Exhibit 13
FIRST FEDERAL BANCSHARES
OF ARKANSAS, INC.
------------------------------------------
1998
------------------------------------------
ANNUAL REPORT
------------------------------------------
TABLE OF CONTENTS
PAGE
President's Letter to Stockholders.................................................................... 1
Corporate Profile..................................................................................... 2
Selected Consolidated Financial and Other Data........................................................ 3
Selected Quarterly Operating Results.................................................................. 5
Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................................... 6
Independent Auditors' Report.......................................................................... 18
Consolidated Financial Statements..................................................................... 19
Directors and Executive Officers...................................................................... 43
Banking Locations..................................................................................... 43
Stockholder Information............................................................................... 44
[GRAPHIC OMITTED]
- --------------------------------------------------------------------------------
FIRST FEDERAL
- --------------------------------------------------------------------------------
BANCSHARES
- --------------------------------------------------------------------------------
OF ARKANSAS, INC.
Dear Stockholder:
First Federal Bancshares of Arkansas continued to have another great year in
1998. We again had record profits with over $6 million in net income. Our
earnings per share exceeded analysts' expectations with a 10.7% increase to
$1.35 per share. In addition, in 1998 we increased our quarterly dividend by
16.7% to 7 cents per share.
In 1998 we completed a second repurchase program of 5% of our stock totaling
244,803 shares. Immediately after completion of our second repurchase, we were
approved for a third repurchase of 5% of our stock. We subsequently completed
that repurchase of 232,563 shares on February 8, 1999. The shares acquired
through both repurchase programs will be held as treasury stock and further
reflect the board's commitment to enhance shareholder value.
We continued to excel in both mortgage and installment lending with
approximately $189 million in new loans originated in 1998 in Northwest and
Northcentral Arkansas. The secondary mortgage division exceeded all their goals
and projections to add to the banner year in lending.
In 1998 we also signed two major contracts for financial services. The first
was with Primevest Financial Services, a broker/dealer. Our Primevest
affiliation will enable the bank to offer full-service stock brokerage,
mutual funds, annuities, bonds and other financial services in all our
locations. Our second contract was with nFront for Internet banking services
through our computer service bureau, BISYS. Internet banking will become a
reality for our customers in 1999.
We recently opened our fifteenth office and second location in the excellent
market area of Mountain Home, Arkansas. The state-of-the-art facility features a
full service lobby, four drive-thru lanes and an ATM. We are committed to
readily meeting the family banking needs of this major retirement area in
Arkansas.
Our Year 2000 Project plan continues to make progress toward Year 2000
preparedness. We anticipate completion of our testing during the second quarter
of 1999. We do not anticipate any major problems with the century rollover but
we do have a business resumption contingency plan in place.
As we enter our 65th year of banking services to Northwest and Northcentral
Arkansas, the board, management, and all "First Team" members remain committed
to our mission of "being the best provider of family banking services in our
market areas and maximizing our shareholders' value". Our vision of "being the
premier family bank in Arkansas" is only possible through the loyalty and
support of our customers and stockholders. We appreciate you and pledge to do
our best to continue to merit your confidence in 1999 and future years.
Sincerely,
/s/ Larry J. Brandt
--------------------------
Larry J. Brandt
President
1
CORPORATE PROFILE
First Federal Bancshares of Arkansas, Inc. (the "Company") was
incorporated in January 1996 under Texas law for the purpose of acquiring all of
the capital stock issued by First Federal Bank of Arkansas, FA ("First Federal"
or the "Bank") in connection with its conversion from a federally chartered
mutual savings and loan association to a federally chartered stock savings and
loan association (the "Conversion"). The Conversion was consummated on May 3,
1996 and, as a result, the Company became a unitary savings and loan holding
company of the Bank. The Company has no significant assets other than the shares
of the Bank's common stock acquired in the Conversion, the Company's loan to the
Employee Stock Ownership Plan ("ESOP") and the portion of the net Conversion
proceeds retained and invested by the Company. The Company has no significant
liabilities.
The Bank is a federally chartered stock savings and loan association
which was formed in 1934. First Federal conducts business from its main office
and eleven full service branch offices, all of which are located in a six county
area in Northcentral and Northwest Arkansas comprised of Benton, Marion,
Washington, Carroll, Baxter and Boone counties. First Federal's deposits are
insured by the Savings Association Insurance Fund ("SAIF"), which is
administered by the Federal Deposit Insurance Corporation ("FDIC"), to the
maximum extent permitted by law. The Bank is a community oriented savings
institution which has traditionally offered a wide variety of savings products
to its retail customers while concentrating its lending activities on the
origination of loans secured by one- to four-family residential dwellings. To a
significantly lesser extent, the Bank's activities have also included
origination of multi-family residential loans, commercial real estate loans,
construction loans, commercial loans and consumer loans. In addition, the Bank
maintains a significant portfolio of investment securities.
At December 31, 1998, the Company had total assets of $615.1 million,
total deposits of $481.1 million and stockholders' equity of $81.0 million. The
Company's and the Bank's principal executive offices are located at 200 West
Stephenson, Harrison, Arkansas 72601, and their telephone number is
(870)741-7641.
2
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Company set
forth below and on the following page does not purport to be complete and should
be read in conjunction with, and is qualified in its entirety by, the more
detailed information, including the Consolidated Financial Statements and
related Notes, appearing elsewhere herein.
At or For the
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- ------------ ------------ ------------ ---------------
(In Thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets $615,055 $549,607 $505,739 $454,479 $428,312
Cash and cash equivalents 26,163 6,627 6,819 8,845 8,280
Investment securities 127,175 95,533 91,322 96,312 130,527
Loans receivable, net 442,486 433,942 396,508 339,505 279,783
Allowance for loan losses 771 1,196 1,251 1,228 1,134
Deposits 481,093 450,874 422,858 417,229 395,483
Federal Home Loan Bank advances 48,985 11,997 - - -
Stockholders' equity 81,023 82,884 80,758 35,308 31,242
SELECTED OPERATING DATA:
Interest income $ 43,814 $ 40,445 $ 37,192 $ 32,964 $ 29,790
Interest expense 25,774 23,748 22,449 21,538 17,700
--------------- ------------ ------------ ------------ ---------------
Net interest income 18,040 16,697 14,743 11,426 12,090
Provision for loan losses 55 - 60 133 54
--------------- ------------ ------------ ------------ ---------------
Net interest income after provision
for loan losses 17,985 16,697 14,683 11,293 12,036
Gain on sale of mortgage-backed
and investment securities -- 394 - 311 446
Noninterest income 1,836 1,526 1,222 1,107 1,137
Noninterest expense(1) 10,482 10,016 10,749 6,836 6,667
--------------- ------------ ------------ ------------ ---------------
Income before income taxes 9,339 8,601 5,156 5,875 6,952
Provision for income taxes 3,309 3,099 1,756 1,871 2,250
--------------- ------------ ------------ ------------ ---------------
Net income(1) $ 6,030 $ 5,502 $ 3,400 $ 4,004 $ 4,702
--------------- ------------ ------------ ------------ ---------------
--------------- ------------ ------------ ------------ ---------------
EARNINGS PER SHARE:
Basic $1.35 $1.22 $0.72 NA NA
Diluted 1.33 1.21 0.72 NA NA
CASH DIVIDENDS DECLARED $0.28 $0.22 -- NA NA
- ------------------------------------
(1) The year ended December 31, 1996 includes a nonrecurring SAIF special
assessment of approximately $2.6 million or approximately $1.7 million
net of the income tax benefit.
3
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
SELECTED OPERATING RATIOS(1):
Return on average assets(2) 1.04% 1.03% .69% .91% 1.12%
Return on average equity(2) 7.22 6.76 5.22 12.03 16.22
Average equity to average assets 14.36 15.26 13.23 7.55 6.91
Interest rate spread(3) 2.55 2.47 2.48 2.37 2.74
Net interest margin(3) 3.20 3.22 3.08 2.66 2.96
Net interest income after provision for
loan losses to noninterest expense 171.58 166.70 136.60 165.20 180.53
Noninterest expense to average assets 1.80 1.88 2.18 1.55 1.59
Average interest-earning assets to
average interest-bearing liabilities 114.20 116.21 112.96 105.92 105.23
Operating efficiency(4) 52.74 53.80 67.33 53.22 48.76
ASSET QUALITY RATIOS(5):
Nonperforming loans to total loans(6) 0.32 1.11 0.18 0.10 0.09
Nonperforming assets to total assets(6) 0.93 0.94 0.17 0.13 0.12
Allowance for loan losses to non-
performing loans(6) 52.65 24.12 173.51 350.86 420.00
Allowance for loan losses to total loans 0.17 0.27 0.30 0.35 0.40
CAPITAL RATIOS(5):
Tangible capital to adjusted total assets 11.67 11.98 12.30 7.74 7.29
Core capital to adjusted total assets 11.67 11.98 12.30 7.74 7.29
Risk-based capital to risk-weighted
assets 22.44 22.52 23.24 15.57 16.62
OTHER DATA:
Dividend payout ratio(7) 22.11 19.58 - - --
Full service offices at end of period 12 12 10 8 8
- ------------------------------------
(1) Ratios for 1998 and 1997 are based on average daily balances. Ratios
prior to 1997 are based on average month end balances.
(2) The year ended December 31, 1996 includes a nonrecurring SAIF special
assessment of approximately $2.6 million or approximately $1.7 million
net of the income tax benefit. For the year ended December 31, 1996,
return on average assets, without the SAIF special assessment, would
have been 1.04% and return on average equity for the same period would
have been 7.83%.
(3) Interest rate spread represents the difference between the weighted
average yield on average interest-earning assets and the weighted
average cost of average interest-bearing liabilities, and net interest
margin represents net interest income as a percent of average
interest-earning assets.
(4) Noninterest expense to net interest income plus noninterest income.
(5) Asset quality ratios and capital ratios are end of period ratios.
(6) Nonperforming assets consist of nonperforming loans and real estate
owned ("REO"). Nonperforming loans consist of non-accrual loans while
REO consists of real estate acquired in settlement of loans.
(7) The calendar year ended December 31, 1997 was the first full year the
Company was publicly traded. Dividend payout ratio is the total
dividends declared divided by net income.
4
SELECTED QUARTERLY OPERATING RESULTS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
FOURTH THIRD SECOND FIRST
YEAR ENDED DECEMBER 31, 1998 QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
Interest income $11,270 $11,052 $10,864 $10,628
Interest expense 6,676 6,545 6,375 6,178
-------------- -------------- -------------- ---------------
Net interest income 4,594 4,507 4,489 4,450
Provision for loan losses 30 -- 10 15
-------------- -------------- -------------- ---------------
Net interest income after provision
for loan losses 4,564 4,507 4,479 4,435
Noninterest income 426 514 438 458
Noninterest expense 2,565 2,583 2,671 2,663
-------------- -------------- -------------- ---------------
Income before income taxes 2,425 2,438 2,246 2,230
Provision for income taxes 854 861 784 810
-------------- -------------- -------------- ---------------
Net income $ 1,571 $ 1,577 $ 1,462 $ 1,420
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
Earnings per share(1):
Basic $0.37 $0.35 $0.32 $0.31
Diluted $0.37 $0.35 $0.31 $0.30
Selected Ratios (Annualized):
Net interest margin 3.15% 3.18% 3.23% 3.26%
Return on average assets 1.04 1.08 1.02 1.01
Return on average equity 7.71 7.52 6.89 6.77
YEAR ENDED DECEMBER 31, 1997 FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
Interest income $10,456 $10,226 $10,048 $9,715
Interest expense 6,191 6,153 5,831 5,573
-------------- -------------- -------------- ---------------
Net interest income 4,265 4,073 4,217 4,142
Provision for loan losses -- -- -- --
-------------- -------------- -------------- ---------------
Net interest income after provision
for loan losses 4,265 4,073 4,217 4,142
Noninterest income 370 360 872 318
Noninterest expense 2,501 2,374 3,029 2,112
-------------- -------------- -------------- ---------------
Income before income taxes 2,134 2,059 2,060 2,348
Provision for income taxes 774 748 739 838
-------------- -------------- -------------- ---------------
Net income $ 1,360 $ 1,311 $ 1,321 $ 1,510
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
Earnings per share(1):
Basic $0.30 $0.29 $0.29 $0.33
Diluted $0.30 $0.29 $0.29 $0.33
Selected Ratios (Annualized):
Net interest margin 3.19% 3.07% 3.29% 3.33%
Return on average assets 0.99 0.96 1.00 1.18
Return on average equity 6.62 6.50 6.50 7.41
- ----------------------------------------
(1) Basic and Diluted Shares Outstanding
YEAR ENDED DECEMBER 31, 1998 FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
Basic weighted - average shares 4,262,883 4,465,271 4,560,765 4,552,948
Effect of dilutive securities 3,790 62,085 152,851 114,397
-------------- -------------- -------------- ---------------
Diluted weighted - average shares 4,266,673 4,527,356 4,713,616 4,667,345
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
YEAR ENDED DECEMBER 31, 1997
Basic weighted - average shares 4,542,544 4,532,143 4,521,744 4,511,344
Effect of dilutive securities 59,015 45,714 1,964 0
-------------- -------------- -------------- ---------------
Diluted weighted - average shares 4,601,559 4,577,857 4,523,708 4,511,344
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Management's discussion and analysis of financial condition and results
of operations is intended to assist in understanding the consolidated financial
condition and results of operations of the Company. The information contained in
this section should be read in conjunction with the Consolidated Financial
Statements and the accompanying Notes to Consolidated Financial Statements and
the other sections contained in this Annual Report.
