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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-24834
MILTON FEDERAL FINANCIAL CORPORATION
(Name of registrant as specified in its charter)
Ohio 31-1412064
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
25 Lowry Drive, West Milton, Ohio 45383
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (937) 698-4168
Securities registered pursuant to Section 12(b)
of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Shares, without par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ X ]
Based upon the last sale price provided by The Nasdaq Stock Market, the
aggregate market value of the voting stock held by nonaffiliates of the issuer
on November 30, 1999, was $26,381,187.
2,099,995 of the registrant's common shares were issued and outstanding on
November 30, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE
The following sections of the definitive Proxy Statement for the 2000 Annual
Meeting of Shareholders of Milton Federal Financial Corporation are incorporated
by reference into Part III of this Form 10-K:
1. Board of Directors;
2. Executive Officers;
3. Compensation of Executive Officers and Directors;
4. Voting Securities and Ownership of Certain Beneficial Owners
and Management;
5. Certain Transactions with MFFC.
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PART I
ITEM 1. BUSINESS
Milton Federal Financial Corporation, an Ohio corporation ("MFFC"), is a unitary
savings and loan holding company which owns all of the issued and outstanding
common shares of Milton Federal Savings Bank ("Milton Federal"), a federal
savings bank chartered under the laws of the United States, together referred to
as the Corporation. On October 6, 1994, MFFC acquired all of the common shares
issued by Milton Federal upon its conversion from a mutual savings and loan
association to a stock savings bank (the "Conversion"). Prior to the Conversion,
Milton Federal's name was Milton Federal Savings and Loan Association.
GENERAL
Milton Federal is principally engaged in the business of making permanent
first-mortgage loans secured by one- to four-family residential real estate
located in Milton Federal's designated lending area. Milton Federal also
originates loans for the construction of one- to four-family residential real
estate and loans secured by multi-family real estate (over four units) and
nonresidential real estate. The origination of consumer loans, including
unsecured loans and loans secured by deposits, automobiles, recreational
vehicles and boats, and home improvement and commercial loans constitutes a
small portion of Milton Federal's lending activities. Loan funds are obtained
primarily from savings deposits, borrowings from the Federal Home Loan Bank (the
"FHLB"), and loan and security repayments. In addition to originating loans,
Milton Federal invests in U.S. Government and agency obligations,
interest-bearing deposits in other financial institutions, mortgage-backed
securities that include collateralized mortgage obligations ("CMOs") and real
estate mortgage investment conduits ("REMICs").
Milton Federal conducts business from its main office in West Milton, Ohio, and
from its full-service branch offices located in Englewood, Brookville and Tipp
City, Ohio. Milton Federal's designated lending area consists of portions of
Miami, Montgomery and Darke Counties, Ohio. Milton Federal's primary market area
for savings deposits consists of Miami and Montgomery Counties and all
contiguous counties.
As a savings and loan holding company, MFFC is subject to regulation,
supervision and examination by the Office of Thrift Supervision of the United
States Department of the Treasury (the "OTS"). As a savings bank chartered under
the laws of the United States, Milton Federal is subject to regulation,
supervision and examination by the OTS and the Federal Deposit Insurance
Corporation (the "FDIC"). Deposits in Milton Federal are insured up to
applicable limits by the FDIC. Milton Federal is also a member of the FHLB of
Cincinnati.
Other than investing excess funds from the Conversion in securities, MFFC's
activities have been limited primarily to holding the common stock of Milton
Federal since acquiring such common stock in connection with the Conversion.
Consequently, the following discussion focuses primarily on the business of
Milton Federal.
FORWARD LOOKING STATEMENTS
When used in this Form 10-K, the words or phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimated," "projected," 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 changes in
economic conditions in the Corporation's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Corporation's market area and competition, that could cause actual results to
differ materially from historical earnings and those presently anticipated or
projected. Factors listed above could affect the
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Corporation's financial performance and could cause the Corporation's actual
results for future periods to differ materially from any statements expressed
with respect to future periods. See Exhibit 99.2 hereto, "Safe Harbor Under the
Private Securities Litigation Reform Act of 1995," which is incorporated by
reference.
The Corporation does not undertake, and specifically disclaims any obligation,
to publicly revise 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.
LENDING ACTIVITIES
GENERAL. Milton Federal's primary lending activity is the origination of
conventional mortgage loans secured by one- to four-family residential real
estate located in Milton Federal's designated lending area. Loans for the
construction of one- to four-family homes and mortgage loans on multi-family
properties containing five units or more and nonresidential properties are also
offered by Milton Federal. Milton Federal does not originate loans insured by
the Federal Housing Authority or loans guaranteed by the Veterans
Administration. In addition to mortgage lending, Milton Federal originates
consumer loans, some unsecured and some secured by deposits, automobiles, boats
and recreational vehicles, as well as, commercial loans.
LOAN PORTFOLIO COMPOSITION. The following table presents certain information
with respect to the composition of Milton Federal's loan portfolio at the dates
indicated:
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At September 30,
-------------------------------------------------------------------------------
1999 1998 1997
--------------------- ------------------------ ----------------------
Percent Percent Percent
of Total of Total of Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Residential real estate loans:
1-4 family (first mortgage) $ 159,291 79.37% $ 141,280 78.37% $ 108,941 81.62%
Home equity (1-4 family
second mortgage) 5,347 2.66 4,244 2.36 4,051 3.04
Multi-family 2,028 1.01 2,670 1.48 1,457 1.09
Nonresidential real estate loans 14,948 7.45 8,805 4.88 6,215 4.66
Construction loans 11,873 5.92 16,413 9.10 9,400 7.04
----------- ------- ----------- ------ ----------- ------
Total real estate loans 193,487 96.41 173,412 96.19 130,064 97.45
Consumer loans:
Automobile loans 3,035 1.51 3,480 1.93 2,305 1.73
Loans on deposits 318 0.16 291 0.16 281 0.21
Other consumer loans 378 0.19 344 0.19 246 0.18
----------- ------- ----------- ------ ----------- ------
Total consumer loans 3,731 1.86 4,115 2.28 2,832 2.12
Commercial loans 3,466 1.73 2,753 1.53 575 0.43
----------- ------- ----------- ------ ----------- ------
Total loans 200,684 100.00% 180,280 100.00% 133,471 100.00%
----------- ======= ----------- ====== ----------- ======
Less:
Net deferred loan fees (609) (605) (536)
Loans in process (7,195) (7,653) (4,977)
Allowance for loan losses (765) (676) (562)
----------- ----------- -----------
Net loans $ 192,115 $ 171,346 $ 127,396
=========== =========== ===========
Loans held for sale $ 2,627 $ -- $ --
=========== =========== ============
At September 30,
-------------------------------------------------
1996 1995
---------------------- ---------------------
Percent Percent
of Total of Total
Amount Loans Amount Loans
------ ----- ------ -----
(Dollars in thousands)
Residential real estate loans:
1-4 family (first mortgage) $ 102,393 83.02% $ 88,899 84.45%
Home equity (1-4 family
second mortgage) 2,929 2.38 1,129 1.07
Multi-family 2,249 1.82 1,986 1.89
Nonresidential real estate loans 4,425 3.59 4,750 4.51
Construction loans 9,083 7.36 6,353 6.04
----------- ------ ---------- ------
Total real estate loans 121,079 98.17 103,117 97.96
Consumer loans:
Automobile loans 1,929 1.56 1,847 1.75
Loans on deposits 199 0.16 193 0.18
Other consumer loans 130 0.11 115 0.11
----------- ------ ---------- ------
Total consumer loans 2,258 1.83 2,155 2.04
Commercial loans -- -- -- --
----------- ------ ---------- ------
Total loans 123,337 100.00% 105,272 100.00%
----------- ====== ---------- =======
Less:
Net deferred loan fees (627) (647)
Loans in process (5,474) (3,534)
Allowance for loan losses (487) (333)
----------- ----------
Net loans $ 116,749 $ 100,758
=========== ===========
Loans held for sale $ -- $ --
=========== ===========
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LOAN MATURITY SCHEDULE. The following table sets forth certain information as of
September 30, 1999, regarding the dollar amount of loans, excluding residential
real estate loans, home equity loans and consumer loans, maturing in Milton
Federal's portfolio based on their contractual terms to maturity. Demand loans
and loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less.
Maturing
------------------------------------------------
One Year One Through After Five
(In thousands) or Less Five Years Years Total
------- ---------- ----- -----
Real estate construction $ 72 $ 618 $ 11,183 $ 11,873
Nonresidential real estate loans 397 2,280 12,271 14,948
Commercial loans 2,300 462 704 3,466
---------- ---------- --------- ----------
Total $ 2,769 $ 3,360 $ 24,158 $ 30,287
========== ========== ========= ==========
The following table sets forth at September 30, 1999, the dollar amount of
loans, excluding one- to four-family, home equity, multi-family and consumer
loans, before net items, due after one year from September 30, 1999, which have
predetermined interest rates and floating or adjustable interest rates:
Floating or
Predetermined Adjustable
Rates Rates
----- -----
(In thousands)
Real estate construction $ 8,396 $ 3,405
Nonresidential real estate loans 11,942 2,609
Commercial loans 1,157 9
------------ -----------
Total loans $ 21,495 $ 6,023
============ ===========
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The primary lending activity
of Milton Federal has been the origination of permanent conventional loans
secured by one- to four-family residences, primarily single-family residences,
located within Milton Federal's designated lending area. Milton Federal also
originates loans for the construction of one- to four-family residences and home
equity loans secured by second mortgages on one- to four-family residential real
estate. Each of such loans is secured by a mortgage on the underlying real
estate and improvements thereon, if any.
OTS regulations limit the amount that Milton Federal may lend in relationship to
the appraised value of the real estate and improvements at the time of loan
origination. In accordance with such regulations, Milton Federal makes
fixed-rate loans on one- to four-family residences up to 95% of the value of the
real estate and improvements (the "Loan-to-Value Ratio" or "LTV"). Milton
Federal requires private mortgage insurance for such loans in excess of 90% of
the value of the real estate securing such loans. Residential real estate loans
are offered by Milton Federal for terms of up to 30 years.
While the majority of Milton Federal's loans have fixed rates of interest,
Milton Federal began originating adjustable rate mortgage loans ("ARMs") in
fiscal year 1995. ARMs are offered by Milton Federal for terms of up to 30
years. The interest-rate adjustment periods on the ARMs are either one year or
three years. Until March 18, 1999, Milton Federal also offered five-year ARMs.
The interest rate adjustments on ARMs presently originated by Milton Federal are
tied to changes in the weekly average yield on the one-, three- and five-year
U.S. Treasury constant maturities index. Rate adjustments are computed by adding
a stated margin, typically 3%, to the index. The maximum allowable adjustment at
each adjustment date is usually 2% with a maximum adjustment of 6% over the term
of the loan. The initial rate is dependent, in part, on how often the rate can
be adjusted. Milton Federal originates ARMs that have initial interest rates
lower
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than the sum of the index plus the margin. Such loans are subject to increased
risk of delinquency or default due to increasing monthly payments as the
interest rates on such loans increase to the fully-indexed level, although such
increase is considered in Milton Federal's underwriting of such loans.
The aggregate amount of Milton Federal's one- to four-family residential real
estate loans equaled approximately $159.3 million at September 30, 1999, and
represented 79.4% of loans at such date. At such date, loans secured by one- to
four-family residential real estate with outstanding balances of $184,000, or
.1% of its one- to four-family residential real estate loan balance, were more
than 90 days delinquent or nonaccruing. See "Delinquent Loans, Nonperforming
Assets and Classified Assets."
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. In addition to loans on one- to
four-family properties, Milton Federal makes loans secured by multi-family
properties containing over four units. Such loans are made with fixed and
adjustable interest rates and a maximum LTV of 75%. ARMs on multi-family
properties are offered with the same adjustment periods and index as ARMs on
one- to four-family properties and typically with a margin of 4% over the index.
Multi-family lending is generally considered to involve a higher degree of risk
because the loan amounts are larger and the borrower typically depends upon
income generated by the project to cover operating expenses and debt service.
The profitability of a project can be affected by economic conditions,
government policies and other factors beyond the control of the borrower. Milton
Federal attempts to reduce the risk associated with multi-family lending by
evaluating the credit-worthiness of the borrower and the projected income from
the project and by obtaining personal guarantees on loans made to corporations
and partnerships. Milton Federal currently requires that borrowers agree to
submit financial statements and tax returns annually to enable Milton Federal to
monitor the loan.
At September 30, 1999, loans secured by multi-family properties totaled
approximately $2.0 million, or 1.0% of total loans, all of which were secured by
property located in Miami and Montgomery Counties, Ohio. At such date, there
were no loans secured by multi-family residential real estate that were more
than 90 days delinquent or nonaccruing. See "Delinquent Loans, Nonperforming
Assets and Classified Assets."
CONSTRUCTION LOANS. Milton Federal makes loans for the construction of
residential and nonresidential real estate. Such loans are structured as
permanent loans with fixed and adjustable rates of interest and for terms of up
to 30 years. Almost all of the construction loans originated by Milton Federal
are made to owner-occupants for the construction of single-family homes by a
general contractor. The remainder are made to builders for small projects, some
of which have not been pre-sold.
Construction loans generally involve greater underwriting and default risks than
do loans secured by mortgages on existing properties due to the concentration of
principal in a limited number of loans and borrowers and the effects of general
economic conditions on real estate developments, developers, managers and
builders. In addition, such loans are more difficult to evaluate and monitor.
Loan funds are advanced upon the security of the project under construction,
which is more difficult to value before the completion of construction.
Moreover, because of the uncertainties inherent in estimating construction
costs, it is relatively difficult to evaluate accurately the LTVs and the total
loan funds required to complete a project. In the event a default on a
construction loan occurs and foreclosure follows, Milton Federal must take
control of the project and attempt either to arrange for completion of
construction or dispose of the unfinished project.
At September 30, 1999, a total of $11.9 million, 5.9% of Milton Federal's total
loans, consisted of construction loans. At such date, there were no construction
loans that were more than 90 days delinquent or nonaccruing. The majority of
Milton Federal's construction loans are secured by property in Miami and
Montgomery Counties and the economy of such lending area has been relatively
stable.
NONRESIDENTIAL REAL ESTATE LOANS. Milton Federal also makes loans secured by
nonresidential real estate consisting primarily of retail stores, office
buildings and churches. Such loans are originated at fixed-rates of
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interest for up to 15 years or as a three-year ARM with terms up to 25 years.
Such loans have a maximum LTV of 80%.
Nonresidential real estate lending is generally considered to involve a higher
degree of risk than residential lending due to the relatively larger loan
amounts and the effects of general economic conditions on the successful
operation of income-producing properties. If the cash flow on the property is
reduced, for example, as leases are not obtained or renewed, the borrower's
ability to repay may be impaired. Milton Federal has endeavored to reduce such
risk by evaluating the credit history and past performance of the borrower, the
location of the real estate, the quality of the management constructing and
operating the property, the debt service ratio, the quality and characteristics
of the income stream generated by the property and appraisals supporting the
property's valuation.
At September 30, 1999, Milton Federal had a total of $14.9 million invested in
nonresidential real estate loans, all of which were secured by property located
in Miami and Montgomery Counties, Ohio. Such loans comprised 7.5% of Milton
Federal's total loans at such date. At such date loans secured by nonresidential
real estate with outstanding balances of $173,000, or 1.2% of Milton Federal's
nonresidential real estate loan portfolio, were more than 90 days delinquent or
nonaccruing. See "Delinquent Loans, Nonperforming Assets and Classified Assets."
Federal regulations limit the amount of nonresidential mortgage loans that an
association may make to 400% of its capital. At September 30, 1999, Milton
Federal's nonresidential mortgage loans totaled 65.9% of Milton Federal's
capital.
CONSUMER LOANS. Milton Federal makes various types of consumer loans, including
unsecured loans and loans secured by deposits, automobiles, boats and
recreational vehicles. Such loans are made at fixed rates of interest only.
Milton Federal has increased the emphasis of originating consumer loans as part
of its interest rate risk management efforts.
Consumer loans may entail greater risk than do residential mortgage loans. The
risk of default on consumer loans increases during periods of recession, high
unemployment and other adverse economic conditions. Although Milton Federal has
not had significant delinquencies on consumer loans, no assurance can be
provided that delinquencies will not increase.
At September 30, 1999, Milton Federal had approximately $3.7 million, or 1.9% of
its total loans, invested in consumer loans. At such date, consumer loans that
were more than 90 days delinquent or nonaccruing totaled $1,000, or less than
0.1% of consumer loans. See "Delinquent Loans, Nonperforming Assets and
Classified Assets."
COMMERCIAL LOANS. Federal law authorizes federally-chartered thrift
institutions, such as Milton Federal, to make secured or unsecured loans for
commercial, corporate, business and agricultural purposes, up to a maximum of
20% of total assets, so long as the amount above 10% of total assets is for
small business purposes.
In fiscal 1997, Milton Federal implemented a commercial loan program, which
includes extending letters of credit and commercial loans to finance commercial
and industrial business activities including equipment financing, commercial
lines of credit and working capital.
Unlike residential mortgage loans, which generally are granted on the basis of
the borrower's ability to repay the debt from employment and other income and
are secured by real property, the value of which tends to be more easily
ascertainable, business loans are of higher risk and typically are granted on
the basis of the borrower's ability to repay the debt from the cash flow of the
underlying business. In addition, it is generally the practice of Milton Federal
to request additional collateral in the form of personal guarantees. Additional
collateral may include, on occasion, a lien on the business owner's personal
residence. Nonetheless, the
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availability of funds for the repayment of business loans generally is dependent
on the success of the business itself.
At September 30, 1999, Milton Federal had approximately $3.5 million, or 1.7% of
its total loans, invested in commercial loans. At such date, commercial loans
with outstanding balances of $82,000, or 2.4% of its commercial loan balance,
were more than 90 days delinquent or nonaccruing. See "Delinquent Loans,
Nonperforming Assets and Classified Assets."
LOAN SOLICITATION AND PROCESSING. Loan originations are developed from a number
of sources, including continuing business with depositors, borrowers and real
estate developers, periodic newspaper and radio advertisements, solicitations by
Milton Federal's lending staff and walk-in customers.
Loan applications for permanent mortgage loans are taken by loan personnel.
Milton Federal obtains a credit report, verification of employment and other
documentation concerning the credit-worthiness of the borrower. An appraisal of
the fair market value of the real estate on which Milton Federal will be granted
a mortgage to secure the loan is prepared by an independent fee appraiser
approved by the Board of Directors. An environmental study is conducted for all
business properties and for other real estate only if the appraiser or the loan
committee has reason to believe that an environmental problem may exist.
Commencing in 1992, Milton Federal required a survey of the property for every
real estate loan.
For multi-family and nonresidential mortgage loans, a personal guarantee of the
borrower's obligation to repay the loan is required. Milton Federal also obtains
information with respect to prior projects completed by the borrower. Upon the
completion of the appraisal and the receipt of information on the borrower, the
application for a loan is submitted to the Loan Committee for approval or
rejection if the loan does not exceed $400,000. If the loan amount exceeds
$400,000, the application is approved or rejected by the full Board of
Directors.
If a mortgage loan application is approved, title insurance is obtained on the
title to the real estate that will secure the mortgage loan. Prior to September
1990, Milton Federal did not require title insurance but did obtain an
attorney's opinion of title. Borrowers are required to carry fire and casualty
insurance and flood insurance, if applicable, and to name Milton Federal as an
insured mortgagee.
The procedure for approval of construction loans is the same as for permanent
mortgage loans, except that an appraiser evaluates the building plans,
construction specifications and estimates of construction costs. Milton Federal
also evaluates the feasibility of the proposed construction project and the
experience and financial status of the builder.
Consumer loans are underwritten on the basis of the borrower's credit history
and an analysis of the borrower's income and expenses, ability to repay the loan
and the value of the collateral, if any.
Milton Federal's loans carry no prepayment penalties but do provide that the
entire balance of the loan is due upon sale of the property securing the loan.
Milton Federal generally enforces such due-on-sale provisions.
LOAN ORIGINATIONS, PURCHASES AND SALES. Prior to 1995, Milton Federal had been
actively originating only new fixed-rate loans. In fiscal 1995, Milton Federal
began to originate variable-rate loans in addition to fixed-rate loans. In
fiscal 1999, Milton Federal began originating one- to four-family first mortgage
loans with the intent of selling them in the secondary market. Prior to fiscal
1999, Milton Federal periodically sold pools of one- to four-family first
mortgage portfolio loans. The loans were sold as a means to manage interest rate
risk by reducing the Milton Federal's investment in various lower-yielding or
longer-term fixed rate loans. Management intends to continue, in the future, to
originate, fixed-rate loans in a manner that permits their sale into the
secondary mortgage market. Milton Federal intends to retain the servicing of
loans sold in the secondary mortgage market. At September 30, 1999, Milton
Federal had mortgage loans of
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$2.6 million classified as held for sale. Milton Federal occasionally
participates in loans originated by other institutions.
The following table presents Milton Federal's loan origination and sale
activity, not including loans held for sale for the periods indicated:
Year ended September 30,
-------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In thousands)
Loans originated
1-4 family residential $ 32,569 $ 64,280 $ 27,150 $ 29,774 $ 17,026
Multi-family residential 417 1,804 -- 71 86
Nonresidential 7,640 1,171 2,263 150 33
Construction 14,518 19,617 8,915 7,912 7,555
Consumer 1,899 3,435 2,286 1,717 1,857
Commercial 4,264 3,350 608 -- --
-------- -------- -------- --------- ---------
Total loans originated 61,307 93,657 41,222 39,624 26,557
-------- -------- -------- --------- ---------
Loan participations purchased -- -- -- -- --
-------- -------- -------- --------- ---------
Reductions:
Principal repayments (40,118) (41,480) (20,316) (23,633) (16,905)
Sales -- (8,226) (10,259) -- --
Transfers from loans to real estate owned and
repossessed assets (210) -- -- -- (70)
-------- -------- -------- --------- ---------
Total reductions (40,328) (49,706) (30,575) (23,633) (16,975)
Increase (decrease) in other items, net (1) (51) 69 (22) 21 (42)
-------- -------- -------- --------- ---------
Net increase (decrease) $ 20,928 $ 44,020 $ 10,625 $ 16,012 $ 9,540
======== ======== ======== ========= =========
(1) Consists of amortization of loan origination fees and provision for
loan losses.
