UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20552
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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 000-29460
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COMMUNITY SAVINGS BANKSHARES, INC.
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(Exact name of registrant as specified in its charter)
UNITED STATES 65-0780334
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(State or Other Jurisdiction of (IRS Employer Identification Number)
Incorporation or Organization)
660 US HIGHWAY ONE, NORTH PALM BEACH, FL 33408
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(Address of Principal Executive Offices) (Zip Code)
(561) 881-2212
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(Registrant's Telephone Number including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
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Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $1.00 PER SHARE
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(Title of Class)
Indicate by check mark whether the Registrant (1) his filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file reports) and (2) has been subject to such
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 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
amendments to this Form 10-K. [ X ]
As of March 17, 1998, there were issued and outstanding 5,100,120
shares of the Registrant's Common Stock. The aggregate value of the voting stock
held by non-affiliates (persons other than the Mutual Holding Company, the
employee stock ownership plan, directors and officers) of the Registrant,
computed by reference to the closing price of the Common Stock as of March 17,
1998 ($38.50) was $ 82,493,488.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Shareholders for the fiscal year ended
December 31, 1997 (Parts II and IV).
2. Proxy Statement for the Annual Meeting of Shareholders (Portions of Parts II
and III).
1
PART I
ITEM 1. BUSINESS
GENERAL
In the following discussion, references to "Bankshares" relate to
Community Savings Bankshares, Inc. together with its wholly-owned subsidiary,
Community Savings, F. A. (the "Association").
COMMUNITY SAVINGS BANKSHARES, INC.
Bankshares is a federally chartered mid-tier stock holding company
organized in August 1997. The only significant asset of Bankshares is its
investment in the Association. Bankshares is majority owned by ComFed, M.H.C.
("ComFed") a federally chartered mutual holding company. Effective September 30,
1997, Bankshares acquired all of the issued and outstanding common stock of the
Association in connection with the Association's reorganization into the
two-tier form of mutual holding company ownership. At that time, each share of
the Association's common stock was converted into one share of Bankshares'
common stock. At December 31, 1997, ComFed owned 2,620,144 shares of Bankshares'
common stock with the remaining 2,474,776 shares being owned by the minority
shareholders. The holding company reorganization was accounted for at historical
cost in a manner similar to a pooling of interests. Therefore, all financial
information has been presented as if Bankshares had been in existence for all
periods included in this report. At December 31, 1997, Bankshares had total
assets of $720.1 million, total loans of $451.7 million, total deposits of
$550.7 million, and total shareholders' equity of $81.3 million.
Bankshares' executive office is located at 660 U.S. Highway One, North
Palm Beach, Florida and its telephone number at that address is (561) 881-2212.
COMMUNITY SAVINGS, F. A.
The Association, founded in 1955, is a federally chartered savings and
loan association headquartered in North Palm Beach, Florida. The Association's
deposits are federally insured by the Federal Deposit Insurance Corporation
("FDIC") through the Savings Association Insurance Fund ("SAIF"). The
Association has been a member of the Federal Home Loan Bank of Atlanta ("FHLB")
since 1955. The Association is regulated by the Office of Thrift Supervision
("OTS"). On October 24, 1994, the Association completed a reorganization into a
federally chartered mutual holding company, ComFed. As part of the
reorganization, the Association organized a new federally chartered stock
savings association and transferred substantially all of its assets and
liabilities to the stock savings association in exchange for a majority of the
common stock of the stock savings association.
The Association is a community-oriented financial institution engaged
primarily in the business of attracting deposits from the general public in the
Association's market area (as described below) and using such funds, together
with other borrowings, to invest in various consumer-based real estate loans,
commercial business loans and mortgage-backed securities ("MBS") as well as
United States government and agency securities, mutual funds, corporate debt
securities, interest-earning deposits in the FHLB and FHLB stock. See "Lending
Activities", "Mortgage-Backed and Related Securities", and "Investment
Activities". The Association's principal source of funds are deposits, principal
and interest payments on loans and securities, and FHLB advances. The principal
source of income is interest received from loans and securities, while principal
expenses are interest paid on deposits and borrowings and employee compensation
and benefits. See "Sources of Funds." The Association's plan is to operate as a
well-capitalized, profitable and independent institution. The Association's
profitability is highly dependent on its net interest income. The components
that determine net interest income are the amount of interest-earning assets and
interest-bearing liabilities, together with the rates earned or paid on such
interest rate-sensitive instruments. The Association is sensitive to managing
interest rate risk exposure by better matching asset and liability maturities
and rates. This is accomplished while considering the credit risk of certain
assets. The Association maintains asset quality by utilizing comprehensive loan
underwriting standards and collection efforts as well as by primarily
originating or purchasing secured or guaranteed assets.
The Association's executive office is located at 660 U.S. Highway One,
North Palm Beach, Florida, and its telephone number at that address is (561)
881-4800
2
FORMATION OF THE MID-TIER HOLDING COMPANY
In January 1997, the Board of Directors of the Association adopted a
resolution to proceed with filing an application with the OTS to reorganize the
Association into a two-tier holding company structure. As a result of the
reorganization, the Association became the wholly-owned subsidiary of Bankshares
and shareholders of the Association became the shareholders of Bankshares.
ComFed, the Association's mutual holding company, holds a majority of
the common stock of the new mid-tier stock holding company, Bankshares, which
owns 100% of the common stock of the Association. Under the reorganization, each
share of Association common stock held by existing shareholders of the
Association was converted into one share of common stock of Bankshares. The
reorganization of the Association was structured as a tax-free reorganization
and was accounted for in a manner similar to a pooling of interests. Completion
of the reorganization was subject to regulatory approval by the OTS and to
shareholder approval. On August 4, 1997, the OTS issued its order approving the
application of Bankshares to become the holding company of the Association. The
reorganization was approved by the shareholders at a special meeting held
September 24, 1997. The reorganization was effective on September 30, 1997. The
common stock of Bankshares was substituted for that of the Association on the
Nasdaq National Market under the symbol "CMSV".
CHANGE OF FISCAL YEAR.
In January 1997, the Board of Directors of the Association approved a
change of the Association's fiscal year from September 30 to December 31,
effective December 31, 1996. Bankshares' fiscal year end is December 31 as well.
FORWARD-LOOKING STATEMENTS
Certain information in this Form 10-K may constitute forward-looking
information that involves risks and uncertainties that could cause actual
results to differ materially from those estimated. Persons are cautioned that
such forward-looking statements are not guarantees of future performance and are
subject to various factors which could cause actual results to differ materially
from those estimated. These factors include, but are not limited to, changes in
general economic and market conditions, legislative and regulatory changes,
monetary and fiscal policies of the federal government, demand for loan and
deposit products and the development of an interest rate environment that
adversely affects the interest rate spread or other income from Bankshares'
investments and operations.
MARKET AREA AND COMPETITION
Bankshares and the Association are headquartered in North Palm Beach,
Florida. Because Bankshares' only significant asset is its ownership of all the
issued and outstanding capital stock of the Association, the market area and
competition are identical for both entities. The Association operates 21 offices
in its market area in southeastern Florida, five of which are located in Martin
County, twelve of which are located in Palm Beach County, three of which are
located in St. Lucie County and one of which is located in Indian River County.
The Association operated a loan production office in Indian River County, which
was closed and moved to the new Vero Beach office during July 1997. During the
first quarter of 1998, another loan production office was opened in Vero Beach
to handle the increased loan activity. In addition, the Association also
operated a loan production office in southern Palm Beach County which was closed
during 1997.
According to county projections from the University of Florida,
population in Palm Beach, Martin, St. Lucie, and Indian River counties was
estimated at l.4 million for 1997. This study projects a 6.6% growth rate to 1.5
million by the year 2000 and a 38.6% growth rate from the year 2001 to the year
2020 to 2.l million. This population growth combined with a lower interest rate
environment during early 1998 suggests an increased demand for mortgage loans in
the four county market, as well as the State of Florida. However, such estimates
may not prove representative of trends for the remainder of 1998.
The counties in the Association's market area, have experienced
significant growth since the 1960s. Several of the counties are currently
experiencing major redevelopment projects. In Palm Beach County, the City of
West Palm Beach is implementing a $375 million project called City Place
designed to continue the revitalization of the downtown area. Also in Palm Beach
County, construction has begun on Abacoa, a new subdivision development which
will feature a new baseball stadium, commercial office space and retail space,
as well as single-family and multi-family residential properties which will
3
accommodate 10,000 residents. The commuter train service for southern Florida
will be extended northward to service this community.
In Martin County, redevelopment of the City of Stuart's downtown area
has been supplemented by the completion of the new Roosevelt bridge facilitating
access to the city from the north.
In St. Lucie County, the Professional Golfers Association ("PGA") has
planned three new championship golf courses, a golf learning center and a
housing development.
The economy in this market area is service-oriented and is
significantly dependent upon government, foreign trade, tourism, and its
continued attraction as a retirement area. In Palm Beach and Martin counties,
cooperative efforts between the counties and local municipalities are producing
business growth and expansion in the county. A variety of county supported
programs have been instituted to create new jobs and to encourage relocation or
expansion of companies with an emphasis placed on high-technology and service
industries. Consequently, commercial building vacancies are at a low level.
Major employers in Palm Beach County include Pratt and Whitney (United
Technologies), Motorola, Inc., St. Mary's and Good Samaritan Hospitals, Florida
Power and Light Co. and Flo Sun, Inc. Martin County major employers include
Martin Memorial Health System, Staff Leasing, and Publix. St. Lucie County major
employers include Indian River Community College, Columbia Lawnwood Regional
Medical, Publix, and Staff Leasing. Indian River County major employers include
Indian River Memorial Hospital, Publix and New Piper Aircraft Corp.
Bankshares' market area in Southeast Florida has a large concentration
of financial institutions, many of which are significantly larger and have
greater financial resources than the Association, and all of which are
competitors of the Association to varying degrees. As a result, the Association
encounters strong competition both in attracting deposits and in originating
real estate and other loans. Its most direct competition for deposits has come
historically from commercial banks, securities broker-dealers, other savings
associations, and credit unions in its market area. Continued strong competition
from such financial institutions is expected in the foreseeable future. The
market area includes branches of several commercial banks that are substantially
larger than the Association in terms of state-wide deposits. The Association
competes for savings by offering depositors a high level of personal service and
expertise together with a wide range of financial services as well as
competitive pricing. In recent years many financial institutions have been
aggressively expanding through the acquisition of branch locations or entire
financial institutions, thereby increasing competition.
Based on total assets as of December 31, 1997, the Association was the
third largest savings institution headquartered in Palm Beach County. The
Association held 2.35%, 5.49% 2.73% and 0.06% of all bank and savings
association deposits in Palm Beach, Martin, St. Lucie, and Indian River
counties, respectively, at September 30, 1997.
The competition for real estate and other loans comes principally from
commercial banks, mortgage-banking companies, and other savings associations.
The competition for loans has increased substantially in recent years as a
result of the large number of institutions competing in the market area as well
as the increased efforts by commercial banks to expand mortgage loan
originations. The Association competes for loans primarily through the
competitive interest rates and loan fees it charges and the efficiency and
quality of services it provides borrowers, real estate brokers, and builders.
Factors that affect competition include general and local economic conditions,
current interest rate levels, and the volatility of the mortgage markets.
LENDING ACTIVITIES
GENERAL. Historically, the principal lending activity of the
Association has been the origination of fixed-and adjustable-rate mortgage loans
collateralized by one- to four-family residential properties located in its
primary market area. It is the Association's intention to offer varied products
in the residential mortgage loan area. The Association currently emphasizes the
origination of adjustable-rate residential mortgage ("ARM") loans and fixed-rate
residential mortgage loans with terms of 15 years or less, as well as a
residential mortgage loan which provides for a fixed-rate of interest during the
first five or seven years and which thereafter converts to an ARM loan, the
interest rate of which adjusts annually. At times, it has been the Association's
policy to sell in the secondary market all fixed-rate mortgage loan originations
with terms greater than 15 years on a servicing retained basis. However, based
on management's assessment of the market at a particular time and Board of
Director limits, the Association may periodically decide to retain such loans in
the portfolio. There were no loans held for sale at December 31, 1997. Loans
serviced for other institutions totaled $22.5 million. The Association
participates with other financial institutions in programs which provide
residential mortgage loans to low income and middle income borrowers. At
December 31, 1997, the net loan portfolio totaled $451.7 million, of which
4
$339.1 million, or 75.1%, consisted of one-to four-family residential mortgage
loans; $34.9 million, or 7.7%, consisted of construction loans; $17.1 million,
or 3.8%, consisted of land loans; $8.8 million, or 2.0%, consisted of
multi-family residential real estate loans; $59.2 million, or 13.1%, consisted
of commercial real estate loans; $15.7 million, or 3.5%, consisted of consumer
loans (primarily home equity lines of credit, automobile loans, and loans
secured by savings deposits); and $3.5 million, or 0.8%, consisted of commercial
business loans. At December 31, 1997, the weighted average remaining term to
maturity of the loan portfolio was approximately 15.6 years. At December 31,
1997, $251.5 million, or 55.7% of the total net loan portfolio consisted of
loans with adjustable interest rates. To supplement local loan originations, the
Association also invests in mortgage-backed and related securities that directly
or indirectly provide funds principally for residential home buyers in the
United States. The Association has also purchased either participations in or
whole residential or commercial real estate loans which are serviced by other
institutions. Such loans totaled $19.4 million, net of premiums, at December 31,
1997.
5
ANALYSIS OF LOAN PORTFOLIO. Set forth below is selected data relating to the
composition of the loan portfolio by type of loan as of the dates indicated.
At
December 31,
--------------------------------------------
1997 1996
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(Dollars in Thousands)
Real estate loans:
Residential 1-4 family (1) $ 339,117 75.07% $ 293,366 75.41%
Construction loans 34,850 7.72 35,358 9.09
Land loans 17,117 3.79 19,426 4.99
Multi-family (2) 8,800 1.95 8,096 2.08
Commercial (3) 59,220 13.11 37,815 9.72
--------- ------ --------- ------
Total real estate loans 459,104 101.64 394,061 101.29
--------- ------ --------- ------
Non-real estate loans:
Consumer loans (4) 15,694 3.47 16,028 4.12
Commercial business 3,530 0.78 2,458 0.63
--------- ------ --------- ------
Total non-real estate loans 19,224 4.25 18,486 4.75
--------- ------ --------- ------
Total loans receivable 478,328 105.89 412,547 106.04
Less:
Undisbursed loan proceeds 24,163 5.35 20,765 5.34
Unearned discount and net
deferred fees (206) (0.05) 200 0.05
Allowance for loan losses 2,662 0.59 2,542 0.65
--------- ------ --------- ------
Total loans receivable,
net $ 451,709 100.00% $ 389,040 100.00%
========= ====== ========= ======
At
September 30,
---------------------------------------------------------------------------------------------
1996 1995 1994 1993
---- ---- ---- ----
Real estate loans:
Residential 1-4 family (1) $ 284,474 75.61% $ 248,769 75.51% $ 247,867 78.16% $ 262,480 79.84%
Construction loans 35,720 9.49 27,314 8.29 12,265 3.87 7,965 2.42
Land loans 16,846 4.48 15,601 4.74 20,476 6.46 17,072 5.19
Multi-family (2) 8,153 2.17 7,351 2.23 6,772 2.14 5,952 1.81
Commercial (3) 38,433 10.22 35,402 10.75 32,612 10.28 34,953 10.64
--------- ------ --------- ------ --------- ------ --------- ------
Total real estate loans 383,626 101.97 334,437 101.52 319,992 100.91 328,422 99.90
--------- ------ --------- ------ --------- ------ --------- ------
Non-real estate loans:
Consumer loans (4) 15,606 4.15 12,638 3.84 10,237 3.23 10,844 3.30
Commercial business 1,874 0.50 1,958 0.59 1,058 0.33 929 0.28
--------- ------ --------- ------ --------- ------ --------- ------
Total non-real estate loans 17,480 4.65 14,596 4.43 11,295 3.56 11,773 3.58
--------- ------ --------- ------ --------- ------ --------- ------
Total loans receivable 401,106 106.62 349,033 105.95 331,287 104.47 340,195 103.48
Less:
Undisbursed loan proceeds 22,318 5.94 15,253 4.63 9,872 3.11 6,466 1.96
Unearned discount and net
deferred fees 257 0.07 846 0.26 908 0.29 1,234 0.38
Allowance for loan losses 2,312 0.61 3,492 1.06 3,390 1.07 3,748 1.14
--------- ------ --------- ------ --------- ------ --------- ------
Total loans receivable,
net $ 376,219 100.00% $ 329,442 100.00% $ 317,117 100.00% $ 328,747 100.00%
========= ====== ========= ====== ========= ====== ========= ======
- --------------------------------
(1) Includes participations or whole loans of $19.5 million, $1.7 million, $1.8
million, $2.2 million, $2.6 million, and $3.6 million at December 31, 1997,
1996, September 30, 1996, 1995, 1994, and 1993, respectively.
(2) Includes participations of $0, $505,000, $360,000, $0, $0, and $0, at
December 31, 1997, 1996, September 30, 1996, 1995, 1994, and 1993,
respectively.