The Company's results of operations depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets and interest expense on interest-bearing liabilities. The Company's
results of operations also are affected by the provision for loan losses, the
level of its noninterest income and expenses, and income tax expense.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap", provides
an indication of the extent to which an institution's interest rate spread will
be affected by changes in interest rates. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest-rate
sensitive liabilities, and is considered negative when the amount of
interest-rate sensitive liabilities exceeds the amount of interest-rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would adversely affect net interest
income, while a positive gap within shorter maturities would result in an
increase in net interest income, and during a period of falling interest rates,
a negative gap within shorter maturities would result in an increase in net
interest income while a positive gap within shorter maturities would have the
opposite effect. As of December 31, 1998, the Bank estimates that the ratio of
its one-year gap to total assets was a negative 9.8% and its ratio of
interest-earning assets to interest-bearing liabilities maturing or repricing
within one year was 78.7%.
In order to minimize the potential for adverse effects of material and
prolonged increases in interest rates on the Company's results of operations,
the Company's management has implemented and continues to monitor asset and
liability management policies to better match the maturities and repricing terms
of the Bank's interest-earning assets and interest-bearing liabilities. Such
policies have consisted primarily of: (i) emphasizing the origination of
adjustable-rate mortgage loans ("ARMs"); (ii) lengthening the maturity on
deposits by offering longer term certificates of deposit; and (iii) utilizing
Federal Home Loan Bank ("FHLB") of Dallas advances. Presently, deposits into
longer term certificates of deposit are minimal due to the prevailing low
interest rate environment.
The Bank focuses its lending activities on the origination of one-,
three-, five- and seven-year adjustable-rate residential mortgage loans.
Although adjustable-rate loans involve certain risks, including increased
payments and the potential for default in an increasing interest rate
environment, such loans decrease the risks associated with changes in interest
rates. As a result of the Bank's efforts, as of December 31, 1998, $234.5
million or 63.3% of the Bank's portfolio of one- to four-family residential
mortgage loans consisted of ARMs, including $190.3 million in seven-year ARMs.
The Company's investment securities portfolio amounted to $127.2 million
or 20.7% of the Company's total assets at December 31, 1998. Of such amount,
$10.0 million or 7.9% is contractually due within one year and $8.2 million or
6.4% is contractually due after one year to five years. However, actual
maturities are normally shorter than contractual maturities due to the ability
of borrowers to call or prepay such obligations without call or prepayment
6
penalties. As of December 31, 1998, there was approximately $113 million of
investment securities with call options held by the issuer, of which
approximately $97 million are callable within one year.
Deposits are the Bank's primary funding source and the Bank prices its
deposit accounts based upon competitive factors and the availability of prudent
lending and investment opportunities. The Bank seeks to lengthen the maturities
of its deposits by soliciting longer term certificates of deposit when market
conditions have created opportunities to attract such deposits. However, the
Bank does not solicit high-rate jumbo certificates of deposit and does not
pursue an aggressive growth strategy which would force the Bank to focus
exclusively on competitors' rates rather than deposit affordability. In 1998,
the Bank utilized FHLB of Dallas advances as an additional funding source.
At December 31, 1998, the Bank had $49.0 million of FHLB advances.
NET PORTFOLIO VALUE
Management also presently monitors and evaluates the potential impact of
interest rate changes upon the market value of the Bank's portfolio equity and
the level of net interest income on a quarterly basis. The Office of Thrift
Supervision ("OTS") adopted a final rule in August 1993 incorporating an
interest rate risk component into the risk- based capital rules. Under the rule,
an institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate component from total capital for
purposes of calculating the risk-based capital requirement. An institution with
a greater than "normal" interest rate risk is defined as an institution that
would incur a loss of net portfolio value ("NPV") exceeding 2% of the estimated
market value of its assets in the event of a 200 basis point increase or
decrease in interest rates. NPV is the difference between incoming and outgoing
discounted cash flows from assets, liabilities, and off-balance sheet contracts.
A resulting change in NPV of more than 2% of the estimated market value of an
institution's assets will require the institution to deduct from its capital 50%
of that excess change. The rule provides that the OTS will calculate the
interest rate risk component quarterly for each institution. The OTS has
indicated that no institution will be required to deduct capital for interest
rate risk until further notice. However, utilizing this measurement concept, at
December 31, 1998, there would be a decrease of approximately 296 basis points
in the Bank's NPV as a percentage of present value of assets, assuming a 200
basis point increase in interest rates.
The following table presents the Bank's NPV as of December 31, 1998, as
calculated by the OTS, based on information provided to the OTS by the Bank.
NET PORTFOLIO VALUE
- ----------------------------------------------------------------------------------------------------------------
Estimated NPV as
a Percentage of
Change in Interest Present Value Amount Percent
Rates (basis points) Estimated NPV of Assets of Change of Change
- -------------------- -------------------- -------------------- -------------------- --------------------
(Dollars in Thousands)
+400 $47,226 8.17% $(48,644) (51)%
+300 59,870 10.06 (36,000) (38)
+200 72,793 11.88 (23,077) (24)
+100 85,269 13.53 (10,061) (11)
-- 95,870 14.84 -- --
-100 104,300 15.80 8,430 9
-200 113,775 16.84 17,905 19
-300 125,218 18.07 29,348 31
-400 136,098 19.16 40,228 42
7
CHANGES IN FINANCIAL CONDITION
GENERAL. At December 31, 1998, the Company's total assets amounted to
$615.1 million as compared to $549.6 million at December 31, 1997. The $65.5
million or 11.9% increase was primarily due to an increase of $19.5 million or
249.8% in cash and cash equivalents, a $8.5 million or 2.0% increase in loans
receivable, net, a $31.6 million or 33.1% increase in investment securities held
to maturity, and a $4.1 million increase in real estate acquired in settlement
of loans, net.
The loans receivable increase resulted from the continued origination of
loans during the year ended December 31, 1998. Originations for the year ended
December 31, 1998 consisted of $114.5 million in one- to four-family residential
loans, $600,000 in multi-family residential, $20.9 million in commercial loans,
$24.0 million in construction loans and $28.8 million in consumer installment
loans, of which $10.3 million consisted of automobile loans and $9.7 million
consisted of home equity loans. At December 31, 1998, the Bank had outstanding
loan commitments of $3.6 million, unused lines of credit of $4.0 million, and
the undisbursed portion of construction loans of $6.8 million. Real estate
acquired in settlement of loans increased $4.1 million primarily due to the Bank
accepting a deed in lieu of foreclosure on a commercial real estate loan, as
discussed below. Liabilities increased $66.4 million or 14.2% to $533.1 million
at December 31, 1998 compared to $466.7 million at December 31, 1997. The
increase in liabilities was primarily due to an increase of $30.2 million or
6.7% in deposits, and a $36.7 million increase in advances from the FHLB of
Dallas. The increases in deposits and advances from the FHLB of Dallas were used
to fund the net loan increase, to increase cash and cash equivalents, and to
purchase additional investment securities. Stockholders' equity amounted to
$81.0 million or 13.17% of total assets at December 31, 1998 compared to $82.9
million or 15.08% of total assets at December 31, 1997.
Nonperforming assets, consisting of nonperforming loans and repossessed
assets, amounted to $5.7 million or .93% of total assets at December 31, 1998,
compared to $5.2 million, or .94% of total assets at December 31, 1997. The Bank
reclassified a previously reported non-accrual commercial real estate loan to
real estate acquired in settlement of loans in the first quarter of 1998. The
majority ownership of a partnership, which owns and operates this commercial
real estate property, was consolidated with the Bank's financial position and
results of operations during the quarter ended September 30, 1998. Such property
has a carrying value at December 31, 1998 of $4.0 million. As a result of such
consolidation, the Bank's real estate acquired in settlement of loans increased
$1.0 million reflecting the minority interest ownership. The property is
currently operated by a management company and is being marketed for
disposition.
LOANS RECEIVABLE. Net loans receivable increased by $8.5 million, or
2.0%, to $442.5 million at December 31, 1998 from $433.9 million at December 31,
1997. Loan originations for 1998 totaled $188.8 million. The net loans
receivable increase was composed of increases in commercial loans of $7.4
million or 30.5%, and consumer loans of $3.0 million or 10.5%, and decreases in
single-family residential loans of $700,000 or .2% and construction loans, net
of undisbursed funds of $2.5 million or 1.2%. Loans were originated using the
Bank's normal underwriting standards, rates, and terms.
Unearned loan fee income at December 31, 1998 amounted to $3.3 million,
down from $3.5 million at December 31, 1997. These unearned fees are recognized
as an adjustment to yield over the contractual lives of the related loans.
Undisbursed amounts of loans in process related to construction loans at
December 31, 1998 were $6.8 million, compared to $7.3 million at December 31,
1997.
ALLOWANCE FOR LOAN LOSSES. The reduction in the allowance for loan
losses from $1.2 million at December 31, 1997, to $800,000 at December 31, 1998
resulted primarily from two changes. First, nonperforming commercial real estate
loans decreased from $3.4 million at December 31, 1997 to $0 at December 31,
1998. Additionally, nonperforming consumer loans decreased from $434,000 at
December 31, 1997 to $159,000 at December 31, 1998. Otherwise, the composition
of the allowance remained relatively unchanged. There were no changes in
concentrations, terms, methods or assumptions that occurred or significantly
affected the allowance during
8
the year ended December 31, 1998. Management compared the loan portfolio's loss
experience ratios from year to year and adjusted the ratios to reflect current
loss experience. Management also considered whether there were any other matters
that might affect the adequacy of the allowance and identified no such matters.
INVESTMENT SECURITIES. Investment securities all of which were
classified as held to maturity amounted to $127.2 million as of December 31,
1998 compared to $95.5 million as of December 31, 1997. In 1998, approximately
$110.2 million of government agency obligations and $900,000 of municipal bonds
were purchased. Securities which matured or were called during 1998 amounted to
$79.5 million, which resulted in an increase of $31.6 million or 33.1% in
investment securities at December 31, 1998 compared to December 31, 1997.
DEPOSITS. Deposits at December 31, 1998 amounted to $481.1 million, an
increase of $30.2 million or 6.7% from the December 31, 1997 balance of $450.9
million. The Bank does not advertise for deposits outside of its primary market
area, Northcentral and Northwest Arkansas, or utilize the services of deposit
brokers. In 1997, the Bank began offering special promotion certificate of
deposits which continued throughout 1998.
BORROWED FUNDS. Borrowed funds, which consist entirely of FHLB of Dallas
advances, increased by $37.0 million to $49.0 million at December 31, 1998 from
$12.0 million at December 31, 1997. The weighted average rate on such borrowings
was 5.57% at December 31, 1998. These borrowings were used to fund loan growth,
to purchase additional investment securities and to increase cash and cash
equivalents.
STOCKHOLDERS' EQUITY. Stockholders' equity decreased $1.9 million to
$81.0 million at December 31, 1998 from $82.9 million at December 31, 1997. The
decrease in stockholders' equity was primarily due to the purchase of treasury
stock totaling $8.0 million. In addition, during the twelve months ended
December 31, 1998 cash dividends aggregating $1.3 million were paid. Such
decreases in stockholders' equity were partially offset by net income in the
amount of $6.0 million for the year ended December 31, 1998.
9
AVERAGE BALANCE SHEETS
The following table sets forth certain information relating to the
Company's average balance sheets and reflects the average yield on assets and
average cost of liabilities for the periods indicated and the yields earned and
rates paid at December 31, 1998. Such yields and costs are derived by dividing
income or expense by the average balance of assets or liabilities, respectively,
for the periods presented and outstanding balances at December 31, 1998. For the
years ended December 31, 1998 and 1997, average balances are based on daily
balances during the period. For the year ended December 31, 1996, average
balances are based on month end balances during the period.
