UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2002
Commission File Number 0-21298
ST. FRANCIS CAPITAL CORPORATION
-------------------------------
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1747461
--------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
13400 Bishops Lane, Suite 350, Brookfield, Wisconsin 53005-6203
---------------------------------------------------------------
(Address of principal executive offices, including zip code)
(262) 787-8700
--------------
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
Common Stock, par value $0.01 per share
Preferred Stock Purchase Rights
(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.
(1) Yes [X] No [ ] (2) Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, computed by reference to the average of the bid and asked
price of such stock as of March 28, 2002 (the last trading day of the
Registrant's most recently completed second quarter), was $173.3 million. Solely
for the purposes of this calculation, all executive officers and directors of
the Registrant are assumed to be affiliates. The exclusion from such amount of
the market value of the shares owned by any person shall not be deemed an
admission by the Registrant that such person is an affiliate of the Registrant.
As of November 29, 2002, there were issued and outstanding 14,579,240 shares and
9,367,695 shares, respectively, of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K - Portions of the Proxy Statement for the 2003
Annual Meeting of Shareholders are incorporated by reference into Part III
hereof.
FORM 10-K TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I
ITEM 1 - BUSINESS........................................................................ 3
ITEM 2 - PROPERTIES...................................................................... 33
ITEM 3 - LEGAL PROCEEDINGS............................................................... 33
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................. 33
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS............................................................. 34
ITEM 6 - SELECTED FINANCIAL DATA......................................................... 35
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................................... 37
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................... 55
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................... 56
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE............................................................ 92
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................. 93
ITEM 11 - EXECUTIVE COMPENSATION.......................................................... 93
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS..................................................... 93
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................. 93
PART IV
ITEM 14 - CONTROLS AND PROCEDURES......................................................... 93
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................. 94
SIGNATURES .................................................................................. 96
</Table>
2
PART I
FORWARD-LOOKING STATEMENTS
This Report contains certain forward looking statements with respect to the
financial condition, results of operation and business of St. Francis Capital
Corporation (the "Company") within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward looking statements include words and
phrases such as "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," "intend" or similar expressions. The
Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors could affect the Company's financial performance
and could cause actual results for future periods to differ materially from
those anticipated or projected. Such factors include, but are not limited to:
(i) general market rates, (ii) general economic conditions, (iii)
legislative/regulatory changes, (iv) monetary and fiscal policies of the U.S.
Treasury and Federal Reserve, (v) changes in the quality or composition of the
Company's loan and investment portfolios, (vi) demand for loan products, (vii)
deposit flows, (viii) competition, (ix) demand for financial services in the
Company's markets, and (x) changes in accounting principles, policies or
guidelines.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect the occurrence of anticipated
or unanticipated events or circumstances after the date of such statements.
ITEM 1. BUSINESS
GENERAL
The Company is a unitary thrift holding company incorporated under the laws of
the State of Wisconsin and is engaged in the financial services business through
its wholly-owned subsidiary, St. Francis Bank, F.S.B. (the "Bank"), a
federally-chartered stock savings bank.
The Bank is headquartered in Milwaukee, Wisconsin and serves southeastern
Wisconsin with a network of 22 full-service, two limited-service and three loan
production offices. In addition, the Bank has a mortgage-banking subsidiary
based in Illinois that purchases single-family mortgage loans for resale,
primarily in the Chicago, Illinois metropolitan marketplace.
The Company's operations include four strategic business segments: Retail
Banking, Commercial Banking, Mortgage Banking and Investments. Management
evaluates the financial performance of each segment primarily based on the
individual segment's direct contribution to the Company's net income.
Information regarding the net interest income, other operating income, profit
and average assets for the fiscal years ended September 30, 2002, 2001 and 2000
is set forth in Note 18 to the Notes to Consolidated Financial Statements
included under Item 8 of this Annual Report on Form 10-K. In fiscal 2000, 2001
and 2002, the Company continued to reduce the size of its mortgage-backed
securities and investment securities portfolios as part of a strategy to
decrease the proportion of earnings from that segment of its balance sheet. The
reduction was primarily accomplished through the repayment of principal,
scheduled maturities and the sale of available-for-sale securities. Funds
generated from the repayment of principal, maturities and sales from the
mortgage-backed securities and investment securities portfolios were used to
grow and diversify the Company's loan portfolio, to reduce the Company's
wholesale debt and as an additional source of liquidity. Management anticipates
that this form of "balance sheet restructuring" will be an ongoing strategic
initiative of the Company in fiscal 2003.
The Company's principal business is attracting retail deposits from the general
public and investing those deposits, together with funds generated from other
operations, primarily to originate mortgage, consumer, commercial and other
loans within its primary market areas, and to invest in mortgage-backed and
related securities. Primary areas of lending include single-family and
multi-family residential mortgages, home equity lines of credit, second
mortgages, commercial real estate loans and commercial loans. The Company also
purchases single-family mortgage loans, either by directly purchasing individual
loans from other local mortgage lenders or by purchasing pools of single-family
mortgage loans originated by other non-local lenders and secured by properties
located outside the State of Wisconsin. The Company invests a significant
portion of its assets in mortgage-backed and related securities, and to a lesser
extent, invests in debt and equity securities, including U.S. Government and
3
federal agency securities, short-term liquid assets and other marketable
securities. The Company also invests in affordable housing projects throughout
the State of Wisconsin. The Company's revenues are derived principally from
interest on its loan portfolio, interest on mortgage-backed and related
securities, and interest and dividends on its debt and equity securities. The
affordable housing projects do not provide a significant source of income before
taxes, but rather provide income in the form of income tax credits which reduce
the Company's income tax liability. The Company's principal sources of funds are
from deposits, including brokered deposits, repayments on loans and
mortgage-backed and related securities, and advances from the Federal Home Loan
Bank - Chicago ("FHLB").
MARKET AREA AND COMPETITION
The Company offers a variety of deposit products, services and consumer,
commercial and mortgage loan offerings primarily within the metropolitan
Milwaukee area. The Company's corporate headquarters is located at 13400 Bishops
Lane, Suite 350, Brookfield, Wisconsin. The primary market area for the Bank's
full-service and limited-service offices consists of Milwaukee and Waukesha
counties, and portions of Ozaukee, Washington and Walworth counties. The Bank's
Illinois mortgage banking subsidiary purchases single-family mortgage loans for
resale, primarily in the Chicago, Illinois metropolitan marketplace. The Bank's
loan production offices include two in the Milwaukee metropolitan area that
originate primarily one- to four-family mortgage loans for both portfolio and
resale purposes. A third loan production office is located in Brookfield,
Wisconsin and originates commercial real estate, multi-family and commercial
loans. The market area for this type of lending is primarily in southeastern
Wisconsin, but also includes the rest of Wisconsin, and other portions of the
Midwest including Illinois and Minnesota. The Company also evaluates lending
opportunities and may originate or purchase all types of loans located outside
the primary market areas.
With the exception of the downtown Milwaukee branch office, all full-service
branches of the Bank are located in areas that generally are characterized as
residential neighborhoods, containing predominantly one- and two-family
residences.
The Company has significant competition in its mortgage, consumer and commercial
lending business, as well as in attracting deposits. The Company's competition
for loans is principally from other thrift institutions, savings banks, mortgage
banking companies, insurance companies and commercial banks. The Company's
competition for deposits comes from other thrifts, savings banks, commercial
banks and credit unions. The Company has additional competition for funds from
other financial service companies, such as brokerage firms and insurance
companies.
LENDING ACTIVITIES
GENERAL
The Company's gross loan portfolio totaled $1.3 billion at September 30, 2002.
At September 30, 2002, one- to four-family mortgage loans totaled $251.7 million
or 18.2% of gross loans. Of the total one- to four-family mortgage loans, $170.5
million or 67.7% were adjustable rate mortgage loans ("ARMs"). Of the remaining
loans held at September 30, 2002, 28.6% were commercial real estate, 20.0% were
home equity loans, 10.8% were commercial, 11.5% were multi-family mortgage
loans, 6.4% were consumer loans, and 4.5% were residential construction. As part
of its strategy to manage interest rate risk, the Company originates primarily
ARM loans or fixed-rate loans which have shorter maturities for its own loan
portfolio. The ARM loans generally include terms under which the borrower may
convert the loan to a fixed-rate loan. Upon conversion to a fixed rate loan, the
loan is typically sold into the secondary market. The Company also originates
longer-term fixed rate mortgage loans, many of which are sold in the secondary
market. Mortgage loans originated and sold into the secondary market totaled
$769.7 million, $453.5 million and $117.7 million for the years ended September
30, 2002, 2001 and 2000, respectively. See "Sale of Mortgage Loans."
The Company has been diversifying its loan portfolio, which in addition to its
traditional one- to four-family lending, includes commercial real-estate,
multi-family, consumer and commercial lending. Areas of lending other than one-
to four-family lending generally have higher levels of credit risk and higher
yields. The Company may purchase loans in the above categories in addition to
originating the loans on its own. Purchased loans involve different types of
underwriting than loans originated directly by the Company and as such represent
a different level of risk.
4
Levels of originations of various lending categories may vary from year-to-year
and result from differing levels of interest rates, market demand for loans and
emphasis by the Company on various types of loans. In fiscal 2002, the level of
originations, in particular mortgage loans, were especially dependent on the
level of interest rates or changes in interest rates throughout the year. The
Company adjusts its lending emphasis occasionally in accordance with its view of
the relative returns and risks available from time to time in each category of
lending. Although there is likely to be activity in all areas in which the
Company makes loans in any given year, the amount may vary given changes in the
above factors.
5
COMPOSITION OF LOAN PORTFOLIO
The following table sets forth the composition of the Company's loan portfolio
in dollar amounts and in percentages of the respective portfolios at the dates
indicated.
<Table>
<Caption>
September 30,
---------------------------------------------------------------------------------------
2002 2001 2000
--------------------------- --------------------------- ---------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Mortgage loans:
One- to four-family .................. $ 251,702 18.2% $ 298,617 22.5% $ 404,505 29.5%
Residential construction ............. 62,973 4.5% 68,936 5.2% 62,260 4.5%
Multi-family ......................... 158,320 11.5% 126,338 9.5% 130,002 9.5%
Commercial real estate ............... 395,473 28.6% 362,329 27.3% 306,778 22.4%
Home equity .......................... 276,437 20.0% 221,559 16.7% 188,349 13.8%
------------ ------------ ------------ ------------ ------------ ------------
1,144,905 82.8% 1,077,779 81.2% 1,091,894 79.7%
Consumer loans:
Interim financing and installment .... 86,884 6.3% 104,984 7.9% 124,910 9.1%
Education ............................ 917 0.1% 3,253 0.3% 1,615 0.1%
------------ ------------ ------------ ------------ ------------ ------------
87,801 6.4% 108,237 8.2% 126,525 9.2%
------------ ------------ ------------ ------------ ------------ ------------
Commercial loans ......................... 148,716 10.8% 140,826 10.6% 152,526 11.1%
------------ ------------ ------------ ------------ ------------ ------------
Gross loans receivable ............. 1,381,422 100.0% 1,326,842 100.0% 1,370,945 100.0%
============ ============ ============
Deduct:
Mortgage loans held for sale ......... 65,006 18,974 8,066
Loans in process ..................... 43,644 57,153 54,679
Deferred loan and guarantee fees and
purchased loan discounts ........... 1,008 993 300
Allowance for loan losses ............ 14,212 11,686 10,404
Unearned insurance premiums .......... 86 136 194
------------ ------------ ------------
Loans receivable, net .................... $ 1,257,466 $ 1,237,900 $ 1,297,302
============ ============ ============
</Table>
<Table>
<Caption>
September 30,
------------------------------------------------------------
1999 1998
---------------------------- ----------------------------
Percent Percent
Amount of Total Amount of Total
------------ ------------ ------------ ------------
(Dollars in thousands)
Mortgage loans:
One- to four-family .................... $ 294,438 23.8% $ 254,047 26.1%
Residential construction ............... 103,100 8.3% 71,092 7.3%
Multi-family ........................... 160,593 13.0% 105,380 10.8%
Commercial real estate ................. 251,914 20.3% 170,562 17.6%
Home equity ............................ 156,695 12.6% 142,993 14.7%
------------ ------------ ------------ ------------
966,740 78.0% 744,074 76.5%
Consumer loans:
Interim financing and installment ...... 148,034 11.9% 131,143 13.5%
Education .............................. 984 0.1% 2,529 0.3%
------------ ------------ ------------ ------------
149,018 12.0% 133,672 13.8%
------------ ------------ ------------ ------------
Commercial loans ........................... 123,899 10.0% 93,927 9.7%
------------ ------------ ------------ ------------
Gross loans receivable ............... 1,239,657 100.0% 971,673 100.0%
============ ============
Deduct:
Mortgage loans held for sale ........... 8,620 23,864
Loans in process ....................... 106,960 83,436
Deferred loan and guarantee fees and
purchased loan discounts ............. 696 1,419
Allowance for loan losses .............. 9,356 7,530
Unearned insurance premiums ............ 634 292
------------ ------------
Loans receivable, net ...................... $ 1,113,391 $ 855,132
============ ============
</Table>
6
The following table sets forth the Company's loan originations and loan
purchases, sales and principal repayments for the years indicated. Mortgage
loans held for sale are included in the totals.
<Table>
<Caption>
Years Ended September 30,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
(In thousands)
Mortgage loans (gross):
At beginning of period ...................................... $ 1,077,779 $ 1,091,894 $ 966,740
Mortgage loans originated:
One- to four-family ................................... 445,126 232,624 112,934
Residential construction .............................. 90,078 80,092 65,439
Multi-family .......................................... 75,494 34,754 26,832
Commercial real estate ................................ 96,023 105,879 75,773
Home equity ........................................... 211,963 159,616 132,020
------------ ------------ ------------
Total mortgage loans originated ..................... 918,684 612,965 412,998
Mortgage loans purchased:
One- to four-family ................................... 341,249 201,051 90,068
------------ ------------ ------------
Total mortgage loans purchased ...................... 341,249 201,051 90,068
------------ ------------ ------------
Total mortgage loans originated and purchased ....... 1,259,933 814,016 503,066
Transfer of mortgage loans to foreclosed properties ... (1,608) (656) (929)
Transfer from commercial loans ........................ 4,076 2,165 6,942
Loans charged-off ..................................... (5) (112) (1,042)
Principal repayments .................................. (425,563) (376,005) (265,209)
Sales of mortgage loans:
Exchanged for mortgage-backed securities .............. -- (1,432) (13,021)
Cash sales ............................................ (769,707) (452,091) (104,653)
------------ ------------ ------------
Total sales of loans ................................ (769,707) (453,523) (117,674)
------------ ------------ ------------
At end of period ............................................ $ 1,144,905 $ 1,077,779 $ 1,091,894
============ ============ ============
Consumer loans (gross):
At beginning of period ...................................... $ 108,237 $ 126,525 $ 149,018
Loans originated ...................................... 84,354 62,338 51,472
Repossessions, foreclosures and charge-offs ........... (570) (367) (325)
Principal repayments .................................. (100,610) (80,259) (72,493)
Loans sold ............................................ (3,610) -- (1,147)
------------ ------------ ------------
At end of period ............................................ $ 87,801 $ 108,237 $ 126,525
============ ============ ============
Commercial loans (gross):
At beginning of period ...................................... $ 140,826 $ 152,526 $ 123,899
Loans originated ...................................... 62,547 51,829 101,677
Transfer of commercial loans to mortgage loans ........ (4,076) (2,165) (6,942)
Repossessions, foreclosures and charge-offs ........... (704) (3,766) (94)
Principal repayments .................................. (49,877) (57,598) (66,014)
------------ ------------ ------------
At end of period ............................................ $ 148,716 $ 140,826 $ 152,526
============ ============ ============
</Table>
7
LOAN MATURITY AND REPRICING
The following table shows the maturity of the Company's loan portfolio at
September 30, 2002. The table does not include prepayments or scheduled
principal amortization. Prepayments and scheduled principal amortization on
mortgage loans totaled $425.6 million, $376.0 million and $265.2 million for the
years ended September 30, 2002, 2001 and 2000, respectively.
<Table>
<Caption>
At September 30, 2002
-----------------------------------------------------------------------------------------------
One- to Commercial Gross
Four- Multi- Real Home Loans
Family(1) Family(1) Estate Equity Consumer Commercial Receivable
------------ ----------- ----------- ----------- ----------- ----------- -----------
(In thousands)
Amounts due:
Within one year ........... $ 868 $ 2,198 $ 20,751 $ 20,819 $ 20,994 $ 64,610 $ 130,240
After one year:
One to three years ...... 3,376 11,518 35,981 135,428 18,139 59,682 264,124
Three to five years ..... 14,351 57,323 106,988 120,190 19,013 22,026 339,891
Over five years ......... 296,080 87,281 231,753 -- 29,655 2,398 647,167
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total due after one year .. 313,807 156,122 374,722 255,618 66,807 84,106 1,251,182
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total amounts due ......... 314,675 158,320 395,473 276,437 87,801 148,716 1,381,422
Less:
Mortgage loans held for
sale ...................... (65,006) -- -- -- -- -- (65,006)
Loans in process .......... (30,646) (3,559) (9,439) -- -- -- (43,644)
Unearned discounts,
premiums and deferred
loan fees, net .......... 211 -- (190) -- (29) (1,086) (1,094)
Allowance for loan
losses .................... (2,117) (868) (3,521) (1,416) (2,363) (3,927) (14,212)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Loans receivable, net ........ $ 217,117 $ 153,893 $ 382,323 $ 275,021 $ 85,409 $ 143,703 $ 1,257,466
=========== =========== =========== =========== =========== =========== ===========
</Table>
(1) Includes some residential construction lending.
The following table sets forth at September 30, 2002 the dollar amount of all
loans and mortgage-backed and related securities due after September 30, 2003,
and whether such loans have fixed interest rates or adjustable interest rates.
<Table>
<Caption>
Due after September 30, 2003
------------------------------------------
Fixed Adjustable Total
------------ ------------ ------------
(In thousands)
Mortgage loans:
One- to four-family (1) ................ $ 81,192 $ 232,615 $ 313,807
Multi-family (1) ....................... 68,214 87,908 156,122
Commercial real estate ................. 120,408 254,314 374,722
Home equity ............................ -- 255,618 255,618
Consumer loans ............................. 66,807 -- 66,807
Commercial ................................. 51,002 33,104 84,106
------------ ------------ ------------
Gross loans receivable ................. 387,623 863,559 1,251,182
Mortgage-backed and related securities ..... 526,449 182,377 708,826
------------ ------------ ------------
Gross loans receivable and mortgage-
backed and related securities ........ $ 914,072 $ 1,045,936 $ 1,960,008
============ ============ ============
</Table>
(1) Includes some residential construction lending.
8
ONE- TO FOUR-FAMILY MORTGAGE LENDING
The most significant portion of the Company's lending activity is the
origination of first mortgage loans secured by one- to four-family,
owner-occupied residences within the Company's primary market area. Long-term
15- and 30-year fixed rate mortgages, and 7-year balloon loans are generally
originated and sold in the secondary market. The Company also originates and
sells 30-year fixed rate mortgages under the Wisconsin Housing and Economic
Development Authority ("WHEDA") program. Shorter-term ARM loans are generally
originated for the Company's loan portfolio. Loans made under special loan terms
or programs, typically originated with lower interest rates or a lower
loan-to-value ratio, principally originated within the purposes of the Community
Reinvestment Act of 1977, as amended ("CRA"), are retained for the Company's own
loan portfolio.
The Company typically follows secondary market underwriting guidelines for most
of its conforming one- to four-family mortgage production, including those
established by Fannie Mae, WHEDA, and other specific investors. In many cases,
the application of these guidelines includes the use of the latest in automated
underwriting systems.
The lending policy of the Company generally allows for mortgage loans to be made
in amounts of up to 100% of the lesser of appraised value or purchase price of
the real estate to be mortgaged to the Company. Loans that are made in excess of
80% of appraised value generally require a credit enhancement such as private
mortgage insurance to mitigate risk. The Company also has several loan programs
whereby for a higher rate, loans in excess of 80% of appraised value are not
required to have private mortgage insurance or another type of credit
enhancement.
ARM loans are included in mortgage loans held by the Company as part of its loan
portfolio. During the adjustment period, ARM loans typically can adjust by a
maximum of two percentage points per year with a lifetime cap approximating six
percentage points above the interest rate established at the origination date of
the ARM loan. Monthly payments of principal and interest are adjusted when the
interest rate adjusts, in order to maintain full amortization of the mortgage
loan within a maximum 30-year term. The initial rates offered on ARM loans
fluctuate with general interest rate changes, and are determined by secondary
market pricing, competitive conditions and the Company's yield requirements.
Currently, the Company utilizes primarily the one-year Constant Maturity
Treasury rate in order to determine the interest rate payable upon the
adjustment date of its ARM loans outstanding. Because the majority of the Bank's
ARM loans are underwritten to meet secondary market standards, these loans
include terms under which the borrower may convert the loan to a fixed-rate
loan. The terms at which the ARM may be converted to a fixed-rate loan are
established at the date of loan origination and are set at a level allowing the
Company to immediately sell the ARM loan at the date of conversion. Upon
conversion of an ARM loan to a fixed-rate loan, the Company typically transfers
the mortgage loan to mortgage loans held for sale and the loans are then sold
into the secondary market. For the year ended September 30, 2002, the Company
transferred $95.0 million converted mortgage loans to mortgage loans held for
sale, compared to $91.0 million for the year ended September 30, 2001.
The volume of one- to four-family mortgage loan origination is highly dependent
on the relative levels of interest rates. During periods of lower interest
rates, the Company originates a higher percentage of loans with fixed rates,
which the Company sells in the secondary market in connection with interest rate
risk management. In such environments, the Company's level of gains on mortgage
loan sales may be higher due to the increased percentage of loans being
originated which are subsequently sold in lieu of being retained in the
Company's portfolio.
At September 30, 2002, the Company had $251.7 million in one- to four-family
mortgage loans or 18.2% of the gross loan portfolio compared with $298.6 million
or 22.5% of the portfolio at September 30, 2001. This decline was largely the
result of decreasing interest rates during the year which motivated consumers to
choose attractively priced fixed-rate mortgage financing alternatives. The
Company's one- to four-family mortgage loan portfolio has a significant level of
adjustable rate loans and during periods of declining interest rates, the
customers convert adjustable rate loans to fixed-rate loans. However, fixed-rate
loans are generally sold in the secondary market and are not maintained on the
Company's balance sheet.
RESIDENTIAL CONSTRUCTION/PERMANENT LENDING
Residential construction/permanent lending typically comprises a significant
portion of the Company's new ARM loan production. These loans are made to
borrowers who have obtained plans, specifications and a construction contract
with a residential home builder. Residential construction loan programs
typically offered by the Company include 1- 2- 3- and 5-year ARM loans. Most
loans are originated with terms of 30 years, with the construction period being
included in the initial portion of that term. The length of the construction
period is the lesser of the
9
time it takes to complete the home or 12 months. During this period, the
borrower is required to pay interest only on the funds advanced. Thereafter, the
borrower is required to begin making principal and interest payments based on an
amortization schedule of the remaining months. Typically, the construction of
most homes financed take five to six months.
At closing, loan proceeds adequate to complete the construction of the home are
placed in escrow and disbursements are made in increments as construction of the
residence progresses. Vendors are contracted to conduct inspections, disburse
proceeds, obtain lien waivers, and ensure that clear title to the property is
maintained.
One- to four-family, residential construction loans typically have loan to value
ratios of up to 95%. When the loan to value ratio exceeds 80%, private mortgage
insurance is generally required upon the completion of the construction period
to reduce the Company's exposure to 80% or less of the loan value.
A significant portion of the Company's residential construction lending results
in permanent mortgage loans that are either retained as ARMs in the mortgage
loan portfolio or sold in the secondary market once converted. At September 30,
2002, the Company had $63.0 million in residential construction/permanent
lending mortgage loans, or 4.5% of the gross loan portfolio, compared with $68.9
million or 5.2% of the portfolio at September 30, 2001.
MULTI-FAMILY MORTGAGE LENDING
The Company originates multi-family mortgage loans which it typically holds in
its loan portfolio. Over the last five years, the Company has increased its
emphasis in multi-family mortgage lending and has offered both adjustable- and
fixed-rate mortgage loans. Multi-family mortgage loans generally have shorter
maturities than one- to four-family mortgage loans, though the Company has made
multi-family mortgage loans with terms of up to 30 years. Multi-family loans
generally are underwritten in amounts up to the lesser of 85% of the appraised
value or 85% of the borrower's purchase price of the underlying property,
although loans of up to 100% of property value have been made.
Loans secured by multi-family real estate generally have higher loan balances,
involve a greater degree of credit risk than one- to four-family loans, have a
higher rate of interest and ARM loans adjust at slightly higher rates. The
increased credit risk is the result of several factors, including the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income-producing properties and the
increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by multi-family real estate is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced, the borrower's ability to
repay the loan may be impaired. In some instances, the risk level is mitigated
by obtaining individual guarantees, which may provide an additional source of
repayment of the loan. Despite the risks inherent in multi-family lending, the
Company's percentage of delinquent multi-family loans to gross multi-family
loans has been minimal.
At September 30, 2002, the Company had $158.3 million in multi-family mortgage
loans or 11.5% of the gross loan portfolio compared with $126.3 million or 9.5%
of the portfolio at September 30, 2001. During fiscal 2002, the increase in
multi-family mortgage loans is primarily due to an increase in originations. The
Company is continuing its efforts to increase the amount of multi-family loans
in the loan portfolio. These loans generally offer a greater yield than
single-family loans, which, the Company believes, justifies the increased credit
risk.
COMMERCIAL REAL ESTATE LENDING
The current lending policy of the Company includes originating or purchasing
non-residential mortgage loans on a variety of commercial properties, including
office buildings, warehouses, industrial/manufacturing buildings, motel
properties, land development and other improved non-residential properties. In
recent years, commercial real estate lending has been identified as a growth
area for the Company with the allocation of additional Company resources. In
fiscal 2002, the Company originated and refinanced an increased amount of
commercial real estate loans within its normal credit risk guidelines. The
Company originated 160 loans with principal balances totaling $96.0 million
during the current fiscal year, compared to 121 loans with principal balances
totaling $105.9 million in fiscal 2001. At September 30, 2002, the Company had
$395.5 million in commercial real estate mortgage loans or 28.6% of the gross
loan portfolio, compared with $362.3 million or 27.3% of the portfolio at
September 30, 2001.
10
The Company's commercial real estate lending area includes the states of
Illinois and Minnesota as well as its' primary geographic focus of Wisconsin.
Commercial real estate loans generally are underwritten in amounts up to the
lesser of 85% of the appraised value or 85% of the borrower's purchase price of
the underlying property. Loans secured by commercial real estate properties are
assumed to involve a greater degree of credit risk than residential mortgage
loans and generally carry larger loan balances. This increased credit risk is a
result of several factors, including concentration of principal in a limited
number of loans and borrowers, the effects of general economic conditions on
income-producing properties and the increased difficulty of evaluating and
monitoring these types of loans. Furthermore, the repayment of loans secured by
commercial real estate is typically dependent upon the successful operation of
the related business occupant. In addition, payments on loans secured by
commercial real estate are often susceptible to adverse conditions in the real
estate market or the economy. The risk may be increased on loans secured by
properties located outside of the Company's primary market area due to the
decreased ability to actively monitor such properties.
HOME EQUITY LENDING
The Company has continued to increase its emphasis in originating home equity
loans secured by one- to four-family residences, usually by a second mortgage,
within its primary market area. These loans currently are originated with an
interest rate indexed to the prime rate and adjustable monthly, and thus play a
role in the Company's management of its interest rate risk. Home equity loans
are revolving lines of credit, which are granted for up to a ten-year term, and
are renewable at the sole discretion of the Company for additional periods. The
minimum monthly payment is interest only for all loan-to-value ratios providing
the collateral is the primary residence and 1.5% of the outstanding balance for
properties other than primary residence, however, the Company does very few
loans that do not use the primary residence as collateral. Typically, the
Company requires borrowers to reimburse out-of-pocket fees for costs associated
with obtaining independent appraisals, title insurance, flood determination and
other items. In instances when closing costs are waived, a deactivation fee is
placed on the loan to compensate the Company for expenses incurred. An
origination fee is occasionally charged upon the origination of the loan and an
annual service fee is charged thereafter. Home equity loans may be made at up to
a 100% loan-to-value level, including any outstanding liens against the property
which serves as collateral for the loan. The Company has chose to charge higher
rates for loans with loan-to-value ratios above 85% to compensate for the
additional risk associated with these transactions. Only rarely does the Company
require additional insurance enhancement through outside sources. At September
30, 2002, the Company held $276.4 million in home equity loans or 20.0% of the
gross loan portfolio, compared with $221.6 million or 16.7% of the portfolio at
September 30, 2001.
CONSUMER LENDING
The Company originates a significant amount of consumer loans with a majority of
the loans originated being secured by real estate or other forms of collateral
and a small percentage being unsecured. These loans include secured consumer
loans, including home improvement loans, automobile loans, educational loans,
fixed-term installment loans and interim financing loans, as well as loans
secured by savings accounts and unsecured loans. Consumer loan terms vary
according to the type of collateral, the term of the loan and the
creditworthiness of the borrower. The Company has been expanding its consumer
lending portfolio because historically it has experienced higher yields,
relatively low delinquency and few losses on such products. Management also
believes that offering consumer loan products helps expand and create stronger
customer relationships. All loans originated are maintained in the Company's
loan portfolio and are serviced by the Company.
At September 30, 2002, consumer loans totaled $87.8 million or 6.4% of gross
loans compared to $108.2 million or 8.2% of gross loans at September 30, 2001.
In fiscal 2002, the decrease in consumer loans is primarily due to repayments of
loans that were not replaced with new originations.
The Company originates consumer loans through two primary delivery channels:
retail and wholesale. The retail delivery channel is the largest delivery
channel and includes the decentralized lenders in the branch network and
centralized lenders at the loan production offices. This delivery channel
originates home equity loans and all other consumer loan products within the
primary market area of southeastern Wisconsin. The wholesale delivery channel
originates home equity products only through mortgage bankers and brokers within
the primary market area of Wisconsin and northern Illinois. A portion of
consumer loans were originated through an indirect automobile program; however,
the Company decided to exit this program during fiscal 2000 and only $5.1
million remains outstanding at September 30, 2002. The Company continues to
originate direct automobile loans on a limited basis.
11
Consumer loans often entail greater risk than residential mortgage loans. In the
case of unsecured loans or loans secured by rapidly depreciating assets such as
automobiles, any repossessed collateral for a defaulted consumer loan may not
provide an adequate source of repayment as a result of the greater likelihood of
damage, loss or depreciation. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be affected by adverse personal circumstances. Furthermore, the
application of various federal and state laws, including bankruptcy and
insolvency laws, may limit the amount which can be recovered from a borrower on
such a loan.
COMMERCIAL LENDING
The Company originates a variety of commercial loans, including inventory and
receivable financing, equipment loans and interim financing loans. Collateral
can take many forms, such as real estate, inventory, and equipment and may
include personal guarantees of business owners or personal or other collateral
of the business owner. Cash flows, historical financials, financial projections
and collateral valuations are analyzed to give the Company assurance that the
business will generate a sufficient level of cash flow to cover ongoing business
expenses and debt service. The loan-to-value ratios vary depending upon the type
and liquidity of the collateral.
Commercial loans involve a greater degree of risk than most other types of
loans, and payments are often susceptible to adverse economic conditions. Also,
the repayment of loans secured by commercial business assets is typically
dependent upon the successful operation and the eventual cash flows of the
business. To the extent the Company originates these loans outside of its
primary market area, the risks are increased due to decreased ability to monitor
the loans. The Company anticipates commercial lending to continue to increase as
management believes this type of lending is providing a higher yield than
residential loans and is an important component of a balanced loan portfolio.
Typically, the Company targets smaller businesses with which to establish
commercial banking relationships.
The Company also participates with other financial institutions in syndicated
credits whereby several lenders participate in commercial loan arrangements that
are larger than those that the Company would typically originate on a
stand-alone basis. However, the Company has participated in only those types of
credits that it would lend to directly from its own operations, except for the
size of the loan. The Company is not the lead lender in these loans, but does
underwrite the credit on its own in addition to the underwriting performed by
the lead lender. The Company also has limited itself to credit facilities to
commercial borrowers with headquarters or significant operational presence in
the Midwest. Syndicated credits in which the Company has participated are
generally variable rate loans, which also help contribute to the Company's
interest rate risk posture. A shared national credit is any loan or formal loan
commitment extended to a borrower that in original amount aggregates to $20
million or more, that is shared by three or more unaffiliated, supervised
institutions under a formal lending agreement. At September 30, 2002, the
Company had $29.9 million or 20.1% of its commercial loan portfolio, in such
credits compared to $38.1 million or 27.1% at September 30, 2001.
At September 30, 2002, the Company had $148.7 million in commercial loans or
10.8% of the gross loan portfolio compared with $140.8 million or 10.6% of the
portfolio at September 30, 2001. During fiscal 2002, the increase in commercial
loans is primarily due to an increase in originations as well as a decline in
repayments. The Company intends to continue to increase its involvement in
commercial lending and expects that this portfolio will grow as a percentage of
the total loan portfolio.
CREDIT ENHANCEMENT PROGRAMS
The Company has entered into agreements whereby, for an initial and annual fee,
it will guarantee payment of an industrial revenue bond issue ("IRB"), issued by
a municipality to finance real estate owned by a third party. The Company does
not pledge collateral for purposes of these agreements. At September 30, 2002,
the amount of IRB's for which the Company has guaranteed payment was $36.6
million.
LOAN SALES AND PURCHASES
SALE OF MORTGAGE LOANS
The Company sells a significant amount of its originated residential mortgage
loans to secondary marketing agencies, principally Fannie Mae, and primarily on
a non-recourse basis. All mortgage loans, upon commitment, are immediately
categorized as either held for investment or held for sale. The level of
mortgage loan sales is dependent on the amount of saleable loans being
originated by the Company. Depending on factors such as interest rates, levels
of borrower refinancing and competitive factors in the Company's primary market
area, the
12
amount of mortgage loans ultimately sold can vary significantly. Mortgage loans
originated and sold to the secondary market totaled $769.7 million with gains of
$12.8 million for the year ended September 30, 2002, and totaled $453.5 million
with gains of $6.1 million for the year ended September 30, 2001. The level of
originations is primarily dependent on the level of interest rates or changes in
interest rates throughout each fiscal year.
The Company is subject to interest rate risk on fixed rate loans from the point
in time that the rate is fixed with the borrower until the loan is sold. The
Company utilizes various financial techniques to mitigate such interest rate
risk, including short call/put option strategies, long put options and forward
sales commitments. Any one or all of these strategies may be used depending upon
management's determination of interest rate volatility, the amount of loans for
which the Company has issued a commitment and current market conditions for
mortgage-backed securities. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Asset/Liability Management."
The Company also makes loans under the WHEDA loan program. These loans are also
sold on a non- recourse basis. For the years ended September 30, 2002 and 2001,
the Company originated $4.3 million and $6.3 million, respectively, of loans
under this governmental program.
Loan commitments are issued as soon as possible upon completion of the
underwriting process, and mortgage loans are closed as soon as all title
clearance and other required procedures have been completed. Because of the
frequency of both the issuance of commitments and the scheduled closing dates of
the loans, the amount of loan commitments outstanding will vary. At September
30, 2002, the Company had outstanding mortgage commitments totaling $90.4
million.
Historically, the Company has retained servicing of the majority of mortgage
loans sold, receiving a servicing fee which represents the difference between
the note rate on the loans sold and the yield at which such loans are sold. The
servicing yield earned by the Company on such transactions is typically 0.25% of
the total balance of the loan serviced. The Company's mortgage banking operation
in Illinois typically sells the servicing on the majority of its loans. The
origination of a high volume of mortgage loans and the related sales of the
loans with servicing retained provides the Company with additional sources of
non-interest income through loan servicing income and gains on the sales of
loans.
At September 30, 2002, the Company had recognized $6.1 million in mortgage
servicing rights as compared to $6.3 million at September 30, 2001. The results
for the year ended September 30, 2002 include a $3.1 million charge related to
an impairment write-down of mortgage servicing rights, which is recorded as a
valuation reserve at September 30, 2002. (For further information regarding this
impairment see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Other Operating Income.") Correspondingly, mortgage loans
serviced for others increased from $622.5 million at September 30, 2001 to
$768.7 million at September 30, 2002.