OTS regulations generally limit the aggregate amount that a savings association
may lend to any one borrower to an amount equal to 15% of the association's
total capital for regulatory capital purposes plus any additional loan reserves
not included in total capital (collectively, "Lending Limit Capital"). A savings
association may lend to one borrower an additional amount not to exceed 10% of
the association's Lending Limit Capital if the additional amount is fully
secured by certain forms of "readily marketable collateral." Real estate is not
considered "readily marketable collateral." In addition, the regulations require
that loans to certain related or affiliated borrowers be aggregated for purposes
of such limits. An exception to these limits permits loans to one borrower of up
to $500,000 "for any purpose."
Based on such limits, Milton Federal was able to lend approximately $3.4 million
to any one borrower at September 30, 1999. The largest amount Milton Federal had
outstanding to one borrower was $1.1 million. Such loans were secured by one- to
four-family and multi-family residential real estate and were current at
September 30, 1999.
LOAN ORIGINATION AND OTHER FEES. Milton Federal realizes loan origination fees
and other fee income from its lending activities. In addition, Milton Federal
also realizes income from late payment charges, application fees, and fees for
other miscellaneous services.
Loan origination fees and other fees are a volatile source of income, varying
with the volume of lending, loan repayments and general economic conditions. All
nonrefundable loan origination fees and certain direct loan origination costs
are deferred and recognized as an adjustment to yield over the life of the
related loan.
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DELINQUENT LOANS, NONPERFORMING ASSETS AND CLASSIFIED ASSETS. When a borrower
fails to make a required payment on a loan, Milton Federal attempts to cause the
deficiency to be cured by contacting the borrower. In most cases, deficiencies
are cured promptly.
When a real estate loan is fifteen days or more delinquent, the borrower is sent
a delinquency notice. When a loan is thirty days delinquent, Milton Federal
sends a letter to the borrower and may telephone the borrower. Depending upon
the circumstances, Milton Federal may also inspect the property and inform the
borrower of the availability of credit counseling from Milton Federal and
counseling agencies. When a loan becomes 90 days delinquent, it is generally
referred to an attorney for foreclosure, unless the Board of Directors deems
appropriate alternative payment arrangements to eliminate the arrearage. A
decision as to whether and when to initiate foreclosure proceedings is based on
such factors as the amount of the outstanding loan in relation to the original
indebtedness, the extent of the delinquency and the borrower's ability and
willingness to cooperate in curing delinquencies. If a foreclosure occurs, the
real estate is sold at public sale and may be purchased by Milton Federal.
Real estate acquired, or deemed acquired, by Milton Federal as a result of
foreclosure proceedings is classified as real estate owned ("REO") until it is
sold. When property is so acquired, or deemed to have been acquired, it is
initially recorded by Milton Federal at the fair value of the real estate.
Interest accrual, if any, ceases no later than the date of acquisition of the
real estate. After acquisition, a valuation allowance reduces the reported
amount to the lower of the initial amount or fair value less costs to sell.
Costs incurred to carry other real estate are charged to expense. Milton Federal
held approximately $201,000 in REO property at September 30, 1999.
In the case of delinquencies on consumer loans, a notice is sent to the borrower
when payment is not received by the tenth business day after the payment due
date. When a payment is fifteen days past due, a letter is sent or the borrower
is contacted by telephone. If no payment or satisfactory promise is made by the
second due date, a collection officer makes a personal visit to the borrower's
residence. If an account is ninety days delinquent, the borrower is provided a
written notice that legal action will be taken if the account is not brought
current within ten days, and the failure to so bring the account current
generally results in repossession of the collateral, if any.
Milton Federal places a loan on nonaccrual status when the loan is delinquent 90
days or more, unless the value of the collateral provides sufficient equity to
warrant the continued accrual of interest.
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The following table reflects the number and amount of loans in a delinquent
status as of the dates indicated:
At September 30,
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1999 1998 1997
------------------------------ ---------------------------------- ------------------------------------
(Dollars in thousands)
Percent of Percent of Percent of
Total Total Total
No. Amt. Loans No. Amt. Loans No. Amt. Loans
--- ---- ----- --- ---- ----- --- ---- -----
Loans delinquent for (1):
30-59 days 12 $ 593 0.29% 15 $ 893 0.50% 6 $ 268 0.20%
60-89 days 6 152 0.08 3 22 0.01 5 212 0.16
90 days and over 10 456 0.23 19 1,101 0.62 18 624 0.47
-- ------ ---- -- -------- ---- -- -------- ----
Total delinquent loans 28 $1,201 0.60% 37 $ 2,016 1.13% 29 $ 1,104 0.83%
== ====== ==== == ======== ==== == ========= ====
At September 30,
---------------------------------------------------------------
1996 1995
---------------------------- --------------------------------
(Dollars in thousands)
Percent of Percent of
Total Total
No. Amt Loans No. Amt Loans
--- --- ----- --- --- -----
Loans delinquent for (1):
30-59 days 13 $ 337 0.27% 9 $ 413 0.39%
60-89 days 3 124 0.10 5 170 0.16
90 days and over 10 597 0.49 11 520 0.50
-- ------- ---- -- ------ ----
Total delinquent loans 26 $ 1,058 0.86% 25 $1,103 1.05%
== ======= ==== == ====== ====
(1) The number of days a loan is delinquent is measured from the day the
payment was due under the terms of the loan agreement.
-12-
13
The following table sets forth information with respect to the accrual and
nonaccrual status of Milton Federal's loans that are 90 days or more past due
and other nonperforming assets at the dates indicated:
At September 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
Accruing loans delinquent more than 90 days $ 225 $ 742 $ 276 $ 285 $ 367
Loans accounted for on a nonaccrual basis:
Real estate:
Residential 58 185 348 312 153
Nonresidential 173 174 -- -- --
--------- --------- -------- -------- ---------
Total nonaccrual loans 231 359 348 312 153
Other nonperforming assets (1) 201 -- -- 32 32
--------- --------- -------- -------- ---------
Total nonperforming assets $ 657 $ 1,101 $ 624 $ 629 $ 552
========= ========= ======== ======== =========
Total loan loss allowance $ 765 $ 676 $ 562 $ 487 $ 333
Total nonperforming assets as a percentage of
total assets 0.26% 0.47% 0.30% 0.35% 0.34%
Loan loss allowance as a percent of
nonperforming loans 116.46% 61.40% 90.06% 81.57% 64.04%
(1) Other nonperforming assets represent real estate acquired by Milton
Federal in settlement of loans, which is initially reported at
estimated fair value at acquisition. After acquisition, a valuation
allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell.
Loans considered impaired within the scope of Statement of Financial Accounting
Standards ("SFAS") No. 114 were not significant in 1999. During 1999, $12,000
would have been recorded on nonaccruing loans had such loans been accruing
pursuant to contractual terms. During such period, no interest income was
recorded on such loans. Management believes that no loans, other than loans
which are currently classified as nonaccrual, more than 90 days past due or
restructured, may be so classified in the near future due to concerns as to the
ability of the borrowers to comply with repayment terms.
OTS regulations require that each thrift institution classify its own assets on
a regular basis. Problem assets are classified as "substandard," "doubtful" or
"loss." "Substandard" assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. "Doubtful" assets have
the same weaknesses as "substandard" assets, with the additional characteristics
that (i) the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable and (ii) there is a
high possibility of loss. An asset classified "loss" is considered uncollectible
and of such little value that its continuance as an asset of the institution is
not warranted. The regulations also contain a "special mention" category,
consisting of assets which do not currently expose an institution to a
sufficient degree of risk to warrant classification but which possess credit
deficiencies or potential weaknesses deserving management's close attention.
-13-
14
Generally, Milton Federal classifies as "substandard" all loans that are
delinquent more than 60 days, unless management believes the delinquency status
is short-term due to unusual circumstances. Loans delinquent fewer than 60 days
may also be classified if the loans have the characteristics described above
rendering classification appropriate.
The aggregate amounts of Milton Federal's classified assets at the dates
indicated were as follows:
At September 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In thousands)
Substandard $ 328 $ 765 $ 790 $ 714 $ 370
Doubtful 279 177 10 -- 38
Loss 34 36 149 149 148
--------- -------- --------- --------- ---------
Total classified assets $ 641 $ 978 $ 949 $ 863 $ 556
========= ======== ========= ========= =========
Federal examiners are authorized to classify an association's assets. If an
association does not agree with an examiner's classification of an asset, it may
appeal this determination to the District Director of the OTS. Milton Federal
had no disagreements with the examiners regarding the classification of assets
at the time of the last examination.
OTS regulations require that Milton Federal establish prudent general allowances
for loan losses for any loan classified as substandard or doubtful. If an asset,
or portion thereof, is classified as loss, the association must either establish
specific allowances for losses in the amount of 100% of the portion of the asset
classified loss, or charge-off such amount.
ALLOWANCE FOR LOAN LOSSES. Milton Federal maintains an allowance for loan losses
based upon a number of relevant factors, including, but not limited to, trends
in the level of nonperforming assets and classified loans, current and
anticipated economic conditions in the primary lending area, past loss
experience, probable losses arising from specific problem assets and changes in
the composition of the loan portfolio.
The single largest component of Milton Federal's loan portfolio consists of one-
to four-family residential real estate loans. Substantially all of these loans
are secured by residential real estate and generally require a down payment of
at least 10% of the lower of the sales price or appraisal value of the real
estate. Private mortgage insurance is required for such loans with less than a
10% down payment. In addition, these loans are secured by property in Milton
Federal's designated lending area consisting of portions of Miami, Montgomery
and Darke Counties in Ohio. Milton Federal's practice of making the majority of
its loans in its designated lending area and requiring a 10% down payment have
contributed to a low historical charge-off rate.
In addition to one- to four-family residential real estate loans, Milton
Federal makes additional real estate loans, including home equity, multi-family
residential real estate, nonresidential real estate and construction loans.
These real estate loans are secured by property in Milton Federal's designated
lending area and also require the borrower to provide a down payment. Milton
Federal has not experienced any charge-offs from these other real estate loan
categories.
A small portion of Milton Federal's total loans consists of consumer loans,
primarily automobile loans. These loans typically have a lower down payment and
are secured by collateral that declines in value. Such loans therefore carry a
higher degree of risk than the real estate loans. Milton Federal has had minimal
charge-offs on consumer loans since these loans have been offered.
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15
Milton Federal began originating commercial loans in fiscal 1997. Commercial
loans are of higher risk and typically are granted on the basis of the
borrower's ability to repay the debt from the cash flow of the underlying
business. Milton Federal has had minimal charge-offs on commercial loans since
these loans have been offered.
The allowance for loan losses is reviewed quarterly by management's Asset
Classification Committee and the Board of Directors. While the Board of
Directors believes that it uses the best information available to determine the
allowance for loan losses, unforeseen market conditions could result in material
adjustments, and net earnings could be significantly adversely affected, if
circumstances differ substantially from the assumptions used in making the final
determination.
The following table sets forth an analysis of Milton Federal's allowance for
loan losses for the periods indicated.
Year ended September 30,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at beginning of period $ 676 $ 562 $ 487 $ 333 $ 269
Charge-offs:
Residential real estate loans -- (100) -- -- --
Consumer loans (22) (15) -- -- --
Commercial loans (9) -- -- -- --
--------- --------- -------- -------- ---------
Total charge-offs (31) (115) -- -- --
Recoveries -- -- -- -- --
Provision for loan losses (charged to
operations) 120 229 75 154 64
--------- --------- -------- -------- ---------
Balance at end of period $ 765 $ 676 $ 562 $ 487 $ 333
========= ========= ======== ======== =========
Ratio of net charge-offs (recoveries) to average
loans outstanding during the period 0.02% 0.08% 0.00% 0.00% 0.00%
Ratio of allowance for loan losses to total loans(1) 0.40 0.39 0.44 0.42 0.33
Allowance for loan losses as a percentage of
nonperforming loans 116.46 61.40 90.06 81.57 64.04
(1) Total loans less net deferred loan fees and loans in process.
-15-
16
The following schedule is a breakdown of the allowance for loan losses allocated
by type of loan and related ratios.
At September 30,
------------------------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------- --------------------- ------------------------ ----------------------
Percent Percent Percent Percent
of Loans of Loans of Loans of Loans
in Each in Each in Each in Each
Category Category Category Category
to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Real estate loans $ 339 96.41% $ 317 96.13% $ 339 97.45% $ 321 98.17%
Consumer loans 10 1.86 6 2.32 8 2.12 3 1.83
Commercial loans 52 1.73 38 1.55 -- .43 -- 0.00
Unallocated 364 -- 315 -- 215 -- 163 --
--------- -------- -------- ------- --------- -------- --------- --------
Total $ 765 100.00% $ 676 100.00% $ 562 100.00% $ 487 100.00%
========= ======== ======== ======= ========= ======= ========= ========
At September 30,
----------------------
1995
----------------------
Percent
of Loans
in Each
Category
to Total
Amount Loans
------ -----
(Dollars in thousands)
Real estate loans $ 298 97.96%
Consumer loans 2 2.04
Commercial loans -- 0.00
Unallocated 33 --
-------- --------
Total $ 333 100.00%
======= ========
While management's periodic analysis of the adequacy of the allowance for loan
losses may allocate portions of the allowance for specific problem loan
situations, the entire allowance is available for any loan charge-offs that may
occur.
-16-
17
MORTGAGE-BACKED SECURITIES
The Corporation maintains a significant portfolio of mortgage-backed securities
in the form of Federal Home Loan Mortgage Corporation ("FHLMC"), Federal
National Mortgage Association ("FNMA") and Government National Mortgage
Association ("GNMA") participation certificates. Mortgage-backed securities
generally entitle the Corporation to receive a portion of the cash flows from an
identified pool of mortgages, and FHLMC, FNMA and GNMA securities are each
guaranteed by their respective agencies as to principal and interest.
The Corporation has also invested significant amounts in CMOs and REMICs that
are included in mortgage-backed securities. CMOs and REMICs are mortgage
derivative products, secured by an underlying pool of mortgages. The Corporation
has no ownership interest in the mortgages, except to the extent they serve as
collateral. Payment streams from the mortgages serving as collateral are
reconfigured with varying terms and time of payment to the investor. Though they
can be used for hedging and investment, CMOs and REMICs can expose investors to
higher risk of loss than direct investments in mortgage-backed pass-through
securities, particularly with respect to price volatility and lack of a broad
secondary market in such securities. The OTS has deemed certain CMOs and other
mortgage derivative products to be "high-risk." None of the Corporation's CMOs
or REMICs are in such "high-risk" category.
Although mortgage-backed securities generally yield less than individual loans
originated by Milton Federal, they present less credit risk, because
mortgage-backed securities are guaranteed as to principal repayment by the
issuing agency and CMOs and REMICs are secured by the underlying collateral. All
of the Corporation's CMOs and REMICs are backed by pools of mortgages that are
insured or guaranteed by FNMA and FHLMC. Although certain mortgage-backed
securities designated as available for sale are a potential source of liquid
funds for loan originations and deposit withdrawals, the prospect of a loss on
the sale of such securities limits the usefulness for liquidity purposes.
The Corporation has purchased adjustable-rate mortgage-backed securities as part
of its effort to reduce its interest rate risk. In a period of declining
interest rates, the Corporation is subject to prepayment risk on such
adjustable-rate mortgage-backed securities. The Corporation attempts to mitigate
this prepayment risk by purchasing mortgage-backed securities at or near par. If
interest rates rise in general, the interest rates on the loans backing the
mortgage-backed securities will also adjust upward, subject to the interest rate
caps in the underlying adjustable-rate mortgage loans. However, the Corporation
is still subject to interest rate risk on such securities if interest rates rise
faster than the 1% to 2% maximum annual interest rate adjustments on the
underlying loans.
At September 30, 1999, almost all of the $48.8 million of the Corporation's
mortgage-backed securities had adjustable rates.
The following table sets forth information regarding the Corporation's carrying
value of mortgage-backed securities at the dates indicated.
At September 30,
-------------------------------------------------------------------------------------
1999 1998 1997
------------------------ -------------------------- ---------------------------
Available Held to Available Held to Available Held to
For Sale Maturity For Sale Maturity For Sale Maturity
-------- -------- -------- -------- -------- --------
(In thousands)
FNMA certificates $ 1,390 $ 3,105 $ 1,899 $ 4,177 $ 2,851 $ 5,191
GNMA certificates 1,593 395 2,709 588 -- 810
FHLMC certificates 1,188 4,043 2,296 5,139 2,863 6,124
Collateralized mortgage
obligations and REMICs 32,483 4,649 29,993 4,656 42,128 --
---------- ---------- ----------- ----------- ----------- -----------
Total $ 36,654 $ 12,192 $ 36,897 $ 14,560 $ 47,842 $ 12,125
========== ========== =========== =========== =========== ===========
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18
The following table sets forth information regarding scheduled maturities,
carrying value, fair value and weighted average yields of the Corporation's
mortgage-backed securities at September 30, 1999. Actual maturities will differ
from contractual maturities due to scheduled repayments and because borrowers
may have the right to call or prepay obligations with or without prepayment
penalties. The following table does not take into consideration the effects of
scheduled repayments or the effects of possible prepayments. The weighted
average yield has been computed using the historical amortized cost for
available for sale securities.
At September 30, 1999
---------------------------------------------
After
One Year or Less One to Five Years
------------------- ----------------------
Carrying Average Carrying Average
Value Yield Value Yield
----- ----- ----- -----
(Dollars in thousands)
Securities available for sale
FNMA certificates $ -- --% $ -- --%
GNMA certificates -- -- -- --
FHLMC certificates -- -- -- --
CMOs and REMICs -- -- -- --
--------- ----- ---------- ---
Total $ -- --% $ -- --%
========= ===== ========== ===
Securities held to maturity
FNMA certificates $ -- --% $ -- --%
GNMA certificates -- -- -- --
FHLMC certificates -- -- -- --
CMOs and REMICs -- -- -- --
--------- ----- --------- ---
Total $ -- --% $ -- --%
========= ===== ========= ===
At September 30, 1999
----------------------------------------------------------------------------------
After Total
Five to Ten Years After Ten Years Mortgage-Backed Portfolio
----------------- ------------------ --------------------------------------
Carrying Average Carrying Average Carrying Fair Average
Value Yield Value Yield Value Value Yield
----- ----- ----- ----- ----- ----- -----
(Dollars in thousands)
Securities available for sale
FNMA certificates $ -- --% $ 1,390 6.79% $ 1,390 $ 1,390 6.79%
GNMA certificates -- -- 1,593 6.42 1,593 1,593 6.42
FHLMC certificates -- -- 1,188 6.66 1,188 1,188 6.66
CMOs and REMICs 6,367 5.56 26,116 5.72 32,483 32,483 5.69
------- ---- ------- ---- ------- ------- ----
Total $ 6,367 5.56% $30,287 5.84% $36,654 $36,654 5.79%
======= ==== ======= ==== ======= ======= ====
Securities held to maturity
FNMA certificates -- --% $ 3,105 6.14% $ 3,105 $ 3,000 6.14%
GNMA certificates 8 8.50 387 6.38 395 413 6.42
FHLMC certificates -- -- 4,043 6.36 4,043 3,926 6.36
CMOs and REMICs -- -- 4,649 6.63 4,649 4,738 6.63
------- ---- ------- ---- ------- ------- ----
Total $ 8 8.50% $12,184 6.41% $12,192 $12,077 6.41%
======= ==== ======= ==== ======= ======= ====
For additional information, see Note 2 of the Notes to Consolidated Financial
Statements.
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19
INVESTMENT ACTIVITIES
OTS regulations require that Milton Federal maintain a minimum amount of liquid
assets, which may be invested in U. S. Treasury obligations, securities of
various federal agencies, certificates of deposit at insured banks, bankers'
acceptances and federal funds. Milton Federal is also permitted to make
investments in certain commercial paper, corporate debt securities rated in one
of the four highest rating categories by one or more nationally recognized
statistical rating organizations, and mutual funds, as well as other investments
permitted by federal regulations. See "REGULATION."
The following table sets forth the composition of the Corporation's
interest-bearing deposits and securities portfolio at the dates indicated:
At September 30,
----------------------------------------------------------------
1999 1998
---------------------------------------- -------------------
Carrying % of Market % of Carrying % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in thousands)
Interest-bearing deposits in other
financial institutions $ 403 74.2% $ 403 74.5% $ 2,528 99.4%
Securities available for sale:
U.S. Government and federal
agency securities -- -- -- -- -- --
Equity securities 15 2.8 15 2.8 15 0.6
Securities held to maturity:
U.S. Government and federal
agency securities -- -- -- -- -- --
Municipal obligations 125 23.0 123 22.7 -- --
------- ----- ---------- ---- --------- -----
Total $ 543 100.0% $ 541 100.0% $ 2,543 100.0%
======= ===== ========== ===== ========= =====
At September 30,
----------------------------------------------------------------
1998 1997
------------------ -------------------------------------------
Market % of Carrying % of Market % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in thousands)
Interest-bearing deposits in other
financial institutions $ 2,528 99.4% $ 4,936 36.0% $ 4,936 36.0%
Securities available for sale:
U.S. Government and federal
agency securities -- -- 5,505 40.2 5,505 40.1
Equity securities 15 0.6 15 0.1 15 0.1
Securities held to maturity:
U.S. Government and federal
agency securities -- -- 3,254 23.7 3,260 23.8
Municipal obligations -- -- -- -- -- --
------- ------ ------- ----- ------- -----
Total $ 2,543 100.0% $13,710 100.0% $13,716 100.0%
======= ------ ======= ===== ======= =====
-19-
20
The following table sets forth the contractual maturities, carrying values,
market values and average yields for the Corporation's interest-bearing deposits
in other financial institutions and investment securities at September 30, 1999.
