prior liens on
the property. The Bank also offers home improvement loans in amounts
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up to 95% of the appraised value, less the amount of any existing prior liens on
the property, provided the loan is guaranteed by an approved insurer. Home
equity loans and home improvement loans have a maximum term of twenty years and
carry fixed interest rates. Home equity lines of credit have a maximum repayment
term of ten years, a five-year term with respect to draws, and carry interest
rates which adjust monthly in accordance with a designated prime rate. The Bank
will secure each of these types of loans with a mortgage on the property
(generally a second mortgage) and will originate the loan even if another
institution holds the first mortgage. At June 30, 2001, home equity loans and
lines of credit and home improvement loans totaled $32.4 million or 89.6% of the
Bank's total consumer loan portfolio.
The Bank currently offers loans secured by deposit accounts, which
amounted to $342,000 or 0.9% of the Bank's total consumer loan portfolio at June
30, 2001. Such loans are originated for up to 95% of the deposit account
balance, with a hold placed on the account restricting the withdrawal of the
account balance.
As of June 30, 2001, automobile and personal loans amounted to $3.4
million or 9.5% of the Bank's total consumer loan portfolio.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral. In addition, consumer lending
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness and
personal bankruptcy. The Bank believes that the generally higher yields earned
on consumer loans compensate for the increased credit risk associated with such
loans, and the Company intends to continue to offer consumer loans in order to
provide a full range of services to its customers.
ASSET QUALITY
LOAN DELINQUENCIES. When a borrower fails to make a required payment on a
loan, the Bank attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made following the fifteenth day after a
payment is due, at which time a late payment is assessed. In most cases,
deficiencies are cured promptly. If a delinquency extends beyond fifteen days,
the loan and payment history is reviewed and efforts are made to collect the
loan. While the Bank generally prefers to work with borrowers to resolve such
problems, when the account becomes ninety days delinquent, the Bank does
institute foreclosure or other proceedings, as necessary, to minimize any
potential loss.
NON-PERFORMING ASSETS. All loans are reviewed on a regular basis and are
placed on non-accrual status when, in the opinion of management, the probability
of collection of additional interest is deemed insufficient to warrant further
accrual. As a matter of policy, the Bank does not accrue interest on loans past
due 90 days or more except when the estimated value of the collateral and
collection efforts are deemed sufficient to ensure full recovery. The Bank
provides an allowance for the loss of uncollected interest on all non-accrual
loans. Impaired loans covered under Statement of Financial Accounting Standards
("SFAS") No. 114 and No. 118 are defined by the Company to consist of
non-accrual commercial loans which have not been collectively evaluated for
impairment. The allowance is established by a charge to interest income equal to
all interest previously accrued, and income is subsequently recognized only to
the extent that cash payments are received until, in management's judgment, the
borrower's ability to make periodic interest and principal payments returns to
normal, in which case the loan is returned to accrual status.
Real estate acquired through foreclosure is carried at the lower of the
loan's unpaid principal balance (cost) or fair value less estimated selling
expenses at the date of transfer. A loan charge-off is recorded for any
write-down in the loan's carrying value to fair value at the date of transfer.
Real estate loss provisions are recorded if the property's fair value
subsequently declines below the value determined at the recording date. In
determining the lower of cost or fair value at acquisition, costs relating to
development and improvement of property are considered. Costs relating to
holding real estate acquired through foreclosure, net of rental income, are
charged against earnings as incurred.
-10-
11
Automobiles acquired through repossession are carried at the lower of
the loan's unpaid principal balance (cost) or fair value based on current
National Automobile Dealers Association valuation, adjusted for any damage or
vandalism. A loan charge-off is recorded for any write-down in the loan's
carrying value to fair value at the date of transfer. Loss provisions are
recorded if the fair value of the automobile subsequently declines below the
value determined at the recording date. After repossession, costs relating to
holding the automobile are charged against earnings as incurred.
The following table sets forth the amounts and categories of the Bank's
non-performing assets at the dates indicated.
JUNE 30,
--------------------------------------------------------
2001 2000 1999 1998 1997
(DOLLARS IN THOUSANDS)
Non-accruing loans:
Single-family residential $ 495 $ 151 $ 70 $ 285 $ 336
Consumer 105 29 6 - -
Commercial 1,564 - - - -
------ ------ ----- ------ -------
Total non-accruing loans $2,164 $ 180 $ 76 $ 285 $ 336
Accruing loans greater than 90 days
delinquent 182 - - - -
------ ------ ----- ------ -------
Total non-performing loans $2,346 $ 180 $ 76 $ 285 $ 336
Real estate owned - - - 18 -
Repossessed automobiles 1 3 22 - -
Other non-performing assets (1) 278 378 502 587 789
------ ------ ----- ------ -------
Total non-performing assets 2,625 561 600 890 1,125
====== ====== ===== ====== =======
Total non-performing loans as a percentage
of total loans 0.71 % 0.07 % 0.03 % 0.17 % 0.36 %
====== ====== ===== ====== =======
Total non-performing assets as a percentage
of total assets 0.64 % 0.13 % 0.13 % 0.18 % 0.25 %
====== ====== ===== ====== =======
Troubled debt restructuring $ 77 $2,054 $ - $ - $ -
====== ====== ===== ====== =======
(1) Consists of a non-agency participation certificate. See "- Classified
Assets."
The interest income that would have been recorded during the years ended
June 30, 2001, 2000, 1999, 1998, and 1997 if the Bank's non-accrual loans at the
end of such periods had been current in accordance with their terms during such
periods was $41,000, $6,000, $1,000, $15,000 and $6,000, respectively.
CLASSIFIED ASSETS. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Another category
designated "special mention" also must be established and maintained for assets
which do not currently expose an insured institution to a sufficient degree of
risk to warrant classification as substandard, doubtful or loss. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
loss, the insured institution must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified loss, or
charge-off such amount. General loss allowances established to cover
-11-
12
possible losses related to assets classified substandard or doubtful may be
included in determining an institution's regulatory capital, while specific
valuation allowances for loan losses do not qualify as regulatory capital.
The Bank's classified assets at June 30, 2001 consisted of $3.0 million
of assets classified as substandard (including $2,685,000 of loans and $278,000
of securities) and twenty-one loans in the amount of $784,000 classified as
doubtful. In addition, at June 30, 2001, $4,406,000 of the Bank's loans were
designated special mention.
The $2,685,000 of loans classified as substandard consisted of six
commercial loans totaling $2,642,000 and two single-family residential loans
totaling $43,000.
The $278,000 of securities classified as substandard at June 30, 2001
relates to a single non-agency participation certificate which was purchased by
the Bank during fiscal 1991. The security was issued by a savings institution
located in Huntington Beach, California and the underlying mortgages consist of
six-month adjustable-rate notes (priced off of LIBOR) which are secured by
single-family properties located in southern California. As of June 30, 2001,
approximately 8.3% of the underlying mortgages were at least 30 days past due
and/or in foreclosure or already foreclosed upon by the servicer. The security
was structured into both senior and subordinate classes and the Bank owns only
senior classes. As of June 30, 2001, the pool had cumulative realized losses of
$23.7 million that were initially absorbed by certain credit supports and
subsequently absorbed by subordinate certificate holders. Currently, senior
certificate holders (such as the Bank) are having to absorb the losses. The
credit supports, which totaled $11.0 million at the date of issuance, had been
depleted as of June 30, 2001. The security is currently held in the Bank's
available for sale portfolio, and its $278,000 carrying value at June 30, 2001
reflects $66,000 of net unrealized gains as of such date as well as $414,000 and
$253,000 of write-downs with respect to such security, that were recognized by
the Bank during fiscal 1995 and 1994, respectively.
ALLOWANCE FOR LOAN LOSSES. It is management's policy to maintain an
allowance for estimated losses on loans based upon the estimated net realizable
value of the underlying collateral; general economic conditions, particularly as
they relate to the Bank's market area; historical loss experience; and other
factors related to the collectibility of the loan portfolio. Although management
believes that it uses the best information available to make such
determinations, future adjustments to the allowance may be necessary, and net
income could be significantly affected, if circumstances differ substantially
from the assumptions used in making the initial determinations.
Effective December 21, 1993, the Office of Thrift Supervision ("OTS"), in
conjunction with the Office of the Comptroller of the Currency, the Federal
Deposit Insurance Corporation ("FDIC") and the Federal Reserve Board, issued an
Interagency Policy Statement on the Allowance for Loan and Lease Losses ("Policy
Statement"). The Policy Statement includes guidance (1) on the responsibilities
of management for the assessment and establishment of an adequate allowance and
(2) for the agencies' examiners to use in evaluating the adequacy of such
allowance and the policies utilized to determine such allowance. The Policy
Statement also sets forth quantitative measures for the allowance with respect
to assets classified substandard and doubtful and with respect to the remaining
portion of an institution's loan portfolio. Specifically, the Policy Statement
sets forth the following quantitative measures which examiners may use to
determine the reasonableness of an allowance: (1) 50% of the portfolio that is
classified doubtful; (2) 15% of the portfolio that is classified substandard and
(3) for the portions of the portfolio that have not been classified (including
loans designated special mention), estimating credit losses over the upcoming
twelve months based on facts and circumstances available on the evaluation date.
While the Policy Statement sets forth this quantitative measure, such guidance
is not intended as a "floor" or "ceiling."
-12-
13
The following table sets forth an analysis of the Bank's allowance for
loan losses during the periods indicated.
YEAR ENDED JUNE 30,
------------------------------------------------------------------
2001 2000 1999 1998 1997
(DOLLARS IN THOUSANDS)
Total loans outstanding, net $ 329,222 $ 270,970 $ 259,674 $ 163,546 $ 93,958
========= ========= ========= ========= ========
Average loans outstanding, net $ 304,682 $ 275,454 $ 223,174 $ 116,982 $ 78,545
========= ========= ========= ========= ========
Balance at beginning of period $ 1,408 $ 868 $ 360 $ 213 $ 120
Charge-offs:
Single-family residential - - - - -
Commercial real estate - - - - -
Consumer 71 49 - - -
--------- --------- --------- --------- --------
Total charge-offs $ 71 $ 49 $ - $ - $ -
--------- --------- --------- --------- --------
Recoveries:
Single-family residential - - 1 - -
Consumer 5 2 - - -
--------- --------- --------- --------- --------
Total recoveries $ 5 $ 2 $ 1 $ - $ -
--------- --------- --------- --------- --------
Net charge-offs 66 47 (1) - -
Provision for loan losses 798 587 509 147 93
--------- --------- --------- --------- --------
Balance at end of period $ 2,140 $ 1,408 $ 868 $ 360 $ 213
========= ========= ========= ========= ========
Allowance for loan losses as a percent
of total loans outstanding 0.7 % 0.5 % 0.3 % 0.2 % 0.2 %
========= ========= ========= ========= ========
Ratio of net charge-offs to average
loans outstanding 0.0 % 0.0 % 0.0 % 0.0 % 0.0 %
========= ========= ========= ========= ========
The Bank established provisions for loan losses of $798,000, $587,000,
$509,000, $147,000 and $93,000 during the years ended June 30, 2001, 2000, 1999,
1998 and 1997, respectively. During such periods, loan charge-offs (net of
recoveries) amounted to $66,000, $47,000, $(1,000), $0, and $0, respectively.
The increases in the provision for loan losses during the periods presented were
due to substantial growth in the Company's mortgage, consumer and commercial
loan portfolios.
-13-
14
The following table sets forth information concerning the allocation of the
Bank's allowance for loan losses by loan categories at the dates indicated.
JUNE 30,
--------------------------------------------------------------------------------------
2001 2000 1999
--------------------------- ---------------------------- --------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
(DOLLARS IN THOUSANDS)
Single-family residential loans $ 106 54.2 % $ 93 66.7 % $ 377 83.5 %
Commercial loans 1,672 34.9 1,098 26.9 411 13.0
Consumer loans 362 10.9 217 6.4 80 3.5
-------- ------- -------- ------- ------ -------
Total $ 2,140 100.0 % $ 1,408 100.0 % $ 868 100.0 %
======== ======= ======== ======= ====== =======
JUNE 30,
--------------------------------------------------
1998 1997
----------------------- -------------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
(DOLLARS IN THOUSANDS)
Single-family residential loans $ 302 94.6 % $ 188 97.2 %
Commercial loans 43 2.9 10 0.3
Consumer loans 15 2.5 15 2.5
------ ------- ------ -------
Total $ 360 100.0 % $ 213 100.0 %
====== ======= ====== =======
-14-
15
INVESTMENT ACTIVITIES
GENERAL. The Company's securities portfolio is managed by investment
officers in accordance with a comprehensive written investment policy which
addresses strategies, types and levels of allowable investments and which is
reviewed and approved by the Bank's Board of Directors on an annual basis. The
management of the securities portfolio is set in accordance with the direction
of the Bank's investment committee. In addition, the Bank has entered into an
agreement with Smith Breeden whereby Smith Breeden has been appointed as
investment advisor with respect to the management of the Bank's securities
portfolio. With the assistance of Smith Breeden, the Bank's Chief Executive
Officer and Chief Investment Officer execute various transactions with respect
to the portfolio and are responsible for informing the investment committee of
the types of investments available, the status and performance of the portfolio
and current market conditions. The investment officers are authorized to:
purchase or sell any securities as well as commitments to hedge eligible
investments; purchase or sell eligible investments under repurchase or reverse
repurchase agreements; execute hedging strategies approved by the investment
committee; pledge securities owned as collateral for public agency deposits or
repurchase accounts or agreements; and lend securities to approved dealers in
government securities or approved commercial banks. Any one investment officer
has the authority to purchase or sell securities up to $5 million in any one
transaction and acting together, two members of the investment committee have
authority to purchase or sell securities up to $30 million in any one
transaction. For purchases or sales greater than $30 million, the prior approval
of a majority of the investment committee is required. Investment officers are
also authorized to invest excess liquidity in approved liquid investment
vehicles. In addition, both the investment committee and the Board of Directors
of the Bank ratify all securities purchased and sold by the Bank.
The Company invests in a portfolio of mortgage-backed securities,
mortgage-backed derivative securities, interest rate risk management contracts,
equity securities and municipal bonds. In selecting securities for its
portfolio, the Company employs option-adjusted pricing analysis with the
assistance of Smith Breeden in order to ascertain the net risk-adjusted spread
expected to be earned with respect to the various investment alternatives. The
nature of this analysis is to quantify the costs embedded in the yield of an
investment, such as the duration matched funding cost, the costs of the options
embedded in the investment's cash flows (such as a borrower's ability to prepay
a mortgage) and servicing costs. The objective of the Company's investment
management process is to select investments with the greatest net spreads and
actively manage the underlying risks of these investments.
The Company actively manages its securities portfolio in order to
enhance net interest and net market value on a risk-adjusted basis. As a result,
the Company continuously monitors the net risk-adjusted spreads of its
investments and compares them with the spreads available with respect to other
securities in the market. Accordingly, as market conditions fluctuate (e.g., as
risk-adjusted spreads narrow), the Company may sell individual securities prior
to their maturity and reinvest the proceeds into new investments which generally
carry wider risk-adjusted spreads. The Company's securities portfolio also
contains various interest rate risk management contracts (such as interest rate
swaps, collars, caps, floors, options and futures) which are primarily utilized
to hedge the Company's interest rate exposure in the trading portfolio and which
require active management in order to respond to changing prepayment rates on
the mortgage securities. The investment portfolio, although hedged for interest
rate risk, is still susceptible to adverse changes in the spreads between the
yields on mortgage securities and the related Treasury and LIBOR based hedges.
Substantially all of these securities and their related interest rate risk
management contracts are classified as trading or available for sale securities
and, pursuant to SFAS 115, are reported at fair value with unrealized gains and
losses included in earnings or equity, respectively.
MORTGAGE-BACKED AND RELATED SECURITIES. At June 30, 2001, the Company's
mortgage-backed and related securities portfolio (including $648,000 of
mortgage-backed derivative securities) amounted to $54.5 million or 99.9% of the
Company's securities portfolio and 13.4% of the Company's total assets. By
investing in mortgage-backed and related securities, management seeks to achieve
a targeted option-adjusted spread over applicable funding costs.
The Company invests in mortgage-backed and related securities, including
mortgage participation certificates, which are insured or guaranteed by U.S.
Government agencies and government sponsored enterprises, and CMOs and real
estate mortgage investment conduits ("REMICs"). Mortgage-backed securities
(which also are known as mortgage participation certificates or pass-through
certificates) represent a participation interest in a pool of single-family or
multi-family mortgages, the principal and interest payments on which are passed
from the
- 15 -
16
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the FHLMC, the
FNMA and the Government National Mortgage Association ("GNMA").
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, (i.e., fixed-rate or
adjustable-rate) as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgage-backed pass-through security thus approximates
the term of the underlying mortgages.
The Company's mortgage-backed derivative securities include CMOs, which
include securities issued by entities which have qualified under the Internal
Revenue Code as REMICs. CMOs and REMICs (collectively CMOs) have been developed
in response to investor concerns regarding the uncertainty of cash flows
associated with the prepayment option of the underlying mortgagor and are
typically issued by governmental agencies, government sponsored enterprises and
special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A CMO can
be collateralized by loans or securities which are insured or guaranteed by
FNMA, FHLMC or GNMA. In contrast to pass-through mortgage-backed securities, in
which cash flow is received pro rata by all security holders, the cash flow from
the mortgages underlying a CMO is segmented and paid in accordance with a
predetermined priority to investors holding various CMO classes. By allocating
the principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity, estimated average life, coupon rate and prepayment
characteristics.
The Company's mortgage-backed derivative securities also include
mortgage-backed residuals and interest-only and principal-only strips.
Mortgage-backed residuals consist of certificates of particular tranches of a
CMO whereby the principal repayments and prepayments with respect to the
underlying pool of loans are generally not allocated to the residual until all
other certificates or tranches have been fully paid and retired. Interest-only
strips are a particular class of mortgage-backed derivative security which
receives and pays only interest with respect to the underlying pool of loans,
while principal-only strips receive and pay only principal repayments and
prepayments. As a result of the foregoing, mortgage-backed derivative securities
often exhibit elasticity and convexity characteristics (i.e., respond
differently to changes in interest rates) which the Company can utilize to
internally hedge other components of the Company's portfolio of assets against
interest rate risk.
The OTS has issued a statement of policy which states, among other
things, that mortgage derivative products (including CMOs and CMO residuals and
stripped mortgage-backed securities such as interest-only and principal-only
strips) which possess average life or price volatility materially different from
benchmark fixed-rate 30-year mortgage-backed securities are "high risk mortgage
securities," and must be carried in the institution's trading account or as
assets held for sale, and therefore marked to market on a regular basis. At June
30, 2001, $648,000 or 1.2% of the securities held in the Company's portfolio
consisted of such "high risk mortgage securities," as defined in such policy
statement. However, the Bank is in compliance with this OTS policy statement
since all of such securities are held in the Company's trading account and
marked to market on a regular basis in accordance with generally accepted
accounting principles.
Like most fixed-income securities, mortgage-backed and related
securities are subject to interest rate risk. However, unlike most fixed-income
securities, the mortgage loans underlying a mortgage-backed or related security
generally may be prepaid at any time without penalty. The ability to prepay a
mortgage loan generally results in significantly increased price and yield
volatility (with respect to mortgage-backed and related securities) than is the
case with non-callable fixed-income securities. Furthermore, mortgage-backed
derivative securities often are more sensitive to changes in interest rates and
prepayments than traditional mortgage-backed securities and are, therefore, even
more volatile. Nevertheless, the Company attempts to hedge against both interest
rate and prepayment risk. Although, as stated, no assurances can be given that
these hedges will be effective.
Although mortgage-backed and related securities often carry lower yields
than traditional mortgage loans, such securities generally increase the quality
of the Company's assets by virtue of the securities' underlying
- 16 -
17
insurance or guarantees, are more liquid than individual mortgage loans (which
enhances the Company's ability to actively manage its portfolio) and may be used
to collateralize borrowings or other obligations of the Company. At June 30,
2001, $47.5 million or 87.1% of the Company's mortgage-backed and related
securities were pledged to secure various obligations of the Company (such as
reverse repurchase agreements and interest rate swaps). In addition, in relation
to the Company maintaining a substantial portion of its assets in
mortgage-backed and related securities, the Company has been able to maintain a
relatively low level of operating expenses. Furthermore, mortgage-backed
derivative securities are often utilized by the Company to internally hedge its
interest rate exposure and can be attractive alternatives to other hedge
vehicles when their option-adjusted spreads are abnormally wide.
- 17 -
18
The following table sets forth information relating to the amortized
cost and fair value of the Company's securities held for trading, securities
available for sale, and securities held to maturity portfolios.
JUNE 30,
----------------------------------------------------------------------
2001 2000 1999
--------------------- --------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
(DOLLARS IN THOUSANDS)
Securities held for trading:
FHLMC participation certificates $ 488 $ 468 $ 14,921 $ 14,378 $ 69,114 $ 67,850
FNMA participation certificates 642 630 8,830 8,462 28,034 27,599
GNMA participation certificates 1,423 1,389 24,662 24,531 37,986 38,116
Commercial participation certificates - - - - 34,896 33,808
Non-agency participation certificates - - - - - -
--------- --------- --------- --------- --------- ---------
Total mortgage-backed securities $ 2,553 $ 2,487 $ 48,413 $ 47,371 $ 170,030 $ 167,373
--------- --------- --------- --------- --------- ---------
Collateralized mortgage obligation $ 370 $ 403 5,609 5,586 10,738 11,069
Residuals 95 117 139 179 205 226
Interest-only strips 555 147 631 257 818 377
Principal only strips 241 334 306 392 403 506
--------- --------- --------- --------- --------- ---------
Total mortgage-backed derivative securities $ 1,261 $ 1,001 $ 6,685 $ 6,414 $ 12,164 $ 12,178
--------- --------- --------- --------- --------- ---------
Interest rate swaps - - - $ (18) - $ (175)
Interest rate collar $ 2 $ 7 $ 3 2 $ 4 4
Interest rate caps - - - - 1,744 587
Interest rate floors - - - - 3,821 4,382
Options - - 181 113 298 328
Futures - - - (41) - (1,611)
--------- --------- --------- --------- --------- ---------
Total interest rate contracts $ 2 $ 7 $ 184 $ 56 $ 5,867 $ 3,515
--------- --------- --------- --------- --------- ---------
Equity securities - - 6 11 69 134
--------- --------- --------- --------- --------- ---------
Total securities held for trading $ 3,816 $ 3,495 $ 55,288 $ 53,852 $ 188,130 $ 183,200
========= ========= ========= ========= ========= =========
Securities available for sale:
FHLMC certificates $ 8,596 $ 8,789 $ - $ - $ - $ -
FNMA certificates 11,506 11,913
GNMA certificates 29,692 30,059 63,806 63,321 - -
Commercial mortgage backed securities - - 353 353 - -
Non-agency participation certificates 212 278 336 378 461 502
--------- --------- --------- --------- --------- ---------
Total mortgage-backed securities 50,006 51,039 64,495 64,052 461 502
--------- --------- --------- --------- --------- ---------
Municipal bonds - - - - - -
--------- --------- --------- --------- --------- ---------
Total securities available for sale $ 50,006 $ 51,039 $ 64,495 $ 64,052 $ 461 $ 502
========= ========= ========= ========= ========= =========
Securities held to maturity:
Mortgage-backed securities $ 3,821 $ 3,835 $ - $ -
FNMA-stock 1 5 - -
Mortgage revenue bonds $ 27 $ 27 35 35 - -
--------- --------- --------- --------- --------- ---------
Total securities held to maturity $ 27 $ 27 $ 3,857 $ 3,875 $ - $ -
========= ========= ========= ========= ========= =========
- 18 -
19
The following table sets forth the fair value of the Company's securities
activities for the periods indicated:
AT OR FOR THE YEARS ENDED JUNE 30,
----------------------------------
2001 2000 1999
(DOLLARS IN THOUSANDS)
Beginning balance $ 121,775 $ 183,702 $ 291,531
--------- --------- ---------
Mortgage-backed securities purchased-held for trading - 319,196 776,200
Mortgage-backed derivative securities purchased-held for trading - - 1,777
Interest rate contracts purchased-held for trading - 138 2,283
Mortgage backed securities purchased - available for sale 61,280 74,407 -
--------- --------- ---------
Total securities purchased 61,280 393,741 780,260
--------- --------- ---------
Less:
Sale of mortgage-backed securities-held for trading 49,400 434,847 830,228
Sale of mortgage-backed derivative securities-held for trading - - 1,720
Sale of mortgage-backed securities-available for sale 67,309 - -
Sale of equity securities - held for trading 6 64 30
--------- --------- ---------
Total securities sold 116,715 434,911 831,978
--------- --------- ---------
Less proceeds from maturities of securities 17,128 17,935 51,865
Realized gain (loss) on sale of securities held for trading 2,742 (4,498) 4,755
Unrealized gain (loss) on securities held for trading 1,115 3,494 (6,402)
Change in net unrealized gain (loss) on securities available for sale 1,459 (484) 25
Amortization of (premium)/discount 33 (1,334) (2,624)
--------- --------- ---------
Ending balance $ 54,561 $ 121,775 $ 183,702
========= ========= =========
At June 30, 2001, the contractual maturity of substantially all of the
Company's mortgage-backed or related securities was in excess of ten years. The
actual maturity of a mortgage-backed or related security is usually less than
its stated maturity due to prepayments of the underlying mortgages. Prepayments
that are faster than anticipated may shorten the life of the security and affect
its yield to maturity. The yield to maturity is based upon the interest income
and the amortization of any premium or discount related to the security. In
accordance with generally accepted accounting principles, premiums and discounts
are amortized over the estimated lives of the loans, which decrease and increase
interest income, respectively. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed or related security, and these assumptions are
reviewed periodically to reflect actual prepayments. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages and the related security. At June 30, 2001, of the $54.5 million of
mortgage-backed and related securities held by the Company, an aggregate of
$22.7 million were secured by fixed-rate mortgage loans and an aggregate of
$31.8 million were secured by adjustable-rate mortgage loans.
OTHER SECURITIES. Other securities owned by the Company at June 30, 2001
includes an interest rate collar. At June 30, 2001, the carrying value of the
Company's interest rate collar amounted to $7,000. See Note 2 to the Notes to
Consolidated Financial Statements.
- 19 -
20
SOURCES OF FUNDS
GENERAL. The Company will consider various sources of funds to fund its
investing and lending activities and evaluates the available sources of funds in
order to reduce the Company's overall funding costs. Deposits, securities sold
under agreements to repurchase, advances from the Federal Home Loan Bank
("FHLB") of Indianapolis, notes payable, and sales, maturities and principal
repayments on loans and securities have been the major sources of funds for use
in the Company's lending and investing activities, and for other general
business purposes. Management of the Company closely monitors rates and terms of
competing sources of funds on a daily basis and utilizes the source which it
believes to be cost effective.
DEPOSITS. The Bank attempts to price its deposits in order to promote
deposit growth and offers a wide array of deposit products in order to satisfy
its customers' needs. The Bank's current deposit products include statement
savings accounts, negotiable order of withdrawal ("NOW") and demand deposit
accounts ("DDA"), money market deposit accounts, fixed-rate, fixed-maturity
retail certificates of deposit ranging in terms from seven days to ten years,
individual retirement accounts, and non-retail certificates of deposit
consisting of jumbo (generally greater than $95,000) certificates, inverse
variable-rate certificates and brokered certificates of deposit.
The Bank's retail deposits are generally obtained from residents in its
primary market area. The principal methods currently used by the Bank to attract
deposit accounts include offering a wide variety of value-added products and
services and competitive interest rates. The Bank utilizes traditional marketing
methods to attract new customers and savings deposits, including various forms
of advertising. Management estimates that as of June 30, 2001, non-retail
deposit accounts totaled $36.4 million or 11.3% of the Bank's total deposits.
These non-retail deposits consist largely of jumbo certificates of deposit and
inverse variable-rate certificates (which are obtained through brokers). The
Bank's jumbo certificates of deposit and other deposits are also obtained
through the posting of deposit rates on national computerized bulletin boards at
no cost to the Bank. The Bank's inverse variable-rate certificates carry rates
which fluctuate inversely with respect to the three-month LIBOR rate. For
example, if LIBOR rates of interest increase, the rates on the inverse
variable-rate certificates would decrease, while if market rates of interest
decrease, the rates on the inverse variable-rate certificates would increase. As
a result, the Bank would generally be paying a higher rate on such certificates
during a declining interest rate environment. The Bank offers inverse
variable-rate certificates when they represent a lower cost source of funds to
comparable duration funding sources. Retail deposits decreased $47.5 million,
from $334.4 million at June 30, 2000 to $286.9 million at June 30, 2001,
primarily due to the sale of $43.5 million of deposits related to the sale of
the Bank's two southern Indianapolis branches.
- 20 -
21
The following table shows the distribution of and certain other
information relating to the Bank's deposits by type as of the dates indicated.
JUNE 30,
-------------------------------------------------------------------------------
2001 2000 1999
----------------------- ------------------------- ----------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS
(DOLLARS IN THOUSANDS)
Transaction accounts:
NOW and DDA $ 40,431 12.5 % $ 37,879 10.5 % $ 16,911 5.1 %
Savings accounts 40,158 12.4 35,646 9.9 33,163 10.0
Money market deposit accounts 47,386 14.7 62,159 17.2 137,463 41.2
---------- ---------- ---------- ---------- ---------- ----------
Total transaction accounts $ 127,975 39.6 % $ 135,684 37.6 % $ 187,537 56.3 %
---------- ---------- ---------- ---------- ---------- ----------
Certificates of deposit:
Within 1 year $ 158,350 49.0 % $ 162,795 45.0 % $ 126,592 38.0 %
1-2 years 18,132 5.6 37,936 10.5 9,543 2.9
2-3 years 5,965 1.8 11,586 3.2 4,730 1.4
3-4 years 10,645 3.3 2,431 0.7 2,867 0.8
Over 4 years 2,257 0.7 10,809 3.0 1,976 0.6
---------- ---------- ---------- ---------- ---------- ----------
Total certificate accounts $ 195,349 60.4 % $ 225,557 62.4 % $ 145,708 43.7 %
---------- ---------- ---------- ---------- ---------- ----------
Total deposits $ 323,324 100.0 % $ 361,241 100.0 % $ 333,245 100.0 %
========== ========== ========== ========== ========== ==========
The following table shows the distribution of and certain other
information relating to the Bank's certificates of deposit as of the dates
indicated.
