Exhibit 13
[CHESTER BANCORP, INC. LOGO]
2002 ANNUAL REPORT
TABLE OF CONTENTS
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<Table>
<Caption>
Page
----
Message to Our Stockholders 1
Common Stock and Related Matters 2
Selected Consolidated Financial Information 3
Management's Discussion and Analysis 5
Independent Auditors' Report 15
Consolidated Balance Sheets 16
Consolidated Statements of Income 17
Consolidated Statements of Stockholders' Equity 18
Consolidated Statements of Comprehensive Income 19
Consolidated Statements of Cash Flows 20
Notes to Consolidated Financial Statements 21
Stockholder Information Inside Back Cover
</Table>
MESSAGE TO OUR STOCKHOLDERS
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To Our Stockholders:
Chester Bancorp, Inc. has completed another profitable year. We earned
$1,005,101 of net income during the year 2002 and ended the year with assets of
$113,849,089. Our basic earnings per share of common stock were $1.26, based on
the average shares outstanding.
The market price of the Company's common stock gradually increased during
2002, and we have continued to increase dividends. During 2002 we paid cash
dividends of 64 cents per share, which is an 11 cent increase over 2001 and
amounts to an approximate annual cash return on your investment of over 3%,
based on the market value of our common stock at the beginning of the year 2002.
Since October 4, 1996, the date that the Company initially offered
2,182,125 shares of common stock to the public, the Company has continually and
gradually reduced the number of outstanding shares of its common stock through
various repurchases. As of December 31, 2002, the Company had 896,568 shares of
common stock outstanding. We intend to continue to repurchase shares from time
to time, to the extent that such repurchases are then determined to be advisable
by the Board of Directors, authorized by the appropriate regulatory authorities
and comply with applicable legal requirements. This practice is considered by
the Board of Directors as a method of increasing value to the Company's
stockholders. Such repurchases have helped the Company maintain growth in
earnings per share.
On behalf of the Board of Directors of Chester Bancorp, Inc. and the
management and employees of Chester National Bank and Chester National Bank of
Missouri, I extend our sincere appreciation to our stockholders and customers
for your support during 2002. As in years past, we look forward to an exciting
and profitable future.
Sincerely,
/s/ Michael W. Welge
Michael W. Welge
Chairman of the Board,
President and Chief
Financial Officer
1
COMMON STOCK AND RELATED MATTERS
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The common stock of Chester Bancorp, Inc. is traded in the over-the-counter
market and is listed for quotation in the Nasdaq SmallCap Market under the
symbol "CNBA." The stock was issued on October 4, 1996 at $10.00 per share. As
of December 31, 2002, there were 896,568 shares of common stock issued and
outstanding.
The following table sets forth the high and low closing prices as reported
by Nasdaq SmallCap Market and dividends paid per share of common stock for the
period indicated.
<Table>
<Caption>
Dividends
Quarter ended High Low paid
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December 31, 1996 $13.750 $12.625 $ .05
March 31, 1997 $15.500 $13.125 $ .06
June 30, 1997 $15.500 $14.000 $ .06
September 30, 1997 $18.750 $14.750 $ .06
December 31, 1997 $20.500 $15.375 $ .07
March 31, 1998 $18.750 $17.125 $ .07
June 30, 1998 $18.000 $16.750 $ .07
September 30, 1998 $18.000 $17.000 $ .07
December 31, 1998 $17.250 $16.750 $ .07
March 31, 1999 $16.937 $16.750 $ .07
June 30, 1999 $16.812 $16.687 $ .08
September 30, 1999 $17.125 $16.687 $ .09
December 31, 1999 $16.750 $16.250 $ .09
March 31, 2000 $17.187 $16.625 $ .10
June 30, 2000 $17.500 $16.625 $ .10
September 30, 2000 $17.000 $16.625 $ .11
December 31, 2000 $17.250 $16.625 $ .12
March 31, 2001 $17.500 $16.620 $ .12
June 30, 2001 $17.500 $16.500 $ .13
September 30, 2001 $22.000 $16.500 $ .14
December 31, 2001 $20.000 $17.250 $ .14
March 31, 2002 $19.750 $18.550 $ .15
June 30, 2002 $22.490 $19.000 $ .15
September 30, 2002 $22.625 $20.000 $ .17
December 31, 2002 $24.000 $20.250 $ .17
</Table>
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and will depend upon a number of factors,
including capital requirements, regulatory limitations on the payment of
dividends, Chester Bancorp's results of operations and financial condition, tax
considerations, and general economic conditions. No assurance can be given that
dividends will be declared or, if declared, what the amount of dividends will
be, or whether such dividends will continue.
2
SELECTED CONSOLIDATED FINANCIAL INFORMATION
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<Table>
<Caption>
At December 31
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(Dollars in thousands) 2002 2001 2000 1999 1998
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SELECTED FINANCIAL CONDITION DATA:
Total assets $113,849 $111,761 $117,580 $120,392 $142,796
Loans receivable, net 35,634 41,097 47,341 48,277 48,209
Mortgage-backed securities, net(1) 3,241 7,110 15,585 21,734 21,870
Investments, net(2) 70,958 59,918 50,273 45,747 68,218
Savings deposits 94,848 91,414 96,991 90,753 99,435
Securities sold under agreements to
repurchase -- -- -- -- 10,880
Federal funds purchased -- -- -- 2,807 --
Federal Home Loan Bank advances 5,000 5,000 -- 5,000 10,000
Stockholders' equity 13,710 14,948 19,880 20,873 21,705
</Table>
<Table>
<Caption>
Year Ended December 31,
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(Dollars in thousands except per share data) 2002 2001 2000 1999 1998
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SELECTED OPERATING DATA:
Interest income $ 5,457 $ 7,342 $ 7,757 $ 8,266 $ 9,077
Interest expense 2,466 4,014 4,139 4,640 5,122
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Net interest income 2,991 3,328 3,618 3,626 3,955
Provision for loan losses -- -- -- 200 17
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Net interest income after provision for
loan losses 2,991 3,328 3,618 3,426 3,938
Gain on sale of investment securities and
mortgage-backed securities(3) 130 128 43 -- 33
Other non-interest income 248 258 192 1,069 207
Non-interest expense 2,158 2,305 2,323 2,532 2,514
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Income before income taxes 1,211 1,409 1,530 1,963 1,664
Income taxes 206 392 439 654 514
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Net income 1,005 1,017 1,091 1,309 1,150
=======================================================================================================================
Earnings per share -- basic $ 1.26 $ 1.00 $ 0.93 $ 1.03 $ 0.75
=======================================================================================================================
Earnings per share -- diluted $ 1.16 $ 0.97 $ 0.91 $ 1.01 $ 0.73
=======================================================================================================================
Dividends declared per common share $ 0.64 $ 0.53 $ 0.43 $ 0.33 $ 0.28
=======================================================================================================================
</Table>
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(1) Includes mortgage backed securities available for sale of $512,000, $5.1
million, $7.0 million, and $11.3 million, at December 31, 2001, 2000, 1999,
and 1998, respectively. The Company had no mortgage backed securities
available for sale at December 31, 2002.
(2) Includes investment securities, marketable securities, nonmarketable equity
securities, trading securities, interest-bearing deposits, federal funds
sold, and certificates of deposits. Includes securities available for sale
of $4.8 million, $5.2 million, $4.1 million, $5.0 million and $12.5 million
at December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(3) Includes unrealized loss on trading securities of $10,000 at December 31,
2002.
3
SELECTED CONSOLIDATED FINANCIAL INFORMATION (CONTINUED)
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<Table>
<Caption>
At or for the Year Ended December 31,
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2002 2001 2000 1999 1998
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KEY OPERATING RATIOS:
Performance Ratios:
Return on average assets (net income divided by
average assets) 0.90% 0.85% 0.94% 1.00% 0.82%
Return on average equity (net income divided by
average equity) 6.89 5.70 5.35 6.38 4.63
Interest rate spread (difference between average
yield on interest-earning assets and average
cost of interest-bearing liabilities)(4) 2.66 2.52 2.74 2.39 2.31
Net interest margin (net interest income as a
percentage of average interest-earning
assets)(4) 2.92 3.03 3.42 2.97 3.03
Non-interest expense to average assets 1.93 1.92 1.99 1.93 1.79
Average interest-earning assets to average
interest-bearing liabilities 111.35 114.46 118.24 115.71 118.91
Asset Quality:
Allowance for loan losses to total loans at end
of period 1.59 1.42 1.25 1.24 0.92
Ratio of allowance for loan losses to
non-performing loans 1,072.50 458.69 460.17 698.60 287.41
Net charge-offs to average outstanding loans
during the period 0.04 0.02 0.02 0.09 0.01
Ratio of non-performing assets to total
assets(5) 0.06 0.13 0.23 0.23 0.20
Capital Ratios:
Average equity to average assets 13.01 14.90 17.52 15.62 17.74
Equity to assets at end of period 12.04 13.37 16.91 17.34 15.20
</Table>
<Table>
<Caption>
At December 31,
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2002 2001 2000 1999 1998
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OTHER DATA:
Number of:
Real estate loans outstanding 765 880 1,023 1,050 1,127
Deposit accounts 6,868 7,301 7,888 8,216 9,970
Full-service offices 4 4 4 4 5
</Table>
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(4) Information is presented on a tax equivalent basis assuming a tax rate of
34%.
(5) Non-performing assets include loans which are contractually past due 90 days
or more, loans accounted for on nonaccrual basis and real estate acquired
through foreclosure.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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GENERAL
The principal business of Chester Bancorp, Inc. and its subsidiaries
consists of attracting deposits from the general public and using these funds to
originate mortgage loans secured by one-to-four family residences and to invest
in investments and mortgage-backed securities. To a lesser extent, the Company
engages in various forms of consumer lending. The Company's profitability
depends primarily on its net interest income, which is the difference between
the interest income it earns on its loans, mortgage-backed securities and
investment portfolio and its cost of funds, which consists mainly of interest
paid on deposits, securities sold under agreements to repurchase, federal funds
purchased and advances from the Federal Home Loan Bank. Net interest income is
affected by the relative amounts of interest-earning assets and interest-bearing
liabilities and the interest rates earned or paid on these balances. When
interest-earning assets approximate or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income.
The Company's profitability is also affected by the level of provisions for
loan losses, noninterest income and noninterest expense. Noninterest income
consists primarily of gains and losses on the sale of investment securities,
late charges on loans, and deposit account fees. Noninterest expense consists of
salaries and benefits, occupancy related expenses, data processing expenses,
deposit insurance premiums paid to the Savings Association Insurance Fund and
other operating expenses.
The operations of the Company are significantly influenced by general
economic conditions and related monetary and fiscal policies of financial
institutions regulatory agencies. Deposit flows and the cost of funds are
influenced by interest rates on competing investments and general market rates
of interest. Lending activities are affected by the demand for financing real
estate and other types of loans, which in turn is affected by the interest rates
at which such financing may be offered and other factors affecting loan demand
and the availability of funds.
On October 4, 1996, the Company, completed its conversion from a federal
mutual savings bank to a federal capital stock savings bank and simultaneously
formed Chester Bancorp, Inc., a Delaware corporation, to act as the holding
company of the converted savings bank. Pursuant to the plan of conversion, the
Bank converted to a national bank known as Chester National Bank, and a newly
chartered bank subsidiary was formed by the Company known as Chester National
Bank of Missouri. The stock conversion resulted in the sale and issuance of
2,181,125 shares of $ .01 par value common stock at a price of $10.00 per share.
In conjunction with the conversion, the Company loaned $1,745,700 to the
Company's employee stock ownership plan for the purchase of 174,570 shares of
common stock in connection with the stock conversion. After reducing gross
proceeds for conversion costs of $939,363 and $1,745,700 related to the sale of
shares to the Company's employee stock ownership plan, net proceeds totaled
$19,136,187.
When used in this Annual Report the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market area and competition, that could cause
actual results to differ materially from the historical earnings and those
presently anticipated or projected. 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. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake, and specifically declines any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
BUSINESS STRATEGY
The Company's current business strategy is to operate as a well
capitalized, profitable and independent community bank dedicated to financing
home ownership and consumer needs in its market area and to providing quality
service to its customers. The Company has implemented this strategy by: (1)
closely monitoring the needs of customers and providing quality service; (2)
emphasizing consumer banking by originating residential mortgage loans and
consumer loans, and by offering checking accounts and other financial services
and products; (3) maintaining asset quality; (4) maintaining
5
significant investments in investment and mortgage-backed securities; (5)
maintaining capital in excess of regulatory requirements; (6) increasing
earnings; and, (7) managing interest rate risk by attempting to match asset and
liability maturities and rates.
FINANCIAL CONDITION
Assets.