(3) Includes participations of $162,000, $190,000, $198,000, $4.9 million, $5.0
million, and $5.5 million at December 31, 1997, 1996, September 30, 1996,
1995, 1994, and 1993, respectively.
(4) Includes primarily home equity lines of credit, automobile loans, and loans
secured by savings deposits. At December 31, 1997 the disbursed portion of
home equity lines of credit totaled $8.8 million.
6
LOAN AND MORTGAGE-BACKED AND RELATED SECURITIES MATURITY AND REPRICING
SCHEDULE. The following table sets forth certain information as of December 31,
1997, regarding the dollar amount of loans and mortgage-backed and related
securities maturing in the Association's portfolio based on their contractual
terms to maturity. Demand loans, loans having no stated schedule of repayments
and no stated maturity, and overdrafts are reported as due in one year or less.
Adjustable and floating-rate loans are included in the period in which interest
rates are next scheduled to adjust rather than in which they contractually
mature, and fixed-rate loans are included in the period in which the final
contractual repayment is due. Fixed-rate mortgage-backed securities are assumed
to mature in the period in which the final contractual payment is due on the
underlying mortgage.
WITHIN 1 1-3 3-5 5-10 MORE THAN
YEAR YEARS YEARS YEARS 10 YEARS TOTAL
-------- ----- ----- ----- ---------- -----
(IN THOUSANDS)
Real estate loans:
One- to four-family residential $196,202 $ 55,097 $ 42,572 $ 39,610 $ 25,727 $359,208
Commercial, multi-family and land 84,256 6,753 3,522 2,678 2,687 99,896
Consumer loans (excluding lines of credit) 3,491 2,922 500 59 -- 6,972
Equity line of credit loans (1) 8,722 -- -- -- -- 8,722
Commercial business loans 3,530 -- -- -- -- 3,530
-------- -------- -------- -------- -------- --------
Total loans receivable (gross) $296,201 $ 64,772 $ 46,594 $ 42,347 $ 28,414 $478,328
======== ======== ======== ======== ======== ========
Mortgage-backed and related securities $ 26,861 $ 29,465 $ 18,287 $ 13,844 $ 4,308 $ 92,765
======== ======== ======== ======== ======== ========
- ------------------------
(1) Variable-rate equity lines of credit reprice on a monthly basis.
The following table sets forth at December 31, 1997, the dollar amount
of all fixed-rate and adjustable-rate loans due after December 31, 1998 based on
either the repricing date or the contractual maturity as described above.
FIXED ADJUSTABLE TOTAL
----- ---------- -----
(IN THOUSANDS)
Real estate loans:
One- to four-family residential $131,300 $ 31,706 $163,006
Commercial, multi-family and land 12,051 3,589 15,640
Consumer and commercial business loans 3,481 -- 3,481
-------- -------- --------
Total $146,832 $ 35,295 $182,127
======== ======== ========
Mortgage-backed and related securities $ 65,904 $ -- $ 65,904
======== ======== ========
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Association's
primary lending activity consists of the origination of one- to four-family,
owner-occupied, residential mortgage loans secured by properties located in its
market area. One- to four-family residential owner-occupied mortgage loans are
generally underwritten in conformity with the criteria established by Fannie Mae
("FNMA"), with the exception of loans exceeding applicable agency dollar limits
and loans purchased through the Association's affiliation with a consortium of
financial institutions which provides loans to low and moderate income borrowers
(discussed below). The Association generally does not originate one- to
four-family residential loans secured by properties outside of its market area.
At December 31, 1997, $339.1 million, or 75.1%, of the total loan portfolio
consisted of one- to four-family residential mortgage loans. The weighted
average contractual maturity of one-to four-family residential mortgage loans at
the time they are originated is 24.0 years. However, it has been the
Association's experience that the average length of time which such loans remain
outstanding is 9.5 years.
The Association currently offers one- to four-family residential
mortgage loans with terms typically ranging from 15 to 30 years, and with
adjustable or fixed interest rates. Originations of fixed-rate mortgage loans
and ARM loans are monitored on an ongoing basis and are affected significantly
by the level of market interest rates, customer preference, the Association's
interest rate sensitivity gap position, and loan products offered by its
competitors. In a relatively low interest rate environment, which existed
throughout fiscal 1997, borrowers typically prefer fixed-rate loans to ARM
loans. The
7
Association has continued to emphasize its ARM loan products. ARM loan
originations totaled $54.6 million, or 73.6%, of all one- to four-family loan
originations during the year ended December 31, 1997. In connection with the
Association's effort to increase mortgage lending, the Association offers
residential mortgage loans which provide for a fixed-rate of interest during the
first five or seven years of the term of the loans and which thereafter convert
to ARM loans on which the interest rate adjusts on an annual basis. This loan
product allows the Association to offer a loan with a relatively short period
during which the interest rate remains fixed but which typically provides for an
initial interest rate which is greater than could be obtained from ARM loans.
This loan is generally offered for terms between l5 and 30 years.
The Association currently offers ARM loans with an adjustment of one
year based on changes in a designated market index plus a margin. Each ARM loan
currently adjusts annually with an annual interest rate adjustment limitation of
200 basis points and a maximum lifetime adjustment of 600 basis points above the
initial rate. Interest rates on the ARM loans currently adjust to either the
changes in the weekly average yield on United States Treasury securities
adjusted to a constant maturity of one year plus a margin, or to the National
Monthly Median Cost of Funds plus a margin. ARM loans are originated with
initial rates which are below the fully indexed rate, the amount of such
discount varying depending upon market conditions, and which provide for an
annual adjustment. Management determines whether a borrower qualifies for an ARM
loan based on the fully indexed rate of the ARM loan at the time the loan is
originated. Negative amortization of the ARM loans is not allowed. One- to
four-family residential ARM loans totaled $192.5 million at December 31, 1997.
The primary purpose of offering ARM loans is to make the loan portfolio
more interest rate sensitive. However, as the interest income earned on ARM
loans varies with prevailing interest rates, such loans do not offer as
consistently predictable interest income as long-term, fixed-rate loans. ARM
loans carry increased credit risk associated with potentially higher monthly
payments by borrowers as general market interest rates increase. It is possible,
therefore, that during periods of rising interest rates, the risk of default on
ARM loans may increase due to the upward adjustment of interest costs to the
borrower.
Fixed-rate loans generally are originated and underwritten according to
standards that permit sale in the secondary mortgage market. Whether management
can or will sell fixed-rate loans into the secondary market, however, depends on
a number of factors including the yield and the term of the loan, market
conditions, the Association's current interest rate sensitivity gap position and
Board of Director established limits. During the first three quarters of 1997,
the Association's policy was to retain in its portfolio fixed-rate mortgage
loans originated with terms of 15 years or less, and to sell fixed-rate mortgage
loans originated (servicing retained) with terms of more than 15 years except
for loans originated for special financing on low and moderate income housing.
Periodically, management and the Board may decide to retain all loans
originated, including loans with terms greater that 15 years based on conditions
in effect at that time. This policy was in effect for the last quarter of 1997.
The Association's fixed-rate mortgage loans are amortized on a monthly basis
with principal and interest due each month. One- to four-family residential real
estate loans often remain outstanding for significantly shorter periods than
their contractual terms because borrowers may refinance or prepay loans at their
option without prepayment penalities.
The Association participates with other financial institutions in local
consortiums which are committed to provide financing of one- to four-family
mortgage loans for low and moderate income borrowers. The consortiums underwrite
and package the loans which are generally sold to participating financial
institutions on a whole loan basis. These loans are originated to borrowers
within the Association's market area and provide for either fixed- or
adjustable-rates of interest. The Association determines which loans it will
purchase after conducting its own due diligence review of the loan package
offered. Although for the fiscal year ended December 31, 1997 the Association
did not purchase any loans originated by the consortiums, it is the
Association's intent, subject to market conditions, to continue to participate
in consortiums of this nature.
The Association also purchases single-family residential loans from
other sources, such as mortgage origination companies, or brokers, under the
same guidelines as described above. In addition, such loan purchases include a
contract between the mortgage origination company and the Association, which
contains an indemnification clause protecting the Association from loss
resulting from misrepresentations in the loan applications or other information
provided to the Association. $24.5 million of such loans were purchased during
fiscal year 1997. It is management's intent, subject to market conditions, to
continue purchasing such loans.
The Association's one- to four-family residential first mortgage loans
customarily include due-on-sale clauses, which are provisions giving the
Association the right to declare a loan immediately due and payable in the
event, among
8
other things, that the borrower sells or otherwise disposes of the underlying
real property serving as security for the loan. Due-on-sale clauses are an
important means of adjusting the rates on the fixed-rate mortgage loan portfolio
(and to a lesser extent ARM loans), and the Association has generally exercised
its rights under these clauses.
Regulations limit the amount that a savings association may lend
relative to the appraised value of the real estate securing the loan, as
determined by an appraisal at the time of loan origination. Appraisals are
generally performed by an independent outside appraiser. Such regulations permit
a maximum loan-to-value ratio of 95% for residential property and 80% for all
other real estate loans. The Association's lending policies generally limit the
maximum loan-to-value ratio on both fixed-rate and ARM loans without private
mortgage insurance to 80% of the lesser of the appraised value or the purchase
price of the property to serve as collateral for the loan. For one- to
four-family real estate loans with loan-to-value ratios of between 80% and 95%,
the borrower is generally required to obtain private mortgage insurance. An
origination fee of between 1 % and 2% of the total loan amount on all one- to
four-family loans may be charged depending on the market conditions. Fire and
casualty insurance (and flood insurance if the property is within a designated
flood plain), as well as a title guaranty regarding good title, are required on
all properties securing real estate loans made by the Association.
The Association may purchase participation or whole loans loans secured
by one- to four-family residences when there are funds available for lending in
excess of the demand for loans in the local market or to facilitate funding of
large projects. At December 31, 1997, the loan portfolio included $19.5 million
of loan participations and whole loans secured by one- to four-family
residences. The Association purchased $18.l million of such loans during 1997.
CONSTRUCTION AND LAND LOANS. At December 31, 1997, $34.9 million, or
7.7%, and $17.1 million, or 3.8%, of the total net loan portfolio consisted of
construction loans and land loans, respectively. Fixed-rate and adjustable-rate
residential construction loans are currently offered primarily for the
construction of owner-occupied single-family residences in the Association's
market area to builders who have a contract for sale of the property or to
owners who have a contract for construction. Advances are made as construction
is completed. In addition, construction loans are also made to builders for
single-family homes held for sale. Such loans totaled $4.2 million at December
31, 1997. Construction loans for owner-occupied single-family residences are
generally structured to become permanent loans upon completion of construction,
and are originated with terms of up to 30 years with an allowance of up to six
months for construction during which period the borrower is obliged to make
interest-only payments. Construction loans to builders for homes held for sale
are generally originated for a term of up to one year and provide for
interest-only payments. Disbursements are made as affidavits of progress are
presented to the Association.
At December 31, 1997, the largest real estate construction loan had an
aggregate principal outstanding balance of $2.5 million, with disbursed funds of
$13,000, which is within the Association's loans-to-one-borrower limit. This
loan is secured by a construction loan to build a single-family home which is
located in the Association's market area. Construction was completed and the
loan was satisfied in full during the March 1998 quarter.
Construction loans are also offered on multi-family and commercial real
estate loans. At December 31, 1997, multi-family and commercial construction
loans totaled $0 and $2.0 million, respectively.
In addition, loans are originated within the market area which are
secured by individual unimproved or improved lots zoned primarily to become
single-family residences, as well as commercial and agricultural properties.
Land loans are currently offered as either one-year ARMs or fixed-rate loans
with terms of up to 15 years. The maximum loan-to-value ratio for such land
loans is 75%.
Adjustable-rate single-family construction and land loans are currently
offered at the weekly average yield on United States Treasury Securities
adjusted to a constant maturity of one year plus a margin. Adjustable-rate
construction loans and land loans have an annual interest rate cap of 200 basis
points and a lifetime interest rate cap of 600 basis points over the initial
interest rate. Initial interest rates may be below the fully indexed rate but
the loan is underwritten at the fully indexed rate.
Construction lending generally involves a greater degree of credit risk
than one- to four-family residential mortgage lending. Risk of loss on a
construction loan is dependent largely upon the accuracy of the initial estimate
of the property's value at completion of construction or development and the
estimated cost (including interest) of construction. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of value proves to be inaccurate, the Association may be confronted, at
or prior to the maturity of the loan, with a project, when completed,
9
having a value which is insufficient to assure full repayment. Loans on lots may
run the risk of adverse zoning changes, environmental, or other restrictions on
future use.
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. Loans secured by
multi-family real estate constituted approximately $8.8 million, or 2.0%, of the
total net loan portfolio at December 31, 1997. At December 31, 1997, a total of
40 loans were secured by multi-family properties. Multi-family real estate loans
are primarily secured by multi-family residences, such as rental properties with
between five and thirty-six units. At December 31, 1997, substantially all
multi-family loans were secured by properties located within the market area. At
December 31, 1997, multi-family real estate loans had an average principal
balance of approximately $220,000 and the largest multi-family real estate loan
had a principal balance of $1.4 million, and was performing in accordance with
its terms. Multi-family real estate loans are currently offered with adjustable
interest rates, although in the past fixed-rate multi-family real estate loans
were originated. Multi-family loans typically have adjustable interest rates
tied to a market index with a 600 basis point lifetime interest rate cap and a
200 basis point cap on annual adjustments, and amortize over 20 to 25 years. An
origination fee of between 1.5% to 2.0% is usually charged on multi-family
loans. Multi-family mortgage loans are generally made up to 75% of the appraised
value of the property securing the loan. The initial interest rate on
multi-family real estate loans is currently priced at the weekly average yield
on United States Treasury securities adjusted to a constant maturity of one year
plus a margin, depending on the nature and size of the project. Originations of
multi-family loans have been limited in recent years due to the limited demand
for such projects in the Association's market area.
In underwriting multi-family real estate loans, the Association reviews
the expected net operating income generated by the real estate to support the
debt service, the age and condition of the collateral, the financial resources
and income level of the borrower, the borrower's experience in owning or
managing similar properties, and any financial reserves the borrower may have. A
debt service coverage ratio of at least 125% of the monthly loan payment is
generally required. Personal guarantees from all the principals of the
multi-family real estate borrowers are generally obtained.
Loans secured by multi-family real estate generally involve a greater
degree of credit risk than one- to four-family residential mortgage loans and
carry larger loan balances. This increased credit risk is a result of several
factors, including the concentration of principal in a limited number of loans
and borrowers, the effects of general economic conditions on income producing
properties, and the increased difficulty of evaluating and monitoring these
types of loans. Furthermore, the repayment of loans secured by multi-family
property is typically dependent upon the successful operation of the related
real estate property. If the cash flow from the project is reduced, the
borrower's ability to repay the loan may be impaired.
COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate
constituted approximately $59.2 million, or 13.1%, of the total net loan
portfolio at December 31, 1997. Commercial real estate loans are secured by
improved property such as offices, hotels, small business facilities, strip
shopping centers, warehouses, commercial land and other non-residential
buildings. At December 31, 1997, substantially all of commercial real estate
loans were secured by properties located within the market area. At December 31,
1997, a total of 182 loans were secured by commercial real estate with an
average principal balance of approximately $325,000. Commercial real estate
loans are currently only offered with adjustable-rates, although in the past the
Association has originated fixed-rate commercial real estate loans. The terms of
each commercial real estate loan are negotiated on a case-by-case basis,
although such loans typically have adjustable interest rates tied to a market
index. An origination fee of up to 2% of the principal balance of the loan is
typically charged on commercial real estate loans. Commercial real estate loans
originated by the Association generally amortize over 15 to 20 years and have a
maximum loan-to-value ratio of 75%.
During fiscal year 1996, the Association decided that a need existed in
the local market for commercial real estate and business loans. In order to
better serve its customers and to increase its share of the commercial loan
market, the Association began an expansion of both its commercial real estate
and business lending activities in late fiscal 1996 with the addition of an
experienced commercial loan officer and a credit analyst to the Lending Division
staff. Such loans were pursued aggressively with $28.7 million of such loans
originated during fiscal year 1997. The Association intends to continue to
pursue such loans aggressively in the future.
At December 31, 1997, the largest commercial real estate borrower had
an aggregate principal outstanding balance of $9.3 million, with undisbursed
funds of $3.8 million, which is within the Association's loans-to-one-borrower
limit. The $9.3 million principal balance represent's the Association's 50%
share of the funding. The remaining 50% was funded by another local lender. The
loan is for the construction of a 24 unit luxury condominium project located in
the Association's market area, and is currently performing in accordance with
its terms.
10
In underwriting commercial real estate loans, the same underwriting
standards and procedures are employed as are employed in underwriting
multi-family real estate loans. Loans secured by commercial real estate
generally involve a higher degree of risk than one- to four-family residential
mortgage loans and carry larger loan balances. This increased credit risk is a
result of several factors, including the concentration of principal in a limited
number of loans and borrowers, the effects of general economic conditions on
income producing properties, and the increased difficulty of evaluating and
monitoring these types of loans. Furthermore, the repayment of loans secured by
commercial real estate is typically dependent upon the successful operation of
the related real estate project. If the cash flow from the project is reduced,
the borrower's ability to repay the loan may be impaired.
