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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 0-28080
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UNITED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
MINNESOTA 81-0507591
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
P.O. Box 2779, 120 1st Avenue North, Great Falls, Montana 59403
(Address of Principal Executive Offices)
(406) 727-6106
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. YES |X| NO | |
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. | |
Indicate by checkmark whether the Registrant is an accelerated filer
(as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes | | No |X|
The aggregate market value of the voting common stock held by
non-affiliates of the Registrant, as of June 28, 2002 (the last day of the
Registrant's most recently completed second fiscal quarter), was $20,791,494
(based on the last sale price of such stock as quoted on the Nasdaq National
Market ($23.00) on such date).
The number of shares of Registrant's common stock outstanding on
February 28, 2003 was 1,626,150. Registrant's common stock is traded on the
Nasdaq National Market, under the symbol UBMT.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.
UNITED FINANCIAL CORP.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 17
ITEM 3. LEGAL PROCEEDINGS 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS 18
ITEM 6. SELECTED FINANCIAL DATA 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 36
ITEM 11. EXECUTIVE COMPENSATION 36
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 36
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 36
ITEM 14. CONTROLS AND PROCEDURES 36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K 37
SIGNATURES AND CERTIFICATIONS 38
EXHIBIT INDEX 41
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PART I
------
ITEM 1. BUSINESS
GENERAL. United Financial Corp. ("UFC") is a bank holding company
headquartered in Great Falls, Montana, with operations in 12 Montana communities
and Phoenix and Scottsdale, Arizona. UFC's banking business in Montana is
conducted through its wholly-owned subsidiary, Heritage Bank ("Heritage Bank"),
and in Arizona is conducted through Valley Bank of Arizona ("Valley Bank"), the
wholly-owned subsidiary of Valley Bancorp, Inc. ("Valley"), a majority-owned
subsidiary of UFC. Heritage Bank and Valley Bank are collectively referred to
herein as the "Banks". UFC's wholly-owned subsidiary, United Financial-Montana
Capital Trust I ("Capital Trust") was established in 2001 to issue and
administer $3.0 million of Capital Trust Pass-Through Securities. (See Part IV,
Item 15-"Notes to Consolidated Financial Statements-Trust Preferred
Securities"). UFC, Capital Trust, Heritage Bank and Valley are collectively
referred to herein as ("United"). United had assets of approximately $378.0
million, deposits of approximately $287.0 million and stockholders' equity of
approximately $30.5 million at December 31, 2002.
UFC owned approximately 65% of Valley at December 31, 2002. As a result of
acquiring over 50% of the outstanding shares of Valley in January 2000, UFC has
consolidated Valley in its financial statements effective January 1, 2000. The
aggregate purchase price of all shares of Valley purchased by UFC to date is
approximately $7.2 million. Valley had assets of approximately $74.5 million,
deposits of approximately $61.8 million and stockholders' equity of
approximately $8.5 million at December 31, 2002.
Effective January 1, 2001, Heritage Bank F.S.B., a federally-chartered
stock savings bank, merged into Heritage State Bank's state banking charter.
Heritage State Bank ("State Bank") then changed its name to Heritage Bank and
relocated its main office to Great Falls, Montana. Since 2001, Heritage Bank has
been regulated by the FDIC and the State of Montana. Heritage Bank F.S.B. and
State Bank were both wholly-owned subsidiary banks of UFC, prior to their
merger.
Heritage Bank is a state-chartered commercial bank with locations in
Bozeman, Chester, Fort Benton, Geraldine, Glendive, Great Falls, Hamilton,
Havre, Kalispell, Libby, Missoula and Shelby, Montana. In 2003, Heritage Bank
received approval from the State of Montana and the Federal Deposit Insurance
Corporation ("FDIC") to open a full service branch in Billings, Montana, which
is scheduled to be in operation by the end of 2003. Valley Bank is a
state-chartered commercial bank with locations in Phoenix and Scottsdale,
Arizona. The Banks are engaged in the community banking business of attracting
deposits from the general public through their offices and using those deposits,
together with other available funds, to originate commercial (including lease
financing), commercial real estate, residential, agricultural and consumer loans
primarily in their market areas in Montana and Arizona. A majority of the Banks'
banking business is conducted in the Great Falls and Phoenix areas. Based on
total assets, 43% of United's assets are located at Heritage Bank's Great Falls
locations and 18% at Valley Bank's Phoenix location. The Banks also invest in
mortgage-backed securities, U.S. Treasury obligations, other U.S. Government
agency obligations and other interest-earning assets. Heritage Bank also holds a
14% ownership interest in Bankers' Resource Center, a computer data center.
The Banks' financial condition and results of operations, and therefore
the financial condition and results of operations of United, are dependent
primarily on net interest income and fee income. The Banks' financial condition
and results of operations are also significantly influenced by local and
national economic conditions, changes in market interest rates, governmental
policies, tax laws and the actions of various regulatory agencies.
UFC's principal offices are located at 120 First Avenue North, Great
Falls, Montana, and its telephone number is (406) 727-6106.
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UFC makes available all periodic and current reports, free of charge, on
its website as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange Commission
("SEC"). UFC's website address is www.ufcmontana.com. The contents of our
website are not incorporated into this report or into our other filings with the
SEC.
LENDING ACTIVITIES
GENERAL. Lending activities are United's primary source of both interest
income and fee income. United's interest income from loans receivable was
approximately $19.5 million, $22.4 million and $20.9 million, or approximately
83%, 83% and 81% of total interest income, for the years ended December 31,
2002, 2001 and 2000, respectively. United's principal lending activity has been
the origination of real estate loans, including conventional residential real
estate loans (loans which are neither insured nor partially guaranteed by
government agencies) and residential real estate loans insured by the Federal
Housing Administration ("FHA") or partially guaranteed by the Veterans
Administration ("VA"). United also originates agricultual and commercial loans
secured by real estate. In addition to loans secured by real estate, United's
lending activity includes the origination of non-mortgage commercial,
agricultural and consumer loans.
The following table sets forth the composition of United's loans
receivable at December 31, 2002, 2001, 2000, 1999 and 1998:
(Dollars in thousands)
December 31, December 31, December 31,
-------------------------- -------------------------- -------------------------
2002 2001 2000
-------------------------- -------------------------- -------------------------
Amount Percent Amount Percent Amount Percent
------------ ------------ ------------ ------------ ----------- -----------
Loans secured by real
estate:
1 - 4 residential $ 27,551 10.9% $ 32,539 12.3% $ 33,855 13.3 %
5 or more residential 4,693 1.9 5,010 1.9 6,326 2.5
Construction 15,259 6.0 19,384 7.3 12,850 5.0
Agricultural 26,298 10.3 24,655 9.3 24,689 9.7
Commercial 72,993 28.7 77,628 29.5 65,268 25.7
------------ ------------ ------------ ------------ ----------- -----------
Total loans secured by real
estate 146,794 57.8 159,216 60.3 142,988 56.2
Commercial loans 59,428 23.4 60,579 22.9 69,324 27.3
Tax exempt municipal loans 1,469 .6 1,685 .6 1,489 .6
Agricultural loans 14,548 5.7 11,607 4.4 10,469 4.1
Savings account and other
loans 875 .3 1,532 .6 1,138 .5
Second mortgage consumer
loans 5,559 2.2 5,438 2.1 4,745 1.9
Consumer loans 25,331 10.0 23,970 9.1 24,019 9.4
------------ ------------ ------------ ------------ ----------- -----------
Total loans receivable 254,004 100.0% 264,027 100.0% 254,172 100.0 %
============ ============ ===========
Less:
Allowance for loan losses 3,573 3,503 2,526
------------ ------------ -----------
Net loans receivable $250,431 $260,524 $251,646
============ ============ ===========
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(Dollars in thousands) December 31, December 31,
-------------------------- --------------------------
1999 1998
-------------------------- --------------------------
Amount Percent Amount Percent
------------ ----------- ------------ ------------
Loans secured by real estate:
1 - 4 residential $ 34,097 18.1% $ 27,109 18.7%
5 or more residential 5,237 2.8 6,601 4.6
Construction 10,564 5.6 9,224 6.4
Agricultural 16,210 8.6 10,275 7.1
Commercial 30,594 16.3 27,449 18.9
------------ ----------- ------------ ------------
Total loans secured by real
Estate
96,702 51.4 80,658 55.7
Commercial loans 60,060 32.0 37,564 25.9
Tax exempt municipal loans 1,428 .8 1,477 1.0
Agricultural loans 9,805 5.2 8,191 5.7
Savings account and other loans 961 .5 728 .5
Second mortgage consumer loans 7,702 4.1 9,066 6.3
Consumer loans 11,276 6.0 7,160 4.9
------------ ----------- ------------ ------------
Total loans receivable 187,934 100.0% 144,844 100.0%
=========== ============
Less:
Allowance for loan losses 1,586 1,485
------------ ------------
Net loans receivable $186,348 $143,359
============ ============
RESIDENTIAL (NON-CONSTRUCTION) REAL ESTATE LENDING. Residential mortgage
lending constitutes a significant portion of United's lending activities.
United's residential loan originations are conducted by residential loan
production officers in its twelve banking offices, its one loan production
office in Montana and the Scottsdale banking office in Arizona. The greatest
majority of United's residential loan production is secured by properties
located in Montana.
Under United's residential lending policies, most loans originated conform
to Government National Mortgage Association/Federal National Mortgage
Association ("GNMA/FNMA") secondary mortgage market standards and are secured by
residential property with a value of not more than 80% (or 95% if private
mortgage insurance is obtained) of the principal amount of the loan. In
accordance with federal guidelines, an appraisal by an independent licensed or
certified appraiser is required for residential loans in excess of $250,000.
United generally also obtains appraisals or valuations on most residential loans
under $250,000. The terms of United's conventional real estate loans provide
that the loan can be prepaid without penalty and typically include a due-on-sale
clause that provides for acceleration of indebtedness upon the sale or other
disposition of secured property. Evidence of fire, casualty and hazard insurance
with a mortgagee clause in favor of United is required prior to settlement of
residential and commercial real estate loans. Title insurance is generally
required on properties securing such loans.
Most of United's residential loans are originated through personal
contacts of loan officers, including contacts with local realtors, and through
referrals from deposit customers. Although the majority of United's loans are
fixed rate loan products that are subsequently sold, United does offer a variety
of adjustable rate residential loans. The interest rates on variable loans vary
with the movement of the index upon which the interest rates are based. If the
interest rates change, loan payments, balances or terms may be adjusted.
United's primary indexes are the 1, 3 and 5-year constant maturity Treasury
indexes. Most of the ARMs currently originated by United have loan terms of 15
to 30 years with rate adjustments generally every 1, 3 or 5 years during the
term of the loan. Generally, interest rate adjustments on United's ARMs are
limited to changes of 2.5% - 3.25% per year and 6% - 10% for the life of the
loan.
The majority of United's total production of long-term (15 to 30-year
maturity) fixed rate residential loans is originated according to pre-arranged
underwriting standards that result in immediate sale to the secondary market,
primarily to mortgage bankers and pension funds. While origination and sale of
these loans produces fee
3
income, the loans are carried at their outstanding principal balance,
which is the contracted purchase price, and therefore no gain or loss is
realized at sale, except for gains associated with recognizing any retained
mortgage servicing rights. United sold long-term fixed-rate mortgage loans to
the secondary market in aggregate amounts of approximately $196.8 million in
2002, $167.5 million in 2001 and $108.7 million in 2000. United also sells
long-term fixed-rate loans that are refinances of existing portfolio loans or
permanent financing of completed construction loans to the secondary market or
State of Montana housing agencies. These loans are carried at their outstanding
principal balance, which was the contracted purchase price, and therefore no
gain or loss is realized at sale. United retains a limited number of adjustable
rate mortgages and fixed rate mortgage loans up to 15-year maturities for its
own portfolio.
REAL ESTATE CONSTRUCTION LOANS. In addition to permanent real estate
mortgage loans, United also provides interim financing for the construction of
single-family and multi-unit dwellings, commercial real estate and improvements
of real estate. Construction loans are generally made for periods of
approximately nine months, with interest paid at periodic intervals. Such loans
may be extended for several months due to adverse weather conditions or other
justifiable delays in construction. United provides financing primarily for a
limited number of registered contractors who have demonstrated an ability to
complete projects in residential development and construction, have operated in
United's lending area for a number of years and are deemed to be financially
responsible. United also provides construction loans for clients who have made
the decision to construct a new home for their personal use and in that case the
Bank client will choose their own contractor who is then approved by the Banks.
The Banks assure that permanent financing is in place prior to entering into a
construction loan for an individual client.
COMMERCIAL AND AGRICULTURAL REAL ESTATE LOANS. United engages in
commercial real estate lending secured by both commercial and agricultural
properties. Occasionally when making such loans, United participates in the U.S.
Small Business Administration's program for guaranteed commercial real estate
loans. United's loans on commercial and agricultural real estate are primarily
first lien loans with 10 to 15-year maturities and adjustable interest rates
based on U.S. Treasury indexes for 1, 3 and 5 years. While government
regulations limit the level of commercial real estate lending by a financial
institution to 400% of its capital, this limitation has not had a material
impact on the lending activities of the Banks to date.
NON-MORTGAGE COMMERCIAL AND AGRICULTURAL LENDING. In addition to real
estate lending, United offers commercial and agricultural non-mortgage loans.
United offers commercial lines of credit, equipment term loans, working capital
loans and loans guaranteed by the Small Business Administration to its business
customers. It also offers seasonal lines of credit and term equipment loans to
its agricultural borrowers and purchases, on a participation basis, loans
originated outside its normal market areas. Participaion loans are generally
purchased from commercial banks and third party loan production offices.
Generally, these purchased participations allow United to diversify its
geographic risk and are purchased with a higher level of underwriting standards
since a direct customer relationship does not exist.
CONSUMER LENDING. United's consumer loan portfolio includes home equity,
home improvement, line of credit, auto, deposit account, dealer loans and credit
card receivables. United has entered into agreements with certain local
merchants to purchase qualifying conditional sales contracts. United's consumer
lending is conducted at branch offices and United's home offices in Great Falls
and Phoenix. United requires fire, hazard and casualty insurance for loans
secured by home equity and casualty insurance for loans secured by autos and
recreational vehicles. The Banks also maintain an underlying vendors single
interest insurance policy to protect it in the event a loss is incurred to a
non-insured customer vehicle.
INVESTMENT ACTIVITIES
The investment activities of United are designed to provide an investment
alternative for funds not presently required to meet loan demand, assist in
maximizing
4
income, supply collateral to secure public funds and retail repurchase
agreements, provide a means for balancing market and credit risks, and provide
consistent income and market value throughout changing economic times.
Interest income from investment activities was approximately $3.6 million,
$3.9 million and $4.4 million, or approximately 15.3%, 14.4% and 17.1% of
United's total interest income, for the years ended December 31, 2002, 2001 and
2000, respectively.
United's portfolio consists primarily of obligations of the U.S.
government and its agencies, mortgage-backed securities, municipal bonds and
corporate bonds and equity securities. United's investment portfolio does not
contain a concentration of investments in any one issuer in excess of 10% of
United's total investment portfolio, except for securities of the U.S.
government and U.S. government agencies. All of United's investments are
classified as available-for-sale.
The following table sets forth the carrying values of United's investments
at December 31, 2002, 2001 and 2000:
(Dollars in thousands)
December 31, December 31, December 31,
2002 2001 2000
--------------- --------------- --------------
U.S. government and federal agencies $14,031 $30,707 $ 23,872
Mortgage-backed securities 43,255 39,282 41,536
Municipal bonds 1,999 1,745 2,717
Corporate bonds and equity securities 1,651 1,529 1,939
--------------- --------------- --------------
$60,936 $73,263 $ 70,064
=============== =============== ==============
During 2002, United received $22.2 million in mortgage-backed security
principal payments and had $48.0 million of calls and maturities of investment
securities. Sales of investment securities and mortgage-backed securities were
$3.1 million in 2002 and purchases totaled $60.0 million. United recorded an
unrealized gain in market values of its investment portfolio of $.9 million,
before taxes. The increase in principal payments on mortgage-backed securities
and the increase in calls of investment securities are both results of the
unprecedented drops in interest rates during 2002 as compared to 2001. United's
purchases of investment securities increased accordingly to maintain its
investment portfolio.
During 2001, United received $14.6 million in mortgage-backed security
principal payments and had $21.4 million of calls and maturities of investment
securities. United sold $7.8 million of investment securities and
mortgage-backed securities while purchasing $46.3 million in investment
securities and mortgage-backed securities. United recorded an unrealized gain in
market values of its investment portfolio of $.8 million, and a realized gain of
$.2 million, before taxes.
SOURCES OF FUNDS
The primary sources of funds for United's lending and investment
activities are deposits, repurchase agreements, Federal Home Loan Bank ("FHLB")
borrowings, loan and mortgage-backed securities repayments, proceeds from loan
sales, investment securities, interest payments and maturities, and net
operating revenues.
DEPOSIT ACTIVITIES. Deposits are attracted from within United's market
area through the offering of a broad selection of deposit instruments, including
NOW accounts, money market accounts, regular savings accounts, certificates of
deposit and retirement savings plans. Deposit account terms vary, according to
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. In determining the terms of its
deposit accounts, United considers current market interest rates, profitability
to United, matching deposit and loan products offered by its competition and its
customer preferences and concerns. United reviews its deposit mix and pricing
weekly.
5
The following table sets forth the composition of United's deposits at
December 31, 2002, 2001 and 2000:
(Dollars in thousands) December 31, December 31, December 31,
------------------------- ------------------------ -------------------------
2002 2001 2000
------------------------- ------------------------ -------------------------
Type: Amount Percent Amount Percent Amount Percent
------------- ---------- ----------- ----------- ------------ -----------
Non-interest bearing $ 48,227 16.8% $ 46,689 16.5% $ 33,349 12.7%
Interest bearing:
NOW & money market
demand accounts 59,752 20.8 50,990 18.1 52,018 20.0
Savings accounts 50,980 17.8 50,829 18.0 39,033 14.9
Time deposits 128,021 44.6 133,892 47.4 136,779 52.4
------------- ---------- ----------- ----------- ------------ -----------
Total $286,980 100.0% $ 282,400 100.0% $ 261,179 100.0%
============= ========== =========== =========== ============ ===========
Scheduled maturities of certificates of deposit at December 31, 2002 are
as follows:
(Dollars in thousands)
Due within one year $ 88,010
Due within two to three years 35,751
Due within four to five years 4,259
-----------
Totals $128,020
Time deposits of $100,000 or more were approximately $36.1 million, $34.0
million and $30.8 million at December 31, 2002, 2001 and 2000, respectively.
Amounts in excess of $100,000 are not insured by a federal agency.
The maturity of time deposits of $100,000 or more at December 31, 2002 was
as follows:
(Dollars in thousands)
Less than three months $12,194
Three to six months 6,244
Six to twelve months 8,787
Greater than twelve months 8,826
-------
Total $36,051
=======
Early withdrawal from time deposits subjects the depositor to an early
withdrawal penalty which is currently equal to six months of simple, nominal
interest when the original maturity is longer than one year, three months of
simple, nominal interest when original maturity is 92 days to one year, and all
interest earned when original maturity is 91 days or less.
As a matter of policy, United does not accept, place or solicit brokered
deposits. Although deposits are not solicited outside of Montana, historically,
a small number of the Banks' depositors have resided outside Montana and
Arizona. As market demand generally dictates deposit maturities and rates,
United intends to continue to offer those types of accounts that it believes
have broad market appeal.
BORROWINGS. United relies to a significant extent on borrowings from the
FHLB to finance its short-term, and increasingly its longer term, financing
needs. The FHLB functions as the central reserve bank providing credit for
savings institutions and certain other member financial institutions. Borrowings
from the FHLB are available at various maturities, which facilitates the
accurate matching of asset and liability maturity dates. In 2002, United used
these available borrowings to manage interest rate risk.
As members of the FHLB, the Banks are required to own capital stock in the
FHLB and are authorized to apply for advances on the security of specified
collateral.
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Advances are made pursuant to several different credit programs. Each
credit program has its own interest rate and range of maturities. Each of
Heritage Bank's and Valley Bank's established available FHLB advance credit
lines for 2002 was 25% of assets. The FHLB is required to review its credit
limitations and standards at least annually. For the years ended December 31,
2002, 2001 and 2000, FHLB advances averaged $44.8 million, $52.4 million and
$53.4 million, respectively. The maximum outstanding at any month end during the
years ended December 31, 2002, 2001 and 2000 was $46.5 million, $61.8 million
and $63.9 million, respectively. At December 31, 2002, 2001 and 2000, $38.0
million, $50.5 million and $52.2 million, respectively, of FHLB advances were
outstanding. The weighted average interest rate on FHLB advances at December 31,
2002, 2001 and 2000 was 4.56%, 5.65% and 6.57%, respectively.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. United also generates
funds through the sale of investment securities under agreements requiring their
repurchase at a premium that represents interest. The securities underlying
agreements to repurchase are for the same securities originally sold and are
held in a custody account by a third party. For the years ended December 31,
2002, 2001 and 2000, securities sold under agreements to repurchase averaged
approximately $9.9 million, $8.7 million and $11.5 million, respectively. The
maximum outstanding at any month end during the years ended December 31, 2002,
2001 and 2000 was approximately $13.5 million, $9.6 million and $13.9 million,
respectively. United had $12.8 million, $9.6 million and $11.4 million of
securities sold under agreements to repurchase at December 31, 2002, 2001 and
2000, respectively. The weighted average interest rate on securities sold under
agreements to repurchase at December 31, 2002, 2001 and 2000 was 1.69%, 3.68%
and 6.16%, respectively.
TRUST PREFERRED SECURITIES. In July 2001, UFC issued junior subordinated
debentures, aggregating $3.0 million to United Financial-Montana Capital Trust I
(Trust). The Trust issued preferred securities, as part of a pooled issue, with
an aggregate liquidation amount of $3.0 million ($1,000 per capital security) to
third-party investors. The junior subordinated debentures and cash are the sole
assets of the Trust. The preferred securities are includable as Tier I capital
for regulatory capital purposes. The offering price was $1,000 per capital
security. The junior subordinated debentures and the preferred securities pay
interest and dividends, respectively, on a semi-annual basis, which are included
in interest expense. The variable interest rate resets on January 30 and July 30
of each year, based upon six month LIBOR plus 3.75%. The interest rate reset on
January 30, 2003 was 5.10%. The Trust is a statutory business trust formed under
the laws of the State of Delaware and is wholly-owned by UFC. The junior
subordinated debentures and preferred securities will mature on July 25, 2031.
The junior subordinated debentures and preferred securities can be redeemed
contemporaneously, in whole or in part, after five years at decreasing premiums
with the permission of the Board of Governors of the Federal Reserve System (the
"Federal Reserve"). UFC has provided a full and unconditional guarantee of the
obligations of the Trust in the event of the occurrence of an event of default,
as defined. Debt issuance costs totaling $118,812 were capitalized related to
the debenture offering and are being amortized over the 10-year non-premium
callable life of the preferred securities.
OTHER ACTIVITIES
Heritage Bank also holds a 14% ownership interest in Bankers' Resource
Center, a computer data center, which provides certain data processing services
to Heritage Bank and UFC. Heritage Bank had a wholly-owned service corporation,
CSC, which owned and managed a limited amount of real estate held for investment
during 1999, was inactive during 2000 and was dissolved in 2001.
MARKET AREA
Great Falls, the county seat of Cascade County and a regional trade
center, is one of the largest cities in Montana. The estimated 2002 Great Falls
and Cascade County populations were approximately 57,000 and 80,000,
respectively. The economy of Great Falls is largely based on agriculture, health
care and Department of Defense activities. Malmstrom Air Force Base ("MAFB"),
which employs approximately 4,000
7
people, is the largest employer in Great Falls and Cascade County. Any
significant reduction in size or closure of MAFB would likely adversely affect
United and its results of operations and financial condition.
