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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, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITY EXCHANGE
ACT OF 1934
For the transition period from _____________ to ___________
Commission file number: 0-28080
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) (Zip Code)
Registrant's telephone number, including area code: (406) 727-6106
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 twelve 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, computed by reference to the closing price of such stock on the
Nasdaq National Market as of February 27, 1998, was $30,522,474.
The number of shares of Registrant's common stock outstanding on February 27,
1998 was 1,698,312. Registrant's common stock is traded on the Nasdaq National
Market, symbol UBMT.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1998 Annual Meeting of Stockholders
to be held on May 18, 1998 are incorporated by reference into III of this Form
10-K.
UNITED FINANCIAL CORP.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page Number
PART I
ITEM 1. BUSINESS............................................................. 1
ITEM 2. PROPERTIES...........................................................22
ITEM 3. LEGAL PROCEEDINGS....................................................22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.................................................23
ITEM 6. SELECTED FINANCIAL DATA..............................................25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........................39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE..............................39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...................39
ITEM 11. EXECUTIVE COMPENSATION...............................................39
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT......................................................40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.........................................................40
PART V
ITEM 15. FINANCIAL INFORMATION OF HERITAGE....................................41
ITEM 16. UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION - HERITAGE
AND UNITED..........................................................41
SIGNATURES....................................................................42
PART I.
ITEM 1. BUSINESS
GENERAL. United Financial Corp. is a savings bank holding company
headquartered in Great Falls, Montana. Its wholly owned subsidiaries, United
Savings Bank, F.A. (United Bank) and Heritage Bank, FSB (Heritage Bank), are
federally chartered stock savings banks. United Financial Corp. and its
subsidiaries are collectively referred to as the Company, and United Financial
is sometimes used to refer to the Company as constituted pre-Merger. Heritage
Bank are collectively referred to herein as the Banks. Full service branches are
located in Shelby, Chester, Havre and Glendive, Montana, and loan production
offices are located in Bozeman, Missoula, Hamilton and Libby, Montana. The
Banks' deposits are insured by the Federal Deposit Insurance Corporation (FDIC)
- - Savings Association Insurance Fund (SAIF). The Banks are members of the
Federal Home Loan Bank (FHLB) of Seattle, Washington and are subject to
comprehensive supervision, regulation, and examination by the Office of Thrift
Supervision (OTS) and the FDIC. The Banks are also subject to the regulations of
the Board of Governors of the Federal Reserve System.
The Company's principal business is attracting deposits from the general
public through its offices and using those deposits, together with other
available funds, to originate commercial (including lease financing), commercial
real estate, residential, agriculture and consumer loans. The residential loans
and certain of the agricultural and commercial loans are secured by mortgages.
The Company also invests in mortgage-backed securities, U.S. Treasury
obligations, other U.S. Government agency obligations and interest-earning
deposits.
The Company's financial condition and results of operations are dependent
primarily on net interest income and fee income. Net interest income is the
difference between the interest income earned on loans, mortgage-backed
securities, other investment securities and interest-earning deposits, less its
cost of funds, consisting of interest paid on deposits and borrowed money. The
Company's 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 Company's principal executive offices are located at 120 First Avenue,
Great Falls, Montana, and its telephone number is (406) 727-6106. United Bank
has a wholly owned subsidiary, Community Service Corporation, which owns and
manages real estate held for investment.
MERGER. On February 3, 1998, United Financial and Heritage Bancorporation
(Heritage) merged. In connection with the Merger, which was structured as a
merger of Heritage into United Financial, each outstanding share of Heritage
common stock was converted into shares of United Financial's Common Stock. An
aggregate of 475,000 shares (or 28%) of United Financial's Common Stock was
issued in connection with the Merger. Prior to the Merger, the former
shareholders of Heritage (the Former Heritage Shareholders) owned approximately
3.3% of the outstanding shares of United Financial's Common Stock. Immediately
following the Merger, the Former Heritage Shareholders owned approximately 30%
of the outstanding shares of the Company's Common Stock. It is expected that
United Bank will merge into Heritage Bank on or about May 3, 1998.
In connection with the Merger, the Board of Directors of the Company was
increased to nine members and five persons nominated by the Former Heritage
Shareholders (the Heritage Nominees) were elected to the Board. Consequently,
the Heritage Nominees now constitute a majority of the Board. Three of the
Heritage Nominees were Former Heritage Shareholders and the other two were
executive officers of other banks controlled by the Former Heritage
Shareholders. There are no contractual or other requirements for the Heritage
Nominees to be nominated or re-elected to the Board in the future. The Heritage
Nominees, representing a majority of the Board, will be able to select and
control the management of the Company as well as the board of directors of the
Company's subsidiary banks.
The new management of the Company intends to change the Company's historical
business strategy and engage in a growth-oriented expansion strategy by pursuing
internal and external growth opportunities, when available. The Company intends
to expand the customer base of the Banks by emphasizing commercial and consumer
loans as well as the mortgage business historically emphasized by United Bank.
Management will consider pursuing external growth through opening new branches,
possible acquisitions of other financial institutions, as well as expansion of
the geographic area currently served. This strategy is consistent with the
growth-oriented expansion historically pursued by Heritage. The Company's new
business strategy may subject the Company to a greater degree of risk. These
risks include increased risk of losses on loans, provision for loan losses which
exceed historical levels, difficulties in integrating or managing new branches
or acquired institutions, and problems relating to the management of growth.
There can be no assurance that the Company will be successful in instituting
this new business strategy or in managing growth. Failure of the Company to
successfully address any of these issues could have a material adverse effect on
the Company's business, results of operations, financial condition or dividend
policy.
The Merger was treated as a reverse acquisition and accounted for as a
purchase in accordance with generally accepted accounting principles. Heritage
was considered the accounting acquirer because Heritage effectively acquired the
operations of United Financial, as a result of the change in control and other
related consequences of the Merger. For information regarding the accounting
treatment of the Merger, see the footnote entitled "Subsequent Event-Merger" in
the Company's consolidated financial statements in Part IV, Item 14.
Consistent with Heritage being the acquiring corporation, the historical
financial statements of the combined entity (i.e. the Company) commencing with
the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 will be
those of Heritage and not United Financial as it existed prior to the Merger.
Accordingly, the historical statements of operations of the combined entity will
reflect only the operations of the United Financial commencing on and after the
closing date of the Merger. United Financial's consolidated financial statements
for the period ending December 31, 1997 contained in this Report reflect the
financial position and results of operations of United Financial for periods
ending prior to the Merger and thus do not reflect or include the financial
position and results of operations of Heritage's operations.
The Company is also filing certain financial statements of Heritage in this
Report, including audited consolidated financial statements for the three years
ending December 31, 1997, 1996 and 1995 and a related Management's Discussion
and Analysis of Financial Condition of Operations of Heritage. The Company is
also filing in this Report Unaudited Pro Forma Combined Financial Information of
Heritage and United Financial. See Part V, Items 15 and 16 of this Report. KPMG
Peat Marwick LLP, United Financial's auditor, was also the auditor for Heritage
for the years ended December 31, 1997 and 1995.
For additional information regarding the Merger and Heritage, see the
Company's Definitive Proxy Statement on Schedule 14A filed with the Securities
and Exchange Commission on January 15, 1998.
MARKET AREA. The Company's primary market area has been the Great Falls,
Montana metropolitan area and the areas surrounding its offices in Shelby,
Glendive and Havre, Montana. With the Merger, Chester, Montana has been added as
a market area as well as market areas served by Loan Production Offices (LPO's)
in Bozeman, Missoula, Hamilton and Libby. Great Falls, the county seat of
Cascade County, is one of the largest cities in Montana. The estimated 1997
Great Falls and Cascade county populations were approximately 58,000 and 81,000,
respectively.
The economy of Great Falls, a regional trade center, is largely based on
agriculture, health care and Department of Defense activities. Located in Great
Falls is Malmstrom Air Force Base (MAFB). MAFB is manned by approximately 4,100
military personnel and civilian employees making it the largest employer in the
city and Cascade county. Also stationed at the MAFB will be the Red Horse Unit,
a new civil engineering group. By October 1998, this new group expects to have
over 400 new military jobs filled. The Montana Air National Guard, 120th Fighter
Wing is also
located in Great Falls. Its complement consists of approximately 1,035 members,
of which approximately 350 are full time. Each of these defense-related
activities contributes significantly to the local economy. There can be no
assurance that future Defense Department cutbacks or base closures will not
adversely influence military operations and thus the economy in the Company's
primary market area.
The economies of Shelby, Chester, Glendive and Havre, Montana are dependent
to a large extent on agricultural, livestock and railroad activities. Areas
served by the Company's LPO's are less dependent upon agriculture. Areas such as
Missoula, Hamilton and Bozeman are also supported by tourism and higher
education. Nevertheless, agriculture is the predominant activity in the state
and any adverse trend could adversely affect the Company.
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 institutions, credit
unions and commercial banks. There are approximately 30 depository institutions,
commercial banks, credit unions and savings institutions with offices in the
Company's market areas. Non-depository financial service organizations,
primarily in the securities and insurance industries, have also become
competitors for retail savings and investment funds. The Company's deposit
programs compete with money market mutual funds, government securities and other
investment alternatives. The Company 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.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
expanded the scope of regulations over the Banks' operations. The current and
potential long-term impact of future legislation on the operations of the Banks
is not predictable. However, further consolidation within the industry as well
as technology improvements and financial modernization are imminent. See
"Regulation - Banks."
LENDING ACTIVITIES
GENERAL. Lending activities are one of the Company's primary sources of
income. The Company's interest income from loans receivable as a percentage of
total interest income for the years ending December 31, 1997, 1996 and 1995 was
approximately 44.1%, 40.8% and 39.0%, respectively. To date, the Company's
principal lending activity has been the origination of residential loans on
existing real estate, 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). As a result of the Merger, the Company intends to broaden its lending
activities and expects its interest income from loans receivable to increase as
a percentage of total interest income in the future. See "Business - General"
FIXED VS ADJUSTABLE RATE LENDING. Generally, fixed rate loans have a greater
interest rate risk than adjustable rate loans. However, borrowers have learned
to take advantage of discounted and below market adjustable starting rates by
making early prepayments and refinancing adjustable rate loans when the
adjustment is not favorable to the borrower. United Bank has not generally
offered discounted first year or starting rates for adjustable rate loans that
it retains for its own portfolio. Instead fixed rate loans of varying terms out
to 15 years have been offered where the loan half-life approximates seven years
(i.e. 15-year loan with 7-year half-life).
If and when mortgage loans with longer half-lives than seven to eight years
are to be retained for loan portfolio, United Bank intends to become more
aggressive in providing adjustable rate loan products. Also, as mortgage loan
fixed rates increase the rate differential between adjustable rates and fixed
rates will make adjustable rates more attractive without the first year rate
discounts that presently result in low yields when adjustable rate loans are
paid off early.
Adjustable rate loans have been available to United Bank's mortgage customers
since 1981, however, the majority of adjustable rate mortgage loans produced in
1997, 1996 and 1995 were sold in the secondary market.
United Bank's policy has been to offer both fixed rate and adjustable rate
mortgage loan products enabling it to provide borrowers an alternative when
fixed rates are rising.
United Bank's mortgage portfolio contained adjustable rate loans at December
31, 1997, 1996 and 1995, totaling $1.5 million, $1.8 million, and $2.2 million,
respectively. The percentage of adjustable rate loans to net loans receivable at
the above dates was approximately 4%, 5% and 7%, respectively.
LENDING RISKS. In addition to the aforementioned rate risks, there are a
number of specific risks inherent in both mortgage and non-mortgage commercial
and consumer lending. Generally, shorter-term loans with payments that pay off
the entire principal balance over the term have less credit risk than loans with
balloon balances at the end of the payment term. Historically, United Bank has
concentrated on residential lending as home loans are believed to present the
least amount of risk because of their 20% or more down payments, the ability to
sell loans with terms exceeding 15 years, and the availability of government or
private insurance coverage to protect against losses on loans with small or no
down payments. Commercial real estate loans have been made where United Bank
believed sizable equity and cash flow positions reduced the risks. Residential
construction loans require greater expertise and have greater risk. United Bank
believes, however, its experienced staff has adequately managed these risks.
Non-mortgage commercial and consumer loans usually have more risk than real
estate loans and therefore are underwritten to manage the collateral and payment
risks by having shorter repayment terms, a required down payment and a good
credit history.
CHANGED LOAN POLICIES. As a result of the Merger, the Company has begun to
use, for both Banks, the historical lending policies, guidelines and procedures
of Hertiage Bank. These policies, guidelines and procedures include commercial,
consumer and agricultural lending as well as residential mortgage lending. The
policies, guidelines and procedures give lending authority to certain senior
bank officers and committees and allow the Banks the flexibility to be
responsive and competitive in their lending activities. It is anticipated that
United Savings Bank will merge into Heritage Bank on or about May 3, 1998. For
additional information regarding Heritage, see Part V, Items 15 and 16 and the
Company's Definitive Proxy Statement on Schedule 14A filed with the Securities
and Exchange Commission on January 15, 1998.
LOAN PORTFOLIO COMPOSITION. The following table shows the composition of the
Company's loans receivable as of the dates indicated:
(Dollars in thousands)
December 31,
------------------------------------------------
1997 1996 1995
--------------- --------------- --------------
Loans secured by real estate:
1-4 residential $20,013 52.9% $20,975 56.8% $20,511 64.1%
5 or more residential 5,531 14.6 4,497 12.2 3,986 12.4
Construction 3,731 9.9 4,620 12.5 3,373 10.5
Agricultural 405 1.0
Commercial 2,660 7.0 3,077 8.4 2,517 7.9
------- ------ ------- ------ ------- -----
32,340 85.4% 33,169 89.9% 30,387 94.9%
Consumer:
Home equity loans and
FHA Title I 1,383 3.7% 1,132 3.1% 1,136 3.5%
Loans to depositors
savings secured 103 .3 92 .2 175 .5
Recreational vehicle
auto and other 1,103 2.9 1,251 3.4 55 .2
Commercial:
Agricultural 424 1.1
Lease financing 561 1.5
Floor plan 454 1.2 884 2.4
Lines of credit and other 1,490 3.9 355 1.0 282 .9
------- ------ ------- ------ ------- -----
5,518 14.6% 3,714 10.1% 1,648 5.1%
Total loans receivable 37,858 100.0% 36,883 100.0% 32,035 100.0%
====== ====== ======
Less:
Discounts on loans 2 4 8
Reserve for possible loan
losses 300 75 75
Loans in process 1,239 1,628 1,600
------- ------- -------
Net loans receivable $36,317 $35,176 $30,352
======= ======= =======
LOAN ACTIVITY. The table below shows the loan activity of the Company for the
years indicated.
(Dollars in thousands)
For Year Ended December 31,
-----------------------------
1997 1996 1995
Real estate secured loans originated: ------- ------- -------
1-4 residential $16,431 $16,960 $12,018
5 or more residential 1,680 289 125
Construction 5,142 7,103 5,190
Agricultural 405
Commercial 1,167 45
Consumer and commercial (non-mortgage)
loans originated 4,717 5,807 1,842
Commercial loan participations 1,561
------- ------- -------
Total loans originated 29,936 31,326 19,220
Loans purchased
------- ------- -------
Total originations and purchases 29,936 31,326 19,220
Secondary market loan sales (12,213) (11,996) (8,425)
Portfolio loan sales (2,973) (3,031) (2,748)
Loan repayments - real estate secured (9,301) (7,643) (7,029)
Loan repayments - consumer & commercial (4,474) (3,741) (1,916)
------- ------- -------
Total sales and repayments (28,961) (26,411) (20,118)
Other net changes:
Loans in process and discounts on loans 391 (24) (262)
Reserve for possible loan losses (225)
Real estate owned transfers (67)
------- ------- -------
Total other net changes 166 (91) (262)
Net loan activity $1,141 $4,824 $(1,160)
======= ======= =======
Total loans originated in 1997 were $29.9 million a decrease of $1.4 million,
or 4%, from the $31.3 million of loan volume generated in 1996. Forty-one
percent, or $12.2 million, of the total 1997 loan production and $12.0 million,
or 38%, of the total 1996 loan production was comprised of long-term fixed rate
mortgage loans originated for sale to the secondary market.
RESIDENTIAL (NON-CONSTRUCTION) REAL ESTATE LENDING. At December 31, 1997,
approximately $25.5 million, or 67%, of the Company's $37.9 million total loans
receivable consisted of loans secured by first liens on single-family and
multi-family residential properties. At December 31, 1997, approximately $4.2
million, or 11%, of the Company's total loans receivable consisted of
FHA-insured and VA-guaranteed loans.
Fifty-five percent, or $16.4 million, of the Company's total loan
originations during 1997 and 54%, or $17.0 million, of total loan originations
during 1996 were secured by one-to-four family dwellings.
SECONDARY MARKET AND PORTFOLIO LOAN SALES. For the past several years, the
Company's total production of long-term (15 to 30-year maturity) fixed rate
residential loans have been originated according to prearranged 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 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. Retaining long-term, fixed-rate loan production for
portfolio in the low market interest rate cycle of the past few years would
expose the Company to declines in market values should interest rates rise. This
origination and sale policy is a component of the Company's overall
"Asset/Liability Management" program. The Company sold long-term fixed-rate
mortgage loans to the secondary market in aggregate amounts of $12.2 million in
1997
and $12.0 million and $8.4 million during 1996 and 1995, respectively. At
December 31, 1997 and 1996, loans held for sale were $1.1 million and $1.2
million, respectively. The Company also sells long-term fixed-rate loans that
were refinances of existing portfolio loans or permanent financing of completed
construction loans to the secondary market or to Montana State agencies. These
loans are carried at their outstanding principal balance, which was the
contracted purchase price, and therefore, no gain or loss was realized at sale.
During 1997, 1996 and 1995 the Company sold portfolio loans in aggregate amounts
of $3.0 million, $3.0 million and $2.7 million, respectively.
See Part II, Item 7. - "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Asset/Liability Management."
REAL ESTATE CONSTRUCTION LOANS. In addition to first-lien mortgage loans,
United Bank also provides interim financing for the construction of
single-family and multi-unit dwellings and improvement of real estate to be used
for the construction of such dwellings. Construction loans are generally made
for periods of six months, with interest paid at quarterly or six-month
intervals. Such loans may be extended for several months due to adverse weather
conditions or other justifiable delays in construction. United Bank provides
financing primarily for a small number of contractors who have demonstrated an
ability to complete projects and financial responsibility in residential
development and construction and have operated in United Bank's lending area for
a number of years. United Bank originated approximately $5.1 million, $7.1
million, and $5.2 million in primarily residential construction loans during
1997, 1996 and 1995, respectively. As of December 31, 1997, construction loans
outstanding were approximately $3.7 million, or 10%, of the Company's total
loans receivable. Ninety percent of construction loans outstanding at December
31, 1997, were residential properties. The $1.2 million of undisbursed loan
funds outstanding at December 31, 1997, was for construction loans.
COMMERCIAL AND AGRICULTURAL REAL ESTATE LOANS. United Bank engages in
commercial real estate lending. Whenever possible in making such loans, United
Bank participates in the United States Small Business Administration's program
for guaranteed commercial real estate loans. United Bank's loans on commercial
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.
Beginning in 1997, United Bank engaged in agricultural real estate lending. At
December 31, 1997 and 1996, commercial and agricultural real estate loans
receivable were approximately $3.1 million and $3.1 million, respectively. $.4
million of agricultural loans were originated during 1997, while no commercial
real estate loans were originated during the year. The Company is limited on the
amount that it can invest in nonresidential real estate loans, but the
limitation does not have a material impact on United Bank's commercial lending
activities.
NON-MORTGAGE LOANS. In addition to real estate lending, United Bank also
offers consumer and commercial non-mortgage loans. Prior to 1996, United Bank's
consumer loan portfolio included home equity, home improvement, auto, and
deposit account loans. During 1996, United Bank entered into an agreement with a
local merchant to purchase qualifying recreational vehicle (RV) loans. United
Bank requires fire, hazard and casualty insurance for loans secured by home
equity and casualty insurance for loans secured by autos and RV units. At
December 31, 1997, consumer non-mortgage loans receivable were approximately
$2.6 million, or less than 7% of the Company's total loans receivable. United
Bank originated $1.7 million in non-mortgage consumer loans in 1997 and $2.4
million of non-mortgage consumer loans in 1996. This decrease was largely due to
increased competition for RV loans, which was partially offset by a increase in
home equity loans.
United Bank also offers commercial non-mortgage loans. Prior to 1997, United
Bank's portfolio consisted of commercial lines of credit and fixed rate
commercial loans. Beginning in 1997, United Bank began to originate agricultural
non-mortgage lines of credit and fixed rate loans. United Bank also entered into
loan participation agreements for lease financing loans and commercial lines of
credit with a loan origination office located in Minneapolis, Minnesota. At
December 31, 1997, the total commercial non-mortgage loan portfolio was
approximately $2.9 million, or almost 8% of the Company's total loans
receivable. United Bank originated
approximately $4.6 million in commercial non-mortgage loans in 1997 and
approximately $3.4 million in commercial non-mortgage loans in 1996. United Bank
makes and retains non-mortgage consumer and commercial loans in its portfolio to
better match the maturities of its assets and liabilities because the term of
consumer loans is relatively short (generally 1 to 15 years).
United Bank mainly originates loans through its loan officers, other staff
members and referrals and now is utilizing outside loan origination offices to
implement a more aggressive loan posture. United Bank's existing customer base
generates many of the loans United Bank originates. United Bank has a written
loan policy in which procedures for loan approval limits by certain loan
officers are set forth.
The use of licensed and/or certified appraisers is required for real
estate-related financial transactions where the value exceeds $250,000. All
transactions of $1,000,000 or more, nonresidential and residential over four
living units where the transaction is $250,000 or more and complex residential
transactions of $250,000 or more require a State Certified Appraiser. United
Bank requires independent appraisals and/or evaluations for all real estate
loans prior to the closing of the loan, with all appraisals conducted in
accordance with applicable OTS or FDIC regulations and United Bank's written
appraisal policy statement. At a minimum, appraisals utilized by United Bank
must be performed in accordance with generally accepted appraisal standards as
evidenced by the standards promulgated by the Appraisal Standards Board of the
Appraisal Foundation. In addition, as part of the loan approval process, United
Bank's loan officers generally conduct on-site inspections of properties
securing real estate loans that are to be held in its portfolio.
Under United Bank's underwriting policies, conventional, owner-occupied,
single-family residential loans can be made up to a 95% loan-to-appraised-value
(LTV) percentage. For these same loans, where the LTV exceeds 80%, United Bank
has the additional requirement of private mortgage insurance. Borrowers
generally may refinance or prepay loans at their option. The terms of United
Bank's conventional real estate loans 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 Bank is required prior to settlement
of residential and commercial real estate loans. Title insurance is generally
required on properties securing such loans to protect United Bank against prior
liens on the property or other claims against the title.
Pursuant to OTS loan policy regulations, United Bank has established lending
policies, loan portfolio diversification standards, prudent underwriting
standards, including LTV procedures for the institution's real estate loan
portfolio, and established documentation, approval and reporting requirements so
that compliance with the institution's real estate lending policies can be
monitored. United Bank's Board of Directors reviews real estate lending policies
at least once a year.
The regulatory LTV maximums are as follows:
Loan Type Maximum LTV Ratio
Raw land 65%
Land development 75%
Construction:
Commercial, multifamily* and other
nonresidential 80%
1-4 family residential 85%
Improved property 85%
*Multifamily construction includes condominiums and cooperatives.
The guidelines stress that LTV ratios are only one of a number of credit
factors that must be considered to prudently underwrite a real estate loan.
Exceptions to the general lending policy may be made on a case-by-case basis;
however, each institution is responsible for establishing an internal process
for the review and approval of any loan that does not conform to its lending
standards and maximum LTV ratios. Such exceptions must be supported by written
justification kept in the permanent loan file.
These exceptions must also be reported to the institution's board of directors.
The total of all loans that exceed the regulatory LTV limits is limited to 100%
of the institution's total capital. United Bank has a written loan policy, which
includes LTV ratios that are more conservative than the new regulatory ratios.
The guidelines have not had any material effect on the lending posture or
procedures of United Bank.
United Bank is also subject to laws and regulations that could impose
liability on lenders and owners for cleanup expenses and other costs resulting
from hazardous waste located on property securing real estate loans made by
United Bank, or on real estate that is owned by United Bank, following a
foreclosure. Although United Bank's lending procedures include measures designed
to limit lender liability for hazardous waste cleanup and other related
liability, there can be no assurance that United Bank will not become subject to
such liability in the future.
Under federal law, the aggregate amount of loans that United Bank is
permitted to make to any one borrower (LTOB) cannot exceed 15% of unimpaired
capital and surplus. Amounts up to an additional 10% of unimpaired capital and
surplus may be extended for loans and extensions of credit fully secured by
readily marketable collateral, which is defined to include certain financial
instruments and bullion having a market value at least equal to the loan amount.
The OTS has amended the loans to one borrower limitation to permit savings
associations meeting certain requirements, including capital requirements, to
extend loans to one borrower in additional amounts under certain circumstance
limited essentially to loans to develop or complete residential housing units.
At December 31, 1997, United Bank's LTOB limit was approximately $2.3 million.
The aggregate amount of loans outstanding to one borrower at December 31, 1997
was approximately $1.7 million and represented ten loans. At December 31, 1997,
United Bank was in compliance with the LTOB limitations.
United Bank offers a variety of adjustable-rate mortgage loans (ARMs), the
interest rates on which 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 Bank's primary indexes are the 1, 3, 5, and
10-year constant maturity Treasury indexes. Most of the ARMs currently
originated by United Bank have loan terms of 15 to 20 years with rate
adjustments generally every 1, 3 or 5 years during the term of the loan.
Generally, interest rate adjustments on United Bank's ARMs are now limited to
caps of 2% per year and 6% for the life of the loan. At December 31, 1997, ARMs
constituted approximately $1.5 million, or 4%, of the Company's net loans
receivable.
In addition to charging interest on loans, United Bank charges fees for
originating and servicing loans. These fees are for the inspection of property,
payment of invoices during construction and other miscellaneous services. Loan
origination fee income recognition is subject to Financial Accounting Standards
Board (FASB) Statement No. 91. See Part IV, Item 14. - "Notes to Consolidated
Financial Statements - Loan Origination Fees."
For those institutions with significant for-portfolio loan production, the
adoption of FASB No. 91 continues to have a major effect upon the reported
amounts of interest on loans, loan origination fees, compensation and other
employee expenses. Its application, however, has no direct effect upon actual
cash flows but, rather, affects only the timing of their recognition as income
and expense.
Due to United Bank's policy of selling long-term, fixed-rate loans and
retaining short-term loans in its portfolio the average maturity of the United
Bank's portfolio has decreased. Also as borrowers continue to repay and payoff
loans, the percentage of long-term, (greater than 15-year maturity) fixed-rate
loans in United Bank's portfolio continues to decline. Additionally, with the
exception of the FHA-insured and VA-guaranteed loans it originates, the terms of
United Bank's mortgage loans contain due-on-sale clauses, which generally result
in a payoff of the subject loan at the time of sale of the property securing the
loan. Although assumptions of loans containing such clauses are generally not
permitted, United Bank will permit assumption of certain conventional loans,
provided that the assuming party agrees to either a reduction in the term of the
loan being assumed or an increase in the
interest rate on the loan, or both. Because due-on-sale clauses cause
acceleration of indebtedness or may result in assumption of renegotiated loans
with reduced terms, the effect of due-on-sale clauses is a decrease in the
average maturity of United Bank's loan portfolio.