CONSUMER LOANS. As of December 31, 1997, consumer loans totaled $15.7
million, or 3.5%, of the total net loan portfolio. The principal types of
consumer loans offered are home equity lines of credit, fixed-rate second
mortgage loans, automobile loans, mobile home loans, boat loans, recreational
vehicle loans, unsecured personal loans, and loans secured by deposit accounts.
Consumer loans are offered primarily on a fixed-rate basis with maturities
generally of five years or less. The home equity lines of credit are secured by
the borrower's principal residence with a maximum loan-to-value ratio, including
the principal balances of both the first and second mortgage loans, of 100%
based on certain credit and occupancy requirements or 80% if such requirements
are not met. Such loans are offered on a monthly adjustable-rate basis with
terms of up to ten years. At December 31, 1997, the disbursed portion of home
equity lines of credit totaled $8.8 million, or 56.1%, of consumer loans. The
undisbursed portion of such loans was $5.6 million at December 31, 1997. The
Association anticipates it will modestly expand its home equity product line in
fiscal 1998.
The underwriting standards employed by the Association for consumer
loans include a determination of the applicant's credit history and an
assessment of ability to meet existing obligations and payments on the proposed
loan. Creditworthiness of the applicant is of primary consideration; however,
the underwriting process also includes a comparison of the value of the
collateral in relation to the proposed loan amount, and in the case of home
equity lines of credit, an independent company is engaged to conduct a title
search.
Consumer loans generally have shorter terms and higher interest rates
than traditional mortgage loans, but generally entail greater credit risk than
do residential mortgage loans, particularly in the case of consumer loans that
are unsecured or secured by assets that depreciate rapidly, such as automobiles,
mobile homes, boats, and recreational vehicles. In such cases, repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment for the outstanding loan and the remaining deficiency often does not
warrant further substantial collection efforts against the borrower. In
particular, amounts realizable on the sale of repossessed automobiles may be
significantly reduced based upon the condition of the automobiles and the
fluctuating demand for used automobiles.
COMMERCIAL BUSINESS LOANS. The Association currently offers commercial
business loans to finance small businesses in its market area. Commercial
business loans are offered as a customer service to business account holders.
Such loans may include commercial lines of credit, loans on inventory,
equipment, receivables, or other collateral and unsecured loans. During the last
quarter of the fiscal year ended September 30, 1996, the Association began
expanding its activities in the commercial business lending market. The
Association aggressively pursued such loans during fiscal year 1997 and intends
to continue pursuing such loans aggressively in the future. At December 31,
1997, 53 commercial business loans were outstanding with an aggregate balance of
$3.5 million and an average loan balance of approximately $66,000. Commercial
business loans originated during the year ended December 31, 1997 totaled $2.7
million. Commercial business loans are offered with both fixed- and
adjustable-interest rates. Adjustable-rates on commercial business loans are
priced against the Citibank or WALL STREET JOURNAL prime rate, plus a margin.
The loans are offered with terms of up to five years.
Underwriting standards employed by the Association for commercial
business loans include a determination of the applicant's ability to meet
existing obligations and payments on the proposed loan from normal cash flows
generated by the applicant's business. The financial strength of each applicant
also is assessed through a review of financial statements provided by the
applicant as well as conducting a credit review.
Commercial business loans generally bear higher interest rates than
residential loans, but they also may involve a higher risk of default since
their repayment is generally dependent on the successful operation of the
borrower's business. Personal guarantees from the borrower or a third party are
generally obtained as a condition to originating its commercial business loans.
11
LOAN ORIGINATIONS, SOLICITATION, PROCESSING, COMMITMENTS, AND
PURCHASES. Loan originations are derived from a number of sources such as real
estate broker referrals, existing customers, developers and walk-in customers.
Upon receiving a loan application, the Association obtains a credit report and
income verification to verify specific information relating to the applicant's
employment, income, and credit standing. In the case of a real estate loan, an
independent appraiser approved by the Association appraises the real estate
intended to secure the proposed loan. A loan processor in the loan department
checks the loan application file for accuracy and completeness, and verifies the
information provided. Outside members of the Board of Directors ("Director"),
the Chairman of the Board of Directors ("Chairman"), the President, the Senior
Vice President of the Lending Division (the "SVP") and certain designated Vice
Presidents of the Lending Division ("VP") have been granted the authority to
approve loans. The President, the SVP and certain VPs have individual authority
to approve mortgage loans between $100,000 and $400,000, secured consumer and
commercial loans between $25,000 and $200,000, and unsecured loans between
$10,000 and $100,000. Additionally, these officers may individually approve an
additional 10% of a customer's currently outstanding debt, even though that
exceeds their individual authority limit. Any two of the President, the SVP and
a designated VP may jointly approve all loan types up to $750,000. Any two of
the Chairman, the President, and the SVP may jointly approve all loan types up
to $l.5 million. The Loan Committee consists of any three of any one Director,
the President, the SVP, and one designated VP. The designated Director or his
representative must be present at Loan Committee. Such committee can approve all
loan types up to $2.0 million. The Loan Committee can approve any loans in
excess of $2.0 million by notifying the entire Board of Directors of its
intention to approve a loan in excess of $2.0 million. The Directors who attend
the meeting have a vote along with the other members of the Committee. The Loan
Committee meets as needed to review and verify that management's loan approvals
are made within the scope of management's authority. After the loan is approved,
a loan commitment letter is promptly issued to the borrower. At December 31,
1997, commitments to originate loans, excluding the undisbursed portion of loans
in process, totaled $7.2 million.
If the loan is approved, the commitment letter specifies the terms and
conditions of the proposed loan including the amount of the loan, interest rate,
amortization term, a brief description of the required collateral, and required
insurance coverage. Fire and casualty insurance is required at the time the loan
is made and throughout the term of the loan, and upon request of the
Association, flood insurance may be required. Title insurance is required on all
loans secured by real property.
In addition to originations, the Association also purchases loans
secured by one- to four-family residences from consortiums, mortgage origination
companies, or brokers, as previously discussed in "One- to Four-Family
Residential Real Estate Loans." In addition, the Association may purchase
participation loans when there are more funds available for lending in excess of
the demand for loans in the local market or to facilitate funding of large
projects. Such participation loans, which totaled $19.9 million at December 31,
1997, are secured by one- to four-family, multi-family and commercial real
estate loans.
12
ORIGINATION, PURCHASE AND SALE OF LOANS. The table below shows the loan
origination, purchase and sales activity for the periods indicated.
For Year For Three
Ended Months Ended For Year Ending
December 31, December 31, September 30,
------------------------------------------------------------------
1997 1996 1996 1995 1994
---- ---- ---- ---- ----
(In Thousands)
Loans receivable, beginning of period $ 389,040 $ 376,219 $ 329,442 $ 317,117 $ 328,747
Originations:
Real estate:
One- to four-family residential (1) 67,923 20,226 82,596 35,909 49,718
Land loans 14,360 5,498 6,848 18,163 6,418
Multi-family 1,427 -- 1,263 -- 696
Commercial 28,667 1,806 16,102 8,197 2,813
--------- --------- --------- --------- ---------
Total real estate loans 112,377 27,530 106,809 62,269 59,645
Non-real estate loans:
Consumer 4,116 1,525 5,698 4,154 2,425
Commercial business 2,699 515 796 646 718
--------- --------- --------- --------- ---------
Total originations 119,192 29,570 113,303 67,069 62,788
Transfer of mortgage loans to
foreclosed real estate (558) (78) (400) (1,394) (5,528)
Loan and participations purchased 24,455 1,998 16,775 2,728 2,395
Repayments (76,816) (20,042) (72,114) (50,452) (63,471)
Loan sales (631) (283) (5,429) (105) (5,115)
Decrease (increase) in allowance for loan losses (120) (230) 1,180 (102) 358
Decrease in amortization of unearned discount and premiums
and net deferred fees and cost 406 63 589 62 326
Increase (decrease) in loans in process (3,398) 1,553 (7,065) (5,381) (3,406)
Change in other 139 270 (62) (100) 23
--------- --------- --------- --------- ---------
Net loan activity 62,669 12,821 46,777 12,325 (11,630)
--------- --------- --------- --------- ---------
Total loans receivable at end of period $ 451,709 $ 389,040 $ 376,219 $ 329,442 $ 317,117
========= ========= ========= ========= =========
(l) Includes loans to finance the construction of one- to four-family
residential properties, and loans originated for sale in the secondary
market.
13
LOAN ORIGINATION FEES AND OTHER INCOME. In addition to interest earned
on loans, the Association may receive loan origination fees. To the extent that
loans are originated or acquired for the portfolio, Statement of Financial
Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases" ("SFAS No. 91") requires that loan origination fees and costs be
deferred and amortized as an adjustment of yield over the life of the loan by
use of the level yield method. ARM loans originated below the fully-indexed
interest rate will have a substantial portion of the deferred amount recognized
as income in the initial adjustment period. Fees and costs deferred under SFAS
No. 91 are recognized into income immediately upon prepayment or the sale of the
related loan. At December 31, 1997, unearned discounts and premiums and deferred
loan origination fees and costs totaled $206,000. Loan origination fees vary
with the volume and type of loans and commitments made and purchased, principal
repayments, and competitive conditions in the mortgage markets which, in turn,
respond to the demand and availability of funds.
In addition to loan origination fees, the Association also receives
servicing income and other fees that consist primarily of servicing fees, late
charges, and other miscellaneous fees which totaled $269,000, $33,000, $148,000,
$184,000 and $163,000 for the year ended December 31, 1997, the three months
ended December 31, 1996 and the years ended September 30, 1996, 1995, and 1994,
respectively.
LOAN SERVICING. While the Association primarily originates loans for
its own portfolio, it also has sold fixed-rate loans to Freddie Mac ("FHLMC")
and to the FNMA. At December 31, 1997, the unpaid balances of loans sold totaled
approximately $19.0 million. Servicing of such loans is retained and a fee is
received of between one-fourth to three-eights of a percent per loan. The
Association does not purchase loan servicing from other sources.
LOANS-TO-ONE BORROWER. Savings and loan associations are subject to the
same loans-to-one borrower limits as those applicable to national banks which,
under current regulations, restrict loans to one borrower to an amount equal to
15% of unimpaired capital and unimpaired surplus on an unsecured basis, and an
additional amount equal to 10% of unimpaired capital and unimpaired surplus if
the loan is secured by readily marketable collateral (generally, financial
instruments and bullion, but not real estate). The 15% limitation resulted in a
dollar limitation of approximately $12.2 million at December 31, 1997. All of
the Association's loans are in compliance with the loans-to-one borrower limits
at December 31, 1997.
The following table presents the five largest lending relationships at December
31, 1997:
At December 31, 1997
-------------------------------------------------------------
Total of Loans Amount disbursed
-------------------------------------------------------------
Description of collateral: (In Thousands)
Construction loans to build single-family
homes and line of credit $10,082 $5,204
Construction loans to build a condominium 9,284 5,497
Construction loans to build single-family homes 5,365 3,592
Loans secured by convenience stores and
gas stations 4,785 4,785
Construction loans to build single-family homes 3,897 487
At December 31, 1997 all of the aforementioned loans were performing in
accordance with their terms.
ASSET QUALITY
DELINQUENCIES. The Association's collection procedures provide that
when a loan is 15 days past due, a computer-generated late charge notice is sent
to the borrower requesting payment. If the delinquency continues at 30 days, a
delinquent notice is sent and personal contact efforts are attempted, either in
person or by telephone, to strengthen the collection process and obtain reasons
for the delinquency. Also, plans to arrange a repayment plan are made. If a loan
becomes 60 days past due and no progress has been made in resolving the
delinquency, a 10-day demand letter is sent and personal contact is attempted.
The loan also becomes subject to possible legal action if suitable arrangements
to repay have not been made. In addition, the borrower is advised that they may
obtain access to consumer counseling services, to the extent required by
regulations of the Department of Housing and Urban Development ("HUD"). When a
loan continues in a delinquent status for 90 days or more, and a repayment
schedule has not been made or kept by the borrower, generally a
14
notice of intent to foreclose is sent to the borrower, giving the borrower 10
days to repay all outstanding interest and principal. If the delinquency is not
cured, foreclosure proceedings are initiated.
DELINQUENT LOANS. Loans are reviewed on a regular basis and are placed
on a non-accrual status when, in the opinion of management, the collection of
additional interest is doubtful. In addition, loans are placed on non-accrual
status when either principal or interest is 90 days or more past due, or less
than 90 days, in the event the loan has been referred to the Association's legal
counsel for foreclosure. Interest accrued and unpaid at the time a loan is
placed on a non-accrual status is charged against interest income.
The following table sets forth information with respect to loans past
due 60 to 89 days in the loan portfolio at the dates indicated.
AT DECEMBER 31, AT SEPTEMBER 30,
----------------------------- ---------------------------------------------
1997 1996 1996 1995 1994
---- ---- ---- ---- ----
(IN THOUSANDS)
Loans past due 60-89 days:
One- to four-family residential $469 $446 $209 $493 $193
Commercial and multi-family real estate -- -- -- -- --
Consumer and commercial business loans 54 72 3 24 --
Land loans -- -- -- -- 95
---- ---- ---- ---- ----
Total past due 60-89 days $523 $518 $212 $517 $288
==== ==== ==== ==== ====
NON-PERFORMING ASSETS. At December 31,1997, non-performing assets
(non-performing loans and real estate owned (" REO")) totaled $2.0 million, and
the ratio of non-performing assets to total assets was 0.47%. Real estate
acquired by the Association as a result of foreclosure or by deed in lieu of
foreclosure is classified as until such time as it is sold. REO is recorded at
cost which is the estimated fair value of the property at the time the loan is
foreclosed. Subsequent to foreclosure, these properties are carried at lower of
cost or fair value less estimated costs to sell. REO totaled $592,000, $1.5
million, $1.4 million, $1.9 million, $3.7 million and $l.3 million at December
31, 1997, and 1996, and at September 30, 1996, 1995, 1994 and 1993,
respectively.
The following table sets forth information regarding non-accrual loans
delinquent 90 days or more, and real estate acquired or deemed acquired by
foreclosure at the dates indicated. When a loan is delinquent 90 days or more,
all accrued interest thereon is fully reserved and the loan ceases to accrue
interest thereafter. For all the dates indicated, there were no material
restructured loans within the meaning of SFAS 15.
AT DECEMBER 31, AT SEPTEMBER 30,
---------------------------------------------------------------------------
1997 1996 1996 1995 1994
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Non-performing loans:
One- to four-family residential $1,289 $1,524 $ 832 $ 605 $1,571
Commercial and multi-family real estate -- -- 1,282
Consumer and commercial business loans 55 107 10 39 20
Land 35 -- -- 18 82
------ ------ ------ ------ ------
Total non-performing loans 1,379 1,631 842 662 2,955
REO 592 1,455 1,384 1,910 3,686
Other non-performing assets -- -- 400 (2) -- --
------ ------ ------ ------ ------
Total non-performing assets (1) $1,971 $3,086 $2,626 $2,572 $6,641
====== ====== ====== ====== ======
Total non-performing loans to net loans
receivable 0.31% 0.42% 0.22% 0.20% 0.93%
Total non-performing loans to total assets 0.19 0.25 0.13 0.12 0.53
Total non-performing loans and REO to total 0.27 0.47 0.40 0.45 1.25
assets
- ------------------------
(1) Net of specific valuation allowances.
(2) The other non-performing asset at September 30, 1996 represented a deposit
account due to the Association whose recovery was in doubt. All funds were
recovered in the subsequent periods.
15
The largest non-performing asset had a balance of $256,000 at December
31, 1997, with a current appraisal of $340,000. The loan was originated in
fiscal 1989 and was collateralized by a citrus grove located in St. Lucie
County. The borrower, which was an insurance company, went into receivership and
was liquidated in October 1991. The Association subsequently obtained a
Receiver's Deed and the property was classified as REO in February 1993. In June
1995, the Association applied for approval of a site plan to allow for 32 lots
for residential use. The Association applied for extension of the site plan in
February 1997 and 1998. The Association has held the REO for five years and has
applied for an extension with the OTS to hold it for one additional year. The
property has been marketed aggressively, but it is located in an area of limited
growth.
During the year ended December 31, 1997, gross interest income of
$86,000 would have been recorded on non-performing loans accounted for on a
non-accrual basis if the loans had been current throughout the period. No
interest income on non-accrual loans was included in income during such period.
The following table sets forth information regarding delinquent loans,
REO and loans to facilitate the sale of REO at December 31, 1997.