PURCHASE OF MORTGAGE LOANS
The Company, as a regular part of its mortgage lending activities, purchases
individual one- to four-family mortgage loans originated in its primary market
area by other lenders, primarily mortgage bankers and brokers. The types of
loans purchased are generally newly originated loans with the same
characteristics as the loans normally originated by the Company in its retail
lending operations. Even though the Company is not as involved in the
origination of these loans, they typically are underwritten by the Company. This
step, coupled with other quality control processes, helps mitigate the
additional risks associated with individual loan purchases. Although the
Company's historical loan purchase activity has been limited to one- to
four-family loans, the Company may purchase other types of loans, or pools of
loans other than one- to four-family loans in the future.
For one- to four-family mortgage loans purchased from mortgage brokers the
Company pays a fee to the originating mortgage banker or broker which is
amortized over the life of the loan for loans retained in the portfolio or which
becomes an adjustment to the gain or loss recognized on loans sold in the
secondary market. The Company maintains the same, or more restrictive
underwriting standards on these loans as it does on the loans it originates
directly. During the fiscal year ended September 30, 2002, the Company purchased
$341.3 million of loans from other originators compared to $201.1 million of
loans purchased during the fiscal year ended September 30, 2001. Included in
purchased loans for fiscal 2002 and 2001 are loans purchased by the Company's
mortgage banking operation in Illinois. During the year ended September 30,
2002, the Company's mortgage banking operation in Illinois purchased $322.3
million one- to four-family mortgage loans for resale in the
13
secondary market compared to $174.4 million purchased during the year ended
September 30, 2001. As part of the Company's plans to diversify its one- to
four-family loan production, it is expected that purchases of loans from other
originators will continue in future years.
From time to time, the Company also has purchased "pools" of one- to four-family
loans originated by other lenders in other parts of the country. The loans
purchased have generally been adjustable rate loans with interest rate
adjustment features of one month to one year and are indexed to current indexes
such as the one-year treasury note or to lagging indexes such as the 11th
district cost of funds. As part of its interest rate risk management, the
Company attempts to identify loans originated in other parts of the country
where adjustable rate lending is more prevalent, since the availability of
similar loan products within its primary market area is limited and competition
for that limited demand may force interest rates to levels considered too low
compared to other available instruments. The purchasing of "pools" of loans can
result in a higher level of risk due to the Company not fully controlling the
origination process. Efforts taken to mitigate the additional risk include a due
diligence process prior to the actual purchase. This process typically
encompasses a review of the payment histories as well as an analysis of the
geographic concentration of the loans contained in the package. It also includes
the individual re-underwriting of the loan file and verification of collateral
value on a sample of loans.
LOAN ORIGINATION, SERVICING AND OTHER FEES
In addition to interest earned on loans, the Company receives income through
fees in connection with loan originations, loan sales, loan modifications, late
payments and for miscellaneous services related to its loans, including loan
servicing. Income from these activities varies from period to period with the
volume and type of loans originated.
In connection with the origination of mortgage loans, the Company typically
charges fees for processing and closing loans in addition to requiring borrower
reimbursement of out-of-pocket fees for costs associated with obtaining
independent appraisals, credit reports, title insurance, flood determination and
other items. The Company also may charge points for the origination of loans in
exchange for a lower interest rate on the loan itself. However, with the
availability of zero point mortgage loans in recent years, most borrowers
typically accept a slightly higher interest rate and pay zero points. A borrower
pays commitment fees at the time of a loan commitment, whereas the origination
and discount fees are paid at the time of closing. Commitment fees are
periodically collected on commercial real estate or multi-family mortgage loans
but are rarely collected as part of the origination of one- to four-family
mortgage loans.
DELINQUENCIES, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS
DELINQUENT LOANS
When a borrower fails to make a required payment by the end of the month in
which the payment is due, the Company generally initiates collection procedures.
The Company will send a late notice, and in most cases, delinquencies are cured
promptly. However, if a loan has been delinquent for more than 60 days, the
Company contacts the borrower directly, to attempt to determine the reason for
the delinquency and to effect a cure, and where it believes appropriate, reviews
the condition of the property and the financial position of the borrower. At
that time the Company may (i) accept a repayment program for the arrearage; (ii)
seek evidence of efforts by the borrower to sell the property; (iii) request a
deed in lieu of foreclosure; or (iv) initiate foreclosure proceedings. When a
loan, secured by a mortgage, is delinquent for three or more monthly installment
periods, the Company generally will initiate foreclosure proceedings. With
respect to delinquencies on FHA, VA or other governmental loan program mortgage
loans, the Company follows the appropriate notification and foreclosure
procedures prescribed by the respective agencies.
On mortgage loans or loan participations purchased by the Company, the Company
receives monthly reports from its loan servicers with which it monitors the loan
portfolio. Based upon servicing agreements with the servicers of the loans, the
Company relies upon the servicers to contact delinquent borrowers, collect
delinquent amounts and initiate foreclosure proceedings, when necessary, all in
accordance with applicable laws, regulations and the terms of the servicing
agreements between the Company and its servicing agents.
NON-PERFORMING ASSETS
Loans are placed on nonaccrual status when, in the judgment of Company
management, the probability of collection of principal or interest is deemed
insufficient to warrant further accrual of interest. Assuming no significant
mitigating circumstances, the Company discontinues the accrual of interest on
loans when the borrower
14
is delinquent as to a contractually due principal or interest payment by 90 days
or more. When a loan is placed on nonaccrual status, all of the accrued interest
on it is reversed by way of a charge to interest income. Interest income is
recorded on nonaccrual loans when cash payments of interest are received. The
accrual of interest on a nonaccrual loan is resumed when the loan is brought to
less than 90 days delinquent unless management believes the collection of the
outstanding loan principal and contractually due interest is in doubt.
Property acquired by the Company as a result of a foreclosure or by deed in lieu
of foreclosure is classified as foreclosed property. Foreclosed property is
recorded at the lower of the unpaid principal balance of the related loan or the
fair market value of the real estate acquired less the estimated costs to sell
the real estate. The amount by which the recorded loan balance exceeds the fair
market value of the real estate acquired less the estimated costs to sell the
real estate is charged against the allowance for loan losses at the date title
is received. Any subsequent reduction in the carrying value of a foreclosed
property, along with expenses incurred to maintain or dispose of a foreclosed
property, is charged against current earnings. At September 30, 2002, the
Company had five loans classified as foreclosed property with a total combined
carrying value of $1.9 million.
Non-performing loans include loans placed on nonaccrual status and accruing
loans which are contractually past due 90 days or more as to principal and
interest payments. Troubled debt restructurings involve forgiving a portion of
interest or principal on any loans or making loans at a rate materially less
than that of market rates. Non-performing assets include non-performing loans
and foreclosed properties. The following table sets forth non-performing loans
and assets:
<Table>
<Caption>
At September 30,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Non-accruing loans:
One-to four-family mortgage loans ............. $ 886 $ 1,169 $ 793 $ 464 $ 600
Multi-family mortgage loans ................... -- -- -- -- --
Commercial real estate loans .................. 640 1,533 -- 848 833
Commercial loans .............................. 88 6,813 11,531 964 593
Consumer loans ................................ 595 747 653 564 835
------------ ------------ ------------ ------------ ------------
Total non-performing loans .................. 2,209 10,262 12,977 2,840 2,861
Foreclosed properties ............................ 1,908 401 241 371 63
------------ ------------ ------------ ------------ ------------
Total non-performing assets ................. $ 4,117 $ 10,663 $ 13,218 $ 3,211 $ 2,924
============ ============ ============ ============ ============
Performing troubled debt
restructurings ................................. 2,440 -- -- -- --
Total non-performing loans to
gross loans ................................... 0.16% 0.77% 0.95% 0.23% 0.29%
Allowance for loan losses to
total non-performing loans .................... 643.37 113.88 80.17 329.44 263.19
Total non-performing assets to
total assets .................................. 0.18 0.48 0.53 0.13 0.16
Interest on non-performing loans
on the accrual basis .......................... $ 211 $ 1,380 $ 1,138 $ 274 $ 388
Actual interest received on
non-performing loans .......................... 52 147 848 150 161
------------ ------------ ------------ ------------ ------------
Net reduction of interest income ................. $ 159 $ 1,233 $ 290 $ 124 $ 227
============ ============ ============ ============ ============
Accruing loans delinquent 90 days or more:
One-to four-family mortgage
loans ......................................... $ 1,303 $ 65 $ 292 $ 607 $ 717
Consumer loans ................................ -- -- 10 -- --
------------ ------------ ------------ ------------ ------------
Total accruing loans ........................ $ 1,303 $ 65 $ 302 $ 607 $ 717
============ ============ ============ ============ ============
</Table>
The Company's non-performing loans at September 30, 2001 included a $5.1 million
commercial credit, which was restructured during the current fiscal year. The
loan was restructured during fiscal 2002 with the Company receiving a new
secured term loan (as a participant bank), cash payments and unregistered shares
of the borrower's common stock. At September 30, 2002, the restructured credit
has a balance of $2.4 million and was returned to accrual status during the
current fiscal year. As a restructured credit, the loan continues to be
classified as a
15
performing troubled debt restructuring. All payments have been made as scheduled
since its restructuring in November 2001.
CLASSIFICATION OF ASSETS
Federal regulations require that each insured financial institution classify its
assets on a regular basis. In addition, in connection with examinations of
insured institutions by regulatory authorities, regulatory examiners have
authority to identify problem assets as "Substandard," "Doubtful" or "Loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the Company will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets, with the additional characteristics that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, questionable, and there is a high possibility of loss. An
asset classified as Loss is considered uncollectible and of such little value
that continuance as an asset of the Company is not warranted. Assets classified
as Substandard or Doubtful require the Company to establish prudent general
allowances for loan losses. Assets classified as Loss must either be charged off
or must have a specific allowance established for 100% of the asset classified
as a Loss. At September 30, 2002, the Company had assets classified as
Substandard of $10.6 million, $1.3 million classified as Doubtful, and $343,000
classified as Loss. The FDIC examination policies also include a "Special
Mention" category, consisting of assets which currently do not expose the
Company to a sufficient degree of risk to warrant adverse classification, but do
possess credit deficiencies deserving management's close attention. At September
30, 2002, $35.6 million of the Company's assets were classified as Special
Mention.
Except for the aforementioned loans included in non-performing assets, the
classified assets principally consist of residential mortgage, consumer loans,
commercial real estate loans, commercial loans and foreclosed properties. None
of these remaining classified assets are considered to represent either
individually or in the aggregate any material loss to the Company; however, such
risk has been considered in establishing the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES
Under federal regulations, when an insured institution classifies problem assets
as either Substandard or Doubtful, it is required to establish general
allowances for loan losses in an amount deemed prudent by management. In
addition to general valuation allowances, the Company may establish specific
loss reserves against specific assets in which a loss is expected to be
realized. General allowances represent loss allowances that have been
established to recognize the inherent risks associated with lending activities,
but which, unlike specific allowances, have not been allocated to recognize
losses on particular problem assets. The Company's determination as to its
classification of assets and the amount of its specific and general valuation
allowances are subject to review by the Company's regulators which can order the
establishment of additional general or specific loss allowances.
The allowance for loan losses is a material estimate that is particularly
susceptible to significant changes in the near term and is established through a
provision for loan losses. The allowance is based upon past loan loss experience
and other factors, which in management's judgement, deserve current recognition
in estimating loan losses. The evaluation includes a review of all loans on
which full collectibility may not be reasonably assured. Such other factors
considered by management include the size and character of the loan portfolio,
concentrations of loans to specific borrowers or industries, existing economic
conditions and historical losses on each portfolio category. In connection with
the determination of the allowance for loan losses, management obtains
independent appraisals for significant properties which collateralize loans.
With respect to loans that are deemed impaired, the calculation of allowance for
loan losses is based upon the discounted present value of expected cash flows
received from the debtor or other measures of market prices or collateral
values.
In general, the level of the allowance for loan losses and changes during each
fiscal year is a function of several factors, including but not limited to
changes in the loan portfolio, provision for loan losses, net charge-offs and
non-performing loans. At September 30, 2002, gross loans receivable were $1.38
billion compared to $1.33 billion at September 30, 2001. The provision for loan
losses for fiscal 2002 decreased to $3.3 million compared to $5.5 million for
fiscal 2001. Net charge-offs for fiscal 2002 decreased to $763,000 compared to
$4.2 million for fiscal 2001. Non-performing loans decreased to $2.2 million or
0.16% of gross loans at September 30, 2002 compared to $10.3 million or 0.77% of
gross loans at September 30, 2001.
In fiscal 2001, the Company recorded a specific loan loss provision of $2.5
million related to a commercial loan credit that had been in non-performing
status since September 2000. During fiscal 2002 the loan was restructured and
was returned to accrual status. The commercial loan had a balance of $2.4
million and $5.1 million,
16
respectively, at September 30, 2002 and 2001. No additional charge-off or
provision was required during the year ended September 30, 2002 in connection
with the loan restructuring. (For further information regarding this particular
commercial credit see "Non-Performing Assets").
Management believes that the allowance for loan losses at September 30, 2002 is
adequate to absorb losses inherent in the portfolio. Management uses the best
information available to make such determinations. If circumstances differ
substantially from the assumptions used in making determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be affected. While the Company believes it has established its
existing allowance for loan losses in conformity with accounting principles
generally accepted in the United States of America, there can be no assurance
that regulators, in reviewing the Bank's loan portfolio, will not request an
increase in the allowance for loan losses. Because future events affecting the
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that increases to the allowance will not be necessary should the
quality of any loans deteriorate as a result of factors discussed herein.
A summary of activity in the allowance for losses on loans follows:
<Table>
<Caption>
Years Ended September 30,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Balance at beginning of year ........... $ 11,686 $ 10,404 $ 9,356 $ 7,530 $ 6,202
Provision for loan losses .............. 3,289 5,527 2,509 1,920 2,300
Charge-Offs:
Mortgage Loans:
One- to four-family ............ 24 29 124 59 176
Multi-family ................... -- -- -- -- --
Commercial real estate ......... -- -- 782 -- --
Home equity .................... 2 95 183 51 71
Consumer .......................... 614 396 380 316 740
Commercial ........................ 260 3,776 94 21 12
------------ ------------ ------------ ------------ ------------
Total charge-offs ........... 900 4,296 1,563 447 999
Recoveries:
Mortgage Loans:
One- to four-family ............ 18 -- 31 -- --
Multi-family ................... -- -- -- -- --
Commercial real estate ......... -- -- -- -- --
Home equity .................... 3 12 16 16 --
Consumer .......................... 44 29 55 33 27
Commercial ........................ 72 10 -- 1 --
------------ ------------ ------------ ------------ ------------
Total recoveries ............ 137 51 102 50 27
------------ ------------ ------------ ------------ ------------
Net charge-offs ........................ 763 4,245 1,461 397 972
Acquired bank's allowance .............. -- -- -- 303 --
------------ ------------ ------------ ------------ ------------
Balance at end of year ................. $ 14,212 $ 11,686 $ 10,404 $ 9,356 $ 7,530
============ ============ ============ ============ ============
Ratio of allowance for loan losses to
gross loans receivable at end of year .. 1.03% 0.88% 0.76% 0.75% 0.77%
Ratio of allowance for loan losses to
non-performing loans at end of year .... 643% 114% 80% 329% 263%
Ratio of net charge-offs to average
gross loans during year ................ 0.06% 0.32% 0.12% 0.04% 0.12%
</Table>
Management is aware of no material loans where serious doubts exist as to the
ability of the borrower to comply with the loan terms.
The allocation methodology applied by the Company, designed to assess the
adequacy of the allowance for loan losses, focuses on changes in the size and
character of the loan portfolio, changes in the level of impaired and
non-performing loans, the risk inherent in specific loans, concentrations of
loans to specific borrowers or industries, existing economic conditions, and
historical losses on each portfolio category. Due to the fact each of the
criteria
17
used is subject to change, the allocation of the allowance for loan losses is
made for analytical purposes and is not necessarily indicative of the trend of
future loan losses in any particular loan category. The total allowance is
available to absorb losses from any segment of the portfolio. Management
allocates the allowance for loan losses by product line for both performing and
non-performing loans based on historical loss experience. In addition to the
above assessment of general reserves, the Company also may establish specific
valuation allowances. Specific valuation allowances are established for specific
loans with probable loss exposure, based on the expected net realizable value.
Estimates of credit losses reflects consideration of all significant factors
that affect collectibility of the loan as of the evaluation date. Based upon the
above evaluation process, the Company calculates an allowance requirement which
is compared to the actual allowance outstanding.
The allocation methods used for September 30, 2002 and 2001 were generally
consistent. For 2002, the amount allocated to commercial loans increased to 28%
of the allowance for loan losses compared to 25% in the prior year. The increase
was a function of changes in the commercial loan portfolio, including an
increase in the gross loan balance, offset partially by a decrease in the amount
of loans in non-performing status in fiscal 2002 compared to the prior year. For
2002, the amount allocated to total mortgage loans decreased to 56% of the
allowance for loan losses compared to 60% in the prior year. The decrease was a
function of a decrease in the amount of loans in non-performing status in fiscal
2002 compared to the prior year.
The allocation methods used for September 30, 2001 and 2000 were generally
consistent. For 2001, the amount allocated to commercial loans decreased to 25%
of the allowance for loan losses compared to 32% in the prior year. The decrease
was a function of changes in the commercial loan portfolio including, a decrease
in the category gross loan balance, a decrease in the amount of loans in
non-performing status in fiscal 2001 compared to the prior year (66% versus 89%,
respectively) and a decrease in the amount of these loans in criticized loan
categories for which specific allocations were made for fiscal 2001 compared to
fiscal 2000. Although the amount allocated to commercial loans was relatively
unchanged, this was partially due to specific provisions being offset by
charge-offs within that category during fiscal 2001. (For further information
see "Non-Performing Assets"). For 2001, the amount allocated to total mortgage
loans increased to 60% of the allowance for loan losses compared to 53% in the
prior year. The increase was a function of an increase in the amount of loans in
non-performing status in fiscal 2001 compared to the prior year and an increase
in the amount of these loans in criticized loan categories for which specific
allocations were made for fiscal 2001 compared to fiscal 2000.
18
The following table shows the Company's total allowance for loan losses and the
allocation to the various categories of loans at the dates indicated.
<Table>
<Caption>
At September 30,
------------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
% of % of
% of Loans in % of Loans in
Total Category Total Category
Loans by to Total Loans by to Total
Amount Category Loans Amount Category Loans
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Allowance Allocations:
Mortgage loans:
One- to four-family ......... $ 2,117 0.67% 22.8% $ 2,024 0.55% 27.7%
Multi-family ................ 868 0.55% 11.5% 699 0.55% 9.5%
Commercial real estate ...... 3,521 0.89% 28.6% 3,045 0.84% 27.3%
Home equity ................. 1,416 0.51% 20.0% 1,254 0.57% 16.7%
---------- ---------- ---------- ----------
Total mortgage loans .......... 7,922 82.9% 7,022 81.2%
Consumer ...................... 2,363 2.69% 6.3% 1,707 1.58% 8.2%
Commercial .................... 3,927 2.64% 10.8% 2,957 2.10% 10.6%
---------- ---------- ---------- ----------
Total allowance for loan
losses ...................... $ 14,212 100.0% $ 11,686 100.0%
========== ========== ========== ==========
<Caption>
At September 30,
-------------------------------------
2000
-------------------------------------
% of
% of Loans in
Total Category
Loans by to Total
Amount Category Loans
---------- ---------- ----------
(Dollars in thousands)
Allowance Allocations:
Mortgage loans:
One- to four-family ......... $ 1,555 0.33% 34.0%
Multi-family ................ 717 0.55% 9.5%
Commercial real estate ...... 2,318 0.76% 22.4%
Home equity ................. 948 0.50% 13.8%
---------- ----------
Total mortgage loans .......... 5,538 79.7%
Consumer ...................... 1,578 1.25% 9.2%
Commercial .................... 3,288 2.16% 11.1%
---------- ----------
Total allowance for loan
losses ...................... $ 10,404 100.0%
========== ==========
</Table>
<Table>
<Caption>
At September 30,
------------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------------
% of % of
% of Loans in % of Loans in
Total Category Total Category
Loans by to Total Loans by to Total
Amount Category Loans Amount Category Loans
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Allowance Allocations:
Mortgage loans:
One- to four-family .............. $ 1,368 0.34% 32.1% $ 1,186 0.36% 33.4%
Multi-family ..................... 1,032 0.64% 13.0% 765 0.73% 10.8%
Commercial real estate ........... 2,879 1.14% 20.3% 2,035 1.19% 17.6%
Home equity ...................... 949 0.61% 12.6% 746 0.52% 14.7%
---------- ---------- ---------- ----------
Total mortgage loans ............... 6,228 78.0% 4,732 76.5%
Consumer ........................... 1,059 0.71% 12.0% 1,074 0.80% 13.8%
Commercial and agriculture ......... 2,069 1.67% 10.0% 1,724 1.84% 9.7%
---------- ---------- ---------- ----------
Total allowance for loan
losses ........................... $ 9,356 100.0% $ 7,530 100.0%
========== ========== ========== ==========
</Table>
INVESTMENT ACTIVITIES
GENERAL
The investment policy of the Company is designed primarily to provide and
maintain required liquidity, generate a favorable return on investments without
incurring undue interest rate and credit risk, and complement the Company's
lending activities. The Company's investment policy permits investment in
various types of liquid assets permissible under Office of Thrift Supervision
("OTS") regulations, which include U.S. Treasury obligations, securities of
various federal agencies, certain certificates of deposits of insured banks and
savings institutions, certain bankers' acceptances and the purchase of federal
funds. The Company also invests in corporate debt and equity securities,
asset-backed securities, mortgage-backed securities ("MBSs") and collateralized
repurchase agreements, municipal securities, mortgage mutual funds,
collateralized mortgage obligations ("CMOs"), real estate mortgage investment
conduits ("REMICs"), interest-only stripped securities ("IOs"), principal-only
stripped securities ("POs") and CMO residuals. At the time of purchase, all of
the Company's investments are investment grade as rated by at least one of the
major rating agencies.
19
The Company determines the appropriate classification of securities at the time
of purchase based on regulatory and accounting guidelines. The Company has
incorporated the requirements of those guidelines into the Company's investment
policy and has categorized its investments in three separate categories: (i)
Held to Maturity: debt and mortgage-backed and related securities are classified
as held to maturity when the Company has the positive intent and ability to hold
the securities to maturity. Held to maturity securities are carried at amortized
cost; (ii) Available for Sale: debt and mortgage-backed and related securities
not classified as held to maturity, or trading and marketable equity securities
not classified as trading are classified as available for sale. Available for
sale securities are stated at fair value, with the unrealized gains or losses,
net of tax, reported as a separate component of shareholders' equity and
accumulated other comprehensive income (loss); and (iii) Trading: the Company
maintains a separate portfolio of assets which are carried at market value and
have been acquired for short term/trading purposes, to enhance the Company's
financial results, with unrealized gains or losses recognized in current income.
INVESTMENT SECURITIES PORTFOLIO
<Table>
<Caption>
At September 30,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
(In thousands)
Investment Securities Available for Sale (AFS):
U. S. Treasury obligations and obligations of
U. S. Government agencies ..................... $ 13,001 $ 36,009 $ 218,116
Corporate notes and bonds .......................... -- -- 99
Marketable equity securities ....................... 3,534 5,558 1,746
Mortgage-backed and related securities ............. 616,029 615,126 802,531
------------ ------------ ------------
Total amortized cost .......................... $ 632,564 $ 656,693 $ 1,022,492
============ ============ ============
Total fair value and carrying value ........... $ 635,176 $ 658,630 $ 991,766
============ ============ ============
Investment Securities Held to Maturity (HTM):
State and municipal obligations .................... $ -- $ -- $ 510
Mortgage-backed and related securities ............. 90,246 95,384 27,088
------------ ------------ ------------
Total amortized cost and carrying value ....... $ 90,246 $ 95,384 $ 27,598
============ ============ ============
Total fair value .............................. $ 91,318 $ 96,237 $ 27,001
============ ============ ============
Total Investment Securities:
Total amortized cost .......................... $ 722,810 $ 752,077 $ 1,050,090
Total fair value .............................. 726,494 754,867 1,018,767
Total carrying value .......................... 725,422 754,014 1,019,364
</Table>
MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgage loans, the principal and interest
payments on which are passed from the mortgage loan originators through
intermediaries that pool and repackage the participation interest in the form of
securities for sale to investors such as the Company. Such intermediaries which
guarantee the payment of principal and interest to investors can be government
sponsored enterprises such as Federal Home Loan Mortgage Corporation ("FHLMC"),
FNMA and Government National Mortgage Association ("GNMA"), or private mortgage
security conduits. Mortgage-backed securities issued by government sponsored
enterprises generally increase the quality of the Company's assets by virtue of
the guarantees that back them and generally are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations
of the Company.
When purchased by the Company, these securities have credit ratings of A or
better and meet the Federal Financial Institutions Examination Council
definition of low-risk securities. At September 30, 2002, private-issue
mortgage-backed securities, CMOs and REMICs totaled $478.8 million, 98% of which
had a credit rating of AAA and 2% of which had a credit rating of AA. At
September 30, 2001, private-issue mortgage-backed securities, CMOs and REMICs
totaled $603.3 million, 98% of which had a credit rating of AAA and, 2% of which
had a credit rating of AA.
The Company continued to reduce the amount of its mortgage-backed securities
portfolio during the year ended September 30, 2002, and management anticipates
that this type of balance sheet restructuring will be an ongoing
20
strategic initiative of the Company in fiscal 2003. During fiscal 2002, the
Company reduced the size of the mortgage-backed securities and investment
securities portfolios from $754.0 million at September 30, 2001 to $725.4
million at September 30, 2002. The reduction in the portfolios was accomplished
through repayments of principal, scheduled maturities and sales during fiscal
2002. The Company used the funds generated from the reduction in the
mortgage-backed securities and investment securities portfolios to fund the
growth in the loan portfolio, to reduce the Company's wholesale debt and as an
additional source of liquidity.
At September 30, 2002, the aggregate securities of any single issuer (excluding
securities of the U.S. government and U.S. government agencies and corporations)
did not exceed 10% of the Company's shareholders' equity.
COMPOSITION OF THE COMPANY'S MORTGAGE-BACKED AND RELATED SECURITIES PORTFOLIO
Held to Maturity. At September 30, 2002, the Company held $90.2 million in its
mortgage-backed and related securities held to maturity portfolio. The estimated
market value of those securities at that date was $91.3 million. Of this amount,
at September 30, 2002, 73% were fixed rate REMIC securities, 19% were fixed rate
FNMA securities and 8% were fixed rate GNMA securities. At September 30, 2002,
the mortgage-backed and related securities held to maturity portfolio
represented 3.9% of the Company's total assets compared to $95.4 million or 4.3%
of total assets at September 30, 2001.
Under SFAS No. 133, the Company was allowed a one-time opportunity to reclassify
investment assets from held to maturity to available for sale. The Company
reclassified all municipal securities held to maturity upon the adoption of FAS
133 to available for sale. The amortized cost and fair value of the securities
transferred was $510,000 and $522,000, respectively, at October 1, 2000. During
the quarter ended March 31, 2001, all municipal securities held by the Company
were sold.
The following table sets forth certain information regarding the amortized cost,
weighted average yields and maturities of the Company's mortgage-backed and
related securities held to maturity at September 30, 2002.
<Table>
<Caption>
Over ten years Total
--------------------------- ---------------------------------------------------------
Average
Weighted Remaining Estimated Weighted
Amortized Average Years to Amortized Fair Average
Cost Yield Maturity Cost Value Yield
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Participation certificates:
FNMA ............................ $ 16,616 4.77% 25.43 $ 16,616 $ 16,736 4.77%
GNMA ............................ 7,518 6.79% 28.97 7,518 7,867 6.79%
REMICs:
Private Issue ................... 66,112 5.54% 23.75 66,112 66,715 5.54%
------------ ------------ ------------
$ 90,246 $ 90,246 $ 91,318
============ ============ ============
</Table>
Available for Sale. At September 30, 2002, the Company had mortgage-backed and
related securities available for sale with an amortized cost of $616.0 million
and an estimated market value of $618.6 million which comprised 26.4% of total
assets. Of these, $12.5 million were private issue MBSs, $36.1 million were
agency MBSs, $169.8 million were agency REMICs, and $400.2 million were private
issue REMICs. At September 30, 2001, the Company's mortgage-backed and related
securities available for sale with an amortized cost of $615.1 million and an
estimated market value of $617.0 million which comprised 28.0% of total assets.
Of these, $15.8 million were private issue MBSs, $99.3 million were agency
REMICs, and $501.9 million were private issue REMICs. Although there may be
various subordination levels within the MBS or REMIC structure or levels of
collateral underlying the securities that should protect the Company's position
in the securities, private issue securities represent an additional level of
credit risk when compared with agency issue securities.
21
The following table sets forth certain information regarding the amortized cost,
weighted average yields and maturities of the Company's mortgage-backed and
related securities available for sale at September 30, 2002.
<Table>
<Caption>
Over five years to
ten years Over ten years
--------------------------- ---------------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
------------ ------------ ------------ ------------
(Dollars in thousands)
Participation certificates:
FNMA .............................. $ -- -- $ 35,998 4.68%
Private Issue ..................... 10 11.69% 12,895 4.03%
REMICs:
GNMA .............................. -- -- 20,018 4.96%
FNMA .............................. -- -- 13,391 5.28%
FHLMC ............................. 2,949 3.64% 133,026 4.46%
Private Issue ..................... 36,927 5.83% 360,815 4.82%
------------ ------------
$ 39,886 $ 576,143
============ ============
<Caption>
Total
---------------------------------------------------------
Average
Remaining Estimated Weighted
Years to Amortized Fair Average
Maturity Cost Value Yield
------------ ------------ ------------ ------------
(Dollars in thousands)
Participation certificates:
FNMA .............................. 14.65 $ 35,998 $ 36,061 4.68%
Private Issue ..................... 17.66 12,905 12,476 4.04%
REMICs:
GNMA .............................. 25.94 20,018 20,222 4.96%
FNMA .............................. 20.36 13,391 13,585 5.28%
FHLMC ............................. 18.59 135,975 135,975 4.44%
Private Issue ..................... 24.46 397,742 400,261 4.91%
------------ ------------
$ 616,029 $ 618,580
============ ============
</Table>
Trading. At September 30, 2002 and 2001, the Company did not have any securities
in its trading portfolio. The trading portfolio of the Company has typically
carried various mortgage-backed or related securities that are purchased for
short-term trading profits or securities that are required to be classified as
such by regulatory definition. The Company may from time to time originate
mortgage loans which are swapped for mortgage-backed securities backed by the
original loans. These securities are classified as trading securities by the
Company as it is the Company's intent to sell those securities over a short
period of time.
OTHER SECURITIES
The Company invests in various types of investment-grade quality liquid assets
that are permissible investments for federally chartered savings associations,
including U.S. Treasury obligations, securities of various federal agencies,
certain certificates of deposit of insured banks and savings institutions,
federal funds and, from time to time, repurchase agreements. Subject to various
restrictions applicable to all federally chartered savings associations, the
Company also invests its assets in commercial paper, investment grade corporate
debt securities, municipal securities, asset-backed securities and mutual funds,
the assets of which conform to the investments the Company is otherwise
authorized to make directly. Debt securities are classified as either available
for sale or held to maturity at the time of purchase, and carried at market
value if available for sale or at amortized cost if held to maturity.
COMPOSITION OF THE COMPANY'S DEBT AND EQUITY SECURITIES PORTFOLIO
Held to Maturity. At September 30, 2002, the Company did not have any debt and
equity securities held to maturity.
Available for Sale. At September 30, 2002, the Company had debt and equity
securities available for sale with an amortized cost of $16.5 million and an
estimated market value of $16.6 million. Of the total amount, $13.1 million were
U.S. Treasury or agency obligations and $3.5 million were marketable equity
securities, primarily shares of mutual funds invested in bank or thrift eligible
securities.
22
The following table sets forth certain information regarding the amortized cost,
weighted average yields and maturities of the Company's investment securities,
excluding marketable equity securities, available for sale at September 30,
2002.
<Table>
<Caption>
Over one year to
five years Total
--------------------------- ---------------------------------------------------------
Average
Weighted Remaining Estimated Weighted
Amortized Average Years to Amortized Fair Average
Cost Yield Maturity Cost Value Yield
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
U.S. Treasury and agency
obligations ............... $ 13,001 3.67% 2.66 $ 13,001 $ 13,062 3.67%
------------ ------------ ------------
$ 13,001 $ 13,001 $ 13,062
============ ============ ============
</Table>
AFFORDABLE HOUSING ACTIVITIES
The Company, through the Bank's subsidiary St. Francis Equity Properties, Inc.
("SFEP"), invests in affordable housing properties throughout the State of
Wisconsin. The properties qualify for tax credits under Section 42 of the
Internal Revenue Code ("Code"). Typically, SFEP will commit to the equity
funding of a specific property that a developer has submitted to WHEDA for
approval and received. The developer then builds the property, generally with
financing from the Bank, with final equity funding from SFEP coming at the
completion of construction. Each property is structured as a limited liability
partnership ("LLP") or limited liability corporation ("LLC"), with SFEP being a
98% or 99% partner or member in each individual LLP or LLC.
The financial condition, results of operations and cash flows of each LLP or LLC
is consolidated in the Company's financial statements. The operations of the
properties are not expected to contribute significantly to the Company's net
income before income taxes. However, the properties do contribute in the form of
income tax credits, which lower the Company's effective tax rate. Once
established, the credits on each property last for ten years and are passed
through from the LLP or LLC to SFEP and reduce the consolidated federal tax
liability of the Company. Gross revenues of SFEP were $3.2 million, $3.0 million
and $3.0 million for the years ended September 30, 2002, 2001 and 2000
respectively. Gross expenses of SFEP were $3.1 million, $3.1 million and $3.2
million for each of the three years, respectively. The net operating loss of
SFEP results in an income tax benefit which is then increased by the income tax
credits which totaled $2.7 million, $2.6 million and $2.6 million for the years
ended September 30, 2002, 2001 and 2000, respectively.
At September 30, 2002, the amount invested in affordable housing projects was
$32.8 million compared with $26.3 million at September 30, 2001. SFEP was an
equity partner in 14 and 12 projects, respectively in each of those years.
The primary risk to the Company's results of operations from the affordable
housing investments involves the maintenance of the tax credits. The Company has
instituted several procedures which it believes will result in the maintenance
of the tax credits. Those procedures include an outside audit of the individual
LLP or LLC, including tenant compliance records, an outside audit of the
original development costs, review of the LLP or LLC and tenant compliance
records by the Company's staff, and a review of audit and compliance records of
the LLP or LLC performed by WHEDA. The Company believes that it has maintained
compliance on all of its properties and that through September 30, 2002, no
income tax credits are at risk. Other risks of the affordable housing
investments include the risks common to the owning and operating of apartment
units.
SOURCES OF FUNDS
GENERAL
The Company's primary sources of funds for use in lending, investing and for
other general purposes are deposits, including brokered deposits, proceeds from
principal and interest payment on loans, mortgage-backed and related securities
and debt and equity securities, FHLB advances, and to a lesser extent, reverse
repurchase agreements. Regular loan payments are a relatively stable source of
funds, while deposit inflows and outflows and loan prepayments are significantly
influenced by general market interest rates and economic conditions. In
particular
23
during the last two fiscal years when interest rates went to historically low
rates, the Company experienced a significant increase in repayments on all types
of loans. Funds received from principal repayments on loans for the years ended
September 30, 2002, 2001 and 2000, were $576.1 million, $513.9 million and
$403.7 million, respectively. Short-term borrowings may be used to compensate
for seasonal or other reductions in normal sources of funds or for deposit
inflows at less than projected levels, or they also may be used on a longer-term
basis to support expanded lending or investment activities. The Company utilizes
advances from the FHLB and reverse repurchase agreements as sources for its
borrowings. At September 30, 2002 and 2001, the Company had advances from the
FHLB of $512.2 million or 23.7% of total liabilities, and $513.4 million or
25.1% of total liabilities, respectively. At September 30, 2002 and 2001, the
Company had reverse repurchase agreements outstanding of $69.9 million or 3.2%
of total liabilities, and zero, respectively. Of the Company's outstanding FHLB
advances at September 30, 2002, $501.3 million will mature or may be called
before September 30, 2003.