The economies of Chester, Fort Benton, Geraldine, Glendive, Havre and
Shelby, Montana are dependent to a large extent on agricultural, livestock and
railroad activities. Areas such as Bozeman, Great Falls, Hamilton, Kalispell,
Libby and Missoula are supported in part by tourism, higher education and
natural resources. Nevertheless, agriculture and natural resources are among the
predominant activities in the State of Montana, and any adverse trends in either
of these two industries could adversely affect United and its results of
operations and financial condition.
Phoenix is the largest metropolitan area in Arizona with a population of
approximately 3 million. Arizona was one of the fastest growing states in the
nation, according to the 2000 Census. Arizona's population grew to 5.1 million
or 40% over the past decade, more than triple the national rate. Major
employment industries are service industries, construction in Arizona and light
manufacturing. A slowdown in the real estate economy or manufacturing could
adversely affect United and its results of operations and financial condition.
COMPETITION
The Banks, like other depository institutions, are operating in a rapidly
changing environment and, therefore, face considerable competition in the
attraction of deposits and the origination of loans. Historically, the most
direct competition for deposits has come from other savings banks, credit unions
and commercial banks. There are approximately 39 depository institutions,
commercial banks, credit unions and savings banks with offices in United's
Montana market areas, and approximately 95 in its Arizona market area. In
addition to these entities, United estimates there are approximately 31 mortgage
companies directly competing with its real estate originators in the Montana
market area. Non-depository financial service organizations, primarily in the
securities and insurance industries, have also become competitors for retail
savings and investment funds. United's deposit programs compete with money
market mutual funds, government securities and other investment alternatives.
United competes for deposits by offering a variety of deposit accounts at
interest rates based upon market conditions, convenient business hours, quality
service and convenient branch locations.
EMPLOYEES
At February 28, 2003, Heritage Bank employed 104 full-time employees and
28 part-time employees, and Valley employed 17 full-time employees and 5
part-time employees. United maintains a comprehensive employee benefit program
providing, among other benefits, hospitalization and major medical insurance,
paid sick leave, disability, life insurance and 401K retirement plans. United's
employees are not represented by any collective bargaining group. See Part IV,
Item 14. - "Notes to Consolidated Financial Statements - Employee Benefit
Plans."
8
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to the executive
officers of UFC. All executive officers are elected annually by the Board of
Directors. There are no arrangements or understandings between individual
officers and any other person pursuant to which he or she was elected as an
officer.
Name Age Position Held
---- --- -------------
John M. Morrison 66 Director of UFC, Heritage Bank and Valley
Kurt R. Weise 46 Chairman and Chief Executive Officer of UFC;
Director and Vice President of Heritage Bank ;
Vice President and Director of Valley and Valley
Bank
Kevin P. Clark 47 Director, Secretary and Senior Vice President of
UFC; Director, President and Chief Executive
Officer of Heritage Bank; Director of Valley
Steve L. Feurt 47 Director, Senior Vice President and Chief Credit
Officer of UFC; Director, Executive Vice
President and Senior Lending Officer of Heritage
Bank
Paula J. Delaney 42 Chief Financial Officer of UFC; Director and
Vice President of Heritage Bank
Mr. Morrison served as Chairman of UFC from February 1998 to his
resignation in January 2003. Mr. Morrison's term of office as director of UFC
expires at UFC's annual shareholder meeting in 2003. Mr. Morrison was elected to
the Valley and Valley Bank boards in March 1996. Prior to February 1998, he
served as Chairman of Heritage Bank since 1994. Mr. Morrison is the Chief
Executive Officer and sole shareholder of Central Bancshares, Inc. ("Central
Bancshares"), the parent company of Central Bank, located in Stillwater,
Minnesota, which was founded by Mr. Morrison in 1988. He is also the sole
shareholder and Chairman of the Board of Directors of Central Financial Services
("CFS"), a bank-consulting firm. In August 2001, Mr. Morrison became Chairman of
the Board of Directors and Chief Executive Officer of Allina Health Systems, a
non-profit organization in Minnesota that provides healthcare services through
hospitals and clinics in Minnesota and Wisconsin. To avoid a conflict of
interest, Mr. Morrison resigned from the boards of Fairview Corporation,
Fairview-University Medical Center and Fairview-University of Minnesota upon
taking the Allina position. He resigned as a director of Valley Bank in October
2002 but continues as a director at Valley. Also in October 2002, Mr. Morrison
resigned as CEO of Allina, but remained as Chairman. In March 2003, Mr. Morrison
resigned as Chairman and remains as Vice Chairman of Allina. Mr. Morrison is
involved in various other businesses, and serves as Chairman of the Executive
Committee of the Board of Trustees of the University of St. Thomas, and is a
member of the board of the University of St. Thomas Law School.
Mr. Weise has served as Chief Executive Officer of UFC since the annual
shareholder meeting in 1999 and became chairman of UFC upon Mr. Morrison's
resignation in January 2003. Mr. Weise has served as President and director of
UFC, and director and Vice President of Heritage Bank, since February 1998. Mr.
Weise's term of office as a director of UFC expires at UFC's annual shareholder
meeting in 2003. Mr. Weise was elected to the Valley and Valley Bank boards in
March 1999. Prior to February 1998, he served as Vice President, Treasurer and a
director of Heritage Bank. Mr. Weise also serves as President of CFS and
President of Central Bancshares. He has been involved in various capacities with
the Central Bank group of companies since they were founded in 1988. He was the
Chief Financial Officer of Bank of Montana Systems ("BMS") until its sale to
Norwest Corporation in 1994.
Mr. Clark has served as Senior Vice President and Secretary of UFC, and
director, President and Chief Executive Officer of Heritage Bank, since February
1998. Mr. Clark was elected as Vice President and a director of UFC in May 1998,
and his term of office as a director of UFC expires at UFC's annual shareholder
meeting in 2003. Mr. Clark was elected to the Valley board in May 2000. Prior to
February 1998, he served as President, Chief Executive Officer and a director of
Heritage Bank since
9
1994. Mr. Clark served in various capacities with BMS until its sale to Norwest
Corporation, including President, Chief Executive Officer and a director of Bank
of Montana, a subsidiary of BMS, and Regional Vice President of BMS.
Mr. Feurt has served as Senior Vice President and Chief Credit Officer of
UFC, and director and Executive Vice President and Senior Lending Officer of
Heritage Bank, since February 1998. Mr. Feurt was elected as a director of UFC
in May 1998, and his term of office as a director of UFC expires at UFC's annual
shareholder meeting in 2005. Prior to February 1998, he served as Senior Vice
President, Senior Credit Officer and a director of Heritage Bank since 1994. Mr.
Feurt served as Senior Vice President, Senior Credit Officer and a director of
BMS and Bank of Montana from 1984 until the sale of BMS to Norwest Corporation.
Ms. Delaney was elected to the Heritage Bank board in October 2000 and has
served as Chief Financial Officer of UFC since January 2001, and as Vice
President of Heritage Bank since December 1998. Previously, Ms. Delaney was
employed in public accounting from 1984 to 1998, with Hamilton Misfeldt & Co.
P.C., a Great Falls based public accounting firm.
SUPERVISION AND REGULATION
UFC is a bank holding company because of its ownership of Heritage Bank, a
Montana- state chartered commercial bank.
Bank holding companies are subject to the general supervision and
regulation by the Federal Reserve Bank ("FRB"). Under the Bank Holding Company
Act of 1956, as amended ("BHCA"), and FRB regulations, a bank holding company
may engage in banking, managing or controlling banks, furnishing or performing
services for banks it controls and conducting activities that the FRB has
determined to be closely related to banking. Bank holding companies must also
obtain the prior approval of the FRB before acquiring 5% or more of the
outstanding shares of another bank or bank holding company and must provide
notice to, and in some situations obtain the prior approval of, the FRB in
connection with the acquisition of 5% or more of the outstanding shares of a
company engaged in a "bank related" business.
Under FRB regulations, a bank holding company is required to serve as a
source of financial and managerial strength to its subsidiary banks and may not
conduct its operations in an unsafe or unsound manner. In addition, it is the
FRB's policy that in serving as a source of strength to its subsidiary banks, a
bank holding company should stand ready to use available resources to provide
adequate capital to its subsidiary banks during periods of financial stress or
adversity. A bank holding company's failure to meet its obligations to serve as
a source of strength to its subsidiary banks will generally be considered by the
FRB to be an unsafe and unsound practice or a violation of FRB regulations, or
both.
Bank holding companies are subject to certain limitations on redemption of
common stock or other equity securities. In addition, the FRB has issued
regulations setting minimum capital standards for bank holding companies.
Depending on the capital classification of a bank holding company, it may be
restricted from engaging in certain non-bank activities or from acquiring
interests in additional banks or other depository institutions. As of December
31, 2002, UFC met the minimum capital requirements issued by the FRB.
Under the BHCA, as amended by the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act"), a bank holding company
may acquire banks throughout the United States subject only to state or federal
deposit caps and state minimum age requirements. Effective June 1, 1997, the
Interstate Act authorized interstate branching by acquisition and consolidation
in those states that had not opted out by that date. Montana opted out of the
interstate branching by acquisition and consolidation until October 1, 2001. The
State of Arizona adopted the Interstate Act immediately and allows interstate
banking.
10
The Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization
Act") came into effect on March 11, 2000. The Financial Services Modernization
Act repeals the two affiliation provisions of the Glass-Steagall Act: Section
20, which restricted the affiliation of Federal Reserve member banks with firms
"engaged principally" in specified securities activities; and Section 32, which
restricts officer, director, or employee interlocks between a member bank and
any company or person "primarily engaged" in specified securities activities. In
addition, the Financial Services Modernization Act contains provisions that
expressly preempt any state law restricting the establishment of financial
affiliation, primarily related to insurance. The general effect of the law is to
establish a comprehensive framework to permit affiliation among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the bank holding company framework to permit
a holding company system to engage in a full range of financial activities
through a new entity known as a financial holding company. To date, UFC has not
elected to become a financial holding company.
Bank holding companies that elect to become a financial holding company
may affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or are incidental or complementary to
activities that are financial in nature. "Financial in nature" activities
include securities underwriting, dealing, and market making, sponsoring mutual
funds and investment companies, insurance underwriting and agency, merchant
banking, and activities that the Federal Reserve, in consultation with the
Secretary of the Treasury, determines from time to time to be so closely related
to banking or managing or controlling banks as to be a proper incident thereto.
United does not believe that the Financial Services Modernization Act has
negatively affected its operations in the near-term. However, to the extent that
the legislation permits banks, securities firms, and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Financial Services Modernization Act is intended to grant to community banks
certain powers as a matter of right that larger institutions have accumulated on
and ad hoc basis. Nevertheless, this legislation may increase the amount of
competition from larger institutions and other types of companies with
substantially greater resources and a wider variety of financial products than
United currently offers.
Under the Financial Services Modernization Act, federal banking regulators
have adopted rules that limit the ability of banks and other financial
institutions to disclose non-public information about consumers to nonaffiliated
third parties. These limitations require disclosure of privacy policies to
consumers and, in some circumstances, allow consumers to prevent disclosure of
certain personal information to a nonaffiliated third party. The rules were
effective November 13, 2000, but compliance was optional until July 1, 2001.
United has implemented procedures to comply with these rules and believes that
compliance has not adversely affected its operations.
United and its subsidiaries are deemed affiliates within the meaning of
the Federal Reserve Act, and transactions between the affiliates are subject to
certain restrictions. Accordingly, UFC and its respective subsidiaries must
comply with Sections 23A and 23B of the Federal Reserve Act (the "FRA").
Generally, these sections restrict "covered transactions" (i.e., loans,
purchases of assets, guaranties and similar transactions) to a percentage of the
depository institution's capital and surplus, require that such transaction be
appropriately collateralized and require that such transactions be on terms as
favorable to the depository institution as transactions with non-affiliates.
Loans to insiders (officers, directors and 10% shareholders) of a depository
institution are subject to Sections 22(g) and (h) of the FRA and regulations
thereunder. Among other things, such loans must be made on terms substantially
the same as loans to non-insiders.
On October 26, 2001, President Bush signed the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism ("USA Patriot Act") of 2001. Among other things, the USA Patriot Act
(1) prohibits banks from providing correspondent accounts directly to foreign
shell banks; (2) imposes due
11
diligence requirements on banks opening or holding accounts for foreign
financial institutions or wealthy foreign individuals (3) required financial
institutions to establish an anti-money-laundering compliance program, and (4)
generally eliminates civil liability for persons who file suspicious activity
reports. The Act also increased governmental powers to investigate terrorism,
including expanded government access to account records. The Department of the
Treasury is empowered to administer and make rules to implement the Act. While
the USA Patriot Act may, to some degree, affect United's record-keeping and
reporting expenses, it does not believe that the Act will have a material
adverse effect on its business and operation. Management believes United is in
compliance with the USA Patriot Act.
DEPOSITORY INSTITUTION SUBSIDIARIES--HERITAGE BANK AND VALLEY BANK.
Effective January 1, 2001, Heritage Bank became a Montana-chartered commercial
bank, having merged into State Bank's commercial bank charter. As such, Heritage
Bank is subject to regulation and supervision by the Montana Department of
Commerce, Division of Banking and Financial Institutions (the "Montana
Division") and the FDIC. Valley Bank is a Arizona-chartered commercial bank and
a member of the Federal Reserve Bank System. As such, Valley Bank is subject to
regulation and supervision by the Arizona State Banking Department (the "Arizona
Department") and the FRB. The Banks' deposits are insured by the FDIC up to
$100,000.
The Montana and Arizona statutes and regulations place limitations on the
business and other activities of Heritage Bank and Valley Bank which may be more
restrictive than limitations applicable to depository institutions that are not
state-chartered commercial banks. In particular, and among other limitations,
the establishment and operation of new branch offices, is limited by, and
subject to approval by, the Montana Division and the Arizona Department. In
addition, state-chartered commercial banks are generally not authorized to make
investments in subsidiary companies or to make other investments in equity
securities or to engage in securities or insurance activities. Some federally
chartered depository institutions located in Montana and Arizona may engage in
such activities without regard to State law.
By reason of FDIC insurance, the Banks are insured depository institutions
for purposes of certain federal laws and regulations. The federal laws that
apply to the Banks regulate, among other things, the scope of their businesses,
their investments, the reserves against deposits, the timing and availability of
deposited funds and certain aspects of their lending activities. These laws and
regulations governing the depository institution activities have generally been
promulgated to protect depositors and not to protect stockholders of such
institutions or their holding companies. These laws and regulations are designed
to ensure that appropriate action is taken to address concerns regarding the
safe and sound operation of insured depository institutions and generally relate
to internal control and information systems, loan documentation and credit
underwriting, asset growth, management performance and earnings. If an insured
depository institution fails to meet the applicable standards and regulatory
requirements, an appropriate banking agency may require that the institution
prepare and submit to the agency an acceptable plan for addressing the
regulatory concern. If the plan submitted is deemed inadequate, or if the
institution fails to submit or comply with the required plan, a banking agency
may take further action with respect to the regulatory concerns, including
institution of an enforcement action with respect to the institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required federal banking regulators to adopt regulations in a number
of specific areas to insure depository institution safety and soundness,
including internal controls, credit underwriting, asset growth, management
compensation, asset quality and earnings performance. FDICIA also contains
provisions intended to change independent auditing requirements, to restrict the
activities of certain insured depository institutions, to change various
consumer banking laws and to limit the ability of "under-capitalized banks" to
borrow from the FRB's discount window or to acquire brokered deposits.
The Financial Institution Reform, Recovery and Enforcement Act of 1989
("FIRREA") significantly changed existing federal banking legislation and
regulation,
12
including significant increases in FDIC insurance premiums, separation of the
FDIC insurance into two deposit insurance funds, authorizing bank holding
companies to own savings associations, increasing the federal banking agencies'
enforcement powers and increasing the civil and criminal penalties for
violations of federal banking laws and regulations.
The Banks are subject to certain federal consumer laws, including the
Community Reinvestment Act of 1977, as amended ("CRA"), and other fair lending
laws and regulations which impose nondiscriminatory lending requirements on
insured depository institutions. In recent periods, federal regulatory agencies
have sought a more rigorous enforcement of the CRA and other fair lending laws
and regulations. A successful challenge to a depository institution's
performance under the CRA and related fair lending laws and regulations could
result in a variety of sanctions, including the required payment of damages and
civil money penalties, prospective and retrospective injunctive relief and the
imposition of restrictions on mergers and acquisitions or other activities of
the depository institution or the holding companies controlling such depository
institutions. Private parties may also have the ability to challenge an
institution's performance under the fair lending laws in private class action
litigation.
The FDIC conducted a CRA performance evaluation in April 2000 and State
Bank was rated as having had "a satisfactory record in providing for the credit
needs of its assessment area". The OTS conducted a CRA performance evaluation in
July 1999 and Heritage Bank was rated as having had "an outstanding record of
meeting community credit needs".
Federal regulatory banking agencies have also established uniform capital
requirements for all insured depository institutions. An insured depository
institution that does not achieve and maintain required capital levels may be
subject to supervisory action through the issuance of capital directives, cease
and desist orders or other written orders or agreements with the appropriate
federal banking agency. Failure of an insured depository institution to meet the
required capital levels may also prohibit or limit the ability of a bank holding
company controlling such institution to engage in merger and acquisition
activities or other expansion activities. As of December 31, 2002, the Banks met
the "well capitalized" requirements issued by the applicable federal banking
agency.
Depository institutions generally depend upon the difference between the
interest rate paid by them on deposits and other borrowings and the interest
rate received on loans extended to customers and on investment securities. The
interest rates are highly sensitive to many factors beyond the control of
depository institutions, including general economic conditions in their primary
market area and the broader economy. In addition to general economic conditions
affecting business generally, depository institutions such as the Banks are
affected by federal government policies and actions of regulatory agencies. In
particular, the FRB through its various operations and powers may affect
interest rates charged on loans or paid on deposits. Such changes in interest
rates affect the growth and quality of depository institution loans, investments
and deposits.
Federal banking regulatory agencies may institute enforcement actions
against depository institutions, their parent holding companies and other
institution-affiliated parties with respect to violations of any federal law or
regulation. Enforcement actions may include the appointment of a conservator or
receiver, the issuance of cease and desist orders or other formal action,
termination of insurance of deposits and the imposition of civil money
penalties. The Banks are currently not subject to any such enforcement actions.
From time to time, various types of federal and state legislation have
been proposed that would result in additional regulation of, or restrictions on,
the business of depository institutions. It cannot be predicted whether such
legislation will be adopted or how such legislation would affect the business of
the Banks.
13
DEPOSIT INSURANCE AND FDIC REGULATION. As a result of the Heritage Bank
and State Bank merger, effective January 1, 2001, Heritage Bank is a member of
the Savings Association Insurance Fund ("SAIF"), and the Bank Insurance Fund
("BIF"), both administered by the FDIC. Section 5(d) of the Federal Deposit
Insurance Act ("FDI Act"), known as the Oakar Amendment, permits merger
transactions between SAIF- and BIF-member institutions resulting in an
institution with deposits that are proportionally insured by both SAIF and BIF.
Valley Bank is a member of the BIF.
Savings deposits are insured up to the applicable limits (generally
$100,000 per insured depositor) by the FDIC. The FDIC is empowered to impose
deposit insurance premiums, conduct examinations and require reporting by the
Banks. The FDIC may also prohibit the Banks from engaging in any activity the
FDIC determines by regulation or order to pose a serious risk to the FDIC. The
FDIC can also initiate enforcement actions against the Banks, after, in the case
of Heritage Bank, giving the OTS an opportunity to take such action, and may
terminate the deposit insurance of the Banks if it determines that the Banks
have engaged or are engaging in any unsafe or unsound practice, or are in an
unsafe or unsound condition.
For 2002, the FDIC assessment rate for the Banks decreased each quarter
from 1.82 basis points per $100 of insured deposits during the first quarter, to
1.70 basis points for the fourth quarter. As a result, the Banks' 2002 FDIC
deposit insurance premium was approximately $.1 million. FDIC has published
assessment rates for the first and second quarters of 2003, per $100 of insured
deposits, of 1.68 and 1.62 basis points, respectively.
STATE LENDING LIMITS. As of January 1, 2001, Heritage Bank became subject
to a State of Montana lending limit of 20% of capital. The maximum aggregate
amount of loans outstanding to a single borrower at Heritage Bank at December
31, 2002 and 2001 was approximately $2.3 million and $2.2 million, respectively.
At December 31, 2002 and 2001 Heritage Bank was in compliance with the State of
Montana lending limit.
The maximum aggregate amount of loans outstanding to a single borrower at
Valley Bank at December 31, 2002 and 2001 was approximately $1.2 million for
both years. At December 31, 2002 and 2001 Valley Bank was in compliance with the
State of Arizona lending limit.
CAPITAL ADEQUACY. FDIC emphasizes capital as a measure of performance and
establishes a rigid regulatory scheme based almost entirely on capital levels.
The five statutory capital categories established by FDIC are "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." The Banks' capital position
exceeds the definition of "well capitalized." FDIC also mandates that
regulations be promulgated adding other risk-based capital requirements covering
(a) concentrations of credit risk, (b) risks from nontraditional activities and
(c) the capital impact of fair value adjustments associated with FASB Statement
No. 115, "Accounting for Certain Investments in Debt and Equity Securities." See
Part IV, Item 14 - "Notes to Consolidated Financial Statements - Regulatory
Matters."
Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below minimum guideline levels, the holding company or bank may be denied
approval to acquire or establish additional banks or nonbank businesses or to
open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks
and bank holding companies. These are designed to make such capital requirements
more sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance sheets items are
assigned to broad risk categories, each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and off-balance sheet items. The guidelines are minimums, and the Federal
Reserve has noted that bank holding companies contemplating significant
expansion programs should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the
14
minimum. The current guidelines require all bank holding companies and federally
regulated banks to maintain a minimum risk-based total capital ratio equal to
8%, of which at least 4% must be Tier I capital.
Tier I capital for bank holding companies includes common shareholders'
equity, qualifying perpetual preferred stock (up to 25% of total Tier I capital,
if cumulative, although under a Federal Reserve rule, redeemable perpetual
preferred stock may not be counted as Tier I capital unless the redemption is
subject to the prior approval of the Federal Reserve), and minority interests in
equity accounts of consolidated subsidiaries, less intangibles, except as
described above.
The Federal Reserve also employs a leverage ratio, which is Tier I capital
as a percentage of total assets less intangibles, to be used as a supplement to
risk-based guidelines. Except for the most highly rated banks, the minimum
leverage ratio is 4%.
Banks are assigned to one of five capital categories depending on their
total risk-based capital ratio, Tier I risk-based capital ratio, and leverage
ratio, together with certain subjective factors. Banks which are deemed to be
"undercapitalized" are subject to certain mandatory supervisory corrective
actions.
LIQUIDITY. In 2001, as a state-chartered bank, Heritage Bank was not
subject to the same liquidity requirements as the OTS requirements for savings
associations. However, a recent FDIC exam found Heritage Bank's liquidity to be
satisfactory. A June 1999 exam by the Arizona State Banking Commission found
Valley Bank's liquidity to be satisfactory. A June 2002 examination by the FRB
found Valley Bank's liquidity to be satisfactory. Savings associations are
required to maintain qualifying liquid assets equal to a percentage designated
by the Director of the OTS (currently 4%) of the balance of its withdrawable
deposit accounts and borrowings payable in one year or less. Liquid assets for
purposes of this ratio include specified short-term assets (e.g., cash, certain
time deposits, certain banker's acceptances and short-term United States
Government obligations), and long-term assets (e.g., United States Government
obligations and certain state agency obligations). Monetary penalties will be
imposed, unless waived, for failure to meet liquidity requirements. Heritage
Bank exceeded liquidity requirements for 2000.
FEDERAL HOME LOAN BANK SYSTEM. Heritage Bank is a member of the FHLB of
Seattle, Washington . Valley Bank is a member of the FHLB of San Francisco,
California. Each FHLB serves as a reserve or central bank for its members within
its assigned region, is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB system and makes loans (advances) to its
members in accordance with the policies and the procedures established by the
FHLB board of directors. All advances from the FHLB are required to be fully
secured by sufficient collateral as is determined by the FHLB. The Banks are
required to purchase and maintain FHLB stock in an amount equal to the greater
of 1% of the unpaid principal of residential mortgage loans, or 5% of FHLB
advances outstanding.