The weighted average yield has been computed using the historical amortized cost
for available for sale securities.
At September 30, 1999
---------------------------------------------------------------------
After After
One Year or Less One to Five Years Five to Ten Years (2)
----------------- ------------------ ------------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- -----
(Dollars in thousands)
Interest-bearing deposits in
other financial institutions $403 5.32% $ -- --% $ -- --%
Securities available for sale:
Equity securities(1) 15 -- -- -- -- --
Securities held to maturity:
Municipal obligations -- -- 125 3.85 -- --
---- ---- ---- ---- ---------- ---
Total $418 5.32% $125 3.85% $ -- --%
==== ==== ==== ==== ========== ===
At September 30, 1999
-----------------------------------------------------
Total Interest-Bearing Deposits in Other
Financial Institutions and Securities
-----------------------------------------------------
Average Weighted
Life Carrying Market Average
In Years Value Value Yield
------------ ------------ ----------- ----------
(Dollars in thousands)
Interest-bearing deposits in other financial
institutions N/A $ 403 $ 403 5.32%
Securities available for sale:
Equity securities(1) N/A 15 15 --
Securities held to maturity:
Municipal obligations 3.17 years 125 123 3.85
---------- --------- -------
Total $ 543 $ 541 4.97%
========== ========= =======
(1) Comprised of Intrieve, Incorporated ("Intrieve"), stock, which is reported
at the fair value, which approximates cost.
DEPOSITS AND BORROWINGS
GENERAL. Deposits are a primary source of Milton Federal's funds for use in
lending and other investment activities. In addition to deposits, Milton Federal
uses borrowings from the FHLB and derives funds from interest payments and
principal repayments on loans and mortgage-backed securities, income on earning
assets, service charges and gains on the sale of assets. Loan payments are a
relatively stable source of funds, while deposit inflows and outflows fluctuate
more in response to general interest rates and money market conditions.
DEPOSITS. Deposits are attracted principally from within Milton Federal's
primary market area through the offering of a broad selection of deposit
instruments, including negotiable order of withdrawal ("NOW") accounts, money
market accounts, passbook savings accounts, term certificate accounts,
individual retirement accounts ("IRAs") and Keogh retirement accounts
("Keoghs"). Interest rates paid,
-20-
21
maturity terms, service fees and withdrawal penalties for the various types of
accounts are established periodically by the management of Milton Federal based
on Milton Federal's liquidity requirements, growth goals and interest rates paid
by competitors. Milton Federal does not use brokers to attract deposits.
At September 30, 1999, the Corporation's certificates of deposit totaled $114.5
million, or 67.95% of total deposits. Of such amount, approximately $75.6
million in certificates of deposit mature within one year. Based on past
experience and the Corporation's prevailing pricing strategies, management
believes that a substantial percentage of such certificates will renew with the
Corporation at maturity. If there is a significant deviation from historical
experience, the Corporation can use borrowings from the FHLB as an alternative
to this source of funds.
The following table sets forth the dollar amount of deposits in the various
types of savings programs offered by the Corporation at the dates indicated:
As of September 30,
--------------------------------------------------------------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Transaction accounts:
Noninterest-bearing
demand deposit $ 10,553 6.26% $ 1,923 1.24% $ 802 0.56%
Interest-bearing
demand deposit(1) -- -- 8,806 5.70 7,993 5.60
Money market accounts(2) 27,671 16.43 10,441 6.75 7,065 4.95
Passbook savings
accounts(3) 15,763 9.36 16,618 10.75 16,461 11.52
----------- ------- ----------- -------- ----------- -------
Total transaction
accounts 53,987 32.05 37,788 24.44 32,321 22.63
Certificates of deposit(4): 114,484 67.95 116,859 75.56 110,511 77.37
----------- ------- ----------- -------- ----------- -------
Total deposits(5) $ 168,471 100.00% $ 154,647 100.00% $ 142,832 100.00%
=========== ======= =========== ======== =========== ======
(1) At September 30, 1998 and 1997, the weighted average rates on
interest-bearing demand accounts were 2.74% and 2.13%, respectively. In
July 1999, Milton Federal discontinued the payment of interest on all
demand accounts.
(2) Milton Federal's weighted average interest rate paid on money market
accounts fluctuates with the general movement of interest rates. At
September 30, 1999, 1998 and 1997, the weighted average rates on money
market accounts were 4.53%, 4.05% and 2.89%, respectively.
(3) Milton Federal's weighted average rate on passbook savings accounts
fluctuates with the general movement of interest rates. The weighted
average interest rate on passbook accounts was 2.53% at September 30,
1999 and 2.52% at September 30, 1998 and 1997.
(4) The interest rate on individual certificates of deposit remains fixed
until maturity. At September 30, 1999, 1998 and 1997 the weighted
average rates on certificates of deposit were 5.57%, 5.76% and 5.91%.
(5) IRAs and Keoghs are included in the various certificates of deposit
balances. IRAs and Keoghs totaled $24.5 million, $23.0 million and
$21.0 million as of September 30, 1999, 1998 and 1997.
At September 30, 1999, scheduled maturities of certificates of deposit were as
follows:
Amount
Year Ended September 30, --------------
------------------------ (In thousands)
2000 $75,554
2001 22,908
2002 7,704
2003 5,709
2004 2,609
--------
$114,484
========
-21-
22
The following table presents the amount of the Corporation's certificates of
deposit of $100,000 or more by the time remaining until maturity as of September
30, 1999:
Maturity Amount
-------- ------
(In thousands)
Three months or less $ 1,301
Over 3 months to 6 months 995
Over 6 months to 12 months 947
Over 12 months 2,235
-----------
Total $ 5,478
===========
The following table sets forth Milton Federal's deposit account balance activity
for the periods indicated:
Year Ended September 30,
------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Beginning balance $ 154,647 $ 142,832 $ 128,554
Deposits 249,290 206,263 180,052
Withdrawals (242,528) (200,871) (171,487)
------------ ------------ ------------
Net increases (decreases) before interest credited 6,762 5,392 8,565
Interest credited 7,062 6,423 5,713
------------ ------------ ------------
Ending balance $ 168,471 $ 154,647 $ 142,832
============ ============ ============
Net increase $ 13,824 $ 11,815 $ 14,278
Percent increase 8.94% 8.27% 11.11%
BORROWINGS. The FHLB System functions as a central reserve bank providing credit
for its member institutions and certain other financial institutions. See
"REGULATION - Federal Home Loan Banks." As a member in good standing of the FHLB
of Cincinnati, Milton Federal is authorized to apply for advances from the FHLB
of Cincinnati, provided certain standards of creditworthiness have been met.
Under current regulations, an association must meet certain qualifications to be
eligible for FHLB advances. The extent to which an association is eligible for
such advances will depend upon whether it meets the Qualified Thrift Lender Test
(the "QTL Test"). See "REGULATION - OTS Regulations -- Qualified Thrift Lender
Test." If an association meets the QTL Test, it will be eligible for 100% of the
advances it would otherwise be eligible to receive. If an association does not
meet the QTL Test, it will be eligible for such advances only to the extent it
holds specified QTL Test assets. At September 30, 1999, Milton Federal complied
with the QTL Test. As of September 30, 1999, 1998 and 1997, Milton Federal had
borrowed $61.5 million, $52.4 million and $39.6 million. In addition to
providing funding for loan growth, borrowed funds have also been invested in
mortgage-backed securities to leverage a portion of Milton Federal's excess
capital.
-22-
23
The following table sets forth certain information regarding FHLB advances for
the periods indicated:
Year ended September 30,
------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Maximum amount of FHLB advances
outstanding at any month end during year $ 61,524 $ 55,251 $ 39,570
Average amount of FHLB advances outstanding
during year 55,376 48,744 24,179
Weighted average interest rate of FHLB advances
outstanding during year 5.43% 5.69% 5.79%
Amount of FHLB advances outstanding at
end of year $ 61,483 $ 52,430 $ 39,570
Weighted average interest rate of FHLB advances
outstanding at end of year 5.50% 5.47% 5.76%
YIELDS EARNED AND RATES PAID
See "Management's Discussion and Analysis of Financial Condition and Resources
of Operations" for an analysis of yields earned and rates paid on the
Corporation's interest-earning assets and interest-bearing liabilities and the
extent to which changes in interest rates and changes in volume of
interest-earning assets and interest-bearing liabilities have afforded the
Corporation's interest income and expense.
COMPETITION
Milton Federal competes for deposits with other savings associations, commercial
banks and credit unions and with the issuers of commercial paper and other
securities, such as shares in money market mutual funds. The primary factors in
competing for deposits are interest rates and convenience of office location. In
making loans, Milton Federal competes with other savings associations,
commercial banks, consumer finance companies, credit unions, leasing companies,
mortgage companies and other lenders. Milton Federal competes for loan
originations primarily through the interest rates and loan fees offered and
through the efficiency and quality of services provided. Competition is affected
by, among other things, the general availability of lendable funds, general and
local economic conditions, current interest rate levels and other factors that
are not readily predictable.
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted
into law. The GLB Act makes sweeping changes in the financial services in which
various types of financial institutions may engage. The Glass-Steagall Act,
which had generally prevented banks from affiliating with securities and
insurance firms, was repealed. A new "financial holding company," which owns
only well capitalized and well managed depository institutions, will be
permitted to engage in a variety of financial activities, including insurance
and securities underwriting and agency activities.
The GLB Act permits unitary savings and loan holding companies in existence on
May 4, 1999, including MFFC, to continue to engage in all activities that they
were permitted to engage in prior to the enactment of the Act. Such activities
are essentially unlimited, provided that the thrift subsidiary remains a
qualified thrift lender. Any thrift holding company formed after May 4, 1999
will be subject to the same restrictions as a multiple thrift holding company.
In addition, a unitary thrift holding company in
-23-
24
existence at May 4, 1999 may be sold only to a financial holding company engaged
in activities permissible for multiple savings and loan holding companies.
The GLB Act is not expected to have a material effect on the activities in which
MFFC and Milton Federal currently engage, except to the extent that competition
with others types of financial institutions may increase as they engage in
activities not permitted prior to enactment of the GLB Act.
SUBSIDIARIES
Milton Federal owns all of the outstanding shares of Milton Financial Service
Corporation ("Milton Financial"), the only asset of which is stock of Intrieve,
Inc., a data service provider. The net book value of Milton Federal's investment
in Milton Financial at September 30, 1999, was $15,000.
PERSONNEL
As of September 30, 1999, Milton Federal had 49 full-time employees and 6
part-time employees. Milton Federal believes that relations with its employees
are good. Milton Federal offers health, disability and life insurance benefits.
None of the employees of Milton Federal are represented by a collective
bargaining unit. MFFC has no full-time employees.
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REGULATIONS
GENERAL
As a savings bank organized under the laws of the United States, Milton Federal
is subject to regulation, examination and oversight by the OTS. Because Milton
Federal's deposits are insured by the FDIC, Milton Federal is also subject to
regulatory oversight by the FDIC. Milton Federal must file periodic reports with
the OTS concerning its activities and financial condition. Examinations are
conducted periodically by the OTS to determine whether Milton Federal complies
with various regulatory requirements and is operating in a safe and sound
manner. Milton Federal is a member of the FHLB of Cincinnati.
MFFC is a savings and loan holding company within the meaning of the Home Owners
Loan Act, as amended (the "HOLA"). Consequently, MFFC is subject to regulation,
examination and oversight by the OTS and must submit periodic reports thereto.
Because MFFC is a corporation organized under Ohio law, it is subject to
provisions of the Ohio Revised Code applicable to corporations generally.
OFFICE OF THRIFT SUPERVISION
GENERAL. The OTS is an office in the Department of the Treasury and is
responsible for the regulation and supervision of all savings associations.
Deposits of federally chartered savings institutions are insured by the Savings
Association Insurance Fund (the "SAIF") of the FDIC. The OTS issues regulations
governing the operation of savings associations, regularly examines such
associations and imposes assessments on savings associations based on their
asset size to cover the cost of general supervision and examination. The OTS
charters federally chartered associations, such as Milton Federal, and
prescribes their permissible investments and activities, including the types of
loans and investments in real estate, subsidiaries and securities they may make.
The OTS has authority over mergers and acquisitions of control of federally
chartered savings and loan associations. The OTS also may initiate enforcement
actions against savings associations and certain persons affiliated with them
for violations of laws or regulations or for engaging in unsafe or unsound
practices. If the grounds provided by law exist, the OTS may appoint a
conservator or receiver for a savings association.
Savings associations are subject to regulatory oversight under various consumer
protection and fair lending laws. These laws govern, among other things,
truth-in-lending disclosure, equal credit opportunity, fair credit reporting and
community reinvestment. Failure to abide by federal laws and regulations
governing community reinvestment could limit the ability of an association to
open a new branch or engage in a merger. Community reinvestment regulations
evaluate how well and to what extent an institution lends and invests in its
designated service area, with particular emphasis on low- to moderate-income
areas. Milton Federal received an "Outstanding" rating under these regulations.
REGULATORY CAPITAL REQUIREMENTS. Milton Federal is required by regulations to
meet certain minimum capital requirements, which must be generally as stringent
as the standards established for commercial banks. Current capital requirements
call for tangible capital of 1.5% of adjusted total assets, core capital (which,
for Milton Federal, consists solely of tangible capital) of 4.0% of adjusted
total assets, except for institutions with the highest examination rating and
acceptable levels of risk, and risk-based capital (which, for Milton Federal,
consists of core capital and general valuation allowances) of 8% of
risk-weighted assets (assets are weighted at percentage levels ranging from 0%
to 100% depending on their relative risk).
The OTS has adopted regulations governing prompt corrective action to resolve
the problems of capital deficient and otherwise troubled savings associations.
At each successively lower defined capital category, an association is subject
to more restrictive and numerous mandatory or discretionary regulatory actions
or limits, and the OTS has less flexibility in determining how to resolve the
problems of
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the institution. In addition, the OTS generally can downgrade an association's
capital category, notwithstanding its capital level, based on less than
satisfactory examination ratings in areas other than capital or, after notice
and opportunity for hearing, if the association is deemed to be in an unsafe or
unsound condition or to be engaging in an unsafe or unsound practice. Each
undercapitalized association must submit a capital restoration plan to the OTS
within 45 days after it becomes undercapitalized. Such institution will be
subject to increased monitoring and asset growth restrictions and will be
required to obtain prior approval for acquisitions, branching and engaging in
new lines of business. Furthermore, critically undercapitalized institutions
must be placed in conservatorship or receivership within 90 days of reaching
that capitalization level, except under limited circumstances. Milton Federal's
capital at September 30, 1999 meets the standards for the highest category, a
"well-capitalized" institution.
Federal law prohibits an insured institution from making a capital distribution
to anyone or paying management fees to any person having control of the
institution if, after such distribution or payment, the institution would be
undercapitalized. In addition, each company controlling an undercapitalized
institution must guarantee that the institution will comply with its capital
plan until the institution has been adequately capitalized on an average during
each of four consecutive calendar quarters and must provide adequate assurances
of performance. The aggregate liability pursuant to such guarantee is limited to
the lesser of (a) an amount equal to 5% of the institution's total assets at the
time the institution became undercapitalized or (b) the amount that is necessary
to bring the institution into compliance with all capital standards applicable
to such association at the time the institution fails to comply with its capital
restoration plan.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. In addition to certain federal income tax
considerations, the OTS regulations impose limitations on the payment of
dividends and other capital distributions by savings associations. Under OTS
regulations applicable to converted savings banks, Milton Federal is not
permitted to pay a cash dividend on its common shares if its regulatory capital
would, as a result of payment of such dividends, be reduced below the amount
required for the Liquidation Account, or below applicable regulatory capital
requirements prescribed by the OTS.
An application must be submitted and approval from the OTS must be obtained by a
subsidiary of a savings and loan holding company (1) if the proposed
distribution would cause total distributions for the year to exceed net income
for that calendar year to date plus the savings association's retained net
income for the preceding two years; (2) if the savings association will not be
at least adequately capitalized following the capital distribution; (3) if the
proposed distribution would violate a prohibition contained in any applicable
statute, regulation or agreement between the savings association and the OTS (or
the FDIC), or a condition imposed on the savings association in an OTS-approved
application or notice; or, (4) if the savings association has not received
certain favorable examination ratings from the OTS. If a savings association
subsidiary of a holding company is not required to file an application, it must
file a notice with the OTS. At September 30, 1999, Milton Federal could dividend
$382,310 without approval from the OTS.
LIQUIDITY. OTS regulations require that savings associations maintain an average
daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified United States Government, state or federal agency
obligations) equal to a monthly average of not less than 4% of its net
withdrawable savings deposits plus borrowings payable in one year or less.
Monetary penalties may be imposed upon associations failing to meet these
liquidity requirements.
QUALIFIED THRIFT LENDER TEST. Savings associations are required to meet the QTL
Test. Prior to September 30, 1997, the QTL Test required savings associations to
maintain a specified amount of investments in assets that are designated as
qualifying thrift investments ("QTI"), which are generally related to domestic
residential real estate and manufactured housing and include stock issued by any
FHLB, the FHLMC or the FNMA. Under this test, 65% of an institution's "portfolio
assets" (total assets less goodwill and other intangibles, property used to
conduct business and 20% of liquid assets) must consist of QTI on a monthly
average basis in 9 out of every 12 months. Congress created a second QTL
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Test, effective September 30, 1997, pursuant to which a savings association may
also meet the QTL Test if at least 60% of the institution's assets (on a tax
basis) consist of specified assets (generally loans secured by residential real
estate or deposits, educational loans, cash and certain governmental
obligations). The OTS may grant exceptions to the QTL Test under certain
circumstances. If a savings association fails to meet the QTL Test, the
association and its holding company become subject to certain operating and
regulatory restrictions. A savings association that fails to meet the QTL Test
will not be eligible for new FHLB advances. At September 30, 1999, Milton
Federal met the QTL Test.
TRANSACTIONS WITH INSIDERS AND AFFILIATES. Loans to executive officers,
directors and principal shareholders and their related interests must conform to
limits on loans to one borrower, and the total of such loans to executive
officers, directors, principal shareholders and their related interests cannot
exceed the association's Lending Limit Capital (200% of total capital for
eligible, adequately capitalized institutions with less than $100 million in
deposits). Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of the board of directors of the association with any "interested"
director not participating. All loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
to all employees of Milton Federal. In addition, no loan may be made to an
executive officer, except loans for specific authorized purposes such as
financing the education of the executive officer's children or financing the
purchase of the executive officer's primary residence. Milton Federal complied
with such restrictions at September 30, 1999.
Savings associations must comply with Sections 23A and 23B of the Federal
Reserve Act (the "FRA") pertaining to transactions with affiliates. An affiliate
of a savings association is any company or entity that controls, is controlled
by or is under common control with the savings association. MFFC is an affiliate
of Milton Federal. Generally, Sections 23A and 23B of the FRA (i) limit the
extent to which a savings association or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus for any one affiliate and 20% of such
capital stock and surplus for the aggregate of such transactions with all
affiliates and (ii) require that all such transactions be on terms substantially
the same, or at least as favorable to the association, as those provided in
transactions with a nonaffiliate. The term "covered transaction" includes the
making of loans, purchase of assets, issuance of a guarantee and other similar
types of transactions. In addition to limits in Sections 23A and 23B, Milton
Federal may not make any loan or other extension of credit to an affiliate
unless the affiliate is engaged only in activities permissible for a bank
holding company and may not purchase or invest in securities of any affiliate,
except for shares of a subsidiary. Exemptions from Section 23A or 23B of the FRA
may be granted only by the Federal Reserve Board. Milton Federal complied with
these requirements at September 30, 1999.
HOLDING COMPANY REGULATION. MFFC is a savings and loan holding company within
the meaning of the HOLA. The HOLA generally prohibits a savings and loan holding
company from controlling any other savings association or savings and loan
holding company, without prior approval of the OTS, or from acquiring or
retaining more than 5% of the voting shares of a savings association or holding
company thereof, which is not a subsidiary. Under certain circumstances, a
savings and loan holding company is permitted to acquire, with the approval of
the OTS, up to 15% of the previously unissued voting shares of an
undercapitalized savings association for cash without such savings association
being deemed to be controlled by the holding company. Except with the prior
approval of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock may also acquire control of any savings institution, other
than a subsidiary institution, or any other savings and loan holding company.
MFFC is a unitary savings and loan holding company. Under current law, there are
generally no restrictions on the activities of a unitary savings and loan
holding company and such companies are the only financial institution holding
companies that may engage in commercial, securities and insurance activities
without limitation. The broad latitude to engage in activities under current law
can be restricted if the OTS determines that there is reasonable cause to
believe that the continuation by a savings and loan
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holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the OTS
may impose such restrictions as deemed necessary to address such risk, including
limiting (i) payment of dividends by the savings association, (ii) transactions
between the savings association and its affiliates, and (iii) any activities of
the savings association that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
association. Notwithstanding the foregoing rules as to permissible business
activities of a unitary savings and loan holding company, if the savings
association subsidiary of a holding company fails to meet the QTL Test, then
such unitary holding company would become subject to the activities restrictions
applicable to multiple holding companies. At September 30, 1999, Milton Federal
met the QTL Test.
If MFFC were to acquire control of another savings institution, other than
through a merger or other business combination with Milton Federal, MFFC would
become a multiple savings and loan holding company. Unless the acquisition is an
emergency thrift acquisition and each subsidiary savings association meets the
QTL Test, the activities of MFFC and any of its subsidiaries (other than Milton
Federal or other subsidiary savings associations) would thereafter be subject to
activity restrictions. The HOLA provides that, among other things, no multiple
savings and loan holding company or subsidiary thereof that is not a savings
institution shall commence or continue for a limited period of time after
becoming a multiple savings and loan holding company or subsidiary thereof, any
business activity other than (i) furnishing or performing management services
for a subsidiary savings institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing or liquidating assets owned by or
acquired from a subsidiary savings institution, (iv) holding or managing
properties used or occupied by a subsidiary savings institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by federal regulation as of March 5, 1987, to be engaged in by
multiple holding companies, or (vii) those activities authorized by the FRB as
permissible for bank holding companies, unless the OTS by regulation prohibits
or limits such activities for savings and loan holding companies. Those
activities described in (vii) above must also be approved by the OTS prior to
being engaged in by a multiple holding company.
