SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-19772
HF FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
Delaware 46-0418532
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 South Main Avenue, Sioux Falls, SD 57104
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(Address of principal executive office) (ZIP Code)
(605) 333-7556
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months(or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of November 3, 1998 there were 4,753,218 issued and outstanding
shares of the Registrant's Common Stock, with $.01 par value.
HF FINANCIAL CORP.
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
-------------------------------
Item 1. Financial Statements (Unaudited):
Consolidated Statements of Financial Condition
As of September 30, 1998 and June 30, 1998 1
Consolidated Statements of Income for the Three
months ended September 30, 1998 and 1997 2
Consolidated Statement of Stockholders' Equity
for the Three months ended September 30, 1998 3
Consolidated Statements of Cash Flows for the Three
months ended September 30, 1998 and 1997 4-5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-19
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 20
PART II. OTHER INFORMATION
--------------------------------
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Default upon Senior Securities 21
Item 4. Submission of Matters to a Vote
of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Item 1.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
(Unaudited)
ASSETS September 30, June 30,
1998 1998
---------------------------
Cash and cash equivalents $ 9,372 $ 25,458
Securities available for sale 38,537 44,232
Mortgage-backed securities available for sale 43,566 39,647
Loans receivable 436,025 426,522
Loans held for sale 7,099 9,616
Accrued interest receivable 4,305 4,338
Foreclosed real estate and other properties 250 229
Office properties and equipment, at cost, net of
accumulated depreciation 14,252 14,317
Prepaid expenses and other assets 2,472 1,999
Mortgage servicing rights 1,489 1,423
Deferred income taxes 3,281 3,198
---------------------------
$ 560,648 $570,979
---------------------------
---------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 421,144 $446,424
Advances from Federal Home Loan Bank
and other borrowings 66,008 50,635
Advances by borrowers for taxes and insurance 6,985 4,792
Accrued interest payable 5,526 5,898
Other liabilities 5,894 6,629
---------------------------
Total liabilities 505,557 514,378
---------------------------
Stockholders' Equity
Preferred stock, $.01 par value, 500,000
shares authorized, none outstanding - - - - - - - -
Series A Junior Participating Preferred
Stock, $1.00 stated value, 50,000
shares authorized, none outstanding - - - - - - - -
Common stock, $.01 par value, 5,000,000
shares authorized, 4,749,180 and
4,730,276 shares outstanding at
September 30,1998 and June 30, 1998 47 47
Additional paid-in capital 15,093 14,863
Retained earnings, substantially
restricted 47,466 46,561
Unearned compensation (340) (340)
Accumulated other comprehensive income 231 (9)
Less cost of treasury stock, September 30,
1998 465,222 shares, June 30, 1998
334,222 shares (7,406) (4,521)
---------------------------
55,091 56,601
---------------------------
$ 560,648 $570,979
---------------------------
---------------------------
See Notes to Consolidated Financial Statements
Page 1
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
Three Months Ended September 30,
--------------------------------
1998 1997
------------ ---------------
Interest and dividend income:
Loans receivable $ 9,884 $ 10,178
Mortgage-backed securities 597 477
Investment securities and interest-bearing
deposits 685 1,052
------------ ---------------
11,166 11,707
------------ ---------------
Interest expense:
Deposits 5,215 5,664
Advances from Federal Home Loan Bank
and other borrowings 784 996
------------ ---------------
5,999 6,660
------------ ---------------
Net interest income 5,167 5,047
Provision for losses on loans 1,562 526
------------ ---------------
Net interest income after provision
for losses on loans 3,605 4,521
------------ ---------------
Noninterest income:
Credit card fee income 3,062 821
Fees on deposits 600 535
Loan servicing income 310 266
Loan fees and service charges 240 327
Gain on sale of loans 197 513
Other 357 364
------------ ---------------
4,766 2,826
------------ ---------------
Noninterest expense:
Compensation and employee benefits 2,633 2,481
Credit card processing expense 1,949 345
Other general and administrative expenses 1,044 1,081
Occupancy and equipment 690 653
Federal insurance premiums 75 68
Other 44 153
------------ ---------------
6,435 4,781
------------ ---------------
Income before income taxes 1,936 2,566
Income tax expense 643 882
------------ ---------------
Net income $1,293 $1,684
------------ ---------------
------------ ---------------
Earnings per share
Basic $0.30 $0.38
------------ ---------------
------------ ---------------
Diluted $0.29 $0.37
------------ ---------------
------------ ---------------
See Notes to Consolidated Financial Statements
Page 2
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Three Months Ended September 30, 1998
(Dollars In Thousands, Except Per Share Data)
(Unaudited)
Accumulated
Additional Other Total
Common Paid-In Retained Unearned Treasury Comprehensive Stockholders'
Stock Capital Earnings Compensation Stock Income Equity
---------- --------- --------- ----------- -------- ------------- -------------
Balance, June 30, 1998 $ 47 $ 14,863 $ 46,561 $ (340) $ (4,521) $ (9) $ 56,601
Comprehensive income:
Net income - - - - - - - - 1,293 - - - - - - - - - - - - 1,293
Change in unrealized gain
(loss), available for sale,
net of related deferred
taxes of $120 - - - - - - - - - - - - - - - - - - - - 240 240
---------- --------- --------- ----------- -------- ------------- -------------
Total comprehensive income - - - - - - - - 1,293 - - - - - - - - 240 1,533
Exercise of stock options for
18,904 shares - - - - 230 - - - - - - - - - - - - - - - - 230
Cash dividends paid ($0.09 per
share) on common stock - - - - - - - - (388) - - - - - - - - - - - - (388)
Purchase of treasury stock - - - - - - - - - - - - - - - - (2,885) - - - - (2,885)
---------- --------- --------- ----------- -------- ------------- -------------
Balance, September 30, 1998 $ 47 $ 15,093 $ 47,466 $ (340) $ (7,406) $ 231 $ 55,091
---------- --------- --------- ----------- -------- ------------- -------------
---------- --------- --------- ----------- -------- ------------- -------------
Page 3