Year Ended December 31,
December 31, ----------------------------------------------------------------
1998 1998 1997
------------- --------------------------------------------- ------------------
Average
Yield/ Average Yield/ Average
Cost Balance Interest Cost Balance
------------- ------------ ------------- ------------- -------------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable(1) 8.05% $441,702 $35,762 8.10% $415,075
Investment securities(2) 6.61 116,504 7,802 6.70 96,170
Mortgage-backed securities 8.24 86 6 7.02 202
Other interest-earning assets 4.65 4,777 244 5.09 7,615
------------ ------------- -------------
Total interest-earning assets 7.63 563,069 43,814 7.78 519,062
------------- -------------
Noninterest-earning assets 18,502 14,550
------------ -------------
Total assets $581,571 $533,612
------------ -------------
------------ -------------
Interest-bearing liabilities:
Deposits 5.01 $462,596 24,004 5.19 $440,147
Other borrowings 5.57 30,452 1,770 5.81 6,493
------------ ------------- -------------
Total interest-bearing liabilities 5.07 493,048 25,774 5.23 446,640
Noninterest-bearing liabilities 5,019 5,561
------------ -------------
Total liabilities 498,067 452,201
Stockholders' equity 83,504 81,411
------------ -------------
Total liabilities and
stockholders' equity $581,571 $533,612
------------ -------------
------------ -------------
-------------
Net interest income $ 18,040
-------------
-------------
Net earning assets $ 70,021 $ 72,422
------------ -------------
------------ -------------
Interest rate spread 2.56% 2.55%
------------- -------------
------------- -------------
Net interest margin 3.20%
-------------
-------------
Ratio of interest-earning assets to
interest-bearing liabilities 114.20%
-------------
-------------
Year Ended December 31,
--------------------------------------------------------------------------------
1997 1996
----------------------------- ----------------------------------------------
Average Average
Yield/ Average Yield/
Interest Cost Balance Interest Cost
------------- ------------- ------------- ------------- -------------
Interest-earning assets:
Loans receivable(1) $33,804 8.14% $369,185 $30,498 8.26%
Investment securities(2) 6,207 6.45 102,398 6,258 6.11
Mortgage-backed securities 17 8.46 264 22 8.33
Other interest-earning assets 417 5.48 6,335 414 6.54
------------- ------------- -------------
Total interest-earning assets 40,445 7.79 478,182 37,192 7.78
------------- -------------
Noninterest-earning assets 13,821
-------
Total assets $492,003
-------------
-------------
Interest-bearing liabilities:
Deposits 23,331 5.30 $420,062 22,409 5.33
Other borrowings 417 6.42 3,264 40 1.23
------------- ------------- -------------
Total interest-bearing liabilities 23,748 5.32 423,326 22,449 5.30
Noninterest-bearing liabilities 3,564
-------------
Total liabilities 426,890
Stockholders' equity 65,113
-------------
Total liabilities and
stockholders' equity $492,003
-------------
-------------
------------ -------------
Net interest income $ 16,697 $ 14,743
------------- -------------
------------- -------------
Net earning assets $ 54,856
-------------
-------------
Interest rate spread 2.47% 2.48%
------------- -------------
------------- -------------
Net interest margin 3.22% 3.08%
------------- -------------
------------- -------------
Ratio of interest-earning assets to
interest-bearing liabilities 116.21% 112.96%
------------- -------------
------------- -------------
- ----------------
(1) Includes non-accrual loans.
(2) Includes FHLB of Dallas stock and for the year 1996 Federal Home Loan
Mortgage Corporation ("FHLMC") preferred stock at cost.
10
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by prior rate); (ii) changes in rate
(change in rate multiplied by prior average volume); (iii) changes in
rate-volume (changes in rate multiplied by the change in average volume); and
(iv) the net change.
Year Ended December 31,
----------------------------------------------------
1998 vs. 1997
----------------------------------------------
Increase (Decrease)
Due to
---------------------------------
Total
Rate/ Increase
Volume Rate Volume (Decrease)
---------- --------- ---------- -----------
(In Thousands)
Interest income:
Loans receivable............. $2,169 $ (198) $ (13) $1,958
Investment securities........ 1,312 234 49 1,595
Mortgage-backed securities (10) (3) 2 (11)
Other interest-earning assets (155) (29) 11 (173)
---------- --------- ---------- -----------
Total interest-earning
assets................. 3,316 4 49 3,369
---------- --------- ---------- -----------
Interest expense:
Deposits..................... 1,190 (492) (25) 673
Other borrowings............. 1,538 (40) (145) 1,353
---------- --------- ---------- -----------
Total interest-bearing
liabilities.............. 2,728 (532) (170) 2,026
---------- --------- ---------- -----------
Net change in interest income.. $ 588 $ 536 $ 219 $ 1,343
---------- --------- ---------- -----------
---------- --------- ---------- -----------
Year Ended December 31,
------------------------------------------------------
1997 vs. 1996
-----------------------------------------------------
Increase (Decrease)
Due to
--------------------------------------
Total
Rate/ Increase
Volume Rate Volume (Decrease)
------------ ---------- ---------- ----------
(In Thousands)
Interest income:
Loans receivable............. $3,791 $(431) $(54) $3,306
Investment securities........ (381) 351 (21) (51)
Mortgage-backed securities (5) - - (5)
Other interest-earning assets 84 (67) (14) 3
------------ ---------- ---------- ----------
Total interest-earning
assets................. 3,489 (147) (89) 3,253
------------ ---------- ---------- ----------
Interest expense:
Deposits..................... 1,072 (143) (7) 922
Other borrowings............. 39 170 168 377
------------ ---------- ---------- ----------
Total interest-bearing
liabilities.............. 1,111 27 161 1,299
------------ ---------- ---------- ----------
Net change in interest income.. $2,378 $(174) $(250) $1,954
------------ ---------- ---------- ----------
------------ ---------- ---------- ----------
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND
1997.
GENERAL. The Company reported net income of $6.0 million for the year
ended December 31, 1998 compared to $5.5 million for the same period in 1997.
The increase of $528,000 or 9.6% in net income in the 1998 period compared to
the same period in 1997 was due to an increase in net interest income which was
partially offset by an increase in noninterest expenses and income taxes and a
reduction in noninterest income. Net interest income increased by $1.3 million
or 8.0% from $16.7 million to $18.0 million for the years ended December 31,
1997 and 1998, respectively. The Company's net interest margin remained
relatively unchanged at 3.20% and the interest rate spread increased to 2.55%
for 1998 compared to 3.22% and 2.47%, respectively, for 1997.
NET INTEREST INCOME. Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities. The Company's net interest income amounted to $18.0 million in
1998, an increase of $1.3 million or 8.0% compared to $16.7 million for 1997.
The Company's interest rate spread increased to 2.55% for 1998 from 2.47% for
1997. The Company's net interest margin remained stable at 3.20% for 1998
compared to 3.22% for 1997.
INTEREST INCOME. Interest income amounted to $43.8 million for the year
ended December 31, 1998 compared to $40.4 million for the same period in 1997.
The increase of $3.4 million or 8.3% was primarily due to an increase in the
average balance of loans receivable and investment securities. The average
balance of loans receivable increased as a result of continued loan demand and
portfolio growth. Such increase was partially offset by a decline in the average
yield earned on such assets due primarily to the origination or modification of
loans at market interest rates which are
11
currently lower than the average yield of the Bank's loan portfolio. The average
balance of investment securities increased due to additional purchases of
investment securities. The average balance and rate earned on investment
securities increased due to the purchase of longer-term investments at rates
higher than the average yield earned on such assets in portfolio. Such increases
were partially offset by a decline in the average balance of other
interest-earning assets, primarily overnight interest-bearing cash accounts.
INTEREST EXPENSE. Interest expense increased $2.0 million or 8.5% to
$25.8 million for the year ended December 31, 1998 compared to $23.8 million for
the same period in 1997. Such increase was primarily due to an increase in the
average balance of FHLB of Dallas advances as well as an increase in the average
balance of deposits. Such increases were offset by a decrease in the average
yield paid on both deposit accounts and FHLB of Dallas advances.
PROVISION FOR LOAN LOSSES. Provisions for loan losses amounted to
$55,000 for 1998. No provisions for loan losses were provided for in 1997.
Provisions for loan losses include charges to reduce the recorded balance of
mortgage loans to their estimated fair value. Such provision and the adequacy of
the allowance for loan losses is evaluated for adequacy quarterly by management
of the Bank based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and current
economic conditions. The increase in the provision for loan losses in 1998
compared to 1997 was due to management's evaluation of the adequacy of the
allowance for loan losses.
NONINTEREST INCOME. Noninterest income amounted to $1.8 million for the
year ended December 31, 1998 compared to $1.9 million for the same period in
1997. The decrease of $84,000 or 4.4% was due primarily to a gain of $394,000
recognized in 1997 on the sale of FHLMC stock and to the recognition in 1997 of
$145,000 on previously deferred profit on the sale of real estate owned. There
were no similar gains in 1998. The decrease in noninterest income for the year
ended December 31, 1998 compared to the year ended December 31, 1997 was
partially offset by an increase of $240,000 from $30,000 to $270,000 in gain on
the sale of mortgage loans in the secondary mortgage market. In addition,
deposit fee income increased $82,000 or 10.1% to $896,000 compared to $814,000
for the year ended December 31, 1998 and 1997, respectively.
NONINTEREST EXPENSE. Noninterest expenses increased $466,000 or 4.7% to
$10.5 million compared to $10.0 million for the year ended December 31, 1998 and
December 31, 1997, respectively. This increase was primarily due to increased
costs associated with the Company's ESOP as a result of an increase in the
Company's daily average stock price, occupancy costs due to branch expansions,
salaries and benefits due to increased personnel and normal salary and merit
increases, and a loss on disposition of real estate held for investment. Such
increases were partially offset by a decrease in costs related to the Management
Recognition and Retention Plan ("MRR Plan"). Such costs amounted to $754,000
compared to $1.2 million for the year ended December 31, 1998 and 1997,
respectively, resulting in a $440,000 decrease. This decrease was due to the
cost recognition, in the second quarter of 1997, of an immediate 20% vesting
after the plan was approved by the Company's shareholders.
INCOME TAXES. Income taxes amounted to $3.3 million and $3.1 million for
the year ended December 31, 1998 and December 31, 1997, respectively, resulting
in effective tax rates of 35.4% and 36.0%, respectively.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
1996.
GENERAL. Net income amounted to $5.5 million for 1997 compared to $3.4
million for 1996. The increase in net income of $2.1 million was due primarily
to an increase in net interest income and noninterest income offset by an
increase in noninterest expenses, excluding the one-time SAIF special
assessment.
NET INTEREST INCOME. The Company's net interest income amounted to $16.7
million in 1997, an increase of $2.0 million or 13.3% compared to $14.7 million
for 1996. The Company's interest rate spread remained virtually unchanged at
2.47% for 1997 compared to 2.48% for 1996. The Company's net interest margin
increased to 3.22%
12
for 1997 compared to 3.08% for 1996. Such increase in the Bank's net interest
margin was due to the increased investment in loans receivable, and an increase
in the ratio of interest-earning assets to interest-bearing liabilities to
116.21% for 1997 compared to 112.96% for 1996, which was partially offset by an
increase in interest expense due to deposit growth and borrowings of FHLB
advances.
INTEREST INCOME. Interest income increased $3.3 million or 8.7% to $40.4
million for 1997 compared to $37.2 million for 1996. The interest income
increase resulted from an increase of $3.3 million in interest income on loans
receivable which was partially offset by a decrease of $51,000 in interest
income from investment securities. The increase in interest income on loans
receivable was due to an increase of $45.9 million or 12.4% in the average
balance of loans receivable as a result of continued loan originations. The
positive impact of the increase on the average balance of loans receivable was
partially offset by a decrease in the average yield earned on such assets to
8.14% for 1997 from 8.26% in 1996. Such decrease in the average yield was due to
originations of loans at lower interest rates and refinancing of higher rate
loans. Interest income on investment securities declined primarily as a result
of a decrease in the average balance of such assets due to maturities and calls
of such investments. The decline was substantially offset by an increase in the
average yield earned on investment securities from 6.11% in 1996 to 6.45% in
1997 due to purchasing investment securities with higher yields and longer
maturity terms. Such bonds typically contain call features.
INTEREST EXPENSE. Interest expense increased $1.3 million or 5.8% to
$23.7 million in 1997 compared to $22.4 million in 1996. The increase was due
primarily to an increase of $20.1 million or 4.8% in the average balance of
deposits resulting from the Bank offering special promotion certificates of
deposit and from interest credited on existing accounts.
PROVISION FOR LOAN LOSSES. Provisions for loan losses amounted to
$60,000 for 1996. No provisions for loan losses were provided for in 1997.
Provisions for loan losses include charges to reduce the recorded balance of
mortgage loans to their estimated fair value. Such provision and the adequacy of
the allowance for loan losses is evaluated for adequacy quarterly by management
of the Bank based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and current
economic conditions. The decrease in the provision for loan losses in 1997
compared to 1996 was due to management's evaluation of the adequacy of the
allowance for loan losses.