DEPOSITS
The Company offers a variety of deposit accounts having a range of interest
rates and terms. The Company's deposits principally consist of demand accounts
(checking and money market demand accounts), passbook, and certificates of
deposit. The flow of deposits is influenced significantly by general economic
conditions, changes in prevailing interest rates and competition. The Company's
deposits are obtained primarily from the areas in which its branches are
located, and the Company relies principally on customer service, marketing
programs and long-standing relationships with customers to attract and retain
these deposits. Various types of advertising and promotions to attract and
retain deposit accounts also are used. Deposit promotions may involve the use of
specific advertising for a type of deposit or it may include some form of
pricing incentive: either a deposit product with a higher rate than currently
offered by most competitors in the Company's market area, or a temporary pricing
concession for a limited period of time. The Company also uses brokered deposits
as a funding source for its business activities. The brokered deposits are used
to fund the general operating activities of the Company. At September 30, 2002,
the Company had $191.4 million of brokered deposits, representing 13.5% of total
deposits, compared to $224.4 million or 15.5% of total deposits at September 30,
2001. Maturities of brokered certificates range from 3 months to 3 years. The
average maturity of brokered deposits was 10 months at September 30, 2002 and 39
months at September 30, 2001. The Company has used brokered deposits to fund
operational activities when such funds offer a better or quicker funding source
than retail deposits or FHLB advances.
Management monitors the Company's certificate accounts and, based on historical
experience, management believes it will retain a large portion of such accounts
upon maturity. However, management believes that the likelihood for retention of
brokered certificates of deposit is more a function of the rate paid on such
accounts as compared to retail deposits which may be established due to branch
location or other intangible reasons. Management considers Company
profitability, the matching of term lengths with assets, the attractiveness to
customers and rates offered by competitors in deposit offerings and promotions.
The Company has been competitive in the types of accounts and interest rates it
has offered on its deposit products. The Company intends to continue its efforts
to attract deposits as a primary source of funds for supporting its lending and
investing activities.
At September 30, 2002, the Company had outstanding $94.9 million in certificates
of deposit, net of brokered deposits, in amounts of $100,000 or more maturing as
follows:
<Table>
<Caption>
Amount at
September 30, 2002
------------------
(In thousands)
Three months or less ....................... $ 17,738
Over three through six months .............. 14,703
Over six months through twelve months ...... 16,514
Over twelve months ......................... 45,954
---------------
Total .................. $ 94,909
===============
</Table>
The following table sets forth the distribution of the Company's deposit
accounts at the dates indicated and the average nominal interest rates on each
category of deposits presented. Management does not believe that the use of
year-end balances instead of average balances resulted in any material
difference in the information presented. In this table, brokered deposits are
included with certificates.
24
<Table>
<Caption>
September 30,
------------------------------------------------------------------------------------------
2002 2001
------------------------------------------- -------------------------------------------
Percent Average Percent Average
of Total Stated of Total Stated
Amount Deposits Rate Amount Deposits Rate
------------------------------------------- -------------------------------------------
(Dollars in thousands)
Demand deposits:
Non-interest bearing ..... $ 113,125 8.0% -- $ 95,554 6.6% --
Interest bearing ......... 94,015 6.6% 0.26% 84,004 5.8% 0.69%
Passbook accounts ............ 93,865 6.6% 0.70% 88,705 6.1% 1.52%
Money market
demand accounts .......... 380,783 26.9% 0.93% 435,233 30.0% 2.87%
Certificates ................. 735,191 51.9% 3.48% 745,824 51.5% 5.09%
------------ ------------ ------------ ------------
Total deposits ............... $ 1,416,979 100.0% 2.12% $ 1,449,320 100.0% 3.61%
============ ============ ============ ============
</Table>
<Table>
<Caption>
September 30,
-------------------------------------------
2000
-------------------------------------------
Percent Average
of Total Stated
Amount Deposits Rate
------------ ------------ ------------
(Dollars in thousands)
Demand deposits:
Non-interest bearing ........ $ 87,072 5.9% --
Interest bearing ............ 78,580 5.3% 0.80%
Passbook accounts ............... 91,544 6.2% 1.95%
Money market
Demand accounts ............. 369,038 25.1% 5.26%
Certificates .................... 845,647 57.5% 6.25%
------------ ------------
Total deposits .................. $ 1,471,881 100.0% 5.07%
============ ============
</Table>
BORROWINGS AND OTHER FINANCING TRANSACTIONS
Although deposits are the Company's largest source of funds, the Company's
policy has been to utilize borrowings as an additional or alternative source of
funds. The primary source of borrowing is advances from the FHLB which are
collateralized by the capital stock of the FHLB held by the Company and certain
of its mortgage loans and mortgage-backed and related securities. Such advances
are made pursuant to several different credit programs, each of which has its
own interest rate and range of maturities. The maximum amount the FHLB will
advance to member institutions for purposes other than meeting withdrawals
fluctuates from time to time in accordance with policies of the OTS and the
FHLB. At September 30, 2002, the Company's FHLB advances totaled $512.2 million,
representing 23.7% of total liabilities, a decrease from the $513.4 million
outstanding at September 30, 2001. At September 30, 2002, the Company had
additional borrowing capacity of $305.2 million from the FHLB; however,
additional securities may have to be pledged as collateral and additional FHLB
stock may have to be purchased.
Of the Company's outstanding FHLB advances at September 30, 2002, $501.3 million
will mature or may be called before September 30, 2003. Included in the amount
maturing or callable within one year are $445.0 million of convertible fixed
rate advances ("CFA" or "CFAs"). A CFA is an advance that allows the FHLB to
demand repayment prior to the stated maturity date of the advance in accordance
with its contractual terms. In the event interest rates rise, the FHLB will more
than likely exercise its right to demand repayment of the CFA. As of September
30, 2002 the Company estimates interest rates would have to rise 200-300 basis
points over the course of the next fiscal year before all of the Company's
outstanding CFAs would be called by the FHLB. In that case, the Bank will have
the option of seeking alternative funding arrangements, if necessary, which may
be to enter into another CFA at the then prevailing interest rates or entering
into other funding arrangements. At September 30, 2002, the $445.0 million of
outstanding CFAs have a maturity of three to nine years and are callable by the
FHLB during the next fiscal year and quarterly thereafter.
The Company also utilizes reverse repurchase agreements as a funding source. A
reverse repurchase agreement is a transaction between the Company and a broker
whereby the Company borrows money against a specific asset,
25
generally a mortgage-backed and related security, for a set interest rate for a
specified term. The reverse repurchase agreements generally have terms of 30 to
60 days, however, the agreements may have terms of up to two years and includes
call features. At September 30, 2002 and 2001, the Company had $69.9 million and
zero, respectively, of reverse repurchase agreements.
The Company's borrowings from time to time include Federal funds purchased. At
September 30, 2002 and 2001, the Company had $38.1 million and $16.8 million,
respectively, of Federal funds purchased. Federal funds purchased averaged $15.6
million and $12.0 million for the years ended September 30, 2002 and 2001,
respectively. The maximum outstanding at any month-end was $38.1 million and
$56.2 million during those years, respectively.
In fiscal 1997, the Company established a line of credit with a third party
lending institution for purposes of funding corporate activities of the Company.
These typically include dividends, share repurchases and acquisitions. Dividends
received from the Bank are used as the primary source of cash to pay principal
and interest on the line of credit. The line of credit has a maximum borrowing
amount of $40.0 million and is collateralized by the stock of the Bank. At
September 30, 2002 and 2001, the Company had $14.0 million and $36.0 million,
respectively, outstanding on the line of credit.
While increases in borrowings and changes in the collateralization levels due to
market interest rate changes could require the Company to add collateral to
secure its borrowings, the Company does not anticipate having a shortage of
qualified collateral to pledge against its borrowings.
26
The following table sets forth certain information regarding the Company's FHLB
advances, borrowed funds and reverse repurchase agreements at or for the years
ended on the dates indicated.
<Table>
<Caption>
At or For the Years Ended September 30,
2002 2001 2000
----------- ----------- ----------
(Dollars in thousands)
FHLB advances:
Average balance outstanding ............................... $ 522,969 $ 513,948 $ 572,800
Maximum amount outstanding at any month-end during
the year ............................................ 535,312 545,500 634,446
Balance outstanding at end of year ........................ 512,188 513,438 532,000
Weighted average interest rate during the year (1) ........ 5.49% 5.62% 5.42%
Weighted average interest rate at end of year ............. 5.46% 5.56% 5.61%
Reverse repurchase agreements:
Average balance outstanding ............................... $ 40,280 $ 129,960 $ 211,572
Maximum amount outstanding at any month-end during
the year ............................................ 70,818 280,188 260,579
Balance outstanding at end of year ........................ 69,880 -- 245,993
Weighted average interest rate during the year (1) ........ 1.50% 4.77% 6.06%
Weighted average interest rate at end of year ............. 1.87% -- 6.59%
Federal funds purchased:
Average balance outstanding ............................... $ 15,558 $ 12,033 $ 31,083
Maximum amount outstanding at any month-end during
the year ............................................ 38,100 56,200 49,500
Balance outstanding at end of year ........................ 38,100 16,800 45,000
Weighted average interest rate during the year (1) ........ 1.51% 2.97% 6.44%
Weighted average interest rate at end of year ............. 2.13% 3.43% 6.96%
Bank line of credit:
Average balance outstanding ............................... $ 21,583 $ 33,917 $ 26,417
Maximum amount outstanding at any month-end during
the year ............................................ 32,000 36,000 36,000
Balance outstanding at end of year ........................ 14,000 36,000 36,000
Weighted average interest rate during the year (1) ........ 3.50% 6.44% 7.44%
Weighted average interest rate at end of year ............. 2.99% 4.70% 7.90%
Total advances, reverse repurchase agreements, Federal funds
purchased and bank line of credit:
Average balance outstanding ............................... $ 600,390 $ 689,858 $ 841,872
Maximum amount outstanding at any month-end during
the year ............................................ 676,230 917,888 980,525
Balance outstanding at end of year ........................ 634,168 566,238 858,993
Weighted average interest rate during the year (1) ........ 5.05% 5.45% 5.68%
Weighted average interest rate at end of year ............. 4.76% 5.40% 6.01%
</Table>
(1) Computed on the basis of average daily balances.
SUBSIDIARY ACTIVITIES
During the fiscal year ended September 30, 2002, the Bank had four wholly owned
subsidiaries: SF Insurance Services Corporation ("SF Insurance"), St. Francis
Equity Properties, Inc. ("SFEP"), SF Investment Corporation ("SF Investment")
and St. Francis Mortgage Corporation ("SF Mortgage").
SF Insurance. SF Insurance is a Wisconsin corporation and offers fixed
annuities, indexed annuities, life insurance, disability income and survivorship
life sold exclusively through licensed agents who also are employees of the
Bank. The Bank is reimbursed by SF Insurance for administration and sales
services provided by the Bank to SF Insurance. At September 30, 2002, the Bank's
total investment in SF Insurance was approximately $338,000, and SF Insurance's
assets of $340,000 consisted primarily of cash.
SFEP. SFEP is a Wisconsin corporation which owns, operates and develops
multi-family rental property, either as a limited partner or through other
ownership status, for investment and subsequent resale. Properties include
27
projects for low-to-moderate income housing, which would qualify for tax credits
under Section 42 of the Code. SFEP is currently a limited partner in 14 projects
within the state of Wisconsin. Additionally, the Bank has provided financing to
all of the projects. However, the primary return to the Company on these
projects is in the form of tax credits earned over the first ten years of the
projects life. At September 30, 2002, the Bank had loans outstanding to such
projects of $17.4 million. At September 30, 2002, the Bank's total investment in
SFEP was approximately $10.1 million and SFEP's assets of $35.1 million
consisted primarily of its interests in the properties developed. See
"-Affordable Housing Activities."
SF Investment. SF Investment is a company incorporated in Nevada for the purpose
of managing a portion of the Bank's investment portfolio. At September 30, 2002,
the Bank's total investment in SF Investment was approximately $402.7 million
and SF Investment's assets of $462.2 million consisted primarily of
mortgage-backed and related securities.
SF Mortgage. SF Mortgage is a Wisconsin corporation with an office in Illinois
that is in the business of purchasing loans originated by mortgage brokers in
the Midwest and then selling these loans to various investors. At September 30,
2002, the Bank's total investment in SF Mortgage was approximately $1.1 million
and SF Mortgage's assets of $26.1 million consisted primarily of mortgage loans
held for sale.
PERSONNEL
As of September 30, 2002, the Company had 425 full-time employees and 136
part-time employees. The employees of the Company are not represented by a
collective bargaining unit and the Company believes its relationship with its
employees to be good.
TAXATION
GENERAL
The following discussion of tax matters is intended to be a summary of the
material tax rules applicable to the Company and does not purport to be a
comprehensive description of all applicable tax rules.
CORPORATE ALTERNATIVE MINIMUM TAX
From time to time the Company may be subject to alternative minimum tax on its
corporate income tax returns. The alternative minimum tax is calculated at a
rate of 20% on alternative minimum taxable income as defined in the Internal
Revenue code. The Company's actual tax payment is then based on the higher of
its regular tax liability or its alternative minimum tax.
DISTRIBUTIONS
To the extent that (i) the Company's reserve for losses on qualifying real
property loans exceeds the amount that would have been allowed under an
experience method and (ii) the Company makes "non-dividend distributions" to
shareholders that are considered to result in distributions from the excess bad
debt reserve or the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Company's taxable income. Non-dividend distributions include
distributions in excess of the Company's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of the Company's current or
accumulated earnings and profits, as calculated for federal income tax purposes,
will not be considered to result in a distribution from the Company's bad debt
reserves.
The amount of additional taxable income created from an Excess Distribution is
an amount that when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if certain portions of the Bank's
accumulated tax bad debt reserve are used for any purpose other than to absorb
qualified bad debt loans, such as for the payment of dividends or other
distributions with respect to the Company's capital stock (including
distributions upon redemption or liquidation), approximately one and one-half
times the amount so used would be includable in gross income for federal income
tax purposes, assuming a 35% corporate income tax rate (exclusive of state
taxes). See "-Regulation," below for limits on the payment of dividends of the
Bank and the Company.
28
STATE TAXATION
The State of Wisconsin imposes a tax on the Wisconsin taxable income of
corporations, including savings institutions, at the rate of 7.9%. The State of
Illinois imposes a replacement tax and income tax on the Illinois taxable income
of corporations at the rates of 2.5% and 4.8%, respectively. The State of Nevada
does not impose a tax on the Nevada taxable income of corporations.
REGULATION AND SUPERVISION
References in this section to applicable laws and regulations are brief
summaries only. All such summaries are qualified in their entirety by the
applicable laws and regulations, which you should consult to understand their
details and operation.
GENERAL
The Company is a unitary thrift holding company registered with and subject to
regulation by the OTS under the Home Owners' Loan Act of 1933, as amended (the
"HOLA"). The Company is required to file certain reports and otherwise comply
with the rules and regulations of the OTS and the Securities and Exchange
Commission (the "SEC") under the federal securities laws. The Bank, as a
federally-chartered savings bank, is subject to regulatory oversight by its
primary regulator, the OTS. As an insured-depository institution the Bank is
also subject to oversight by the FDIC. In addition, the Bank is subject to
certain limited regulation by the Federal Reserve Board.
HOLDING COMPANY REGULATIONS
The Company is subject to examination by the OTS, which could take enforcement
action if it determined that the Company's actions presented a risk to the
safety, soundness, or stability of the Bank. OTS approval is required before the
Company or any other person may acquire control of more than 5% of the voting
shares of another institution whose deposits are insured by the Savings
Association Insurance Fund ("SAIF") of the FDIC. (See "New Financial Services
Act" below for further applicable regulation).
REGULATION OF FEDERAL SAVINGS BANKS
The OTS has extensive regulatory, supervisory and enforcement authority over the
operations of the Bank and its affiliated parties. This regulation and
supervision establishes a comprehensive framework of activities in which the
entities can engage, is intended primarily for the protection of the insurance
fund and depositors, and addresses various issues including, but not limited to,
insurance of deposits, capital requirements, and community reinvestment
requirements. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes.
The Bank is required to file periodic reports with the OTS Regional Director and
is subject to periodic examinations by the OTS and the FDIC. When these
examinations are conducted, examiners may, among other things, require the Bank
to provide for higher general or specific loan loss reserves or write down the
value of certain assets. The last regular examination by the OTS was in April
2002.
ASSESSMENTS
Savings institutions are required by OTS regulations to pay assessments to fund
the operations of the OTS. The general assessment, paid on a semiannual basis,
is computed upon the savings institution's total assets, including consolidated
subsidiaries, as reported in the institution's latest quarterly Thrift Financial
Report. The Bank's OTS assessment for the six month period ended June 30, 2002
was $119,000, based on Bank assets as of June 30, 2002 of $2.2 billion and the
current OTS assessment rate.
QUALIFIED THRIFT LENDER REQUIREMENT
In order for the Bank to exercise the powers granted to SAIF-insured
institutions and maintain full access to FHLB advances, it must qualify as a
qualified thrift lender ("QTL"). Under the HOLA and OTS regulations, a savings
institution is required to maintain a level of qualified thrift investments
equal to at least 65% of its "portfolio assets" (as defined by statute) on a
monthly basis for nine out of 12 months per calendar year. Qualified thrift
investments for purposes of the QTL test consist primarily of residential
mortgages and related investments. As of September 30, 2002, the Company
maintained 81.2% of its portfolio assets in qualified thrift investments and
therefore met the QTL test.
29
NEW FINANCIAL SERVICES ACT
On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 (the "Financial
Services Modernization Act" or "Act") was signed into law. The new law does a
number of things intended to increase competition in the financial services
area, including repealing sections of the 1933 Glass-Steagall Act so that
financial firms, such as banks, securities and insurance firms can affiliate
with each other through the formation of financial holding companies. The Act
appoints the Federal Reserve as the "umbrella" regulator for such entities. The
Act also restricts the chartering and transferring of unitary thrift holding
companies, although it does not restrict the operations of unitary holding
companies which were in existence prior to May 4, 1999, and which continue to
meet the QTL test and control only a single savings institution. Since the
Company was treated as a unitary holding company prior to May 4, 1999 and is in
compliance with the QTL test, the Act will not prohibit it from engaging in
nonfinancial activities or acquiring nonfinancial subsidiaries; however, the Act
would restrict any nonfinancial entity from acquiring the Company, unless that
entity was, or had submitted an application to become, a unitary savings and
loan holding company prior to May 4, 1999. The Act provided a number of consumer
protections, including provisions aimed at protecting the privacy of consumer
information. Many of the Act's provisions, including those pertaining to
consumer privacy, require regulatory action, including the promulgation of
regulations, to become effective. The regulation implementing the Act's consumer
privacy requirements became effective July 1, 2001, requiring among other things
that the Bank (i) provide new customers with a notice explaining their privacy
rights at the time they become customers, (ii) provide an initial privacy rights
notice to existing customers, (iii) provide an annual privacy rights notice to
all continuing customers, (iv) implement internal privacy safeguards, and (v)
not disclose protected information to any unaffiliated third party (except as
required to effect, administer or enforce a transaction requested by the
customer or certain other limited exceptions) without first giving the customer
the option to elect not to allow such disclosure. The Bank does not believe that
compliance with the new consumer privacy provisions will have a significant
impact on its business. It is too early to assess the eventual impact of the Act
or other implementing regulations on the financial services industry in general
or on the specific operations of the Company and the Bank.
ANTI-TERRORISM ACT
On October 6, 2002 the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the "USA
Patriot Act") was signed into law. While not primarily banking legislation, the
USA Patriot Act contained provisions requiring financial institutions to adopt a
variety of policies aimed at preventing money-laundering. The OTS is the primary
regulator for purposes of insuring compliance by the Bank with USA Patriot Act
requirements and certain of those requirements will not become effective until
adoption of implementing regulations by the OTS. The Bank does not believe that
compliance with the USA Patriot Act and its implementing regulations will have a
significant impact on its business.
INSURANCE OF DEPOSIT ACCOUNTS
The bank is a member of the SAIF. The Federal Deposit Insurance Corporation
maintains a risk-based assessment system by which institutions are assigned to
one of three categories based on their capitalization and one of three
subcategories based on examination ratings and other supervisory information. An
institution's assessment rate depends upon the categories to which it is
assigned. Assessment rates for insured institutions are determined semiannually
by the Federal Deposit Insurance Corporation and currently range from zero basis
points for the healthiest institutions to 27 basis points for the riskiest.
The Federal Deposit Insurance Corporation has authority to increase insurance
assessments and is required under federal law to establish assessment rates that
will maintain the insurance fund's ratio of reserves to insured deposits at
$1.25 per $100. The SAIF currently meets that requirement, although a failure to
do so in the future might result in an increase in SAIF insurance premiums which
could, depending on the size of such increase, have an adverse effect on the
operating expenses and results of operations of the Bank. Management cannot
predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit Insurance
Corporation upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
Federal Deposit Insurance Corporation or the OTS. Management of the Bank is not
aware of any practice, condition or violation that might lead to termination of
deposit insurance.
30
CAPITAL REQUIREMENTS
OTS REGULATION
For the fiscal years ended September 30, 2002 and 2001, the OTS capital
regulations require savings institutions to meet two capital standards: (i)
"tier 1 core capital" in an amount not less than 4% of adjusted total assets and
(ii) "risk-based capital" of at least 8% of risk-weighted assets. Savings
institutions must meet both standards to comply with the capital requirements.
The following table summarizes the Bank's capital ratios and the ratios required
by federal regulations:
<Table>
<Caption>
To Be Adequately To Be Well
Capitalized Under Capitalized Under
Prompt Corrective Prompt Corrective
Actual Action Provisions Action Provisions
--------------------- ----------------------------------- -------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- -------- ------------------ -------------- ------------------- ----------------
(Dollars in thousands)
As of September 30, 2002:
Tangible capital.............. $175,889 7.57% > or = to $ 92,971 > or = to 4.0% > or = to $ 116,214 > or = to 5.0%
Core capital ................. 175,889 7.57% > or = to 92,971 > or = to 4.0% > or = to 116,214 > or = to 5.0%
Tier 1 risk-based capital..... 175,889 10.56% > or = to 66,646 > or = to 4.0% > or = to 99,968 > or = to 6.0%
Risk-based capital............ 189,793 11.39% > or = to 133,291 > or = to 8.0% > or = to 166,614 > or = to 10.0%
As of September 30, 2001:
Tangible capital.............. $178,436 8.14% > or = to $ 87,666 > or = to 4.0% > or = to $ 109,582 > or = to 5.0%
Core capital ................. 178,436 8.14% > or = to 87,666 > or = to 4.0% > or = to 109,582 > or = to 5.0%
Tier 1 risk-based capital..... 178,436 12.61% > or = to 56,586 > or = to 4.0% > or = to 84,879 > or = to 6.0%
Risk-based capital............ 189,656 13.41% > or = to 113,172 > or = to 8.0% > or = to 141,465 > or = to 10.0%
</Table>
Unrealized gains and losses on securities available for sale are not included in
the above tangible, core and risk-based capital amounts.
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act of 1977, as amended (the "CRA"), a
depository institution has a continuing and affirmative obligation consistent
with safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the federal regulators to assess the
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications from such
institution. The CRA also requires all institutions to make public disclosure of
their CRA ratings and requires an institution's primary regulator to provide a
written evaluation of an institution's performance. The Bank's latest CRA
rating, received in April 2001, was "Satisfactory."
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Bank System, consisting of 12 FHLBs, is under the
jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated
duties of the FHFB are to supervise the FHLBs; ensure that the FHLBs carry out
their housing finance mission; ensure that the FHLBs remain adequately
capitalized and able to raise funds in the capital market; and ensure that the
FHLBs operate in a safe and sound manner.
Members of the FHLB-Chicago are required to acquire and hold shares of capital
stock in the FHLB-Chicago in an amount equal to 1% of their aggregate
outstanding principal amount of residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year. Further, at no
time shall advances (borrowings) from the FHLB-Chicago exceed 20 times the
amount paid by such member for FHLB-Chicago capital stock. The Bank is in
compliance with these requirements with a total investment in FHLB-Chicago stock
of $90.8 million at September 30, 2002.
31
Among other benefits, the FHLBs provide a central credit facility primarily for
member institutions and make advances to members in accordance with policies and
procedures established by the FHFB and the Board of Directors of the
FHLB-Chicago. At September 30, 2002, the Bank had $512.2 million in advances
from the FHLB-Chicago. See "Business of the Company."
RESERVE REQUIREMENTS
Regulation D, promulgated by the Federal Reserve Board ("FRB"), imposes reserve
requirements on all depository institutions which maintain transaction accounts
or non-personal time deposits. Checking accounts, NOW accounts and certain other
types of accounts that permit payments or transfers to third parties fall within
the definition of transaction accounts and are subject to Regulation D reserve
requirements, as are any non-personal time deposits (including certain money
market deposit accounts). Regulation D requires that a depository institution
maintain average daily reserves equal to 3% on the first $46.5 million of
transaction accounts. There is no reserve requirement on non-personal deposits.
In addition, the first $4.9 million of otherwise reservable liabilities are
exempt from the reserve requirement. The Bank must reserve for transaction
accounts in excess of $46.5 million in an amount equal to 10% of such excess.
These levels and percentages are subject to adjustment by the FRB. As of
September 30, 2002, the Bank was in compliance with Regulation D reserve
requirements.
OTHER FEDERAL LAWS
RESTRICTIONS ON LOANS TO INSIDERS
Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the
Federal Reserve Board establish limits on the total amount an institution may
lend to its executive officers, directors, and principal shareholders, and their
related interests (collectively referred to in this section as "insiders").
Generally, an insider may borrow an aggregate amount not exceeding 15% of the
institution's unimpaired capital and unimpaired surplus on an unsecured basis
and up to an additional 10% on a secured basis. The regulations limit, with
certain exceptions, the aggregate amount a depository institution may lend to
its insiders as a class to an amount not exceeding the institution's unimpaired
capital and unimpaired surplus.
Among other things, these provisions require that extensions of credit to
insiders (a) be made on terms that are substantially the same as, and follow
credit underwriting procedures that are not less stringent than, those
prevailing for comparable transactions with unaffiliated persons, (b) do not
involve more than the normal risk of repayment or present other features
unfavorable to the Bank, and (c) not exceed certain limitations on the amount of
credit extended to such persons, individually and in the aggregate, which limits
are based, in part, on the amount of the Bank's capital. In addition, extensions
of credit in excess of certain limits must be approved by the Bank's Board of
Directors. However, recent legislation permits the Bank to make loans to
executive officers, directors and principal stockholders on preferential terms,
provided the extension of credit is made pursuant to a benefit or compensation
program of the Bank that is widely available to employees of the Bank or its
affiliates and does not give preference to any insider over other employees of
the Bank or affiliate. It is a violation for an insider to knowingly receive, or
permit a related interest to receive, a loan that violates applicable
regulations. The Bank has not been significantly affected by such restrictions
on loans to insiders.
TRANSACTIONS WITH AFFILIATES
The Bank is required to comply with Sections 23A and 23B of the Federal Reserve
Act ("Sections 23A and 23B") relative to transactions with affiliates.
Generally, Sections 23A and 23B limit the extent to which the insured
institution or its subsidiaries may engage in certain covered transactions with
an affiliate to an amount equal to 10% of such institution's capital and
surplus, place an aggregate limit on all such transactions with affiliates to an
amount equal to 20% of such capital and surplus, and 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 guaranty and similar other types of transactions. Exemptions from 23A or
23B may be granted only by the FRB. The Company has not been significantly
affected by such restrictions on transactions with affiliates.
FEDERAL SECURITIES LAWS
The Company's Common Stock is registered with the SEC under Section 12(g) of the
Securities and Exchange Act of 1934, under which the Company is subject to
various restrictions and requirements.
32
ITEM 2. PROPERTIES
The Company conducts its business through 22 full-service locations, two limited
service offices in residential retirement communities, three loan production
offices and a mortgage banking subsidiary based in Illinois. Eleven of the
full-service branches are located in Milwaukee County, five are in Waukesha
County, four are in Washington County, one is in Ozaukee County, and one is in
Walworth County. Management believes the current facilities are adequate to meet
the present and immediately foreseeable needs of the Company. The total net book
value of property owned by the Company was $21.6 million at September 30, 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved as a plaintiff or defendant in various legal actions
arising in the normal course of its business. While the ultimate outcome of
these various legal proceedings cannot be predicted with certainty, it is the
opinion of management that the resolution of these legal actions will not have a
material effect on the Company's consolidated financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the three months
ended September 30, 2002.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information as to the business experience is supplied with respect
to the executive officers of the Company who do not serve on the Company's Board
of Directors. There are no arrangements or understandings between the persons
named and any other person pursuant to which such officers were selected, nor
are there any family relationships among them.
JAMES S. ECKEL, age 47, is an Executive Vice President of the Bank. Mr. Eckel
has held his position with the Bank since January 1999. Prior to that Mr. Eckel
was a Senior Vice President of the Bank.
JUDITH M. GAUVIN, age 44, is an Executive Vice President of the Bank. Ms. Gauvin
has held her position with the Bank since October 1999. Prior to that Ms. Gauvin
was a Senior Vice President of the Bank.
JAMES C. HAZZARD, age 57, is an Executive Vice President of the Bank. Mr.
Hazzard has held his position with the Bank since September 1997. From November
1994 to September 1997, Mr. Hazzard was President of Bank Wisconsin.
WILLIAM R. HOTZ, age 57, is Secretary and General Counsel of the Company and of
the Bank. Mr. Hotz joined the Company in those positions in May 1997. Prior to
joining the Company and the Bank, Mr. Hotz was a shareholder of the law firm of
von Briesen, Purtell & Roper, s.c.
WILLIAM T. JAMES, age 43, is an Executive Vice President of the Company and the
Bank. Mr. James has held those positions since January 1999. Mr. James was a
Senior Vice President of the Company and the Bank from 1997 to 1999. Prior to
1997, Mr. James was an Assistant Vice President of the Company and a Vice
President of the Bank.
BRADLEY J. SMITH, age 47, is an Executive Vice President of the Bank. Mr. Smith
became Executive Vice President of the Bank in January 1997. Prior to joining
the Bank, Mr. Smith was a Senior Vice President of Provident Bank in Cincinnati,
Ohio.
JON D. SORENSON, age 47, is Chief Financial Officer and Treasurer and is an
Executive Vice President of the Company and of the Bank. Mr. Sorenson became
Chief Financial Officer and Treasurer of the Company in November 1992, and of
the Bank in September 1997. From December 1992 to September 1997, Mr. Sorenson
was a Senior Vice President of the Bank.
33
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock is currently being traded on the Nasdaq National
Market System over-the-counter exchange under the symbol of STFR. Information
required by this item is incorporated by reference to the "Quarterly financial
information (Unaudited)" shown in Note 22 to Notes to Consolidated Financial
Statements and the "Earnings per share" Note 13 to Notes to Consolidated
Financial Statements included under Item 8 of this Annual Report on Form 10-K.
As of September 30, 2002, there were approximately 1,100 holders of record and
approximately 2,300 beneficial holders owning a total of 9,350,873 shares of the
Company's common stock.
The Company paid quarterly dividends of $0.15 per share for fiscal 2002 and
$0.10 per share for fiscal 2001. While there can be no assurance of the payment
of future dividends, the Company anticipates that future dividends, if paid,
would be paid on a quarterly basis in February, May, August and November. Future
payments of dividends will be subject to determination and declaration by the
Company's Board of Directors, which will take into account the Company's
financial condition, results of operations, tax considerations, industry
standards, economic conditions and other factors, including regulatory
restrictions which affect the payment of dividends by the Company's subsidiaries
to the Company.
On June 30, 2000, the Company announced a share repurchase program for its
common stock whereby the Company may purchase up to 5% of the outstanding common
stock, or approximately 485,000 shares, commencing June 30, 2000. The
repurchased shares became treasury shares and are to be used for the exercise of
stock options under the stock option plan and for general corporate purposes.
The share repurchase program was completed on September 20, 2001 at an average
price of $17.16 per share. This was the eleventh such repurchase program that
the Company has undertaken. At September 30, 2002, an aggregate of 7,002,204
shares had been repurchased in all such repurchase programs at an average price
of $13.48. On September 18, 2001, the Company announced a share repurchase
program for its common stock whereby the Company may purchase up to 5% of the
outstanding stock, or approximately 460,000 shares. The repurchase program
started on September 20, 2001. At September 30, 2002, 70,300 shares had been
repurchased at an average price of $20.78 per share.
34
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
Set forth below are selected consolidated financial and other data. The
financial data is derived in part from, and should be read in conjunction with,
the Consolidated Financial Statements and notes thereto presented elsewhere in
this Annual Report on Form 10-K.
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------------
September 30,
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(In thousands)
SELECTED FINANCIAL DATA:
Total assets .......................................... $2,339,117 $2,206,266 $2,493,083 $2,476,199 $1,864,176
Cash and cash equivalents ............................. 45,835 38,100 34,747 32,562 30,746
Loans receivable, net ................................. 1,257,466 1,237,900 1,297,302 1,113,391 855,132
Mortgage loans held for sale .......................... 65,006 18,974 8,066 8,620 23,864
Debt securities held to maturity ...................... -- -- 510 810 1,817
Debt and equity securities available for sale ......... 16,596 41,661 213,848 216,649 109,061
Mortgage-backed and related securities held to
maturity .............................................. 90,246 95,384 27,088 39,475 63,087
Mortgage-backed and related securities available
for sale .............................................. 618,580 616,969 777,918 919,879 634,003
Real estate held for investment ....................... 32,803 26,255 27,145 28,402 29,997
Real estate held for sale ............................. -- -- -- -- 20,772
Deposits .............................................. 1,416,979 1,449,320 1,471,881 1,484,303 1,216,874
Borrowings ............................................ 642,063 571,433 864,676 834,738 504,677
Shareholders' equity .................................. 179,081 160,475 130,923 131,514 121,545
</Table>
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------
Years Ended September 30,
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Total interest and dividend income .................... $ 123,145 $ 161,135 $ 174,654 $ 145,545 $ 117,909
Total interest expense ................................ 67,419 107,591 120,731 93,282 76,063
---------- ---------- ---------- ---------- ----------
Net interest income before provision for
loan losses ..................................... 55,726 53,544 53,923 52,263 41,846
Provision for loan losses ............................. 3,289 5,527 2,509 1,920 2,300
---------- ---------- ---------- ---------- ----------
Net interest income .............................. 52,437 48,017 51,414 50,343 39,546
Other operating income (expense), net
Loan servicing and loan related fees .................. 1,182 3,298 2,734 2,016 2,125
Securities gains (losses) ............................. 1,312 996 12 (253) 1,243
Gain on sales of loans ................................ 12,751 6,055 1,133 2,806 4,367
Other operating income ................................ 11,151 10,987 10,326 11,717 11,173
---------- ---------- ---------- ---------- ----------
Total other operating income, net ................ 26,396 21,336 14,205 16,286 18,908
---------- ---------- ---------- ---------- ----------
General and administrative expenses(1) ................ 48,094 44,318 49,132 43,563 41,831
---------- ---------- ---------- ---------- ----------
Income before income tax expense and cumulative
effect of change in accounting principle ........ 30,739 25,035 16,487 23,066 16,623
Income tax expense .................................... 8,867 6,967 5,364 6,410 1,826
---------- ---------- ---------- ---------- ----------
Income before cumulative effect of change in
accounting principle ............................. 21,872 18,068 11,123 16,656 14,797
Cumulative effect of a change in accounting for
derivative instruments and hedging
activities, net of income taxes .................. -- (84) -- -- --
---------- ---------- ---------- ---------- ----------
Net income .................................... $ 21,872 $ 17,984 $ 11,123 $ 16,656 $ 14,797
========== ========== ========== ========== ==========
Basic earnings per share:
Before cumulative effect of a change
in accounting principle ............. $ 2.36 $ 1.93 $ 1.13 $ 1.78 $ 1.51
Cumulative effect of a change in
accounting principle ................ -- (0.01) -- -- --
---------- ---------- ---------- ---------- ----------
$ 2.36 $ 1.92 $ 1.13 $ 1.78 $ 1.51
========== ========== ========== ========== ==========
Diluted earnings per share:
Before cumulative effect of a change
in accounting principle ............. $ 2.25 $ 1.88 $ 1.12 $ 1.70 $ 1.43
Cumulative effect of a change in
accounting principle ................ -- (0.01) -- -- --
---------- ---------- ---------- ---------- ----------
$ 2.25 $ 1.87 $ 1.12 $ 1.70 $ 1.43
========== ========== ========== ========== ==========
Dividends per share ........................... $ 0.60 $ 0.40 $ 0.36 $ 0.32 $ 0.28
</Table>
- ----------
(1) General and administrative expenses for the year ended September 30,
2000 include the effect of an additional ESOP expense of $7.1 million
voluntarily incurred by the Company to repay the remaining loan
principal to its ESOP plan. See Note 15 to the Notes to Consolidated
Financial Statements included under Item 8 of this Annual Report on
Form 10-K.