The Company's total assets increased by $2.1 million, or 1.9%, to $113.8
million at December 31, 2002 from $111.8 million at December 31, 2001. The
increase in the Company's asset size was mainly attributable to an increase in
cash and cash equivalents of $8.9 million, which resulted from an increase in
savings deposits of $3.4 million and, partially offset by the purchase of
treasury stock of $1.9 million during the twelve months ended December 31, 2002.
The increase in cash and cash equivalents resulted from decreases in loans
receivable and mortgage-backed securities.
Loans receivable decreased $5.5 million or 13.3%, to $35.6 million at
December 31, 2002 from $41.1 million at December 31, 2001. The average balance
on loans receivable decreased $7.7 million, or 17.2%, for the twelve months
ended December 31, 2002, coupled with a 53 basis point decline in the average
interest rate on loans receivable. Repayments on loans receivable were $12.3
million for 2002 compared to $13.4 for 2001. New loan originations decreased to
$6.9 million in 2002 from $7.4 million in 2001. Refinancing volume was high due
to the low level of interest rates throughout 2002, positively offset by new
loan origination increasing during the second half of 2002. During this period
of record low interest rates and economic instability, management has decided to
continue to focus on originating high quality loans.
Mortgage-backed securities at December 31, 2002 were $3.2 million compared
to $7.1 million at December 31, 2001. Investment securities, marketable
securities, nonmarketable equity securities and trading securities increased
$2.6 million, or 6.4%, to $42.3 million at December 31, 2002. As a function of
management's plan to re-align the mix of interest earning assets, proceeds from
maturities, calls and sales of investment securities and mortgage-backed
securities, along with principal repayments on loans and mortgage-backed
securities, were re-invested in short-term, callable investment securities and
short-term interest-bearing deposits.
On a combined basis cash, interest-bearing deposits, federal funds sold and
certificates of deposit, increased $8.9 million, or 42.5%, to $30.0 million at
December 31, 2002 from $21.0 million at December 31, 2001. Management invested
the funds received from maturing investment securities, calls and sales, and the
principal repayment on loans and mortgage-backed securities into short-term
interest-bearing deposits.
Liabilities.
Savings deposits increased $3.4 million, or 3.8%, to $94.8 million at
December 31, 2002 from $91.4 million at December 31, 2001. The increase in
savings deposits reflects a $5.9 million increase in the level of deposits from
Gilster-Mary Lee Corporation (Gilster-Mary Lee), a food manufacturing and
packaging company headquartered in Chester, Illinois. The Chairman of the Board
of the Company is also the Executive Vice President, Treasurer and Secretary of
Gilster-Mary Lee.
Over the last several years, the Company has maintained a deposit
relationship with Gilster-Mary Lee, which at times has had as much as $25
million in funds on deposit, typically with short terms. At December 31, 2002
and 2001, the balance of funds on deposit with the Company was $27.7 million and
$21.8 million, respectively.
A significant loss of funds from Gilster-Mary Lee could impair future
earnings as there is no intent to replace the Gilster-Mary Lee savings deposits
with other wholesale funds. At December 31, 2002, the Company maintained an
adequate liquidity level to cover the withdrawal of such deposits and/or
additional reduction of such borrowings.
Advances from the Federal Home Loan Bank (FHLB) were $5.0 million at
December 31, 2002, and 2001. The advance has a ten year term at a fixed rate of
interest of 4.87%. Management invested the funds from the advances into U.S.
government agency securities with a five year maturity and a rate of 6.00%. The
average balance of borrowed money was $5.0 and $4.8 million for 2002 and 2001,
respectively. The average cost of borrowed money was 4.8% for both 2002 and
2001.
RESULTS OF OPERATIONS
The Company's operating results depend primarily on its level of net
interest income, which is the difference between the interest income earned on
its interest-earning assets (loans, mortgage-backed securities, investment
securities, and interest-bearing deposits) and the interest expense paid on its
interest-bearing liabilities (deposits and borrowings). Operating results are
also significantly affected by provisions for losses on loans, noninterest
income, and noninterest
6
expense. Each of these factors is significantly affected not only by the
Company's policies, but, to varying degrees, by general economic and competitive
conditions and by policies of federal regulatory authorities.
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST
The following table sets forth certain information for the periods
indicated regarding average balances of assets and liabilities as well as the
total dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and average yields and
costs. Yields and costs are derived by dividing income or expense by the average
monthly balance of assets or liabilities, respectively, for the periods
presented. Average balances are derived from month-end balances instead of daily
balances, which management believes has not caused any material difference in
the information presented.
<Table>
<Caption>
2002 2001
------------------------------- -------------------------------
Average Average
Average yield/ Average yield/
(Dollars in thousands) balance Interest cost balance Interest cost
- ----------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Loans receivable, net(1) $ 37,202 $2,840 7.63% $ 44,910 $3,663 8.16%
Investments, net(2)(3) 39,657 2,126 5.36 37,254 2,389 6.41
Mortgage-backed securities,
net 4,670 266 5.70 12,435 751 6.04
Interest-bearing deposits(4) 25,777 367 1.42 20,398 698 3.42
------------------------------------------------------------------
Total interest-earning
assets 107,306 5,599 5.22 114,997 7,501 6.52
------ ------ ------ ------
Noninterest-earning assets 4,758 4,747
-------- --------
Total assets $112,064 $119,744
======== ========
INTEREST-BEARING LIABILITIES:
Deposits $ 91,368 2,223 2.43 $ 95,678 3,781 3.95%
Federal funds purchased -- -- -- -- -- --
Other short-term borrowed
money -- -- -- -- -- --
FHLB Advances 5,000 243 4.86 4,794 233 4.86
------------------------------------------------------------------
Total interest-bearing
liabilities 96,368 2,466 2.56 100,472 4,014 4.00
------ ------ ------ ------
Noninterest-bearing
liabilities 1,112 1,434
-------- --------
Total liabilities 97,480 101,906
Stockholders' equity 14,584 17,838
-------- --------
Total liabilities and
stockholders' equity $112,064 $119,744
======== ========
Net interest income $3,133 $3,487
====== ======
Interest rate spread(5) 2.66% 2.52%
====== ======
Net interest margin(6) 2.92% 3.03%
====== ======
Ratio of average
interest-earning assets to
average interest-bearing
liabilities 111.35% 114.46%
====== ======
<Caption>
2000
-------------------------------
Average
Average yield/
(Dollars in thousands) balance Interest cost
- ------------------------------
INTEREST-EARNING ASSETS:
Loans receivable, net(1) $ 48,061 $4,032 8.39%
Investments, net(2)(3) 40,259 2,569 6.38
Mortgage-backed securities,
net 18,475 1,131 6.12
Interest-bearing deposits(4) 3,863 192 4.97
-------------------------------
Total interest-earning
assets 110,658 7,924 7.16
------ ------
Noninterest-earning assets 5,859
--------
Total assets $116,517
========
INTEREST-BEARING LIABILITIES:
Deposits $ 91,962 4,041 4.39
Federal funds purchased 884 56 6.33
Other short-term borrowed
money 142 11 8.40
FHLB Advances 601 31 5.16
-------------------------------
Total interest-bearing
liabilities 93,589 4,139 4.42
------ ------
Noninterest-bearing
liabilities 2,510
--------
Total liabilities 96,099
Stockholders' equity 20,418
--------
Total liabilities and
stockholders' equity $116,517
========
Net interest income $3,785
======
Interest rate spread(5) 2.74%
======
Net interest margin(6) 3.42%
======
Ratio of average
interest-earning assets to
average interest-bearing
liabilities 118.24%
======
</Table>
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(1) Average balance includes nonaccrual loans.
(2) Includes FHLB stock, FRB stock, marketable securities, trading securities
and investment securities.
(3) Information is presented on a tax equivalent basis assuming a tax rate of
34%.
(4) Includes interest-bearing deposits, federal funds sold, and certificates of
deposit.
(5) Represents the difference between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities.
(6) Represents net interest income as a percentage of average interest-earning
assets.
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing volumes and rates on
net interest income of the Company. Information is provided with respect to (i)
effects on interest income and expense attributable to changes in volume
(changes in volume when multiplied by prior rate); (ii) effects on interest
income and expense attributable to changes in
7
rate (changes in rate multiplied by prior volume); and (iii) changes in rate
volume (change in rate multiplied by change in volume). Information is presented
on a tax equivalent basis assuming a tax rate of 34% for all years presented.
<Table>
<Caption>
2002 COMPARED TO 2001 2001 Compared to 2000
-------------------------------------- ------------------------------------
Total Total
Rate/ Increase Rate/ Increase
(Dollars in thousands) Volume Rate Volume (Decrease) Volume Rate Volume (Decrease)
- ---------------------------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Loans receivable, net(1) $(629) $ (235) $ 41 $ (823) $(264) $(112) $ 7 $(369)
Investments, net(2)(3) 154 (392) (25) (263) (192) 13 (1) (180)
Mortgage-backed securities, net (469) (43) 27 (485) (370) (15) 5 (380)
Interest-bearing deposits(4) 184 (407) (108) (331) 822 (60) (256) 506
- ---------------------------------------------------------------------------------------------------------------------------------
Total net change in income on interest-earning
assets (760) (1,077) (65) (1,902) (4) (174) (245) (423)
- ---------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Deposits (170) (1,453) 65 (1,558) 163 (407) (16) (260)
Borrowings 10 -- -- 10 191 (19) (37) 135
- ---------------------------------------------------------------------------------------------------------------------------------
Total net change in expense on
interest-bearing liabilities (160) (1,453) 65 (1,548) 354 (426) (53) (125)
- ---------------------------------------------------------------------------------------------------------------------------------
Net change in net interest income $(600) $ 376 $(130) $ (354) $(358) $ 252 $(192) $(298)
=================================================================================================================================
</Table>
(1) Average balance includes nonaccrual loans.
(2) Includes FHLB stock, FRB stock, marketable securities, trading securities
and investment securities.
(3) Information is presented on a tax equivalent basis assuming a tax rate of
34%.
(4) Includes interest-bearing deposits, federal funds sold, and certificates of
deposits.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
Net Income.
The Company's net income for 2002 was $1.01 million compared to $1.02
million for 2001. The lower net income level in 2002 reflects a $337,000 decline
in net interest income which was partially offset by a $147,000 decrease in
noninterest expense and a $187,000 decrease in income tax expense. The decline
in income tax expense resulted from a realignment of deferred and current income
taxes during 2002.
Net Interest Income.
Net interest income decreased $337,000, or 10.1%, to $3.0 million for 2002
from $3.3 million for 2001. The decrease in net interest income was the result
of a $1.9 million decrease in interest income, positively offset by a $1.5
million decrease in interest expense. The decrease in net interest income was
the result of a decline in the ratio of average interest-earning assets to
average interest-bearing liabilities of 111.35% in 2002 from 114.46% in 2001.
Interest Income.
Interest income on loans receivable totaled $2.8 million for 2002 compared
to $3.7 million for 2001. The $823,000, or 22.5%, decrease in interest income on
loans receivable resulted from a $7.7 million, or 17.2%, decrease in the average
balance of loans receivable. The impact of decreased volume was further impacted
by a decline in the average yield on loans receivable to 7.63% in 2002 from
8.16% in 2001.
Interest income on mortgage-backed securities decreased $485,000, or 64.6%,
to $266,000 for 2002 from $751,000 for 2001. The decrease in interest income on
mortgage-backed securities resulted from a $7.8 million, or 62.4%, decrease in
the average balance of mortgage-backed securities. The impact of a decreased
average balance was further impacted by a decrease in the average yield on
mortgage-backed securities to 5.70% in 2002 from 6.04% in 2001. Management
invested the funds received from the repayments of mortgage-backed securities
into short-term, interest-bearing deposits.
Interest earned on investment securities totaled $2.0 million for 2002
compared to $2.2 million for 2001. The $247,000, or 11.1% decrease in interest
income on investment securities was the result of a decrease in the average tax
equivalent yield on investment securities to 5.36% in 2002 from 6.41% in 2001,
positively offset by an increase in the average balance of investment securities
of $2.4 million, or 6.5% for 2002.
Interest income on interest-bearing deposits, federal fund sold and
certificates of deposit, totaled $367,000 for 2002 compared to $698,000 for
2001. The $331,000, or 47.4%, decrease in interest income on interest-bearing
deposits was the result of a decrease in the average yield on interest-bearing
deposits to 1.42% in 2002 from 3.42% in 2001, partially offset by an increase in
the average balance of interest-bearing deposits of $5.4 million. The increase
in the average balance on
8
interest-bearing deposits resulted primarily from management's decision to
invest excess funds into short-term, interest-bearing deposits while longer term
investment opportunities were evaluated.
Interest Expense.