JUNE 30,
---------------------------------------------------------------------
2001 2000 1999
--------------------- ---------------------- ----------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS
(DOLLARS IN THOUSANDS)
Total retail certificates $158,554 49.0 % $198,367 54.9 % $134,027 40.2 %
-------- ------ -------- ------ -------- -----
Non-retail certificates:
Jumbo certificates 33,705 10.4 23,368 6.5 7,440 2.2
Inverse variable-rate certificates 1,939 0.6 2,706 0.7 2,907 0.9
Non-brokered out-of-state deposits 1,151 0.4 1,116 0.3 1,334 0.4
-------- ------ -------- ------ -------- -----
Total non-retail certificates (1) $ 36,795 11.4 % $ 27,190 7.5 % $ 11,681 3.5 %
-------- ------ -------- ------ -------- -----
Total certificates of deposit $195,349 60.4 % $225,557 62.4 % $145,708 43.7 %
======== ====== ======== ====== ======== =====
(1) Of the Company's $36.8 million of non-retail certificates as of June 30,
2001, $33.4 million was scheduled to mature in six months or less, $1.9
million was scheduled to mature in 7-12 months, $1.5 million was
scheduled to mature in 13-36 months and $47,000 was scheduled to mature
in over 36 months.
- 21 -
22
The following table presents the average balance of each deposit type
and the average rate paid on each deposit type for the periods indicated.
YEAR ENDED JUNE 30,
-------------------------------------------------------------------
2001 2000 1999
------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID
(DOLLARS IN THOUSANDS)
NOW and DDA accounts $ 20,781 5.7 % $ 31,090 3.3 % $ 13,050 2.3 %
Savings accounts 32,007 4.3 33,291 4.1 30,520 4.2
Money market deposit accounts 63,562 3.6 105,441 4.9 73,256 4.8
Certificates of deposit 209,607 6.3 186,308 5.7 156,262 5.7
-------- ----- -------- ----- -------- -----
Total deposit $325,957 5.5 % $356,130 5.1 % $273,088 5.2 %
======== ===== ======== ===== ======== =====
The following table sets forth the deposit account activities of the
Bank during the periods indicated.
YEAR ENDED JUNE 30,
--------------------------------------
2001 2000 1999
(DOLLARS IN THOUSANDS)
Deposits $ 307,920 $ 292,808 $ 878,151
Withdrawals 321,562 283,014 742,612
Deposits sold as part of branch sale 43,524 - -
--------- --------- ---------
Net increase (decrease) before interest credited (57,166) 9,794 135,539
Interest credited 19,249 18,202 19,395
--------- --------- ---------
Deposit activity $ (37,917) $ 27,996 $ 154,934
========= ========= =========
The following table shows the interest rate and maturity information for
the Bank's certificates of deposit at June 30, 2001.
MATURITY DATE
----------------------------------------------
ONE YEAR OVER
OR LESS 1-2 YEARS 2-3 YEARS 3 YEARS TOTAL
(DOLLARS IN THOUSANDS)
INTEREST RATE
3.00% or less $ 586 $ 340 $ - $ 3 $ 929
3.01 - 5.00% 64,712 1,542 548 322 67,124
5.01 - 7.00% 88,482 15,077 5,221 10,947 119,727
7.01 - 9.00% 3,599 1,173 196 1,630 6,598
9.01% or greater 971 - - - 971
-------- -------- -------- -------- --------
Total $158,350 $ 18,132 $ 5,965 $ 12,902 $195,349
======== ======== ======== ======== ========
The following table sets forth the maturities of the Bank's certificates
of deposit having principal amounts of $100,000 or more at June 30, 2001.
AMOUNT
(IN THOUSANDS)
CERTIFICATES OF DEPOSIT MATURING IN QUARTER ENDING:
September 30, 2001 $ 45,011
December 31, 2001 7,018
March 31, 2002 2,845
After March 31, 2002 7,684
------------
Total certificates of deposit with balances of $100,000 or more $ 62,558
============
- 22 -
23
BORROWINGS. The following table sets forth certain information regarding
the borrowings of the Company at or for the dates indicated.
AT OR FOR THE YEAR ENDED JUNE 30,
---------------------------------------
2001 2000 1999
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding $ 22,554 $ 15,540 $ 36,172
Maximum amount outstanding at any month-end during the period $ 51,000 $ 40,000 $ 40,000
Balance outstanding at end of period $ 11,000 $ 7,000 $ 40,000
Average interest rate during the period 6.0 % 7.7 % 6.9 %
Average interest rate at end of period 5.5 % 6.9 % 4.9 %
Securities sold under agreements to repurchase:
Average balance outstanding $ 52,767 $ 52,466 $213,428
Maximum amount outstanding at any month-end during the period $ 63,735 $102,953 $334,160
Balance outstanding at end of period $ 35,675 $ 28,038 $ 60,198
Average interest rate during the period 5.8 % 5.4 % 5.4 %
Average interest rate at end of period 3.7 % 6.3 % 4.9 %
The Company obtains both fixed-rate and variable-rate long-term and
short-term advances from the FHLB of Indianapolis upon the security of certain
of its residential first mortgage loans and other assets, provided certain
standards related to creditworthiness of the Bank have been met. FHLB of
Indianapolis advances are available for general business purposes to expand
lending and investing activities. Borrowings have generally been used to fund
the purchase of mortgage-backed and related securities or lending activities and
have been collateralized with specific mortgages pledged as collateral.
Advances from the FHLB of Indianapolis are made pursuant to several
different credit programs, each of which has its own interest rate and range of
maturities. At June 30, 2001 and 2000, the Company had advances with the FHLB of
Indianapolis in the amount of $11.0 million at a weighted average interest rate
of 5.5% and $7.0 million at a weighted average interest rate of 6.9%,
respectively.
The Company also obtains funds from the sales of securities to
investment dealers under agreements to repurchase ("reverse repurchase
agreements"). In a reverse repurchase agreement transaction, the Company will
generally sell a mortgage-backed security agreeing to repurchase either the same
or a substantially identical security (i.e., "dollar rolls") on a specified
later date (generally not more than 90 days) at a price that is generally less
than the original sales price. The difference in the sale price and purchase
price is the spread between the mortgage cash flows and the implied financing
rate. The mortgage-backed securities underlying the agreements are delivered to
the dealers who arrange the transactions. For agreements in which the Company
has agreed to repurchase substantially identical securities, the dealers may
sell, loan or otherwise dispose of the Company's securities in the normal course
of their operations; however, such dealers or third party custodians safe-keep
the securities which are to be specifically repurchased by the Company. Reverse
repurchase agreements represent a competitive cost funding source for the
Company. Nevertheless, the Company is subject to the risk that the lender may
default at maturity and not return the collateral. The amount at risk is the
value of the collateral which exceeds the balance of the borrowing. In order to
minimize this potential risk, the Company normally deals with large, established
investment brokerage firms when entering into these transactions. Reverse
repurchase transactions are accounted for as financing arrangements rather than
as sales of such securities, and the obligation to repurchase such securities is
reflected as a liability in the Consolidated Financial Statements.
At June 30, 2001, the Company maintained a $12,995,000 term loan from
Firstar Bank N.A. Overland Park (formerly Mercantile Bancorporation, Inc. and
Mark Twain Bank) of which $12,995,000 was outstanding as of June 30, 2001. The
loan facility matures in September 2001 and carries an interest rate equal to
the prime rate published in the Wall Street Journal. The loan facility requires
quarterly interest-only repayments with the unpaid
- 23 -
24
principal balance outstanding payable in full at maturity. The loan facility is
secured by: (1) a general pledge agreement between the parties pursuant to which
the Company has pledged 100% of the outstanding stock of the Bank; (2) a
security agreement between the parties pursuant to which the Company has
provided a blanket security interest in all of its assets; and (3) the
assignment of life insurance policies on Messrs. Breeden and Cerny by the
Company in the aggregate amount of $1.25 million. At June 30, 2000, the total
balance of the loan facility was $12,995,000 million.
SUBSIDIARIES
In February 1999, the Bank formed Harrington Wealth Management Company
("HWM"), which provides trust, investment management, and custody services for
individuals and institutions. HWM is a strategic alliance between the Bank (51%
owner) and Los Padres Bank (49% owner), a federally chartered savings bank
located in California. HWM is an operating subsidiary of the Bank and, as such,
is restricted to engage in activities that the Bank can engage in directly. As
of June 30, 2001, HWM administered 220 trust/fiduciary accounts, with aggregate
assets of approximately $70.4 million at such date, a portion of which were
formerly administered by Harrington Investment Management and Trust Services, a
separate division of the Bank. The Bank's investment in HWM is not material to
its operations or financial condition. The accompanying consolidated balance
sheet includes 100 percent of the assets and liabilities of HWM, and the
ownership of Los Padres Bank is recorded as "Minority interest." The results of
operations include 100 percent of the revenues and expenses of HWM from the date
of formation, and the ownership of Los Padres Bank is recorded as "Minority
interest" net of income taxes. See Note 1 to the Notes to Consolidated Financial
Statements.
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or secured or unsecured loans to, service corporations, with an
additional investment of 1% of assets when such additional investments is
utilized primarily for community development purposes. The Bank's only service
corporation, Pine Tree Mortgage Corp., is an inactive corporation formed in 1987
to originate mortgage loans in North Carolina and has conducted no business
since 1988. The Bank's investment in the service corporation is not material to
its operations or financial condition.
SUPERVISION AND REGULATION
Set forth below is a brief description of those laws and regulations
which, together with the descriptions of laws and regulations contained
elsewhere herein, are deemed material to an investor's understanding of the
extent to which the Company and the Bank are regulated. The description of the
laws and regulations hereunder, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is qualified in
its entirety by reference to applicable laws and regulations. Certain federal
banking laws have been recently amended. See "Supervision and Regulation-The
Company-Financial Modernization."
THE COMPANY
GENERAL. The Company is a registered savings and loan holding company
within the meaning of the Home Owners' Loan Act ("HOLA"), and is subject to OTS
regulations, examinations, supervision and reporting requirements. The Company
is further subject to various reporting and other requirements of the Securities
and Exchange Commission ("SEC"). The Bank, as a federally chartered savings
bank, is subject to comprehensive regulation and examination by the OTS, as its
chartering authority and primary regulator, and by the FDIC, which administers
the Savings Association Insurance Fund ("SAIF"), which insures the Bank's
deposits to the maximum extent permitted by law. The Bank is a member of the
FHLB of Indianapolis, which is one of the twelve regional banks that comprise
the FHLB System. The Bank is further subject to regulations of the Board of
Governors of the Federal Reserve System ("Federal Reserve Board") governing
reserves required to be maintained against deposits and certain other matters.
As a subsidiary of a savings and loan holding company, the Bank is subject to
certain restrictions in its dealings with the Company and affiliates thereof.
ACTIVITIES RESTRICTIONS. Although there are generally no restrictions on
the activities of a savings and loan holding company which controls only one
subsidiary savings institution on or before May 4, 1999 under applicable OTS
regulations, the Company may be considered to be a multiple savings and loan
holding company because principals and affiliates of Smith Breeden may be deemed
for regulatory purposes to control both the Company and
- 24 -
25
Harrington West Financial Group, a savings and loan holding company which owns
all of the outstanding common stock of Los Padres Savings Bank, F.S.B., Los
Padres, California.
As a general rule, multiple savings and loan holding companies are
subject to restrictions which do not apply to unitary savings and loan holding
companies. They could not commence or continue any business activity other than:
(1) those permitted for a bank holding company under section 4(c) of the Bank
Holding Company Act (unless the Director of the OTS by regulation prohibits or
limits such 4(c) activities); (2) furnishing or performing management services
for a subsidiary savings institution; (3) conducting an insurance agency or
escrow business; (4) holding, managing, or liquidating assets owned by or
acquired from a subsidiary savings institution; (5) holding or managing
properties used or occupied by a subsidiary savings institution; (6) acting as
trustee under deeds of trust; or (7) engaging in those activities authorized by
regulation as of March 5, 1987 to be permissible for multiple savings and loan
holding companies. The Company does not believe that if the OTS designates it as
a multiple thrift holding company, such a designation will limit its ability to
conduct its normal business operations.
In addition, if the Director of the OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings institution, the Director may
impose such restrictions as deemed necessary to address such risk, including
limiting (1) payment of dividends by the savings institution; (2) transactions
between the savings institution and its affiliates; and (3) any activities of
the savings institution that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
institution.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between
savings institutions and any affiliate are governed by Section 11 of the HOLA
and Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings
institution is any company or entity which controls, is controlled by or is
under common control with the savings institution. In a holding company context,
the parent holding company of a savings institution (such as the Company) and
any companies which are controlled by such parent holding company are affiliates
of the savings institution. Generally, Sections 23A and 23B (1) limit the extent
to which the savings institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (2) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, Section 11 of the HOLA prohibits a savings institution from (1)
making a loan or other extension of credit to an affiliate, except for any
affiliate which engages only in certain activities which are permissible for
bank holding companies, or (2) purchasing or investing in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons unless the loans are made pursuant to a benefit or compensation program
that (1) is widely available to employees of the institution and (2) does not
give preference to any director, executive officer or principal stockholder, or
certain affiliated interests of either, over other employees of the savings
institution. Section 22(h) also requires prior board approval for certain loans.
In addition, the aggregate amount of extensions of credit by a savings
institution to all insiders cannot exceed the institution's unimpaired capital
and surplus. Furthermore, Section 22(g) places additional restrictions on loans
to executive officers. At June 30, 2001, the Bank was in compliance with the
above restrictions.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (1) control of any other savings
institution or savings and loan holding company or substantially all the assets
thereof or (2) more than 5% of the
- 25 -
26
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Except with the prior approval of the Director of the OTS, no
director or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
acquire control of any savings institution, other than a subsidiary savings
institution, or of any other savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if (1) the multiple savings and loan holding
company involved controls a savings institution which operated a home or branch
office located in the state of the institution to be acquired as of March 5,
1987; (2) the acquirer is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (3) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by the state-chartered institutions or savings and loan holding
companies located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered savings institutions).
Under the Bank Holding Company Act of 1956, the Federal Reserve Board is
authorized to approve an application by a bank holding company to acquire
control of a savings institution. In addition, a bank holding company that
controls a savings institution may merge or consolidate the assets and
liabilities of the savings institution with, or transfer assets and liabilities
to, any subsidiary bank which is a member of the BIF with the approval of the
appropriate federal banking agency and the Federal Reserve Board. As a result of
these provisions, there have been a number of acquisitions of savings
institutions by bank holding companies in recent years.
FINANCIAL MODERNIZATION. Under the Gramm-Leach-Bliley Act enacted into
law on November 12, 1999, no company may acquire control of a savings and loan
holding company after May 4, 1999, unless the company is engaged only in
activities traditionally permitted to a multiple savings and loan holding
company or newly permitted to a financial holding company under Section 4(k) of
the Bank Holding Company Act. Existing savings and loan holding companies and
those formed pursuant to an application filed with the OTS before May 4, 1999,
may engage in any activity including non-financial or commercial activities
provided such companies control only one savings and loan association that meets
the Qualified Thrift Lender test. Corporate reorganizations are permitted, but
the transfer of grandfathered unitary thrift holding company status through
acquisition is not permitted.
THE BANK
GENERAL. The OTS has extensive authority over the operations of
federally chartered savings institutions. As part of this authority, savings
institutions are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The last regulatory examination of the Bank
by the OTS was conducted beginning on April 9, 2001. The Bank was not required
to make any material changes to its operations as a result of such examination.
The investment and lending authority of savings institutions are prescribed by
federal laws and regulations, and such institutions are prohibited from engaging
in any activities not permitted by such laws and regulations. Those laws and
regulations generally are applicable to all federally chartered savings
institutions and may also apply to state-chartered savings institutions. Such
regulation and supervision is primarily intended for the protection of
depositors.
The OTS' enforcement authority over all savings institutions and their
holding companies includes, among other things, the ability to assess civil
money 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. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
INSURANCE OF ACCOUNTS. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U.S. Government. As insurer, the FDIC
is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings institutions, after giving the OTS an
opportunity to take such action.
- 26 -
27
Both the SAIF and Bank Insurance Fund ("BIF") are statutorily required
to be capitalized to a ratio of 1.25% of insured reserve deposits. The BIF met
its required capitalization levels in 1995 and, as a result, most BIF insured
banks have been paying significantly lower premiums than SAIF institutions. The
legislation enacted by the U.S. Congress, which was signed by the President on
September 30, 1996, has recapitalized the SAIF by a one-time charge of $0.657
for each $100 of assessable deposits held at March 31, 1995.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices or is in
an unsafe or unsound condition to continue operations, or if the insured
depository institution or any of its directors or trustees have violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. OTS capital regulations require savings
institutions to satisfy minimum capital standards: risk-based capital
requirements, a leverage requirement and a tangible capital requirement. Savings
institutions must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require
savings institutions to maintain capital above the minimum capital levels.
All savings institutions are required to meet a minimum risk-based
capital requirement of total capital (core capital plus supplementary capital)
equal to 8% of risk-weighted assets (which includes the credit risk equivalents
of certain off-balance sheet items). In calculating total capital for purposes
of the risk-based requirement, supplementary capital may not exceed 100% of core
capital. A savings institution is also required to maintain tangible capital in
an amount at least equal to 1.5% of its adjusted total assets.
In March 1999, the federal banking agencies amended their risk-based and
leverage capital standards to make uniform their regulations. In particular, the
agencies made risk-based capital treatments for construction loans on pre-sold
residential properties, real estate loans secured by junior liens on 1-to
4-family residential properties, and investments in mutual funds consistent
among the agencies, and simplified and made uniform the agencies' Tier 1
leverage capital standards. The most highly-rated institutions must maintain a
minimum Tier 1 leverage ratio of 3.0 percent, with all other institutions
required to maintain a minimum leverage ratio of 4.0 percent. (In addition,
under the prompt corrective action provisions of the OTS regulations, all but
the most highly-rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately capitalized. See "--Prompt Corrective Action.") The
OTS regulations now state that higher-than-minimum capital levels may be
required if warranted, and that institutions should maintain capital levels
consistent with their risk exposures.
The OTS regulations provide that minimum capital levels higher than
those provided in the regulations may be established by the OTS for individual
savings institutions, upon a determination that the savings institution's
capital is or may become inadequate in view of its circumstances. The OTS
regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings institution has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings institution is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
institution may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings institutions with
which it has significant business relationships. The Bank is not subject to any
such individual minimum regulatory capital requirement.
Any savings institution that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on the institution's operations
(including growth), termination of federal deposit insurance and the appointment
of a conservator or receiver. The OTS' capital regulation provides that such
actions, through enforcement proceedings or otherwise, could require one or more
of a variety of corrective actions.
- 27 -
28
PROMPT CORRECTIVE ACTION. Under Section 38 of the Federal Deposit
Insurance Act ("FDIA"), each federal banking agency was required to implement a
system of prompt corrective action for institutions which it regulates. The
federal banking agencies, including the OTS, adopted substantially similar
regulations to implement Section 38 of the FDIA, effective as of December 19,
1992. Under the regulations, an institution is deemed to be (1) "well
capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1
risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of
5.0% or more and is not subject to any order or final capital directive to meet
and maintain a specific capital level for any capital measure, (2) "adequately
capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier
1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio
of 4.0% or more (3.0% under certain circumstances) and does not meet the
definition of "well capitalized," (3) "undercapitalized" if it has a total
risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital
ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less
than 4.0% (3.0% under certain circumstances), (4) "significantly
undercapitalized" if it has a total risk-based capital ratio that is less than
6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1
leverage capital ratio that is less than 3.0% and (5) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Section 38 of the FDIA and the regulations
promulgated thereunder also specify circumstances under which a federal banking
agency may reclassify a well capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category (except that the FDIC may not reclassify a significantly
undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. A federal banking agency must provide the
institution with written notice of approval or disapproval within 60 days after
receiving a capital restoration plan, subject to extensions by the agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that controls
the institution. Such guaranty shall be limited to the lesser of (1) an amount
equal to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (2) the amount
necessary to restore the relevant capital measures of the institution to the
levels required for the institution to be classified as adequately capitalized.
Such a guarantee shall expire after the federal banking agency notifies the
institution that it has remained adequately capitalized for each of four
consecutive calendar quarters. An institution which fails to submit a written
capital restoration plan within the requisite period, including any required
performance guarantee(s), or fails in any material respect to implement a
capital restoration plan, shall be subject to the restrictions in Section 38 of
the FDIA which are applicable to significantly undercapitalized institutions.
Immediately upon becoming undercapitalized, an institution shall become
subject to the provisions of Section 38 of the FDIA (1) restricting payment of
capital distributions and management fees, (2) requiring that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital, (3) requiring submission of a capital restoration plan,
(4) restricting the growth of the institution's assets and (5) requiring prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject in certain cases to
specified procedures. These discretionary supervisory actions include requiring
the institution to raise additional capital; restricting transactions with
affiliates; restricting interest rates paid by the institution on deposits;
requiring replacement of senior executive officers and directors; restricting
the activities of the institution and its affiliates; requiring divestiture of
the institution or the sale of the institution to a willing purchaser; and any
other supervisory action that the agency deems appropriate. These and additional
mandatory and permissive supervisory actions may be taken with respect to
significantly undercapitalized and critically undercapitalized institutions.
At June 30, 2001, the Bank was deemed a "well capitalized" institution
for purposes of the above regulations and as such was not subject to the above
mentioned restrictions.
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29
LIQUIDITY REQUIREMENTS. For years prior to the year ended June 30, 2001
the Bank was required under applicable federal regulations to maintain specified
levels of "liquid" investments as defined by the OTS. As of November 24, 1997,
the required level of such liquid investments was changed from 5% to 4% of
certain liabilities as defined by the OTS. In addition to the change in the
percentage of required level of liquid assets, the OTS also modified its
definition of investments that are considered liquid. As a result of this
change, the level of assets eligible for regulatory liquidity calculations
increased considerably. This requirement was eliminated during the year ended
June 30, 2001. At June 30, 2001, the Bank's "liquid" assets totaled
approximately $25.1 million.
CAPITAL DISTRIBUTIONS. OTS regulations govern capital distributions by
savings institutions, which include cash dividends, stock redemptions or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other transactions charged to the capital account of a savings institution to
make capital distributions.
In January 1999, the OTS amended its capital distribution regulation to
bring such regulations into greater conformity with the other bank regulatory
agencies. Under the regulation, certain savings institutions would not be
required to file with the OTS. Specifically, savings institutions that would be
well capitalized following a capital distribution would not be subject to any
requirement for notice or application unless the total amount of all capital
distributions, including any proposed capital distribution, for the applicable
calendar year would exceed an amount equal to the savings institution's net
income for that year to date plus the savings institution's retained net income
for the preceding two years. Because the Bank is a subsidiary of the Company,
the regulation, however, would require the Bank to provide notice to the OTS of
its intent to make a capital distribution, unless an application is otherwise
required. The Bank does not believe that the regulation will adversely affect
its ability to make capital distributions.
LOANS TO ONE BORROWER. The permissible amount of loans-to-one borrower
now generally follows the national bank standard for all loans made by savings
institutions, as compared to the pre-FIRREA rule that applied that standard only
to commercial loans made by federally chartered savings institutions. The
national bank standard generally does not permit loans-to-one borrower to exceed
15% of unimpaired capital and unimpaired surplus. Loans in an amount equal to an
additional 10% of unimpaired capital and unimpaired surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. If a
savings institution's aggregate lending limitation is less than $500,000, then,
notwithstanding the aforementioned aggregate limitation, such savings
institution may have total loans and extensions of credit, for any purpose, to
one borrower outstanding at one time not to exceed $500,000. For information
about the largest borrowers from the Bank, see "- Lending Activities."
BRANCHING BY FEDERAL SAVINGS INSTITUTIONS. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if, among
other things, the law of the state where the branch would be located would
permit the branch to be established if the federal savings institution were
chartered by the state in which its home office is located. Furthermore, the OTS
will evaluate a branching applicant's record of compliance with the Community
Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis
for denial of a branching application.
QUALIFIED THRIFT LENDER TEST. All savings institutions are required to
meet a QTL test to avoid certain restrictions on their operations. Under Section
2303 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, a
savings association can comply with the QTL test by either meeting the QTL test
set forth in the HOLA and implementing regulations or qualifying as a domestic
building and loan association as defined in Section 7701(a)(19) of the Internal
Revenue Code of 1986, as amended ("Code"). The QTL test set forth in the HOLA
requires a thrift institution to maintain 65% of portfolio assets in Qualified
Thrift Investments ("QTIs"). Portfolio assets are defined as total assets less
intangibles, property used by a savings institution in its business and
liquidity investments in an amount not exceeding 20% of assets. Generally, QTIs
are residential housing related assets. At June 30, 2001, the qualified thrift
investments of the Bank were approximately 70.6% of its portfolio assets.
A savings institution that does not meet the QTL test must either
convert to a bank charter or comply with the following restrictions on its
operations: (1) the institution may not engage in any new activity or make any
new investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (2) the
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30
branching powers of the institution shall be restricted to those of a national
bank; (3) the institution shall not be eligible to obtain any advances from its
FHLB; and (4) payment of dividends by the institution shall be subject to the
rules regarding payment of dividends by a national bank. Upon the expiration of
three years from the date the savings institution ceases to be a QTL, it must
cease any activity and not retain any investment not permissible for a national
bank and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations).
ACCOUNTING REQUIREMENTS. Applicable OTS accounting regulations and
reporting requirements apply the following standards: (1) regulatory reports
will incorporate generally accepted accounting principles ("GAAP") when GAAP is
used by federal banking agencies; (2) savings institution transactions,
financial condition and regulatory capital must be reported and disclosed in
accordance with OTS regulatory reporting requirements that will be at least as
stringent as for national banks; and (3) the Director of the OTS may prescribe
regulatory reporting requirements more stringent than GAAP whenever the Director
determines that such requirements are necessary to ensure the safe and sound
reporting and operation of savings institutions.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of
Indianapolis, which is one of 12 regional FHLBs that administers the home
financing credit function of savings institutions. 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. At
June 30, 2001, the Company had a $11.0 million FHLB advance. See "- Sources of
Funds - Borrowings."
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Indianapolis in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year. At June 30, 2001, the Bank had $4.9 million in FHLB
stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid in the past and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all
depository institutions to maintain reserves against their transaction accounts
(primarily NOW and Super NOW checking accounts) and non-personal time deposits.
As of June 30, 2001, the Bank was in compliance with this requirement. Because
required reserves must be maintained in the form of vault cash or a non-interest
bearing account at a Federal Reserve Bank, the effect of this reserve
requirement is to reduce an institution's earning assets.
FEDERAL TAXATION
GENERAL. The Company and Bank are subject to the generally applicable
corporate tax provisions of the Code, and Bank is subject to certain additional
provisions of the Code which apply to thrifts and other types of financial
institutions. The following discussion of federal taxation is intended only to
summarize certain pertinent federal income tax matters material to the taxation
of the Company and the Bank and is not a comprehensive discussion of the tax
rules applicable to the Company and Bank.
YEAR. The Company files a consolidated federal income tax return on the
basis of a fiscal year ending on June 30. The Company's federal income tax
returns for the tax years ended June 30, 1998 forward are open under the statute
of limitations and are subject to review by the IRS.
BAD DEBT RESERVES. Prior to the enactment, on August 20, 1996, of the
Small Business Job Protection Act of 1996 (the "Small Business Act"), for
federal income tax purposes, thrift institutions such as the Bank, which met
certain definitional tests primarily relating to their assets and the nature of
their business, were permitted to establish tax reserves for bad debts and to
make annual additions thereto, which additions could, within specified
limitations, be deducted in arriving at their taxable income. The Bank's
deduction with respect to "qualifying loans," which are
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31
generally loans secured by certain interest in real property, could be computed
using an amount based on a six-year moving average of the Bank's actual loss
experience (the "Experience Method"), or a percentage equal to 8.0% of the
Bank's taxable income (the "PTI Method"), computed without regard to this
deduction and with additional modifications and reduced by the amount of any
permitted addition to the non-qualifying reserve.
Under the Small Business Act, the PTI Method was repealed and the Bank
will be required to use the Experience Method of computing additions to its bad
debt reserve for taxable years beginning with the Bank's taxable year beginning
July 1, 1996. In addition, the Bank will be required to recapture (i.e., take
into taxable income) over a six-year period, beginning with the Bank's taxable
year beginning July 1, 1996, the excess of the balance of its bad debt reserves
(other than the supplemental reserve) as of June 30, 1996 over (a) the greater
of the balance of such reserves as of June 30, 1988 or (b) an amount that would
have been the balance of such reserves as of June 30, 1996 had the Bank always
computed the additions to its reserves using the Experience Method. However,
under the Small Business Act such recapture requirements will be suspended for
each of the two successive taxable years beginning July 1, 1996 in which the
Bank originates a minimum amount of certain residential loans during such years
that is not less than the average of the principal amounts of such loans made by
the Bank during its six taxable years preceding July 1, 1996. The Bank delayed
the timing of this recapture for taxable years 1998 and 1997 as certain
residential loan test requirements were met. The six year recovery period for
the excess reserves began in taxable year 1999.
STATE TAXATION
The State of Indiana imposes a franchise tax on the "adjusted gross
income" of financial institutions at a fixed rate of 8.5% per annum. This
franchise tax is imposed in lieu of the gross income tax, adjusted gross income
tax, and supplemental net income tax otherwise imposed on certain corporate
entities. "Adjusted gross income" is computed by making certain modifications to
an institution's federal taxable income. Tax-exempt interest, for example, is
included in the savings association's adjusted gross income and the bad debt
deduction is limited to actual charge-offs for purposes of the financial
institutions tax.
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32
ITEM 2. PROPERTIES
The Company's principal executive office is located at 722 East Main
Street, Richmond, Indiana, 47374. The following table sets forth certain
information with respect to the offices and other properties of the Bank at June
30, 2001.
NET BOOK VALUE
DESCRIPTION/ADDRESS LEASED/OWNED OF PROPERTY (1) DEPOSITS
----------------------------- --------------------- ---------------- --------------
(IN THOUSANDS)
Main Office Owned $ 1,490 $ 69,600
722 Main Street
Richmond, Indiana
Carmel Branch (2) Leased (3) 73 72,317
11592 Westfield Boulevard
Carmel, Indiana
Fishers Branch (4) Owned 830 23,457
7150 East 116th
Street
Fishers, Indiana
Noblesville Branch (5) Owned 776 24,293
107 West Logan
Street
Noblesville, Indiana
Geist Branch (6) Owned 882 15,714
9775 Fall Creek Road
Indianapolis,
Indiana
Shawnee Mission Branch (7) Leased (8) 112 72,156
6300 Nall Road
Shawnee Mission , Kansas
Chapel Hill Branch (9) Leased (10) 61 45,787
The Europa Center, Suite 271
Chapel Hill, North Carolina
Executive Offices Leased (11) 15 N/A
10801 Mastin Boulevard, Suite 740
Overland Park,
Kansas
--------------------------------
(1) Includes leasehold improvements.
(2) Branch opened in May 1994.
(3) The lease expires in June 2008 and may be extended for an additional ten
years provided that proper notice is timely given.
(4) Branch opened in December 1995.
(5) Branch opened in June 1997.
(6) Branch opened in December 1997
(7) Branch opened in August 1998.
(8) The lease expires in December 2010 and has four options for additional
terms of five years each.