SARBANES-OXLEY ACT OF 2002. United is also subject to the information,
proxy solicitation, insider trading restrictions and other requirements of the
Securities Exchange Act of 1934, including certain requirements under the
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 ("the Act") implementing legislative reforms intended
to address corporate and accounting fraud. The Act, which applies to any issuer
that has securities registered, or that is required to file reports, under the
Securities Exchange Act, provides significant revisions to the U.S. securities
laws. Among other things, the Act and the accompanying regulation include the
following:
o Certification and Accountability. The Act requires chief executive officers
and chief financial officers or their equivalent to certify to the accuracy
of periodic reports filed with the SEC, subject to civil and criminal
penalties if they knowingly or willfully violate this certification
requirement.
15
o Criminal Penalty Enhancement. Longer prison terms will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its
officers has been extended, and bonuses issued to top executives prior to
restatement of a company's financial statements are now subject to
disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
"blackout" periods, and loans to company executives are restricted. In
addition, a provision directs that civil penalties levied by the SEC as a
result of any judicial or administrative action under the Act be deposited
to a fund for the benefit of harmed investors.
o Enhanced Financial Disclosures and Reporting Requirements. The legislation
accelerates the time frame for disclosures by public companies and
insiders, as they must more promptly disclose any material changes in their
financial condition or operations. Directors and executive officers must
also provide information for most changes in ownership in a company's
securities within two business days of the change.
o Audit Committee Independence Requirements. United anticipates that the SEC
will adopt the proposed rules regarding audit committee independence as
final rules on, or around April 26, 2003. The final rules will direct all
national securities exchanges and national securities associated, including
NYSE and NASDAQ, to prohibit the listing of any security of an issuer that
is not in compliance with the audit committee requirements set out in the
proposed rules. United anticipates on being in compliance with the rules
when they become final rules and at such time when the final rules are
applicable to United.
o Financial Expert. The Act also requires issuers to disclose whether at
least one member of the audit committee is a "financial expert" (as such
term will be defined by the SEC) and if not, why not. United is not
required to disclose whether at least one member of its audit committee is
a "financial expert" in this report; however, United will be required to
make such a disclosure in its next annual report for fiscal year ending
2003.
o Code of Ethics. The Act also requires issuers to disclose whether they have
adopted a code of ethics for their senior financial officers, and if not,
the reason therefore, as well as changes to, or waiver of any provision of,
that code of ethics. United is not required to disclose whether it has a
code of ethics in place for its senior financial officers in this report;
however, United will be required to make such a disclosure in its next
annual report for fiscal year ending 2003.
TAXATION
GENERAL. UFC files consolidated Federal and State of Montana income tax
returns pursuant to a tax sharing agreement. Valley files separate consolidated
Federal and State of Arizona income tax returns. Generally, with some
exceptions, including Heritage Bank's reserve for bad debts discussed below, the
Banks are subject to Federal and state income taxes in the same manner as other
corporations.
The following discussion of tax matters is intended solely as a summary
and does not purport to be a comprehensive description of all the tax rules
applicable to the Banks.
TAX BAD DEBT RESERVES. For taxable years beginning prior to January 1,
1996, savings institutions, which met certain definitional tests primarily
relating to their assets and the nature of their business ("qualifying
thrifts"), were permitted to establish a reserve for bad debts and to make
annual additions thereto, which additions may, within specified formula limits,
were deducted in arriving at their taxable income.
16
Federal legislation repealed the reserve method of accounting for bad debt
reserves for tax years beginning after December 31, 1995. As a result, savings
associations could no longer calculate their deduction for bad debts using the
percentage-of-taxable-income method. Instead, savings associations were required
to compute their deduction based on actual charge-offs during the taxable year
or, if the savings association or its controlled group had assets of less than
$500 million, based on actual loss experience over a period of years. This
legislation also required savings associations to recapture into income over a
six-year period their post-1987 additions to their bad debt tax reserves,
thereby generating additional current tax liability. At December 31, 2002,
Heritage Bank's bad debt reserve for tax purposes was approximately $3.5
million. For additional information regarding federal and state income taxes,
see Part IV, Item 14 - "Notes to Consolidated Financial Statements - Income
Taxes."
ITEM 2. PROPERTIES
At December 31, 2002, United owned 12 of its 16 offices, including its
headquarters and other property having an aggregated book value including land
of approximately $5.2 million, and leased the remaining branches. Three
locations are leased in Montana and one office is leased in Arizona. The
following schedule provides property information for the United's locations as
of December 31, 2002.
(Dollars in thousands) Properties Properties Net Leasehold Net Book
Leased Owned Improvements Value Owned
---------- ---------- ------------- -----------
HERITAGE BANK:
Great Falls 1 2 $ 36 $2,155
Bozeman - 1 - 1,250
Missoula - 1 - 793
Havre - 1 - 242
Libby - 1 - 159
Chester - 1 - 147
Shelby - 1 - 131
Fort Benton - 1 - 121
Glendive - 1 - 88
Geraldine - 1 - 74
Kalispell 1 - 102 -
Hamilton 1 - 2 -
---------- ---------- ------------- -----------
Total Montana locations 3 11 $140 $5,160
========== ========== ============= ===========
VALLEY BANK:
Phoenix 1 - $ 38 -
Scottsdale 1 - 772 -
---------- ---------- ------------- -----------
Total Arizona locations 2 - $810 $ -
========== ========== ============= ===========
ITEM 3. LEGAL PROCEEDINGS
Although United was not involved in any material pending litigation as
of February 28, 2003, it is a plaintiff in various legal proceedings arising in
the normal course of business. In the opinion of management, the disposition of
current litigation will not have a material effect on United's consolidated
financial position, results of operations, or liquidity.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the quarter ended December 31, 2002.
17
PART II
-------
ITEM 5. MARKET FOR UFC'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
UFC common stock is quoted on the Nasdaq National Market under the symbol
"UBMT." The closing sale price per share of UFC common stock on February 28,
2003 was $24.20.
SHAREHOLDER DATA
As of February 17, 2003 there were approximately 190 owners of record of
UFC common stock and an estimated 875 additional beneficial holders whose shares
of UFC common stock were held in street name by brokerage houses.
COMMON STOCK MARKET PRuICES
The quarterly (high and low) sale prices for UFC's common stock on the
Nasdaq National Market the past two years were as follows:
UBMT Stock Price
----------------------
High Low
--------- --------
2001 First Quarter $16.75 $15.07
Second Quarter 17.50 16.51
Third Quarter 19.23 17.01
Fourth quarter 18.98 16.96
2002 First Quarter $21.00 $18.35
Second Quarter 24.10 19.50
Third Quarter 23.50 19.61
Fourth quarter 22.40 20.45
DIVIDEND PAYMENT HISTORY ON UFC COMMON STOCK
- --------------------------------------------
The UFC Board declared the following cash dividends for each of the four
quarters of 2001 and 2002, adjusted for the 10% stock dividend in June 2002:
2001 First Quarter $ .23
Second Quarter .24
Third Quarter .24
Fourth quarter .24
------------
$ .95
============
2002 First Quarter $ .25
Second Quarter .25
Third Quarter .25
Fourth quarter .25
------------
$ 1.00
============
The declaration and payment of future dividends by the UFC Board is
dependent upon United's net income, financial condition, economic and market
conditions, industry standards, certain regulatory and tax considerations and
limitations and other conditions. See "Supervision and Regulation." No assurance
can be given, or should be assumed, as to the amount, timing or frequency of
future dividend payments.
18
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR SUMMARY OF OPERATIONS AND SELECTED FINANCIAL DATA
(Dollars in thousands, As Of And For The Years Ended December 31,
except per share data) --------------------------------------------------------------------
2002(3) 2001(3) 2000(3) 1999 1998
--------- --------- --------- -------- --------
OPERATING DATA:
Interest income $ 23,637 $ 26,882 $ 25,740 $ 17,517 $ 14,249
Interest expense 10,736 14,824 14,956 9,538 7,393
--------- --------- --------- -------- --------
Net interest income 12,901 12,058 10,784 7,979 6,856
Provision for loan losses 1,170 1,640 1,629 204 335
--------- --------- --------- -------- --------
Net interest income after provision
for loan losses 11,731 10,418 9,155 7,775 6,521
Non-interest income 5,400 4,914 3,837 3,335 3,292
Non-interest expense 12,041 11,168 9,550 7,102 6,147
--------- --------- --------- -------- --------
Income before income taxes 5,090 4,164 3,442 4,008 3,666
Provision for income taxes 1,922 1,633 1,287 1,539 1,399
--------- --------- --------- -------- --------
Net income before minority interest 3,168 2,531 2,155 2,469 2,267
Minority interest (213) (156) (151) -- --
--------- --------- --------- -------- --------
Net income $ 2,955 $ 2,375 $ 2,004 $ 2,469 $ 2,267
========= ========= ========= ======== ========
PER SHARE DATA(1):
Basic earnings per share $ 1.82 $ 1.42 $ 1.11 $ 1.33 $ 1.30
Diluted earnings per share $ 1.79 $ 1.41 $ 1.11 $ 1.33 $ 1.30
Cash dividends per share $ 1.00 $ .95 $ .95 $ .95 $ .68
Book value per share $ 18.74 $ 17.59 $ 16.82 $ 16.16 $ 16.34
Shares used to calculate per share
data (Book Value) 1,626 1,626 1,776 1,817 1,868
Shares used to calculate per share
data (Earnings - basic) 1,626 1,677 1,812 1,852 1,747
Shares used to calculate per share
data (Earnings - diluted) 1,645 1,683 1,812 1,852 1,747
FINANCIAL CONDITION DATA(2):
Assets $ 377,980 $ 382,730 $ 363,801 $270,226 $232,561
Net loans and loans held for sale 264,079 268,238 254,627 187,539 149,076
Investment securities 60,936 73,263 70,064 53,044 51,900
Deposits 286,980 282,400 261,179 179,882 167,620
FHLB advances 38,000 50,500 52,175 46,425 22,175
Other borrowings and securities sold
under agreements to repurchase
13,487 11,604 12,616 11,546 9,451
Stockholders' equity 30,476 28,597 29,947 29,359 30,528
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
Return on average assets .77% .64% .57 % .98 % 1.06 %
Return on average stockholders'
equity 10.06 8.21 6.87 8.44 7.47
Net interest margin 3.60 3.42 3.31 3.40 3.34
Efficiency ratio 65.79 65.80 65.32 62.77 60.58
Net charge-offs to average loans .42 .25 .44 .06 .03
Nonperforming loans to total loans .38 .91 .46 .18 .68
Allowance for loan losses to total
loans 1.40 1.33 .99 .84 1.03
Nonperforming loans to allowance for
loan losses 27.36 68.74 45.96 21.88 66.07
Average equity to average assets 7.66 7.69 8.37 11.62 14.17
Dividend payout ratio 54.30 66.40 85.52 70.94 56.18
(1) Share and per share amounts in 1998 have been restated to retroactively
reflect the issuance of 475,000 shares of United common stock in
exchange for all outstanding shares of common stock of Heritage. All
years have been restated for the effect of the June 2002 10% stock
dividend.
(2) At year end.
(3) Includes Valley Bancorp. Inc.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS. This Annual Report on Form 10-K contains
forward-looking statements. Statements that are not historical or current facts,
including statements about beliefs and expectations, are forward-looking
statements. Forward-looking statements involve inherent risks and uncertainties,
and important factors could cause actual results to differ materially from those
anticipated, including the following. In addition to those contained in United's
reports on file with the SEC; (i) general economic or industry conditions could
be less favorable than expected, resulting in a deterioration in credit quality,
a change in the allowance for loan losses, or a reduced demand for United's
products and services (ii) changes in the domestic interest rate environment
could reduce net interest income and could increase loan losses; (iii) changes
in the extensive laws, regulations and policies governing financial services
companies could alter United's business environment or affect operations; (iv)
the potential need to adapt the industry changes in information technology
systems, on which United is highly dependent, could present operational issues
or require significant capital spending; (v) competitive pressures could
intensify and affect United's profitability, including as a result of continued
industry consolidation, the increased availability of financial services from
non-banks, technological developments, or bank regulatory reform; (vi) the
impact of weather conditions in the geographic markets and business areas in
which United conducts it business; and (vii) capital investments in United's
businesses may not produce expected growth in earnings anticipated at the time
of the expenditure. Forward-looking statements speak only as of the date they
are made, and United undertakes no obligation to update them in light of new
information of future events.
GENERAL. UFC is the result of the combination on February 3, 1998("the
Heritage Merger") of two Montana-based savings and loan holding companies:
Heritage Bancorporation ("Heritage") and United Financial Corp. (as it existed
prior to the merger, "Old United"). Although UFC was the surviving corporation,
the merger was treated as a reverse merger for accounting purposes because the
stockholders and management of Heritage controlled the operation of UFC after
the Heritage Merger. Using purchase accounting, the historical financial
statements of UFC included in this Report for periods preceding the Heritage
Merger reflect only the operations of Heritage, while the historical financial
statements for periods after the Heritage Merger reflect combined operations.
20
SELECTED UNITED FINANCIAL DATA
The following results of operations for 2002, 2001 and 2000 is derived
from the audited consolidated financial statements.
(In thousands, December December December
except per share data) 31, 31, 31,
-------- -------- --------
2002 2001 2000
-------- -------- --------
Total interest income $ 23,637 $ 26,882 $ 25,740
Total interest expense 10,736 14,824 14,956
-------- -------- --------
Net interest income 12,901 12,058 10,784
Provision for loan losses 1,170 1,640 1,629
-------- -------- --------
Net interest income after
Provision for loan losses
provision for loan losses 11,731 10,418 9,155
Total non-interest income 5,400 4,914 3,837
Total non-interest expense 12,041 11,168 9,550
-------- -------- --------
Income before income taxes 5,090 4,164 3,442
Provision for income tax expense 1,922 1,633 1,287
-------- -------- --------
Net income before minority interest 3,168 2,531 2,155
--------
-------- --------
Minority interest (213) (156) (151)
-------- -------- --------
Net income $ 2,955 $ 2,375 $ 2,004
======== ======== ========
Net income per share - basic $ 1.82 $ 1.42 $ 1.11
======== ======== ========
Weighted average shares
outstanding - basic 1,626 1,677 1,812
======== ======== ========
Net income per share - diluted $ 1.79 $ 1.41 $ 1.11
======== ======== ========
Weighted average shares
outstanding - diluted 1,645 1,683 1,812
RESULTS OF OPERATIONS
Net income for 2002 was $3.0 million, an increase of $.6 million from
2001. Net interest income increased $.8 million or 7.0% and the provision for
loan losses decreased $.5 million, resulting in a total increase of $1.3 million
or 12.6% in net interest income after provision for loan losses. The majority of
the $.5 million increase in non-interest income was the result of the increase
in gain on sale of loans generated by United's mortgage lending activities in
2002. Salaries and commissions are the bulk of the $.8 million increase in
non-interest expense in 2002.
United's net income, and more specifically its net interest income, for
2002 was also affected by the following two interest related events which
occurred in December 2002. Heritage Bank incurred prepayment penalties when it
repaid $8.0 million in FHLB advances prior to their scheduled maturity dates in
the form of interest expense on the repayments. Heritage Bank also incurred a
writedown of loan premium of $.2 million, which was also charged against net
income in the form of interest expense.
Net income was $2.4 million in 2001 as compared to $2.0 million in 2000.
Increased loan volumes in 2001 were the primary reason for increased interest
income. Net interest income increased $1.3 million, or 11.8%, to $12.1 million
in 2001 from $10.8 million in 2000. Non-interest income increased $1.1 million,
or 28.9%, in 2001 compared to 2000. Non-interest expense increased $1.6 million,
or 16.7% in 2001 as compared to 2000.
NET INTEREST INCOME. Like most financial institutions, the most
significant component of United's earnings is net interest income, which is the
difference between the interest earned on interest-earning assets (loans,
investment securities, mortgage-backed securities and other interest-earning
assets), and the interest paid on deposits and borrowings. This amount, when
divided by average interest-earning assets, is referred to as the net interest
margin and expressed as a percentage. Net
21
interest income and net interest margin are affected by changes in interest
rates, the volume and the mix of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. The difference between the
yield on interest-earning assets and the cost of interest-bearing liabilities
expressed as a percentage is referred to as the net interest rate spread.
The following table illustrates the changes in United's net interest
income due to changes in volume and changes in net interest income due to
changes in rates:
(Dollars in thousands) Year Ended December 31, Year Ended December 31,
2002 vs. 2001 2001 vs. 2000
------------------------------------- --------------------------------------
Increase (decrease) due to Increase (decrease) due to
------------------------------------- --------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ------- ------ ------- ------- ----- ------ -------
Interest earning assets:
Loans $(278) $(2,633) $ 33 $(2,878) $ 1,888 $(425) $ (38) $ 1,425
Investment and mortgage
backed securities 103 (352) (9) (258) (232) (316) 17 (531)
Other interest earning
assets
310 (282) (136) (108) 491 (108) (135) 248
----- ------- ----- ------- ------- ----- ----- -------
Total interest earning
assets 135 (3,267) (112) (3,244) 2,147 (849) (156) 1,142
Interest bearing
liabilities:
Interest bearing
checking 193 (508) (78) (393) 335 (645) (126) (436)
Savings deposits (45) (458) 14 (489) 529 (261) (102) 166
Time deposits 80 (2,580) (25) (2,525) 183 312 7 502
Borrowings (322) (323) (36) (681) (293) (191) 121 (363)
----- ------- ----- ------- ------- ----- ----- -------
Total interest bearing
liabilities (94) (3,869) (125) (4,088) 754 (785) (100) (131)
----- ------- ----- ------- ------- ----- ----- -------
Net interest income $ 229 602 13 844 $ 1,393 $ (64) $ (56) $ 1,273
===== ======= ===== ======= ======= ===== ===== =======
22
The following tables set forth average balances for interest-earning
assets and interest-bearing liabilities, the interest and yield on interest
earning assets, the interest and rate paid on interest bearing liabilities, the
net interest income and net interest spread, and the net interest margin for the
years indicated:
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2002
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $264,983 $ 19,497 7.36 %
Investment and mortgage backed
securities 70,492 3,605 5.11 %
Other interest earning assets 23,006 536 2.33 %
--------- --------- ----------
Total interest earning assets 358,481 23,638 6.59 %
Non-interest earning assets 25,022
---------
Total assets $383,503
=========
Interest bearing liabilities:
Interest bearing checking $ 98,570 879 .89 %
Savings deposits 53,156 1,026 1.93 %
Time deposits 131,557 5,625 4.28 %
Borrowings 58,608 3,206 5.47 %
--------- --------- ----------
Total interest bearing liabilities $341,891 10,736 3.14 %
=========
Stockholders' equity 29,389
=========
---------
Net interest income $ 12,902
=========
Net interest spread 3.45 %
Net interest margin(2) 3.60 %
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2001
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $268,322 $ 22,376 8.34 %
Investment and mortgage
backed securities 68,648 3,863 5.63 %
Other interest earning assets 15,527 643 4.14 %
--------- --------- ---------
Total interest earning assets 352,497 26,882 7.63 %
Non-interest earning assets 23,866
---------
Total assets $376,363
=========
Interest bearing liabilities:
Interest bearing checking $ 85,570 1,271 1.49 %
Savings deposits 54,789 1,515 2.77 %
Time deposits 130,275 8,150 6.26 %
Borrowings 64,203 3,888 6.06 %
--------- --------- ---------
Total interest bearing liabilities $334,837 14,824 4.43 %
=========
Stockholders' equity $ 28,935
=========
---------
Net interest income $ 12,058
=========
Net interest spread 3.20 %
Net interest margin(2) 3.42 %
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent yields.
23
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2000
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $246,137 $ 20,951 8.51 %
Investment and mortgage
backed securities 72,469 4,394 6.06 %
Other interest earning assets 6,920 395 5.71 %
--------- --------- --------
Total interest earning assets 325,526 25,740 7.91 %
Non-interest earning assets 23,116
---------
Total assets $348,642
=========
Interest bearing liabilities:
Interest bearing checking $ 71,541 1,707 2.39 %
Savings deposits 39,347 1,349 3.43 %
Time deposits 127,226 7,648 6.01 %
Borrowings 67,604 4,252 6.29 %
--------- --------
---------
Total interest bearing liabilities $305,718 14,956 4.89 %
=========
Stockholders' equity $ 29,185
=========
---------
Net interest income $10,784
=========
Net interest spread 3.02 %
Net interest margin(2) 3.31 %
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent yields.
United's net interest income increased $.8 million to $12.9 million in
2002 from $12.1 million in 2001, and increased $1.3 million in 2001 from $10.8
million in 2000.
As illustrated in the preceding tables, the principal reason for the
increase in net interest income from 2001 to 2002, was a change in the rates on
United's interest earning assets and liabilities. Interest income decreased $3.3
million in 2002 as compared to 2001. Decreased loan volumes, and more
importantly decreased rates, represented $2.9 million of this decrease.
Decreases in rates on investment securities contributed to a further decrease of
$.3 million. The remaining $.1 million decrease in interest income came from
lower rates on other interest earning assets.
The principal reason for the increase in net interest income from 2000 to
2001 was an increase in the volume of United's interest earning assets. Interest
income increased $1.1 million in 2001 as compared to 2000. Increased loan
volumes, offset by decreased rates, represented $1.4 million of this increase.
Decreases in volumes of investment securities and in rates partially offset the
increases from loans receivable.
Rates paid on deposits decreased dramatically from 2001 to 2002 and from
2000 to 2001 due to rate cuts by the FRB. The decreased interest income in 2002
was more than offset by the decreased interest expense resulting from decreases
in deposit rates of $3.4 million and borrowing rates of $.7 million for a total
decrease of $4.1 million in interest expense in 2002.
Decreases due to rates in 2001 were $.6 million in deposits and $.2
million in borrowings. Increased volumes in deposits offset the rate decreases
somewhat for a net decrease of $.1 million in interest expense in 2001 compared
with 2000. The $.1
24
million decrease in interest expense in 2001 and the $1.2 million increase in
interest income combined for a net interest income increase for United of $1.3
million from $10.8 million in 2000 to $12.1 million in 2001.
PROVISION FOR LOAN LOSS. United provided $1.2 million for loan losses in
2002 compared to $1.6 million in both 2001 and 2000. The slight decrease in the
loan loss provision in 2002 reflects management's estimate of the improvement in
loan quality during 2002.
The provision for loan losses is determined by management as the amount to
be added to the allowance for loan losses after net charge-offs have been
deducted to bring the allowance to a level which is considered adequate to
absorb losses inherent in the loan portfolio in accordance with accounting
principles generally accepted in the United States of America ("GAAP"). Future
additions to United's allowance for loan losses and any change in the related
ratio of the allowance for loan losses to non-performing assets are dependent
upon the performance and composition of United's loan portfolio, the economy,
inflation, changes in real estate values and interest rates and the view of the
regulatory authorities toward adequate reserve levels.
United has identified its most critical accounting policy to be that
related to the allowance for loan losses. United's allowance for loan losses
methodology incorporates a variety of risk considerations in establishing an
allowance for loan losses that management believes is appropriate. Risk factors
include historical loss experience, delinquency and charge-off trends,
collateral values and an internal loan grading system adopted by the Banks.
Other factors include the general economic environment in United's markets and,
in particular, the state of certain industries. Changes in any of the above
factors could have a significant affect on the calculation of the allowance for
loan losses in any given period.
NON-INTEREST INCOME. In addition to net interest income, United generates
significant non-interest income from a range of retail banking services,
including mortgage banking activities and service charges for deposit services.
Non-interest income increased by $.5 million, or 10%, in 2002 to $5.4 million
compared to $4.9 million in 2001, primarily due to the continued increase in
gain on sale of loans from the real estate production activity at the Banks in
2002. Non-interest income increased $1.1 million, or 29%, in 2001 to $4.9
million compared to $3.8 million in 2000. This increase was directly the result
of additional real estate loan production activity at the Banks during 2001.