AT DECEMBER 31, 1997
--------------------------
BALANCE NUMBER
--------------------------
(DOLLARS IN THOUSANDS)
Residential real estate:
Loans 60 to 89 days delinquent $ 469 9
Loans more than 89 days delinquent 1,289 20
Commercial and multi-family real estate:
Loans 60 to 89 days delinquent -- --
Loans more than 89 days delinquent -- --
Consumer and commercial business loans:
Loans 60 to 89 days delinquent 54 4
Loans more than 89 days delinquent 55 3
Land 35 2
REO 592 8
Restructured loans within the meaning of Statement of Financial Accounting
Standards No. 15 (not included in other non-performing categories above) -- --
Loans to facilitate sale of REO 217 4
------ ---
Total $2,711 50
====== ===
CLASSIFICATION OF ASSETS. Federal regulations provide for the
classification of loans and other assets such as debt and equity securities
considered by OTS to be of lesser quality as "substandard," "doubtful," or
"loss" assets. An asset is considered "substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the savings institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "doubtful" have all
of the weaknesses inherent in those classified "substandard," with the added
characteristic that the weaknesses present make "collection or liquidation in
full, " on the basis of currently existing facts, conditions, and values,
"highly questionable and improbable." Assets classified as "loss" are those
considered "uncollectible" and of such little value that their continuance as
assets without the establishment of a specific loss reserve is not warranted.
Assets that do not expose the savings institution to risk sufficient to warrant
classification in one of the aforementioned categories, but which possess some
weaknesses, are required to be designated "special mention" by management.
When a savings institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. General allowances represent
loss allowances that have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets. When a savings institution
classifies problem assets as "loss," it is required either to establish a
specific allowance for losses equal to 100% of the amount of the assets so
classified, or to charge off such amount. A savings institution's determination
as to the classification of its assets and the amount of its valuation
allowances is subject to review by the OTS, which can order the establishment of
additional general or specific loss allowances. Problem loans in the portfolio
are regularly reviewed to determine whether any loans require classification in
accordance with applicable regulations.
16
The following table sets forth the aggregate amount of the
Association's classified assets at the dates indicated.
At December 31 At September,
----------------- -------------------------------------
1997 1996 1996 1995 1994 1993
---- ---- ---- ---- ---- ----
(In Thousands)
Substandard assets $ 3,056 $ 4,205 $ 3,745 $ 8,652 $10,166 $12,447
Doubtful assets -- -- -- -- -- --
Loss assets -- 344 544 1,565 1,520 1,848
- ------------------------ ------- ------- ------- ------- ------- -------
Total classified assets $ 3,056 $ 4,549 $ 4,289 $10,217 $11,686 $14,295
======= ======= ======= ======= ======= =======
ALLOWANCE FOR LOAN LOSSES. Management's policy is to provide for
estimated losses on the loan portfolio based on management's evaluation of the
potential losses that may be incurred. Provisions for losses, which increase the
allowances for loan losses, are established by charges to income. Such
allowances represent the amounts which, in management's judgment, are adequate
to absorb charge-offs of existing loans which may become uncollectible. The
adequacy of the allowance is determined by management's monthly evaluation of
the loan portfolio and related collateral, in light of past loss experience,
present economic conditions and other factors considered relevant by management.
Anticipated changes in economic factors which may influence the level of the
allowances are considered in the evaluation by management when the likelihood of
the changes can be reasonably determined.
Management continues to review the entire loan portfolio to determine
the extent, if any, to which further additional loan loss provisions may be
deemed necessary. Management believes that the current allowance for loan losses
is adequate, however, there can be no assurance that the allowance for loan
losses will be adequate to cover losses that may in fact be realized in the
future or that additional provisions for loan losses will not be required.
17
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES. The following table sets
forth the analysis of the allowance for loan losses for the periods indicated.
AT DECEMBER 31, AT SEPTEMBER 30,
---------------------------------------------------------------------------------
1997 1996 1996 1995 1994 1993
---- ---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Total loans outstanding $ 451,709 $ 389,040 $ 376,219 $ 329,442 $ 317,117 $ 328,747
========= ========= ========= ========= ========= =========
Average loans outstanding for the period $ 411,098 $ 383,258 $ 346,880 $ 321,849 $ 321,721 $ 352,173
========= ========= ========= ========= ========= =========
Allowance balance (at beginning of period) $ 2,542 $ 2,312 $ 3,492 $ 3,390 $ 3,748 $ 2,281
Provision for losses:
Real estate loans 264 243 84 234 967 2,395
Consumer and commercial business loans 14 6 22 3
Recoveries -- -- -- -- -- --
Charge-offs:
Real estate loans (143) (13) (1,264)(1) (132) (1,325) (885)
Consumer and commercial business loans (1) -- (14) (6) (22) (46)
--------- --------- --------- --------- --------- ---------
Allowance balance (at end of period) $ 2,662 $ 2,542 $ 2,312 $ 3,492 $ 3,390 $ 3,748
========= ========= ========= ========= ========= =========
Allowance for loan losses as a percent
of net loans receivable at end of period 0.59% 0.65% 0.61% 1.06% 1.07% 1.14%
Net loans charged off as a percent of
average loans outstanding 0.04% --% 0.37% 0.04% 0.41% 0.26%
Ratio of allowance for loan losses to total
non-performing loans at end of period (2) 193.04% 155.8% 274.58% 527.49% 114.72% 55.65%
Ratio of allowance for loan losses to total
non-performing loans and REO
at end of period (2) 135.06% 82.3% 103.86% 135.77% 51.05% 46.51%
- ------------------------
(1) Charge offs at September 30, 1996 primarily reflected the reversal of a
specific reserve of $1.2 million which was related to a participation
interest in a note which was sold during the year.
(2) Net of specific reserves.
18
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES. The following table sets forth
the allocation of allowance for loan losses by loan category for the periods
indicated. Management believes that the allowance can be allocated by category
only on an approximate basis. The allocation of the allowance by category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.
AT DECEMBER 31,
--------------------------------------------
1997 1996
-------------------- -------------------
% OF LOANS % OF LOANS
IN EACH IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS (1) AMOUNT TOTAL LOANS (1)
------ ----------- ------ -----------
Balance at end of period
applicable to:
One- to four-family
residential mortgage $1,042 78.18% $1,037 79.68%
Land 650 3.58 630 4.71
Multi-family residential
mortgage 300 1.84 300 1.96
Commercial real estate 550 12.38 500 9.17
Consumer and commercial
business 120 4.02 75 4.48
------ ------ ------ ------
Total allowance for loan
losses $2,662 100.00% $2,542 100.00%
====== ====== ====== ======
AT SEPTEMBER 30,
-------------------------------------------
1996 1995
-------------------- ------------------
% OF LOANS % OF LOANS
IN EACH IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS (1) AMOUNT TOTAL LOANS (1)
------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
Balance at end of period
applicable to:
One- to four-family
residential mortgage $ 870 79.83% $ 790 79.10%
Land 630 4.20 630 4.47
Multi-family residential
mortgage 300 2.03 300 2.11
Commercial real estate 452 9.58 1,712 10.14
Consumer and commercial
business 60 4.36 60 4.18
------ ------- ------ ------
Total allowance for loan
losses $2,312 100.00% $3,492 100.00%
====== ====== ====== ======
----------------------------------------------
1994 1993
---------------------- -------------------
% OF LOANS % OF LOANS
IN EACH IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS (1) AMOUNT TOTAL LOANS (1)
------ ----------- ------ -----------
Balance at end of period
applicable to:
One- to four-family
residential mortgage $ 700 78.52% $ 700 79.50%
Land 630 6.18 600 5.02
Multi-family residential
mortgage 300 2.05 453 1.75
Commercial real estate 1,700 9.84 1,935 10.27
Consumer and commercial
business 60 3.41 60 3.46
------ ------ ------ ------
Total allowance for loan
losses $3,390 100.00% $3,748 100.00%
====== ====== ====== ======
- ----------------------------
(1) Percentages do not reflect adjustments for undisbursed loan proceeds,
unearned discount and net deferred fees, and allowance for loan losses.
19
SECURITIES PORTFOLIO.
The Association's primary focus is the origination of loans. However,
during past periods when mortgage loan demand was moderate and the Association
had de-emphasized the origination of fixed-rate loans, management invested
excess liquidity in investment securities, including mutual funds, and in
mortgage-backed and related securities rather than purchasing whole loans or
loan participations. Such securities are subject to classification based on the
intentions of management. Securities purchased for the portfolio are classified
as either held to maturity or as available for sale. The Association has no
securities classified as trading. During December 1995, the provisions of SFAS
No. 115 "Questions and Answers Guide ("SFAS No. 115 Q & A") were adopted which
allowed between November 15, 1995 and December 31, 1995 a one-time
reclassification of securities from held to maturity to available for sale. The
Association reclassified $49.5 million of securities from investments-held to
maturity and mortgage-backed and related securities-held to maturity to
securities available for sale. Such reclassification resulted in a credit of
$247,000 to shareholders' equity. Subsequently, $749,000 of the securities were
sold at no gain or loss.
The Association maintains an Investment Committee which meets on a
monthly basis to review the securities portfolio and make recommendations to be
carried out by management. All investments must be rated BBB or higher by a
recognized rating service. The Investment Committee consists of the
Association's President and Chief Executive Officer, James B. Pittard, Jr.,
Senior Vice President, Chief Financial Officer and Treasurer, Larry J. Baker,
and Senior Vice Presidents, Cecil F. Howard, Jr., Feriel G. Hughes, Mary L.
Kaminske, and Michael E. Reinhardt.
MORTGAGE-BACKED AND RELATED SECURITIES. At December 31, 1997, net
mortgage-backed and related securities totaled $92.8 million, or 12.9%, of total
assets. Of this amount, $46.4 million was classified as held to maturity and
$46.4 million was available for sale. At December 31, 1997, the market value of
the net mortgage-backed and related securities portfolio totaled approximately
$93.3 million. Management primarily invests in fixed-rate mortgage-backed and
related securities with weighted average lives of five to seven years.
Management believes that investing in short-term mortgage-backed and related
securities limits the exposure to higher interest rates. During fiscal years
1997, $679,000 of mortgage-backed and related securities were purchased. These
purchases were funded with public funds deposits, odd-term certificates of
deposit and FHLB advances, instead of excess liquidity as in previous years.
Also included in the mortgage-backed securities portfolio at December 31, 1997,
was $80.0 million of collateralized mortgage obligations ("CMOs"), $7.5 million
of pass-through securities issued by the FHLMC, $3.3 million of pass-through
securities issued by the FNMA and $1.8 million of pass-through securities issued
by the Government National Mortgage Association ("GNMA"). The FHLMC and FNMA
pass-through securities are primarily comprised of five-year and seven-year
balloon mortgage loans. The GNMA pass-through securities were purchased in the
early 1980s and the loans underlying the GNMAs are well seasoned. A limited
amount of mortgage-backed securities issued by the Agency for International
Development ("AID") are also included in the portfolio. The AID mortgage-backed
securities are fixed-rate instruments and are securitized with loans to Korea,
Venezuela, and Israel. At December 31, 1997, AID mortgage-backed securities
totaled $236,000. Such mortgage-backed securities are guaranteed by governmental
agencies or quasi-governmental agencies of the United States Government. By
investing in mortgage-backed and related securities, the Association lowers the
credit risk of its asset base in exchange for lower yields than would typically
be available on internally generated loans.
CMOs are typically issued by a special-purpose entity (in the
Association's case, private issuers), which may be organized in a variety of
legal forms, such as a trust, a corporation, or a partnership. The entity
aggregates pools of pass-through securities, which are used to collateralize the
CMO. Once combined, the cash flows are divided into "tranches" or "classes" of
individual bonds, thereby creating more predictable average durations for each
bond than the underlying pass-through pools. Accordingly, under the CMO
structure all principal paydowns from the various mortgage pools are allocated
to a CMO's first class until it has been paid off, then to a second class until
such class has been paid off, and then to the next classes in order of priority.
Substantially all of the CMOs held in the mortgage-backed and related securities
portfolio consist of senior sequential tranches, primarily investments in one of
the first three tranches of the CMO. By purchasing senior sequential tranches,
management is attempting to ensure the cash flow associated with such an
investment. Generally, such tranches have stated maturities ranging from 6.5
years to 30 years; however, because of prepayments, the expected weighted
average life of these securities is less than the stated maturities. At December
31, 1997, the fixed-rate CMOs had coupon rates ranging from 6.0 % to12.0 % with
a weighted average yield of 7.38%. The adjustable-rate CMOs are indexed to the
London InterBank Offered Rate ("LIBOR") or to the Ten Year Treasury Index.
Management's policy is to purchase tranches in CMOs which are deemed to be
investment grade by the Federal Financial Institutions Examination Council
("FFIEC"). In the past, CMO residuals were purchased in which the repayment of
principal is only made after the senior tranches of the CMO are repaid in full
as to principal. Consequently, investments in CMO residuals are riskier than
investments in senior sequential tranches because of their relatively junior
position to moresenior tranches and the interest rate risk associated with such
securities, in that they could result in a loss of a substantial portion of the
original investment.
20
Cash flows from residual interests are very sensitive to prepayments and,
therefore, contain a high degree of interest rate risk. Residual interests
represent an ownership interest in the underlying collateral, subject to the
first lien of the CMO investors. At December 31, 1997, the carrying value of the
CMO residuals was $7,000. The Association no longer invests in CMO residuals.
OTS regulations require the classification of CMOs as high-risk if they
fail the FFIEC test. No CMOs are purchased which fail the FFIEC test at the time
of purchase. The FFIEC test is reperformed annually during the life of the
securities. During fiscal year 1997, one CMO issue totaling $9.3 million failed
the FFIEC test and is classified as high-risk for OTS reporting purposes.
The following tables set forth the carrying value of, and activity in,
the mortgage-backed and related securities portfolio at the dates indicated.
AT DECEMBER 31, AT SEPTEMBER 30,
--------------------------------------------
1997 1996 1996 1995
---- ---- ---- ----
(IN THOUSANDS)
Mortgage-backed and related securities:
Held to maturity:
CMOs $ 33,638 $ 37,359 $ 38,308 $ 57,586
CMO residuals 7 15 20 118
FHLMCs 7,465 9,673 9,973 11,943
GNMAs 1,751 2,108 2,233 2,774
FNMAs 3,316 3,933 4,076 4,691
AID loans 236 317 335 387
Total mortgage-backed and related securities held -------- -------- -------- --------
to maturity 46,413 53,405 54,945 77,499
-------- -------- -------- --------
Available for sale: (shown at market value)
CMOs 46,350 51,974 53,318 --
-------- -------- -------- --------
Total mortgage-backed and related securities
available for sale 46,350 51,974 53,318 --
-------- -------- -------- --------
Total mortgage-backed and related securities $ 92,763 $105,379 $108,263 $ 77,499
======== ======== ======== ========
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
---------------------------------------------
1997 1996 1996 1995
---- ---- ---- ----
(IN THOUSANDS)
Mortgage-backed and related securities at:
Beginning of period $105,379 $108,263 $ 77,499 $ 41,281
Purchases 679 -- 43,703 41,549
Calls -- -- (311) --
Sales -- -- (749) --
Repayments (14,421) (2,840) (11,454) (5,286)
Discount (premium) amortization 216 60 189 (45)
Gain on call -- -- 254 --
(Increase) decrease in market value available
for sale (net) 910 (104) (868) --
-------- ------- -------- --------
Mortgage-backed and related securities at
end of period $ 92,763 $105,379 $108,263 $ 77,499
======== ======== ======== ========
21
The following table sets forth the allocation of fixed- and
adjustable-rate mortgage-backed and related securities for the periods
indicated.
AT DECEMBER 31, AT SEPTEMBER 30,
----------------------------------------------------------------------------------
1997 1996 1996 1995
----------------- ----------------- ----------------- -----------------
$ % $ % $ % $ %
----------------- ----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
Mortgage-backed and related securities, net:
Held to maturity:
Adjustable-rate CMOs $ 3,028 3.26% $ 3,027 2.87% $ 3,030 2.80% $ 3,980 5.14%
-------- ------ -------- ------ -------- ------ ------- ------
Fixed-rate:
FHLMCs 7,465 8.05 9,673 9.18 9,973 9.21 11,943 15.41
FNMAs 1,751 1.89 2,108 2.00 4,076 3.76 4,691 6.05
GNMAs 3,316 3.57 3,933 3.73 2,233 2.06 2,774 3.58
CMOs 30,617 33.01 34,347 32.59 35,298 32.60 53,724 69.32
AID loans 236 0.25 317 0.30 335 0.32 387 0.50
-------- ------ -------- ------ -------- ------ ------- ------
Total fixed-rate 43,385 46.77 50,378 47.81 51,915 47.95 73,519 94.86
-------- ------ -------- ------ -------- ------ ------- ------
Total mortgage-backed and
related securities-held to
maturity, net 46,413 50.03 53,405 50.68 54,945 50.75 77,499 100.00
-------- ------ -------- ------ -------- ------ ------- ------
Available for sale: (at market value)
Adjustable-rate CMOs 3,331 3.59 3,594 3.41 3,670 3.39 -- --
Fixed-rate CMOs 43,019 46.38 48,380 45.91 49,648 45.86 -- --
-------- ------ -------- ------ -------- ------ ------- ------
Total mortgage-backed and related
securities available for
sale, net 46,350 49.97 51,974 49.32 53,318 49.25 -- --
-------- ------ -------- ------ -------- ------ ------- ------
Total mortgage-backed and related $ 92,763 100.00% $105,379 100.00% $108,263 100.00% $77,499 100.00%
securities, net ======== ====== ======== ====== ======== ====== ======= ======
22
INVESTMENTS. Investments purchased are comprised primarily of United
States Government and agency obligations, mutual funds that invest in
mortgage-backed securities and government and agency obligations, corporate debt
securities and FHLB stock, as well as interest-earning deposits at the FHLB. The
carrying value of the interest-earning deposits, investments and securities
available for sale totaled $134.2 million or18.6% of total assets.