The OTS may approve acquisitions resulting in the formation of a multiple
savings and loan holding company that controls savings associations in more than
one state only if the multiple savings and loan holding company involved
controls a savings association that operated a home or branch office in the
state of the association to be acquired as of March 5, 1987, or if the laws of
the state in which the institution to be acquired is located specifically permit
institutions to be acquired by state-chartered institutions or savings and loan
holding companies located in the state where the acquiring entity is located (or
by a holding company that controls such state-chartered savings institutions).
As under prior law, the OTS may approve an acquisition resulting in a multiple
savings and loan holding company controlling savings associations in more than
one state in the case of certain emergency thrift acquisitions.
Federal legislative proposals have been introduced or are under consideration
that would either limit unitary savings and loan holding companies to the same
activities as multiple savings and loan holding companies and other financial
institutions holding companies or would permit certain bank holding companies to
engage in commercial activities. MFFC cannot predict when, and in what form,
these proposals might become law.
No subsidiary savings association of a savings and loan holding company may
declare or pay a dividend on its permanent or nonwithdrawable stock unless it
first gives the Director of the OTS 30 days advance notice of such declaration
and payment.
FEDERAL REGULATION OF ACQUISITIONS OF CONTROL OF MFFC AND MILTON FEDERAL. In
addition to the Ohio law limitations on the merger and acquisition of MFFC
previously discussed, federal limitations generally require regulatory approval
of acquisitions at specified levels. Under pertinent federal law and
regulations, no person, directly or indirectly, or acting in concert with
others, may acquire control of Milton Federal or MFFC without 60 days prior
notice to the OTS. "Control" is generally defined as having more than 25%
ownership or voting power; however, ownership or voting power of more than
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10% may be deemed "control" if certain factors are in place. If the acquisition
of control is by a company, the acquirer must obtain approval, rather than give
notice, of the acquisition as a savings and loan holding company.
In addition, any merger of Milton Federal or of MFFC in which MFFC is not the
resulting company must also be approved by the OTS.
FEDERAL DEPOSIT INSURANCE CORPORATION
DEPOSIT INSURANCE. The FDIC is an independent federal agency that insures the
deposits, up to prescribed statutory limits, of federally insured banks and
thrifts and safeguards the safety and soundness of the banking and thrift
industries. The FDIC administers two separate insurance funds, the Bank
Insurance Fund ("BIF") for commercial banks and state savings banks and the SAIF
for savings associations. Milton Federal is a member of the SAIF and its deposit
accounts are insured by the FDIC, up to the prescribed limits. The FDIC has
examination authority over all insured depository institutions, including Milton
Federal, and has authority to initiate enforcement actions against federally
insured savings associations, if the FDIC does not believe the OTS has taken
appropriate action to safeguard safety and soundness and the deposit insurance
fund.
ASSESSMENTS. The FDIC is required to maintain designated levels of reserves in
each fund. The FDIC may increase assessment rates for either fund if necessary
to restore the fund's ratio of reserves to insured deposits to its target level
within a reasonable time and may decrease such assessment rates if such target
level has been met. The FDIC has established a risk-based assessment system for
both SAIF and BIF members. Under this system, assessments vary based on the risk
the institution poses to its deposit insurance fund. This risk level is
determined based on the institution's capital level and the FDIC's level of
supervisory concern about the institution.
FEDERAL RESERVE BOARD
Effective December 1, 1999, FRB regulations require savings associations to
maintain reserves of 3% of net transaction accounts (primarily NOW accounts) up
to $44.3 million (subject to an exemption of up to $5.0 million) and of 10% of
net transaction accounts in excess of $44.3 million. At September 30, 1999,
Milton Federal complied with the reserve requirements then in effect as well as
the new requirements.
FEDERAL HOME LOAN BANKS
The FHLBs, under the regulatory oversight of the Federal Housing Financing
Board, provide credit to their members in the form of advances. Milton Federal
is a member of the FHLB of Cincinnati and must maintain an investment in the
capital stock of that FHLB in an amount equal to the greater of 1.0% of the
aggregate outstanding principal amount of Milton Federal's residential mortgage
loans, home purchase contracts and similar obligations at the beginning of each
year, or 5% of its advances from the FHLB. Milton Federal complies with this
requirement with an investment in stock of the FHLB of Cincinnati of $3.1
million at September 30, 1999.
Upon the origination or renewal of a loan or advance, the FHLB of Cincinnati is
required by law to obtain and maintain a security interest in collateral in one
or more of the following categories: fully disbursed, whole first-mortgage loans
on improved residential property or securities representing a whole interest in
such loans; securities issued, insured or guaranteed by the United States
government or an agency thereof; deposits in any FHLB; or other real estate
related collateral (up to 30% of the member association's capital) acceptable to
the applicable FHLB, if such collateral has a readily ascertainable value and
the FHLB can perfect its security interest in the collateral.
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Each FHLB is required to establish standards of community investment or service
that its members must maintain for continued access to long-term advances from
the FHLBs. The standards take into account a member's performance under the
Community Reinvestment Act and its record of lending to first-time home buyers.
All long-term advances by each FHLB must be made only to provide funds for
residential housing finance.
FEDERAL TAXATION
MFFC and Milton Federal are subject to the federal tax laws and regulations that
apply to corporations generally. However, certain thrift institutions such as
Milton Federal were, prior to the enactment of the Small Business Jobs
Protection Act, which was signed into law on August 21, 1996, allowed deductions
for bad debts under methods more favorable to those granted to other taxpayers.
Qualified thrift institutions could compute deductions for bad debts using
either the specific charge-off method of Section 166 of the Code, or the reserve
method of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect to deduct bad debts
under either (i) the "percentage of taxable income" method applicable only to
thrift institutions, or (ii) the "experience" method that also was available to
small banks. Under the "percentage of taxable income" method, a thrift
institution generally was allowed a deduction for an addition to its bad debt
reserve equal to 8% of its taxable income (determined without regard to this
deduction and with additional adjustments). Under the "experience" method, a
thrift institution was generally allowed a deduction for an addition to its bad
debt reserve equal to the greater of (i) an amount based on its actual average
experience for losses in the current and five preceding taxable years, or (ii)
an amount necessary to restore the reserve to its balance as of the close of the
base year. A thrift institution could elect annually to compute its allowable
addition to bad debt reserves for qualifying loans either under the "experience"
method or the "percentage of taxable income" method.
Section 1616(a) of the Small Business Job Protection Act repealed the Section
593 reserve method of accounting for bad debts by thrift institutions, effective
for taxable years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to use the "experience" method applicable to
such institutions, while thrift institutions that are treated as large banks are
required to use on the specific charge-off method. The "percentage of taxable
income" method of accounting for bad debts is no longer available for any
financial institution.
A thrift institution required to change its method of computing reserves for bad
debt treated such change as a change in the method of accounting, initiated by
the taxpayer, and having been made with the consent of the Secretary of the
Treasury. Any adjustments under Section 481(a) of the Code required to be
recaptured with respect to such change generally were determined solely with
respect to the "applicable excess reserves" of the taxpayer. The amount of the
"applicable excess reserves" are being taken into account ratably over a
six-taxable-year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement described below. In the case
of a thrift institution that becomes a large bank, the amount of the
institution's applicable excess reserves generally is the excess of (i) the
balances of its reserve for losses on qualifying real property loans (generally
loans secured by improved real estate) and its reserve for losses on
nonqualifying loans (all other types of loans) as of the close of its last
taxable year beginning before January 1, 1996, over (ii) the balances of such
reserves as of the close of its last taxable year beginning before January 1,
1988 (i.e., the "pre-1988 reserves"). In the case of a thrift institution that
becomes a small bank, like Milton Federal, the amount of the institution's
"applicable excess reserves" generally is the excess of (i) the balances of its
reserve for loan losses on qualifying real property loans and its reserve for
losses on nonqualifying loans as of the close of its last taxable year beginning
before January 1, 1996, over (ii) the greater balance of (a) its "pre-1988
reserves" or (b) what the thrift's reserves would have been at the close of its
last year beginning before January 1, 1996, had the thrift always used the
"experience" method.
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For taxable years that begin after December 31, 1995, and before January 1,
1998, if a thrift meets the residential loan requirement for a tax year, the
recapture of the "applicable excess reserves" otherwise required to be taken
into account as a Code Section 481(a) adjustment for the year will be suspended.
A thrift meets the residential loan requirement if, for the tax year, the
principal amount of residential loans made by the thrift during the year is not
less than its "base amount." The "base amount" generally is the average of the
principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before January 1, 1996.
A residential loan is a loan as described in Section 7701(a)(19)(C)(v)
(generally a loan secured by residential real and church property and certain
mobile homes), but only to the extent that the loan is made to the owner of the
property to acquire, construct or improve the property.
The balance of the "pre-1988 reserves" is subject to the provisions of Section
593(e) as modified by the Small Business Job Protection Act that requires
recapture in the case of certain excessive distributions to shareholders. The
"pre-1988 reserves" may not be utilized for payment of cash dividends or other
distributions to a shareholder (including distributions in dissolution or
liquidation) or for any other purpose (except to absorb bad debt losses).
Distribution of a cash dividend by a thrift institution to a shareholder is
treated as made: First, out of the institution's post-1951 accumulated earnings
and profits; second, out of the "pre-1988 reserves"; and, third, out of such
other accounts as may be proper. To the extent a distribution by Milton Federal
to MFFC is deemed paid out of its "pre-1988 reserves" under these rules, the
"pre-1988 reserves" would be reduced and Milton Federal's gross income for tax
purposes would be increased by the amount which, when reduced by the income tax,
if any, attributable to the inclusion of such amount in its gross income, equals
the amount deemed paid out of the "pre-1988 reserves." As of September 30, 1999,
Milton Federal's "pre-1988 reserves" subject to potential recapture for tax
purposes totaled approximately $3.4 million. Milton Federal believes it has
approximately $5.4 million of accumulated earnings and profits for tax purposes
as of September 30, 1999, which would be available for dividend distributions,
provided regulatory restrictions applicable to the payment of dividends are met.
No representation can be made as to whether Milton Federal will have current or
accumulated earnings and profits in subsequent years.
In addition to the regular income tax, MFFC and Milton Federal may be subject to
a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of
20% on "alternative minimum taxable income" (which is the sum of a corporation's
regular taxable income, with certain adjustments, and tax preference items),
less any available exemption. Such tax preference items include interest on
certain tax-exempt bonds issued after August 7, 1986. In addition, 75% of the
amount by which a corporation's "adjusted current earnings" exceeds its
"alternative minimum taxable income" computed without regard to this preference
item and prior to reduction by net operating losses, is included in "alternative
minimum taxable income." Net operating losses can offset no more than 90% of
"alternative minimum taxable income." The alternative minimum tax is imposed to
the extent it exceeds the corporation's regular income tax. Payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years. In addition, for taxable years after 1986 and before 1997, MFFC
and Milton Federal are also subject to an environmental tax equal to 0.12% of
the excess of "alternative minimum taxable income" for the taxable year
(determined without regard to net operating losses and the deduction for the
environmental tax) over $2.0 million.
The tax returns of Milton Federal have been audited or closed without audit
through September 30, 1995. In the opinion of management, any examination of
open returns would not result in a deficiency that could have a material adverse
effect on the financial condition of Milton Federal.
OHIO TAXATION
MFFC is subject to the Ohio corporation franchise tax, which, as applied to
MFFC, is a tax measured by both net earnings and net worth. The rate of tax is
the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable income and
8.9% of computed Ohio taxable income in excess of $50,000 or (ii) 0.582% times
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taxable net worth. For tax years beginning after December 31, 1998, the tax rate
is the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable income
and 8.5% of computed Ohio taxable income in excess of $50,000 or (ii) .400%
times taxable net worth.
Certain holding companies, such as MFFC, qualify for complete exemption from the
net worth tax if certain conditions are met. MFFC will most likely meet these
conditions and, thus, calculate its Ohio franchise tax on the net income basis.
A special litter tax is also applicable to all corporations, including MFFC,
subject to the Ohio corporation franchise tax other than "financial
institutions." If the franchise tax is paid on the net income basis, the litter
tax is equal to .11% of the first $50,000 of computed Ohio taxable income and
.22% of computed Ohio taxable income in excess of $50,000. If the franchise tax
is paid on the net worth basis, the litter tax is equal to .014% times taxable
net worth.
Milton Federal is a "financial institution" for State of Ohio tax purposes. As
such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which is imposed annually at a rate of 1.5% of Milton Federal's
book net worth determined in accordance with generally accepted accounting
principles. For the tax year 1999, however, the franchise tax on financial
institutions will be 1.4% of book net worth and for the tax year 2000 and years
thereafter, the tax will be 1.3% of book net worth. As a "financial
institution," Milton Federal is not subject to any tax based upon net income or
net profits imposed by the State of Ohio.
ITEM 2. PROPERTIES
The following table sets forth certain information at September 30, 1999,
regarding the properties on which the main office and the branch office of
Milton Federal are located:
Owned Date Square Net
Location or leased acquired footage book value(1)
- -------- --------- -------- ------- -------------
25 Lowry Drive
West Milton, Ohio 45383 Owned 1966 7,606 $ 776,092
415 West National Road
Englewood, Ohio 45322 Owned 1972 3,249 210,387
709 Arlington Road
Brookville, Ohio 45309 Owned 1996 3,750 1,166,896
280-A South Garber Road
Tipp City, Ohio 45371 Leased 1998 400 57,167
(1) At September 30, 1999, Milton Federal's office premises and equipment had a
total net book value of $2,629,439. For additional information regarding
Milton Federal's office premises and equipment, see Notes 1 and 4 to
Financial Statements.
The management of MFFC believes that its properties are adequately insured.
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ITEM 3. LEGAL PROCEEDINGS
Neither MFFC nor Milton Federal is presently involved in any legal proceedings
of a material nature. From time to time, Milton Federal is a party to legal
proceedings incidental to its business to enforce its security interest in
collateral pledged to secure loans made by Milton Federal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were brought to a vote of security holders during the fourth quarter of
the Corporation's fiscal year ending September 30, 1999.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation had 2,099,995 common shares outstanding on November 30, 1999,
held of record by approximately 1,004 shareholders. Price information with
respect to the Corporation's common shares is quoted on The Nasdaq National
Market System ("Nasdaq"). The high and low daily closing prices for the common
shares of the Corporation, as quoted by Nasdaq, by quarter, are shown below.
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1998 1999 1999 1999
---- ---- ---- ----
High $ 15.63 $ 15.00 $ 14.25 $ 13.50
Low 12.56 13.00 11.75 11.63
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1997 1998 1998 1998
---- ---- ---- ----
High $ 15.94 $ 17.00 $ 16.44 $ 15.00
Low 14.50 15.13 15.00 12.31
For the fiscal year ended September 30, 1999, the Corporation paid regular
quarterly dividends per common share of $.15 on November 15, 1998, $.15 on
February 15, 1999, $.15 on May 15, 1999 and $.15 on August 16, 1999. For the
fiscal year ended September 30, 1998, the Corporation paid regular quarterly
dividends per common share of $.15 on November 15, 1997, $.15 on February 16,
1998, $.15 on May 15, 1998 and $.15 on August 15, 1998. Income of MFFC primarily
consists of interest on mortgage-backed securities and other securities and
dividends that were periodically declared and paid by the Board of Directors of
Milton Federal on common shares of Milton Federal held by MFFC.
In addition to certain federal income tax considerations, OTS regulations impose
limitations on the payment of dividends and other capital distributions by
savings associations. Under OTS regulations applicable to converted savings
associations, Milton Federal is not permitted to pay a cash dividend on its
common shares if its regulatory capital would, as a result of payment of such
dividend, be reduced below the amount required for the Liquidation Account (the
account established for the purpose of granting a limited priority claim on the
assets of Milton Federal in the event of complete liquidation to those members
of Milton Federal before the Conversion who maintain a savings account at Milton
Federal after the Conversion), or applicable regulatory capital requirements
prescribed by the OTS.
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34
An application must be submitted and approval from the OTS must be obtained by a
subsidiary of a savings and loan holding company (1) if the proposed
distribution would cause total distributions for that calendar year to exceed
net income for that year to date plus the savings association's retained net
income for the preceding two years; (2) if the savings association will not be
at least adequately capitalized following the capital distribution; (3) if the
proposed distribution would violate a prohibition contained in any applicable
statute, regulation or agreement between the savings association and the OTS (or
the FDIC), or a condition imposed on the savings association in an OTS-approved
application or notice; or, (4) if the savings association has not received
certain favorable examination ratings from the OTS. If a savings association
subsidiary of a holding company is not required to file an application, it must
file a notice with the OTS.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth certain information concerning the consolidated
financial condition, earnings and other data regarding the Corporation at the
dates and for the periods indicated.
SELECTED FINANCIAL CONDITION At September 30,
--------------------------------------------------------------------------
DATA: 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In thousands)
Total amount of:
Assets $ 256,677 $ 235,276 $ 209,958 $ 180,831 $ 161,680
Cash and cash equivalents(1) 3,542 3,578 5,633 1,301 1,701
Securities available for sale 36,669 36,912 53,362 34,009 17,110
Securities held to maturity 12,317 14,560 15,379 14,502 25,974
FHLB stock 3,132 2,814 2,013 1,182 1,099
Loans held for sale 2,627 -- -- -- --
Loans, net 192,115 171,346 127,396 116,749 100,758
Deposits 168,471 154,647 142,832 128,554 117,898
Borrowings 61,483 52,430 39,570 17,489 5,260
Shareholders' equity 25,028 26,283 26,388 33,479 37,502
- ------------------------
(1) Includes cash and amounts due from depository institutions,
interest-bearing deposits in other financial institutions and overnight
deposits.
Year ended September 30,
--------------------------------------------------------------------------
SUMMARY OF EARNINGS: 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In thousands except per share data)
Interest and dividend income $ 17,364 $ 16,219 $ 13,773 $ 12,665 $ 11,139
Interest expense 11,033 10,348 8,149 6,819 5,236
------------ ------------- ------------ ------------ ------------
Net interest income 6,331 5,871 5,624 5,846 5,903
Provision for loan losses 120 229 75 154 64
------------ ------------- ------------ ------------ ------------
Net interest income after
provision for loan losses 6,211 5,642 5,549 5,692 5,839
Noninterest income 552 796 497 457 257
Noninterest expense 4,337 4,146 3,959 4,410 3,300
------------ ------------- ------------ ------------ ------------
Income before income taxes 2,426 2,292 2,087 1,739 2,796
Income tax expense 823 790 709 595 947
------------ ------------- ------------ ------------ ------------
Net income $ 1,603 $ 1,502 $ 1,378 $ 1,144 $ 1,849
============ ============= ============ ============ ============
Earnings per common share
Basic $ .80 $ .72 $ .65 $ .51 $ .77
============ ============ ============ ============ ===========
Diluted $ .80 $ .71 $ .65 $ .50 $ .77
============ ============ ============ ============ ===========
Dividends declared per share $ .60 $ .60 $ 3.09 $ 1.43 $ .19
============ ============ ============ ============ ===========
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At or for the year ended September 30,
--------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Return on equity (2) 6.31% 5.82% 5.08% 3.28% 5.01%
Return on assets (3) 0.64 0.67 0.73 0.67 1.22
Interest rate spread (4) 2.19 2.16 2.42 2.55 2.95
Net interest margin (5) 2.61 2.68 3.08 3.50 4.01
Operating expenses to average assets (6) 1.74 1.84 2.11 2.58 2.18
Equity-to-assets ratio (7) 10.21 11.47 14.46 20.36 24.36
Dividend payout ratio (8) 77.39 87.24 503.34 296.89 24.66
Nonperforming assets to total assets 0.25 0.47 0.30 0.35 0.34
Nonperforming loans to total loans 0.32 0.64 0.49 0.51 0.51
Allowance for loan losses as a
percentage of nonperforming
loans 116.46 61.40 90.06 81.57 64.04
Allowance for loan losses to total loans 0.40 0.39 0.44 0.42 0.33
Net charge-offs to average loans 0.02 0.08 -- -- --
Number of full service offices 4 4 3 2 2
- ------------------------
(2) Net income divided by average total equity.
(3) Net income divided by average total assets.
(4) Difference between average yield on interest-earning assets and average
cost of interest-bearing liabilities.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Noninterest expense divided by average total assets.
(7) Average equity divided by average total assets.
(8) Cash dividends declared divided by net income.
QUARTERLY FINANCIAL DATA
The following table is a summary of selected quarterly results of operations for
the years ended September 30, 1999 and 1998.