Interest expense decreased $1.5 million, or 38.6%, during 2002. Interest
expense on savings deposits decreased $1.6 million, or 41.2%, to $2.2 million
for 2002 from $3.8 million for 2001. This decrease resulted primarily from the
decrease in the average cost of deposits to 2.43% in 2002 from 3.95% in 2001,
combined with a decrease in the average balance of savings deposits of $4.3
million.
Interest expense on FHLB advances increased $10,000, or 4.3%, for 2002 from
$233,000 for 2001. The Company borrowed $5.0 million from the FHLB in January
2001 and invested the funds in a U.S. government agency security with a five
year maturity and a rate of 6.00%. The average balance and the average cost on
FHLB advances for 2002 and 2001 was $5.0 million and 4.86%, and $4.8 and 4.86%,
respectively.
Provision for Loan Losses.
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risk inherent in its loan
portfolio and the general economy. Such evaluation considers numerous factors
including general economic conditions, loan portfolio composition, prior loss
experience, the estimated fair value of the underlying collateral, and other
factors that warrant recognition in providing for an adequate loan loss
allowance.
The Company had no provisions for loan losses during 2002 and 2001 as no
significant problem loans were identified and the allowance for loan losses was
deemed by management to be adequate.
The Company's allowance for loan losses was $575,000, or 1.59%, of loans
outstanding at December 31, 2002, compared to $591,000, or 1.42%, of loans
outstanding at December 31, 2001. The Company's level of net loans charged-off
during the year ended December 31, 2002 was $15,000, which represented .04% of
average loans outstanding. Based on current levels in the allowance for loan
losses in relation to loans receivable and delinquent loans, management's
continued effort to favorably resolve problem loan situations, and the low level
of charge-offs in recent years, management believes the allowance is adequate at
December 31, 2002. At December 31, 2002, loans 90 days or more delinquent
totaled $54,000, or .15% of net loans receivable, compared to $129,000, or .31%
of net loans receivable at December 31, 2001.
The allowance for loan losses is maintained to absorb losses inherent in
the loan portfolio. The balance of the allowance is based on ongoing, quarterly
assessments of the probable estimated losses in the loan portfolio. The Bank's
methodology for assessing the appropriateness of the allowance consists of
applying several formula methods to identified problem loans and portfolio
segments. The allowance is calculated by applying loss factors to outstanding
loan balances, based on a internal risk grade of such loans or pools of loans.
Changes in risk grades of both performing and nonperforming loans affect the
amount of the allowance. Loss factors are based primarily on historical loss
experience over the past three to five years, and may be adjusted for other
significant conditions that, in management's judgement, affect the
collectibility of the loan portfolio.
Since the allowance for loan losses is based upon estimates of probable
losses, the amount actually observed can vary significantly from the estimated
amounts. The historical loss factors attempt to reduce this variance by taking
into account recent loss experience. Management evaluates several other
conditions in connection with the allowance, including general economic and
business conditions, credit quality trends, collateral values, loan volumes and
concentrations, seasoning of the portfolio, and regulatory examination results.
Management believes the current balance of the allowance for loan losses is
adequate. Management will continue to monitor the loan portfolio and assess the
adequacy of the allowance at least quarterly.
The financial statements of the Company are prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP)
and, accordingly, provisions for loan losses are based on management's
assessment of the factors set forth above. The Company regularly reviews its
loan portfolio, including problem loans, to determine whether any loans are
impaired, require classification and/or the establishment of appropriate
reserves. Management believes it has established its existing allowance for loan
losses in accordance with GAAP; however, future additions may be necessary if
economic conditions or other circumstances differ substantially from the
assumptions used in making the initial determination.
9
Noninterest Income.
Noninterest income was $378,000 for 2002 compared to $386,000 for 2001. The
$8,000, or 2.1%, decrease was attributable to a $28,000 decrease in other
income, positively offset by a $17,000 increase in fee income. The decrease in
other noninterest income was primarily due to a $31,000 state income tax refund
related to a prior accounting period.
Noninterest Expense.
Noninterest expense decreased $147,000, or 6.4%, for 2002. The decrease in
noninterest expense resulted primarily from a $144,000 decrease in compensation
and employee expense, combined with a $12,000 decrease in professional fees, a
$4,000 decrease in data processing expense and a $3,000 decrease in advertising
expense, partially offset by a $18,000 increase in other expense. The decrease
in compensation expense was due to the 1997 Management Retention Plan ending in
April, 2002. These fluctuations are the result of normal operating procedures.
Income Tax Expense.
Income tax expense for 2002 was $206,000 compared to $393,000 for 2001. The
Company's effective tax rate for 2002 and 2001 was 17.0% and 27.9%,
respectively. The effective tax rate for each year was below the statutory
federal rate of 34% due to the Company's investment in tax exempt securities.
During 2002 the Company reclassified deferred tax assets to current tax expense,
reducing the current tax liability in order to better align the accounts with
tax assets and liabilities expected to be realized in the future.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Income.
The Company's net income for 2001 was $1.0 million compared to $1.1 million
for 2000. The lower net income level in 2001 reflects a $290,000 decline in net
interest income, positively offset by a $151,000 increase in noninterest income.
The decline in interest income resulted from a decrease in the Company's
interest spread.
Net Interest Income.
Net interest income decreased $290,000, or 8.0%, to $3.3 million for 2001
from $3.6 million for 2000. The decrease in net interest income was the result
of a $415,000 decrease in interest income, positively offset by a $125,000
decrease in interest expense. The decrease in net interest income was the result
of a decline in the ratio of average interest-earning assets to average
interest-bearing liabilities of 114.46% in 2001 from 118.24% in 2000.
Interest Income.
Interest income on loans receivable totaled $3.7 million for 2001 compared
to $4.0 million for 2000. The $369,000, or 9.2%, decrease in interest income on
loans receivable resulted from a $3.2 million, or 6.6%, decrease in the average
balance of loans receivable. The impact of decreased volume was further impacted
by a decline in the average yield on loans receivable to 8.16% in 2001 from
8.39% in 2000.
Interest income on mortgage-backed securities decreased $380,000, or 33.6%,
to $751,000 for 2001 from $1.1 million for 2000. The decrease in interest income
on mortgage-backed securities resulted from a $6.0 million, or 32.7%, decrease
in the average balance of mortgage-backed securities. The impact of a decreased
average balance was further impacted by a decrease in the average yield on
mortgage-backed securities to 6.04% in 2001 from 6.12% in 2000. Management used
funds received from the decline in mortgage-backed securities to purchase
additional shares of treasury stock.
Interest earned on investment securities totaled $2.2 million for 2001
compared to $2.4 million for 2000. The $172,000, or 7.2% decrease in interest
income on investment securities resulted from a $3.0 million, or 7.5%, decrease
in the average balance of investment securities. The average yield on investment
securities for 2001 and 2000 was 6.41% and 6.38%, respectively. Management used
funds received from the decline in investment securities to purchase additional
shares of treasury stock.
Interest income on interest-bearing deposits, federal fund sold and
certificates of deposit, totaled $698,000 for 2001 compared to $192,000 for
2000. The $506,000, or 263.5%, increase in interest income on interest-bearing
deposits resulted from a $16.5 million, or 428.0%, increase in the average
balance of interest-bearing deposits. The increase in interest income from
interest-bearing deposits was partially offset by a decrease in the average
yield on interest-bearing deposits to 3.42% in 2001 from 4.97% in 2000. The
increase in the average balance on interest-bearing deposits resulted primarily
from management's decision to invest excess funds into short-term,
interest-bearing deposits while longer term investment opportunities were
evaluated.
10
Interest Expense.
Interest expense decreased $125,000, or 3.0%, during 2001. Interest expense
on savings deposits decreased $260,000, or 6.4%, to $3.8 million for 2001 from
$4.0 million for 2000. This decrease resulted primarily from the decrease in the
average cost of deposit to 3.95% in 2001 from 4.39% in 2000. The decrease in the
average cost of deposits was due to the lower interest rate environment.
Interest expense on FHLB advances increased $202,000, or 651.6%, for 2001
from $31,000 for 2000. The Company borrowed $5.0 million from the FHLB in
January 2001 and invested the funds in a U.S. government agency security with a
five year maturity. The average balance and the average cost on FHLB advances
for 2001 and 2000 was $4.8 million and 4.86%, and $601,000 and 5.16%,
respectively.
Interest expense on federal funds purchased decreased $56,000, or 100.0%,
for 2001. The Company had no federal funds purchased during 2001, whereas the
average balance and the average cost on federal funds purchased for 2000 was
$884,000 and 6.33%, respectively.
Provision for Loan Losses.
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risk inherent in its loan
portfolio and the general economy. Such evaluation considers numerous factors
including general economic conditions, loan portfolio composition, prior loss
experience, the estimated fair value of the underlying collateral, and other
factors that warrant recognition in providing for an adequate loan loss
allowance.
The Company had no provisions for loan losses during 2001 and 2000 as no
significant problem loans were identified and the allowance for loan losses was
deemed by management to be adequate.
The Company's allowance for loan losses was $591,000, or 1.42%, of loans
outstanding at December 31, 2001, compared to $598,000, or 1.25%, of loans
outstanding at December 31, 2000. The Company's level of net loans charged-off
(recovered) during the year ended December 31, 2001 was ($7,000), which
represented -.02% of average loans outstanding. Based on current levels in the
allowance for loan losses in relation to loans receivable and delinquent loans,
management's continued effort to favorably resolve problem loan situations, and
the low level of charge-offs in recent years, management believes the allowance
is adequate at December 31, 2001. At December 31, 2001, loans 90 days or more
delinquent totaled $129,000, or .31% of net loans receivable, compared to
$130,000, or .27% of net loans receivable at December 31, 2000.
The allowance for loan losses is maintained to absorb losses inherent in
the loan portfolio. The balance of the allowance is based on ongoing, quarterly
assessments of the probable estimated losses in the loan portfolio. The Bank's
methodology for assessing the appropriateness of the allowance consists of
applying several formula methods to identified problem loans and portfolio
segments. The allowance is calculated by applying loss factors to outstanding
loan balances, based on a internal risk grade of such loans or pools of loans.
Changes in risk grades of both performing and nonperforming loans affect the
amount of the allowance. Loss factors are based primarily on historical loss
experience over the past three to five years, and may be adjusted for other
significant conditions that, in management's judgement, affect the
collectibility of the loan portfolio.
Since the allowance for loan losses is based upon estimates of probable
losses, the amount actually observed can vary significantly from the estimated
amounts. The historical loss factors attempt to reduce this variance by taking
into account recent loss experience. Management evaluates several other
conditions in connection with the allowance, including general economic and
business conditions, credit quality trends, collateral values, loan volumes and
concentrations, seasoning of the portfolio, and regulatory examination results.
The formulas used in the analysis were changed in 2001 to reflect the changing
mix of the loan portfolio. Management believes the current balance of the
allowance for loan losses is adequate. Management will continue to monitor the
loan portfolio and assess the adequacy of the allowance at least quarterly.
The financial statements of the Company are prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP)
and, accordingly, provisions for loan losses are based on management's
assessment of the factors set forth above. The Company regularly reviews its
loan portfolio, including problem loans, to determine whether any loans are
impaired, require classification and/or the establishment of appropriate
reserves. Management believes it has established its existing allowance for loan
losses in accordance with GAAP; however, future additions may be necessary if
economic conditions or other circumstances differ substantially from the
assumptions used in making the initial determination.
11
Noninterest Income.
Noninterest income was $386,000 for 2001 compared to $235,000 for 2000. The
$151,000, or 64.3%, increase resulted primarily from the impact of the $128,000
net gain on the sale of investment securities, marketable securities and
mortgage-backed securities during 2001, combined with a $30,000 increase in late
charges and other fee income and a $36,000 increase in other noninterest income.
The increase in other noninterest income was primarily due to a $31,000 state
income tax refund for a prior accounting period.
Noninterest Expense.
Noninterest expense decreased $18,000, or .8%, for 2001. The decrease in
noninterest expense resulted primarily from a $29,000 decrease in professional
fees, combined with a $7,000 decrease in data processing expense and a $5,000
decrease in advertising expense, partially offset by a $10,000 increase in
compensation and employee expense and a $13,000 increase in occupancy expense.
These fluctuations are the result of normal operating procedures.
Income Tax Expense.
Income tax expense for 2001 was $392,000 compared to $439,000 for 2000. The
Company's effective tax rate for 2001 and 2000 was 27.9% and 28.7%,
respectively. The effective tax rate for each year was below the statutory
federal rate of 34% due to the Company's investment in tax exempt securities.