NONINTEREST INCOME. Noninterest income increased $698,000 or 57.1% to
$1.9 million compared to $1.2 million for 1997 and 1996, respectively. The
increase was due primarily to a gain of $394,000 on the sale of Federal Home
Loan Mortgage Corporation stock, which was previously classified as an available
for sale investment security, and to the current recognition of $145,000 on
previously deferred profit on the sale of real estate owned.
NONINTEREST EXPENSE. Noninterest expenses, excluding the SAIF special
assessment of $2.6 million in 1996, increased $1.9 million or 23.1% to $10.0
million in 1997 compared to $8.1 million in 1996. The increase was primarily due
to an increase in salaries and employee benefits, including costs associated
with the implementation of the Company's ESOP and the Company's MRR Plan,
additional costs attributable to being a public company, advertising costs
related to targeting special promotions and branch openings and occupancy costs
due to branch expansions. Such increases were partially offset by a decline in
the quarterly FDIC premiums from $902,000 in 1996 to $272,000 in 1997.
The salaries and employee benefits increased $2.1 million or 47.6% to
$6.4 million compared to $4.3 million for 1997 and 1996, respectively. Such
increase included the $754,000 fair market value of 39,170 vested shares of
stock granted to key officers as well as to non-employee directors during the
second quarter ended June 30, 1997 pursuant to the MRR Plan adopted by the
Company's shareholders on May 7, 1997. An additional cost of $440,000 was
accrued during the year for shares awarded under the plan that will vest in May
1998. The costs related to the Company's ESOP amounted to $745,000 for 1997
compared to $402,000 for 1996. This $343,000 or 85.3% increase resulted, in
part, from the recognition of compensation expense for ESOP shares committed to
be released at the fair
13
market value which increased during 1997. In addition, the ESOP expense for 1996
represented a partial year commencing upon conversion on May 3, 1996. Other
increases in salaries and employee benefits are attributable to an increase in
the number of employees due to expansion and growth.
Net occupancy expense amounted to $804,000 in 1997 compared to $672,000
in 1996, an increase of $132,000 or 19.7%. Such increase was primarily due to
branch expansion as previously discussed. Advertising costs increased $81,000 or
41.6% to $275,000 for 1997 compared to $194,000 for 1996. The increase was
related to targeting special promotions for product offerings and advertising
branch openings. Noninterest expenses also increased as a result of additional
costs attributable to being a public company. Noninterest expense increases were
partially offset by a reduction in the FDIC premiums which amounted to $272,000
in 1997 compared to $902,000 in 1996. Such reduction in the premium was mandated
by the legislation requiring the payment, in the third quarter of 1996, of the
one-time special assessment used to recapitalize the SAIF.
INCOME TAXES. Income taxes amounted to $3.1 million and $1.8 million for
1997 and 1996, respectively, resulting in effective tax rates of 36.0% and
34.1%, respectively. Such increase was primarily due to an increase in pre-tax
income and additional state income tax in 1997 attributable to tax exempt
investment security interest income not sufficient to reduce state taxable
income to the 1996 level of zero.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's liquidity, represented by cash and cash equivalents and
eligible investment securities, is a product of its operating, investing and
financing activities. The Bank's primary sources of funds are deposits,
collections on outstanding loans, maturities and calls of investment securities
and other short-term investments and funds provided from operations. While
scheduled loan amortization and maturing investment securities and short-term
investments are relatively predictable sources of funds, deposit flows and loan
prepayments are greatly influenced by general interest rates, economic
conditions and competition. The Bank manages the pricing of its deposits to
maintain a steady deposit balance. In addition, the Bank invests excess funds in
overnight deposits and other short-term interest-earning assets which provide
liquidity to meet lending requirements. The Bank has generally been able to
generate enough cash through the retail deposit market, its traditional funding
source, to offset the cash utilized in investing activities. As an additional
source of funds, the Bank has borrowed from the FHLB of Dallas. At December 31,
1998, the Bank had outstanding advances from the FHLB of Dallas of $49.0
million. Such advances were used in the Bank's normal operating and investing
activities.
All savings institutions are required to maintain an average daily
balance of liquid assets equal to a certain percentage of the sum of its average
daily balance of net withdrawable deposit accounts and borrowings payable in one
year or less. The liquidity requirement may vary from time to time (between 4%
and 10%) depending upon economic conditions and savings flows of all savings
institutions. At the present time, the required minimum liquid asset ratio is
4%. At December 31, 1998, the Bank's liquidity ratio was 28.0%.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer-term basis, the Bank maintains a
strategy of investing in various lending products. The Bank uses its sources of
funds primarily to meet its ongoing commitments, to pay maturing savings
certificates and savings withdrawals, to repay maturing FHLB of Dallas advances,
and to fund loan commitments. At December 31, 1998, the total approved mortgage
loan origination commitments outstanding, excluding the undisbursed portion of
construction loans, amounted to $3.6 million. At the same date, the undisbursed
portion of construction loans approximated $6.8 million. The Bank's unused lines
of credit at December 31, 1998 were approximately $4.0 million. Certificates of
deposit scheduled to mature in one year or less at December 31, 1998 totaled
$237.0 million. Management believes that a significant portion of maturing
deposits will remain with the Bank. FHLB of Dallas advances scheduled to mature
within one year at December 31, 1998 totaled $19.0 million. Investment
securities scheduled to mature in one year or less at December 31, 1998 totaled
$10.0 million. However, actual maturities are normally shorter than contractual
14
maturities due to the ability of borrowers to call or prepay such obligations
without call or prepayment penalties. As of December 31, 1998, there was
approximately $97.4 million of investment securities with call options held by
the issuer exercisable within one year.
As of December 31, 1998, the Bank's regulatory capital was well in
excess of all applicable regulatory requirements. At December 31, 1998, the
Bank's tangible, core and risk-based capital ratios amounted to 11.67%, 11.67%
and 22.44%, respectively.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data 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 changes in relative purchasing
power over time due to inflation.
Unlike most industrial companies, virtually all of the Bank's assets and
liabilities are monetary in nature. As a result, interest rates generally have a
more significant impact on a financial institution's performance than does the
effect of inflation.
THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have time-sensitive coding may recognize a date using "00" as the
year 1900 rather than the Year 2000. Systems that do not properly recognize such
information could result in a system failure or generation of erroneous data.
The Federal Financial Institutions Examination Council ("FFIEC"),
through bank regulatory agencies including the OTS and the FDIC, has issued
mandatory guidelines requiring all financial institutions to develop and
implement plans for addressing Year 2000 issues as they relate to the operations
of financial institutions. The Bank has developed a Year 2000 Project plan,
required by these guidelines, that is intended to ensure that its computer
systems and software will function properly with respect to dates in the Year
2000 and thereafter. The Year 2000 Project consists of various phases including
an awareness phase, assessment phase, renovation phase, testing phase and
implementation phase. The awareness and assessment phases are substantially
complete. In the assessment phase, hardware, software, third-party vendors,
customers, and non-technological systems that could be affected by the century
rollover were identified. In this assessment, various systems were identified as
mission-critical. The primary focus of the renovation and testing phases is on
these mission-critical systems. The testing phase for mission-critical systems
is well underway and the Bank expects that such testing will be completed in the
second quarter of 1999.
The majority of the Bank's data processing is performed by a third party
service bureau. Processing by the servicer includes account processing for all
deposit and loan accounts. The servicer has completed the remediation of its
host deposit and loan systems. The Bank is substantially complete with testing
of the servicer's system. Dates tested on the servicer's system included the
century date rollover from December 31, 1999 through January 3, 2000, leap year
2000, year-end 2000 and 2001 rollover. This testing was performed by Bank
personnel.
The Bank utilizes various third party software systems that interface
with the servicer's system that are deemed to be mission-critical. Approximately
50% of these software packages currently utilized by the Bank are not Year 2000
compliant, but upgrades or replacement systems are currently available and will
be installed by the Bank. These upgrades or replacements for Year 2000 will also
upgrade the systems to a Windows operating system. The majority of the other
third party software systems will be converted to a Windows operating
environment as well. These upgrades or replacements are scheduled to be
installed by the end of the second quarter of 1999. The testing of these systems
is scheduled to be conducted as the software is replaced and should also be
completed in the second quarter of 1999.
15
Approximately 85% of the computers within the Bank were identified as
not being Year 2000 compliant. These computers are currently being replaced with
completion scheduled in the second quarter of 1999. Installation of a wide area
network and conversion to a Windows operating environment will be implemented
along with the replacement of the computers. Testing of the computers and the
network is scheduled to be conducted as the hardware and the network are
installed and should be completed in the second quarter of 1999.
The majority of the software and hardware being replaced are or will be
fully depreciated and are a part of a scheduled plan to upgrade the Bank's
systems to a Windows operating environment. Therefore, the Bank is not
accelerating the replacement due to Year 2000 issues and all costs associated
with the replacement of systems are considered costs incurred in the ordinary
course of business. To date the Bank has spent approximately $5,000 in costs
directly related to Year 2000. These costs were primarily related to customer
communications regarding the century date rollover. Any additional costs related
to Year 2000 are not expected to be material to the on-going operating costs of
the Company.
The failure to correct a Year 2000 problem of a mission-critical system
could result in an interruption in, or a failure of, certain normal business
activities or operations. Such failures could materially and adversely affect
the Company's results of operations, liquidity, and financial condition. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of third-party suppliers, including power companies and
telephone companies, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
result of operations, liquidity or financial condition. The Bank's Year 2000
Project is anticipated to significantly reduce the uncertainty about the Year
2000 problem and, in particular, about the Year 2000 readiness of the Bank's
data processing servicer. The Company believes that, based on the data
processing servicer's Year 2000 efforts, the Bank's testing of the servicer's
system, and the completion of the Year 2000 Project by the Bank, the likelihood
of significant interruptions of normal operations should be reduced. However, a
"worst case scenario" would be one in which the servicer's system was not
available for an extended period of time. Non-availability of the servicer's
system would most likely be the result of a power or telecommunications failure.
In this "worst case scenario" the Bank could experience material disruptions in
its ability to process customer accounts and otherwise conduct its business.
Contingency plans for Year 2000 issues relating to mission-critical
systems are being addressed by the Bank. The Bank currently has a business
resumption recovery plan that addresses various contingencies within the Bank
including the servicer's computer system being inoperable as well as other
mission-critical systems. Contingency planning for a "worst case scenario", such
as a power failure, is being addressed as well. Due to the possibility of a
power outage occurring at any given time, even outages unrelated to Year 2000,
the Bank is installing a generator powered by natural gas at the corporate
office of the Bank to provide power to mission critical equipment. Contingency
planning for Year 2000 is ongoing as systems are replaced and additional
information becomes available regarding Year 2000 issues. The updating and
validation of the business resumption recovery plan, including contingency plans
for Year 2000 related issues, is expected to be completed by June 30, 1999.
16
This page left blank intentionally.
17
INDEPENDENT AUDITORS' REPORT
The Board of Directors of
First Federal Bancshares of Arkansas, Inc.:
We have audited the consolidated statements of financial condition of First
Federal Bancshares of Arkansas, Inc. and its subsidiary (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of income
and comprehensive income, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Federal Bancshares of
Arkansas, Inc. and its subsidiary at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
[GRAPHIC OMITTED]
/s/ Deloitte & Touche LLP
Little Rock, Arkansas
February 26, 1999
18
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997 (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
ASSETS 1998 1997
------ ------
Cash and cash equivalents:
Cash and collection items $ 8,842 $ 6,548
Interest-bearing deposits with banks 17,321 79
--------- ----------
Total cash and cash equivalents 26,163 6,627
Investment securities:
Held to maturity, at amortized cost (fair value at December 31, 1998
and 1997, of $127,013 and $95,614, respectively) 127,175 95,533
Federal Home Loan Bank stock 3,912 3,603
Loans receivable, net of allowance at December 31, 1998 and 1997,
of $771 and $1,196, respectively 442,486 433,942
Accrued interest receivable 4,755 4,134
Real estate acquired in settlement of loans, net 4,270 195
Office properties and equipment, net 6,055 5,218
Prepaid expenses and other assets 239 355
--------- ----------
TOTAL $ 615,055 $ 549,607
--------- ----------
--------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits $ 481,093 $ 450,874
Federal Home Loan Bank advances 48,985 11,997
Advance payments by borrowers for
taxes and insurance 1,006 900
Other liabilities 1,990 2,952
--------- ----------
Total liabilities 533,074 466,723
--------- ----------
MINORITY INTEREST 958 --
--------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock, no par value, 5,000,000 shares authorized, none issued
Common stock, $.01 par value, 20,000,000 shares authorized, 5,153,751
shares issued, 4,512,760 and 4,896,063 shares outstanding at 52 52
December 31, 1998 and 1997, respectively
Additional paid-in capital 50,487 50,237
Employee stock benefit plans (5,037) (6,207)
Retained earnings - substantially restricted 47,678 42,982
--------- ----------
93,180 87,064
Treasury stock, at cost, 640,991 and 257,688 shares at
December 31, 1998 and 1997, respectively (12,157) (4,180)
--------- ----------
Total stockholders' equity 81,023 82,884
--------- ----------
TOTAL $ 615,055 $ 549,607
--------- ----------
--------- ----------
See notes to consolidated financial statements.