Three months ended
------------------------------------------------------------------
December 31, March 31, June 30, September 30,
SEPTEMBER 30, 1999 1998 1999 1999 1999
---- ---- ---- ----
(In thousands except per share data)
Interest and dividend income $ 4,215 $ 4,365 $ 4,345 $ 4,439
Interest expense 2,761 2,783 2,728 2,761
----------- ----------- ----------- -----------
Net interest income 1,454 1,582 1,617 1,678
Provision for loan losses 30 30 30 30
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 1,424 1,552 1,587 1,648
Noninterest income 157 146 125 124
Noninterest expense 1,108 1,120 1,022 1,087
----------- ----------- ----------- -----------
Income before income taxes 473 578 690 685
Income tax expense 162 197 233 231
----------- ----------- ----------- -----------
Net income $ 311 $ 381 $ 457 $ 454
=========== =========== =========== ===========
Earnings per share
Basic $ .15 $ .19 $ .23 $ .23
=========== ========== =========== ==========
Diluted $ .15 $ .19 $ .23 $ .23
=========== ========== =========== ==========
Dividends declared per share $ .15 $ .15 $ .15 $ .15
=========== ========== =========== ==========
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36
Three months ended
-----------------------------------------------------------------
December 31, March 31, June 30, September 30,
SEPTEMBER 30, 1998 1997 1998 1998 1998
---- ---- ---- ----
(In thousands except per share data)
Interest and dividend income $ 3,926 $ 3,979 $ 4,157 $ 4,157
Interest expense 2,470 2,520 2,657 2,701
----------- ----------- ----------- -----------
Net interest income 1,456 1,459 1,500 1,456
Provision for loan losses 24 60 110 35
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 1,432 1,399 1,390 1,421
Noninterest income 79 254 311 152
Noninterest expense 1,065 1,020 1,014 1,047
----------- ----------- ----------- -----------
Income before income taxes 446 633 687 526
Income tax expense 155 219 238 178
----------- ----------- ----------- -----------
Net income $ 291 $ 414 $ 449 $ 348
=========== =========== =========== ===========
Earnings per share
Basic $ .14 $ .20 $ .21 $ .17
=========== ========== =========== ==========
Diluted $ .14 $ .20 $ .21 $ .16
=========== ========== =========== ==========
Dividends declared per share $ .15 $ .15 $ .15 $ .15
=========== ========== =========== ==========
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The following discusses the Corporation's financial condition and results of
operations as of and for the year ended September 30, 1999, compared to prior
years. This discussion should be read in conjunction with the financial
statements, footnotes and the selected financial data included herein.
FORWARD-LOOKING STATEMENTS
When used in this document, the words or phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimated," "projected," 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 changes in
economic conditions in the Corporation's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Corporation's market area and competition, that could cause actual results to
differ materially from historical earnings and those presently anticipated or
projected. Factors listed above could affect the Corporation's financial
performance and could cause the Corporation's actual results for future periods
to differ materially from any statements expressed with respect to future
periods.
The Corporation does not undertake, and specifically disclaims any obligation,
to publicly revise 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.
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37
ANALYSIS OF FINANCIAL CONDITION
The Corporation's assets totaled $256.7 million, at September 30, 1999, an
increase of $21.4 million, or 9.1%, from $235.3 million at September 30, 1998.
The growth in assets was primarily in loans. Such growth was funded by the use
of overnight deposits in other financial institutions and increased deposits and
borrowed funds.
Total securities, including Federal Home Loan Bank stock, decreased $2.2 million
from $54.3 million at September 30, 1998, to $52.1 million at September 30,
1999. The decrease was due to sales, maturities and principal repayments of
$15.8 million, partly offset by $13.8 million in purchases of securities.
Included in the security portfolio are mortgage-backed securities, which include
Federal Home Loan Mortgage Corporation ("FHLMC"), Government National Mortgage
Association ("GNMA") and Federal National Mortgage Association ("FNMA")
participation certificates and CMOs and REMICs. The majority of the securities
are classified as available for sale to provide the Corporation with the
flexibility to move funds into loans as demand warrants. The mortgage-backed
securities also provide the Corporation with a constant cash flow stream from
principal repayments.
Management's strategy emphasizes investment in securities guaranteed by the U.S.
Government and its agencies as a means to mediate credit risk. The investment
strategy also includes purchasing variable-rate mortgage-backed security
products with monthly payments and interest rates that adjust annually or more
frequently to mediate interest-rate risk.
The Corporation's investment policy limits investments in U.S. Treasury and
government agency securities to those with terms of 10 years or less for
fixed-rate investments and 30 years or less for variable-rate investments.
Mortgage-backed securities guaranteed by FHLMC, GNMA or FNMA may have terms of
up to 40 years. Substantially all CMOs and REMICs are collateralized with FHLMC,
GNMA or FNMA securities and may have terms of up to 40 years. CMOs and REMICs
must meet OTS guidelines and not be "high risk" at the time of purchase as
defined by Thrift Bulletin No. 52. The Corporation has not invested in any
derivative securities other than CMOs and REMICs.
Net loans increased from $171.3 million at September 30, 1998, to $192.1 million
at September 30, 1999. The growth in loans was primarily in one- to four-family
first-mortgage loans and nonresidential real estate loans, which increased $18.0
million and $6.1 million, respectively. Much of the growth occurred during the
first six months of fiscal 1999 resulting from customers refinancing their
higher rate loans from the Corporation's competitors during the lower interest
rate period. As interest rates have increased since March 31, 1999, growth has
slowed. Growth in real estate loans is also related to the growth in the
Corporation's market area, as the Corporation has not changed its philosophy
regarding pricing or underwriting standards during the period. Construction
loans decreased $5.5 million as loans were converted to more permanent financing
upon completion of construction. Changes in other types of loans were not
significant.
Additionally, the Corporation began originating one- to four-family
first-mortgage loans with the intent of selling them in the secondary market in
fiscal 1999. The loans were sold as a means to manage interest rate risk by
reducing the Corporation's investment in longer term, fixed rate loans. The
Corporation retained the right to service the loans for a fixed spread to
provide an additional source of fee income. As a result, $2.6 million in loans
were held for sale at September 30, 1999. Total originations of loans classified
as held for sale were $7.0 million in 1999. Prior to fiscal 1999, the
Corporation had sold pools of portfolio loans from time to time to manage
interest-rate risk.
Total deposits increased $13.8 million, or 8.9%, from $154.7 million at
September 30, 1998, to $168.5 million at September 30, 1999. Money market
accounts increased $17.2 million, or 165.0%, and had the largest increase of all
types of deposits. The increase in money market accounts is a result of a new
tiered pricing system which was implemented late in fiscal 1998, increased
advertising for the product and the
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38
customers' desire for liquidity. Additionally, during the last quarter of fiscal
1999, the Corporation converted all of its demand accounts to
noninterest-bearing accounts. The Corporation only experienced a modest decline
in demand accounts as a result of this business decision.
Borrowed funds totaled $61.5 million at September 30, 1999 and $52.4 million at
September 30, 1998. The increase primarily resulted from short-term advances of
$9.2 million under Milton Federal's cash management line of credit. The borrowed
funds were a temporary source of funding the loan growth discussed above.
COMPARISON OF RESULTS OF OPERATIONS - SEPTEMBER 30, 1999 COMPARED TO SEPTEMBER
30, 1998
NET INCOME. The operating results of the Corporation are affected by general
economic conditions, monetary and fiscal policies of federal agencies and
policies of agencies regulating financial institutions. The Corporation's cost
of funds is influenced by interest rates on competing investments and general
market rates of interest. Lending activities are influenced by demand for real
estate loans and other types of loans which, in turn, is affected by the
interest rates at which such loans are made, general economic conditions and
availability of funds for lending activities.
The Corporation's net income is primarily dependent upon its net interest income
(the difference between interest income generated on interest-earning assets and
interest expense incurred on interest-bearing liabilities). Net income is also
affected by provisions for loan losses, service charges, gains on sale of assets
and other income, noninterest expense and income taxes. The Corporation's net
income of $1,603,000 for the year ended September 30, 1999 represented an
increase of $101,000 when compared to the year ended September 30, 1998. Basic
earnings per share increased $.08 per share from $.72 per share for 1998 to $.80
per share for 1999. Similarly, diluted earnings per share increased $.09 per
share from $.71 per share for 1998 to $.80 for 1999.
NET INTEREST INCOME. Net interest income is the largest component of the
Corporation's income and is affected by the interest rate environment and volume
and composition of interest-earning assets and interest-bearing liabilities.
Net interest income totaled $6,331,000 at September 30, 1999 compared to
$5,871,000 at September 30, 1998. The increase resulted from the Corporation's
overall growth in assets. Additionally, the Corporation had a larger proportion
of funds invested in higher yielding loans as opposed to securities. The
Corporation remains liability sensitive, whereby its interest-bearing
liabilities will generally reprice more quickly than its interest-earning
assets. Therefore, the Corporation's net interest margin will generally increase
in periods of falling interest rates in the market and will decrease in periods
of rising interest rates. Accordingly, in a rising rate environment, the
Corporation may need to increase rates to attract and retain deposits. Due to a
negative gap position, such a rise in interest rates may not have such an
immediate impact on interest-earning assets. This lag could negatively affect
net interest income. See "Yields Earned and Rates Paid."
Interest and fees on loans totaled $14,179,000 for 1999 compared to $11,937,000
for 1998. The increase in interest and fees on loans was due to higher average
loan balances primarily related to the origination of one- to four-family
first-mortgage loans, partially offset by a decrease in the average yield earned
from 7.95% to 7.64%.
Interest on securities totaled $2,961,000 for 1999 compared to $4,044,000 for
1998. The decrease was primarily due to a decrease in the average balance of
securities. The Corporation's security portfolio declined during fiscal 1998 and
remained relatively stable during fiscal 1999 as funding sources were used to
support the loan growth.
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39
Interest on deposits totaled $8,029,000 in 1999 compared to $7,574,000 in 1998.
The increase resulted from higher average deposit balances, partially offset by
a decrease in the average cost of deposits.
Interest on borrowed funds totaled $3,005,000 in 1999 compared to $2,774,000 in
1998. The increase was the result of higher average balances of borrowed funds
during 1999. Beginning in the fourth quarter of fiscal 1995, the Corporation
borrowed funds and invested a portion of these funds in mortgage-backed
securities to leverage excess capital. From time to time, the Corporation has
borrowed additional adjustable rate funds for similar purposes as well as to
provide funding for loan growth. The Corporation has also borrowed fixed-rate
funds to provide for long-term liquidity needs. As opportunities arise, the
Corporation may make additional borrowings to fund loan demand and
mortgage-backed and related security purchases.
PROVISION FOR LOAN LOSSES. The Corporation maintains an allowance for losses on
loans in an amount that, in management's judgment, is adequate to absorb
probable losses inherent in the loan portfolio. While management utilizes its
best judgment and information available, ultimate adequacy of the allowance is
dependent upon a variety of factors, including the performance of the
Corporation's loan portfolio, the economy, changes in real estate values and
interest rates and the view of the regulatory authorities toward loan
classifications. The provision for loan losses is determined by management as
the amount to be added to the allowance for loan losses after net charge-offs
have been deducted to bring the allowance to a level considered adequate to
absorb probable losses in the loan portfolio. The amount of the provision is
based on management's regular review of the loan portfolio and consideration of
such factors as historical loss experience, general prevailing economic
conditions, changes in size and composition of the loan portfolio and specific
borrower considerations, including the ability of the borrower to repay the loan
and the estimated value of the underlying collateral.
Other than $115,000 in charge-offs during fiscal 1998, the Corporation has not
experienced any significant charge-offs for the past several years. The majority
of the $115,000 in net charge-offs was related to a single loan relationship for
which the Corporation maintained a specific valuation allowance. The
Corporation's low historical charge-off history is the product of a variety of
factors, including the Corporation's underwriting guidelines, which generally
require a down payment of 20% of the lower of the sales price or appraised value
of one-to four-family residential real estate loans, established income
information and defined ratios of debt to income. Loans secured by real estate
make up 96.4% of the Corporation's loan portfolio and loans secured by first
mortgages on one- to four-family residential real estate constituted 79.4% of
total loans at September 30, 1999. Notwithstanding the historically low level of
charge-offs, management believes it is prudent to continue increasing the
allowance for losses as total loans increase. Accordingly, management
anticipates it will continue its provisions to the allowance for loan losses at
current levels for the near future, providing the volume of nonperforming loans
remains insignificant. The provision for loan losses totaled $120,000 and
$229,000 in 1999 and 1998. The primary reason for the decrease in the provision
for loan losses relates to the $115,000 charge-off that occurred during fiscal
1998.
NONINTEREST INCOME. Noninterest income totaled $552,000 in 1999 compared to
$796,000 in 1998. The decrease was primarily the result of gains realized on
sales of loans and securities during fiscal 1998. This decrease was partly
offset by an increase in service charges and other fees in 1999. The securities
and loan sales were made for interest-rate-risk strategy purposes. The increase
in service charges and other fees was the result of a change in pricing for
overdraft, stop payment and ATM surcharge fees as well as the overall growth in
the Corporation's customer deposit base.
NONINTEREST EXPENSE. Noninterest expense totaled $4,337,000 in 1999 compared to
$4,146,000 in 1998. The Corporation experienced modest increases in most of the
components of noninterest expense. The increase in occupancy expense and data
processing services resulted from the expanded account base and services
associated with the growth experienced in the two offices opened over the past
twenty-four months. The increase in other expenses related to legal and
consulting services.
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40
INCOME TAX EXPENSE. The volatility of income tax expense is primarily
attributable to the change in income before income taxes. Income tax expense
totaled $823,000 in 1999 and $790,000 in 1998 resulting in effective tax rates
of 33.9% and 34.5%. See Note 7 of the Notes to Consolidated Financial
Statements.
COMPARISON OF RESULTS OF OPERATIONS SEPTEMBER 30, 1998 COMPARED TO SEPTEMBER 30,
1997
NET INCOME. The Corporation's net income of $1,502,000 for 1998 represented a
$124,000 increase from the $1,378,000 in net income for 1997. Basic earnings per
share increased by $.07 per share from $.65 per share for 1997 to $.72 per share
for 1998. Also, diluted earnings per share increased by $.06 per share from $.65
per share for 1997 to $.71 per share for 1998. The increase in earnings was
primarily due to increases in net interest income and noninterest income partly
offset by increases in the provision for loan losses and noninterest expense.
NET INTEREST INCOME. The net interest income of the Corporation increased by
$247,000 for 1998 compared to 1997. The increase in net interest income resulted
from the Corporation's growth in assets. Additionally, the Corporation had a
larger proportion of funds invested in higher-yielding loans as opposed to
securities and interest-bearing deposits in other financial institutions. The
increase in net interest income was mitigated by a higher cost of funds. The
cost of funds increased due to an increase in the average level of borrowings
and certificates of deposit. Management has employed strategies such as large,
special dividends and common stock repurchase programs to reduce the excess
capital position of the Corporation in an effort to improve its return on
equity. As a result, deposits and borrowed funds have increased in order to
continue funding the Corporation's growth. See "Yields Earned and Rates Paid."
Interest and fees on loans totaled $11,937,000 for 1998 compared to $9,579,000
for 1997. The increase in interest and fees on loans was due to a higher average
loan balance, despite selling a pool of portfolio loans in 1998, partially
offset by a decrease in the average yield earned to 7.95% in 1998 from 8.17% in
1997.
Interest on securities totaled $4,044,000 for 1998 compared to $4,034,000 for
1997. The increase was due to an increase in the average balance of securities
over the comparable period, partially offset by a decrease in the average yield
on securities. The decrease in the yield is the result of most mortgage-backed
securities repricing to lower yield levels due to declining market rates.
Despite the negative effects in a declining interest rate environment, the
variable rate feature of these securities helps mitigate the Corporation's
exposure to upward interest rate movements due to its primarily fixed-rate loan
portfolio.
Interest paid on deposits totaled $7,574,000 in 1998 compared to $6,749,000 in
1997. The increase resulted from a higher average deposit balance over the
comparable period combined with an overall increase in the average cost of
deposits to 5.09% in 1998 from 5.00% in 1997. The increase in the average cost
of deposits was a result of a larger percentage of average deposits being in
high-yielding certificates of deposit as well as an increase in the yield on
money market accounts from 2.94% in 1997 to 3.56% in 1998.
Interest on borrowed funds totaled $2,774,000 in 1998 compared to $1,400,000 in
1997. The increase is the result of a higher average balance of borrowed funds
over the comparable period. The Corporation uses the borrowings to provide for
loan growth and long term liquidity needs. Additionally, a portion of the funds
is invested in mortgage-backed securities to leverage excess capital. The
Corporation may make additional borrowings, as needed, to fund loan demand and
mortgage-backed securities purchases.
PROVISION FOR LOAN LOSSES. Other than $115,000 in charge-offs during 1998, the
Corporation has not experienced any significant charge-offs for the past several
years. The majority of the $115,000 in net charge-offs was related to a single
loan relationship for which the Corporation maintained a specific valuation
allowance. The provision for loan losses totaled $229,000 and $75,000 in 1998
and 1997. The
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41
increase in the provision in 1998 was primarily the result of the growth in
loans and to replenish the allowance for losses on loans after the charge-off
discussed above.
NONINTEREST INCOME. Noninterest income totaled $796,000 in 1998 compared to
$498,000 in 1997. The increase in 1998 over 1997 was due to increases in service
charges and other fees and increased gains on the sales of loans and
available-for-sale securities. The increase in service charges and other fees
has been due to growth in the Corporation's customer deposit base as well as
increases in various fees charged. The loan sales were primarily made for
interest-rate risk strategy purposes while the securities sales were made for
similar reasons as well as to provide funding for loan growth. Other changes in
noninterest income were insignificant.
NONINTEREST EXPENSE. Noninterest expense totaled $4,146,000 in 1998 compared to
$3,959,000 in 1997. Occupancy expense, salaries and employee benefits make up
the majority of the increase over the comparable period. Occupancy expense
increased as a result of the new branch office in Brookville, Ohio, which opened
during the latter part of fiscal 1997. Salaries and employee benefits increased
due to annual merit increases, additional personnel to staff the new Brookville
office and increased compensation expense related to the ESOP. Other changes in
noninterest expense were not significant.
INCOME TAX EXPENSE. The volatility of income tax expense is primarily
attributable to the change in income before income taxes. See Note 7 of the
Notes to Consolidated Financial Statements. Income tax expense totaled $790,000
in 1998 and $709,000 in 1997 resulting in effective tax rates of 34.5% and
34.0%.
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42
YIELDS EARNED AND RATES PAID. The following table sets forth certain information
relating to the Corporation's average balance sheet information and reflects the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities for the periods indicated. Such yields and costs
are derived by dividing income or expense by the average monthly balance of
interest-earning assets or interest-bearing liabilities, respectively, for the
periods presented. Average balances are derived from daily balances, which
include nonaccruing loans in the loan portfolio, net of the allowance for loan
losses.
Year ended September 30,
-----------------------------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------------------------
Average Interest Average Interest Average Interest
outstanding earned/Yield/ outstanding earned/Yield/ outstanding earned/Yield/
balance paid rate% balance paid rate% balance paid rate%
------- ----- ----- ------- ---- ----- ------- ---- -----
(Dollars in thousands)
Interest-earning assets:
Interest-bearing deposits in
other financial institutions $ 931 $ 17 1.83% $ 1,166 $ 58 4.97% $ 1,516 $ 59 3.89%
Securities available for sale
(1) 39,327 2,176 5.55 47,722 2,924 6.13 46,975 3,056 6.51
Securities held to maturity 13,356 784 5.87 17,577 1,120 6.37 15,478 977 6.31
Loans (2) 185,627 14,180 7.64 150,186 11,937 7.95 117,194 9,579 8.17
Federal Home Loan Bank stock 2,925 207 7.08 2,481 180 7.26 1,428 102 7.14
-------- ------- -------- ------- -------- -------
Total interest-earning assets 242,166 17,364 7.17 219,132 16,219 7.40 182,591 13,773 7.54
Noninterest-earning assets: 6,461 5,924 5,205
-------- -------- --------
Total assets $248,627 $225,056 $187,796
======== ======== ========
Interest-bearing liabilities:
Demand accounts $ 12,069 148 1.23% $ 10,467 179 1.71% 9,101 166 1.82%
Money market accounts 19,192 865 4.51 7,593 270 3.56 6,909 203 2.94
Passbook savings accounts 15,966 401 2.51 16,529 420 2.54 16,804 419 2.49
Certificates of deposit 118,795 6,614 5.57 114,326 6,705 5.86 102,270 5,961 5.83
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total deposits 166,022 8,028 4.84 148,915 7,574 5.09 135,084 6,749 5.00
Borrowings 55,376 3,005 5.43 48,744 2,774 5.69 24,179 1,400 5.79
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 221,398 11,033 4.98 197,659 10,348 5.24 159,263 8,149 5.12
------- ------- -------
Noninterest-bearing liabilities 1,843 1,584 1,386
-------- -------- --------
Total liabilities 223,241 199,243 160,649
Shareholders' equity 25,386 25,813 27,147
-------- -------- --------
Total liabilities and
shareholders' equity $248,627 $225,056 $187,796
======== ======== ========
Net interest income;
interest rate spread $ 6,331 2.19% $ 5,871 2.16% $ 5,624 2.42%
======= ==== ======= ==== ======= ====
Net interest margin (3) 2.62% 2.68% 3.08%
==== ==== ====
Average interest-earning assets to
average interest-bearing
liabilities 109.33% 110.87% 114.74%
====== ====== ======
- ------------------------
(1) Average balance includes unrealized gains and losses while yield is based on
amortized cost.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and
allowance for loan losses.
(3) Net interest income as a percent of average interest-earnings assets.
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The table below describes the extent to which changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
have affected the Corporation's interest income and expense during the years
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (1) changes in
volume (multiplied by prior year rate), (2) changes in rate (multiplied by prior
year volume) and (3) total changes in rate and volume. The combined effects of
changes in both volume and rate, that are not separately identified, have been
allocated proportionately to the change due to volume and change due to rate:
Year ended September 30,
-----------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
----------------------------- ------------------------------
Increase Increase
(decrease) (decrease)
due to due to
------------------ ----------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
Interest income attributable to:
Interest-bearing deposits in
other financial institutions $ (10) $ (31) $ (41) $ (15) $ 14 $ (1)
Securities available for sale (490) (258) (748) 44 (176) (132)
Securities held to maturity (253) (83) (336) 132 11 143
Loans 2,723 (480) 2,243 2,629 (271) 2,358
Federal Home Loan Bank stock 32 (5) 27 76 2 78
--------- -------- --------- ------- -------- -------
Total interest income 2,002 (857) 1,145 2,866 (420) 2,446
--------- -------- --------- ------- -------- -------
Interest expense attributable to:
NOW accounts 25 (56) (31) 24 (11) 13
Money market accounts 506 89 595 21 46 67
Passbook savings accounts (14) (5) (19) (7) 8 1
Certificates of deposit 256 (347) (91) 707 37 744
Borrowings 364 (133) 231 1,398 (24) 1,374
--------- -------- --------- ------- -------- -------
Total interest expense 1,137 (452) 685 2,143 56 2,199
--------- -------- --------- ------- -------- -------
Increase (decrease) in net
interest income $ 865 $ (405) $ 460 $ 723 $ (476) $ 247
========= ======== ========= ======= ======== =======
LIQUIDITY AND CAPITAL RESOURCES
The Corporation's liquidity, primarily represented by cash equivalents, is a
result of operating, investing and financing activities. These activities are
summarized below for the years ended September 30, 1999, 1998 and 1997.