ASSET/LIABILITY MANAGEMENT
The principal operating objective of the Company is the achievement of a
positive interest rate spread that can be sustained during fluctuations in
prevailing interest rates. Since the Company's principal interest-earning assets
have substantially longer terms to maturity than its primary source of funds,
i.e., deposit liabilities, increases in general interest rates will generally
result in an increase in the Company's cost of funds before the yield on its
asset portfolio adjusts upward. The Company has generally sought to reduce its
exposure to adverse changes in interest rates by attempting to achieve a closer
match between the periods in which their interest-bearing liabilities and
interest-earning assets can be expected to reprice through the origination of
adjustable-rate mortgages and investment in loans and securities with shorter
terms.
The term "interest rate sensitivity" refers to those assets and liabilities
which mature and reprice periodically in response to fluctuations in market
rates and yields. Many banks have historically operated in a mismatched position
with interest-sensitive liabilities greatly exceeding interest-sensitive assets
in the short-term time periods. As noted above, one of the principal goals of
the Company's asset/liability program is to more closely match the interest rate
sensitivity characteristics of the asset and liability portfolios.
In order to increase the interest rate sensitivity of its assets, the
Company has originated adjustable rate residential mortgage loans and maintained
a consistent level of short- and intermediate-term investment securities and
interest-bearing deposits. At December 31, 2002, the Company had $8.1 million of
adjustable rate mortgages, $33.3 million of investment securities,
mortgage-backed securities and interest-bearing deposits maturing within one
year, and $22.4 million of investment securities and mortgage-backed securities
maturing within one to five years. In addition, at December 31, 2002, the
Company had $2.5 million of consumer loans which typically have maturities of
five years or less.
In managing its future interest rate sensitivity, the Company intends to
continue to stress the origination of adjustable rate mortgages and loans with
shorter maturities, the maintenance of a consistent level of short- and
intermediate-term securities, and pricing strategies that will extend the term
of deposit liabilities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds consist of deposits, securities sold
under agreements to repurchase, repayments and prepayments of loans and
mortgage-backed securities, maturities of investments and interest-bearing
deposits, and funds provided from operations. While scheduled repayments of
loans and mortgage-backed securities and maturities of investment securities are
predictable sources of funds, deposit flows and loan prepayments are greatly
influenced by general interest rates, economic conditions and competition. The
Company manages the pricing of its deposits to maintain a steady deposit base.
The Company uses its liquidity resources principally to fund existing and future
loan commitments, to fund maturing certificates of deposit and deposit
withdrawals, to invest in other interest-bearing assets, to maintain liquidity,
and to meet operating expenses. Management anticipates that loan repayments and
other sources of funds will be adequate to meet and exceed the Company's
liquidity needs for 2003.
12
A major portion of the Company's liquidity consists of cash and cash
equivalents, which include investments in highly liquid, short-term deposits.
The level of these assets is dependent on the Company's operating, investing,
lending and financing activities during any given period. At December 31, 2002,
cash and cash equivalents totaled $30.0 million.
The primary investing activities of the Company include origination of
loans and purchase of mortgage-backed securities and investment securities.
During the year ended December 31, 2002, purchases of investment securities
totaled $43.8 million, while loan originations totaled $6.9 million. These
investments were funded primarily from loan and mortgage-backed security
repayments of $15.7 million and investment and mortgage-backed security sales
and maturities of $42.4 million.
In April 1997, the Company announced its initial plan to repurchase 5% of
its then outstanding common stock. Since that time the Company has continued to
repurchase shares when it was determined to be advisable by the Board of
Directors and authorized by the appropriate regulatory authorities. As of
December 31, 2002, the Company had repurchased approximately 1,285,557, or
58.9%, of its original common shares issued. Management expects to continue to
repurchase common shares when it is viewed as a method of increasing value to
the Company's stockholders.
Liquidity management is both a daily and long-term function of business
management. If the Company requires funds beyond its ability to generate them
internally, the Company believes that it could borrow additional funds from the
Federal Home Loan Bank or through federal funds purchased. At December 31, 2002,
the Company had $5.0 million of long-term advances from the FHLB.
At December 31, 2002, the Company exceeded all of its regulatory capital
requirements.
INTEREST RATE RISK MANAGEMENT
Interest rate sensitivity is closely monitored through the Company's
asset-liability management procedures. At the end of this section is a table
reflecting the Company's interest rate gap (rate sensitive assets minus rate
sensitive liabilities) analysis at December 31, 2002, individually and
cumulatively, through various time periods.
At December 31, 2002, the static gap analysis indicated substantial
liability sensitivity over one-year time periods. Generally, such a position
indicates that an overall rise in interest rates would result in an unfavorable
impact on the Company's net interest margin, as liabilities would reprice more
quickly than assets. Conversely, the net interest margin would be expected to
improve with an overall decline in interest rates. As savings, NOW and money
market accounts are subject to withdrawal on demand, they are presented in the
analysis based on their GAP BETA, which is the average of the rising and falling
betas. Based on the Company's experience, pricing such deposits is not expected
to change in direct correlation with changes in the general level of short-term
interest rates. Accordingly, management believes that gradual increase in the
general level of interest rates will not have a material effect on the Company's
net interest income.
The asset/liability management process, which involves structuring the
consolidated balance sheet to allow approximately equal amounts of assets and
liabilities to reprice at the same time, is a process essential to minimize the
effect of fluctuating interest rates on net interest income. The following table
reflects the Company's interest rate gap (rate-sensitive assets minus
rate-sensitive liabilities) analysis as of December 31, 2002, individually and
cumulatively, through various time periods. Amortizing accounts, which include
MBS, CMO's and loans are first adjusted to cash flow.
13
Following amortization, prepayment speeds are applied. The floating rate loans
are estimated by subtracting the average maturity from loans repricing less than
3 months.
<Table>
<Caption>
More than
three More than
Three months one year
months through through More than
(Dollars in thousands) Floating or less one year five years five years Total
- ------------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Loans receivable, net $ 4,913 $ 3,349 $ 6,589 $ 10,428 $10,930 $36,209
Investment and mortgage-backed securities -- 14,892 3,376 15,006 8,419 41,693
Other interest-earning assets 14,800 -- 17,706 -- -- 32,506
- ------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 19,713 18,241 27,671 25,434 19,349 110,408
- ------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING ASSETS:
Savings, NOW, and money market accounts $ 6,420 $ -- $ -- $ 31,425 $ -- $37,845
Certificate of deposit -- 15,109 26,209 10,535 -- 51,853
Other borrowed money -- -- -- 5,000 -- --
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 6,420 15,109 26,209 46,960 -- 94,698
Interest sensitivity gap $13,293 $ 3,132 $ 1,462 $(21,526) $19,349 $15,710
==================================================================================================================
Cumulative interest-sensitivity gap $13,293 $16,425 $17,887 $ (3,639) $15,710
==================================================================================================================
Ratio of cumulative gap to total assets .12 .14 .16 (.03) .14
==================================================================================================================
</Table>
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented herein
have been prepared in accordance with accounting principles generally accepted
in the United States of America, which require the measurement of financial
position and results of operations in terms of historical dollars without
considering changes in the relative purchasing power of money over time because
of inflation. Unlike most industrial companies, virtually all of the assets and
liabilities of the Company are monetary in nature. As a result, interest rates
have a more significant impact on the Company's performance than the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, Statement of Financial Accounting Standards No. 143
"Accounting for Asset Retirement Obligations" was issued to address financial
reporting and obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This Statement applies to all
entities and to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development or normal
operations of a long-lived asset, except for certain obligations of lessees.
Statement No. 143 is effective for financial statements issued for fiscal years
beginning after June 15, 2002. Management does not believe the adoption of
Statement No. 143 will have a significant impact on its financial statements.
14
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
To the Board of Directors
Chester Bancorp, Inc.
Chester, Illinois
We have audited the accompanying consolidated balance sheets of Chester
Bancorp, Inc. as of December 31, 2002 and 2001, and the related consolidated
statements of income, stockholders' equity, comprehensive income, and cash flows
for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chester
Bancorp, Inc. as of December 31, 2002 and 2001, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
/s/ McGladrey & Pullen, LLP
Springfield, Illinois
January 24, 2003
15
CHESTER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
December 31, 2002 and 2001 2002 2001
- --------------------------------------------------------------------------------------------
ASSETS
Cash $ 1,298,481 $ 851,602
Interest-bearing deposits 18,676,709 3,406,480
Federal funds sold 9,975,000 16,760,000
- --------------------------------------------------------------------------------------------
Total cash and cash equivalents 29,950,190 21,018,082
Investment securities:
Available for sale, at fair value (cost of $900,000 and
$1,659,955 at December 31, 2002 and 2001, respectively) 899,863 1,632,477
Held to maturity, at cost (fair value of $38,524,739 and
$35,273,053 at December 31, 2002 and 2001, respectively) 37,551,853 34,572,352
Trading securities, at fair value 352,551 --
Nonmarketable equity securities 3,502,400 3,547,000
Mortgage-backed securities:
Available for sale, at fair value (cost of $500,388 at
December 31, 2001) -- 511,578
Held to maturity, at cost (fair value of $3,378,408 and
$6,689,342 at December 31, 2002 and 2001, respectively) 3,240,925 6,598,411
Loans, net of the allowance for loan losses ($575,234 and
$590,590 at December 31, 2002 and 2001, respectively) 35,633,544 41,097,027
Office properties and equipment, net 1,404,783 1,527,507
Accrued interest receivable 756,248 778,175
Other assets 556,732 478,689
- --------------------------------------------------------------------------------------------
Total assets $113,849,089 $111,761,298
============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest bearing $ 5,149,295 $ 5,022,030
Interest bearing 89,698,414 86,391,754
- --------------------------------------------------------------------------------------------
Deposit total 94,847,709 91,413,784
FHLB advances 5,000,000 5,000,000
Advance payments by borrowers for taxes and insurance 162,860 183,378
Accrued interest payable 53,204 61,826
Accrued expenses and other liabilities 75,353 154,510
- --------------------------------------------------------------------------------------------
Total liabilities 100,139,126 96,813,498
- --------------------------------------------------------------------------------------------
Stockholders' Equity
Common stock, $.01 par value, 3,000,000 shares authorized,
2,182,125 shares issued 21,821 21,821
Additional paid-in capital 21,137,443 21,268,104
Retained earnings, partially restricted 16,221,066 15,737,450
Accumulated other comprehensive (loss) (85) (10,068)
Unearned ESOP (1,392,620) (1,428,120)
Unearned restricted stock awards -- (61,092)
Treasury stock, at cost: 1,285,557 and 1,204,155 shares at
December 31, 2002 and 2001, respectively (22,277,662) (20,580,295)
- --------------------------------------------------------------------------------------------
Total stockholders' equity 13,709,963 14,947,800
- --------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $113,849,089 $111,761,298
============================================================================================
</Table>
See Notes to Consolidated Financial Statements.
16
CHESTER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
Interest income:
Loans $2,839,830 $3,662,799 $4,032,225
Investment securities -- taxable 1,633,212 1,869,771 2,027,611
Investment securities -- tax exempt 350,621 360,657 374,891
Mortgage-backed securities 265,882 751,323 1,130,549
Other 366,984 697,595 192,282
- ------------------------------------------------------------------------------------------------------
Total interest income 5,456,529 7,342,145 7,757,558
- ------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,222,404 3,780,633 4,040,678
FHLB advances and other borrowings 243,333 233,333 98,568
- ------------------------------------------------------------------------------------------------------
Total interest expense 2,465,737 4,013,966 4,139,246
- ------------------------------------------------------------------------------------------------------
Net interest income 2,990,792 3,328,179 3,618,312
Provision for loan losses -- -- --
- ------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 2,990,792 3,328,179 3,618,312
- ------------------------------------------------------------------------------------------------------
Noninterest income:
Late charges, deposit account fees, and other fees 208,336 190,845 160,350
Unrealized (loss) on trading securities (10,068) -- --
Gain on sale of securities, net 140,082 127,748 43,339
Other 39,837 67,651 31,435
- ------------------------------------------------------------------------------------------------------
Total noninterest income 378,187 386,244 235,124
- ------------------------------------------------------------------------------------------------------
Noninterest expense:
Compensation and employee benefits 1,129,859 1,274,241 1,264,442
Occupancy 288,256 288,344 274,928
Data processing 142,431 146,072 153,602
Professional fees 198,759 210,622 239,428
Advertising 42,614 45,322 50,473
Federal deposit insurance premiums 15,713 18,188 19,112
Other 340,213 322,291 321,335
- ------------------------------------------------------------------------------------------------------
Total noninterest expense 2,157,845 2,305,080 2,323,320
- ------------------------------------------------------------------------------------------------------
Income before income taxes 1,211,134 1,409,343 1,530,116
Income taxes 206,033 392,738 438,734
- ------------------------------------------------------------------------------------------------------
Net income $1,005,101 $1,016,605 $1,091,382
======================================================================================================
Basic net income per share $ 1.26 $ 1.00 $ 0.93
======================================================================================================
Diluted net income per share $ 1.16 $ 0.97 $ 0.91
======================================================================================================
</Table>
See Notes to Consolidated Financial Statements.