The Association is required under federal regulations to maintain a
minimum amount of liquid assets that may be invested in specified short-term
securities and certain other investments. The Association generally has
maintained a portfolio of liquid assets that exceeds regulatory requirements.
Liquidity levels may be increased or decreased depending upon the yields on
investment alternatives and upon management's judgment as to the attractiveness
of the yields then available in relation to other opportunities and its
expectation of the level of yield that will be available in the future, as well
as management's projections as to the short term demand for funds to be used in
loan origination and other activities. For further information regarding the
investments see Notes 1, 2 and 3 to the Notes to Consolidated Financial
Statements contained in Bankshares' Annual Report to Shareholders for the Year
Ended December 31, 1997 (the "Annual Report") attached hereto as Exhibit 13.
INTEREST-EARNING DEPOSITS. Excess funds are primarily invested on a
daily basis in an interest-earning overnight account at the FHLB of Atlanta. The
balance of this account was $13.6 million at December 31, 1997. Such funds are
available to provide liquidity to meet lending requirements and daily
operations.
INVESTMENT SECURITIES. At December 31, 1997, investment securities
included United States Government and agency obligations totaling $13.0 million,
corporate debt issues totaling $8.3 million, and FHLB stock totaling $3.3
million.
Included in corporate debt issues are asset-backed securities which
include two debt securities secured by automobile loan receivables totaling $1.5
million at December 31, 1997 purchased during fiscal year 1994, the repayment of
which is secured by automobile receivables. These securities are rated BBB or
above by Standard & Poors and provide an effective yield of 6.29%. While these
securities have a stated maturity of six years, it is expected because of
prepayments that the receivables underlying the securities have a weighted
average life of less than the stated maturities. Debt instruments which depend
on the repayment of automobile loans involve a certain degree of risk since in
the event that borrowers of the automobile loan default, the issuer of the
security may have insufficient funds to repay the principal or interest of the
security in accordance with its terms.
The FHLB requires its members to own a required amount of FHLB stock.
During 1996, the FHLB decided to begin redeeming all stock held by members in
excess of the required amount. During October 1996, the Association received
$2.5 million leaving a FHLB stock balance of $2.9 million. Since that time, due
to the growth of the Association's balance sheet, purchases of $400,000 have
occurred. At December 31, 1997, FHLB stock totaled $3.3 million.
SECURITIES AVAILABLE FOR SALE. Securities available for sale are
carried on the books at fair value as required by FASB No. 115 and totaled $95.9
million at December 31, 1997. Included in securities available for sale are
equity securities totaling $23,000, mutual funds totaling $40.7 million, and
United States Government and agency obligations totaling $55.2 million.
Mutual fund investments include mutual funds that invest primarily in
mortgage-backed securities and government and agency securities, and are
classified as available for sale for accounting purposes. The mutual funds which
invest in mortgage-backed securities have characteristics similar to the
mortgage-backed securities in which they invest. Mutual fund investments include
approximately $35.7 million in funds which invest in adjustable-rate
mortgage-backed securities issued by FNMA, FHLMC and GNMA, as well as CMOs and
real estate mortgage investment conduits and other securities collateralized by
or representing interests in real estate mortgages, and approximately $5.0
million in funds which invest in asset backed, corporate and CMO obligations.
23
INVESTMENT PORTFOLIO. The following tables set forth the carrying value
of the investment portfolio and securities available for sale at the dates
indicated. At December 31, 1997, the market value of the investments was
approximately $138.4 million. The market value of investments and securities
available for sale includes interest-earning deposits and FHLB stock at book
value, which approximates market value.
AT DECEMBER 31, AT SEPTEMBER 30,
------------------------------------- -----------------------------
1997 1996 1996 1995
---- ---- ---- ----
(IN THOUSANDS)
Interest-earning deposits:
FHLB-Atlanta $ 13,621 $ 28,695 $ 28,580 $ 28,171
Other deposits -- 200 600 1,200
-------- -------- -------- --------
Total interest-earning deposits 13,621 28,895 29,180 29,371
-------- -------- -------- --------
Investment securities:
United States Government and agency obligations 13,039 11,701 11,691 38,987
Corporate debt issues 8,349 10,138 10,602 13,692
Certificates of deposit -- -- -- 7,000
FHLB stock 3,264 2,864 5,384 7,384
-------- -------- -------- --------
Total investment securities 24,652 24,703 27,677 67,063
-------- -------- -------- --------
Securities available for sale:
(shown at fair value)
Equity securities (1) 23 14 115 96
Mutual funds 40,721 43,067 42,912 26,932
United States Government and agency obligations 55,175 28,097 27,942 --
-------- -------- -------- --------
Total securities available for sale 95,919 71,178 70,969 27,028
-------- -------- -------- --------
Total investment portfolio $134,192 $124,776 $127,826 $123,462
======== ======== ======== ========
(1) Consists of $23,000, $14,000, $14,000, and $10,000 in FNMA stock which was
purchased in order for the Association to qualify as a FNMA sevicer for the
years ended December 31, 1997 and 1996, and September 30, 1996 and 1995,
respectively, and $0, $0, $101,000, and $86,000 in securities issued by the
Financial Institutions Insurance Group Limited for the years ended December
31, 1997 and 1996 and September 30, 1996 and 1995, respectively.
24
SECURITIES PORTFOLIO MATURITIES. The following table sets forth the
scheduled maturities, carrying values, market values and average yields for the
investment securities and securities available for sale at December 31, 1997.
At December 31, 1997
------------------------------------------
One Year Or Less One To Five Years
---------------- -----------------
Annualized Annualized
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-------- ------- -------- -------
(Dollars in Thousands)
Interest-earning deposits:
FHLB of Atlanta $13,621 5.20% $ -- --%
------- ----- ------- -----
Total interest-earning deposits 13,621 5.20 -- --
------- ----- ------- -----
Investment securities:
United States Government
and agency obligations 1,250 10.99 -- --
Corporate debt issues -- -- 1,493 6.32
FHLB stock -- -- -- --
------- ----- ------- -----
Total investment securities 1,250 10.99 1,493 6.32
------- ----- ------- -----
Securities available for sale:
United States Government
and agency obligations 5,000 5.89 44,835 6.40
Equity securities 23 1.33 -- --
Mutual funds: 40,721 5.93 -- --
------- ----- ------- -----
Total securities available
for sale 45,744 5.92 44,835 6.40
------- ----- ------- -----
Total investment securities and
securities available for sale 46,994 6.06 46,328 6.40
------- ----- ------- -----
Total securities portfolio $60,615 5.86% $46,328 6.40%
======= ===== ======= =====
At December 31, 1997
------------------------------------------
Five To Ten Years More Than Ten Years
----------------- -------------------
Annualized Annualized Total Annualized
Weighted Weighted ------------------ Average Weighted
Carrying Average Carrying Average Carrying Market Life in Average
Value Yield Value Yield Value Value Years (1) Yield
--------- ------- --------- ------- -------- ------ ----- -------
(Dollars in Thousands)
Interest-earning deposits:
FHLB of Atlanta $ -- --% $ -- --% $ 13,621 $ 13,621 -- 5.20%
-------- ----- -------- ----- -------- -------- -----
Total interest-earning deposits -- -- -- -- 13,621 13,621 -- 5.20
-------- ----- -------- ----- -------- -------- -----
Investment securities:
United States Government
and agency obligations 11,284 11.33 505 9.36 13,039 17,204 5.44 11.22
Corporate debt issues -- -- 6,856 6.27 8,349 8,655 10.10 6.28
FHLB stock -- -- 3,264 7.25 3,264 3.264 -- 7.25
-------- ----- -------- ----- -------- -------- ----- -----
Total investment securities 11,284 11.33 10,625 6.71 24,652 29,123 7.26 8.16
-------- ----- -------- ----- -------- -------- ----- -----
Securities available for sale:
United States Government
and agency obligations 5,340 6.99 -- -- 55,175 55,175 4.18 6.39
Equity securities -- -- -- -- 23 23 -- 1.33
Mutual funds: -- -- -- -- 40,721 40,721 -- 5.93
-------- ----- -------- ----- -------- -------- ----- -----
Total securities available
for sale 5,340 6.99 -- -- 95,919 95,919 4.18 6.20
-------- ----- -------- ----- -------- -------- ----- -----
Total investment securities and
securities available for sale 16,624 9.94 10,625 6.71 120,571 125,042 5.04 6.61
-------- ----- -------- ----- -------- -------- ----- -----
Total securities portfolio $ 16,624 9,94% $ 10,625 6.71% $134,192 $138,663 5.04 6.48%
======== ===== ======== ===== ======== ======== ===== =====
- ------------------------
(1) Total weighted average life in years calculated only on United States
Government and agency obligations.
25
SOURCES OF FUNDS
GENERAL. Deposits are the major source of funds for lending and other
investment purposes. In addition to deposits, funds are derived from the
amortization and prepayment of loans and mortgage-backed and related securities,
the maturity of investment securities, operations and, if needed, advances from
the FHLB. Scheduled loan principal repayments are a relatively stable source of
funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and market conditions. Borrowings may be
used on a short-term basis to compensate for reductions in the availability of
funds from other sources or on a longer term basis for general business
purposes.
DEPOSITS. Consumer and commercial deposits are attracted principally
from within the market area through the offering of a broad selection of deposit
instruments including non-interest-bearing demand accounts, NOW accounts,
passbook savings, money market deposit accounts, term certificate accounts and
individual retirement accounts. While deposits of $100,000 or more are accepted,
premium rates for such deposits are not currently offered. Deposit account terms
vary according to the minimum balance required, the period of time during which
the funds must remain on deposit, and the interest rate, among other factors. A
management committee meets weekly to evaluate the internal cost of funds, survey
rates offered by competing institutions, review the Association's cash flow
requirements for lending and liquidity and the amount of certificates of deposit
maturing in the upcoming weeks. This committee executes rate changes when deemed
appropriate. Funds are not obtained through brokers, nor are funds solicited
outside the Association's market area.
The following table sets forth information regarding interest rates,
terms, minimum amounts and balances of deposits as of December 31, 1997.
WEIGHTED PERCENTAGE
AVERAGE MINIMUM MINIMUM OF TOTAL
INTEREST RATE TERM CHECKING AND SAVINGS DEPOSITS (1) AMOUNT BALANCES DEPOSITS
------------- ---- ------------------------------ ------ -------- ----------
(IN THOUSANDS)
0.00% None Non-interest-bearing account None $ 24,715 4.49%
1.00 None NOW accounts $ 100 69,862 12.69
1.73 None Passbook accounts 100 30,221 5.49
3.40 None Money market deposit accounts 1,000 78,832 14.31
-------- ------
Total checking and savings deposits 203,630 36.98
-------- ------
CERTIFICATES OF DEPOSIT (1)
-----------------------
4.71 1 - 5 months Fixed term, fixed-rate 1,000 12,531 2.28
5.04 6-11 months Fixed term, fixed-rate 1,000 54,099 9.82
5.60 12-17 months Fixed term, fixed-rate 1,000 165,026 29.97
5.68 24-30 months Fixed term, fixed-rate 1,000 36,654 6.65
5.96 36-47 months Fixed term, fixed-rate 1,000 15,358 2.79
5.93 48-59 months Fixed term, fixed-rate 1,000 2,335 0.42
6.11 Over 60 months Fixed term, fixed-rate 1,000 58,342 10.59
1.73 Various Fixed term, fixed-rate 1,000 1,436 0.26
5.03 Various Negotiated Jumbo 100,000 1,297 0.24
-------- ------
Total certificates of deposit 347,078 63.02
-------- ------
Total deposits $550,708 100.00%
======== ======
- ---------------------------------------------------------------------
(1) IRA and KEOGH accounts are generally offered throughout all terms stated
above with balances of $45.0 million and $1.4 million, respectively.
26
The following tables sets forth the change in dollar amount in the
various types of savings accounts offered between the dates indicated:
Balance Percent Balance Percent
at of Incr. at of Incr.
12/31/97 Deposits (Decr.) 12/31/96 Deposits (Decr.)
-------------------------------------------------------------------------
Non-interest-bearing demand
accounts $ 24,715 4.49% 6,088 $ 18,627 3.63% $ (905)
NOW accounts 69,862 12.69 2,786 67,076 13.06 3,978
Passbooks 30,221 5.49 (600) 30,821 6.00 (54)
Money market deposit
accounts 78,832 14.31 9,318 69,514 13.53 93
Time deposits which mature:
Within 12 months 260,772 47.35 6,975 253,797 49.40 13,557
Within 12-36 months 58,794 10.67 17,590 41,204 8.02 (1,510)
Beyond 36 months 27,512 5.00 (5,158) 32,670 6.36 (379)
-------- ------ -------- -------- ------ --------
Total $550,708 100.00% $ 36,999 $513,709 100.00% $ 14,780
======== ====== ======== ======== ====== ========
Balance Percent Balance Percent
at of Incr. at of
9/30/96 Deposits (Decr.) 9/30/95 Deposits
--------------------------------------------------------
(Dollars in Thousands)
Non-interest-bearing demand
accounts $ 19,532 3.91% $ 4,688 $ 14,844 3.39%
NOW accounts 63,098 12.65 (763) 63,861 14.60
Passbooks 30,875 6.19 1,174 29,701 6.79
Money market deposit
accounts 69,421 13.91 (6,299) 75,720 17.32
Time deposits which mature:
Within 12 months 240,240 48.15 46,740 193,500 44.24
Within 12-36 months 42,714 8.56 10,290 32,424 7.41
Beyond 36 months 33,049 6.63 5,723 27,326 6.25
-------- ------ -------- -------- ------
Total $498,929 100.00% $ 61,553 $437,376 100.00%
======== ====== ======== ======== ======
27
The following table sets forth the certificates of deposit classified
by rates as of the dates indicated.
AT DECEMBER 31, AT SEPTEMBER 30,
-----------------------------------------
1997 1996 1996 1995
---- ---- ---- ----
Rate (IN THOUSANDS)
3.00% or less $ 1,436 $ 1,035 $ 1,600 $ 930
3.01 - 3.99% 11 598 903 5,257
4.00 - 4.99% 35,699 51,484 80,831 55,583
5.00 - 5.99% 262,029 232,313 193,281 108,608
6.00 - 6.99% 39,186 33,568 29,571 70,456
7.00 - 7.99% 8,717 8,673 9,817 12,416
-------- -------- -------- --------
$347,078 $327,671 $316,003 $253,250
======== ======== ======== ========
The following table sets forth the amount and maturities of
certificates of deposit at December 31, 1997.
AMOUNT DUE
----------------------------------------------------------------------------
LESS THAN 1-2 2-3 3-4 4-5 AFTER 5
ONE YEAR YEARS YEARS YEARS YEARS YEARS TOTAL
------- ----- ----- ----- ----- ----- -----
RATE (IN THOUSANDS)
3.00% or less $ 25 $ 38 $ 2 $ 30 $ 114 $ 1,227 $ 1,436
3.01 - 3.99% -- -- 11 -- -- -- 11
4.00 - 4.99% 34,693 1,006 -- -- -- -- 35,699
5.00 - 5.99% 219,566 21,680 10,841 3,096 6,846 -- 262,029
6.00 - 6.99% 6,488 7,860 8,639 8,094 8,105 -- 39,186
7.00 - 7.99% -- 378 8,339 -- -- -- 8,717
-------- -------- -------- -------- -------- -------- --------
$260,772 $ 30,962 $ 27,832 $ 11,220 $ 15,065 $ 1,227 $347,078
======== ======== ======== ======== ======== ======== ========
The following table indicates the amount of negotiable certificates of
deposit of $100,000 or more by time remaining until maturity as of December 31,
1997.
CERTIFICATES
OF DEPOSIT
OF $100,000
REMAINING MATURITY OR MORE
------------------ ------------------
(IN THOUSANDS)
Three months or less $16,919
Three through six months 13,460
Six through twelve months 10,491
Over twelve months 14,188
-------
Total $55,058
=======
Deposits are used to fund loan originations, the purchase of securities
and for general business purposes. The deposit growth in fiscal year 1997 of
$37.0 million reflected the use of odd-term and promotional certificate of
deposit products, the opening of three new branch offices, as well as increased
retail deposits generated by aggressive, competitive pricing of such products in
the market area.