NON-INTEREST EXPENSE. Non-interest expense increased $.8 million, or 7.1%,
to $12.0 million in 2002, and increased $1.6 million, or 16.7%, to $11.2 million
in 2001. Salary and employee benefit expense increased $.6 million in 2002
largely from salary and bonus increases. Occupancy and equipment expenses
increased $.2 million in 2002. Salary and employee benefit expense represented
$.8 million of the 2001 increase and was the result of additional staffing and
salary increases for existing employees. The remaining $.8 million increase in
2001 was primarily due to higher occupancy expense due in part to significantly
higher utility costs in 2001 as well as additional costs at the new branch
locations.
INCOME TAXES. Income tax expense increased $.3 million in both 2002 and
2001, to $1.9 million for 2002 and to $1.6 million for 2001. The increase is
consistent with the increase in income before taxes. Income tax expense averages
approximately 38% of income before income taxes.
FINANCIAL CONDITION
GENERAL. United's total assets decreased $4.7 million to $378.0 at
December 31, 2002 from $382.7 million at December 31, 2001. The 2002 decrease in
assets included a $4.2 million decrease in loans receivable and loans held for
sale, a $12.4 million decrease in securities available-for-sale, offset by an
$11.2 million increase in cash and cash equivalents. Other assets increased $.7
million in 2002.
25
LOANS RECEIVABLE AND LOANS HELD FOR SALE. Net loans receivable decreased
$10.1 million during 2002 to $250.4 million at December 31, 2002 from $260.5
million at December 31, 2001. Construction loans decreased $4.1 million, 1-4
family residential loans decreased $4.9 million and commercial real estate loans
decreased $4.6 millioN. The decrease in 5 or more residential loans was $.4
million. Agricultural real estate loans increased $1.6 million for a net
decrease in loans secured by real estate of $12.4 million. Commercial
non-mortgage loans decreased $1.2 million in 2002 while agricultural
non-mortgage loans increased $2.9 million. Consumer and other loans increased
$.6 million for a decrease in total loans receivable of $10.1 million.
The diverse loan portfolio includes: real estate residential mortgages,
commercial and agricultural mortgages, agricultural and commercial
non-mortgages, consumer loans secured by real estate, and various consumer
installment loans. The Banks also purchase and participate in commercial and
lease financing loans. The Banks had $41.3 million and $44.4 million of
participation and purchased loans as of December 31, 2002 and 2001,
respectively.
Heritage Bank sells and retains servicing for a portion of its residential
real estate loans to agencies of Montana such as the Montana Board of
Investments and the Montana Board of Housing. Heritage Bank recognizes mortgage
servicing rights as an asset regardless of whether the servicing rights are
acquired or retained on loans originated and subsequently sold. The mortgage
servicing rights are assessed for impairment based on the fair value of the
mortgage servicing rights. In November 2000, Heritage Bank entered into an
agreement with an unrelated third party to sell all of its servicing rights
associated with Montana Board of Housing loans existing at November 30, 2000
which had outstanding principal balances of approximately $49.6 million. The
sales price was 1.03% of the outstanding principal balance at close of business
November 30, 2000, or approximately $510,000. A gain on the sale of
approximately $.3 million is included in other non-interest income for the year
ended December 31, 2000. At December 31, 2000, Heritage Bank had a receivable
related to the sale of approximately $.3 million, which was collected in March
2001. The receivable is included in other assets in the consolidated statement
of financial condition. As of December 31, 2002 and 2001, the carrying value of
originated servicing rights was approximately $.2 million and $.1 million,
respectively. Heritage Bank's servicing portfolio as of December 31, 2002 was
$29.6 million and as of December 31, 2001 was $17.2 million.
Approximately $49.5 million of the servicing portfolio at December 31,
2000 was being serviced under a short-term sub-servicing agreement which expired
in February 2001.
During 2002, loans held for sale by United increased $5.9 million to $13.6
million at December 31, 2002 from $7.7 million at December 31, 2001.
Approximately $202.9 and $172.2 million of loans were originated for sale and
$196.8 and $167.5 million of loans were sold to the secondary market during the
years ending December 31, 2002 and 2001, respectively.
SECURITIES AVAILABLE-FOR-SALE. United's securities available-for-sale
decreased $12.4 million to $60.9 million at December 31, 2002 as compared to
$73.3 million at December 31, 2001. In 2002, United's purchases of securities
available-for-sale were approximately $60.0 million while proceeds from sales,
maturities and paydowns totaled approximately $73.4 million. United also
recorded an unrealized gain in market values of approximately $.9 million in
2002 and a realized gain on sales of $.1 million.
United has identified its accounting method for securities
available-for-sale to be a critical accounting policy. Securities
available-for-sale are carried at fair value and unrealized gains and losses
(net of related tax effects) are excluded from earnings and reported as a
separate component of stockholders' equity. While fair values are determined per
market quotes from independent brokers and not subject to management estimation,
the carrying value of the securities is subject to market variations. At
December 31, 2002, 2001 and 2000, the unrealized gain (loss) on securities
available-for-sale to mark them to market was $1.5 million, $.6 million and $(.1
million), respectively. (See Part IV, Item 15-"Notes to Consolidated Financial
Statements - Securities Available-For-Sale").
26
CASH AND CASH EQUIVALENTS. Cash and cash equivalents increased $11.2
million during 2002 to $33.2 million at December 31, 2002 from $22.0 million at
December 31, 2001. Net cash used by operating activities, or net income adjusted
for non-cash items, was $1.6 million in 2002. Net cash provided by investing
activities such as the net decrease in loans receivable and the net decrease in
securities available-for-sale was $20.5 million in 2002. Net cash used in
financing activities such as increases in deposits, net changes in borrowings
and dividends paid to stockholders was $7.7 million, for a net increase in cash
and cash equivalents for 2002 of $11.2 million.
OTHER ASSETS. Real estate and other personal property owned decreased $.1
million during 2002 to $.6 million at December 31, 2002 from $.7 million at
December 31, 2001. The decrease resulted from the depreciation of real estate
held for investment and a decrease in other personal property. The balance held
at December 31, 2002 is primarily a previous banking facility which United was
required by its regulators to reclassify to real estate owned in 2000. At
December 31, 2002 this facility had a net carrying value of $.5 million and is
generating an annual cash flow from rental activities of approximately $.1
million.
Premises and equipment increased $1.1 million during 2002 due to the $.7
million construction addition to a building in Great Falls, Montana for a new
branch location opened in 2002, and $.4 million in furniture and fixtures
purchased for the branch. A total of $.2 million was used to purchase a building
and related land in Libby, Montana to upgrade the Libby loan production office
to a full service branch opening in 2003. Purchases of other premises and
equipment totaling $.3 million consisted of equipment and computer upgrades at
the main facilities and various branch locations. The purchases were offset by
$.5 million in depreciation expense on existing premises and equipment.
At December 31, 2002, United had $3.4 million of recorded goodwill which
in accordance with its current accounting policies, is no longer amortized to
expense during the year ended December 31, 2002, but rather is reviewed annually
by management for any impairment writedown. This accounting policy for goodwill
is considered a critical one for United because of the significant accounting
estimates made by management in assessing any potential impairment writedown.
Such accounting estimates can be significant due to the possibility that future
events affecting them may differ from management's current judgements. (See Part
IV, Item 15-"Notes to Consolidated Financial Statements - Goodwill and Other
Intangible Assets").
DEPOSITS AND BORROWINGS. United experienced a net increase in deposits of
$4.6 million or 1.6% in 2002 as deposits grew to $287.0 million in 2002 from
$282.4 million in 2001. The increase in deposits resulted from a combination of
competitive rates on all deposit offerings, and United's commitment to community
banking, both of which have attracted depositors. Lower interest rates offered
on deposits in 2002 in part impacted the lower growth rate in deposits in 2002
compared to 2001.
FHLB advances and securities sold under agreements to repurchase decreased
$9.3 million in 2002 to $50.8 million from $60.1 million in 2001. United was
able to repay $26.5 million in FHLB advances in 2002 and received proceeds of
$14.0 million on new FHLB advances, for a net decrease of $12.5 million.
Securities sold under agreement to repurchase increased $3.2 million while line
of credit borrowings and federal funds purchased had a net decrease of $1.3
million.
CAPITAL RESOURCES. United has issued and outstanding $3.0 million of Trust
Preferred Securities. (See Part IV, Item 15-"Notes to Consolidated Financial
Statements-Trust Preferred Securities").
NONPERFORMING ASSETS. When a borrower fails to make a scheduled payment on
a loan and does not cure the delinquency within 15 days, United's policy is to
contact the borrower between the 15th and 30th day of delinquency to establish a
repayment schedule. If a loan is not current, or a realistic repayment schedule
is not being followed by the 90th day of delinquency, United will generally
proceed with legal
27
action to foreclose the property after the loan has become contractually
delinquent 90 days. Loans contractually past due 90 days are classified as
nonperforming. However, not all loans past due 90 days automatically result in
the non-accrual of interest income. If a 90 days past due loan has adequate
collateral, or is FHA insured or VA guaranteed, and management concludes that
loss of principal and interest would likely not be realized, then interest
income will continue to be accrued.
The following schedule details the amounts of United's nonperforming
assets, consisting of nonaccrual loans, accruing loans past due over 90 days and
restructured loans.
(Dollars in thousands)
December 31, December 31, December 31, December 31, December 31,
2002 2001 2000 1999 1998
------------- ------------- ------------ ------------- -------------
Accruing loans past due
over 90 days $ 553 $ 294 $ 258 $ 117 $ 387
Non-accrual loans 339 2,114 903 230 594
------------- ------------- ------------ ------------- -------------
Total $ 892 $ 2,408 $ 1,161 $ 347 $ 981
------------- ------------- ------------ ------------- -------------
Interest:
Due on non-accrual loans $ 88 $ 224 $ 264 $ 14 $ 12
Included in income none none none none none
United is required to review, classify and report to its Board of
Directors its assets on a regular basis and classify them as "substandard"
(distinct possibility that some loss will be sustained), "doubtful" (high
likelihood of loss), or "loss" (uncollectible). Adequate valuation allowances
are required to be established for assets classified as substandard or doubtful
in accordance with GAAP. If an asset is classified as a loss, the institution
must either establish a specific valuation allowance equal to the amount
classified as loss or charge off such amount. At December 31, 2002, United had
$.1 million of reported doubtful assets and no assets classified as loss. At
December 31, 2001, United had $.8 million of reported doubtful assets and no
assets classified as loss. At December 31, 2002, 2001 and 2000, United had $.8
million, $1.9 million and $.8 million, respectively, of reported substandard
assets. As a percent of total assets, substandard assets were approximately
..21%, .50% and .21% at December 31, 2002, 2001 and 2000, respectively.
28
PROVISION FOR LOAN LOSSES. The following schedule details changes in
United's loan loss reserve at December 31 for each of the five years indicated:
Pro Forma
(Dollars in thousands) Combined (1)
---------------
Year Ended Year Ended Year Ended Year Ended Year Ended
December December December December December
31, 2002 31, 2001 31, 2000 31, 1999 31, 1998
-------------- ------------- ------------ ------------- -------------
Balance beginning of year $ 3,503 $ 2,526 $ 1,586 $ 1,485 $ 1,146
Provision for loan losses 1,170 1,640 1,629 204 340
Acquired from State Bank - - - - 43
Acquired from Valley - - 393 - -
Charge-offs:
Residential (243) (5) (3) (16) -
Commercial (768) (481) (1,073) (59) (4)
Consumer (178) (215) (62) (34) (52)
------------- ------------- ------------ ------------- -------------
Total charge-offs (1,189) (701) (1,138) (109) (56)
Recoveries 89 38 56 7 12
------------- ------------- ------------ ------------- -------------
Net charge-offs (1,100) (663) (1,082) (102) (44)
------------- ------------- ------------ ------------- -------------
Balance end of year end $3,573 $ 3,503 $ 2,526 $ 1,587 $ 1,485
============= ============= ============ ============= =============
Allowance for loan losses to
Total loans at year end 1.41% 1.33% .99% .84% 1.03%
============= ============= ============= ============= =============
Net charge-offs to average
Loans .42% .25% .44% .06% .04%
============= ============= ============= ============= ==============
(1) The unaudited pro forma combined financial data as of December 31,
1998 is based upon the audited annual consolidated balance sheets of
Heritage and Old United, and is presented for comparative purposes only.
The following schedule allocates the loan loss reserve based on
management's judgment of potential losses in the respective areas. While
management has allocated the reserve to various portfolio segments for
purposes of this table, the reserve is general in nature and is available
for the portfolio in its entirety.
(Dollars in thousands)
December 31, 2002 December 31, 2001 December 31, 2000
----------------------------- ----------------------------- -----------------------------
% of loans % of loans % of loans
in each in each in each
category to category to category to
Allowance total loans Allowance total loans Allowance total loans
------------- ------------- ------------- ------------- ------------- -------------
Real estate loans:
1 - 4 residential $ 101 2.8% $ 112 3.2% $ 123 4.9%
5 or more residential 66 1.9 66 1.9 63 2.5
Construction 215 6.0 256 7.3 126 5.0
Commercial and agricultural 1,397 39.1 1,678 47.9 1,107 43.8
Non-real estate loans:
Commercial and agricultural 1,327 37.1 956 27.3 793 31.4
Consumer 467 13.1 435 12.4 314 12.4
------------- ------------- ------------- ------------- ------------- -------------
Total $ 3,573 100.0% $ 3,503 100.0% $ 2,526 100.0%
============= ============= ============= ============= ============= =============
29
(Dollars in thousands)
December 31, 1999 December 31, 1998
----------------------------- ----------------------------
% of loans % of loans
in each in each
category to category to
Allowance total loans Allowance total loans
-------------- ------------- -------------- -------------
Real estate loans:
1 - 4 residential $ 128 18.1% $ 124 18.7%
5 or more residential 52 2.8 66 4.6
Construction 84 5.6 92 6.4
Commercial and agricultural 488 24.9 462 26.0
Non-real estate loans:
Commercial and agricultural 712 37.2 601 31.6
Consumer 122 11.4 140 12.7
-------------- ------------- -------------- -------------
Total $ 1,586 100.0% $ 1,485 100.0%
============== ============= ============== =============
REAL ESTATE AND OTHER PERSONAL PROPERTY OWNED. Total real estate and other
personal property owned ("REO") of United was $.6 million, $.7 million and $1.0
million at December 31, 2002, 2001 and 2000, respectively. The schedule below
details properties both held for sale and investment by United as of the dates
indicated.
(Dollars in thousands)
December 31, December 31, December 31,
2002 2001 2000
----------------- ----------------- -----------------
REO held for sale $ 54 $ 92 $ 332
Allowance for possible losses - - -
----------------- ----------------- -----------------
Total REO held for sale $ 54 $ 92 $ 332
================= ================= =================
REO held for investment $ 567 $ 547 $ 547
Accumulated depreciation (55) (35) (15)
----------------- ----------------- -----------------
Total REO held for investment 512 $ 512 $ 532
================= ================= =================
As a percent of total assets .15% .16% .24%
================= ================= =================
Other personal property
held for sale $ 20 $ 64 $ 158
================= ================= =================
As a percent of total assets .01% .02% .04%
================= ================= =================
ASSET/LIABILITY MANAGEMENT. United's earnings depend to a large extent on
the level of its "net interest income." Net interest income depends upon the
difference (referred to as "interest rate spread") between the yield on United's
loan and investment portfolios and interest-earning cash balances
("interest-earning assets"), and the rates paid on its deposits and borrowings
("interest-bearing liabilities"). Net interest income is further affected by the
relative amounts of United's interest-earning assets and interest-bearing
liabilities. In recent years, United's interest-earning assets have exceeded
interest-bearing liabilities. However, when interest-earning assets decrease as
a result of non-accrual loans and investments in non-interest earning assets,
net interest income and interest rate spread also decrease and any continued
decrease in the level of interest-earning assets would generally result in a
negative impact on earnings.
One of the primary objectives of United's management has been to
restructure United's balance sheet to reduce its vulnerability to changes in
interest rates (Interest Rate Risk). Savings institutions historically have
suffered from a mismatch in the term to maturity of their assets and
liabilities, with mortgage loan assets tending to be of a much longer term than
deposits, the primary liabilities of savings institutions. In periods of rising
interest rates, this mismatch can render savings institutions vulnerable to
increases in costs of funds (deposits and borrowings) that
30
can outstrip increases in returns on longer-term fixed rate loans and
investments, resulting in a decrease in positive interest rate spread and lower
earnings.
Several strategies have been employed by United to minimize the mismatch
of asset and liability maturities. For the past several years, Heritage Bank has
maintained a policy of selling the majority of newly-originated long-term (15 to
30-year maturity) fixed-rate mortgage loans to the secondary market. These loans
are sold at their outstanding principal balance, which is the prearranged
contract purchase price, and therefore, no gain or loss is realized at sale.
United promotes the origination and retention of loans providing for periodic
interest rate adjustments, shorter terms to maturity or balloon provisions.
United also emphasizes investment in adjustable rate or shorter-term
mortgage-backed securities and other interest-earning investments. When
maturities of loans increase, United offsets the increased interest rate risk
with matching funds and maturities with FHLB borrowings.
The following tables provide information regarding the maturity of loans
included in United's portfolio as of December 31, 2002. The amounts reflected in
the following table give no effect to assumptions regarding loan prepayments or
payoffs. Loans with variable rates of interest are classified as due when the
loan principal balances are contractually due, not when the interest rate
reprices.
(Dollars in thousands)
December 31, 2002
------------------------------------------------------------
5 Years
1 Year or 1 - 5 and
Less Years Beyond Total
-------------- ------------- -------------- -------------
Loans:
Loans secured by real estate:
Adjustable rate (all
property types) $34,609 $47,112 $ 23,066 $ 104,787
1-4 family residential 2,309 8,529 18,290 29,128
Multi-family and commercial 2,830 9,157 15,549 27,536
Construction and undeveloped
land 12,571 5,516 1,291 19,378
-------------- ------------- -------------- -------------
Loans secured by real
estate 52,319 70,314 58,196 180,829
Commercial non-real
estate(1) 8,942 23,733 4,943 37,618
Agricultural non-real estate 4,946 4,308 365 9,619
Consumer(2) 1,967 16,912 3,486 22,365
-------------- ------------- -------------- -------------
Net loans $ 68,174 $115,267 $ 66,990 $250,431
============== ============= ============== =============
Net loans due after
December 31, 2003
--------------------
Fixed interest rates $112,079
Floating or adjustable rates
or balloon payments 70,178
--------------------
$182,257
====================
(1) Includes loans on commercial savings accounts
(2) Includes consumer loans secured by real estate
31
The following table sets forth the book value, maturities and weighted
average yield of United's investment portfolio at the dates indicated:
(Dollars in thousands)
December 31, 2002
------------------------------------------------------
10 years
1 Year 1 - 5 5 - 10 and
or Less years years beyond Total
------- ------ ------- -------- -------
U.S. government and agencies $ 299 $3,049 $ 8,677 $ 2,006 $14,031
Mortgage-backed securities 320 1,182 8,262 33,491 43,255
Municipal bonds -- 598 -- 1,400 1,998
Other -- -- 1,620 32 1,652
------- ------ ------- -------- -------
Total securities $ 619 $4,829 $18,559 $ 36,929 $60,936
======= ====== ======= ======== =======
Weighted average yield 3.92% 5.01% 5.55% 5.48% 5.46%
December 31, 2001
------------------------------------------------------
10 years
1 Year 1 - 5 5 - 10 and
or Less years years beyond Total
------- ------ ------- -------- -------
U.S. government and agencies $12,482 $3,620 $11,596 $ 3,009 $30,707
Mortgage-backed securities 210 2,392 8,119 28,561 39,282
Municipal bonds -- 181 201 1,363 1,745
Other -- -- 1,487 42 1,529
------- ------ ------- -------- -------
Total securities $12,692 $6,193 $21,403 $ 32,975 $73,263
======= ====== ======= ======== =======
Weighted average yield 2.39% 6.29% 6.04% 6.15% 5.49%
December 31, 2000
------------------------------------------------------
10 years
1 Year 1 - 5 5 - 10 and
or Less years years beyond Total
------- ------- ------- -------- -------
U.S. government and agencies $ 998 $16,978 $ 5,896 $ -- $23,872
Mortgage-backed securities -- 3,158 5,938 32,440 41,536
Municipal bonds -- 381 562 1,775 2,718
Other -- 495 1,415 28 1,938
------- ------- ------- -------- -------
Total securities $ 998 $21,012 $13,811 $ 34,243 $70,064
======= ======= ======= ======== =======
Weighted average yield 6.67% 6.07% 6.51% 6.48% 6.43%
STOCKHOLDERS' EQUITY. Stockholders' equity at December 31, 2002 was $30.5
million, or 8.06% of total assets, an increase of $1.9 million from $28.6
million, or 7.47% of total assets, at December 31, 2001. At December 31, 2002,
book value was $18.74 per share. The increase in stockholders' equity is
primarily due to net income of $3.0 million for 2002 and an increase in net
unrealized gain on securities available-for-sale of $.5 million. These increases
were offset by the payment of $1.6 million in dividends on UFC's common stock.
LIQUIDITY AND CAPITAL RESOURCES. United's primary sources of funds are
deposits, repurchase agreements, FHLB borrowings, proceeds from loan sales, and
loan and mortgage-backed securities repayments. While maturities and scheduled
amortization of loans and mortgage-backed securities are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by market
interest rates, economic conditions and competition. In a period of declining
interest rates, it is anticipated that mortgage prepayments would increase. As a
result, these proceeds from mortgage prepayments generally would be invested in
lower yielding loans or other investments which have the effect of reducing
interest income. In a period of rising interest rates, it is anticipated that
mortgage prepayments
32
would decrease and the proceeds from such prepayments generally would be
invested in higher yielding loans or investment which would have the effect of
increasing interest income.
United's liquidity, represented by cash and cash equivalents, is a result
of its operations, investing and financing activities. There activities are
summarized below for the years ended December 31, 2002, 2001 and 2000.
(Dollars in thousands) For the Year Ended December 31,
2002 2001 2000
-------------------------------------
Net Income $ 2,955 $ 2,375 $ 2,004
Adjustments to reconcile net income to net
cash provided (used) by operating activities (4,601) (2,731) 839
-------- -------- --------
Net cash provided (used) by operating activities (1,646) (356) 2,843
Net cash provided(used) by investing activities 20,541 (14,191) (28,890)
Net cash provided (used) by financing activities (7,698) 17,123 34,041
-------- -------- --------
Net increase in cash and cash equivalents 11,197 2,576 7,994
Cash and cash equivalents at beginning of year 22,027 19,451 11,457
-------- -------- --------
Cash and cash equivalents at end of year $ 33,224 $ 22,027 $ 19,451
======== ======== ========
The primary investing activities of United are the origination of loans
held for sale and the purchase of investment and mortgage-backed securities.
During the years ended December 31, 2002, 2001 and 2000, United's loan
originations totaled $202.9 million, $172.2 million and $110.5 million,
respectively. Purchase of securities available-for-sale totaled $60.0 million,
$46.3 million and $7.8 million for the years ended December 31, 2002, 2001 and
2000, respectively. During 2000 a net $.7 million of cash ($1.9 million paid in
cash consideration less $1.2 million in cash and cash equivalents purchased) was
used to acquire shares of Valley.
During 2002, 2001 and 2000, investing activities were funded primarily
by principal repayments on loans and securities available-for-sale, the maturity
of securities available-for-sale, and the sales of loans and securities
available for sale totaling $270.1 million, $211.3 million, and $118.3 million,
respectively.
The major sources of cash flows from financing activities are deposits
into savings accounts and additional borrowings. The major uses of cash flows
from financing activities are withdrawals from savings accounts, payments on
borrowings, purchases of common stock, and payment of dividends to stockholders.
For the years ended December 31, 2002, 2001, and 2000 the net increase
(decrease) in cash flows from financing activities was $(7.7) million, $17.1
million and $34.0 million, respectively.
The Banks' most liquid assets are cash and cash in banks and highly
liquid, short-term investments. The levels of these assets are dependent on the
Banks' operating, financing, lending, and investing activities during any given
period.