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Three Months Ended September 30,
--------------------------------
1998 1997
-------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,293 $ 1,684
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for losses on loans 1,562 526
Depreciation 384 360
Amortization of premiums and discounts, net:
Securities available for sale (7) (101)
Mortgage-backed securities available for sale 7 12
Reduction in mortgage servicing rights 65 51
Increase (decrease) in deferred loan fees 213 (323)
Loans originated for resale (20,096) (24,675)
Proceeds from the sale of loans 20,293 24,891
(Gain) on sale of loans (197) (216)
Mortgage servicing rights capitalized (61) (36)
(Gain) on sale of securities, net (3) (5)
Losses and provision for losses on sales of
foreclosed real estate and other properties, net 9 116
(Gain) loss on disposal of office properties and
equipment, net (1) 2
(Increase) decrease in accrued interest receivable 33 (83)
(Increase) in prepaid expenses and other assets (473) (156)
(Increase) decrease in deferred income taxes (206) 98
(Decrease) in accrued interest payable and other
liabilities (1,107) (509)
-------------- -------------
Net cash provided by operating activities $ 1,708 $ 1,636
-------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans purchased (9,243) (4,199)
Loans made to customers (51,784) (40,833)
Principal collected on loans 49,631 43,206
Sale of participation interests in loans 2,500 2,345
Mortgage-backed securities available for sale:
Sales 4,489 - - - -
Purchases (11,512) - - - -
Repayments 3,270 1,464
Securities available for sale:
Sales and maturities 15,005 6,033
Purchases (9,110) (18,558)
Proceeds from sale of office properties and equipment 1 46
Purchase of office properties and equipment (319) (132)
Purchase of mortgage servicing rights (70) (49)
Proceeds from sale of foreclosed real estate
and other properties, net 105 - - - -
-------------- -------------
Net cash (used in) investing activities $ (7,037) $ (10,677)
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See Notes to Consolidated Financial Statements
Page 4
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Dollars in Thousands)
(Unaudited)
Three Months Ended September 30,
1998 1997
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits ($25,280) $16,396
Proceeds of advances from Federal Home Loan
Bank and other borrowings 24,400 5,000
Payments on advances from Federal Home Loan
Bank and other borrowings (9,027) (12,024)
Increase (decrease) in advances by borrowers
for taxes and insurance 2,193 2,701
Purchase of treasury stock (2,885) (488)
Proceeds from issuance of common stock 230 122
Cash dividends paid (388) (314)
------------ ------------
Net cash provided by (used in) financing
activities $(10,757) $11,393
------------ ------------
Increase (decrease) in cash and cash
equivalents $(16,086) $2,352
Cash and Cash Equivalents
Beginning 25,458 17,957
------------ ------------
Ending $9,372 $20,309
------------ ------------
------------ ------------
See Notes to Consolidated Financial Statements
Page 5
HF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three months ended September 30, 1998 and 1997
(Dollars in Thousands)
(unaudited)
NOTE 1. SELECTED ACCOUNTING POLICIES
BASIS OF PRESENTATION:
The foregoing consolidated financial statements are unaudited. However, in
the opinion of management, all adjustments (which consist of normal recurring
accruals) necessary for a fair presentation of the consolidated financial
statements have been included. Results for any interim period are not
necessarily indicative of results to be expected for the year. The interim
consolidated financial statements include the accounts of HF Financial Corp.
(the "Company"), its subsidiaries, HomeFirst Mortgage Corp.(formerly known as HF
Mortgage Corp. ), HF Card Services L.L.C. and Home Federal Savings Bank, (the
"Bank") and the Bank's subsidiaries.
NOTE 2. REGULATORY CAPITAL
The following table sets forth the Bank's compliance with its capital
requirements at September 30, 1998:
Amount Percent
------ -------
Tier I (Core) capital:
Required. . . . . . . . . . . . $16,770 3.00%
Actual. . . . . . . . . . . . . 44,246 7.91
Excess. . . . . . . . . . . . . 27,476 4.91
Risk-based capital:
Required. . . . . . . . . . . . $30,958 8.00%
Actual. . . . . . . . . . . . . 49,120 12.69
Excess. . . . . . . . . . . . . 18,162 4.69
NOTE 3. EARNINGS PER SHARE
Earnings (loss) per share are calculated in accordance with the provisions
of Financial Accounting Standards Board ("FASB") Statement No. 128, "Earnings
Per Share", which was effective for fiscal year 1998. This Statement
establishes standards for computing and presenting earnings (loss) per share
("EPS"). It replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures.
All prior periods EPS data in this report have been recalculated to reflect the
provisions of Statement No. 128. The Company restated the three months ended
September 30, 1997 which increased basic earnings per share by 1 cent.
Basic earnings per share is computed by dividing income available to common
stockholders (the numerator) by the weighted-average number of common shares
outstanding (the denominator) during the period. Shares issued during the
period and shares reacquired during the period are weighted for the portion of
the period that they were outstanding. The weighted average number of common
shares outstanding for the three month period ended September 30, 1998 and 1997
as adjusted was 4,321,832 and 4,473,970 respectively.
Dilutive earnings per share is similar to the computation of basic earnings
per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the dilutive
options outstanding had been exercised. The weighted average number of common
and dilutive potential common shares outstanding for the three month period
ended September 30, 1998 and 1997 as adjusted was 4,450,830 and 4,587,424
respectively. The Company restated the three months ended September 30, 1997
which had no affect on diluted earnings per share.
Page 6
NOTE 4. NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS")
The FASB issued SFAS No. 130, " Reporting Comprehensive Income". This
Statement establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full
set of general-purpose financial statements. This Statement requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that
is displayed with the same prominence as other financial statements. This
Statement requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. This Statement was adopted July 1, 1998 and
is reflected in the accompanying consolidated financial statements .