The following table provides information regarding the maturity of all loans
included in the Company's loan portfolio as of December 31, 1997. 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)
Loan Due Dates
As of December 31, 1997
-------------------------------------------------------
1 yr }1 yr }2 yrs }3 yrs }5 yrs }10 yrs
thru thru thru thru thru thru 15
Real estate first- less 2 yrs 3 yrs 5 yrs 10 yrs 15 yrs yrs Total
mortgage loans: ---- ----- ----- ----- ------ ------- ---- -----
Adjustable rate (all
property types) $35 $42 $115 $699 $177 $430 $1,498
Fixed rate:
1-4 dwelling units 230 355 464 1,222 5,032 9,625 158 17,086
Other residential and
all nonresidential 5 655 867 4,028 1,949 205 7,709
Construction:
Residential 2,492 2,492
Second trust deed 10 13 54 323 551 1,024 39 2,014
Non-mortgage loans:
Consumer 754 67 144 398 817 409 2,589
Commercial 466 15 463 1,000 1,944
Lease loans 383 178 561
Agricultural loans 68 2 89 240 25 424
------ ------ ------ ------ ------- ------- ---- -------
$4,443 $1,107 $1,256 $3,343 $12,152 $13,184 $832 $36,317
====== ====== ====== ====== ======= ======= ==== =======
Total Loans Due after December 31, 1998
(Dollars in thousands)
Fixed interest rates $30,411
Floating or adjustable rates or balloon payments 1,463
-------
$31,874
=======
For additional information regarding loans, see Part IV, Item 14. - "Notes to
Consolidated Financial Statements."
CLASSIFICATION OF ASSETS
GENERAL. When a borrower fails to make a scheduled payment on a loan and does
not cure the delinquency within 15 days, United Bank'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 Bank will generally
proceed with legal 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, leading to
the conclusion that loss of principal and interest would likely not be realized,
then interest income will continue to be accrued.
United Bank, pursuant to federal regulations, 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 generally accepted accounting
principles. 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. As of December 31, 1997 and 1996, United Bank had no
asset classified as doubtful or loss. At December 31, 1997, United Bank had
$50,500 of substandard assets consisting of two repossessed recreational
vehicles held for sale. At December 31, 1996, United Bank had $40,125 of
reported substandard assets. As a percent of total assets, substandard assets
were approximately .05% and .04% at December 31, 1997 and 1996, respectively.
A savings institution is also required to set aside adequate valuation
allowances to the extent that any affiliate possesses assets which pose a risk
to the savings institution. The institution's OTS District Director has the
authority to approve, disapprove or modify any asset classification and amount
established as an allowance pursuant to such classification. In addition, a
savings institution is required to record as liabilities reserves for
off-balance-sheet items, such as letters of credit, when a loss becomes probable
or estimable. Pursuant federal regulations, United Bank has established written
board-approved valuation and loss reserve policies as well as an Internal Asset
Review Committee. Delinquent loans and classified assets are reported to the
Board of Directors monthly.
NONPERFORMING ASSETS. The following schedule details the amounts of the
Company's nonperforming assets consisting of nonaccrual loans, accruing loans
past due over 90 days, restructured loans, other repossessed assets and all real
estate owned held-for-sale (REO/HFS) as of the dates indicated.
(Dollars in thousands)
December 31,
---------------
1997 1996
Principal Balances: ---- ----
Accruing loans past due over 90 days $174 $18
Non-accrual loans
Restructured loans
Other repossessed assets 51
REO/HFS 40
---- ----
$225 $58
==== ====
As a percent of total assets .23% .06%
==== ====
Interest:
Due on non-accrual loans
Included in income None None
PROVISION FOR LOAN LOSSES. The following schedule details changes in United
Bank's loan loss reserve at December 31 for each of the three years indicated:
(Dollars in thousands)
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
Balance beginning of year $ 75 $ 75 $ 75
Provision for loan losses 225
Charge-offs
Recoveries
---- ---- ----
Balance end of year $300 $ 75 $ 75
==== ==== ====
Loan loss reserve to total loans .79% .20% .23%
Loan loss reserve to nonperforming assets 133% 130% 96%
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,
------------------------------------------------------------
1997 1996 1995
Allowance Allowance Allowance
for % to for % to for % to
loan loans in loan loans in loan loans in
losses category losses category losses category
------------------- -------------------- -----------------
Real estate loans:
Commercial and
agricultural $ 46 1.50%
1-4 residential 75 .38%
5 or more residential 55 1.00%
Construction 28 .75%
Other loans:
Commercial and
agricultural 44 1.50%
Consumer 52 2.00%
Unallocated $75 $75
------ ------ ------
$300 .79% $75 .20% $75 .23%
====== ====== ======
For additional information regarding loss reserve policy see Part II, Item 7.
- - "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Provision for Losses on Loans and Assets Quality" and Part IV, Item
14. - "Notes to Consolidated Financial Statements - Reserve for possible loan
losses."
REAL ESTATE OWNED
The schedule below details real estate owned (REO) both held for sale and
investment by United Bank as of the dates indicated.
(Dollars in thousands)
December 31,
---------------
1997 1996
---- ----
REO held for sale $ 40
Allowance for possible losses
REO held for investment $755 755
Accumulated depreciation (406) (370)
---- ----
349 385
---- ----
$349 $425
==== ====
As a percent of total assets .36% .41%
REO HELD FOR SALE. At December 31, 1997 United Bank had no property
classified as held for sale. In 1997, two Great Falls commercial lots (with a
book value of $40,125, which were acquired in partial satisfaction of a judgment
and held for over five years) were sold to an individual in exchange for cash at
no loss for United Bank.
REO HELD FOR INVESTMENT. This category at December 31, 1997 and 1996
consisted of two 24-unit apartment complexes located in Glendive, Montana,
foreclosed by United Bank and sold to its subsidiary, the Community Service
Corporation (CSC). The CSC purchased one apartment complex in 1985 for $480,176,
and after thirteen years of
depreciation, the December 31, 1997 net book value was $175,742. The second
complex was sold to the CSC in 1990 for $274,475 and after eight years of
depreciation, the December 31, 1997 net book value was $172,715. The decrease in
REO held for investment between December 31, 1997 and 1996, reflects only
additional depreciation.
For additional information regarding real estate held for sale and loss
reserve policy, see Part IV, Item 14. - "Notes to Consolidated Financial
Statements - Real estate owned."
SOURCES OF FUNDS
The primary sources of funds are deposits, FHLB borrowings, loan and
mortgage-backed securities repayments, proceeds from loan sales, investment
securities interest payments and maturities, and net operating revenues. The
principal uses of funds are loan originations, mortgage-backed securities and
other investment securities purchases, maturing savings certificates and deposit
withdrawals, repayment of FHLB borrowings, cash dividends, maintaining liquidity
and meeting operating expenses. See Part II, Item 7. - "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources," and Part IV, Item 14. - "Consolidated Statements of Cash
Flows." As demonstrated by the referenced Statements of Cash Flows, $1.5 million
of net cash provided by operating activities and $6.2 million of net cash
provided by investing activities were utilized to fund a $7.8 million decrease
in deposits and pay $1.2 million of cash dividends to shareholders. During 1997,
unlike 1996, United Bank experienced deposits as a use, rather than a source of
funds. United Bank's borrowing limit from the FHLB is 25% of assets and there
were no FHLB advances outstanding at December 31, 1997 and 1996.
DEPOSIT ACTIVITIES
Deposits are attracted from within United Bank'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 Bank considers current market interest rates, profitability to
United Bank, matching deposit and loan products offered by its competition and
its customer preferences and concerns. United Bank reviews its deposit mix and
pricing weekly.
The principal types of deposit accounts offered by United Bank at December
31, 1997 are summarized as follows:
(Dollars in thousands)
Weighted Avg.
Type Term Interest Rate Amount Percent
---- ---- ------------- ------- -------
NOW accounts 2.84% $ 6,100 8.6%
MMDA 3.49% 2,319 3.3%
Savings deposits 3.56% 25,592 36.1%
Time deposits 91-Day 4.31% 192 .3%
182-Day 4.99% 6,338 8.9%
1-Year 5.24% 10,347 14.6%
1 1/2-Year 5.00% 19 - %
2-Year 5.50% 7,623 10.7%
2 1/2-Year 5.65% 1,133 1.6%
4-Year 5.77% 10,709 15.1%
6-Year 4.79% 41 .1%
8-Year 6.00% 511 .7%
----- ------- ------
5.42% 36,913 52.0%
4.46% $70,924 100.0%
===== ======= ======
IRA/Keogh retirement account balances, of all types, at December 31, 1997
were approximately $5.6 million or 7.9% of all deposits. At December 31, 1997,
there were no jumbo time deposits (required minimum balance of $.1 million).
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.
Traditionally, a relatively small number of United Bank's depositors have
resided outside Montana. Deposits are not solicited outside of Montana. At
December 31, 1997, accounts held by out-of-state depositors were approximately
$2.5 million, or 3.6% of total deposits.
United Bank experienced a net decrease in deposits of $7.8 million for the
year ended December 31, 1997, and net increase in deposits of $.4 million for
the year ended December 31, 1996, and a net decrease of $10.8 million for the
year ended December 31, 1995. The 1997 outflow was a result of several factors.
First, United Bank has traditionally offered a limited array of loan and deposit
products in its role as a traditional thrift. This limited selection of products
has required that customers go to other financial institutions or other
alternate sources for a wider selection of products to meet their financial
needs. With the Merger, United Bank now offers more varied financial products
and is attempting to keep its customers from migrating to competitors. Secondly,
due to the limited loan products offered by United Bank in the past, its need
for loan funding dictated interest rates on its deposit products be less than
competitive. Management is taking steps to prevent further deposit outflows
while recognizing the need to price its products competitively.
Inasmuch as market demand generally dictates deposit maturities and rates,
United Bank intends to continue to offer those types of accounts that have broad
market appeal. It is United Bank's policy not to accept or place brokered
deposits. See "Regulation - Bank."
The following table presents, by various weighted average interest rate
categories, the amounts of United Bank's time deposits at December 31, 1997,
which mature within the periods indicated.
(Dollars in thousands)
Weighted Avg. Within Within Within
Interest Rate 1 Year 2 Years 3 Years Thereafter Total
------------- ------- ------- ------- ---------- -------
3.25 - 4.99% $ 6,531 $ 37 $ 3 $ 6,571
5.00 - 5.99% 15,786 7,305 4,204 $2,980 30,275
6.00 - 6.75% 67 67
------- ------ ------ ------ -------
Total $22,317 $7,342 $4,207 $3,047 $36,913
======= ====== ====== ====== =======
The following table presents, by various weighted average interest rate
categories, the amounts of United Bank's time deposits at December 31, 1996,
which mature within the periods indicated.
(Dollars in thousands)
Weighted Avg. Within Within Within
Interest Rate 1 Year 2 Years 3 Years Thereafter Total
------------- ------- ------- ------- ---------- -------
3.25 - 4.99% $ 7,432 $ 36 $ 3 $ 7,471
5.00 - 5.99% 19,583 $5,500 3,073 4,420 32,576
6.00 - 7.99% 63 63
------- ------ ------ ------ -------
Total $27,015 $5,500 $3,109 $4,486 $40,110
======= ====== ====== ====== =======
BROKERED DEPOSITS. The Banks, due to their capital position are empowered to,
but by policy do not accept, place or solicit brokered deposits.
For additional information regarding deposits see Part IV, Item 14. - "Notes
to Consolidated Financial Statements - Deposits."
BORROWINGS
The FHLB of Seattle functions as the central reserve bank providing credit
for savings institutions and certain other member financial institutions. As a
member of the FHLB of Seattle, United Bank is required to own capital stock in
the FHLB of Seattle and is authorized to apply for advances on the security of
specified collateral. Advances are made pursuant to several different credit
programs. Each credit program has its own interest rate and range of maturities.
United Bank's currently established available FHLB advance credit line is 25% of
assets. The FHLB of Seattle is required to review its credit limitations and
standards at least annually. Historically, United Bank has relied upon deposits,
loan repayments and investment securities cash flows as its major source of
funds, and consequently has made limited use of FHLB advances. At December 31,
1997 and December 31, 1996, no FHLB advances were outstanding.
For additional information regarding borrowings, see "Regulation - Bank,"
Part II, Item 7. - "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Part IV, Item 14. - "Notes to Consolidated
Financial Statements - FHLB advances".
INVESTMENT ACTIVITIES
Historically, a major source of the Company's income was from investment
securities and mortgage-backed securities. Interest income from these two
sources as a percentage of total interest income for the years ending December
31, 1997, 1996 and 1995 was approximately 52.1%, 57.1% and 57.6%, respectively.
Commencing with the Merger, the Company expects loan interest income to
significantly exceed investment activity income. See Part IV, Item 14. - "Pro
Forma Combined Financial Statements."
Pursuant to OTS regulatory requirements (including Thrift Bulletin No. 52),
the Company has established an investment committee and has developed
comprehensive, Board of Directors' approved, written investment policies
relating to the investment in income producing assets other than loan
originations. The Company's stated investment policy is to purchase only
held-to-maturity or available-for-sale investments and not for trading. The
Company reports monthly to its Board of Directors all investment activity,
including purchases, sales, maturities and book-vs-market-value comparisons. The
Company reports quarterly to its Board of Directors minutes of Investment
Committee meetings, recapping past activities, forecasting expected cash flows,
interest rate projections and investment strategies for the upcoming quarter.
Federally chartered savings institutions are authorized to invest in various
types of liquid assets, including U.S. Treasuries and securities of various U.S.
Government agencies, certificates of deposit at insured banks and thrift
institutions, bankers' acceptances, state and local municipal bonds, federal
funds and mortgage-backed securities. Subject to various restrictions, federally
chartered savings institutions may also invest a portion of their assets in
commercial paper, corporate debt securities and in mutual funds (the assets of
which conform to the investments that such an institution is authorized to make
directly). As of December 31, 1997, the Company had approximately $53.5 million
of investments comprised of $36.2 million, and $17.3 million of securities
classified as held-to-maturity and available-for-sale, respectively.
The following table sets forth the book value, maturities and weighted
average yields of the Company's investment portfolio at December 31, 1997.
Mortgage-backed securities due dates are expected average lives for REMIC
certificates, GNMA, FNMA and FHLMC adjustable rate and maturity dates for 5 and
7-year balloons and fixed rate GNMA. The Kemper U.S. Government bond mutual fund
yield is based on cost.
(Dollars in thousands)
FHLB CD's/ Mortgage- Kemper
U.S. Treasuries/ Backed U.S. Gov't Bond
U.S. Gov't Agencies Securities Mutual Fund Totals
----------------------------------------------------------------
Book Book Book Book
Value Yield Value Yield Value Yield Value Yield
------- ----- ------- ----- ------ ----- ------- -----
Less than 1 yr $11,837 5.63% $ 1,509 5.53% $5,260 6.00% $18,606 5.73%
After 1 yr
through 2 yrs 1,010 6.45% 3,835 6.13% 4,845 6.20%
After 2 yrs
through 5 yrs 11,025 7.00% 8,213 6.45% 19,238 6.77%
After 5 yrs
through 10 yrs 3,000 7.32% 5,013 6.59% 8,013 6.86%
After 10 yrs 2,816 6.28% 2,816 6.28%
------- ----- ------- ----- ------ ----- ------- -----
$26,872 6.41% $21,386 6.34% $5,260 6.00% $53,518 6.34%
======= ===== ======= ===== ====== ===== ======= =====
For additional information regarding investment securities, see Part IV, Item
14. - "Notes to Consolidated Financial Statements - Investments", "Investment
Securities", "Fair Value of Financial Instruments" and "Derivative financial
instruments".
SERVICE CORPORATION ACTIVITIES
United Financial has no direct subsidiaries other than United and Heritage
Banks. United Bank has a wholly owned service corporation, the Community Service
Corporation, which owns and manages real estate held for investment. At December
31, 1997, United Bank had an investment of approximately $349,000 in its service
corporation. A federal savings institution's aggregate outstanding investment to
its service corporation cannot exceed 3% of the institution's assets. United
Bank is in compliance with the subsidiary investment limits.
EMPLOYEES
At March 16, 1998, the Company employed fifty-nine full-time employees and
thirteen part-time employees. Management considers its relations with its
employees to be excellent. The Company 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. The Company's employees are not represented by any collective
bargaining group. See Part IV, Item 14. - "Notes to Consolidated Financial
Statements - Retirement plans".
EXECUTIVE OFFICERS OF THE REGISTRANT. The following table sets forth
information with respect to the executive officers of the Company (and the
Banks). All executive officers are elected annually by the Board of Directors
and serve at the discretion of the Board of Directors. There are no arrangements
or understandings between individual officers and any other person pursuant to
which he was elected as an officer.
Name Age Position Held
- --------------------- --- -------------------------------------------------
John M. Morrison 61 Chairman and Chief Executive Officer
Kurt R. Weise 41 President and Chief Operating Officer, Vice
President/C.O.O./Investments/Treasurer-Heritage
Bank and United Bank
Kevin P. Clark 42 Secretary to the Board, President and C.E.O.-
Heritage Bank and United Bank
Steve Feurt 42 Chief Credit Officer, Senior Vice President and
C.C.O.-Heritage Bank United Bank
MR. MORRISON has served as Chairman and Chief Executive Officer of the
Company since its merger with Heritage on February 3, 1998. Before joining the
Company, he served as Chairman of Heritage since 1994. Mr. Morrison is also the
Chief Executive Officer and sole shareholder of Central Bancshares, Inc., the
parent company of Central Bank located in Stillwater, Minnesota, which was
founded by Mr. Morrison in 1988. Mr. Morrison was the Chairman and majority
shareholder of Bank of Montana System, a bank holding company with approximately
$800 million in assets, prior to its sale to Norwest Corp. in 1994. He is
currently involved as a shareholder in businesses such as cellular phone
service and precision parts manufacturing.
MR. WEISE has served as President and Chief Operating Officer of the Company
since its merger with Heritage. Before joining the Company, he served as Vice
President, Treasurer and a director of Heritage. Mr. Weise also serves as
President of Central Financial Services Inc., a bank consulting firm, and
President of Central Bancshares, Inc. He has been involved with the Central Bank
group of companies since they were founded in 1988. He was the Chief Financial
Officer of Bank of Montana System until its sale to Norwest Corporation.
MR. CLARK has served as Secretary of the Company and President and Chief
Executive Officer of the Banks since the Company's merger with Heritage. Before
joining the Company, he served as President, Chief Executive Officer and a
director of Heritage Bank since 1994. Prior to 1994, Mr. Clark served in various
capacities with Bank of Montana, most recently as Regional Vice President and
director.
MR. FEURT has served as Chief Credit Officer of the Company and Senior Vice
President/Chief Credit Officer of the Banks since the Company's merger with
Heritage. Before joining the Company, he served as Senior Vice President and
Senior Credit Officer of Heritage Bank since 1994. Mr. Feurt served as Senior
Vice President and Senior Credit Officer of Bank of Montana from 1984 until its
sale to Norwest Corporation.
REGULATION - HOLDING COMPANY
GENERAL. United Financial Corp. is a savings and loan holding company within
the meaning of Section 10 of the Home Owners' Loan Act, as amended (HOLA). As
such, United Financial Corp. is subject to OTS examination and supervision as
well as certain reporting requirements. As SAIF-insured subsidiaries of a
savings institution holding company, the Banks are is subject to certain
restrictions in dealing with United Financial Corp.
Prior to the Merger, United Financial Corp. was a unitary thrift holding
company. There are few limitations on unitary thrift holding companies whose
insured savings association subsidiary complies with the Qualified Thrift Lender
(QTL) test described below under "Regulation - Bank - Qualified Thrift Lender
Test," except for limitations on further acquisitions. The activities of a
multiple savings and loan holding company and its subsidiaries (other than
SAIF-insured savings associations) are
generally subject to the same restrictions as are bank holding companies, unless
all or all but one of such savings and loan holding company's savings
association subsidiaries were acquired in a supervisory acquisition and all of
such savings association subsidiaries qualify as QTLs. Currently, United
Financial Corp. is a multiple savings and loan holding company because of its
ownership of the two Banks. After the merger of Heritage Bank and United Bank,
United Financial Corp. expects to be a unitary savings and loan holding company.
If the Company were to acquire another thrift, the Company would be a multiple
savings and loan holding company unless it merged its thrift subsidiaries. If
the Company were to acquire a commercial bank, the Company would no longer be a
unitary thrift holding company and would be subject to bank holding company
regulations.
HOLA generally prohibits a savings and loan holding company, directly or
indirectly, from (i) acquiring control of another savings institution (or a
holding company thereof) without the prior approval of the OTS, (ii) acquiring
5% or more of the voting shares of another savings institution (or a holding
company thereof) which is not a subsidiary, or (iii) acquiring control of a
savings institution not insured by the FDIC. Further, under the Change of Bank
Control Act and the HOLA, no company or person may acquire direct or indirect
control (including indirect control by acquiring control of a holding company)
of a thrift without approval of the OTS upon application (unless the transaction
qualifies for one of several exemptions). Any person or company is deemed to
have acquired control of a thrift if it acquires more than 25% of the voting
securities of the thrift or its holding company. In addition, any person or
company is presumed to have acquired control of a thrift if it acquires more
than 10% of the voting securities of the thrift or the thrift's holding company
and is subject to certain "control factors." Upon acquiring such ownership, a
holder is required to file a certification with the OTS that such holder is not
in control of the thrift. The OTS may deny an application for control based on a
number of factors and may refute a rebuttal of a presumption of control.
REGULATION - BANKS
GENERAL. The Banks are federally chartered stock savings banks, the deposits
of which are insured and backed by the full faith and credit of the United
States Government. As a result, the Banks are subject to broad federal
regulation and oversight. The Banks are members of the SAIF and the deposits of
the Banks are insured by the FDIC. As a result, the FDIC has certain regulatory
and examination authority over the Banks.
TRANSACTIONS WITH AFFILIATES. All transactions involving a savings
association and its affiliates are subject to sections 23A and 23B of the
Federal Reserve Act (FRA). Generally, these sections restrict "covered
transactions" (i.e. loans, purchases of assets, guarantees and similar
transactions) to a percentage of a savings institution's capital and surplus and
require such transactions to be on terms as favorable to the savings association
as transactions with nonaffiliates. Loans to insiders (officers, directors and
10% shareholders) of a savings association are subject to sections 22(g) and (h)
of FRA and the regulations promulgated thereunder. Among other things, such
loans must be made on terms substantially the same as loans to non-insiders. The
OTS has also adopted Regulation O of the Federal Reserve Board (FRB), which
implements legislative restrictions on insider loan transactions.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS. The OTS has extensive authority
over the operations of the Banks, including, among other things, the ability to
assess civil money penalties, to issue cease and desist orders or removal
orders, and to initiate injunctive actions for violations of laws and
regulations and for unsafe or unsound practices. The Banks are required to file
periodic reports with the OTS and is also subject to periodic examinations by
the OTS and the FDIC. The last regular OTS safety and soundness and FDIC
examinations of the Banks were completed January 1997 and April 1990,
respectively, for United Bank and March 1997 and October 1990, respectively, for
Heritage Bank. The OTS and the FDIC have entered into an agreement that provides
for joint examinations by the FDIC with the OTS.
DEPOSIT INSURANCE AND FDIC REGULATION. The Banks are members of the SAIF,
which is administered by the FDIC. Savings deposits are insured up to the
applicable limits (generally $100,000 per insured depositor) by the FDIC and
backed by the full faith
and credit of the United States Government. 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 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 is in an unsafe or unsound condition.
Legislation was enacted in 1996 that provided for a special assessment
against FDIC/SAIF member institutions that capitalized the SAIF insurance
reserve to the prescribed 1.25% of insured deposits level. For United Bank, this
one-time special assessment was $549,700, or 65.7 basis points per $100 of
United Bank's insured deposit base on March 31, 1995. The Company's 1996
consolidated financial statements reflect the expense and payment of this
$549,700 special assessment. For Heritage Bank, this one-time special assessment
was $239,300, or 65.7 basis points per $100 of Heritage Bank's insured deposit
base on March 31, 1995. The Banks' FDIC/SAIF assessment rate, beginning January
1, 1997 decreased from 23 basis points to 6.5 basis points per $100 of insured
deposits. Most commercial banks, insured under the FDIC/Bank Insurance Fund
(BIF), beginning January 1, 1997, were assessed 1.3 basis points per $100 of
insured deposits. For the second half of 1997, the Banks' FDIC/SAIF assessment
rate were 6.3 basis points per $100 of insured deposits, compared 1.26 basis
points for BIF members. As a result, United Bank's 1997 FDIC/SAIF deposit
insurance premium was $49,109 and Heritage's Bank's was $27,389.
REGULATORY CAPITAL REQUIREMENTS. OTS capital regulations require federal
savings institutions such as the Banks to satisfy three capital requirements:
(i) tangible capital must not be less than 1.5% of adjusted total assets, (ii)
core capital must not be less than 3% of adjusted total assets, and (iii)
risk-based capital must not be less than 8.0% of "risk-adjusted" assets. United
Bank and Heritage Bank exceeded these minimum standards at December 31, 1997.
See Part IV, Item 14. - "Notes to Consolidated Financial Statements - Regulatory
Capital". For information regarding Heritage's capital requirements, see Note 14
to the consolidated financial statements of Heritage in Part V, Item 15.
Tangible capital includes shareholder's equity, noncumulative perpetual
preferred stock, certain nonwithdrawable accounts, pledged deposits of mutual
savings institutions, and minority interests in fully consolidated subsidiaries,
less intangible assets and certain investments in subsidiaries that conduct
activities not permissible for a national bank. Purchased mortgage servicing
rights may be included in tangible capital at the lower of 90% of fair market
value, 90% of original cost, or 100% of current amortized book value.
Core capital consists of tangible capital plus a percentage of certain
marketable intangible assets, and a decreasing portion (through 1994) of
qualifying supervisory goodwill.
Risk-based capital is determined by assigning a risk-weight, ranging from 0%
for government securities to 100% for certain equity investments, to each of an
institution's assets, including the credit-equivalent amount of off-balance
sheet assets. An institution is required to maintain total regulatory capital
(consisting of both "core capital" and supplementary capital) equal to the
regulatory mandated percentage (8%) of the sum of its assets multiplied by their
respective risk-weights. The OTS also requires institutions with more than a
"normal" level of interest-rate risk (IRR) to maintain additional risk-based
capital. A savings institution with a greater than normal IRR is required to
deduct from total capital, for purposes of calculating its risk-based capital
requirement, an amount equal to one-half the difference between the
institution's measured IRR and the normal level of IRR, multiplied by the
present value of its total assets. Based on their current capital position, most
recent OTS calculated IRR, and proposed exemption criteria, the Banks would not
have an IRR capital adjustment.
The FDICIA places much greater emphasis on 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 the FDICIA
are "well capitalized",
"adequately capitalized", "undercapitalized", "significantly undercapitalized"
and "critically undercapitalized". Each Bank's capital position substantially
exceeds the definition of "well capitalized." The FDICIA 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". At
December 31, 1997, United Bank was well capitalized and Heritage Bank was
adequately capitalized. Upon the merger of United Bank into Heritage Bank,
management believes the merged bank will be well capitalized.
QUALIFIED THRIFT LENDER TEST. Unless a savings institution meets the QTL
test, it is classified and subject to regulation as a national bank or becomes
subject to a number of limitations on investment, branching, advances, dividends
and other activities. In addition, a unitary savings and loan holding company
that owns a thrift failing the QTL test becomes subject to limitations on
activities applicable to multiple savings and loan holding companies. The QTL
test generally requires that an insured institution's Qualified Thrift
Investments (QTIs) (primarily residential mortgages and related investments,
including certain mortgage-related securities) equal or exceed 65% of the
institution's portfolio assets (defined as all assets minus intangible assets,
property used by the institution in conducting its business and qualifying
liquid assets up to 20% of total assets). Certain assets are subject to a
percentage limitation of 20% of portfolio assets. Savings associations may
include shares of stock of the FHLBs, Federal National Mortgage Association, and
Federal Home Loan Mortgage Corporation as QTIs. As of December 31, 1997, over
90% of United Bank's assets and over 79% of Heritage Bank's assets were invested
in QTIs.