33
Liquidity management of the Banks is both a daily and long-term
function of United's management strategy. Excess funds are generally invested in
FHLB overnight funds. If the Banks should require funds beyond their ability to
generate them internally, additional sources of funds are available through the
use of FHLB advances. At December 31, 2002 the Banks had outstanding borrowings
of $51.5 million which included $38.0 million of FHLB advances, $12.8 million of
securities sold under agreements to repurchase and $.7 million of other borrowed
money. (See Part IV, Item 15-"Notes to Consolidated Financial Statements-Federal
Home Loan Bank Advances and Lines of Credit"). Future maturities on these
outstanding borrowings are presented in the following table.
(Dollars in thousands) December 31, 2002
-------------------------------------------------
5 Years
1 Year 1 - 3 4 - 5 and
or Less Years Years Beyond Total
------- ------- ------ ------- -------
FHLB advances $10,000 $17,000 $9,000 $ 2,000 $38,000
Securities sold under
agreements to repurchase 6,318 841 220 5,408 12,787
Other borrowed money 700 -- -- -- 700
------- ------- ------ ------- -------
Total $17,018 $17,841 $9,220 $ 7,408 $51,487
======= ======= ====== ======= =======
At December 31, 2002, the Banks had outstanding commitments to originate
loans of $7.8 million, on 1-4 family mortgages at fixed interest rates. These
loans are to be secured by properties located in the Bank's primary market
areas. Other outstanding commitments at December 31, 2002 for the Banks include
$34.5 million in unused lines of credit, $1.8 million in variable rate loan
commitments, $2.6 million in unfunded Bankcard arrangements, and $.5 million in
letters of credit. The Banks anticipate that they will have sufficient funds
available to meet current loan commitments. Certificates of deposit scheduled to
mature in less than one year from December 31, 2002 totaled $88.0 million.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK. Market risk is the risk of loss in a financial instrument
arising from adverse changes in market rates/prices such as interest rates,
foreign currency exchange rates, commodity prices and equity prices. Since
United's earnings depend on its level of interest rate spread, its primary
market risk exposure is interest rate risk ("IRR").
INTEREST RATE RISK. United has established a formal IRR policy, and the
Banks have an Asset/Liability Management Committee ("ALCO") and an Investment
Committee, which meet at least quarterly to review and report on management's
efforts to minimize IRR. Several asset/liability management strategies have been
employed by United to minimize its exposure to IRR. These include selling most
newly-originated long-term fixed-rate mortgages, promoting the origination and
retention of loans providing for periodic interest rate adjustments, shorter
terms to maturity or balloon provisions, and investing in adjustable rate or
shorter-term mortgage-backed securities and other interest-earning investments.
The Asset/Liability Management Committee utilizes an institutional funds
management service detailed simulation model to quantify the estimated exposure
of net interest income ("NII") to sustained interest rate changes. The model
predicts the impact of changing interest rates on the interest income received
and interest expense paid on assets and liabilities. This sensitivity analysis
is compared to ALCO policy limits which specify a maximum tolerance level for
NII given a 100 basis point (bp) rise or decline in interest rates.
The following summarizes the sensitivity analysis for the Banks as of
December 31, 2002, the most recent information available. Management believes
there has been no material change in interest rate risk since December 31, 2002.
For additional
34
information, see Management's Discussion and Analysis of Financial Condition and
Results of Operations included herein in Item 7.
HERITAGE BANK
ESTIMATED INCREASE (DECREASE)
IN NET INTEREST INCOME: +200 BP -200 BP
----------- -----------
0-90 days $ (18,381) $ (64,497)
91-360 days (256,663) (82,460)
2 years (521,193) (160,692)
3 years (775,243) (249,402)
VALLEY BANK
ESTIMATED INCREASE (DECREASE)
IN NET INTEREST INCOME: +200 BP -200 BP
---------- -----------
0-90 days $ (25,617) $ (39,544)
91-360 days (76,872) (122,676)
2 years (111,390) (367,556)
3 years (116,358) (641,985)
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of assets and liability cash flows
and others. Sensitivity analysis does not reflect actions that United might take
in responding to or anticipating changes in interest rates.
INTEREST RATE SENSITIVITY OF THE ECONOMIC VALUE OF EQUITY. Mismatches of
interest rate repricing between assets and liabilities create interest rate
risk. Interest rate risk affects the market value of equity, also called the
economic value of equity ("EVE"). Measurement of the EVE is an attempt to
establish a methodology to gauge the potential for the reduction of future
earnings and stockholders' equity resulting from both lower net interest income
("NII") and lower EVE caused by changes in market interest rates. EVE is the
difference between United's depository portfolio value and its loans receivable
portfolio value. EVE thus provides a leading indicator of future potential
changes in both NII and stockholders' equity.
Heritage Bank and Valley Bank have both established maximum percentage
changes for EVE at 1.5% of total assets, given an 100 basis point change in
interest rates. EVE, as a percent to total assets, was as follows:
ERITAGE BANK VALLEY BANK
PERCENT TO TOTAL ASSETS:
2002 .85% .96%
2001 1.21% 1.55%
2000 1.12% Not available
Heritage Bank periodically reviews and makes changes to established limits
for EVE changes due to mergers and other market factors. Though Valley Bank was
slightly over 1.5% of assets in 2001, management considers this to be within
prudent standards and continues to monitor the ratio. The EVE calculation
contains a significant number of assumptions, some of which are not always
reliable. Management does not consider this to be a significant departure from
policy.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operation results.
These hypothetical
35
estimates are based upon numerous assumptions, including the nature and timing
of interest rate levels including yield curve shape, prepayments on loans and
securities, deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of assets and liability cash flows and others. The EVE
analysis does not reflect actions that Heritage Bank or Valley Bank might take
in responding to or anticipating changes in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The management of United has prepared and is responsible for the
consolidated financial statements of United. These statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America applied on a consistent basis.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the captions "Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance" in United's definitive
Proxy Statement for its 2003 Annual Meeting of Shareholders (the "Proxy
Statement") is incorporated herein by reference. Information regarding executive
officers is set forth in Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "Executive Compensation and
Other Information," "Compensation of Directors" and "Stock Price Performance
Graph" in the Proxy Statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information set forth under the captions "Equity Compensation Plan
Information", "Securities Ownership of Certain Beneficial Owners" and
"Securities Ownership of Management" in the Proxy Statement is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships and
Related Transactions between Management and the Company" in the Proxy Statement
is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
United's Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation within 90 days of the filing date of this
report, that United's disclosure controls and procedures are adequately designed
to ensure that information required to be disclosed by United in the reports it
files or submits under the Securities and Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported, within the time periods specified
in applicable rules and forms. There were no significant changes made in our
internal controls or, to our knowledge, in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(A) (1) FINANCIAL STATEMENTS:
The following consolidated financial statements of United Financial Corp.
are included in Part II, Item 8 of this Annual Report as follows:
Pages in Annual Report
----------------------
INDEPENDENT AUDITORS' REPORTS F-1
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION F-3
December 31, 2002 and 2001
CONSOLIDATED STATEMENTS OF INCOME - YEARS ENDED F-4
December 31, 2002, 2001, and 2000
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND
COMPREHENSIVE INCOME - YEARS ENDED F-5
December 31, 2002, 2001, and 2000
CONSOLIDATED STATEMENTS OF CASH FLOWS - YEARS ENDED F-6
December 31, 2002, 2001, and 2000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-7
(2) FINANCIAL STATEMENT SCHEDULES:
Financial statement schedules have been omitted because they are
inapplicable or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
(3) EXHIBITS.
Exhibits are listed in the Exhibit Index beginning on page 41 of this
report.
(B) REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 2002.
None
(C) SEE ITEM 15(A)(3) ABOVE.
(D) SEE ITEM 15(A)(2) ABOVE.
37
SIGNATURES AND CERTIFICATIONS
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:
UNITED FINANCIAL CORP.
By: /s/ Kurt R. Weise By: /s/ Paula J. Delaney
------------------------------ --------------------------------
Kurt R. Weise Paula J. Delaney
Chairman and Chief Executive Officer Chief Financial Officer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
and Director
Date: March 28, 2003 Date: March 28, 2003
---------------------------- -------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated:
By: /s/ Larry D. Albert By: /s/ Dr. J. William Bloemendaal
------------------------------ --------------------------------
Larry D. Albert Dr. J. William Bloemendaal
Director Director
Date: March 28, 2003 Date: March 28, 2003
---------------------------- ------------------------------
By: /s/ Kevin P. Clark By: /s/ Elliott L. Dybdal
------------------------------ --------------------------------
Kevin P. Clark Elliott L. Dybdal
Director Director
Date: March 28, 2003 Date: March 28, 2003
---------------------------- ------------------------------
By: /s/ Steve L. Feurt By: /s/ Jerome H. Hentges
------------------------------ --------------------------------
Steve L. Feurt Jerome H. Hentges
Director Director
Date: March 28, 2003 Date: March 28, 2003
---------------------------- ------------------------------
By: /s/ William L. Madison By: /s/ John M. Morrison
------------------------------ ------------------------------
William L. Madison John M. Morrison
Director Director
Date: March 28, 2003 Date: March 28, 2003
---------------------------- ----------------------------
38
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Kurt R. Weise, certify that:
1. I have reviewed this annual report on Form 10-K of United Financial Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered
by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15b-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or person performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date March 28, 2003 /s/ Kurt R. Weise
------------------------ -----------------------------------
Kurt R. Weise
Chairman and Chief
Executive Officer
(Principal Executive
Officer)
39
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Paula J. Delaney, certify that:
1. I have reviewed this annual report on Form 10-K of United Financial Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered
by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15b-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or person performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date March 28, 2003 /s/ Paula J. Delaney
----------------------- -----------------------------------
Paula J. Delaney
Chief Financial Officer
(Principal Financial and
Accounting Officer)
40
INDEX TO EXHIBITS
-----------------
Exhibit No. Exhibit
- ----------- --------------------------------------------------------------------
3.1 Articles of Incorporation of United Financial Corp., as amended
(incorporated by reference to Exhibit 3.1 of UFC's Annual Report on
Form 10-K dated March 31, 1998).
3.2 Bylaws of United Financial Corp., as amended (incorporated by
reference to Exhibit 3.1 of UFC's Annual Report on Form 10-K dated
March 31, 1998).
10.1 Promissory Note issued by United Financial Corp. to Wells Fargo Bank
Minnesota National Association, dated November 16, 2001
(incorporated by reference to Exhibit 10.1 of UFC's Quarterly Report
on Form 10-Q dated June 30, 2002).
10.2 Second Amendment to Letter Agreement between Wells Fargo Bank
Minnesota National Association and United Financial Corp., dated
November 16, 2001 (incorporated by reference to Exhibit 10.2 of
UFC's Quarterly Report on Form 10-Q dated June 30, 2002).
10.3 Service Agreement between United Financial Corp. and Central
Financial Services, Inc., dated January 1, 2002 (incorporated by
reference to Exhibit 10.3 of UFC's Quarterly Report on Form 10-Q
dated June 30, 2002).
10.4 Service Agreement between Heritage Bank and Central Financial
Services, Inc., dated January 1, 2002 (incorporated by reference to
Exhibit 10.4 of UFC's Quarterly Report on Form 10-Q dated June 30,
2002).
10.5* Management Retention Supplemental Retirement Income Salary
Continuation Plan between Kevin Clark and Heritage Bank, revised
January 10, 1996 (incorporated by reference to Exhibit 10.5 of UFC's
Quarterly Report on Form 10-Q dated June 30, 2002).
10.6* Heritage Bank Supplemental Retirement Agreement between Heritage
Bank and Steve L. Feurt, dated October 25, 1999 (incorporated by
reference to Exhibit 10.6 of UFC's Quarterly Report on Form 10-Q
dated June 30, 2002).
10.7 Indenture between United Financial Corp. and The Bank of New York,
as trustee, dated July 16, 2001 (incorporated by reference to
Exhibit 10.7 of UFC's Quarterly Report on Form 10-Q dated June 30,
2002).
10.8 Amended and Restated Declaration of Trust of United Financial -
Montana Capital Trust I among United Financial Corp. and the
trustees, administrators and holders named therein, dated July 16,
2001 (incorporated by reference to Exhibit 10.8 of UFC's Quarterly
Report on Form 10-Q dated June 30, 2002).
10.9 Guarantee Agreement between United Financial Corp. and The Bank of
New York, as trustee, dated July 16, 2001 (incorporated by reference
to Exhibit 10.9 of UFC's Quarterly Report on Form 10-Q dated June
30, 2002).
10.10 United Financial Corp. 2000 Long-Term Incentive and Stock Option
Plan (incorporated by reference to Exhibit 10.10 of UFC's Quarterly
Report on Form 10-Q dated June 30, 2002).
10.11 Letter Agreement between Wells Fargo Bank Minnesota National
Association and United Financial Corp., dated November 17,
1999(incorporated by reference to Exhibit 10.11 of UFC's Quarterly
Report on Form 10-Q dated September 30, 2002).
10.12 First Amendment to Letter Agreement between Wells Fargo Bank
Minnesota National Association and United Financial Corp., dated
September 29, 2000(incorporated by reference to Exhibit 10.12 of
UFC's Quarterly Report on Form 10-Q dated September 30, 2002).
10.13 Revolving Line of Credit Note between Wells Fargo Bank Minnesota
National Association and United Financial Corp. dated October 30,
2002.
10.14 Credit Agreement between Wells Fargo Bank Minnesota National
Association and United Financial Corp. dated October 30, 2002.
10.15 General Pledge Agreement between Wells Fargo Bank Minnesota National
Association and United Financial Corp. dated October 30, 2002.
41
21.1 Subsidiaries List.
23.1 Consent of Moss Adams LLP.
23.2 Consent of KPMG LLP.
99.1 Certification of principal executive officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
99.2 Certification of principal financial officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
* Management contract or compensation plan or arrangement required to be filed
as an exhibit to Form 10-K pursuant to Item 15(a)-3 of the Annual Report.
42
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(With Independent Auditors' Report Thereon)
Moss Adams LLP
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
United Financial Corp. and Subsidiaries
Great Falls, Montana
We have audited the accompanying consolidated statements of financial condition
of United Financial Corp. and subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, stockholders' equity and
comprehensive income, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of United Financial
Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/s/ Moss Adams LLP
Spokane, Washington
February 14, 2003
F-1
KPMG LLP
Independent Auditors' Report
----------------------------
The Board of Directors and Stockholders
United Financial Corp.:
We have audited the accompanying consolidated statements of income,
stockholders' equity and comprehensive income, and cash flows of United
Financial Corp. and subsidiaries for the year ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
United Financial Corp. and subsidiaries for the year ended December 31, 2000 in
conformity with accounting principles generally accepted in the United States of
America.
/s/ KPMG LLP
Billings, Montana
February 16, 2001
F-2
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
DECEMBER 31,
---------------------------
ASSETS 2002 2001
------------ -----------
Cash and cash equivalents $ 33,223,713 22,026,493
Securities available-for-sale 60,936,117 73,262,867
Restricted stock, at cost 4,326,800 3,993,600
Loans held for sale 13,647,657 7,713,306
Loans receivable, net 250,431,226 260,524,282
Accrued interest receivable 2,525,102 2,768,684
Premises and equipment, net 7,667,968 6,609,322
Real estate and other personal property owned 586,176 667,528
Deferred tax asset, net 154,807 553,534
Goodwill, net of accumulated amortization 3,429,177 3,076,065
Identifiable intangibles, net of accumulated amortization -- 398,710
Other assets 1,051,057 1,135,675
------------ -----------
$377,979,800 382,730,066
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Non-interest bearing deposits $ 48,227,093 46,688,634
Interest bearing deposits 238,753,015 235,711,604
Federal Home Loan Bank advances 38,000,000 50,500,000
Securities sold under agreements to repurchase 12,787,240 9,603,651
Line of credit 700,000 1,000,000
Federal funds purchased -- 1,000,000
Advances from borrowers for taxes and insurance 103,777 163,668
Income taxes payable 264,489 503,308
Accrued interest payable 1,410,091 1,928,736
Trust preferred securities 3,000,000 3,000,000
Accrued expenses and other liabilities 1,308,277 1,188,303
------------ -----------
Total liabilities 344,553,982 351,287,904
------------ -----------
Minority interest 2,950,090 2,844,947
------------ -----------
Commitments and contingencies (Note 24)
Stockholders' equity:
Preferred stock, no par value; authorized 2,000,000
shares; no shares issued and outstanding -- --
Common stock, no par value; authorized 8,000,000
shares; 1,626,150 and 1,625,967 shares issued
at December 31, 2002 and 2001, respectively 27,166,756 23,950,437
Retained earnings, substantially restricted 2,476,481 4,339,060
Accumulated other comprehensive income,
net of taxes 832,491 307,718
------------ -----------
Total stockholders' equity 30,475,728 28,597,215
------------ -----------
$377,979,800 382,730,066
============ ===========
See accompanying notes to consolidated financial statements.
F-3
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Income
YEARS ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ----------- -----------
Interest income:
Loans receivable $ 19,496,789 22,375,775 20,950,657
Mortgage-backed securities 2,797,584 2,910,051 3,898,950
Other investment securities 807,737 953,251 495,207
Other interest-earning assets 535,672 643,033 395,117
------------ ----------- -----------
Total interest income 23,637,782 26,882,110 25,739,931
------------ ----------- -----------
Interest expense:
Deposits 7,528,936 10,936,144 10,703,543
Federal Home Loan Bank advances 2,716,697 3,198,764 3,444,117
Securities sold under agreements to repurchase 277,683 487,822 672,773
Other borrowings 36,307 95,738 135,222
Trust preferred securities 176,678 105,980 --
------------ ----------- -----------
Total interest expense 10,736,301 14,824,448 14,955,655
------------ ----------- -----------
Net interest income 12,901,481 12,057,662 10,784,276
Provision for loan losses 1,170,000 1,640,125 1,628,569
------------ ----------- -----------
Net interest income after provision for
loan losses 11,731,481 10,417,537 9,155,707
------------ ----------- -----------
Non-interest income:
Gain on sale of loans 3,955,216 3,426,147 2,269,504
Loan servicing fees 172,440 222,955 296,474
Customer service charges 949,292 788,310 569,246
Gain on sale of securities 87,322 157,916 --
Other 235,908 319,070 701,295
------------ ----------- -----------
Total non-interest income 5,400,178 4,914,398 3,836,519
------------ ----------- -----------
Non-interest expense:
Compensation and benefits 6,534,326 6,004,634 5,165,880
Occupancy and equipment 1,600,628 1,432,772 1,139,624
Data processing fees 795,794 761,517 671,237
Management fees 484,315 378,828 348,053
Marketing and business development 282,410 244,089 246,019
Telephone and postage 334,283 327,029 297,386
Legal and accounting 469,409 440,730 304,820
Other 1,540,342 1,578,240 1,376,605
------------ ----------- -----------
Total non-interest expense 12,041,507 11,167,839 9,549,624
------------ ----------- -----------
Income before income taxes and minority interest 5,090,152 4,164,096 3,442,602
Income taxes 1,922,495 1,633,306 1,287,477
------------ ----------- -----------
Income before minority interest 3,167,657 2,530,790 2,155,125
Minority interest (212,402) (156,065) (151,171)
------------ ----------- -----------
Net income $ 2,955,255 2,374,725 2,003,954
============ =========== ===========
Basic earnings per share $ 1.82 1.42 1.11
============ =========== ===========
Diluted earnings per share $ 1.79 1.41 1.11
============ =========== ===========
See accompanying notes to consolidated financial statements.
F-4
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended December 31, 2002, 2001 and 2000
ACCUMULATED
OTHER TOTAL
COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK EARNINGS INCOME (LOSS) EQUITY
------------ ---------- ------------- -------------
Balances at December 31, 1999 $ 27,069,930 3,250,876 (961,850) 29,358,956
Comprehensive income:
Net income -- 2,003,954 -- 2,003,954
Decrease in net unrealized losses on securities
available-for-sale, net of reclassification
adjustment -- -- 881,895 881,895
-----------
Total comprehensive income 2,885,849
-----------
Dividends declared ($.95 per share) -- (1,713,724) -- (1,713,724)
Treasury shares purchased at cost
(40,700 shares) (583,601) -- -- (583,601)
------------ ---------- -------- -----------
Balances at December 31, 2000 26,486,329 3,541,106 (79,955) 29,947,480
Comprehensive income:
Net income -- 2,374,725 -- 2,374,725
Decrease in net unrealized loss on securities
available-for-sale, net of reclassification
adjustment -- -- 387,673 387,673
-----------
Total comprehensive income 2,762,398
-----------
Issuance of 264 shares; employee stock options 3,570 -- -- 3,570
Dividends declared ($.95 per share) -- (1,576,771) -- (1,576,771)
Treasury shares purchased at cost
(151,140 shares) (2,539,462) -- -- (2,539,462)
------------ ---------- -------- -----------
Balances at December 31, 2001 23,950,437 4,339,060 307,718 28,597,215
Comprehensive income:
Net income -- 2,955,255 -- 2,955,255
Increase in net unrealized gain on securities
available-for-sale, net of reclassification
adjustment -- -- 524,773 524,773
-----------
Total comprehensive income 3,480,028
-----------
Issuance of 225 shares; employee stock options 3,300 -- -- 3,300
Dividends declared ($1.00 per share) -- (1,604,815) -- (1,604,815)
10% stock dividend 3,213,019 (3,213,019) --
------------ ---------- -------- -----------
Balances at December 31, 2002 $ 27,166,756 2,476,481 832,491 30,475,728
============ ========== ======== ===========
----------------------------------------
Disclosure of reclassification amount: 2002 2001 2000
----------------------------------------
Unrealized holding gains arising during the period $ 1,001,668 844,521 1,437,089
Tax benefit (380,634) (321,514) (552,488)
----------- -------- ----------
Net after tax 621,034 523,007 884,601
----------- -------- ----------
Reclassification adjustment for gains included in net income (87,322) (157,916) --
Tax expense 33,182 60,008 --
----------- -------- ----------
Net after tax (54,140) (97,908) --
Portion of unrealized gain allocated to minority interest (42,121) (37,426) (2,706)
----------- -------- ----------
Net change in unrealized gain on availiable-for-sale
securities $ 524,773 387,673 881,895
=========== ======== ==========
See accompanying notes to consolidated financial statements.