19
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
- --------------------------------------------------------------------------------
1998 1997 1996
------ ------ ------
INTEREST INCOME:
Loans receivable $ 35,762 $ 33,804 $ 30,498
Investment securities 7,802 6,207 6,258
Mortgage-backed securities 6 17 22
Other 244 417 414
-------- -------- -------
Total interest income 43,814 40,445 37,192
INTEREST EXPENSE:
Deposits 24,004 23,331 22,409
Federal Home Loan Bank advances 1,770 417 40
-------- -------- -------
Total interest expense 25,774 23,748 22,449
-------- -------- -------
NET INTEREST INCOME 18,040 16,697 14,743
PROVISION FOR LOAN LOSSES 55 -- 60
-------- -------- -------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 17,985 16,697 14,683
NONINTEREST INCOME:
Gain on sales of available for sale investment securities -- 394 --
Deposit fee income 896 814 764
Other 940 712 458
-------- -------- -------
Total noninterest income 1,836 1,920 1,222
-------- -------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,525 6,384 4,325
Net occupancy expense 874 804 672
Federal insurance premiums 276 272 902
SAIF special assessment -- -- 2,611
Provision for real estate losses 15 37 38
Data processing 804 810 745
Postage and supplies 393 369 309
Other 1,595 1,340 1,147
-------- -------- -------
Total noninterest expenses 10,482 10,016 10,749
-------- -------- -------
INCOME BEFORE INCOME TAXES 9,339 8,601 5,156
INCOME TAX PROVISION 3,309 3,099 1,756
-------- -------- -------
NET INCOME 6,030 5,502 3,400
OTHER COMPREHENSIVE INCOME, Net of tax:
Unrealized holding gain on securities arising during period -- 58 51
Less: reclassification adjustment for gains included
in net income -- (260) --
-------- -------- -------
COMPREHENSIVE INCOME $ 6,030 $ 5,300 $ 3,451
-------- -------- -------
-------- -------- -------
EARNINGS PER SHARE:
Basic $ 1.35 $ 1.22 $ 0.72
-------- -------- -------
-------- -------- -------
Diluted $ 1.33 $ 1.21 $ 0.72
-------- -------- -------
-------- -------- -------
See notes to consolidated financial statements.
20
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
ACCUMULATED
ISSUED ADDITIONAL EMPLOYEE OTHER
COMMON STOCK PAID-IN STOCK COMPREHENSIVE RETAINED
----------------------- -
SHARES AMOUNT CAPITAL BENEFIT PLANS INCOME EARNINGS
BALANCE, JANUARY 1, 1996 $ 151 $ 35,157
Net income 3,400
Issuance of common stock $ 5,153,751 $ 52 $ 49,848
Loan to Employee Stock
Ownership Plan ("ESOP") $ (4,123)
Release of ESOP shares 127 275
Net change in unrealized gain
on securities available for sale 51
Purchase of treasury stock, at cost
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1996 5,153,751 52 49,975 (3,848) 202 38,557
Net income 5,502
Release of ESOP shares 414 416
Common stock acquired or committed to be
acquired for employee stock benefit plan (152) (3,968)
Stock compensation expense 1,193
Net change in unrealized gain on
securities available for sale (202)
Dividends paid (1,077)
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1997 5,153,751 52 50,237 (6,207) -- 42,982
Net income 6,030
Release of ESOP shares 564 416
Common stock acquired for employee
stock benefit plan (434)
Stock compensation expense 754
Shares released from restricted stock trust 120
Purchase of treasury stock, at cost
Dividends paid (1,334)
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1998 5,153,751 $ 52 $ 50,487 $ (5,037) $ -- $ 47,678
------------ ------- -------- --------- ------ --------
------------ ------- -------- --------- ------ --------
TOTAL
TREASURY STOCK STOCKHOLDERS'
--------------------------
SHARES AMOUNT EQUITY
BALANCE, JANUARY 1, 1996 $ 35,308
Net income 3,400
Issuance of common stock 49,900
Loan to Employee Stock
Ownership Plan ("ESOP") (4,123)
Release of ESOP shares 402
Net change in unrealized gain
on securities available for sale 51
Purchase of treasury stock, at cost 257,688 (4,180) (4,180)
--------- -------- -------
BALANCE, DECEMBER 31, 1996 257,688 (4,180) 80,758
Net income 5,502
Release of ESOP shares 830
Common stock acquired or committed to be
acquired for employee stock benefit plan (4,120)
Stock compensation expense 1,193
Net change in unrealized gain on
securities available for sale (202)
Dividends paid (1,077)
--------- -------- -------
BALANCE, DECEMBER 31, 1997 257,688 (4,180) 82,884
Net income 6,030
Release of ESOP shares 980
Common stock acquired for employee
stock benefit plan (434)
Stock compensation expense 754
Shares released from restricted stock trust 120
Purchase of treasury stock, at cost 383,303 (7,977) (7,977)
Dividends paid (1,334)
--------- -------- -------
BALANCE, DECEMBER 31, 1998 640,991 $(12,157) $ 81,023
--------- -------- -------
--------- -------- -------
See notes to consolidated financial statements.
21
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
- --------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
OPERATING ACTIVITIES:
Net income $ 6,030 $ 5,502 $ 3,400
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 55 -- 60
Provision for real estate losses 15 37 38
Deferred tax provision 227 27 111
Gain on sale of investment securities - available for sale -- (394) --
Gain (loss) on sale of real estate owned, net 47 (158) (10)
Gain on sale of mortgage loans originated to sell (270) (30) --
Depreciation 508 465 403
Real estate owned depreciation 115 -- --
Accretion of deferred loan fees, net (855) (621) (640)
Release of ESOP shares 980 830 402
Stock compensation expense 754 1,193 --
Other (42) -- --
Changes in operating assets and liabilities:
Accrued interest receivable (621) (514) (143)
Prepaid expenses and other assets 116 370 (433)
Other liabilities 314 299 (21)
-------- -------- --------
Net cash provided by operating activities 7,373 7,006 3,167
-------- -------- --------
INVESTING ACTIVITIES:
Purchases of investment securities - held to maturity (111,418) (51,678) (41,172)
Proceeds from sales of investment securities - available
for sale -- 406 --
Proceeds from maturities of investment securities -
held to maturity 79,467 46,550 46,040
Loan originations, net of repayments (31,688) (39,305) (56,518)
Proceeds from sales of mortgage loans originated to sell 20,709 2,251 --
Proceeds from sales of real estate owned 253 205 146
Purchases of office properties and equipment (1,345) (2,118) (975)
-------- -------- --------
Net cash used by investing activities (44,022) (43,689) (52,479)
-------- -------- --------
FINANCING ACTIVITIES:
Net increase in deposits 30,219 28,016 5,629
Advances from Federal Home Loan Bank 36,988 11,997 --
Net increase in advance payments by borrowers for taxes
and insurance 106 94 60
Issuance of common stock, net of related expenses -- -- 45,777
Purchase of treasury stock (7,977) -- (4,180)
Common stock acquired for employee stock benefit plan (1,817) (2,539) --
Dividends paid (1,334) (1,077) --
-------- -------- --------
Net cash provided by financing activities 56,185 36,491 47,286
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 19,536 (192) (2,026)
CASH AND CASH EQUIVALENTS:
Beginning of year 6,627 6,819 8,845
-------- -------- --------
End of year $ 26,163 $ 6,627 $ 6,819
-------- -------- --------
-------- -------- --------
(Continued)
22
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
- --------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid for:
Interest $ 25,635 $ 23,656 $ 22,451
-------- -------- --------
-------- -------- --------
Income taxes $ 3,125 $ 2,908 $ 1,899
-------- -------- --------
-------- -------- --------
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING ACTIVITIES:
Real estate acquired in settlement of loans $ 3,888 $ 272 $ 95
-------- -------- --------
-------- -------- --------
Loans to facilitate sales of real estate owned $ 341 $ -- $ 110
-------- -------- --------
-------- -------- --------
(Concluded)
See notes to consolidated financial statements.
23
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION - First Federal
Bancshares of Arkansas, Inc. (the "Company") was incorporated in January
1996 by First Federal Bank of Arkansas, FA (the "Bank") in connection with
the conversion of the Bank from a federally chartered mutual savings and
loan association to a federally chartered stock savings and loan
association, the issuance of the Bank's common stock to the Company, and
the offer and sale of the Company's common stock by the Company (the
"Conversion"). Upon consummation of the Conversion on May 3, 1996, the
Company became a unitary holding company for the Bank. Approximately 50%
of the net proceeds from the Conversion were used to acquire 100% of the
common stock of the Bank. The remaining net proceeds from the Conversion
were retained by the Company. The Conversion was accounted for at
historical cost in a manner similar to that in pooling of interests
accounting.
The Bank provides a broad line of financial products to individuals and
small to medium-sized businesses. The consolidated financial statements
also include the accounts of the Bank's wholly-owned subsidiary, First
Harrison Service Corporation ("FHSC"), whose activities are limited to
owning an interest in a repossessed commercial property. During the first
quarter of 1998, in settlement of a loan, FHSC obtained 75% ownership of a
partnership that owned and operated a 202 room hotel in Oklahoma. The
financial position and results of operations of this hotel property have
been consolidated in the 1998 financial statements. The 25% ownership is
reflected in the consolidated statement of financial condition at December
31, 1998, as minority interest. All material intercompany transactions
have been eliminated in consolidation. Results of operations and cash
flows of the Bank for the period from January 1, 1996 to May 3, 1996, are
included in the consolidated financial statements of the Company for the
year ended December 31, 1996.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates and such differences could be significant.
LIQUIDITY REQUIREMENT - Regulations require the Bank to maintain an amount
equal to 4% of deposits (net of loans on deposits) plus short-term
borrowings in cash and U.S. Government and other approved securities.
CASH AND CASH EQUIVALENTS - For purposes of reporting cash flows, cash and
cash equivalents includes cash on hand and amounts due from depository
institutions, which includes interest-bearing amounts available upon
demand.
INVESTMENT SECURITIES - The Company classifies investment securities into
one of two categories: held to maturity or available for sale. The Company
does not engage in trading activities. Debt securities that the Company
has the positive intent and ability to hold to maturity are classified as
held to maturity and recorded at cost, adjusted for the amortization of
premiums and the accretion of discounts.
24
Investment securities that the Company intends to hold for indefinite
periods of time are classified as available for sale and are recorded at
fair value. Unrealized holding gains and losses are excluded from earnings
and reported net of tax as a separate component of stockholders' equity
until realized. Investment securities in the available for sale portfolio
may be used as part of the Company's asset and liability management
practices and may be sold in response to changes in interest rate risk,
prepayment risk, or other economic factors.
Premiums are amortized into interest income using the interest method to
the earlier of maturity or call date. Discounts are accreted into interest
income using the interest method over the period to maturity. The specific
identification method of accounting is used to compute gains or losses on
the sales of investment securities.
The overall return or yield earned on mortgage-backed securities depends
on the amount of interest collected over the life of the security and the
amortization of any premium or accretion of any discount. Premiums and
discounts are recognized in income using a method that approximates the
level-yield method over the assets' remaining lives adjusted for actual
and anticipated prepayments. Although the Company receives the full amount
of principal if prepaid, the interest income that would have been
collected during the remaining period to maturity, net of any discount
accretion or premium amortization is lost. Accordingly, the actual yields
and maturities of mortgage-backed securities depend on when the underlying
mortgage principal and interest are prepaid. Prepayments generally result
when market interest rates fall below a mortgage's contractual interest
rate and it is to the borrower's advantage to prepay the existing loan and
obtain new, lower rate financing. In addition to changes in interest
rates, mortgage prepayments depend on other factors such as loan types and
geographic location of the related properties.
If the fair value of an investment security declines for reasons other
than temporary market conditions, the carrying value of such a security is
written down to fair value by a charge to operations.
LOANS RECEIVABLE - Loans receivable that management has the intent and
ability to hold until maturity or pay-off are stated at unpaid principal
balances adjusted for any charge-offs, the allowance for loan losses and
deferred loan fees or costs and discounts. Deferred loan fees or costs and
discounts on first mortgage loans are amortized or accreted to income
using the level-yield method over the remaining period to contractual
maturity.
Mortgage loans originated and committed for sale in the secondary market
are carried at the lower of cost or estimated market value in the
aggregate. At December 31, 1998 and 1997, the balances of such loans are
not material, and are carried at cost due to the short period of time
between funding and sale, generally one to two weeks.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due or when the loan becomes 90 days past due, whichever occurs
first. When interest accrual is discontinued, all unpaid accrued interest
is reversed. Interest income is subsequently recognized only to the extent
cash payments in excess of principal due are received, until such time
that in management's opinion, the borrower will be able to meet payments
as they become due.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a valuation
allowance to provide for incurred but not yet realized losses. The Bank
reviews its non-homogeneous loans for impairment on a quarterly basis.