17
CHESTER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<Table>
<Caption>
Retained Accumulated Unearned
Common Stock Additional Earnings, Other Restricted
Years Ended December 31, 2002, ------------------- Paid-In Substantially Comprehensive Unearned Stock
2001 and 2000 Shares Amount Capital Restricted (Loss) ESOP Awards
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 2,182,125 $21,821 $21,521,985 $14,681,473 $(129,165) $(1,538,040) $(393,480)
Net income -- -- -- 1,091,382 -- -- --
Purchase of treasury stock -- -- -- -- -- -- --
Issuance of treasury stock for
restricted stock awards -- -- (166,110) (10,382) -- -- --
Stock options exercised -- -- -- (5,728) -- -- --
Amortization of stock awards -- -- -- -- -- -- 166,194
ESOP shares released -- -- 37,339 -- -- 54,960 --
Dividends on common stock at
$.43 per share -- -- -- (504,507) -- -- --
Change in unrealized gain on
securities available for
sale, net of tax of $67,430 -- -- -- -- 110,018 -- --
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 2,182,125 21,821 21,393,214 15,252,238 (19,147) (1,483,080) (227,286)
Net income -- -- -- 1,016,605 -- -- --
Purchase of treasury stock -- -- -- -- -- -- --
Issuance of treasury stock for
restricted stock awards -- -- (166,110) (10,382) -- -- --
Stock options exercised -- -- -- (763) -- -- --
Amortization of stock awards -- -- -- -- -- -- 166,194
ESOP shares released -- -- 41,000 -- -- 54,960 --
Dividends on common stock at
$.53 per share -- -- -- (520,248) -- -- --
Change in unrealized gain on
securities available for
sale, net of tax of $5,564 -- -- -- -- 9,079 -- --
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 2,182,125 21,821 21,268,104 15,737,450 (10,068) (1,428,120) (61,092)
Net income -- -- -- 1,005,101 -- -- --
Purchase of treasury stock -- -- -- -- -- -- --
Issuance of treasury stock for
restricted stock awards -- -- (166,516) (10,407) -- -- --
Stock options exercised -- -- -- (1,528) -- -- --
Amortization of stock awards -- -- -- -- -- -- 61,092
ESOP shares released -- -- 35,855 -- -- 35,500 --
Dividends on common stock at
$.64 per share -- -- -- (509,550) -- -- --
Change in unrealized gain on
securities available for
sale, net of tax of $6,118 -- -- -- -- 9,983 -- --
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 2,182,125 $21,821 $21,137,443 $16,221,066 $ (85) $(1,392,620) $ --
============================================================================================================================
<Caption>
Treasury Stock Total
Years Ended December 31, 2002, ------------------------ Stockholders'
2001 and 2000 Shares Amount Equity
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 792,572 $(13,291,412) $20,873,182
Net income -- -- 1,091,382
Purchase of treasury stock 121,818 (2,040,452) (2,040,452)
Issuance of treasury stock for
restricted stock awards (11,865) 176,492 --
Stock options exercised (6,546) 97,372 91,644
Amortization of stock awards -- -- 166,194
ESOP shares released -- -- 92,299
Dividends on common stock at
$.43 per share -- -- (504,507)
Change in unrealized gain on
securities available for
sale, net of tax of $67,430 -- -- 110,018
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 895,979 (15,058,000) 19,879,760
Net income -- -- 1,016,605
Purchase of treasury stock 320,914 (5,711,772) (5,711,772)
Issuance of treasury stock for
restricted stock awards (11,865) 176,492 --
Stock options exercised (873) 12,985 12,222
Amortization of stock awards -- -- 166,194
ESOP shares released -- -- 95,960
Dividends on common stock at
$.53 per share -- -- (520,248)
Change in unrealized gain on
securities available for
sale, net of tax of $5,564 -- -- 9,079
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 1,204,155 (20,580,295) 14,947,800
Net income -- -- 1,005,101
Purchase of treasury stock 95,042 (1,900,262) (1,900,262)
Issuance of treasury stock for
restricted stock awards (11,894) 176,923 --
Stock options exercised (1,746) 25,972 24,444
Amortization of stock awards -- -- 61,092
ESOP shares released -- -- 71,355
Dividends on common stock at
$.64 per share -- -- (509,550)
Change in unrealized gain on
securities available for
sale, net of tax of $6,118 -- -- 9,983
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 1,285,557 $(22,277,662) $13,709,963
========================================================================
</Table>
See Notes to Consolidated Financial Statements.
18
CHESTER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
<Table>
<Caption>
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Net income $1,005,101 $1,016,605 $1,091,382
Other comprehensive income, net of tax:
Unrealized holding gain on securities available for sale
(net of tax of $10,458, $54,109 and $83,899 for 2002,
2001 and 2000, respectively) 17,065 88,282 136,888
Less adjustment for realized gain included in net income
(net of tax benefit of $4,340, $48,545 and $16,469 for
2002, 2001 and 2000, respectively) (7,082) (79,203) (26,870)
- --------------------------------------------------------------------------------------------------
Total other comprehensive income (loss) 9,983 9,079 110,018
- --------------------------------------------------------------------------------------------------
Comprehensive income $1,015,084 $1,025,684 $1,201,400
==================================================================================================
</Table>
See Notes to Consolidated Financial Statements.
19
CHESTER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<Table>
<Caption>
Years Ended December 31, 2002, 2001 and 2000 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 1,005,101 $ 1,016,605 $ 1,091,382
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization:
Office properties and equipment 146,451 153,309 150,528
Deferred fees, discounts, and premiums (102,134) (87,399) 43,601
Amortization of stock plans 132,447 262,154 258,493
Provision for deferred taxes 77,896 9,397 (15,000)
Decrease in accrued interest receivable 21,927 330,475 42,530
Increase (decrease) in accrued interest payable (8,622) (125,907) 48,664
Purchases of trading securities (1,403,645) -- --
Proceeds from sale of trading securities 1,069,686 -- --
Unrealized loss on trading securities 10,068 -- --
Gain on sale of securities (140,082) (127,748) (43,339)
Provision for loan losses -- -- --
FHLB stock dividend (155,400) (97,000) (44,300)
Net change in other assets and other liabilities (246,547) 21,917 (333,383)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 407,146 1,355,803 1,199,176
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Investment securities:
Available-for-sale:
Purchases (900,000) (5,756,442) (1,741,082)
Proceeds from sales 1,667,527 4,883,555 2,258,282
Proceeds from calls and maturities -- 1,000,000 500,000
Held-to-maturity:
Purchases (42,885,000) (32,665,000) (2,700,000)
Proceeds from maturities and paydowns 40,026,000 32,896,145 4,149,000
Nonmarketable equity securities:
Purchases -- (2,150,000) --
Proceeds from sales 300,000 1,045,750 --
Mortgage-backed securities:
Available-for-sale:
Proceeds from sales 435,101 3,794,185 538,389
Proceeds from maturities and paydowns 69,383 910,817 1,509,219
Held-to-maturity:
Purchases -- (1,497,672) --
Proceeds from maturities and paydowns 3,335,901 5,393,027 4,214,016
Principal repayments on loans 12,329,882 13,447,983 9,661,854
Origination of loans (6,902,707) (7,367,780) (8,778,943)
Purchase of certificates of deposit (12,000,000) -- (1,000,000)
Proceeds from the maturity of certificates of deposit 12,000,000 1,000,000 --
Proceeds from sales of real estate acquired through
foreclosure 44,563 304,745 95,226
Purchase of office properties and equipment (23,727) (256,865) (50,283)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 7,496,923 14,982,448 8,655,678
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Increase (decrease) in deposits 3,433,925 (5,577,702) 6,238,545
Proceeds from (payments on) FHLB advances -- 5,000,000 (5,000,000)
Payments on federal funds purchased -- -- (2,807,000)
Increase (decrease) in advance payments by borrowers for
taxes and insurance (20,518) (211,023) 17,970
Purchase of treasury stock (1,900,262) (5,711,772) (2,040,452)
Exercise of stock options 24,444 12,222 91,644
Dividends paid (509,550) (520,248) (504,507)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 1,028,039 (7,008,523) (4,003,800)
- -----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 8,932,108 9,329,728 5,851,054
Cash and cash equivalents:
Beginning of year 21,018,082 11,688,354 5,837,300
- -----------------------------------------------------------------------------------------------------------
End of year $ 29,950,190 $ 21,018,082 $11,688,354
===========================================================================================================
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest $ 2,474,360 $ 4,139,873 $ 4,090,582
===========================================================================================================
Income taxes $ 260,562 $ 350,130 $ 777,099
===========================================================================================================
Supplemental Schedule of Noncash Investing and Financing
Activities
Loans transferred to real estate acquired by foreclosure $ 39,232 $ 164,544 $ 45,776
===========================================================================================================
</Table>
See Notes to Consolidated Financial Statements.
20
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS -- Chester Bancorp, Inc. and Subsidiaries (the
Company) provides a full range of financial services to individual and corporate
customers through its home office in Chester, Illinois, and its two banking
offices in neighboring cities in Southern Illinois and a banking office in
Perryville, Missouri. The Company is subject to competition from other financial
institutions in the area, is subject to the regulations of certain federal
agencies, and undergoes periodic examinations by those regulatory authorities.
The Company has not included segment disclosures regarding specific
segments since management makes operating decisions and assesses performance
based on the Company as a whole.
The significant accounting and reporting policies of the Company and its
subsidiaries follow:
BASIS OF CONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION -- The
financial statements include the accounts of the Company and its wholly owned
subsidiaries, Chester National Bank and Chester National Bank of Missouri.
Significant intercompany accounts and transactions have been eliminated in
consolidation.
The consolidated financial statements of the Company have been prepared in
conformity with accounting principles generally accepted in the United States of
America and conform to predominate practice within the banking industry.
In preparing the consolidated financial statements, Company management is
required to make estimates and assumptions, which significantly affect the
amounts reported in the consolidated financial statements. Significant estimates
which are particularly susceptible to change in a short period of time include
the market value of investment and mortgage-backed securities, the determination
of the allowance for loan losses and valuation of real estate and other
properties acquired in connection with foreclosures or in satisfaction of
amounts due from borrowers on loans. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS -- For purposes of reporting cash flows, cash
equivalents include cash and amounts due from depository institutions,
interest-bearing deposits in other depository institutions, excluding
certificates of deposits, and federal funds sold.
SECURITIES HELD TO MATURITY -- Debt securities and mortgage backed
securities for which the Company has both the positive intent and ability to
hold to maturity are classified as held-to-maturity and reported at amortized
cost. Amortization of premiums and accretion of discounts, computed by the
interest method over their contractual lives, is included in interest income.
SECURITIES AVAILABLE FOR SALE -- Securities classified as available for
sale are those debt securities, mortgage backed securities, mutual fund shares
and marketable equity securities that the Company intends to hold for an
indefinite period of time, but not necessarily to maturity. Any decision to sell
a security classified as available for sale would be based on various factors,
including significant movements in interest rates, changes in the maturity mix
of the Company's assets and liabilities, liquidity needs, regulatory capital
considerations, and other similar factors.
Securities available for sale are reported at fair value with unrealized
gains or losses reported as a separate component of other comprehensive income,
net of the related deferred tax effect. The amortization of premiums and
accretion of discounts, computed by the interest method over their contractual
lives, are recognized in interest income.
Realized gains or losses, determined on the basis of the cost of specific
securities sold, are included in earnings.
Declines in the fair value of individual securities classified as either
held to maturity or available for sale below their amortized cost that are
determined to be other than temporary result in write-downs of the individual
securities to their fair value with the resulting write-downs included in
current earnings as realized losses.
TRADING SECURITIES -- Trading securities, which are generally held for the
short term, in anticipation of market gains, are carried at fair value. Realized
and unrealized gains and losses on trading account securities are included in
current income as a component of other income.
NONMARKETABLE EQUITY SECURITIES -- Nonmarketable equity securities at
December 31, 2002 and 2001 include Federal Home Loan Bank and Federal Reserve
Bank stock. These securities are carried at cost, as they have no readily
ascertainable market value.
21
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS -- Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff is stated at the unpaid principal
amounts less the allowance for loan losses and net deferred loan origination
fees. Loan origination fees, net of certain direct loan origination costs are
deferred and amortized to interest income over the contractual lives of the
loans using the level yield method.
Interest on loans is accrued based upon the principal amounts outstanding.