CONSUMER ISSUES. The Community Reinvestment Act (CRA) and other fair lending
laws and regulations impose nondiscriminatory lending requirements on financial
institutions. In recent periods, federal regulatory agencies, including the FRB,
the OTS and the Department of Justice (DOJ), have sought a more rigorous
enforcement of the CRA and other fair lending laws and regulations. The DOJ is
authorized to use the full range of its enforcement authority under the fair
lending laws. A successful challenge to an institution's performance under the
CRA and related laws and regulations could result in a wide 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 activity. Private parties may also have
the ability to challenge an institution's performance under fair lending laws in
private class action litigation. During the most recent OTS compliance
examinations of United Bank and Heritage Bank completed in October 1997 and July
1997, respectively, the OTS conducted CRA performance evaluations and each Bank
was rated as having had "an outstanding record of meeting community credit
needs."
LIQUIDITY. All 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.
FEDERAL HOME LOAN BANK SYSTEM. The Banks are members of the FHLB of Seattle,
Washington, one of several regional banks that administer the home financing
credit function for savings associations. 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, .3% of total assets or 5% of FHLB advances
outstanding.
FEDERAL RESERVE SYSTEM. As a creditor and a financial institution, the Banks
are subject to various regulations promulgated by the FRB. Regulations of the
FRB require savings institutions to maintain non-interest-earning reserves
against certain of their transaction accounts (primarily deposit accounts that
may be accessed by writing checks), nonpersonal time deposits and Eurocurrency
liabilities.
PROPOSED LEGISLATION. The Economic Growth and Regulatory Paperwork Reduction
Act of 1996 (the EGRPRA) requires that the Department of the Treasury prepare a
study on the adoption of a common federal depository institution charter in
anticipation of action by Congress to merge the SAIF and BIF insurance funds and
the thrift and bank charters. If there remains no thrift charter on January 1,
1999, the EGRPRA provides that the BIF and SAIF insurance funds will be merged.
It is unclear the effect a merger of the bank and thrift charters would have
on United Financial Corp. and the Banks. After the merger of the Banks, United
Financial Corp. will have substantial flexibility in its operations as a unitary
thrift holding company. If, however, the Banks become national banks and United
Financial Corp. becomes a bank holding company subject to regulation by the FRB,
the activities of United Financial Corp. would be limited to the bank-related
activities provided for in the Bank Holding Company Act. Further, significant
differences remain between the authority of a national bank and a thrift,
including differences in branching authority, insurance activities, and service
corporation activities imposed on banks but not thrifts, and restrictions on
certain forms of loans and investments imposed on thrifts and not banks.
Although the OTS, the FRB and the Office of the Comptroller of the Currency have
increasingly amended regulations or changed their interpretations of regulations
to equalize such powers, there can be no assurances that a new federal banking
charter would not reduce the authority of the Banks to conduct their operations.
Legislation currently before Congress would allow banks, securities firms and
insurance companies to affiliate with one another under the umbrella of a
financial holding company. This legislation would also prohibit the further
grant of charters for unitary thrift holding companies. As presently
contemplated, existing unitary thrift holding companies would be grandfathered
in and would be regulated by the FRB.
For more information regarding legislation see Part II, Item 7. - "Management
Discussion and Analysis of Financial Condition - Legislation." The full impact
that current, proposed and future legislative rules and regulations will have on
the Banks and other financial institutions are not known at this time and cannot
be predicted.
TAXATION
GENERAL. United Financial and its subsidiaries report their income on a
calendar year basis and have elected to file a consolidated federal income tax
return. The State of Montana allows the filing of a combined Montana income tax
return for the first time in 1997, and thus the Company has elected to file a
combined 1997 state income tax return. A tax sharing agreement provides that
United Financial and the Banks "... pay their respective federal and state taxes
as separate corporations on a stand alone basis." Generally with some
exceptions, including United Bank's reserve for bad debts discussed below, the
Company is subject to federal 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 Company.
TAX BAD DEBT RESERVES. For taxable years beginning prior to January 1, 1996,
savings institutions, such as United Bank, 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,
have been deducted in arriving at their taxable income. United Bank's deduction
with respect to "qualifying loans," which are generally loans secured by certain
interests in real property, including various types of mortgage-backed
securities, may have been computed using an amount based on its actual loss
experience or a percentage equal to
8% of its taxable income, computed with certain modifications and reduced by the
amount of any permitted additions tot he nonqualifying reserve. United Bank's
deduction with respect to nonqualifying loans was computed under the experience
method, which essentially allows a deduction based on United Bank's actual loss
experience over a period of several years. Each year United Bank selected the
most favorable way to calculate the deduction attributable to an addition to the
tax bad debt reserve.
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, 1997,
United Bank's bad debt reserve for tax purposes was approximately $3.2 million.
At December 31, 1997, there were no post-1987 reserves.
For additional information regarding federal and state income taxes, see Part
IV, Item 14. - "Notes to Consolidated Financial Statements - Income Taxes".
ITEM 2. PROPERTIES
The physical assets of the Company as of March 1, 1998 consist of a modern
banking facility located at 120 First Avenue North, Great Falls, Montana, which
is the location of the corporate offices as well as the main branch location for
Heritage Bank. This two story facility and basement provide for a full service
bank with 4 drive-up lanes, a loan production office, accounting and loan
servicing departments, and support staff for the Company's employees. This
facility is owned by Heritage Bank. In addition, Heritage Bank leases a drive-up
detached facility located on 10th Avenue South, Great Falls, Montana. The United
Bank facility, located at 601 First Avenue North, Great Falls, Montana,
presently serves its deposit customers through its main teller area and a
three-lane independent drive-up facility. The Banks also have four full-service
branches located in Chester, Glendive, Havre, and Shelby, Montana. These four
facilities are owned by the Banks and have drive-up services. Heritage Bank also
leases four Loan Production Offices which are located in Bozeman, Missoula,
Libby and Hamilton, Montana. There is no debt on any of the owned facilities.
ITEM 3. LEGAL PROCEEDINGS
Although not involved in any pending material litigation, the Company from
time to time engages in litigation normal for its type of business.
ITEM 4. SUBMISSION OF MATTERS 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, 1997.
On February 3, 1998 shareholders, through a proxy solicitation, approved the
plan of merger with Heritage Bancorporation.
For additional information regarding the Merger and Heritage, see the
Company's Definitive Proxy Statement on Schedule 14A filed with the Securities
and Exchange Commission on January 15, 1998.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The common stock of the Registrant is traded on the Nasdaq National Market .
The trading symbol is UBMT. As of February 27, 1998, the closing bid price per
share as quoted by NASDAQ on such date was $27.00.
STOCKHOLDERS. As of January 8, 1998, there were approximately 260
shareholders of record, and another approximately 1,100 beneficial owners, for a
total estimated 1,360 shareholders.
COMMON STOCK MARKET PRICES. The Company's quarterly (high and low) stock
prices for the past two years are as follows:
UBMT Stock Price
-----------------
High Low
------ ------
1996 First quarter $18.50 $17.50
Second quarter 18.75 17.75
Third quarter 19.25 18.00
Fourth quarter 19.75 18.50
1997 First quarter $19.75 $18.75
Second quarter 22.25 18.94
Third quarter 24.25 21.75
Fourth quarter 27.00 23.75
DIVIDENDS
The Company's Board of Directors declared dividends of $.235, $.24, $.245 and
$.25 for the four quarters of 1997, for a total of $.97 per share and declared
dividends of $.215, $.22, $.225 and $.23 for the four quarters of 1996, for a
total of $.89 per share. On January 26, 1998, the Company's Board of Directors
declared a quarterly dividend of $.25 per share, paid February 23, 1998, to
shareholders of record on February 9, 1998. The declaration and payment of
future dividends by the new Board of Directors is dependent upon the Company's
net income, financial condition, economic and market conditions, industry
standards, certain regulatory and tax considerations described below and other
conditions. No assurance can be given, or should be assumed, as to the amount,
timing, or frequency of future dividend payments. There are limited restrictions
on the ability of United to pay dividends from its retained earnings.
The OTS utilizes a three-tiered approach to permit savings associations,
based upon their capital level and supervisory condition, to make capital
distributions which includes dividends, stock redemptions or repurchases,
cash-out mergers and other transactions charged to the Bank's capital account.
Generally, Tier 1 institutions, like United Bank, meeting their fully-phased-in
capital requirement (see "Regulation - Bank - Regulatory Capital Requirements")
according to the capital standards effective on January 1, 1995, may
automatically make capital distributions up to 100% of net income to date during
the calendar year, "plus an amount that would reduce by one half its surplus
capital ratio as of the beginning of the calendar year." "Surplus capital ratio"
means the percentage by which an institution's capital-to-assets ratio exceeds
the ratio of its fully phased in capital requirements to assets. Also, the rule
is applied on a pro forma basis: that is, the institution must still meet its
fully phased in capital requirements after the proposed capital distribution.
Tier 2 institutions (those which meet the current minimum capital requirement on
a pro forma basis, but not meeting capital rules applicable on January 1, 1995)
can pay dividends from 25% to 75% of net income, determined on a generally
accepted accounting principles basis, depending on how close they are to meeting
their fully-phased-in,
risk-based component of the capital standards. Tier 3 institutions, which do not
meet their current regulatory capital requirements, may pay dividends with prior
regulatory approval.
Under current federal income tax laws, any dividend distribution of property
(cash or in-kind) by a "tax-qualified" thrift will be taxable as income to the
recipient and not deductible by the issuer. Such nondeductible distributions are
deemed under the Internal Revenue Code Section 593(e) to come from first: (a)
the accumulated "earnings and profits" of the institution amassed since the
onset of federal taxation in 1952, then (b) the tax bad-debt reserves on
qualifying real property loans of the institution then (c) the supplemental
reserve for losses on loans, and (d) other capital accounts.
Any dividend by a thrift deemed to come from the tax bad debt reserves must,
under the Code, be included in taxable income (because of the required recapture
of the original tax benefit of the thrift percentage of taxable income bad-debt
method) to the extent of the lesser of the tax bad debt reserves or the amount
of the distribution grossed up for taxes attributable to the distribution.
ITEM 6. SELECTED FINANCIAL DATA
UNITED FINANCIAL CORP. -
FIVE YEAR SUMMARY OF OPERATIONS AND SELECTED FINANCIAL DATA (Dollar amounts
in thousands, except per share amounts)
December 31,
----------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Summary of Financial Condition:
Total assets $96,258 $103,837 $114,440 $112,506 $119,041
Cash and cash equivalents 1,629 2,934 1,221 636 6,001
Investments 53,518 61,013 78,379 74,843 71,971
Loans receivable, net 36,317 35,176 30,352 31,512 36,388
Deposits 70,924 78,697 78,291 89,086 95,292
Federal Home Loan Bank advances 10,500
Stockholders' equity 24,650 24,416 24,688 22,548 22,655
Per share 20.15 19.96 20.18 18.43 18.52
As a percent of assets 25.61% 23.51% 21.57% 20.04% 19.03%
Year Ended December 31,
----------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Summary of Operations:
Interest income $7,314 $7,253 $7,394 $7,926 $8,253
Interest expense 3,461 3,565 3,420 3,616 4,046
------ ------ ------ ------ ------
Net interest income 3,853 3,688 3,974 4,310 4,207
Provision for loan losses 225
Non-interest income (1) 675 835 595 772 1,045
Non-interest expense (2) 2,142 2,771 2,133 2,085 2,091
------ ------ ------ ------ ------
Income before income taxes 2,161 1,752 2,436 2,997 3,161
Income taxes 809 649 714 1,111 1,189
------ ------ ------ ------ ------
Net income $1,352 $1,103 $1,722 $1,886 $1,972
====== ====== ====== ====== ======
Ratios:
Net income as a percent of
average assets 1.30% 1.03% 1.62% 1.58% 1.64%
Net income as a percent of
average equity 5.50% 4.50% 7.21% 8.16% 8.89%
Average equity as a percent
of average assets 23.66% 23.00% 22.39% 19.41% 18.40%
Net interest spread 2.83% 2.62% 2.91% 3.04% 2.92%
Net interest margin 3.85% 3.59% 3.83% 3.72% 3.62%
Efficiency ratio (3) 47.31% 49.10% 46.68% 41.03% 39.81%
December 31,
----------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Other Data:
Total number of full service
offices 4 4 4 4 4
Number of deposit accounts 5,535 5,998 6,145 6,429 6,736
(1) 1996 includes pre-tax gain of $150,200 from the sale of investment
securities.
(2) 1996 includes pre-tax charge of $549,700 for the FDIC/SAIF deposit insurance
special assessment
(3) 1996 pretax charge of $549,700 for the FDIC/SAIF deposit insurance special
assessment not included.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BASIS OF PRESENTATION. The following is management's discussion and analysis
of the results of operations and the historical financial condition of United
Financial Corp. and United Bank. The following discussion and analysis is
intended to provide greater details of the results of operations and financial
condition of United Financial Corp. and United Bank. The following discussion
should be read in conjunction with the information under Part I, Item 6 -
"Selected Financial Data" and the Company's consolidated financial statements
and notes thereto and other financial data included elsewhere in this Report.
Certain statements under this caption constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which involve
risks and uncertainties. United Financial Corp.'s actual results may differ
significantly from the results discussed in such forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
economic conditions, competition in the geographic and business areas in which
United Financial Corp. conducts its operations, fluctuations interest rates,
credit quality and government regulations.
CHANGES IN FINANCIAL CONDITION DURING 1997. During 1997, total assets
decreased $7.6 million, or 7%, to $96.3 million. The primary reason for this
change was a $7.8 million, or 10%, net deposit outflow, with deposits of $70.9
million at the end of 1997. The deposit outflow was funded primarily from a $7.5
million, or 12%, decrease in investment securities. Loans receivable increased
$1.1 million, or 3%, to $36.3 million, and cash and cash equivalents declined
$1.3 million, or 45%, to $1.6 million. Stockholders' equity increased $.2
million to $24.6 million.
United Bank experienced a net decrease in deposits of $7.8 million for the
year ended December 31, 1997, a net increase in deposits of $.4 million for the
year ended December 31, 1996, and a net decrease of $10.8 million for the year
ended December 31, 1995. The 1997 outflow was a result of several factors.
First, United Bank has traditionally offered a limited array of loan and deposit
products in its role as a traditional thrift. This limited selection of products
has required that customers go to other financial institutions or other
alternate sources for a wider selection of products to meet their financial
needs. With the Merger, United Bank now offers more varied financial products
and is attempting to keep its customers from migrating to competitors. Secondly,
due to the limited loan products offered by United Bank in the past, its need
for loan funding dictated interest rates on its deposit products be less than
competitive. Management is taking steps to prevent further deposit outflows
while recognizing the need to price its products competitively.
The $.2 million increase in stockholders' equity was comprised of $1.4
million of net income, less $1.2 million of cash dividends paid to shareholders
and a less than $.1 million improvement in the unrealized loss adjustment for
available-for-sale investment securities. Stockholders' equity at December 31,
1997 was 25.6% of assets and book value was $20.15 per share.
Total 1997 loan production was $29.9 million, a $1.4 million, or 4%, decrease
compared to 1996. Forty one percent, or $12.2 million, of the total 1997 loan
production was comprised of long-term fixed-rate mortgage loans originated for
sale to the secondary market.
The following table summarizes the major components of the Company's net
income for each of the three years ended December 31, 1997, as well as the
changes which occurred between the periods shown.
(Dollars in thousands)
Years Ended December 31,
----------------------------------------
1997 1996 1995
-------------- -------------- ------
Amount Change Amount Change Amount
------ ------ ------ ------ ------
Interest income $7,314 $ 61 $7,253 $(141) $7,394
Interest expense 3,461 (104) 3,565 145 3,420
------ ----- ------ ------ ------
Net interest income 3,853 165 3,688 (286) 3,974
Provision for losses on loans 225 225
Non-interest income 675 (160) 835 240 595
Non-interest expense 2,142 (629) 2,771 638 2,133
------ ------ ------ ------ ------
Income before income taxes 2,161 409 1,752 (684) 2,436
Provision for income taxes 809 160 649 (65) 714
------ ------ ------ ------ ------
Net income $1,352 $ 249 $1,103 $(619) $1,722
====== ====== ====== ====== ======
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND DECEMBER 31, 1996
GENERAL. Net income for 1997 was $1,351,600, a $248,700, or 23%, increase
over 1996. The primary reasons for this change were a $164,700 increase in 1997
net interest income and the 1996 one-time $549,700 FDIC/SAIF deposit insurance
special assessment. These two positive changes were partially offset by a
$225,000 1997 loan loss reserve provision and a $159,800 reduction in
non-interest income due primarily to a 1996 gain from the sale of investment
securities.
Net interest margin (net interest income divided by average interest-earning
assets) improved 26 basis points to 3.85%. Net interest spread (the difference
between the average yield on interest-earning assets less the average cost of
interest-bearing liabilities) improved 21 basis points to 2.83%. Return on
average assets for 1997 was 1.30%, compared to 1.03% for 1996. Based on weighted
average shares outstanding, 1997 net income was $1.10 per share compared to $.90
per share in 1996.
INTEREST INCOME. Average 1997 interest-earning assets declined $2.7 million,
or 3%, to $100.0 million. Average 1997 loans receivable increased $3.0 million,
or 9%, to $34.8. Average mortgage-backed securities declined $9.3 million, or
29%, to $23.2 million. Average other investments increased $1.3 million, or 4%,
to $36.8 million and average interest-earning deposits increased $2.3 million,
or 79%, to $5.2 million. Loans receivable average yields declined 3 basis points
to 9.26%, mortgage-backed securities average yields increased 31 basis points to
6.51%, other investment average yields increased 24 basis points to 6.25% and
average interest-earning assets yields increased 21 basis points to 5.43%. As a
result, the 1997 average yield for all interest-earning assets was 25 basis
points higher, 7.32% compared to 7.07% in 1996.
INTEREST EXPENSE. Average 1997 deposits decreased $4.1 million, or 5%, to
$74.3 million. Average daily savings deposits declined $3.2 million, or 10%, and
average time deposits declined $.8 million, or 2%. The 1997 average cost for all
deposits was 4.43%, approximately the same as in 1996. As a result, total
deposit interest expense in 1997 declined $179,500, or 5%, to $3,293,100.
Average 1997 FHLB advances were $2.8 million, a $1.2 million, or a 75%, increase
compared to 1996. The 1997 average cost and interest expense for FHLB advances
were 5.98% and $168,000, compared to 5.72% and $92,000 in 1996. The 1997 average
cost of all interest-bearing liabilities was 4.49%, compared to 4.45% in 1996.
NET INTEREST INCOME. This category improved $164,700, or 4%, to $3,852,700
for the reasons cited above.
NON-INTEREST INCOME. This category decreased $159,800, or 19%, to $674,700.
The primary reason for this decline was $150,200 in 1996 gains from the sale of
available-for-sale investment securities. Loan fees and discount income remained
approximately the same, $435,100 in 1997, compared to $443,500 in 1996. During
1997 loans originated for sale to the secondary market were $12.2 million,
compared to $12.0 million in 1996, while loans originated for portfolio were
$17.7 million, compared to $19.3 million in 1996.
NON-INTEREST EXPENSE. This category decreased $629,100, or 23%, to
$2,141,700. The primary reason for this decrease was the 1996 $549,700 FDIC/SAIF
deposit insurance premium previously discussed. The after tax impact of this
one-time special assessment was a $338,300, or a $.28 per share, reduction in
1996 net income. Compared to the prior year, 1997 salaries and employees
benefits were $86,100 higher. This 7% increase was due primarily to salary
increases, the employment of two experienced agricultural and commercial loan
officers and additional expenses resulting from termination of United Bank's
Savings Association Retirement Fund. Due to a decrease in both deposit balances
and FDIC/SAIF insurance rates, regular FDIC/SAIF insurance premium expense
declined $121,200, or 71%, from $170,300 in 1996 to $49,100 in 1997. Other
expenses declined $48,800, or over 9%, to $489,000 due primarily to a $25,100,
or 27%, decrease in advertising related expenses, from $91,600 in 1996 to
$66,500 in 1997 and a $15,900 1996 loss on the sale of real estate owned.
PROVISION FOR INCOME TAXES. Income before taxes in 1997 was $2,161,700, a
$409,000, or 23%, improvement compared to 1996. Total 1997 income taxes were
$809,000, a $160,300, or 25%, increase compared to 1996. For both 1997 and 1996
the Company incurred the 34% federal corporate tax rate and a 6.75% Montana
corporate license tax.
PROVISION FOR LOSSES ON LOANS AND ASSET QUALITY. 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 to bring the allowance to a level
considered adequate to absorb losses inherit in the loan portfolio. United Bank
provided $225,000 for loan losses in 1997, bringing the total reserve to
$300,200 at December 31, 1997 compared to $75,200 at December 31, 1996. There
were no loan charge-offs in 1997. Non-performing assets consisting of
non-accrual loans, accruing loans past due over 90 days, restructured loans,
other repossessed assets and real estate owned held-for-sale (REO/HFS) were
$225,000 at December 31, 1997 and $57,000 at December 31, 1996, representing
.23% and .06% of total assets, respectively. The loan loss reserve as a
percentage of nonperforming assets at December 31, 1997 and December 31, 1996
were 133% and 130%, respectively. United Bank's allowance for loan losses as a
percentage of total loans was .79% at December 31, 1997 and .20% at December 31,
1996.
United Bank has recently embarked on a growth orientated expansion strategy,
which has already resulted in an increase and a change in its traditional loan
portfolio. This strategy reflects the beginning of a transition from a
traditional thrift to activities resembling those of a commercial bank. This
business strategy is subject to greater risk, including the increased risk of
losses on loans.
In 1997, United Bank has hired two experienced Montana agricultural and
commercial lenders to originate agricultural and commercial loans for United
Bank's portfolio. In addition, United Bank is purchasing lease financing and
commercial loan participations originated out of United Bank's market area.
These loans have different risks in terms of loan monitoring and higher exposure
due to economic conditions and markets outside of United Bank's traditional
market area.
United Bank's market area is concentrated in Montana, increasing its exposure
to loan losses from a deterioration in economic conditions in this state.
Montana has experienced a decline in consumer credit quality consistent with
that experienced on a national level. The filings of personal bankruptcies in
Montana have increased in recent years. Based on the average for all insured
commercial banks in Montana, the net loss to average total loans increased 300%
in 1995 and increased nearly 100% in 1996. The average loan loss reserve for
Montana commercial banks at December 31, 1997 and December 31, 1996 was 1.55%
and 1.62% of total loans, respectively.
The initial growth and ongoing change in United Bank's loan portfolio,
combined with the apparent deterioration and economic trends both on a national
and a Montana state-wide basis and deficiencies in United Bank's loan loss
reserve coverage compared to state-wide averages, resulted in management's
addition to the loan loss reserve in 1997. United Bank's portfolio is and will
in future periods continue to be exposed to greater risk than has historically
been experienced with a portfolio comprised primarily of secured residential
loans. Additional provisions to the loan loss reserve and future charge-offs can
be expected to occur.
COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
GENERAL. Net income for 1996 was $1,102,900, a $618,900, or 36%, decrease
compared to 1995. The primary reasons for this decline were: (1) a $549,700
FDIC/SAIF deposit insurance special assessment, (2) a $285,800 decline in net
interest income resulting primarily from higher deposit costs and borrowing
expense, and (3) higher other expenses due to $91,600 of advertising expense.
Net interest margin (net interest income divided by average interest-earning
assets) declined 24 basis points to 3.59%. Net interest spread (the difference
between the average yield on interest-earning assets less the average cost of
interest-bearing liabilities) declined 29 basis points to 2.62%. The return on
average assets for 1996 was 1.03% compared to 1.62% for 1995. Based on weighted
average shares outstanding, 1996 net income was $.90 per share, compared to
$1.41 per share for 1995.
INTEREST INCOME. Average 1996 interest-earning assets declined $1.1 million,
or 1%, to $102.6 million. Average 1996 loans receivable increased $1.0 million,
or 3%, to $31.8 million, and average other interest-earning assets declined $2.1
million to $70.8 million. Loans receivable average yields decreased 4 basis
points to 9.29% and overall lower yields on all other interest-earning assets
resulted in a 1996 average yield for all interest-earning assets of 7.07%,
compared to 7.13% in 1995.
INTEREST EXPENSE. Average 1996 deposits decreased $2.5 million, or 3%, to
$78.5 million. The mix of average deposits changed with average lower cost
statement savings decreasing $5.2 million, or 15%, while higher cost/repricing
average time deposits increased $2.5 million, or 7%. The 1996 cost of average
time deposits increased 29 basis points to 5.43%. The 1996 average cost of
deposits rose to 4.43%, compared to 4.22% in 1995. Deposit interest expense in
1996 therefore increased $60,900, or 2%, to $3,472,600. Primarily due to $10.5
million dollars of FHLB advances outstanding at the end of 1995, average 1996
borrowings were $1.6 million, a $1.5 million increase over 1995, resulting in
$92,000 of interest expense in 1996, compared to $8,200 in 1995. The 1996
average cost of borrowings was 5.72%, compared to 5.89% in 1995. The 1996
average cost of all interest-bearing liabilities increased to 4.45%, compared to
4.22% in 1995.
NET INTEREST INCOME. This category decreased $285,800, or 7%, to $3,688,000
for the reasons cited above.
NON-INTEREST INCOME. This category increased $240,000, or 40%, to $834,500.
The primary reason for this increase was $150,200 in gains from 1996 sales of
available-for-sale investment securities. In 1996, loan origination fee and
discount income increased $85,400, or 24%, to $443,500. This improvement was the
direct result of increased loan production. During 1996 loans originated for
sale to the secondary market were $12 million, compared to $8.4 million in 1995,
and loans originated for portfolio in 1996 were $19.3 million, compared to $10.8
million in 1995.
NON-INTEREST EXPENSE. This category increased $638,100, or 30%, to
$2,770,800. The primary reason for this increase was the 1996 $549,700 FDIC/SAIF
deposit insurance premium previously discussed. The after tax impact of this
special assessment was a $338,300, or a 28 cent per share, reduction in 1996 net
income. Other expenses increased $119,400, or 29%, to $537,800 due primarily to
a $60,700, or an 196% increase in advertising related expenses, from $30,900 in
1995 to $91,600 in 1996 and a $15,900 1997 loss on the sale of real estate
owned.
PROVISION FOR INCOME TAXES. Income before taxes in 1996 was $1,751,700, a
$684,000, or 28%, reduction from 1995. Total 1996 income taxes were $648,800, a
$65,100, or 9%, decrease compared to 1995. This disproportionate decrease in
1996 taxes, compared to the pre-tax earnings decrease, was due primarily to the
1995 federal statutory bad debt deduction which was repealed in 1996. This 1995
bad debt deduction reduced 1995 federal income taxes by approximately $152,000.
For 1996 and 1995, the Company incurred the 6.75% marginal Montana corporate
license tax.
FDIC/SAIF INSURANCE LEGISLATION
Enacted into law in 1996 was legislation providing for a special assessment
against FDIC/SAIF member institutions, which capitalized the SAIF insurance
reserve to the prescribed 1.25% of insured deposits level. For United Bank, this
one-time special assessment was $549,700, or 65.7 basis points per $100 of
United Bank's insured deposit base on March 31, 1995. The Company's 1996
consolidated financial statements reflect the expense and payment of this
$549,700 special assessment.
Based upon United Bank's "1A" FDIC risk classification, United Bank's
FDIC/SAIF assessment rate, beginning January 1, 1997, decreased from 23 basis
points to 6.5 basis points per $100 of insured deposits. Most commercial banks
insured under the FDIC/Bank Insurance Fund (BIF), beginning January 1, 1997,
were assessed 1.3 basis points per $100 of insured deposits. For the second half
of 1997, United Bank's FDIC/SAIF assessment rate was 6.3 basis points per $100
of insured deposits, while BIF members began paying 1.26 basis points.
LEGISLATION
Regulatory and legislative changes continue to have a dramatic effect on
United Bank and all other federally regulated depository institutions.