Year Ended September 30,
1999 1998 1997
---- ---- ----
(In thousands)
Net income $ 1,603 $ 1,502 $ 1,378
Adjustments to reconcile net income to net cash from
operating activities (2,663) 961 (323)
------------- ------------ ------------
Net cash from operating activities (1,060) 2,463 1,055
Net cash from investing activities (18,993) (26,921) (24,074)
Net cash from financing activities 20,017 22,403 27,351
------------- ------------ ------------
Net change in cash and cash equivalents (36) (2,055) 4,332
Cash and cash equivalents at beginning of period 3,578 5,633 1,301
------------- ------------ ------------
Cash and cash equivalents at end of period $ 3,542 $ 3,578 $ 5,633
============= ============ ============
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The Corporation's principal sources of funds are deposits, loan and securities
repayments, securities available for sale and other funds provided by
operations. The Corporation also has the ability to borrow additional funds from
the FHLB of Cincinnati. While scheduled loan repayments and maturing securities
are relatively predictable, deposit flows and early loan and mortgage-backed
security repayments are more influenced by interest rates, general economic
conditions and competition. The Corporation maintains investments in liquid
assets based upon management's assessment of (1) the need for funds, (2)
expected deposit flows, (3) the yields available on short term liquid assets and
(4) the objectives of the asset/liability management program.
OTS regulations presently require the Corporation to maintain an average daily
balance of investments in U. S. Treasury, federal agency obligations and other
investments having maturities of five years or less in an amount equal to 4% of
the sum of the Corporation's average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less. The liquidity requirement,
which may be changed from time to time by the OTS to reflect changing economic
conditions, is intended to provide a source of relatively liquid funds on which
the Corporation may rely, if necessary, to fund deposit withdrawals or other
short term funding needs. At September 30, 1999, the Corporation's regulatory
liquidity ratio was 29.7%. At such date, the Corporation had commitments to
originate fixed rate loans totaling $1,437,000 and variable rate loans totaling
$223,000. The Corporation had no commitments to purchase or sell loans. The
Corporation considers its liquidity and capital reserves sufficient to meet its
outstanding short and long-term needs. See Note 9 of the Notes to Consolidated
Financial Statements.
Milton Federal is required by regulations to meet certain minimum capital
requirements, which must be generally as stringent as the standards established
for commercial banks. Current capital requirements call for tangible capital of
1.5% of adjusted total assets, core capital (which, for Milton Federal, consists
solely of tangible capital) of 4.0% of adjusted total assets, except for
institutions with the highest examination rating and acceptable levels of risk,
and risk-based capital (which, for Milton Federal, consists of core capital and
general valuation allowances) of 8% of risk-weighted assets (assets are weighted
at percentage levels ranging from 0% to 100% depending on their relative risk).
The following table summarizes Milton Federal's regulatory capital requirements
and actual capital at September 30, 1999.
Excess of Actual
Capital Over Current
Actual capital Current requirement Requirement Applicable
Amount Percent Amount Percent Amount Percent Asset Total
------ ------- ------ ------- ------ ------- -----------
(Dollars in thousands)
Tangible Capital $ 22,806 8.9% $ 3,849 1.5% $ 18,957 7.4% $ 256,589
Core Capital 22,806 8.9 10,264 4.0 12,542 4.9 256,589
Risk-based Capital 23,538 17.7 10,643 8.0 12,895 9.7 133,041
In April 1999, the Board of Directors of the Corporation authorized the purchase
of up to 5% of the Corporation's outstanding common shares over a twelve-month
period. At September 30, 1999, 25,000 shares have been repurchased. The
remaining 81,249 shares may be purchased in the over-the-counter market. The
number of shares to be purchased and the price paid depends on the availability
of shares, the prevailing market prices and any other considerations which may,
in the opinion of the Corporation's Board of Directors or management, affect the
advisability of purchasing shares.
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YEAR 2000 ISSUE
Milton Federal's lending and deposit activities are almost entirely dependent on
computer systems which process and record transactions, although Milton Federal
can effectively operate with manual systems for brief periods when its
electronic systems malfunction or cannot be accessed. Milton Federal uses the
services of a nationally recognized data processing service bureau specializing
in data processing for financial institutions. In addition to its basic
operating activities, Milton Federal's facilities and infrastructure, such as
security systems and communications equipment, are dependent, to varying
degrees, upon computer systems.
Milton Federal has placed great emphasis on making sure its systems are ready
for the Year 2000 ("Y2K"). In order to address any potential problems that could
occur, in early 1997 Milton Federal formed a Year 2000 Compliance Committee and
began evaluating the status of all its technological systems which includes its
state of readiness in addressing the Y2K issue. After the analysis was
completed, a Technology Plan was developed and implementation of the plan
started in mid-1997.
In the Technology Plan, four major issues were addressed. The first was to
identify the potential problems and what could or would be affected by the
handling of this date and any subsequent dates. Second, was to develop
corrective action plans along with time lines for completion of each corrective
action that needed to take place. Third, was to complete the modifications
required. The last step performed was testing of all technology systems for
compliance and accuracy.
Milton Federal made many changes over the last year testing, upgrading and
replacing hardware and software systems. The most critical aspect of the Y2K
issue for Milton Federal is to ensure that the data processing provider for all
of its customers with savings, checking and loan accounts is compliant. Milton
Federal has completed numerous renovations, implemented updated systems and
upgraded systems as needed. Milton Federal has completed numerous renovations,
implemented updated systems and upgraded systems as needed. Milton Federal has
incurred costs of approximately $55,000 to make its systems Y2K compliant.
Testing was performed on all internal hardware and software systems. Milton
Federal completed three proxy tests with its main data service provider. The
final test occurred in October 1999. All Year 2000 related problems noted from
testing have been corrected.
As a contingency plan, Milton Federal has determined that, if such providers
were to have their systems fail, Milton Federal would implement manual systems
until such systems could be re-established. Milton Federal does not anticipate
that such short-term manual systems would have a material adverse affect on
Milton Federal's operations.
Management is confident that its internal systems will not be significantly
affected by Y2K. Management does anticipate that some problems may occur with
customers' systems and with their suppliers and customers. This could create
slower collection of receivables by Milton Federal's customers and result in an
increase in demand for line-of-credit loans or a decrease in checking and
savings account balances for Milton Federal. Milton Federal plans to maintain
higher than average levels of liquidity in the second half of 1999 and into the
Year 2000 to offset that risk. Milton Federal does not expect any significant or
prolonged Year 2000 difficulties will affect net earnings or cash flow.
IMPACT OF NEW ACCOUNTING STANDARDS
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" - SFAS 133 requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. SFAS 133 does not
allow hedging of a
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46
security which is classified as held to maturity, accordingly, upon adoption of
SFAS 133, companies may reclassify any security from held to maturity to
available for sale if they wish to be able to hedge the security in the future.
SFAS 133 as amended by SFAS 137 is effective for fiscal years beginning after
June 15, 2000 with early adoption encouraged for any fiscal quarter beginning
July 1, 1998 or later, with no retroactive application. Management does not
expect the adoption SFAS 133 to have a significant impact on the Corporation's
financial statements.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes included herein have been
prepared in accordance with generally accepted accounting principles ("GAAP").
Presently, GAAP requires the Corporation to measure financial position and
operating results primarily in terms of historic dollars. Changes in the
relative value of money due to inflation or recession are generally not
considered.
In management's opinion, changes in interest rates affect the financial
condition of a financial institution to a far greater degree than changes in the
inflation rate. While interest rates are greatly influenced by changes in the
inflation rate, they do not change at the same rate or in the same magnitude as
the inflation rate. Rather, interest rate volatility is based on changes in the
expected rate of inflation, as well as on changes in monetary and fiscal
policies.
REGULATORY MATTERS
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted
into law. The GLB Act makes sweeping changes in the financial services in which
various types of financial institutions may engage. The Glass-Steagall Act,
which had generally prevented banks from affiliating with securities and
insurance firms, was repealed. A new "financial holding company," which owns
only well capitalized and well managed depository institutions, will be
permitted to engage in a variety of financial activities, including insurance
and securities underwriting and agency activities.
The GLB Act permits unitary savings and loan holding companies in existence on
May 4, 1999, including MFFC, to continue to engage in all activities that they
were permitted to engage in prior to the enactment of the Act. Such activities
are essentially unlimited, provided that the thrift subsidiary remains a
qualified thrift lender. Any thrift holding company formed after May 4, 1999
will be subject to the same restrictions as a multiple thrift holding company.
In addition, a unitary thrift holding company in existence at May 4, 1999 may be
sold only to a financial holding company engaged in activities permissible for
multiple savings and loan holding companies.
The GLB Act is not expected to have a material effect on the activities in which
MFFC and Milton Federal currently engage, except to the extent that competition
with others types of financial institutions may increase as they engage in
activities not permitted prior to enactment of the GLB Act.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
Milton Federal's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk. Interest rate risk is the risk that Milton
Federal's financial condition will be adversely affected due to movements in
interest rates. The income of financial institutions is primarily derived from
the excess of interest earned on interest-earning assets over the interest paid
on interest-bearing liabilities. Accordingly, Milton Federal places great
importance on monitoring and controlling interest rate risk.
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As part of its effort to monitor and manage interest rate risk, Milton Federal
uses the "net portfolio value" ("NPV") methodology adopted by the OTS as part of
its capital regulations. Although Milton Federal is not currently subject to NPV
regulation because such regulation does not apply to institutions with less than
$300 million in assets and risk-based capital in excess of 12%, application of
NPV methodology may illustrate Milton Federal's interest rate risk.
Generally, NPV is the discounted present value of the difference between
incoming cash flows on interest-earning and other assets and outgoing cash flows
on interest-bearing and other liabilities. The application of the methodology
attempts to quantify interest rate risk as the change in the NPV that would
result from a theoretical 200 basis point (1 basis point equals 0.01%) change in
market interest rates. Both a 200 basis point increase in market interest rates
and a 200 basis point decrease in market interest rates are considered. If the
NPV would decrease by more than 2% of the present value of the institution's
assets with either an increase or a decrease in market rates, the institution
must deduct 50% of the amount of decrease in excess of such 2% in the
calculation of the institution's risk-based capital. See "Liquidity and Capital
Resources."
As of September 30, 1999, 2% of the present value of Milton Federal's assets was
approximately $5,152,000. Because the interest rate risk of a 200 basis point
increase in market interest rates (which was greater than the interest rate risk
of a 200 basis point decrease) was $12,607,000 at September 30, 1999, Milton
Federal would have been required to deduct approximately $3,728,000 (50% of the
approximate $7,455,000 difference) from its capital in determining whether
Milton Federal met its risk-based capital requirement. Regardless of such
reduction, however, Milton Federal's risk-based capital at September 30, 1999,
would still have exceeded the regulatory requirement by approximately
$9,167,000.
Presented below, as of September 30, 1999 and 1998, is an analysis of Milton
Federal's interest rate risk as measured by changes in NPV for instantaneous and
sustained parallel shifts of 100 basis points in market interest rates. The
table also contains policy limits set by the Board of Directors of Milton
Federal as the maximum change in NPV that the Board of Directors deems advisable
in the event of various changes in interest rates. Such limits are established
with consideration of the dollar impact of various rate changes and Milton
Federal's strong capital position.
As illustrated in the table, NPV is more sensitive to rising rates than
declining rates. Such difference in sensitivity occurs principally because, as
rates rise, borrowers do not prepay fixed rate loans as quickly as they do when
interest rates are declining. Thus, in a rising interest rate environment,
because Milton Federal has predominantly fixed rate loans in its loan portfolio,
the amount of interest Milton Federal would receive on its loans would increase
relatively slowly as loans are slowly prepaid and new loans at higher rates are
made. Moreover, the interest Milton Federal would pay on its deposits would
increase rapidly because Milton Federal's deposits generally have shorter
periods to repricing. Assumptions used in calculating the amounts in this table
are OTS assumptions.
September 30, 1999 September 30, 1998
Board --------------------------- ----------------------------
Change in Interest Rate limit + or - $ change % change $ change % change
(Basis Points) % change in NPV in NPV in NPV in NPV
-------------- -------- ------ ------ ------ ------
(Dollars in thousands)
+300 40% $ (19,379) (79)% $ (13,003) (53)%
+200 30 (12,607) (51) (7,777) (31)
+100 15 (6,005) (24) (3,220) (13)
0 0 0 0 0 0
-100 15 4,564 19 1,581 6
-200 20 7,590 31 2,841 11
-300 25 10,135 41 4,369 18
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As with any method of measuring interest rate risk, certain shortcomings are
inherent in the NPV approach. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Further, in the event of a change in interest
rates, expected rates of prepayment on loans and mortgage-backed securities and
early withdrawal levels from certificates of deposit, would likely deviate
significantly from those assumed in making risk calculations.
At September 30, 1999, Milton Federal exceeded the Board limit percentage change
for all interest rate shifts. At September 30, 1998, Milton Federal exceeded the
Board limit percentage change for an increase in interest rates of 200 and 300
basis points. As part of management's overall strategy to manage interest rate
risk, the mortgage-backed security portfolio was structured so that
substantially all of the mortgage-backed securities reprice on at least an
annual basis. In addition, management has increased the emphasis of originating
consumer and commercial lending although such loans still remain a small
percentage of the overall loan portfolio. Consumer loans typically have a
significantly shorter weighted average maturity and offer less exposure to
interest rate risk while commercial loans primarily carry variable interest
rates which are tied to a market index. In addition, management is continuing to
originate variable rate mortgage loans as an additional tool to manage interest
rate risk. Variable rate loans increased from $26.2 million at September 30,
1998 to $41.5 million at September 30, 1999. Additionally, during 1999 and 1998,
Milton Federal sold pools of fixed rate mortgage loans and invested the funds in
shorter term fixed rate loans, variable rate loans and adjustable rate
mortgage-backed securities which have less exposure to interest rate risk.
Despite the strategies employed by management, Milton Federal was more interest
rate sensitive at September 30, 1999 than September 30, 1998.
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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Milton Federal Financial Corporation
West Milton, Ohio
We have audited the accompanying consolidated balance sheets of Milton Federal
Financial Corporation as of September 30, 1999 and 1998, and the related
consolidated statements of income, comprehensive income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended September 30, 1999. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 Milton Federal
Financial Corporation as of September 30, 1999 and 1998 and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 1999 in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Columbus, Ohio
October 15, 1999
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50
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 1999 and 1998
1999 1998
---- ----
ASSETS
Cash and amounts due from depository institutions $ 3,138,920 $ 1,049,982
Interest-bearing deposits in other financial institutions 403,342 327,941
Overnight deposits in other financial institutions -- 2,200,000
------------- -------------
Total cash and cash equivalents 3,542,262 3,577,923
Securities available for sale 36,668,997 36,912,196
Securities held to maturity (Estimated fair value
of $12,199,160 in 1999 and $14,528,202 in 1998) 12,317,173 14,559,907
Federal Home Loan Bank stock 3,131,700 2,814,200
Loans held for sale 2,626,923 --
Loans, net 192,115,024 171,346,497
Premises and equipment, net 2,629,439 2,739,778
Cash surrender value of life insurance 1,661,644 1,593,383
Accrued interest receivable 1,335,349 1,225,037
Real estate owned 201,015 --
Other assets 447,108 506,702
------------- -------------
Total assets $ 256,676,634 $ 235,275,623
============= =============
LIABILITIES
Deposits
Noninterest-bearing demand $ 10,552,744 $ 1,922,658
Interest-bearing demand -- 8,806,042
Money market 27,670,839 10,441,306
Passbook savings 15,763,490 16,618,056
Certificates of deposit 114,484,210 116,859,080
------------- -------------
Total deposits 168,471,283 154,647,142
Borrowed funds 61,483,463 52,430,023
Advance payments by borrowers for taxes and insurance 551,027 258,357
Accrued interest payable 352,075 284,706
Other liabilities 790,896 1,372,169
------------- -------------
Total liabilities 231,648,744 208,992,397
SHAREHOLDERS' EQUITY
Preferred stock, no par value, 1,000,000 shares authorized,
none outstanding -- --
Common stock, no par value, 9,000,000 shares authorized,
2,578,875 shares issued -- --
Additional paid-in capital 25,231,035 25,143,563
Retained earnings 8,529,714 8,167,236
Treasury stock, at cost, 478,880 shares in 1999
and 342,039 shares in 1998 (7,017,271) (5,104,494)
Unearned employee stock ownership plan shares (969,101) (1,199,087)
Unearned recognition and retention plan shares (638,715) (839,194)
Accumulated other comprehensive income (107,772) 115,202
------------- -------------
Total shareholders' equity 25,027,890 26,283,226
------------- -------------
Total liabilities and shareholders' equity $ 256,676,634 $ 235,275,623
============= =============
See accompanying notes to consolidated financial statements.
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51
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
INTEREST AND DIVIDEND INCOME
Loans, including fees $14,179,426 $11,937,278 $ 9,578,767
Securities 2,960,529 4,043,965 4,033,602
Dividends on Federal Home Loan Bank stock 206,578 179,692 101,880
Other 17,042 57,703 58,696
----------- ----------- -----------
17,363,575 16,218,638 13,772,945
INTEREST EXPENSE
Deposits 8,028,545 7,574,249 6,749,161
Borrowed funds 3,004,548 2,773,629 1,399,995
----------- ----------- -----------
11,033,093 10,347,878 8,149,156
----------- ----------- -----------
NET INTEREST INCOME 6,330,482 5,870,760 5,623,789
Provision for loan losses 120,000 229,000 75,000
----------- ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 6,210,482 5,641,760 5,548,789
NONINTEREST INCOME
Service charges and other fees 304,163 215,542 147,232
Gain on sale of securities 46,672 247,996 115,072
Gain on sale of loans 73,913 207,662 118,281
Other income 127,404 125,110 117,209
----------- ----------- -----------
552,152 796,310 497,794
NONINTEREST EXPENSE
Salaries and employee benefits 2,460,241 2,419,868 2,295,007
Occupancy expense 437,075 387,626 289,902
Data processing services 265,712 220,504 179,096
State franchise taxes 327,854 350,175 371,575
Federal deposit insurance premiums 94,651 89,547 121,044
Advertising 63,335 67,782 57,541
Other expenses 687,706 610,071 644,980
----------- ----------- -----------
4,336,574 4,145,573 3,959,145
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,426,060 2,292,497 2,087,438
Income tax expense 823,000 790,000 709,000
----------- ----------- -----------
NET INCOME $ 1,603,060 $ 1,502,497 $ 1,378,438
=========== =========== ===========
Earnings per common share - Basic $ .80 $ .72 $ .65
=========== =========== ===========
Earnings per common share - Diluted $ .80 $ .71 $ .65
=========== =========== ===========
See accompanying notes to consolidated financial statements.
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52
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
NET INCOME $ 1,603,060 $ 1,502,497 $ 1,378,438
Other comprehensive income
Unrealized holding gains (losses) on
available for sale securities
arising during the period (291,164) 507,442 165,765
Reclassification adjustment for (gains)
losses realized on securities
sales included in net income (46,672) (247,996) (115,072)
----------- ----------- -----------
Net unrealized gain (loss) (337,836) 259,446 50,693
Tax effect 114,862 (88,211) (17,234)
----------- ----------- -----------
Total other comprehensive income (loss) (222,974) 171,235 33,459
----------- ----------- -----------
COMPREHENSIVE INCOME $ 1,380,086 $ 1,673,732 $ 1,411,897
=========== =========== ===========
See accompanying notes to consolidated financial statements.
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53
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended September 30, 1999, 1998 and 1997
Unearned Accumulated
Additional Employee Other
Paid-In Retained Treasury Benefit Comprehensive
Capital Earnings Stock Plan Shares Income Total
------- -------- ----- ----------- ------ -----
Balance, October 1, 1996 $24,951,691 $13,535,280 $(1,997,640) $(2,920,436) $(89,492) $33,479,403
Net income for the year
ended September 30, 1997 1,378,438 1,378,438
Cash dividends -
$3.09 per share (6,938,183) (6,938,183)
Commitment to release
19,124 employee stock
ownership plan shares 62,719 206,310 269,029
14,957 shares earned under
recognition and retention
plan 215,382 215,382
Tax benefit realized on
vesting of recognition and
retention plan shares 3,009 3,009
Purchase 145,096 shares
of treasury stock, at cost (2,052,667) (2,052,667)
Change in net unrealized gain
(loss) on securities available
for sale, net of tax 33,459 33,459
----------- ----------- ----------- ----------- -------- -----------
Balance, September 30, 1997 25,017,419 7,975,535 (4,050,307) (2,498,744) (56,033) 26,387,870
Net income for the year
ended September 30, 1998 1,502,497 1,502,497
Cash dividends -
$.60 per share (1,310,796) (1,310,796)
Commitment to release
20,931 employee stock
ownership plan shares 94,333 245,082 339,415
14,957 shares earned under
recognition and retention
plan 215,381 215,381
Tax benefit realized on
vesting of recognition and
retention plan shares 31,811 31,811
Purchase 68,000 shares
of treasury stock, at cost (1,054,187) (1,054,187)
Change in net unrealized gain
(loss) on securities available
for sale, net of tax 171,235 171,235
----------- ----------- ----------- ----------- -------- -----------
Balance, September 30, 1998 $25,143,563 $ 8,167,236 $(5,104,494) $(2,038,281) $115,202 $26,283,226
=========== =========== =========== =========== ======== ===========
(Continued)
-53-
54
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Continued) Years ended September 30, 1999,
1998 and 1997
Unearned Accumulated
Additional Employee Other
Paid-In Retained Treasury Benefit Comprehensive
Capital Earnings Stock Plan Shares Income Total
------- -------- ----- ----------- ------ -----
Balance, September 30, 1998 $ 25,143,563 $ 8,167,236 $ (5,104,494) $ (2,038,281) $ 115,202 $ 26,283,226
Net income for the year
ended September 30, 1999 1,603,060 1,603,060
Cash dividends -
$.60 per share (1,240,582) (1,240,582)
Commitment to release
19,531 employee stock
ownership plan shares 58,279 229,986 288,265
13,923 shares earned under
recognition and retention
plan 200,479 200,479
Tax benefit realized on
vesting of recognition and
retention plan shares 29,193 29,193
Purchase 136,841 shares
of treasury stock, at cost (1,912,777) (1,912,777)
Change in net unrealized gain
(loss) on securities
available for sale, net
of tax (222,974) (222,974)
------------ ----------- ------------ ------------ ----------- ------------
Balance, September 30, 1999 $ 25,231,035 $ 8,529,714 $ (7,017,271) $ (1,607,816) $ (107,772) $ 25,027,890
============ =========== ============ ============ =========== ============
See accompanying notes to consolidated financial statements.