The FASB issued SFAS No. 131, "Disclosures about Segments of Enterprise and
Related Information". This Statement establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. This Statement is
effective for financial statements for periods beginning after December 15,
1997. Management has determined that the adoption of SFAS No. 131 does not
presently have an impact on the Company's consolidated financial statements.
The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits". This Statement standardizes the disclosure
requirements for pensions and other postretirement benefits, requires additional
information on changes in the benefit obligations and fair values of plan
assets, and eliminates certain disclosures that are no longer useful. This
Statement also permits reduced disclosures for nonpublic entities. This
Statement supersedes the disclosure requirements in FASB Statements No. 87,
"Employers' Accounting for Pensions", No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits", and No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions". This Statement is effective for financial
statements for periods beginning after December 15, 1997. Management
anticipates providing the required disclosures in its June 30, 1999 consolidated
financial statements.
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities". This Statement establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a
hedge of the exposure to changes in the fair value of a recognized asset
liability or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the
foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. This Statement is
effective for all fiscal quarters of fiscal years beginning after June 15,
1999. Initial application of this Statement should be as of the beginning of
an entity's fiscal quarter; on that date, hedging relationships must be
designated anew and documented pursuant to the provisions of this Statement.
Earlier application of all of the provisions of this Statement is encouraged,
but it is permitted only as of the beginning of any fiscal quarter that
begins after issuance of this Statement. This Statement should not be
applied retroactively to financial statements of prior periods. Management
is evaluating the impact of this Statement on the Company's consolidated
financial statements.
The FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise". This statement further amends SFAS No. 65, "Accounting for
Certain Mortgage Banking Activities" to require that after the securitization of
mortgage loans held for sale, an entity engaged in mortgage banking activities
classify the resulting mortgage-backed securities or other retained interests
based on its ability and intent to sell or hold those investments. This
Statement conforms the subsequent accounting for securities retained after the
securitization of mortgage loans by a mortgage banking enterprise with the
subsequent accounting for securities retained after the securitization of other
types of assets by a nonmortgage banking enterprise. This Statement is effective
for the first fiscal quarter beginning after December 15, 1998. Management is
evaluating the impact of this Statement on the Company's consolidated financial
statements.
Page 7
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
HF Financial Corp. ("Company") was incorporated under the laws of the State
of Delaware in November 1991 for the purpose of owning all of the outstanding
stock of Home Federal Savings Bank ("Bank") issued in the mutual to stock
conversion of the Bank. The Company acquired all of the stock of the Bank on
April 8, 1992. In October 1994, the Company acquired and began operating a new
mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). The Company
ceased operation of the Mortgage Corp. during fiscal 1998. In May, 1996 the
Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF
Card Services") and became the owner of 51% of this entity. The activities of
the Company itself have no significant impact on the results of operations on a
consolidated basis. Unless otherwise indicated, all activities discussed herein
relate to the Company, and its direct and indirect subsidiaries, including
without limitation, the Bank, HF Card Services and the Mortgage Corp.
HomeFirst Mortgage Corp. is a South Dakota Corporation which had an office
in Omaha, Nebraska. The Mortgage Corp. was a mortgage banking operation that
originated one- to four-family residential loans which were sold into the
secondary market and to the Bank. The Company intends to ceased operation of
HomeFirst Mortgage Corp. during the first quarter of fiscal 1998.
HF Card Services was established to provide secured, partially-secured and
unsecured credit cards nationwide. The target market for HF Card Services is
sub-prime credit customers who have either an insufficient credit history or a
negative credit history and are unable to obtain a credit card from more
traditional card issuers.
The Company's net income is primarily dependent upon the difference (or
"spread") between the average yield earned on loans, mortgage-backed securities
and investments and the average rate paid on deposits and borrowings, as well as
the relative amounts of such assets and liabilities. The interest rate spread
is affected by regulatory, economic and competitive factors that influence
interest rates, loan demand and deposit flows. The Company, like other
financial institutions, is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different times, or on a
different basis, than its interest-earning assets. To better insulate itself
from such risk, the Company has, over the last few years, attempted to increase
both numerically and on a percentage basis its holding of consumer and
commercial loans. The Company has also decreased its ratio of fixed-rate to
adjustable-rate loans. The Company's net income is also affected by, among other
things, gains and losses on sales of foreclosed property, loans, mortgage-backed
securities and securities available for sale, provisions for loan losses,
service charge fees, subsidiary activities, operating expenses and income taxes.
THIS DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING TERMINOLOGY
SUCH AS "BELIEVES," "ANTICIPATES," "WILL," AND "INTENDS," OR COMPARABLE
TERMINOLOGY. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED.
POTENTIAL PURCHASERS OF THE COMPANY'S SECURITIES ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS WHICH ARE QUALIFIED IN THEIR
ENTIRETY BY THE CAUTIONS AND RISKS DESCRIBED HEREIN AND IN OTHER REPORTS FILED
BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
YEAR 2000
The Year 2000 issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Bank is heavily dependent on computer processing in its
business activities and the Year 2000 issue creates risk for the Bank from
unforeseen problems in the Bank's computer system and from third parties with
whom the Bank processes financial information. Such failures of the Bank's
computer system and/or third parties computer systems could have a material
impact on the Bank's ability to conduct its business.
In May 1997, the Company developed a five-step plan that follows the
guidelines as specified by the Federal Financial Institutions Examination
Councils. As this council provides new requirements, the plan is modified to
reflect the new requirements. Management of the Company is updated at least
monthly on the status of the plan and the Bank's Information Systems Steering
Committee has changed from a quarterly meeting to a bi-monthly meeting to be
more proactive on Year 2000. In addition, the Board of Directors of the
Company is updated on the status of the Year 2000 project at each of its
Page 8
meetings. The five stages of the plan are as follows: awareness, assessment,
renovation, validation and implementation. The awareness and assessment phases
were completed by December 31, 1997. The assessment phase included hardware,
software and third party vendors that provide a service to the Company (i.e.
utility companies, alarm companies, payroll providers, electronic funds transfer
providers, insurance providers, loan participation companies, mortgage loan
secondary market agencies, and governmental agencies). The renovation,
validation and implementation phases are currently in process and progressing as
planned. Currently, systems that are known to be noncompliant with Year 2000
have already been replaced or are scheduled to be upgraded or replaced by
December 31, 1998. In May 1996, the Bank installed new hardware and operations
systems software that the vendor has represented to be Year 2000 compliant.