Regulatory agencies have become more aggressive in their oversight role and have
been implementing a get-tough approach to compliance examinations and fair
lending law interpretation and enforcement. The current Administration is
focusing on consumer compliance issues, in particular fair lending, while
Congress continues to focus on areas that pose potential safety and soundness
problems. It is doubtful that the complexity of the laws, regulations and
guidelines facing United Bank, and all other federally regulated depository
institutions, will materially abate in the near future. Their impact on United
Bank has become clear. United Bank will continue to be burdened with regulatory
compliance issues that add to United Bank's costs of operations, while at the
same time providing certain distinct competitive advantages to nonregulated
competitors.
Now being debated in the U.S. Congress and Senate are several "Banking" and
"Financial Modernization" bills that include such issues as thrift and thrift
holding company charter changes, conversion of thrifts to national bank charter
status, changes in bank holding company powers, merger of the BIF and SAIF FDIC
insurance funds, consolidation of federal regulatory agencies, "modernization"
of the FHLB, branch banking and several other "consumer" and regulatory issues.
What final form, and impact, this type of legislation and other potential
changes in federal law regarding interstate banking and branching, Glass-Stegall
Act revisions, the continued consolidation of the banking industry and other
regulatory changes will have on United Bank's operations cannot be predicted at
this time.
YEAR 2000
The Company is aware of the issues associated with computer systems as the
year 2000 approaches. The Company recognizes the need to ensure that its
operations will not be adversely impacted by year 2000 date-related failures.
The Company has provided its business customers, suppliers and vendors with
information regarding the Company's progress on year 2000 issues and has
requested similar information in return. All software currently used within the
Company is supplied by vendors. The data center operations of United Financial
will be converted to Heritage Bank's data processing center, which is
anticipated to be completed by June 30, 1998. Heritage has been advised by their
data processing provider that a new generation of software, to be implemented by
early 1998, will be year 2000 certified. The Company continues to bear some risk
related to the year 2000 issue and could be adversely affected if
other entities not affiliated with the Company do not appropriately address
their own year 2000 compliance issues. Based on the study and analysis
conducted, the dollar amount required to remediate the known year 2000 issues is
not expected to be material to the Company's business. Unanticipated problems or
difficulties, however, could significantly increase the Company's estimated
expenditures for the year 2000 project.
ASSET/LIABILITY MANAGEMENT
United Bank'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 Bank'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 Bank's interest-earning assets and interest-bearing liabilities. When
interest-earning assets approximate or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. When the amount
of interest-earning assets is less than the amount of interest-bearing
liabilities, the net yield on interest-earning assets is less than the interest
rate spread. Should this difference in amounts become too great, United Bank
could incur a net interest expense despite a positive spread.
One of the primary objectives of United Bank's management over the past
several years has been to restructure United Bank'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 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 Bank to minimize the mismatch
of asset and liability maturities. For the past several years, United Bank has
maintained the policy of selling all 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 Bank
promotes the origination and retention of loans providing for periodic interest
rate adjustments, shorter terms to maturity or balloon provisions. United Bank
also emphasizes investment in adjustable rate or shorter-term mortgage-backed
securities and other interest-earning investments. Liquidity not utilized for
retained loan production has resulted, over the past several years, in an
increase in the relative percentage to total assets of shorter-term investments
versus longer-term loans. In the very low market interest rate and flat yield
curve environment of the past few years, no real opportunity existed to extend
loan portfolio or investment maturity purchases for a higher yield. Longer term
(15 to 30-year) fixed-rate mortgage loan retention, or greater than 7-year to
maturity investment purchases would have provided only a marginal increase in
interest income while exposing United Bank to significant declines in market
values if interest rates rose substantially. Starting in 1996, United Bank began
retaining selected portfolio loans for higher earnings by engaging in increased
multi-family and commercial real estate lending, as well as increased
non-mortgage commercial and consumer lending. Multi-family, all commercial real
estate lending and commercial and consumer non-mortgage lending is generally
shorter-term in nature than single family residential lending and, although
typically fixed rate, bears higher interest rates.
While United Bank believes that its ongoing asset/liability management
strategies have reduced exposure to interest rate risk, future earnings and
stockholders' equity will continue to be influenced by changes in levels of
market interest rates, competition, and other economic factors beyond the
control of United Bank's management. Management believes that its conservative
short-term maturity and adjustable rate investment and loan portfolio policies,
enable United Bank to minimize portfolio market value declines, and maintain
earnings, while providing the liquidity to reprice assets to offset higher
market interest rates and increased deposit costs.
For further information see Part I, Item 1. - "Regulation - Bank" -
"Regulatory Capital Requirements" and Item 7a. - "Quantitative and Qualitative
Disclosures About Market Risk."
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
AVERAGE BALANCE SHEETS. The following tables set forth for each of the three
years indicated information regarding the Company's: (1) average balance sheets,
and (2) an analysis of net interest earnings as follows: (i) for each category
of interest-earning asset and interest-bearing liability, the average amount
outstanding during the year and interest earned and paid, (ii) the average yield
for each category of interest-earning asset, and average cost for each category
of interest-bearing liability, (iii) the average yield for all interest-earning
assets and the average cost for all interest-bearing liabilities, (iv) the net
yield for interest-earning assets, and (v) other information regarding return on
average assets, return on average equity, equity to average assets ratio, and
dividend payout ratio.
United Financial Corp. Average Balance Sheet
(Dollars in thousands)
For the Year Ended December 31, 1997
------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS -------- --------- ----------
Mortgage loans receivable $ 31,361 $2,922 9.32%
Non-mortgage loans 3,455 301 8.71%
Mortgage-backed securities 23,199 1,510 6.51%
Investments-other 36,749 2,298 6.25%
Interest-earning deposits 5,210 283 5.43%
-------- ------ -----
Total interest-earning assets 99,974 $7,314 7.32%
====== =====
Non-earning assets 3,903
--------
Total assets $103,877
========
LIABILITIES & STOCKHOLDERS' EQUITY
NOW and money market accounts $ 8,344 248 2.97%
Savings deposits 27,404 962 3.51%
Time deposits 38,577 2,083 5.40%
-------- ------ -----
Total deposits 74,325 3,293 4.43%
FHLB advances 2,808 168 5.98%
-------- ------ -----
Total interest-bearing liabilities $ 77,133 $3,461 4.49%
======== ====== =====
Stockholders' equity 25,076
Unrealized loss on securities
available-for-sale (500)
--------
Total stockholders' equity $ 24,576
========
Net interest-earning assets $ 22,841
Net interest income $3,853
======
Net interest spread (1) 2.83%
=====
Net interest margin (2) 3.85%
Net income $1,352
======
Return on average assets (3) 1.30%
Return on average equity (4) 5.50%
Equity to average assets ratio (5) 23.66%
Dividend payout ratio (6) 88%
Interest-earning assets to
Interest-bearing liabilities ratio 1.30
Income per share $1.10
Cash dividends paid per share $.97
(1) Average yield interest-earning assets minus average rate
interest-bearing liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
United Financial Corp. Average Balance Sheet
(Dollars in thousands)
For the Year Ended December 31, 1996
------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS -------- --------- ----------
Mortgage loans receivable $ 29,123 $2,714 9.32%
Non-mortgage loans 2,698 242 8.97%
Mortgage-backed securities 32,524 2,017 6.20%
Investments-other 35,389 2,128 6.01%
Interest-earning deposits 2,907 152 5.22%
-------- ------ -----
Total interest-earning assets 102,641 $7,253 7.07%
====== =====
Non-earning assets 4,017
--------
Total assets $106,658
========
LIABILITIES & STOCKHOLDERS' EQUITY
NOW and money market accounts $ 8,500 257 3.02%
Savings deposits 30,617 1,078 3.52%
Time deposits 39,334 2,138 5.44%
-------- ------ -----
Total deposits 78,451 3,473 4.43%
FHLB advances 1,608 92 5.72%
-------- ------ -----
Total interest-bearing liabilities $ 80,059 $3,565 4.45%
======== ====== =====
Stockholders' equity 24,977
Unrealized loss on securities
available-for-sale (442)
--------
Total stockholders' equity $ 24,535
========
Net interest-earning assets $ 22,582
Net interest income $3,688
======
Net interest spread (1) 2.62%
=====
Net interest margin (2) 3.59%
Net income $1,103
======
Return on average assets (3) 1.03%
Return on average equity (4) 4.50%
Equity to average assets ratio (5) 23.00%
Dividend payout ratio (6) 99%
Interest-earning assets to
Interest-bearing liabilities ratio 1.28
Income per share $.90
Cash dividends paid per share $.89
(1) Average yield interest-earning assets minus average rate
interest-bearing liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
United Financial Corp. Average Balance Sheet
(Dollars in thousands)
For the Year Ended December 31, 1995
------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS -------- --------- ----------
Mortgage loans receivable $ 29,154 $2,718 9.32%
Non-mortgage loans 1,716 162 9.44%
Mortgage-backed securities 20,183 1,262 6.25%
Investments-other 48,388 3,000 6.20%
Interest-earning deposits 4,319 252 5.83%
-------- ------ -----
Total interest-earning assets 103,760 $7,394 7.13%
====== =====
Non-earning assets 2,839
--------
Total assets $106,599
========
LIABILITIES & STOCKHOLDERS' EQUITY
NOW and money market accounts $ 7,965 243 3.05%
Statement savings 35,857 1,277 3.56%
Time deposits 36,801 1,892 5.14%
Average balance adjustment 304
-------- ------ -----
Total deposits 80,928 3,412 4.22%
FHLB advances 137 8 5.89%
-------- ------ -----
Total interest-bearing liabilities $ 81,065 $3,420 4.22%
======== ====== =====
Stockholders' equity $ 24,551
Unrealized loss on securities
available-for-sale (687)
--------
Total stockholders' equity $ 23,864
========
Net interest-earning assets $ 22,695
Net interest income $3,974
======
Net interest spread (1) 2.91%
=====
Net interest margin (2) 3.83%
Net income $1,722
======
Return on average assets (3) 1.62%
Return on average equity (4) 7.21%
Equity to average assets ratio (5) 22.39%
Dividend payout ratio (6) 57%
Interest-earning assets to
Interest-bearing liabilities ratio 1.28
Income per share $1.41
Cash dividends paid per share $.81
(1) Average yield interest-earning assets minus average rate
interest-bearing liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
The following table sets forth the Company's weighted average yield on
interest-earning assets and cost of interest-bearing liabilities at December
31st for each of the three years indicated:
At December 31,
--------------------------------
1997 1996 1995
Year-end yield: ----- ----- -----
Loans receivable 9.04% 9.18% 9.16%
Mortgage-backed securities 6.34 6.27 5.77
Investments-other 6.34 5.76 6.00
Interest-earning deposits 6.05 6.41 4.75
----- ----- -----
Interest-earning assets 7.43% 7.14% 6.79%
Year-end cost:
Deposits 4.46% 4.45% 4.44%
FHLB advances N/A N/A 5.78
----- ----- -----
Interest-bearing liabilities 4.46% 4.45% 4.60%
Interest rate spread 2.97% 2.69% 2.19%
===== ===== =====
The following tables set forth information regarding changes in interest
income and interest expense for the Company for the years indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to (1) changes in volume (changes in volume
multiplied by previous rate), (2) changes in rates (changes in rate multiplied
by previous volume) and (3) change in rate/volume (change in rate multiplied by
the change in volume):
United Financial Corp. Rate Volume Analysis
(Dollars in thousands)
Years Ended December 31,
--------------------------------
1997 v. 1996
------------
Increase (decrease) due to:
Rate/
Volume Rate Volume Total
Interest income: ------ ---- ------ -----
Loans receivable $277 $ (8) $ (2) $267
Mortgage-backed securities (578) 100 (29) (507)
Investments 82 85 3 170
Interest-earning deposits 120 6 5 131
---- ---- ---- ----
Total interest income (99) 183 (23) 61
Interest expense:
Deposits (159) (21) (180)
FHLB advances 69 5 2 76
---- ---- ---- ----
Total interest expense (90) (16) 2 (104)
---- ---- ---- ----
Net interest income $ (9) $199 $(25) $165
==== ==== ==== ====
United Financial Corp. Rate Volume Analysis (Continued)
(Dollars in thousands)
Years Ended December 31,
--------------------------------
1996 v. 1995
------------
Increase (decrease) due to:
Rate/
Volume Rate Volume Total
Interest income: ------ ---- ------ -----
Loans receivable $ 90 $ (9) $(5) $ 76
Mortgage-backed securities 771 (10) (6) 755
Investments (806) (91) 25 (872)
Interest-earning deposits (82) (26) 8 (100)
---- ----- --- -----
Total interest income (27) (136) 22 (141)
Interest expense:
Deposits (40) 92 9 61
FHLB advances 87 (3) 84
---- ----- --- -----
Total interest expense 47 92 6 145
---- ----- --- -----
Net interest income $(74) $(228) $16 $(286)
==== ===== === =====
1995 v. 1994
------------
Interest income:
Loans receivable $(230) $ (16) $ 1 $(245)
Mortgage-backed securities (15) 99 (1) 83
Investments (510) 114 (54) (450)
Interest-earning deposits 18 56 6 80
----- ----- --- -----
Total interest income (737) 253 (48) (532)
Interest expense:
Deposits (534) 387 (57) (204)
FHLB advances 8 8
----- ----- --- -----
Total interest expense (534) 387 (49) (196)
----- ----- --- -----
Net interest income $(203) $(134) $ 1 $(336)
===== ===== === =====
LIQUIDITY AND CAPITAL RESOURCES
Federal regulations now require United Bank to maintain a daily average
balance of liquid assets equal to 4%, of net withdrawable deposits (excluding
accounts with unexpired maturities exceeding one year) and other borrowings
payable in one year or less. As of December 31, 1997 and December 31, 1996,
United Bank's liquidity ratios were 32.8% and 28.9%, respectively. Eliminated in
1997 was a separate rule requiring United Bank to maintain a short-term liquid
assets ratio equal to at least 1% of its liquidity base in cash or short-term
liquid assets. During the fiscal years 1997 and 1996, United Bank consistently
maintained liquidity ratios far in excess of regulatory requirements. United
Bank's liquidity investments for regulatory purposes were approximately $23.4
million at December 31, 1997, and consisted primarily of cash, interest-earning
bank accounts, FHLB certificates of deposit, and U.S. Government agencies.
United Bank's primary sources of funds are deposits, FHLB borrowings, loan
and mortgage-backed securities repayments, proceeds from loan sales, investment
securities interest payments and maturities, and net operating revenues. The
principal uses of funds are loan originations, mortgage-backed securities and
other investment securities purchases, maturing savings certificates and deposit
withdrawals, repayment of FHLB borrowings, cash dividends, maintaining liquidity
and meeting operating expenses. As demonstrated by the 1997 Statement of Cash
Flows, $1.5 million of cash
provided by operating activities and $6.2 million of net cash provided by
investing activities were utilized to fund a $7.8 million decrease in deposits
and pay $1.2 million of cash dividends to shareholders. During 1997, unlike
1996, the Company experienced deposits as a use, rather than a source of funds.
United Bank can borrow from the FHLB in an amount not to exceed 25% of
assets. The Company currently has no material commitments for loan fundings or
other expenditures.
At December 31, 1997, the Company's stockholders' equity was approximately
$24.6 million, or over 25.6% of assets. Additionally, United Bank's regulatory
capital is over $12.1 million more than the highest of three regulatory capital
standards required by federal regulations. The Company's current level of
capital and liquidity provides it with the opportunity to manage its balance
sheet with a great deal of flexibility while still complying with regulatory
requirements. Management believes that the present facilities and equipment
required to conduct its business are adequate for the immediate future.
Management will review facility needs in conjunction with the merger with
Heritage Bancorporation.
EFFECT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared
in accordance with generally accepted accounting principles which require the
measurement of financial position and operating results in terms of historic
dollars, without considering changes in the relative purchasing power of money
over time due to inflation. Unlike industrial companies, virtually all of the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates have a more significant impact on a financial
institution's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services.
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 the
Company's earnings depend on its level of interest rate spread (the difference
between the yield on the Company's interest-earning assets and the rates paid on
its interest bearing liabilities), its primary market risk exposure is interest
rate risk (IRR).
INTEREST RATE RISK. The Company has established a formal written Board of
Director's approved IRR policy. The Banks have also established an
Asset/Liability Management Committee and an Investment Committee, which meets at
least quarterly to review and report in writing to the Banks' Board of Directors
management's efforts to minimize IRR. Several asset/liability management
strategies have been employed by the Company to minimize its exposure to IRR
These include selling all 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.
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE. Interest rate risk
sensitivity of net portfolio Value (NPV) measurement seeks to establish a
methodology to measure the potential for the reduction of earnings and
stockholders' equity resulting from both lower net interest income (NII) and
lower NPV caused by changes in market interest rates. NPV thus provides a
leading indicator of future potential changes in both NII and stockholders'
equity. Because if their asset size (less than $500 million), the Banks fall
under an OTS exemption that allows utilization of an asset/liability computer
simulation program prepared and distributed by the OTS. The OTS Thrift Financial
Report includes Schedule CMR that provides detailed information about the
balances, interest rates, repricing, and maturity characteristics of the Banks'
financial instruments. By utilizing the Banks' provided Schedule CMR data, the
OTS runs computer simulations ("Net Portfolio Value Model") utilizing OTS
assumptions. The Banks' Board of Directors, per OTS requirements, has
established maximum percentage changes, or policy limits for NPV of 10% per
instantaneous 100 basis point change in rates.
The following table demonstrates United Bank's December 31, 1997 NPV and the
$ present value of total assets, NPV ratio, and basis point change for four
instantaneous increases and the four instantaneous decreases in interest rates:
(Dollars in thousands)
Net Portfolio Value - NPV NPV as % of PV of Assets
Instantaneous --------------------------- -------------------------------
Change $PV of NPV
in Rates $Amount $Change %Change Total Assets Ratio Change
- ------------- ------- ------- ------- ------------ ------ -------
+400 bp 14,317 -3,687 -20% 84,593 16.92% -322 bp
+300 bp 15,365 -2,639 -15% 85,911 17.88% -226 bp
+200 bp 16,378 -1,626 -9% 87,195 18.78% -136 bp
+100 bp 17,305 -699 -4% 88,394 19.58% -57 bp
0 18,004 89,371 20.15%
-100 bp 18,653 649 +4% 90,324 20.65% +51 bp
-200 bp 19,505 1,501 +8% 91,535 21.31% +116 bp
-300 bp 20,524 2,520 +14% 92,944 22.08% +194 bp
-400 bp 21,828 3,824 +21% 94,634 23.07% +293 bp
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operation 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 cashflows,
and others. Sensitivity analysis does not reflect actions that the Company might
take in responding to or anticipating changes in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The management of United Financial Corp. has prepared and is responsible for
the consolidated financial statements of the Company. These statements have been
prepared in accordance with generally accepted accounting principles 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 the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission on or before April 25, 1998
(the Proxy Statement is incorporated herein by reference. Information regarding
executive offers 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
The information set forth under the captions "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.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
List of Documents filed by Company as part of this Report.
(a) (1) FINANCIAL STATEMENTS:
The following financial statements of United Financial are included herein
as follows:
Page Number
-----------
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION, F-3
December 31, 1997 and 1996
CONSOLIDATED STATEMENTS OF INCOME - Years Ended F-4
December 31, 1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF CASH FLOWS - Years Ended F-5
December 31, 1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY F-6
- Years Ended December 31, 1997, 1996 and 1995
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.
The exhibits listed in the accompanying index are filed as part of this
Report or incorporated by reference as indicated therein.
(b) REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 1997
None
PART V
ITEM 15. FINANCIAL INFORMATION REGARDING HERITAGE
The Merger of Heritage into United Financial, which closed on February 3,
1998, was treated as a reverse acquisition. Heritage was considered the
accounting acquirer because Heritage effectively acquired the operations of
United Financial as a result of the change in control and other related
consequences of the Merger. Consistent with Heritage being the accounting
acquirer, the historical financial statements of the combined entity commencing
with the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 will
be those of Heritage and not United Financial as it existed prior to the Merger.
The Company is including certain financial statements of Heritage, including
audited consolidated financial statements for the three years ending December
31, 1997, 1996 and 1995 and a related Management's Discussion and Analysis of
Financial Condition of Operations of Heritage. These financial statements are
being filed because, in the future, the ongoing financial statements of the
Company will be the financial statements of Heritage and will be compared to the
historical financial information of Heritage
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS F-25
INDEPENDENT AUDITORS' REPORTS F-38
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION, F-40
December 31, 1997 and 1996
CONSOLIDATED STATEMENTS OF INCOME - Years Ended F-41
December 31, 1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-42
Years Ended December 31, 1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF CASH FLOWS - Years Ended F-43
December 31, 1997, 1996 and 1995
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-44
ITEM 16. UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
The Company is including Unaudited Pro Forma Combined Financial Information
of Heritage and United Financial. This pro Forma information is being included
because Heritage was the accounting acquirer in the Merger and the Company
believes pro Forma information is more meaningful than the separate historical
financial statements of United Financial and Heritage.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF FINANCIAL CONDITION F-61
HERITAGE AND UNITED FINANCIAL, December 31, 1997
UNAUDITED PRO FORMA COMBINED STATEMENTS OF INCOME F-62
HERITAGE AND UNITED FINANCIAL, Year Ended December 31, 1997
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION F-63
SIGNATURES
Pursuant to the requirements of section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:
UNITED FINANCIAL CORP.
By: /s/ John M. Morrison By: /s/ Kurt R. Weise
-------------------------------- -------------------------------------
John M. Morrison Kurt R. Weise
Chairman of the Board and President and Chief Operating Officer
Chief Executive Officer (Duly Authorized Representative)
(Duly Authorized Representative)
Date: March 27, 1998 Date: March 30, 1998
-------------- --------- --------------- ---------
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/ John M. Morrison By: /s/ Kurt R. Weise
-------------------------------- -------------------------------------
John M. Morrison Kurt R. Weise
Director Director
Date: March 27, 1998 Date: March 30, 1998
-------------- --------- --------------- ---------
By: /s/ Larry D. Albert By: /s/ Dr. J. William Bloemendaal
-------------------------------- -------------------------------------
Larry D. Albert Dr. J. William Bloemendaal
Director Director
Date: March 30, 1998 Date: March 31, 1998
-------------- --------- --------------- ---------
By: By:
-------------------------------- -------------------------------------
Elliott L. Dybdal Janice M. Graser
Director Director
Date: March , 1998 Date: March , 1998
-------------- --------- --------------- ---------
By: By: /s/ William L. Madison
-------------------------------- -------------------------------------
Jerome H. Hentges William L. Madison
Director Director
Date: March , 1998 Date: March 31, 1998
-------------- --------- --------------- ---------
UNITED FINANCIAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of United Financial Corp.:
We have audited the accompanying consolidated statements of financial
condition of United Financial Corp. and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
Billings, Montana
January 16, 1998, except for the "Subsequent
Event - Merger" footnote beginning on page
F-21 which is as of February 3, 1998
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share and per share data)
December 31,
------------------
1997 1996
ASSETS ------- --------
Cash and cash equivalents:
Cash and amounts due from banks $ 950 $ 921
Interest-earning deposits with banks 680 2,013
------- --------
1,630 2,934
Investments:
Securities held-to-maturity (estimated fair value
$36,334,359 in 1997 and $35,942,573 in 1996) 36,186 35,828
Securities available-for-sale, net 17,332 25,185
------- --------
53,518 61,013
Loans receivable, net 36,317 35,176
Loans held for sale 1,107 1,239
Premises and equipment, net 1,349 1,407
Real estate owned 349 425
Accrued interest receivable 909 817
Federal Home Loan Bank stock, at cost 535 379
Other assets 544 447
------- --------
$96,258 $103,837
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
NOW and money market demand accounts $ 8,419 $ 8,669
Savings deposits 25,592 29,918
Time deposits 36,913 40,110
------- --------
70,924 78,697
Federal Home Loan Bank advances
Accrued interest payable 65 66
Advance payments by borrowers for taxes
taxes and insurance 190 211
Income taxes payable 49 36
Deferred income taxes 149 223
Other liabilities 231 188
------- --------
71,608 79,421
Stockholders' equity:
Preferred stock, $1.00 par value
(2,000,000 shares authorized; none outstanding)
Common stock, $1.00 par value
(8,000,000 shares authorized;
1,223,312 outstanding) 8,849 1,223
Paid-in capital 7,626
Retained earnings-partially restricted 16,225 16,060
Unrealized loss on securities
available-for-sale, net (424) (493)
------- --------
24,650 24,416
------- --------
Commitments and contingencies
$96,258 $103,837
======= ========
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
Years Ended December 31,
---------------------------
1997 1996 1995
------ ------ ------
Interest Income:
Loans $3,223 $2,956 $2,880
Mortgage-backed securities 1,510 2,017 1,262
Investment securities 2,298 2,128 3,000
Interest-earning deposits 283 152 252
------ ------ ------
7,314 7,253 7,394
Interest Expense:
Deposits 3,293 3,473 3,412
Federal Home Loan Bank advances 168 92 8
------ ------ ------
3,461 3,565 3,420
------ ------ ------
Net interest income 3,853 3,688 3,974
Provision for losses on loans 225
------ ------ ------
Net interest income after
provision for losses on loans 3,628 3,688 3,974
Non-interest Income:
Fees and discounts 435 444 358
FHLB stock dividends 38 31 23
Investment securities sales, net gain 150 6
Other income 202 210 208
------ ------ ------
675 835 595
Non-interest Expense:
Salaries and employee benefits 1,258 1,172 1,174
Net occupancy and equipment expense 257 248 250
Data processing expense 89 93 91
FDIC/SAIF deposit insurance premium 49 170 199
FDIC/SAIF deposit insurance special assessment 550
Other expenses 489 538 419
------ ------ ------
2,142 2,771 2,133
------ ------ ------
Income before income taxes 2,161 1,752 2,436
Provision for income tax expense 809 649 714
------ ------ ------
Net income $1,352 $1,103 $1,722
====== ====== ======
Net income per share $1.10 $.90 $1.41
====== ====== ======
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
-------------------------
1997 1996 1995
------- ------- -------
Operating Activities:
Net income $ 1,352 $ 1,103 $ 1,722
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for losses on loans 225
Depreciation and amortization of bank
premises and equipment 116 114 118
Depreciation of real estate held for investment 36 37 38
Investment securities net accretion (76) (208) (54)
Sales of available-for-sale securities, net gain (150) (6)
Loans originated for the secondary market (12,213) (11,996) (8,426)
Proceeds from secondary market loan sales 12,345 11,482 8,725
Federal Home Loan Bank stock dividends (38) (30) (23)
Net change in income taxes payable 13 17 13
Net change in deferred income taxes (74) (18) (45)
Net change in accrued interest receivable (92) 98 91
Net change in accrued interest payable (1) (2) 26
Net change in other assets (173) 114 (138)
Net change in other liabilities 43 (222) 139
------- ------- -------
Net cash provided by operating activities 1,463 339 2,180
------- ------- -------
Investing Activities:
Purchases of held-to-maturity securities (25,164) (25,047) (25,092)
Proceeds from matured and called
Held-to-maturity securities 16,950 7,000 3,195
Mortgage-backed securities principal collections 7,928 25,559 4,707
Purchases of available-for-sale securities (3,998) (6,908)
Proceeds from matured and called
Available-for-sale securities 12,000 12,556 3,294
Proceeds from sales of available-for-sale securities 4,141 12,797
Loans originated for portfolio (17,723) (19,330) (10,794)
Loan principal collections 13,775 11,384 8,945
Proceeds from sales of portfolio loans 2,973 3,031 2,748
All other changes in loans, net (391) 92 262
Purchases of premises and equipment (58) (28) (301)
Net change in real estate owned 40 29 35
Federal Home Loan Bank stock net change (118) 128 (62)
------- ------- -------
Net cash provided (used) by investing activities 6,214 12,607 (266)
------- ------- -------
Financing Activities:
Net change deposits (7,773) 406 (10,795)
Net change in Federal Home Loan Bank advances (10,500) 10,500
Net decrease in advance escrow payments by borrowers (21) (13) (42)
Holding company formation costs (37)
Cash dividends paid (1,187) (1,089) (991)
------- ------- -------
Net cash used by financing activities (8,981) (11,233) (1,328)
------- ------- ------
Net change in cash and cash equivalents (1,304) 1,713 586
Cash and cash equivalents at beginning of year 2,934 1,221 635
------- ------- -------
Cash and cash equivalents at end of year $ 1,630 $ 2,934 $ 1,221
======= ======= =======
Cash payments for interest $ 3,462 $ 3,566 $ 3,394
Cash payments for income taxes $ 870 $ 513 $ 915
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Three Years Ended December 31, 1997
--------------------------------------------
Unrealized
holding
gains
Common Paid-In Retained (losses)
Stock Capital Earnings net Total
------ ------- -------- ------- -------
Balance - December 31, 1994 $1,223 $7,663 $15,315 $(1,652) $22,549
Net income 1,722 1,722
Cash dividends paid
($.81 per share) (991) (991)
Decrease in unrealized loss
on investment securities
available-for-sale 1,408 1,408
------ ------ ------- ------- -------
Balance - December 31, 1995 1,223 7,663 16,046 (244) 24,688
Net income 1,103 1,103
Cash dividends paid
($.89 per share) (1,089) (1,089)
Holding company formation costs (37) (37)
Increase in unrealized loss
on investment securities
available-for-sale (249) (249)
------ ------ ------- ------- -------
Balance - December 31, 1996 1,223 7,626 16,060 (493) 24,416
Net income 1,352 1,352
Cash dividends paid
($.97 per share) (1,187) (1,187)
Elimination of par value 7,626 (7,626)
Decrease in unrealized loss on
investment securities
available-for-sale 69 69
------ ------ ------- ------- -------
Balance - December 31, 1997 $8,849 $16,225 $ (424) $24,650
====== ====== ======= ======= =======
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The accompanying consolidated financial statements
include the accounts of United Financial Corp. (the Company) a savings bank
holding company, and its wholly-owned subsidiary, United Savings Bank, F.A. (the
Bank). The consolidated financial statements also include the Community Service
Corporation, a wholly-owned subsidiary of the Bank. All significant intercompany
balances and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported and disclosed amounts of assets and liabilities as of
the date of the balance sheet 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 reserve for possible loan
losses. In connection with the determination of the reserve for losses on loans,
management obtains independent appraisals for significant properties. Management
believes that the reserve for losses on loans is adequate. While management uses
available information to recognize losses on loans, future additions to the
reserves may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's reserve for losses on loans. Such agencies may
require the Bank to recognize additions to the reserves based on their judgments
about information available to them at the time of their examination.