(9) Branch opened in July 1999.
(10) The lease expires in July 2004.
(11) The lease expires in March 2004.
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ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings to which the Company is a party
or to which any of their property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Shares of the Company's common stock are traded nationally under the
symbol "HFGI" on the Nasdaq National Market. The following table sets forth the
high, low and closing sales prices for the common stock as reported by the
Nasdaq Stock Market, as well as the dividends paid, for fiscal years 2001 and
2000:
STOCK PRICE PER SHARE
---------------------------
HIGH LOW CLOSE DIVIDENDS
2001
First quarter $7.500 $6.000 $6.125 $0.03
Second quarter 7.000 5.500 5.938 0.03
Third quarter 8.500 5.625 8.000 0.03
Fourth quarter 12.500 6.600 12.100 0.03
2000
First quarter $8.000 $7.125 $7.500 $0.03
Second quarter 7.750 6.875 7.188 0.03
Third quarter 7.250 5.500 6.250 0.03
Fourth quarter 6.500 5.500 6.500 0.03
There have been no stock dividends, stock splits or reverse stock
splits. Payment of future dividends is subject to a declaration by the Company's
Board of Directors. Factors considered in determining the size of dividends are
the amount and stability of profits, adequacy of capitalization and expected
asset and liability growth of the Bank.
At September 20, 2001, the Company had approximately 49 stockholders of
record.
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ITEM 6. SELECTED FINANCIAL DATA.
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
The following table presents selected consolidated financial and other data of
the Company for the five years in the period ended June 30, 2001. The selected
consolidated financial data should be read in conjunction with the Consolidated
Financial Statements of the Company, including the accompanying Notes, presented
elsewhere herein.
-----------------------------------------------------------------------------------------------------------------------------------
AT OR FOR THE YEARS ENDED JUNE 30, 2001 2000 1999 1998 1997
-----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Securities held for trading and available for sale $ 54,534 $ 117,904 $ 183,702 $ 291,531 $ 318,480
Loans receivable-net 329,222 270,970 259,632 163,546 93,958
Total assets 408,040 435,192 471,339 446,797 446,797
Deposits 323,324 361,241 333,245 178,311 136,175
Core retail deposits 286,966 334,467 322,898 166,818 123,489
Securities sold under agreements to repurchase 35,675 28,038 60,198 240,396 245,571
Federal Home Loan Bank advances 11,000 7,000 40,000 26,000 26,000
Note payable 12,995 12,995 13,995 13,495 9,995
Stockholders' equity 18,726 16,257 19,139 22,664 24,994
Stockholders' equity per share 5.98 5.16 5.97 6.92 7.67
INCOME STATEMENT DATA
Interest income $ 33,459 $ 31,893 $ 35,204 $ 33,956 $ 34,474
Interest expense 23,673 23,522 29,123 29,032 26,408
--------- --------- --------- --------- ---------
Net interest income 9,786 8,371 6,081 4,924 8,066
Provision for loan losses 798 587 511 147 92
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 8,988 7,784 5,570 4,777 7,974
Retail banking fees and other income 903 772 433 295 239
--------- --------- --------- --------- ---------
Total net revenue 9,891 8,556 6,003 5,072 8,213
Operating expenses 8,870 9,627 8,500 6,460 5,444
--------- --------- --------- --------- ---------
Income (loss) before tax provision, gain (loss) on securities
and minority interest 1,021 (1,071) (2,497) (1,388) 2,769
--------- --------- --------- --------- ---------
Gain (loss) on sale of securities held for trading 2,742 (4,498) 4,755 (775) (1,623)
Unrealized gain (loss) on securities held for trading 1,346 3,494 (6,402) (930) 2,117
Gain (loss) on sale of loans and branch sale 1,424 (1,173)
--------- --------- --------- --------- ---------
Net gain (loss) on securities, loans and branch sale 5,512 (2,177) (1,647) (1,705) 494
--------- --------- --------- --------- ---------
Income (loss) before income tax provision and minority interest 6,533 (3,248) (4,144) (3,093) 3,263
Income tax provision (benefit) 2,584 (1,277) (1,646) (1,234) 1,261
--------- --------- --------- --------- ---------
Income (loss) before minority interest 3,949 (1,971) (2,498) (1,859) 2,002
Minority interest 82 92 43
--------- --------- --------- --------- ---------
Net income (loss) before cumulative effect of accounting change 4,031 (1,879) (2,455) (1,859) 2,002
Cumulative effect of adoption of SFAS 133, net of income tax (829)
--------- --------- --------- --------- ---------
Net income (loss) $ 3,202 $ (1,879) $ (2,455) $ (1,859) $ 2,002
========= ========= ========= ========= =========
Basic earnings (loss) per share $ 1.02 $ (0.59) $ (0.76) $ (0.57) $ 0.61
Diluted earnings (loss) per share $ 1.02 $ (0.59) $ (0.76) $ (0.57) $ 0.61
Cash dividends per share $ 0.12 $ 0.12 $ 0.12 $ 0.12 $ 0.03
Market value, at June 30 per share $ 12.10 $ 6.50 $ 7.25 $ 11.25 $ 12.13
PERFORMANCE RATIOS
Return on average assets (1) 0.73 % (0.41)% (0.44)% (0.34)% 0.50 %
Return on average equity (1) 17.26 (10.70) (12.54) (7.56) 10.52
Interest rate spread 2.08 1.75 1.06 0.79 1.43
Net interest margin 2.28 1.87 1.12 0.94 1.62
Average interest-earning assets to average interest-bearing
liabilities 103.58 102.16 101.14 102.73 103.67
Net interest income after provision for loan losses to total
other expenses (1) 101.33 80.86 65.53 73.95 172.82
Total other expenses to average total assets (1) 2.01 2.08 1.51 1.20 0.91
Full service offices 7 9 8 7 4
ASSET QUALITY RATIOS (AT END OF PERIOD)
Non-performing loans to total loans (2) 0.71 0.07 0.03 0.17 0.36
Non-performing assets to total assets (2) 0.64 0.13 0.13 0.18 0.25
Allowance for loan losses to total loans 0.65 0.52 0.33 0.22 0.23
Allowance for loan losses to total non-performing loans 91.22 782.22 1,142.11 126.32 63.39
CAPITAL RATIOS (3)
Tangible capital ratio 7.40 6.62 6.95 6.88 6.96
Core capital ratio 7.40 6.62 6.95 6.88 6.96
Risk-based capital ratio 11.87 12.64 12.33 21.92 31.14
Equity to assets at end of period 4.59 3.74 4.06 4.68 5.59
(1) For comparability purposes, the 1997 fiscal year ratios exclude the effect
of the special SAIF assessment of $830,000.
(2) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, assets acquired by foreclosure or
repossession and a single non-agency participation certificate classified
as substandard.
(3) Regulatory capital ratios apply to the Bank (Harrington Bank, FSB) as a
federally chartered savings bank.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Harrington Financial Group, Inc. ("Harrington" or the "Company") is an
Indiana-chartered, registered thrift holding company for Harrington Bank, FSB
(the "Bank"). The following presents an analysis of the Company's results of
operations and financial condition for the periods presented in this annual
report.
GENERAL
Harrington's business strategy focuses on achieving attractive returns
consistent with prudent risk management. Harrington has sought to implement this
strategy by: (1) expanding its banking locations and product offerings in order
to build a strong community banking franchise; (2) controlling interest rate
risk by matching the interest rate sensitivity of its assets to that of its
liabilities; (3) controlling credit risk by originating well-collateralized
loans and by applying conservative underwriting standards and credit risk
monitoring; and (4) utilizing excess capital balances through the management of
a hedged investment portfolio.
On May 30, 2001, the Company announced that it had reached a definitive
agreement to merge with Hasten Bancshares after the sale of both its banking
operations in North Carolina and Kansas and its 51% interest in Harrington
Wealth Management Company to third parties. The total consideration to be paid
by Hasten for all the outstanding and issued shares and options of the Company
is $40 million or $12.4916 per share. The merger is expected to be completed in
late December, 2001 or early January, 2002.
Highlights of the principal elements of the Company's business strategy are as
follows:
EXPAND BANKING LOCATIONS AND PRODUCT OFFERINGS. An integral part of the
Company's strategy has been to expand opportunistically the products, services,
and banking locations for business and retail customers in markets where the
Company's management and directors have market knowledge and customer
relationship potential. A total of eight new banking locations have been opened
since May 1994, and the commercial loan division was developed in the Spring of
1998. With the primary expansion complete, the Company is focused on efficiency
and revenue enhancement to improve profitability.
In March 2000, the Company reached a definitive agreement to sell the
Bank's two southern Indianapolis branches. The Company determined that the
branches did not strategically fit with its market development on the north side
of Indianapolis in Hamilton County. On September 8, 2000, the Company sold
deposits and certain assets of the two branch banking locations. The Company
sold $43.5 million of deposits, $0.4 million of office properties and equipment,
and paid approximately $41.7 million. The sale resulted in a pre-tax gain of
approximately $1.4 million.
The Company's lending emphasis is on the origination of loans secured by
first and second liens on single-family (one to four units) residences and
commercial real estate, equipment, inventory, and receivables lending through
its Commercial Loan Division. In fiscal year 2001, the Company originated $22.8
million in single family related loans, $29.2 million in consumer related loans,
and $86.4 million in commercial related loans. Total loans have increased to
$329.2 million at June 30, 2001 from $94.0 million at June 30, 1997.
The Company believes that retail deposits are a cost-effective source of
funds, provide an additional source of fee income, and also permit the further
cross selling of additional products and services. Consequently, the Company is
focusing on increasing its retail deposit base while controlling deposit cost.
Core deposits (total consolidated deposits less public funds deposits and
brokered deposits) were $287.0 million at June 30, 2001 and have increased from
$123.5 million at June 30, 1997.
The Company also formed Harrington Wealth Management Company ("HWM") in
February 1999. HWM is a strategic alliance between the Bank (51% owner) and Los
Padres Bank (49% owner), a federally chartered savings bank located in
California. HWM provides trust, investment management, and custody services for
individuals and institutions.
CONTROL INTEREST RATE RISK. The Company attempts to manage its assets and
liabilities in order to maintain a portfolio that produces positive returns in
either an increasing or decreasing interest rate environment. The Company has
sought to control interest rate risk both internally through the management of
the composition of its assets and liabilities and externally through the
utilization of interest rate contracts. Interest rate contracts are purchased
with the intention of protecting the market value of the Bank's portfolio and
net interest income.
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36
CONTROL CREDIT RISK. In order to limit the Company's credit exposure, the
Company originates and adds to portfolio well-secured residential and commercial
loans and maintains strict underwriting standards. As such, non-performing loans
have remained relatively low, with only $2,346,000 or 0.71% of total loans at
June 30, 2001.
UTILIZE EXCESS CAPITAL BALANCES. The Company utilizes excess capital
balances through the management of a hedged investment portfolio primarily
consisting of mortgage-backed securities and corporate bonds. Although these
securities often carry lower yields than traditional loans, such securities
generally increase the quality of the Company's assets, are more liquid than
individual loans, and may be used to collateralize borrowings or other
obligations of the Company. The funds invested in the securities portfolio can
be quickly redeployed to pursue community bank expansion opportunities as they
arise.
During fiscal year 2001, the Company marked almost all of its investment
securities and related interest rate contracts to market either in earnings
(trading portfolio) or in equity (available for sale portfolio). This method of
accounting was consistent with the Company's strategy of active portfolio
management and provided the Company with the flexibility to adjust quickly the
mix of its interest earning assets in response to changing market conditions or
to take advantage of community banking growth opportunities. With the growth in
the core retail and commercial banking business, the level of assets subject to
mark-to-market accounting has declined.
In summary, the Company continues to build a community-oriented banking
operation in order to sustain loan originations and deposit growth, benefit from
economies of scale, and generate additional fee and net interest income.
Management's primary goal is to increase stockholders' value as measured on a
risk-adjusted total return basis.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
In addition to historical information, forward-looking statements
contained in this annual report are subject to risks and uncertainties that
could cause actual results to differ materially from those reflected in the
forward-looking statements. Factors that could cause future results to vary from
current expectations include, but are not limited to, the impact of economic
conditions (both generally and more specifically in the markets in which
Harrington operates), the impact of competition for Harrington's customers from
other providers of financial services, the impact of government legislation and
regulation (which changes from time to time and over which Harrington has no
control), and other risks detailed in the Annual Report and in Harrington's
other Securities and Exchange Commission ("SEC") filings. Readers are cautioned
not to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. Harrington undertakes no
obligation to publicly revise these forward-looking statements to reflect events
or circumstances that arise after the date hereof. Readers should carefully
review the risk factors described in other documents Harrington files from time
to time with the SEC, including the Quarterly Reports on Form 10-Q to be filed
by Harrington and any Current Reports on Form 8-K filed by Harrington.
CHANGES IN FINANCIAL CONDITION
GENERAL. At June 30, 2001, Harrington's total assets amounted to $408.0
million, as compared to $435.2 million at June 30, 2000. The decrease in total
assets was primarily due to a $67.2 million decrease in the Company's securities
portfolio, a $13.7 million decrease in cash and interest bearing deposits, and a
$3.8 million decrease in income taxes receivable and other assets which were
partially offset by a $58.3 million increase in the loan portfolio.
CASH AND INTEREST-BEARING DEPOSITS. Cash and interest-bearing deposits
amounted to $10.7 million and $24.3 million at June 30, 2001 and 2000,
respectively. Harrington actively manages its cash and cash equivalents based
upon the Company's operating, investing and financing activities. Based upon the
Company's current size, cash and cash equivalents generally fluctuate within a
range of approximately $10.0 million to $25.0 million. Harrington attempts to
invest its excess liquidity in higher yielding assets such as loans or
securities.
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SECURITIES HELD FOR TRADING AND AVAILABLE FOR SALE. In order to reduce
the Company's credit risk exposure, to enhance balance sheet liquidity, and to
utilize excess capital balances, Harrington maintains a portion of its assets in
a hedged investment portfolio, the securities of which are primarily issued or
guaranteed by U.S. Government agencies or government sponsored enterprises.
Almost all of these securities and their related interest rate risk management
contracts are classified as held for trading or available for sale and, pursuant
to SFAS 115, are reported at fair value with unrealized gains and losses
included in earnings or equity, respectively.
Securities held for trading (consisting of mortgage-backed securities,
mortgage-backed derivative securities, interest rate contracts and equity
securities) amounted to $3.5 million and $53.9 million at June 30, 2001 and
2000, respectively. Securities classified as available for sale (consisting of a
non-agency mortgage-backed security, corporate bonds, and adjustable rate
mortgage securities) decreased from $64.1 million at June 30, 2000 to $51.0
million at June 30, 2001.
LOANS RECEIVABLE. At June 30, 2001, loans receivable (net of the
Company's allowance for loan losses) amounted to $329.2 million, an increase of
21.5% over the June 30, 2000 total of $271.0 million. Harrington has
significantly increased its community banking operations, including the
origination of single-family residential and commercial loans. Loans originated
through correspondents must meet the same pricing and underwriting standards as
loans originated internally. The Bank's consumer and commercial loan portfolio
increased from $90.1 million at June 30, 2000 to $151.7 million at June 30,
2001.
ALLOWANCE FOR LOAN LOSSES. At June 30, 2001, Harrington's allowance for
loan losses totaled $2.1 million, compared to $1.4 million at June 30, 2000. At
June 30, 2001, the Company's allowance represented approximately 0.65% of the
total loan portfolio as compared to 0.52% at June 30, 2000. The ratio of total
non-performing loans to total loans amounted to 0.71% at June 30, 2001 compared
to 0.07% at June 30, 2000, which reflects Harrington's emphasis on maintaining
low credit risk with respect to its operations.
Although Harrington's management believes that its allowance for loan
losses at June 30, 2001 was adequate based on facts and circumstances available
to it (including the historically low level of loan charge-offs), there can be
no assurances that additions to the allowance will not be necessary in future
periods, which could adversely affect the Company's results of operations.
DEPOSITS. At June 30, 2001, deposits totaled $323.3 million, as compared
to $361.2 million as of June 30, 2000. Core deposits decreased $47.5 million,
from $334.5 million at June 30, 2000 to $287.0 million at June 30, 2001,
primarily due to the sale of $43.5 million of deposits related to the sale of
the Bank's two southern Indianapolis branches. Non-retail deposits increased by
$9.6 million during the same period for a net decrease in deposits of $37.9
million.
BORROWINGS. At June 30, 2001, reverse repurchase agreements and dollar
rolls (both of which are securities sold under agreements to repurchase and are
accounted for as a financing) totaled $35.7 million, as compared to $28.0
million as of June 30, 2000.
Advances from the FHLB of Indianapolis amounted to $11.0 million and
$7.0 million as of June 30, 2001 and 2000, respectively. At June 30, 2001, the
FHLB advance was scheduled to mature in fiscal 2002, with an average interest
rate thereon of 5.51%, as compared to 6.87% at June 30, 2000.
The Company's note payable amounted to $13.0 million at both June 30,
2001 and 2000. The note payable relates to a loan facility that was used to
refinance, to a significant extent, the unpaid balance of a $10.0 million
acquisition loan which financed the Company's acquisition of the Bank.
-37-
38
STOCKHOLDERS' EQUITY. Stockholders' equity increased from $16.3 million
at June 30, 2000 to $18.7 million at June 30, 2001. This increase was due
primarily to the $3.2 million of net income recognized during fiscal 2001, the
cumulative effect type adjustment of $3.8 million, net of tax, in accumulated
other comprehensive income to recognize the fair value of all derivatives that
are designated as cash flow hedges, and unrealized net gains of $889,000 on
investment securities available for sale. These increases were partially offset
by cash dividends paid of $377,000, unrealized net losses of $2.3 million, net
of tax, on deposit hedges and reclassification of OCI to earnings in accordance
with FAS 133 of $2.7 million which is included in the net income of $3.2
million noted above and the purchase of treasury stock amounting to $191,000.
RESULTS OF OPERATIONS
SUMMARY OF OPERATIONS. Harrington reported net income of $3.2 million or
$1.02 basic income per share for the year ended June 30, 2001 compared to a net
loss of $1.9 million or $0.59 basic loss per share for the year ended June 30,
2000. This $5.1 million or 268.4% increase in net income was due primarily to a
$1.6 million increase in interest income, a gain on the branch sale of $1.4
million, a $6.4 million increase in other gains and losses, and a $757,000
decrease in operating expense, which were partially offset by an increase in
the income tax provision of $3.9 million and the cumulative effect of the
adoption of SFAS 133 net of tax of $829,000.
The Company's primary goal in fiscal years 2000 and 2001 was to improve
the value of the banking franchise through profitable deposit, loan, and market
and business line expansion. The market expansion into Kansas and North Carolina
and the establishment of the necessary infrastructure were substantially
completed during fiscal year 2000. The recent losses are due primarily to the
underperformance of the investment portfolio combined with the necessary
investment spending to complete the market expansion and develop the
infrastructure to support continued growth into the future. With the foundation
now in place for its community banks in Indiana, Kansas and North Carolina, the
Company is making marked improvement in its core banking income (net interest
income after provision for loan losses plus fees minus operating expenses). Net
interest income has increased by $1.4 million over fiscal year 2000, which
reflects the growth in the Company's commercial loan portfolio and core
deposits. Furthermore, core income has increased from a $1.1 million deficit in
fiscal year 2000 to $1.0 million income in fiscal year 2001. Contributing to
this improvement is higher spread earning loans, the reduction in deposit costs
related to borrowings, and the control of operating expenses through staff
reductions, a senior management realignment, and a cost reduction program.
The net loss for the year ended June 30, 2000 was $1.9 million or $0.59
basic loss per share, compared to a net loss of $2.5 million or $0.76 basic loss
per share for the year ended June 30, 1999. The $576,000 or 23.5% decrease in
net loss was due primarily to a $2.6 million increase in net revenue which was
partially offset by a $1.1 million increase in operating expense, a $530,000
increase in other losses, and a $369,000 decrease in the income tax benefit.
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID.
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in dollars and rates, and the net interest margin. The table does not
reflect any effect of income taxes. All average balances are based on average
daily balances for the Bank during the periods presented.
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39
YEARS ENDED JUNE 30,
---------------------------------------------------------------
2001 2000
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE (1) BALANCE INTEREST RATE (1)
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-bearing deposits $ 9,531 $ 488 5.12 % $ 15,795 $ 784 4.96 %
Securities held for trading (2) 22,445 2,197 9.79 % 132,550 8,816 6.65 %
Securities available for sale (3) 86,523 6,125 7.08 % 17,479 1,094 6.26 %
Securities held to maturity 965 6 0.62 % 2,308 171 7.41 %
Loans receivable, net (4) 304,682 24,244 7.96 % 275,454 20,637 7.49 %
Federal Home Loan Bank stock 4,878 399 8.18 % 4,878 391 8.01 %
-------- -------- -------- --------
Total interest-earning assets 429,024 33,459 7.80 % 448,464 31,893 7.11 %
====== ======
Non-interest-earning assets 12,371 14,774
-------- --------
Total assets $441,395 $463,238
======== ========
Interest-Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 20,781 1,175 5.65 % $ 18,612 1,013 5.44 %
Savings accounts 32,007 1,382 4.32 % 33,291 1,371 4.12 %
Money market deposit accounts 63,562 2,313 3.64 % 117,919 5,148 4.37 %
Certificates of deposit 209,607 13,197 6.30 % 186,308 10,694 5.74 %
-------- -------- -------- --------
Total deposits 325,957 18,067 5.54 % 356,130 18,226 5.12 %
Securities sold, repurchase agreement 52,698 3,078 5.84 % 52,550 2,809 5.35 %
Federal Home Loan Bank advances 22,554 1,359 6.03 % 15,540 1,192 7.67 %
Note payable 12,995 1,169 9.00 % 14,753 1,295 8.78 %
-------- -------- -------- --------
Total interest-bearing liabilities 414,204 23,673 5.72 % 438,973 23,522 5.36 %
-------- ====== -------- ======
Non-interest bearing liabilities 7,838 5,782
-------- --------
Total liabilities 422,042 444,755
Minority interest 805 916
Stockholders' equity 18,548 17,567
-------- --------
Total liabilities and stockholders' equity $441,395 $463,238
======== ========
Net interest income; interest rate spread(5) $ 9,786 2.08 % $ 8,371 1.75 %
======== ====== ======== ======
Net interest margin (5)(6) 2.28 % 1.87 %
====== ======
Average interest-earning assets
to average interest-bearing liabilities 103.58 % 102.16 %
======== ========
YEARS ENDED JUNE 30,
--------------------------------
1999
AVERAGE YIELD/
BALANCE INTEREST RATE (1)
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-bearing deposits $ 13,489 $ 611 4.53 %
Securities held for trading (2) 300,223 18,104 6.03 %
Securities available for sale (3) 699 66 9.44 %
Securities held to maturity -- -- 0.00 %
Loans receivable, net (4) 223,174 16,032 7.18 %
Federal Home Loan Bank stock 4,878 391 8.01 %
-------- --------
Total interest-earning assets 542,463 35,204 6.49 %
======
Non-interest-earning assets 19,207
--------
Total assets $561,670
========
Interest-Bearing Liabilities:
Deposits:
NOW and DDA accounts $ 13,050 306 2.34 %
Savings accounts 30,520 1,279 4.19 %
Money market deposit accounts 73,256 3,546 4.84 %
Certificates of deposit 156,262 8,969 5.74 %
-------- --------
Total deposits 273,088 14,100 5.16 %
Securities sold, repurchase agreement 213,428 11,433 5.36 %
Federal Home Loan Bank advances 36,172 2,481 6.86 %
Note payable 13,672 1,109 8.11 %
-------- --------
Total interest-bearing liabilities 536,360 29,123 5.43 %
-------- ======
Non-interest bearing liabilities 5,328
-------
Total liabilities 541,688
Minority interest 401
Stockholders' equity 19,581
-------
Total liabilities and stockholders' equity $561,670
========
Net interest income; interest rate spread(5) $ 6,081 1.06 %
======== ======
Net interest margin (5)(6) 1.12 %
======
Average interest-earning assets
to average interest-bearing liabilities 101.14 %
========
(1) At June 30, 2001, the yields earned and rates paid were as follows:
interest-bearing deposits, 3.25%; securities held for trading, 10.33%;
securities available for sale, 7.15%; securities held to maturity, 5.05%;
loans receivable, net 7.67%; FHLB stock, 7.75%; total interest-earning
assets, 7.5%; deposits, 4.89%; securities sold under agreements to
repurchase, 3.73%; FHLB advances, 5.51%; note payable, 6.75%; total
interest-bearing liabilities, 4.86%; interest rate spread 2.67%.
(2) Both the interest and yields earned on the Company's securities portfolio
reflect the net interest expense incurred with respect to various interest
rate contracts (such as interest rate swaps, collars, caps, floors, options
and futures) which were utilized to hedge the Company's interest rate
exposure. During the years ended June 30, 2001, 2000 and 1999, the net costs
of hedging the Company's interest rate exposure with respect to its
securities held for trading amounted to $39,000 or 0.35%, $85,000 or 0.06%,
and $580,000 or 0.19%, respectively.
(3) The average balance reflects the carrying value of available for sale
investments net of the average valuation allowance related to a single
non-agency participation certificate of $95,000, $97,000 and $114,000 for
the years ended June 30, 2001, 2000 and 1999, respectively.
(4) Net of deferred loan fees, loan discounts and undisbursed loan funds.
Includes nonaccrual loans. Interest on nonaccrual loans is recorded when
received.
(5) Excluding the costs of hedging the Company's interest rate exposure (which
has effectively reduced the yields earned on the Company's securities
portfolio), the Company's interest rate spread amounted to 2.09%, 1.77% and
1.17% and the Company's net interest margin amounted to 2.28%, 1.89% and
1.23% for the years ended June 30, 2001, 2000 and 1999, respectively.
(6) Net interest margin is net interest income divided by average
interest-earning assets.
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40
RATE/VOLUME ANALYSIS. The following table describes the extent to which
changes in interest rates and changes in volume of interest-related assets and
liabilities have affected the Company's interest income and interest expense
during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in volume (change in volume multiplied by prior year rate), (2)
changes in rate (change in rate multiplied by prior year volume), and (3) total
change in rate and volume. The combined effect of changes in both rate and
volume has been allocated in proportion to the absolute dollar amounts of the
changes due to rate and volume.
YEAR ENDED JUNE 30, 2001 VS. 2000 2000 VS. 1999
--------------------------------- ---------------------------------
(DOLLARS IN THOUSANDS) INCREASE (DECREASE) TOTAL INCREASE (DECREASE) TOTAL
DUE TO INCREASE DUE TO INCREASE
----------------------- ---------------------
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
Interest earning assets:
Interest bearing deposits $ 24 $ (320) $ (296) $ 63 $ 110 $ 173
Securities held for trading 2,907 (9,526) (6,619) 2,099 (11,387) (9,288)
Securities available for sale 161 4,870 5,031 (14) 1,042 1,028
Securities held to maturity (101) (64) (165) (6) 146 140
Loans receivable net 1,331 2,276 3,607 734 3,901 4,635
Federal Home Loan Bank stock 8 -- 8 -- -- --
-------- -------- -------- -------- -------- --------
Total interest earning assets $ 4,330 $ (2,764) $ 1,566 $ 2,876 $ (6,188) $ (3,312)
======== ======== ======== ======== ======== ========
Interest bearing liabilities:
NOW and DDA accounts $ 40 $ 122 $ 162 $ 534 $ 172 $ 706
Savings accounts 65 (54) 11 (22) 114 92
Money market deposits accounts (752) (2,083) (2,835) (307) 1,909 1,602
Certificates of deposits 1,093 1,410 2,503 -- 1,725 1,725
-------- -------- -------- -------- -------- --------
Total deposits 446 (605) (159) 205 3,920 4,125
Securities sold under agreements to repurchase 261 8 269 (24) (8,600) (8,624)
Federal Home Loan Bank advances (293) 460 167 338 (1,626) (1,288)
Note payable 31 (157) (126) 95 91 186
-------- -------- -------- -------- -------- --------
Total interest bearing liabilities $ 445 $ (294) $ 151 $ 614 $ (6,215) $ (5,601)
======== ======== ======== ======== ======== ========
Increase (decrease) in net interest income $ 1,415 $ 2,289
======== ========
INTEREST INCOME
For the year ended June 30, 2001, Harrington's interest income increased
by $1.6 million compared to the year ended June 30, 2000. This increase was
primarily due to a $3.6 million increase in interest income on the Company's
loan portfolio which was partially offset by a $1.8 million decrease in interest
income from the securities portfolio. The increase in interest income on the
loan portfolio was the result of the $29.2 million increase in the average
balance and a 47 basis point increase in the yield of the portfolio. The
decrease in interest income from the securities portfolio was the result of the
$42.4 million decrease in the average balances partially offset by a 96 basis
point increase in the yield of the portfolio.
For the year ended June 30, 2000, Harrington's interest income decreased
by $3.3 million or 9.4% to $31.9 million, compared to the year ended June 30,
1999. This decrease was primarily due to an $8.1 million decrease in interest
income from the securities portfolio. This decrease was partially offset by a
$4.6 million increase in interest income on the Company's loan portfolio. The
increase in interest income on the loan portfolio was a direct result of the
$52.3 million increase in the level of the average loan portfolio which was
partially offset by a 31 basis point increase in the interest yield earned
caused primarily by an overall increase in the level of interest rates during
fiscal 2000. The decrease in interest income from the investment portfolio was a
result of the $148.6 million decrease in the average balances offset by a 57
basis point increase in the yield of the portfolio.
-40-
41
INTEREST EXPENSE. For the year ended June 30, 2001, Harrington's
interest income increased by $151,000 or 0.6% to $23.7 million, compared to the
year ended June 30, 2000. This increase was primarily due to a 36 basis point
increase in the cost of interest-bearing liabilities, which was partially offset
by a $24.8 million decrease in the level of average interest-bearing
liabilities. For the year ended June 30, 2000, Harrington's interest expense
decreased by $5.6 million or 19.2% to $23.5 million, compared to the year ended
June 30, 1999. This decrease was primarily due to a $97.4 million decrease in
the level of average interest-bearing liabilities and a 7 basis point decrease
in the cost of interest-bearing liabilities.
NET INTEREST INCOME. Net interest income increased by $1.4 million or
16.9% to $9.8 million during fiscal year 2001 as compared to fiscal year 2000.
Net interest income increased by $2.3 million or 37.7% to $8.4 million during
fiscal year 2000 as compared to fiscal year 1999.
PROVISION FOR LOAN LOSSES. The provision for loan losses is charged to
earnings to bring the total allowance to a level considered appropriate by
management based on the estimated net realizable value of the underlying
collateral, general economic conditions, particularly as they relate to the
Company's market areas, historical loan loss experience and other factors
related to the collectibility of the Company's loan portfolio. While management
endeavors to use the best information available in making its evaluations,
future allowance adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations.