Impairment is determined by assessing the probability that the borrower
will not be able to fulfill the contractual terms of the agreement. If a
loan is determined to be impaired, the amount of the impairment is
measured based on the present value of expected future cash flows
discounted at
25
the loan's effective interest rate or by use of the observable market
price of the loan or fair value of collateral if the loan is collateral
dependent. Throughout the year management estimates the level of probable
losses to determine whether the allowance for loan losses is appropriate
considering the estimated losses existing in the portfolio. Based on these
estimates, an amount is charged to the provision for loan losses and
credited to the allowance for loan losses in order to adjust the allowance
to a level determined by management to be appropriate relative to losses.
The allowance for loan losses is increased by charges to income
(provisions) and decreased by charges-offs, net of recoveries.
Management's periodic evaluation of the appropriateness of the allowance
is based on the Company's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and
current economic conditions.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis.
The Bank considers the characteristics of (1) one- to- four family
residential first mortgage loans; (2) unsecured consumer loans and; (3)
secured consumer loans to permit consideration of the appropriateness of
the allowance for losses of each group of loans on a pool basis. The
primary methodology used to determine the appropriateness of the allowance
for losses includes segregating certain specific, poorly performing loans
based on their performance characteristics from the pools of loans as to
type, grading these loans, and then applying a loss factor to the
remaining pool balance based on several factors including past loss
experience, inherent risks, economic conditions in the primary market
areas, and other factors which usually are beyond the control of the Bank.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans, construction loans, multi-family, and
commercial first mortgage loans, but which differ in other characteristics
to the extent that valuation on a pool basis is not valid. Those
segregated specific loans are evaluated using the present value of future
cash flows, usually determined by estimating the fair value of the loan's
collateral reduced by any cost of selling and discounted at the loan's
effective interest rate if the estimated time to receipt of monies is more
than three months or by use of the observable market price of the loan or
fair value of collateral if the loan is collateral dependent. After
segregating specific, poorly performing loans, the remaining loans are
evaluated based on payment experience, known difficulties in the borrowers
business or geographic area, loss experience, inherent risks, and other
factors usually beyond the control of the Bank. A factor, based on
experience, is applied to these loans to estimate the probable loss.
Estimates of the probability of loan losses involve judgment. While it is
possible that in the near term the Bank may sustain losses which are
substantial in relation to the allowance for loan losses, it is the
judgment of management that the allowance for loan losses reflected in the
consolidated statements of financial condition is appropriate considering
the estimated probable losses in the portfolio.
FORECLOSED REAL ESTATE - Real estate acquired in settlement of loans is
initially recorded at estimated fair value less estimated costs to sell
and is subsequently carried at the lower of carrying amount or fair value
less estimated disposal costs. Valuations are periodically performed by
management, and an allowance for losses is established by a charge to
operations or the balance is written off if the carrying value of a
property exceeds its estimated fair value. Costs relating to the
development and improvement of the property are capitalized, whereas those
relating to holding the property are expensed.
26
OFFICE PROPERTIES AND EQUIPMENT - Office properties and equipment are
stated at cost less accumulated depreciation and amortization. The Company
computes depreciation of office properties and equipment using the
straight-line method over the estimated useful lives of the individual
assets which range from 3 to 30 years.
LOAN ORIGINATION FEES - Loan origination fees and certain direct loan
origination costs are deferred and the net fee or cost is recognized as an
adjustment to interest income using the level-yield method over the
contractual life of the loans. When a loan is fully repaid or sold, the
amount of unamortized fee or cost is recorded in income.
INCOME TAXES - The Company recognizes deferred tax liabilities and assets
for the expected future tax consequences of temporary differences between
the carrying amounts and the tax bases of assets and liabilities.
INTEREST RATE RISK - The Bank's asset base is exposed to risk including
the risk resulting from changes in interest rates and changes in the
timing of cash flows. The Bank monitors the effect of such risks by
considering the mismatch of the maturities of its assets and liabilities
in the current interest rate environment and the sensitivity of assets and
liabilities to changes in interest rates. The Bank's management has
considered the effect of significant increases and decreases in interest
rates and believes such changes, if they occurred, would be manageable and
would not affect the ability of the Bank to hold its assets as planned.
However, the Bank is exposed to significant market risk in the event of
significant and prolonged interest rate changes.
EMPLOYEE STOCK OWNERSHIP PLAN - Compensation expense for the Employee
Stock Ownership Plan ("ESOP") is determined based on the average fair
value of shares committed to be released during the period and is
recognized as the shares are committed to be released. For the purpose of
earnings per share, ESOP shares are included in weighted-average common
shares outstanding as the shares are committed to be released.
EARNINGS PER SHARE - Earnings per share of common stock has been computed
on the basis of the weighted-average number of shares of common stock
outstanding, assuming the Company was a public company since January 1,
1996.
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 128, EARNINGS PER SHARE ("SFAS 128") for the year ended December 31,
1997, and prior periods were restated. As required by SFAS 128, dual
presentation of basic and diluted earnings per share ("EPS") is included
on the face of the income statement and a reconciliation of the numerator
and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation is presented in the notes to
the consolidated financial statements. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
RECENTLY ISSUED ACCOUNTING STANDARDS - In June 1998, the Financial
Accounting Standards Board ("FASB") issued Statement No. 133, ACCOUNTING
FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"). SFAS 133
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 condition and measure those
instruments at fair value. SFAS 133 is effective for fiscal years
beginning after June 15, 1999. Management has not yet made a determination
as to the effect, if any, the adoption of SFAS 133 will have on the
Company's financial position or results of operations.
27
In October 1998, the FASB issued Statement No. 134, ACCOUNTING FOR
MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE
LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE ("SFAS 134"). This
statement amends SFAS 65 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. The adoption of SFAS No. 134 is not
expected to have a material effect on the Company's consolidated financial
statements.
RECENTLY ADOPTED ACCOUNTING STANDARDS - In 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, REPORTING
COMPREHENSIVE INCOME ("SFAS 130"). SFAS 130 establishes standards for
reporting and displaying comprehensive income and its components in the
financial statements. In addition, SFAS 130 requires the Company to
classify items of other comprehensive income by their nature in a
financial statement and display the accumulated balance of other
comprehensive income separately in the stockholders' equity section of the
statement of financial condition.
The Company also adopted Statement of Financial Accounting Standards
No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS, an amendment of FASB Statement Nos. 87, 88, and 106
("SFAS 132"). The statement revises employers' disclosure about pension
and other postretirement benefit plans. It does not change the
measurement or recognition of those plans. It standardizes the
disclosure requirements for pension and other postretirement benefits
to the extent practicable, requires additional information on changes
in the benefit obligations and fair values of plan assets that will
facilitate financial analysis, and eliminates certain disclosures that
are no longer as useful as they were when FASB Statement Nos. 87, 88,
and 106 were issued.
RECLASSIFICATIONS - Certain amounts in the 1997 and 1996 consolidated
financial statements have been reclassified to conform to the
classifications adopted for reporting in 1998.
2. INVESTMENT SECURITIES
Investment securities consisted of the following at December 31 (in
thousands):
1998
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY COST GAINS LOSSES VALUE
U.S. Government and Agency obligations $ 127,150 $ 397 $ 560 $ 126,987
Mortgage-backed securities - FHLMC 25 1 26
--------- ---------- ---------- -----------
Total $ 127,175 $ 398 $ 560 $ 127,013
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
1997
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY COST GAINS LOSSES VALUE
U.S. Government and Agency obligations $ 95,376 $ 428 $ 351 $ 95,453
Mortgage-backed securities - FHLMC 157 4 161
--------- ---------- ---------- -----------
Total $ 95,533 $ 432 $ 351 $ 95,614
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
28
The Company has pledged investment securities held to maturity with
carrying values of approximately $16 million and $15 million at December
31, 1998 and 1997, respectively, as collateral for certain deposits in
excess of $100,000.
Gross realized gains on sales of available for sale securities were
approximately $394,000 in 1997. There were no significant gross losses.
The scheduled maturities of debt securities at December 31, 1998, by
contractual maturity are shown below (in thousands). Expected maturities
may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
1998
--------------------------------
AMORTIZED FAIR
COST VALUE
Due in one year or less $ 10,008 $ 10,063
Due from one year to five years 8,188 8,236
Due from five years to ten years 14,100 14,245
Due after ten years 94,854 94,443
Mortgage-backed securities 25 26
-------------- ------------
Total $ 127,175 $ 127,013
-------------- ------------
-------------- ------------
As of December 31, 1998 and December 31, 1997, there were approximately
$113 million and $71 million, respectively, of investments with call
options held by the issuer, of which approximately $97 million and $60
million, respectively, are callable within one year.
3. LOANS RECEIVABLE
Loans receivable consisted of the following at December 31 (in thousands):
1998 1997
First mortgage loans:
One- to- four family residences $ 370,211 $ 370,955
Other properties 24,736 19,896
Construction 18,226 20,753
Less:
Unearned discounts (287) (331)
Undisbursed loan funds (6,770) (7,305)
Deferred loan fees, net (3,174) (3,320)
--------------- -------------
Total first mortgage loans 402,942 400,648
--------------- -------------
Consumer and other loans:
Commercial loans 8,437 5,649
Automobile 10,693 8,307
Consumer loans 3,977 4,065
Home equity and second mortgage 13,308 13,023
Savings loans 1,537 1,339
Other 2,199 1,968
Deferred loan costs 164 139
--------------- -------------
Total consumer and other loans 40,315 34,490
--------------- -------------
Allowance for loan losses (771) (1,196)
--------------- -------------
Loans receivable, net $ 442,486 $ 433,942
--------------- -------------
--------------- -------------
29
The Company originates and maintains loans receivable which are
substantially concentrated in its lending territory (primarily Northwest
and Northcentral Arkansas). The majority of the Company's loans are
residential mortgage loans and construction loans for residential
property. The Company's policy calls for collateral or other forms of
repayment assurance to be received from the borrower at the time of loan
origination. Such collateral or other form of repayment assurance is
subject to changes in economic value due to various factors beyond the
control of the Company.
In the normal course of business, the Company has made loans to its
directors, officers, and their related business interests. In the opinion
of management, related party loans are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with unrelated persons and do not involve
more than the normal risk of collectibility. The aggregate dollar amount
of loans outstanding to directors, officers, and their related business
interests totaled approximately $2.6 million and $2.9 million at December
31, 1998 and 1997, respectively.
Loans identified by management as impaired at December 31, 1998 and 1997,
were not significant. The Company is not committed to lend additional
funds to debtors whose loans have been modified.
4. LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal
balances of these loans at December 31 are summarized as follows (in
thousands):
1998 1997
Mortgage loans underlying FHLMC
pass-through securities $ - $ 297
Mortgage loan portfolios serviced
for other investors 849 1,037
-------- ---------
Total $ 849 $ 1,334
-------- ---------
-------- ---------
Servicing loans for others generally consists of collecting mortgage
payments, maintaining escrow accounts, disbursing payments to investors,
and foreclosure processing. Loan servicing income is recorded on the
accrual basis and includes servicing fees from investors and certain
charges collected from borrowers, such as late payment fees.
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at December 31 (in
thousands):
1998 1997
Loans $ 2,482 $ 2,645
Investment securities 2,273 1,489
---------- ----------
Total $ 4,755 $ 4,134
---------- ----------
---------- ----------
30
6. ALLOWANCE FOR LOAN LOSSES
A summary of the activity in the allowance for loan losses is as follows
for the years ended December 31 (in thousands):
1998 1997 1996
Balance, beginning of year $ 1,196 $ 1,251 $ 1,228
Provisions for estimated losses 55 60
Recoveries 9 12 3
Losses charged off (489) (67) (40)
-------- -------- ---------
Balance, end of year $ 771 $ 1,196 $ 1,251
-------- -------- ---------
-------- -------- ---------
7. FEDERAL HOME LOAN BANK STOCK
The Bank is a member of the Federal Home Loan Bank System. As a member of
this system, it is required to maintain an investment in capital stock of
the Federal Home Loan Bank ("FHLB") in an amount equal to the greater of
1% of its outstanding home loans or .3% of its total assets. No ready
market exists for such stock and it has no quoted market value. The
carrying value of the stock is its cost.
8. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consisted of the following at December 31
(in thousands):
1998 1997
Land $ 2,226 $ 2,014
Buildings and improvements 3,600 3,276
Furniture and equipment 3,956 3,237
Automobiles 443 410
-------- --------
Total 10,225 8,937
Accumulated depreciation (4,170) (3,719)
-------- --------
Office properties and equipment, net $ 6,055 $ 5,218
-------- --------
-------- --------
9. DEPOSITS
Deposits are summarized as follows at December 31 (in thousands):
1998 1997
Demand and NOW accounts, including noninterest-bearing
deposits of $14,133 and $10,539 in 1998 and 1997, respectively $ 60,248 $ 49,963
Money market 16,164 15,438
Regular savings 25,916 25,330
Certificates of deposit 378,765 360,143
-------- ----------
Total $481,093 $450,874
-------- ----------
-------- ----------
31
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100 thousand was approximately $31 million and
$27 million at December 31, 1998 and 1997, respectively.
At December 31, 1998, scheduled maturities of certificates of deposit are
as follows (in thousands):
Years ending December 31:
1999 $237,029
2000 62,567
2001 22,982
2002 18,759
2003 and thereafter 37,428
---------
Total $378,765
---------
---------
Interest expense on deposits consisted of the following (in thousands):
YEARS ENDED
DECEMBER 31,
--------------------------------
1998 1997 1996
NOW and money market $ 1,358 $ 1,299 $ 1,324
Regular savings and certificate accounts 22,745 22,145 21,178
Early withdrawal penalties (99) (113) (93)
-------- -------- --------
Total $ 24,004 $ 23,331 $ 22,409
-------- -------- --------
-------- -------- --------
Eligible deposits of the Bank are insured up to $100 thousand by the
Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC").
Legislation, passed by the U.S. House of Representatives and the Senate,
was signed into law by the President on September 30, 1996, to
recapitalize the SAIF. As a result of such legislation, the Bank was
required to pay a one-time special assessment of $2.6 million which had an
approximate $1.7 million after-tax effect. The legislation also mandated
that the deposit insurance premiums charged SAIF-insured institutions
(such as the Bank) decline to approximately 6.5 basis points effective
January 1, 1997. Effective July 1, 1998, the deposit insurance premium
declined to 6.10 basis points.
10. FEDERAL HOME LOAN BANK ADVANCES
The Bank pledges as collateral for FHLB advances their FHLB stock and has
entered into blanket collateral agreements with the FHLB whereby the Bank
agrees to maintain, free of other encumbrances, qualifying single family
first mortgage loans with unpaid principal balances, when discounted at
75% of such balances, of at least 100% of total outstanding advances.
Advances at December 31, 1998 and 1997, consisted of the following:
1998 1997
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RATE AMOUNT RATE AMOUNT
Amounts maturing in years ending
December 31:
1999 5.71 % $19,000 6.19 % $ 4,000
2000 5.31 % 14,000 6.04 % 2,000
2001 4.85 % 7,000
2002 6.60 % 3,985 6.59 % 3,997
2003 5.56 % 1,000
Thereafter 6.01 % 4,000 6.26 % 2,000
-------- ----------
Total 5.57 % $48,985 6.31 % $11,997
-------- ----------
-------- ----------
32
11. INCOME TAXES
The provisions for income taxes are summarized as follows (in thousands):
YEARS ENDED
DECEMBER 31,
----------------------------------------
1998 1997 1996
Income tax provision:
Current $ 3,082 $ 3,072 $ 1,645
Deferred 227 27 111
------------ ---------- -----------
Total $ 3,309 $ 3,099 $ 1,756
------------ ---------- -----------
------------ ---------- -----------
The reasons for the differences between the statutory federal income tax
rates and the effective tax rates are summarized as follows:
YEARS ENDED
DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996
Taxes at statutory rate $ 3,175 34.0 % $ 2,924 34.0 % $ 1,753 34.0 %
Increase resulting from:
State income tax, net 48 0.5 % 119 1.4 % - -
Other, net 86 0.9 % 56 0.6 % 3 0.1 %
------------- --------- --------- -------- --------- -------
Total $ 3,309 35.4 % $ 3,099 36.0 % $ 1,756 34.1 %
------------- --------- --------- -------- --------- -------
------------- --------- --------- -------- --------- -------
During the year ended December 31, 1996, new legislation was enacted which
provides for the recapture into taxable income of certain amounts
previously deducted as additions to the bad debt reserves for income tax
purposes. The Bank began changing its method of determining bad debt
reserves for tax purposes following the year ended December 31, 1995. The
amounts to be recaptured for income tax reporting purposes are considered
by the Bank in the determination of the net deferred tax liability.
The Company's net deferred tax liability account was comprised of the
following at December 31 (in thousands):
1998 1997
Deferred tax assets:
Loan fees deferred $ 79 $ 158
Stock based compensation 168 168
Loan loss reserves 4 --
Other -- 72
--------- --------
Total deferred tax assets 251 398
Deferred tax liabilities:
Office properties (159) (168)
Federal Home Loan Bank stock (629) (544)
Loan loss reserves -- (61)
Other (65) --
--------- --------
Total deferred tax liabilities (853) (773)
--------- --------
Net deferred tax liability $(602) $(375)
--------- --------
--------- --------
33
Specifically exempted from deferred tax recognition requirements are bad
debt reserves for tax purposes of U.S. savings and loans in the
institution's base year, as defined. Base year reserves totaled
approximately $4.2 million. Consequently, a deferred tax liability of
approximately $1.6 million related to such reserves was not provided for
in the consolidated statements of financial condition at December 31, 1998
and 1997. Payment of dividends to shareholders out of retained earnings
deemed to have been made out of earnings previously set aside as bad debt
reserves may create taxable income to the Bank. No provision has been made
for income tax on such a distribution as the Bank does not anticipate
making such distributions.
12. OTHER COMPREHENSIVE INCOME
The amount of income tax expense or benefit allocated to each component of
comprehensive income, including reclassification adjustments, are shown
below. There were no other comprehensive income components for the year
ended December 31, 1998.
YEAR ENDED DECEMBER 31, 1997
---------------------------------------
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OF BENEFIT AMOUNT
Unrealized gains on securities:
Unrealized holding gains arising during period $ 66 $ (8) $ 58
Less: reclassification of adjustment for gains
realized in net income (394) 134 (260)
-------- -------- -----------
-------- -------- -----------
Other comprehensive income $(328) $ 126 $(202)
-------- -------- -----------
-------- -------- -----------
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OF BENEFIT AMOUNT
Unrealized gains on securities:
Unrealized holding gains arising during period $ 83 $ (32) $ 51
Less: reclassification of adjustment for gains
realized in net income - - -
-------- -------- -----------
Other comprehensive income $ 83 $ (32) $ 51
-------- -------- -----------
-------- -------- -----------
13. BENEFIT PLANS
In 1997, the Company's shareholders approved the Stock Option Plan ("SOP")
and Management Recognition and Retention Plan ("MRR Plan").
STOCK OPTION PLAN - The SOP provides for a committee of the Company's
Board of Directors to award incentive stock options, non-qualified or
compensatory stock options and stock appreciation rights representing up
to 515,375 shares of Company stock. One-fifth of the options granted
vested immediately upon grant, with the balance vesting in equal amounts
on the four subsequent anniversary dates of the grant. Two-fifths of the
options granted during 1997 have vested as of December 31, 1998. Options
granted vest immediately in the event of retirement, disability, or death.
Stock options granted expire in ten years.
Under the SOP, options have been granted to directors and key employees to
purchase common stock of the Company. The exercise price in each case
equals the fair market value of the Company's stock at the date of grant.
Options granted in 1997 have exercise prices ranging from $19.25 to
$20.38, and a weighted average remaining contract life of 8.4 years at
December 31, 1998. Options granted in 1998 have exercise prices ranging
from $23.25 to $24.00 and a weighted average remaining contract life of
9.1 years at December 31, 1998.
34
A summary of the status of the Company's SOP as of December 31, 1998 and
1997, and changes during the years ending on those dates are presented
below:
WEIGHTED
AVERAGE
EXERCISE
OPTIONS SHARES PRICE
Outstanding at January 1, 1997 -- $ --
Granted 496,073 19.27
Exercised -- --
Forfeited (1,600) 19.25
------- ---------
Outstanding at December 31, 1997 494,473 19.27
Granted 13,000 23.31
Exercised -- --
Forfeited (3,600) 20.00
------- ---------
Outstanding at December 31, 1998 503,873 $ 19.37
------- ---------
------- ---------
Options exercisable at December 31, 1998 200,630 $ 19.33
------- ---------
------- ---------
The Company applies the provisions of APB Opinion No. 25 in accounting
for its stock option plan, as allowed under SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION ("SFAS 123"). Accordingly, no compensation cost
has been recognized for options granted to employees. Had compensation
cost for these plans been determined based on the fair value at the
grant dates for awards under those plans consistent with the methods of
SFAS 123, the Company's pro forma net income and pro forma earnings per
share would have been as follows:
1998 1997
------------------------- ------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
Net income (in thousands) $ 6,030 $ 5,505 $ 5,502 $ 4,987
Earnings per share:
Basic $ 1.35 $ 1.23 $ 1.22 $ 1.10
Diluted $ 1.33 $ 1.21 $ 1.21 $ 1.10
In determining the above pro forma disclosure, the fair value of options
granted during 1997 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions: expected volatility - 22%, expected life of options - 6.5
years, risk-free interest rate - 5.7%, and expected dividend rate -
1.05%. The weighted average fair value of options granted during the
fiscal year ended December 31, 1997, was $7.85 per share.
The fair value of options granted during 1998 was estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions: expected volatility - 20.28% to 21.09%, expected life of
options - 7.0 years, risk-free interest rate - 5.59% and expected dividend
rate - 1.04% to 1.17%. The weighted average fair value of options granted
during the fiscal year ended December 31, 1998, was $9.02 per share.
MANAGEMENT RECOGNITION AND RETENTION PLAN - The MRR Plan provides for a
committee of the Company's Board of Directors to award restricted stock to
key officers as well as non-employee directors. The MRR Plan authorizes
the Company to grant up to 206,150 shares of the Company stock, of which
195,844 shares were granted during 1997. Compensation expense will be
recognized based on
35
the fair market value of the shares on the grant date of $19.25 over the
vesting period. One-fifth of the shares granted to date (39,170 shares)
vested immediately on the date of grant. The remainder will vest at a rate
of 25% per year over the next four anniversary dates of the grants.
Two-fifths of the shares granted to date have vested as of December 31,
1998. Shares granted will be deemed vested in the event of disability or
death. All shares granted under the plan have been purchased in the open
market at a total cost of $4.4 million. A liability has been established,
based on the grant price, for the remainder of the shares to be purchased.
Differences between the price at the date of grant and the actual purchase
price will be recorded as an adjustment to stockholders' equity.
Approximately $754,000 and $1.2 million in compensation expense was
recognized during the years ended December 31, 1998 and 1997,
respectively.
EMPLOYEE STOCK OWNERSHIP PLAN - The Company established an Employee Stock
Ownership Plan on May 3, 1996. During 1996, the ESOP borrowed $4.1 million
from the Company to purchase shares of Company stock. The loan is
collateralized by the shares that were purchased with the proceeds of the
loan. As the loan is repaid, ESOP shares will be allocated to participants
of the ESOP and are available for release to the participants subject to
the vesting provisions of the ESOP.
Forfeitures of nonvested benefits will be reallocated among remaining
participating employees in the same proportion as contributions. During
each of the years ended December 31, 1998, 1997, and 1996, 41,604, 41,604,
and 27,465 shares, respectively, were released by the ESOP to participant
accounts. At December 31, 1998, there were 109,061 shares allocated to
participant accounts and 301,627 unallocated shares. The fair value of the
unallocated shares amounted to approximately $5,618,000 at December 31,
1998.
During the years ended December 31, 1998, 1997, and 1996, ESOP expense was
approximately $884,000, $745,000, and $402,000, respectively.
OTHER POSTRETIREMENT BENEFITS - The Bank is a participant in a
multi-employer retirement plan and therefore separate information is not
available. The plan is noncontributory and covers substantially all
employees. The plan provides a retirement benefit and a death benefit.
Retirement benefits are payable in monthly installments for life and must
begin not later than the first day of the month coincident with or next
following the seventieth birthday or the participant may elect a lump-sum
distribution. Death benefits are paid in a lump-sum distribution, the
amount of which depends on years of service. For the years ended December
31, 1997 and 1996, there was a net pension cost of approximately $56,000,
and $100,000, respectively. There was no net pension cost for the year
ended December 31, 1998.
36
14. EARNINGS PER SHARE
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
Basic EPS -
Income available to common stockholders $ 6,029,505 4,459,685 $ 1.35
Effect of dilutive securities -
Stock options -- 89,506
-------------- ----------
Diluted EPS -
Income available to common stockholders
and assumed conversions $ 6,029,505 4,549,191 $ 1.33
-------------- ----------
-------------- ----------
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
Basic EPS -
Income available to common stockholders $ 5,501,617 4,527,043 $ 1.22
Effect of dilutive securities -
Stock options -- 22,365
------------ ----------
Diluted EPS -
Income available to common stockholders
and assumed conversions $ 5,501,617 4,549,408 $ 1.21
------------- ----------
------------- ----------
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
Basic and Diluted EPS -
Income available to common stockholders $ 3,400,036 4,730,010 $ 0.72
During the year ended December 31, 1996, there were no potential
dilutive securities.