INVESTMENTS. Investments are required to be classified into three categories
and accounted for as follows:
1) Debt securities that the Company has the positive intent and ability to
hold to maturity are classified as held-to-maturity and reported at
amortized cost.
2) Debt and equity securities, if bought and held principally for the
purpose of selling them in the near term, are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings.
3) Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale and
reported at fair value, with net unrealized gains and losses excluded from
earnings and reported (net of tax effect) as a separate component of
stockholders' equity.
At December 31, 1997 and 1996, the net unrealized gains and losses for all
available-for-sale securities were losses of $690,013 and $834,590, for which
the net unrealized tax benefit (included in other assets) was $265,345 and
$341,336, respectively.
The Company's investment portfolio contains both debt and equity securities.
The Kemper U.S. Government bond fund is the Company's only equity investment,
while the Company's debt investments include U.S. Treasuries, U.S. Government
agencies (including FHLB certificates of deposit) and mortgage-backed
securities. Nonmortgage-backed investment securities are classified as either
held-to-maturity or available-for-sale. Mortgage-backed investment securities
represent participating interests in
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pools of first-mortgage loans originated and serviced by issuers of the
securities. Mortgage-backed securities are classified as held-to-maturity and
are recorded at cost in the underlying pool of mortgage loans at the time of
purchase, adjusted for any premium or discount. Investment discount is accreted
or, in the case of premium, is amortized into income, using a method that
approximates the level yield method, over the remaining term to maturity,
adjusted for prepayments as received. The company, by policy, does not purchase
any investment for trading purposes. The cost of any investment, if sold, is
determined by specific identification. Declines in the fair value of
available-for-sale or held-to-maturity 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.
LOANS HELD FOR SALE. For the past several years, the Company's total
production of long-term, fixed-rate loans has been originated according to
prearranged purchaser underwriting standards that result in immediate sale to
the secondary market, primarily to mortgage bankers and pension funds. These
loans are carried at their outstanding principal balance, which is the
contracted purchase price, and therefore, no gain or loss is realized at sale.
LOAN ORIGINATION FEES. Material loan origination fees and direct loan
origination costs are capitalized and recognized over the lives of the related
loans as an adjustment of the loan's yield using a method which approximates the
level-yield method. Origination fees on loans sold to the secondary market are
recognized when the loan is sold. The amortization of deferred loan fees and
costs and the accretion of unearned discounts on nonperforming loans are
discontinued during periods of nonperformance.
LOANS RECEIVABLE AND NONACCRUAL LOANS. Loans receivable are stated at unpaid
principal balances, less the reserve for possible loan losses, discounts,
unearned income and loans in process. Loans contractually past due 90 days are
classified as non performing. However, not all loans past due 90 days
automatically result in the nonaccrual of interest income. If a 90 days past due
loan has adequate collateral, or is FHA insured or VA guaranteed, leading to the
conclusion that loss of principal and interest would likely not be realized,
then interest income will continue to be accrued. For nonaccrual loans, all loan
interest previously accrued is provided an allowance by a charge to interest
income, and income is subsequently recognized only to the extent that cash
payments are received.
RESERVE FOR POSSIBLE LOAN LOSSES. The reserve for possible loan losses is
established through a provision for losses on loans which is charged to expense.
Loan losses are charged against the reserve when management believes that the
collectability of principal is unlikely. The reserve balance is an amount
management believes will be adequate to absorb losses inherent in existing loans
and commitments to extend credit, based on evaluations of collectability and
prior loss experience. The evaluations consider such factors as changes in the
nature and volume of the portfolio, overall portfolio quality, loan
concentrations, specific problem loans, commitments, and current and anticipated
economic conditions that may affect the borrowers' ability to pay.
The Company provides a reserve 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 the Company
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 reserve for possible 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 will be used in place of discounted
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
cash flows. The Company recognizes interest income on impaired loans only to the
extent that cash payments are received.
The reserve for possible loan losses as determined above, includes the
reserve for impaired loans. The Company's existing policies for evaluating the
adequacy of the reserve for loan losses and policies for discontinuing the
accrual of interest on loans are used to establish the basis for determining
whether a loan is impaired. At December 31, 1997 and 1996, no loans were
classified as non-accrual or impaired.
REAL ESTATE OWNED. Real estate owned represents real estate assets acquired
through foreclosure or deed in lieu, and is comprised of properties both held
for sale and held for investment, i.e., the production of income. Foreclosed
assets held for sale are carried at the lower of (1) fair value minus estimated
cost to sell, or (2) 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. Management conducts an evaluation
of each asset after foreclosure, and periodically thereafter. If the fair value
of the asset minus the estimated cost to sell is less than the cost of the
property, this deficiency is recognized as a valuation allowance and is charged
to expense. Foreclosed assets held for the production of income are properties
sold at their carrying value to the Bank's subsidiary, the Community Service
Corporation, in exchange for loans and cash. The subsidiary carries these assets
at their cost, less depreciation, which is computed using the straight-line
method over the estimated useful lives of the assets. For both types of real
estate owned, costs, if any, related to development and improvement are
capitalized, whereas costs related to the holding of the assets are expensed.
PREMISES AND EQUIPMENT. Premises and equipment are recorded at cost.
Depreciation and amortization are computed on the straight-line method over the
estimated useful lives of the assets which range from 10 to 40 years for
buildings and improvements and 3 to 10 years for furniture and equipment.
FEDERAL HOME LOAN BANK STOCK. Federal law requires a member institution of
the Federal Home Loan Bank (FHLB) System to hold common stock of its district
FHLB according to predetermined formulas.
FHLB ADVANCES. FHLB advances are secured by pledges of FHLB stock, funds on
deposit and by a blanket assignment of the Bank's unpledged, qualifying mortgage
loans, mortgage-backed securities and other investment securities.
INCOME TAXES. The Company and its subsidiaries have elected to file a
consolidated federal income tax return. State statue allows filing of a
consolidated Montana income tax return for the first time in 1997. Deferred tax
assets and liabilities are recognized for the estimated future consequences
attributable to differences between the financial statement amounts of assets
and liabilities and their 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.
RETIREMENT PLANS. The Bank contributes to the Savings Associations Retirement
Fund "the Fund" (a multi-employer defined benefit plan) which covers
substantially all employees. The Bank funds actuarially determined pension costs
as accrued. Consulting actuaries to the plan have indicated that the Fund
continues to maintain the ERISA full funding limitation. Accordingly, normal
plan costs of $103,369, $111,971 and $102,779, were offset from full funding for
the plan years ending June 30, 1997, 1996 and 1995, respectively. Actual
recorded pension expense, representing fiduciary insurance and administrative
costs only, was $2,719, $2,697 and $2,709, for the years ending December 31,
1997, 1996 and 1995, respectively. Effective January 1, 1998, the Bank
terminated its Fund participation for all employees. The Fund's remaining full
funding was utilized at termination by an increase in employee vested benefits
with $19,500 of additional pension expense incurred in 1997.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Bank has an employees' savings plan under Section 401(k) of the Internal
Revenue Code (the Code). The Bank allows eligible employees to contribute up to
15% of their monthly wages. Subject to Code limitations in 1997, 1996 and 1995,
the Bank matched an amount equal to 50% of the employee's contribution, up to 6%
of total wages. Beginning January 1, 1998, the Bank's match was raised to 75%
for up to 6% of total wages. Participants are at all times fully vested in their
contributions and are immediately vested in the Bank's contributions. The Bank's
401(k) contributions and administrative costs were $29,118, $23,345 and $25,583
respectively in 1997, 1996 and 1995.
NET INCOME PER SHARE. Net income or earnings per share is calculated by
dividing net income by the weighted average number of common shares outstanding
during the period. The weighted average number of common shares outstanding for
the years ended December 31, 1997 and December 31, 1996, were 1,223,312. In
February 1997, the Financial Accounting Standards Board issued Statement No. 128
"Earnings Per Share." This statement simplifies the standards for computing
earnings per share (EPS) by replacing the presentation of primary and fully
diluted EPS with a presentation of basic EPS and diluted EPS on the face of the
income statement for all entities with complex capital structures. Statement No.
128 also requires a reconciliation of the numerator and the denominator of the
basic EPS computations to the numerator and denominator of diluted EPS
computations. The provisions of Statement No. 128 apply to financial statements
issued for periods ending after December 15, 1997. Earlier adoption in not
permitted. Adoption did not have a material impact on the Company's reported
earnings per share. The Company had no potential common shares at December 31,
1997, 1996 or 1995 and therefore basic and diluted earnings per share are the
same for these periods.
CASH EQUIVALENTS. For purposes of the statements of cash flows, the Company
considers all cash, daily interest and non-interest-bearing deposits with banks
with original maturities of three months or less as cash equivalents.
DERIVATIVE FINANCIAL INSTRUMENTS. The Company has not entered into any swaps,
options, or futures contracts. Included in U.S. Government agencies are
investments, which have call features.
IMPAIRMENT AND DISPOSAL OF LONG-LIVED ASSETS. Long-lived assets and certain
identifiable intangibles are reviewed for impairment whenever events or
circumstances indicate that the carrying amount of an 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.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES. FASB Statement No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" provides guidance on
accounting for transfers and servicing of financial assets, recognition and
measurement of servicing assets and liabilities, financial assets subject to
prepayment, secured borrowings and collateral, and extinguishment of
liabilities.
Statement No. 125 generally requires the recognition as separate assets the
rights to service mortgage loans for others, whether the servicing rights are
acquired through purchases or loan originations. Statement No. 125 also
specifies that financial assets subject to prepayment, including loans that can
be contractually prepaid or otherwise settled in such a way that the holder
would not recover substantially all of its recorded investment, be measured like
debt securities available-for-sale under Statement No. 115, as amended by
Statement No. 125. Statement No. 125 was adopted January 1, 1997, and did not
have a material impact on the Company's consolidated financial position or
results of operations.
As of December 31, 1997, 1996 and 1995, real estate loans serviced for others
totaled $5.1 million, $4.4 million and $3.7 million, respectively. These loans
are not included in the consolidated financial statements. The portfolio of
loans
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
serviced by the Bank resulted from the production of Montana Board of Investment
loans originated for the State of Montana and funded by the State of Montana,
with servicing only retained. The Bank did not pay any fees for the servicing
rights to these loans. The Bank's servicing fee income for the above loans
totaled $16,300, $14,800 and $10,500 for the years ended December 31, 1997, 1996
and 1995, respectively.
COMPREHENSIVE INCOME. In June 1997, the FASB issued Statement No. 130,
"Reporting Comprehensive Income." Statement No. 130 establishes standards for
the reporting and display of comprehensive income and its components in a full
set of financial statements. All items required to be recognized under
accounting standards as components of comprehensive income are to be reported in
a financial statement that is displayed as prominently as other financial
statements. Statement No. 130 also requires the classification of items of other
comprehensive income by their nature in a financial statement and the display of
other comprehensive income separately from retained earnings and capital surplus
in the equity section of the Statement of Financial Condition. Statement No. 130
is effective January 1, 1998, with all prior periods presented restated.
OTHER EXPENSES. Included in other expenses in 1997, 1996 and 1995 were
advertising expenses of $66,500, $91,600 and $30,900, respectively.
RECLASSIFICATIONS. Certain reclassifications have been made to the 1996
financial statements to conform with the presentation in 1997.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES. A comparison of the amortized cost and estimated fair
value of investment securities at the dates indicated is as follows:
(Dollars in thousands)
December 31, 1997
-----------------------------------------
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Fair
Gains Losses Value
-----------------------------------------
Held-to-Maturity:
U.S. Government agencies $ 9,000 $ 20 $ (3) $ 9,017
FHLB certificates of deposit 5,800 5,800
------- ---- ------ -------
U.S. Government agencies and other 14,800 20 (3) 14,817
GNMA fixed and adjustable rate 3,653 36 (12) 3,677
FNMA and FHLMC adjustable rate 5,602 62 (64) 5,600
FNMA and FHLMC 7 year and
FHLMC 5 year balloons 11,195 112 11,307
FHLMC REMIC certificate 936 (3) 933
------- ---- ------ -------
Mortgage-backed securities 21,386 210 (79) 21,517
------- ---- ------ -------
$36,186 $230 $ (82) $36,334
======= ==== ====== =======
Available-for-Sale:
U.S. Treasuries and U.S.
Government agencies $12,026 $ 52 $ (6) $12,072
Kemper U.S. Government bond
mutual fund 5,996 (736) 5,260
------- ---- ------ -------
$18,022 $ 52 $(742) $17,332
======= ==== ====== =======
December 31, 1996
-----------------------------------------
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Fair
Gains Losses Value
-----------------------------------------
Held-to-Maturity:
U.S. Government agencies $ 2,600 $ 9 $ 2,609
FHLB certificates of deposit 6,000 6,000
------- ---- ------ -------
U.S. Government agencies and other 8,600 9 8,609
GNMA fixed and adjustable rate 2,092 31 $ (1) 2,122
FNMA and FHLMC adjustable rate 5,787 28 (79) 5,736
FNMA and FHLMC 7 yr and FHLMC
5 yr balloons 14,965 143 (3) 15,105
FNMA and FHLMC REMIC certificates 4,384 (13) 4,371
------- ---- ------ -------
Mortgage-backed securities 27,228 202 (96) 27,334
------- ---- ------ -------
$35,828 $211 $ (96) $35,943
======= ==== ====== =======
Available-for-Sale:
U.S. Treasuries and U.S.
Government agencies $20,024 $ 94 $(115) $20,003
Kemper U.S. Government bond
mutual fund 5,996 (814) 5,182
------- ---- ------ -------
$26,020 $ 94 $(929) $25,185
======= ==== ====== =======
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A comparison of the amortized cost and estimated fair values of
held-to-maturity and available-for-sale investment securities by contractual
maturities at December 31, 1997 is shown below. Expected maturities may differ
from contractual maturities as some securities have call or prepayment options.
(Dollars in thousands)
December 31, 1997
-----------------------------
Amortized Estimated
Cost Fair Value
--------- ----------
Held-to-Maturity:
Due in 1 year or less $ 5,800 $ 5,800
Due after 1 year through 5 years 6,000 6,015
Due after 5 years through 10 years 3,000 3,001
Mortgage-backed securities 21,386 21,518
------- -------
$36,186 $36,334
======= =======
Available-for-Sale:
Due in 1 year or less $ 6,033 $ 6,036
Due after 1 year through 2 years 999 1,010
Due after 2 years through 4 years 4,994 5,026
Kemper U.S. Government bond mutual fund 5,996 5,260
------- -------
$18,022 $17,332
======= =======
There were no sales of investment securities in 1997. Gross proceeds from
sales of investment securities available-for-sale for the year ended December
31, 1996, were $4,141,328 resulting in gross gains of $150,235. Gross proceeds
from sales of investment securities available-for-sale for the year ended
December 31, 1995, were $12,796,898 resulting in gross gains of $154,608 and
gross losses of $149,305.
ACCRUED INTEREST RECEIVABLE. Accrued interest receivable at the dates
indicated consisted of the following:
(Dollars in thousands)
December 31,
----------------
1997 1996
---- ----
Accrued interest receivable on:
Interest-earning deposits $ 47 $ 15
Mortgage-backed securities 113 142
Other investment securities 460 371
Loans receivable 289 289
---- ----
$909 $817
==== ====
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LOANS RECEIVABLE. Loans receivable at the dates indicated consisted of the
following:
(Dollars in thousands)
December 31,
--------------------
1997 1996
------- -------
Loans secured by real estate:
1-4 residential $20,013 $20,975
5 or more residential 5,531 4,497
Construction 3,731 4,620
Agricultural 405
Commercial 2,660 3,077
Consumer:
Home equity loans and FHA Title I 1,383 1,132
Loans to depositors, saving secured 103 92
Recreational vehicle, auto and other 1,103 1,251
Commercial:
Agricultural 424
Lease financing 561
Floor plan 454 884
Lines of credit and other 1,490 355
------- -------
37,858 36,883
Less:
Discounts on loans 2 4
Reserve for possible loan losses 300 75
Loans in process 1,239 1,628
------- -------
$36,317 $35,176
======= =======
There were no nonaccrual loan principal balances for which interest income
had not been recognized at December 31, 1997, 1996 and 1995.
The average yield on loans was 9.26%, 9.29% and 9.33% for the years ended
December 31, 1997, 1996 and 1995, respectively. At December 31, 1997, 1996 and
1995, the contractual average yield on loans was 9.04%, 9.18% and 9.16%,
respectively.
The Company 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 involve, to
varying degrees, elements of credit risk.
The Company'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. The Company uses the
same credit policies in making commitment and conditional obligations as it does
for on-balance-sheet instruments.
Financial instruments outstanding at December 31, 1997, whose contract
amounts represent credit risk are fixed-rate commitments to extend credit
totaling approximately $4,003,700.
At December 31, 1997 and 1996, the Company had adjustable rate loans in its
portfolio of approximately $1,498,000 and $1,765,000, respectively.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of changes in the reserve for possible loan losses for the years
indicated is as follows:
(Dollars in thousands)
December 31,
--------------------------
1997 1996 1995
---- ---- ----
Balance at beginning of period $ 75 $ 75 $ 75
Provision charged to operating expense 225
Losses charged off
---- ---- ----
$300 $ 75 $ 75
==== ==== ====
REAL ESTATE OWNED. Real estate owned at the dates indicated consisted of the
following:
(Dollars in thousands)
December 31,
------------
1997 1996
---- ----
Real estate held for investment (net of
accumulated depreciation of $406 and $370) $349 $385
Real estate held for sale 40
---- ----
$349 $425
==== ====
During 1997, the Bank sold real estate held for sale with a $40,125 book
value at no loss. During 1996, the Bank sold real estate held for sale with a
$245,924 book value to an individual in exchange for a $184,000 loan and cash.
There was a $15,924 loss recognized on the sale. During 1996, the Bank's
subsidiary sold real estate held for investment with a $33,168 book value to an
individual in exchange for cash. There was a $13,832 gain recognized on the
sale.
PREMISES AND EQUIPMENT. Premises and equipment at the dates indicated are
summarized as follows:
(Dollars in thousands)
December 31,
-------------------
1997 1996
------ ------
Land $ 264 $ 264
Buildings and improvements 2,257 2,257
Furniture and equipment 367 341
------ ------
2,888 2,862
Accumulated depreciation (1,539) (1,455)
------ ------
$1,349 $1,407
====== ======
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DEPOSITS. Deposits at the dates indicated are comprised of the following:
(Dollars in thousands)
December 31, 1997 December 31, 1996
------------------------------- -----------------
Weighted Avg.
Interest Rate Amount Percent Amount Percent
------------- ------- ------- ------- -------
NOW accounts 2.84% $ 6,100 8.6% $ 6,250 7.9%
Money market demand accounts 3.49% 2,319 3.3% 2,419 3.1%
----- ------- ------ ------- ------
3.02% 8,419 11.9% 8,669 11.0%
Savings deposits 3.56% 25,592 36.1% 29,918 38.0%
Time deposits 3.25 - 4.99% 6,571 9.2% 7,471 9.5%
5.00 - 5.99% 30,275 42.7% 32,576 41.4%
6.00 - 6.99% 67 .1% 63 .1%
----- ------- ------ ------- ------
5.42% 36,913 52.0% 40,110 51.0%
----- ------- ------ ------- ------
4.46% $70,924 100.0% $78,697 100.0%
===== ======= ====== ======= ======
There were no jumbo time deposits (minimum $.1 million) at December 31, 1997
and December 31, 1996.
Maturities of time deposits are as follows:
(Dollars in thousands)
December 31,
-----------------------
1997 1996
------- -------
Due date:
Within one year $22,317 $27,015
Within two years 7,342 5,500
Within three years 4,207 3,109
Thereafter 3,047 4,486
------- -------
$36,913 $40,110
======= =======
Interest expense on deposits consisted of the following:
Years Ended December 31,
----------------------------------
1997 1996 1995
Interest on deposits: ------ ------ ------
NOW and money market demand accounts $ 248 $ 257 $ 243
Savings deposits 962 1,078 1,277
Time deposits 2,087 2,147 1,898
Less withdrawal penalties (4) (9) (6)
------ ------ ------
$3,293 $3,473 $3,412
====== ====== ======
The average cost of deposits was 4.43%, 4.43% and 4.22% for the years ended
December 31, 1997, 1996 and 1995, respectively. At December 31, 1997, 1996 and
1995, the cost of deposits was 4.46%, 4.45% and 4.44%, respectively.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INCOME TAXES. A summary of the current and deferred components of income tax
expense (benefit) for the dates indicated are as follows:
(Dollars in thousands)
Years Ended December 31,
-----------------------------
1997 1996 1995
---- ---- ----
Current - Federal $725 $549 $595
- State 158 118 164
---- ---- ----
883 667 759
---- ---- ----
Deferred - Federal (61) (15) (44)
- State (13) (3) (1)
---- ---- ----
(74) (18) (45)
---- ---- ----
Provision for income taxes $809 $649 $714
==== ==== ====
The Company's provision for income taxes differ from those computed at the
federal statutory corporate tax rate of 34% for 1997, 1996 and 1995 as follows:
(Dollars in thousands)
Years Ended December 31,
-----------------------------
1997 1996 1995
---- ---- ----
Tax provision at statutory rate $735 $596 $828
Tax-exempt interest (18) (23) (29)
State tax, net of federal income tax benefit 96 76 108
Tax reserve for loan losses due to an
increase in base year reserves (194)
Other (4) 1
---- ---- ----
Provision for income taxes $809 $649 $714
==== ==== ====
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at the dates
indicated are as follows:
(Dollars in thousands)
December 31,
-----------------
1997 1996
---- ----
Deferred tax assets:
Loans, due to the reserve for possible loan
losses deferred for tax purposes $116 $ 29
Vacation/termination benefits not recognized
for tax purposes until paid 25 27
Other deferred tax assets 13 13
---- ----
154 69
---- ----
Deferred tax liabilities:
Premises and equipment, principally due to
differences in depreciation 210 211
Federal Home Loan Bank stock, principally due
to dividends currently not recognized for
tax purposes 82 68
Other deferred tax liabilities 11 13
---- ----
303 292
---- ----
Net deferred tax liability $149 $223
==== ====
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
projections for future taxable income over the periods which the deferred tax
assets are deductible, at december 31, 1997 and 1996, management believes it is
more likely than not that the company and the bank will realize the benefits of
those deductible differences.
Retained earnings, at December 31, 1997, includes approximately $3.2 million
for which no provision for federal income tax has been made. This amount
represents the base year tax bad debt reserve, which is essentially an
allocation of earnings to pre-1988 bad debt deductions for income tax purposes
only. This amount is treated as a permanent difference and deferred taxes are
not recognized unless it appears that this amount will be reduced and thereby
result in taxable income. Under current tax regulations, management does not
foresee any changes in its business or operations, which would result in a
recapture of its base year federal bad debt reserve into taxable income.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The Company is required to disclose the
fair value of financial instruments, whether recognized or not recognized in the
statement 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.
Quoted market prices are used for fair value when available, but do not exist
for some of the Company's financial instruments, primarily loans and time
deposits. The fair value of these instruments has been derived from the Office
of Thrift Supervision Net Portfolio Value Model (OTS Model). This OTS Model
primarily employs the static discounted cash flow method which estimates the
fair value of loans and time deposits 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 OTS Model makes assumptions about the size and
timing of expected cash flows and appropriate discount rates. Different
assumptions could materially change these instruments' estimated value.
The following assumptions and methods are used by the Company in estimating
fair value:
Financial Assets - The fair value approximates book value for cash and
cash equivalents as they represent over-night funds. For all investment
securities, the fair value is based upon quoted market prices. The fair value
of loans receivable was obtained from the OTS Model. The fair value of
accrued interest receivable approximates book value as the Company expects
contractual receipt in the short-term. The fair value of FHLB stock
approximates redemption value. Loan held for sale approximate book value as
each loan is contracted for immediate sale.
Financial Liabilities - The fair value of NOW and money market demand
accounts and non-term savings deposits approximates book value as these
deposits are payable on demand. The fair value of time deposits was obtained
from the OTS Model. The fair value of FHLB advances and accrued interest
payable approximates book value due to contractual payment in the short-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 no fair value adjustment is necessary.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 the Company's entire holdings of a
particular instrument. Because no market exists for a significant portion of
the Company'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.
Fairvalue 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.
The approximate book value and estimated fair value of the Company's
financial instruments at the dates indicated are as follows:
(Dollars in thousands)
December 31,
-----------------------------------
1997 1996
---------------- ----------------
Book Fair Book Fair
Value Value Value Value
------- ------- ------- -------
Financial Assets:
Cash and cash equivalents $ 1,630 $ 1,630 $ 2,934 $ 2,934
Securities held-to-maturity 36,186 36,334 35,828 35,943
Securities available-for-sale 17,332 17,332 25,185 25,185
Loans receivable 36,317 36,995 35,176 35,700
Accrued interest receivable 909 909 817 817
Federal Home Loan Bank stock 535 535 379 379
Loans held for sale 1,107 1,107 1,239 1,239
Financial Liabilities:
NOW and money market demand accounts 8,419 8,419 8,669 8,669
Savings deposits 25,592 25,592 29,918 29,918
Time deposits 36,913 36,866 40,110 40,000
Accrued interest payable 65 65 66 66
MATERIAL CONTRACTS. Beginning in 1993, and renewed each year since, the
Bank's Board of Directors provided change of control severance agreements to its
President and each of its five Vice Presidents. The agreements provide for
severance compensation in the event any company or person acquires control of
the Bank, as determined in accordance with applicable federal regulations.