The Company's policy is to discontinue the accrual of interest income on any
loan when, in the opinion of management, there is reasonable doubt as to the
timely collectibility of interest or principal or generally when a loan becomes
contractually past due ninety days or more with respect to principal or
interest. Accrued interest on nonaccrual loans is reversed and offset against
interest income in the period the loan is deemed uncollectible. Nonaccrual loans
are returned to accrual status when, in the opinion of management, the financial
position of the borrower indicates there is no longer any reasonable doubt as to
the timely collectibility of interest or principal.
ALLOWANCE FOR LOAN LOSSES -- The Company considers a loan to be impaired
when management believes it is probable that it will be unable to collect all
principal and interest due according to the contractual terms of the loan. If a
loan is impaired, the Company records a loss valuation equal to the excess of
the loan's carrying value over the present value of the estimated future cash
flows discounted at the loan's effective rate, based on the loan's observable
market price, or the fair value of the collateral if the loan is collateral
dependent. One-to-four family residential loans and consumer loans are
collectively evaluated for impairment. Loans on residential properties with
greater than four units and loans on construction and development and commercial
properties are evaluated for impairment on a loan-by-loan basis.
The allowance for loan losses is established through a provision for loan
losses charged to operating expenses. Loans are charged against the allowance
for loan losses when management believes that the collectibility of the
principal is unlikely. The allowance is an amount that management believes will
be adequate to absorb losses on existing loans that may become uncollectible,
based on evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as changes in
the nature and volume of the loan portfolio, overall portfolio quality, review
of specific problem loans and current economic conditions that may affect the
borrowers' ability to pay. While management uses the best information available
to make its evaluation, future adjustments to the allowance may be necessary if
there are significant changes in economic conditions. In addition, various
regulatory agencies periodically review the allowance for loan losses. These
agencies may require the Banks to make additions to the allowance for loan
losses based on their judgments of collectibility based on information available
to them at the time of their examination.
OFFICE PROPERTIES AND EQUIPMENT -- Office properties and equipment are
stated at cost, less accumulated depreciation. Depreciation charged to
operations is primarily computed utilizing the straight-line method over the
estimated useful lives of the related assets. Estimated lives are 10 to 35 years
for buildings and improvements, and 3 to 15 years for furniture and equipment.
Management periodically reviews the carrying value of its long-lived assets to
determine if impairment has occurred or whether changes in circumstances have
occurred that would require a revision to the remaining useful life. In making
such determination, management evaluates the performance, on an undiscounted
basis, of the underlying operations or assets, which give rise to such amount.
INCOME TAXES -- Deferred taxes are provided on a liability method which
recognizes deferred tax assets for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities for
taxable temporary differences. Temporary differences are the differences between
the reported amounts of assets and liabilities and their tax bases. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.
STOCK OPTION PLAN -- The Company has two stock-based employee compensation
plans which have been in existence for all periods presented, and which are more
fully described in Note 9. As permitted under accounting principles generally
accepted in the United States of America, grants of options under the plans are
accounted for under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
Because options granted under the plans had an exercise price equal to market
value of the
22
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
underlying common stock on the date of the grant, no stock-based employee
compensation cost is included in determining net income. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
For purposes of pro forma disclosures the estimated fair value of the stock
options is amortized to expense over the vesting period. The pro forma effects
on income for the years ended December 31, 2002, 2001 and 2000, based on options
granted from 1997 to 2001 are as follows:
<Table>
<Caption>
Year Ended December 31,
--------------------------------------
2002 2001 2000
- -----------------------------------------------------------------------------------------------
Net income, as reported $1,005,101 $1,016,605 $1,091,382
Deduct total stock-based compensation expense
determined under the fair value method for all
awards, net of related tax effects (86,805) (182,867) (167,634)
- -----------------------------------------------------------------------------------------------
Pro forma net income $ 918,296 $ 833,738 $ 923,748
===============================================================================================
Earnings per share:
Basic:
As reported $ 1.26 $ 1.00 $ 0.93
Pro forma $ 1.10 $ 0.82 $ 0.79
Diluted:
As reported $ 1.16 $ 0.97 $ 0.91
Pro forma $ 1.01 $ 0.79 $ 0.77
</Table>
The per share fair value of stock options granted in 2001 and 2000 were
estimated on the date of grant at $5.98 and $5.49, respectively, using the
Black-Scholes option-pricing model. The following assumptions were used to
determine the per share fair value of the stock options granted in 2001:
dividend yield of .14%; risk-free interest rate of 5.00%; expected volatility of
20.01%; and an estimated life of 7 years. The following assumptions were used to
determine the per share fair value of the stock options granted in 2000:
dividend yield of .14%; risk-free interest rate of 6.00%; expected volatility of
2.25%; and an estimated life of 7 years.
RECLASSIFICATION OF CERTAIN ITEMS -- Certain items on the financial
statements for the year ended December 31, 2001 have been reclassified, with no
effect on net income, or earnings per share, to be consistent with the
classifications adopted for the year ended December 31, 2002.
NET INCOME PER SHARE -- Basic earnings per share for the years ended
December 31, 2002, 2001, and 2000 are determined by dividing net income for the
year by the weighted average number of common shares. Shares acquired by the
ESOP are held in trust but were not considered in the weighted average shares
outstanding until the shares were committed for allocation.
Diluted earnings per share considers the potential dilutive effects of the
exercise of the outstanding stock options under the Bank's stock option plans as
well as unreleased ESOP shares.
23
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following reflects earnings per share calculations for basic and
diluted methods:
<Table>
<Caption>
2002 2001 2000
- -----------------------------------------------------------------------------------------------
Net income available to common shareholders $1,005,101 $1,016,605 $1,091,382
===============================================================================================
Basic potential common shares:
Weighted average shares outstanding $ 934,059 $1,157,790 $1,319,841
Weighted average ESOP shares unallocated (139,325) (145,560) (149,510)
- -----------------------------------------------------------------------------------------------
Basic average shares outstanding 794,734 1,012,230 1,170,331
- -----------------------------------------------------------------------------------------------
Diluted potential common shares:
Average stock option equivalents 69,893 39,483 31,818
- -----------------------------------------------------------------------------------------------
Diluted average shares outstanding 864,627 1,051,713 1,202,149
- -----------------------------------------------------------------------------------------------
Basic earnings per share $ 1.26 $ 1.00 $ 0.93
===============================================================================================
Diluted earnings per share $ 1.16 $ 0.97 $ 0.91
===============================================================================================
</Table>
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS -- In June 2001, Statement on
Financial Accounting Standards No. 143 Accounting for Asset Retirement
Obligations was issued to address financial reporting and obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. This Statement applies to all entities and to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development or normal operations of a long-lived
asset, except for certain obligations of lessees. Statement No. 143 is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
Management does not believe the adoption of Statement No. 143 will have a
significant impact on the financial statements.
NOTE 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES
The amortized cost and fair value of investment and mortgage-backed
securities available for sale follow:
<Table>
<Caption>
December 31, 2002
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
- -------------------------------------------------------------------------------------------------
Securities of states and municipalities $ 900,000 $ -- $ (137) $ 899,863
- -------------------------------------------------------------------------------------------------
Total $ 900,000 $ -- $ (137) $ 899,863
=================================================================================================
</Table>
<Table>
<Caption>
December 31, 2001
- -------------------------------------------------------------------------------------------------
Mutual fund shares $1,659,955 $ -- $(27,478) $1,632,477
Mortgage-backed securities 500,338 11,240 -- 511,578
- -------------------------------------------------------------------------------------------------
Total $2,160,293 $11,240 $(27,478) $2,144,055
=================================================================================================
</Table>
24
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES (CONTINUED)
The amortized cost and fair value of investment and mortgage-backed
securities classified as held to maturity follow:
<Table>
<Caption>
December 31, 2002
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
- -------------------------------------------------------------------------------------------------
Securities of U.S. government and
agencies $27,866,601 $ 337,686 $ -- $28,204,287
Mortgage-backed bonds 1,000,000 34,444 -- 1,034,444
Securities of states and municipalities 6,179,457 389,180 (1,091) 6,567,546
Corporate bonds 2,505,795 212,667 -- 2,718,462
------------------------------------------------------
Investment securities 37,551,853 973,977 (1,091) 38,524,739
Mortgage-backed securities 3,240,925 137,483 -- 3,378,408
- -------------------------------------------------------------------------------------------------
Total $40,792,778 $1,111,460 $ (1,091) $41,903,147
=================================================================================================
</Table>
<Table>
<Caption>
December 31, 2001
- -------------------------------------------------------------------------------------------------
Securities of U.S. government and
agencies $25,900,566 $ 432,251 $ (7,810) $26,325,007
Mortgage-backed bonds 1,000,000 824 -- 1,000,824
Securities of states and municipalities 7,671,786 320,922 (45,486) 7,947,222
------------------------------------------------------
Investment securities 34,572,352 753,997 (53,296) 35,273,053
Mortgage-backed securities 6,598,411 96,586 (5,655) 6,689,342
- -------------------------------------------------------------------------------------------------
Total $41,170,763 $ 850,583 $(58,951) $41,962,395
=================================================================================================
</Table>
The amortized cost and fair value at December 31, 2002, by contractual
maturity, are shown below. Maturities may differ from contractual maturities in
mortgage-backed securities because the mortgages underlying the securities may
be called or repaid without any penalties. Therefore, stated maturities are not
disclosed.
<Table>
<Caption>
Available for Sale Held to Maturity
--------------------- --------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- ------------------------------------------------------------------------------------------------
One year or less $900,000 $899,863 $ 3,438,389 $ 3,505,187
One year through five years -- -- 22,194,715 22,672,137
Five years through ten years -- -- 9,036,075 9,217,684
Over ten years -- -- 2,882,674 3,129,731
- ------------------------------------------------------------------------------------------------
Investment securities 900,000 899,863 37,551,853 38,524,739
Mortgage-backed securities -- -- 3,240,925 3,378,408
- ------------------------------------------------------------------------------------------------
$900,000 $899,863 $40,792,778 $41,903,147
================================================================================================
</Table>
25
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES (CONTINUED)
Gross realized gains and (losses) from the sale of investment and
mortgage-backed securities follow:
<Table>
<Caption>
For the Year Ended
December 31,
--------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------
Gross realized gains:
Trading securities $ 28,660 $ -- $ --
Nonmarketable securities 100,000 -- --
Available for sale securities 12,330 127,748 66,366
- ---------------------------------------------------------------------------------------------
Gross realized gains 140,990 127,748 66,366
- ---------------------------------------------------------------------------------------------
Gross realized (losses) on available for sale securities (908) -- (23,027)
- ---------------------------------------------------------------------------------------------
Net gains $140,082 $127,748 $ 43,339
=============================================================================================
</Table>
Investment securities and mortgage backed securities with a carrying value
of approximately $3,900,000 and $2,500,000 at December 31, 2002 and 2001,
respectively, were pledged to collateralize certain deposit accounts with
balances in excess of $100,000 and for other purposes as required or permitted
by law.
NOTE 3. LOANS
Loans consist of:
<Table>
<Caption>
December 31,
-------------------------------
2002 2001
- ----------------------------------------------------------------------------------------------
Loans secured by real estate:
Residential:
1-4 family $28,760,735 $32,659,775
Multifamily 253,439 377,190
- ----------------------------------------------------------------------------------------------
Total residential 29,014,174 33,036,965
Agricultural and land 317,040 367,487
Commercial 2,599,323 3,307,068
- ----------------------------------------------------------------------------------------------
Total loans secured by real estate 31,930,537 36,711,520
- ----------------------------------------------------------------------------------------------
Commercial loans 1,748,128 2,235,990
- ----------------------------------------------------------------------------------------------
Consumer loans:
Automobile loans 554,611 680,857
Home improvement 503,819 678,686
Credit cards 549,316 617,681
Loans secured by deposits 454,394 409,536
Other 470,627 358,924
- ----------------------------------------------------------------------------------------------
Total consumer loans 2,532,767 2,745,684
- ----------------------------------------------------------------------------------------------
Total loans 36,211,432 41,693,194
- ----------------------------------------------------------------------------------------------
Less:
Deferred loan fees, net 2,654 5,577
Allowance for loan losses 575,234 590,590
- ----------------------------------------------------------------------------------------------
577,888 596,167
- ----------------------------------------------------------------------------------------------
Loans, net $35,633,544 $41,097,027
==============================================================================================
</Table>
26
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 3. LOANS (CONTINUED)
The Banks utilize their data processing system to identify loan payments
not made by their contractual due date and calculate the number of days each
loan exceeds the contractual due date. The accrual of interest on any loan is
discontinued when in the opinion of management; there is reasonable doubt as to
the collectibility of interest and principal, or the loan reaches ninety days
past due. Total loans no longer accruing interest as of December 31, 2002, 2001
and 2000 were $53,635, $128,756 and $129,861, respectively.