-54-
55
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,603,060 $ 1,502,497 $ 1,378,438
Adjustments to reconcile net income to net
cash from operating activities
Amortization of deferred loan fees (170,550) (160,278) (97,093)
Amortization of premiums, accretion
of discounts, net 39,593 45,205 24,759
Amortization of mortgage servicing rights 52,625 29,019 6,894
Provision for loan losses 120,000 229,000 75,000
Depreciation 219,674 214,952 151,028
Increase in cash value of life insurance (68,261) (68,881) (69,009)
Net realized gain on sale of securities
available for sale (46,672) (247,996) (115,072)
Origination of loans held for sale (6,977,250) -- --
Proceeds from sale of loans held for sale 4,371,901 -- --
Net gain on sale of loans (73,913) (207,662) (118,281)
Federal Home Loan Bank stock dividends (206,300) (179,600) (101,700)
Compensation expense for ESOP shares 288,265 339,415 269,029
Compensation expense for RRP shares 200,479 215,381 215,382
Tax benefit realized on vesting of RRP shares 29,193 31,811 3,009
Deferred taxes (31,745) 52,035 284,289
Net change in accrued interest receivable
and other assets (42,474) 153,911 (385,058)
Net change in accrued interest payable
and other liabilities (367,296) 514,255 (466,500)
------------ ------------ ------------
Net cash from operating activities (1,059,671) 2,463,064 1,055,115
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases (13,549,457) (9,693,205) (36,287,712)
Proceeds from maturities and principal payments 7,472,623 11,336,810 6,855,042
Proceeds from sales 6,038,015 15,321,317 18,785,046
Securities held to maturity
Purchases (125,000) (5,661,533) (4,006,975)
Proceeds from maturities and principal payments 2,318,994 6,428,744 3,086,696
Purchase of Federal Home Loan Bank stock (111,200) (621,400) (730,000)
Net increase in loans (20,927,522) (52,246,154) (20,883,830)
Proceeds from sale of loans -- 8,434,138 10,377,554
Premises and equipment expenditures (109,335) (220,022) (1,344,060)
Proceeds from sale of real estate owned -- -- 74,710
------------ ------------ ------------
Net cash from investing activities (18,992,882) (26,921,305) (24,073,529)
(Continued)
-55-
56
MILTON FEDERAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits $ 13,824,141 $ 11,815,359 $ 14,277,676
Net change in advance payments by
borrowers for taxes and insurance 292,670 92,552 (17,005)
Net change in short term borrowings 9,200,000 (1,600,000) (1,600,000)
Long term advances from Federal Home
Loan Bank 1,000,000 54,320,000 24,975,000
Principal payments on long term Federal
Home Loan Bank advances (1,146,560) (39,859,883) (1,294,297)
Cash dividends paid (1,240,582) (1,310,796) (6,938,183)
Purchase of treasury stock (1,912,777) (1,054,187) (2,052,667)
------------ ------------ ------------
Net cash from financing activities 20,016,892 22,403,045 27,350,524
------------ ------------ ------------
Net change in cash and cash equivalents (35,661) (2,055,196) 4,332,110
Cash and cash equivalents at beginning
of year 3,577,923 5,633,119 1,301,009
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,542,262 $ 3,577,923 $ 5,633,119
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the year for
Interest $ 10,965,724 $ 10,255,367 $ 8,061,779
Income taxes 636,750 858,317 398,000
Noncash activities
Transfers of loans to real estate owned 209,545 -- --
See accompanying notes to consolidated financial statements.
-56-
57
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of Milton Federal Financial Corporation ("MFFC") and its wholly-owned
subsidiary, Milton Federal Savings Bank (the "Bank"), a federal stock savings
bank, together referred to as the Corporation. The financial statements of the
Bank include the accounts of its wholly-owned subsidiary, Milton Financial
Service Corporation. Milton Financial Service Corporation holds stock in
Intrieve, Inc., which is the data processing center utilized by the Bank. All
significant intercompany accounts and transactions have been eliminated.
Nature of Operations: MFFC is a thrift holding company and through its
subsidiary Bank, is engaged in the business of commercial and retail banking
services with operations conducted through its main office in West Milton, Ohio
and its full service branch offices located in Englewood, Brookville and Tipp
City, Ohio. The Corporation is primarily organized to operate in the financial
institution industry. Substantially all revenues are derived from the financial
institution industry. Miami, Montgomery and Darke Counties provide the source of
substantially all of the Bank's deposit and lending activities.
Use of Estimates: To prepare financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions based
on available information. These estimates and assumptions affect the amounts
reported in the financial statements and the disclosures provided, and future
results could differ. The allowance for loan losses, fair values of financial
instruments and status of contingencies are particularly subject to change.
Cash Flows: Cash and cash equivalents include cash on hand, amounts due from
depository institutions, federal funds sold and interest-bearing deposits in
other financial institutions with original maturities of 90 days or less. Net
cash flows are reported for customer loan and deposit transactions, as well as
short-term borrowings under its cash management line of credit with the Federal
Home Loan Bank ("FHLB").
Securities: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported separately in other
comprehensive income.
Interest income includes amortization of purchase premiums and discounts. Gains
and losses on sales are determined using the amortized cost of the specific
security sold. Securities are written down to fair value when a decline in fair
value is not considered temporary.
Loans: Loans are reported at the principal balance outstanding, net of deferred
loan fees, loans in process and the allowance for loan losses. Loans held for
sale are reported at the lower of cost or market, on an aggregate basis.
Interest income is reported on the interest method and includes the amortization
of net deferred loan fees and costs over the loan term. Interest income is not
reported when full loan repayment is in doubt, typically when the loan is
impaired or payments are past due over 90 days (180 days for residential
mortgages). Payments received on such loans are reported as principal
reductions.
(Continued)
-57-
58
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Losses on Loans: The allowance for losses on loans is a valuation
allowance for probable credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Management estimates the allowance
balance required based on past loan loss experience, known and inherent risks in
the nature and volume of the portfolio, information about specific borrower
situations and estimated collateral values, economic conditions and other
factors. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for any loan that, in management's judgment,
should be charged-off.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential first-mortgage loans secured by one- to four-family
residences, residential construction loans, automobile, home equity and second
mortgage loans. Commercial loans and mortgage loans secured by other properties
are evaluated individually for impairment. If a loan is impaired, a portion of
the allowance is allocated so that the loan is reported, net, at the present
value of expected future cash flows using the loan's existing rate, or at the
fair value of collateral if repayment is expected solely from the collateral.
Premises and Equipment: Asset cost is reported net of accumulated depreciation.
Depreciation expense is calculated using a straight-line method based on the
estimated useful lives of the assets. These assets are reviewed for impairment
when events indicate the carrying amount may not be recoverable. Maintenance and
repairs are charged to expense as incurred and improvements are capitalized.
Real Estate Owned: Real estate acquired in settlement of a loan is initially
recorded at estimated fair value at acquisition. Any reduction to fair value
from the carrying value of the related loan at the time the property is acquired
is accounted for as a loan charge-off. After acquisition, a valuation allowance
reduces the reported amount to the lower of the initial amount or fair value
less costs to sell. Expenses, gains and losses on disposition, and changes in
the valuation allowance are reported in the net gain or loss on other real
estate included in "Other income" on the accompanying consolidated statements of
income.
Servicing Rights: Servicing rights are recognized as assets for purchased rights
and for the allocated value of retained servicing rights on loans sold.
Servicing rights are expensed in proportion to, and over the period of,
estimated net servicing revenues. Impairment is evaluated based on the fair
value of the rights, using groupings of the underlying loans as to interest
rates and then, secondarily, as to geographic and prepayment characteristics.
Any impairment of a grouping is reported as a valuation allowance.
Income Taxes: Income tax expense is the total of the current-year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax consequences for the
temporary differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
Concentrations of Credit Risk: The Bank grants loans to customers located
primarily in Miami, Montgomery and Darke Counties. At year-end 1999 and 1998,
approximately 78.6% and 84.8% of the loans in the Bank's loan portfolio had
interest rates fixed until the maturity of the loans.
(Continued)
-58-
59
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
At September 30, 1999 and 1998, the Bank had interest-bearing deposits and
overnight deposits in the FHLB of Cincinnati totaling $403,342 and $2,527,941
and owned stock in the FHLB with a carrying value of $3,131,700 and $2,814,200.
Employee Stock Ownership Plan: The cost of shares issued to the Employee Stock
Ownership Plan ("ESOP"), but not yet allocated to participants, is shown as a
reduction of shareholders' equity. Compensation expense is based on the market
price of shares as they are committed to be released to participant accounts.
Dividends on allocated ESOP shares reduce retained earnings; dividends on
unearned ESOP shares reduce debt and accrued interest.
Earnings Per Common Share: Basic earnings per common share is net income divided
by the weighted average number of common shares outstanding during the period.
ESOP shares are considered outstanding for this calculation unless unearned.
Recognition and Retention Plan ("RRP") shares are considered outstanding as they
become vested. Diluted earnings per common share include the dilutive effect of
RRP shares and the additional potential common shares issuable under stock
options.
Stock Compensation: Employee compensation expense under stock option plans is
reported if options are granted below market price at grant date. Pro forma
disclosures of net income and earnings per share are shown using the fair value
method of Statement of Financial Accounting Standards ("SFAS") No. 123 to
measure expense for options granted after fiscal 1995, using an option pricing
model to estimate fair value.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale, which is also recognized as a separate
component of shareholders' equity. The accounting standard that requires
reporting comprehensive income first applies for fiscal 1999, with prior
information restated to be comparable.
Dividend Restriction: Banking regulations require maintaining certain capital
levels and may limit the dividends paid by the Bank to the holding company or by
the holding company to its shareholders.
Fair Value of Financial Instruments: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
described in a separate note. Fair value estimates involve uncertainties and
matters of significant judgement regarding interest rates, credit risk,
prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates.
Reclassifications: Some items in prior financial statements have been
reclassified to conform to the current presentation.
(Continued)
-59-
60
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 2 - SECURITIES
The amortized cost and fair values of securities were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
SEPTEMBER 30, 1999
Available for sale
Equity $ 15,000 $ -- $ -- $ 15,000
Mortgage-backed 36,817,287 254,886 (418,176) 36,653,997
--------------- ----------- ------------- ----------------
Total $ 36,832,287 $ 254,886 $ (418,176) $ 36,668,997
=============== =========== ============= ================
Held to maturity
Municipal obligations $ 125,000 $ -- $ (1,820) $ 123,180
Mortgage-backed 12,192,173 136,856 (253,049) 12,075,980
--------------- ----------- ------------- ----------------
Total $ 12,317,173 $ 136,856 $ (254,869) $ 12,199,160
=============== =========== ============= ================
SEPTEMBER 30, 1998
Available for sale
Equity $ 15,000 $ -- $ -- $ 15,000
Mortgage-backed 36,722,650 304,109 (129,563) 36,897,196
--------------- ----------- ------------- ----------------
Total $ 36,737,650 $ 304,109 $ (129,563) $ 36,912,196
=============== =========== ============= ================
Held to maturity
Mortgage-backed $ 14,559,907 $ 85,137 $ (116,842) $ 14,528,202
=============== =========== ============= ================
The municipal obligation classified as held to maturity at September 30, 1999
matures December 2002.
The Corporation maintains a significant portfolio of mortgage-backed securities
in the form of Federal Home Loan Mortgage Corporation ("FHLMC"), Federal
National Mortgage Association ("FNMA") and Government National Mortgage
Association ("GNMA") participation certificates. Mortgage-backed securities
generally entitle the Corporation to receive a portion of the cash flows from an
identified pool of mortgages, and FHLMC, FNMA and GNMA securities are each
guaranteed by their respective agencies as to principal and interest. The
Corporation has also invested significant amounts in collateralized mortgage
obligations ("CMOs") and real estate mortgage investment conduits ("REMICs")
which are included in mortgage-backed securities. Substantially all CMOs and
REMICs are backed by pools of mortgages insured or guaranteed by the FNMA and
FHLMC.
During 1999, proceeds from the sales of securities available for sale were
$6,038,015 with gross realized gains of $46,672 included in earnings. During
1998, proceeds from sales of securities available for sale were $15,321,317 with
gross realized gains of $247,996 included in earnings. During 1997, proceeds
from the sales of securities available for sale were $18,785,046 with gross
realized gains of $115,862 and gross realized losses of $790 included in
earnings.
(Continued)
-60-
61
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 3 - LOANS
Year-end loans were as follows:
1999 1998
---- ----
Residential real estate loans
1-4 family (first mortgage) $ 159,291,522 $ 141,279,664
Home equity (1-4 family second mortgage) 5,347,292 4,244,314
Multi-family 2,028,190 2,670,477
Nonresidential real estate loans 14,947,922 8,804,909
Construction loans 11,872,585 16,412,903
------------- -------------
Total real estate loans 193,487,511 173,412,267
Consumer
Automobile loans 3,034,752 3,480,341
Loans on deposits 317,653 290,640
Other consumer loans 378,095 344,244
------------- -------------
Total consumer loans 3,730,500 4,115,225
Commercial loans 3,466,079 2,753,493
------------- -------------
Total loans 200,684,090 180,280,985
Less:
Net deferred loan fees (609,131) (605,224)
Loans in process (7,194,703) (7,652,849)
Allowance for loan losses (765,232) (676,415)
------------- -------------
Net loans $ 192,115,024 $ 171,346,497
============= =============
The Corporation has sold various loans to other financial intermediaries
while retaining the servicing rights. Gains and losses on loan sales are
recorded at the time of the sale. Loans sold for which the Corporation has
retained servicing totaled $15,428,430 at September 30, 1999 and, $15,615,077 at
September 30, 1998. Capitalized mortgage servicing rights totaled $189,000 at
September 30, 1999 and 1998. At September 30, 1999, $2,626,923 of one- to
four-family residential real estate loans have been designated as held for sale.
At September 30, 1998, no loans were held for sale. Proceeds from the sale of
loans during 1999, 1998 and 1997 were $4,371,901, $8,434,138 and $10,377,554
with net realized gains of $73,913, $207,662 and $118,281 included in earnings.
Activity in the allowance for loan losses was as follows:
1999 1998 1997
---- ---- ----
Beginning balance $ 676,415 $ 562,202 $ 487,202
Provision for loan losses 120,000 229,000 75,000
Loans charged-off (31,203) (115,090) --
Recoveries 20 303 --
------------ ------------ ------------
Ending balance $ 765,232 $ 676,415 $ 562,202
============ ============ ============
(Continued)
-61-
62
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 3 - LOANS (Continued)
Nonaccrual loans for which interest has been suspended totaled $231,000 and
$359,000 at September 30, 1999 and 1998. Loans considered impaired within the
scope of SFAS No. 114 were not significant in 1999, 1998 or 1997.
Certain directors, executive officers and companies with which they are
affiliated were loan customers of the Bank during the year ended September 30,
1999. A summary of activity on related party loans during 1999 was as follows:
Beginning balance - October 1, 1998 $ 567,280
New loans 140,079
Repayments (247,925)
--------------
Ending balance - September 30, 1999 $ 459,434
==============
NOTE 4 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
1999 1998
---- ----
Land $ 282,031 $ 282,031
Buildings and improvements 2,692,341 2,685,146
Leasehold improvements 62,879 62,879
Furniture and equipment 1,412,267 1,311,416
------------- -------------
4,449,518 4,341,472
Accumulated depreciation (1,820,079) (1,601,694)
------------- -------------
$ 2,629,439 $ 2,739,778
============= =============
NOTE 5 - DEFERRED COMPENSATION
The Corporation provides a deferred compensation plan for its Board of
Directors. Under the terms of the plan, directors may elect to defer a portion
of their fees that would be retained by the Corporation, with interest being
credited to the participant's deferred balance. Upon retirement, the participant
would be entitled to receive the accumulated deferred balance, paid over a
specified number of years. The Corporation accrued deferred compensation expense
of $57,337, $53,472, and $49,866 for 1999, 1998 and 1997.
The Corporation has purchased insurance contracts on the lives of the
participants in the deferred compensation plan and has named the Corporation as
beneficiary. While no direct contract exists between the deferred compensation
plan and the life insurance contracts, it is management's current intent that
the insurance contracts would be used as a funding source for the deferred
compensation plan.
(Continued)
-62-
63
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 6 - DEPOSITS
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was $5,478,000 and $5,476,000 at year-end 1999 and 1998. Deposits in
excess of $100,000 are not insured by the FDIC.
At year-end 1999, scheduled maturities of certificates of deposit were as
follows:
Year ending September 30:
2000 $ 75,554,110
2001 22,908,299
2002 7,704,438
2003 5,708,449
2004 2,608,914
---------------
$ 114,484,210
===============
NOTE 7 - INCOME TAXES
Income tax expense was as follows:
1999 1998 1997
---- ---- ----
Current $ 825,552 $ 706,154 $ 421,702
Tax effect of vesting RRP shares 29,193 31,811 3,009
Deferred (31,745) 52,035 284,289
------------ ------------ ------------
$ 823,000 $ 790,000 $ 709,000
============ ============ ============
The sources of year-end gross deferred tax assets and liabilities were as
follows:
1999 1998
---- ----
Deferred tax assets
Deferred compensation $ 109,787 $ 95,460
Recognition and retention plan 68,163 73,231
Unrealized loss on securities available for sale 55,518 --
Other 8,045 6,589
------------- -------------
241,513 175,280
Deferred tax liabilities
Allowance for loan losses 49,871 149,102
Federal Home Loan Bank stock dividends 370,402 300,261
Depreciation 43,171 40,031
Mortgage servicing rights 64,280 64,377
Unrealized gain on securities available for sale -- 59,346
Other 10,033 5,016
------------- -------------
537,757 618,133
------------- -------------
Net deferred tax liability $ 296,244 $ 442,853
============= =============
(Continued)
-63-
64
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 7 - INCOME TAXES (Continued)
Effective tax rates differ from the statutory federal income tax rate applied to
financial statement income due to the following:
1999 1998 1997
---- ---- ----
Income tax computed at the
statutory rate $ 824,860 $ 779,449 $ 709,729
Tax effect of
Officer's life insurance (23,209) (23,420) (23,463)
ESOP 26,408 38,669 21,359
Other (5,059) (4,698) 1,375
------------- ------------- -------------
$ 823,000 $ 790,000 $ 709,000
============= ============= =============
Statutory tax rate 34.0% 34.0% 34.0%
============= ============= =============
Effective tax rate 33.9% 34.5% 34.0%
============= ============= =============
Prior to the enactment of legislation discussed below, thrifts which met certain
tests relating to the composition of assets had been permitted to establish
reserves for bad debts and to make annual additions thereto which could, within
specified formula limits, be taken as a deduction in computing taxable income
for federal income tax purposes. The amount of the bad debt reserve deduction
for "nonqualifying loans" was computed under the experience method. The amount
of the bad debt reserve deduction for "qualifying real property loans" could be
computed under either the experience method or the percentage of taxable income
method, based on an annual election.
In August 1996, legislation was enacted that repealed the percentage of taxable
income method of accounting used by many thrifts to calculate their bad debt
reserve for federal income tax purposes. As a result, thrifts such as the Bank
must recapture that portion of the reserve that exceeds the amount that could
have been taken under the experience method for tax years beginning after
December 31, 1987. The legislation also requires thrifts to account for bad
debts for federal income tax purposes on the same basis as commercial banks for
tax years beginning after December 31, 1995. The recapture will occur over a
six-year period, the commencement of which was delayed until the first taxable
year beginning after December 31, 1997, because the institution met certain
residential lending requirements. At September 30, 1999 and 1998, the Bank had
$941,420 and $1,129,704 in bad debt reserves subject to recapture for federal
income tax purposes. The deferred tax liability related to the recapture has
been previously established. In fiscal 1999, $188,284 bad debt reserves were
recaptured.
Retained earnings at September 30, 1999 and 1998, include $3,436,000 for which
no provision for federal income taxes has been made. This amount represents the
qualifying and nonqualifying tax bad debt reserve as of December 31, 1987 that
is the Corporation's base year for purposes of calculating the bad debt
deduction for tax purposes. The related amount of unrecognized deferred tax
liability was $1,168,000 at September 30, 1999 and 1998. If this portion of
retained earnings is used in the future for any purpose other than to absorb bad
debts, it will be added to future taxable income.
(Continued)
-64-
65
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 8 - BORROWED FUNDS
At September 30, 1999, the Bank had a cash-management line-of-credit enabling it
to borrow up to $12,413,550 from the FHLB of Cincinnati. The line of credit must
be renewed on an annual basis. The next renewal date is April 16, 2000. Variable
rate borrowings of $9,200,000 were outstanding related to this cash-management
line-of-credit at September 30, 1999. There were no borrowings outstanding on
this line of credit at September 30, 1998.