All mission critical systems of the 1996 installation, both hardware and
software, are scheduled to be tested in the first half of fiscal 1999. Testing
has been completed and verified for the bank's core processing system for the
dates of December 31, 1999 and January 2, 2000. In addition, testing will be
performed with service providers that are providing the capability to test with
the Bank. The Company has included in its test plan the various dates that have
been required by regulatory agencies. The overall plan of the Company has a
scheduled completion date of December 31, 1998.
The Bank is in the process of writing contingency plans for all software
and hardware providers. In addition, contingency plans are also being written
for all outside service providers. The contingency plan is scheduled to be
completed by November 30, 1998. The Bank is also involved in a customer
awareness and employee education program regarding the Year 2000.
Based on the Bank's review of its computer systems, management believes the
cost of the remediation effort to make the systems Year 2000 compliant is
approximately $100,000. Approximately $20,000 was incurred in fiscal 1998 with
the remaining $80,000 to be incurred in fiscal 1999. In addition,
approximately 2000 to 2,500 man hours are expected to be incurred by Bank
personnel related to Year 2000 issues which have an estimated cost of $70,000.
Management expects these costs to be incurred in fiscal 1999. Such costs will
be charged against income as they are incurred.
FINANCIAL CONDITION DATA
At September 30, 1998, the Company had total assets of $560.6 million,
a decrease of $10.3 million from the level at June 30, 1998. The decrease in
assets was due primarily to a decrease of cash and cash equivalents of $16.1
million and securities available for sale of $5.7 million. The decrease in cash
and cash equivalents and securities available for sale were partially used to
fund the increase in loans receivable of $9.5 million and mortgage-backed
securities of $3.9 million from the levels at June 30, 1998. The decrease in
deposits of $25.3 million was partially offset by an increase in advances from
Federal Home Loan Bank ("FHLB") and other borrowings of $15.4 million and
advances by borrowers for taxes and insurance of $2.2 million from levels at
June 30, 1998 with the remaining being offset from cash and cash equivalents and
securities available for sale. In addition, stockholders' equity decreased
from $56.6 million at June 30, 1998 to $55.1 million at September 30, 1998,
primarily due to the purchase of treasury stock of $2.9 million and the payment
of cash dividends of $388,000 which was partially offset by net income of $1.3
million.
The increase in loans receivable of $9.5 million was primarily the result
of originations exceeding amortizations, sales and prepayments of principal.
The increase in loans receivable resulted partially from growth in the credit
card loan portfolio of $4.7 million to $17.0 million at September 30, 1998 as
compared to $12.3 million at June 30, 1998.
The increase in mortgage-backed securities of $3.9 million was primarily
the result of purchases exceeding amortizations and prepayments of principal.
The Bank purchased mortgage-backed securities in the amount of $11.5 million
during the three months ended September 30, 1998. The Bank's purchases of
mortgage-backed securities were comprised primarily of thirty year, fixed-rate,
mortgage-backed securities that have a principal payment balloon in the fifth or
seventh year.
The decrease in securities of $5.7 million from the level at June 30, 1998
is primarily due to sales and maturities of $15.0 million exceeding purchases of
securities available for sale of $9.1 million during the three months ended
September 30, 1998. The Bank's purchases of securities available for sale were
comprised primarily of U.S. Government agency securities which have a maturity
of three years or less that have a call feature that varies from three months to
one year.
The $25.3 million decrease in deposits was primarily due to a decrease in
savings accounts of $21.0 million and a decrease in certificates of deposit of
$6.5 million which were partially offset by an increase in money market accounts
of $3.0 million. The decrease in deposits primarily related to the withdrawal of
savings account funds from one local governmental entity in the amount of $25.0
million during the three month period ended September 30, 1998. As of September
30, 1998, the Bank had total deposits from local governmental entities of $40.7
million.
Page 9
Advances from the FHLB and other borrowings increased $15.4 million for the
three month period ended September 30, 1998 primarily due to obtaining new
advances in the amount of $24.4 million which were partially offset by payments
of $9.0 million on advances and other borrowings during the three month period
ended September 30, 1998.
The $2.2 million increase in advances by borrowers for taxes and insurance was
due primarily to the receipt of escrow payments in excess of amounts paid out.
The major escrow payments are primarily paid semiannually in April and October.
Page 10
ANALYSIS OF NET INTEREST INCOME
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income depends upon the volume of interest-earning assets and
interest-bearing liabilities and the interest rate earned or paid on them.
AVERAGE BALANCES, INTEREST RATES AND YIELDS. The following table presents
for the periods indicated the total dollar amount of interest income from
average interest-earning assets and the resulting yields, as well as the
interest expense on average interest-bearing liabilities, expressed both in
dollars and rates, and the net interest margin. The table does not reflect any
effect of income taxes. All average balances are monthly average balances and
include the balances of nonaccruing loans. The yields and costs for the three
months ended September 30, 1998 and 1997 include fees which are considered
adjustments to yield.