Harrington established provisions for loan losses of $798,000, $587,000
and $509,000 during the years ended June 30, 2001, 2000, and 1999, respectively.
During such respective periods, loan charge-offs (net of recoveries) amounted to
$66,000, $47,000 and (1,000), respectively. Although the Company's
non-performing loans remain low, given the growth in the commercial and
consumer loan portfolios, the Company's analysis of loan reserve requirements
indicated that additional reserves were prudent. The allowance for loan losses
as a percentage of total loans was .65% and .52% at June 30, 2001 and 2000,
respectively.
OTHER INCOME (LOSS). Other income (loss) is comprised of two distinct
components: gains and losses on the Company's investment securities and hedging
instruments, and fee and other income from retail bank operations. Gains or
losses on investments and hedges which have been sold are reported as realized
gains or losses, and market value gains or losses on investments and hedges
which remain in the Company's portfolio are reported as unrealized gains or
losses.
Management's goal is to attempt to offset any change in the market value
of its securities portfolio with the change in the market value of the interest
rate risk management contracts and mortgage-backed derivative securities
utilized by the Company to hedge its interest rate exposure. In addition,
management attempts to produce an overall positive return on its securities
portfolio relative to its funding costs through the use of option-adjusted
pricing analysis. The Company utilizes such analysis to select securities with
wider spreads for purchase and to select securities to sell for a gain as
spreads tighten (net of the gain or loss recognized with respect to related
interest rate contracts).
However, the use of mark-to-market accounting for the trading portfolio
can cause volatility in reported earnings due to short-term fluctuations in the
market value of the securities relative to that of the hedge instruments.
Harrington realizes that a major benefit of marking assets to market is that it
provides shareholders with more timely information on the economic value of the
Company's portfolio, and it allows flexibility to grow or reduce investments as
opportunities allow. The Company, however, has reduced the level of the assets
subject to "mark-to-market" accounting through its community banking expansion
and reduction in its investment portfolio.
41
42
The following table sets forth information regarding other income (loss) for
the periods shown.
(DOLLARS IN THOUSANDS) YEARS ENDED JUNE 30,
-----------------------------
2001 2000 1999
Gain (loss) on sale of securities held for trading $ 2,742 $(4,498) $ 4,755
Gain (loss) on sale of loans 1 (1,173)
Unrealized gain (loss) on securities held for trading 1,346 3,494 (6,402)
Gain on branch sale 1,423
Other (1) 903 772 433
------- ------- -------
Total other income (loss) $ 6,415 $(1,405) $(1,214)
======= ======= =======
(1) Consists primarily of loan servicing fees and late charges, checking account
fees, trust and investment management service fees, rental income and other
miscellaneous fees.
Total other income amounted to $6.4 million for the year ended June 30,
2001. This total consisted of a net realized and unrealized gain of $4.1 million
on the trading portfolio, gain on branch sale of $1.4 million and fee and other
retail bank income of $903,000.
Total other income (loss) amounted to $(1.4) million for the year ended
June 30, 2000. This total consisted of a net realized and unrealized loss of
$1.0 million on the trading portfolio, a loss on sale of loans of $1.2 million
plus fee and other retail bank income of $772,000. Total other income (loss)
amounted to $(1.2) million for the year ended June 30, 1999. This total
consisted of a net realized and unrealized loss of $1.6 million on the trading
portfolio, plus fee and other retail bank income of $433,000. The gains (losses)
on the trading portfolio, net of hedges, reflect only a portion of the total
income (loss) produced from this portfolio in fiscal 2001, 2000 and 1999. Total
income from this portfolio consists of both interest income and net realized and
unrealized gains and losses on the investments and hedges.
The Company seeks to produce a positive spread between the total income
of this portfolio and one month LIBOR, the Company's marginal cost of borrowing.
In the fiscal years 2001, 2000 and 1999, this portfolio produced a net-hedged
spread to one-month LIBOR of 3.54%, (.98)%, and 0.28%, respectively. Due to the
market uncertainty over Federal Reserve action, an oversupply of corporate debt
issuances due to Y2K concerns which increased both financing and credit margins,
concerns that the government sponsored agencies would be privatized, and spreads
of mortgage securities to Treasury widening during fiscal years 1999 and 2000,
the hedge gains therefore lagged the realized and unrealized losses on
securities. The Company's community banking expansion is expected to reduce the
reliance on investment returns over the coming years, although the Company
remains confident in its core competency in fixed income investments.
OTHER EXPENSE. In order to enhance the Company's profitability,
management strives to maintain a favorable level of operating expenses relative
to its peer group. However, during fiscal years through 1999, the Company
accelerated its investment spending in operating expenses to accomplish the
business line and facilities expansion in order to grow revenue in future years.
This expansion culminated with the opening of the North Carolina branch in
August 1999. With the primary expansion complete in fiscal year 2000, management
implemented efficiency enhancements within the 2000 fiscal year, a senior
management realignment, administrative staffing reductions, and a cost
containment program to improve profitability. Also, two underperforming branches
and related deposits were sold in southern Indianapolis on September 8, 2000 for
a pretax gain on sale of $1.4 million. The following table sets forth certain
information regarding other expense for the periods shown.
42
43
(DOLLARS IN THOUSANDS) YEARS ENDED JUNE 30,
----------------------
2001 2000 1999
Salaries and employee benefits $4,804 $5,090 $4,290
Pemises and equipment 1,392 1,516 1,262
FDIC insurance premiums 67 133 125
Marketing 131 382 314
Computer services 636 611 509
Consulting fees 270 276 301
Other (1) 1,570 1,619 1,699
------ ------ ------
Total other expense $8,870 $9,627 $8,500
====== ====== ======
(1)Consists primarily of costs relating to postage, forms and supplies,
professional fees and other miscellaneous expenses.
The principal category of Harrington's other expense is salaries and
employee benefits, which decreased by $286,000 or 5.6% during fiscal 2001 and
increased $800,000 or 18.6% during fiscal 2000. The major causes of these
changes were the sale of two southern Indianapolis branches in September 2000
and the continuing implementation of Harrington's community bank expansion
strategy. A total of eight new banking locations were opened since May 1994,
with one each being opened in the first quarters of fiscal year 1999 and 2000.
In addition, new employees were hired in connection with the growth in the
Bank's development of the commercial loan division.
Premises and equipment expense decreased $124,000 or 8.2% during fiscal
year 2001 due primarily to the branch sale in September 2000. Premises and
equipment expense increased by $254,000 or 20.1% during fiscal 2000. The
increase in premises and equipment expense during this period was primarily due
to the opening of new branches.
Federal Deposit Insurance Corporation ("FDIC") premiums decreased by
$66,000 or 49.6% due to the sale of deposits in September 2000. FDIC premiums
increased by $8,000 or 6.4% during fiscal year 2000 due to the increase in
deposit size.
Harrington incurred marketing expenses of $131,000, $382,000, and
$314,000 during the years ended June 30, 2001, 2000, and 1999, respectively. The
fluctuations in marketing expense during the periods reflected the advertising
costs associated with the opening of the Bank's new branch offices.
Computer services expense increased by $25,000 or 4.1% and $102,000 or
20.0% during fiscal years 2001 and 2000, respectively. Computer services expense
relates to the fees paid by Harrington to a third party who performs the
Company's data processing functions as well as to the third party servicer who
performs the back-office functions with respect to the Company's trust and
investment management services. The increase in expense for the years presented
relates primarily to the increase in the number of deposit and loan accounts
held by Harrington and the cost of the new computer operating system. In
addition, during fiscal year 1999, the Company incurred approximately $107,000
in non-recurring expense related to on-line system conversions.
Harrington has contracted with Smith Breeden to provide investment
advisory services and interest rate risk analysis. Certain stockholders of the
Company are also principals of Smith Breeden. The consulting fees paid by
Harrington to Smith Breeden during the years ended June 30, 2001, 2000, and
1999, which are based on the Company's asset size, amounted to $270,000,
$276,000, and $301,000, respectively.
INCOME TAX PROVISION. The Company provided $2.6 million for income taxes
for the year ended June 30, 2001. The Company received income tax benefits of
$1.3 million and $1.6 million during the years ended June 30, 2000 and 1999,
respectively. The Company's effective tax rate amounted to 39.6%, 39.3%, and
39.7% during the years ended June 30, 2001, 2000, and 1999, respectively.
43
44
LIQUIDITY
For the years prior to the year ended June 30, 2001 the Bank was
required under applicable federal regulations to maintain specified levels of
"liquid" investments as defined by the OTS. As of November 24, 1997, the
required level of such liquid investments was changed from 5% to 4% of certain
liabilities as defined by the OTS. In addition to the change in the percentage
of required level of liquid assets, the OTS also modified its definition of
investments that are considered liquid. As a result of this change, the level of
assets eligible for regulatory liquidity calculations increased considerably.
This requirement was eliminated during the year ended June 30, 2001.
The total eligible regulatory liquidity of the Bank was 24.4% at June
30, 2000, and the Bank's liquid assets as defined by the OTS totaled
approximately $85.3 million, which was $71.3 million in excess of the OTS
minimum requirement. At June 30, 2001, the Bank's "liquid" assets totaled
approximately $25.1 million.
The Bank maintains liquid assets at a level believed adequate to support
its normal operations, including funding loans and paying deposit withdrawals.
Cash flow projections are regularly reviewed and updated to ensure that adequate
liquidity is maintained. Cash for these purposes is generated through the sale
or maturity of securities, the receipt of loan payments, and increases in
deposits and borrowings. While the level of loan and deposit activity is not
entirely under the control of the Bank, the sale of securities and increases in
borrowings are entirely at the Bank's discretion and thus provide a ready source
of cash when needed.
As a member of the FHLB System, the Bank may borrow from the FHLB of
Indianapolis. FHLB advances may be obtained on very short notice due to the
Bank's blanket collateral agreement with the FHLB. In addition, the Bank can
pledge securities for collateralized borrowings such as reverse repurchase
agreements and quickly obtain cash whenever needed. In the opinion of
management, Harrington has sufficient cash flow and borrowing capacity to meet
current and anticipated funding commitments.
The Bank's liquidity, represented by cash and cash equivalents, is a
result of its operating, investing and financing activities. During the year
ended June 30, 2001, there was a net decrease of $13.7 million in cash and cash
equivalents. The primary uses of cash during the year included purchases of
securities available for sale of $61.2 million, repayments of Federal Home Loan
Bank advances of $221.0 million, the sale of deposits of $43.5 million and the
change in loans receivable of $59.1 million. Partially offsetting these cash
uses, the main sources of cash during the fiscal year were $54.1 million in
proceeds from sales and maturities of securities held for trading, $79.7 million
in proceeds from sales and maturities of securities available for sale, and
$225.0 million from proceeds from Federal Home Loan Bank advances.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 141 ("SFAS 141"),
"Business Combinations," was issued in July 2001. SFAS 141 requires the purchase
method of accounting for business combinations initiated after June 30, 2001 and
eliminates the pooling-of-interests method.
Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets," was issued in July 2001. Under SFAS 142, goodwill
amortization ceases when the new standard is adopted. The new rules also require
an initial goodwill impairment assessment in the year of adoption and at least
annual impairment tests thereafter.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET AND LIABILITY MANAGEMENT
In general, financial institutions are negatively affected by an increase
in interest rates to the extent that interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. The lending activities of
savings institutions have historically emphasized the origination of long-term,
fixed-rate loans secured by single-family residences, and the primary source of
funds of such institutions has been deposits, which largely mature or are
subject to repricing within a shorter period of time.
44
45
This factor has historically caused the income and market value of
portfolio equity ("MVPE") of savings institutions to be more volatile than other
financial institutions. MVPE is defined as the net present value of the
cash flows from an institution's existing assets, liabilities and off-balance
sheet instruments. While having liabilities that reprice more frequently than
assets is generally beneficial to net interest income and MVPE in times of
declining interest rates, such an asset/liability mismatch is generally
detrimental during periods of rising interest rates.
The Company's management believes that its asset and liability management
strategy, as discussed below, provides Harrington with a competitive advantage
over other financial institutions. Harrington's ability to effectively hedge its
interest rate exposure through the use of various financial instruments allows
the Company to acquire loans and investments that offer attractive net
risk-adjusted spreads and meet customer preferences whether the individual loans
or investments are fixed-rate or adjustable-rate or short-term or long-term.
Similarly, the Company can choose a cost-effective source of funds and
subsequently engage in an interest rate swap or other hedging transaction so
that the interest rate sensitivities of its interest-earning assets and
interest-bearing liabilities are generally matched.
Harrington's asset and liability management strategy is formulated and
monitored by the Boards of Directors of the Company and the Bank, the Company's
wholly owned subsidiary. The Boards' written policies and procedures are
implemented by the Investment Committee of the Bank, which is comprised of the
Chief Executive Officer, Chief Investment Officer, Chief Financial Officer and
three outside directors. The Investment Committee meets at least monthly to
review, among other things, the sensitivity of the Bank's assets and liabilities
to interest rate changes, investment opportunities and the performance of the
investment portfolios, and the past month's purchase and sale activity of
securities. The Committee also provides guidance to management on reducing
interest rate risk and on investment strategy and consults with the Chief
Investment Officer of the Bank regarding retail pricing and funding decisions
with respect to the Bank's overall asset and liability composition. In
accordance therewith, the Investment Committee reviews the Bank's liquidity,
cash flow needs, interest rate sensitivity of investments, deposits and
borrowings, core deposit activity, current market conditions and interest rates
on both a local and national level.
Harrington has contracted with Smith Breeden Associates, Inc. ("Smith
Breeden") for the provision of consulting services regarding, among other
things, the management of its investments and borrowings, the pricing of loans
and deposits, and the use of various financial instruments to reduce interest
rate risk. Smith Breeden is a consulting firm which renders investment advice
and asset and liability management services to financial institutions, corporate
and government pension plans, foundations, The Managers Mutual Funds, and
government agencies nationally. Certain directors of the Company and the Bank
are principals of Smith Breeden.
The Investment Committee regularly reviews interest rate risk by
utilizing analyses prepared by Smith Breeden with respect to the impact of
alternative interest rate scenarios on net interest income and on the Bank's
MVPE. The Investment Committee also reviews analyses prepared by Smith Breeden
concerning the impact of changing market volatility, prepayment forecast error,
and changes in option-adjusted spreads and non-parallel yield curve shifts.
MVPE analysis is used by regulatory authorities for assessing an
institution's interest rate risk. The extent to which assets will gain or lose
value net of the gains or losses of liabilities and/or interest rate contracts
determines the appreciation or depreciation in equity on a market-value basis.
Such market value analysis is intended to evaluate the impact of immediate and
sustained parallel interest rate shifts upon the market value of the current
balance sheet.
In the absence of the Company's hedging activities, the MVPE of the
Company would decline as a result of a general increase in market rates of
interest. This decline would be due to the market values of Harrington's assets
being generally more sensitive to interest rate fluctuations than are the market
values of the Company's liabilities due to Harrington's investment in and
origination of generally longer-term assets which are funded with shorter-term
liabilities. Consequently, the elasticity (i.e., the change in the market value
of an asset or liability as a result of a change in interest rates) of
Harrington's assets is greater than the elasticity of its liabilities.
Accordingly, the primary goal of Harrington's asset and liability
management policy is to effectively increase the elasticity of the Company's
liabilities and/or effectively contract the elasticity of the Company's assets
so that the respective elasticities are matched as closely as possible. This
elasticity adjustment can be accomplished internally by restructuring
Harrington's balance sheet or externally by adjusting the elasticities of
Harrington's assets and/or liabilities through the use of interest rate
contracts, such as interest rate swaps, collars, caps, floors, options and
futures. Harrington's strategy is to hedge either internally through the use of
longer-term certificates of deposits or less sensitive
45
46
non-defined maturity (transaction) deposits, FHLB advances and mortgage-backed
derivative securities or externally through the use of various interest rate
contracts.
External hedging involves the use of interest rate swaps, collars, caps,
floors, options and futures. The notional amount of interest rate contracts
represents the underlying amount on which periodic cash flows are calculated and
exchanged between counterparties. However, this notional amount does not
necessarily represent the principal amount of securities which would effectively
be hedged by that interest rate contract.
In selecting the type and amount of interest rate contract to utilize,
the Company compares the elasticity of a particular contract to that of the
securities to be hedged. An interest rate contract with the appropriate
offsetting elasticity could have a notional amount much greater than the face
amount of the securities being hedged.
An interest rate swap is an agreement where one party (generally the
Company) agrees to pay a fixed rate of interest on a notional principal amount
to a second party (generally a broker or money center bank) in exchange for
receiving from the second party a variable rate of interest on the same notional
amount for a predetermined period of time. No actual assets are exchanged in a
swap of this type and interest payments are generally netted. These swaps are
generally utilized by Harrington to synthetically convert fixed-rate assets into
adjustable-rate assets without having to sell or transfer the underlying assets.
The net expense relating to Harrington's interest rate contracts held in
the trading portfolio was $39,000, $85,000, and $580,000 during the years ended
June 30, 2001, 2000, and 1999, respectively. The approximate market value of the
interest rate swap maintained in the trading portfolio was $(18,000) as of June
30, 2000.
In addition, the Company also has swaps which hedge liabilities, and are
not included in the trading portfolio. The six swap agreements excluded from the
trading portfolio had an aggregate notional amount of $60.0 million and
maturities from February 2004 to February 2009. With respect to these
agreements, Harrington makes fixed interest payments ranging from 5.27% to 6.93%
and receives payments based upon the three-month LIBOR. These fixed-pay swaps,
in addition to cap agreements that are not included in the Company's trading
portfolio, are used to effectively modify the interest rate sensitivity of a
portion of the Bank's short-term LIBOR correlated borrowings which include
short-term deposits, securities sold under agreements to repurchase and the
Federal Home Loan Bank advances.
The net income (expense) relating to Harrington's swaps which are not
included in the trading portfolio was $0, $(75,000), and $31,000 during the
years ended June 30, 2001, 2000, and 1999, respectively. This income (expense)
is netted against interest expense in the Company's Consolidated Statements of
Operations. The approximate market value of these interest rate swaps (which is
not reflected in the Company's financial statements) was $0 million, $1.9
million and $2.3 million as of June 30, 2001, 2000, and 1999, respectively.
An interest rate cap or an interest rate floor consists of a guarantee
given by the issuer (i.e., a broker), to the purchaser (i.e., the Company), in
exchange for the payment of a premium. This guarantee states that if interest
rates rise above (in the case of a cap) or fall below (in the case of a floor) a
specified rate on a specified interest rate index, the issuer will pay to the
purchaser the difference between the then current market rate and the specified
rate on a notional principal amount. No funds are actually borrowed or repaid.
Similarly, an interest rate collar is a combination of a purchased cap
and a written floor at different strike rates. Accordingly, an interest rate
collar requires no payments if interest rates remain within a specified range,
but will require the Company to be paid if interest rates rise above the cap
rate or require the Company to pay if interest rates fall below the floor rate.
Consequently, interest rate caps are a means of reducing interest expense by
placing a ceiling on the cost of floating-rate liabilities, or offsetting the
caps on the coupons inherent in the Company's adjustable rate mortgage loans and
securities. Interest rate floors permit Harrington to maintain its desired
interest rate spread in the event that falling interest rates lead to increased
prepayments with respect to the Company's mortgage-backed and related securities
portfolio requiring reinvestment at lower rates.
At June 30, 2000, Harrington held one interest rate collar in its trading
portfolio. The collar provides for a payment to be received whenever the defined
floating rate is greater than 10.25% or a payment to be made whenever the
floating rate is less than 5.25%.
46
47
The aggregate net expense (income) relating to the Company's interest
rate caps, collars, swaptions, and floors held in the trading portfolio was
$29,000, $(87,000), and $(343,000) during the years ended June 30, 2001, 2000,
and 1999, respectively. The approximate market value of Harrington's interest
rate caps, collars and floors which are maintained in the trading portfolio was
$7,000, $2,000 and $5.0 million as of June 30, 2001, 2000, and 1999,
respectively.
Interest rate futures are commitments to either purchase or sell
designated instruments at a future date for a specified price. Futures contracts
are generally traded on an exchange, are marked-to-market daily and are subject
to initial and maintenance margin requirements. Harrington generally uses 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off LIBOR as well as Treasury Note and Bond futures contracts.
The Company will from time to time agree to sell a specified number of contracts
at a specified date. To close out a contract, Harrington will enter into an
offsetting position to the original transaction.
If interest rates rise, the value of the Company's short futures
positions increase. Consequently, sales of futures contracts serve as a hedge
against rising interest rates. There were no Eurodollar and Treasury Note
futures contracts in place at June 30, 2001. The Company had total gains
(losses) on its futures contracts of $(284,000), $4.2 million, and $3.2 million
for the fiscal years ended June 30, 2001, 2000, and 1999, respectively.
Options are contracts which grant the purchaser the right to buy or sell
the underlying asset by a certain date for a specified price. Generally,
Harrington will purchase options on financial futures to hedge the changing
elasticity exhibited by mortgage loans and mortgage-backed securities. The
changing elasticity results from the ability of a borrower to prepay a mortgage.
As market interest rates decline, borrowers are more likely to prepay their
mortgages, shortening the elasticity of the mortgages. Consequently, where
interest rates are declining, the value of mortgage loans or mortgage-backed
securities will increase at a slower rate than would be expected if borrowers
did not have the ability to prepay their mortgages.
Harrington, therefore, generally purchases out-of-the-money calls and
puts so that the increase in value of the options resulting from interest rate
movements offsets the reductions in MVPE resulting from the changing elasticity
inherent in the Company's balance sheet. At June 30, 2001 and 2000, Harrington
did not have any purchased options contracts in portfolio. The net expense
relating to purchased options contracts was $10,000, $172,000, and $466,000
during the years ended June 30, 2001, 2000, and 1999, respectively.
The following table summarizes the periodic exchanges of interest
payments with counterparties including the amortization of premiums paid for
interest rate contracts prior to July 1, 2000 as discussed above. Such payments
and amortization amounts are accounted for as adjustments to the yields of
securities held for trading and are reported as a separate component of interest
income.
(DOLLARS IN THOUSANDS) YEARS ENDED JUNE 30,
-----------------------
2001 2000 1999
Interest rate contract (income) expense:
Swaps $ -- $ -- $ 457
Caps, floors, and collars 29 (87) (343)
Options 10 172 466
----- ----- -----
Net interest expense on interest rate contracts $ 39 $ 85 $ 580
===== ===== =====
The above table does not include realized and unrealized gains and losses
with respect to the market value of interest rate contracts held in the trading
portfolio. Such gains and losses are generally offset by fluctuations in the
market value of the Company's assets held for trading. All realized and
unrealized gains and losses pertaining to interest rate contracts in the trading
portfolio are reported as other income in the Company's Consolidated Statements
of Operations.
Harrington is subject to the risk that its counterparties with respect to
various interest rate contracts (such as swaps, collars, caps, floors, options
and futures) may default at or prior to maturity of a particular instrument. In
such a case, the Company might be unable to recover any unrealized gains with
respect to a particular contract.
47
48
To reduce this potential risk, the Company generally deals with large,
established investment brokerage firms when entering into these transactions. In
addition, if the Company enters into an interest rate contract with a non
AA-rated (or above) entity and the Company has an unrealized gain with respect
to such contract, the Company generally requires the entity to post some form of
collateral to secure its obligations. Furthermore, the Company has a policy
whereby it limits its unsecured exposure to any one counterparty to 25% of the
Bank's equity during any two-month period and 35% of the Bank's equity during
any one-month period.
The Office of Thrift Supervision ("OTS") requires each thrift institution
to calculate the estimated change in the institution's MVPE assuming an
instantaneous, parallel shift in the Treasury yield curve of 100 to 300 basis
points either up or down in 100 basis point increments. The OTS permits
institutions to perform this MVPE analysis using their own internal model based
upon reasonable assumptions. The Company retains Smith Breeden to assist in
performing the required calculation of the sensitivity of its market value to
changes in interest rates.
In estimating the market value of mortgage loans and mortgage-backed
securities, the Company utilizes various prepayment assumptions which vary, in
accordance with historical experience, based upon the term, interest rate and
other factors with respect to the underlying loans. At June 30, 2001, these
prepayment assumptions varied from 8% to 17% for fixed-rate mortgages and
mortgage-backed securities and varied from 19% to 23% for adjustable rate
mortgages and mortgage-backed securities.
The following table sets forth at June 30, 2001 the estimated sensitivity
of the Bank's MVPE to parallel yield curve shifts using Harrington's internal
market value calculation. The table demonstrates the sensitivity of the Bank's
assets and liabilities both before and after the inclusion of its interest rate
contracts.
CHANGE IN INTEREST RATES (IN BASIS POINTS) (1)
(DOLLARS IN THOUSANDS) -300 -200 -100 - +100 +200 +300
------------------------------------------------------------------------- --------
Market value gain (loss) in assets $ 13,758 $ 9,934 $ 6,095 - $ (8,214) $(17,475) $(27,153)
Market value gain (loss) of liabilities (16,644) (11,108) (5,591) - 5,764 11,740 17,909
-------- -------- -------- -------- -------- --------
Market value gain (loss) of net assets
before interest rate contracts (2,886) (1,174) 504 - (2,450) (5,735) (9,244)
Market value gain (loss) of interest
rate contracts (28) (17) (8) - 5 7 8
-------- -------- -------- -------- -------- --------
Total change in MVPE(2) $ (2,914) $ (1,191) $ 496 - $ (2,445) $ (5,728) $ (9,236)
======== ======== ======== ======== ======== ========
Change in MVPE as a percent of:
MVPE(2) (9.9)% (4.1)% 1.7 % - (8.3)% (19.5)% (31.5)%
Total assets of the Bank (0.7)% (0.3)% (0.1)% - (0.6)% (1.4)% (2.3)%
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $29.0 million at June 30, 2001.
The table set forth above does not purport to show the impact of
interest rate changes on Harrington's equity under generally accepted accounting
principles. Market value changes only impact the Company's income statement or
the balance sheet (1) to the extent the affected instruments are marked to
market, and (2) over the life of the instruments as an impact on recorded
yields.
Since a portion of Harrington's assets is recorded at market value, the
following table is included to show the estimated impact on the Company's equity
of instantaneous, parallel shifts in the yield curve, and constant option
adjusted spreads on assets and liabilities. The assets and interest rate
contracts included in the table below are only those which are either classified
by the Company as held for trading or available for sale and, therefore,
reflected at market value. Consequently, Harrington's liabilities, which are
reflected at cost, are not included in the table below. All amounts are shown
net of taxes, with an estimated effective tax rate of 39.0%.
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49
CHANGE IN INTEREST RATES (IN BASIS POINTS)
(DOLLARS IN THOUSANDS) -300 -200 -100 - +100 +200 +300
--------------------------------------------------------------------------
After tax market value gain (loss) of assets $ 770 $ 493 $ 249 - $ (313) $ (725) $(1,271)
After tax market value gain (loss) of
interest rate contracts (17) (10) (4) - 3 5 5
------- ------- ------- ------- ------- -------
After tax gain (loss) in equity $ 753 $ 483 $ 245 - $ (310) $ (720) $(1,266)
======= ======= ======= ======= ======= =======
After tax gain (loss) in equity as a percent of
the Company's equity at June 30, 2001 4.0 % 2.6 % 1.3 % - (1.7)% (3.8)% (6.8)%
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars (except with respect to securities which are carried
at market value), without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
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Item 8. Financial Statements and Supplementary Data.
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Harrington Financial Group, Inc.
Richmond, Indiana
We have audited the accompanying consolidated balance sheets of Harrington
Financial Group, Inc. and its subsidiary (the "Company") as of June 30, 2001 and
2000, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 2001. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Harrington Financial Group, Inc.
and its subsidiary as of June 30, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2001 in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 1 to the consolidated financial statements, effective July
1, 2000 the Company changed its method of accounting for derivative instruments
and hedging activities.
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
August 3, 2001
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HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
--------------------------------------------------------------------------------
JUNE 30,
------------------------
ASSETS 2001 2000
Cash $ 1,895 $ 2,314
Interest-bearing deposits (Note 13) 8,768 22,007
--------- ---------
Total cash and cash equivalents 10,663 24,321
Securities held for trading - at fair value (amortized cost of $3,816 and $55,288)
(Notes 2, 13) 3,495 53,852
Securities available for sale - at fair value (amortized cost of $50,006 and $64,495) (Note 2) 51,039 64,052
Securities held to maturity - at amortized cost (fair value of $27 and $3,875) (Note 2) 27 3,857
Loans receivable (net of allowance for loan losses of $2,140 and $1,408) (Note 3) 329,222 270,970
Interest receivable, net (Note 4) 2,264 2,186
Premises and equipment, net (Note 5) 5,003 5,828
Federal Home Loan Bank of Indianapolis stock - at cost 4,878 4,878
Deferred income taxes, net (Note 10) 532 2,089
Income taxes receivable (Note 10) 51
Other 917 3,108
--------- ---------
TOTAL ASSETS $ 408,040 $ 435,192
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 6) $ 323,324 $ 361,241
Securities sold under agreements to repurchase (Note 7) 35,675 28,038
Federal Home Loan Bank advances (Note 8) 11,000 7,000
Note payable (Note 9) 12,995 12,995
Interest payable on securities sold under agreements to repurchase (Note 7) 51 5
Other interest payable 1,669 2,360
Advance payments by borrowers for taxes and insurance 696 746
Income tax payable 277
Accrued expenses payable and other liabilities 2,864 5,705
--------- ---------
Total liabilities 388,551 418,090
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 13, 14, 16)
MINORITY INTEREST (Note 1) 763 845
--------- ---------
STOCKHOLDERS' EQUITY (Notes 1, 10, 11, 12 16):
Preferred stock ($1 par value) authorized and unissued - 5,000,000 shares
Common stock:
Voting ($.125 par value) authorized - 10,000,000 shares, issued 3,399,938
shares, outstanding 3,129,670 and 3,150,632 shares, respectively 425 425
Additional paid-in capital 16,909 16,946
Treasury stock, 270,268 and 249,306 shares at cost (2,586) (2,488)
Accumulated other comprehensive (income)/loss, net of deferred taxes of $(209) and $(178) (489) (268)
Retained earnings 4,467 1,642
--------- ---------
Total stockholders' equity 18,726 16,257
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 408,040 $ 435,192
========= =========
See notes to consolidated financial statements.