F-5
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
------------- ------------ ------------
Cash flows from operating activities:
Net income $ 2,955,255 2,374,725 2,003,954
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 1,170,000 1,640,125 1,628,569
Amortization of goodwill and identifiable intangibles 45,598 259,421 259,196
Depreciation 657,492 604,668 500,167
Net gain on sale of premises and equipment (1,801) (1,292) (5,807)
Deferred income tax expense (benefit) 49,073 (371,182) (33,814)
Amortization/accretion of premiums and discounts
on securities and loans, net (15,356) 61,647 133,253
Gain on sale of investment securities (87,322) (157,916) --
Gain on sale of real estate owned -- (46,456) --
Writedown of loan premium 232,542 -- --
Mortgage loans originated and held for sale (202,918,074) (172,228,007) (110,510,643)
Proceeds from sales of mortgage loans held for sale 196,751,181 167,495,540 108,720,915
FHLB stock dividends (238,200) (242,100) (208,100)
Decrease (increase) in accrued interest receivable 243,582 582,178 (707,302)
Decrease (increase) in other assets 84,618 (26,989) (159,793)
Increase (decrease) in income taxes payable (238,819) 194,678 (197,232)
Increase (decrease) in accrued interest payable (518,645) (546,208) 888,315
Increase in accrued expenses and other liabilities 119,974 32,517 380,058
Net change in minority interest 63,022 18,633 151,171
------------- ------------ ------------
Net cash provided (used) by operating
activities (1,645,880) (356,018) 2,842,907
------------- ------------ ------------
Cash flows from investing activities:
Net (increase) decrease in loans receivable 7,960,049 (10,816,854) (27,393,985)
Purchases of securities available-for-sale (59,994,142) (46,263,354) (7,834,019)
Proceeds from maturities, calls and paydowns and sales
of securities available-for-sale 73,340,118 43,847,274 9,570,153
Proceeds from redemption of FHLB stock -- -- 31,300
Purchases of restricted stock (95,000) (42,850) (271,300)
Purchase of Valley Bancorp, Inc. stock -- (831,251) (1,923,050)
Purchases of premises and equipment (1,722,033) (800,251) (2,350,777)
Proceeds from sale of premises and equipment 27,800 37,050 26,100
Proceeds from sale of real estate and other personal
property owned 1,093,212 706,059 105,045
Additions of real estate and other personal
property owned (68,957) (26,877) (55,476)
Acquired cash and cash equivalents of Valley
Bancorp, Inc. -- -- 1,205,576
------------- ------------ ------------
Net cash provided (used) by investing activities 20,541,047 (14,191,054) (28,890,433)
------------- ------------ ------------
Cash flows from financing activities:
Net increase in deposits 4,579,870 21,220,952 31,215,127
Proceeds from FHLB advances 14,000,000 25,000,000 26,000,000
Payments on FHLB advances (26,500,000) (26,675,000) (20,250,000)
Advances on line of credit -- 1,750,000 1,555,000
Payments on line of credit (300,000) (2,000,000) (305,000)
Net increase (decrease) in securities sold under
repurchase agreements 3,183,589 (1,762,048) (180,260)
Net increase (decrease) in federal funds purchased (1,000,000) 1,000,000 (1,750,000)
Net increase (decrease) in advances from borrowers
for taxes and insurance (59,891) (298,401) 53,908
Issuance of trust preferred securities -- 3,000,000 --
Proceeds from issuance of common stock 3,300 3,570 --
Purchase of treasury stock -- (2,539,462) (583,601)
Dividends paid to stockholders (1,604,815) (1,576,771) (1,713,724)
------------- ------------ ------------
Net cash provided (used) by financing activities (7,697,947) 17,122,840 34,041,450
------------- ------------ ------------
Net increase in cash and cash equivalents 11,197,220 2,575,768 7,993,924
Cash and cash equivalents at beginning of year 22,026,493 19,450,725 11,456,801
------------- ------------ ------------
Cash and cash equivalents at end of year $ 33,223,713 22,026,493 19,450,725
============= ============ ============
Cash paid during the year for:
Interest, approximately $ 11,255,000 15,369,000 14,074,000
Income taxes, approximately 2,113,000 1,810,000 1,519,000
============= ============ ============
See accompanying notes to consolidated financial statements.
F-6
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) GENERAL
The accompanying consolidated financial statements include the
accounts of United Financial Corp. (UFC), a bank holding company
headquartered in Great Falls, Montana, UFC's wholly-owned
subsidiary, Heritage Bank and, effective January 1, 2000, UFC's
majority-owned subsidiary Valley Bancorp, Inc. (Valley). UFC owned
65.32% of the outstanding stock of Valley at both December 31, 2002
and 2001 compared to 56.52% at December 31, 2000. UFC, Heritage
Bank, and Valley are herein referred to collectively as United. The
aggregate purchase price of all shares of Valley purchased by UFC to
date is approximately $7.2 million. Valley had assets of
approximately $74.5 million, deposits of approximately $61.8 million
and stockholders' equity of approximately $8.5 million at December
31, 2002. UFC's wholly-owned subsidiary, United Financial-Montana
Capital Trust I administers the $3.0 million of Capital Trust
Pass-Through Securities (See Note 12). All significant intercompany
balances and transactions have been eliminated in consolidation.
UFC's banking business in Montana is conducted through its
wholly-owned subsidiary, Heritage Bank, and in Arizona is conducted
through Valley Bank of Arizona (Valley Bank), the wholly-owned
subsidiary of Valley. Heritage Bank and Valley Bank are collectively
referred to herein as the subsidiary banks. United, through its
subsidiary banks, provides a full range of banking services to
individual and corporate customers in twelve Montana communities and
Phoenix and Scottsdale, Arizona. Heritage Bank is a state-chartered
commercial bank with locations in Bozeman, Chester, Fort Benton,
Geraldine, Glendive, Great Falls, Hamilton, Havre, Kalispell, Libby,
Missoula and Shelby, Montana. Valley Bank is a state-chartered
commercial bank with locations in Phoenix and Scottsdale, Arizona.
The subsidiary banks are engaged in the community banking business
of attracting deposits from the general public through their offices
and using those deposits, together with other available funds, to
originate commercial (including lease financing), commercial real
estate, residential, agricultural and consumer loans primarily in
their market areas in Montana and Arizona. A majority of the
subsidiary banks' banking business is conducted in the Great Falls
and Phoenix areas. Based on total assets, 43% of United's assets are
located at Heritage Bank's Great Falls locations and 18% at Valley
Bank's Phoenix location. The subsidiary banks are subject to
competition from other financial service providers. UFC and its
subsidiary banks are also subject to the regulations of certain
government agencies and undergo periodic examinations by those
regulatory authorities.
The subsidiary banks' financial condition and results of operations,
and therefore the financial condition and results of operations of
United, are dependent primarily on net interest income and fee
income. The subsidiary banks' financial condition and results of
operations are also significantly influenced by local and national
economic conditions, changes in market interest rates, governmental
policies, tax laws and the actions of various regulatory agencies.
The financial statements for 2000 included the accounts of Heritage
State Bank (Heritage State) a state-chartered commercial bank formed
in August 1998 to acquire a portion of the business of a failed bank
in Fort Benton, Montana. Effective January 1, 2001, Heritage Bank
merged into Heritage State's state banking charter. Effective at the
time of the merger, Heritage State changed its name to Heritage Bank
and relocated its main office to Great Falls, Montana.
F-7
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Heritage Bank also holds a 14% ownership interest in Bankers'
Resource Center, a computer data center. A former wholly-owned
subsidiary of Heritage Bank, Community Service Corporation (CSC),
was inactive in 2000 and the corporation was dissolved in 2001.
(B) BASIS OF PRESENTATION
The consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America. In preparing the consolidated financial
statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the
date of the statement of financial condition and income and expenses
for the period. Actual results could differ significantly from those
estimates.
Material estimates that are particularly susceptible to significant
change in the near-term relate to the determination of the allowance
for loan losses. Management believes the allowance for loan losses
is adequate, however, future additions to the allowance may be
necessary based on changes in factors affecting the borrowers'
ability to repay. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the
allowance for loan losses. Such agencies may require United to
recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.
(C) CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, United
considers all cash, daily interest demand deposits, amounts due from
banks and interest-bearing deposits with banks with original
maturities of three months or less to be cash equivalents.
(D) SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale include all investment and
mortgage-backed securities that management intends to use as part of
its overall asset/liability management strategy and that may be sold
in response to changes in interest rates and resultant prepayment
risk and other related factors. Securities available-for-sale are
carried at fair value and unrealized gains and losses (net of
related tax effects) are excluded from earnings and reported as a
separate component of stockholders' equity.
Declines in the fair value of available-for-sale securities below
carrying value that are other than temporary are charged to expense
as realized losses and the related carrying value is reduced to fair
value. The cost of any investment, if sold, is determined by the
specific identification method.
Premiums and discounts on investment securities are amortized or
accreted into income using a method which approximates the
level-yield interest method.
(E) LOANS RECEIVABLE AND LOAN FEES
Loans receivable are stated at unpaid principal balances, less
unearned discounts and net of deferred loan origination fees.
Interest on loans is credited to income as earned. Interest
receivable is accrued only if deemed collectible. Discounts on
purchased loans are amortized into interest income using the
level-yield method over the remaining period to contractual
maturity, adjusted for anticipated prepayments.
F-8
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Loans are placed on nonaccrual status when collection of principal
or interest is considered doubtful. Interest income previously
accrued on these loans, but not yet received, is reversed in the
current period. Interest subsequently recovered is credited to
income in the period collected.
Material loan origination fees and related direct origination costs
are deferred and the net fee or cost is recognized as interest
income using the level-yield method over the contractual life of the
loans, adjusted for prepayments. Origination fees on loans sold to
the secondary market are recognized when the loan is sold.
Amortization of deferred loan origination fees and costs and the
accretion of unearned discounts are suspended during periods in
which the related loan is on nonaccrual status.
(F) ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is based on management's evaluation of
the adequacy of the allowance, including an assessment of United'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, current
economic conditions and independent appraisals.
Additions to the allowance arise from charges to operations through
the provision for loan losses or from the recovery of amounts
previously charged off. The allowance is reduced by loans charged
off. Loans are charged off when management believes the loan's
principal balance, or a portion thereof, is no longer collectable.
United also provides an allowance for losses on specific loans which
are deemed to be impaired. Groups of small balance homogeneous loans
(generally consumer loans) are evaluated for impairment
collectively. A loan is considered impaired when, based upon current
information and events, it is probable that United will be unable to
collect, on a timely basis, all principal and interest according to
the contractual terms of the loan's original agreement. When a
specific loan is determined to be impaired, the allowance for loan
losses is increased through a charge to expense for the amount of
the impairment. The amount of the impairment is measured using cash
flows discounted at the loan's effective interest rate, except when
it is determined that the sole source of repayment for the loan is
the operation or liquidation of the underlying collateral. In such
cases, the current value of the collateral, reduced by anticipated
selling costs, is used in place of discounted cash flows. Generally,
when a loan is deemed impaired, current period interest previously
accrued but not collected is reversed against current period
interest income. Income on such impaired loans is then recognized
only to the extent that cash in excess of any amounts charged off to
the allowance for loan losses is received and where the future
collection of principal is probable. Interest accruals are resumed
on such loans only when they are brought fully current with respect
to interest and principal and when, in the judgment of management,
the loans are estimated to be fully collectible as to both principal
and interest.
(G) LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary
market are carried at the lower of cost or fair value. United
expects the loans to be sold with no gain or loss, in the
short-term.
F-9
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(H) GOODWILL AND IDENTIFIABLE INTANGIBLES
Goodwill and identifiable intangibles represent the excess of cost
over the fair value of the net assets at the date of acquisition.
Identifiable intangibles are amortized to expense using the
straight-line method over 5 to 15 years. UFC recorded $95,449 and
$493,567 of goodwill in 2001 and 2000, respectively, related to the
acquisition of Valley shares. No goodwill was recorded in 2002.
Effective January 1, 2002, United adopted FAS No. 142, which
requires that goodwill and intangible assets that have indefinite
lives no longer be amortized but be reviewed for impairment
annually, or more frequently if certain indicators arise. Prior to
the adoption of FAS No. 142, goodwill was being amortized using the
straight-line method over a period of 15 to 25 years. United did not
incur any goodwill impairment in 2002 in adopting FAS 142.
(I) RESTRICTED STOCK INVESTMENTS
Federal Home Loan Bank (FHLB) stock is a required investment for
institutions that are members of the FHLB system. The required
investment in the common stock is based on a predetermined formula
and is carried at cost on the statement of financial condition. The
stock is pledged as security for advances from the FHLB. During
2002, the FHLB revised its capital structure from the issuance of
one class of stock to two, B(1) and B(2) stock. B(1) stock can be
sold back to the FHLB at cost, but is restricted as to purchase,
sale, and redemption. Class B(2) is not a required investment for
institutions and is not restricted as to purchase and sale, but has
the same redemption restrictions as class B(1) stock. Included in
restricted stock on the statement of financial condition, Heritage
Bank has $3,908,800 and $0 of class B(1) and B(2) stock,
respectively at December 31, 2002. Heritage Bank held $3,676,200 of
FHLB stock at December 31, 2001. Valley Bank has also included in
restricted stock, $202,000 and $0 of class B(1) and B(2) stock,
respectively at December 31, 2002. In addition to FHLB stock, Valley
Bank has $216,000 in Federal Reserve Bank (FRB) stock at December
31, 2002. At December 31, 2001, Valley Bank had $101,400 and
$216,000 in FHLB and FRB stock, respectively.
(J) PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed by straight-line and
accelerated methods over the estimated useful lives of 39 years for
buildings, 5 to 40 years for improvements, and 3 to 10 years for
furniture, fixtures and equipment.
(K) REAL ESTATE AND OTHER PERSONAL PROPERTY OWNED
Real estate owned represents real estate assets acquired through
foreclosure or deed in lieu of foreclosure and is comprised of
properties held for sale and held for investment. Foreclosed assets
held for sale are carried at the lower of fair value less estimated
costs to sell, or cost. Fair value is determined as the amount that
could be reasonably expected in a current sale (other than a forced
or liquidation sale) between a willing buyer and a willing seller.
(L) STOCK REPURCHASED
In January 1999, UFC's Board of Directors (the Board) approved a
stock repurchase plan, which was extended in July 1999. Under the
plan UFC could buy up to 93,390 shares or $2,037,600 of UFC's
F-10
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
common stock. At December 31, 1999, UFC had repurchased 50,600
shares for a total of $931,649, at an average price of $18.41. This
stock repurchase program ended in January 2000.
In May 2000, the Board approved a second stock repurchase plan for a
period of one year, to buy back 110,000 shares of UFC's common
stock. Total shares repurchased under this plan were 59,950 for
$889,326, an average price of $14.83. This stock repurchase program
ended in May 2001.
In September 2002, a third stock repurchase plan was approved by the
Board to repurchase up to 81,300 shares or $1,707,300 of UFC's
common stock. No shares have been repurchased under this plan and at
December 31, 2002, total shares available under this plan were
81,300.
In a privately negotiated transaction in May 2001, UFC repurchased
131,890 shares of its common stock at $16.94 for a total of
$2,233,737.
Total shares repurchased under the three plans described above and
the private transaction were 242,440 for a total of $4,054,712. UFC
used existing funds, its line of credit, and proceeds from the trust
preferred issue (see Note 12) to finance the repurchases.
(M) STOCK-BASED COMPENSATION
At December 31, 2002, United has a stock-based employee compensation
plan, which is described more fully in Note 1819. United accounts
for the plan under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost
is reflected in net income, as all options granted under those plans
had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates
the effect on net income and earnings per share if United had
applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2002 2001 2000
------------ ------------ --------------
Net income: As reported $ 2,955,255 2,374,725 2,003,954
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (81,931) (37,614) (25,755)
----------- ------------ ------------
Pro forma net income $ 2,873,324 2,337,111 1,978,199
=========== ============ ============
Earnings per share:
Basic - as reported $ 1.82 1.42 1.11
=========== ============ ============
Basic - pro forma $ 1.77 1.39 1.09
=========== ============ ============
Diluted - as reported $ 1.79 1.41 1.11
=========== ============ ============
Diluted - pro forma $ 1.75 1.39 1.09
=========== ============ ============
(N) INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated
future consequences attributable to differences between the
financial statement carrying amounts of assets and liabilities and
their
F-11
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
respective tax bases. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in tax expense in
the period that includes the enactment date.
(O) EARNINGS PER SHARE
Basic earnings per share (EPS) is calculated by dividing net income
by the weighted average number of common shares outstanding during
the period. Diluted EPS is calculated by dividing net income by the
weighted average number of common shares used to compute basic EPS
plus the incremental amount of potential common stock determined by
the treasury stock method.
On May 21, 2002, a 10% stock dividend was approved by the Board,
payable June 28, 2002, to shareholders of record on June 24, 2002.
As a result, all per share amounts from time periods prior to this
date have been restated to illustrate the effect of the stock
dividend. Any fractional shares were paid in cash. The net effect on
United's stockholders'equity as a result of the 10% stock dividend
was to reduce retained earnings and increase common stock by $3.2
million, respectively.
(P) LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment whenever events or
circumstances indicate that the carrying amount of the asset may not
be recoverable. An impairment loss is recognized if the sum of the
expected future cash flows is less than the carrying amount of the
asset. The amount of the impairment loss, if any, is based on the
asset's fair value, which may be estimated by discounting the
expected future cash flows. At December 31, 2002 and 2001, there
were no assets that were considered impaired. There were no
impairment losses recognized during 2002, 2001 or 2000.
(Q) MORTGAGE SERVICING RIGHTS
United recognizes as assets the rights to service mortgage loans for
others, whether acquired or internally originated. Servicing assets
are initially recorded at fair value based on comparable market
quotes and are amortized in proportion to and over the period of
estimated net servicing income. Servicing assets are periodically
evaluated for impairment by stratifying the servicing assets based
on predominant risk characteristics of the underlying loans
including loan type, note rate and loan term. Servicing assets are
included in other assets on the accompanying consolidated statements
of financial condition.
(R) COMPREHENSIVE INCOME
United is required to report its comprehensive income, which
includes net income as well as other changes in stockholders' equity
that result from transactions and economic events other than those
with stockholders, in a separate statement. United's only
significant element of other comprehensive income is unrealized
gains and losses on securities available-for-sale, net of tax
effects.
(S) RECLASSIFICATIONS
Certain reclassifications have been made to the 2001 and 2000
amounts to conform to the 2002 presentation.
F-12
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(T) NEW ACCOUNTING PRONOUNCEMENTS
On April 30, 2002, FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB No. 13, and
Technical Corrections." SFAS No. 145 updates, clarifies, and
simplifies existing accounting pronouncements, by rescinding SFAS
No. 4, which required all gains and losses from extinguishment of
debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result,
the criteria in Accounting Principles Board Opinion 30 will now be
used to classify those gains and losses. Additionally, SFAS No. 145
amends SFAS No. 13 to require that certain lease modifications that
have economic effects similar to sale-leaseback transactions be
accounted for in the same manner as sale-leaseback transactions.
Finally, SFAS No. 145 also makes technical corrections to existing
pronouncements. United believes that the adoption of SFAS No. 145
did not have a material impact on United's financial position or
results of operations.
In June 2002, FASB approved for issuance SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." SFAS No. 146
was issued to clarify the date at which a liability should be
recognized for costs associated with exit and disposal activities.
SFAS No. 146 nullifies Emerging Issues Task Force ("EITF") Issue No.
94-3. Under Issue No. 94-3, the date at which the liability was
recognized was the date of an entity's commitment to an exit plan.
SFAS No. 146 requires that a liability for the cost of exit or
disposal activities be recognized when the liability is incurred. A
fundamental conclusion in this statement is that an entity's
commitment to a plan, by itself, does not create a present
obligation to others that meets the definition of a liability. Also,
this statement establishes that fair value is the objective for
initial measurement of the liability. SFAS No. 146 is effective for
exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. United currently believes
that the adoption of SFAS No. 146 will not have a material impact on
United's financial position or results of operations.
In October 2002, FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - an amendment of FASB No. 72 and 144 and
FASB Interpretation No. 9." SFAS No. 147 concluded that for a
transaction that is a business combination, the unidentified
intangible asset that is required to be recognized under paragraph 5
of SFAS No. 72 represents goodwill that should be accounted for
under SFAS No. 142. The statement also concluded that SFAS No. 141
provides sufficient guidance for assigning amounts to assets
acquired and liabilities assumed; therefore, the specialized
industry guidance in Interpretation 9 and paragraph 4 of SFAS No. 72
is no longer necessary. Finally, SFAS No. 147 clarifies that a
branch acquisition that meets the definition of a business should be
accounted for as a business combination, otherwise the transaction
should be accounted for as an acquisition of net assets that does
not result in the recognition of goodwill. This statement is
effective on October 1, 2002. United does not expect SFAS No. 147 to
have a material effect on United's financial position or results of
operations.
In December 2002, FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure - an amendment to
FASB Statement No. 123. SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement No. 123 to
require prominent disclosures about the method of accounting for
stock-based employee compensation and the effect of the method used
on reporting results.
F-13
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
United's adoption of SFAS No. 148 did not have a material impact on
United's financial position or results of operations. United has
elected to continue recognizing employee stock options under APB No.
25, as permitted by this statement. In addition, the disclosures in
United's financial statements reflect the guidance provided by SFAS
No. 148.
(2) CASH ON HAND AND IN BANKS
The subsidiary banks are required to maintain an average reserve balance
with the FRB, or maintain such reserve in cash on hand. The amount of this
required reserve balance at December 31, 2002 and 2001 was approximately
$2,036,000 and $1,289,000, respectively. An additional $25,000
compensating balance is required to be maintained with the FRB for check
clearing services.
United places its cash with high credit quality institutions. The amount
on deposit fluctuates, and at times exceeds the insured limit by the
Federal Deposit Insurance Corporation, which potentially subjects United
to credit risk.
(3) SECURITIES AVAILABLE-FOR-SALE
The amortized cost, unrealized gains and losses, and estimated fair values
of investment and mortgage-backed securities available-for-sale at
December 31 are as follows:
2002
-----------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ----------- ----------
U.S. Government and
federal agencies $13,793,090 238,418 -- 14,031,508
Mortgage-backed
securities 42,194,844 1,059,922 -- 43,254,766
Municipal bonds 1,945,287 53,712 -- 1,998,999
Corporate bonds and
equity securities 1,525,493 125,351 -- 1,650,844
----------- ---------- ----------- ----------
$59,458,714 1,477,403 -- 60,936,117
=========== ========== =========== ==========
2001
-----------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ----------- ----------
U.S. Government and
federal agencies $30,438,554 338,269 (70,022) 30,706,801
Mortgage-backed
securities 38,937,680 399,674 (55,724) 39,281,630
Municipal bonds 1,783,502 7,527 (45,825) 1,745,204
Corporate bonds and
equity securities 1,542,276 731 (13,775) 1,529,232
----------- ---------- ----------- ----------
$72,702,012 746,201 (185,346) 73,262,867
=========== ========== =========== ==========
F-14
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Maturities of securities available-for-sale by contractual maturity at
December 31, 2002 are shown below. Maturities of securities do not reflect
repricing opportunities present in many adjustable rate securities. At
December 31, 2002 and 2001, market values of variable rate securities
included in securities available-for-sale are $19,339,670 and $12,398,040,
respectively.
ESTIMATED
AMORTIZED FAIR
COST VALUE
------------- -------------
Due within one year $ 299, 274 299,274
Due after one year through five years 3,586,678 3,647,456
Due after five years through ten years 9,991,306 10,296,740
Due after ten years 3,386,612 3,437,881
------------- -------------
Mortgage-backed securities 42,194,844 43,254,766
------------- -------------
$ 59,458,714 60,936,117
============= =============
United has not entered into any swaps, options, or futures contracts.
Included in the municipal bonds and U.S. Government and federal agencies
security amounts are investments which have call features. At December 31,
2002, United had securities callable within one year with amortized cost
and estimated fair value of $10,818,273 and $10,953,771, respectively. The
securities are primarily included in the due after five years through ten
years category in the table above.
Gross proceeds from sales of securities were $3,103,025 and $6,804,564 for
the years ended December 31, 2002 and 2001, respectively, resulting in
gross gains of $87,322 in 2002 and $157,916 in 2001. There were no sales
of securities available-for-sale during the year ended December 31, 2000.
There are no significant concentrations of investments at December 31,
2002 (greater than 10% of stockholders' equity) in any individual security
issuer, except for U.S. Government or agency-backed securities.
At December 31, 2002 and 2001, investment securities available-for-sale
were pledged as follows:
2002 2001
---------------------------------------------------------------------------
ESTIMATED FAIR ESTIMATED FAIR
PLEDGED TO SECURE: AMORTIZED COST VALUE AMORTIZED COST VALUE
- ----------------------------------- -------------- ---------------- -------------- --------------
Repurchase agreements $12,869,297 13,079,611 15,777,168 15,906,997
FHLB advances 18,236,077 18,648,152 21,002,294 21,004,805
Public and nonpublic deposits,
federal funds purchased
and other 14,882,743 15,360,600 23,700,280 24,040,538
----------- ---------- ---------- ----------
45,988,117 47,088,363 60,479,742 60,952,340
Unpledged 13,470,597 13,847,754 12,222,270 12,310,527
----------- ---------- ---------- ----------
$59,458,714 60,936,117 72,702,012 73,262,867
=========== ========== ========== ==========
F-15
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(4) LOANS RECEIVABLE, NET
Loans receivable, net of unamortized net deferred loan fees, at December
31 are summarized as follows:
2002 2001
---------------- -----------------
First mortgage loans and contracts secured by real estate $ 73,801,359 81,588,470
Commercial real estate loans 72,992,566 77,627,030
Commercial loans 59,427,705 60,578,808
Auto and other consumer loans 25,331,132 23,970,037
Second mortgage consumer loans 5,558,925 5,438,463
Agricultural loans 14,548,002 11,606,658
Tax exempt municipal loans 1,468,858 1,684,846
Savings account and other loans 875,500 1,532,563
---------------- -----------------
254,004,047 264,026,875
Less: Allowance for loan losses 3,572,821 3,502,593
---------------- -----------------
$ 250,431,226 260,524,282
================ =================
A summary of activity in the allowance for loan losses for the years ended
December 31 follows:
2002 2001 2000
----------- ---------- ----------
Balance, beginning of year $ 3,502,593 2,525,545 1,585,819
Balance acquired -- -- 392,857
Provision for loan losses 1,170,000 1,640,125 1,628,569
Losses charged off (1,189,078) (700,614) (1,137,661)
Recoveries 89,306 37,537 55,961
----------- ---------- ----------
Balance, end of year $ 3,572,821 3,502,593 2,525,545
=========== ========== ==========
Loans receivable include approximately $104,788,000 and $93,381,000 in
adjustable rate loans at December 31, 2002 and 2001, respectively.