35
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONT.)
<Table>
<Caption>
At or For the Years Ended September 30,
2002 2001 2000 1999 1998
------- ------- ------- ------- ------
(Dollars in thousands)
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios (4):
Return on average assets ...................... 0.99% 0.76% 0.44% 0.75% 0.87%
Return on average equity ...................... 12.84 12.08 8.70 13.12 11.29
Shareholders' equity to total assets .......... 7.66 7.27 5.25 5.31 6.52
Average shareholders' equity to average
assets ...................................... 7.72 6.33 5.11 5.73 7.71
Dividend payout ratio ......................... 26.67 21.39 32.14 18.82 19.65
Net interest spread during the period (1) ..... 2.45 2.06 1.98 2.33 2.47
Net interest margin (1) ....................... 2.68 2.38 2.24 2.51 2.68
General and administrative expenses to
average assets .............................. 2.18 1.88 1.96 1.97 2.46
Other operating income to average assets ...... 1.20 0.91 0.57 0.74 1.11
Average interest-earning assets to average
interest-bearing liabilities ................ 107.25 106.63 105.20 103.93 104.41
Asset Quality Ratios:
Non-performing loans to gross loans (2) ....... 0.16 0.77 0.95 0.23 0.29
Non-performing assets to total assets (2) ..... 0.18 0.48 0.53 0.13 0.16
Allowance for loan losses to gross loans ...... 1.03 0.88 0.76 0.75 0.77
Allowance for loan losses to
non-performing loans (2) .................... 643.37 113.88 80.17 329.44 263.19
Allowance for loan losses to
non-performing assets (2) ................... 345.20 109.59 78.71 291.37 257.52
Net charge-offs to average loans .............. 0.06 0.32 0.12 0.04 0.12
Regulatory Capital Ratios (3):
Tangible ratio ................................ 7.57 8.14 6.78 5.82 6.48
Core ratio .................................... 7.57 8.14 6.78 5.82 6.48
Tier 1 risk-based ratio ....................... 10.56 12.61 10.92 9.98 10.23
Total risk-based ratio ........................ 11.39 13.41 11.57 10.63 10.88
Other Data:
Number of deposit accounts .................... 141,820 141,888 141,080 136,292 128,643
Number of real estate loans outstanding ....... 2,463 3,045 3,804 3,482 3,486
Number of real estate loans serviced .......... 9,921 9,684 9,531 9,046 8,479
Mortgage loan originations (in thousands) ..... $ 918,684 $ 612,965 $ 412,998 $ 636,066 $ 505,849
Consumer loan originations (in thousands) ..... $ 84,534 $ 62,338 $ 51,472 $ 102,998 $ 93,700
Commercial loan originations (in thousands) ... $ 62,547 $ 51,829 $ 101,677 $ 114,532 $ 84,549
Full service customer facilities .............. 22 22 22 22 21
</Table>
- ----------
(1) Net interest spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earning assets.
(2) Non-performing loans consist of nonaccrual loans. Non-performing assets
consist of non-performing loans and foreclosed properties, which consist of
real estate acquired by foreclosure or deed-in-lieu thereof.
(3) Capital ratios are those of St. Francis Bank, F.S.B. only.
(4) Performance ratios for the year ended September 30, 2000 include the effects
of the additional ESOP expense of $7.1 million. See Note 15 to the Notes to
Consolidated Financial Statements included under Item 8 of this Annual
Report on Form 10-K.
36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is a unitary thrift holding company engaged in the financial
services business serving southeastern Wisconsin through its wholly-owned
subsidiary, the Bank, and the Chicago, Illinois metropolitan marketplace through
the Bank's Illinois-based mortgage banking subsidiary.
The earnings of the Company depend on its level of net interest income and other
operating income offset by general and administrative expenses and the level of
low income housing credits. Net interest income is a function of the Company's
net interest spread, which is the difference between the average yield earned on
interest-earning assets and the average rate paid on interest-bearing
liabilities, as well as a function of average ratio of interest-earning assets
as compared to interest-bearing liabilities. Other operating income consists
primarily of loan servicing fees, deposit charges, gains on sales of loans and
securities, income from the operation of affordable housing properties and
commissions on insurance, annuity and brokerage products. General and
administrative expenses consist primarily of employee compensation and benefits,
occupancy and equipment costs, expenses from operation of affordable housing
properties, data processing and advertising expenses. The Company's affordable
housing subsidiary generates tax credits which reduce the Company's federal
income tax expense.
The Company's operations include four strategic business segments: Retail
Banking, Commercial Banking, Mortgage Banking and Investments. Management
evaluates the financial performance of each segment primarily based on the
individual segment's direct contribution to the Company's net income.
Information regarding the net interest income, other operating income, profit
and average assets for the fiscal years ended September 30, 2002, 2001 and 2000
is set forth in Note 18 to the Notes to Consolidated Financial Statements
included under Item 8 of this Annual Report on Form 10-K.
The Company's operating results are significantly affected by general economic
conditions and the monetary, fiscal and regulatory policies of governmental
agencies. Lending activities are influenced by the demand for and supply of
housing, competition among lenders, the level of interest rates and the
availability of funds. Deposit flows and costs of funds likewise are heavily
influenced by prevailing market rates of interest on competing investment
alternatives, account maturities and the levels of personal income and savings
in the Company's market areas.
FINANCIAL CONDITION
Total assets at September 30, 2002 were $2.3 billion, an increase of $132.9
million from $2.2 billion at September 30, 2001. The increase is primarily due
to an increase of $65.6 million in loans receivable, including mortgage loans
held for sale. In fiscal 2002, the Company continued the restructuring of the
balance sheet as it continues to reduce the size of its mortgage-backed and
related securities and investment securities portfolios.
The restructuring of the balance sheet continues to be one of the strategic
initiatives of the Company. During the past three years the Company has reduced
the size of its mortgage-backed securities and investment securities portfolios
as repayments, scheduled maturities and sales occurred. Funds received from
these repayments, maturities and sales have been and are expected to be used to
grow and diversify the Company's loan portfolio, to reduce the Company's
wholesale debt and as an additional source of liquidity. This restructuring is
part of a long-range plan to make the Company's balance sheet composition more
representative of "community banks" with a greater percentage of assets in the
loan portfolio as opposed to investments. Management anticipates that this
restructuring should improve the Company's margins due to the generally higher
interest rates on loans, and this will continue to be an ongoing initiative of
the Company in fiscal 2003.
Mortgage-backed and related securities, including securities available for sale,
decreased $3.6 million to $708.8 million at September 30, 2002 from $712.4
million at September 30, 2001, which represented 30.3% and 32.3% of total
assets, respectively. Debt and equity securities decreased $25.1 million to
$16.6 million from $41.7 million at September 30, 2001. These decreases were due
to repayments, scheduled maturities and sales during the current year. The
decrease in mortgage-backed and related securities was partially offset by
purchases of $465.9 million during the year ended September 30, 2002. As noted
above, in connection with the balance sheet restructuring program, in fiscal
2001 and 2002, the Company reduced the size of its mortgage-backed securities
and investment securities portfolios.
Net loans receivable, including loans held for sale, increased $65.6 million to
$1.32 billion at September 30, 2002 from $1.26 billion at September 30, 2001.
During fiscal 2002, one-to four-family mortgage loans and consumer
37
loans decreased, offset by increases in multi-family, commercial real estate,
commercial and home equity loans. The generally lower interest rate environment
during the current year impacted the amount and type of loans originated during
fiscal 2002 compared with fiscal 2001. One- to four-family mortgage loans
decreased $46.9 million to $251.7 million at September 30, 2002 from $298.6
million at September 30, 2001. The Company's one-to four-family mortgage loan
portfolio has a significant level of adjustable rate loans and during periods of
declining interest rates, the customers generally convert adjustable rate loans
to fixed-rate loans. However, fixed rate loans are generally sold in the
secondary market and are not maintained on the Company's balance sheet. Consumer
loans decreased $20.4 million to $87.8 million. The decrease in consumer loans
is due to accelerated repayments of consumer loans and the discontinuance of the
Company's indirect auto loan program during fiscal 2000. Commercial loans
increased $7.9 million to $148.7 million. Commercial loans increased due to an
increase in originations. Gross commercial real estate loans increased by $33.2
million to $395.5 million. Multi-family loans increased $32.0 million to $158.3
million. Home equity lines of credit increased $54.8 million to $276.4 million.
Home equity lines of credit increased due to an increase in originations.
The Company originated $96.0 million of commercial real estate loans for the
year ended September 30, 2002 compared with $105.9 million for the year ended
September 30, 2001. Multi-family loan originations increased to $75.5 million
for the year ended September 30, 2002 compared with $34.8 million in the prior
year. One- to four-family and residential construction loan originations
increased to $535.2 million for the year ended September 30, 2002 compared with
$312.7 million in the prior year. The Company originated $212.0 million of home
equity loans for the year ended September 30, 2002 compared to $159.6 million
for the year ended September 30, 2001. Consumer loan originations increased to
$84.4 million for the year ended September 30, 2002 compared with $62.3 million
in the prior year. Commercial loan originations increased to $62.5 million loans
for the year ended September 30, 2002 compared with $51.8 million in the prior
year. The generally lower interest rate environment during the current year
impacted the amount and type of loans originated during fiscal 2002 compared
with fiscal 2001.
Real estate held for investment increased to $32.8 million at September 30,
2002, from $26.3 million at September 30, 2001, consisting of 14 affordable
housing projects within the state of Wisconsin, which qualify for tax credits
under Section 42 of the Internal Revenue Code.
Deposits decreased $32.3 million to $1.42 billion at September 30, 2002 from
$1.45 billion at September 30, 2001. The decrease in deposits was due primarily
to decreases of $54.5 million in money market demand account deposits and of
$10.6 million in certificates of deposit offset by increases of $27.6 million in
demand deposits as well as slight increases in other types of deposit products.
At September 30, 2002, certificates of deposits included $191.4 million in
brokered certificates of deposit compared with $224.4 million at September 30,
2001, a decrease of $33.0 million. The brokered deposits are used to fund the
general operating activities of the Company, with terms from three months to
three years in maturity. The majority of the money market demand accounts are
tied to a national money market fund index and compete with money market funds.
The level of deposit flows during any given period is heavily influenced by
factors such as the general level of interest rates as well as alternative
yields that investors may obtain on competing instruments, such as money market
mutual funds.
Advances and other borrowings increased to $642.1 million at September 30, 2002
from $571.4 million at September 30, 2001. The Company uses wholesale funding
sources, primarily advances from the FHLB, to fund that part of loan growth not
funded by growth in retail deposits and the reduction in the size of its
mortgage-backed securities and investment securities portfolios.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2002 AND 2001
GENERAL
Net income for the year ended September 30, 2002 increased to $21.9 million
compared with $18.0 million for the year ended September 30, 2001. Net income
for the year ended September 30, 2002 increased primarily due to an increase of
$5.1 million in other operating income and an increase of $4.4 million in net
interest income offset by an increase of $3.8 million in general and
administrative expenses. The results for the year ended September 30, 2002
include a $3.1 million impairment write-down on the Company's mortgage servicing
rights portfolio. The results for the year ended September 30, 2001 include a
$2.5 million additional provision for loan losses related to a commercial
credit. Fiscal 2001 included a reduction in net income of $84,000 for the
cumulative effect of a change in accounting principle resulting from the
adoption of Financial Accounting Standard Number 133, "Accounting for Derivative
Instruments and Hedging Activities." Fiscal 2001 also included goodwill
38
amortization of $1.2 million. This expense was eliminated with the Company's
adoption of Financial Accounting Standard Number 142 effective October 1, 2001.
NET INTEREST INCOME
Net interest income before provision for loan losses increased $2.2 million to
$55.7 million for the year ended September 30, 2002 compared to $53.5 million
for the year ended September 30, 2001. The increase was due to an increase in
the net interest margin to 2.68% in 2002 from 2.38% in 2001, partially offset by
a decrease of $169.6 million in average earning assets. The decrease in average
earning assets is largely the result of the Company's restructuring efforts to
reduce the amount of investment and mortgage-backed securities and of a decrease
in the Company's one- to four-family mortgage loan portfolio, which have been
refinancing in the recent lower interest rate environment.
Total interest income decreased $38.0 million or 23.6% to $123.1 million for the
year ended September 30, 2002 compared to $161.1 million for the year ended
September 30, 2001. The decrease in interest income was primarily the result of
decreases of $17.5 million in interest on mortgage-backed and related
securities, $15.7 million in interest on loans and $5.8 million in interest on
debt and equity securities. The decrease in interest on mortgage-backed and
related securities was due to a decrease in the average balance to $677.9
million for the year ended September 30, 2002, compared to $779.0 million for
the year ended September 30, 2001, as well as a decrease in the average yield on
mortgage-backed and related securities to 4.42% for the year ended September 30,
2002 from 6.10% for the year ended September 30, 2001. The decrease in interest
on debt and equity securities was due to a decrease in the average balance to
$42.1 million for the year ended September 30, 2002, compared to $124.5 million
for the year ended September 30, 2001, as well as a decrease in the average
yield on debt and equity securities to 4.30% for the year ended September 30,
2002 from 6.10% for the year ended September 30, 2001. The decrease in the
average balances of mortgage-backed and related securities and debt and equity
securities is due to the continuation of the aforementioned balance sheet
restructuring effort in fiscal 2002. The decrease in interest on loans was due
to a decrease in the average yield on loans which decreased to 6.81% for the
year ended September 30, 2002 from 7.92% for the year ended September 30, 2001,
while the average balance of loans remained at $1.3 billion for the years ended
September 30, 2002 and 2001. The decrease in the average yields is due primarily
to the lower interest rate environment in effect during the year as compared to
historical rates.
Total interest expense decreased $40.2 million or 37.3% to $67.4 million for the
year ended September 30, 2002 compared to $107.6 million for the year ended
September 30, 2001. Interest expense on deposits decreased $30.0 million or
45.2% to $36.3 million for the year ended September 30, 2002 compared to $66.3
million for the year ended September 30, 2001. The average balance of deposits
decreased to $1.33 billion for the year ended September 30, 2002, from $1.39
billion for the year ended September 30, 2001. The decrease in the average
balance of deposits is primarily due to the decline in the balance of
certificates of deposit. The average cost of deposits decreased to 2.74% for the
year ended September 30, 2002, from 4.75% for the year ended September 30, 2001.
Brokered deposits decreased to $191.4 million during the year compared to $224.4
million in 2001 at weighted average stated rates of 2.59% and 4.99%,
respectively. As part of a continuing strategy, the Company continues to offer
deposit products that compete more effectively with money market funds and other
non-financial deposit products. Such accounts have generally changed the
Company's traditional mix of deposit accounts to one that is more adjustable to
current interest rates such as the money market demand account. This has
resulted in passbook and certificate of deposit accounts representing a lower
percentage of the Company's deposit portfolio.
Interest expense on advances and other borrowings decreased $10.2 million or
24.7% to $31.1 million for the year ended September 30, 2002 compared to $41.4
million in the prior year. The decrease is due to a decrease in the average
balance of advances and other borrowings to $606.2 million for the year ended
September 30, 2002 compared to $708.5 million for the year ended September 30,
2001, as well as a decrease in the average cost of advances and other borrowings
to 5.13% from 5.83% for the same periods.
PROVISION FOR LOAN LOSSES
The provision for loan losses decreased $2.2 million to $3.3 million for the
year ended September 30, 2002 compared with $5.5 million for the year ended
September 30, 2001. In fiscal 2001, the Company recorded a specific loan loss
provision of $2.5 million related to a commercial loan credit that had been in
non-performing status since September 2000. For the year ended September 30,
2002, net charge-offs were $763,000 compared with $4.2 million for the year
ended September 30, 2001. The decrease in charge-offs in the current fiscal year
is due to a $3.5 million charge-off on the aforementioned commercial credit in
fiscal 2001. The allowance for loan
39
losses totaled $14.2 million and $11.7 million at September 30, 2002 and 2001,
respectively, representing 1.03% and 0.88% of total gross loans, respectively.
The Company's loan portfolio is increasingly more diversified than in previous
years. The Company has and continues to expect to increase its commercial,
consumer and commercial real estate loan portfolios, which are generally
presumed to have more risk than single-family mortgage loans. The amount of
non-performing loans was $2.2 million or 0.16% of gross loans at September 30,
2002, compared to $10.3 million or 0.77% of gross loans at September 30, 2001.
The provision for loan loss is established based on management's evaluation of
the risk inherent in its loan portfolio and the general economy. (For further
information see "Allowance for Loan Losses").
OTHER OPERATING INCOME
Other operating income increased $5.1 million or 23.7% to $26.4 million for the
year ended September 30, 2002 compared to $21.3 million for the year ended
September 30, 2001. The results for fiscal 2002 include a $3.1 million charge
related to an impairment write-down of the Company's mortgage servicing rights,
which is recorded as a valuation reserve at September 30, 2002. The Company's
mortgage servicing rights are accounted for at the lower of book or market
value. As part of the calculation of the market value of mortgage servicing
rights, the Company calculates the present value of the future stream of
servicing fee income expected to be received from its mortgage loan servicing
portfolio, relying in part on median loan prepayment speeds as forecast by the
major mortgage dealers. These mortgage dealer forecasts utilize a number of
assumptions, including an assumption as to the future direction of interest
rates. The forecasted prepayment speeds increased primarily in the 30-year
fixed-rate category of the Company's loan servicing portfolio as compared to the
previous period (reflecting forecasts for continued low interest rates and a
correspondingly high level of mortgage repayments and refinancings) and resulted
in the impairment write-down. In addition to the calculated effects of the
changes in prepayment speeds, part of the write-down was attributable to a
decline in the Company's servicing portfolio caused by mortgage repayments and
refinancings in the low interest rate environment this fiscal year. The Company
services $769 million in mortgage loans for others, with those servicing rights
valued, net of valuation allowances, at $6.1 million.
Other than the aforementioned impairment on mortgage servicing rights, the
increase was primarily due to increases in gains on sales of mortgage loans,
securities gains and increases in loan servicing and deposit fee income. Gains
on the sale of mortgage loans increased to $12.8 million for the year ended
September 30, 2002 compared with $6.1 million for the prior year. The level of
gains on loans is highly dependent on the interest rate environment and
resulting level of origination and sale of mortgage loans. The decrease in
interest rates on mortgage loans in the current fiscal year has resulted in an
increased level of loan originations and also in a higher proportion of fixed
rate mortgage loans, which the Company generally sells in the secondary market.
Excluding the impairment write-down, loan servicing and loan related fees
increased to $4.3 million from $3.3 million for the years ended September 30,
2002 and 2001, respectively. The increase was due to a number of factors
including increases in prepayment penalties received on early repayment of
loans, annual consumer loan fees, origination fees and loan modification fees.
Deposit fees and service charges increased to $5.6 million for the year ended
September 30, 2002 compared with $5.3 million in the prior year. The Company has
been increasing its mix of deposit accounts that generate various fee incomes
such as overdraft fees and ATM surcharges.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased $3.8 million or 8.5% to $48.1
million for the year ended September 30, 2002, compared to $44.3 million for the
year ended September 30, 2001. The increase is primarily due to additional
levels of compensation, including increased commissions and incentive pay
related to the Company's increased loan origination activity, higher benefit
costs and normal merit increases at the start of the Company's fiscal year.
Including commissions and salaries, mortgage loan-related compensation increased
by approximately $2.0 million for the year ended September 30, 2002 compared to
the prior year. Retirement plan expenses increased to $1.6 million for the year
ended September 30, 2002 compared to $796,000 for the year ended September 30,
2001. The increase in benefit costs results from comparison to reduced benefit
costs reflected in the prior year as a result of the Company having paid off its
ESOP loan in June 2000 and having benefited from reduced retirement plan costs
for the remainder of calendar year 2000. Normal retirement benefit costs resumed
on January 1, 2001. The prior fiscal year also included goodwill amortization of
$1.2 million. This expense was eliminated with the Company's adoption of
Financial Accounting Standard Number 142 effective as of October 1, 2001.
40
INCOME TAX EXPENSE
Income tax expense increased by $1.9 million to $8.9 million for the year ended
September 30, 2002 compared to $7.0 million for the year ended September 30,
2001. The Company's effective tax rate was 28.9% for the year ended September
30, 2002, compared to 27.8% for the year ended September 30, 2001. The Company's
effective tax rate is lower than the combined federal and state tax rates
primarily due to the effect of the tax credits earned by the Company's
affordable housing subsidiary. The increase in the effective tax rate in the
current year is primarily due to an increase in state taxes of $542,000,
partially offset by a decrease in acquisition intangible amortization of
$228,000. State taxes were lower in the prior fiscal year due to the utilization
of state net operating losses. Income tax credits were $2.7 million and $2.6
million, respectively, for the years ended September 30, 2002 and 2001.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2001 AND 2000
GENERAL
Net income for the year ended September 30, 2001 increased to $18.0 million
compared with $11.1 million for the year ended September 30, 2000. The results
for the year ended September 30, 2001 include an after-tax effect of $1.5
million on an additional provision for loan losses related to a commercial
credit. The results for the year ended September 30, 2000 included an after-tax
effect of $6.3 million on the accelerated loan principal payments to the
Company's Employee Stock Ownership Plan ("ESOP"). Excluding the effect of these
two items from fiscal 2001 and 2000, net income increased to $19.5 million from
$17.4 million. Fiscal 2001 included a reduction in net income of $84,000 for the
cumulative effect of a change in accounting principle resulting from the
adoption of Financial Accounting Statement Number 133, "Accounting for
Derivative Instruments and Hedging Activities." Net income for the year ended
September 30, 2001 increased primarily due to an increase of $7.1 million in
other operating income offset by a decrease of $3.4 million in net interest
income.
NET INTEREST INCOME
Net interest income before provision for loan losses decreased $379,000 to $53.5
million for the year ended September 30, 2001 compared to $53.9 million for the
year ended September 30, 2000. The slight decrease was due to a decrease of
$153.6 million in average earning assets from $2.40 billion for the prior year
to $2.25 billion for the year ended September 30, 2001, partially offset by a
decrease of $174.7 million in average interest-bearing liabilities from $2.28
billion for the prior year to $2.11 billion for the year ended September 30,
2001, and an increase in the net interest margin to 2.38% in 2001 from 2.24% in
2000. The decrease in average earning assets is largely the result of the
Company's restructuring efforts to reduce the amount of investment and
mortgage-backed securities and of a decrease in the Company's one- to
four-family mortgage loan portfolio, which have been refinancing in the recent
lower interest rate environment.
Total interest income decreased $13.5 million or 7.7% to $161.1 million for the
year ended September 30, 2001 compared to $174.6 million for the year ended
September 30, 2000. The decrease in interest income was primarily the result of
decreases of $10.8 million in interest on mortgage-backed and related securities
and $5.5 million in interest on debt and equity securities, partially offset by
a $2.7 million increase in interest on loans. The decrease in interest on
mortgage-backed and related securities was due to a decrease in the average
balance to $779.0 million for the year ended September 30, 2001, compared to
$899.7 million for the year ended September 30, 2000, as well as a decrease in
the average yield on mortgage-backed and related securities to 6.10% for the
year ended September 30, 2001 from 6.47% for the year ended September 30, 2000.
The decrease in interest on debt and equity securities was due to a decrease in
the average balance to $124.5 million for the year ended September 30, 2001,
compared to $222.1 million for the year ended September 30, 2000, partially
offset by an increase in the average yield on debt and equity securities to
6.10% for the year ended September 30, 2001 from 5.88% for the year ended
September 30, 2000. The decrease in the average balances of mortgage-backed and
related securities and debt and equity securities is due to the aforementioned
balance sheet restructuring effort in fiscal 2001. The increase in interest on
loans was due to an increase in the average balance of loans to $1.3 billion for
the year ended September 30, 2001, compared to $1.2 billion for the year ended
September 30, 2000, partially offset by a decrease in the average yield on loans
which decreased to 7.92% for the year ended September 30, 2001 from 8.09% for
the year ended September 30, 2000. The decrease in the average yields is due
primarily to the lower interest rate environment in effect during the year as
compared to historical rates.
Total interest expense decreased $13.1 million or 10.9% to $107.6 million for
the year ended September 30, 2001 compared to $120.7 million for the year ended
September 30, 2000. Interest expense on deposits decreased $6.2 million or 8.6%
to $66.3 million for the year ended September 30, 2001 compared to $72.5 million
for the year
41
ended September 30, 2000. The average balance of deposits decreased to $1.39
billion for the year ended September 30, 2001, from $1.43 billion for the year
ended September 30, 2000. The decreases in the balances of deposits are
primarily due to the decline in brokered certificates of deposit. The average
cost of deposits decreased to 4.75% for the year ended September 30, 2001, from
5.05% for the year ended September 30, 2000. Brokered deposits decreased to
$224.4 million during the year compared to $341.3 million in 2000 at weighted
average stated rates of 4.99% and 6.44%, respectively. As part of a continuing
strategy, the Company continues to offer deposit products that compete more
effectively with money market funds and other non-financial deposit products.
Such accounts have generally changed the Company's traditional mix of deposit
accounts to one that is more adjustable to current interest rates such as the
money market demand account. This has resulted in passbook and certificate of
deposit accounts representing a lower percentage of the Company's deposit
portfolio.
Interest expense on advances and other borrowings decreased $6.9 million or
14.3% to $41.4 million for the year ended September 30, 2001 compared to $48.3
million in the prior year. The decrease is due to a decrease in the average
balance of advances and other borrowings to $708.5 million for the year ended
September 30, 2001 compared to $843.2 million for the year ended September 30,
2000, partially offset by an increase in the average cost of advances and other
borrowings to 5.83% from 5.72% for the same periods.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased $3.0 million to $5.5 million for the
year ended September 30, 2001 compared with $2.5 million for the year ended
September 30, 2000. In fiscal 2001, the Company recorded a specific loan loss
provision of $2.5 million related to a commercial loan credit that has been in
non-performing status since September 2000. After consideration of specific
reserves already established for the loan, the Company felt the provision was
appropriate given the current known status of the credit. At September 30, 2001,
the commercial loan credit had a balance of $5.1 million and an associated
impairment reserve of $513,000. During the year ended September 30, 2001, the
balance of the commercial loan credit was reduced by a $3.5 million charge-off
and by the receipt of $1.4 million in payments. (For further information
regarding this particular commercial credit see "Non-Performing Assets"). For
the year ended September 30, 2001, net charge-offs were $4.2 million compared
with $1.5 million for the year ended September 30, 2000. The increase in
charge-offs in the current fiscal year is due to a $3.5 million charge-off on
the aforementioned commercial credit. The allowance for loan losses totaled
$11.7 million and $10.4 million at September 30, 2001 and 2000, respectively,
representing 0.88% and 0.76% of total gross loans, respectively. The Company's
loan portfolio is increasingly more diversified than in previous years. The
Company has and continues to expect to increase its commercial, consumer and
commercial real estate loan portfolios, which are generally presumed to have
more risk than single-family mortgage loans. The amount of non-performing loans
was $10.3 million or 0.77% of gross loans at September 30, 2001, compared to
$13.0 million or 0.95% of gross loans at September 30, 2000. The provision for
loan loss is established based on management's evaluation of the risk inherent
in its loan portfolio and the general economy. (For further information see
"Allowance for Loan Losses").
OTHER OPERATING INCOME
Other operating income increased $7.1 million or 50.2% to $21.3 million for the
year ended September 30, 2001 compared to $14.2 million for the year ended
September 30, 2000. The increase was primarily due to increases in gains on
sales of mortgage loans, securities gains and increases in loan servicing and
deposit fee income. Gains on the sale of mortgage loans increased to $6.1
million for the year ended September 30, 2001 compared with $1.1 million for the
prior year. The level of gains on loans is highly dependent on the interest rate
environment and resulting level of origination of mortgage loans. The decrease
in interest rates on mortgage loans in the current fiscal year has resulted in
an increased level of loan originations and also in a higher proportion of fixed
rate mortgage loans, which the Company generally sells in the secondary market.
Loan servicing and loan related fees increased to $3.3 million from $2.7 million
for the years ended September 30, 2001 and 2000, respectively. Deposit fees and
service charges increased to $5.3 million for the year ended September 30, 2001
compared with $4.9 million in the prior year. The Company has been increasing
its mix of deposit accounts that generate various fee incomes such as overdraft
fees and ATM surcharges.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased $4.8 million or 9.8% to $44.3
million for the year ended September 30, 2001, compared to $49.1 million for the
year ended September 30, 2000. The prior year included an additional ESOP
expense of $7.1 million due to accelerated payments made to retire the Company's
ESOP debt. Excluding the effect of the additional ESOP expense, general and
administrative expenses increased $2.3 million for the year ended September 30,
2001 compared to the same period in the prior year. The increase is primarily
42
due to additional levels of compensation, including increased commissions and
incentive pay related to the Company's increased loan origination activity,
normal merit increases at the start of the Company's fiscal year and the
Company's mortgage banking subsidiary having become fully operational by the
beginning of the current fiscal year.
INCOME TAX EXPENSE
Income tax expense increased by $1.6 million to $7.0 million for the year ended
September 30, 2001 compared to $5.4 million for the year ended September 30,
2000. The Company's effective tax rate was 27.8% for the year ended September
30, 2001, compared to 32.5% for the year ended September 30, 2000. The Company's
effective tax rate is lower than the combined federal and state tax rates
primarily due to the effect of the tax credits earned by the Company's
affordable housing subsidiary. The decrease in the effective tax rate in the
current year is due primarily to the fact that the majority of the ESOP expense
in the prior year was non-deductible for tax purposes. Income tax credits were
$2.6 million in both fiscal 2001 and 2000.
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the Company's
consolidated average statements of financial condition and the consolidated
statements of income for the years ended September 30, 2002, 2001 and 2000, and
reflects the average yield on assets and average cost of liabilities for the
years indicated. Such yields and costs are derived by dividing income or expense
by the average balance of assets or liabilities, respectively, for the years
shown. Average balances are derived principally from average daily balances and
include non-accruing loans. The yields and costs include fees which are
considered adjustments to yields. The amount of interest income resulting from
the recognition of loan fees was $387,000, $123,000 and $520,000 for the years
ended September 30, 2002, 2001 and 2000, respectively. Interest income on
non-accruing loans is reflected in the year that it is collected. Such amounts
are not material to net interest income or net change in net interest income in
any year. Non-accrual loans are included in the average balances and do not have
a material effect on the average yield. Tax-exempt investments are immaterial
and the tax-equivalent method of presentation is not included in the schedule.
Interest rate swaps, which are accounted for as a hedge of the cost of various
liabilities, are included in the category of the liability being hedged.
43
<Table>
<Caption>
YEARS ENDED SEPTEMBER 30,
--------------------------------------
AVERAGE BALANCE SHEET 2002
--------------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
----------- ----------- -----------
(Dollars in thousands)
ASSETS
Federal funds sold and overnight deposits .................. $ 2,474 $ 44 1.78%
Trading account securities ................................. -- -- --
Debt and equity securities ................................. 42,143 1,812 4.30
Mortgage-backed and related securities ..................... 677,913 29,955 4.42
Loans:
First mortgage ........................................... 798,009 57,169 7.16
Home equity .............................................. 244,337 13,608 5.57
Consumer ................................................. 98,987 8,221 8.31
Commercial ............................................... 148,882 8,903 5.98
----------- -----------
Total loans ............................................ 1,290,215 87,901 6.81
Federal Home Loan Bank stock ............................... 66,246 3,433 5.18
----------- -----------
Total earning assets ................................. 2,078,991 123,145 5.92
-----------
Valuation allowances ....................................... (11,160)
Cash and due from banks .................................... 33,315
Other assets ............................................... 104,582
-----------
Total assets ......................................... $ 2,205,728
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts ............................................. $ 90,144 $ 262 0.29%
Money market demand accounts ............................. 425,209 5,393 1.27
Passbook ................................................. 90,932 676 0.74
Certificates of deposit .................................. 719,400 29,956 4.16
----------- -----------
Total interest-bearing deposits ........................ 1,325,685 36,287 2.74
Advances and other borrowings .............................. 606,237 31,120 5.13
Advances from borrowers for taxes and insurance ............ 6,576 12 0.18
----------- -----------
Total interest-bearing liabilities ................... 1,938,498 67,419 3.48
-----------
Non-interest bearing deposits .............................. 81,176
Other liabilities .......................................... 15,691
Shareholders' equity ....................................... 170,363
-----------
Total liabilities and shareholders' equity ................. $ 2,205,728
===========
Net interest income ........................................ $ 55,726
===========
Net yield on interest-earning assets ....................... 2.68%
Interest rate spread ....................................... 2.45
Ratio of earning assets to interest-bearing liabilities .... 107.25
<Caption>
YEARS ENDED SEPTEMBER 30,
--------------------------------------
AVERAGE BALANCE SHEET 2001
--------------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
----------- ----------- -----------
(Dollars in thousands)
ASSETS
Federal funds sold and overnight deposits .................. $ 3,307 $ 158 4.78%
Trading account securities ................................. 98 8 8.16
Debt and equity securities ................................. 124,477 7,595 6.10
Mortgage-backed and related securities ..................... 778,950 47,478 6.10
Loans:
First mortgage ........................................... 835,851 65,239 7.81
Home equity .............................................. 205,333 16,939 8.25
Consumer ................................................. 117,169 10,168 8.68
Commercial ............................................... 150,365 11,285 7.51
----------- ----------- -
Total loans ............................................ 1,308,718 103,631 7.92
Federal Home Loan Bank stock ............................... 32,994 2,265 6.86
----------- ----------- -
Total earning assets ................................. 2,248,544 161,135 7.17
-----------
Valuation allowances ....................................... (22,248)
Cash and due from banks .................................... 28,444
Other assets ............................................... 99,197
-----------
Total assets ......................................... $ 2,353,937
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts ............................................. $ 79,587 $ 477 0.60%
Money market demand accounts ............................. 406,068 17,091 4.21
Passbook ................................................. 88,134 1,556 1.77
Certificates of deposit .................................. 819,427 47,115 5.75
----------- ----------- -
Total interest-bearing deposits ........................ 1,393,216 66,239 4.75
Advances and other borrowings .............................. 708,524 41,336 5.83
Advances from borrowers for taxes and insurance ............ 6,920 16 0.23
----------- ----------- -
Total interest-bearing liabilities ................... 2,108,660 107,591 5.10
-----------
Non-interest bearing deposits .............................. 78,398
Other liabilities .......................................... 18,001
Shareholders' equity ....................................... 148,878
-----------
Total liabilities and shareholders' equity ................. $ 2,353,937
===========
Net interest income ........................................ $ 53,544
===========
Net yield on interest-earning assets ....................... 2.38%
Interest rate spread ....................................... 2.06
Ratio of earning assets to interest-bearing liabilities .... 106.63
<Caption>
YEARS ENDED SEPTEMBER 30,
--------------------------------------
AVERAGE BALANCE SHEET 2000
--------------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
----------- ----------- -----------
(Dollars in thousands)
ASSETS
Federal funds sold and overnight deposits .................. $ 1,381 $ 75 5.43%
Trading account securities ................................. 654 59 9.02
Debt and equity securities ................................. 222,070 13,065 5.88
Mortgage-backed and related securities ..................... 899,651 58,250 6.47
Loans:
First mortgage ........................................... 805,125 62,674 7.78
Home equity .............................................. 172,312 15,407 8.94
Consumer ................................................. 139,725 11,793 8.44
Commercial ............................................... 130,166 11,048 8.49
----------- -----------
Total loans ............................................ 1,247,328 100,922 8.09
Federal Home Loan Bank stock ............................... 31,041 2,283 7.35
----------- -----------
Total earning assets ................................. 2,402,125 174,654 7.27
-----------
Valuation allowances ....................................... (42,966)
Cash and due from banks .................................... 31,649
Other assets ............................................... 112,013
-----------
Total assets ......................................... $ 2,502,821
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts ............................................. $ 76,485 $ 500 0.65%
Money market demand accounts ............................. 364,326 17,330 4.76
Passbook ................................................. 102,547 2,184 2.13
Certificates of deposit .................................. 890,341 52,451 5.89
----------- -----------
Total interest-bearing deposits ........................ 1,433,699 72,465 5.05
Advances and other borrowings .............................. 843,186 48,248 5.72
Advances from borrowers for taxes and insurance ............ 6,486 18 0.28
----------- -----------
Total interest-bearing liabilities ................... 2,283,371 120,731 5.29
-----------
Non-interest bearing deposits .............................. 74,686
Other liabilities .......................................... 16,924
Shareholders' equity ....................................... 127,840
-----------
Total liabilities and shareholders' equity ................. $ 2,502,821
===========
Net interest income ........................................ $ 53,923
===========
Net yield on interest-earning assets ....................... 2.24%
Interest rate spread ....................................... 1.98
Ratio of earning assets to interest-bearing liabilities .... 105.20
</Table>
44
RATE/VOLUME ANALYSIS
Net interest income represents the difference between income on interest-earning
assets and expense on interest-bearing liabilities. Net interest income depends
upon the volumes of interest-earning assets and interest-bearing liabilities and
the interest rate earned or paid on them.