Activity in the allowance for loan losses follows:
<Table>
<Caption>
Year Ended December 31,
--------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------
Balance, beginning of year $590,590 $597,580 $605,347
Provision -- -- --
Charge-offs (19,642) (16,250) (21,952)
Recoveries 4,286 9,260 14,185
- ---------------------------------------------------------------------------------------------
Balance, end of year $575,234 $590,590 $597,580
=============================================================================================
</Table>
The Banks have granted loans to officers and directors and related
interests. In management's opinion, these loans and transactions were on the
same terms as those for comparable loans and transactions with nonrelated
parties. At December 31, 2002, all loans to officers and directors were current
with respect to principal and interest. Changes in loans to officers and
directors for the year ended December 31, 2002 are summarized as follows:
<Table>
Balance beginning of year $428,860
Additions 435,241
Repayments (482,076)
- ------------------------------------------------------------------------
Balance, end of year $382,025
========================================================================
</Table>
NOTE 4. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consist of:
<Table>
<Caption>
December 31,
------------------------
2002 2001
- ----------------------------------------------------------------------------------------
Land $ 167,227 $ 167,227
Office buildings and improvements 2,235,585 2,234,001
Furniture, fixtures and equipment 1,508,976 1,486,834
- ----------------------------------------------------------------------------------------
3,911,788 3,888,062
Less accumulated depreciation 2,507,005 2,360,555
- ----------------------------------------------------------------------------------------
Total $1,404,783 $1,527,507
========================================================================================
</Table>
NOTE 5. DEPOSITS
Certificates of deposit of $100,000 or more totaled $12,357,790 and
$10,315,536 at December 31, 2002 and 2001, respectively.
27
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 5. DEPOSITS (CONTINUED)
At December 31, 2002, the scheduled maturities of certificates of deposit
were as follows:
<Table>
<Caption>
Amount
- ---------------------------------------------------------------------------
2003 $41,316,510
2004 6,958,716
2005 3,331,689
2006 245,679
- ---------------------------------------------------------------------------
Total $51,852,594
===========================================================================
</Table>
At December 31, 2002 and 2001, the Banks had deposits totaling
approximately $27,700,000 and $21,800,000, respectively, from a corporation to
which the Company's Chairman of the Board is an executive officer.
NOTE 6. FHLB ADVANCES
Advances from the Federal Home Loan Bank totaled $5,000,000 at December 31,
2002 and 2001. The advances bear interest at 4.8% and mature on January 17,
2011. Pursuant to collateral agreements with the FHLB, advances are
collateralized by all the institution's stock in the FHLB and qualifying first
mortgage loans.
NOTE 7. INCOME TAXES
Under provisions of the Internal Revenue Code and similar sections of state
income tax laws that apply to tax years beginning before December 31, 1995,
qualifying thrifts were allowed to claim bad debt deductions based on the
greater of (1) a specified percentage of taxable income, as defined, or (2)
actual loss experience. If, in the future, any of the accumulated bad debt
deductions are used for any purpose other than to absorb bad debt losses, gross
taxable income may result and income taxes may be payable.
The Small Business Job Protection Act became law on August 20, 1996. One of
the provisions in this law repealed the reserve method of accounting for bad
debts for thrift institutions so that the bad debt deduction described in the
preceding paragraph will no longer be effective for tax years beginning after
December 31, 1995. The change in the law requires that the tax bad debt reserves
accumulated after December 31, 1987 be recaptured into taxable income over a
six-year period. The start of the six-year period can be delayed for up to two
tax years if the Company meets certain residential lending thresholds. Deferred
taxes have been provided on the portion of the tax reserve for loan loss that
must be recaptured.
Retained earnings at December 31, 2002 and 2001 includes approximately
$2,066,000 of the tax reserve which accumulated prior to 1988, for which no
deferred income tax liability has been recognized. This amount represents an
allocation of income to bad debt deductions for tax purposes only. Reduction of
amounts so allocated for purposes other than tax bad debt losses or adjustments
arising from carryback of net operating losses would create income for tax
purposes only, which would be subject to the then-current corporate income tax
rate. The unrecorded deferred income tax liability on the above amounts was
approximately $800,000 as of December 31, 2002 and 2001.
28
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 7. INCOME TAXES (CONTINUED)
Income taxes for the years ended December 31, 2002, 2001 and 2000 are
summarized as follows:
<Table>
<Caption>
Year Ended December 31,
--------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------
Current:
Federal $119,472 $361,225 $442,704
State 8,665 22,116 11,030
- ---------------------------------------------------------------------------------------------
Total current 128,137 383,341 453,734
Deferred 77,896 9,397 (15,000)
- ---------------------------------------------------------------------------------------------
Total $206,033 $392,738 $438,734
=============================================================================================
</Table>
Income tax expense differs from that computed at the maximum Federal
statutory rate of 35% as follows:
<Table>
<Caption>
Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000
------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent
- ----------------------------------------------------------------------------------------------------
Computed "expected" income tax
expense $423,897 35.0% $493,270 35.0% $535,541 35.0%
Items affecting federal income
tax rate:
Amortization of ESOP awards (32,586) (2.7)% (4,960) (0.4)% (2,009) (0.1)%
State income taxes, net of
Federal benefit 5,632 0.5% 14,375 1.0% 7,170 0.5%
Tax-exempt interest (115,782) (9.6)% (96,734) (6.9)% (121,848) (8.0)%
Other (75,128) (6.2)% (13,213) (0.8)% 19,880 1.3%
- ----------------------------------------------------------------------------------------------------
$206,033 17.0% $392,738 27.9% $438,734 28.7%
====================================================================================================
</Table>
The components of the deferred tax assets and liabilities follow:
<Table>
<Caption>
December 31,
--------------------
2002 2001
- ------------------------------------------------------------------------------------
Deferred tax assets:
General loan loss allowance $222,213 $228,069
Restricted stock awards -- 48,418
Other 12,886 15,885
Available-for-sale securities market valuation 53 6,171
- ------------------------------------------------------------------------------------
Total deferred tax assets 235,152 298,543
- ------------------------------------------------------------------------------------
Deferred tax liabilities:
Excess of tax bad debt reserves over base year (5,679) (37,513)
Tax depreciation in excess of that recorded for book
purposes (18,898) (31,223)
FHLB stock dividends (155,811) (98,685)
Other (7,656) --
- ------------------------------------------------------------------------------------
Total deferred tax liabilities (188,044) (167,421)
- ------------------------------------------------------------------------------------
Net deferred tax asset $ 47,108 $131,122
====================================================================================
</Table>
29
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 8. REGULATORY CAPITAL REQUIREMENTS
The Company and the Banks 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 financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and Banks must meet specific capital guidelines that involve
quantitative measures of the Company and Banks' assets, liabilities, and certain
off- balance-sheet items as calculated under regulatory accounting practices.
The Company and Banks' 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 Banks to maintain minimum amounts and ratios (set forth
in the table below) of total and Tier I capital (as defined in the regulations)
to risk- weighted assets (as defined) and Tier I capital (as defined) to average
assets (as defined). Management believes, at December 31, 2002, that the Company
and Banks meet all capital adequacy requirements to which they are subject.
As of December 31, 2002, the most recent notification from the regulatory
agencies categorized the Banks as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed the Banks'
category.
The Company's primary source of cash is dividends received from the Banks.
By regulation, the Banks are prohibited from paying dividends in excess of the
current year's net income plus the retained net earnings from the prior two
years, without regulatory approval. At December 31, 2002, the Banks had
approximately $819,000 of retained earnings available for the payment of
dividends without obtaining prior regulatory approval and have been receiving
approval for special dividends for the past three years. As a practical matter,
dividends distributed by the Banks are restricted to amounts that maintain
prudent capital levels.
During 2002, the Company received regulatory approval from their primary
regulators to restructure the capital of the organization to better utilize the
capital. As a result, Chester National Bank and Chester National Bank of
Missouri provided $2,500,000 and $1,000,000, respectively to Chester Bancorp,
Inc.
30
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 8. REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
The Company's and the Banks' actual capital amounts and ratios were as
follows:
<Table>
<Caption>
December 31, 2002
------------------------------------------------------
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
---------------- --------------- ---------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total capital (to risk-weighted
assets):
Company $14,230 33.9% $3,353 8.0% $-- N/A
Chester National Bank 9,935 26.9% 2,951 8.0% 3,689 10.0%
Chester National Bank of Missouri 2,728 58.3% 374 8.0% 468 10.0%
Tier I capital (to risk-weighted
assets):
Company 13,710 32.7% 1,677 4.0% -- N/A
Chester National Bank 9,474 25.7% 1,475 4.0% 2,213 6.0%
Chester National Bank of Missouri 2,669 57.0% 187 4.0% 281 6.0%
Tier I capital (to average assets):
Company 13,710 12.0% 4,553 4.0% -- N/A
Chester National Bank 9,474 9.1% 4,143 4.0% 5,179 5.0%
Chester National Bank of Missouri 2,669 28.2% 378 4.0% 473 5.0%
</Table>
<Table>
<Caption>
December 31, 2001
------------------------------------------------------
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
---------------- --------------- ---------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total capital (to risk-weighted
assets):
Company $15,495 35.7% $3,476 8.0% $-- N/A
Chester National Bank 11,759 30.7% 3,064 8.0% 3,829 10.0%
Chester National Bank of Missouri 3,602 71.3% 404 8.0% 505 10.0%
Tier I capital (to risk-weighted
assets):
Company 14,958 34.4% 1,738 4.0% -- N/A
Chester National Bank 11,286 29.5% 1,532 4.0% 2,298 6.0%
Chester National Bank of Missouri 3,538 70.1% 202 4.0% 303 6.0%
Tier I capital (to average assets):
Company 14,958 13.3% 3,362 3.0% -- N/A
Chester National Bank 11,286 11.2% 3,014 3.0% 5,024 5.0%
Chester National Bank of Missouri 3,538 31.4% 338 3.0% 563 5.0%
</Table>
NOTE 9. EMPLOYEE BENEFITS
DEFINED BENEFIT PENSION PLAN -- Substantially all employees are included in
a trusteed defined benefit pension plan. The benefits contemplated by the plan
are funded through payments to the Financial Institutions Retirement Fund, which
operates as an industry-wide plan and does not report relative plan assets and
actuarial liabilities of the individual
31
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 9. EMPLOYEE BENEFITS (CONTINUED)
participating associations. The cost of funding is charged to current
operations. There is no unfunded liability for past service. Expense for the
years ended December 2002, 2001 and 2000 was $27,944, $66,000 and $24,000,
respectively.
EMPLOYEE STOCK OWNERSHIP PLAN -- The Company has an employee stock
ownership plan which covers substantially all employees who have attained the
age of 21 and completed one year of service. In connection with the conversion
to a stock corporation, the ESOP purchased 174,570 shares of the Company's
common stock at a subscription price of $10.00 per share using funds loaned by
the Company. The Company loan is being repaid with level principal payments over
30 years. During October 2002, the loan was restructured to a term of forty
years. All shares are held in a suspense account for allocation among the
participants as the loan is repaid. Shares released from the suspense account
are allocated among the participants based upon their pro rata annual
compensation. The purchases of the shares by the ESOP were recorded by the
Company as unearned ESOP shares in a contra equity account. As ESOP shares are
committed to be released to compensate employees, the contra equity account is
reduced and the Company recognizes compensation expense equal to the fair market
value of the shares committed to be released. Dividends on allocated ESOP shares
are recorded as a reduction of retained earnings; dividends on unallocated ESOP
shares are recorded as a reduction of debt. Compensation expense related to the
ESOP was $71,355, $95,960 and $92,299 for the years ended December 31, 2002,
2001 and 2000, respectively.
The ESOP shares follow:
<Table>
<Caption>
December 31,
------------------------
2002 2001
- ----------------------------------------------------------------------------------------
Allocated shares 35,308 31,758
Unreleased shares 139,262 142,812
- ----------------------------------------------------------------------------------------
Total ESOP shares 174,570 174,570
========================================================================================
Fair value of unreleased shares $3,103,871 $2,649,163
========================================================================================
</Table>
RESTRICTED STOCK AWARDS -- The 1997 Management Recognition and Development
Plan provides that 82,921 shares of common stock can be awarded to directors and
employees in key management positions to encourage such directors and key
employees to remain with the Company. The shares vest over a five-year period
beginning on the adoption date. The value of the common stock contributed to the
Plan is being amortized to compensation expense over the vesting period.
Compensation expense was $61,092 for the years ended December 31, 2002 and
$166,194 for both of the years ended 2001 and 2000.