Nonaccrual loans amounted to approximately $339,000 and $2,114,000 at
December 31, 2002 and 2001, respectively. If interest on nonaccrual loans
had been accrued, such income would have approximated $88,000, $224,000
and $264,000 for the years ended December 31, 2002, 2001 and 2000,
respectively. Loans contractually past due ninety days or more aggregating
approximately $553,000 and $294,000 as of December 31, 2002 and 2001,
respectively, were on accrual status. Such loans are deemed adequately
secured and in the process of collection.
Impaired loans at December 31, 2002 and 2001 were approximately $912,000
and $2,724,000, respectively. The allowance associated with impaired
loans included in the allowance for loan losses at December 31, 2002 and
2001 were approximately $184,000 and $640,000, respectively. The average
recorded investment in impaired loans for the years ended December 31,
2002, and 2001 was approximately $1,818,000and $1,962,000, respectively.
Interest income recognized on impaired loans during 2002, 2001 and 2000
was approximately $48,300, $13,000, and $128,000, respectively.
F-16
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
At December 31, 2002, United had no concentrations of loans which exceeded
10% of total loans other than the categories disclosed above.
At December 31, 2002 and 2001 approximately $41,269,000 and $44,423,000,
respectively, of United's loans receivable are obligations of customers
located outside of United's market area.
United 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 letters of credit and involve, to varying degrees, elements of
credit risk. United's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of
those instruments. United uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
Financial instruments outstanding at December 31 whose contract amounts
represent credit risk include:
2002 2001
----------- ----------
Unused lines of credit $34,469,000 35,931,000
Commitments outstanding - variable rate 1,844,000 1,028,000
Unfunded commitments under Bankcard arrangements 2,564,000 2,643,000
Letters of credit 521,000 169,000
The majority of the subsidiary bank's loans, commitments, and standby
letters of credit have been granted to customers in the subsidiary bank's
market area, primarily in central and western Montana and Phoenix and
Scottsdale, Arizona. Substantially all such customers are also depositors
of the subsidiary banks. The concentrations of credit by type of loan are
set forth above. The distribution of commitments to extend credit
approximates the distribution of loans outstanding. Outstanding
commitments and standby letters of credit were granted primarily to
commercial borrowers as of December 31, 2002 and 2001.
(5) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at December 31 is summarized as follows:
2002 2001
---------- ---------
Loans receivable $2,108,746 2,259,470
Mortgage-backed securities 191,103 200,687
Investment securities 213,816 285,192
Time deposits in banks and other
interest-earning assets 11,437 23,335
---------- ---------
$2,525,102 2,768,684
========== =========
F-17
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(6) PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
2002 2001
------------ ----------
Land $ 1,479,441 1,180,331
Building and improvements 5,480,053 4,399,859
Furniture, fixtures and equipment 3,806,767 3,107,864
Construction in progress 14,225 410,396
------------ ----------
10,780,486 9,098,450
Accumulated depreciation (3,112,518) (2,489,128)
------------ ----------
$ 7,667,968 6,609,322
============ ==========
(7) REAL ESTATE AND OTHER PERSONAL PROPERTY OWNED
During 2002 and 2001, United sold real estate and other personal property
acquired through foreclosure with an aggregate book value of approximately
$1,093,000 and $660,000, respectively, and reported a gain of $0 and
approximately $46,000, respectively, on the sales. During 2000, United
sold real estate and other personal property acquired through foreclosure
with an aggregate book value of approximately $105,000 and reported no
gain or loss.
United transferred loans of $1,174,909, $474,466 and $330,365 to real
estate and other personal property owned during the years ended December
31, 2002, 2001 and 2000 respectively.
(8) GOODWILL AND OTHER INTANGIBLE ASSETS
Acquired intangible assets are as follows at December 31:
2002
-----------------------------------------------
GROSS CARRYING ACCUMULATED NET
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ -------
Missoula Branch office purchase $ 108,316 (108,316) -
Hamilton Branch office purchase 75,000 (75,000) -
-------------- ----------- -------
Total $ 183,316 (183,316) -
============== =========== =======
GROSS CARRYING ACCUMULATED NET
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ -------
Missoula Branch office purchase $ 108,316 (81,373) 26,943
Hamilton Branch office purchase 75,000 (56,345) 18,655
Fort Benton Branch intangibles
(reclassified to goodwill in 2002) 454,000 (100,888) 353,112
-------------- ----------- -------
Total $ 637,316 238,606 398,710
============== =========== =======
F-18
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Amortization expense for the years ended December 31, 2002, 2001 and 2000
was $45,599, $39,085 and $39,085, respectively. No amortization expense is
estimated for 2003 as the assets were fully amortized at December 31,
2002.
The changes in the carrying amount of goodwill for the year ended December
31, 2002 are as follows:
Balance as of December 31, 2001 $ 3,076,065
Goodwill reclassified from intangibles
as of January 1, 2002 353,112
Impairment losses -
---------------
Balance as of December 31, 2002 $ 3,429,177
===============
As discussed in Note 1, United adopted Statement 142 effective January 1,
2002. The following schedule presents reported net income for all periods
presented exclusive of amortization expense recognized in those periods
related to goodwill and identifiable intangibles. Beginning in January
2002, United is no longer required to expense its amortization of
goodwill. Certain identifiable intangible assets were amortized in 2002 as
disclosed above.
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000(1)
------------- ------------ ------------
Reported net income $ 2,955,255 2,374,725 2,003,954
Add back: Goodwill amortization (net of tax effects) -- 208,698 208,473
------------- ------------ ------------
Adjusted net income $ 2,955,255 2,583,423 2,212,427
============= ============ ============
Basic earnings per share:
Reported net income $ 1.82 1.56 1.22
Goodwill amortization -- 0.13 0.12
Adjusted net income $ 1.82 1.69 1.34
Diluted earnings per share:
Reported net income $ 1.79 1.55 1.22
Goodwill amortization -- 0.14 0.12
Adjusted net income $ 1.79 1.69 1.34
(1) Prior year information for 2000 is unaudited.
F-19
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(9) DEPOSITS
Deposits at December 31 are summarized as follows:
2002 2001
-------------------------------------------- ----------------------
WEIGHTED
AVERAGE RATE AMOUNT % AMOUNT %
------------ -------------- ------ ---------- -----
Demand accounts 0.00% $ 48,227,093 16.8 46,688,634 16.5%
NOW and money market accounts .99% 59,752,373 20.8 50,990,350 18.1
Savings accounts 1.52% 50,980,233 17.8 50,829,353 18.0
Certificates of deposit: 2.00 to 2.99% 56,447,126 19.7 7,874,721 2.8
3.00 to 3.99% 22,658,324 7.9 20,564,901 7.3
4.00 to 4.99% 17,245,916 6.0 40,629,821 14.4
5.00 to 5.99% 18,823,059 6.6 36,390,647 12.9
6.00 to 6.99% 9,327,799 3.3 22,123,273 7.8
7.00 to 7.99% 3,518,185 1.1 6,308,538 2.2
-------------- -------- ----------- -----
Total certificates of deposit 3.72% 128,020,409 44.6 133,891,901 47.4
-------------- -------- ----------- -----
Total interest-bearing deposits 2.36% 238,753,015 83.2 235,711,604 83.5
-------------- -------- ----------- -----
1.96% $ 286,980,108 100.0 282,400,238 100%
============== ======== =========== =====
Scheduled maturities of certificates of deposit at December 31, 2002 are
as follows:
Due within one year $ 88,009,624
Due within two to three years 35,751,555
Due within four to five years 4,259,230
-------------
$ 128,020,409
=============
Certificates of deposit of $100,000 or more are approximately $36,050,747
and $34,009,000 at December 31, 2002 and 2001, respectively. Amounts in
excess of $100,000 are not insured by a federal agency.
Interest expense on deposits for the years ended December 31 is summarized
as follows:
2002 2001 2000
----------- ---------- ----------
NOW and money market accounts $ 878,685 1,271,307 1,707,370
Savings accounts 1,025,967 1,515,306 2,002,317
Certificates of deposit 5,624,284 8,149531 7,647,406
----------- ---------- ----------
$ 7,528,936 10,936,144 10,703,543
=========== ========== ==========
F-20
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(10) FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances at December 31 are summarized as follows:
2002 2001
------------ -----------
2.70% to 6.01% fixed rate advances, interest payable monthly $ 34,000,000 46,500,000
5.52% to 6.12% putable advances, put options exercisable quarterly,
interest payable monthly 4,000,000 4,000,000
------------ -----------
$ 38,000,000 50,500,000
============ ===========
The weighted average interest rate on these advances was 4.56% and 5.65%
at December 31, 2002 and 2001, respectively.
Contractual principal repayments on advances from the Federal Home Loan
Bank subsequent to December 31, 2002 are as follows:
YEARS ENDING DECEMBER 31,
-------------------------
2003 $ 10,000,000
2004 6,000,000
2005 11,000,000
2006 4,000,000
2007 5,000,000
Thereafter 2,000,000
-------------
$ 38,000,000
=============
Advances from the FHLB are secured by pledges of FHLB stock and a blanket
assignment of Heritage Bank's unpledged, qualifying mortgage loans,
mortgage-backed securities and U.S. Government and federal agency
securities.
During 2002, Heritage Bank had a Cash Management Advance (CMA) credit
facility with a maximum allowable advance of $72,819,000, subject to
available collateral limits. The CMA credit facility expired May 29, 2002.
During the year ended December 31, 2002, there were no advances or
repayments made on the CMA credit facility and there was no outstanding
balance due as of December 31, 2002. The CMA credit facility is renewable
upon request by Heritage Bank.
At December 31, 2002, the current established available FHLB advance
credit line for Heritage Bank was 25% of its assets. Valley Bank also has
a FHLB advance credit line of 25% of its assets at December 31, 2002.
F-21
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
In December 2002, Heritage Bank repaid $8,000,000 in FHLB advances prior
to their scheduled maturity dates. As a result, Heritage Bank incurred
prepayment penalties in the form of interest expense on the repayments of
$274,927. Interest expense on FHLB advances consists of the following:
YEARS ENDING DECEMBER 31,
---------------------------------------
2002 2001 2000
---------- --------- ---------
Interest expense on contractual maturities $2,441,770 3,198,764 3,444,117
Interest expense on prepayment of
advances 274,927 -- --
---------- --------- ---------
$2,716,697 3,198,764 3,444,117
========== ========= =========
(11) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase at December 31 consist of
the following:
2002
--------------------------------------------------------------------
ESTIMATED FAIR
WEIGHTED BOOK VALUE VALUE
REPURCHASE AVERAGE OF UNDERLYING OF UNDERLYING
AMOUNT RATE SECURITIES SECURITIES
-------------- ------------- ------------- --------------
To repurchase
within:
1 - 30 days $ 2,672,543 2.71% 2,962,883 2,976,892
31 - 90 days 1,064,935 3.83% 1,597,511 1,620,667
Greater than 90
days 9,049,762 1.14% 8,308,903 8,482,052
-------------- ---------- ----------
$ 12,787,240 1.69% 12,869,297 13,079,611
============== ========== ==========
2001
--------------------------------------------------------------------
ESTIMATED FAIR
WEIGHTED BOOK VALUE VALUE
REPURCHASE AVERAGE OF UNDERLYING OF UNDERLYING
AMOUNT RATE SECURITIES SECURITIES
-------------- ------------- ------------- --------------
To repurchase
within:
1 - 30 days $ 2,847,558 4.02% 3,674,611 3,718,569
31 - 90 days 1,486,716 3.85% 2,497,990 2,488,855
Greater than 90 days 5,269,377 3.45% 9,604,567 9,699,573
-------------- ---------- ----------
$ 9,603,651 3.68% 15,777,168 15,906,997
============== ========== ==========
F-22
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Securities underlying the agreements to repurchase are for the same
securities originally sold and are held in a custodial account by a third
party. For the year ended December 31, 2002 and 2001, securities sold
under agreements to repurchase averaged approximately $9,908,000 and
$8,745,000, respectively, and the maximum outstanding at any month end
during the year was approximately $13,518,000 and $9,604,000,
respectively.
(12) TRUST PREFERRED SECURITIES
In July 2001, UFC issued junior subordinated debentures, aggregating
$3,000,000 to United Financial-Montana Capital Trust I (Trust). The Trust
issued preferred securities, as part of a pooled issue, with an aggregate
liquidation amount of $3,000,000 ($1,000 per capital security) to
third-party investors. The junior subordinated debentures and cash are the
sole assets of the Trust. The preferred securities are includable as Tier
I capital for regulatory capital purposes. The offering price was $1,000
per capital security. The junior subordinated debentures and the preferred
securities pay interest and dividends, respectively, on a semi-annual
basis, which are included in interest expense. The variable interest rate
resets on January 30 and July 30 of each year, based upon six month LIBOR
plus 3.75%. The current interest rate reset on January 30, 2003 was 5.10%.
The Trust is a statutory business trust formed under the laws of the State
of Delaware and is wholly-owned by UFC. The junior subordinated debentures
and preferred securities will mature on July 25, 2031. The junior
subordinated debentures and preferred securities can be redeemed
contemporaneously, in whole or in part, after five years at decreasing
premiums with the permission of the Board of Governors of the Federal
Reserve System (the Federal Reserve). UFC has provided a full and
unconditional guarantee of the obligations of the Trust in the event of
the occurrence of an event of default, as defined. Debt issuance costs
totaling $118,812 were capitalized related to the debenture offering and
are being amortized over the 10-year non-premium callable life of the
preferred securities.
(13) LINES OF CREDIT
UFC has a line of credit of $3,000,000 with Wells Fargo with an interest
rate of 1.75% over the Wells Fargo federal funds rate, which totaled 3.06%
and 3.37% at December 31, 2002 and 2001. This line is secured by UFC's
Heritage Bank stock and by UFC's Valley stock, and expires October 30,
2003. Interest is payable quarterly. Principal is payable at maturity. The
principal balance outstanding at December 31, 2002 and 2001 was $700,000
and $1,000,000, respectively.
Heritage Bank also has established a federal funds line with Wells Fargo.
The total line is $10,000,000 with a daily interest rate equal to the
Wells Fargo federal funds rate, which was 1.31% and 1.625% at December 31,
2002 and 2001. Advances up to $5,000,000 are unsecured, and advances over
$5,000,000 are secured by investment securities. There were no amounts
outstanding at December 31, 2002 or 2001.
Valley Bank has a federal funds line of $3,000,000 at Wells Fargo at
December 31, 2002 and 2001, with a daily interest rate equal to the Wells
Fargo federal funds rate, which was 1.31% and 1.625% at December 31, 2002
and 2001. There were no amounts outstanding at December 31, 2002 and 2001.
All outstanding principal and unpaid accrued interest is due and payable
the next business day. Borrowings are secured by securities
available-for-sale.
F-23
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Also at Wells Fargo, Valley Bank has a $500,000 line of credit for letters
of credit, secured by securities available-for-sale. The amount of unused
line of credit, subject to the terms of the related agreement, at December
31, 2002 was $148,000. The line of credit is subject to an automatic
renewal.
In addition, Valley Bank has a federal funds line of $3,000,000 at M & I
Thunderbird Bank (M & I) as of December 31, 2002 and 2001, with an
interest rate equal to the M & I federal funds rate . The principal
balance outstanding at December 31, 2002 and 2001 was $0and $1,000,000,
respectively. All outstanding principal and unpaid accrued interest is due
and payable two business days from the date of advance. Borrowings are
secured by securities available-for-sale.
(14) INCOME TAXES
Income tax expense for the years ended December 31 is summarized as
follows:
FEDERAL STATE TOTAL
----------- ---------- ----------
2002:
Current $ 1,549,144 324,278 1,873,422
Deferred 43,388 5,685 49,073
----------- ---------- ----------
$ 1,592,532 329,963 1,922,495
=========== ========== ==========
2001:
Current $ 1,701,327 303,161 2,004,488
Deferred (320,863) (50,319) (371,182)
----------- ---------- ----------
$ 1,380,464 252,842 1,633,306
=========== ========== ==========
2000:
Current $ 1,128,159 193,132 1,321,291
Deferred (71,352) 37,538 (33,814)
----------- ---------- ----------
$ 1,056,807 230,670 1,287,477
=========== ========== ==========
Income tax expense for the years ended December 31 differs from "expected"
income tax expense (computed by applying the Federal corporate income tax
rate of 34% to income before income taxes) as follows:
2002 2001 2000
----------- ---------- ----------
Computed "expected" tax expense $ 1,730,652 1,415,792 1,170,485
Increase (decrease) resulting from:
State taxes, net of Federal income tax
effects 238,711 199,068 152,242
Goodwill amortization -- 64,624 64,548
Tax-exempt interest (44,116) (50,646) (55,867)
Other, net (2,752) 4,468 (43,931)
----------- ---------- ----------
$ 1,922,495 1,633,306 1,287,477
=========== ========== ==========
F-24
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Differences between the financial statement carrying amounts and the tax
bases of assets and liabilities that give rise to significant portions of
deferred tax assets and liabilities at December 31 are as follows:
2002 2001
----------- -------------
Deferred tax assets:
Loans, principally due to allowance for loan losses $ 1,338,928 1,313,528
Investments, due to difference in basis 121,046 121,046
Premises and equipment and real estate owned, due to difference
in basis 59,152 59,152
Purchase accounting basis differences 47,388 34,552
Other 83,502 127,596
----------- -------------
Total gross deferred tax assets 1,650,016 1,655,874
----------- -------------
Deferred tax liabilities:
Loans, due to difference in basis 28,862 162,913
Stock in FHLB, principally due to stock dividends not recognized
for tax purposes 530,318 440,872
Premises and equipment, principally due to differences in
depreciation 323,997 222,699
Prepaid SAIF assessment 7,053 7,453
Unrealized gains on securities available-for-sale 562,659 213,005
Other 42,320 55,398
----------- -------------
Total gross deferred tax liabilities 1,495,209 1,102,340
----------- -------------
Net deferred tax asset $ 154,807 553,534
=========== =============
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the existence of, or generation of,
taxable income in the periods which those temporary differences are
deductible. Management considers the scheduled reversal of deferred tax
liabilities, taxes paid in carryback years, projected future taxable
income, and tax planning strategies in making this assessment. Based upon
the level of historical taxable income and estimates of future taxable
income over the periods which the deferred tax assets are deductible, at
December 31, 2002 and 2001 management believes it is more likely than not
that United will realize the benefits of these deductible differences.
Retained earnings at December 31, 2002 includes approximately $3,477,000
for which no provision for Federal income tax has been made. This amount
represents the base year income tax bad debt reserve. This amount is
treated as a permanent difference and deferred taxes are not recognized
unless it appears this reserve will be reduced and thereby result in
taxable income in the foreseeable future. United is not currently
contemplating any changes to its business or operations which would result
in a recapture of the base year bad debt reserve into taxable income.
F-25
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(15) MORTGAGE SERVICING RIGHTS
Total mortgage servicing rights, net of accumulated amortization, were
$223,867 and $158,441 at December 31, 2002 and 2001, respectively.
Servicing rights of $110,000, $162,000 and $169,000 were capitalized in
2002, 2001 and 2000, respectively. Amortization expense of $44,173,
$12,183 and $29,141 was recognized in 2002, 2001 and 2000, respectively.
There were no impairment losses recognized in 2002, 2001, and 2000. At
December 31, 2002, the estimated fair value of United's servicing assets
approximates its carrying value.
Real estate loans serviced for others, which are not included in the
accompanying consolidated financial statements, totaled approximately
$29,618,000 and $17,239,000 at December 31, 2002 and 2001, respectively.
(16) LEASES
United as Lessor:
In April 2000, Heritage Bank entered into an operating lease to rent a
duplicate facility which had been held for sale in 1999. The lease is for
a period of three years, terminating in April 2003, with one three-year
option to renew. Monthly rentals are $8,500, with an increase upon renewal
not to exceed 6%. In January 2003, the parties amended the lease to
provide for a shorter extension period and a set monthly rental charge for
the option to renew portion of the lease. The amended renewal period is
for two years rather than three, and the new monthly rent will be $9,010
rather than the original formula. The amendment is effective April 15,
2003 at which time the lease will be renewed under the amended terms
described above. The lease includes a purchase option for a price of
$650,000, with 25% of all lease payments applied to reduce the purchase
price.
At December 31, 2002, the cost of the asset under lease was approximately
$567,300 and accumulated depreciation was approximately $54,700. The net
carrying value of approximately $512,600 is included in real estate and
other personal property owned on the accompanying December 31, 2002
consolidated statement of financial condition.
Future minimum rental income under this lease including the renewal option
are as follows:
YEAR ENDING DECEMBER 31,
-----------------------------
2003 $ 106,590
2004 108,120
2005 27,030
----------
$ 241,740
==========
For the years ended December 31, 2002 and 2001, rental income included in
the accompanying consolidated statement of income was $95,880.
F-26
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
United as Lessee:
Valley Bank leases certain land and office space under noncancelable
operating leases. Total rental expense for the years ended December 31,
2002, 2001 and 2000 was $285,242, $256,230 and $194,120, respectively.
The total future minimum lease payments required under operating leases
which have initial or remaining noncancelable lease terms in excess of one
year at December 31, 2002 are as follows:
YEAR ENDING DECEMBER 31,
-----------------------------
2003 $ 238,637
2004 238,637
2005 236,780
2006 145,662
2007 65,000
Thereafter 876,666
----------
$1,801,382
==========
(17) RELATED PARTIES
Central Financial Services (CFS) provides various management services for
United, including accounting, tax and insurance advisory services, and
investment, personnel and regulatory consulting. CFS is owned by UFC's
former Chairman of the Board and its current largest shareholder. The
charges for their services were $484,315, $378,828 and $348,053 for the
years ended December 31, 2002, 2001, and 2000, respectively.
United acquires loan participations from a bank controlled by UFC's former
Chairman of the Board and its current largest shareholder. At December 31,
2002 and 2001, the outstanding balances of loans purchased from this bank
were $6,478,934 and $5,067,810, respectively.
Banker's Resource Center (BRC) provides data processing services for
United. United has a 14% ownership interest in BRC, a computer data
center. The charges for BRC's services were $591,395, $539,392 and
$499,077 for the years ended December 31, 2002, 2001 and 2000,
respectively.
As of December 31, 2002 and 2001, the Board of Directors and officers of
United had approximately $2,214,536 and $2,890,000, respectively, on
deposit with subsidiary banks.
At December 31, 2002 and 2001, the Board of Directors and executive
officers of United had $2,209,025 and $1,718,998, respectively, in
outstanding loans with subsidiary banks. These loans were made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable loans with equivalent risk of
collectibility.
F-27
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
A summary of activity with respect to aggregate loans to related parties
for the years ended December 31, 2002 and 2001 follows:
2002 2001
----------- ----------
Balance, beginning of year $ 1,718,998 1,765,413
New loans 1,081,680 1,131,439
Repayments (591,653) (1,177,854)
----------- ----------
Balance, end of year $ 2,209,025 1,718,998
=========== ==========
(18) EMPLOYEE BENEFIT PLANS
Heritage Bank has a savings plan under Section 401(k) of the Internal
Revenue Code. Eligible employees can contribute up to 20% of their monthly
wages. Heritage Bank matches an amount equal to 75% of the employee's
contribution, up to 4.5% of total wages. Participants are at all times
fully vested in their contributions and are immediately vested in the
employer's contributions. Heritage Bank 401(k) contributions and
administrative costs were approximately $157,000, $128,000 and $115,000
during the years ended December 31, 2002, 2001 and 2000, respectively.