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate
----------- ----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable (1) $440,782 $ 9,884 8.97% $453,790 $ 10,178 8.97%
Mortgage-backed securities 40,273 597 5.93% 29,901 477 6.38%
Other investment securities (2) 41,251 623 6.04% 66,040 960 5.81%
FHLB stock 3,657 62 6.78% 5,222 92 7.05%
----------- ----------- ----------- ----------- ----------- -----------
Total interest-earning assets $525,963 $ 11,166 8.49% $554,953 $ 11,707 8.44%
----------- ----------- ----------- -----------
Noninterest-earning assets 28,122 29,241
----------- -----------
Total assets $554,085 $584,194
----------- -----------
----------- -----------
Interest-bearing liabilities:
Deposits:
Checking and money market $99,614 $ 656 2.63% $80,989 $ 507 2.50%
Savings 48,849 420 3.44% 60,794 579 3.81%
Certificates of deposit 278,671 4,139 5.94% 302,201 4,578 6.06%
----------- ----------- ----------- ----------- ----------- -----------
Total deposits $427,134 $ 5,215 4.88% $443,984 $ 5,664 5.10%
FHLB advances and other borrowings 54,628 784 5.74% 68,135 996 5.85%
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing liabilities $481,762 $ 5,999 4.98% $512,119 $ 6,660 5.20%
----------- ----------- ----------- -----------
Other liabilities 17,598 18,417
----------- -----------
Total liabilities $499,360 $530,536
Equity 54,725 53,658
----------- -----------
Total liabilities and equity $554,085 $584,194
----------- -----------
----------- -----------
Net interest income; interest rate spread $ 5,167 3.51% $ 5,047 3.24%
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net interest margin (3) 3.93% 3.64%
----------- -----------
----------- -----------
- ------------------------------------------------------------------------------
(1) Includes interest on accruing loans past due 90 days or more.
(2) Includes primarily U.S. Government securities.
(3) Net interest margin is net interest income divided by average interest-
earning assets.
Page 11
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
The following schedule presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the increases and
decreases due to fluctuating outstanding balances that are due to the levels and
volatility of interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume). For purposes
of this table, changes attributable to both rate and volume, which cannot be
segregated, have been allocated proportionately to the change due to volume and
the change due to rate.
Three Months Ended September 30,
----------------------------------
1998 vs 1997
----------------------------------
Increase Increase
(Decrease) (Decrease) Total
Due to Due to Increase
Volume Rate (Decrease)
---------- ----------- ---------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable (1) $(292) $(2) $(294)
Mortgage-backed securities 154 (34) 120
Other investment securities (2) (374) 37 (337)
FHLB stock (27) (3) (30)
---------- ----------- ---------
Total interest-earning assets $(539) $(2) $(541)
---------- ----------- ---------
---------- ----------- ---------
Interest-bearing liabilities:
Deposits:
Checking and money market $123 $26 $149
Savings (103) (56) (159)
Certificates of deposit (349) (90) (439)
---------- ----------- ---------
Total deposits (329) (120) (449)
FHLB advances and other borrowings (194) (18) (212)
---------- ----------- ---------
Total interest-bearing liabilities $(523) $(138) $(661)
---------- ----------- ---------
---------- ----------- ---------
Net interest income increase $120
---------
- ------------------------------------------------------------------------------
(1) Includes interest on loans past due 90 days or more.
(2) Includes primarily U. S. Government securities.
Page 12
ASSET QUALITY
In accordance with the Bank's internal classification of assets policy,
management evaluates the loan portfolio on a monthly basis to identify loss
potential and determine the adequacy of the allowance for possible loan losses.
The following table sets forth the amounts and categories of the Bank's
nonperforming assets for the periods indicated.
Nonperforming Assets As Of
---------------------------
September 30, June 30,
------------- -----------
1998 1998
------------- -----------
(Dollars in Thousands)
Nonaccruing loans:
One- to four-family $ 645 $ 623
Commercial real estate 1,153 719
Multi-family - - - - - - - -
Mobile homes 39 31
Credit cards - - - - - - - -
Consumer 647 482
Agriculture - - - - - - - -
Commercial business 1,118 396
------------- -----------
Total $ 3,602 $ 2,251
------------- -----------
Accruing loans delinquent more than 90 days:
One- to four-family $- - - - $- - - -
Commercial real estate - - - - - - - -
Multi-family - - - - - - - -
Mobile homes - - - - - - - -
Credit cards 1,343 530
Consumer - - - - - - - -
Agriculture - - - - - - - -
Commercial business - - - - - - - -
------------- -----------
Total $ 1,343 $ 530
------------- -----------
Foreclosed Assets:
One- to four-family $ 95 $ 22
Commercial real estate - - - - - - - -
Multi-family - - - - - - - -
Mobile homes 84 67
Credit cards - - - - - - - -
Consumer 71 140
Agriculture - - - - - - - -
Commercial business - - - - - - - -
------------- -----------
Total $ 250 $ 229
------------- -----------
Total nonperforming assets $ 5,195 $ 3,010
------------- -----------
------------- -----------
Ratio of nonperforming assets to total assets 0.93% 0.53%
------------- -----------
------------- -----------
Ratio of nonperforming loans to total loans 1.10% 0.63%
------------- -----------
------------- -----------
When a loan becomes 90 days delinquent, except for credit card loans, the
Bank places the loan on a nonaccrual status and, as a result, accrued interest
income on the loan is taken out of income. Future interest income is recognized
on a cash basis. The loan will remain on a nonaccrual status until the borrower
has brought the loan current. Credit card loans remain in accrual status until
120 days, when accrued interest income on the loan is taken out of income.
Page 13
Nonperforming assets increased to $5.2 million at September 30, 1998 from
$3.0 million at June 30, 1998, an increase of $2.2 million. In addition, the
ratio of nonperforming assets to total assets, which is one indicator of credit
risk exposure, increased to 0.93% at September 30, 1998 as compared to 0.53% at
June 30, 1998.
Nonaccruing loans increased to $3.6 million at September 30, 1998 from $2.3
million at June 30, 1998, an increase of $1.3 million. Included in nonaccruing
loans at September 30, 1998 were sixteen loans totaling $645,000 secured by one-
to four-family real estate, ten loans totaling $1.2 million secured by
commercial real estate, five mobile home loans totaling $39,000, fifty consumer
loans totaling $647,000 and seven commercial business loans totaling $1.2
million. For the three months ended September 30, 1998, gross interest income of
$81,000 would have been recognized on loans accounted for on a nonaccrual basis
had such loans been current in accordance with their original terms. Gross
interest income of $124,000 was recognized as income on loans accounted for on a
nonaccrual basis.