28
The following table sets forth the net changes in the deposit
activities for the periods indicated:
THREE MONTHS
YEAR ENDED ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
-----------------------------------------------------
1997 1996 1996 1995
---- ---- ---- ----
(IN THOUSANDS)
Deposits $ 2,433,375 $ 554,294 $ 2,158,898 $ 1,952,009
Withdrawals 2,416,860 549,264 2,114,903 1,988,577
----------- ----------- ----------- -----------
Net increase (decrease) before
interest credited 16,515 5,030 43,995 (36,568)
Interest credited 20,484 9,750 17,558 13,965
----------- ----------- ----------- -----------
Net increase (decrease) in deposits $ 36,999 $ 14,780 $ 61,553 $ (22,603)
=========== =========== =========== ===========
BORROWINGS. Savings deposits are the primary source of funds for
lending and investment activities and for general business purposes. If the need
arises, advances from the FHLB may be used to supplement the supply of lendable
funds and to meet deposit withdrawal requirements. Advances from the FHLB
typically are collateralized by the Association's stock in the FHLB and a
blanket floating lien on the Association's one- to four-family first mortgage
loans. At December 31, 1997, $57.3 million of FHLB advances were outstanding
with a weighted average interest rate of 6.25%.
The FHLB functions as a central reserve bank providing credit for the
Association and other member savings institutions and financial institutions. As
a member, the Association is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities that are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met. Advances are made pursuant to several
different programs. Each credit program has its own interest rate and range of
maturities. Depending on the program, limitations on the amount of advances are
based either on a fixed percentage of a member institution's net worth or on the
FHLB's assessment of the institution's creditworthiness. Although advances may
be used on a short-term basis for cash management needs, FHLB advances have not
been, nor are they expected to be, a significant long-term funding source for
the Association, although the Association periodically utilizes its ability to
access advances in order to take advantage of investment opportunities which may
arise.
On September 30, 1983, the Association sold two of its branches to
another financial institution. Under terms of the sale, the Association issued a
10.94%, 30-year term mortgage-backed bond (the "Bond") for approximately $41.6
million. The Bond issue has a stated interest rate which was less than the
market rate (assumed to have been 17.53 %) for similar debt at the effective
date of the sale. Accordingly, a discount was recorded on the Bond which is
being accreted on the interest method of accounting over the life of the Bond.
The Bond bears an interest rate that is adjustable semi-annually on each April 1
and October 1 to reflect changes in the average of the United States 10-year and
30-year long-term bond rates. At December 31, 1997, the outstanding balance of
the Bond was $16.3 million with a rate of 10.49%. For further information on the
Bond, see Note 15 to the Notes to the Consolidated Financial Statements in the
Annual Report attached hereto as Exhibit 13.
On October 24, 1994, in connection with the Association's Plan of
Reorganization into a mutual holding company, the Association established an
Employee Stock Ownership Plan ("ESOP") for all eligible employees. The ESOP
purchase of 190,388 shares of common stock in the common market is funded by a
loan currently held by an unaffliated financial institution. The loan is being
repaid from the Association's contributions to the ESOP over a period of up to
seven years and had an outstanding balance of $1.4 million at December 31, 1997.
The loan bears interest at a monthly average of the Federal Funds high and low
rate plus 2.35%, which was 9.60% at December 31, 1997. Subsequent to December
31, 1997, Bankshares loaned sufficient funds to the ESOP to permit the ESOP to
repay the loan to the unaffiliated lender. The terms of the loan to the ESOP
from Bankshares are substantially identical to those of the loan from the
unaffiliated lender, however, the interest rate used will be the New York prime
rate. The Association may, in any plan year, make additional discretionary
contributions for the benefit of plan participants in either cash or shares of
Common Stock, which may be acquired through the purchase of outstanding shares
in the market or from individual shareholders, upon the original issuance of
additional shares by the Association or upon the sale of treasury shares by the
Association. Such purchases, if made, would be funded through additional
borrowings by the ESOP or additional contributions from the Association. The
timing, amount and manner of future contributions to the ESOP will be affected
by various factors, including prevailing
29
regulatory policies, the requirements of applicable laws and regulations and
market conditions. For further information, see Note 14 to the Notes to the
Consolidated Financial Statements in the Annual Report, attached hereto as
Exhibit 13.
The following table sets forth the source, balance, and rate of
borrowings for the year ended December 31, 1997, for the three months ended
December 31, 1996, and for the years September 30, 1996, and 1995.
DURING THE DURING THE
YEAR THREE MONTHS DURING THE
ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
----------------------------------------------
1997 1996 1996 1995
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
FHLB advances:
Maximum month-end balance $57,341 $36,350 $36,350 $18,679
Balance at end of period 57,341 34,763 36,350 18,200
Average balance (1) 42,952 35,657 22,110 3,846
Weighted average interest rate
during the period 6.38% 6.72% 6.36% 10.80%
Weighted average interest rate
at end of period 6.25% 6.69% 6.70% 6.86%
Mortgage-backed bond:
Maximum month-end balance $17,312 $18,204 $18,660 $19,618
Balance at end of period 16,333 17,230 17,454 18,344
Average balance (1) 16,888 17,428 18,033 19,030
Weighted average interest rate
during the period 10.94% 11.17% 10.41% 11.72%
Weighted average interest
rate at end of period 10.49% 11.19% 10.52% 11.65%
ESOP loan:
Maximum month-end balance $ 1,817 $ 1,966 $ 2,409 $ 2,776
Balance at end of period 1,424 1,915 2,114 2,557
Average balance (1) 1,681 1,978 2,273 2,257
Weighted average interest during
the period 7.85% 8.72% 7.98% 8.83%
Weighted average interest rate
at end of period 9.60% 7.76% 7.77% 8.20%
- -------------------------------------------------------------
(1) Computed on the basis of month-end balances.
SUBSIDIARY ACTIVITIES
The Association currently has one active subsidiary. ComFed, Inc. was
formed in February 1971 for the purpose of owning and operating an insurance
agency, Community Insurance Agency, which sells property and casualty insurance.
ComFed, Inc. also receives income and incurs related expenses from the sale of
third party mutual funds and annuities. Such third party mutual funds and
annuities include products widely marketed to the investing public and have
investment advisors that are not affiliated with ComFed, Inc. For the year ended
December 31, 1997, ComFed, Inc. reported net income of $35,000. At December 31,
1997, the Association had an equity investment in ComFed, Inc. of $73,000.
Under the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989 ("FIRREA"), SAIF-insured institutions are required to provide 30 days
advance notice to the OTS and FDIC before establishing or acquiring a subsidiary
or conducting a new activity in a subsidiary. The insured institution must also
provide the FDIC and the OTS such information as may be required by applicable
regulations and must conduct the activity in accordance with the rules and
orders of the OTS.
30
In addition to other enforcement and supervision powers, the OTS may
determine after notice and opportunity for a hearing that the continuation of an
institution's ownership of or relation to a subsidiary (i) constitutes a serious
risk to the safety, soundness or stability of the institution; or (ii) is
inconsistent with the purposes of FIRREA. Upon the making of such a
determination, the OTS may order the institution to divest the subsidiary or
take other actions.
CONTINGENCIES
The Association has completed its investigation of a possible former
employee defalcation which may have occurred for several years. The Association
maintains insurance to cover possible defalcation losses with a claim deductible
of $200,000. A liability for the amount of the deductible was established during
the year ended September 30, 1996. The Association notified its insurance
company of the potential claim and the insurance company acknowledged coverage.
The insurance company has completed its due diligence related to the claim. The
Association and insurance company are currently negotiating the final
settlement. Management does not believe that the claim will have any material
effect on its financial position or results of its operations.
REGULATION
As a federally chartered SAIF-insured savings and loan association, the
Association is subject to examination, supervision and extensive regulation by
the OTS and the FDIC. The Association is a member of and owns stock in the FHLB
of Atlanta, which is one of the twelve regional banks in the Federal Home Loan
Bank System. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors.
The Association also is subject to regulation by the Board of Governors
of the Federal Reserve System (the "Federal Reserve Board") governing reserves
to be maintained against deposits and certain other matters. Bankshares and
ComFed are also subject to supervision and regulation by the OTS.
The OTS regularly examines the Association and prepares reports for the
consideration of the Association's Board of Directors on any deficiencies that
they may find in the Association's operations. The FDIC also examines the
Association in its role as the administrator of the SAIF. The Association's
relationship with its depositors and borrowers also is regulated to a great
extent by both federal and state laws especially in such matters as the
ownership of savings accounts and the form and content of the Association's
mortgage documents. Any change in such regulation, whether by the FDIC, OTS, or
Congress, could have a material adverse impact on Bankshares and the Association
and their operations.
INDUSTRY RECAPITALIZATION OF SAIF
The deposits of savings and loans, such as the Association, are
presently insured by the SAIF. SAIF and the Bank Insurance Fund ("BIF") are the
two insurance funds administered by the FDIC. On August 8, 1995, in recognition
of BIF achieving its mandated reserve ratio, the FDIC revised the premium
schedule for BIF members to provide a new range of .04% to .31% of deposits (as
compared to the then existing range of .23% to .31% of deposits for BIF and SAIF
insured institutions). Subsequent revisions in such schedule resulted in most
BIF-insured institutions paying the statutory annual minimum premium of $2,000.
As a result, well capitalized and healthy BIF members paid significantly lower
premiums than SAIF-insured institutions. Without a substantial increase in
premium rates, or the imposition of special assessments or other significant
developments, such as a merger of SAIF and BIF, it was not anticipated that SAIF
would be adequately recapitalized until 2002. As a result of the disparity in
BIF and SAIF premium rates, SAIF members were placed at a significant
competitive disadvantage in relation to BIF members with respect to pricing of
loans and deposits and the ability to lower their operating costs.
On September 30, 1996 Congress passed, and the President signed, the
Deposit Insurance Funds Act of 1996 (the "DIF") which mandated that all
institutions which have deposits are insured by SAIF were required to pay a
one-time special assessment of 65.7 basis points on SAIF-insured deposits
(subject to adjustment for certain types of banks with SAIF deposits) that were
held at March 31,1995 payable by November 27, 1996 to recapitalize the SAIF. The
assessment increased the SAIF's reserve ratio to a comparable level to that of
the BIF at 1.25% of total insured deposits. The Association's share of this
special assessment totaled $2.8 million and is reflected in the 1996 operating
results. The FDIC, in connection with the recapitalization, also lowered SAIF
premiums from $0.23 per $100 to $0.065 per $100 of insured deposits beginning in
January 1997.
31
THE FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") became law. FDICIA primarily addresses the
recapitalization of the FDIC, which insures the deposits of commercial banks and
savings and loan associations. In addition, FDICIA established a number of new
mandatory supervisory measures for savings associations and banks.
STANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal bank
regulatory agencies to prescribe regulatory standards for all insured depository
institutions and depository institution holding companies relating to: (i)
internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v)
asset growth; and (vi) compensation, fees and benefits. The compensation
standards would prohibit employment contracts, compensation or benefit
arrangements, stock option plans, fee arrangements or other compensatory
arrangements that provide excessive compensation, fees or benefits which could
lead to material financial loss. In addition, the federal banking regulatory
agencies are required to prescribe by regulation standards specifying: (i)
maximum classified assets to capital ratios; (ii) minimum earnings sufficient to
absorb losses without impairing capital; and (iii) to the extent feasible, a
minimum ratio of market value to book value for publicly traded shares of
depository institutions and depository institution holding companies. In July
1995, the federal banking agencies, including the OTS and the FDIC, adopted
final rules regarding implementation of these standards.
FINANCIAL MANAGEMENT REQUIREMENTS. Pursuant to FDICIA, in May 1993, the
FDIC adopted rules establishing annual independent audits and financial
reporting requirements for all depository institutions with assets of more than
$500 million. The rules also establish new requirements for the composition,
duties, and authority of such institutions' audit committees and boards of
directors, effective in fiscal years beginning after September 30, 1993. Among
other things, all depository institutions with assets in excess of $500 million
are required to prepare and make available to the public annual reports on their
financial condition and management, including statements of management's
responsibility under regulations relating to safety and soundness, and an
assessment of the institution's compliance with internal controls, laws and
regulations. The institution's independent auditors are required to attest to
these management assessments. Each such institution also is required to have an
audit committee composed of independent directors. Audit committees of large
institutions (institutions with assets exceeding $3.0 billion) must: (i) include
members with banking or related financial management experience; (ii) have the
ability to engage their own independent legal counsel; and (iii) must not
include as members any large customers (as defined) of the institution.
PROMPT CORRECTIVE ACTION REGULATION. FDICIA establishes a system of
prompt corrective action to resolve the problems of undercapitalized
institutions. Under this system, which became effective on December 19, 1992,
the OTS and the other banking regulators established five capital categories
("well-capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized") and to take
certain mandatory supervisory actions (and are authorized to take other
discretionary actions) with respect to institutions in the three
undercapitalized categories, the severity of which will depend upon the capital
category in which the institution is placed. Generally, FDICIA requires the
requisite banking regulator to appoint a receiver or conservator for an
institution that is critically undercapitalized.
Under the OTS rule implementing the prompt corrective action
provisions, a savings institution that: (i) has a total risk-based capital ratio
of 10.0% or greater, a Tier I (core) risk-based capital ratio of 6.0% or greater
and a leverage ratio of 5.0% or greater; and (ii) is not subject to any written
agreement, order, capital directive or prompt corrective action directive issued
by the OTS, is deemed to be well-capitalized. An institution with a total
risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio
of 4.0% or greater and a leverage ratio of 4.0% or greater, is considered to be
adequately capitalized. A savings institution that has a total risk-based
capital ratio of less than 8.0%, a Tier I risk-based capital ratio of less than
4.0%, or a leverage ratio that is less than 4.0 % is considered to be
undercapitalized. A savings institution that has a total risk-based capital
ratio of less than 6.0%, a Tier I risk-based capital ratio of less than 3.0% or
a leverage ratio that is less than 3.0%, is considered to be significantly
undercapitalized. A savings institution that has a tangible equity capital to
assets ratio equal to or less than 2.0% is deemed to be critically
undercapitalized. For purposes of the regulation, the term "tangible equity"
includes core capital elements counted as Tier I capital for purposes of the
risk-based capital standards plus the amount of outstanding cumulative perpetual
preferred stock (including related surplus), minus all intangible assets except
certain purchased mortgage servicing rights and qualifying supervisory goodwill.
At December 31, 1997, the Association was in the "well capitalized" category.
32
FDICIA authorizes the appropriate federal banking agency, after notice
and an opportunity for a hearing, to treat a well-capitalized, adequately
capitalized or undercapitalized insured depository institution as if it had a
lower capital classification if it is in an unsafe or unsound condition or is
engaging in an unsafe or unsound practice. Thus, an adequately capitalized
institution can be subjected to the restrictions on undercapitalized
institutions (provided that a capital restoration plan cannot be required of the
institution) described below and an undercapitalized institution can be
subjected to the restrictions applicable to significantly undercapitalized
institutions.
OTHER DEPOSIT INSURANCE REFORMS. FDICIA amended the FDI Act to prohibit
insured depository institutions that are not well-capitalized from accepting
brokered deposits unless a waiver has been obtained from the FDIC. Deposit
brokers are required to register with the FDIC.
The FDIC is required to establish a risk-based assessment system for
deposit insurance to become effective no later than January 1, 1993. The FDIC
established a transactional risk-based insurance assessment system which is
effective for the semi-annual assessment period beginning January 1, 1993.
Furthermore, the FDIC has proposed a risk-based system to replace the
transitional system and is in the process of adopting final regulations with
respect to this matter. FDICIA also authorizes the FDIC to privately reinsure up
to 10% of its risk loss with respect to an institution and base its assessment
on the cost of such reinsurance.
FEDERAL REGULATIONS
REGULATORY CAPITAL. The OTS capital requirements consist of a "tangible
capital requirement," a "leverage capital requirement" and a "risk-based capital
requirement."
Under the tangible capital requirement, a savings association must
maintain tangible capital in an amount equal to at least 1.5% of adjusted total
assets. Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), plus a specified amount of purchased mortgage
servicing rights.
Under the leverage capital requirement adopted by the OTS, associations
maintain "capital" in an amount equal to at least 3% of adjusted total assets.
Core capital is defined as common stockholders' equity (including retained
earnings), non-cumulative perpetual preferred stock, and minority interests in
the equity accounts of consolidated subsidiaries, plus purchased mortgage
servicing rights valued at the lower of 90% of fair market value, 90% of
original cost or the current amortized book value as determined under generally
accepted accounting principles ("GAAP"), and "qualifying supervisory goodwill,"
less non-qualifying intangible assets. At December 31, 1997, the Association's
ratio of core capital to total adjusted assets was 9.8%.
Under the risk-based capital requirement, a savings association must
maintain total capital (which is defined as core capital plus supplementary
capital) equal to at least 8.0% of risk-weighted assets. A savings association
must calculate its risk-weighted assets by multiplying each asset and
off-balance sheet item by various risk factors, which range from 0% for cash and
securities issued by the United States Government or its agencies to 100% for
repossessed assets or loans more than 90 days past due. Qualifying one- to
four-family residential real estate loans and qualifying multi-family
residential real estate loans (not more than 90 days delinquent and having an
80% or lower loan-to-value ratio), which at December 31, 1997, represented 72.2%
of the total loans receivable, are weighted at a 50% risk factor. Supplementary
capital may include, among other items, cumulative perpetual preferred stock,
perpetual subordinated debt, mandatory convertible subordinated debt,
intermediate-term preferred stock, and general allowances for loan losses. The
allowance for loan losses includable in supplementary capital is limited to
1.25% of risk-weighted assets. Supplementary capital is limited to 100% of core
capital.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital, in addition to the adjustments
required for calculating core capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
non-residential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. However, in calculating
regulatory capital, institutions can add back unrealized losses and deduct
unrealized gains net of taxes, on debt securities reported as a separate
component of GAAP capital.