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate), (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume), (iii) changes attributable to the combined
impact of volume and rate (changes in the rate multiplied by the changes in the
volume) and (iv) the net change.
<Table>
<Caption>
YEARS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
2002 COMPARED TO 2001 2001 COMPARED TO 2000
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
----------------------------------------- -----------------------------------------
RATE/ RATE/
(In thousands) RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
-------- -------- -------- -------- -------- -------- -------- --------
INTEREST-EARNING ASSETS:
Federal funds sold and
overnight deposits ............... $ (99) $ (40) $ 25 $ (114) $ (9) $ 105 $ (13) $ 83
Trading account securities ........ (8) (8) 8 (8) (6) (50) 5 (51)
Debt and equity securities ........ (2,243) (5,024) 1,484 (5,783) 485 (5,742) (213) (5,470)
Mortgage-backed and related
securities ....................... (13,058) (6,158) 1,693 (17,523) (3,415) (7,815) 458 (10,772)
Loans:
Mortgage ....................... (5,359) (2,954) 243 (8,070) 167 2,392 6 2,565
Home equity .................... (5,503) 3,218 (1,046) (3,331) (1,192) 2,952 (228) 1,532
Consumer ....................... (437) (1,578) 68 (1,947) 332 (1,903) (54) (1,625)
Commercial and agriculture ..... (2,294) (111) 23 (2,382) (1,279) 1,714 (198) 237
-------- -------- -------- -------- -------- -------- -------- --------
Gross loans receivable ....... (13,593) (1,425) (712) (15,730) (1,972) 5,155 (474) 2,709
Federal Home Loan Bank stock ...... (555) 2,283 (560) 1,168 (152) 144 (10) (18)
-------- -------- -------- -------- -------- -------- -------- --------
Change in interest income..... (29,556) (10,372) 1,938 (37,990) (5,069) (8,203) (247) (13,519)
INTEREST-BEARING LIABILITIES:
Deposits:
NOW accounts ................... (245) 63 (33) (215) (41) 20 (2) (23)
Money market demand accounts ... (11,941) 806 (563) (11,698) (1,996) 1,986 (229) (239)
Passbook ....................... (901) 49 (28) (880) (374) (307) 53 (628)
Certificates of deposit ........ (12,994) (5,751) 1,586 (17,159) (1,258) (4,178) 100 (5,336)
-------- -------- -------- -------- -------- -------- -------- --------
Total deposits ............... (26,081) (4,833) 962 (29,952) (3,669) (2,479) (78) (6,226)
Advances and other borrowings ..... (4,965) (5,698) 717 (10,216) 944 (7,705) (151) (6,912)
Advances from borrowers for
taxes and insurance ............ (3) (1) -- (4) (3) 1 -- (2)
-------- -------- -------- -------- -------- -------- -------- --------
Change in interest
expense ..................... (31,049) (10,802) 1,679 (40,172) (2,728) (10,183) (229) (13,140)
-------- -------- -------- -------- -------- -------- -------- --------
Change in net interest
income ...................... $ 1,493 $ 430 $ 259 $ 2,182 $ (2,341) $ 1,980 $ (18) $ (379)
======== ======== ======== ======== ======== ======== ======== ========
</Table>
ASSET/LIABILITY MANAGEMENT
The Company's profitability, like that of most financial institutions, depends
to a large extent upon its net interest income, which is the difference between
interest earned on its interest-earning assets, such as loans and investments,
and its interest expense paid on interest-bearing liabilities, such as deposits
and borrowings.
In an attempt to manage vulnerability to interest rate changes, management
monitors the Company's interest rate risks. The Company has established its
investment strategies through an Asset/Liability Committee, which reports to the
Board of Directors. The Committee generally meets monthly and reviews the
Company's interest rate risk position, maturing securities and borrowings,
interest rates and programs for raising deposits, including retail wholesale
deposits, and originating and purchasing of loans, and develops policies dealing
with these issues. The
45
Company seeks primarily to manage its interest rate risk through structuring its
balance sheet by adjusting the asset and liability allocation in order to reduce
its vulnerability to changes in interest rates and to enhance its income. One
measure the Company uses to measure interest rate risk is gap. Gap is defined as
the difference between the level of assets and the level of liabilities
repricing or maturing in a given time period. A positive/(negative) gap occurs
when the amount of assets/(liabilities) maturing or repricing within one year
are greater than the amount of liabilities/(assets) maturing or repricing within
the same period of time. The Company attempts to maintain a positive or negative
one-year gap of less than 15% of total assets. If in the estimation of
management, the one-year gap exceeded or was soon to exceed that limit, actions
would be taken to reduce the Company's exposure to changing interest rates.
At September 30, 2002, the Company's total interest-earning assets maturing or
repricing within one year exceeded total interest-bearing liabilities maturing
or repricing in the same period by $236.2 million, representing a positive
cumulative one-year gap ratio of 10.10%, compared to a negative cumulative
one-year gap ratio of 1.2% at September 30, 2001. The Company's three-year
cumulative gap as of September 30, 2002 was a positive 3.05% of total assets.
The change in the Company's gap position is due to the decline in interest rates
during fiscal 2001 and 2002. As interest rates declined, the terms of the
Company's assets shortened as prepayments of the Company's mortgage-related
assets increased and the terms of the liabilities lengthened as consumers
invested in longer term certificates of deposit and the Company issued longer
term brokered certificates of deposit.
The Company's interest rate risk position, as defined by gap, is dynamic as
interest rates change. While static gap analysis may be a useful measure of
determining short-term risk to future net income under certain circumstances, it
does not measure the sensitivity of the market value of assets and liabilities
to changes in interest rates. For example, gap analysis is limited in its
ability to predict trends in future earnings and makes no assumptions about
changes in prepayment tendencies, deposit or loan maturity preferences or
repricing time lags that may occur in response to a change in the market
interest rate environment. With a positive gap position, during periods of
rising interest rates it is expected that the yield of the Company's
interest-earning assets will rise more quickly than the cost on its
interest-bearing liabilities, which will have a positive effect on its net
interest income. The opposite effect on net interest income would occur in
periods of falling interest rates, the Company could experience substantial
prepayments of its fixed-rate mortgage loans and mortgage-backed and related
securities, which would result in the reinvestment of such proceeds at market
rates which are lower than current rates.
However, in the event market interest rates increase 200 to 300 basis points
from the current rates at September 30, 2002, the Company expects that its
one-year positive gap would become negative due to the anticipated shortening of
the terms of the Company's fixed rate callable FHLB advances becoming callable.
In addition, prepayments of the Company's mortgage-related assets will slow
causing a lengthening of the terms of these assets.
46
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 2002:
<Table>
<Caption>
More than More than
Within Four to One Year Three
Three Twelve to Three Years to Over Five
Months Months Years Five Years Years Total
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
INTEREST-EARNING ASSETS: (1)
Loans: (2)
Residential ............................ $ 28,544 $ 56,430 $ 48,707 $ 17,215 $ 41,421 $ 192,317
Commercial ............................. 162,086 124,887 237,807 55,973 120,630 701,383
Consumer ............................... 270,354 21,836 29,342 26,479 15,755 363,766
Mortgage-backed and related securities ..... 22,672 28,392 26,460 8,061 4,661 90,246
Assets available for sale:
Mortgage loans ........................ 65,006 -- -- -- -- 65,006
Fixed rate mortgage related ........... 64,882 100,724 191,003 43,819 35,775 436,203
Variable rate mortgage related ........ 182,377 -- -- -- -- 182,377
Investment securities ................. 8,572 3,011 5,013 -- -- 16,596
Other assets ............................... 93,104 -- -- -- -- 93,104
---------- ---------- ---------- ---------- ---------- ----------
Total .................................. $ 897,597 $ 335,280 $ 538,332 $ 151,547 $ 218,242 $2,140,998
========== ========== ========== ========== ========== ==========
INTEREST-BEARING LIABILITIES:
Deposits: (3)
NOW accounts .......................... $ 7,736 $ 23,208 $ 34,623 $ 15,542 $ 12,906 $ 94,015
Passbook savings accounts ............. 3,305 9,916 19,186 13,309 48,149 93,865
Money market deposit accounts ......... 94,516 283,548 770 1,248 701 380,783
Certificates of deposit ............... 119,117 295,001 291,858 29,070 145 735,191
Borrowings (4) ............................. 130,631 29,680 356,752 125,000 -- 642,063
---------- ---------- ---------- ---------- ---------- ----------
Total ................................. $ 355,305 $ 641,353 $ 703,189 $ 184,169 $ 61,901 $1,945,917
========== ========== ========== ========== ========== ==========
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities ... $ 542,292 $ (306,073) $ (164,857) $ (32,622) $ 156,341 $ 195,081
========== ========== ========== ========== ========== ==========
Cumulative excess (deficiency) of
interest-earning assets over
interest- bearing liabilities .............. $ 542,292 $ 236,219 $ 71,362 $ 38,740 $ 195,081
========== ========== ========== ========== ==========
Cumulative excess (deficiency) of
interest-earning assets over interest-
bearing liabilities as a percent of
total assets ............................... 23.18% 10.10% 3.05% 1.66% 8.34%
========== ========== ========== ========== ==========
</Table>
(1) Adjustable and floating rate assets are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due, and fixed rate assets are included in the periods in
which they are scheduled to be repaid based on scheduled amortization, in
each case adjusted to take into account estimated prepayments utilizing the
Company's historical prepayment statistics, modified for forecasted
statistics using the Public Securities Association model of prepayments.
For fixed rate mortgage loans and mortgage-backed and related securities,
annual prepayment rates ranging from 8% to 50%, based on the loan coupon
rate and the type of loan, were used. The increase in prepayment rates
during the current fiscal year are due to the decline in interest rates
during fiscal 2002.
(2) Balances have been reduced for undisbursed loan proceeds, unearned
insurance premiums, deferred loan fees, purchased loan discounts and
allowances for loan losses, which aggregated $59.0 million at September 30,
2002.
(3) Although the Company's NOW accounts, passbook savings accounts and money
market deposit accounts generally are subject to immediate withdrawal,
management considers a certain portion of such accounts to be core deposits
having significantly longer effective maturities based on the Company's
retention of such deposits in changing interest rate environments. NOW
accounts, passbook savings accounts and money market deposit accounts are
assumed to be withdrawn at annual rates of 33%, 14% and 99%, respectively,
of the declining balance of such accounts during the period shown. The
withdrawal rates used are higher than the Company's historical rates but
are considered by management to be more indicative of expected withdrawal
rates in a rising interest rate environment. If all the Company's NOW
accounts, passbook savings accounts and money market deposit accounts had
been assumed to be repricing within one year, the one-year cumulative
deficiency of interest-earning assets to interest-bearing liabilities would
have been $89.8 million or 3.84% of total assets.
(4) Fixed rate callable FHLB advances are included in the period of their
modified duration rather than in the period in which they are due.
Borrowings include fixed rate callable FHLB advances of $320 million
maturing in one to three years and $125 million maturing in three to five
years.
47
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as ARM loans and mortgage-backed and
related securities, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In addition, the proportion of
ARM loans and mortgage-backed and related securities in the Company's portfolios
could decrease in future periods if market interest rates remain at or decrease
below current levels due to the exercise of conversion options and refinance
activity. Further, in the event of a change in interest rates, prepayment and
early withdrawal levels would likely deviate significantly from those assumed in
the table. Finally, the ability of many borrowers to service their debt may
decrease in the event of an interest rate increase.
For regulatory reporting the Corporation utilizes a dynamic gap analysis. The
dynamic gap analysis involves analyzing the impact on contractual repricing and
maturity characteristics for rate sensitive assets, liabilities, and off balance
sheet instruments adjusted for the anticipated impact on repricing, prepayment,
and option features for different interest rate scenarios (various parallel
yield curve shifts). A dynamic consolidated gap position is then analyzed for
the impact on net interest income in the various environments. The Corporation's
consolidated one year positive gap is 10.10% as of September 30, 2002. The
projected sensitivity on net interest income for an immediate and parallel
upward yield curve shift of 100 and 200 basis points is an increase of 4% and an
increase of 9%, respectively.
The Corporation further measures interest rate risk by analyzing the impact of
changing interest rates on the Corporation's market value portfolio equity
(market value adjusted capital). The market value portfolio equity analysis
involves analyzing the market value of all rate sensitive assets and liabilities
under different interest rate and prepayment environments. The change in the
market value portfolio equity for changes in interest rates is measured against
its current base case. This sensitivity is monitored and compared to desired
internal levels and current industry standards. The consolidated market value
portfolio equity sensitivity to an immediate and parallel upward yield curve
shift of up 100 and 200 basis points is - 8% and -12%, respectively.
The Company enters into interest rate exchange agreements ("swaps") from time to
time in order to reduce the interest rate risk associated with brokered
certificates of deposit. The agreements have been both fixed-pay,
floating-receive swaps whereby the Company pays interest at a fixed rate and
receives interest at a floating rate based on a notional amount of principal,
locking in a fixed cost of funds and fixed-receive, floating-pay swaps whereby
the Company receives interest at a fixed rate and pays interest at a floating
rate based on a notional amount of principal, locking in a floating cost of
funds. The net interest income or expense resulting from the differential
between exchanging floating rate and fixed rate interest payments is recorded on
a current basis. There are certain risks associated with swaps, including the
risk that the counterparty may default and that there may not be an exact
correlation between the indices on which the swap agreements are based and the
terms of the hedged liabilities. In order to offset these risks, the Company
generally enters into swap agreements only with nationally recognized securities
firms and monitors the credit status of counterparties, the level of collateral
for such swaps and the correlation between the hedged liabilities and indices
utilized. Generally, the swaps have been designed to more accurately match the
interest cash flows of certain liabilities used to fund specific assets to the
interest rate characteristics of those assets. At September 30, 2002, the
Company did not have any interest rate swaps outstanding. The largest aggregate
notional amount of the Company's interest rate swaps at any one time over the
past five years is $410.0 million.
For the years ended September 30, 2002, 2001 and 2000, the Company realized net
interest income on interest rate exchange agreement activity of $1.4 million,
$1.6 million and $1.1 million, respectively. While this activity resulted in net
interest income in fiscal years 2002, 2001 and 2000, the Company effectively
matched the related funding costs of certain assets with the interest rate
characteristics of those assets. The Company's Investment Policy limits the
notional amount of outstanding interest rate exchange agreements to $450.0
million. Any notional amounts of interest rate exchange agreements in excess of
$450.0 million must be approved by the Company's Board of Directors.
48
The Company has primarily utilized forward loan sale commitments to reduce
exposure to interest rate risk of its mortgage loans held for sale and saleable
loan production. These commitments are entered into on both a mandatory and best
efforts delivery basis. Under a mandatory delivery commitment, the Company is
required to deliver the targeted loans by a set date. Best efforts delivery
involves the Company agreeing, but not required to, deliver targeted loans by a
set date. Commitments can be conducted in groups of similar loans or on an
individual loan basis.
The Company also has the authority to use the mortgage loans held for sale as
collateral to create a mortgage backed security ("MBS"). The MBS can then be
sold in whole or in part to reduce the Company's exposure to interest rate risk.
In addition, the Company has the authority to engage in financial futures or
options on financial futures to reduce the exposure to interest rate risk from
mortgage banking activities. No securitizations, financial futures, or options
on financial futures were utilized to manage the risks associated with mortgage
banking activities during the fiscal year ended September 30, 2002. In order to
limit the risks associated with financial futures and options, the Company's
investment policy limits the notional amount of outstanding options to $50
million.
While no options on financial futures were used to reduce the exposure to
interest rate risk of its mortgage loans held for sale, the Company did utilize
options with its available for sale portfolio during the fiscal year. Options
were used in order to enhance the yield of the mortgage-backed and related
securities available-for-sale. No options were outstanding as of September 30,
2002. The options were not considered to be hedges under SFAS No. 133 and any
changes in market value of the outstanding options related to that activity are
included in securities gains on the consolidated income statement.
49
The following table sets forth the amounts of estimated cash flows for the
various interest-earning assets and interest-bearing liabilities outstanding at
September 30, 2002.
<Table>
<Caption>
More than More than More than
Within One Year Two Years Three Years
One Year to Two Years to Three Years to Four Years
--------------------- --------------------- --------------------- ---------------------
(In millions)
Interest Earning Assets
Loans:
Residential ............. $ 0.9 9.40% $ 1.3 7.88% $ 2.1 6.58% $ 0.3 8.02%
Commercial .............. 87.6 5.12% 51.3 6.18% 61.9 6.51% 45.2 5.42%
Consumer ................ 41.8 5.35% 42.5 5.53% 111.1 5.43% 124.0 5.36%
Mortgage-backed
securities:
Fixed rate .............. 216.7 4.76% 108.7 4.76% 108.7 4.76% 26.0 4.76%
Adjustable rate ......... 36.4 2.19% 31.0 2.19% 23.7 2.19% 21.9 2.19%
Debt and equity
securities ................ 11.6 3.00% 5.0 3.69% -- -- -- --
Other ....................... 93.1 5.00% -- -- -- -- -- --
--------- --------- --------- ---------
Total interest
earning assets ............ $ 488.1 4.70% $ 239.8 4.86% $ 307.5 5.17% $ 217.4 4.99%
========= ========= ========= =========
Interest Bearing Liabilities
Deposits:
NOW accounts ............ $ 30.9 0.25% $ 17.3 0.25% $ 17.3 0.25% $ 7.8 0.25%
Passbooks ............... 13.2 0.35% 9.6 0.35% 9.6 0.35% 6.7 0.35%
Money market ............ 378.1 0.91% 0.4 0.91% 0.4 0.91% 0.6 0.91%
Certificates ............ 414.1 3.05% 244.2 3.87% 47.7 4.48% 17.9 4.76%
Borrowings
Fixed rate .............. 25.0 2.78% 25.0 4.80% 362.9 5.55% 25.0 5.02%
Adjustable rate ......... 129.2 1.95% -- -- -- -- -- --
--------- --------- --------- ---------
Total interest
bearing liabilities ....... $ 990.5 1.96% $ 296.5 3.62% $ 437.9 5.11% $ 58.0 3.72%
========= ========= ========= =========
<Caption>
More than Fair
Four Years Over Market
to Five Years Five Years Total Value
--------------------- --------------------- ---------------------- ---------
(In millions)
Interest Earning Assets
Loans:
Residential ............. $ 14.0 6.77% $ 238.7 6.60% $ 257.3 6.63% $ 265.0
Commercial .............. 141.1 6.89% 314.3 7.04% 701.4 6.56% 715.4
Consumer ................ 15.2 8.54% 29.2 8.94% 363.8 5.82% 364.7
Mortgage-backed
securities:
Fixed rate .............. 25.9 4.76% 40.4 4.76% 526.4 4.76% 527.5
Adjustable rate ......... 20.1 2.19% 49.3 2.19% 182.4 2.19% 182.4
Debt and equity
securities ................ -- -- -- -- 16.6 3.21% 16.6
Other ....................... -- -- -- -- 93.1 5.00% 93.1
--------- --------- --------- ---------
Total interest
earning assets ............ $ 216.3 6.31% $ 671.9 6.47% $ 2,141.0 5.53% $ 2,164.7
========= ========= ========= =========
Interest Bearing Liabilities
Deposits:
NOW accounts ............ $ 7.8 0.25% $ 12.9 0.25% $ 94.0 0.25% $ 90.7
Passbooks ............... 6.7 0.35% 48.1 0.35% 93.9 0.35% 87.9
Money market ............ 0.6 0.91% 0.7 0.91% 380.8 0.91% 379.9
Certificates ............ 11.2 4.75% 0.1 8.00% 735.2 3.48% 749.2
Borrowings
Fixed rate .............. 75.0 5.95% -- -- 512.9 5.41% 567.9
Adjustable rate ......... -- -- -- -- 129.2 1.95% 129.2
--------- --------- --------- ---------
Total interest
bearing liabilities ....... $ 101.3 4.98% $ 61.8 0.35% $ 1,946.0 3.08% $ 2,004.8
========= ========= ========= =========
</Table>
50
The following table sets forth the amounts of estimated cash flows for the
various interest-earning assets and interest-bearing liabilities outstanding at
September 30, 2001.
<Table>
<Caption>
More than More than More than
Within One Year Two Years Three Years
One Year to Two Years to Three Years to Four Years
--------------------- --------------------- --------------------- ---------------------
(In millions)
Interest Earning Assets
Loans:
Residential ................ $ 0.9 9.40% $ 1.0 7.94% $ 3.8 7.52% $ 0.6 7.87%
Commercial ................. 91.3 5.95% 21.8 7.95% 52.6 7.79% 29.6 7.77%
Consumer ................... 26.6 6.39% 38.5 6.63% 110.7 6.80% 97.6 7.01%
Mortgage-backed
securities:
Fixed rate ................. 192.5 6.31% 79.3 6.31% 79.4 6.31% 25.5 6.31%
Adjustable rate ............ 55.1 4.72% 46.9 4.72% 35.8 4.72% 33.1 4.72%
Debt and equity
securities ................... 41.7 6.32% -- -- -- -- -- --
Other .......................... 62.8 6.00% -- -- -- -- -- --
--------- --------- --------- ---------
Total interest
earning assets ............... $ 470.9 6.02% $ 187.5 6.18% $ 282.3 6.59% $ 186.4 6.63%
========= ========= ========= =========
Interest Bearing Liabilities
Deposits:
NOW accounts ............... $ 27.7 0.50% $ 15.5 0.50% $ 15.5 0.50% $ 7.0 0.50%
Passbooks .................. 13.3 0.75% 9.4 0.75% 9.4 0.75% 6.3 0.75%
Money market ............... 428.9 2.95% 1.9 2.95% 1.9 2.95% 0.7 2.95%
Certificates ............... 496.1 4.93% 112.1 5.15% 46.7 4.61% 9.1 5.51%
Borrowings
Fixed rate ................. 26.2 4.85% 31.3 4.80% 271.2 5.76% 184.7 5.84%
Adjustable rate ............ 58.0 3.42% -- -- -- -- -- --
--------- --------- --------- ---------
Total interest
bearing liabilities .......... $ 1,050.2 3.87% $ 170.2 4.39% $ 344.7 5.22% $ 207.8 5.48%
========= ========= ========= =========
<Caption>
More than Fair
Four Years Over Market
to Five Years Five Years Total Value
--------------------- --------------------- ---------------------- ---------
(In millions)
Interest Earning Assets
Loans:
Residential ................... $ 17.2 7.26% $ 318.3 7.45% $ 341.8 7.45% $ 345.2
Commercial .................... 77.0 7.94% 313.5 7.69% 585.8 7.47% 591.6
Consumer ...................... 24.2 8.72% 31.7 9.51% 329.3 7.21% 334.3
Mortgage-backed
securities:
Fixed rate .................... 25.4 6.31% 34.6 6.31% 436.7 6.31% 440.3
Adjustable rate ............... 30.3 4.72% 74.4 4.72% 275.6 4.72% 273.8
Debt and equity
securities ...................... -- -- -- -- 41.7 6.32% 41.7
Other ............................. -- -- -- -- 62.8 6.00% 62.8
--------- --------- --------- ---------
Total interest
earning assets .................. $ 174.1 7.18% $ 772.5 7.32% $ 2,073.7 6.75% $ 2,089.7
========= ========= ========= =========
Interest Bearing Liabilities
Deposits:
NOW accounts .................. $ 6.9 0.50% $ 11.4 0.50% $ 84.0 0.50% $ 76.4
Passbooks ..................... 6.4 0.75% 43.9 0.75% 88.7 0.75% 66.5
Money market .................. 0.6 2.95% 1.3 2.95% 435.3 2.95% 434.7
Certificates .................. 3.4 5.50% 78.4 6.13% 745.8 5.08% 752.9
Borrowings
Fixed rate .................... -- -- -- -- 513.4 5.68% 547.1
Adjustable rate ............... -- -- -- -- 58.0 3.42% 58.0
--------- --------- --------- ---------
Total interest
bearing liabilities ............. $ 17.3 1.66% $ 135.0 3.84% $ 1,925.2 4.31% $ 1,935.6
========= ========= ========= =========
</Table>
51
CRITICAL ACCOUNTING POLICES
In the ordinary course of business, the Company has made a number of estimates
and assumptions relating to the reporting of results of operations and financial
condition in preparing its financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ significantly from those estimates under different assumptions and
conditions. The Company believes the following discussion addresses the
Company's most critical accounting policies, which are those that are most
important to the portrayal of the Company's financial condition and results and
require management's most difficult, subjective and complex judgments, often as
a result of the need to make estimates about the effect of matters that are
inherently uncertain.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a material estimate
that is particularly susceptible to significant changes in the near term and is
established through a provision for loan losses. The allowance is based upon
past loan loss experience and other factors which, in management's judgement,
deserve current recognition in estimating loan losses. The evaluation includes a
review of all loans on which full collectibility may not be reasonably assured.
Other factors considered by management include the size and character of the
loan portfolio, concentrations of loans to specific borrowers or industries,
existing economic conditions and historical losses on each portfolio category.
In connection with the determination of the allowance for loan losses,
management obtains independent appraisals for significant properties which
collateralize loans. With respect to loans that are deemed impaired, the
calculation of allowance for loan losses is based upon the discounted present
value of expected cash flows received from the debtor or other measures of
market prices or collateral values.
Management believes it uses the best information available to make such
determinations. If circumstances differ substantially from the assumptions used
in making determinations, future adjustments to the allowance for loan losses
may be necessary and results of operations could be affected. While the Company
believes it has established its existing allowance for loan losses in conformity
with accounting principles generally accepted in the United States of America,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request an increase in the allowance for loan losses.
Because future events affecting the borrowers and collateral cannot be predicted
with certainty, there can be no assurance that increases to the allowance will
not be necessary if loan quality deteriorates.
ACCOUNTING FOR INCOME TAXES - As part of the process of preparing the
consolidated financial statements the Company is required to estimate income
taxes for federal and state purposes. This process involves estimating the
Company's actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the Company's consolidated
statements of financial condition. Management must then assess the likelihood
that the deferred tax assets will be recovered from future taxable income and to
the extent management believes that recovery is not likely, a valuation
allowance must be established. To the extent the Company establishes a valuation
allowance or increases this allowance in a period, the Company would include an
expense within the tax provision in the statements of income.
Significant management judgment is required in determining the provision for
income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. A valuation allowance is based on
management's estimates of taxable income in the jurisdictions in which the
Company operates and the period over which deferred tax assets will be
recoverable. In the event actual results differ from these estimates, or if
management adjusts these estimates in future periods the Company may need to
establish an additional valuation allowance which could materially impact the
financial position and results of operations.
MORTGAGE SERVICING RIGHTS - The Company recognizes as a separate asset the
rights to service mortgage loans for others. The value of mortgage servicing
rights is amortized in relation to the servicing revenue expected to be earned.
Estimating the fair value of the mortgage servicing rights involves judgment,
particularly of estimated prepayment speeds of the underlying mortgages
serviced. Net income could be affected if management's estimate of the
prepayment speeds or other factors differ materially from actual prepayments.
The above listing is not intended to be a comprehensive list of all of the
Company's accounting policies. In many cases, the accounting treatment of a
particular transaction is specifically dictated by accounting principles
generally accepted in the United States of America, with no need for
management's judgement in their application.
52
There are also areas in which management's judgement in selecting any available
alternative would not produce a materially different result.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits, borrowings from the FHLB,
proceeds from principal and interest payments on loans and principal and
interest payments on mortgage-backed and related securities and on debt and
equity securities. Although maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows, mortgage prepayments and
prepayments on mortgage-backed and related securities are influenced
significantly by general interest rates, economic conditions and competition.
Mortgage loan and mortgage security prepayments were generally higher during
2001 and 2002 because of the generally lower level of interest rates throughout
those years.
The ratio of liquid assets to deposits and short-term borrowings required by the
OTS is currently 4.0%. The Bank's liquidity ratio was 7.7% and 12.4% at
September 30, 2002 and 2001, respectively. The Bank adjusts its liquidity levels
in order to meet various funding needs and to meet its asset and liability
management objectives.
The Bank's most liquid assets are cash and cash equivalents and highly liquid,
short-term investments. The levels of these assets are dependent on the Bank's
operating, financing, lending and investing activities during any given period.
At September 30, 2002 and 2001, liquid assets of the Bank (as defined in the OTS
regulations) were $155.3 million and $238.9 million, respectively.
In fiscal 2001 and 2002, the Company continued to reduce the size of its
mortgage-backed securities and investment securities portfolios as part of a
strategy to decrease the proportion of earnings from that segment of its balance
sheet. The reduction was primarily accomplished through the repayment of
principal, scheduled maturities and the sale of available-for-sale securities.
Funds generated from the repayment of principal, maturities and sales from the
mortgage-backed securities and investment securities portfolios were used to
grow and diversify the Company's loan portfolio, to reduce the Company's
wholesale debt and as an additional source of liquidity. Management anticipates
that this form of "balance sheet restructuring" will be an ongoing strategic
initiative of the Company in fiscal 2003.
Excess funds generally are invested in short-term investments such as federal
funds or overnight deposits at the FHLB. The Company has found brokered
certificates of deposit to be an efficient source and a cost-effective method,
relative to local retail market deposits, of meeting the Company's funding
needs. Management believes that a significant portion of its retail deposits
will remain with the Company, and in the case of brokered deposits, may be
replaced with similar type accounts even should the level of interest rates
change. However, in the event of a significant increase in market interest
rates, the cost of obtaining replacement brokered deposits would increase as
well. Whenever the Company requires funds beyond its ability to generate them
internally, additional sources of funds are available and obtained from
borrowings from the FHLB. Funds also may be available through reverse repurchase
agreements wherein the Company pledges mortgage-backed securities. The Company
utilizes its borrowing capabilities on a regular basis. At September 30, 2002,
FHLB advances totaled $512.2 million or 23.7% of total liabilities and at
September 30, 2001, FHLB advances were $513.4 million or 25.1% of total
liabilities. At September 30, 2002, the Company had a borrowing capacity
available of $305.2 million from the FHLB. At September 30, 2002 and 2001, the
Company had $69.9 million and zero, respectively, of reverse repurchase
agreements. The Company's reverse repurchase agreements are generally
short-term, with maturities of less than 90 days, however, the agreements may
have maturities of up to 2 years. In a rising interest rate environment, such
short-term borrowings present the risk that upon maturity, the borrowings will
have to be replaced with higher rate borrowings. The Company generally has
matched such borrowings to specific assets and has relatively little liquidity
risk due to the fact that the assets and borrowings mature at approximately the
same time.
The amount of principal repayments on loans and mortgage securities are heavily
influenced by the general level of interest rates in the economy. Funds received
from principal repayments on mortgage securities for the years ended September
30, 2002 and 2001, were $336.4 million and $139.4 million, respectively. Funds
received from principal repayments on loans for the years ended September 30,
2002 and 2001, were $576.1 million and $513.9 million, respectively. In addition
to principal repayments, the Company sells mortgage loans to government agencies
(primarily FNMA) and to institutional investors. Total mortgage loan sales to
FNMA and others were $769.7 million and $453.5 million for the years ended
September 30, 2002 and 2001, respectively.
53
Funds generated from principal repayments and sales of loans and mortgage-backed
and related securities are reinvested back into loans receivable and
mortgage-backed and related securities through origination and purchase, used to
reduce the Company's wholesale debt and as an additional source of liquidity.
Loan originations totaled $1.1 billion and $727.1 million for the years ended
September 30, 2002 and 2001, respectively. Purchases of mortgage-backed and
related securities totaled $465.9 million and $124.7 million for the years ended
September 30, 2002 and 2001, respectively. During the years ended September 30,
2002 and 2001, the Company repurchased approximately 70,300 shares and 258,400
shares of its common stock in share repurchase programs at a total cost of
approximately $1.5 million and $5.2 million, respectively. Shares repurchased
are funded through dividends received from the Bank and the Company's line of
credit. Due to the Company's access to liquidity, shares repurchased have a
minimal effect on the Company's liquidity.
At September 30, 2002 and 2001, the Company had outstanding loan commitments
including lines of credit of $451.1 million and $304.0 million, respectively.
The Company had no commitments to purchase loans outstanding at either of these
dates. The Company anticipates it will have sufficient funds available to meet
its current loan commitments, including loan applications received and in
process prior to the issuance of firm commitments. Certificates of deposit,
including brokered certificates, which are scheduled to mature in one year or
less at September 30, 2002 and 2001, were $414.1 million and $496.6 million,
respectively. Management believes that a significant portion of such deposits
will remain with the Company.
Through the normal course of operations, the Company has entered into certain
contractual obligations and other commitments. Such obligations generally relate
to funding of operations through deposits or debt issuances, as well as leases
for premises and equipment. As a financial service provider the Company
routinely enters into commitments to extend credit. While contractual
obligations represent future cash requirements of the Company, a significant
portion of commitments to extend credit may expire without being drawn upon.
Such commitments are subject to the same credit policies and approval process
accorded to loans made by the Company.
The following table summarizes significant contractual obligations and other
commitments at September 30, 2002.
<Table>
<Caption>
Short and
Certificates of Long Term Operating
Years Ended September 30, Deposit Borrowings(1) Leases Total
- ------------------------- --------------- ------------- --------- -----------
(In thousands)
2003..................................... $ 414,118 $ 154,169 $ 1,462 $ 569,749
2004..................................... 244,193 25,000 1,075 270,268
2005..................................... 47,665 362,894 617 411,176
2006..................................... 17,864 25,000 581 43,445
2007..................................... 11,206 75,000 581 86,787
2008 and thereafter...................... 145 -- 9,187 9,332
--------------- ------------- --------- -----------
Total.................................... $ 735,191 $ 642,063 $ 13,503 $ 1,390,757
=============== ============= ========= ===========
Commitments to extend credit............. $ 451,095
===========
</Table>
(1) Fixed rate callable FHLB advances are included in the period of their
modified duration rather than in the period in which they are due. Short and
long term borrowings include fixed rate callable advances of $320 million
maturing in fiscal 2005, $25 million maturing in fiscal 2006 and $75 million
maturing in fiscal 2007.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto 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 without considering the change in the relative purchasing
power of money over time due to inflation. The impact of inflation is reflected
in the increased cost of the Company's operations. Unlike most industrial
companies, nearly all the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation.
54
CURRENT ACCOUNTING DEVELOPMENTS
The FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities"--a replacement of FASB
Statement No. 125. This statement provides accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities. Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes liabilities
when extinguished. This Statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. This Statement is effective for transfers and servicing
of financial assets and extinguishments of liabilities occurring after March 31,
2002. This Statement is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2002. This Statement is to
be applied prospectively with certain exceptions. Therefore, earlier or
retroactive application of this Statement is not permitted. Adoption of this
standard did not materially affect the results of operations or financial
position of the Company.
The FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses how and when to
measure impairment of long-lived assets and how to account for long-lived assets
that an entity plans to dispose of either through sale, abandonment, exchange,
or distribution to owners. SFAS No. 144 supersedes FASB Statement No. 121, which
addressed asset impairment, and certain provisions of APB Opinion No. 30 related
to reporting the effects of the disposal of a business segment, and requires
expected future operating losses from discontinued operations to be recorded in
the period in which the losses are incurred rather than the measurement date.
Under SFAS No. 144, more dispositions may qualify for discontinued operations
treatment in the income statement. This Statement is effective for fiscal years
beginning after December 15, 2001, with early application encouraged. The
provisions of this Statement generally are to be applied prospectively. Adoption
of this standard is not expected to materially affect the results of operations
or financial position of the Company.
The FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. Adoption of this standard is not expected to materially
affect the results of operations or financial position of the Company.
The FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions"
("SFAS No. 147"). SFAS No. 147 amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," to remove the acquisition of
financial institutions from the scope of that statement and provides guidance on
the accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. Except for transactions between two or
more mutual enterprises, SFAS No. 147 requires acquisitions of financial
institutions that meet the definition of a business combination to be accounted
for in accordance with SFAS No. 141 and SFAS No. 142. The provisions of SFAS No.