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HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
--------------------------------------------------------------------------------
JUNE 30,
------------------------------------
2001 2000 1999
INTEREST INCOME:
Securities held for trading $ 2,236 $ 8,901 $ 18,684
Net interest expense on interest rate contracts maintained in the trading portfolio
(Note 13) (39) (85) (580)
Securities available for sale 6,125 1,094 66
Securities held to maturity 6 171 31
Loans receivable (Note 3) 24,244 20,637 16,001
Dividends on Federal Home Loan Bank of Indianapolis stock 399 391 391
Deposits 488 784 611
-------- -------- --------
33,459 31,893 35,204
-------- -------- --------
INTEREST EXPENSE:
Deposits (Notes 6, 13) 18,067 18,226 14,100
Federal Home Loan Bank advances (Note 8) 1,359 1,192 2,481
Securities sold under agreements to repurchase (Note 7) 3,078 2,809 11,433
Note payable (Note 9) 1,169 1,295 1,109
-------- -------- --------
23,673 23,522 29,123
-------- -------- --------
NET INTEREST INCOME 9,786 8,371 6,081
PROVISION FOR LOAN LOSSES (Note 3) 798 587 511
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 8,988 7,784 5,570
-------- -------- --------
OTHER INCOME (LOSS):
Gain (loss) on sale of securities held for trading (Notes 2, 13) 2,742 (4,498) 4,755
Gain (loss) on sale of loans 1 (1,173)
Unrealized gain (loss) on securities held for trading (Notes 2, 13) 1,346 3,494 (6,402)
Gain on branch sale 1,423
Other 903 772 433
-------- -------- --------
6,415 (1,405) (1,214)
-------- -------- --------
OTHER EXPENSE:
Salaries and employee benefits (Note 12) 4,804 5,090 4,290
Premises and equipment expense (Note 5) 1,392 1,516 1,262
FDIC insurance premiums 67 133 125
Marketing 131 382 314
Computer services 636 611 509
Consulting fees (Note 15) 270 276 301
Other 1,570 1,619 1,699
-------- -------- --------
8,870 9,627 8,500
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) AND MINORITY INTEREST 6,533 (3,248) (4,144)
INCOME TAX PROVISION (BENEFIT) (Note 10) 2,584 (1,277) (1,646)
-------- -------- --------
NET INCOME (LOSS) BEFORE MINORITY INTEREST 3,949 (1,971) (2,498)
MINORITY INTEREST 82 92 43
-------- -------- --------
NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 4,031 (1,879) (2,455)
CUMULATIVE EFFECT OF ADOPTION OF SFAS 133, LESS APPLICABLE INCOME TAX BENEFIT OF $530 (829)
-------- -------- --------
NET INCOME (LOSS) $ 3,202 $ (1,879) $ (2,455)
======== ======== ========
BASIC INCOME (LOSS) PER SHARE:
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 1.28 $ (0.59) $ (0.76)
PER SHARE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (0.26)
-------- -------- --------
BASIC NET INCOME (LOSS) PER SHARE (NOTE 1) $ 1.02 $ (0.59) $ (0.76)
======== ======== ========
DILUTED INCOME (LOSS) PER SHARE:
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 1.28 $ (0.59) $ (0.76)
PER SHARE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (0.26)
-------- -------- --------
DILUTED NET INCOME (LOSS) PER SHARE (NOTE 1) $ 1.02 $ (0.59) $ (0.76)
======== ======== ========
See notes to consolidated financial statements.
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HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
--------------------------------------------------------------------------------
ADDITIONAL
SHARES COMMON PAID-IN TREASURY
OUTSTANDING STOCK CAPITAL STOCK
BALANCES, JUNE 30, 1998 3,275,886 $ 425 $ 16,962 $ (1,467)
Net loss
Cash dividends declared on common stock ($0.12 per share)
Purchase of treasury stock (78,178) (784)
Issuance of treasury stock 7,674 (16) 89
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $17
---------- --------- --------- ---------
BALANCES, JUNE 30, 1999 3,205,382 425 16,946 (2,162)
Net loss
Cash dividends declared on common stock ($0.12 per share)
Purchase of treasury stock (54,750) (326)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $(195)
---------- --------- --------- ---------
BALANCES, JUNE 30, 2000 3,150,632 425 16,946 (2,488)
Net income
Cash dividends declared on common stock ($0.12 per share)
Purchase of treasury stock (30,250) (191)
Issuance of treasury stock 9,288 (37) 93
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $679
SFAS 133 transition adjustment, net of deferred tax of $2,453
Unrealized gain (loss) on deposit hedges net of
deferred tax of $(1,463)
Reclassification adjustment to earnings in accordance with
SFAS 133 net of deferred tax of $1,700
---------- --------- --------- ---------
BALANCES, June 30, 2001 $3,129,670 $ 425 $ 16,909 $ (2,586)
========== ========= ========= =========
ACCUMULATED
OTHER
COMPREHENSIVE TOTAL COMPREHENSIVE
INCOME RETAINED STOCKHOLDERS' INCOME
(LOSS) EARNINGS EQUITY (LOSS)
BALANCES, JUNE 30, 1998 $ (1) $ 6,745 $ 22,664 $ (1,825)
=========
Net loss (2,455) (2,455) $ (2,455)
Cash dividends declared on common stock ($0.12 per share) (385) (385)
Purchase of treasury stock (784)
Issuance of treasury stock 73
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $17 26 26 26
--------- --------- --------- ---------
BALANCES, JUNE 30, 1999 25 3,905 19,139 $ (2,429)
=========
Net loss (1,879) (1,879) $ (1,879)
Cash dividends declared on common stock ($0.12 per share) (384) (384)
Purchase of treasury stock (326)
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $(195) (293) (293) (293)
--------- --------- --------- ---------
BALANCES, JUNE 30, 2000 (268) 1,642 16,257 $ (2,172)
=========
Net income 3,202 3,202 $ 3,202
Cash dividends declared on common stock ($0.12 per share) (377) (377)
Purchase of treasury stock (191)
Issuance of treasury stock 56
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of $679 889 889 889
SFAS 133 transition adjustment, net of deferred tax of $2,453 3,837 3,837 3,837
Unrealized gain (loss) on deposit hedges net of
deferred tax of $(1,463) (2,288) (2,288) (2,288)
Reclassification adjustment to earnings in accordance with
SFAS 133 net of deferred tax of $(1,700) (2,659) (2,659) (2,659)
--------- --------- --------- ---------
BALANCES, June 30, 2001 $ (489) $ 4,467 $ 18,726 $ 2,981
========= ========= ========= =========
See notes to consolidated financial statements.
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54
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
YEARS ENDED JUNE 30,
---------------------------------------
2001 2000 1999
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 3,202 $ (1,879) $ (2,455)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Provision for loan losses 798 587 511
Depreciation 687 770 549
Premium and discount amortization on securities, net (33) 1,213 2,624
(Gain) loss on sale of securities held for trading (2,742) 4,498 (4,755)
Unrealized (gain) loss on securities held for trading and available for sale (1,346) (3,494) 6,402
Loss on disposal of fixed assets 1
Effect of minority interest (82) (92) (43)
Purchases of securities held for trading (319,334) (780,260)
Proceeds from maturities of securities held for trading 4,727 11,554 51,419
Proceeds from sales of securities held for trading 49,406 434,911 831,978
Increase (decrease) in amounts due brokers (4,597) 4,597
Deferred income tax provision and other (2,207) (883) (68)
Net increase (decrease) in other assets and liabilities 5,897 1,106 617
--------- --------- ---------
Net cash from operating activities 53,711 133,554 106,519
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities available for sale (61,280) (70,408)
Proceeds from maturities of securities available for sale 12,393 6,394 446
Proceeds from sale of securities available for sale 67,309
Increase in securities held to maturity 0 (3,813)
Increase in loans receivable, net (59,144) (11,925) (96,927)
Minority interest and other 23 980
Purchases of premises and equipment (133) (108) (1,436)
Proceeds from sale of fixed assets at sold branches 255
--------- --------- ---------
Net cash from investing activities (40,577) (79,860) (96,937)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 5,607 27,996 154,934
Deposits sold as part of branch sale (43,524)
Increase (decrease) in securities sold under agreements to repurchase 7,637 (32,160) (180,198)
Proceeds from Federal Home Loan Bank advances 225,000 47,000 83,000
Principal repayments on Federal Home Loan Bank advances (221,000) (80,000) (69,000)
Other (1,000) 500
Dividends paid on common stock (377) (384) (385)
Purchase of treasury stock (191) (326) (784)
Proceeds from issuance of treasury stock 56 73
--------- --------- ---------
Net cash from financing activities (26,792) (38,874) (11,860)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (13,658) 14,820 (2,278)
CASH AND CASH EQUIVALENTS, beginning of year 24,321 9,501 11,779
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 10,663 $ 24,321 $ 9,501
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 24,319 $ 23,431 $ 28,682
Cash paid for income taxes $ 97 $ 43
See notes to consolidated financial statements.
55
55
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS OF THE COMPANY - Harrington Financial Group, Inc. ("HFG" or the
"Company") is a savings and loan holding company incorporated on March
3, 1988 to acquire and hold all of the outstanding common stock of
Harrington Bank, FSB (the "Bank"), a federally chartered savings bank
with principal offices in Richmond, Indiana and seven full-service
branch offices located in Carmel, Fishers, Noblesville and Indianapolis,
Indiana; Mission, Kansas; and Chapel Hill, North Carolina. The Company
is a community bank with a focus on the origination and management of
mortgage loans and securities. The Bank also operates a commercial loan
division for business customers and owns a 51% interest in Harrington
Wealth Management Company (HWM), which provides trust, investment
management, and custody services for individuals and institutions.
On May 30, 2001, the Company announced that Hasten Bancshares, the
holding company for First National Bank & Trust, ("Hasten") would
acquire all of the outstanding shares of the Company's common stock for
$12.4916 per share at closing. The aggregate purchase price for all
shares is approximately $40 million. The acquisition is expected to
close during the first quarter of calendar year 2002. The Board of
Directors of the company approved the merger agreement at a special
meeting on May 29, 2001. The sale of the Company to Hastens is dependent
on receiving appropriate regulatory approvals, and the sale of certain
portions of the Company, as defined in the agreement. Pursuant to the
agreement, the Company is required to sell the Kansas operations to Los
Padres Bank, the North Carolina operations to Community First Financial
Group, Inc. and its interest in Harrington Wealth Management to Los
Padres Bank.
BASIS OF PRESENTATION - The consolidated financial statements include
the accounts of HFG, the Bank and HWM. All significant intercompany
accounts and transactions have been eliminated.
Harrington West Financial Group, Inc. ("HWFG"), the holding company for
Los Padres Bank ("LPB"), is a related party to Harrington Financial
Group, Inc. ("HFGI") and Harrington Bank, FSB ("HB") in that certain
officers and directors of HWFG and LPB are also officers and directors
of HFGI and HB.
In February 1999, the Company formed HWM. HWM is a strategic alliance
between the Bank (51% owner) and Los Padres Bank (49% owner), a
federally chartered savings bank located in California. The accompanying
consolidated balance sheet includes 100 percent of the assets and
liabilities of HWM, and the ownership of Los Padres Bank is recorded as
"minority interest." The results of operations include 100 percent of
the revenues and expenses of HWM from the date of formation, and the
ownership of Los Padres Bank is recorded as "minority interest" net of
income taxes.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
CASH AND CASH EQUIVALENTS - All highly liquid investments with an
original maturity of three months or less are considered to be cash
equivalents.
SECURITIES HELD FOR TRADING, HELD TO MATURITY, AND AVAILABLE FOR SALE -
The Company classifies its securities in one of three categories and
accounts for the investments as follows:
56
56
- Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as "securities held to maturity"
and reported at amortized cost.
- Debt and equity securities that are acquired and held principally
for the purpose of selling them in the near term with the objective
of generating economic profits on short-term differences in market
characteristics are classified as "securities held for trading" and
reported at fair value, with unrealized gains and losses included in
earnings.
- Debt and equity securities not classified as either held to maturity
or trading securities are classified as "securities available for
sale" and reported at fair value, with unrealized gains and losses,
after applicable taxes, excluded from earnings and reported in a
separate component of stockholders' equity. Declines in the value of
debt securities and marketable equity securities that are considered
to be other than temporary are recorded as a permanent impairment of
securities available for sale in the statement of operations.
As discussed below, SFAS No. 133, "Accounting For Derivative
Investments," as amended permits a one time transfer of securities
previously classified as held to maturity into the available for sale
category. On July 1, 2000 the Company transferred mortgage-backed
securities previously classified as held to maturity to the available
for sale category at fair value. At the time of the transfer these
securities had an amortized cost of $3,822,000 and a fair value of
$3,840,000.
Premiums and discounts are amortized over the contractual lives of the
related securities using the level yield method. Purchases and sales of
securities are recorded in the balance sheet on the trade date. Gains
and losses from security sales or disposals are recognized as of the
trade date in the statement of operations for the period in which
securities are sold or otherwise disposed of. The Company also enters
into forward contracts to purchase or sell securities held for trading.
Changes in the fair value of the forward contract are recognized in
earnings as they occur. Securities purchased or sold under a forward
contract are recorded at their fair values at the settlement date.
The Company's trading portfolio consists of mortgage-backed securities,
mortgage-backed security derivatives, equity securities and interest
rate contracts, which accordingly are carried at fair value. Realized
and unrealized changes in fair values are recognized in other income in
the period in which the changes occur. Interest income from trading
activities is included in the statement of operations as a component of
net interest income.
The Company's available for sale portfolio consists of a non-agency
participation certificate and mortgage backed securities.
Fair values of securities are based on quoted market prices or dealer
quotes. Where such quotes are not available, estimates of fair value of
securities are based upon a number of assumptions such as prepayments
which may shorten the life of such securities. Although prepayments of
underlying mortgages depend on many factors, including the type of
mortgages, the coupon rate, the age of mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and
general levels of market interest rates, the difference between the
interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate
of prepayments. While management endeavors to use the best information
available in determining prepayment assumptions, actual results could
differ from those assumptions.
DERIVATIVE FINANCIAL INSTRUMENTS - On July 1, 2000, the Company adopted
Statement of Financial Accounting Standards No. 133, ("SFAS 133"),
"Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts. All derivatives, whether designated as a hedge, or not, are
required to be recorded on the balance sheet at fair value. The Company
designates its
57
57
fixed rate and variable rate interest rate swaps as fair value and cash
flow hedge instruments, respectively. If the derivative is designated as
a fair value hedge, the changes in fair value of the derivative and of
the hedged item attributable to the hedged risk are recognized in
earnings. If the derivative is designated as a cash flow hedge, the
changes in fair value of the derivative and of the hedged item
attributable to the hedged risk are recorded in accumulated other
comprehensive income (OCI), net of income taxes.
The adoption of SFAS 133 by the Company on July 1, 2000 resulted in the
cumulative effect of an accounting change of an $829,000 loss net of tax
being recognized in the statement of operations and an increase in other
comprehensive income totaling $3.8 million net of tax in the statement
of changes in shareholders' equity.
The Bank is party to a variety of interest rate contracts consisting of
interest rate futures, options, caps, swaps, floors and collars in the
management of the interest rate exposure of its trading portfolio. These
financial instruments are included in the trading portfolio and are
reported at fair value with realized and unrealized gains and losses on
these instruments recognized in other income (see Note 2).
The Bank entered into a floating-pay interest rate swap agreement as a
means of managing the interest rate exposure of certain inverse variable
rate deposits. The Bank also entered into fixed-pay interest rate swap
agreements and interest rate cap agreements to modify the interest rate
sensitivity of a portion of the Bank's short-term LIBOR correlated
borrowings, which include short-term deposits, securities sold under
agreements to repurchase and the Federal Home Loan Bank advances. The
premiums paid to enter into such interest rate cap agreements are
included in other assets and are amortized using the straight-line
method over the related term of the agreements. These interest rate
agreements are accounted for under the accrual method. Under this
method, the differential to be paid or received on these interest rate
agreements is recognized over the lives of the agreements in interest
expense. Prior to the adoption of SFAS 133, changes in fair value of
interest rate swaps and of the interest rate caps accounted for under
the accrual method were not reflected in the accompanying financial
statements. Realized gains and losses on terminated interest rate swaps
accounted for under the accrual method were deferred as an adjustment to
the carrying amount of the designated instruments and amortized over the
remaining original life of the agreements. If the designated instruments
are disposed of, the fair value of the interest rate swap, interest rate
cap or unamortized deferred gains or losses are included in the
determination of the gain or loss on the disposition of such
instruments. To qualify for such accounting, the floating-pay interest
rate swap is designated to the inverse variable rate deposits, and the
fixed-pay interest rate swaps and the interest rate caps are designated
to a portion of the Bank's short-term LIBOR correlated borrowings which
include short-term deposits, securities sold under agreements to
repurchase and the Federal Home Loan Bank advances.
LOANS RECEIVABLE are carried at the principal amount outstanding,
adjusted for premiums or discounts which are amortized or accreted using
a level-yield method. SFAS No. 114 and No. 118, "Accounting by Creditors
for Impairment of a Loan" and "Income Recognition" and Disclosures,
require that impaired loans be measured based on the present value of
future cash flows discounted at the loan's effective interest rate or
the fair value of the underlying collateral, and specifies alternative
methods for recognizing interest income on loans that are impaired or
for which there are credit concerns. For purposes of applying these
standards, impaired loans have been defined as all nonaccrual
commercial loans which have not been collectively evaluated for
impairment. An impaired loan is charged off by management as a loss
when deemed uncollectible although collection efforts continue and
future recoveries may occur.
Discounts and premiums on purchased residential real estate loans are
amortized to income using the effective interest method over the
remaining period to contractual maturity.
58
58
Nonrefundable origination fees net of certain direct origination costs
are deferred and recognized, as a yield adjustment, over the life of the
underlying loan.
ALLOWANCE FOR LOSSES - A provision for estimated losses on loans is
charged to operations based upon management's evaluation of the
potential losses. Such an evaluation, which includes a review of all
loans for which full collectibility may not be reasonably assured,
considers, among other matters, the estimated net realizable value of
the underlying collateral, as applicable, economic conditions,
historical loan loss experience and other factors that are particularly
susceptible to changes that could result in a material adjustment in the
near term. While management endeavors to use the best information
available in making its evaluations, future allowance adjustments may be
necessary if economic conditions change substantially from the
assumptions used in making the evaluations.
INTEREST RECEIVABLE - Interest income on securities and loans is accrued
according to the contractual terms of the underlying asset including
interest rate, basis and date of last payment. Income on derivatives of
mortgage-backed securities is recorded based on projected cash flows
using the median of major brokers' prepayment assumptions for the
underlying securities. The Bank provides an allowance for the loss of
uncollected interest on loans which are more than 90 days past due. The
allowance is established by a charge to interest income equal to all
interest previously accrued, and income is subsequently recognized only
to the extent that cash payments are received until, in management's
judgment, the borrower's ability to make periodic interest and principal
payments returns to normal, in which case the loan is returned to
accrual status.
PREMISES AND EQUIPMENT are carried at cost less accumulated
depreciation. Depreciation is computed on the straight-line method over
the estimated useful lives ranging from 3 to 40 years. Maintenance and
repairs are expensed as incurred while major additions and improvements
are capitalized. Gains and losses on dispositions are included in
current operations.
FEDERAL INCOME TAXES - The Company and its wholly owned subsidiary, the
Bank, file a consolidated tax return. HWM files a separate tax return,
as the total ownership of the company does not qualify for consolidated
tax filing. Deferred income tax assets and liabilities reflect the
impact of temporary differences between amounts of assets and
liabilities for financial reporting purposes and basis of such assets
and liabilities as measured by tax laws and regulations.
EARNINGS PER SHARE - Earnings per share of common stock is based on the
weighted average number of common shares outstanding during the year.
The following is a reconciliation of the weighted average common shares
for the basic and diluted earnings per share computations:
YEARS ENDED JUNE 30,
--------------------------------------------
2001 2000 1999
Basic earnings per share:
Weighted average common shares 3,138,973 3,199,034 3,216,626
========== ========== ==========
Diluted earnings per share:
Weighted average common shares 3,138,973 3,199,034 3,216,626
Dilutive effect of stock options (1) 13,814
---------- ---------- ----------
Weighted average common and incremental
shares 3,152,787 3,199,034 3,216,626
========== ========== ==========
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59
(1) The impact of stock options was not included due to the
anti-dilutive effect for the fiscal years ended June 30, 2000 and
1999.
NEW ACCOUNTING PRONOUNCEMENT - Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets,"
was issued in July 2001. Under SFAS 142, goodwill amortization ceases
when the new standard is adopted. The new rules also require an initial
goodwill impairment assessment in the year of adoption and at least
annual impairment tests thereafter.
RECLASSIFICATIONS of certain amounts in the 2000 and 1999 consolidated
financial statements have been made to conform to the 2001 presentation.
2. SECURITIES
The amortized cost and estimated fair values of securities held for
trading and securities available for sale are summarized as follows:
(Dollars in Thousands) JUNE 30, 2001
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
Securities held for trading:
GNMA certificates $ 1,423 $ 12 $ 46 $ 1,389
FHLMC certificates 488 4 24 468
FNMA certificates 642 6 18 630
Collateralized mortgage obligations 370 33 403
Residuals 95 22 117
Interest-only strips 555 408 147
Principal-only strips 241 93 334
Interest rate collar 2 5 7
------- ------- ------- -------
Totals $ 3,816 $ 175 $ 496 $ 3,495
======= ======= ======= =======
Securities available for sale:
GNMA certificates $29,692 $ 367 $ $30,059
FHLMC certificates 8,596 193 8,789
FNMA certificates 11,506 407 11,913
Non-agency participation certificate 212 66 278
------- ------- ------- -------
Totals $50,006 $ 1,033 $ $51,039
======= ======= ======= =======
Securities held to maturity:
Mortgage revenue bonds 27 27
------- ------- ------- -------
Totals $ 27 $ $ $ 27
======= ======= ======= =======
The Bank's collateralized mortgage obligation (CMO) portfolio at June
30, 2001 consisted of one agency investment with an estimated remaining
weighted average life of 2.42 years.
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60
(Dollars in Thousands) JUNE 30, 2000
-------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
Securities held for trading:
GNMA certificates $ 24,662 $ 111 $ 242 $ 24,531
FHLMC certificates 14,921 102 645 14,378
FNMA certificates 8,830 3 371 8,462
Collateralized mortgage obligations 5,609 34 57 5,586
Residuals 139 40 - 179
Interest-only strips 631 - 374 257
Principal-only strips 306 86 - 392
Interest rate swaps - - 18 (18)
Interest rate collar 3 - 1 2
Swaptions 181 - 68 113
Futures - - 41 (41)
Equity securities 6 5 - 11
-------- -------- -------- --------
Totals $ 55,288 $ 381 $ 1,817 $ 53,852
======== ======== ======== ========
Securities available for sale:
GNMA certificates $ 63,806 $ 3 $ 488 $ 63,321
Commercial mortgage backed securities 353 - - 353
Non-agency participation certificate 336 42 - 378
-------- -------- -------- --------
Totals $ 64,495 $ 45 $ 488 $ 64,052
======== ======== ======== ========
Securities held to maturity:
Mortgage backed securities $ 3,821 $ 14 $ - $ 3,835
Other 1 4 - 5
Mortgage revenue bonds 35 - - 35
-------- -------- -------- --------
Totals $ 3,857 $ 18 $ - $ 3,875
======== ======== ======== ========
The Bank's collateralized mortgage obligation (CMO) portfolio at June
30, 2000 consisted of three agency investments with an estimated
remaining weighted average life of 9.9 years.
For a complete discussion of the Bank's Risk Management Activities, see
Note 13.
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The amortized cost and estimated fair values of securities by
contractual maturity are as follows:
(Dollars in Thousands) JUNE 30, 2001
---------------------------------------------------------------------------------
HELD FOR TRADING AVAILABLE FOR SALE HELD TO MATURITY
------------------------ ------------------------ --------------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
Debt securities (due after 1 year
through 5 years):
Mortgage-backed securities $ 2,553 $ 2,487 $49,794 $50,761
Non-agency participation certificates 212 278
Collateralized mortgage obligations 370 403
Mortgage-backed derivatives 891 598
Interest rate contracts 2 7
Mortgage revenue bonds $ 27 $ 27
------- ------- ------- ------- ------- -------
Other $ 3,816 $ 3,495 $50,006 $51,039 $ 27 $ 27
======= ======= ======= ======= ======= =======
Securities with a total amortized cost of $46,552,000 and $35,889,000
and a total fair value of $47,477,000 and $35,633,000 were pledged at
June 30, 2001 and 2000, respectively, to secure interest rate swaps,
securities sold under agreements to repurchase, and letters of credit.
The Bank had mortgages pledged as collateral for Federal Home Loan Bank
advances of approximately $101,000,000 and $149,000,000 at June 30, 2001
and 2000, respectively.
Activities related to the sale of securities are summarized as follows:
(Dollars in Thousands) JUNE 30,
----------------------------------------
2001 2000 1999
Proceeds from sale of securities held for trading $ 49,406 $434,911 $831,978
Gross gains on sales of securities held for trading 2,702 40,381 64,966
Gross losses on sales of securities held for trading 1,889 44,879 60,218
Gross gains on sales of securities available for sale 2,023 7
Gross losses on sales of securities available for sale 94
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3. LOANS RECEIVABLE
Loans receivable are summarized as follows:
(Dollars in Thousands) JUNE 30,
--------------------------
2001 2000
Real estate mortgage $177,889 $181,350
Commercial 115,103 72,965
Property improvement 15,116 4,935
Consumer and home equity lines of credit 17,269 9,313
Automobile loans 3,134 2,371
Other loans 1,661 997
-------- --------
Subtotal 330,172 271,931
Net deferred loan fees and origination costs, premiums and
discounts, and other 1,190 447
Allowance for loan losses (2,140) (1,408)
-------- --------
Loans receivable, net $329,222 $270,970
======== ========
Approximately 88% of the Bank's loans are to customers located in the
immediate market areas of its offices in Richmond and Indianapolis, Indiana
as well as Mission, Kansas and Chapel Hill, North Carolina.
The principal balance of loans on nonaccrual status totaled approximately
$2,164,000 and $180,000 at June 30, 2001 and 2000, respectively. For the
years ended June 30, 2001, 2000 and 1999, gross interest income which would
have been recorded had the Bank's nonaccruing loans been current with their
original terms amounted to $41,000, $6,000, and $1,000, respectively. At
June 30, 2001 and June 30, 2000, the Company had $2,164,000 and $180,000,
respectively of impaired loans.
The Bank had commitments to originate or purchase loans consisting
primarily of real estate mortgages secured by one to four family residences
approximating $394,000 and $1,379,000 excluding undisbursed portions of
loans in-process at June 30, 2001 and 2000, respectively. In addition, as
of June 30, 2001 and 2000, the Bank had commitments to fund approximately
$13.8 million and $7.2 million, respectively in commercial loans secured
primarily by commercial real estate.
The Bank has granted loans to its directors, officers, employees and an
affiliate (Smith Breeden Associates, Inc., see Note 15). These loans to
related parties are summarized as follows:
(Dollars in Thousands) JUNE 30,
---------------------
2001 2000
Beginning balance $8,834 $4,515
Loans made 1,313 4,358
Principal repayments (1,648) (38)
Change due to status of officers and employees (249) (1)
------ ------
Ending balance $8,250 $8,834
====== ======
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The amount of loans serviced for others totaled $21.1 million and $24.2
million at June 30, 2001 and 2000, respectively. Servicing loans for others
generally consists of collecting mortgage payments, maintaining escrow
amounts, disbursing payments to investors and foreclosure processing. In
connection with loans serviced for others, the Bank held borrowers' escrow
balances of $96,000 and $13,000 at June 30, 2001 and 2000, respectively.
Loan servicing fee income included in other income for the years ended June
30, 2001, 2000 and 1999 was $8,000, $7,000 and $10,000, respectively.
An analysis of the allowance for loan losses is as follows:
(Dollars in Thousands) JUNE 30,
--------------------------------
2001 2000 1999
Beginning balance $1,408 $868 $360
Provision for loan losses 798 587 511
Net charge-offs (66) (47) (3)
------ ------ ----
Ending balance $2,140 $1,408 $868
====== ====== ====
As a federally chartered savings bank, aggregate commercial real estate
loans may not exceed 400% of capital as determined under the capital
standards provisions of FIRREA. This limitation was approximately $116
million at June 30, 2001. Also under FIRREA, the loans-to-one borrower
limitation is generally 15% of unimpaired capital and surplus which, for
the Bank, was approximately $4 million at June 30, 2001. The Bank was in
compliance with all of these requirements at June 30, 2001.
4. INTEREST RECEIVABLE
Interest receivable is summarized as follows:
(Dollars in Thousands) JUNE 30,
------------------
2001 2000
Loans (less allowance for uncollectibles - $41 and $6) $1,856 $1,479
Securities held for trading 136 317
Securities available for sale 264 345
Other 8 45
------ ------
Interest receivable, net $2,264 $2,186
====== ======
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5. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
(Dollars in Thousands) JUNE 30,
-----------------------
2001 2000
Land $ 1,003 $ 1,003
Buildings and leasehold improvements 4,543 4,684
Furniture, fixtures and equipment 2,483 2,709
------- -------
Total 8,029 8,396
Less accumulated depreciation (3,026) (2,568)
------- -------
Premises and equipment, net $ 5,003 $ 5,828
======= =======
Depreciation expense included in operations during the years ended June 30,
2001, 2000 and 1999 totaled $687,000, $770,000 and $549,000 respectively.
6. DEPOSITS
(Dollars in Thousands) JUNE 30,
--------------------------------------------------
2001 2000
----------------------- ------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
NOW and DDA accounts $ 40,431 2.70 % $ 37,879 3.29 %
Savings accounts 40,158 4.23 % 35,646 4.37 %
Money market deposit accounts 47,386 4.44 % 62,159 5.20 %
-------- --------
127,975 135,684
-------- --------
Certificates of deposit:
1 year and less 158,350 162,795
1 to 2 years 18,132 37,936
2 to 3 years 5,965 11,586
3 to 4 years 10,645 2,431
Over 4 years 2,257 10,809
-------- --------
195,349 5.59 % 225,557 6.13 %
-------- --------
Total deposits $323,324 $361,241
======== ========
Certificates of deposit in the amount of $100,000 or more totaled
approximately $63 million and $57 million at June 30, 2001 and 2000,
respectively.
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A summary of certificate accounts by scheduled fiscal year maturities at
June 30, 2001, is as follows:
(Dollars in Thousands)
2002 2003 2004 2005 2006 2007 THEREAFTER TOTAL
3.00% or less $ 586 $ 340 $ 3 $ 929
3.01% - 5.00% 64,712 1,542 $ 548 $ 266 $ 56 67,124
5.01% - 7.00% 88,482 15,077 5,221 8,749 1,738 $ 170 290 119,727
7.01% - 9.00% 3,599 1,173 196 1,630 6,598
9.01% or greater 971 971
--------- -------- ------- -------- ------- ----- ----- ---------
Totals $ 158,350 $ 18,132 $ 5,965 $ 10,645 $ 1,794 $ 170 $ 293 $ 195,349
========= ======== ======= ======== ======= ===== ===== =========
Interest expense on deposits is as follows:
(Dollars in Thousands)
YEARS ENDED JUNE 30,
--------------------------------
2001 2000 1999
NOW and DDA accounts $ 1,175 $ 1,013 $ 306
Savings accounts 1,382 1,371 1,279
Money market deposit accounts 2,313 5,148 3,546
Certificates of deposit 13,197 10,694 8,969
------- ------- -------
$18,067 $18,226 $14,100
======= ======= =======
Interest expense on certificates of deposit is net of interest income
(expense) on interest rate contracts of $(99,000), $(75,000), and $31,000
for the years ended June 30, 2001, 2000 and 1999, respectively.