The OTS regulations establish special capitalization requirements for
savings associations that own service corporations and other subsidiaries,
including subsidiary savings associations. According to these regulations,
certain subsidiaries are consolidated for capital purposes and others are
excluded from assets and capital. In determining
33
compliance with the capital requirements, all subsidiaries engaged solely in
activities permissible for national banks, engaged solely in mortgage-banking
activities, or engaged in certain other activities solely as agent for its
customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership, including the
assets of includable subsidiaries in which the association has a minority
interest that is not consolidated for GAAP purposes. For excludable
subsidiaries, the debt and equity investments in such subsidiaries are deducted
from assets and capital. At December 31, 1997 the Association had no investments
subject to a deduction from tangible capital.
The OTS amended its risk-based capital requirements that would require
institutions with an "above normal" level of interest rate risk to maintain
additional capital. A savings association is considered to have a " normal "
level of interest rate risk if the decline in the market value of its portfolio
equity after an immediate 200 basis point increase or decrease in market
interest rates (whichever leads to the greater decline) is less than two percent
of the current estimated market value of its assets. The market value of
portfolio equity is defined as the net present value of expected cash inflows
and outflows from an association's assets, liabilities and off-balance sheet
items. The amount of additional capital that an institution with an above normal
interest rate risk is required to maintain (the "interest rate risk component")
equals one-half of the dollar amount by which its measured interest rate risk
exceeds the normal level of interest rate risk. The interest rate risk component
is in addition to the capital otherwise required to satisfy the risk-based
capital requirement. Implementation of this component has been postponed by the
OTS. The final rule was to be effective as of January 1, 1994, subject however
to a three quarter lag time in implementation. However, the OTS has recently
indicated that no savings association will be required to deduct capital for
interest rate risk until further notice.
The OTS and the FDIC generally are authorized to take enforcement
action against a savings association that fails to meet its capital
requirements, which action may include restrictions on operations and banking
activities, the imposition of a capital directive, a cease-and-desist order,
civil money penalties or harsher measures such as the appointment of a receiver
or conservator or a forced merger into another institution. In addition, under
current regulatory policy, an association that fails to meet its capital
requirements is prohibited from paying any dividends.
FEDERAL HOME LOAN BANK SYSTEM. The Association is a member of the FHLB
of Atlanta, which is one of the 12 regional FHLBs. As a member of the FHLB, the
Association is required to purchase and maintain stock in the FHLB of Atlanta in
an amount equal to the greater of 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar obligations at the beginning
of each year, or 1/20 (or such greater fraction as established by the FHLB) of
outstanding FHLB advances. During 1996, the FHLB required all stockholders with
stock in excess of the required amount to redeem the excess stock at par. The
Association's excess was $4.5 million of which $2.0 million was redeemed during
fiscal year 1996, with the remaining $2.5 million being redeemed by the FHLB
during fiscal year 1997. During 1997, due to increases in the loan portfolio and
FHLB advances, the Association was required to purchase an additional $400,000
in FHLB stock, resulting in FHLB stock totaling $3.3 million at December 31,
1997. In past years, the Association has received dividends on its FHLB stock.
Such dividends were 7.25% for the fiscal years ended December 31, 1997 and 1996.
Certain provisions of FIRREA require all 12 FHLBs to provide financial
assistance for the resolution of troubled savings associations and to contribute
to affordable housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions could cause rates on the FHLB advances to increase
and could affect adversely the level of FHLB dividends paid and the value of
FHLB stock in the future.
Each FHLB serves as a reserve or central bank for its members within
its assigned region. It is funded primarily from proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by the board of
directors of the FHLB. These policies and procedures are subject to the
regulation and oversight of the Federal Housing Finance Board (the "FHFB").
QUALIFIED THRIFT LENDER TEST. The Qualified Thrift Lender ("QTL") test,
requires that a savings association maintain either at least 65 % of its total
tangible assets in "qualified thrift investments" on an average basis in nine
out of every twelve months in accordance with the Home Owners' Loan Act
("HOLA"), or meet the requirements to qualify as a domestic building and loan
association as defined in the Internal Revenue Code of 1986, as amended
("Code"). The Association is a domestic building and loan association as defined
in the Code.
For purposes of the test under HOLA, portfolio assets are defined as
the total assets of the savings association minus goodwill and other intangible
assets, the value of property used by the savings association to conduct its
business, and liquid assets not to exceed 20% of the savings association's total
assets.
34
Under the QTL statutory and regulatory provisions, all forms of home
mortgages, home improvement loans, home equity loans, and loans on the security
of other residential real estate and mobile homes as well as consumer loans and
small business loans are "qualified thrift investments," as are shares of stock
of an FHLB, investments or deposits in other insured institutions, securities
issued by the FNMA, FHLMC, GNMA, or the RTC Financing Corporation and other
mortgage-related securities. Investments in nonsubsidiary corporations or
partnerships whose activities include servicing mortgages or real estate
development are also considered qualified thrift investments in proportion to
the amount of primary revenue such entities derive from housing-related
activities. Also included in qualified thrift investments are mortgage servicing
rights, whether such rights are purchased by the insured institution or created
when the institution sells loans and retains the right to service such loans.
A savings institution that fails to become or maintain its status as a
qualified thrift lender must either become a bank (other than a savings and loan
association) or be subject to certain restrictions. A savings institution that
fails to meet the QTL test and does not convert to a bank will be: (1)
prohibited from making any investment or engaging in activities that would not
be permissible for national banks; (2) prohibited from establishing any new
branch office where a national bank located in the savings institution's home
state would not be able to establish a branch office; (3) ineligible to obtain
new advances from any FHLB; and (4) subject to limitations on the payment of
dividends comparable to the statutory and regulatory dividend restrictions
applicable to national banks. Also, beginning three years after the date on
which the savings institution ceases to be a qualified thrift lender, the
savings institution would be prohibited from retaining any investment or
engaging in any activity not permissible for a national bank and would be
required to repay any outstanding advances to any FHLB. A savings institution
may requalify as a qualified thrift lender if it thereafter complies with the
QTL test.
As of December 31, 1997, the Association was in compliance with the QTL
requirement with approximately 80.0% of the Association's assets being
"qualified thrift investments."
LIQUIDITY REQUIREMENTS. Federally insured savings associations are
required to maintain an average daily balance of liquid assets equal to a
certain percentage of the sum of average daily balances of net withdrawable
deposit accounts and borrowings payable in one year or less. The liquidity
requirement may vary from time to time (between 4.0% and 10.0%) depending upon
economic conditions and savings flows of all savings associations. At the
present time, the required liquid asset ratio is 5.0%.
For purposes of this ratio, liquid assets include specified short-term
assets (such as cash, certain time deposits, certain bankers' acceptances and
short-term United States Treasury obligations), and long-term assets such as
United States Treasury obligations of more than one and less than five years and
federal agency obligations with a minimum term of 18 months. Short-term liquid
assets currently must constitute at least 1% of an association's average daily
balance of net withdrawable deposit accounts and current borrowings. Penalties
may be imposed upon associations for violations of the liquidity requirements.
The monthly average liquidity ratio of the Association for December 1997 was
14.2% and exceeded the then applicable requirement of 5.0%.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC. The Association's
deposits are insured up to $100,000 per insured member (as defined by law and
regulation) by the FDIC. This insurance is backed by the full faith and credit
of the United States Government. As insurer, the FDIC is authorized to conduct
examinations of and to require reporting by insured associations. It also may
prohibit any insured association from engaging in any activity the FDIC
determines by regulation or order to pose a serious threat to the insurance
fund. The FDIC also has the authority to initiate enforcement actions against
savings associations, after first giving the OTS an opportunity to take such
action.
Pursuant to the FDICIA, the FDIC has issued a new regulation that
imposes, on a transitional basis, a risk-based deposit insurance premium based
on the condition of the insured institution, and that increases the average
assessment rate paid by insured institutions. The risk-based system, which
applies to insured members, establishes nine assessment risk classifications; an
institution assigned to the highest risk classification will pay deposit
insurance premiums at a rate of 0.27% while an institution assigned to the
lowest risk classification will pay a premium of 0.00%.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines, after a hearing, that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations or has violated any applicable law, regulation,
order, or any condition imposed by an agreement with the FDIC. The FDIC also may
suspend deposit insurance temporarily for any savings association during the
hearing process for the permanent termination of insurance, if the association
has no tangible capital. If insurance of accounts is terminated,
35
the insured accounts at the institution at the time of the termination, less
subsequent withdrawals, shall continue to be insured for a period of six months
to two years, as determined by the FDIC.
OTS REGULATORY ASSESSMENTS. As a result of FIRREA, the OTS will not
receive funds from contributions of the FHLBs and the insurance funds in order
to fund its operations. The OTS has adopted a regulation to assess fees to fund
its operations and expenses. These fees include: (i) semi-annual assessments
based on the consolidated assets of a savings association; (ii) fees of $485 per
day, per examiner, to cover the costs of examinations of savings associations,
holding companies, subsidiaries, and their affiliates; (iii) application fees
which apply to nearly all regulatory and securities applications and filings;
and (iv) fees to recover the costs of OTS seminars and publications. Based on
its assets at December 31, 1997, the Association is required to pay a
semi-annual assessment of approximately $76,000.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose
limitations on all capital distributions by savings institutions. Capital
distributions include cash dividends, payments to repurchase or otherwise
acquire the savings association's shares, payments to stockholders of another
institution in a cash-out merger, and other distributions charged against
capital. The rule establishes three tiers of institutions. An institution that
exceeds all fully phased-in capital requirements before and after a proposed
capital distribution ("Tier 1 Association") may, after prior notice but without
the approval of the OTS, make capital distributions during a calendar year up to
the greater of (i) 100% of its net income to date during the calendar year plus
the amount that would reduce by one-half its surplus capital at the beginning of
the calendar year or (ii) 75% of its net income over the most recent
four-quarter period. Any additional capital distributions would require prior
regulatory approval. An institution that meets its minimum regulatory capital
requirement before and after its capital distribution ("Tier 2 Association")
may, after prior notice but without the approval of the OTS, make capital
distributions of up to 75% of its net income over the most recent four quarter
period. A savings institution that does not meet its current regulatory capital
requirement before or after payment of a proposed capital distribution or has
been notified that it needs more than normal supervision ("Tier 3 Association")
may not make any capital distributions without the prior approval of the OTS. As
of December 31, 1997, the Association was a Tier 1 Association.
LOAN-TO-VALUE LIMITATIONS. As required by FDICIA, the banking agencies,
including the OTS, recently adopted regulations that require insured depository
institutions to adopt and maintain a written policy that establishes appropriate
limits and standards for extensions of credit that are secured by liens on or
interests in real estate, or are made for the purpose of constructing buildings
or other improvements. In addition, the regulations establish maximum
loan-to-value limits for certain categories of loans. A loan-to-value limit has
not been established for permanent mortgage or home equity loans on
owner-occupied, one- to four-family residential property. The regulations state
that for my such loan with a loan-to-value ratio that equals or exceeds 90% at
origination, an institution should require appropriate credit enhancement in the
form of either mortgage insurance or readily marketable collateral. The
Association's current internal loan-to-value limits are less than the maximum
established by the regulation.
HOLDING COMPANY REGULATION
Upon completion of the Reorganization, Bankshares became a savings and
loan holding company within the meaning of Section 10(o) of the HOLA. Under the
terms of the OTS approval of the Reorganization, Bankshares was limited to the
powers permitted to mutual holding companies. As such, Bankshares is registered
with and is subject to OTS examination and supervision as well as certain
reporting requirements. In addition, the operations of Bankshares are subject to
the regulations promulgated by the OTS from time to time. As an insured
subsidiary of a savings and loan holding company, the Association is subject to
certain restrictions in dealing with Bankshares and with other persons
affiliated with Bankshares, and continues to be subject to examination and
supervision by the OTS and the FDIC.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, from: (i) acquiring control (as defined) of another insured
institution (or holding company thereof) without prior OTS approval; (ii)
acquiring more than 5% of the voting shares of another insured institution (or
holding company thereof which is not a subsidiary), subject to certain
exceptions; (iii) acquiring through merger, consolidation or purchase of assets,
another savings association or holding company thereof, or acquiring all or
substantially all of the assets of such institution (or holding company thereof)
without prior OTS approval; or (iv) acquiring control of a savings association
not insured by the SAIF (except through a merger with and into the holding
company's savings association subsidiary that is approved by the OTS). A savings
and loan holding company may acquire up to 15% of the voting shares of an
undercapitalized savings association. A savings and loan holding company may not
acquire as a separate subsidiary an insured institution that has principal
offices outside of the state where the principal offices of its subsidiary
institution is located, except: (i) in the case of certain emergency
acquisitions approved by the FDIC; (ii) if the holding company controlled (as
defined) such insured institution as of March
36
5, 1987; or (iii) if the laws of the state in which the insured institution to
be acquired is located specifically authorize a savings association chartered by
that state to be acquired by a savings association chartered by the state where
the acquiring savings association or savings and loan holding company is
located, or by a holding company that controls such a state chartered
association. No director or officer of a savings and loan holding company or
person owning or controlling more than 25% of such holding company's voting
shares may, except with the prior approval of the OTS, acquire control of any
SAIF-insured institution that is not a subsidiary of such holding company. If
the OTS approves such an acquisition, any holding company controlled by such
officer, director or person shall be subject to the activities limitations that
apply to multiple savings and loan holding companies, unless certain supervisory
exceptions apply.
RESTRICTIONS APPLICABLE TO MUTUAL HOLDING COMPANIES. Pursuant to
Section 10(o) of the HOLA and the Regulations, a mutual holding company may
engage in the following activities:
(i) Investing in the stock of a savings association.
(ii) Acquiring a mutual association through the merger of
such association into a savings association subsidiary
of such holding company or an interim savings
association subsidiary of such holding company.
(iii) Merging with or acquiring another holding company, one
of whose subsidiaries is a savings association.
(iv) Investing in a corporation the capital stock of which is
available for purchase by a savings association under
federal law or under the law of any state where the
subsidiary savings association or associations share
their home offices.
(v) Furnishing or performing management services for a
savings association subsidiary of such company.
(vi) Holding, managing, or liquidating assets owned or
acquired from a savings association subsidiary of such
company.
(vii) Holding or managing properties used or occupied by a
savings association subsidiary of such company.
(viii) Acting as trustee under deed of trust.
(ix) Any other activity (A) that the Federal Reserve Board,
by regulation, has determined to be permissible for bank
holding companies under section 4(c) of the Bank Holding
Company Act of 1956, unless the Director, by regulation,
prohibits or limits any such activity for savings and
loan holding companies; or (B) in which multiple savings
and loan holding companies were authorized (by
regulation) to directly engage on March 5, 1987.
(x) Purchasing, holding, or disposing of stock acquired in
connection with a qualified stock issuance if the
purchase of such stock by such savings and loan holding
company is approved by the Director of the OTS.
If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from such
merger or acquisition may only invest in assets and engage in activities listed
in (i) through (x) above, and has a period of two years to cease any
non-conforming activities and divest of any nonconforming investments.
37
TRANSACTIONS WITH AFFILIATES
Section 11 of HOLA provides that transactions between an insured
subsidiary of a holding company and an affiliate thereof will be subject to the
restrictions that apply to transactions between banks that are members of the
Federal Reserve System and their affiliates pursuant to Sections 23A and 23B of
the Federal Reserve Act ("FRA"). Generally, Sections 23A and 23B: (i) limit the
extent to which a financial institution or its subsidiaries may engage in
"covered transactions" with an "affiliate," to an amount equal to 10% of the
institution's capital and surplus, and limit all "covered transactions" in the
aggregate with all affiliates to an amount equal to 20% of such capital and
surplus; and (ii) require that all transactions with an affiliate, whether or
not "covered transactions," be on terms substantially, the same, or at least as
favorable to the institution or subsidiary as those provided to a non-affiliate.
The term "covered transaction" includes the making of loans, purchase of assets,
issuance of a guarantee and similar types of transactions. Management believes
that the Association is in compliance with the requirements of Sections 23A and
23B. In addition to the restrictions that apply to financial institutions
generally under Sections 23A and 23B, Section 11 of the HOLA places three other
restrictions on savings associations, including those that are part of a holding
company organization. First, savings associations may not make any loan or
extension of credit to an affiliate unless that affiliate is engaged only in
activities permissible for bank holding companies. Second, savings associations
may not purchase or invest in affiliate securities except for those of a
subsidiary. Finally, the Director is granted authority to impose more stringent
restrictions when justifiable for reasons of safety and soundness.