147 are effective on October 1, 2002, with earlier application permitted.
Adoption of this standard is not expected to materially affect the results of
operations or financial position of the Company.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required herein pursuant to Item 305 of Regulation S-K is
contained in the section captioned "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and is incorporated herein by
reference.
55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors
St. Francis Capital Corporation:
We have audited the accompanying consolidated statements of financial condition
of St. Francis Capital Corporation and Subsidiary (the "Company") as of
September 30, 2002 and 2001, and the related consolidated statements of income,
changes in shareholders' equity and comprehensive income, and cash flows for
each of the years in the three-year period ended September 30, 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of St. Francis Capital
Corporation and Subsidiary as of September 30, 2002 and 2001, and the results of
their operations and their cash flows for each of the years in the three-year
period ended September 30, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Notes 1 and 20 to the consolidated financial statements, the
Company changed its method of accounting for goodwill in fiscal 2002.
/s/ KPMG LLP
Milwaukee, Wisconsin
October 18, 2002
56
ST. FRANCIS CAPITAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
<Table>
<Caption>
September 30,
(In thousands, except share data) 2002 2001
- --------------------------------- ----------- -----------
ASSETS
Cash and due from banks (note 2) .................................................... $ 43,515 $ 37,989
Federal funds sold and overnight deposits ........................................... 2,320 111
----------- -----------
Cash and cash equivalents ........................................................... 45,835 38,100
----------- -----------
Assets available for sale, at fair value:
Debt and equity securities (notes 3 and 9) ...................................... 16,596 41,661
Mortgage-backed and related securities (notes 4 and 9) .......................... 618,580 616,969
Mortgage loans held for sale, at lower of cost or market (note 5) ................... 65,006 18,974
Securities held to maturity, at amortized cost:
Mortgage-backed and related securities (fair value of $91,318
and $96,237, respectively) (notes 4 and 9) .................................. 90,246 95,384
Loans receivable, net (notes 5 and 9) ............................................... 1,257,466 1,237,900
Federal Home Loan Bank stock, at cost ............................................... 90,784 62,691
Accrued interest receivable (note 6) ................................................ 9,398 11,115
Foreclosed properties ............................................................... 1,908 401
Real estate held for investment ..................................................... 32,803 26,255
Premises and equipment, net (note 7) ................................................ 29,824 29,128
Receivable for securities sales ..................................................... 48,089 --
Other assets (notes 5,11 and 20) .................................................... 32,582 27,688
----------- -----------
Total assets ........................................................................ $ 2,339,117 $ 2,206,266
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits (note 8) ................................................................... $ 1,416,979 $ 1,449,320
Short term borrowings (note 9) ...................................................... 605,236 497,152
Long term borrowings (note 9) ....................................................... 36,827 74,281
Advances from borrowers for taxes and insurance ..................................... 9,886 10,350
Payable for securities purchases .................................................... 71,544 --
Accrued interest payable and other liabilities (notes 8 and 15) ..................... 19,564 14,688
----------- -----------
Total liabilities ................................................................... 2,160,036 2,045,791
----------- -----------
Commitments and contingencies (note 16) ............................................. -- --
Shareholders' equity:
Preferred stock $.01 par value:
Authorized, 6,000,000 shares
None issued ..................................................................... -- --
Common stock $.01 par value:
Authorized 24,000,000 shares
Issued 14,579,240 shares
Outstanding, 9,350,873 and 9,208,244 shares, respectively ....................... 146 146
Additional paid-in-capital .......................................................... 89,324 88,826
Retained earnings, substantially restricted (note 12) ............................... 160,494 144,630
Accumulated other comprehensive income .............................................. 1,632 1,137
Treasury stock, at cost (5,228,367 and 5,370,996 shares, respectively)(note 14) ..... (72,515) (74,264)
----------- -----------
Total shareholders' equity .......................................................... 179,081 160,475
----------- -----------
Total liabilities and shareholders' equity .......................................... $ 2,339,117 $ 2,206,266
=========== ===========
</Table>
See accompanying Notes to Consolidated Financial Statements
57
ST. FRANCIS CAPITAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Income
<Table>
<Caption>
Years Ended September 30,
-----------------------------------------------
(In thousands, except per share data) 2002 2001 2000
- ------------------------------------- ------------ ------------ ------------
Interest and dividend income:
Loans (note 5) ...................................................... $ 87,901 $ 103,631 $ 100,922
Mortgage-backed and related securities .............................. 29,955 47,478 58,250
Debt and equity securities .......................................... 1,812 7,595 13,065
Federal funds sold and overnight deposits ........................... 44 158 75
Federal Home Loan Bank stock ........................................ 3,433 2,265 2,283
Trading account securities .......................................... -- 8 59
------------ ------------ ------------
Total interest and dividend income ........................................ 123,145 161,135 174,654
Interest expense:
Deposits (note 8) ................................................... 36,287 66,239 72,465
Advances and other borrowings ....................................... 31,132 41,352 48,266
------------ ------------ ------------
Total interest expense .................................................... 67,419 107,591 120,731
------------ ------------ ------------
Net interest income before provision for loan losses ...................... 55,726 53,544 53,923
Provision for loan losses (note 5) ........................................ 3,289 5,527 2,509
------------ ------------ ------------
Net interest income ....................................................... 52,437 48,017 51,414
------------ ------------ ------------
Other operating income (expense), net:
Loan servicing and loan related fees ................................ 1,182 3,298 2,734
Depository fees and service charges ................................. 5,586 5,318 4,933
Securities gains (notes 3 and 4) .................................... 1,312 996 12
Gain on sales of loans (note 5) ..................................... 12,751 6,055 1,133
Insurance, annuity and brokerage commissions ........................ 1,556 1,238 1,412
Gain (loss) on foreclosed properties ................................ 69 (17) 36
Income from real estate held for investment ......................... 3,190 3,026 3,014
Other income ........................................................ 750 1,422 931
------------ ------------ ------------
Total other operating income, net ......................................... 26,396 21,336 14,205
------------ ------------ ------------
General and administrative expenses:
Compensation and other employee benefits .......................... 27,022 22,096 19,293
ESOP expense ...................................................... 327 188 8,176
Occupancy expenses, including depreciation ........................ 4,907 4,718 4,471
Furniture and equipment, including depreciation ................... 3,874 4,250 4,465
Real estate held for investment expenses .......................... 3,120 3,114 3,223
Other general and administrative expenses (note 10) ............... 8,844 9,952 9,504
------------ ------------ ------------
Total general and administrative expenses ................................. 48,094 44,318 49,132
------------ ------------ ------------
Income before income tax expense and cumulative effect of
change in accounting principle ....................................... 30,739 25,035 16,487
Income tax expense (note 11) .............................................. 8,867 6,967 5,364
------------ ------------ ------------
Income before cumulative effect of change in accounting principle ......... $ 21,872 $ 18,068 $ 11,123
Cumulative effect of a change in accounting for derivative
instruments and hedging activities (net of income taxes of $55) ...... -- (84) --
------------ ------------ ------------
Net income ................................................................ $ 21,872 $ 17,984 $ 11,123
============ ============ ============
Basic earnings per share (note 13):
Before cumulative effect of a change in accounting principle ......... $ 2.36 $ 1.93 $ 1.13
Cumulative effect of a change in accounting principle ................ -- (0.01) --
------------ ------------ ------------
$ 2.36 $ 1.92 $ 1.13
============ ============ ============
Diluted earnings per share (note 13):
Before cumulative effect of a change in accounting principle ......... $ 2.25 $ 1.88 $ 1.12
Cumulative effect of a change in accounting principle ................ -- (0.01) --
------------ ------------ ------------
$ 2.25 $ 1.87 $ 1.12
============ ============ ============
</Table>
See accompanying Notes to Consolidated Financial Statements
58
ST. FRANCIS CAPITAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Changes in Shareholders' Equity
and Comprehensive Income
<Table>
<Caption>
Shares of
Common Additional Unearned
Stock Common Paid-In ESOP Retained
Outstanding Stock Capital Compensation Earnings
----------- ----------- ----------- ------------- -----------
(In thousands, except per share data)
BALANCE AT SEPTEMBER 30, 1999 .......... 10,156,770 $ 146 $ 82,426 $ (2,260) $ 123,193
Net income ............................. -- -- -- -- 11,123
Change in unrealized loss on
securities available for sale ..... -- -- -- -- --
Reclassification adjustment for
gains realized in net income ...... -- -- -- -- --
Income taxes ........................... -- -- -- -- --
Comprehensive income ...................
Cash dividend - $0.36 per share ........ -- -- -- -- (3,578)
Purchase of treasury stock ............. (769,388) -- -- -- --
Exercise of stock options, net ......... 49,815 -- 10 -- (339)
Amortization of unearned
compensation ...................... -- -- 6,363 2,260 --
----------- ----------- ----------- ------------- -----------
BALANCE AT SEPTEMBER 30, 2000 .......... 9,437,197 $ 146 $ 88,799 $ -- $ 130,399
Net income ............................. -- -- -- -- 17,984
Change in unrealized loss on
securities available for sale ..... -- -- -- -- --
Reclassification adjustment for
gains realized in net income ...... -- -- -- -- --
Income taxes ........................... -- -- -- -- --
Comprehensive income ...................
Cash dividend - $0.40 per share ........ -- -- -- -- (3,753)
Purchase of treasury stock ............. (258,353) -- -- -- --
Exercise of stock options, net ......... 29,400 -- 27 -- --
----------- ----------- ----------- ------------- -----------
BALANCE AT SEPTEMBER 30, 2001 .......... 9,208,244 $ 146 $ 88,826 $ -- $ 144,630
Net income ............................. -- -- -- -- 21,872
Change in unrealized gain on
securities available for sale ..... -- -- -- -- --
Reclassification adjustment for
gains realized in net income ...... -- -- -- -- --
Income taxes ........................... -- -- -- -- --
Comprehensive income ...................
Cash dividend - $0.60 per share ........ -- -- -- -- (5,559)
Purchase of treasury stock ............. (32,459) -- -- -- --
Exercise of stock options, net ......... 175,088 -- 498 -- (449)
----------- ----------- ----------- ------------- -----------
BALANCE AT SEPTEMBER 30, 2002 .......... 9,350,873 $ 146 $ 89,324 $ -- $ 160,494
=========== =========== =========== ============= ===========
<Caption>
Accumulated
Other
Comprehensive
Income/ Treasury
(Loss) Stock Total
------------ ----------- -----------
(In thousands, except per share data)
BALANCE AT SEPTEMBER 30, 1999 .......... $ (13,057) $ (58,934) $ 131,514
Net income ............................. -- -- 11,123
Change in unrealized loss on
securities available for sale ..... (9,168) -- (9,168)
Reclassification adjustment for
gains realized in net income ...... (12) -- (12)
Income taxes ........................... 3,314 -- 3,314
-----------
Comprehensive income ................... 5,257
Cash dividend - $0.36 per share ........ -- -- (3,578)
Purchase of treasury stock ............. -- (11,226) (11,226)
Exercise of stock options, net ......... -- 662 333
Amortization of unearned
compensation ...................... -- -- 8,623
------------ ----------- -----------
BALANCE AT SEPTEMBER 30, 2000 .......... $ (18,923) $ (69,498) $ 130,923
Net income ............................. -- -- 17,984
Change in unrealized loss on
securities available for sale ..... 33,660 -- 33,660
Reclassification adjustment for
gains realized in net income ...... (996) -- (996)
Income taxes ........................... (12,604) -- (12,604)
-----------
Comprehensive income ................... 38,044
Cash dividend - $0.40 per share ........ -- -- (3,753)
Purchase of treasury stock ............. -- (5,166) (5,166)
Exercise of stock options, net ......... -- 400 427
------------ ----------- -----------
BALANCE AT SEPTEMBER 30, 2001 .......... $ 1,137 $ (74,264) $ 160,475
Net income ............................. -- -- 21,872
Change in unrealized gain on
securities available for sale ..... 1,988 -- 1,988
Reclassification adjustment for
gains realized in net income ...... (1,312) -- (1,312)
Income taxes ........................... (181) -- (181)
-----------
Comprehensive income ................... 22,367
Cash dividend - $0.60 per share ........ -- -- (5,559)
Purchase of treasury stock ............. -- (679) (679)
Exercise of stock options, net ......... -- 2,428 2,477
------------ ----------- -----------
BALANCE AT SEPTEMBER 30, 2002 .......... $ 1,632 $ (72,515) $ 179,081
============ =========== ===========
</Table>
See accompanying Notes to Consolidated Financial Statements
59
ST. FRANCIS CAPITAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
<Table>
<Caption>
Years Ended September 30,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................. $ 21,872 $ 17,984 $ 11,123
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses ........................................ 3,289 5,527 2,509
Depreciation, accretion and amortization ......................... 8,171 7,932 7,116
Deferred income taxes ............................................ (507) (7,546) 2,211
Securities gains ................................................. (1,312) (996) (12)
Originations of loans held for sale .............................. (819,349) (462,999) (118,267)
Proceeds from sales of loans held for sale ....................... 786,068 458,146 119,954
ESOP expense ..................................................... 327 188 8,623
Gain on sales of loans ........................................... (12,751) (6,055) (1,133)
Impairment write-down on mortgage servicing rights ............... 3,100 -- --
Stock dividends received on Federal Home Loan Bank stock ......... (3,093) (2,273) (1,096)
Other, net ....................................................... (9,422) (6,077) 1,092
------------ ------------ ------------
Net cash provided by (used in) operating activities .................... (23,607) 3,831 32,120
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of debt securities held to maturity ....... -- -- 300
Purchases of mortgage-backed and related securities
held to maturity .............................................. (67,204) (82,598) --
Principal repayments on mortgage-backed and related
securities held to maturity ...................................... 72,342 14,302 12,387
Purchases of mortgage-backed securities available for sale ......... (398,668) (42,071) --
Proceeds from sales of mortgage-backed securities
available for sale ............................................... 157,114 104,425 29,105
Principal repayments on mortgage-backed securities
available for sale ............................................... 264,106 125,052 103,318
Purchases of debt and equity securities available for sale ......... (69,296) (5,480) --
Proceeds from sales of debt and equity securities available
for sale ......................................................... 12,321 30,663 2,757
Proceeds from maturities of debt and equity securities
available for sale ................................................. 82,008 153,720 402
Purchases of Federal Home Loan Bank stock .......................... (25,000) (30,000) (1,495)
Redemption of Federal Home Loan Bank stock ......................... -- -- 3,000
Purchases of loans ................................................. (341,249) (201,050) (90,067)
(Increase) decrease in loans, net of loans held for sale ........... 321,683 260,452 (93,844)
Increase in real estate held for investment ........................ (7,916) (462) (210)
Purchases of premises and equipment, net ........................... (2,963) (2,286) (396)
------------ ------------ ------------
Net cash provided by (used in) investing activities .................... (2,722) 324,667 (34,743)
------------ ------------ ------------
</Table>
See accompanying Notes to Consolidated Financial Statements
60
ST. FRANCIS CAPITAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
<Table>
<Caption>
Years Ended September 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
(In thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits ................................................... (32,341) (23,093) (12,422)
Proceeds from advances and other borrowings ................................ 223,668 623,324 1,260,093
Repayments on advances and other borrowings ................................ (222,918) (670,574) (1,298,494)
Increase (decrease) in securities sold under agreements
to repurchase ............................................................ 69,880 (245,993) 68,339
Increase (decrease) in advances from borrowers for taxes
and insurance ............................................................ (464) (317) 1,763
Dividends paid ............................................................. (5,559) (3,753) (3,578)
Stock option transactions .................................................. 2,477 427 333
Purchase of treasury stock ................................................. (679) (5,166) (11,226)
----------- ----------- -----------
Net cash provided by (used in) financing activities ............................ 34,064 (325,145) 4,808
----------- ----------- -----------
Increase in cash and cash equivalents .......................................... 7,735 3,353 2,185
Cash and cash equivalents:
Beginning of year ........................................................ 38,100 34,747 32,562
----------- ----------- -----------
End of year .............................................................. $ 45,835 $ 38,100 $ 34,747
=========== =========== ===========
Supplemental disclosures of cash flow information: Cash paid during the year
for:
Interest ................................................................. $ 70,568 $ 108,981 $ 120,874
Income taxes ............................................................. 12,355 14,915 178
Supplemental schedule of noncash investing and financing activities:
The following summarizes significant noncash investing and financing
activities:
Mortgage loans secured as mortgage-backed securities ..................... $ -- $ 1,432 $ 13,021
Transfer from loans to foreclosed properties ............................. 2,124 656 929
Transfer of mortgage loans to mortgage loans held for sale ............... 94,996 90,962 16,911
Transfer of debt securities to assets available for sale ................. -- 510 --
</Table>
See accompanying Notes to Consolidated Financial Statements
61
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of St. Francis Capital Corporation and
Subsidiary (the "Company") conform to accounting principles generally accepted
in the United States of America and to general practice within the banking
industry. The Company provides a full range of banking and related financial
services to individual and corporate customers through its network of bank
affiliates. The Company is subject to competition from other financial
institutions and is regulated by federal and state banking agencies and
undergoes periodic examinations by those agencies. The following is a
description of the more significant of those policies that the Company follows
in preparing and presenting its consolidated financial statements. In preparing
the consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiary, St. Francis Bank, F.S.B. ("Bank"), the Bank's
subsidiaries, SF Investment Corp. ("SF Investment"), SF Insurance Services
Corp., St. Francis Mortgage Corp ("SFMC") and St. Francis Equity Properties
("SFEP") and limited partnerships which are all more than 50% owned by SFEP. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
(b) Statements of Cash Flows
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash on hand, interest-bearing deposits with the Federal
Home Loan Bank-Chicago ("FHLB") and other financial institutions and federal
funds sold.
(c) Trading Account Securities
Trading account securities include debt securities which are held for resale in
anticipation of short-term market movements. Trading account securities are
stated at fair value. Gains and losses, both realized and unrealized, are
included in securities gains (losses).
(d) Securities Held to Maturity and Available For Sale
Management determines the appropriate classification of debt and equity
securities at the time of purchase. Debt securities are classified as held to
maturity when the Company has the positive intent and ability to hold the
securities to maturity. Held to maturity securities are stated at amortized
cost.
Debt securities not classified as held to maturity, or debt and marketable
equity securities not classified as trading are classified as available for
sale. Available for sale securities are stated at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity and accumulated other comprehensive income (loss).
The cost of debt securities classified as held to maturity or available for sale
is adjusted for amortization of premiums and accretion of discounts to maturity,
or in the case of mortgage-backed and related securities, over the estimated
life of the security. Such amortization is based on a level-yield method and is
included in interest income from the respective security. Interest and dividends
are included in interest and dividend income from investments. Realized gains
are included in securities gains (losses). The cost of securities sold is based
on the specific identification method.
In determining if declines in value in mortgage-backed and related securities
are other than temporary, management estimates future cash flows to be generated
by pools of loans underlying the securities. Included in this evaluation are
such factors as i) estimated loan prepayment rates, ii) a review of
delinquencies, foreclosures, repossessions and recovery rates relative to the
underlying mortgage loans collateralizing each security, iii) the level of
available subordination or other credit enhancements, iv) an assessment of the
servicer of the underlying mortgage portfolio and v) the rating assigned to each
security by independent national rating agencies.
(e) Loans Held For Sale
Mortgage loans held for sale generally consist of certain fixed-rate and
adjustable-rate first mortgage loans. Mortgage loans held for sale are carried
at the lower of cost (less principal payments received) or market value, as
determined by outstanding commitments from investors or current quoted investor
yield requirements on an aggregate basis.
62
(f) Loans and Fees and Income on Loans
Loans are carried at the outstanding principal amount reduced by purchased
discount, deferred fees, unearned insurance premiums, loans in process and the
allowance for loan losses. Loans sold with recourse are derecognized at the time
of sale. The estimated liability related to recourse provisions is periodically
evaluated with increases charged to expense. Loans for which management has the
intent and ability to hold for the foreseeable future or until maturity or
repayment are carried at their unpaid principal balances. Interest on loans is
recorded as income in the period earned.
Loans are normally placed on non-accrual status when contractually past due 90
days or more as to interest or principal payments. Additionally, whenever
management becomes aware of facts or circumstances that may adversely impact the
collectibility of principal or interest on loans, it is management's practice to
place such loans on non-accrual status immediately, rather than delaying such
action until the loans become 90 days past due. Previously accrued and
uncollected interest on such loans is reversed, amortization of related loan
fees is suspended, and income is recorded only to the extent that interest
payments are subsequently received in cash and a determination has been made
that the principal balance of the loan is collectible. If collectibility of the
principal is in doubt, payments received are applied to loan principal.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement, including principal and interest. The
Company defines impaired loans as commercial, commercial real estate and
multi-family loans that are on nonaccrual status. Large groups of homogeneous
loans, such as residential one- to four-family, home equity and consumer loans
are collectively evaluated for impairment.
Loan origination and commitment fees and certain direct loan origination costs
are deferred and the net amounts amortized as an adjustment of the related
loan's yield. These amounts are amortized to income using the level yield
method, over the contractual life of the related loans. Discounts on purchased
loans are amortized using a method which approximates level yield. Unamortized
discounts on purchased loans which prepay are amortized immediately.
Loan origination fees and costs associated with loans sold are deferred and
recognized at the time of sale as a component of gain or loss on the sale of
loans. Fees for the servicing of loans are recognized as income when earned.
(g) Mortgage Servicing Rights
The Bank recognizes as a separate asset the rights to service mortgage loans for
others. Mortgage servicing rights are not subject to SFAS No. 142, but rather,
are amortized over their expected life and subject to periodic impairment
testing. Amortization expense for the mortgage servicing rights asset are based
on assumptions made during each reporting period. Such assumptions include, but
are not limited to, the current level of interest rates and the forecast
prepayment speeds as estimated by major mortgage dealers. Actual amortization
expense is also affected by the amount of loans sold with servicing retained.
For the purpose of evaluating impairment of mortgage servicing rights, serviced
loans are stratified based upon loan type. Mortgage servicing rights are carried
at the lower of cost or market value and are included in other assets on the
consolidated balance sheet. Amortization expense and charges related to an
impairment write-down are included in loan servicing and loan related fees on
the consolidated income statement.
(h) Intangibles
Effective October 1, 2001, the Company adopted Financial Accounting Statement
142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 142
provides that intangible assets with finite useful lives be amortized and that
goodwill and intangible assets with indefinite lives will not be amortized, but
rather will be tested at least annually for impairment. As required under SFAS
No. 142, the Company discontinued the amortization of goodwill with a net
carrying value of $13.4 million at October 1, 2001 and annual amortization of
approximately $1.2 million that resulted from business combinations prior to the
adoption of SFAS No. 141. The Company will evaluate goodwill for impairment at
least annually. (See Note 20) If goodwill is considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the goodwill exceeds the implied fair value of the goodwill.
Prior to the adoption of SFAS No. 142, the excess of the purchase price over the
fair value of net assets of subsidiaries acquired consisted primarily of
goodwill that was being amortized on a straight-line method. Goodwill was
amortized to operating expense over periods of 15 to 25 years. The Company
reviewed long-lived assets and certain identifiable intangibles for impairment
whenever events or changes in
63
circumstances indicated that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value, less costs to
sell.
Prior to the adoption of SFAS No. 142 on October 1, 2001, the Company had
recorded goodwill of $18.4 million and accumulated amortization of $5.0 million.
Goodwill, net of accumulated amortization, at September 30, 2001 was $13.4
million.
(i) Allowance for Loan Losses
The allowance for loan losses is maintained at a level adequate to provide for
loan losses through charges to operating expense. The allowance is based upon
past loan loss experience and other factors which, in management's judgment,
deserve current recognition in estimating loan losses. Such other factors
considered by management include size and character of the loan portfolio,
changes in the level of impaired and non-performing loans, the risk inherent in
specific loans, concentrations of loans to specific borrowers or industries,
existing economic conditions, and historical losses on each portfolio category.
In connection with the determination of the allowance for loan losses,
management obtains independent appraisals for significant properties which
collateralize loans. With respect to loans which are deemed impaired, the
calculation of allowance levels is based upon the discounted present value of
expected cash flows received from the debtor or other measures of value such as
market prices or collateral values.
Management believes, based upon all relevant and available information, that the
allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to or reductions in
the allowance may be necessary based on changes in economic conditions beyond
management's control. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Company's allowance
for losses on loans. Such agencies may require the Company to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination.
(j) Derivative Instruments
Under SFAS 133, all derivative instruments are recorded at fair value on the
statement of financial condition. For those derivative instruments that qualify
as fair value hedges, the Company measures the effectiveness of these hedges on
a periodic basis. The effective portion of the hedge is recorded as an
adjustment to the carrying value of the hedged item. Any difference between the
fair value change of the hedge versus the fair value change of the hedged item
is considered to be the "ineffective" portion of the hedge. The ineffective
portion of the hedge is recorded as an increase or decrease in the related
income statement classification of the item being hedged. If the ineffectiveness
of a hedge exceeds certain levels as described in the accounting standard, the
derivative would no longer be eligible for hedge treatment and future changes in
fair value of the derivative would be recorded on the income statement.
For those derivative instruments that do not qualify as hedges, changes in the
fair value are recorded on the income statement. Fees received on options
written are deferred at the time the fees are received and recognized in other
operating income at the earlier of the settlement or the expiration of the
contract.
Prior to adoption of SFAS 133 on October 1, 2001, realized and unrealized gains
and losses on these instruments were deferred and amortized over the life of the
hedged assets and liabilities. Financial instruments which did not meet the
criteria for hedge accounting were marked to market and any gains or losses were
recognized in the income statement as securities gains (losses).
(k) Foreclosed Properties
Foreclosed properties (which were acquired by foreclosure or by deed in lieu of
foreclosure) are initially recorded at the lower of the carrying value of the
related loan balance or the fair market value of the real estate acquired less
the estimated costs to sell the real estate at the date title is received. Costs
relating to the development and improvement of the property are capitalized.
Income and expenses incurred in connection with holding and operating the
property are charged to expense. Valuations are periodically performed by
management and independent third parties and an allowance for loss is
established by a charge to expense if the carrying value of a property exceeds
its fair value less estimated costs to sell.
64
(l) Real Estate Held for Investment
Real estate held for investment represents multi-family rental property
(affordable housing projects) that SFEP owns, operates and develops as a limited
partner. The properties are recorded at cost less accumulated depreciation. The
Company evaluates the recoverability of the carrying value on a regular basis.
If the recoverability was determined to be in doubt, a valuation allowance would
be established by way of a charge to expense. Depreciation expense is provided
on a straight-line basis over the estimated useful life of the assets.
Expenditures for normal repairs and maintenance are charged to expense as
incurred.
The financial condition, results of operations and cash flows of each LLP or LLC
is consolidated in the Company's financial statements. The operations of the
properties are not expected to contribute significantly to the Company's net
income before income taxes. However, the properties do contribute in the form of
income tax credits, which lower the Company's effective tax rate. Once
established, the credits on each property last for ten years and are passed
through from the LLP or LLC to SFEP and reduce the consolidated federal tax
liability of the Company.
(m) Premises and Equipment
Premises and equipment are recorded at cost less accumulated depreciation and
amortization. Depreciation and amortization expense are provided on a
straight-line basis over the estimated useful lives of the assets. The cost of
leasehold improvements is amortized on the straight-line basis over the lesser
of the term of the respective lease or the estimated economic life of the
improvements.
Expenditures for normal repairs and maintenance are charged to expense as
incurred. When properties are retired or otherwise disposed of, the related cost
and accumulated depreciation are removed from the respective accounts and the
resulting gain or loss is recorded in income.
(n) Federal Home Loan Bank Stock
The Company's investment in FHLB stock meets the minimum amount required by
current regulation and is carried at cost which is its redeemable (fair) value
since the market for this stock is limited.
(o) Income Taxes
The Company and its Subsidiary file a consolidated Federal income tax return.
Federal income tax expense is allocated to the Bank and its subsidiaries based
on an intercompany tax sharing agreement. Each Bank subsidiary files separate
state and local income or franchise tax returns.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to the differences between the financial statement
carrying amount of assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
Affordable housing tax credits are recognized as a reduction of income tax
expense in the year they are available to be used in the Company's consolidated
income tax return.
(p) Stock-based Compensation Plans
The Company has various stock based compensation plans that authorize the
granting of stock options, restricted stock, and other stock based awards to
eligible employees. As permitted, the Company has elected not to follow the
recognition provisions of SFAS No. 123, "Accounting for Stock Based
Compensation," which requires a fair-value based method of accounting for stock
options and equity awards, but follows APB No. 25, "Accounting for Stock Issued
to Employees," and related interpretations to account for its stock based
compensation plans. Pursuant to the disclosure requirements of SFAS No. 123, the
Company has included in Note 15 the effect of the fair value of employee
stock-based compensation plans on net income and earnings per share on a pro
forma basis as if the fair value based method of accounting defined in SFAS No.
123 was applied.
(q) Advertising and Promotion
In the ordinary course of business the Company incurs costs for advertising and
promotion expenses. It is the Company's policy to expense all advertising and
promotion expenditures as incurred.
65
(r) Future Accounting Pronouncements
The FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities"--a replacement of FASB
Statement No. 125. This statement provides accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities. Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes liabilities
when extinguished. This Statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. This Statement is effective for transfers and servicing
of financial assets and extinguishments of liabilities occurring after March 31,
2002. This Statement is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2002. This Statement is to
be applied prospectively with certain exceptions. Therefore, earlier or
retroactive application of this Statement is not permitted. Adoption of this
standard did not materially affect the results of operations or financial
position of the Company.
The FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses how and when to
measure impairment of long-lived assets and how to account for long-lived assets
that an entity plans to dispose of either through sale, abandonment, exchange,
or distribution to owners. SFAS No. 144 supersedes FASB Statement No. 121, which
addressed asset impairment, and certain provisions of APB Opinion No. 30 related
to reporting the effects of the disposal of a business segment, and requires
expected future operating losses from discontinued operations to be recorded in
the period in which the losses are incurred rather than the measurement date.
Under SFAS No. 144, more dispositions may qualify for discontinued operations
treatment in the income statement. This Statement is effective for fiscal years
beginning after December 15, 2001, with early application encouraged. The
provisions of this Statement generally are to be applied prospectively. Adoption
of this standard is not expected to materially affect the results of operations
or financial position of the Company.
The FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. Adoption of this standard is not expected to materially
affect the results of operations or financial position of the Company.
The FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions"
("SFAS No. 147"). SFAS No. 147 amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," to remove the acquisition of
financial institutions from the scope of that statement and provides guidance on
the accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. Except for transactions between two or
more mutual enterprises, SFAS No. 147 requires acquisitions of financial
institutions that meet the definition of a business combination to be accounted
for in accordance with SFAS No. 141 and SFAS No. 142. The provisions of SFAS No.
147 are effective on October 1, 2002, with earlier application permitted.
Adoption of this standard is not expected to materially affect the results of
operations or financial position of the Company.
(s) Reclassification
Certain amounts for prior years have been reclassified to conform to the 2002
presentation.
(2) RESTRICTIONS ON CASH AND DUE FROM BANKS
The Corporation's bank subsidiary is required to maintain certain vault cash and
reserve balances with the Federal Reserve Bank to meet specific reserve
requirements. These requirements approximated $5.7 million at September 30,
2002.
66
(3) DEBT AND EQUITY SECURITIES
The following is a summary of available for sale debt and equity securities:
<Table>
<Caption>
Amortized Gross Unrealized
(In thousands) Cost Gains (Losses) Fair Value
- -------------- ------------ ------------ ------------ ------------
At September 30, 2002:
Available for sale:
U.S. Treasury obligations and obligations of
U.S. Government agencies ..................... $ 13,001 $ 61 $ -- $ 13,062
Marketable equity securities .................... 3,534 -- -- 3,534
------------ ------------ ------------ ------------
$ 16,535 $ 61 $ -- $ 16,596
============ ============ ============ ============
At September 30, 2001:
Available for sale:
U.S. Treasury obligations and obligations of
U.S. Government agencies ..................... $ 36,009 $ 94 $ -- $ 36,103
Marketable equity securities .................... 5,558 -- -- 5,558
------------ ------------ ------------ ------------
$ 41,567 $ 94 $ -- $ 41,661
============ ============ ============ ============
</Table>
The amortized cost and fair value of debt and equity securities available for
sale at September 30, 2002, by contractual maturity, are as follows:
<Table>
<Caption>
Amortized
(In thousands) Cost Fair Value
- -------------- ------------ ------------
Less than one year .................................. $ -- $ --
Greater than one year but less than five years ...... 13,001 13,062
Greater than five years but less than ten years ..... -- --
Greater than ten years .............................. -- --
------------ ------------
13,001 13,062
Marketable equity securities ........................ 3,534 3,534
------------ ------------
$ 16,535 $ 16,596
============ ============
</Table>
During the years ended September 30, 2002, 2001 and 2000, proceeds from the sale
of available for sale debt and equity securities were $12.3 million, $30.7
million and $2.8 million, respectively. The gross realized gains on such sales
totaled zero, $6,000 and zero in 2002, 2001 and 2000, respectively. There were
no gross realized losses on such sales in 2002, 2001 and 2000. There were no
sales of held to maturity debt securities in 2002, 2001 and 2000.
Under Statement 133, the Company was allowed a one-time opportunity to
reclassify investment assets from held to maturity to available for sale. The
Company reclassified all municipal securities held to maturity upon the adoption
of FAS 133 to available for sale. The amortized cost and fair value of the
securities transferred was $510,000 and $522,000, respectively. During the
quarter ended March 31, 2001, all municipal securities held by the Company were
sold.
67
(4) MORTGAGE-BACKED AND RELATED SECURITIES
The following is a summary of available for sale mortgage-backed and related
securities and held to maturity mortgage-backed and related securities:
<Table>
<Caption>
Amortized Gross Unrealized
(In thousands) Cost Gains (Losses) Fair Value
- -------------- ------------ ------------ ------------ ------------
At September 30, 2002:
Available for sale:
Participation certificates:
FNMA ......................... $ 35,998 $ 63 $ -- $ 36,061
Private issue ................ 12,905 -- (429) 12,476
REMICs:
GNMA ......................... 20,018 204 -- 20,222
FNMA ......................... 13,391 194 -- 13,585
FHLMC ........................ 135,975 413 (413) 135,975
Private issue ................ 397,706 3,177 (658) 400,225
CMO residual .................... 36 -- -- 36
------------ ------------ ------------ ------------
$ 616,029 $ 4,051 $ (1,500) $ 618,580
============ ============ ============ ============
Held to maturity:
Participation certificates:
GNMA ......................... $ 7,518 $ 349 $ -- $ 7,867
REMICs:
FNMA ......................... 16,616 120 -- 16,736
Private issue ................ 66,112 603 -- 66,715
------------ ------------ ------------ ------------
$ 90,246 $ 1,072 $ -- $ 91,318
============ ============ ============ ============
At September 30, 2001:
Available for sale:
Participation certificates:
Private issue ................ $ 16,456 $ -- $ (643) $ 15,813
REMICs:
FNMA ......................... 13,549 167 -- 13,716
FHLMC ........................ 85,832 520 (757) 85,595
Private issue ................ 499,253 3,842 (1,286) 501,809
CMO residual .................... 36 -- -- 36
------------ ------------ ------------ ------------
$ 615,126 $ 4,529 $ (2,686) $ 616,969
============ ============ ============ ============
Held to maturity:
Participation certificates:
GNMA .......................... $ 9,744 $ 220 $ -- $ 9,964
REMICs:
Private issue ................. 85,640 633 -- 86,273
------------ ------------ ------------ ------------
$ 95,384 $ 853 $ -- $ 96,237
============ ============ ============ ============
</Table>
During the years ended September 30, 2002, 2001 and 2000, proceeds from the sale
of available for sale mortgage-backed and related securities were $157.1
million, $104.4 million and $29.1 million, respectively. The gross realized
gains on such sales totaled $1.1 million, $689,000 and $47,000 in 2002, 2001 and
2000, respectively. The gross realized losses on such sales totaled $51,000,
$49,000 and $54,000 in 2002, 2001 and 2000, respectively. There were no sales of
held to maturity mortgage-backed and related securities in 2002, 2001 and 2000.
At September 30, 2002 and 2001, $466.1 million and $409.2 million, respectively,
of mortgage-related securities were pledged as collateral for FHLB advances.