Pursuant to his agreement upon a change of control, the Bank's President would
be entitled to lump-sum compensation equal to two times his annual base salary
plus any target bonuses, and 24 months of continued welfare and employee
benefits. The agreements with the Bank's five Vice Presidents provide for
payment, upon a change of control, of lump-sum compensation equal to their
annual base salary, plus any target bonuses, and 12 months of continued welfare
and employee benefits.
REGULATORY CAPITAL. The Bank is required to meet three FIRREA-enacted capital
requirements: a tangible capital requirement (stockholders' equity adjusted for
the effects of intangibles, investments and advances to "nonincludable"
subsidiaries and other factors) equal to not less than 1.5% of tangible assets
(as defined in the
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
regulations), a core capital requirement, comprised of tangible capital adjusted
for supervisory goodwill and other defined factors equal to not less than 3% of
tangible assets, and a risk-based capital requirement equal to at least 8% of
all risk-weighted assets. For risk-weighting, selected assets are given a risk
assignment of 0% to 100%. The Bank's total risk-weighted assets at December 31,
1997 and 1996, were approximately $36,239,000 and $35,775,000 respectively. At
December 31, 1997 and 1996, the Bank was categorized as "Well Capitalized" under
the regulatory guidelines.
The following table demonstrates as of December 31, 1997 and 1996, the extent
to which the Bank exceeds in dollars and in percent, the three FIRREA minimum
capital requirements:
(Dollars in thousands)
December 31, 1997
Regulatory Capital
--------------------------------
Actual Requirement Excess
------- ----------- -------
Tangible capital:
$ Amount $14,875 $1,298 $13,577
% of tangible assets 17.2% 1.5% 15.7%
Core capital:
$ Amount $14,875 $2,596 $12,279
% of tangible assets 17.2% 3.0% 14.2%
Risk-based capital:
$ Amount $15,175 $2,899 $12,276
% of risk-weighted assets 41.9% 8.0% 33.9%
December 31, 1996
Regulatory Capital
--------------------------------
Actual Requirement Excess
------- ----------- -------
Tangible capital:
$ Amount $14,974 $ 1,417 $13,557
% of tangible assets 15.9% 1.5% 14.4%
Core capital:
$ Amount $14,974 $ 2,834 $12,140
% of tangible assets 15.9% 3.0% 12.9%
Risk-based capital:
$ Amount $15,009 $ 2,862 $12,147
% of risk-weighted assets 42.0% 8.0% 34.0%
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stockholders' equity as shown on the Company's consolidated financial
statements differs from tangible, core and risk-based regulatory capital at the
dates indicated, as follows:
(Dollars in thousands)
December 31,
-------------------
1997 1996
------- -------
Consolidated stockholders' equity $24,650 $24,416
Parent holding company stockholders' equity (9,421) (9,100)
------- -------
Bank stockholders' equity 15,229 15,316
Nonincludable investments and notes of
Bank subsidiary (348) (386)
Unrealized loss on debt investment securities
available-for-sale (6) 44
------- -------
Tangible and core Bank capital 14,875 14,974
Reserve for possible loan losses 300 75
Other assets required to be deducted (40)
------- -------
Risk-based capital $15,175 $15,009
======= =======
Failure to comply with applicable regulatory capital requirements can result
in capital directives from the director of the OTS, restrictions on growth, and
other limitations on a savings association's operations.
LITIGATION. The Company is not involved in any pending material legal
proceedings.
REORGANIZATION. During the year ended December 31, 1996, the Board of
Directors of the Bank approved a plan of reorganization whereby the Bank became
a wholly-owned subsidiary of United Financial Corp. The plan was approved by
stockholders and federal regulators, and each common share of United Savings
Bank, F.A. was exchanged for one share of United Financial Corp. The
reorganization was a business combination between entities under common control
and accounted for similar to a pooling-of-interests.
STOCKHOLDERS' EQUITY - PAR VALUE CHANGE. During the year ended December 31,
1997, the Board of Directors and stockholders of the Company approved a
resolution which amended the Company's Articles of Incorporation and changed the
par value of the Company's common stock and preferred stock from $1.00 par value
to no par value. As a result, the Company's additional paid-in capital account
has combined with common stock as presented in the Consolidated Statement of
Changes in Stockholders' Equity. The Stockholders' Equity section of the
Company's 1997 Consolidated Statements of Financial Condition now reflects no
par value for preferred and common stock.
SUBSEQUENT EVENT - MERGER. In August 1997, the Company and Heritage
Bancorporation entered into a definitive agreement to merge. Heritage
Bancorporation is the parent company of Heritage Bank, FSB, a Great Falls,
Montana federally chartered savings bank with approximately $86 million in
assets. All required approvals were received from regulatory agencies and
following approval by stockholders at a meeting held on February 3, 1998, the
merger was consummated.
The merger resulted in a combined entity, United Financial Corp., with two
subsidiary Banks (United Savings Bank and Heritage Bank.) The two banks will be
combined into one bank, Heritage Bank, in the future. Under the terms of the
merger, the former stockholders of Heritage Bancorporation received
approximately 28% of the Company's common stock.
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The merger was accounted for as a purchase under generally accepted
accounting principles. Even though the merger resulted in the former United
Financial Corp. stockholders continuing to own a majority of the combined
entity, Heritage was deemed the acquirer in the merger for accounting purposes.
Among other factors, this accounting treatment resulted from the fact that the
majority of the new United Financial Corp. Board of Directors were nominated by
the former Heritage Bancorporation stockholders who now have effective control
regarding the business and management of the combined entity and its
subsidiaries. The merger is considered a change of control under the terms of
the severance agreements.
Consistent with Heritage Bancorporation being the "accounting acquiror," the
historical financial statements of the combined entity commencing with the
quarter ended March 31, 1998 will be those of Heritage Bancorporation.
Accordingly, the historical statements of operations of the combined entity will
only reflect the operations of the Company commencing on and after the closing
date of the merger.
UNITED FINANCIAL CORP. (PARENT ONLY)
STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
December 31,
--------------------
1997 1996
------- -------
ASSETS
Cash and cash equivalents - interest-earning
deposits with banks $ 400 $ 593
Investments:
Securities held-to-maturity (estimated fair
value $3,000,000 in 1997 and $1,602,280 in 1996) 3,000 1,600
Securities available-for-sale 5,014 5,998
------- -------
8,014 7,598
Loans receivable 754 802
Accrued interest receivable 128 138
Investment in subsidiary 15,229 15,316
Other assets 151
------- -------
$24,676 $24,447
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Income taxes payable $ 26 $ 31
------- -------
Stockholders' equity:
Common stock, no par value 8,849 1,223
Paid-in capital 7,626
Retained earnings-partially restricted 16,225 16,060
Unrealized loss on securities available-for-sale (424) (493)
------- -------
24,650 24,416
------- -------
$24,676 $24,447
======= =======
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNITED FINANCIAL CORP. (PARENT ONLY)
STATEMENTS OF INCOME
(Dollars in thousands)
Years Ended December 31,
------------------------
1997 1996
------ ------
Income
Interest Income:
Loans $ 74 $ 13
Investment securities 405 290
Interest-earning deposits 109 41
------ ------
588 344
Gain on sale of investment security 18
Dividends from subsidiary 1,187 556
------ ------
1,775 918
Expenses 56 11
------ ------
Income before income taxes and equity in
undistributed income of subsidiary 1,719 907
Provision for current income tax expense 200 133
------ ------
Income before equity in undistributed
income of subsidiary 1,519 774
Equity in undistributed income (dividends
in excess of earnings) of subsidiary (167) 329
------ ------
Net income $1,352 $1,103
====== ======
(Continued)
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNITED FINANCIAL CORP. (PARENT ONLY)
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
-----------------------
1997 1996
------ ------
Operating Activities:
Net income $1,352 $1,103
Adjustments to reconcile net cash provided
by operating activities:
Investment securities discount accretion (34) (20)
Gain on sale of available-for-sale security (18)
Net change in accrued interest receivable 10 (138)
Net change in other assets (150)
Net change in income taxes payable 2 10
Equity in undistributed income (dividends
in excess of earnings) of subsidiary 167 (329)
------ ------
Net cash provided by operating activities 1,347 608
------ ------
Investing Activities:
Purchases of held-to-maturity securities (4,000) (2,600)
Proceeds from matured and called held-to-maturity
security 2,600 1,000
Purchases of available-for-sale securities (6,908)
Proceeds from matured and called available-
for-sale securities 1,000
Proceeds from sale of available-for-sale security 1,002
Purchase of mortgage loan participation from
subsidiary (810)
Loan principal collections 47 8
------ ------
Net cash used by investing activities (353) (8,308)
------ ------
Financing Activities:
Initial capitalization from subsidiary 8,886
Holding company formation costs (37)
Cash dividends paid (1,187) (556)
------ ------
Net cash (used) provided by financing activities (1,187) 8,293
------ ------
Net change in cash and cash equivalents (193) 593
Cash and cash equivalents at beginning of year 593
Cash and cash equivalents at end of year $ 400 $ 593
====== ======
Cash payments for income taxes $ 198 $ 123
(Concluded)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
HERITAGE SELECTED FINANCIAL DATA
The following table sets forth certain financial data concerning Heritage.
The historical selected financial data as of and for each of the three years
ended December 31, 1997 have been derived from the audited consolidated
financial statements of Heritage included herein. This information should be
read in conjunction with the consolidated financial statements of Heritage
appearing elsewhere in this filing.
Heritage
--------------------------------
As Of or Year Ended December 31,
--------------------------------
1997 1996 1995
----------- --------- ----------
(Amounts in thousands, except per share and percentage data)
Operating Data:
Interest income $ 5,773 $ 4,520 $ 3,469
Interest expense 3,157 2,419 1,941
------- ------- -------
Net interest income 2,616 2,101 1,528
Provision for loan losses 492 160 46
------- ------- -------
Net interest income after
provision for loan losses 2,124 1,941 1,482
Non-interest income 1,103 1,059 631
Non-interest expense 2,361 2,251 1,505
------- ------- -------
Income before income taxes 866 749 608
Provision for income taxes 324 263 214
------- ------- -------
Net income $ 542 $ 486 $ 394
======= ======= =======
Restated Per Share Data(1):
Income per share $ 1.14 $ 1.02 $ .83
Dividends per share -- -- --
Book value per share(2) 5.78 4.59 3.57
Tangible book value per share(2) 4.75 3.45 2.35
Shares used to calculate per share data 475 475 475
Financial Condition Data:
Assets $86,352 $71,280 $55,210
Net loans 58,263 43,853 29,169
Investment securities 14,219 14,172 16,090
Deposits 70,386 57,641 42,742
Long-term debt 2,350 2,550 2,650
Stockholders' equity 2,748 2,178 1,694
Selected Financial Ratios and Other Data:
Return on average assets .73% .81% .83%
Return on average stockholders' equity 21.45% 25.78% 27.81%
Net interest margin 3.83% 3.74% 3.45%
Efficiency ratio(3) 63.46% 63.67% 69.71%
Net charge-offs to average loans .06% .27% .18%
Nonperforming loans to total loans .47% .06% .02%
Allowance for loan losses to total loans 1.43% .88% 1.10%
Nonperforming loans to allowance for loan losses 31.56% 6.96% 1.8%
Stockholders' equity to assets(2) 3.19% 3.05% 3.07%
- -----------------------
(1) Share and per share amounts for Heritage have been restated to
retroactively reflect the issuance of 475,000 shares of United Common Stock
in exchange for all outstanding shares of Heritage common stock in
connection with the Merger.
(2) At period end.
(3) Excludes September 1996 pre-tax charge for SAIF assessment of $239,000.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
BASIS OF PRESENTATION
The following is Heritage's management's discussion and analysis of the
results of operations and the historical financial condition of Heritage and its
consolidated subsidiary for 1997, 1996 and 1995. These periods are prior to the
Merger which occurred on February 3, 1998.
The following discussion and analysis is intended to provide greater
details of the results of operations and financial condition of Heritage and
Heritage Bank (The Bank). The following discussion should be read in conjunction
with the information under "Heritage Selected Financial Data" and Heritage's
consolidated financial statements and notes thereto. Certain statements under
this caption constitute "forward-looking statements" which involve risks and
uncertainties. Heritage's actual results may differ significantly from the
results discussed in such forward-looking statements. Factors that might cause
such a difference include, but are not limited to, economic conditions,
competition in the geographic and business areas in which Heritage conducts its
operations, fluctuations in interest rates, credit quality and government
regulation.
RESULTS OF OPERATIONS
NET INCOME. Net income increased 11.5% from $486,000 in 1996 to
$542,000 in 1997. The increase was the result of an increase in loans at
Heritage Bank resulting in an increase in net interest income. In September
1996, the Heritage Bank was assessed a pretax charge of approximately $239,000
by the SAIF, as a result of legislation enacted to capitalize the SAIF to the
statutory prescribed level of 1.25% of insured deposits. The assessment was .66%
of Heritage Bank's insured deposits as of March 31, 1995. The after-tax effect
of the charge was $148,000. Excluding this assessment, net income for 1996 would
have been $634,000, an increase of 60.9% over 1995. 1997 net income was affected
by a loan loss provision of $492,000, compared to a provision in 1996 of
$160,000. See additional comments under PROVISIONS FOR LOAN LOSSES. Net income
increased by 23.4% from $394,000 in 1995 to $486,000 in 1996, primarily due to
growth in loans, increased margins in a decreasing interest rate environment and
increased mortgage loan fees.
The following is a condensed summary of the consolidated statement of
operations, along with selected profitability ratios:
ANALYSIS OF NET INCOME
Year Ended December 31,
--------------------------------------
1997 1996 1995
--------------------------------------
(In thousands, except percentage data)
Net interest income $ 2,616 $ 2,101 $ 1,528
Provision for loan losses 492 160 46
Other operating income 1,103 1,059 631
Other operating expense 2,361 2,251 1,505
Net income 542 486 394
Return on average assets .73% .81% .83%
Return on average equity 21.45% 25.78% 27.81%
NET INTEREST INCOME. Net interest income increased by 24.5% from $2.10
million in 1996 to $2.6 million for 1997 due primarily to an increase in the
interest earning asset base as well as a slight improvement in margins on most
interest earning assets. Net interest income increased by 37.5% from $l.5
million for 1995 to $2.1 million for 1996, similarly due to an increase in
earning assets and a slightly improved net interest margin. Net interest income
is affected by changes in both interest rates and the volume of average earning
assets and interest-bearing liabilities. The following table presents Heritage's
average balance sheets, interest earned or paid, and the related yields and
rates on major categories of Heritage's interest earning assets and
interest-bearing liabilities for the periods indicated:
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
ANALYSIS OF AVERAGE RATES AND BALANCES
Years Ended December 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance(1) Interest Rate Balance(1) Interest Rate Balance(1) Interest(3) Rate
---------------------------------------------------------------------------------------------
(In thousands, except percentage data)
Interest Earning Assets:
Loans $50,280 $4,529 9.00% $35,890 $3,226 8.99% $24,137 $2,226 9.22%
Investment securities 14,984 1,048 6.99% 15,335 1,089 7.10% 13,189 1,033 7.83%
Other interest earning assets 5,249 196 3.73% 4,936 205 4.15% 4,566 210 4.60%
------ ----- ------ ----- ------ -----
Total interest earning
assets 70,513 5,773 8.19% 56,161 4,520 8.05% 41,892 3,469 8.28%
Non-interest earning assets 3,719 3,381 5,340
------ ------ ------
Total assets $74,232 $59,542 $47,232
====== ====== ======
Interest Bearing Liabilities:
Savings/interest bearing
Checking $18,833 $698 3.71% $17,522 $629 3.59% $14,993 $540 3.60%
Time deposits 32,496 1,937 5.96% 24,100 1,430 5.93% 17,560 1,037 5.91%
Short-term borrowings 6,066 332 5.47% 3,538 169 4.78% 2,614 143 5.47%
Long-term borrowings 2,475 190 7.68% 2,569 191 7.44% 2,681 221 8.24%
----- ----- ----- ----- ------ ----- ----
Total interest bearing
liabilities 59,870 3,157 5.27% 47,729 2,419 5.07% 37,848 1,941 5.13%
Non-interest bearing
liabilities 11,835 9,928 7,967
Common stockholders' equity 2,527 1,885 1,417
------ ------ -----
Total liabilities
and equity $74,232 $59,542 $47,232
====== ====== ======
Net interest income $2,616 $2,101 $1,528
===== ===== =====
Net interest spread 2.92% 2.98% 3.15%
Net interest margin(2) 3.71% 3.74% 3.65%
- ------------------------
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent yields.
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
The most significant impact on Heritage's net interest income between
periods is derived from changes in the volume of and rates earned or paid on
interest earning assets and interest bearing liabilities. The volume of average
interest earning assets increased from $56.2 million for the year ended December
31, 1996 to $70.5 million for the same period in 1997, a 25.4% increase.
Additionally, non-interest bearing liabilities increased 19.2%, as did the yield
on earning assets. An increase in liability costs offset the increase in earning
asset yields causing a 3 basis point reduction in net interest margin for 1997.
The following table reflects changes in interest income and expense
attributable to changes in the volume and interest rates of significant interest
earning assets and interest bearing liabilities.
ANALYSIS OF VOLUME AND INTEREST RATES
Year Ended December 31, Year Ended December 31,
1997 Compared to 1996 Compared to
Year Ended Year Ended
December 31, 1996 December 31, 1995
Favorable/(Unfavorable) Favorable/(Unfavorable)
--------------------------------------------------
Volume Rate Net Volume Rate Net
--------------------------------------------------
(In thousands)
Interest Income:
Loans $1,297 $7 $1,303 $1,057 $(56) $1,000
Investment securities (25) (17) (41) 152 (96) 56
Other interest earning assets 12 (21) (9) 15 (21) (5)
------ --- ----- ----- ---- -----
Total interest income 1,284 (31) 1,253 1,224 (173) 1,051
Interest Expense:
Savings/interest bearing
deposits 49 21 69 91 (1) 89
Time deposits 500 7 507 388 4 393
Short term borrowings 138 24 163 44 (18) 26
Long term borrowings (7) 6 (1) (8) (22) (30)
------ --- ----- ----- ---- -----
Total interest expense 680 58 738 515 (37) 478
Increase (decrease) in net
interest income $604 $(89) $515 $709 $(136) $573
===== === ===== ==== ===== =====
The change in interest income and expense attributable to volume
reflects the change in volume times the current year's rate and the change in
interest income and expense attributable to rate reflects the change in rates
times the prior year's volume.
For the year ended December 31, 1997 compared to the year ended
December 31, 1996, the increase in interest income is primarily caused by volume
increases. Net interest income for the same periods increased $515,000, of which
$604,000 was a result of volume increases and $(89,000) was due to rate
increases. Net interest income for 1996 compared to 1995 increased $573,000, of
which $709,000 was due to volume increases and $(136,000) was due to rate
increases. Both comparisons are consistent with Heritage's continued growth of
earning assets.
PROVISION FOR LOAN LOSSES. Heritage made a provision to its loan loss
reserve in 1997 and 1996 of $492,000 and $160,000, respectively. The provisions
were determined based on management's assessment of an adequate reserve for
possible loan losses. This increase in 1997 over 1996 reflects management's view
of potential loan losses inherent in the increased loan portfolio.
The provision for loan losses creates an allowance for future losses.
The loan loss provision for each year is dependent on many factors, including
loan growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's assessment of the quality of the loan portfolio, the
value of the underlying collateral on problem loans and the general economic
conditions in
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
Heritage's market area. Heritage Bank performs a monthly assessment of the risk
inherent in its loan portfolio, as well as a detailed review of each asset
determined to have identified weaknesses. Based on this analysis, which includes
reviewing historical loss trends, current economic conditions, industry
concentrations and specific reviews of assets classified with identified
weaknesses, Heritage Bank makes provision for potential loan losses. Specific
allocations are made for loans where the probability of a loss can be defined
and reasonably determined, while the balance of the provision for loan losses
are based on historical data, delinquency trends, economic conditions in the
market area and industry averages. Annual fluctuations in the provision for loan
losses result from management's assessment of the adequacy of the allowance for
loan losses. Ultimate loan losses may vary from current estimates.
Heritage's market is concentrated in Montana, increasing its exposure
to loan losses resulting from a deterioration in economic conditions in its
market area. In addition, Heritage has lease financing and commercial loan
participations, which were originated out of Heritage's market area. Those loans
have differing risks in terms of loan monitoring and higher exposure due to
economic conditions and markets outside of Heritage's market area. Montana has
experienced a deterioration in consumer credit quality consistent with those
experienced on a national level. The instances of bankruptcies in Montana have
doubled in recent years. Heritage's loan loss reserve as a percentage of total
loans was 1.43% and .88% at December 31, 1997 and 1996 respectively. The
corresponding average loan loss reserve as a percentage of total loans for
commercial banks in Montana at December 31, 1997 and 1996 was 1.55% and 1.62%,
respectively.
The continued growth of Heritage's loan portfolio combined with the
apparent deterioration in economic trends both on a national and state-wide
basis, and the difference in Heritage's loan loss reserve coverage compared to
other commercial banks, indicated to management that additional provisions were
required for the period ended December 31, 1997. Future provision will be
evaluated by management using national and local economic trends, loan portfolio
trends relating to growth and volume, and any other factors management believes
may have an impact on the loan loss reserve.
NON-INTEREST INCOME. The following table presents a summary of
non-interest income:
ANALYSIS OF NON-INTEREST INCOME
Year Ended December 31,
----------------------------
1997 1996 1995
----------------------------
(thousands)
Service charges $275 $253 $209
Loan origination fees 649 679 300
Loan servicing fees 66 46 45
Other 113 81 77
----- ----- ---
Total $1,103 $1,059 $631
===== ===== ===
Non-interest income which continues to be a significant source of
revenue for Heritage, increased by 4.2%, or $44,000, for the year ended December
31, 1997 compared to the same period in 1996. Increases in service charge income
and servicing income in 1997 were partially offset by a decrease in loan
origination fees. Non-interest income increased by 67.8% from $631,000 in 1995
to $1.1 million in 1996. The increase in 1996 over 1995 resulted from increased
mortgage activity resulting from the addition of more mortgage originators and
fees associated with sold mortgages.
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
NON-INTEREST EXPENSE. The following table presents a summary of
non-interest expense:
ANALYSIS OF NON-INTEREST EXPENSE
Year Ended December 31,
------------------------------
1997 1996 1995
------------------------------
(In thousands)
Salaries and benefits $1,207 $1,007 $706
Premises and equipment 228 192 124
Other expenses 926 1,052 675
--- ----- -----
Total $2,361 $2,251 $1,505
====== ===== =====
Non-interest expense increased 4.9% from $2.25 million for the year ended
December 31, 1996 to $2.36 million for the year ended December 31, 1997. The
increase resulted primarily from the opening of the new branch in Chester,
Montana in the third quarter of 1996, and costs associated with its startup,
including premises and equipment expenses as well as salaries. Additional
salaries and benefits also resulted from the overall growth at Heritage Bank,
where assets have increased over 21% from year-end 1996 to 1997. Total
non-interest expense increased by 49.6% from $1.5 million for 1995 to $2.3
million for 1996. The increase in 1996 is largely attributable to salaries,
wages and commission on sales of mortgage products and the one-time assessment
by the SAIF of approximately $239,000 on a pretax basis. Excluding that charge,
non-interest expense would have been $2.0 million in 1996, an increase of 33.7%
over 1995.
INCOME TAXES. Heritage's income tax provision for 1997 was $324,000
compared to $263,000 in 1996 and $214,000 in 1995. The effective tax rates were
37.4% in 1997, 35.0% in 1996, and 35.2% in 1995. The effective tax rate differs
from the federal statutory rate primarily as a result of tax-exempt interest
income and state tax benefits in 1997 attributable to utilization of previously
unrecognized operating loss carry-forwards.
HERITAGE FINANCIAL CONDITION
OVERVIEW. Heritage's total consolidated assets increased by 21% from
$71.3 million in 1996 to $86.3 million in 1997. Consolidated assets increased
29.2%, from $55.2 million at December 31, 1995 to $71.3 million at December 31,
1996. The increases primarily resulted from increases in loans and deposits.
LOANS. The following table presents the balance of each major category
of loans at the dates indicated. Commercial loans include loans to service,
retail and wholesale businesses. The majority of Heritage's real estate loan
portfolio consists of local residential first mortgages. The majority of these
mortgages are fixed-rate mortgages with short-term balloon payments or
adjustable rate term mortgages. Heritage has typically sold a majority of real
estate mortgages into the secondary market, with select mortgages that fit
Heritage's underwriting standards retained for its portfolio. Loans classified
as agricultural loans primarily include operating and equipment loans to local
farmers. Loans secured by farmland are listed in the real estate classification.
Loans classified as consumer and other include automobile, home improvement and
dealer paper.
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
ANALYSIS OF LOANS
December 31,
--------------------------------------------------------------
1997 1996 1995
Amount % Amount % Amount %
--------------------------------------------------------------
(In thousands, except percentage data)
Loan Category:
Commercial and
Agricultural $24,774 41.9% $17,861 40.3% $11,639 39.2%
Real Estate:
Residential 13,876 23.5% 10,570 23.8% 9,042 30.4%
Construction 2,983 5.0% 1,444 3.3% 261 0.9%
Farmland 2,521 4.2% 785 1.8%
Other 1,467 2.5% 2,399 5.4% 1,395 4.7%
Consumer/other 13,519 22.9% 11,269 25.4% 7,379 24.8%
------ ------ ------ ------ ------ ------
Total Loans 59,140 100.0% 44,328 100.0% 29,716 100.0%
====== ====== ======
Less Unearned Discounts
and Fees 31 87 221
Less Allowance for
Loan Losses 846 388 326
------ ------ ------
Total Net Loans $58,263 $43,853 $29,169
====== ====== ======
A principal component of Heritage's earning assets is its loan
portfolio. Total loans increased by 33.4% from $44.3 million at December 31,
1996 to $59.1 million at December 31, 1997. Total loans increased by 49.2% from
$29.7 million at December 31, 1995 to $44.3 million at December 31, 1996. These
increases are a direct result of strong loan demand generated through officer
call programs, the Bozeman loan production office, the establishment of Hertiage
Bank's new branch in Chester, Montana, and continued purchase of participation
loans and lease financing loans.
NON-PERFORMING ASSETS. Heritage follows regulatory guidelines with
respect to placing loans on non-accrual status. When a loan is placed on
non-accrual status, all previously accrued and uncollected interest is reversed.
Certain non-performing assets of Heritage are summarized in the following table.
NONACCRUAL, RESTRUCTURED AND PAST DUE LOANS
December 31,
--------------------------
1997 1996 1995
--------------------------
(In thousands, except percentage data)
Nonaccrual loans $4
Restructured loans
Loans past due 90 days or more 263 27 6
--- -- --
Total non-performing loans 267 27 6
Total OREO
Total non-performing assets $267 $27 $6
=== == ==
Non-performing assets to loans
.47% .06% .02%
ALLOWANCE FOR LOAN LOSSES. Heritage Bank's loan loss reserve is
available to absorb future loan losses. The current level of the loan loss
reserve is a result of management's assessment of the risk within the loan
portfolio based on the information revealed in the credit reporting processes.
Heritage utilizes a risk-rating system on loans and a monthly credit review and
reporting process, which results in the calculation of the guideline reserves
based on the risk within the portfolio. This assessment of risk takes into
account the composition of the loan portfolio, previous loss experience, current
economic conditions and other factors that, in management's judgment, deserve
recognition.