Extensions of credit by the Association to executive officers,
directors, and principal shareholders of Bankshares and related interests of
such persons are subject to Sections 22 (g) and 22(h) of the FRA and Subpart A
of the Federal Reserve Board's Regulation 0. These rules prohibit loans to any
such individual where the aggregate amount exceeds an amount equal to 15% of an
institution's unimpaired capital and surplus plus an additional 10% of
unimpaired capital and surplus in the case of loans that are fully secured by
readily marketable collateral, and/or when the aggregate amount outstanding to
all such individuals exceeds the institution's unimpaired capital and unimpaired
surplus. The rules identify limited circumstances in which an institution is
permitted to extend credit to executive officers. Management believes that the
Association is in compliance with Sections 22(g) and 22(h) of the FRA and
Subpart A of the Federal Reserve Board's Regulation 0.
THE FEDERAL RESERVE SYSTEM
Federal Reserve Board regulations require all depository institutions
to maintain non-interest earning reserves against their transaction accounts
(primarily NOW and Super NOW checking accounts) and non-personal time deposits.
At December 31, 1997, the Association was in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements that
may be imposed by the OTS.
Savings associations are authorized to borrow from a Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require savings
associations to exhaust other reasonable alternative sources of funds, including
FHLB advances, before borrowing from a Federal Reserve Bank.
38
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
For federal income tax purposes, Bankshares files a consolidated
federal income tax return with the Association on a fiscal year basis. Since
ComFed owns less than 80% of the outstanding Common Stock of Bankshares, ComFed
is not permitted to file a consolidated federal income tax return with
Bankshares. Because ComFed has nominal assets other than the stock of
Bankshares, it has no material federal income tax liability.
On May 13, 1997, permission was received from the Internal Revenue
Service ("IRS") to change the accounting period, for federal income tax
purposes, from September 30th to December 31st, effective December 31, 1996.
Bankshares, ComFed and the Association are subject to the rules of
federal income taxation generally applicable to corporations under the Code.
Most corporations are not permitted to make deductible additions to bad debt
reserves under the Code. However, savings and loan associations and savings
associations such as the Association, which meet certain tests prescribed by the
Code may benefit from favorable provisions regarding deductions from taxable
income for annual additions to their bad debt reserve. For purposes of the bad
debt reserve deduction, loans are separated into "qualifying real property
loans," which generally are loans secured by interests in real property, and
non-qualifying loans, which are all other loans. The bad debt reserve deduction
with respect to non-qualifying loans must be based on actual loss experience.
The amount of the bad debt reserve deduction with respect to qualifying real
property loans may be based upon actual loss experience (the "experience
method") or a percentage of taxable income determined without regard to such
deduction (the "percentage of taxable income method").
Bankshares has elected to use the method that results in the greatest
deduction for federal income tax purposes, which historically has been the
percentage of taxable income method. The amount of the bad debt deduction that a
thrift institution may claim with respect to additions to its reserve for bad
debts is subject to certain limitations. First, the full deduction is available
only if at least 60% of the institution's assets fall within certain designated
categories. Second, under the percentage of taxable income method the bad debt
deduction attributable to "qualifying real property loans" cannot exceed the
greater of (i) the amount deductible under the experience method or (ii) the
amount which, when added to the bad debt deduction for non-qualifying loans,
equals the amount by which 12% of the sum of the total deposits and the advance
payments by borrowers for taxes and insurance at the end of the taxable years
exceeds the sum of the surplus, undivided profits, and reserves at the beginning
of the taxable year. Third, the amount of the bad debt deduction attributable to
qualifying real property loans computed using the percentage of taxable income
method is permitted only to the extent that the institution's reserve for losses
on qualifying real property loans at the close of the taxable year does not
exceed 6% of such loans outstanding at such time.
During 1996 legislation was passed that repealed section 593 of the
Internal Revenue Code for taxable years beginning after December 31, 1995.
Section 593 allowed thrift institutions, including the Association, to use the
percentage-of-taxable income bad debt accounting method, if more favorable than
the specific charge-off method, for federal income tax purposes. The excess
reserves (deduction based on the percentage-of-taxable income less the deduction
based on the specific charge-off method) accumulated post-1987 are required to
be recaptured ratably over a six year period beginning in 1996. There were no
excess reserves as of December 31, 1996 and the recapture had no effect on
Bankshares' statement of operations as taxes were provided for in prior years in
accordance with SFAS 109, "Accounting for Income Taxes" ("SFAS 109"). The same
legislation forgave the tax liability on pre-1987 accumulated bad debt reserves
which would have penalized any thrift choosing to adopt a bank charter because
the tax would have become due and payable. The unrecorded potential liability
that was forgiven approximated $4.3 million. See Note 12 to the Notes to the
Consolidated Financial Statements in the Annual Report, attached hereto as
Exhibit 13.
Deferred income taxes arise from the recognition of certain items of
income and expense for tax purposes in years different from those in which they
are recognized in the financial statements. In February 1992, the FASB issued
SFAS 109. SFAS 109 was implemented by Bankshares retroactively, effective
October 1, 1993. The liability method accounts for deferred income taxes by
applying the enacted statutory rates in effect at the balance sheet date to
differences between the book cost and the tax cost of assets and liabilities.
The resulting deferred tax liabilities and assets are adjusted to reflect
changes in tax laws.
Bankshares is subject to the corporate alternative minimum tax which is
imposed to the extent it exceeds Bankshares' regular income tax for the year.
The alternative minimum tax will be imposed at the rate of 20% of a specially
computed tax base. Included in this base will be a number of preference items,
including the following: (i) 100% of the
39
excess of a thrift institution's bad debt deduction over the amount that would
have been allowable on the basis of actual experience; and (ii) interest on
certain tax-exempt bonds issued after August 7, 1986. In addition. for purposes
of the new alternative minimum tax, the amount of alternative minimum taxable
income that may be offset by net operating losses is limited to 90% of
alternative minimum taxable income.
Bankshares was audited by IRS for the tax year 1990 during fiscal year 1994.
Based upon the audit, Bankshares received a "no-change" letter from the IRS. See
Notes 1 and 12 to the Notes to the Consolidated Financial Statements in the
Annual Report, attached hereto as exhibit 13.
STATE TAXATION
Under the laws of the State of Florida, Bankshares and its subsidiary
are generally subject to 5.5% tax on net income. The tax may be reduced by a
credit of up to 65% of the tax due as a result of certain intangible taxes. The
tax is deductible by Bankshares in determining its federal income tax liability.
Bankshares has not been audited by the State of Florida.
PERSONNEL
As of December 31, 1997, Bankshares had no compensated employees.
Officers of Bankshares are employees of the Association and receive all
compensation from the Association. Because Bankshares' only activity is holding
the stock of the Association, employees of the Association perform limited
duties for Bankshares.
As of December 31, 1997, the Association had 247 full-time and 62
part-time employees. None of such employees is represented by a collective
bargaining group. The Association believes its relationship with its employees
to be good.
40
ITEM 2. PROPERTIES
===============================================================================
Bankshares owns no property independently from the Association. The
Association conducts its business through its home office located in North Palm
Beach, Florida, and 21 full service branch offices, located in Palm Beach,
Martin, St. Lucie and Indian River Counties. The following table sets forth
certain information concerning the home office and each branch office of the
Association at December 31, 1997. The aggregate net book value of the
Association's premises and equipment was $20.2 million at December 31, 1997. For
additional information regarding the Association's properties, see Note 8 to the
Notes to the Consolidated Financial Statements in the Annual Report, attached
hereto as Exhibit 13.
LOCATION ADDRESS OPENING DATE OWNED/LEASE
- -------- ------- ------------ -----------
Home Office 660 U.S. Highway l, North Palm Beach, 02/19/88 Owned
Florida
BRANCH OFFICES
Riviera Beach 2600 Broadway, Riviera Beach, Florida 08/19/55 Owned
Tequesta 101 N. U.S. Highway 1, Tequesta, Florida 07/19/59 Owned
Port Salerno 5545 SE Federal Highway, Port Salerno, 11/05/74 Owned
Florida
Palm Beach Gardens 9600 N. Alternate AlA, Palm Beach 12/19/74 Owned
Gardens, Florida
Jensen Beach 1170 NE Jensen Beach Boulevard, 01/28/75 Owned
Jensen Beach, Florida
Singer Island 1100 East Blue Heron Boulevard, 04/01/75 Owned
Riviera Beach, Florida
Gallery Square 389 Tequesta Drive, Tequesta, Florida 01/30/76 Lease (1)
Ft. Pierce 1050 Virginia Avenue, Ft. Pierce, Florida 07/23/85 Owned
Port St. Lucie 1540 SE Floresta Drive, Port St. Lucie, 07/30/84 Lease (2)
Florida
Martin Downs 3102 Martin Downs Boulevard, 07/24/85 Lease (3)
Palm City, Florida
Chasewood 6350 Indiantown Road., Suite 1, 02/26/86 Lease (4)
Jupiter, Florida
Bluffs 3950 U.S. Highway 1, Jupiter, Florida 09/18/86 Lease (5)
Village Commons 971 Village Boulevard, West Palm Beach, 06/26/89 Lease (6)
Florida
Hobe Sound 11400 SE Federal Highway, Hobe Sound, 02/05/90 Owned
Florida
41
LOCATION ADDRESS OPENING DATE OWNED/LEASE
- -------- ------- ------------ -----------
St. Lucie West 1549 St. Lucie West Boulevard, 06/06/94 Owned
Port St. Lucie, Florida
Jupiter 520 Toney Penna Drive, Jupiter, Florida 07/10/95 Owned
PGA PGA Shoppes on the Green, 7102 Fairway 04/22/96 Lease (7)
Drive, Palm Beach Gardens, Florida
Vero Beach 6030 20th Street, Vero Beach, Florida 07/21/97 Lease (8)
Hutchinson Island 4417 NE Ocean Boulevard, Jensen Beach, 01/21/97 Lease (9)
Florida
Lake Worth 5702 Lake Worth Road, Suite # 3, 10/20/97 Lease (10)
Lake Worth, Florida
(1) This lease expires on December 31, 2000 and provides for a renewal option
which runs through December 31, 2015.
(2) This lease expires on January 31, 1999 and provides for a renewal option
which runs through January 31, 2004.
(3) This lease expires on August 8, 1998 and provides for a renewal option
which runs through August 8, 2004. (4)
(4) This lease expires on January 31, 1998 and provides for a renewal option
which runs through January 31, 2006.
(5) This lease expires on October 31, 2001 and provides for a renewal option
which runs through October 31, 2016.
(6) This lease expires on June 25, 2004 and provides for a renewal option
which runs through June 25, 2014.
(7) This lease expires on December 31, 2000 and provides for a renewal option
which runs through December 31, 2005. There is an option to purchase the
land which is exerciseable through June 30, 1999.
(8) This lease expires on July 1, 2002 and provides for a renewal option which
runs through July 1, 2017. There is an option to purchase the land
exerciseable on July 1, 2002.
(9) This lease expires on June 30, 1999 and provides for a renewal option
which runs through December 31, 2002.
(10) This lease expires on March 1, 2000 and provides for a renewal option
which runs through August 1, 2002.
42
ITEM 3. LEGAL PROCEEDINGS
===============================================================================
There are various claims and lawsuits in which Bankshares is
periodically involved incident to its business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits. See Note
13 in the Notes to the Consolidated Financial Statements in the Annual Report,
attached hereto as Exhibit 13.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
===============================================================================
The Association held a Special Meeting of Shareholders on September 24,
1997 to vote on the proposal to adopt the Agreement and Plan of Reorganization
pursuant to which the Association reorganized into a two-tier holding company
structure. Of the 5,090,120 shares eligible to vote, holders of 4,153,712 shares
or 81.6%, including 2,620,144 shares owned by ComFed, were represented in person
or by proxy at the meeting.
The votes cast produced the following result:
Number of Votes
- -------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
--- ------- -------
4,119,753 13,056 20,903
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
===============================================================================
Bankshares had 5,094,920 issued and outstanding shares at December 31,
1997. For information concerning the market for Bankshares' common stock, see
the section captioned "Corporate Information" in Bankshares' Annual Report which
is incorporated herein by reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
===============================================================================
The "Financial Highlights" section of Bankshares' Annual Report is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
===============================================================================
The "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section of Bankshares' Annual Report is incorporated
herein by reference.
ITEM 7-A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
===============================================================================
Information with respect to quantitative and qualitative disclosures
about market risk are incorporated by reference to the section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - " Market Risk Analysis", "Market Value of Portfolio Equity" and
"GAP Table" in the Annual Report.
ITEM 8. FINANCIAL STATEMENTS
===============================================================================
The financial statements identified in Item 14(a)(1) hereof are
incorporated by reference to Bankshares' Annual Report.
43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
===============================================================================
Information required by this section is incorporated herein by
reference from Bankshares' definitive Proxy Statement for the Annual Meeting of
Shareholders dated March 20, 1998 (the "Proxy Statement"), specifically the
section captioned "Ratification of Appointment of Auditors".
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
===============================================================================
Information concerning Directors and Executive Officers of Bankshares
is incorporated herein by reference from the Proxy Statement, specifically the
section captioned "Information with Respect to Nominees for Directors, Directors
Whose Term Continues and Executive Officers".
ITEM 11. EXECUTIVE COMPENSATION
===============================================================================
Information concerning executive compensation is incorporated herein by
reference from the Proxy Statement, specifically the section captioned
"Management Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
===============================================================================
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the Proxy Statement,
specifically the section captioned "Beneficial Ownership of Common Stock by
Certain Beneficial Owners and Management".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
===============================================================================
Information concerning relationships and transactions is incorporated
herein by reference from the Proxy Statement, specifically the section captioned
"Indebtedness of Management and Affiliated Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
===============================================================================
The exhibits and financial statement schedules filed as a part of this
Form 10-K are as follows:
(a)(1) Financial Statements
--------------------
Independent Auditors' Report
Consolidated Statements of Financial Condition,
December 31, 1997, 1996 and September 30, 1996
Consolidated Statements of Operations,
Year Ended December 31, 1997, Three Months Ended
December 1996, Years Ended September 30, 1996, 1995
and 1994.
Consolidated Statements of Shareholders' Equity,
Year Ended December 31, 1997, Three Months Ended
December 31, 1996, Years Ended September 30, 1996,
1995 and 1994.
Consolidated Statements of Cash Flows,
Year Ended December 31, 1997, Three Months Ended
December 31, 1996, Years Ended September 30, 1996,
1995 and 1994,
Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
-----------------------------
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No financial statement schedules are filed because the
required information is not applicable or is included in the
consolidated financial statements or related notes.
(a)(3) Exhibits
--------
*3.1 Federal Stock Charter of Bankshares (Incorporated by
reference to Exhibit 3.1 of Bankshares Form 8-K filed
October 1, 1997 ("Form 8-K").
*3.2 Bylaws of Bankshares (Incorporated by reference to
Exhibit 3.2 of the Form 8-K).
*4 Common Stock Certificate of Bankshares (Incorporated by
reference to Exhibit 4.0 of the Form 8-K).
*10.1 1995 Stock Option Plan (Incorporated by reference to
Exhibit 10.1 of Bankshares' Registration Statement on
Form S-8 (file No. 333-38971) filed October 29, 1997).
10.2 1995 Recognition and Retention Plan for Employees and
Outside Directors.
11.0 Statement of Computation of Earnings.
13 1997 Annual Report to Shareholders.
21 Subsidiaries of the Registrant - Reference is made to
Item 1 "Business" for the required information.
23 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
(b) Reports on Form 8-K:
--------------------
(1) Form 8-K Current Report filed October 1, 1997. "Changes in
Control of Registrant".
(2) Form 8-K Current Report filed October 30, 1997. "Other
Events".
(3) Form 8-K Current Report filed November 6, 1997. "Changes in
Registrant's Certifying Accountant".
(c) The exhibits listed under (a)(3) above are filed herewith.
(d) Not applicable.
------------------------
* Previously filed.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMMUNITY SAVINGS BANKSHARES, INC.
Date: March 26, 1998 By: /s/ JAMES B. PITTARD, JR.
-----------------------------------------
James B. Pittard, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By:/s/ James B. Pittard, Jr. By: /s/ Larry J. Baker, CPA
------------------------------------ ----------------------------------
James B. Pittard, Jr., President Larry J. Baker, CPA, Senior
and Chief Executive Officer Vice president, Chief
(Principal Executive Officer) Financial Officer and
Treasurer
(Principal Financial and
Accounting Officer)
Date: March 26, 1998 Date: March 26, 1998
By: /s/ Frederick A. Teed By: /s/ Forest C. Beaty
----------------------------------- -----------------------------------
Frederick A. Teed, Chairman Forest C. Beaty, Jr., Director
the Board
Date: March 26, 1998 Date: March 26, 1998
By: /s/ Robert F. Cromwell By: /s/ Karl D. Griffin
---------------------------------- ----------------------------------
Robert F. Cromwell, Director Karl D. Griffin, Director
Date: March 26, 1998 Date: March 26, 1998
By: /s/ Harold I. Stevenson
---------------------------------
Harold I. Stevenson, CPA,
Director
Date: March 26, 1998
46