68
(5) LOANS RECEIVABLE
Loans receivable are summarized as follows:
<Table>
<Caption>
September 30,
(In thousands) 2002 2001
- -------------- ------------ ------------
First mortgage - one- to four-family ......... $ 251,702 $ 298,617
First mortgage - residential construction .... 62,973 68,936
First mortgage - multi-family ................ 158,320 126,338
Commercial real estate ....................... 395,473 362,329
Home equity .................................. 276,437 221,559
Commercial ................................... 148,716 140,826
Consumer secured by real estate .............. 56,231 71,325
Interim financing and consumer loans ......... 25,055 18,027
Indirect autos ............................... 5,598 15,632
Education .................................... 917 3,253
------------ ------------
Total gross loans ........................ 1,381,422 1,326,842
------------ ------------
Less:
Loans in process ......................... 43,644 57,153
Unearned insurance premiums .............. 86 136
Deferred loan and guarantee fees ......... 607 445
Purchased loan discount .................. 401 548
Allowance for loan losses ................ 14,212 11,686
------------ ------------
Total deductions ......................... 58,950 69,968
------------ ------------
Total loans receivable ....................... 1,322,472 1,256,874
Less: First mortgage loans held for sale .... 65,006 18,974
------------ ------------
Loans receivable, net ........................ $ 1,257,466 $ 1,237,900
============ ============
</Table>
Activity in the allowance for loan losses is as follows:
<Table>
<Caption>
Years Ended September 30,
--------------------------------------------
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Balance at beginning of year ....... $ 11,686 $ 10,404 $ 9,356
Provision charged to expense ... 3,289 5,527 2,509
Charge-offs .................... (900) (4,296) (1,563)
Recoveries ..................... 137 51 102
------------ ------------ ------------
Balance at end of year ............. $ 14,212 $ 11,686 $ 10,404
============ ============ ============
</Table>
Non-performing loans totaled approximately $2.2 million and $10.3 million at
September 30, 2002 and 2001, respectively. Impaired loans totaled $2.0 million
and $7.8 million at September 30, 2002 and 2001, respectively. Impaired loans
had associated reserves of $696,000 and $1.3 million at September 30, 2002 and
2001, respectively. During 2002, 2001 and 2000 the average balance of impaired
loans was $6.3 million, $11.0 million and $6.4 million, respectively. Interest
income on impaired loans for the years ended September 30, 2002, 2001 and 2000
was $231,000, $211,000 and $881,000, respectively. Interest income on impaired
loans is recognized only to the extent that payments are expected to exceed the
amount of principal due on the loans.
The effect of non-performing loans on interest income is as follows:
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Interest at original contractual rate ....... $ 211 $ 1,380 $ 1,138
Interest collected .......................... 52 147 848
------------ ------------ ------------
Net reduction of interest income ........ $ 159 $ 1,233 $ 290
============ ============ ============
</Table>
69
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans are summarized as follows:
<Table>
<Caption>
September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Mortgage loans underlying pass-through securities - FNMA ........... $ 35,496 $ 64,335 $ 92,039
Mortgage loan portfolios serviced for:
FNMA .......................................................... 700,677 522,251 370,132
WHEDA ......................................................... 31,416 34,592 31,698
Other investors ............................................... 1,101 1,291 4,072
------------ ------------ ------------
Total loans serviced for others ............................... $ 768,690 $ 622,469 $ 497,941
============ ============ ============
Custodial escrow balances maintained in connection with the
foregoing loan servicing and included in demand deposits ....... $ 19,461 $ 17,861 $ 13,785
============ ============ ============
</Table>
At September 30, 2002, 2001 and 2000, mortgage loan portfolios serviced for FNMA
includes $12.3 million, $15.1 million and $28.1 million, respectively of
mortgage loans sold with recourse.
In the ordinary course of business the Bank extends credit to directors,
executive officers of the Company and the Bank, or their related affiliates.
These loans were made on substantially the same terms, including rates and
collateral, as those prevailing at the time for comparable transactions with
other unrelated customers, and do not involve more than the normal risk of
collection. These loans to related parties are summarized as follows:
<Table>
<Caption>
Year Ended
September 30,
(In thousands) 2002
- -------------- -------------
Balance at beginning of year ...... $ 2,607
New loans ......................... 3,630
Repayments ........................ (2,663)
-------------
Balance at end of year ............ $ 3,574
=============
</Table>
(6) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
<Table>
<Caption>
September 30,
(In thousands) 2002 2001
- -------------- ------------ ------------
Mortgage-backed and related securities ...... $ 2,582 $ 2,810
Loans receivable ............................ 5,834 7,063
Debt and equity securities .................. 67 667
Federal Home Loan Bank stock ................ 915 575
------------ ------------
$ 9,398 $ 11,115
============ ============
</Table>
70
(7) PREMISES AND EQUIPMENT
A summary of premises and equipment, at cost, follows:
<Table>
<Caption>
September 30,
(In thousands) 2002 2001
- -------------- ------------ ------------
Land and land improvements ....................... $ 4,837 $ 4,754
Office buildings and improvements ................ 20,687 19,603
Furniture, fixtures and equipment ................ 24,383 22,758
Leasehold improvements ........................... 5,472 5,301
------------ ------------
55,379 52,416
Accumulated depreciation and amortization ... (25,555) (23,288)
------------ ------------
$ 29,824 $ 29,128
============ ============
</Table>
Range of depreciable lives:
Computer equipment and software 3 years
Office buildings and improvements 5 - 40 years
Furniture, fixtures and equipment 5 - 10 years
Leasehold improvements 5 - 40 years
(8) DEPOSITS
Deposit accounts are summarized as follows:
<Table>
<Caption>
September 30,
---------------------------------------------------------------------------------------
(Dollars in thousands) 2002 2001
- ----------------------- ------------------------------------------ ------------------------------------------
Average Average
Stated Stated
Rate Amount Percent Rate Amount Percent
------------ ------------ ------------ ------------ ------------ ------------
Demand deposits:
Non-interest bearing ..... -- $ 113,125 8.0% -- $ 95,554 6.6%
Interest bearing ......... 0.26% 94,015 6.6 0.69% 84,004 5.8
Passbook accounts ............ 0.70 93,865 6.6 1.52 88,705 6.1
Money market
demand accounts .......... 0.93 380,783 26.9 2.87 435,233 30.0
Certificates ................. 3.48 735,191 51.9 5.09 745,824 51.5
------------ ------------ ------------ ------------
Total deposits ............... 2.12% $ 1,416,979 100.0% 3.61% $ 1,449,320 100.0%
============ ============ ============ ============
</Table>
The certificates category above includes approximately $191.4 million and $224.4
million of brokered deposits at average stated rates of 2.59% and 4.99% at
September 30, 2002 and 2001, respectively. At September 30, 2002, original
maturities of brokered certificates range from three months to three years.
Aggregate annual maturities of certificate accounts at September 30, 2002 are as
follows:
<Table>
<Caption>
Average
Stated
Maturities during year ended September 30: Amount Rate
- ------------------------------------------ ------------ ------------
(In thousands)
2003 ................................ $ 414,118 3.05%
2004 ................................ 244,193 3.87
2005 ................................ 47,665 4.48
2006 ................................ 17,864 4.76
2007 ................................ 11,206 4.75
Thereafter........................... 145 8.00
------------
$ 735,191
============
</Table>
Certificates, net of brokered deposits, include approximately $94.9 million and
$80.7 million in denominations of $100,000 or more at September 30, 2002 and
2001, respectively.
71
Interest expense on deposits is as follows:
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Demand deposits ................... $ 306 $ 477 $ 500
Money market demand accounts ...... 5,349 17,091 17,330
Passbook accounts ................. 676 1,556 2,184
Certificates of deposit ........... 29,956 47,115 52,451
------------ ------------ ------------
$ 36,287 $ 66,239 $ 72,465
============ ============ ============
</Table>
Accrued interest payable on deposits totaled approximately $1.8 million and $5.6
million at September 30, 2002 and 2001, respectively.
(9) SHORT AND LONG TERM BORROWINGS
Advances and other borrowings consist of the following:
<Table>
<Caption>
(Dollars in thousands) Weighted Average
Interest Rate
-----------------------------
September 30, Maturity/Call Date September 30,
----------------------------- in fiscal ----------------------------
Description 2002 2001 year ended 2002 2001
- ----------- ------------ ------------ ------------------ ------------ ------------
Reverse repurchase agreements ............... 1.80% --% 2003 $ 44,880 $ --
2.00 -- 2004 25,000 --
Retail repurchase agreements ................ -- 3.30 2002 -- 2,552
1.74 -- 2003 5,290 --
Bank line of credit ......................... -- 4.70 2002 -- 36,000
2.99 -- 2003 14,000 --
Advances from Federal Home
Loan Bank Of Chicago ..................... -- 5.68 2002 -- 440,000
5.48 4.91 2003 501,250 50,000
4.75 4.75 2005 10,938 23,438
Federal funds purchased ..................... 2.13 3.43 Daily overnight 38,100 16,800
Federal Reserve Bank
Treasury tax & loan advances .............. 1.19 6.41 Daily overnight 1,716 1,800
Mortgages payable ........................... 6.93 7.98 Various 889 843
------------ ------------
$ 642,063 $ 571,433
Less: short term borrowings ................. 605,236 497,152
------------ ------------
Long term borrowings ........................ $ 36,827 $ 74,281
============ ============
</Table>
The Company is required to maintain as collateral unencumbered one- to
four-family mortgage loans and mortgage-related securities such that the
outstanding balance of FHLB advances does not exceed 60% of the book value of
unencumbered one- to four-family mortgage loans and 100% of the market value of
mortgage-related securities. In addition, these notes are collateralized by all
FHLB stock. At September 30, 2002 and 2001, $237.3 million and $284.7 million,
respectively, of mortgage loans and $466.1 million and $409.2 million,
respectively, of mortgage-related securities were pledged as collateral for FHLB
advances. FHLB advances are subject to a prepayment penalty if they are repaid
prior to maturity. The maximum amount of borrowings from the FHLB at any month
end during the years ended September 30, 2002 and 2001 was approximately $535.3
million and $545.5 million, respectively. The approximate average amount
outstanding was $523.0 million and $513.9 million for those same years. The
weighted average interest rate was 5.49% and 5.62% during those years. The table
above is presented at maturity date or call date, whichever is earlier. Included
in the FHLB advances that mature in fiscal year 2003 are $445.0 million of
convertible fixed rate advances ("CFA"). A CFA is an advance that allows the
FHLB to demand repayment prior to the stated maturity date in accordance with
its contractual terms. At
72
September 30, 2002, the $445.0 million of outstanding CFA's have a maturity of
2005 to 2011 and are callable by the FHLB during fiscal year 2003 and quarterly
thereafter.
The Federal Reserve Bank advances are collateralized by agency debt securities
with a carrying value of $2.0 million at September 30, 2002 and 2001.
Reverse repurchase agreements averaged $40.3 million and $130.0 million based on
average daily balances during the years ended September 30, 2002 and 2001,
respectively. The maximum amount outstanding at any month-end was $70.8 million
and $280.2 million during those years, respectively. The average balances are
calculated based on daily balances. Securities sold under agreements to
repurchase were delivered for escrow to the broker-dealer who arranged the
transactions.
Federal funds purchased averaged $15.6 million and $12.0 million for the years
ended September 30, 2002 and 2001, respectively. The maximum outstanding at any
month-end was $38.1 million and $56.2 million during those years, respectively.
The Bank line of credit averaged $21.6 million and $33.9 million for the years
ended September 30, 2002 and 2001, respectively. The maximum amount outstanding
at any month-end was $32.0 million and $36.0 million during the years ended
September 30, 2002 and 2001, respectively. The line of credit allows for
individual advances of one to six months at rates tied to equivalent term LIBOR
indices and is collateralized by the stock of the Bank. The line of credit
allows for up to $40.0 million in borrowings.
(10) OTHER GENERAL AND ADMINISTRATIVE EXPENSES
Other general and administrative expenses are as follows:
<Table>
<Caption>
Years Ended September 30,
--------------------------------------------
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Federal deposit insurance premiums ............... $ 254 $ 617 $ 386
Data processing .................................. 1,735 1,738 1,690
Advertising ...................................... 957 919 815
Stationery, printing and office supplies ......... 701 674 646
Telephone and postage ............................ 1,548 1,530 1,658
Insurance and surety bond premiums ............... 274 228 219
Professional fees and services ................... 521 377 678
Supervisory assessment ........................... 367 458 397
Amortization of intangible assets ................ -- 1,233 1,231
Organization dues and subscriptions .............. 151 165 143
Consumer lending ................................. 272 352 190
Other ............................................ 2,064 1,661 1,451
------------ ------------ ------------
$ 8,844 $ 9,952 $ 9,504
============ ============ ============
</Table>
(11) INCOME TAXES
Income tax expense (benefit) consists of the following:
<Table>
<Caption>
(In thousands) Federal State Total
- -------------- ------------ ------------ ------------
YEAR ENDED SEPTEMBER 30, 2002
Current ....................... $ 7,992 $ 1,382 $ 9,374
Deferred ...................... (489) (18) (507)
------------ ------------ ------------
$ 7,503 $ 1,364 $ 8,867
============ ============ ============
YEAR ENDED SEPTEMBER 30, 2001
Current ....................... $ 12,760 $ 1,753 $ 14,513
Deferred ...................... (6,323) (1,223) (7,546)
------------ ------------ ------------
$ 6,437 $ 530 $ 6,967
============ ============ ============
YEAR ENDED SEPTEMBER 30, 2000
Current ....................... $ 3,076 $ 77 $ 3,153
Deferred ...................... 2,233 (22) 2,211
------------ ------------ ------------
$ 5,309 $ 55 $ 5,364
============ ============ ============
</Table>
73
Actual income tax expense differs from the "expected" income tax expense
computed by applying the statutory Federal corporate tax rate to income before
income tax expense, as follows:
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Federal income tax expense at statutory rate of 35% ........ $ 10,759 $ 8,762 $ 5,770
State income taxes, net of Federal income tax benefit ...... 887 345 36
Tax exempt interest ........................................ (71) (79) (117)
Non-deductible compensation ................................ -- -- 2,071
Acquisition intangible amortization ........................ -- 228 227
Affordable housing credits ................................. (2,690) (2,609) (2,609)
Other, net ................................................. (18) 320 (14)
------------ ------------ ------------
$ 8,867 $ 6,967 $ 5,364
============ ============ ============
</Table>
Included in other assets are net deferred tax assets of $2.5 million and $1.8
million at September 30, 2002 and 2001, respectively. The tax effects of
temporary differences that give rise to significant portions of deferred tax
assets and deferred tax liabilities are presented below:
<Table>
<Caption>
September 30,
(In thousands) 2002 2001
- -------------- ------------ ------------
DEFERRED TAX ASSETS:
Allowance for loan losses ............................. $ 5,717 $ 4,462
Deferred interest and fee income ...................... 1,479 389
Net operating losses .................................. 1,508 1,345
Valuation adjustments and reserves .................... 47 47
Accrued expenses ...................................... 47 230
Deferred compensation ................................. 499 528
Non-qualified stock option exercise ................... 292 27
------------ ------------
Gross deferred tax asset .............................. 9,589 7,028
Less valuation allowance .............................. (1,508) (1,353)
------------ ------------
Net deferred tax asset ................................ 8,081 5,675
DEFERRED TAX LIABILITIES:
Fixed asset tax basis adjustments ..................... (1,760) (1,399)
FHLB stock tax basis adjustment ....................... (3,267) (1,889)
Unrealized gains on available for sale securities ..... (18) (195)
Acquisition intangible amortization ................... (169) --
Other ................................................. (392) (430)
------------ ------------
Gross deferred tax liability .......................... (5,606) (3,913)
------------ ------------
Net deferred tax asset ................................ $ 2,475 $ 1,762
============ ============
</Table>
At September 30, 2002 and 2001, deferred tax assets include approximately $29.4
million and $26.2 million of various state net operating loss carry forwards
respectively, which begin to expire in 2007 and are reduced by the valuation
allowance to the extent full realization is in doubt.
74
(12) SHAREHOLDERS' EQUITY
In accordance with federal regulations, at the time the Bank converted from a
federal mutual savings bank to a federal stock savings bank, the Bank
established a liquidation account equal to its retained earnings of $63.0
million to provide a limited priority claim for the benefit of qualifying
depositors who maintain their deposit accounts at the Bank after conversion. The
liquidation account is reduced annually to the extent that eligible account
holders have reduced their qualifying deposits. Subsequent increases will not
restore an eligible account holder's interest in the liquidation account. In the
unlikely event of a complete liquidation of the Bank, and only in such event,
each eligible account holder would receive from the liquidation account a
liquidation distribution based on his or her proportionate share of the then
remaining qualifying deposits. At September 30, 2002, the balance of the
liquidation account was approximately $16.1 million. Under current regulations,
the Bank is not permitted to pay dividends on its stock if the effect would
reduce its regulatory capital below the liquidation account.
Office of Thrift Supervision ("OTS") regulations also provide that an
institution that exceeds all fully phased-in capital requirements before and
after a proposed capital distribution could, and after prior notice but without
approval by the OTS, make capital distributions during the calendar year of up
to 100% of its net income to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the excess capital over
its fully phased-in capital requirements) at the beginning of the calendar year.
Any additional capital distributions would require prior regulatory approval.
During the year ended September 30, 2002, the Bank paid dividends to the Company
totaling $26.0 million. As of September 30, 2002, retained earnings of the Bank
of approximately $30.4 million were free of restriction and available for
dividend payments.
Unlike the Bank, the Company is not subject to these regulatory restrictions on
the payment of dividends to its shareholders. However, the Company's source of
funds for future dividends may depend upon dividends from the Bank.
Under the Internal Revenue Code and the Wisconsin Statutes, for tax years
beginning before 1996, the Company was permitted to deduct an annual addition to
a reserve for bad debts. This amount differed from the provision for loan losses
recorded for financial accounting purposes. Under prior law, bad debt deductions
for income tax purposes were included in taxable income of later years only if
the bad debt reserves were used for purposes other than to absorb bad debt
losses. Because the Company did not intend to use the reserve for purposes other
than to absorb losses, no deferred income taxes were provided. Shareholders'
equity at September 30, 2002 includes approximately $21.9 million, for which no
federal or state income taxes were provided. Under SFAS No. 109, deferred income
taxes have been provided on certain additions to the tax reserve for bad debts.
The Small Business Job Protection Act of 1996 repealed the bad debt reserve
method for tax years beginning after 1995. The Bank will not be required to
recapture into income any of the restricted amounts previously deducted except
in the unlikely event of a partial or complete liquidation of the Bank or if
nondividend distributions to shareholders exceed current and accumulated
earnings and profits.
The Company and the Bank are 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 Company's and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of the Company's and the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Company's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as defined).
Management believes, as of September 30, 2002 and 2001, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of September 30, 2002 and 2001, the most recent notification from the OTS
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action. A well-capitalized
75
institution significantly exceeds the required minimum level for each relevant
capital measure. There are no conditions or events since that notification that
management believes have changed the institution's category.
The following table summarizes the Bank's capital ratios and the ratios required
by federal regulations:
<Table>
<Caption>
To Be Adequately To Be Well
Capitalized Under Capitalized Under
Prompt Corrective Prompt Corrective
Actual Action Provisions Action Provisions
--------------- ------------------------------------ --------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ ------------------ -------------- ------------------ ---------------
(Dollars in thousands)
As of September 30, 2002:
Tangible capital............ $175,889 7.57% > or = to $ 92,971 > or = to 4.0% > or = to $116,214 > or = to 5.0%
Core capital ............... 175,889 7.57% > or = to 92,971 > or = to 4.0% > or = to 116,214 > or = to 5.0%
Tier 1 risk-based capital... 175,889 10.56% > or = to 66,646 > or = to 4.0% > or = to 99,968 > or = to 6.0%
Total risk-based capital.... 189,793 11.39% > or = to 133,291 > or = to 8.0% > or = to 166,614 > or = to 10.0%
As of September 30, 2001:
Tangible capital............ $178,436 8.14% > or = to $ 87,666 > or = to 4.0% > or = to $109,582 > or = to 5.0%
Core capital ............... 178,436 8.14% > or = to 87,666 > or = to 4.0% > or = to 109,582 > or = to 5.0%
Tier 1 risk-based capital... 178,436 12.61% > or = to 56,586 > or = to 4.0% > or = to 84,879 > or = to 6.0%
Total risk-based capital.... 189,656 13.41% > or = to 113,172 > or = to 8.0% > or = to 141,465 > or = to 10.0%
</Table>
On September 25, 1997, the Company's Board of Directors adopted a shareholders'
rights plan (the "Rights Plan"). Under the terms of the Rights Plan, the Board
of Directors declared a dividend of one preferred share purchase right for each
outstanding share of common stock. Upon becoming exercisable, each right
entitles shareholders to buy one one-hundredth of a share of the Company's
preferred stock at an exercise price of $150. Rights do not become exercisable
until eleven business days after any person or group has acquired, commenced, or
announced its intention to commence a tender or exchange offer to acquire 15% or
more of the Company's common stock, or in the event a person or group owning 10%
or more of the Company's common stock is deemed to be "adverse" to the Company.
If the rights become exercisable, holders of each right, other than the
acquiror, upon payment of the exercise price, will have the right to purchase
the Company's common stock (in lieu of preferred shares) having a value equal to
two times the exercise price. If the Company is acquired in a merger, share
exchange or other business combination or 50% or more of its consolidated assets
or earning power are sold, rights holders, other than the acquiring or adverse
person or group, will be entitled to purchase the acquiror's shares at a similar
discount. If the rights become exercisable, the Company may also exchange
rights, other than those held by the acquiring or adverse person or group, in
whole or in part, at an exchange ratio of one share of the Company's common
stock per right held. Rights are redeemable by the Company at any time until
they are exercisable at the exchange rate of $.01 per right. Issuance of the
rights has no immediate dilutive effect, does not currently affect reported
earnings per share, is not taxable to the Company or its shareholders, and will
not change the way in which the Company's shares are traded. The rights expire
ten years from the date of issuance.
(13) EARNINGS PER SHARE
Basic earnings per share of common stock have been determined by dividing net
income by the weighted average number of shares of common stock outstanding
during the year. Diluted earnings per share of common stock have been determined
by dividing net income by the weighted average number of shares of common stock
outstanding during the year, adjusted for the dilutive effect of outstanding
stock options. Total shares outstanding for earnings per share calculation
purposes for the year ended September 30, 2000 has been reduced by the
unallocated ESOP shares that had not been committed to be released.
76
The computation of earnings per common share for the years ended September 30 is
as follows:
<Table>
<Caption>
2002 2001 2000
------------ ------------ ------------
Income before cumulative effect of change in
accounting principle ..................................... $ 21,872,000 $ 18,068,000 $ 11,123,000
Cumulative effect of change in accounting principle .......... -- (84,000) --
------------ ------------ ------------
Net income ................................................... $ 21,872,000 $ 17,984,000 $ 11,123,000
============ ============ ============
Common shares issued ......................................... 14,579,240 14,579,240 14,579,240
Weighted average treasury shares ............................. 5,317,188 5,198,116 4,655,160
Weighted average unallocated ESOP shares ..................... -- -- 120,772
------------ ------------ ------------
Weighted average common shares outstanding
during the year .......................................... 9,262,052 9,381,124 9,803,308
Effect of dilutive stock options outstanding ................. 465,039 252,096 172,185
------------ ------------ ------------
Diluted weighted average common shares
outstanding during the year .............................. 9,727,091 9,633,220 9,975,493
============ ============ ============
Basic earnings per share:
Before cumulative effect of a change in accounting
principle ............................................ $ 2.36 $ 1.93 $ 1.13
Cumulative effect of a change in accounting principle .... -- (0.01) --
------------ ------------ ------------
$ 2.36 $ 1.92 $ 1.13
============ ============ ============
Diluted earnings per share:
Before cumulative effect of a change in accounting
principle ............................................ $ 2.25 $ 1.88 $ 1.12
Cumulative effect of a change in accounting principle .... -- (0.01) --
------------ ------------ ------------
$ 2.25 $ 1.87 $ 1.12
============ ============ ============
</Table>
(14) STOCK REPURCHASE PROGRAM
On June 30, 2000, the Company announced a share repurchase program for its
common stock whereby the Company may purchase up to 5% of the outstanding common
stock, or approximately 485,000 shares, commencing June 30, 2000. The
repurchased shares became treasury shares and are to be used for the exercise of
stock options under the stock option plan and for general corporate purposes.
The share repurchase program was completed on September 20, 2001 at an average
price of $17.16 per share. This was the eleventh such repurchase program that
the Company has undertaken. At September 30, 2002, an aggregate of 7,002,204
shares had been repurchased in all such repurchase programs at an average price
of $13.48. On September 18, 2001, the Company announced a share repurchase
program for its common stock whereby the Company may purchase up to 5% of the
outstanding stock, or approximately 460,000 shares. The repurchase program
started on September 20, 2001. At September 30, 2002, 70,300 shares had been
repurchased at an average price of $20.78 per share.
77
(15) EMPLOYEE BENEFIT PLANS
DEFINED CONTRIBUTION PLANS:
The Company has a defined contribution pension plan which covers substantially
all employees who are at least 21 years of age and have completed 1,000 hours or
more of service each year. Company contributions are based on a set percentage
of each participant's compensation for the plan year. Plan expense for the years
ended September 2002, 2001 and 2000 was approximately $916,000, $336,000 and
$96,000, respectively.
The Company also has a defined contribution savings plan for substantially all
employees. The plan is qualified under Section 401(k) of the Internal Revenue
Code. Participation in the plan requires that an employee be at least 21 years
of age and have completed one month of service. Participants may elect to defer
a portion of their compensation (between 2% and 10%) and contribute this amount
to the plan. Under the plan, the Company will match the contribution made by
each employee up to fifty percent of 6% of the eligible employee's annual
compensation. Plan expense for the years ended September 30, 2002, 2001 and 2000
was approximately $403,000, $272,000 and $229,000, respectively.
The aggregate benefit payable to any employee of both defined contribution plans
is dependent upon the rates of contribution, the earnings of the fund and the
length of time such employee continues as a participant.
OFFICER DEFERRED COMPENSATION PLAN:
The Company has deferred compensation plans covering certain officers of the
Company. These arrangements provide for monthly payments to be made upon
retirement or reaching certain age levels for periods of 10 to 15 years. A
liability is recorded for the present value of the future payments under these
agreements, amounting to $677,000 and $749,000, respectively at September 30,
2002 and 2001. The Company owns insurance policies on the lives of these
officers, which have cash surrender values of approximately $2.5 million and
$2.3 million, respectively at September 30, 2002 and 2001, and are intended to
fund these benefits. Plan expense for the years ended September 30, 2002, 2001
and 2000 was approximately $54,000, $56,000 and $58,000, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN:
In conjunction with the conversion of the Bank to a stock savings bank, an
employee stock ownership plan ("ESOP") was adopted covering all employees of the
Company who have attained age 21 and completed one year of service during which
they work at least 1,000 hours. The ESOP borrowed $4.9 million from the Company
and purchased 981,296 common shares issued in the conversion. The debt bears a
variable interest rate based on the borrower's prime lending rate. The Bank made
annual contributions to the ESOP equal to the ESOP's debt service less dividends
received by the ESOP. All dividends received by the ESOP were used to pay debt
service. The ESOP shares initially were pledged as collateral for its debt. As
the debt is repaid, shares are released from collateral and allocated to active
employees, based on the proportion of debt service paid in the year. The Company
accounts for its ESOP in accordance with Statement of Position 93-6.
Accordingly, the debt of the ESOP is recorded as debt and the shares pledged as
collateral are reported as unearned ESOP shares in the statement of financial
position. As shares are released from collateral, the Company reports
compensation expense equal to the current market price of the shares. The excess
of the current market price of shares released over the cost of those shares is
credited to paid-in-capital. As shares are released they become outstanding for
earnings-per-share computations. Dividends on allocated ESOP shares are recorded
as a reduction of shareholders' equity; dividends on unallocated ESOP shares are
recorded as a reduction of debt and accrued interest.
The Company made a voluntary acceleration of the repayment of all of the
remaining loan principal to its ESOP plan during the year ended September 30,
2000. The increased payments resulted in additional ESOP expense of $7.1 million
for the year ended September 30, 2000. All shares had been allocated at
September 30, 2000. For 2001 and 2002, the Bank made cash contributions to the
ESOP plan based on a set percentage of each participant's compensation for the
plan year. All dividends received by the ESOP are allocated to the participants.
All contributions and dividends are used to purchase additional shares of stock.
ESOP compensation expense for the years ended September 30, 2002, 2001 and 2000
was $327,000, $188,000 and $8.2 million, respectively.
78
STOCK OPTION PLANS:
The Company has adopted stock option plans for the benefit of directors and
officers of the Company. The option exercise price cannot be less than the fair
value of the underlying common stock as of the date of the option grant, and the
maximum term cannot exceed ten years. Stock options awarded to directors may be
exercised at any time or on a cumulative basis over varying time periods,
provided the grantee remains a director of the Company. The stock options
awarded to officers are exercisable on a cumulative basis over varying time
periods, depending on the individual option grant terms, which may include
provisions for acceleration of vesting periods.
At September 30, 2002, 60,650 shares were reserved for future grants. Further
information concerning the options is as follows:
<Table>
<Caption>
Option Price
Shares Per Share
-------------- --------------
Shares under option
September 30, 1999 ...................... 1,565,682 $ 5.00 - 19.38
Options granted ....................... 189,548 15.62 - 21.31
Options canceled ...................... (4,800) 14.50 - 20.25
Options exercised ..................... (50,282) 5.00 - 18.50
-------------- --------------
September 30, 2000 ...................... 1,700,148 5.00 - 21.31
Options granted ....................... 10,000 13.88 - 22.00
Options canceled ...................... (65,850) 18.88
Options exercised ..................... (29,400) 5.00 - 15.62
-------------- --------------
September 30, 2001 ...................... 1,614,898 5.00 - 22.00
Options granted ....................... -- --
Options canceled ...................... (11,302) 15.62 - 18.50
Options exercised ..................... (175,088) 5.00 - 19.00
-------------- --------------
September 30, 2002 ...................... 1,428,508 $ 5.00 - 22.00
============== ==============
Options exercisable at September 30, 2002 1,111,002 $ 5.00 - 22.00
============== ==============
</Table>
The following table summarizes information about stock options outstanding at
September 30, 2002:
<Table>
<Caption>
Options Outstanding Options Exercisable
---------------------------------------------- ------------------------------
Weighted Weighted
Exercise Number Average Average Number Average
Price Range Outstanding Exercise Price Life* Outstanding Exercise Price
- ------------------ ------------ -------------- ------------ ------------ --------------
$ 5.00 47,658 $ 5.00 0.71 47,658 $ 5.00
8.38 17,000 8.38 1.83 14,168 8.38
13.13-14 50 707,772 14.30 5.37 622,361 14.37
15.62-18 50 26,694 17.33 6.21 26,694 17.33
18.88 484,800 18.88 6.41 266,870 18.88
19.19-22 00 144,584 20.16 6.20 133,251 20.02
------------ ------------
1,428,508 1,111,002
============ ============
</Table>
*Average contractual life remaining in years
79
For purposes of providing the pro forma disclosures required under SFAS No. 123,
"Accounting for Stock-Based Compensation," the fair value of stock options
granted was estimated using the Black-Scholes option pricing model. There were
no options granted during fiscal year 2002. The per share weighted-average fair
value of stock options granted during 2001 and 2000 was $5.13 and $4.37
respectively, on the date of grant with the following weighted-average
assumptions used for grants:
<Table>
<Caption>
September 30,
2001 2000
----------------- ----------------
Expected dividend yield........................ 1.88% 3.05%
Risk-free interest rate........................ 4.44% 5.99%
Expected lives................................. 10 years 10 years
Expected volatility............................ 15% 15%
</Table>
Had compensation cost for the Company's stock-based plans been determined in
accordance with SFAS No. 123, net income and earnings per share would have been
reduced to the pro forma amounts indicated below. This pro forma net income
reflects only options granted in the fiscal years 1997 through 2002. Therefore,
the full impact of calculating compensation cost under SFAS No. 123 is not
reflected in the pro-forma net income and earnings per share amounts.
<Table>
<Caption>
Years Ended September 30,
2002 2001 2000
----------- ----------- -----------
Net Income As reported............. $21,872,000 $17,984,000 $11,123,000
Pro forma............... $21,201,000 $17,295,000 $10,370,000
Basic earnings per share As reported............. $2.36 $1.92 $1.13
Pro forma............... $2.29 $1.85 $1.05
Diluted earnings per share As reported............. $2.25 $1.87 $1.12
Pro forma............... $2.18 $1.80 $1.04
</Table>
(16) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND OTHER COMMITMENTS
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the consolidated financial statements. The contractual or notional
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for the commitments to extend credit is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments and conditional obligations
as it does for instruments reflected in the consolidated financial statements.
80
<Table>
<Caption>
Contractual or Notional
Amount(s)
September 30,
2002 2001
------------ ------------
(In thousands)
Financial instruments whose contract amounts
represent credit risk, are as follows:
Commitments to extend credit:
Fixed-rate loans...................... $ 69,156 $ 19,375
Variable-rate loans................... 41,824 29,157
Mortgage loans sold with recourse....... 12,334 15,090
Guarantees under IRB issues............. 36,581 38,080
Interest rate swap agreements........... -- 80,000
Unused and open-ended lines of credit:
Consumer.............................. 273,704 232,046
Commercial............................ 66,411 24,423
Commitments to fund equity investments... -- 3,811
</Table>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates of 45 days or less or other termination
clauses and may require a fee. Fixed-rate loan commitments as of September 30,
2002 have interest rates ranging from 5.25% to 8.38%. Because some commitments
expire without being drawn upon, the total commitment amounts do not necessarily
represent cash requirements. The Company evaluates the creditworthiness of each
customer on a case-by-case basis. The amount of collateral obtained if deemed
necessary by the Company upon extension of credit is based on management's
credit evaluation of the counterparty. The Company generally extends credit on a
secured basis. Collateral obtained consists primarily of one- to four-family
residences and other residential and commercial real estate.
Loans sold with recourse represent one- to four-family mortgage loans that are
sold to secondary market agencies, primarily FNMA, with the servicing of these
loans being retained by the Company. The Company receives a larger servicing
spread on those loans being serviced then it would if the loans had been sold
without recourse.
The Company has entered into agreements whereby, for an initial and annual fee,
it will guarantee payment for an industrial development revenue bond issue
("IRB"). The IRBs are issued by municipalities to finance real estate owned by a
third party. Potential loss on a guarantee is the notional amount of the
guarantee less the value of the real estate collateral. At September 30, 2002,
appraised values of the real estate collateral exceeded the amount of the
guarantees.
Interest rate swap agreements generally involve the exchange of fixed and
variable rate interest payments without the exchange of the underlying notional
amount on which the interest rate payments are calculated. The notional amounts
of these agreements represent the amounts on which interest payments are
exchanged between the counterparties. The notional amounts do not represent
direct credit exposures. The Company is exposed to credit-related losses in the
event of nonperformance by the counterparties on interest rate payments but does
not expect any counterparty to fail to meet their obligations. These fixed
receive-floating pay agreements were entered into as hedges of the interest
rates on fixed rate certificates of deposit. Interest receivable or payable on
interest rate swaps is recognized using the accrual method. The use of interest
rate swaps enables the Company to synthetically alter the repricing
characteristics of designated interest earning assets and interest-bearing
liabilities. At September 30, 2002, the Company did not have any interest rate
swap agreements outstanding. The interest rate swap agreements outstanding at
the beginning of fiscal 2002 were called during the year.
The unused and open consumer lines of credit are conditional commitments issued
by the Company for extensions of credit such as home equity, auto, credit card
or other similar consumer type financing. Furthermore, the unused and open
commercial lines of credit are also conditional commitments issued by the
Company for extensions of credit such as working capital, equipment or other
similar commercial type financing. The credit risk involved in extending lines
of credit is essentially the same as that involved in extending loan facilities
to customers. Collateral held for these commitments may include, but may not be
81
limited to, real estate, investment securities, equipment, accounts receivable,
inventory and Company deposits.
The commitments to fund equity investments represent amounts SFEP is committed
to invest in low-income housing projects which would qualify for tax credits
under Section 42 of the Internal Revenue Code (the "Code"). The investment in
the low-income housing projects is included in the Company's balance sheet as
real estate held for investment.
The Company's primary business activities include granting residential mortgage
and consumer loans to customers located within the proximity of their branch
locations, primarily within the State of Wisconsin. Approximately $119.7 million
of commercial real estate and multi-family loans are outside Wisconsin as of
September 30, 2002.