For a complete discussion of the Bank's Risk Management Activities, see
Note 13.
7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
(Dollars in Thousands) JUNE 30,
------------------------
2001 2000
Securities sold under agreements to repurchase:
Same securities $35,675 $28,038
------- -------
$35,675 $28,038
======= =======
Accrued interest on securities sold under agreements to repurchase $ 51 $ 5
======= =======
At June 30, 2001, securities sold under agreements to repurchase mature
within one month.
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An analysis of securities sold under agreements to repurchase, excluding
related accrued interest, is as follows:
(Dollars in Thousands) YEARS ENDED JUNE 30,
------------------------------------
2001 2000 1999
Maximum amount outstanding at any month-end $ 63,735 $102,953 $334,160
Daily average amount outstanding 52,767 52,466 213,428
Weighted average interest rate at end of year 3.73 % 6.31 % 4.85 %
Assets pledged to secure securities sold under agreements to repurchase are
concentrated among one dealer and ten business customers and one dealer and
eight business customers as of June 30, 2001 and 2000, respectively. The
Bank exercises control over the securities pledged when the same security
is repurchased. Assets pledged are as follows:
(Dollars in Thousands) JUNE 30,
------------------------
2001 2000
Mortgage-backed securities:
At amortized cost $33,359 $30,932
At fair value 34,076 30,675
An analysis of the amount at risk under repurchase agreements with
counterparties exceeding 10% of stockholders' equity at June 30, 2001 is as
follows:
(Dollars in Thousands) WEIGHTED
AVERAGE
AMOUNT ACCRUED MATURITY
OUTSTANDING INTEREST (IN DAYS)
Dean Witter $32,287 $ 50 20
======= ====
8. FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis are as follows:
(Dollars in Thousands) JUNE 30,
--------------------------------------------
2001 2000
--------------------- ---------------------
VARIABLE VARIABLE
WEIGHTED WEIGHTED
AVERAGE AVERAGE
FISCAL YEAR MATURITY AMOUNT RATE AMOUNT RATE
2001 $ 7,000 6.87 %
2002 $11,000 5.51 %
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The Bank was eligible to receive advances from the Federal Home Loan Bank
up to $67.2 million and $93.7 million at June 30, 2001 and 2000,
respectively. The Bank has pledged qualifying mortgage loans.
9. NOTE PAYABLE
At June 30, 2001, the Company has a $12,995,000 term loan from Firstar Bank
N.A. Overland Park (formerly Mercantile Bancorporation, Inc. and Mark Twain
Bank). Quarterly interest-only payments, based on the prime rate published
in the Wall Street Journal (6.75% at June 30, 2001), are payable through
maturity of September 30, 2001. The unpaid principal balance outstanding is
payable in full on September 30, 2001.
As of June 30, 2001, the loan was secured by the Harrington Bank, FSB stock
held by HFG, a blanket security interest in all of the Company's assets and
the assignment of certain life insurance policies owned by HFG. Under the
terms of the agreement, the Company is bound by certain restrictive debt
covenants. As of June 30, 2001, HFG was in compliance with all such debt
covenants.
10. INCOME TAXES
An analysis of the income tax provision (benefit) is as follows:
(Dollars in Thousands) YEARS ENDED JUNE 30,
---------------------------------------
2001 2000 1999
Current:
Federal $ 290
State 87
Deferred:
Federal $ 1,766 $(1,161) $(1,304)
State 441 (116) (342)
------- ------- -------
Total income tax provision (benefit) $ 2,584 $(1,277) $(1,646)
======= ======= =======
The difference between the financial statement income tax rate and the
amount computed by using the statutory rate of 34% is reconciled as
follows:
(Dollars in Thousands) YEARS ENDED JUNE 30,
--------------------------------
2001 2000 1999
Federal statutory income tax at 34% 2,221 $(1,104) $(1,409)
State income taxes, net of federal tax benefit 352 (186) (226)
Other, net 11 13 (11)
----- ------- -------
Total income tax provision (benefit) 2,584 $(1,277) $(1,646)
===== ======= =======
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The Company's deferred income tax assets (liabilities) are as follows:
(Dollars in Thousands) JUNE 30,
----------------------
2001 2000
Net operating loss carryforwards $ 2,112
Bad debt reserves, net $ 794 520
Unrealized (gain) loss on securities available for sale included in
accumulated other comprehensive income (439) 173
Unrealized gain on securities held for trading 709 (505)
Differences in income recognition on investments (312) (246)
Property and equipment (102)
Other, net (118) 35
------- -------
Deferred income taxes, net $ 532 $ 2,089
======= =======
Retained earnings at June 30, 2001 and 2000 includes approximately $3
million of income that has not been subject to tax because of deductions
for bad debts allowed for federal income tax purposes. Deferred income
taxes have not been provided on such bad debt deductions since the Company
does not intend to use the accumulated bad debt deductions for purposes
other than to absorb loan losses. If, in the future, this portion of
retained earnings is used for any purpose other than to absorb bad debt
losses, federal income taxes may be imposed on such amounts at the then
current corporation income tax rate.
In August 1996, the "Small Business Job Protection Act of 1996" was passed
into law. One provision of the act repeals the special bad debt reserve
method for thrift institutions currently provided for in Section 593 of the
IRC. The provision requires thrifts to recapture any reserve accumulated
after 1987 but forgives taxes owed on reserves accumulated prior to 1988.
The Bank delayed the timing of this recapture for taxable years 1998 and
1997 as certain residential loan test requirements were met. The six-year
recovery period for the excess reserves began in taxable year 1999. The
adoption of the act did not have a material adverse effect on the Company's
consolidated financial position.
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt 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 that have been established by regulation to ensure
capital adequacy require the Bank to maintain minimum capital amounts and
ratios (set forth in the table below). The Bank's primary regulatory
agency, the OTS, currently requires that the Bank maintain minimum ratios
of tangible capital (as defined in the regulations) of 1.5%, core capital
(as defined) of 4%, and total risk-based capital (as defined) of 8%. The
Bank is also subject to prompt corrective action capital requirement
regulations set forth by the Federal Deposit Insurance Corporation
("FDIC"). The FDIC requires the Bank to maintain minimum capital amounts
and ratios of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of June 30, 2001, that
the Bank meets all capital adequacy requirements to which it is subject.
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69
As of June 30, 2001, the most recent notification from the OTS categorized
the Bank as "well capitalized" under the regulatory framework for prompt
corrective action. To be categorized as "well capitalized" the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage
ratios as set forth in the table. There are no conditions or events since
that notification that management believes have changed the institution's
category.
(Dollars in Thousands) TO BE CATEGORIZED
AS "WELL CAPITALIZED"
UNDER PROMPT
FOR CAPITAL CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
--------------------- --------------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
AS OF JUNE 30, 2001:
Tangible capital (to total assets) $30,164 7.39% $ 6,117 1.50% N/A N/A
Core capital (to total assets) 30,164 7.39 16,312 4.00 N/A N/A
Total risk-based capital (to risk weighted assets) 32,304 11.87 21,780 8.00 $27,226 10.00%
Tier I risk-based capital (to risk weighted assets) 30,164 11.08 N/A N/A 16,335 6.00
Tier I leverage capital (to average assets) 30,164 7.40 N/A N/A 20,390 5.00
AS OF JUNE 30, 2000:
Tangible capital (to total assets) $28,735 6.62% $ 6,514 1.50% N/A N/A
Core capital (to total assets) 28,735 6.62 17,371 4.00 N/A N/A
Total risk-based capital (to risk weighted assets) 30,143 12.64 19,085 8.00 $23,857 10.00%
Tier I risk-based capital (to risk weighted assets) 28,735 12.04 N/A N/A 14,314 6.00
Tier I leverage capital (to average assets) 28,735 6.62 N/A N/A 21,713 5.00
12. EMPLOYEE BENEFIT PLANS
PROFIT-SHARING PLAN - The Company had a qualified noncontributory
profit-sharing plan for all eligible employees through June 30, 2000. The
plan provided for contributions by the Company in such amounts as its Board
of Directors annually determined. Contributions charged to expense for the
years ended June 30, 2000 and 1999 were $49,000, and $99,000, respectively.
During the year ended June 30, 2001 the profit-sharing plan was rolled into
the new 401(k) plan.
401(k) PLAN - The Company established a 401(k) plan effective January 1,
2001. This plan replaces the profit-sharing plan which was rolled over into
the new 401(k) plan. The Company's discretionary and matching contributions
that were charged to expense for the year ended June 30, 2001 were $45,000.
STOCK OPTIONS - The Company has granted stock options to existing
stockholders, officers, directors and other affiliated individuals to
purchase shares of the Company's stock at prices at least equal to the fair
value of the stock on the date of the grant. The options are
nontransferable and are forfeited upon termination of employment, as
applicable. Awarded options vest at a rate of 20% per year. At June 30,
2001, all outstanding stock options were exercisable up to December 2010.
The following is an analysis of stock option activity for each of the three
years in the period ended June 30, 2001 and the stock options outstanding
at the end of the respective years:
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YEARS ENDED JUNE 30,
----------------------------------------------------------
2001 2000 1999
----------------- ------------------ -----------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding, beginning of fiscal year 153,700 $ 9.16 102,200 $ 10.57 60,000 $ 11.33
Granted 65,750 6.00 62,000 7.02 43,000 9.52
Forfeited or expired (9,550) 8.95 (10,500) 10.29 (800) 10.00
------- -------- ------- --------- ------- ---------
Outstanding, end of fiscal year 209,900 $ 8.18 153,700 $ 9.16 102,200 $ 10.57
======= ======== ======= ========= ======= =========
Options exercisable at end of fiscal year 64,190 $ 9.98 37,230 $ 10.75 20,290 $ 10.98
======= ======== ======= ========= ======= =========
As of June 30, 2001, options outstanding have exercise prices between $5.75
and $12.50 and a weighted average remaining contractual life of 8.1 years.
The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for the options;
accordingly, since the grant price of the stock options is at least 100% of
the fair value at the date of the grant, no compensation expense has been
recognized by the Company in connection with the option grants. Had
compensation cost for the plans been determined based on the fair value at
the grant dates for awards under the plan consistent with the fair value
method of SFAS No. 123, Accounting for Stock-Based Compensation, the
Company's net income (loss) per share would have been the pro forma amounts
indicated below:
(Dollars in Thousands, except per share data) YEARS ENDED JUNE 30,
-----------------------------------------------------------------
2001 2000 1999
Net income (loss):
As reported $ 3,202 $(1,879) $(2,455)
Pro forma $ 3,157 $(1,910) $(2,482)
Basic income (loss) per share:
As reported $ 1.02 $ (0.59) $ (0.76)
Pro forma $ 1.01 $ (0.60) $ (0.77)
Diluted income (loss) per share:
As reported $ 1.02 $ (0.59) $ (0.76)
Pro forma $ 1.01 $ (0.60) $ (0.77)
The weighted average fair value of options granted was $1.71, $1.99 and
$1.69 in fiscal years 2001, 2000 and 1999, respectively. The fair value of
the option grants is estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions: dividend yields
ranging from 0% to 2.09%, risk-free interest rates ranging from 4.38% to
6.76%, expected volatilities ranging from 15.80% to 28.63% and expected
lives of five years. The pro forma amounts are not representative of the
effects on reported net income for future years.
EMPLOYEE STOCK OWNERSHIP PLAN - The Company has an Employee Stock Ownership
Plan (ESOP) for all eligible employees of the Company, the Bank and HWM.
Employees who have been credited with at least 1,000 hours of service
during a twelve-month period are eligible to participate in the ESOP.
During the 2000 fiscal year, the ESOP purchased 7,250 shares at a price of
$5.75 per share. These shares have been allocated to eligible employees.
During the 1999 fiscal year, the ESOP purchased
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22,674 shares at prices ranging from $8.06 to $9.63 per share, which have
been allocated to eligible employees. The ESOP did not purchase any shares
in fiscal 2001. Contributions are allocated to eligible employees based on
their eligible compensation as defined in the ESOP Agreement. Gross
compensation expense (i.e. the value of shares contributed or committed to
be contributed to the ESOP by the Company) for fiscal years 2001, 2000 and
1999 was $0, $49,000 and $121,000, respectively.
13. RISK MANAGEMENT ACTIVITIES
The Bank closely monitors the sensitivity of its balance sheet and income
statement to potential changes in the interest rate environment. Derivative
financial instruments such as interest rate swaps, caps, floors, collars,
futures, and options are used on an aggregate basis to protect the trading
portfolio and certain liabilities from adverse rate movements. The Bank's
objective, with regard to managing interest rate risk, is to maintain at an
acceptably low level the sensitivity to rising or falling rates of its
market value of portfolio equity.
INTEREST RATE SWAPS are contracts in which the parties agree to exchange
fixed and floating rate payments for a specified period of time on a
specified (notional) amount. The notional amount is only used to calculate
the amount of the periodic interest payments to be exchanged, and does not
represent the amount at risk. The Bank uses swaps to modify the effective
duration of various assets and liabilities. The floating rates are
generally indexed to the three-month London Interbank Offered Rates
(LIBOR).
INTEREST RATE CAPS AND FLOORS are instruments in which the writer (seller)
agrees to pay the holder (purchaser) the amount that an agreed-upon index
is above or below the specified cap or floor rate, respectively, times the
notional amount. In return for this promise of future payments, the
purchaser pays a premium to the seller. The notional amount is never
exchanged between the two parties and does not represent the amount at
risk. The Bank purchases interest rate caps and floors to reduce the impact
of rising or falling interest rates on the market value of its trading
portfolio. The interest rate caps and floors generally have indexes equal
to one or three month LIBOR.
The Bank is a party to an INTEREST RATE COLLAR which also is used to manage
interest rate risk in the trading portfolio. The interest rate collar
consists of an interest rate cap held by the Bank and an interest rate
floor written by the Bank. The notional amount of the interest rate collar
is based on the balance in the collection accounts of certain Merrill Lynch
collateralized mortgage obligation trusts.
INTEREST RATE FUTURES CONTRACTS are commitments to either purchase or sell
designated instruments at a future date for a specified price. Initial
margin requirements are met in cash or other instruments, and changes in
the contract values are settled in cash daily. The Bank enters into futures
contracts when these instruments are economically advantageous to interest
rate swaps, caps and floors. The Bank uses primarily Eurodollar contracts
which are structured in calendar quarter increments and therefore result in
a much larger notional amount than longer maturity swap, cap or floor
contracts which represent a series of quarterly repricings.
FINANCIAL OPTIONS are contracts which grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer a
specified financial instrument under agreed-upon terms. Financial options
to buy or sell securities are typically traded in standardized contracts on
organized exchanges. The Bank purchases financial options to reduce the
risk of the written financial options embedded in mortgage related assets.
CASH RESTRICTIONS - The Bank maintained $999,000 at June 30, 2000, in U.S.
Treasury Securities, which are considered cash equivalents, as a deposit
with a broker for its futures activities. The Bank had no restrictions on
its cash and cash equivalents at June 30, 2001.
72
72
CREDIT RISK - The Bank is dedicated to managing credit risks associated
with hedging activities. The Bank maintains trading positions with a
variety of counterparties or obligors ("counterparties"). To limit credit
exposure arising from such transactions, the Bank evaluates the credit
standing of counterparties, establishes limits for the total exposure to
any one counterparty, monitors exposure against the established limits and
monitors trading portfolio composition to manage concentrations. In
addition, the Bank maintains qualifying netting agreements with its
counterparties and records gains and losses on derivative financial
instruments net in the trading portfolio.
The Bank's exposure to credit risk from derivative financial instruments is
represented by the fair value of instruments. Credit risk amounts represent
the replacement cost the Bank could incur should counterparties with
contracts in a gain position completely fail to perform under the terms of
those contracts and any collateral underlying the contracts proves to be of
no value to the Bank. Counterparties are subject to the credit approval and
credit monitoring policies and procedures of the Bank. Certain instruments
require the Bank or the counterparty to maintain collateral for all or part
of the exposure. Limits for exposure to any particular counterparty are
established and monitored. Notional or contract amounts indicate the total
volume of transactions and significantly exceed the amount of the Bank's
credit or market risk associated with these instruments.
The following positions are included in the Bank's trading portfolio and
are thus reported in the financial statements at current fair value.
(Dollars in Thousands) JUNE 30, 2001
---------------------------------------------------------------------------------------------
CONTRACT OR ESTIMATED
NOTIONAL FAIR VALUE WEIGHTED AVERAGE INTEREST RATE
--------------------- -----------------------------------------------------
AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE CAP FLOOR
Interest rate collar $ 255 $ 7 N/A 6.57 % 3.86 % 10.25 5.25
(Dollars in Thousands) JUNE 30, 2000
---------------------------------------------------------------------------------------------
CONTRACT OR ESTIMATED
NOTIONAL FAIR VALUE WEIGHTED AVERAGE INTEREST RATE
---------------------- --------------------------------------------------
AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE CAP FLOOR
Interest rate swaps:
Pay fixed rate $ 5,000 $ 18 6.58 % 6.28 % N/A N/A
Interest rate collar 343 $ 2 6.57 % 6.23 % 10.25 5.25
Futures 516,000 41 N/A N/A N/A N/A
Swaptions 15,000 113 N/A N/A N/A N/A
--------- ----- ----
$ 536,343 $ 115 $ 59
========= ===== ====
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(Dollars in Thousands) YEARS ENDED JUNE 30,
--------------------------------------------------------------
2001 2000
----------------------------- ------------------------------
MONTHLY MONTHLY
AVERAGE AVERAGE
FAIR VALUE FAIR VALUE
----------------------------- ------------------------------
ASSET LIABILITY ASSET LIABILITY
Interest rate swaps:
Pay fixed rate $ (9)
Interest rate collar $ 4 N/A $ 3
Futures 190
Swaptions 184
--- ----- -----
$ 4 $ 187 $ 181
=== ===== =====
The following table shows the various components of the Company's recorded
net gain on its trading portfolio. All realized and unrealized gains and
losses are reported as other income in the statement of operations. The
periodic exchanges of interest payments and the amortization of premiums
paid for contracts are accounted for as adjustments to the yields, and are
reported on the statements of operations as interest income.
(Dollars in Thousands) YEARS ENDED JUNE 30, 2001
-----------------------------------------
REALIZED UNREALIZED NET TRADING
GAINS/ GAINS/ GAINS/
(LOSSES) (LOSSES) (LOSSES)
Interest rate contracts:
Swaps $ 596 $ 214 $ 810
Caps 1,000 1,000
Collar 6 6
Futures (325) 41 (284)
Swaptions (48) 68 20
------- ------- -------
Total 1,223 329 1,552
MBS and other trading assets 1,519 1,017 2,536
------- ------- -------
Total trading portfolio $ 2,742 $ 1,346 $ 4,088
======= ======= =======
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(Dollars in Thousands) YEARS ENDED JUNE 30, 2000
--------------------------------------
REALIZED UNREALIZED NET TRADING
GAINS/ GAINS/ GAINS/
(LOSSES) (LOSSES) (LOSSES)
Interest rate contracts:
Swaps $ 129 $ 192 $ 321
Caps (746) 596 (150)
Floors (1,008) (1,008)
Collar (1) (1)
Futures 2,667 1,570 4,237
Swaptions (43) (99) (142)
------- ------- -------
Total 999 2,258 3,257
MBS and other trading assets (5,497) 1,235 (4,262)
------- ------- -------
Total trading portfolio $(4,498) $ 3,493 $(1,005)
======= ======= =======
(Dollars in Thousands) YEARS ENDED JUNE 30, 1999
----------------------------------------
REALIZED UNREALIZED NET TRADING
GAINS/ GAINS/ GAINS/
(LOSSES) (LOSSES) (LOSSES)
Interest rate contracts:
Swaps $ 13 $ 222 $ 235
Caps 1,000 1,000
Floors (469) (469)
Collar 60 60
Futures 4,591 (1,354) 3,237
Options 48 48
------- ------- -------
Total 4,604 (493) 4,111
MBS and other trading assets 144 (5,909) (5,765)
------- ------- -------
Total trading portfolio $ 4,748 $(6,402) $(1,654)
======= ======= =======
The following table sets forth the maturity distribution and weighted
average interest rates of financial instruments used on an aggregate basis
to protect the trading portfolio from adverse rate movements at June 30,
2001.
(Dollars in Thousands)
Interest rate collar
Notional amount $ 255
Weighted average cap rate 10.25 %
Weighted average floor rate 5.25 %
Maturities during fiscal years ending June 30, 2006
At June 30, 2000, one of the interest rate swaps was used to modify the
interest rate sensitivity of certain certificates of deposit issued by the
Bank. These certificates of deposit, called inverse variable rate CDs,
adjust according to a formula in such a way as to pay a higher rate of
interest when the index falls, and a lower rate of interest when the index
rises. As of June 30, 2001 and 2000, the Bank held approximately
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75
$1.9 million and $2.7 million of inverse variable rate CDs, with original
terms to maturity ranging from three to ten years. In 2000, the Bank
utilized the interest rate swap to convert the inverse variable rate
certificates of deposit effectively to fixed rate deposits. The interest
rate swap protects the Bank against the exposure to falling interest rates
inherent in these CDs. There was no swap contract in place at June 30,
2001.
In addition, the Bank also has interest rate swaps which are used to modify
the interest rate sensitivity of a portion of the Bank's short-term LIBOR
correlated borrowings, which include short-term deposits, securities sold
under agreements to repurchase and the Federal Home Loan Bank advances. As
of June 30, 2001, these swaps had a total notional amount of $60 million.
The repricing characteristics of the Bank's short-term borrowings are
similar in nature to those of the related interest rate swap instruments.
The short term borrowings reach their maturities before the maturities of
the matched interest rate swaps; however, it is the Bank's intent to
consistently maintain such short term LIBOR correlated borrowings in the
normal course of business which will be designated against these specific
interest rate swaps.
During the year ended June 30, 2001, the Company terminated $93.0 million
of caps and swaps.
As a result of the extinguishment of short-term liabilities associated with
the terminated swaps and caps, certain hedged transactions were deemed by
management to be no longer probable of occurring. In accordance with
SFAS 133, amounts relating to hedged transactions which were no longer
probable of occurring were reclassed to earnings, and all other
gains/losses were deferred.
At June 30, 2001 the Bank had no interest rate caps on its short-term LIBOR
correlated borrowings. As of June 30, 2000, the Bank held three 6% and one
7% interest rate caps which were used to effectively cap the interest rates
on a portion of the Company's short-term LIBOR correlated borrowings, which
include short-term deposits, securities sold under agreements to repurchase
and the Federal Home Loan Bank advances. As of June 30, 2000, the caps had
a total notional amount of $90 million and reprice based on the three month
LIBOR. The repricing characteristics of the Company's short-term borrowings
are similar in nature to those of the related interest rate cap agreements.
Due to the implementation of SFAS 133 as of July 1, 2000, the fair values
of derivatives are reflected on the Company's balance sheet as other assets
or other liabilities. For the year ended June 30, 2000, the fair values of
the following interest rate swaps and interest rate caps are not reflected
in the Company's financial statements. The periodic exchanges of interest
payments and the net expense of the interest rate caps are included in
interest expense in the statements of operations.
(Dollars in Thousands) JUNE 30, 2000
------------------------------------------------------------------------------------
CONTRACT OR WEIGHTED AVERAGE
NOTIONAL FAIR VALUE INTEREST RATE
AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE
Interest rate swaps:
Pay fixed rate $35,000 $ 1,929 N/A 6.03 % 6.64 %
Interest rate caps 90,000 5,124 N/A N/A 6.83
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The following table sets forth the maturity distribution and weighted
average interest rates of the interest rate swaps used to fix a portion of
the Bank's LIBOR correlated borrowings which include short-term deposits,
securities sold under agreements to repurchase and the Federal Home Loan
Bank advance as of June 30, 2001:
MATURITIES DURING FISCAL
YEARS ENDING JUNE 30, 2002 2003 2004 2005 2006 THEREAFTER
Interest rate swaps-pay fixed rate
Notional amount $15,000 $ 10,000 $ 35,000
Weighted average payable rate 6.10 % 6.48 % 6.51 %
Weighted average receivable rate 4.11 % 3.99 % 3.96 %
14. COMMITMENTS
The Bank is a party to commitments to extend credit as part of its normal
business operations to meet the financing needs of its customers. These
commitments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the balance sheet. Exposure
to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit is represented by the
contract amount of those instruments. The Bank uses the same credit
policies in making commitments as it does for on-balance-sheet instruments.
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with credit risk.
The following table sets forth the Bank's loan commitments whose contract
amounts represent credit risk and the applicable range of interest rates
for such loan commitments.
(DOLLARS IN THOUSANDS) JUNE 30,
----------------------------------------------------------------------
2001 2000
------------------------------- ------------------------------------
INTEREST INTEREST
AMOUNT RATES AMOUNT RATES
One to four family real estate-fixed rate $ 394 6.38%-7.50% $ 1,379 7.63%-8.63%
Commercial loans-fixed rate 126 9.00%
Commercial loans-adjustable rate 13,804 6.75%-11.00% 7,025 9.50%-11.00%
-------- -------
$ 14,198 $ 8,530
======== =======
At June 30, 2001, the Company was obligated under noncancelable leases for
buildings. Several of these leases contain renewal options and escalation
clauses calling for rentals to be adjusted for increased real estate taxes
and other operating expenses or proportionately adjusted for increases in
the consumer price indices or other basis.
77
77
The following summary reflects the future minimum rental payments, by
fiscal year, required under operating leases that have remaining
noncancelable lease terms in excess of one year as of June 30, 2001:
YEAR ENDED JUNE 30,
(Dollars in Thousands)
2002 $ 297
2003 299
2004 289
2005 218
2006 216
2007 and thereafter 1,534
------
Total minimum payments $2,853
======
Rental expense under operating leases for fiscal years 2001, 2000 and 1999
was $281,000, $320,000 and $292,000, respectively.
15. RELATED PARTY TRANSACTIONS
The Company has contracted with Smith Breeden Associates, Inc. ("SBA") to
provide investment advisory services and interest rate risk analysis.
Certain stockholders and directors of HFG are also principals of SBA. The
amount of consulting expense relating to SBA for fiscal years ending June
30, 2001, 2000 and 1999 was $270,000, $276,000 and $301,000 respectively.
SBA has a commercial loan outstanding with the Bank at June 30, 2001, see
Note 3.
16. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
LIQUIDATION ACCOUNT - On July 10, 1985, the Bank converted from a federally
chartered mutual association to a federally chartered stock association
through the issuance of 463,173 shares of common stock ($1 par value) at a
price of $8 per share. From the proceeds, $463,000 was allocated to capital
stock at the par value of $1 per share and $2,919,000, which is net of
conversion costs of $324,000, was allocated to additional paid-in-capital.
The Bank established a special liquidation account (in memorandum form) in
an amount equal to its total retained earnings as of June 1, 1984 for the
purpose of granting to eligible savings account holders a priority in the
event of future liquidation. In the event of future liquidation of the
converted institution (and only in such event), an eligible account holder
who continues to maintain his savings account shall be entitled to receive
a distribution from the liquidation account. The total amount of the
liquidation account will be decreased in an amount proportionately
corresponding to decreases in the savings accounts of eligible account
holders on each subsequent annual determination date.
DIVIDEND RESTRICTIONS - Regulations provide that the Bank may not declare
or pay a cash dividend on or repurchase any of its stock if the result
thereof would be to reduce the consolidated stockholders' equity of the
Bank below the amount required for the liquidation account (as defined by
regulations). Under the capital distribution regulations of the OTS, the
Bank, as a "Tier 1" institution, is permitted to make capital distributions
during a calendar year up to one hundred percent of its net income to date
from the current calendar year plus the prior two calendar years. Under
this limitation, as of June 30, 2001, the Bank would be required to file an
application with the OTS for any proposed capital distribution.
78
78
RESERVE REQUIREMENTS - As of June 30, 2001, the Bank was not required to
maintain reserve balances with the Federal Reserve Bank.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments:
(Dollars in Thousands) JUNE 30,
------------------------------------------
2001 2000
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
ASSETS:
Cash $ 1,895 $ 1,895 $ 2,314 $ 2,314
Interest-bearing deposits 8,768 8,768 22,007 22,007
Securities held for trading 3,495 3,495 53,852 53,852
Securities available for sale 51,039 51,039 64,052 64,052
Securities held to maturity 27 27 3,857 3,875
Loans receivable, net 329,222 329,377 270,970 261,500
Interest receivable 2,264 2,264 2,186 2,186
Federal Home Loan Bank stock 4,878 4,878 4,878 4,878
Interest rate swaps 372 372 N/A N/A
LIABILITIES:
Deposits 323,324 321,642 361,241 356,200
Securities sold under agreements to repurchase 35,675 35,676 28,038 28,036
Federal Home Loan Bank advances 11,000 10,997 7,000 7,000
Interest payable on securities sold under
agreements to repurchase 51 51 5 5
Other interest payable 1,669 1,669 2,360 2,360
Note payable 12,995 12,995 12,995 12,995
Advance payments by borrowers for taxes and insurance 696 696 746 746
Interest rate swaps 2,014 2,014 N/A N/A
OFF BALANCE SHEET HEDGING INSTRUMENTS:
Interest rate swaps N/A N/A N/A 1,929
Interest rate caps N/A N/A 2,606 5,124
The estimated fair value amounts are determined by the Company, using
available market information and appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data to
develop the 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 a material effect on
the estimated fair value amounts.
CASH, INTEREST-BEARING DEPOSITS, INTEREST RECEIVABLE AND PAYABLE, ADVANCE
PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE AND NOTE PAYABLE - The
carrying amounts of these items are a reasonable estimate of their fair
value.
LOANS RECEIVABLE - The fair value of loans receivable is estimated by
discounting future cash flows at market interest rates for loans of similar
terms and maturities, taking into consideration repricing characteristics
and prepayment risk.
79
79
SECURITIES HELD FOR TRADING consist of mortgage-backed securities,
collateralized mortgage obligations, residuals, interest-only strips,
principal-only strips, interest rate swaps, an interest rate collar,
interest rate caps, interest rate floors, options, futures and equity
securities. Fair values are based on quoted market prices or dealer
quotes. Where such quotes are not available, fair value is estimated by
using quoted market prices for similar securities or by discounting
future cash flows at a risk adjusted spread to Treasury.
FEDERAL HOME LOAN BANK STOCK - The fair value is estimated to be the
carrying value which is par. All transactions in the capital stock of
the Federal Home Loan Bank of Indianapolis are executed at par.
INTEREST RATE SWAPS - Fair values are based on quoted market prices or
dealer quotes. Where such quotes are not available, fair value is
estimated by using quoted market prices for similar securities or by
discounting future cash flows at a risk adjusted spread to Treasury.