STOCK OPTION PLAN -- The 1997 Stock Option Plan provides for the granting
of options for a maximum of 218,212 shares of common stock to directors, key
officers and employees. The options vest in five equal installments beginning on
the first anniversary of the grant date of the options.
On April 4, 2000, the Company adopted the 2000 Stock Option Plan, which
provided for the granting of options for a maximum of 50,000 shares of common
stock to directors, key officers and employees. Interest in the plan for each
participant vests in five equal installments beginning on the first anniversary
of the grant date of the options.
32
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 9. EMPLOYEE BENEFITS (CONTINUED)
Activity within the plan is summarized as follows:
<Table>
<Caption>
Year Ended December 31,
---------------------------------------------------------------
2002 2001 2000
------------------- ------------------- -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Fixed Options Shares Price Shares Price Shares Price
- ------------------------------------------------------------------------------------------------
Outstanding at beginning of
year 237,302 $14.56 224,612 $14.42 216,468 $14.24
Granted -- -- 14,000 17.00 16,000 16.69
Exercised (1,746) 14.00 (873) 14.00 (6,546) 14.00
Forfeited (436) 14.00 (437) 14.00 (1,310) 14.00
------- ------- -------
Outstanding at end of year 235,120 14.57 237,302 14.56 224,612 14.42
======= ======= =======
Options exercisable at
year-end 214,028 166,598 121,676
======= ======= =======
Weighted-average fair value of
options granted during the
year N/A $ 5.98 $ 5.49
====== ====== ======
</Table>
NOTE 10. CONTINGENCIES
The Company is a defendant in legal actions arising from normal business
activities. Management, after consultation with legal counsel, believes that the
resolution of these actions will not have any material adverse effect on the
Company's consolidated financial statements.
NOTE 11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATION OF
CREDIT RISK
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers in
the way of commitments to extend credit. They involve, to varying degrees,
elements of credit risk in excess of the amount recognized in the balance
sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as they
do for on-balance-sheet instruments. Substantially all commitments to extend
credit are at adjustable rates. The Company has not issued any standby letters
of credit. A summary of the Company's commitments is as follows:
<Table>
<Caption>
Range of Rates
Variable Rate Fixed Rate Total on Fixed Rate
Commitments to extend credit Commitments Commitments Commitments Commitments
- ---------------------------------------------------------------------------------------------
December 31, 2002 $1,298,015 $3,845,838 $5,143,853 5.25% - 12.9%
December 31, 2001 $ 842,483 $2,937,132 $3,779,615 7.0% - 12.9%
</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. Since
many of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
Credit card commitments are unsecured.
Substantially all of the Company's loans are to borrowers located in
Randolph, Jackson, Williamson and Perry counties in Illinois and Perry and Cape
Girardeau counties in Missouri.
33
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 12. LIQUIDATION ACCOUNT
At the time of conversion to a stock corporation, the Bank established a
liquidation account for the benefit of eligible savings account holders who
continue to maintain their savings accounts with the Bank after conversion. In
the event of a complete liquidation of the Bank (and only in such event),
eligible savings account holders who continue to maintain their accounts with
the Bank shall be entitled to receive a distribution from the liquidation
account after payment to all creditors but before any liquidation distribution
with respect to common stock. The initial liquidation account was established at
approximately $11.9 million. This account is proportionately reduced for any
subsequent reduction in the eligible holders' deposit accounts. The creation and
maintenance of the liquidation account will not restrict the use or application
of any of the capital accounts of the Company, except that the Company may not
declare or pay a cash dividend on, or purchase any of, its capital stock, if the
effect of such dividends or repurchase would be to cause the Company's net worth
to be reduced below the aggregate amount then required for the liquidation
account, or the amount required by federal or state law. Due to various natural
events, such as death, relocation and general attrition of accounts, the balance
in the liquidation account has been reduced to approximately $6.2 million as of
December 31, 2002.
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has estimated fair value amounts by using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Approximate carrying values and fair values are summarized below:
<Table>
<Caption>
December 31,
--------------------------------------------------------
2002 2001
-------------------------- --------------------------
Carrying Fair Carrying Fair
Value Value Value Value
- -------------------------------------------------------------------------------------------------
Interest-earning assets:
Cash and cash equivalents $29,950,190 $29,950,190 $21,018,082 $21,018,082
Investment securities 42,306,667 43,279,553 39,751,829 40,452,530
Mortgage-backed securities 3,240,925 3,378,408 7,109,989 7,200,920
Loans 35,633,544 36,275,000 41,097,027 41,513,000
Accrued interest receivable 756,248 756,248 778,175 778,175
Interest-bearing liabilities:
Deposits:
Checking, money market demand,
and passbooks 42,995,115 42,995,115 38,089,911 38,089,911
Certificates of deposit 51,852,594 52,324,515 53,323,873 53,946,174
Fixed-term advances from FHLB 5,000,000 5,000,000 5,000,000 5,000,000
Accrued interest payable 53,204 53,204 61,826 61,826
</Table>
The carrying value of cash and cash equivalents, checking, money market,
demand and passbooks are considered reasonable estimates of those instruments
fair values.
The fair value of investment securities, mortgage-backed securities and
trading securities is based on quoted market prices and prices obtained from
independent pricing services. Nonmarketable securities, for which current market
values are not readily available, are believed to have carrying values, which
approximate market values. The fair value of loans and certificates of deposit,
are estimated based on present values using published rates currently available
that are applicable to each category of such financial instruments. The carrying
value of accrued interest receivable and accrued interest payable approximates
its fair value.
34
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
No adjustment was made to the interest rates for changes in credit of
performing loans for there are no known credit concerns. Management segregates
loans in appropriate risk categories. Management believes that the risk factor
embedded in the interest rates along with the general reserves applicable to the
performing loan portfolio results in a fair valuation of such loans.
The fair value of fixed-term advances from FHLB is based on the discounted
value of contractual cash flows. The discount rate is estimated using rates
currently available to the Company for similar terms to maturity.
The Company does not have unrecognized financial instruments, other than
those discussed in Note 11, which are subject to fair value disclosure. The
difference between the fair value and the face value for the instruments
disclosed in Note 11 was not considered material.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2002 and 2001. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
NOTE 14. PARENT COMPANY FINANCIAL INFORMATION
The following are condensed balance sheets and condensed statements of
income and cash flows for Chester Bancorp, Inc. (parent company only):
CONDENSED BALANCE SHEETS
<Table>
<Caption>
December 31,
---------------------
(In thousands) 2002 2001
- -------------------------------------------------------------------------------------
Assets:
Cash $ 1,419 $ 123
Investment securities 352 200
Investment in subsidiaries 12,143 14,815
Other assets 4 48
- -------------------------------------------------------------------------------------
$13,918 $15,186
=====================================================================================
Liabilities and stockholders' equity:
Other liabilities $ 208 $ 238
Stockholders' equity 13,710 14,948
- -------------------------------------------------------------------------------------
$13,918 $15,186
=====================================================================================
</Table>
35
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 14. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
Year Ended December 31,
----------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------
Interest income $ 8 $ 12 $ 20
Dividend income from subsidiaries 185 5,300 2,458
Gain on sale of investments, including trading
securities 129 23 --
Unrealized (loss) on trading securities (10) -- --
- ----------------------------------------------------------------------------------------------
312 5,335 2,478
Net operating expenses 169 280 287
- ----------------------------------------------------------------------------------------------
Income before income tax (benefit) and equity in
undistributed earnings of subsidiaries 143 5,055 2,191
Income tax (benefit) (43) (80) (122)
- ----------------------------------------------------------------------------------------------
Income before equity in undistributed earnings of
subsidiaries 186 5,135 2,313
Equity in undistributed earnings of subsidiaries 819 (4,118) (1,222)
- ----------------------------------------------------------------------------------------------
$1,005 $ 1,017 $ 1,091
==============================================================================================
</Table>
CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
Year Ended December 31,
-----------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------
Operating activities:
Net income $ 1,005 $ 1,017 $ 1,091
Equity in undistributed earnings of subsidiaries (819) 4,118 1,222
Purchases of trading securities (1,403) -- --
Proceeds from sale of trading securities 1,041 -- --
Unrealized loss on trading securities 10 -- --
Amortization of stock plans 133 262 258
Other, net 15 2 (252)
- ----------------------------------------------------------------------------------------------
Net cash provided by (used in) operating
activities (18) 5,399 2,319
- ----------------------------------------------------------------------------------------------
Investing activities -- decrease in investment
securities 200 873 199
- ----------------------------------------------------------------------------------------------
Net cash provided by investing activities 200 873 199
- ----------------------------------------------------------------------------------------------
Financing activities:
Purchase of treasury stock (1,900) (5,712) (2,040)
Dividends paid (510) (520) (505)
Stock options exercised 24 12 92
Capital restructure 3,500 -- --
- ----------------------------------------------------------------------------------------------
Net cash (used in) provided by financing
activities 1,114 (6,220) (2,453)
- ----------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 1,296 52 65
Cash and cash equivalents at beginning of year 123 71 6
- ----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,419 $ 123 $ 71
==============================================================================================
</Table>
36
CHESTER BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
<Table>
<Caption>
Year Ended December 31, 2002
------------------------------------------------------
Three Months Ended
(Thousands of dollars, ------------------------------------------------------
except per share data) December 31, September 30, June 30, March 31,
- -----------------------------------------------------------------------------------------------
Interest income $1,265 $1,296 $1,439 $1,457
Interest expense 592 606 616 652
- -----------------------------------------------------------------------------------------------
Net interest income 673 690 823 805
Provision for losses on loans -- -- -- --
- -----------------------------------------------------------------------------------------------
Net interest income after provision
for losses on loans 673 690 823 805
Noninterest income 184 63 62 69
Noninterest expense 478 546 558 575
- -----------------------------------------------------------------------------------------------
Income before income taxes 379 207 327 299
Income taxes 23 46 86 52
- -----------------------------------------------------------------------------------------------
Net income $ 356 $ 161 $ 241 $ 247
===============================================================================================
Basic earnings per share $ 0.45 $ 0.20 $ 0.29 $ 0.30
===============================================================================================
Diluted earnings per share $ 0.41 $ 0.18 $ 0.27 $ 0.28
===============================================================================================
</Table>
<Table>
<Caption>
Year Ended December 31, 2001
------------------------------------------------------
Three Months Ended
(Thousands of dollars, ------------------------------------------------------
except per share data) December 31, September 30, June 30, March 31,
- -----------------------------------------------------------------------------------------------
Interest income $1,542 $1,834 $1,945 $2,021
Interest expense 789 986 1,080 1,159
- -----------------------------------------------------------------------------------------------
Net interest income 753 848 865 862
Provision for losses on loans -- -- -- --
- -----------------------------------------------------------------------------------------------
Net interest income after provision
for losses on loans 753 848 865 862
Noninterest income 109 118 98 61
Noninterest expense 562 589 577 577
- -----------------------------------------------------------------------------------------------
Income before income taxes 300 377 386 346
Income taxes 77 110 106 99
- -----------------------------------------------------------------------------------------------
Net income $ 223 $ 267 $ 280 $ 247
===============================================================================================
Basic earnings per share $ 0.27 $ 0.26 $ 0.25 $ 0.22
===============================================================================================
Diluted earnings per share $ 0.27 $ 0.25 $ 0.24 $ 0.21
===============================================================================================
</Table>
37
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
<Table>
BOARD OF DIRECTORS TRANSFER AGENT
Michael W. Welge, Chairman Registrar and Transfer Company
John R. Beck, M.D. 10 Commerce Drive
Edward K. Collins Cranford, NJ 07016
James C. McDonald (800) 368-5948
Thomas E. Welch, Jr.
Carl H. Welge FDIC DISCLAIMER
CORPORATE HEADQUARTERS This Annual Report has not been
reviewed, or confirmed for accuracy
1112 State Street or relevance, by the FDIC.
Chester, IL 62233
(618) 826-5038 GENERAL INQUIRIES AND REPORTS
ANNUAL MEETING A copy of the Company's 2002 Annual Report to
the Securities and Exchange Commission, Form
Friday, April 11, 2003 10-K, may be obtained without charge by written
10:00 A.M. request of shareholders to:
American Legion Hall Michael W. Welge, President
500 E. Opdyke St. Chester Bancorp, Inc.
Chester, IL 62233 1112 State Street
Chester, IL 62233
STOCK LISTING
Nasdaq SmallCap Market
Symbol: CNBA
INDEPENDENT AUDITORS
McGladrey & Pullen, LLP
15 South Old State Capitol Plaza, Suite 200
Springfield, IL 62705
</Table>
[CHESTER BANCORP, INC. LOGO]
1112 State Street - Chester, Illinois 62233 - Telephone (618) 826-5038