Accruing loans delinquent more than 90 days increased to $1.3 million at
September 30, 1998 from $530,000 at June 30, 1998, an increase of $813,000 due
to credit card loans.
Foreclosed assets increased to $250,000 at September 30, 1998 from $229,000
at June 30, 1998, an increase of $21,000.
At September 30, 1998, the Bank had approximately $9.3 million of other
loans of concern that management has determined need to be closely monitored
because of possible credit problems of the borrowers or the cash flows of the
secured properties. These loans were considered in determining the adequacy of
the allowance for possible loan losses. The allowance for possible loan losses
is established based on management's evaluation of the risks inherent in the
loan portfolio and changes in the nature and volume of loan activity. Such
evaluation, which includes a review of all loans for which full collectability
may not be reasonably assured, considers the estimated fair market value of the
underlying collateral, economic conditions, historical loan loss experience and
other factors that warrant recognition in providing for an adequate loan loss
allowance. Although the Bank's management believes that the September 30, 1998
recorded allowance for loan losses was adequate to provide for potential losses
on the related loans, there can be no assurance that the allowance existing at
September 30, 1998 will be adequate in the future.
The following table sets forth information with respect to activity in the
Bank's allowance for loan losses during the periods indicated.
Page 14
Three Months Ended
------------------------
9/30/98 9/30/97
---------- ----------
(Dollars in Thousands)
Balance at beginning of period $ 7,199 $ 4,526
Charge-offs:
One- to four-family - - - - (16)
Commercial - - - - - - - -
Multi-family - - - - - - - -
Commercial business (44) - - - -
Consumer (252) (172)
Agriculture - - - - - - - -
Credit cards (713) (175)
Mobile homes (14) (64)
---------- ----------
Total charge-offs $ (1,023) $ (427)
---------- ----------
Recoveries:
One- to four-family $- - - - $6
Commercial - - - - - - - -
Multi-family - - - - - - - -
Commercial business 41 - - - -
Consumer 36 45
Agriculture - - - - - - - -
Credit cards 27 137
Mobile homes 3 9
---------- ----------
Total recoveries $ 107 $ 197
---------- ----------
Net (charge-offs) $ (916) $ (230)
Additions charged to operations 1,562 526
---------- ----------
Balance at end of period $ 7,845 $ 4,822
---------- ----------
---------- ----------
Ratio of net (charge-offs) recoveries during
the period to Average loans outstanding
during the period (0.21)% (0.05)%
---------- ----------
---------- ----------
Ratio of allowance for loan losses to total
loans at end of period 1.74% 1.08%
---------- ----------
---------- ----------
Ratio of allowance for loan losses to
nonperforming loans at end of period (1) 158.65% 196.32%
---------- ----------
---------- ----------
(1) Nonperforming loans includes nonaccruing loans
and accruing loans delinquent more than 90 days.
Page 15
The distribution of the Bank's allowance for loan losses at the dates
indicated is summarized as follows:
At September 30, 1998 At June 30, 1998
--------------------- ---------------------
Percent of Percent of
Loans in Loans in
Each Each
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------- -----------
(Dollars in Thousands)
One- to four-family $1,192 28.12% $1,203 29.12%
Commercial and multi-family real estate (1) 1,008 23.79% 967 23.41%
Commercial business 380 8.97% 377 9.13%
Consumer 1,248 29.45% 1,219 29.49%
Agricultural 164 3.88% 150 3.63%
Credit cards 3,756 3.49% 3,181 2.74%
Mobile homes 97 2.30% 102 2.48%
------ ----------- ------- -----------
Total $7,845 100.00% $7,199 100.00%
------ ----------- ------- -----------
------ ----------- ------- -----------
(1) Includes construction loans.
The allowance for loan losses was $7.8 million at September 30, 1998 as
compared to $7.2 million at June 30, 1998. The ratio of the allowance for
loan losses to total loans was 1.74% at September 30, 1998 and 1.08% at
September 30, 1997. The Bank's management has considered nonperforming assets
and other assets of concern in establishing the allowance for loan losses. The
Bank continues to monitor its allowance for possible loan losses and make future
additions or reductions in light of the level of loans in its portfolio and as
economic conditions dictate.
The current level of the allowance for loan losses is a result of
management's assessment of the risks within the portfolio based on the
information revealed in credit reporting processes. The Company utilizes a
risk-rating system on all commercial business, agricultural, construction and
multi-family and commercial real estate loans, including purchased loans,
that exceed $250,000 and a monthly credit review and reporting process on all
types of loans that results in the calculation of the guidelines reserves
based on the risk within the portfolio. This assessment of risk takes into
account the composition of the loan portfolio, previous loan experience,
current economic conditions and other factors that in management's judgment
deserve recognition. In regard to credit card loans, the Company is providing
a reserve in a range of 22% to 30% of the loan balance until the credit card
portfolio becomes seasoned. As of September 30, 1998, $3.8 million of the
$7.8 million allowance for loan losses was reserved for the credit card loan
portfolio. The Office of Thrift Supervision ("OTS") has reviewed the
Company's methodology for determining allowance requirements on the Company's
loan portfolio and have made no recommendations for increases in the
allowances during the three months ended September 30, 1998 and the fiscal
year ended June 30, 1998. The Company has historically maintained a positive
variance from the minimum estimated allowance for loan losses based on the
analyses that are conducted by Bank management and corporate credit
personnel. Management has reviewed the allocations in the various
classifications of loans and believes the allowance was adequate at all times
during the three months ended September 30, 1998 and the fiscal year ended
June 30, 1998.
Page 16
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
GENERAL. The Company's net income decreased $391,000 to $1.3 million for
the three months ended September 30, 1998 as compared to $1.7 million for the
three months ended September 30, 1997. As discussed in more detail below, this
decrease was due primarily to a decrease in loan fees and service charges of
$87,000, a decrease in gain on sale of loans of $316,000, and a decrease in
commission and insurance income of $71,000. These reductions in income were
partially offset by a reduction in income tax expense of $239,000.