DEPOSITS - The fair value of NOW, DDA, savings and money market deposit
accounts is the amount payable on demand at the reporting date. The fair
value of fixed maturity certificates is estimated using rates currently
offered for deposits of similar remaining maturities.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Fair values are based
on the discounted value of contractual cash flows using dealer quoted
rates for agreements of similar terms and maturities.
FEDERAL HOME LOAN BANK ADVANCES - The fair value is estimated by
discounting future cash flows using rates currently available to the
bank for advances of similar maturities.
OFF BALANCE SHEET HEDGING INSTRUMENTS consist of interest rate swaps and
interest rate caps used to modify the interest rate sensitivity of
certain certificates of deposit and a portion of the Bank's LIBOR
correlated short-term borrowings, including short-term deposits,
securities sold under agreements to repurchase and the Federal Home Loan
Bank advances. Fair values are based on quoted market prices or dealer
quotes. Where such quotes are not available, fair value is estimated by
using quoted market prices for similar securities or by discounting
future cash flows at a risk adjusted spread to Treasury. With the
adoption of SFAS 133 on July 1, 2000 these instruments are now carried
on the balance sheet at fair values.
COMMITMENTS - The estimated fair value of commitments to originate
fixed-rate loans is determined based on the fees currently charged to
enter into similar agreements and the difference between current levels
of interest rates and the committed rates. Based on that analysis, the
estimated fair value of such commitments is a reasonable estimate of the
loan commitments at par.
The fair value estimates presented herein are based on information
available to management as of June 30, 2001 and 2000. Although
management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these consolidated financial
statements since such dates, and therefore, current estimates of fair
value may differ significantly from the amounts presented herein.
18. SEGMENT INFORMATION
The Company's principal business lines include community banking in the
Indiana, Kansas, and North Carolina markets, investment activities,
including treasury management, and other activities. The community
banking segment provides a full range of deposit products as well as
mortgage, consumer and commercial loans. The investment segment is
comprised of the Company's held for trading and available for sale
securities, as well as the treasury management function.
80
80
Results of operations and asset information by operating segment are
presented below for the fiscal years ended June 30, 2001 and 2000. No
comparative segment information is available for prior years. The
financial information for each operating segment is reported on the
basis used internally by the Company's management to evaluate
performance and allocate resources.
The measurement of the performance of the operating segments is based on
the management and corporate structure of the Company and is not
necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily
indicative of the segments' asset size and results of operations if they
were independent entities.
SEGMENT INFORMATION YEAR ENDED JUNE 30, 2001
------------------------------------------------------------------------------------
(Dollars in Thousands) COMMUNITY BANKING
---------------------------------
NORTH
INDIANA KANSAS CAROLINA INVESTMENTS HWM OTHER TOTAL
Net interest income (1) $ 5,694 $ 2,236 $ 1,020 $ 1,907 $ 95 $(1,166) $9,786
Provision for loan losses 413 99 286 798
-------- ------- ------- ------- ------ -------- --------
Net interest income after
provision loan losses 5,281 2,137 734 1,907 95 (1,166) 8,988
Other operating income 551 102 21 17 224 3 918
Depreciation expense 236 60 57 2 9 323 687
Other operating expense 4,371 1,210 994 853 514 241 8,183
-------- ------- ------- ------- ------ -------- --------
CORE BANKING INCOME
(LOSS) BEFORE TAXES 1,225 969 (296) 1,069 (204) (1,727) 1,036
Realized and unrealized gain
(loss) on securities, net of
hedging 16 5 2,768 (72) 2,780 5,497
-------- ------- ------- ------- ------ -------- --------
Income (loss) before income
taxes 1,241 974 (296) 3,837 (276) 1,053 6,533
Applicable income taxes 496 389 (118) 1,509 (108) 416 2,584
-------- ------- ------- ------- ------ -------- --------
NET INCOME (LOSS) BEFORE
MINORITY INTEREST 745 585 (178) 2,328 (168) 637 3,949
Minority interest, net of taxes 82 82
-------- ------- ------- ------- ------ -------- --------
Net income (loss) before
cumulative effect of
accounting
change 745 585 (178) 2,328 (168) 719 4,031
Cumulative effect of adoption
of SFAS 133, net of income
tax - - - (829) - - (829)
-------- ------- ------- ------- ------ -------- --------
NET INCOME (LOSS) $ 745 $ 585 $ (178) $ 1,499 $ (168) $ 719 $ 3,202
======== ======= ======= ======= ====== ======== ========
Identifiable assets $233,672 $65,773 $36,792 $67,664 $1,626 $ 2,513 $408,040
======== ======= ======= ======= ====== ======== ========
(1) Interest income is presented net of interest expense
81
81
SEGMENT INFORMATION YEAR ENDED JUNE 30, 2000
---------------------------------------------------------------------------------------
(Dollars in Thousands) COMMUNITY BANKING
-----------------------------------
NORTH
INDIANA KANSAS CAROLINA INVESTMENTS HWM OTHER TOTAL
Net interest income (1) $ 4,093 $ 2,267 $ 245 $ 1,701 $ 88 $ (23) $ 8,371
Provision for loan losses 179 362 49 (3) 587
--------- --------- --------- --------- --------- --------- ---------
Net interest income after
provision loan losses 3,914 1,905 196 1,701 88 (20) 7,784
Other operating income 643 49 3 6 106 18 825
Depreciation expense 316 61 55 4 8 351 795
Other operating expense 4,590 1,362 1,025 876 494 485 8,832
--------- --------- --------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (349) 531 (881) 827 (308) (838) (1,018)
Realized and unrealized loss
on
securities, net of hedging (1,096) (47) (1,025) (62) (2,230)
--------- --------- --------- --------- --------- --------- ---------
Loss before income taxes (1,445) 484 (881) (198) (308) (900) (3,248)
Applicable income taxes (549) 193 (340) (44) (121) (416) (1,277)
--------- --------- --------- --------- --------- --------- ---------
NET LOSS BEFORE
MINORITY INTEREST (896) 291 (541) (154) (187) (484) (1,971)
Minority interest, net of
taxes 92 92
--------- --------- --------- --------- --------- --------- ---------
NET LOSS $ (896) $ 291 $ (541) $ (154) $ (187) $ (392) $ (1,879)
========= ========= ========= ========= ========= ========= =========
Identifiable assets $ 127,264 $ 54,471 $ 11,510 $ 148,651 $ 1,760 $ 91,536 $ 435,192
========= ========= ========= ========= ========= ========= =========
(1) Interest income is presented net of interest expense
82
82
YEAR ENDED JUNE 30, 1999
-------------------------------------------------------------
COMMUNITY BANKING
-----------------------------------
SEGMENT INFORMATION
(Dollars in Thousands) INDIANA KANSAS INVESTMENTS OTHER TOTAL
Net interest income (1) $ 3,826 $ 748 $ 1,504 $ 3 $ 6,081
Provision for loan losses 192 318 1 511
--------- --------- --------- --------- ---------
Net interest income after
provision loan losses 3,634 430 1,504 2 5,570
Other operating income 343 8 9 73 433
Depreciation expense 439 70 30 11 550
Other operating expense 5,129 1,244 955 622 7,950
--------- --------- --------- --------- ---------
CORE BANKING INCOME
(LOSS) BEFORE TAXES (1,591) (876) 528 (558) (2,497)
Realized and unrealized loss on
securities, net of hedging (10) (1) (1,636) (1,647)
--------- --------- --------- --------- ---------
Loss before income taxes (1,601) (877) (1,108) (558) (4,144)
Applicable income taxes (636) (348) (441) (221) (1,646)
--------- --------- --------- --------- ---------
NET LOSS BEFORE
MINORITY INTEREST (965) (529) (667) (337) (2,498)
Minority interest, net of taxes 43 43
--------- --------- --------- --------- ---------
NET LOSS $ (965) $ (529) $ (667) $ (294) $ (2,455)
========= ========= ========= ========= =========
Identifiable assets $ 219,607 $ 42,851 $ 198,672 $ 10,209 $ 471,339
========= ========= ========= ========= =========
(1) Interest income is presented net of interest expense
19. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION (PARENT COMPANY
ONLY)
The following condensed balance sheets as of June 30, 2001 and 2000, and
condensed statements of operations and cash flows for the three years in
the period ended June 30, 2001 for Harrington Financial Group, Inc.
should be read in conjunction with the consolidated financial statements
and notes thereto.
83
83
CONDENSED BALANCE SHEETS JUNE 30,
--------------------
(Dollars in Thousands) 2001 2000
ASSETS
Cash and cash equivalents $ 629 $ 215
Securities held for trading 11
Deferred income taxes, net 2,193 1,533
Income taxes receivable 28
Other assets 135 21
Intercompany receivable 33 1
Investment in subsidiary 28,910 27,623
-------- --------
TOTAL ASSETS $ 31,900 $ 29,432
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable $ 12,995 $ 12,995
Accrued expenses payable and other liabilities 179 180
-------- --------
Total liabilities 13,174 13,175
-------- --------
Common stock 425 425
Additional paid-in capital 16,909 16,946
Treasury stock (2,586) (2,488)
Accumulated other comprehensive income (loss), net of taxes (489) (268)
Retained earnings 4,467 1,642
-------- --------
Total stockholders' equity 18,726 16,257
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 31,900 $ 29,432
======== ========
CONDENSED STATEMENTS OF OPERATIONS JUNE 30,
-----------------------------
(Dollars in Thousands) 2001 2000 1999
Interest income from securities held for trading $ 1 $ 2
Interest on deposits $ 3 6 3
Other income 3
Gain on sale of securities held for trading 5 81 21
Unrealized gain (loss) on securities held for trading (5) (60) (35)
------- ------- -------
Total income (loss) 6 28 (9)
------- ------- -------
Interest expense on long-term borrowings 1,169 1,295 1,109
Salaries and employee benefits 280 274 294
Other expenses 342 158 174
------- ------- -------
Total expenses 1,791 1,727 1,577
------- ------- -------
Income (loss) before equity in undistributed earnings (1,785) (1,699) (1,586)
Income tax provision (benefit) (660) (673) (627)
Equity in undistributed earnings of subsidiary 4,327 (853) (1,496)
------- ------- -------
Net income (loss) $ 3,202 $(1,879) $(2,455)
======= ======= =======
84
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CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30,
-----------------------------
(Dollars in Thousands) 2001 2000 1999
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ 3,202 $(1,879) $(2,455)
Adjustments to reconcile net loss to net cash from
operating activities:
Net increase (decrease) in assets and liabilities (119) 230 (91)
Gain on sale of securities held for trading (5) (81) (21)
Unrealized loss on securities held for trading 5 60 35
Proceeds from sales of securities held for trading 11 144 52
Deferred income tax provision (660) (679) (62)
(Increase) decrease in undistributed earnings of subsidiary (1,508) 3,853 1,471
------- ------- -------
Net cash from operating activities 926 1,648 (1,071)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Other (1,000) 500
Dividends paid on common stock (377) (384) (385)
Purchase of treasury stock (191) (326) (784)
Proceeds from issuance of treasury stock 56 73
------- ------- -------
Net cash from financing activities (512) (1,710) (596)
------- ------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 414 (62) (1,667)
CASH AND CASH EQUIVALENTS, beginning of year 215 277 1,944
------- ------- -------
CASH AND CASH EQUIVALENTS, end of year $ 629 $ 215 $ 277
======= ======= =======
85
85
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table presents information concerning the directors of the
Company:
-------------------------------------------------------------------------------------------
Director
Name Since Age
-------------------------------------------------------------------------------------------
Douglas T. Breeden 1988 50
-------------------------------------------------------------------------------------------
Sharon E. Fankhauser 1998 52
-------------------------------------------------------------------------------------------
Michael J. Giarla 1988 43
-------------------------------------------------------------------------------------------
David F. Harper 1995 58
-------------------------------------------------------------------------------------------
John J. McConnell 1995 55
-------------------------------------------------------------------------------------------
Russell Breeden III 1998 52
-------------------------------------------------------------------------------------------
Craig J. Cerny 1988 46
-------------------------------------------------------------------------------------------
Stanley J. Kon 1994 52
-------------------------------------------------------------------------------------------
The following table presents information concerning the executive
officers of the Company or its subsidiaries, all executive officers are elected
by a board of directors and serve until their successors are elected and
qualified:
--------------------------------------------------------------------------------------------------------------
Name Executive Position Terms of Office Age
--------------------------------------------------------------------------------------------------------------
Craig J. Cerny President and Chief Executive Officer for the Since February 1992 46
Company and and October 1999,
Chief Executive Officer of the Bank respectively
--------------------------------------------------------------------------------------------------------------
John E. Fleener Chief Financial Officer, Vice President and Since June 2000 52
Treasurer of Company and Senior Vice President
and Chief Financial Officer of Bank
--------------------------------------------------------------------------------------------------------------
Randy J. Collier President of Harrington Bank Indiana Since March 2000 41
--------------------------------------------------------------------------------------------------------------
Mark R. Larrabee President of Harrington Bank Kansas and Chief Since February 1998 43
Commercial Lending Officer of the Bank
--------------------------------------------------------------------------------------------------------------
Lawrence T. Loeser President of Harrington Bank North Carolina Since March 1999 49
--------------------------------------------------------------------------------------------------------------
Daniel H. Haglund Senior Vice President, Treasurer and Chief Since June 1994 and 51
Investment Officer of the Bank October 1995
--------------------------------------------------------------------------------------------------------------
Information concerning the principal positions with the Company and its
subsidiaries and principal occupation of each member of the Board and executive
officer continuing in office during the past five years is set forth below. No
executive officer is related to any director or other executive officer by
blood, marriage or adoption with the exception of Dr. Douglas T. Breeden,
Chairman of the Company, and Mr. R. Breeden III, a Director of the Company, and
President and Director of the Bank, who are brothers. There are no arrangements
or understandings between a director of the Company and any other person
pursuant to which such person was elected an executive officer.
Douglas T. Breeden. Dr. Douglas T. Breeden is currently Chairman of the
Board of the Company and Chairman of the Board and Chief Executive Officer of
Smith Breeden, which he co-founded in June 1982. Dr. Douglas T. Breeden also
serves as Chairman of the Board of the Smith Breeden Mutual Funds, and Chairman
of the Board of Wyandotte Community Corporation, which owns The Overlook
Restaurant, The Leavenworth Inn, and Provisions located in Indiana.
86
86
Dr. Breeden is the Dean at Duke University's Fuqua School of Business. Dr.
Douglas T. Breeden has also served on business school faculties at Duke
University, Stanford University, and the University of Chicago, and as a
visiting professor at Duke University, Yale University and Massachusetts
Institute of Technology. He is Editor of the Journal of Fixed Income. Dr.
Douglas T. Breeden has served as Associate Editor for five journals in financial
economics, and was elected to the Board of Directors of the American Finance
Association. He has published several well-cited articles in finance and
economics journals. Dr. Douglas T. Breeden holds a Ph.D. in Finance from
Stanford University Graduate School of Business, and a B.S. in Management
Science from Massachusetts Institute of Technology. Dr. Douglas T. Breeden was
formerly Chairman of the Board of Roosevelt Financial Group, a $9 billion thrift
(acquired by Mercantile Bancorp). He is also the principal investor in Community
First Financial Group, Inc. In philanthropic activities, he serves as Chairman
of the Breeden Family Foundation and Director of the Fund for Human
Possibilities. He is a member of the President's Council of Massachusetts
Institute of Technology, and the Founding Grant Society of Stanford University.
Dr. Douglas T. Breeden is the brother of Mr. Russell Breeden III.
Russell Breeden III. Mr. Russell Breeden III has been a Director of the
Company and a Director of the Bank since January 1998. In March 2000, Mr.
Russell Breeden was elected Vice Chairman of the Bank. From October 1993 through
March 2001, Mr. Russell Breeden III was Chairman and Chief Executive Officer of
Community First Financial Group, Inc., an Indiana bank holding company that owns
100 percent of English State Bank, English, Indiana, 52.9 percent of Peoples
Trust Bank Company, Corydon, Indiana, and 89.5 percent of Peninsula Banking
Group, Inc., Redondo Beach, California. Mr. Russell Breeden III is Chairman of
the Board of Peoples Trust Bank Company and Peninsula Banking Group, Inc., and
Chairman and President of English State Bank. Mr. Russell Breeden III is
Chairman of the Board of Bay Cities National Bank, Redondo Beach, California; a
subsidiary of Peninsula Banking Group, Inc. He is also a Director of the Indiana
Bond Bank, Indianapolis, Indiana, a state agency issuing debt for communities
throughout the State of Indiana, and Bettenhausen Motorsports, Inc., a
championship auto racing team. After graduating from DePauw University in
Greencastle, Indiana, Mr. Russell Breeden III spent 20 years in investment
banking at Raffensperger, Hughes & Co., Inc. Indiana's largest investment
banking firm. From his entry-level position in 1973, he moved up through
management to become Director, President and Chief Executive Officer in 1990. He
is a member of the Community Bankers Association of Indiana and the Indiana
Bankers Association, and serves on the Finance Council for the Eiteljorg Museum
of American Indian and Western Art. Mr. Russell Breeden III is the brother of
Dr. Douglas T. Breeden.
Craig J. Cerny. Since February 1992, Mr. Cerny has been the President of
the Company and Chairman of the Board and Chief Executive Officer of the Bank.
In October 1999, Mr. Cerny was named Chief Executive Officer of the Company.
Prior thereto, Mr. Cerny was the Company's Executive Vice President since 1988
and the Bank's President from July 1994 to January 1998. Mr. Cerny currently
serves as the Chairman of the Board and Chief Executive Officer of Harrington
West Financial Group, Inc., a $546 million thrift holding company that he
founded, and as Director of its wholly owned subsidiary, Los Padres Bank, FSB
with offices on the southern and central coast of California. Mr. Cerny is a
former Principal, Executive Vice President and Director of Smith Breeden
Associates, Inc. ("Smith Breeden"), a company that currently advises, or manages
on a discretionary basis, assets exceeding $23 billion, where he was employed
from April 1985 to December 1996. Mr. Cerny was active in Smith Breeden's bank
consulting and investment advisory practice. Prior to joining Smith Breeden, Mr.
Cerny held a number of financial management related positions with Hallmark
Cards, Inc. and Pizza Hut Restaurants, Inc. He holds a Master of Business
Administration in Finance from Arizona State University, where he graduated with
distinction. Mr. Cerny earned a Bachelor of Science in Finance from Arizona
State University and was a member of the Honors Convocation.
Stanley J. Kon. Dr. Kon is a Principal and Director of Smith Breeden
Associates, Inc., Director of Research, and Co-Director of the Investment
Management Group. Dr. Kon was a Professor of Finance at the University of
Michigan from 1982 to June 1999. During this time he served as Chairman of the
Finance Department, Director of the J. Ira Harris Center for the Study of
Corporate Finance, and a member of the Advisory Board for the Mitsui Life
Financial Research Center. Prior to 1982, Dr. Kon served on the faculties of New
York University, University of Chicago, and the University of Wisconsin at
Madison. He has written extensively in the areas of investment management,
performance measurement, asset pricing, statistical models of stock returns, and
mortgage-backed securities portfolio risk management. Dr. Kon has also served as
a consultant to government, business and financial institutions. Dr. Kon is also
a Director of Harrington Bank, Harrington West Financial Group, Inc., and Los
Padres Bank, FSB. Dr. Kon holds a Ph.D. in Finance from the State University of
New York at Buffalo; a Master of Business Administration in Finance and
Economics from St. John's University and a Bachelor of Science in Chemical
Engineering from Lowell Technological Institute.
87
87
Sharon E. Fankhauser. Ms. Fankhauser is a Director of Smith Breeden
where she has been employed since January 1986. Ms. Fankhauser's primary
responsibilities are in the areas of accounting, compliance, and administration.
In April 1998, she became a Director of Wyandotte Community Corporation which
owns The Overlook Restaurant, The Leavenworth Inn, and Provisions located in
Indiana. Prior to joining Smith Breeden, Ms. Fankhauser, a Certified Public
Accountant, was employed by Mayer Hoffman McCann, Kansas City, Missouri. She
earned a Bachelor of Arts in sociology from Drake University where she was named
to Phi Beta Kappa. She concentrated in accounting in the Master of Business
Administration program at California State University at Sacramento, where she
was elected to Beta Alpha Psi Honor Society. Ms. Fankhauser was awarded the
Elijah Watts Sells Award for the top 100 candidates passing the Certified Public
Accountant exam.
Michael J. Giarla. Mr. Giarla is Executive Vice President and Chief
Operating Officer of Smith Breeden Associates. As a member of the firm's
Executive Committee and Board of Directors, he is primarily involved with
management and administrative issues. Mr. Giarla also serves as President of the
Smith Breeden Mutual Funds. Formerly, Smith Breeden's Director of Research, he
was involved in research and programming, particularly in the development and
implementation of models to evaluate and hedge mortgage securities. Before
joining Smith Breeden Associates, Mr. Giarla was employed in Goldman Sachs &
Company's Equity Strategy Group in New York. He has published a number of
articles and book chapters regarding mortgage-backed securities investments,
risk management and hedging. He served as an Associate Editor of The Journal of
Fixed Income from 1991 until 1992. Mr. Giarla holds a Master of Business
Administration with Concentration in Finance from Stanford University Graduate
School of Business. He earned a Bachelor of Arts in Statistics, summa cum laude,
from Harvard University.
David F. Harper. Mr. Harper has been Vice President of Harris Harper
Counsel, Inc., an investment advisory firm located in Richmond, Indiana, since
January 1991. Mr. Harper also has maintained a public accounting practice since
October 1990. He previously was a Partner in the Indiana C.P.A. firm of Olive,
LLP from October 1978 to October 1990. Mr. Harper has served as a Director of
the Bank since 1991. He holds a Bachelor of Business Administration in
Accounting, magna cum laude, from the University of Cincinnati.
John J. McConnell. Dr. McConnell is the Emanuel T. Weiler Distinguished
Professor of Management at the Krannert School of Management, Purdue University
where he has been a faculty member since 1976. Dr. McConnell currently serves as
Director of Harrington West Financial Group, Inc. and its wholly owned
subsidiary, Los Padres Bank, FSB. He served on the Board of Directors of the
Federal Home Loan Bank of Indianapolis from 1983 to 1986 and has been a
consultant for various government agencies, trade associations, law firms, and
corporations. Dr. McConnell has authored numerous publications on topics related
to financial institutions and financial markets. Dr. McConnell holds a Ph.D. in
Finance from Purdue University and a Master of Business Administration in
Finance and Accounting from the University of Pittsburgh. He received his
undergraduate degree in Economics from Denison University.
Randy J. Collier. Mr. Collier was hired as Senior Vice President and
Manager of the Commercial Lending Division for the Indiana Region of the Bank
since August 1999. Mr. Collier was subsequently promoted to President of the
Indiana Region of the Bank in March 2000. His primary duties involve oversight
of all functions of the retail, mortgage lending, consumer lending and
commercial lending functions for the Bank's Indiana market. Mr. Collier also
serves on the Bank's Commercial Loan Committee and Community Reinvestment Act
Committee. Prior to joining the Bank, Mr. Collier worked for 18 years as a
middle-market and large corporate lender in the Indianapolis market with
National City Bank. Mr. Collier received a Bachelor of Finance from Indiana
University. Mr. Collier is a Trustee for the Crohn's and Colitis Foundation of
America and serves on the School Commission for St. Simon School in
Indianapolis.
John E. Fleener. Mr. Fleener was hired as Vice President and Principal
Finance and Accounting Officer of the Bank and the Company on June 14, 1999. In
June 2000, he was elected Chief Financial Officer of the Company. He holds a
Bachelor of Science in Accounting from Indiana University and is a Certified
Public Accountant. Mr. Fleener has over twenty eight years experience in the
banking industry with extensive expertise in accounting and finance related
functions.
Mark R. Larrabee. Mr. Larrabee has been President of the Kansas Region
and Chief Commercial Lending Officer of the Bank since February 1998. In January
1999, he was elected to the Bank's Board of Directors. His primary
responsibilities include the implementation of the Bank's expansion plans in the
Kansas City market and the development of the Bank's commercial line of
business. Mr. Larrabee is Chairman of the Bank's Commercial Loan Committee. From
January 1996 to February 1998, Mr. Larrabee served as Executive Vice President
for Country Club Bank, Kansas City,
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Missouri. Prior thereto, Mr. Larrabee was Senior Vice President for Bank IV
Kansas, National Association, Overland Park, Kansas, from March 1984 to January
1996. His previous experience over his nineteen year career includes an
extensive commercial lending background, senior management positions with
various responsibilities including strategic planning and corporate development,
and the start up of a de novo national bank. Mr. Larrabee holds a Bachelor of
Science in Business Administration from the University of Kansas and a Master of
Business Administration from the University of Missouri, graduating with Highest
Distinction.
Lawrence T. Loeser. Mr. Loeser has been President of Harrington Bank at
Chapel Hill since March 1999 when he was also elected to the Bank's Board of
Directors. His primary responsibilities include establishing the Bank's
community banking presence in the North Carolina market and developing the
Bank's wide range of business lines. Mr. Loeser also serves on the Bank's
commercial loan committee. Mr. Loeser joined the Bank with an extensive
background in corporate lending, small business banking, and consumer banking.
He served as a senior executive with NationsBank in Chicago and founded and
managed a community bank in Lake Forest, Illinois. Mr. Loeser received a
Bachelor of Arts in Economics from Duke University, cum laude, and a Master of
Management with concentration in Finance and Accounting from Northwestern
University's Kellogg Graduate School of Management.
Daniel H. Haglund. Mr. Haglund has been Chief Investment Officer and
Treasurer of the Bank since June 1994 and Senior Vice President since October
1995. From September 1988 to June 1994, Mr. Haglund served as Portfolio Manager
for Hemet Federal Savings and Loan Association, Hemet, California. Mr. Haglund
holds a Master of Business Administration in Finance from Indiana University and
a Bachelor of Arts in Psychology from Alma College.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's officers,
directors and persons who own more than 10% of the Company's Common Stock to
file reports of ownership and changes in ownership with the SEC and the National
Association of Securities Dealers, Inc. by certain dates. The Company believes
that in the fiscal year ended June 30, 2001, all of these filing requirements
were satisfied by its directors and executive officers. In making the foregoing
statements, the Company has relied on representations of its directors and
executive officers and copies of the reports that they have filed with the SEC.
The Company knows of no person, other than Dr. Douglas T. Breeden, the Company's
Chairman of the Board, who owns 10% or more of the Company's Common Stock.
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ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table includes individual compensation information with
respect to the executive officers whose total compensation exceeded $100,000 for
services rendered in all capacities during the fiscal year ended June 30, 2001.
---------------------------------------------------------------------------------------------------------------------
Long-Term
Name and Fiscal Compensation All Other
Principal Position Year Annual Awards Compensation
Compensation*
---------------------------------------------------------------------------------------------------------------------
Number of
Salary(1) Bonus Options
---------------------------------------------------------------------------------------------------------------------
Russell Breeden III 2001 0 0 0 24,000(2)
President/Harrington Bank Indianapolis --------------------------------------------------------------------
(3) 2000 $100,961 0 7,000 $32,750(2)
--------------------------------------------------------------------
1999 $111,538 $25,000 5,000 $17,409(2)
---------------------------------------------------------------------------------------------------------------------
Craig J. Cerny 2001 $204,807 $25,000 0 $19,875(4)
President/CEO --------------------------------------------------------------------
Harrington Financial Group, Inc. 2000 $204,807 $25,000 10,000 $18,296(4)
--------------------------------------------------------------------
1999 $200,000 $50,000 10,000 $30,000(4)
---------------------------------------------------------------------------------------------------------------------
Randy J. Collier 2001 $135,000 $35,336 10,000 $1,157(6)
President/Harrington Bank Indiana (5) --------------------------------------------------------------------
2000 $103,500 $ 0 5,000 $0(6)
--------------------------------------------------------------------
1999 $ 0 $ 0 0 $0(6)
---------------------------------------------------------------------------------------------------------------------
Mark R. Larrabee 2001 $155,000 $25,000 7,000 $3,072(8)
President/Harrington Bank Kansas (7) --------------------------------------------------------------------
2000 $147,692 $20,000 8,000 $6,400(8)
--------------------------------------------------------------------
1999 $124,231 $30,000 5,000 $4,672(8)
---------------------------------------------------------------------------------------------------------------------
Lawrence T. Loeser 2001 $155,000 $15,000 7,000 $1,386(10)
President/Harrington Bank North --------------------------------------------------------------------
Carolina(9) 2000 $155,769 $50,000 3,000 $2,133(10)
---------------------------------------------------------------------------------------------------------------------
1999 $ 0 $ 0 5,000 $0(10)
--------------------------------------------------------------------
---------------------------
*The Company implemented a 401(k) plan on January, 2001.
(1) Does not include amounts attributable to miscellaneous benefits
received by the named executive officers. The cost to the Company of
providing such benefits to the named executive officers during the
indicated period did not exceed the lesser of $50,000 or 10% of the
total of annual salary and bonus reported.
(2) Comprised $24,000 of Bank/Company director fees for fiscal year 2001,
$15,500 Bank/Company director fees, and $17,250 of Bank consulting fees
for fiscal year 2000, and 12,000 of Bank directors fees, $2,404 in
contributions pursuant to the Bank's Profit Sharing Plan, and $3,005 in
allocations on behalf of Mr. R. Breeden under the Company's ESOP for
fiscal year 1999.
(3) Mr. R. Breeden III joined the Bank as President in January 1998 and
shifted to a nonemployee Director status at the Bank in March, 2001.
(4) Comprised of $18,000, $12,000, and $12,000 of Bank director fees,
$1,875, $0, and $8,000, in contributions pursuant to the Bank's Profit
Sharing Plan, and $0, $6,296, and $10,000 in allocations on behalf of
Mr. Cerny under the Company's ESOP, in each case for fiscal 2001, 2000,
and 1999, respectively. See "- Benefits - Profit Sharing Plan."
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(5) Mr. Randy J. Collier joined the Bank as Senior Vice President and
Manager of the commercial lending division for the Indiana Region of the
Bank in August 1999. Mr. Collier was subsequently promoted to President
of the Indiana Region of the Bank in March, 2000.
(6) Comprised of $1,157, $0, and $0 in contributions pursuant to the Bank's
Profit Sharing Plan and the allocations on behalf of Mr. Collier under
the Company's ESOP for fiscal years 2001, 2000, and 1999, respectively.
See "- Benefits - Profit Sharing Plan".
(7) Mr. Larrabee joined the Bank as President of the Kansas Region and Chief
Commercial Lending Officer in February 1998. Mr. Larrabee has been
President of the Kansas Region and Chief Commercial Lending Officer of
the Bank since February 1998. In January 1999, he was elected to the
Bank's Board of Directors.
(8) Comprised of $3,072, $6,400, and $4,672 in contributions pursuant to the
Bank's Profit Sharing Plan and the allocations on behalf of Mr. Larrabee
under the Company's ESOP for fiscal years 2001, 2000, and 1999,
respectively. See "- Benefits - Profit Sharing Plan".