15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit and standby letters of credit. Those instruments involve, to
varying degrees, elements of credit risk in excess of the amount
recognized in the consolidated statements of financial condition. The Bank
does not use financial instruments with off-balance sheet risk as part of
its asset/liability management program or for trading purposes. The Bank's
exposure to credit loss in the event of nonperformance by the other party
to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amounts of those
instruments. The Bank uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Bank upon extension of credit, is based
37
on management's credit evaluation of the counterparty. Such collateral
consists primarily of residential properties. Standby letters of credit
are conditional commitments issued by the Bank to guarantee the
performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers.
The Bank had the following outstanding commitments at December 31, 1998
(in thousands):
Undisbursed construction loans $ 6,770
Commitments to originate mortgage loans 3,581
Letters of credit 53
Unused lines of credit 3,967
--------
Total $ 14,371
--------
--------
The funding period for construction loans is generally less than nine
months and commitments to originate mortgage loans are generally
outstanding for 60 days or less. At December 31, 1998, interest rates on
commitments ranged from 5.75% to 10.00%.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. The estimated fair values of financial
instruments are as follows (in thousands):
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
ASSETS:
Cash and cash equivalents $ 26,163 $ 26,163 $ 6,627 $ 6,627
Investment securities -
Held to maturity 127,175 127,013 95,533 95,614
Federal Home Loan Bank stock 3,912 3,912 3,603 3,603
Loans receivable, net 442,486 448,755 433,942 438,775
Accrued interest receivable 4,755 4,755 4,134 4,134
LIABILITIES:
Deposits:
Demand, NOW, money
market and regular savings 102,328 102,328 90,731 90,731
Certificates of deposit 378,765 385,084 360,143 363,640
Federal Home Loan Bank advances 48,985 49,872 11,997 12,147
Accrued interest payable 665 665 526 526
Advance payments by borrowers
for taxes and insurance 1,006 1,006 900 900
Commitments -- -- -- --
For cash and cash equivalents, Federal Home Loan Bank stock and accrued
interest receivable, the carrying value is a reasonable estimate of fair
value, primarily because of the short-term nature of the instruments or,
as to Federal Home Loan Bank stock, the ability to sell the stock back to
the Federal Home Loan Bank at cost. The fair value of investment
securities is based on quoted market prices, dealer quotes and prices
obtained from independent pricing services. The fair value of variable
rate loans are based on repricing dates. Fixed rate commercial loans and
installment loans were valued using discounted cash flows. The discount
rates used to determine the present value of these loans were based on
interest rates currently being charged by the Bank on comparable loans as
to credit risk and term.
38
The fair value of demand deposit accounts, NOW accounts, savings accounts
and money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit and Federal
Home Loan Bank advances is estimated using the rates currently offered for
deposits and advances of similar remaining maturities at the reporting
date. For advance payments by borrowers for taxes and insurance and
accrued interest payable the carrying value is a reasonable estimate of
fair value, primarily because of the short-term nature of the instruments.
Commitments are generally made at prevailing interest rates at the time of
funding and, therefore, there is no difference between the contract amount
and fair value.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1998 and 1997.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since
the reporting date and, therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
17. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements (see Note 15). In addition,
the Company is a defendant in certain claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters
is not expected to have a material adverse effect on the consolidated
financial statements of the Company.
18. RETAINED EARNINGS - SUBSTANTIALLY RESTRICTED
Upon conversion, the Company established a special liquidation account for
the benefit of eligible account holders and the supplemental eligible
account holders in an amount equal to the net worth of the Bank as of the
date of its latest statement of financial condition contained in the final
offering circular used in connection with the conversion. The liquidation
account will be maintained for the benefit of eligible account holders and
supplemental eligible account holders who continue to maintain their
accounts in the Bank after conversion. In the event of a complete
liquidation (and only in such event), each eligible and supplemental
eligible account holder will be entitled to receive a liquidation
distribution from the liquidation account in an amount proportionate to
the current adjusted qualifying balances for accounts then held.
The Company may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause the Company's stockholders' equity
to be reduced below applicable regulatory capital maintenance requirements
for insured institutions or below the special liquidation account referred
to above.
19. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the Office of Thrift Supervision ("OTS"). Failure to meet
minimum capital requirements can initiate certain mandatory--and possible
additional discretionary--actions by regulators that, if undertaken, could
have a direct material effect on the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance sheet items as
39
calculated under regulatory accounting practices. The Bank's capital
amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of tangible capital (as defined in the regulations) to
tangible assets (as defined) and core capital (as defined) to adjusted
tangible assets (as defined), and of total risk-based capital (as defined)
to risk-weighted assets (as defined).
At December 31, 1998 and 1997, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the
Bank must maintain minimum core (Tier I leverage), Tier I risk-based, and
total risk-based ratios as set forth in the table. There are no conditions
or events since that notification that management believes have changed
the Bank's category.
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the table:
TO BE CATEGORIZED
AS WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- -------------------- ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
As of December 31, 1998:
Tangible Capital to Tangible Assets $71,654 11.67 % $ 9,211 1.50 % N/A N/A
Core Capital to Adjusted Tangible Assets 71,654 11.67 % 18,423 3.00 % $30,705 5.00 %
Total Capital to Risk-Weighted Assets 72,334 22.44 % 25,786 8.00 % 32,233 10.00 %
Tier I Capital to Risk-Weighted Assets 71,654 22.23 % N/A N/A 19,340 6.00 %
As of December 31, 1997:
Tangible Capital to Tangible Assets $65,852 11.98 % $ 8,244 1.50 % N/A N/A
Core Capital to Adjusted Tangible Assets 65,852 11.98 % 16,488 3.00 % $27,480 5.00 %
Total Capital to Risk-Weighted Assets 66,619 22.52 % 23,661 8.00 % 29,576 10.00 %
Tier I Capital to Risk-Weighted Assets 65,852 22.27 % N/A N/A 17,746 6.00 %
20. PARENT COMPANY ONLY FINANCIAL INFORMATION
The following condensed statements of financial condition, as of December
31, 1998 and 1997, and condensed statements of income and of cash flows
for the years ended December 31, 1998 and 1997, for First Federal
Bancshares of Arkansas, Inc. should be read in conjunction with the
consolidated financial statements and the notes herein.
40
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS)
DECEMBER 31, 1998 AND 1997
- ----------------------------------------------------------------------------
ASSETS 1998 1997
Cash and cash equivalents (deposits in Bank) $ 85 $ 72
Loan to Bank subsidiary 8,573 17,793
Accrued interest receivable 35 82
Investment in Bank 71,654 65,852
Other assets 893 866
------- -------
TOTAL ASSETS $81,240 $84,665
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 217 $ 1,781
Stockholders' equity 81,023 82,884
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $81,240 $84,665
------- -------
------- -------
CONDENSED STATEMENTS OF INCOME (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1998 AND 1997
- ------------------------------------------------------------------------------------------------------
1998 1997
INCOME:
Interest income - investment securities $ -- $ 418
Interest income - loan to Bank 771 714
------- -------
Total income 771 1,132
EXPENSES:
Management fees 66 66
Other operating expenses 143 142
------- -------
Total expenses 209 208
------- -------
INCOME BEFORE INCOME TAX PROVISION AND EQUITY
IN UNDISTRIBUTED EARNINGS OF BANK SUBSIDIARY 562 924
INCOME TAX PROVISION 215 343
------- -------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF BANK SUBSIDARY 347 581
EQUITY OF UNDISTRIBUTED EARNINGS OF
BANK SUBSIDIARY 5,683 4,921
------- -------
NET INCOME $6,030 $5,502
------- -------
------- -------
41
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1998 AND 1997
- ---------------------------------------------------------------------------------------------------------------
1998 1997
OPERATING ACTIVITIES:
Net income $ 6,030 $ 5,502
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed net income of Bank (5,683) (4,921)
Repayment of ESOP loan 980 830
Stock compensation expense 754 1,193
Changes in operating assets and liabilities:
Accrued interest receivable 47 128
Other assets (26) (688)
Accrued expenses and other liabilities (181) 133
-------- --------
Net cash provided by operating activities 1,921 2,177
-------- --------
INVESTING ACTIVITIES:
Loan to Bank, net of repayments 9,220 (8,525)
Proceeds from maturities of investment securities - held to maturity -- 9,987
-------- --------
Net cash provided by investing activities
9,220 1,462
-------- --------
FINANCING ACTIVITIES:
Purchase of treasury stock (7,977) --
Common stock acquired for employee stock benefit plan (1,817) (2,539)
Dividends paid (1,334) (1,077)
-------- --------
Net cash used in financing activities (11,128) (3,616)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 13 23
CASH AND CASH EQUIVALENTS:
Beginning of period 72 49
-------- --------
End of period $ 85 $ 72
-------- --------
-------- --------
* * * * * *
42
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
FIRST FEDERAL BANK OF ARKANSAS, FA
- --------------------------------------------------------------------------------
DIRECTORS EXECUTIVE OFFICERS
FRANK L. COFFMAN, JR. FRANK L. COFFMAN, JR.
Chairman of the Board and Chairman of the Board and
Chief Executive Officer Chief Executive Officer
LARRY J. BRANDT LARRY J. BRANDT
President and Chief Operating President and Chief Operating
Officer Officer
JOHN P. HAMMERSCHMIDT CAROLYN M. THOMASON
U. S. Congressman, Retired Executive Vice President and Secretary
JAMES D. HEUER TOMMY W. RICHARDSON
Farming and Investments Senior Vice President and Chief Financial Officer
WILLIAM F. SMITH SHERRI R. BILLINGS
Retired Pharmacist and Investments Senior Vice President and Treasurer
BANKING LOCATIONS
- --------------------------------------------------------------------------------
MAIN OFFICE
200 West Stephenson
Harrison, Arkansas 72601
BRANCH OFFICES
128 West Stephenson Ozark Mall - Highway 62-65 North 301 Highway 62 West
Harrison, Arkansas 72601 Harrison, Arkansas 72601 Yellville, Arkansas 72687
Corner Central & Willow 324 Highway 62-65 Bypass 307 North Walton Blvd.
Harrison, Arkansas 72601 Harrison, Arkansas 72601 Bentonville, Arkansas 72712
210 South Main 1303 West Hudson 3460 North College
Berryville, Arkansas 72616 Rogers, Arkansas 72756 Fayetteville, Arkansas 72703
668 Highway 62 East 201 East Henri De Tonti Blvd. 2025 North Crossover Road
Mountain Home, Arkansas 72653 Tontitown, Arkansas 72762 Fayetteville, AR 72703
1337 Hwy 62 SW 249 West Main Street
Mountain Home, Arkansas 72653 Farmington, AR 72730
43
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
First Federal Bancshares of Arkansas, Inc. is a unitary savings and loan
holding company conducting business through its wholly-owned subsidiary, First
Federal Bank of Arkansas, FA. The Bank is a federally-chartered, SAIF- insured
savings institution operating through its main office and eleven full service
branch offices. The Company's and the Bank's principal executive office is
located at 200 West Stephenson, Harrison, Arkansas 72601.
TRANSFER AGENT/REGISTRAR
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
Phone: (800) 368-5948
- --------------------------------------------------------------------------------
STOCKHOLDER REQUESTS
Request for annual reports, quarterly reports and related stockholder literature
should be directed to Investor Relations, First Federal Bancshares of Arkansas,
Inc., P. O. Box 550, Harrison, Arkansas 72602.
Stockholders needing assistance with stock records, transfers or lost
certificates, should contact the Company's transfer agent, Registrar and
Transfer Company, at the telephone number listed above.
- --------------------------------------------------------------------------------
COMMON STOCK INFORMATION
Shares of the Company's common stock are traded under the symbol "FFBH"
on the Nasdaq National Market System. At March 15, 1999, the Company had
4,418,697 shares of common stock outstanding and had approximately 1,291
stockholders of record. Such holdings do not reflect the number of beneficial
owners of common stock.
The following table sets forth the reported high and low sale prices of
a share of the Company's common stock as reported by Nasdaq for the periods
indicated.
- -----------------------------------------------------------------------------------------------------------
QUARTER YEAR ENDED YEAR ENDED
ENDED DECEMBER 31, 1998 DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------------------
High Low Dividend High Low Dividend
--------------- ------------ ------------- ----------- ----------- --------------
MARCH 31 $30.25 $22.75 $0.07 $20.38 $15.88 $0.05
JUNE 30 30.13 26.31 0.07 20.63 17.38 0.05
SEPTEMBER 30 26.31 18.50 0.07 21.75 20.13 0.06
DECEMBER 31 21.00 16.00 0.07 24.38 20.00 0.06
- -----------------------------------------------------------------------------------------------------------
44