INTEREST INCOME. Interest income decreased $541,000 from $11.7 million for
the three months ended September 30, 1997 to $11.2 million for the three months
ended September 30, 1998. This decrease was primarily due to a decrease in
interest earned on interest-earning assets due to a decrease in the average
balance of interest-earnings assets. The average yield on interest-earning
assets remained relatively stable at 8.49% and 8.44% for the three months ended
September 30, 1998 and September 30, 1997, respectively. The average balance of
interest-earning assets decreased $29.0 million when comparing the three months
ended September 30, 1998 to the same period in the prior fiscal year.
INTEREST EXPENSE. Interest expense decreased $661,000 from $6.7 million
for the three months ended September 30, 1997 to $6.0 million for the three
months ended September 30, 1998. This decrease was largely attributable to a
decrease in the average balance of interest-bearing liabilities. The average
rates on interest-bearing liabilities decreased from 5.20% to 4.98% for the
three months ended September 30, 1997 and September 30, 1998, respectively. The
average balance of interest-bearing liabilities decreased $30.4 million for the
three months ended September 30, 1998 as compared to the same period in the
prior fiscal year.
NET INTEREST INCOME. The Company's net interest income for the three
months ended September 30, 1998 increased $120,000, or 2.37%, to $5.2 million
as compared to $5.0 million for the same period ended September 30, 1997.
The increase in the net interest income reflects an overall increase in the
net interest spread on average interest-earning assets from 3.24% for the
three months ended September 30, 1997 to 3.51% for the three months ended
September 30, 1998. The increase in the net interest spread was primarily
due to a decrease in the rates paid on interest-bearing liabilities from
5.20% for the three months ended September 30, 1997 to 4.98% for the three
months ended September 30, 1998.
During the three months ended September 30, 1998, the Company increased
its average balances of commercial, agricultural, credit card and consumer
loans. The Company anticipates activity in this type of lending to continue
in future years, subject to market demand. In addition, the Company sold the
majority of conventional single-family residential real estate loan
originations into the secondary market. Net interest income is expected to
trend upward as a result of this lending activity as interest rate yields are
generally higher on these types of loans compared to the yield provided by
conventional single-family residential real estate loans. However, lending
activity will carry a higher level of risk due to the nature of the
collateral and the size of the individual loans. As such, the Company
anticipates continued increases in its allowance for loan losses.
PROVISION FOR LOSSES ON LOANS. During the three months ended September
30, 1998, the Company recorded a provision for losses on loans of $1.6
million as compared to $526,000 for the three months ended September 30,
1997. The provision for losses on loans of $1.6 million for the three months
ended September 30, 1998 compared to the same period in fiscal 1998 is
primarily to provide for future expected write-offs on credit card loans and
to management's continued evaluation of the loan portfolio in light of
general economic conditions. See "Asset Quality" for further discussion.
NONINTEREST INCOME. Noninterest income was $4.8 million for the three
months ended September 30, 1998 as compared to $2.8 million for the three months
ended September 30, 1997, an increase of $1.9 million.
The increase in credit card fee income of $2.2 million for the three
months ended September 30, 1998 as compared to the same period in fiscal 1998
is primarily due to an increase in fees received on unsecured credit cards.
This represents processing fees, interchange fees, annual fees, late fees and
other miscellaneous fees. This credit card program was initiated in fiscal
1997. Interest income on credit card loans is included in interest income on
loans.
Page 17
NONINTEREST EXPENSE. Noninterest expense increased $1.7 million from
$4.8 million for the three months ended September 30, 1997 to $6.4 million
for the three months ended September 30, 1998.
There was an increase of $1.6 million in the cost of third party processors
of credit cards. This represents costs for processing of applications,
collecting loans, and marketing costs for the acquisition of credit cards for
the unsecured credit card program. The Company began processing credit cards in
the second quarter of fiscal 1997.
INCOME TAX EXPENSE. The Company's income tax expense for the three months
ended September 30, 1998 was $643,000 as compared to $882,000 for the three
months ended September 30, 1997, a decrease of $239,000. This decrease was
proportionate to the decrease in the Company's income before income tax and due
to the decrease in the effective tax rate to 33.21% for the three months ended
September 30, 1998 as compared to 34.37% for the same period in the prior fiscal
year.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's primary sources of funds are deposits, amortization and
prepayments of loan principal (including mortgage-backed securities), advances
from the FHLB and, to a lesser extent, sales of mortgage loans, sales and/or
maturities of securities, mortgage-backed securities, and short-term
investments. While scheduled loan payments and maturing securities are
relatively predictable, deposit flows and loan prepayments are more influenced
by interest rates, general economic conditions, and competition. The Bank
attempts to price its deposits to meet its asset/liability objectives consistent
with local market conditions. Excess balances are invested in overnight funds.
Federal regulations have historically required the Bank to maintain minimum
levels of liquid assets. The required percentage has varied from time to time
based upon economic conditions and savings flows and is currently 4% of net
withdrawable savings deposits and current borrowings. Liquid assets for
purposes of this ratio include cash, certain time deposits, U. S. Government
and corporate securities and other obligations generally having remaining
maturities of less than five years. The Bank has historically maintained its
liquidity ratio at a level in excess of that required by these regulations. At
September 30, 1998, the Bank's regulatory liquidity ratio was 6.06%.
Liquidity management is both a daily and long-term responsibility of
management. The Bank adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) projected loan sales,
(iii) expected deposit flows, (iv) yields available on interest-bearing
deposits, and (v) the objectives of its asset/liability management program.
Excess liquidity is invested generally in interest-bearing overnight deposits
and other short-term government and agency obligations. During the three months
ended September 30, 1998, the Bank required funds beyond its ability to generate
funds internally. Thus it used its borrowing capacity with the FHLB by
obtaining advances, which increased its borrowings with the FHLB by $15.4
million. The Bank renewed its open line of credit with the FHLB in January 1998
at an amount of $10.0 million which will expire December 31, 1998. Management
expects this line of credit to be renewed at this time. There were no
outstanding advances on this line of credit at September 30, 1998.