In the normal course of business, various legal proceedings involving the
Company are pending. Management, based upon advice from legal counsel, does not
anticipate any significant losses as a result of these actions.
The Company leases 16 offices under agreements which expire at various dates
through August 2056, with eleven leases having renewable options. Rent expense
under these agreements totaled approximately $1.4 million, $1.3 million and $1.2
million for the years ended September 30, 2002, 2001 and 2000, respectively.
The future minimum rental commitments as of September 30, 2002 under these
leases for the next five years and thereafter, are as follows:
<Table>
<Caption>
Years Ended September 30, Amount
- ------------------------- --------------
(In thousands)
2003 ................... $ 1,462
2004 ................... 1,075
2005 ................... 617
2006 ................... 581
2007 ................... 581
2008 and thereafter ..... 9,187
</Table>
(17) FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS No. 107), requires disclosure of fair
value information about financial instruments, whether or not recognized on the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are
materially affected by the assumptions used, including the discount rate and
estimates of future cash flows. In that regard, the derived fair value estimates
cannot be substantiated by comparison to independent markets and, in many cases,
could not be realized in immediate settlement of the instrument. SFAS No. 107
excludes certain financial instruments and all non-financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent, and should not be interpreted to represent, the
underlying value of the Company.
82
The following table presents the estimates of fair value of financial
instruments at September 30, 2002:
<Table>
<Caption>
Carrying Fair
(In thousands) Value Value
- -------------- ------------ ------------
Financial Assets:
Cash and cash equivalents ................ $ 45,835 $ 45,835
Debt and equity securities ............... 16,596 16,596
Mortgage-backed and related securities ... 708,826 709,898
Mortgage loans held for sale ............. 65,006 65,006
Loans receivable ......................... 1,257,466 1,280,121
Federal Home Loan Bank stock ............. 90,784 90,784
Financial Liabilities:
Certificate accounts ..................... 735,191 749,197
Other deposit accounts ................... 681,788 681,788
Advances and other borrowings ............ 642,063 697,065
</Table>
<Table>
<Caption>
Contractual
or Notional Carrying Fair
(In thousands) Amount Value Value
- -------------- ------------ ------------ ------------
Off-Balance Sheet Items:
Commitments to extend credit ........ $ 110,980 -- *
Unused and open-ended lines of credit 340,115 -- *
</Table>
* Amount is not material.
The following table presents the estimates of fair value of financial
instruments at September 30, 2001:
<Table>
<Caption>
Carrying Fair
(In thousands) Value Value
- -------------- ------------ ------------
Financial Assets:
Cash and cash equivalents ................ $ 38,100 $ 38,100
Debt and equity securities ............... 41,661 41,661
Mortgage-backed and related securities ... 712,353 713,206
Mortgage loans held for sale ............. 18,974 18,991
Loans receivable ......................... 1,237,900 1,252,094
Federal Home Loan Bank stock ............. 62,691 62,691
Financial Liabilities:
Certificate accounts ..................... 745,824 752,889
Other deposit accounts ................... 703,496 703,496
Advances and other borrowings ............ 571,433 605,074
</Table>
<Table>
<Caption>
Contractual
or Notional Carrying Fair
(In thousands) Amount Value Value
- -------------- ------------ ------------ ------------
Off-Balance Sheet Items:
Commitments to extend credit ............. $ 47,516 -- *
Unused and open-ended lines of credit .... 256,469 -- *
Interest rate swap agreements ............ 80,000 $ 744 $ 392
</Table>
* Amount is not material.
83
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the statement of
financial condition for cash and short-term instruments approximate those
assets' fair values.
DEBT AND EQUITY AND MORTGAGE-BACKED AND RELATED SECURITIES: Fair values for debt
and equity and mortgage-backed and related securities are based on quoted market
prices, where available. If quoted market prices are not available, fair values
are based on quoted market prices of comparable instruments.
MORTGAGE LOANS HELD FOR SALE: The fair values for mortgage loans held for sale
are based on quoted market prices of similar loans sold in conjunction with
securitization transactions, adjusted for differences in loan characteristics.
LOANS RECEIVABLE: For variable-rate mortgage loans that reprice frequently and
with no significant change in credit risk, fair values are based on carrying
values. The fair values for residential mortgage loans are based on quoted
market prices of similar loans sold in conjunction with securitization
transactions, adjusted for differences in loan characteristics. The fair values
for commercial real estate loans, rental property mortgage loans, and consumer
and other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
FEDERAL HOME LOAN BANK STOCK: FHLB stock is carried at cost which is its
redeemable (fair) value since the market for this stock is limited.
CERTIFICATE ACCOUNTS: The fair values of fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities of the outstanding certificates of deposit. In accordance
with SFAS No. 107, the fair value of liabilities cannot be less than the
carrying value.
OTHER DEPOSITS: The fair values disclosed for other deposits, which include
interest and non-interest checking accounts, passbook accounts and money market
accounts, are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying value amounts).
FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS: The fair values of the
Company's long-term borrowings are estimated using discounted cash flow
analyses, based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
OFF-BALANCE SHEET ITEMS: The fair value of the Company's off-balance sheet
instruments are based on quoted market prices and fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the credit standing of the related counterparty.
The fair value of the interest rate swap agreements is based on the present
value of the swap using dealer quotes. These values represent the estimated
amount the Company would receive or pay to terminate the agreements, taking into
account current interest rates and market volatility. The carrying value of the
swaps at September 30, 2001 represents the fair value of the swaps and the net
accrued interest receivable.
The fair value estimates are presented for on-balance sheet financial
instruments without attempting to estimate the value of the Company's long-term
relationships with depositors and the benefit that results from low-cost funding
provided by deposit liabilities.
84
(18) SEGMENT INFORMATION
The Company's operations include four strategic business segments: Retail
Banking, Commercial Banking, Mortgage Banking and Investments. Financial
performance is primarily based on the individual segments direct contribution to
Company net income. The Company's segments do not include the operations of the
parent holding company, nor the operations of the Bank's operating subsidiaries.
Capital is not allocated to the segments and thus net interest income related to
the free funding associated with capital is not included in the individual
segments. The Company only charges the segments with direct expenses. Costs
associated with administrative and centralized back-office support areas of the
Bank are not allocated to the segments. Income taxes are allocated to the
segments based on the Bank's effective tax rate prior to the consolidation with
its affordable housing subsidiary.
The Retail Banking segment consists of the Bank's retail deposits, branch and
ATM network, consumer lending operations, annuity and brokerage services and
call center. The segment includes a much higher level of interest-bearing
liabilities than earning assets. The Company views this segment as a significant
funding vehicle for the other lending segments. The Company's transfer pricing
model has the effect of viewing this segment as a comparison to the cost of
wholesale funds.
The Commercial Banking segment consists of the Bank's commercial, commercial
real estate and multi-family lending operations. It also includes the lending
aspects of the Company's affordable housing subsidiary.
The Mortgage Banking segment consists of the Bank's single-family mortgage
lending operation. Single-family lending consists of three primary operations:
portfolio lending, lending for sale in the secondary market and loan servicing.
The Investment segment consists of the Company's portfolio of mortgage-backed
and related securities, its debt and equity securities and other short-term
investments. This segment also includes the Company's wholesale sources of
funding including FHLB advances, brokered certificates of deposits, reverse
repurchase agreements and federal funds purchased.
85
<Table>
<Caption>
BUSINESS SEGMENTS Retail Commercial Mortgage Total
(In thousands) Banking Banking Banking Investments Segments
- ----------------- ------------ ------------ ------------ ------------ ------------
Year ended September 30, 2002
Net interest income (expense) .......... $ 15,013 $ 25,602 $ 9,717 $ (2,103) $ 48,229
Provision for loan losses .............. 1,386 1,804 99 -- 3,289
Other operating income ................. 8,268 1,142 9,603 1,312 20,325
General and administrative expenses .... 22,880 3,522 5,358 781 32,541
Income tax expense (benefit) ........... (343) 7,453 4,855 (547) 11,418
------------ ------------ ------------ ------------ ------------
Segment profit (loss) .................. $ (643) $ 13,966 $ 9,009 $ (1,025) $ 21,306
============ ============ ============ ============ ============
Goodwill ............................... $ 13,182 $ -- $ -- $ -- $ 13,182
============ ============ ============ ============ ============
Segment average assets ................. $ 343,421 $ 673,008 $ 270,857 $ 772,076 $ 2,059,362
============ ============ ============ ============ ============
Year ended September 30, 2001
Net interest income .................... $ 21,101 $ 15,811 $ 8,072 $ 3,505 $ 48,489
Provision for loan losses .............. 886 4,145 496 -- 5,527
Other operating income ................. 7,418 1,121 6,169 860 15,568
General and administrative expenses .... 21,532 2,908 4,318 946 29,704
Income tax expense ..................... 1,938 3,138 3,003 1,086 9,165
------------ ------------ ------------ ------------ ------------
Segment profit ......................... $ 4,163 $ 6,741 $ 6,424 $ 2,333 $ 19,661
============ ============ ============ ============ ============
Goodwill ............................... $ 13,351 $ -- $ -- $ -- $ 13,351
============ ============ ============ ============ ============
Segment average assets ................. $ 322,932 $ 599,661 $ 391,391 $ 935,781 $ 2,249,765
============ ============ ============ ============ ============
Year ended September 30, 2000
Net interest income .................... $ 24,658 $ 14,102 $ 6,949 $ 5,961 $ 51,670
Provision for loan losses .............. 789 1,447 273 -- 2,509
Other operating income ................. 7,170 950 1,777 (3) 9,894
General and administrative expenses .... 21,189 2,588 3,637 791 28,205
Income tax expense ..................... 3,713 4,152 1,819 1,948 11,632
------------ ------------ ------------ ------------ ------------
Segment profit ......................... $ 6,137 $ 6,865 $ 2,997 $ 3,219 $ 19,218
============ ============ ============ ============ ============
Goodwill ............................... $ 14,584 $ -- $ -- $ -- $ 14,584
============ ============ ============ ============ ============
Segment average assets ................. $ 312,042 $ 546,169 $ 400,558 $ 1,151,184 $ 2,409,953
============ ============ ============ ============ ============
</Table>
86
RECONCILEMENT OF SEGMENT INFORMATION TO FINANCIAL STATEMENTS
<Table>
<Caption>
Years Ended September 30,
2002 2001 2000
------------ ------------ ------------
(In thousands)
NET INTEREST INCOME AND OTHER OPERATING INCOME
Total for segments ............................................ $ 68,554 $ 64,057 $ 61,564
Unallocated transfer pricing credit (primarily on capital) .... 8,886 8,191 5,189
Income from affordable housing subsidiary ..................... 3,190 3,026 3,014
Holding company interest expense .............................. (833) (2,265) (1,964)
Elimination of intercompany interest income ................... (1,064) (1,383) (1,093)
Other ......................................................... 3,389 3,254 1,418
------------ ------------ ------------
Consolidated total revenue .................................... $ 82,122 $ 74,880 $ 68,128
============ ============ ============
PROFIT
Total for segments ............................................ $ 21,306 $ 19,661 $ 19,218
Unallocated transfer pricing credit (primarily on capital) .... 5,332 4,915 3,113
Unallocated administrative and centralized support costs(a)... (5,449) (5,556) (5,536)
Holding company net loss ...................................... (1,096) (1,887) (1,494)
Elimination of intercompany interest income ................... (638) (830) (656)
Affordable housing tax credits ................................ 2,690 2,609 2,609
Additional ESOP expense not allocated to segments ............. -- -- (6,317)
Other ......................................................... (273) (928) 186
------------ ------------ ------------
Consolidated net income ....................................... $ 21,872 $ 17,984 $ 11,123
============ ============ ============
AVERAGE ASSETS
Total for segments ............................................ $ 2,059,362 $ 2,249,765 $ 2,409,953
Elimination of intercompany loans ............................. (15,381) (13,346) (13,390)
Other assets not allocated .................................... 161,747 117,518 106,528
------------ ------------ ------------
Consolidated average assets ................................... $ 2,205,728 $ 2,353,937 $ 2,502,821
============ ============ ============
</Table>
(a) After-tax effect of $9.1 million, $9.3 million and $9.2 million of
general and administrative expenses for the years ended September 30,
2002, 2001 and 2000, respectively.
(19) DERIVATIVE AND HEDGING ACTIVITIES
Effective October 1, 2000, the Company adopted Financial Accounting Statement
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes new rules for the recognition and measurement of derivatives and
hedging activities. The Company utilizes derivative hedging instruments in the
course of its asset/liability management. The hedging instruments primarily used
by the Company are interest rate swap agreements which are used to convert
fixed-rate payments or receipts to variable-rate payments or receipts and thus
hedge the Company's fair market value of the item being hedged and certain
forward loan sale commitments which hedge the change in fair value of loans held
for sale. The items being hedged generally expose the Company to variability in
fair value in rising or declining interest rate environments.
The Company's mortgage banking activities include the issuance of commitments to
extend residential mortgage loans. When the loan is originated or purchased, it
may be recorded as a mortgage loan held for sale. The loans held for sale are
hedged with forward contracts and a fair value hedge is designated. The Company
is in a short position with forward contracts, whereby the Company agrees to
sell mortgage loans held for sale at a pre-established price at some future
date, and in a long position with the mortgage loans held for sale. The hedging
relationship is highly effective and hedges changes in the fair value of the
mortgage loans held for sale due to interest rate changes. The change in fair
value of mortgage loans held for sale is included in the consolidated income
statement.
The Company utilizes interest rate swaps to hedge the fair value of brokered
certificates of deposit ("CD's"). The interest rate swaps that hedge brokered
CD's are matched with the CD as to final maturity, interest payment dates and
call features. The interest rate swaps are a floating pay-fixed receive
instrument and as such, they convert the fixed rate payment on the brokered CD's
to a floating rate and thus hedge the fair value of the brokered CD's from
changes in interest rates.
The Company measures the effectiveness of its' hedges on a periodic basis. Any
difference between the fair value change of the hedge versus the fair value
change of the hedged item is considered to be the
87
"ineffective" portion of the hedge. The ineffective portion of the hedge is
recorded as an increase or decrease in the related income statement
classification of the item being hedged. If the ineffectiveness of a hedge
exceeds certain levels the derivative would no longer be eligible for hedge
treatment and future changes in fair value of the derivative would be recorded
in the income statement.
The Company's commitments to originate mortgage loans held-for-sale and forward
loan sale commitments are considered derivatives under the accounting standards.
As such, the change in fair value of such commitments, are recorded as an
adjustment to the gains on the sale of loans.
As of the adoption date of Statement 133, the Company had two interest rate swap
agreements that were not considered hedges under the accounting standard. Both
agreements were terminated during the quarter ended December 31, 2000. The fair
value of the agreements as of October 1, 2000 is included in the cumulative
effect of an accounting change and the change in fair value during the quarter
is included in securities gains (losses) in the income statement.
Upon adoption of Statement 133, the Company recorded the cumulative effect of an
accounting change in an amount equal to the accounting effects of the statement
as of the beginning of the fiscal year. The cumulative effect, net of taxes, was
a decrease in net income of $84,000 for the year ended September 30, 2001.
During the years ended September 30, 2002 and 2001, the Company recorded the
effects of the ineffectiveness of any hedge transaction as part of the income
statement line item pertaining to each item. The individual changes in value
resulted in an increase of $9,000 and $146,000 in interest expense on deposits
for the years ended September 30, 2002 and 2001, respectively.
(20) GOODWILL AND INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142
Effective October 1, 2001, the Company adopted Financial Accounting Statement
142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 142
provides that intangible assets with finite useful lives be amortized and that
goodwill and intangible assets with indefinite lives will not be amortized, but
will rather be tested at least annually for impairment. As required under SFAS
No. 142, the Company discontinued the amortization of goodwill with a net
carrying value of $13.4 million at October 1, 2001 and annual amortization of
approximately $1.2 million that resulted from business combinations prior to the
adoption of SFAS No. 141. The Company will evaluate goodwill for impairment at
least annually. Impairment testing of goodwill was completed as of October 1,
2001 and resulted in no impairment, therefore, goodwill has a net carrying value
of $13.4 million at September 30, 2002.
Net income and earnings per share adjusted for the adoption of SFAS No. 142 is
as follows:
<Table>
<Caption>
Years Ended September 30,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
(In thousands, except per share data)
Net income, as reported ................................ $ 21,872 $ 17,984 $ 11,123
Add back: Goodwill amortization, net of tax benefit .... -- 1,030 1,015
------------ ------------ ------------
Adjusted net income .................................... $ 21,872 $ 19,014 $ 12,138
============ ============ ============
BASIC EARNINGS PER SHARE:
Net income, as reported ........................... $ 2.36 $ 1.92 $ 1.13
Goodwill amortization, net of tax benefit ......... -- 0.11 0.11
------------ ------------ ------------
Adjusted net income ............................... $ 2.36 $ 2.03 $ 1.24
============ ============ ============
DILUTED EARNINGS PER SHARE:
Net income, as reported ........................... $ 2.25 $ 1.87 $ 1.12
Goodwill amortization, net of tax benefit ......... -- 0.11 0.10
------------ ------------ ------------
Adjusted net income ............................... $ 2.25 $ 1.98 $ 1.22
============ ============ ============
</Table>
In addition to goodwill, the Company's other intangible assets consist of
mortgage servicing rights which are included in other assets on the consolidated
balance sheet. Mortgage servicing rights are not subject to SFAS No. 142 but
rather, are amortized over their expected life and subject to periodic
impairment testing. The results for the year ended September 30, 2002 include a
$3.1 million charge related to an impairment write-down of the Company's
mortgage servicing rights. The write-down was the result of an increase in
88
forecasted prepayment speeds, which resulted primarily from the current lower
interest rate environment. At September 30, 2002 and 2001 the valuation reserve
totaled $3.1 million and zero, respectively. Changes in the carrying value of
capitalized mortgage servicing rights are summarized as follows:
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Balance at beginning of year ........... $ 6,287 $ 4,575 $ 4,729
Servicing rights capitalized ....... 4,926 3,086 665
Amortization of servicing rights ... (1,968) (1,374) (819)
Impairment of servicing rights ..... (3,100) -- --
------------ ------------ ------------
Balance at end of year ................. $ 6,145 $ 6,287 $ 4,575
============ ============ ============
Market value at end of year ............ $ 6,496 $ 6,963 $ 6,490
============ ============ ============
</Table>
Amortization expense for the mortgage servicing rights asset are based on
assumptions made during each reporting period. Such assumptions include, but are
not limited to, the current level of interest rates and the forecast prepayment
speeds as estimated by major mortgage dealers. Actual amortization expense is
also affected by the amount of loans sold with servicing retained.
The following table shows the future estimated amortization expense for
originated mortgage servicing rights based on existing balances and the interest
rate environment as of September 30, 2002. The Company's actual amortization
expense in any given period may be significantly different from the estimated
amounts displayed depending on the amount of additional servicing rights,
changes in mortgage interest rates, estimated prepayment speeds and market
conditions.
Estimated future amortization expense:
<Table>
<Caption>
Years Ended September 30, Amount
- ------------------------- ------
(In thousands)
2003.............................................................. $ 2,374
2004.............................................................. 1,123
2005.............................................................. 807
2006.............................................................. 579
2007.............................................................. 414
2008 and thereafter............................................... 848
</Table>
89
(21) FINANCIAL INFORMATION OF ST. FRANCIS CAPITAL CORPORATION (PARENT ONLY)
STATEMENTS OF FINANCIAL CONDITION
<Table>
<Caption>
September 30,
(In thousands) 2002 2001
- -------------- ------------ ------------
ASSETS
Cash, all with Bank ........................................................ $ 2,713 $ 3,998
Investment in subsidiary, at equity ........................................ 190,703 192,949
Accrued interest receivable and other assets ............................... 27 27
------------ ------------
Total assets ......................................................... $ 193,443 $ 196,974
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Advances and other borrowings .......................................... $ 14,000 $ 36,000
Accrued interest and other liabilities ................................. 362 499
------------ ------------
Total liabilities .................................................... 14,362 36,499
------------ ------------
Shareholders' equity:
Common stock ........................................................... 146 146
Additional paid-in capital ............................................. 89,324 88,826
Accumulated other comprehensive income ................................. 1,632 1,137
Treasury stock, at cost ................................................ (72,515) (74,264)
Retained earnings, substantially restricted ............................ 160,494 144,630
------------ ------------
Total shareholders' equity ........................................... 179,081 160,475
------------ ------------
Total liabilities and shareholders' equity ........................... $ 193,443 $ 196,974
============ ============
</Table>
STATEMENTS OF INCOME
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Dividends received from Bank ............................... $ 26,000 $ 12,000 $ 5,021
Interest and other dividend income ......................... 44 84 224
Other income ............................................... -- -- 49
Interest expense on advances and other borrowings .......... (833) (2,266) (1,964)
General and administrative expenses ........................ (897) (721) (608)
------------ ------------ ------------
Income before income tax expense and equity in
undistributed earnings of subsidiary ................. 24,314 9,097 2,722
Income tax benefit ......................................... (590) (1,016) (805)
------------ ------------ ------------
Income before equity in undistributed earnings of
subsidiary ........................................... 24,904 10,113 3,527
Equity in undistributed earnings of subsidiary ............. (3,032) 7,871 7,596
------------ ------------ ------------
Net income ................................................. $ 21,872 $ 17,984 $ 11,123
============ ============ ============
</Table>
90
STATEMENTS OF CASH FLOWS
<Table>
<Caption>
Years Ended September 30,
(In thousands) 2002 2001 2000
- -------------- ------------ ------------ ------------
Cash flows from operating activities:
Net income .............................................. $ 21,872 $ 17,984 $ 11,123
Adjustments to reconcile net income to cash provided
by operations:
Equity in undistributed earnings of subsidiary ...... 3,032 (7,871) (7,596)
Increase (decrease) in liabilities .................. (137) (116) 48
Other, net .......................................... (291) (26) (3,674)
------------ ------------ ------------
Cash provided by (used in) operations ................... 24,476 9,971 (99)
------------ ------------ ------------
Cash flows from financing activities:
Stock option transactions ............................... 2,477 427 333
Proceeds from advances and other borrowings ............. 54,000 125,000 112,000
Repayments from advances and other borrowings ........... (76,000) (125,000) (97,000)
Purchase of treasury stock .............................. (679) (5,166) (11,226)
Dividends paid .......................................... (5,559) (3,753) (3,578)
------------ ------------ ------------
Cash provided by (used in) financing activities ......... (25,761) (8,492) 529
------------ ------------ ------------
Increase (decrease) in cash ............................. (1,285) 1,479 430
Cash at beginning of year ............................... 3,998 2,519 2,089
------------ ------------ ------------
Cash at end of year ..................................... $ 2,713 $ 3,998 $ 2,519
============ ============ ============
</Table>
91
(22) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<Table>
<Caption>
For the quarter ended,
-----------------------------------------------------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30,
2002 2002 2002 2001 2001
---------- ---------- ----------- ----------- -----------
(In thousands, except per share data and market prices)
Interest and dividend
income ........................ $ 29,822 $ 30,636 $ 29,976 $ 32,711 $ 35,920
Interest expense ................ 15,765 16,249 16,734 18,671 21,460
---------- ---------- ----------- ----------- -----------
Net interest income ............. 14,057 14,387 13,242 14,040 14,460
Provision for loan losses ....... 556 913 909 911 908
---------- ---------- ----------- ----------- -----------
Net interest income after
provision for loan losses ..... 13,501 13,474 12,333 13,129 13,552
Securities gains ................ 256 322 677 57 245
Gain on sales of loans held
for sale, net ................. 5,201 2,273 2,074 3,203 2,313
Other operating income .......... 1,911 2,690 3,602 4,130 3,375
---------- ---------- ----------- ----------- -----------
Total other operating income .... 7,368 5,285 6,353 7,390 5,933
General and administrative
expenses ...................... 12,272 11,912 11,967 11,943 11,460
---------- ---------- ----------- ----------- -----------
Income before income tax
expense........................ 8,597 6,847 6,719 8,576 8,025
Income tax expense .............. 2,710 1,783 1,792 2,582 2,557
---------- ---------- ----------- ----------- -----------
Income before accounting
change......................... 5,887 5,064 4,927 5,994 5,468
Cumulative effect of
accounting change ............. -- -- -- -- --
---------- ---------- ----------- ----------- -----------
Net income ...................... $ 5,887 $ 5,064 $ 4,927 $ 5,994 $ 5,468
========== ========== =========== =========== ===========
Basic earnings per share:(1)
Before accounting change ...... $ 0.63 $ 0.55 $ 0.53 $ 0.65 $ 0.59
Cumulative effect of
accounting change ........... -- -- -- -- --
---------- ---------- ----------- ----------- -----------
$ 0.63 $ 0.55 $ 0.53 $ 0.65 $ 0.59
========== ========== =========== =========== ===========
Diluted earnings per share:(2)
Before accounting change ... $ 0.60 $ 0.52 $ 0.51 $ 0.62 $ 0.56
Cumulative effect of
accounting change ....... -- -- -- -- --
---------- ---------- ----------- ----------- -----------
$ 0.60 $ 0.52 $ 0.51 $ 0.62 $ 0.56
========== ========== =========== =========== ===========
Weighted average shares -
basic ......................... 9,348,097 9,291,005 9,229,437 9,179,274 9,323,822
Weighted average shares -
diluted ....................... 9,796,911 9,785,807 9,694,565 9,621,097 9,766,495
Market Information:
High ........................ $ 25.09 $ 25.20 $ 23.71 $ 23.13 $ 22.80
Low ......................... 20.51 22.12 22.00 20.25 20.40
Close ....................... 23.01 24.79 23.71 23.13 21.35
<Caption>
For the quarter ended,
--------------------------------------
Jun 30, Mar 31, Dec 31,
2001 2001 2000
----------- ----------- ----------
(In thousands, except per share data and market prices)
Interest and dividend
income ........................ $ 37,957 $ 42,297 $ 44,961
Interest expense ................ 24,268 29,360 32,503
----------- ----------- ----------
Net interest income ............. 13,689 12,937 12,458
Provision for loan losses ....... 3,310 706 603
----------- ----------- ----------
Net interest income after
provision for loan losses ..... 10,379 12,231 11,855
Securities gains ................ 275 199 277
Gain on sales of loans held
for sale, net ................. 1,642 1,487 613
Other operating income .......... 3,982 3,660 3,268
----------- ----------- ----------
Total other operating income .... 5,899 5,346 4,158
General and administrative
expenses ...................... 11,441 11,157 10,260
----------- ----------- ----------
Income before income tax
expense........................ 4,837 6,420 5,753
Income tax expense .............. 1,365 1,661 1,384
----------- ----------- ----------
Income before accounting
change......................... 3,472 4,759 4,369
Cumulative effect of
accounting change ............. -- -- (84)
----------- ----------- ----------
Net income ...................... $ 3,472 $ 4,759 $ 4,285
=========== =========== ==========
Basic earnings per share:(1)
Before accounting change ...... $ 0.37 $ 0.51 $ 0.46
Cumulative effect of
accounting change ........... -- -- (0.01)
----------- ----------- ----------
$ 0.37 $ 0.51 $ 0.45
=========== =========== ==========
Diluted earnings per share:(2)
Before accounting change ... $ 0.36 $ 0.50 $ 0.46
Cumulative effect of
accounting change ....... -- -- (0.01)
----------- ----------- ----------
$ 0.36 $ 0.50 $ 0.45
=========== =========== ==========
Weighted average shares -
basic ......................... 9,387,005 9,402,121 9,413,249
Weighted average shares -
diluted ....................... 9,759,264 9,602,015 9,492,615
Market Information:
High ........................ $ 21.85 $ 18.56 $ 15.25
Low ......................... 18.69 13.88 12.56
Close ....................... 21.85 18.38 13.13
</Table>
- ------------
(1) Basic earnings per share of common stock have been determined by dividing
net income for the period by the weighted average number of shares of common
stock outstanding during the period.
(2) Diluted earnings per share of common stock have been determined by dividing
net income for the period by the weighted average number of shares of common
stock outstanding during the period adjusted for the dilutive effect of
outstanding stock options.
On October 18, 2002, the Company declared a dividend of $0.20 per share on the
Company's common stock for the quarter ended September 30, 2002. The dividend
was payable on November 20, 2002 to shareholders of record as of November 11,
2002. At November 29, 2002, the closing price of the Company's common stock was
$24.00 per share.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
92
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item with respect to directors is included under
the heading "Election of Directors" in the Company's definitive Proxy Statement,
dated December 20, 2002, relating to the 2003 Annual Meeting of Shareholders
currently scheduled for January 22, 2003, which is incorporated herein by
reference. Information concerning executive officers who are not directors is
contained in Part I of this Form 10-K pursuant to paragraph (b) of Item 401 of
Regulation S-K in reliance on Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the heading "Compensation of
Executive Officers and Directors" in the Company's definitive Proxy Statement,
dated December 20, 2002, relating to the 2003 Annual Meeting of Shareholders
currently scheduled for January 22, 2003, which is incorporated herein by
reference. However, the information set forth under the heading "Compensation
Committee Report" in the Company's definitive Proxy Statement dated December 20,
2002, shall not be deemed to be incorporated by reference by any general
statement into any filing and shall not otherwise be deemed to be filed under
the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934,
as amended.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required by this item is included under the heading "Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters" in the Company's definitive Proxy Statement, dated December 20, 2002,
relating to the 2003 Annual Meeting of Shareholders currently scheduled for
January 22, 2003, which is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading "Indebtedness of
Management and Certain Transactions" in the Company's definitive Proxy
Statement, dated December 20, 2002, relating to the 2003 Annual Meeting of
Shareholders currently scheduled for January 22, 2003, which is incorporated
herein by reference.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
An evaluation of the Company's disclosure controls and procedures (as defined in
Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the "Act")) was
carried out under the supervision and with the participation of the Company's
Chief Executive Officer, Chief Financial Officer and several other members of
the Company's senior management within the 90-day period preceding the filing
date of this annual report. The Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures as currently in effect are effective in ensuring that the information
required to be disclosed by the Company in the reports it files or submits under
the Act is (i) accumulated and communicated to the Company's management
(including the Chief Executive Officer and Chief Financial Officer) in a timely
manner, and (ii) recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. In the year ended September 30,
2002, the Company did not make any significant changes in, nor take any
corrective actions regarding, its internal controls or other factors that could
significantly affect these controls.
93
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS
The following financial statements and financial statement schedules are
included under a separate caption "Financial Statements and Supplementary Data"
in Part II, Item 8 hereof and are incorporated herein by reference:
Independent Auditors' Report
Consolidated Statements of Financial Condition at September 30, 2002
and 2001
Consolidated Statements of Income for the Years Ended September 30,
2002, 2001 and 2000
Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the Years Ended September 30, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the Years Ended September 30,
2002, 2001 and 2000
Notes to Consolidated Financial Statements
(a) (2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules have been omitted as the required information
is inapplicable or has been included in the Consolidated Financial Statements.
(a) (3) EXHIBITS:
3.1 Articles of Incorporation of Registrant(1)
3.2 Amended By-laws of Registrant(2)
3.3 Stock Charter of St. Francis Bank, F.S.B.(1)
3.4 By-laws of St. Francis Bank, F.S.B.(1)
3.5 Articles of Amendment to the Articles of Incorporation of Registrant
(3)
4.0 Shareholders' Rights Agreement dated as of September 25, 1997 between
the Registrant and Firstar Trust Company(4)
10.1 St. Francis Bank, F.S.B. Money Purchase Pension Plan(1)
10.2 St. Francis Bank, F.S.B. 401(k) Savings Plan(1)
10.3 St. Francis Bank, F.S.B. Employee Stock Ownership Plan(1)
10.4 Credit Agreement by and between St. Francis Bank, F.S.B. Employee Stock
Ownership Trust and Registrant(1)
10.5 St. Francis Bank, F.S.B. Management Recognition and Retention Plan and
Trust(1)
10.6 St. Francis Capital Corporation 1993 Incentive Stock Option Plan(1)
10.7 St. Francis Capital Corporation 1993 Stock Option Plan for Outside
Directors(1)
10.8 1986 Deferred Compensation Agreement as Amended-Thomas R. Perz(4)
10.9 1987 Deferred Compensation Agreement-Thomas R. Perz(1)
10.10 1988 Deferred Compensation Agreement-Edward W. Mentzer(1)
10.11 2000 St. Francis Bank, FSB Employment Agreement-Thomas R. Perz(5)
10.12 2000 St. Francis Capital Corporation Employment Agreement-Thomas R.
Perz(5)
10.13 1996 Amended Employment Agreement-James C. Hazzard(5)
10.14 1997 Amended Employment Agreement-Bradley J. Smith(5)
10.15 1998 Amended Employment Agreement-Jon D. Sorenson(5)
10.16 1998 Amended Employment Agreement-James S. Eckel(5)
10.17 St. Francis Capital Corporation 1997 Stock Option Plan(3)
10.18 Split Dollar Life Insurance Agreement-Thomas R. Perz(3)
11.1 Statement regarding computation of per share earnings
See footnote (14) in Part II Item 8
13.1 2002 Summary Annual Report to Shareholders(7)
21.1 Subsidiaries of the Registrant
See "Subsidiaries" in Part I Item I
23.1 Consent of KPMG LLP(6)
24.1 Powers of Attorney for certain officers and directors(1)
99.1 Proxy Statement for 2003 Annual Meeting of Shareholders(6)
99.2 Certification of Chief Executive Officer and Chief Financial Officer
under the Sarbanes-Oxley Act of 2002(6)
94
(1) Incorporated by reference to exhibits filed with the Registrant's Form S-1
Registration Statement declared effective on April 22, 1993. (Registration
Number 33-58680).
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30, 1995.
(3) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30, 1997.
(4) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30, 1999.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30, 2000.
(6) Filed herewith.
(7) Filed in paper format pursuant to Rule 101(b)(1) of Regulation S-T.
A copy of one or more of the exhibits listed herein can be obtained by writing
Jon D. Sorenson, Chief Financial Officer, St. Francis Capital Corporation, 13400
Bishops Lane, Suite 350, Brookfield, WI 53005-6203.
(b) REPORTS ON FORM 8-K
None
(c) EXHIBITS
Reference is made to the exhibit index set forth above at (a)(3).
(d) FINANCIAL STATEMENT SCHEDULES
Reference is made to the disclosure set forth above at (a)(1 and 2).
95
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.
ST. FRANCIS CAPITAL CORPORATION
By: /s/ Thomas R. Perz
--------------------------------
Thomas R. Perz, Chairman of the
Board, President and Chief
Executive Officer
(Duly Authorized Representative)
Date: December 18, 2002
--------------------------------
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 registrants and
in the capacities and on the dates indicated.
<Table>
/s/ Thomas R. Perz /s/ Jon D. Sorenson
----------------------------------- -----------------------------------
Thomas R. Perz, Chairman of the Jon D. Sorenson, Chief Financial
Board, President, Chief Executive Officer and Treasurer (Principal
Officer and Director (Principal Financial and Accounting Officer)
Executive and Operating Officer)
Date: December 18, 2002 Date: December 18, 2002
-------------------------- --------------------------
/s/ David J. Drury /s/ Gerald A. Kiefer
----------------------------------- -----------------------------------
David J. Drury, Director Gerald A. Kiefer, Director
Date: December 18, 2002 Date: December 18, 2002
-------------------------- --------------------------
/s/ Edward W. Mentzer /s/ Jeffrey A. Reigle
----------------------------------- -----------------------------------
Edward W. Mentzer, Director Jeffrey A. Reigle, Director
Date: December 18, 2002 Date: December 18, 2002
-------------------------- --------------------------
/s/ Julia H. Taylor /s/ Edmund O. Templeton
----------------------------------- -----------------------------------
Julia H. Taylor, Director Edmund O. Templeton, Director
Date: December 18, 2002 Date: December 18, 2002
-------------------------- --------------------------
</Table>
96
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Thomas R. Perz, certify that:
1. I have reviewed this annual report on Form 10-K of St. Francis Capital
Corporation (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this annual report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the Registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
Registrant's ability to record, process, summarize and report
financial data and have identified for the Registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 18, 2002 /s/ Thomas R. Perz
--------------------------------
Thomas R. Perz, Chairman of the
Board, President and Chief
Executive Officer
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Jon D. Sorenson, certify that:
1. I have reviewed this annual report on Form 10-K of St. Francis Capital
Corporation (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this annual report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the Registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
Registrant's ability to record, process, summarize and report
financial data and have identified for the Registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 18, 2002 /s/ Jon D. Sorenson
--------------------------------
Jon D. Sorenson, Chief Financial
Officer and Treasurer