The following table sets forth changes in Heritage Bank's loan loss
reserve as of the dates indicated:
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Year Ended December 31,
------------------------
1997 1996 1995
------------------------
(In thousands, except percentage data)
Balance beginning of period $388 $326 $324
Provision for loan losses 492 160 46
Charge-offs:
Commercial 10 98 46
Consumer 25
Real estate
Other
Total charge-offs 35 98 46
Recoveries:
Commercial
Consumer 1 2
Real estate
Other
Total loan recoveries 2
--- --- ---
Net charge-offs 34 98 44
--- --- ---
Balance end of year $846 $388 $326
=== === ===
Allowance for loan losses to:
total loans at yearend 1.47% .88% 1.10%
Net charge-offs to average loans .06% .27% .18%
The loan loss reserve at December 31, 1997 was $846,000 compared to
$388,000 at December 31, 1996. The allowance for loan losses was $326,000 at
December 31, 1995. Activity with the allowance for loan losses primarily
reflected charge-offs of loans determined by management to be uncollectible.
However, management aggressively pursues recoveries. The loan loss reserve at
December 31, 1997 is an amount which management believes is adequate given the
low level of non-performing assets and management's assessment of loan risk.
The continued growth of Heritage's loan portfolio combined with the
apparent deterioration in economic trends both on a national and state-wide
basis, and the difference in Heritage's loan loss reserve coverage compared to
other commercial banks, indicated to management that additional provisions were
required for the year ended December 31, 1997. Future provisions will be
evaluated by management using national and local economic trends, loan portfolio
trends relating to growth and volume, and any other factors management believes
may have an impact on the loan loss reserve.
The following table allocates the loan loss reserve based on
management's judgment of potential losses in the respective areas. While
management has allocated reserves to various portfolio segments for purposes of
this table, the reserve is general in nature and is available for the portfolio
in its entirety:
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
ALLOCATION OF ALLOWANCE OF LOAN LOSSES
(In thousands, except percentage data)
December 31,
---------------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------------
Allowance % to Allowance % to Allowance % to
for loans in for loans in for loans in
loan losses category loan losses category loan losses category
---------------------------------------------------------------------
Commercial and
Agricultural $403 1.63% $277 1.55% $176 1.51%
Real estate 183 .88% 72 .47% 54 .50%
Consumer 237 1.75% 28 .25% 18 .24%
Unallocated 23 11 78
---- ----- --- ---- --- -----
Total $846 1.43% $388 .88% $326 1.10%
==== === ===
INVESTMENT PORTFOLIO. The investment activities of Heritage are
designed to provide an investment alternative for funds not presently required
to meet loan demand, assist Heritage Bank in meeting potential liquidity
requirements, assist in maximizing income consistent with quality and liquidity
requirements, 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.
Heritage's portfolio consists primarily of obligations of U.S.
government and its agencies and mortgage backed securities, state and local
governments, and agency collateralized obligation securities. Heritage's
investment portfolio does not contain concentration of investments in any one
issuer in excess of 10% of Heritage's total investment portfolio. Exempt from
this calculation are securities of the U.S. government and U.S. government
agencies. All of Heritage's investments are classified as available-for-sale.
The following table sets forth the composition of Heritage's investment
portfolio at the dates indicated:
INVESTMENT PORTFOLIO
December 31,
------------------------------
1997 1996 1995
------------------------------
(In thousands)
U.S. government and agencies $2,545 $759 $3,575
Mortgage backed securities 10,028 12,306 11,994
Municipal 1,239 864 521
Other 407 243
------ ------ ------
Total investments $14,219 $14,172 $16,090
====== ====== ======
ANALYSIS OF INVESTMENT YIELDS AND MATURITIES
December 31, 1997
Up to 10 years
1 year 1-5 years 5-10 years and beyond Total
----------------------------------------------------
(In thousands, except percentage data)
U.S. government and agencies $1,402 $576 567 $2,545
Mortgage backed 884 5,024 1,057 3,063 10,028
Municipal bonds 67 1,069 103 1,239
Other securities 407 407
--- ----- ----- ----- ------
Total $884 $6,493 $3,109 $3,733 $14,219
=== ===== ===== ===== ======
Weighted average yield 5.64% 6.69% 6.27% 7.42% 6.70%
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
ANALYSIS OF INVESTMENT YIELDS AND MATURITIES
December 31, 1996
Up to 10 years
1 year 1-5 years 5-10 years and beyond Total
----------------------------------------------------
(In thousands, except percentage data)
U.S. government and agencies $509 $250 $759
Mortgage backed securities 1,213 5,531 1,347 4,215 12,306
Municipal bonds 64 499 301 864
Other securities 243 243
----- ----- ----- ----- ------
Total $1,213 $6,104 $2,339 $4,516 $14,172
===== ===== ===== ===== ======
Weighted average yield 6.99% 6.34% 6.26% 7.08% 6.62%
DEPOSITS. The following table sets forth a summary of Heritage's deposits as of
the dates indicated:
ANALYSIS OF DEPOSITS
December 31,
--------------------------------
1997 1996 1995
--------------------------------
(In thousands)
Non-interest bearing $15,151 $10,001 $7,448
Interest bearing:
Savings and NOW 21,023 14,559 11,354
Time deposits
{ $100M 28,770 28,626 22,072
Time deposits }$100M 5,442 4,455 1,868
------ ------ ------
Total deposits $70,386 $57,641 $42,742
====== ====== ======
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
{ 3 months 3-6 months 6-12 months } 12 months Total
- --------------------------------------------------------------------------------
(In thousands)
December 31, 1997 $951 $867 $2,471 $1,153 $5,442
December 31, 1996 600 1,396 1,652 807 4,455
December 31, 1995 0 543 705 620 1,868
Deposits increased by 22.1% from $57.6 million at December 31, 1996 to
$70.4 million at December 31, 1997. Deposits increased by 34.9% from $42.7
million at December 31, 1995 to $57.6 million at year-end December 31, 1996.
These increases are attributable to marketing efforts implemented by Heritage
Bank and consumer deposits as a result of new loan relationships that have been
established in Heritage Bank.
REGULATORY CAPITAL. As required by the Financial Institutions Reform
Recovery and Enforcement Act of 1989 ("FIRREA"), the Office of Thrift
Supervision requires that Heritage Bank maintain minimum levels of capital under
three separate calculations.
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
The following table demonstrates as of December 31, 1997 and December
31, 1996, the extent to which the Heritage Bank exceeds in dollars and in
percent, the three FIRREA minimum capital requirements:
December 31, 1997 December 31, 1996
--------------------------------------------------------
Actual Requirement Excess Actual Requirement Excess
- --------------------------------------------------------------------------------------
(In thousands, except percentage data)
TANGIBLE CAPITAL:
Amount $4,308 $1,285 $3,023 $3,879 $1,060 $2,819
% of tangible assets 5.0% 1.5% 3.5% 5.5% 1.5% 4.0%
CORE CAPITAL:
Amount $4,308 $2,570 $1,738 $3,879 $2,119 $1,760
% of tangible assets 5.0% 3.0% 2.0% 5.5% 3.0% 2.5%
RISK-BASED CAPITAL:
Amount $4,956 $4,126 $830 $4,266 $3,248 $1,018
% of risk-weighted assets 9.6% 8.0% 1.6% 10.5% 8.0% 2.5%
LIQUIDITY AND FUNDS MANAGEMENT. Liquidity management requires Heritage
to meet, in a timely fashion, contractual commitments and to respond to other
requirements for funds. Heritage Bank has an Asset/Liability Management
Committee (ALCO) responsible for managing balance sheet and off-balance sheet
commitments to meet the needs of customers while achieving financial objectives.
Heritage Bank's ALCO meets regularly to review funding capacities, current and
forecasted loan demand and investment opportunities.
Asset liquidity is provided by regular maturities of loans and by
maintaining relatively liquid marketable investment securities and federal
funds. Heritage's investment securities due within one year, cash flow from
mortgage backed securities, and federal funds sold have historically been
adequate for funding needs. Heritage bank has a stable core deposit base with a
relatively small percentage of volatile funding. Increases in deposits and other
sources of funds have been sufficient to fund all assets. If funding
requirements increase substantially, heritage has in place liquidity contingency
plans, which include the ability to borrow federal funds, borrow from the
federal home loan bank, sell loan participations or liquidate short-term
marketable investment securities held in its investment portfolios.
INTEREST RATE SENSITIVITY. Significant changes in interest rates affect
the composition, yield and cost of balance sheet components. The rate
sensitivity of these assets and liabilities is monitored and matched to control
the risk associated with movements in rates. The ALCO for Heritage Bank meets
periodically to monitor and formulate strategies and policies to provide
sufficient levels of net interest income while maintaining acceptable levels of
interest rate sensitivity, risk and liquidity. The primary object of rate
sensitivity management is to ensure earnings stability by minimizing the
sensitivity of net interest income to fluctuations in interest rates.
Heritage Bank uses gap and other systems to measure, monitor and adapt to
changing interest rate environments.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1996, the Financial
Accounting Standards Board (the "FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities." This statement provides accounting
and reporting standards for transfers and servicing of financial assets and
extinguishment of liabilities. The provisions of SFAS No. 125 apply to
transactions occurring after December 31, 1996. This adoption did not have a
material effect on the consolidated financial position or results of operations
of Heritage.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share."
This statement simplifies the standards for computing earnings per share ("EPS")
by replacing the presentation of primary and fully diluted EPS with a
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures. SFAS No. 128 also requires a
reconciliation of the numerator and the denominator of the basic EPS computation
to the numerator and
(Continued)
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
denominator of the diluted EPS computation. The provisions of SFAS No. 128 apply
to financial statements issued for periods ending after December 15, 1997.
Earlier adoption is not permitted. Adoption did not have a material effect on
reported EPS of Heritage.
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was
issued and is effective January 1, 1998. SFAS No. 130 establishes standards for
the reporting and display of comprehensive income and its components in a full
set of financial statements. All items required to be recognized under
accounting standards as components of comprehensive income are to be reported in
a financial statement that is displayed as prominently as other financial
statements. SFAS No. 130 also requires the classification of items of other
comprehensive income by their nature in a financial statement and the display of
other comprehensive income separately from retained earnings and paid-in-capital
in the stockholders' equity section of the statement of financial condition.
Heritage's only significant element of comprehensive income is the unrealized
gains and losses on available-for-sale securities.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for the way public companies are to report information about operating segments
in annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. SFAS No. 131
replaces the "industry segment" concept with a "management approach" concept as
the basis for identifying reportable segments. The management approach is based
on the way that management organizes the segments within the enterprise for
making operating decisions and assessing performance. Consequently, the segments
are evident from the structure of the enterprise's internal organization.
Furthermore, the management approach facilitates consistent descriptions of an
enterprise in its annual report and various other published information. It
focuses on financial information that an enterprise's decision makers use to
make decisions about the enterprise's operating matters. SFAS No. 131 is
effective for financial statements for periods beginning after December 15,1997.
Earlier application is encouraged.
YEAR 2000. Heritage is aware of the issues associated with computer
systems as the year 2000 approaches. Heritage recognizes the need to ensure that
its operations will not be adversely impacted by year 2000 date-related
failures. Heritage has provided its business customers, suppliers and vendors
with information regarding Heritage's progress on year 2000 issues and has
requested similar information in return. All software currently used within
Heritage is supplied by vendors. Heritage has been advised by their data
processing provider that a new generation of software, to be implemented by
early 1998, will be year 2000 certified. Heritage continues to bear some risk
related to the year 2000 issue and could be adversely affected if other Heritage
entities not affiliated with Heritage do not appropriately address their own
year 2000 compliance issues. Based on the study and analysis conducted, the
dollar amount required to remediate the known year 2000 issues is not expected
to be material to Heritage's business. Unanticipated problems or difficulties,
however, could significantly increase Heritage's estimated expenditures for the
year 2000 project.
(Concluded)
HERITAGE BANCORPORATION
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heritage Bancorporation:
We have audited the accompanying consolidated statement of financial condition
of Heritage Bancorporation and subsidiary as of December 31, 1997, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the years ended December 31, 1997 and 1995. 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. The accompanying financial statements of the
Heritage Bancorporation and subsidiary as of and for the year ended December 31,
1996 were audited by other auditors whose report thereon dated March 31, 1997,
expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1997 and 1995 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Heritage Bancorporation and subsidiary as of December 31, 1997, and the results
of their operations and their cash flows for each of the years ended December
31, 1997 and 1995 in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Billings, Montana
February 20, 1998
INDEPENDENT AUDITORS' REPORT
To Board of Directors
Heritage Bancorporation
Great Falls, Montana
We have audited the accompanying consolidated statements of financial
condition of Heritage Bancorporation and subsidiary as of December 31, 1996, and
the related consolidated statements of income, stockholders' equity and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the management of Heritage Bancorporation. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audit. The consolidated financial statements of Heritage Bancorporation and
subsidiary as of December 31, 1995, were audited by other auditors whose report
dated March 7, 1996 expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all materials respects, the financial position of Heritage
Bancorporation and subsidiary as of December 31, 1996, and the results of its
operations and cash flows for the year then ended in conformity with generally
accepted accounting principles.
/s/ Douglas Wilson & Company, PC
Great Falls, Montana
March 31, 1997
HERITAGE BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 and 1996
Assets 1997 1996
------ ---- ----
Cash and cash equivalents $ 9,868,985 10,089,203
Time deposits in banks 98,000 98,000
Investment and mortgage-backed securities available
-for-sale 14,219,330 14,172,122
Loans receivable, net 56,795,635 41,454,506
Loans held for sale 1,467,387 2,398,942
Goodwill, net of accumulated amortization of
$150,444 and $107,460 at December 31, 1997 and
1996, respectively 494,345 537,329
Stock in Federal Home Loan Bank of Seattle, at cost 404,000 328,100
Accrued interest receivable 687,820 480,693
Premises and equipment, net 1,635,873 1,189,648
Deferred income taxes 133,270 16,691
Other assets 547,632 515,184
----------- -----------
$86,352,277 71,280,418
=========== ===========
Liabilities and Stockholders' Equity
------------------------------------
Liabilities:
Deposits $70,386,094 57,640,689
Federal Home Loan Bank advances 6,425,000 1,425,000
Securities sold under agreements to repurchase 3,173,149 6,374,786
Advances from borrowers for taxes and insurance 137,582 143,019
Income taxes payable 167,243 64,894
Accrued interest payable 807,061 573,397
Accrued expenses and other liabilities 158,233 330,481
Long-term debt 2,350,000 2,550,000
----------- -----------
Total liabilities 83,604,362 69,102,266
----------- -----------
Minority interest -- 451
Stockholders' equity:
Common stock, par value $.01; authorized
2,000,000 shares; 10,000 shares issued and
outstanding 100 100
Additional paid-in capital 1,080,028 1,080,028
Retained earnings, substantially restricted 1,539,605 997,384
Net unrealized gains on securities available-
for-sale 128,182 100,189
----------- -----------
Total stockholders' equity 2,747,915 2,177,701
----------- -----------
Commitments and contingencies
$86,352,277 71,280,418
=========== ===========
See accompanying notes to consolidated financial statements.
HERITAGE BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
Interest income:
Loans receivable $ 4,529,566 3,225,854 2,226,432
Mortgage-backed securities 832,182 873,379 722,836
Investment securities 209,263 194,484 263,701
Time deposits in banks 6,860 21,923 46,461
Other interest-earning assets 195,579 204,724 209,787
------------ ------------ ------------
Total interest income 5,773,450 4,520,364 3,469,217
------------ ------------ ------------
Interest expense:
Deposits 2,635,234 2,058,630 1,576,235
Long-term debt 189,657 191,234 220,988
Federal Home Loan Bank advances 253,407 31,559 -
Securities sold under agreements
to repurchase 79,035 137,565 143,689
------------ ------------ ------------
Total interest expense 3,157,333 2,418,988 1,940,912
------------ ------------ ------------
Net interest income 2,616,117 2,101,376 1,528,305
Provision for loan losses 492,400 160,000 46,000
------------ ------------ ------------
Net interest income after
provision for loan losses 2,123,717 1,941,376 1,482,305
Non-interest income:
Loan origination fees 649,354 678,575 300,135
Loan servicing fees 65,739 45,687 44,959
Customer service charges 275,509 253,493 208,797
Other 112,992 81,143 76,650
------------ ------------ ------------
Total non-interest income 1,103,594 1,058,898 630,541
------------ ------------ ------------
Non-interest expense:
Compensation and benefits 1,206,812 1,006,825 706,476
Occupancy and equipment 227,861 191,693 124,473
Deposit insurance premiums 27,389 104,144 86,816
Special assessment by the SAIF - 239,297 -
Data processing fees 199,263 156,715 127,484
Other 699,604 552,114 459,471
------------ ------------ ------------
Total non-interest expense 2,360,929 2,250,788 1,504,720
------------ ------------ ------------
Income before income taxes 866,382 749,486 608,126
Income taxes 324,161 263,457 214,511
------------ ------------ ------------
Net income $ 542,221 486,029 393,615
============ ============ ============
Pro forma net income per share $ 1.14 1.02 .83
============ ============ ============
Pro forma weighted average shares outstanding $ 475,000 475,000 475,000
============ ============ ============
See accompanying notes to consolidated financial statements.
HERITAGE BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1997, 1996 and 1995
Net unrealized
gain (loss) Total
Additional on securities stock-
Common paid-in Retained available- holders'
stock capital earnings for-sale equity
---------- ---------- ---------- ---------- ----------
Balances at December 31, 1994 $ 100 1,080,028 117,740 (18,606) 1,179,262
Net income -- -- 393,615 -- 393,615
Increase in net unrealized gains on
securities available-for-sale -- -- -- 120,643 120,643
---------- ---------- ---------- ---------- ----------
Balances at December 31, 1995 100 1,080,028 511,355 102,037 1,693,520
Net income -- -- 486,029 -- 486,029
Decrease in net unrealized gains on
securities available-for-sale -- -- -- (1,848) (1,848)
---------- ---------- ---------- ---------- ----------
Balances at December 31, 1996 100 1,080,028 997,384 100,189 2,177,701
Net income -- -- 542,221 -- 542,221
Increase in net unrealized gains on
securities available-for-sale -- -- -- 27,993 27,993
---------- ---------- ---------- ---------- ----------
Balances at December 31, 1997 $ 100 1,080,028 1,539,605 128,182 2,747,915
========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
HERITAGE BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 542,221 486,029 393,615
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 492,400 160,000 46,000
Goodwill amortization 42,984 42,984 42,984
Depreciation of premises and equipment 110,329 87,582 57,502
Deferred loan origination fees, net (54,037) (42,770) (12,384)
Amortization of discounts on loans 2,040 (91,541) (18,525)
Decrease (increase) of loans held for sale 931,555 (1,004,263) (1,099,125)
Stock dividends reinvested in Federal Home
Loan Bank of Seattle (26,800) (24,300) (19,000)
Increase in accrued interest receivable (207,127) (80,394) (98,169)
Decrease (increase) in deferred income taxes (133,003) 64,745 57,689
Increase in other assets (32,448) (156,099) (57,942)
Increase (decrease) in income taxes payable 102,349 (107,978) 159,117
Increase in accrued interest payable 233,664 136,772 289,124
Increase (decrease) in accrued expenses and other liabilities (172,248) 32,981 176,864
Net cash provided (used) by operating activities 1,831,879 (496,252) (82,250)
------------ ------------ ------------
Cash flows from investing activities:
Net decrease in time deposits in banks -- 247,485 701,109
Net increase in loans receivable (15,781,532) (13,705,750) (6,476,498)
Purchases of securities held-to-maturity -- -- (5,013,729)
Proceeds from maturities and paydowns of securities
held-to-maturity -- -- 1,099,507
Purchases of securities available-for-sale (6,872,431) (4,561,250) (1,594,179)
Proceeds from maturities and paydowns of securities
available-for-sale 6,869,640 6,476,883 1,976,187
Purchases of Federal Home Loan Bank stock (49,100) -- --
Purchases of premises and equipment (556,554) (341,070) (223,997)
Increase (decrease) in minority interest (451) 39 36
------------ ------------ ------------
Net cash used in investing activities (16,390,428) (11,883,663) (9,531,564)
------------ ------------ ------------
Cash flows from financing activities:
Net increase in deposits 12,745,405 14,899,047 4,826,395
Net increase in Federal Home Loan Bank advances 5,000,000 1,425,000 --
Payments on long-term debt (200,000) (100,000) (75,000)
Net increase (decrease) in securities sold under
repurchase agreements (3,201,637) (716,196) 6,830,948
Increase (decrease) in advances from borrowers for
taxes and insurance (5,437) 16,453 (25,780)
------------ ------------ ------------
Net cash provided by financing activities 14,338,331 15,524,304 11,556,563
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (220,218) 3,144,389 1,942,749
Cash and cash equivalents at beginning of year 10,089,203 6,944,814 5,002,065
------------ ------------ ------------
Cash and cash equivalents at end of year $ 9,868,985 10,089,203 6,944,814
============ ============ ============
Cash paid during the year for:
Interest $ 2,924,000 2,282,000 2,525,000
Income taxes 355,000 130,000 82,000
============ ============ ============
See accompanying notes to consolidated financial statements.
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 1997
(1) Summary of Significant Accounting Policies
(a) General
Heritage Bancorporation (the Company) was organized in 1993 as a
savings and loan holding company and on June 7, 1994 completed the
acquisition of Heritage Bank, (the Bank).
The Bank provides a full range of banking services to individual
and corporate customers in central Montana. The Bank is subject to
competition from other financial service providers. The Bank is
also subject to the regulations of certain government agencies and
undergoes periodic examinations by those regulatory authorities.
The accounting and consolidated financial statement reporting
policies of the Company conform with generally accepted accounting
principles and prevailing practices within the banking industry.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the
reported and disclosed 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. While management uses available
information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review
the Bank's allowance for losses on loans. Such agencies may
require the Bank to recognize additions to the allowance based on
their judgments about information available to them at the time of
their examination.
(b) Basis of Presentation
The consolidated financial statements include the accounts of the
Company and the Bank. All significant intercompany transactions
have been eliminated in consolidation.
(c) Cash Equivalents
For purposes of the consolidated statements of cash flows, the
Company considers all cash, daily interest demand deposits,
non-interest-bearing deposits with banks and time deposits in
banks having maturities of three months or less at date of
purchase to be cash equivalents.
(d) Investment and Mortgage-Backed Securities
Debt securities for which the Company has the positive intent and
ability to hold to maturity are classified as held-to-maturity and
stated at amortized cost. Debt and equity securities held
primarily for the purpose of selling them in the near term are
classified as trading securities and are reported at fair market
value, with unrealized gains and losses included in income. Debt
and equity securities not classified as held-to-maturity or
trading are classified as available-for-sale and are reported at
fair value with unrealized gains and losses, net of income taxes,
as a separate component of stockholders' equity.
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Declines in the fair value of available-for-sale or
held-to-maturity securities below carrying value that are other
than temporary are charged to expense as realized losses and the
related carrying value reduced to fair value. The cost of any
investment, if sold, is determined by specific identification.
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 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.
Material loan origination fees and related direct origination
costs are capitalized and recognized as an adjustment of the yield
of the related loan. Origination fees on loans sold to the
secondary market are recognized when the loan is sold. The
amortization of deferred loan fees and costs and the accretion of
unearned discounts on non-performing loans is discontinued during
periods of non-performance.
(f) Allowance for Loan Losses
Management's periodic evaluation of the adequacy of the allowance
is based on factors such as the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to pay, the
estimated value of any underlying collateral, current economic
conditions and independent appraisals.
The Company 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 the
Company 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, will be 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.
During 1997 and 1996, the amount of impaired loans was not
material.
(g) Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary
market are carried at the lower of cost or estimated market value.
Net unrealized losses are recognized through a valuation allowance
by charges to income.
(h) Amortization of Goodwill
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill represents the excess of cost over the fair value of the
Bank's net assets at the date acquired and is being amortized
against income using the straight-line method over a period of 15
years.
(i) Stock in Federal Home Loan Bank
The Company is required to hold stock in the Federal Home Loan
Bank (FHLB) according to specified amounts to access FHLB
borrowing sources. This investment is carried at cost.
(j) Premises and Equipment
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed on straight-line and
accelerated methods over the estimated useful lives, which range
from 5 to 39 years, of the respective assets.
(k) Income Taxes
Deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the
enactment date.
(l) Pro Forma Net Income Per Share
In February 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share." SFAS No. 128 replaces the presentation of
primary and fully diluted earnings per share (EPS) with a
presentation of basic and diluted EPS on the face of the income
statement for all entities with complex capital structures. SFAS
No. 128 also requires a reconciliation of the numerator and
denominator of the basic and diluted EPS computation.
Pro Forma net income per share for the years ended December 31,
1997, 1996 and 1995 is calculated by dividing net income by the
pro forma weighted average common shares outstanding. Pro forma
weighted average shares outstanding is based on the 475,000 shares
assumed to be outstanding after the February 3, 1998 assumed
recapitalization effected in conjunction with the acquisition of
United Financial Corp. (see note 18).
(m) Impairment and Disposal of Long-Lived Assets
Long-lived assets and certain identifiable intangibles are
reviewed for impairment whenever events or circumstances indicate
that the carrying amount of an 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. At
December 31, 1997 and 1996, there were no assets that were
considered impaired.
(n) Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
In June 1996, the FASB issued SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." SFAS No. 125 provides guidance on accounting for
transfers and servicing of financial assets, recognition and
measurement of servicing assets and liabilities, financial assets
subject to prepayment, secured borrowings and collateral, and
extinguishment of liabilities.
SFAS No. 125 generally requires the recognition as separate assets
the rights to service mortgage loans for others, whether the
servicing rights are acquired through purchases or loan
originations. SFAS No. 125 also specifies that
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial assets subject to prepayment, including loans that can
be contractually prepaid or otherwise settled in such a way that
the holder would not recover substantially all of its recorded
investment, be measured like debt securities available-for-sale or
trading securities under SFAS No. 115. SFAS No. 125 was adopted by
the Company on January 1, 1997 and did not have a material impact
on the Company's financial position or results of operations.
(o) Reclassifications
Certain reclassifications have been made to the 1996 financial
statements to conform with the 1997 presentation.
(p) Future Accounting Pronouncements
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was
issued and is effective January 1, 1998. SFAS No. 130 establishes
standards for the reporting and display of comprehensive income
and its components in a full set of financial statements. All
items required to be recognized under accounting standards as
components of comprehensive income are to be reported in a
financial statement that is displayed as prominently as other
financial statements. SFAS No. 130 also requires the
classification of items of other comprehensive income by their
nature in a financial statement and the display of other
comprehensive income separately from retained earnings and paid-in
capital in the stockholders' equity section of the statement of
financial condition. The Company's only significant element of
comprehensive income is the unrealized gains and losses on
available-for-sale securities.
(2) Cash on Hand and In Banks
The Bank is required to maintain an average reserve balance with the
Federal Reserve Bank, or maintain such reserve in cash on hand. The
amount of this required reserve balance at December 31, 1997 was
approximately $505,000.
(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:
1997
----------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
U.S. Government and Federal agencies $ 2,528,702 21,100 (4,937) 2,544,865
Mortgage-backed securities 9,890,471 154,354 (17,179) 10,027,646
Municipal bonds 1,206,893 40,401 (7,905) 1,239,389
Other 389,799 17,631 -- 407,430
----------- ----------- ----------- -----------
$14,015,865 233,486 (30,021) 14,219,330
=========== =========== =========== ===========
1996
----------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
U.S. Government and Federal agencies $ 750,000 9,295 -- 759,295
Mortgage-backed securities 12,163,382 180,819 (38,351) 12,305,850
Municipal bonds 860,965 3,312 -- 864,277
Other 238,727 3,973 -- 242,700
----------- ----------- ----------- -----------
$14,013,074 197,399 (38,351) 14,172,122
=========== =========== =========== ===========
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Maturities of securities available-for-sale by contractual maturity at
December 31, 1997 are shown below. Maturities of securities do not
reflect repricing opportunities present in many adjustable rate
securities. Estimated Amortized fair cost value
Due after one year through five years $ 1,454,106 1,468,887
Due after five years through ten years 2,003,245 2,053,508
Due after ten years 668,043 669,289
Mortgage-backed securities 9,890,471 10,027,646
-------------- -------------
$ 14,015,865 14,219,330
============== =============
There were no sales of investment securities available-for-sale during
the years ended December 31, 1997, 1996 and 1995.