(9) Mr. Lawrence T. Loeser joined the Bank as President of the North
Carolina Region in March 1999 when he was also elected to the Bank's
Board of Directors.
(10) Comprised of $1,386, $2,133, and $0 in contributions pursuant to the
Bank's Profit Sharing Plan and the allocations on behalf of Mr. Loeser
under the Company's ESOP for fiscal years 2001, 2000 and 1999,
respectively. See "- Benefits - Profit Sharing Plan".
The following table sets forth, with respect to the executive officers
named in the Summary Compensation Table, information with respect to the
aggregate amount of options exercised during the last fiscal year, any value
realized thereon, the number of unexercised options at the end of the fiscal
year (exercisable and unexercisable) and the value with respect thereto under
specified assumptions.
-------------------------------------------------------------------------------------------------------
Shares
Acquired
on Value Value of Unexercised
Name Exercise Realized Number of Unexercised in the Money Options at
Options at Fiscal Year End June 30, 2001*
-------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
-------------------------------------------------------------------------------------------------------
Russell Breeden III (1) -- -- 5,200 9,800 $10,640 $32,060
-------------------------------------------------------------------------------------------------------
Craig J. Cerny (2) -- -- 14,500 18,000 $24,950 $52,550
-------------------------------------------------------------------------------------------------------
Randy J. Collier (3) -- -- 1,000 14,000 $4,600 $81,900
-------------------------------------------------------------------------------------------------------
Mark R. Larrabee (4) -- -- 5,400 17,600 $11,560 $80,190
-------------------------------------------------------------------------------------------------------
Lawrence T. Loeser (5) -- -- 2,600 12,400 $6,960 $61,790
-------------------------------------------------------------------------------------------------------
*Market Value of HFGI Common Stock at June 30, 2001: $12.10 Per Share.
(1) 3,000 shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (January 13, 1998) at
$12.50 per share. 5,000 shares are exercisable at the rate of 20% per
year on each annual anniversary of the date the options were granted
(January 26, 1999) at $10.00 per share. 7,000 shares are exercisable at
the rate of 20% per year on each annual anniversary of the date the
options were granted (January 19, 2000) at $7.50 per share.
The following values are calculated given the $12.10 market value at
June 30, 2001: 3,000 shares, 60% vested, with a $12.50 strike price
equals 1,800 exercisable shares at $0, and 1,200 unexercisable shares at
$0, 5,000
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shares, 40% vested with a $10.00 strike price equals 2,000 exercisable
shares at $20,000 and 3,000 unexercisable shares at $30,000, and 7,000
shares, 20% vested, with a 7.50 strike price, equals 1,400 exercisable
shares at $10,500 and 5,600 unexercisable shares at $42,000.
(2) 5,000 shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (January 9, 1997) at
$10.00 per share. 7,500 shares are exercisable at the rate of 20% per
year on each annual anniversary of the date the options were granted
(January 13, 1998) at $12.50 per share. 10,000 shares are exercisable at
the rate of 20% per year on each annual anniversary of the date the
options were granted (January 26, 1999) at $10.00 per share, and 10,000
shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted January 19, 2000 at
7.50 per share.
The following values are calculated given the $12.10 market value at
June 30, 2001: 5,000 shares, 80% vested, with a $10.00 strike price
equals 4,000 exercisable shares at $40,000 and 1,000 unexercisable
shares at $2,100, 7,500 shares, 60% vested, with a $12.50 strike price
equals 4,500 exercisable shares at $0 and 3,000 unexercisable shares at
$0, 10,000 shares, 40% vested, with a $10.00 strike price equals 4,000
exercisable shares at $40,000 and 6,000 unexercisable shares $60,000,
10,000 shares, 20% vested, with a $7.50 strike price equals 2,000
exercisable shares at $15,000 and 8,000 unexercisable shares at
$60,000.
(3) 2,000 shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (August 3, 1999) at
$9.00 per share, 3,000 shares are exercisable at the rate of 20% per
year on each annual anniversary of the date the options were granted
(March 10, 2000) at $6.50 per share, and 10,000 shares are exercisable
at the rate of 20% per year on each annual anniversary of the date the
option were granted (December 18, 2000) at $5.75 per share.
The following values are calculated given the $12.10 market value at
June 30, 2001: 2,000 shares, 20% vested, with a $9.00 strike price,
equals 400 exercisable shares at $13,600 and 1,600 unexercisable shares
at $14,400, 3,000 shares, 20% vested with a $6.50 strike price equals
600 exercisable shares at $3,900 and 2,400 unexercisable shares at
$15,000, 10,000 shares, 0% vested, with a $5.75 strike price, equals 0
exercisable shares at $0 and 10,000 unexercisable shares at $57,500.
(4) 3,000 shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (January 13, 1998) at
$12.50 per share and 5,000 shares are exercisable at the rate of 20% per
year on each annual anniversary of the date the options were granted
(January 26, 1999) at $10.00 per share, 8,000 shares are exercisable at
the rate of 20% per year on each annual anniversary of the date the
options were granted (January 19, 2000) at $7.50 per share and 7,000
shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (December 18, 2000) at
$5.75 per share,
The following values are calculated given the $12.10 market value at
June 30, 2001: 3,000 shares, 60% vested, with a $12.50 strike price,
equals 1,800 exercisable shares at $0 and 1,200 unexercisable shares at
$0, 5,000 shares, 40% vested, with a $10.00 strike price, equals 2,000
exercisable shares at $20,000 and 3,000 unexercisable shares at $30,000,
8,000 shares, 20% vested, with a $7.50 strike price equals 1,600
exercisable shares at $12,000 and 6,400 unexercisable shares at $48,000,
and 7,000 shares, 0% vested, with a $5.75 strike price, equals 0
exercisable shares at $0, and 7,000 unexercisable shares at $44,250,
(5) 5,000 shares are exercisable at the rate of 20% per year on each annual
anniversary of the date the options were granted (March 25, 1999) at
$10.00 per share, 3,000 shares are exercisable at the rate of 20% per
year on each annual anniversary of the date the options were granted
(January 19, 2000) at $7.50 per share and 7,000 shares are exercisable
at the rate of 20% per year on each annual anniversary of the date the
options were granted (December 18, 2000) at $5.75 per share.
The following values are calculated given the $12.10 market value at
June 30, 2001: 5,000 shares, 40% vested, with a $10.00 strike price,
equals 2,000 exercisable shares at $20,000 and 3,000 unexercisable
shares at $30,000, 3,000 shares, 20% vested, with a $7.50 strike price,
equals 600 exercisable shares at $4,500 and 2,400 unexercisable shares
at $18,000, and 7,000 shares, 0% vested, with a $5.75 strike price,
equals 0 exercisable shares at $0, and 7,000 unexercisable shares at
$40,250.
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Board Fees
Directors of the Company (except for Mr. Cerny) received fees of $500
for each board meeting attended between July 2001 through December 2001. From
January 2001 through June 2001 the Directors of the Company received the
following fees for each meeting attended: Dr. Douglas T. Breeden $3,000, Mr.
Russell Breeden III $2,000, Mr. Michael J. Giarla $2,000, Ms. Sharon E.
Fankhauser $1,500, Mr. David F. Harper $1,500, Dr. Stanley J. Kon $2,000 and Dr.
John J. McConnell $1,500. All directors of the Bank (except for Messrs.
Larrabee, Loeser, and Collier) received fees of $1,500 for each Board meeting
attended in person or by conference call. Company Directors (except for Mr.
Cerny who does not receive committee fees) received $300 per Audit Committee
Meeting. In addition, Bank directors (except for Messrs. Cerny, Collier,
Larrabee, and Loeser who do not receive committee fees) received $500 per
executive committee meeting, $750 per investment committee meeting, $300 per
audit committee meeting, $300 per Community Reinvestment Act Committee meeting,
and $200 per Trust Services Committee meeting.
Stock Option Plan.
The Stock Option Plan was approved by the Company's stockholders in
March 1996. An amount of the Company's common stock equal to 126,500 shares (10%
of the shares of common stock sold in the offering) has been authorized under
the Stock Option Plan, which may be filled by authorized but unissued shares,
Treasury shares or shares purchased by the Company on the open market or from
private sources. In October 1999, stockholders approved an amendment to the
Stock Option Plan to increase the number of shares of the Company's common stock
by 150,000 to 276,000 shares which may be issued pursuant to the Stock Option
Plan. The Stock Option Plan provides for the grant of incentive stock options
intended to comply with the requirements of Section 422 of the Code ("incentive
stock options"), non-incentive or compensatory stock options and stock
appreciation rights (collectively "Awards"). Awards are available for grant to
directors and key employees of the Company and any subsidiaries, except that
directors will not be eligible to receive incentive stock options.
The Stock Option Plan is administered and interpreted by a committee of
the Board of Directors ("Committee") which is "disinterested" pursuant to
applicable regulations under the federal securities laws. Unless earlier
terminated, the Stock Option Plan will be in effect for a period of ten years
from the adoption by the Board of Directors. Under the Stock Option Plan, the
Committee will determine which officers and key employees will be granted
options, whether such options will be incentive or compensatory options, the
number of shares subject to each option, whether such options may be exercised
by delivering other shares of the Company's common stock and when such options
become exercisable. The per share exercise price of all stock options shall be
required to be at least equal to the fair market value of a share of common
stock on the date the option is granted.
Stock options shall become vested and exercisable in the manner
specified by the committee at the rate of 20% per year, beginning one year from
the date of grant. Each stock option or portion thereof shall be exercisable at
any time on or after it vests and is exercisable until ten years after its date
of grant or three months after the date on which the optionee's employment
terminates other than retirement, unless extended by the committee to a period
not to exceed one year from such termination. However, failure to exercise
incentive stock options within three months after the date on which the
optionee's employment terminates, may result in adverse tax consequences to the
optionee. Stock options are non-transferable except by will or the laws of
descent and distribution.
Under the Stock Option Plan, the committee will be authorized to grant
rights to optionees ("stock appreciation rights") under which an optionee may
surrender any exercisable incentive stock option or compensatory stock option or
part thereof in return for payment by the Company to the optionee of cash or
common stock in an amount equal to the excess of the fair market value of the
shares of common stock subject to option at the time over the option price of
such shares, or a combination of cash and common stock. Stock appreciation
rights may be granted concurrently with the stock options to which they relate
or at any time thereafter which is prior to the exercise or expiration of such
options.
Options are granted to directors of the Company and those subsidiaries
designated by the committee under the Stock Option Plan pursuant to a formula.
Under the formula, amended in October 1999, non-employee directors of the
Company and the Bank received options to purchase 2,000 and 1,000 shares,
respectively, upon commencement of the Company's initial public offering and
will receive a similar amount on each annual anniversary thereafter for as long
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as shares remain available. Such stock options to directors will be vested and
exercisable under the same terms as options granted by the Committee to officers
and employees.
The following table shows the number of options issued to the named
groups under the Stock Option Plan during fiscal year 2001:
------------------------------------------------------------------------------------------
Group Number of Options (1)
------------------------------------------------------------------------------------------
All executive officers as a group 40,000
------------------------------------------------------------------------------------------
All directors (who are not executive officers) as a group 0
------------------------------------------------------------------------------------------
All employees (who are not executive officers) as a group 24,750
------------------------------------------------------------------------------------------
(1) The exercise price for the non-employee awards was determined by the
Common Stock's market value on the day the option was granted.
All unvested options are accelerated in the event of retirement under
the Bank's retirement policies or a change in control of the Company, as defined
in the Stock Option Plan. In addition, if an optionee dies or terminates service
due to disability, while serving as an employee or non-employee director, all
unvested options are accelerated. Under such circumstances, the optionee or, as
the case may be, the optionee's executors, administrators, legatees or
distributees, shall have the right to exercise all unexercised options during
the twelve-month period following termination due to disability, retirement or
death, provided no option will be exercisable within six months after the date
of grant or more than ten years from the date it was granted.
In the event of a stock split, reverse stock split or stock dividend,
the number of shares of Common Stock under the Stock Option Plan, the number of
shares to which any award relates and the exercise price per share under any
option or stock appreciation right shall be adjusted to reflect such increase or
decrease in the total number of shares of the Common Stock outstanding.
Profit Sharing Plan. On July 1, 1990, the Bank adopted the Financial
Institutions Thrift Plan ("Profit Sharing Plan"), which is a tax-qualified
defined contribution plan. Prior to July 1, 1997, all employees were eligible to
participate in the Profit Sharing Plan on the first day of the month following
the employee's date of employment. Effective July 1, 1997, employees of the Bank
who have been employed by the Bank for at least one year and 1,000 hours of
service are eligible to participate in the Profit Sharing Plan. Under the Profit
Sharing Plan, a separate account is established for each participating employee,
and the Bank may make discretionary contributions to the Profit Sharing Plan,
which are allocated to the participants' accounts. Participants vest in employer
discretionary contributions over a six-year period. Distributions from the
Profit Sharing Plan are made upon termination of service, death or disability in
a lump sum. The normal retirement age under the plan is age 65.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth the beneficial ownership of the Company's
common stock as of September 20, 2001, and certain other information with
respect to (i) each person or entity, including any "group" as that term is used
in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), who or which was known to the Company to be a beneficial owner
of more than 5% of the issued and outstanding common stock, (ii) each director
of the Company, (iii) each executive officer of the Company and its subsidiaries
and (iv) all directors and executive officers of the Company and its
subsidiaries as a group. All beneficial owners share a business address with the
Company at 10801 Mastin Boulevard, Suite 740, Overland Park, Kansas, 66210.
Name of Beneficial Amount and Nature of Percent of
Owner or Number Beneficial Ownership Outstanding
of Persons in Group as of September 20, 2001(1) Common Stock
---------------------------------------- --------------------------- ----------------
Douglas T. Breeden 1,549,911(2) 49.52%
Russell Breeden III 42,370(3) 1.25
Craig J. Cerny 220,972(4) 7.06
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Randy J. Collier 2,000(5) .06
Sharon E. Fankhauser 14,759(6) .47
John E. Fleener 1,600(7) 0.05
Michael J. Giarla 202,319(8) 6.46
David F. Harper 25,892(9) .83
Stanley J. Kon 22,724(10) .73
Mark R. Larrabee 12,809(11) .41
Lawrence T. Loeser 3,928(12) .13
John J. McConnell 27,892(13) .89
All directors and executive officers of
the Company and the Bank as a
group (13 persons) 2,148,020(14) 68.63%
---------------------
(1) For purposes of this table, pursuant to rules promulgated under the
Exchange Act, an individual is considered to beneficially own shares of
the Company's common stock if he or she directly or indirectly has or
shares (i) voting power, which includes the power to vote or to direct
the voting of the shares; or (ii) investment power, which includes the
power to dispose or direct the disposition of the shares. Unless
otherwise indicated, an individual has sole voting power and sole
investment power with respect to the indicated shares. Shares which are
subject to stock options and which may be exercised within 60 days of
September 20, 2001 are deemed to be outstanding for the purpose of
computing the percentage of the Company's common stock beneficially
owned by such person.
(2) Includes 11,400 shares held by Dr. Douglas T. Breeden's spouse, 4,000
shares held by Dr. Douglas T. Breeden's spouse as custodian for their
children, 41,421 shares held by Wyandotte Community corporation, a
corporation controlled by Dr. Douglas T. Breeden and presently
exercisable options to acquire 3,200 shares of the Company's common
stock. Does not include 42,370 shares held by Mr. R. Breeden III, his
brother who is a director of the Company and Vice Chairman of the Bank,
nor options to acquire 2,800 shares of the Company's common stock which
will be exercisable in connection with the completion of the merger.
(3) Includes 1,300 shares held by Mr. R. Breeden's spouse, 325 shares held
by the Company's Employee Stock Ownership Plan ("ESOP") for the account
of Mr. R. Breeden, 20 shares held by Mr. R. Breeden's son, 23,000 shares
held by Community First Financial Group, Inc., for which Mr. Russell
Breeden III was formerly Chairman and Chief Executive Officer, and
presently exercisable options to acquire 5,200 shares of the Company's
common stock. Does not include 1,549,911 shares held by his brother, Dr.
Douglas T. Breeden, who is Chairman of the Company, nor 9,800 shares of
the Company's common stock which may be acquired upon exercise of
options at the completion of the merger.
(4) Includes 30,000 shares held by Mr. Cerny's spouse, 5,335 shares held by
the Company's ESOP for the account of Mr. Cerny, and presently
exercisable options to acquire 14,500 shares of the Company's common
stock. Does not include 18,000 shares of the Company's common stock
which may be acquired upon exercise of options at the completion of the
merger.
(5) Includes presently exercisable options to acquire 1,000 shares of the
Company's common stock. Does not include 14,000 shares of the Company's
common stock which may be acquired upon exercise of options at the
completion of the merger.
(6) Includes 2,000 shares held by an IRA and presently exercisable options
to acquire 1,200 shares of the Company's common stock. Does not include
2,800 shares of the Company's common stock which may be acquired upon
exercise of options at the completion of the merger.
(7) Comprised of presently exercisable option to acquire 1,600 shares of the
Company's common stock. Does not include 14,400 shares of the Company's
common stock which may be acquired upon exercise of options at the
completion of the merger.
(8) Includes 30,347 shares held by a profit sharing plan maintained by Smith
Breeden & Associates, Inc., 12,353 shares held by Mr. Giarla's spouse as
custodian for their child, 3,899 shares held by Mr. Giarla's spouse in
her Individual Retirement Account, 79,445 shares held by his spouse in
trust, 74,075 shares held by Mr. Giarla in trust, and presently
exercisable options to acquire 3,200 shares of Harrington common stock.
Does not include 2,800 shares of the Company's common stock which may be
acquired upon exercise of options at the completion of the merger.
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(9) Includes presently exercisable options to acquire 4,800 shares of the
Company's common stock. Does not include 4,200 shares of the Company's
common stock which may be acquired upon exercise of options at the
completion of the merger.
(10) Includes 3,536 shares held by Dr. Kon as custodian for his children and
presently exercisable options to acquire 4,800 shares of the Company's
common stock. Does not include 4,200 shares of the Company's common
stock which may be acquired upon exercise of options at the completion
of the merger.
(11) Includes 1,409 shares held by the Company's ESOP for the account of
Mr. Larrabee and presently exercisable options to acquire 5,400 shares
of the Company's common stock. Does not include 17,600 shares of the
Company's common stock which may be acquired upon exercise of options at
the completion of the merger.
(12) Includes 371 shares held by the Company's ESOP for the account of
Mr. Loeser and presently exercisable options to acquire 2,600 shares of
the Company's common stock. Does not include 12,400 shares of the
Company's common stock which may be acquired upon exercise of options at
the completion of the merger.
(13) Includes 23,092 shares held jointly with Dr. McConnell's spouse and
presently exercisable options to acquire 4,800 shares of the Company's
common stock. Does not include 4,200 shares of the Company's common
stock which may be acquired upon exercise of options at the completion
of the merger.
(14) Includes presently exercisable options to acquire 58,950 shares of the
Company's common stock by all directors and executive officers of
Harrington as a group. Also includes 14,801 shares held by the Company's
ESOP, which have been allocated to the accounts of executive officers.
Under the terms of the ESOP, Craig J. Cerny, and John E. Fleener,
trustees of the plan, must vote the allocated shares held in the ESOP in
accordance with the instructions of the executive officers. Does not
include 116,560 shares of the Company's common stock which may be issued
upon completion of the merger to all directors and executive officers.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Under applicable federal law, loans or extensions of credit to executive
officers and directors must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with the general public, unless the loans are made pursuant to a
benefit or compensation program that (i) is widely available to employees of the
institution and (ii) does not give preference to any director, executive officer
or principal stockholder, or certain affiliated interests of either, over other
employees of the savings institution, and must not involve more than the normal
risk of repayment or present other unfavorable features.
The Bank's policy provides that all loans made by the Bank to its
directors and officers are made in the ordinary course of business, on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons. The
Bank's policy provides that such loans may not involve more than the normal risk
of collectibility or present other unfavorable features. As of June 30, 2001,
mortgage and consumer loans to directors and officers in excess of $60,000
aggregated $1,188,000 or 6.31% of the Company's consolidated stockholders'
equity as of such date. All such loans were made by the Bank in accordance with
the aforementioned policy.
The Bank entered into an Investment Advisory Agreement with Smith
Breeden dated April 1, 1992, which was amended on March 1, 1995. Under the terms
of the agreement, the Bank appointed Smith Breeden as investment advisor with
respect to the management of the Bank's portfolio of investments and its asset
and liability management strategies (the "Account"). Specifically, Smith Breeden
advises and consults with the Bank with respect to its investment activities,
including the acquisition of mortgage-backed securities, the use of repurchase
agreement transactions in funding and the acquisition of certain hedging
instruments to reduce the interest rate risk of the Account's investments. Under
the Agreement, Smith Breeden, as agent with respect to the Account, may (i) buy,
sell, exchange and otherwise trade in mortgage-backed securities or other
investments, and (ii) arrange for necessary placement of orders, execution of
transactions, purchases, sales and conveyances with or through such brokers,
dealers, issuers or other persons as Smith Breeden may select, subject to the
approval of the Bank, and establish the price and trade conditions, including
brokerage commissions. For its services, Smith Breeden receives a monthly fee,
based on its standard fee schedule for such services, which is based on the
Bank's total consolidated assets plus unsettled purchases of securities and
minus unsettled sales of securities. Smith Breeden received fees of $271,000,
$276,000, and $301,000 during fiscal 2001, 2000, and 1999, respectively, under
such agreement. In addition, at June 30, 2000, Smith Breeden had outstanding
loans from the Bank in
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the ordinary course of business in the aggregate amount of $14,180,000 secured
by marketable securities. Such loans are at normal market rates and do not
involve more than the normal risk of repayment.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Company reviews the compensation of
Mr. Cerny, the President of the Company, and recommends to the Board adjustments
in his compensation and reviews the recommendations for compensation adjustments
for the other senior officers of the Company. The Compensation Committee of the
Company also administers the stock benefit plans of the Company. The
Compensation Committee is comprised of Dr. Douglas T. Breeden (Chairman), Mr.
Harper, and Dr. McConnell.
The Executive Committee of the Bank's Board of Directors reviews the
compensation of the Bank's senior executive officers, other than Mr. Cerny, and
recommends to the Board adjustments in such compensation. During fiscal 2001,
the members of the Executive Committee were Mr. R. Breeden III, Mr. Cerny, Dr.
Kon, and Dr. McConnell.
The report of the Compensation Committee and the Executive Committee
with respect to compensation for Mr. Cerny and all other executive officers for
the fiscal year ended June 30, 2001 is set forth below:
During fiscal year 2001, the Executive Committee of the Bank's Board of
Directors was responsible for administering compensation matters related to the
Bank's senior officers, other than Mr. Cerny. The Compensation Committee of the
Company, in consultation with the Company's and Bank's Boards of Directors,
administered compensation matters with respect to the Chief Executive Officer of
the Bank and President of the Company.
The purpose of the Compensation Committee is to assist the Boards of
Directors of the Company, the Bank, and its subsidiaries in attracting and
retaining qualified, competent management, motivating executives to achieve a
range of performance goals consistent with a business plan approved by the
Boards of Directors, and ensuring that proposed compensation and benefit
programs are reasonable and consistent with industry standards, management
performance and shareholder interests.
THE COMMITTEES CONSIDER THE FOLLOWING CRITERIA IN ANNUAL PERFORMANCE
REVIEWS PRIOR TO MAKING RECOMMENDATIONS WITH REGARD TO THE COMPENSATION OF THE
CHIEF EXECUTIVE OFFICER AND OTHER EXECUTIVE OFFICERS OF THE COMPANY AND THE
BANK:
1. The overall financial performance of the Company and the Bank during the
fiscal year under consideration, relative to stated management
objectives and financial goals and budgets.
2. Individual as well as combined measures of progress of the Company and
the Bank including the quality of the loan portfolio, execution of
retail expansion programs, interest rate risk and investment management,
deposit and loan growth, operating efficiency, personnel development and
training, and other objectives as may be established by management and
the Boards of Directors.
3. The CRA, Compliance, and CAMEL ratings as determined by the Office of
Thrift Supervision.
4. The performance of the Chief Executive Officer relative to management,
leadership, professional involvement, maintenance of corporate stature,
and enhancing the image of the Bank in it marketplace.
5. The compensation and benefit levels of comparable positions at peer
group financial institutions.
The compensation recommendations of the Committee include a base salary,
with the possibility of bonus and stock option components, if the Executive's
performance is judged to warrant such compensation.
The base compensation for Craig J. Cerny, Chief Executive Officer, was
established by the Compensation Committee at $200,000 on January 23, 2001. Mr.
Cerny's compensation level was determined with regard to the aforementioned
criteria using as a benchmark the executive compensation survey for savings
institutions as published by
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America's Community Bankers for the Midwest and other regions. In addition,
during the fiscal years 2001 and 2000, Mr. Cerny was paid bonuses totaling
$25,000 and $25,000, respectively, based on his performance and the performance
of the Company relative to community banking goals. Mr. Cerny does not
participate in the review of his compensation.
With respect to the Bank's other executive officers, the Executive
Committee of the Bank considered salary and bonus recommendations prepared by
the Chief Executive Officer to establish compensation levels for the fiscal year
ending 2001. Salary and bonus recommendations were based on the individual's and
the Company's overall performance in the past year as well as an analysis of
competitive compensation levels in the financial services industry from
America's Community Bankers surveys.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report.
(1) The following financial statements are filed as part of this
report:
Independent Auditor's Report
Consolidated Balance Sheets as of June 30, 2001, 2000,
Consolidated Statements of Operations for the Years Ended June 30,
2001, 2000 and 1999,
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended June 30, 2001, 2000 and 1999,
Consolidated Statements of Cash Flows for the Years Ended June 30,
2001, 2000, and 1999,
Notes to Consolidated Financial Statements.
(2) The following exhibits are filed as part of this Form 10-K, and
this list includes the Exhibit Index.
No. Description
------------- ---------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of Harrington Financial Group, Inc.(1/)
3.2 Amended and Restated Bylaws of Harrington Financial Group, Inc.(1/)
10.1 Amended and Restated Stock Option Plan of Harrington Financial Group, Inc.(6/*/)
10.2 Loan Agreement between Financial Research Corporation (now Harrington
Financial Group, Inc.) and Mark Twain Kansas Bank (now Mercantile
Bancorporation, Inc.), dated April 14, 1994, First Amendment and Loan
Agreement between such parties and Smith Breeden Associates, Inc. and
Douglas T. Breeden, dated July 21, 1995.(1/)
10.2.1 Second Amendment and Loan Modification Agreement between Harrington
Financial Group, Inc. and Mark Twain Kansas City Bank (now Mercantile
Bancorporation, Inc.), dated July 26, 1996 (modifies version set forth in
Exhibit 10.2)(2/)
10.2.2 Third Amendment and Loan Modification Agreement between Harrington
Financial Group, Inc. and Mark Twain Kansas City Bank (now Mercantile
Bancorporation, Inc.), dated January 13, 1997 (modifies version set forth
in Exhibits 10.2 and 10.2.1)(3/)
10.2.3 Fourth Amendment and Loan Modification Agreement between Harrington
Financial Group, Inc. and Mark Twain Kansas City Bank (now FIRSTAR Bank
Midwest, N.A.), dated June 30, 2000 (modifies version set forth in
Exhibits 10.2, 10.2.1 and 10.2.2)(6/)
10.2.4 Fifth Amendment and Loan Modification Agreement between Harrington
Financial Group, Inc. and Mark Twain Kansas City Bank (now FIRSTAR Bank
N.A., Overland Park), dated January 31, 2001 (modifies version set forth
in Exhibits 10.2, 10.2.1, 10.2.2, and 10.2.3)
10.3 Investment Advisory Agreement between Peoples Federal Savings Association
(now Harrington Bank, FSB) and Smith Breeden Associates, Inc. dated April
1, 1992, as amended on March 1, 1995.(1/)
10.4 Lease Agreement on Carmel Branch Office Facility, set forth in Assignment
of Lease, between NBD Bank, N.A. and Peoples Federal Savings Association,
dated November 8, 1993.(1/)
10.5 Trust Services Agreement dated September 30, 1994 by and between Harrington
Bank, FSB and the Midwest Trust Company.(1/)
10.6 Trust Services Agreement dated April 30, 1998 by and between Harrington
Bank, FSB and INFOVISA.(4/)
10.7 Terms of Employment between Harrington Bank, FSB and Lawrence T. Loeser dated
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January 25, 1999.(5/*/)
21 Subsidiaries of the Registrant - Reference is made to Item 1. "Business"
for the Required information
23 Consent of Deloitte & Touche LLP
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(1/) Incorporated by reference from the Registration Statement on Form S-1
(Registration No. 333-1556) filed by the Registrant with the Securities and
Exchange Commission ("SEC") on February 20, 1996, as amended.
(2/) Incorporated by reference from the Form 10-K for the fiscal year ended
June 30, 1996 filed by the Registrant with the SEC on September 30, 1996.
(3/) Incorporated by reference from the Form 10-K for the fiscal year ended
June 30, 1997 filed by the Registrant with the SEC on September 29, 1997.
(4/) Incorporated by reference from the Form 10-K for the fiscal year ended
June 30, 1998 filed by the Registrant with the SEC on September 28, 1998.
(5/) Incorporated by reference from the Form 10-Q for the quarterly period
ended March 31, 1999 filed by the Registrant with the SEC on May 17, 1999.
(6/) Incorporated by reference from the Form 10-K for the fiscal year ended
June 30, 2000 filed by the Registrant with the SEC on September 28, 2000.
(*/) Management contract or compensatory plan or arrangement.
(3)(b) Reports filed on Form 8-K.
Form 8-K was filed on June 1, 2001 and related to a proposed merger
agreement between Harrington Financial Group, Inc. and Hasten Bancshares.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HARRINGTON FINANCIAL GROUP, INC.
By: /s/ Craig J. Cerny
------------------
Craig J. Cerny
President and Chief Executive 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.
/s/ Craig J. Cerny September 27, 2001
------------------
Craig J. Cerny
President (Principal Executive Officer)
and Chief Executive Officer
/s/ John E. Fleener September 27, 2001
-------------------
John E. Fleener
Chief Financial Officer
/s/ Douglas T. Breeden September 27, 2001
----------------------
Douglas T. Breeden
Chairman of the Board
/s/ Russell Breeden III September 27, 2001
-----------------------
Russell Breeden III
Director
/s/ Michael J. Giarla September 27, 2001
---------------------
Michael J. Giarla
Director
/s/ Sharon E. Fankhauser September 27, 2001
------------------------
Sharon E. Fankhauser
Director
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/s/ David F. Harper September 27, 2001
-------------------
David F. Harper
Director
/s/ Stanley J. Kon September 27, 2001
------------------
Stanley J. Kon
Director
/s/ John J. McConnell September 27, 2001
---------------------
John J. McConnell
Director