Valley Bank has a savings and profit sharing plan for employees meeting
certain service requirements. This plan qualifies under Section 401(k) of
the Internal Revenue Code. The plan allows each employee to contribute up
to 20% of his or her annual compensation. At the discretion of its Board
of Directors, Valley Bank may also make additional contributions,
dependent on profits, but not to exceed 25% of the employee's annual
compensation after taking into consideration Valley Bank's previous
matching contributions. Valley Bank contributed approximately $26,000,
$21,000 and $20,000 to the plan during the years ended December 31, 2002,
2001 and 2000.
Heritage Bank has a deferred compensation agreement with an employee that
provides for predetermined periodic payments over 15 years upon retirement
or death. In the event of acquisition of United by a third party,
disability or early retirement, the predetermined payments are based on
years of service. Amounts expensed under this agreement were approximately
$7,400, $6,400 and $8,500, respectively, for the years ended December 31,
2002, 2001 and 2000. Heritage Bank owns two single premium insurance
policies in connection with this agreement. The policies have a cash
value, which is included in other assets on the accompanying consolidated
statements of financial condition, of approximately $329,000 and $313,000
at December 31, 2002 and 2001, respectively.
In October 1999, Heritage Bank adopted a supplemental retirement agreement
with an employee that provides for salary continuation benefits upon
retirement, disability or death. The employee is vested in the plan 10%
for every plan year of employment and 100% vested after 10 plan years. The
effective date for vesting was January 1, 1997. The employee is considered
100% vested upon determination of full or partial disability, death, or
change of control, with payment made in a lump sum within 60 days. The
normal retirement benefit will be paid in either a lump sum or at the
election of the employee an annuity shall be purchased for the amount of
UFC's obligation. The amount expensed under this agreement was
approximately $6,900, $7,400 and $4,900, respectively, for the years ended
December 31, 2002, 2001 and 2000.
F-28
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(19) STOCK OPTION PLANS
In 2000, the United Financial Corp. 2000 Long-Term Incentive and Stock
Option Plan (the Plan) was adopted. UFC's existing stock appreciation
rights plan, pursuant to which no stock appreciation rights were granted,
was rescinded by the Board upon approval of the Plan. The Plan provides
for the grant of incentive stock options (ISOs) and non-qualified stock
options to certain full and part-time employees of Heritage Bank and
directors of UFC. The plan provides for award of options for a maximum of
132,000 shares of common stock. Vesting for each award is at the
discretion of the compensation committee of the Board Directors. The term
of the options is 10 years for ISOs and for non-qualified stock options.
The option price for all ISOs granted under the Plan shall be determined
by the compensation committee, but shall not be less than 100% of the fair
market value of the common stock at the date of grant of such option. The
option price for all non-qualified options shall also be determined by the
compensation committee. Options granted to 10% or greater shareholders
will have exercise prices equal to 110% of market value and can not be
exercised after five years. A change in control, as defined in the Plan,
will immediately vest all options upon completion of such a change in
control.
At December 31, 2002, total shares available for option grants under the
Plan were 8,369. Changes in shares issuable under options granted by UFC
for the years ended December 31, 2002 and 2001, are summarized as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------- ----------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
OF AVERAGE OF AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- ---------------
Balance at January 1, 2001 34,612 $ 13.74 -- --
Granted 41,488 16.19 -- --
Canceled (2,180) 15.08 -- --
Became exercisable -- -- 8,445 13.74
Exercised (264) 13.52 (264) 13.52
-------- --------- ------- -----
Balance at December 31, 2001 73,656 15.08 8,181 13.74
======== =======
Granted 52,262 21.27 -- --
Canceled (2,553) 18.44 (1,237) 15.43
Became exercisable -- -- 18,482 14.91
Exercised (225) 14.63 (225) 14.63
-------- --------- ------- -----
Balance at December 31, 2002 123,140 $ 17.64 25,200 14.51
======== =======
Weighted-average fair value
of options granted during year $ 2.71 $ 2.36
======== =======
F-29
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The stock options outstanding at December 31, 2002 consist of the
following:
NUMBER OF WEIGHTED AVERAGE WEIGHTED AVERAGE OPTIONS
SHARES EXERCISE PRICE REMAINING LIFE EXERCISABLE
------------- ------------------ ------------------ -------------
50,947 $ 21.27 9.5 years --
39,109 $ 16.19 8.5 years 17,019
33,084 $ 13.75 7.5 years 8,181
------------- ------------------ -------------
123,140 $ 17.64 25,200
============= ================== =============
Valley has a stock option plan for officers and directors (the 1995 Plan).
Options are granted at the discretion of Valley's Board of Directors. The
option price for all options granted under the 1995 Plan shall not be less
than 100% of the fair market value of the common stock on the date of
grant of such option. The options granted are available to be exercised at
the rate of 20% per year from the date of grant and expire ten years from
date of grant. Valley has reserved 200,000 shares of common stock for
exercise of options under the 1995 Plan.
At December 31, 2002, total shares available for option grants under the
1995 Plan were 111,750. The following table is presented to summarize
stock option activity:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------- ----------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
OF AVERAGE OF AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- ---------------
Balance at January 1, 2001 94,250 $ 5.00 65,300 5.00
Granted -- -- -- --
Canceled -- -- -- --
Became exercisable -- -- 15,000 5.00
Exercised -- -- -- --
------- ------- ------ ----
Balance at December 31, 2001 94,250 5.00 80,300 5.00
Granted -- -- -- --
Canceled (6,000) 5.00 (6,000) 5.00
Became exercisable -- -- -- --
Exercised -- -- -- --
------- ------- ------- ----
Balance at December 31, 2002 88,250 $ 5.00 74,300 5.00
======= =======
The stock options outstanding at December 31, 2002 consist of the following:
NUMBER OF WEIGHTED AVERAGE WEIGHTED AVERAGE OPTIONS
SHARES EXERCISE PRICE REMAINING LIFE EXERCISABLE
------------- ------------------ ------------------ -------------
88,250 $ 5.00 4.3 years 74,300
============= ================== ================== =============
F-30
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes pricing model with the following weighted-average
assumptions:
2002 2001 2000
--------------------------------------
Risk-free interest rate 4.50% 5.39% 6.74%
Expected life 5 years 5 years 5 years
Expected volatility 23.90% 23.12% 23.35%
Expected dividend yield 6.40% 6.40% 6.40%
United expects all options to be exercised.
Based on the intrinsic value method, no compensation cost has been
recognized for any stock option grants in the accompanying financial
statements. Had United determined compensation cost based on the estimated
fair value at the grant date for its stock options, United's net income
and net income per share would have been as shown in Note 1.
(20) EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share for the years ended December 31:
2002 2001 2000
----------- ---------- ----------
Weighted average shares outstanding during
the year on which basic earnings per
share is calculated 1,626,062 1,677,409 1,811,199
Add: incremental shares under stock option
plans 19,411 5,439 169
----------- ---------- ----------
Average outstanding shares on which diluted
earnings per share is calculated 1,645,473 1,682,848 1,811,368
=========== ========== ==========
Net income applicable to common stockholders,
basic $ 2,955,255 2,374,725 2,003,954
Less: reduction of proportionate share of
Valley net income assuming option
exercises (1,986) (1,776) (3,126)
----------- ---------- ----------
Net income applicable to common stockholders,
diluted $ 2,953,269 2,372,949 2,000,828
=========== ========== ==========
Basic earnings per share $ 1.82 1.42 1.11
=========== ========== ==========
Diluted earnings per share $ 1.79 1.41 1.11
=========== ========== ==========
United had no common stock equivalent that would have been antidilutive
for the year ended December 31, 2002. All per share amounts have been
restated to include the effect of the June 2002 stock dividend.
F-31
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(21) CONDENSED QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
United's condensed quarterly income statements for the years ended
December 31, 2002 and 2001 are summarized as follows:
YEAR ENDED DECEMBER 31, 2002
----------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
----------- ---------- ---------- ---------
Interest income $ 5,550,320 5,883,609 6,071,310 6,132,543
Interest expense 2,554,168 2,503,279 2,770,311 2,908,543
----------- ---------- ---------- ----------
Net interest income 2,996,152 3,380,330 3,300,999 3,224,000
Provision for loan losses (270,000) (445,000) (215,000) (240,000)
Non-interest income 1,744,945 1,488,226 1,076,046 1,090,961
Non-interest expense (3,220,123) (3,100,538) (2,900,705) (2,820,141)
----------- ---------- ---------- ----------
Income before income taxes 1,250,974 1,323,018 1,261,340 1,254,820
Income tax expense (480,369) (504,112) (470,063) (467,951)
----------- ---------- ---------- ----------
Net income before minority interest $ 770,605 818,906 791,277 786,869
Minority interest (60,116) (52,873) (50,172) (49,241)
----------- ---------- ---------- ----------
Net income $ 710,489 766,033 741,105 737,628
=========== ========== ========== ==========
Net income per share:
Basic $ .44 0.47 0.46 0.45
=========== ========== ========== ==========
Diluted $ .43 0. 46 0.45 0.45
=========== ========== ========== ==========
F-32
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
YEAR ENDED DECEMBER 31, 2001
----------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
----------- ---------- ---------- ----------
Interest income $ 6,538,726 6,760,441 6,820,965 6,761,978
Interest expense 3,262,820 3,674,638 3,901,062 3,985,928
----------- ---------- ---------- ----------
Net interest income 3,275,906 3,085,803 2,919,903 2,776,050
Provision for loan losses (750,125) (431,250) (249,375) (209,375)
Non-interest income 1,415,612 1,284,306 1,208,073 1,006,407
Non-interest expense (2,976,243) (2,871,750) (2,771,934) (2,547,912)
----------- ---------- ---------- ----------
Income before income taxes
and minority interest 965,150 1,067,109 1,106,667 1,025,170
Income tax expense (395,169) (413,434) (428,647) (396,056)
----------- ---------- ---------- ----------
Net income before minority interest 569,981 653,675 678,020 629,114
Minority interest (20,379) (42,148) (47,214) (46,324)
----------- ---------- ---------- ----------
Net income $ 549,602 611,527 630,806 582,790
=========== ========== ========== ==========
Net income per share:
Basic $ 0.34 0.37 0.38 0.33
=========== ========== ========== ==========
Diluted $ 0.34 0.37 0.37 0.33
=========== ========== ========== ==========
YEAR ENDED DECEMBER 31, 2000
----------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
----------- ---------- ---------- ----------
Interest income $ 6,857,751 6,699,673 6,274,203 5,908,304
Interest expense 4,058,021 4,012,338 3,601,998 3,283,298
----------- ---------- ---------- ----------
Net interest income 2,799,730 2,687,335 2,672,205 2,625,006
Provision for loan losses (252,819) (847,125) (364,250) (164,375)
Non-interest income 1,091,237 1,014,673 972,105 758,504
Non-interest expense (2,499,479) (2,564,950) (2,277,828) (2,207,367)
----------- ---------- ---------- ----------
Income before income taxes
and minority interest 1,138,669 289,933 1,002,232 1,011,768
Income tax expense (434,568) (107,213) (347,994) (397,702)
----------- ---------- ---------- ----------
Net income before minority interest 704,101 182,720 654,238 614,066
Minority interest (34,078) (14,907) (46,976) (55,210)
----------- ---------- ---------- ----------
Net income $ 670,023 167,813 607,262 558,856
=========== ========== ========== ==========
Net income per share:
Basic $ 0.37 0.09 0.34 0.31
=========== ========== ========== ==========
Diluted $ 0.37 0.09 0.34 0.31
=========== ========== ========== ==========
F-33
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(22) REGULATORY MATTERS
United is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a
direct material effect on United's operations. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action,
United must meet specific capital guidelines that involve quantitative
measures of the assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting guidelines. 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 United to maintain minimum amounts and ratios (set forth in the
tables below). As of December 31, 2002, United met all capital adequacy
requirements to which it is subject.
As of December 31, 2002, the most recent notifications from the federal
banking agencies categorized Heritage Bank and Valley Bank as "well
capitalized" under the regulatory framework for prompt corrective action
(PCA). To be categorized as "well capitalized" the banks must maintain
minimum ratios as set forth in the following tables. There are no
conditions or events that management believes have changed the
institutions' PCA category.
MINIMUM TO BE "WELL
MINIMUM FOR CAPITAL CAPITALIZED" UNDER PCA
ACTUAL ADEQUACY PURPOSES PROVISIONS
---------------------- ---------------------- ------------------------
CONSOLIDATED: (IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------------- -------- --------- ---------- -------- ---------- --------
December 31, 2002:
Total capital $35,676 12.62% 22,618 8.0% N/A --
Tier I capital 32,142 11.37 -- -- N/A --
Tier I leverage 32,142 8.49 15,138 4.0 N/A --
December 31, 2001:
Total capital 34,143 11.90 22,947 8.0 N/A --
Tier I capital 30,640 10.68 -- -- N/A --
Tier I leverage 30,640 8.08 15,165 4.0 N/A --
Tangible capital
HERITAGE BANK:
December 31, 2002:
Total capital 26,231 11.17 18,783 8.0 23,479 10.0%
Tier I capital 23,294 9.92 9,392 4.0 14,087 6.0
Tier I leverage 23,294 7.69 12,124 4.0 15,155 5.0
December 31, 2001:
Total capital 24,973 10.65 18,761 8.0 23,451 10.0
Tier I capital 22,179 9.46 9,381 4.0 14,071 6.0
Tier I leverage 22,179 7.34 12,083 4.0 15,104 5.0
Tangible capital
F-34
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
MINIMUM TO BE "WELL
MINIMUM FOR CAPITAL CAPITALIZED" UNDER PCA
ACTUAL ADEQUACY PURPOSES PROVISIONS
---------------- ------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----- ----- ------ ----- ------ -----
VALLEY BANK:
December 31, 2002:
Total capital 8,152 17.22% 3,786 8.0% 4,733 10.0%
Tier I capital 7,692 16.25 1,893 4.0 2,840 6.0
Tier I leverage 7,692 10.26 2,998 4.0 3,747 5.0
December 31, 2001:
Total capital 8,223 15.94 4,126 8.0 5,158 10.0
Tier I capital 7,578 14.69 2,063 4.0 3,095 6.0
Tier I leverage 7,578 10.39 2,918 4.0 3,648 5.0
The total capital and Tier I capital ratios are determined based on
risk-weighted assets. The Tier I leverage and tangible capital ratios are
determined based on tangible assets.
State banks, such as Heritage Bank and Valley Bank, may pay dividends up
to the total of the prior two years earnings without permission of State
regulators.
(23) FAIR VALUE OF FINANCIAL INSTRUMENTS
United is required to disclose the fair value for financial instruments,
whether or not recognized in the statements of financial condition. A
financial instrument is defined as cash, evidence of an ownership
interest in an entity, or a contract that both imposes a contractual
obligation on one entity to deliver cash or another financial instrument
to a second entity.
The following assumptions and methods were used by United in estimating
the fair value of its financial instruments:
Financial Assets. Due to the liquid nature of the instruments, the
carrying value of cash and cash equivalents and time deposits in
banks approximates fair value. For all securities
available-for-sale, the fair value is based upon quoted market
prices. The fair value of loans receivable was estimated by
discounting future cash flow using current rates at which similar
loans would be made. The fair value of loans receivable for Valley
Bank for 2002 and 2001, and Heritage Bank for 2002 and 2001 was
obtained from an internally generated fair value model which
primarily employs the discounted cash flow method which estimates
fair value by discounting the cash flows the instruments are
expected to generate by the yields currently available to investors
on instruments of comparable risk and duration. Therefore, to
calculate present value, the model uses assumptions about the size
and timing of expected cash flows and appropriate discount rates.
The fair value of loans held for sale approximates carrying fair, as
the carrying value is the lower of cost or fair value, and United
expects the loans to be sold, with no gain or loss, in the
short-term. The fair value of restricted stock approximates
redemption value. The fair value of accrued interest receivable
approximates book value as United expects contractual receipt in the
near-term.
Financial Liabilities. The fair value of NOW, money market accounts,
demand accounts and non-term savings deposits approximates book
values as rates are periodically adjusted to market rates. The fair
F-35
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
value of time deposits held by Valley Bank for 2002 and 2001, and
Heritage Bank for 2002 and 2001 was obtained from an internally
generated fair value model. The fair value of time deposits held by
Valley Bank was estimated by discounting future cash flow using
current rates at which deposits would be acquired. The fair value of
time deposits was estimated by discounting the future cash flows
using current rates for similar deposits. Because the interest rate
on the line of credit, fed funds line, and trust preferred
securities approximates United's current long-term borrowing rate,
the fair value of these liabilities approximates the carrying value.
The fair value of FHLB advances and securities sold under agreements
to repurchase was obtained from an internally generated fair value
model for 2002 and 2001. The fair value of accrued interest payable
approximates book value due to contractual payment in the near-term.
Off-Balance Sheet. Commitments made to extend credit represent
commitments for loan originations, the majority of which are
contracted for immediate sale and, therefore, fair value
approximates the commitment amount.
Limitations. Fair value estimates are made at a specific point in
time, based on relevant market information and information about the
financial instrument. These estimates do not reflect any premium or
discount that could result from offering for sale at one time
United's entire holdings of a particular instrument. Because no
market exists for a significant portion of United's financial
instruments, fair value estimates are based on judgments regarding
comparable market interest rates, future expected loss experience,
current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are
subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with
precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. In addition, the tax effect of
the difference between the fair value and carrying value of financial
instruments can have a significant effect on fair value estimates and have
not been considered in the estimates presented herein.
F-36
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The approximate book value and fair value of United's financial
instruments as of December 31 are as follows:
2002 2001
--------------------------------- -------------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
--------------- --------------- --------------- -------------
Financial assets:
Cash and cash equivalents $ 33,224,000 33,224,000 22,026,000 22,026,000
Securities available-for-sale 60,936,000 60,936,000 73,263,000 73,263,000
Loans receivable, net 250,431,000 256,41 0,000 260,524,000 265,818,000
Loans held for sale 13,648,000 13,648,000 7,713,000 7,713,000
Restricted stock 4,327,000 4,327,000 3,994,000 3,994,000
Accrued interest receivable 2,525,000 2,525,000 2,769,000 2,769,000
Financial liabilities:
Deposits 286,980,000 289,568,000 282,400,000 284,989,000
FHLB advances and securities sold under
agreements to repurchase 50,787,000 52,006,000 60,104,000 61,356,000
Line of credit 700,000 700,000 1,000,000 1,000,000
Accrued interest payable 1,410,000 1,410,000 1,929,000 1,929,000
Federal funds purchased - - 1,000,000 1,000,000
Trust preferred securities 3,000,000 3,000,000 3,000,000 3,000,000
(24) COMMITMENTS AND CONTINGENCIES
Heritage Bank has sold loans to various investors in the secondary market
under sales agreements which contain repurchase provisions. Under the
repurchase provisions, Heritage Bank may be required to repurchase a loan
if a borrower fails to make three monthly payments within 120 days after
the sale of the loan. The balance of loans sold with repurchase provisions
remaining at December 31, 2002 is approximately $9,367,000. In 2002,
Heritage Bank was required to repurchase one such loan that had been sold
in the amount of approximately $62,000. The loan is currently in
foreclosure. There were no loans repurchased during 2001.
In December 2001, Heritage Bank entered into a five-year service contract
for data processing services with BRC. In 2002, Valley Bank entered into a
five-year service contract for data processing services with an
independent third party. In the event of early termination of either of
these service contracts by United, United has agreed to pay an amount
equal to fifty percent of the average monthly fee paid for services
multiplied by the number of months remaining under the term of the
contract.
United is a defendant in legal proceedings arising in the normal course of
business. In the opinion of management, the disposition of pending
litigation will not have a material effect on United's consolidated
financial position, results of operations, or liquidity.
At December 31, 2002, Heritage Bank had loan commitments outstanding on
1-4 family fixed rate mortgages totaling approximately $7,760,000. These
loans were approved prior to December 31, 2002 to be closed and funded in
2003.
F-37
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(25) PARENT COMPANY INFORMATION (CONDENSED)
The summarized financial information for United Financial Corp. is
presented below:
Condensed Statements of Financial Condition DECEMBER 31,
----------------------------
ASSETS 2002 2001
------ ------------ -----------
Cash and cash equivalents ($303,890 and $394,005,
respectively, deposited with Heritage) $ 755,280 575,673
Securities available-for-sale 533,795 750,479
Investment in subsidiary banks 25,399,314 23,896,133
Investment in Valley Bancorp, Inc. 5,556,572 5,358,501
Loans receivable -- 28,442
Accrued interest receivable 2,714 3,957
Goodwill, net 2,007,265 2,007,265
Other assets 125,543 165,317
----------- ----------
Total assets $34,380,483 32,785,767
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Line of credit $ 700,000 1,000,000
Other liabilities 204,755 188,552
Trust preferred securities 3,000,000 3,000,000
----------- ----------
Total liabilities 3,904,755 4,188,552
----------- ----------
Common stock 27,166,756 23,950,437
Retained earnings 2,476,481 4,339,060
Accumulated other comprehensive income 832,491 307,718
----------- ----------
Total stockholders' equity 30,475,728 28,597,215
----------- ----------
Total liabilities and stockholders' equity $34,380,483 32,785,767
=========== ==========
Condensed Statements of Income YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
----------- ---------- ----------
Revenues:
Cash dividends from bank subsidiaries $ 2,231,323 2,033,817 2,200,000
Interest income 44,999 77,447 124,073
Other income 2,633 1,259 1,263
----------- ---------- ----------
2,278,955 2,112,523 2,325,336
----------- ---------- ----------
Expenses:
Interest expense 210,880 198,232 78,461
Other operating expenses 565,302 485,828 400,320
----------- ---------- ----------
776,182 684,060 478,781
----------- ---------- ----------
Income before equity in undistributed
earnings of subsidiaries and income
taxes 1,502,773 1,428,463 1,846,555
Equity in undistributed earnings of subsidiaries 1,194,082 764,189 10,084
----------- ---------- ----------
Income before income taxes 2,696,855 2,192,652 1,856,639
Income tax benefit (258,400) (182,073) (147,315)
----------- ---------- ----------
Net income $ 2,955,255 2,374,725 2,003,954
=========== ========== ==========
F-38
UNITED FINANCIAL CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Condensed Statements of Cash Flows YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
----------- ---------- ----------
Cash flows from operating activities:
Net income $ 2,955,255 2,374,725 2,003,954
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sale of securities
unavailable-for-sale (1,436) -- --
Equity in undistributed earnings of
subsidiaries (1,194,082) (764,190) (10,084)
Amortization of goodwill -- 79,742 79,517
Increase (decrease) in other assets and
liabilities, net 46,221 (165,447) 236,485
----------- ---------- ----------
Net cash provided by operating
activities 1,805,958 1,524,830 2,309,872
----------- ---------- ----------
Cash flows from investing activities:
Proceeds from sales and maturities of
securities available-for-sale 246,722 1,143,238 97,990
Purchase of Valley stock -- (735,804) --
Acquisition of minority interest in Valley -- (95,449) (1,923,050)
Net decrease in loans receivable 28,442 3,091 104,351
----------- ---------- ----------
Net cash provided by (used in) investing
activities 275,164 315,076 (1,720,709)
----------- ---------- ----------
Cash flows from financing activities:
Advances on line of credit -- 1,750,000 1,555,000
Payments on line of credit (300,000) (2,000,000) (305,000)
Purchase of treasury stock -- (2,539,462) (583,601)
Issuance of trust preferred securities -- 3,000,000 --
Proceeds from issuance of common stock 3,300 3,570 --
Dividends paid to stockholders (1,604,815) (1,576,771) (1,713,724)
----------- ---------- ----------
Net cash used in financing activities (1,901,515) (1,362,663) (1,047,325)
----------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents 179,607 477,243 (458,162)
Cash and cash equivalents at beginning of year 575,673 98,430 556,592
----------- ---------- ----------
Cash and cash equivalents at end of year $ 755,280 575,673 98,430
=========== ========== ==========
F-39