The Bank anticipates that it will have sufficient funds available to meet
current loan commitments. At September 30, 1998, the Bank had outstanding
commitments to originate or purchase loans of $48.1 million and to sell loans of
$15.7 million. The Bank had no commitments to purchase or sell mortgage-backed
securities or securities available for sale.
Although deposits are the Bank's primary source of funds, the Bank's policy
has been to utilize borrowings where the funds can be invested in either loans
or securities at a positive rate of return or to use the funds for short term
liquidity purposes. See "Financial Condition Data" for further analysis.
In April of 1997, the Company initiated a stock buy back program in
which up to 10% of the common stock of the Company could be acquired
beginning May 1, 1997 through April 30, 1998. A total of 111,750 shares of
common stock were purchased pursuant to this program. In April of 1998, the
Company initiated another stock buy back program in which up to 10% of the
common stock of the Company may be acquired beginning May 1, 1998 through
April 30, 1999. In accordance with the provisions of the current stock buy
back program, the Company had purchased 146,000 shares of common stock as of
September 30, 1998.
Page 18
Savings institutions insured by the Federal Deposit Insurance Corporation
are required by the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA") to meet three regulatory capital requirements. If a
requirement is not met, regulatory authorities may take legal or administrative
actions, including restrictions on growth or operations or, in extreme cases,
seizure. Institutions not in compliance may apply for an exemption from the
requirements and submit a recapitalization plan. Under these capital
requirements, at September 30, 1998, the Bank met all current capital
requirements.
The OTS has adopted a core capital requirement for savings institutions
comparable to the requirement for national banks. The OTS core capital
requirement is 3% of total adjusted assets for thrifts that receive the highest
supervisory rating for safety and soundness. The Bank had core capital of 7.91%
at September 30, 1998.
Pursuant to FDICIA, the federal banking agencies, including the OTS, have
also proposed regulations authorizing the agencies to require a depository
institution to maintain additional total capital to account for concentration of
credit risk and the risk of non-traditional activities. No assurance can be
given as to the final form of any such regulation.
During the first quarter of fiscal 1997, the Small Business Job Protection
Act of 1996 was signed into law which repealed the percentage of taxable income
method of computing the bad debt deduction for savings institutions for tax
years beginning after December 31, 1995. Beginning in fiscal year 1997, the
Bank is required to recapture into income the excess of its June 30, 1996 loan
loss reserves for "qualifying" and "nonqualifying" loans over its June 30, 1988
loan loss reserves for "qualifying" and "nonqualifying" loans. This excess
which was $720,000 at June 30, 1998, is required to be recaptured ratably over a
six year period. The onset of recapture was delayed in fiscal years 1998 and
1997 since the Bank met a residential loan origination requirement which allowed
for a two year delay in recapture. At June 30, 1998, the Bank's recorded
deferred tax liability of $245,000 provides for the recapture of the loan loss
reserves.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time due to inflation. The impact of inflation
is reflected in the increased cost of the Bank's operations. Unlike most
industrial companies, nearly all the assets and liabilities of the Bank are
monetary in nature. As a result, interest rates have a greater impact on the
Bank's performance than do the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
Page 19
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The composition of the Bank's balance sheet results in maturity mismatches
between interest-earning assets and interest-bearing liabilities. The scheduled
maturities of the Bank's fixed rate interest-earning assets are longer than the
scheduled maturities of its fixed rate interest-bearing liabilities. This
mismatch exposes the Bank to interest rate risk. In a rising rate scenario, as
measured by the OTS interest rate risk exposure simulation model, the estimated
market or portfolio value ("PV") of the Bank's assets would decline in value to
a greater degree than the change in the PV of the Bank's liabilities, thereby
reducing net portfolio value ("NPV"), the estimated market value of its
shareholders' equity.
As of March 31, 1998, under a rate shock scenario of plus 200 basis points
("bp"), the Bank's pre-shock NPV ratio (NPV as a % of PV of assets) was
estimated in the OTS model to be 10.57%. The post-shock NPV ratio was estimated
to be 9.99%, a decline of 58bp. As of June 30, 1998, the most recent report
available, the Bank's sensitivity to interest rate changes decreased slightly.
The post-shock ratio for a 200 bp increase in market interest rates as of June
30, 1998 was estimated to be 10.18%, a decrease of 30bp from the pre-shock NPV
ratio estimate of 10.48%.
In managing the asset/liability mix, the Bank has placed its emphasis on
developing a portfolio in which, to the extent practicable, assets and
liabilities reprice within similar periods. The effect of this policy will
generally be to reduce the Bank's sensitivity to interest rate changes. The
goal of this policy is to provide a relatively consistent level of net interest
income in varying interest rate cycles and to minimize the potential for
significant fluctuations from period to period.
Other types of market risk, such as foreign exchange rate risk and commodity
price risk, do not arise in the normal course of the Company's business
activities.
Page 20
HF FINANCIAL CORP.
FORM 10-Q
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES
None
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS OF FORM 8-K
a. Exhibit 27.1 and Exhibit 27.2 are attached.
b. Report Form 8-K is not required to be filed at this time.
- ------------------------------------------------------------------------------
No other information is required to be filed under Part II of the form
Page 21
HF FINANCIAL CORP.
FORM 10-Q
SIGNATURES
Pursuant to the requirements 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.
HF Financial Corp.
-------------------------------------------
(Registrant)
Date: 11/5/98 by /s/ Curtis L. Hage
---------- -------------------------------------------
Curtis L. Hage, Chairman, President
and Chief Executive Officer
(Duly Authorized Officer)
Date: 11/6/98 by /s/ Gene F. Uher
---------- -------------------------------------------
Gene F. Uher, Executive Vice President,
Chief Operations Officer and Secretary
(Principal Financial and Accounting
Officer)
Page 22