As a member of the FHLB system, the Bank has the ability to obtain additional
borrowings up to a maximum total of 50% of Bank assets subject to the level of
qualified, pledgable one- to four-family residential real estate loans. The Bank
had variable rate borrowings totaling $7,000,000, with interest rates ranging
from 5.33% to 5.51%, at September 30, 1999 and $4,000,000, with an interest rate
of 5.54% at September 30, 1998. The Bank had fixed rate borrowings totaling
$11,283,463 at September 30, 1999 and $12,430,023 at September 30, 1998. The
interest rates on these borrowings ranged from 5.80% to 6.42% at September 30,
1999 and 1998. The Bank also had $34,000,000 and $36,000,000 in convertible
advances at September 30, 1999 and 1998 whereby the interest rates are fixed for
a specified period of time and then change to variable for the remaining term of
the advance. The interest rates on these advances ranged from 5.12% to 5.65% at
September 30, 1999 and 4.66% to 5.65% at September 30, 1998.
The maximum month-end balance of FHLB advances outstanding was $61,524,000 in
1999 and $55,251,000 in 1998. Average balances of borrowings outstanding during
1999 and 1998 were $55,376,000 and $48,744,000. Mortgage loans and all shares of
FHLB stock owned by the Bank totaling $92,225,195 and $3,131,700 at September
30, 1999 and $78,645,035 and $2,814,200 at September 30, 1998, were pledged as
collateral for the FHLB advances.
At September 30, 1999, required annual principal payments were as follows:
Year ending September 30:
2000 $ 14,615,031
2001 3,910,033
2002 2,226,352
2003 2,259,852
2004 707,248
Thereafter 37,764,947
---------------
$ 61,483,463
===============
NOTE 9 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES
Various contingent liabilities are not reflected in the consolidated financial
statements, including claims and legal actions arising in the ordinary course of
business. In the opinion of management, after consultation with legal counsel,
the ultimate disposition of these matters is not expected to have a material
effect on the financial condition or the results of operations of the
Corporation.
Some financial instruments are used in the normal course of business to meet
financing needs of customers and reduce exposure to interest rate changes. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. These involve, to varying degrees, credit and
interest rate risk in excess of the amounts reported in the financial
statements.
(Continued)
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66
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 9 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES (Continued)
Exposure to credit loss if the other party does not perform is represented by
the contractual amount for commitments to extend credit, standby letters of
credit and financial guarantees written. The same credit policies are used for
commitments and conditional obligations as are used for loans. The amount of
collateral obtained, if deemed necessary, on extension of credit is based on
management's credit evaluation and generally consists of residential or
commercial real estate. Lines of credit are primarily home equity lines
collateralized by second mortgages on one- to four-family residential real
estate and commercial lines of credit collateralized by business assets.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the commitment.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being used, the total commitments do not necessarily represent
future cash requirements.
As of September 30, 1999 and 1998, the Corporation had commitments to make fixed
rate one- to four-family residential real estate loans at current market rates
totaling $1,040,000 and $1,516,000. Loan commitments are generally for thirty
days. The interest rate on the fixed rate commitments ranged from 7.00% to
10.25% at September 30, 1999 and 6.38% to 8.50% at September 30, 1998. The
Corporation had commitments to make nonresidential real estate loans at 7.75%
totaling $397,000 at September 30, 1999. The Corporation had commitments to make
variable rate, one- to four-family residential real estate loans totaling
$223,000, with interest rates ranging from 7.13% to 7.63 at September 30, 1999.
The Corporation had no such commitments at September 30, 1998. As of September
30, 1999 and 1998, the Corporation had $4,540,000 and $4,711,000 in unused
variable rate home equity lines of credit and $2,034,000 and $820,000 in unused
variable rate commercial lines of credit.
At September 30, 1999 and 1998, the Corporation had standby letter of credit
commitments totaling $465,000 and $150,000.
At September 30, 1999 and 1998, compensating balances of $1,693,000 and $518,000
were required as deposits with the FHLB and Federal Reserve Bank. These balances
do not earn interest.
The Corporation has entered employment agreements with certain officers of the
Corporation. Each of the agreements provide for a term of three years and a
salary and performance review by the Board of Directors not less than annually,
as well as inclusion of the employee in any formally established employee
benefit, bonus, pension and profit-sharing plans for which management personnel
are eligible.
(Continued)
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67
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 10 - REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by
the federal regulatory agencies. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about the Bank's components,
risk weightings and other factors. Failure to meet minimum capital requirements
can initiate certain mandatory actions that, if undertaken, could have a direct
material effect on the Bank's financial statements. At September 30, 1999 and
1998, management believes the Bank complies with all regulatory capital
requirements. Based upon the computed regulatory capital ratios, the Bank is
considered well capitalized under the Federal Deposit Insurance Improvement Act
criteria at September 30, 1999 and 1998. Management believes no conditions or
events have occurred subsequent to the last notification by regulators that
would cause the Bank's capital category to change.
At year-end 1999 and 1998, the Bank's actual capital level and minimum required
levels were:
Minimum
Required To Be Minimum
Adequately Capitalized Required To Be
Under Prompt Well Capitalized
Corrective Under Prompt Corrective
Actual Action Regulations Action Regulations
----------------- ---------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
SEPTEMBER 30, 1999
Total capital (to risk-weighted assets) $ 23,538 17.7% $ 10,643 8.0% $ 13,304 10.0%
Tier 1 (core) capital (to
risk-weighted assets) 22,806 17.1 5,322 4.0 7,892 6.0
Tier 1 (core) capital (to adjusted
total assets) 22,806 8.9 10,264 4.0 12,829 5.0
Tangible capital (to adjusted total assets) 22,806 8.9 3,849 1.5 N/A
SEPTEMBER 30, 1998
Total capital (to risk-weighted assets) $ 22,323 18.5% $ 9,635 8.0% $ 12,043 10.0%
Tier 1 (core) capital (to
risk-weighted assets) 21,681 18.0 4,817 4.0 7,226 6.0
Tier 1 (core) capital (to adjusted
total assets) 21,681 9.3 9,332 4.0 11,666 5.0
Tangible capital (to adjusted total assets) 21,681 9.3 3,500 1.5 N/A
In addition to certain federal income tax considerations, the Office of Thrift
Supervision ("OTS") regulations impose limitations on the payment of dividends
and other capital distributions by savings associations. Under OTS regulations
applicable to converted savings banks, the Bank is not permitted to pay a cash
dividend on its common shares if its regulatory capital would, as a result of
payment of such dividends, be reduced below the amount required for the
Liquidation Account, or below applicable regulatory capital requirements
prescribed by the OTS.
(Continued)
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68
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 10 - REGULATORY CAPITAL REQUIREMENTS (Continued)
An application must be submitted and approval from the OTS must be obtained by a
subsidiary of a savings and loan holding company (1) if the proposed
distribution would cause total distributions for the year to exceed net income
for that calendar year to date plus the savings association's retained net
income for the preceding two years; (2) if the savings association will not be
at least adequately capitalized following the capital distribution; (3) if the
proposed distribution would violate a prohibition contained in any applicable
statute, regulation or agreement between the savings association and the OTS (or
the FDIC), or a condition imposed on the savings association in an OTS-approved
application or notice; or, (4) if the savings association has not received
certain favorable examination ratings from the OTS. If a savings association
subsidiary of a holding company is not required to file an application, it must
file a notice with the OTS. At September 30, 1999, the Bank could dividend
$382,310 without approval from the OTS.
NOTE 11 - EMPLOYEE PENSION AND PROFIT INCENTIVE PLANS
The Corporation is part of a qualified noncontributory multi-employer trust,
defined-benefit pension plan covering substantially all of its employees. The
plan is administered by the trustees of the Financial Institutions Retirement
Fund ("Retirement Fund"). The cost of the plan is set annually as an established
percentage of wages. The Corporation has not been required to contribute to the
Retirement Fund and as a result, did not recognize any pension expense in 1999,
1998 or 1997.
The Corporation offers a 401(k) profit sharing plan covering substantially all
employees. The annual expense of the plan is based on a partial matching of
voluntary employee contributions of up to 4% of individual compensation. The
matching percentage was 25% for 1999, 1998 and 1997. Employee contributions are
vested at all times and the Corporation's matching contributions become fully
vested after an individual has completed three years of service. The
contribution expense included in salaries and employee benefits was $12,490,
$11,509, and $9,484 for 1999, 1998 and 1997.
NOTE 12 - STOCK OPTION PLAN
On March 20, 1995, the Stock Option Committee of the Board of Directors granted
options to purchase 238,545 common shares at an exercise price of $13.69 to
certain officers and directors of the Bank and Corporation. One-fifth of the
options awarded become first exercisable on each of the first five anniversaries
of the date of grant. The option period expires 10 years from the date of grant.
Options to purchase 190,836 and 143,127 shares were exercisable at September 30,
1999 and 1998. No options were exercised during 1999, 1998, or 1997. In
addition, 19,342 shares of authorized but unissued common stock are reserved for
which no options have been granted.
NOTE 13 - EMPLOYEE STOCK OWNERSHIP PLAN
The Corporation offers an ESOP for the benefit of substantially all employees of
the Corporation. The ESOP has received a favorable determination letter from the
Internal Revenue Service on the qualified status of the ESOP under applicable
provisions of the Internal Revenue Code.
(Continued)
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69
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 13 - EMPLOYEE STOCK OWNERSHIP PLAN (Continued)
The ESOP borrowed funds from MFFC with which to acquire common shares of the
Corporation. The loan is secured by the shares purchased with the loan proceeds
and will be repaid by the ESOP with funds from the Bank's discretionary
contributions to the ESOP and earnings on ESOP assets. All dividends on
unallocated shares received by the ESOP are used to pay debt service. The shares
purchased with the loan proceeds are held in a suspense account for allocation
among participants as the loan is repaid. When loan payments are made, ESOP
shares are allocated to participants based on relative compensation.
ESOP compensation expense was $288,265, $339,415, and $269,029 for 1999, 1998,
and 1997. ESOP shares at September 30, 1999 and 1998 were as follows:
1999 1998
---- ----
Allocated shares 90,922 69,991
Shares released for allocation 19,531 20,931
Unreleased shares 80,787 100,318
-------------- --------------
Total ESOP shares 191,240 191,240
============== ==============
Fair value of unreleased shares $ 939,149 $ 1,279,055
============== ==============
NOTE 14 - RECOGNITION AND RETENTION PLAN
The Corporation maintains a recognition and retention plan ("RRP") for the
benefit of directors and certain key employees of the Corporation. The RRP is
used to provide such individuals ownership interest in the Corporation in a
manner designed to compensate such directors and key employees for services. The
Bank contributed sufficient funds to enable the RRP to purchase a number of
common shares in the open market equal to 4% of the common shares sold in
connection with the Conversion.
On October 16, 1995, the RRP Committee of the Board of Directors awarded 74,784
shares to certain directors and officers of the Corporation. No shares had been
previously awarded. One-fifth of such shares will be earned and nonforfeitable
on each of the first five anniversaries of the date of the awards. In the event
of the death or disability of a participant or a change in control of the
Corporation, however, the participant's shares will be deemed to be earned and
nonforfeitable upon such date. There were 2,064 shares forfeited during the year
ended September 30, 1999. As a result, there were 30,435 and 28,371 shares at
September 30, 1999 and 1998 reserved for future awards. Compensation expense is
based on the cost of the shares, which approximates fair value at the date of
grant, and was $200,479, $215,381 and $215,382 for 1999, 1998 and 1997.
(Continued)
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70
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 15 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of financial instruments at year-end were:
1999 1998
----------------------- ------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
FINANCIAL ASSETS (In thousands)
Cash and cash equivalents $ 3,542 $ 3,542 $ 3,578 $ 3,578
Securities available for sale 36,669 36,669 36,912 36,912
Securities held to maturity 12,317 12,199 14,560 14,528
FHLB stock 3,132 3,132 2,814 2,814
Loans held for sale 2,627 2,627 -- --
Loans, net 192,115 190,505 171,346 174,776
Cash surrender value of life insurance 1,662 1,662 1,593 1,593
Accrued interest receivable 1,335 1,335 1,225 1,225
Mortgage servicing rights 189 189 189 189
FINANCIAL LIABILITIES
Deposits $(168,471) $(168,446) $(154,647) $(155,366)
Borrowed funds (61,483) (60,902) (52,430) (52,646)
Advance payments by borrowers
for taxes and insurance (551) (551) (258) (258)
Accrued interest payable (352) (352) (285) (285)
The following methods and assumptions were used to estimate fair values for
financial instruments. The carrying amount is considered to estimate fair value
for all items except those described below. The fair values of securities are
based on quoted market prices or, if no quotes are available, on the rate and
term of the security and on information about the issuer. For fixed rate loans
or deposits and for variable rate loans or deposits with infrequent repricing or
repricing limits, the fair value is estimated by discounted cash flow analysis
using current market rates for the estimated life and credit risk. Fair values
for impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable. Fair value of loans held for
sale is based on market estimates. The fair value of borrowed funds is based on
currently available rates for similar financing. The fair value of
off-balance-sheet items is based on the fees or cost that would currently be
charged to enter into or terminate such arrangements and such amounts are not
material.
(Continued)
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71
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 16 - EARNINGS PER SHARE
The factors used in the earnings per share computation are as follows:
1999 1998 1997
---- ---- ----
BASIC EARNINGS PER COMMON SHARE
Net income $ 1,603,060 $ 1,502,497 $ 1,378,438
=========== =========== ===========
Weighted average common shares outstanding 2,159,040 2,252,091 2,343,916
Less: Average unallocated ESOP shares (91,204) (111,596) (144,170)
Less: Average nonvested RRP shares (51,873) (66,349) (81,304)
----------- ----------- -----------
Average shares 2,015,963 2,074,146 2,118,442
=========== =========== ===========
Basic earnings per common share $ .80 $ .72 $ .65
=========== =========== ===========
DILUTED EARNINGS PER COMMON SHARE
Net income $ 1,603,060 $ 1,502,497 $ 1,378,438
=========== =========== ===========
Weighted average common shares outstanding
for basic earnings per common share 2,015,963 2,074,146 2,118,442
Add: Dilutive effects of average nonvested
RRP shares -- 10,992 5,822
Add: Dilutive effects of stock options -- 20,575 4,272
----------- ----------- -----------
Average shares and dilutive potential
common shares 2,015,963 2,105,713 2,128,536
=========== =========== ===========
Diluted earnings per common share $ .80 $ .71 $ .65
=========== =========== ===========
Unearned RRP shares and stock options did not have a dilutive effect on EPS for
the year ended September 30, 1999, as the fair value of the RRP shares on the
date of grant and the exercise price of the stock options were greater than the
average market price for the period.
(Continued)
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72
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 17 - PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
Condensed financial information of MFFC is as follows:
Condensed Balance Sheets
September 30, 1999 and 1998
1999 1998
---- ----
ASSETS
Cash and cash equivalents $ 869,585 $ 2,045,724
Securities available for sale -- 625,427
Investment in subsidiary 22,698,994 21,822,890
Loan receivable from ESOP 1,237,860 1,444,170
Accrued interest receivable and other assets 228,541 350,895
--------------- ----------------
Total assets $ 25,034,980 $ 26,289,106
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities $ 7,090 $ 5,880
Shareholders' equity 25,027,890 26,283,226
--------------- ----------------
Total liabilities and shareholders' equity $ 25,034,980 $ 26,289,106
=============== ================
Condensed Statements of Income
Years Ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
INTEREST AND DIVIDEND INCOME
Dividends from subsidiary $ 1,000,000 $ 1,700,000 $ 1,000,000
Securities 24,509 71,650 175,512
Loan to ESOP 111,794 139,428 157,263
Other 54,981 26,422 46,310
-------------- -------------- ---------------
Total interest and dividend income 1,191,284 1,937,500 1,379,085
Gain on sale of securities 846 1,023 34,621
Operating expenses 59,971 80,033 99,322
-------------- -------------- ---------------
INCOME BEFORE TAXES AND EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARY 1,132,159 1,858,490 1,314,384
Income tax expense 45,000 54,000 104,348
-------------- -------------- ---------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF
SUBSIDIARY 1,087,159 1,804,490 1,210,036
Equity in undistributed earnings of subsidiary
(distributions in excess of earnings) 515,901 (301,993) 168,402
-------------- -------------- ---------------
NET INCOME $ 1,603,060 $ 1,502,497 $ 1,378,438
============== ============== ===============
(Continued)
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73
MILTON FEDERAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
NOTE 17 - PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
Condensed Statement of Cash Flows
Years Ended September 30, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,603,060 $ 1,502,497 $ 1,378,438
Adjustments to reconcile net income to cash
provided by operations:
(Equity in undistributed income) distributions
in excess of earnings of subsidiary (515,901) 301,993 (168,402)
Gain on sale of securities (846) (1,023) (34,621)
Amortization of premiums, accretion of
Discount, net 756 1,723 391
Net change in other assets 124,989 352,955 (326,345)
Net change in other liabilities 1,210 207 (62,206)
----------- ----------- -----------
Net cash from operating activities 1,213,268 2,158,352 787,255
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases -- -- (994,145)
Proceeds from maturities and principal payments 100,649 463,375 259,633
Proceeds from sales 517,116 284,960 5,136,692
Proceeds from principal payments on loan to ESOP 206,310 206,310 206,310
----------- ----------- -----------
Net cash from investing activities 824,075 954,645 4,608,490
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock (1,912,777) (1,054,187) (2,052,667)
Cash dividends paid (1,240,582) (1,310,796) (6,938,183)
Dividends on unallocated ESOP shares (60,123) (42,706) (472,745)
----------- ----------- -----------
Net cash from financing activities (3,213,482) (2,407,689) (9,463,595)
----------- ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,176,139) 705,308 (4,067,850)
Cash and cash equivalents at beginning of year 2,045,724 1,340,416 5,408,266
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 869,585 $ 2,045,724 $ 1,340,416
=========== =========== ===========
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74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the definitive Proxy Statement for the 2000 Annual
Meeting of Shareholders of Milton Federal Financial Corporation (the "Proxy
Statement") under the captions "Board of Directors," "Executive Officers,"
"Voting Securities and Ownership of Certain Beneficial Owners and Management"
and "Section 16(a) Beneficial Ownership Reporting Compliance" is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the Proxy Statement under the caption "Compensation
of Executive Officers and Directors" is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the Proxy Statement under the caption "Voting
Securities and Ownership of Certain Beneficial Owners and Management" is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the Proxy Statement under the caption "Certain
Transactions with MFFC" is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
2 FINANCIAL STATEMENT SCHEDULES. All schedules are omitted because they
are not applicable or the required information is shown in the financial
statements or notes thereto.
3 EXHIBITS.
3.1 Articles of Incorporation
3.2 Code of Regulations
10.1 Employment Agreement with Mr. Aidt
10.2 Employment Agreement with Mr. Eyer
10.3 Milton Federal Savings Bank Recognition and Retention Plan and Trust Agreement
10.4 Milton Federal Financial Corporation 1995 Stock Option and Incentive Plan
10.5 Employment Agreement with Mr. Piper
21 Subsidiaries of Milton Federal Financial Corporation
27 Financial Data Schedule
99.1 Proxy Statement
99.2 Safe Harbor Under the Private Securities Litigation Reform Act of 1995
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75
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MILTON FEDERAL FINANCIAL CORPORATION
By /s/ Glenn E. Aidt
---------------------------------------
Glenn E. Aidt
President
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been duly signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
By /s/ Glenn E. Aidt By /s/ Thomas P. Eyer
------------------------------------ ----------------------------------------
Glenn E. Aidt Thomas P. Eyer
President and Director Treasurer
(Principal Financial Officer)
Date December 27, 1999 Date December 27, 1999
---------------------------------- --------------------------------------
By /s/ E. Lynn App By /s/ Kenneth J. Faze, M.D.
------------------------------------ ----------------------------------------
E. Lynn App Kenneth J. Faze, M.D.
Director Director
Date December 27, 1999 Date December 27, 1999
---------------------------------- --------------------------------------
By /s/ David R. Hayes, D.V.M. By /s/ Robert E. Hine
---------------------------------- --------------------------------------
David R. Hayes, D.V.M. Robert E. Hine
Director Director/Vice Chairman
Date December 27, 1999 Date December 27, 1999
---------------------------------- --------------------------------------
By /s/ Christopher S. Long
----------------------------------
Christopher S. Long
Director
Date December 27, 1999
----------------------------------
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76
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE NUMBER
- ------ ----------- -----------
3.1 Articles of Incorporation of Milton Federal Financial 77
Corporation
3.2 Code of Regulations of Milton Federal Financial Corporation 82
10.1 Employment Agreement with Mr. Aidt Incorporated by reference to the 1997 10-K,
Exhibit 10.1
10.2 Employment Agreement with Mr. Eyer Incorporated by reference to the 1997 10-K,
Exhibit 10.2
10.3 Milton Federal Savings Bank Recognition and Retention Plan Incorporated by reference to annual report
and Trust Agreement on Form 10-KSB for the fiscal year ended
September 30, 1995 (the "1995 10-KSB"),
Exhibit 10.3.
10.4 Milton Federal Financial Corporation 1995 Stock Option and Incorporated by reference to the 1995
Incentive Plan 10-KSB, Exhibit 10.4.
10.5 Employment Agreement with Mr. Piper 95
11 Statement Regarding Computation of Earnings Per Share Reference is hereby made to the
Consolidated Statements of Income on page
53, Note 1 on page 61 and Note 16 on page
73 of Notes to Consolidated Financial
Statements, hereof.
21 Subsidiaries of Milton Federal Financial Corporation Incorporated by reference to the 1995
10-KSB, Exhibit 21.
27 Financial Data Schedule 103
99.1 Proxy Statement 105
99.2 Safe Harbor Under the Private Securities Litigation Reform 119
Act of 1995
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