(4) Loans Receivable, Net
Loans receivable, net at December 31 is summarized as follows:
1997 1996
---- ----
First mortgage loans and contracts secured by real estate $ 16,857,570 12,013,810
Commercial real estate loans 11,108,988 8,814,436
Commercial loans 10,931,879 8,578,642
Second mortgage consumer loans 7,375,192 5,692,364
Auto and other consumer loans 5,304,928 5,388,508
Agricultural loans 4,952,483 1,252,851
Savings account loans 431,190 188,503
Tax exempt municipal loans 710,180 -
------------- ------------
57,672,410 41,929,114
Less:
Unearned discount and deferred loan origination fees 30,870 86,952
Allowance for loan losses 845,905 387,656
------------- -------------
$ 56,795,635 41,454,506
============= =============
A summary of activity in the allowance for loan losses for the years
ended December 31 follows:
1997 1996 1995
---- ---- ----
Balance, beginning of year $ 387,656 325,492 324,021
Provision for loan losses 492,400 160,000 46,000
Losses charged off, net of recoveries (34,151) (97,836) (44,529)
----------- ---------- ----------
Balance, end of year $ 845,905 387,656 325,492
=========== ========== ==========
Loans receivable include approximately $19,114,000 and $14,347,000 in
adjustable rate loans at December 31, 1997 and 1996, respectively.
Real estate loans serviced for others totaled approximately $17,693,000
and $14,104,000 at December 31, 1997 and 1996, respectively.
At December 31, 1997 and 1996, approximately $8,015,000 and $5,978,000,
respectively, of loans are obligations of customers who are out of the
state of Montana. Anticipated credit losses arising from these
transactions compare favorably with the Company's credit loss experience
of its loan portfolio as a whole.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company 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. The Company'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. The Company 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, 1997 whose contract
amounts represent credit risk include:
Letters of credit $ 385,000
=============
Loans and loans in process $ 4,185,000
=============
Unused lines of credit $ 7,257,000
=============
(5) Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized as follows:
1997 1996
---- ----
Loans receivable $ 527,128 316,403
Mortgage-backed securities 62,477 98,563
Investment securities 81,264 49,876
Time deposits in banks and other interest-earning
assets 16,951 15,851
---------- ---------
$ 687,820 480,693
========== =========
(6) Premises and Equipment
Premises and equipment at December 31 are summarized as follows:
1997 1996
---- ----
Land $ 120,531 120,531
Building and improvements 1,365,533 913,215
Furniture, fixtures and equipment 757,079 652,844
------------ ------------
2,243,143 1,686,590
Accumulated depreciation (607,270) (496,942)
------------ ------------
$ 1,635,873 1,189,648
============ ============
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) Deposits
Deposits at December 31 are summarized as follows:
1997 1996
----------------------------------------- ----------------------
Weighted
average rate Amount % Amount %
------------ ------ --- ------ ---
Savings accounts 3.23% $ 12,007,918 17.1% 5,780,992 10.0%
NOW and demand accounts 1.46% 24,166,180 34.3 18,778,245 32.6
------------- ------ ------------- -----
36,174,098 51.4 24,559,237 42.6
------------- ------ ------------- -----
Certificates of deposit: 2.00 to 2.99% 272 - - -
3.00 to 3.99% 19,961 - - -
4.00 to 4.99% 404,541 .6 361,107 .6
5.00 to 5.99% 9,615,525 13.7 25,606,360 44.4
6.00 to 6.99% 23,320,442 33.1 7,113,985 12.4
7.00 to 7.99% 851,255 1.2 - -
------------- ------ ------------- -----
Total certificates of deposit 6.08% 34,211,996 48.6 33,081,452 57.4
------------- ------ ------------- -----
4.01% $ 70,386,094 100.0% $ 57,640,689 100.0%
============= ===== ============= =====
Scheduled maturities of certificates of deposit at December 31, 1997 are
as follows:
Due within one year $ 26,177,103
Due within two to three years 7,502,251
Due within four to five years 564,642
--------------
$ 34,243,996
==============
Certificates of deposit of $100,000 or more are approximately
$5,442,000 and $4,455,000 at December 31, 1997 and 1996, 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:
1997 1996 1995
---- ---- ----
Savings accounts $ 468,392 376,563 307,543
NOW and demand accounts 229,475 251,771 230,663
Certificates of deposit 1,937,367 1,430,296 1,038,029
------------ ------------ ------------
$ 2,635,234 2,058,630 1,576,235
============ ============ ============
(8) Long-Term Debt
Long-term debt consists of a note payable due in annual installments
beginning July 1996 with a $1,000,000 final payment on January 15, 2005.
The note is secured by the outstanding shares of the Bank and is
guaranteed by certain principal shareholders of the Company. Interest is
at an annual rate equal to 2% over the Federal Funds rate. The note was
paid in full in February 1998 in conjunction with the acquisition of
United Financial Corp. (see note 18).
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) Federal Home Loan Bank Advances
Federal Home Loan Bank advances at December 31 are summarized as follows:
1997 1996
--------------------------------------------
Weighted
average rate Amount Amount
------------ ------ ------
Fixed rate advances, due April through
December 1998 6.03% $ 3,000,000 -
Adjustable rate advance, due June 1998 5.71% 2,000,000 -
Fixed rate advances, due January through
February 2001 5.75% 425,000 425,000
Putable advance, put option exercisable
by FHLB quarterly, due June 2002 5.39% 1,000,000 -
Fixed rate advance, repaid January 1997 - 1,000,000
----------- ------------
$ 6,425,000 1,425,000
=========== ============
These advances were collateralized by the Federal Home Loan Bank of
Seattle stock held by the Company, unpledged investment and
mortgage-backed securities and qualifying real estate loans. Interest is
payable monthly.
During 1997, the Bank signed a Cash Management Advance note with a
maximum allowable advance of $3,446,000. There were no outstanding
advances as of December 31, 1997. There was only one advance under the
note during 1997 of $150,000 which was outstanding for less than one
week.
(10) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase at December 31, consist of
the following:
1997
---------------------------------------------
Book Market
Weighted value of value of
Repurchase average underlying underlying
amount rate securities securities
------ ---- ---------- ----------
To repurchase within:
1 - 30 days $ 845,000 5.60% $ 888,683 884,187
31 - 90 days 600,000 5.72 914,445 926,230
Greater than 90 days 1,728,149 5.78 2,147,951 2,202,701
---------- ---- ---------- ----------
$3,173,149 5.72% $3,951,079 4,013,118
========== ==== ========== ==========
1996
---------------------------------------------
Book Market
Weighted value of value of
Repurchase average underlying underlying
amount rate securities securities
------ ---- ---------- ----------
To repurchase within:
1 - 30 days $4,980,000 5.34% $5,006,905 5,004,650
31 - 90 days 1,150,789 5.04 1,327,653 1,347,463
Greater than 90 days 243,997 3.20 514,821 513,019
---------- ---- ---------- ----------
$6,374,786 5.00% $6,849,379 6,865,132
========== ==== ========== ==========
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 year ended December 31, 1997, securities sold under
agreements to repurchase averaged approximately $1,755,000 and the
maximum outstanding at any month end during the year was approximately
$3,173,000.
(11) Income Taxes
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income tax expense is summarized as follows:
Federal State Total
------- ----- -----
Year ended December 31, 1997:
Current $ 417,425 39,739 457,164
Deferred (112,368) (20,635) (133,003)
------------ ---------- -----------
$ 305,057 19,104 324,161
============ ========== ===========
Year ended December 31, 1996:
Current $ 251,541 79,661 328,202
Deferred (52,530) (12,215) (64,745)
------------ ---------- -----------
$ 199,011 67,446 263,457
============ ========== ===========
Year ended December 31, 1995:
Current $ 105,019 51,803 156,822
Deferred 48,236 9,453 57,689
------------ ---------- -----------
$ 153,255 61,256 214,511
============ ========== ===========
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:
1997 1996 1995
---- ---- ----
Computed "expected" tax expense $ 294,570 254,845 206,781
Increase (decrease) resulting from:
State taxes, net of Federal income tax effects 40,159 44,514 34,190
Goodwill amortization 14,615 14,615 14,615
Decrease in valuation allowance (41,743) - -
Other, net 16,560 (50,517) (41,075)
---------- ---------- ----------
$ 324,161 263,457 214,511
========== ========== ==========
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:
1997 1996
---- ----
Deferred tax assets:
Loans, principally due to reserve for loan losses $ 297,250 107,010
Purchase accounting 43,856 63,731
State net operating loss carryforward - 41,743
Other 11,703 4,750
------------ -----------
Total gross deferred tax assets 352,809 217,234
Valuation allowance - (41,743)
------------ -----------
Net deferred tax assets 352,809 175,491
------------ -----------
Deferred tax liabilities:
Stock in Federal Home Loan Bank of Seattle,
principally due to dividends not recognized for
tax purposes 110,935 81,748
Unrealized gains on securities available-for-sale 75,283 58,859
Premises and equipment, principally due to
differences in deprecation 25,300 18,193
Prepaid SAIF assessment 8,021 -
------------ ----------
Total gross deferred tax liabilities 219,539 158,800
------------ -----------
Net deferred tax asset $ 133,270 16,691
============ ===========
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 1997 and 1996 management believes it is more likely than not
that the Company will realize the benefits of these deductible
differences.
Retained earnings at December 31, 1997 and 1996 includes approximately
$265,000 for which no provision for Federal income tax has been made.
This amount represents the base year 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. The Company 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.
(12) Related Parties
Central Financial Services (CFS) provides various management services to
the Bank, including accounting and tax services, investment consulting,
personnel consulting, insurance advisory services and regulatory
consulting. CFS is owned by Heritage's majority stockholder. The charges
were $81,347, $70,009 and $63,942 for the years ended December 31, 1997,
1996 and 1995, respectively.
(13) Employee Benefit Plan
The Bank has an employee savings plan. To be eligible for the plan, an
employee must complete one year of full-time employment with the Bank.
Annual contributions, which are determined by the Bank's Board of
Directors, are to be at least 2% of the participating employees' wages.
Contributions for the years ended December 31, 1997, 1996 and 1995 were
approximately $36,000, $28,000 and $21,000, respectively.
During 1996, the Bank has entered into a deferred compensation agreement
with the Bank's president that provides for predetermined periodic
payments over 15 years upon retirement or death. In the event of
acquisition of the Bank by a third party, disability or early retirement
the predetermined payments are based on time served. Amounts expensed
under this agreement were approximately $3,300 and $2,800 in 1997 and
1996, respectively.
(14) Regulatory Matters of the Bank
The Bank 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 the Bank's operations. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
guidelines. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total risk based capital to risk-weighted
assets (RWA) and of core and tangible capital to average tangible assets
(all determined as defined in the regulations). Management believes, as
of December 31, 1997, that the Bank meets all capital adequacy
requirements to which it is subject.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 1997, the Bank was categorized as "adequately
capitalized" under the regulatory framework for prompt corrective action
(PCA). To be categorized as "adequately capitalized" the Bank must
maintain minimum total risk-based, Tier I risk-based, Tier I leverage
ratios as set forth in the following table. There are no conditions or
events since that notification that management believes have changed the
institution's PCA category.
Minimum
Minimum to be "adequately
for capital capitalized"under
Actual adequacy purposes PCA provisions
------ ----------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1997:
Total capital (to RWA) $4,956 9.6 4,126 8.0 4,126 8.0
Tier I capital (to RWA) 4,308 8.4 - - 2,603 4.0
Core capital (to tangible assets 4,308 5.0 2,570 3.0 3,427 4.0
Tangible capital (to tangible assets 4,308 5.0 1,285 1.5 - -
December 31, 1996:
Total capital (to RWA) 4,266 10.5 3,248 8.0 3,248 8.0
Tier I capital (to RWA) 3,879 9.6 - - 1,614 4.0
Core capital (to tangible assets 3,879 5.5 2,119 3.0 2,826 4.0
Tangible capital (to tangible assets 3,879 5.5 1,060 1.5 - -
Savings banks that before and after proposed dividend distributions meet
or exceed their fully phased-in capital requirements, may make capital
distributions with prior notice to the OTS during any calendar year up to
100% of year-to-date net income plus 50% of the amount in excess of their
fully phased-in capital requirements as of the beginning of the calendar
year. However, the OTS may impose greater restrictions if an institution
is deemed to be in need or more than normal supervision.
(15) Fair Value of Financial Instruments
The Company is required to disclose the fair value for financial
instruments, whether or not recognized in the statement 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.
Quoted market prices are used for fair value when available, but do not
exist for some of the Company's financial instruments, primarily loans
and time deposits. The fair value of these instruments has been derived
from the Federal Home Loan Bank (FHLB) Rate Shock Analysis (FHLB
Analysis). This FHLB Analysis primarily employs the discounted cash flow
method which estimates the fair value of loans and time deposits 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 FHLB model
has assumptions about the size and timing of expected cash flows and
appropriate discount rates. Different assumptions could materially change
these instruments' estimated values.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following assumptions and methods were used by the Company 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 investment and mortgage-backed
securities available-for-sale, the fair value is based upon quoted
market prices. The fair value of loans receivable was obtained from
the FHLB Analysis. The fair value of loans held for sale approximates
carrying value, as the carrying value is the lower of cost or fair
value, and the Company expects the loans to be sold, with no gain or
loss, in the short-term. The fair value of FHLB stock approximates
redemption value. The fair value of accrued interest receivable
approximates book value as the Company expects contractual receipt in
the near-term.
FINANCIAL LIABILITIES. The fair value of NOW and demand accounts and
non-term savings deposits approximates book values as these deposits
are payable on demand. The fair value of time deposits was obtained
from the FHLB Analysis. Because the interest rate on the long-term
debt approximates the Company's current long-term borrowing rate, the
fair value of long-term debt approximates the carrying value. The
fair value of Federal Home Loan Bank advances was obtained from the
FHLB Analysis. The fair value of securities sold under agreements to
repurchase and 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 no fair value adjustment
is necessary.
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 the
Company's entire holdings of a particular instrument. Because no
market exists for a significant portion of the Company'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.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The approximate book value and fair value of the Company's financial
instruments as of December 31 are as follows:
1997 1996
--------------------------- ---------------------------
Carrying Value Fair Value Carrying Value Fair Value
-------------- ----------- -------------- -----------
Financial Assets:
Cash and cash equivalents $ 9,869,000 9,869,000 10,089,000 10,089,000
Time deposits in banks 98,000 98,000 98,000 98,000
Investment and mortgage-backed
securities available-for-sale 14,219,000 14,219,000 14,172,000 14,172,000
Loans receivable, net 56,796,000 57,076,000 41,455,000 41,224,000
Loans held for sale 1,467,000 1,467,000 2,399,000 2,399,000
Stock in FHLB of Seattle 404,000 404,000 328,000 328,000
Accrued interest receivable 688,000 688,000 481,000 481,000
----------- ----------- ----------- -----------
$83,541,000 83,821,000 69,022,000 68,791,000
=========== =========== =========== ===========
Financial Liabilities:
Deposits $70,386,000 70,528,000 57,641,000 57,721,000
Long-term debt 2,350,000 2,350,000 2,550,000 2,550,000
FHLB advances 6,425,000 6,392,000 1,425,000 1,425,000
Securities sold under
agreements to repurchase 3,173,000 3,173,000 6,375,000 6,375,000
Accrued interest payable 807,000 807,000 573,000 573,000
----------- ----------- ----------- -----------
$83,141,000 83,250,000 68,564,000 68,644,000
=========== =========== =========== ===========
(16) Commitments and Contingencies
The Bank has sold loans to various investors in the secondary market
under sales agreements which contain repurchase provisions. Under the
repurchase provisions, the 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, 1997 is approximately $8,265,000. Loans
repurchased during 1997 were approximately $9,500. Total loans sold
during 1997 were approximately $31,650,000.
In June 1997, the Bank entered into a five-year service contract for data
processing services. In the event of early termination of the service
contract by the Bank, the Bank 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.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(17) Parent Company Information (Condensed)
The summarized financial information for Heritage Bancorporation is
presented below:
CONDENSED BALANCE SHEETS
December 31,
------------------------
1997 1996
---------- ----------
Assets
Cash (deposited with Bank) $ 60,795 91,196
Investment in Bank 4,929,946 4,515,681
Other assets 157,347 161,731
---------- ----------
$5,148,088 4,768,608
========== ==========
Liabilities and Stockholders' Equity
Long-term debt $2,350,000 2,550,000
Other liabilities 50,173 40,907
---------- ----------
Total liabilities 2,400,173 2,590,907
---------- ----------
Common stock 100 100
Additional paid-in capital 1,080,028 1,080,028
Retained earnings 1,539,605 997,384
Net unrealized gains on securities available-for-sale 128,182 100,189
---------- ----------
Total stockholders' equity 2,747,915 2,177,701
---------- ----------
$5,148,088 4,768,608
========== ==========
CONDENSED STATEMENTS OF INCOME
Year ended December 31,
---------------------------------
1997 1996 1995
-------- -------- --------
Revenues:
Cash dividends from the Bank $320,000 200,000 160,000
Interest income 4,323 16,665 2,338
-------- -------- --------
324,323 216,665 162,338
-------- -------- --------
Expenses:
Interest expense 189,657 191,234 220,988
Other operating expenses 81,850 43,846 34,276
-------- -------- --------
271,507 235,080 255,264
-------- -------- --------
Income (loss) before income tax benefit 52,816 (18,415) (92,926)
Income tax benefit 100,944 104,332 120,953
-------- -------- --------
Income before undistributed income 153,760 85,917 28,027
Equity in undistributed income of the Bank 388,461 400,112 365,588
-------- -------- --------
Net income $542,221 486,029 393,615
======== ======== ========
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
Cash flows from operating activities:
Net income $ 542,221 486,029 393,615
Adjustments:
Equity in undistributed income (388,461) (400,112) (365,588)
Decrease in other assets and liabilities, net 15,839 72,259 46,275
--------- --------- ---------
Net cash provided by operating activities 169,599 158,176 74,302
--------- --------- ---------
Cash flows from financing activities:
Payments on long-term debt (200,000) (100,000) (75,000)
--------- --------- ---------
Increase (decrease) in cash (30,401) 58,176 (698)
Cash at beginning of year 91,196 33,020 33,718
--------- --------- ---------
Cash at end of year $ 60,795 91,196 33,020
========= ========= =========
(18) Subsequent Events
On February 3, 1998, the Company merged with United Financial Corp.
("United") pursuant to an Agreement and Plan of Merger dated August 25,
1997, as amended, under which the Company was merged with and into
United. United Financial Corp. is the parent company of United Savings
Bank, a Great Falls, Montana federally chartered savings bank with
approximately $96 million in assets.
The merger resulted in a combined entity, United Financial Corp., with
two subsidiary banks (Heritage Bank and United Savings Bank) which will
be combined into one bank in 1998 called Heritage Bank. Under the terms
of the merger, the holders of the Company's common stock now own
approximately 30% of the new combined entity's common stock and the
stockholders of United Financial Corp. own approximately 70%.
As a condition of the merger, the Board of Directors of the combined
entity (the "Board") was increased to nine members and five persons
nominated by the Company shareholders (the "Heritage Nominees") were
elected to the Board. Consequently, the Heritage Nominees will now
constitute a majority of the Board. Three of the Heritage Nominees were
former Company shareholders and the other two are executive officers of
other entities controlled by Mr. Morrison. The Heritage Nominees,
representing a majority of the Board, will be able to select and control
the management of the combined entity as well as the board of directors
of the subsidiary banks.
The merger will be treated as a reverse acquisition accounted for as a
purchase of United by the Company. The Company is considered the
accounting acquiror because the Company effectively acquired the
operations of United, including its assets and liabilities, as a result
of the change in control and other related consequences of the merger.
Accordingly, the assets and liabilities of United will be recorded by the
Company at their respective fair values on the closing date. The purchase
consideration assumed to be paid to the United shareholders for financial
reporting purposes is calculated based on a valuation per share of $20.25
times the 1,223,312 shares of the Company's common stock assumed to be
issued. Any excess of the purchase consideration over the fair value of
identifiable tangible and intangible net assets will be assigned to
goodwill. Due to the difficulty and practicality in determining the value
of United Savings Bank's core deposit relationships and the value of
United Savings Bank's non-Great Falls markets being served, any such
intangible values are necessarily included in the amount of goodwill
recorded. As such, goodwill is expected to be amortized on a straight
line basis over a short period, currently not expected to exceed 10
years.
(Continued)
HERITAGE BANCORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Consistent with the Company being the acquiring corporation, the
historical financial statements of the combined entity commencing with
the quarter ended March 31, 1998 will be those of the Company.
Accordingly, the historical statements of operations of the combined
entity will only reflect the operations of United Financial Corp.
commencing on and after the closing date of the merger.
Immediately preceding the closing, the Company was required to pay off
its long-term debt with funding from a corresponding contribution of
capital. In connection with the merger, each outstanding share of Company
common stock was converted into 47.50 shares of United common stock (an
aggregate of 475,000 shares of United's common stock).
Accordingly, for financial reporting purposes, the merger will be
reported as if the Company was recapitalized at the closing date with
475,000 common shares outstanding and United acquired through the
issuance of 1,223,312 shares of Company common stock to United
shareholders.
In addition, John M. Morrison, the majority shareholder of the Company
prior to the merger, was granted certain rights of first refusal by
shareholders of United holding approximately 15.5% of United's
outstanding common stock. Under those rights of first refusal, such
shareholders may not sell their shares of the combined entity's common
stock for a period of two years without first offering such stock to Mr.
Morrison.
In February 1998, the Company purchased the assets of three loan
production facilities, located in Missoula, Hamilton and Libby, Montana,
for approximately $225,000.
(Concluded)
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
HERITAGE AND UNITED FINANCIAL
The following unaudited pro forma combined financial information gives
effect to the Merger of Heritage and United based on the purchase accounting
adjustments, estimates and other assumptions described in the accompanying
notes. The unaudited pro forma combined balance sheet and statement of income as
of and for the year ended December 31, 1997 are based upon the audited
consolidated balance sheet and statement of income of Heritage and United. The
unaudited pro forma combined balance sheet combines the historical consolidated
balance sheets of Heritage and United as if the Merger had become effective on
December 31, 1997. The unaudited pro forma combined statement of income for the
year ended December 31, 1997 combines the historical consolidated statements of
income of Heritage and United as if the Merger had become effective on January
1, 1997. Certain amounts in the historical financial statements of United have
been reclassified in the unaudited 1997 pro forma combined financial information
to conform to Heritage's historical financial statements.
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
HERITAGE AND UNITED FINANCIAL
UNAUDITED PRO FORMA COMBINED STATEMENTS OF FINANCIAL CONDITION HERITAGE AND
UNITED FINANCIAL
(Dollars in thousands)
At December 31, 1997
---------------------------------------------
Pro Forma Pro Forma
United Adjustments Combined
Heritage Financial (Unaudited) (Unaudited)
-------- --------- ----------- -----------
ASSETS
Cash and cash equivalents $ 9,869 $ 1,630 $ 11,499
Time deposits with banks 98 98
Investments:
Securities held-to-maturity 36,186 $ 183 (D) 36,369
Securities available-for-sale 14,219 17,332 31,551
------- ------- ------ --------
14,219 53,518 183 67,920
Loans receivable, net 56,796 36,317 678 (D) 93,791
Loans held for a sale 1,467 1,107 2,574
Goodwill 494 4 (D) 498
Real estate owned 349 554 (D) 903
FHLB stock 404 535 939
Accrued interest receivable 688 909 1,597
Premises and equipment 1,636 1,349 295 (D) 3,280
Income taxes (167) (49) 572 (D) 356
Other assets 548 279 (114)(C) 713
------- ------- ------ --------
$86,052 $95,944 $2,172 $184,168
======= ======= ====== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $70,386 $70,924 (47)(D) $141,263
Borrowed funds 2,350 (2,350)(D)
FHLB advances 6,425 6,425
Repurchase agreements 3,173 3,173
Advances for taxes and insurance 138 190 328
Deferred income taxes (133) (116) 676 (D) 427
Accrued interest payable 807 65 (38)(D) 834
Other liabilities 158 231 1,487 (D) 1,941
65 (D)
------- ------- ------ --------
83,304 71,294 (207) 154,391
Stockholders' equity:
Common stock & paid-in capital 1,080 8,849 (8,849)(A)
(126)(A)
2,389 (D)
24,766 (B) 28,109
Retained earnings-partially
Restricted 1,540 16,225 (16,225)(A) 1,540
Unrealized gain (loss) on
Securities available-for-sale 128 (424) 424 (A) 128
------- ------- ------ --------
2,748 24,650 2,379 29,777
------- ------- ------ --------
$86,052 $95,944 $2,172 $184,168
======= ======= ====== ========
See accompanying notes to pro forma financial information.
(Continued)
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
HERITAGE AND UNITED FINANCIAL
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME HERITAGE AND UNITED FINANCIAL
(Dollars in thousands, except share and per share data)
Year Ended December 31, 1997
-----------------------------------------------
United Pro Forma Pro Forma
Heritage Financial Adjustments Combined
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ----------- ----------- -----------
Interest Income:
Loans $4,530 $3,223 $(75)(D) $7,678
Investment securities 1,243 4,091 (61)(D) 5,273
------ ------ ---- ------
5,773 7,314 (136) 12,951
Interest Expense:
Deposits 2,635 3,293 16 (D) 5,944
Short-term borrowings 332 168 500
Long-term debt 190 (190)(D)
------ ------ ---- ------
3,157 3,461 (174) 6,444
------ ------ ---- ------
Net interest income 2,616 3,853 38 6,507
Provision for losses on loans 492 225 717
------ ------ ---- ------
Net interest income after
provision for losses on loans 2,124 3,628 38 5,790
Non-interest Income:
Fees and discounts 990 435 1,425
Other income 113 240 353
------ ------ ---- ------
1,103 675 1,778
Non-interest Expense:
Salaries and employee benefits 1,207 1,258 2,465
Net occupancy and equipment
Expense 228 257 42 (D) 527
Data processing expense 199 89 288
Other expenses 727 538 1,265
------ ------ ---- ------
2,361 2,142 42 4,545
------ ------ ---- ------
Income before income taxes 866 2,161 (4) 3,023
Provision for income tax 324 809 (2)(D) 1,131
------ ------ ---- ------
Net income $ 542 $1,352 $ (2) $1,892
====== ====== ==== ======
Net income per share $ 1.11
------
Weighted average shares outstanding 1,698,312
=========
See accompanying notes to pro forma financial information
(Continued)
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
HERITAGE AND UNITED FINANCIAL
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
NOTE A: BASIS OF PRESENTATION. The unaudited pro forma combined balance sheet
combines the historical consolidated balance sheets of Heritage and United as if
the Merger, which was effective February 3, 1998 (Effective Date), had become
effective on December 31, 1997. The unaudited pro forma combined statement of
income for the year ended December 31, 1997 combines the historical consolidated
statements of income of Heritage and United as if the Merger had become
effective on January 1, 1997. Certain amounts in the historical financial
statements of United have been reclassified in the unaudited pro forma combined
financial information to conform to Heritage's historical financial statements.
At the Effective Date, Heritage shareholders received 475,000 shares of
United common stock for all of the issued and outstanding common stock of
Heritage. Heritage was merged with United and Heritage Bank became a
wholly-owned subsidiary of United. Heritage is deemed the acquirer in the Merger
for accounting purposes, even though the former United shareholders owned,
immediately after the Merger, a majority of the outstanding shares of the
combined entity. Among other factors, this accounting treatment resulted from
the fact that both the Board of Directors and the ongoing management of the
combined entity (including the bank subsidiaries) are controlled by the former
Heritage shareholders.
The Merger was accounted for using the purchase method of accounting. Under
this method of accounting, assets and liabilities of United are adjusted to
their estimated fair value and combined with the historical recorded book values
of the assets and liabilities of Heritage. Applicable income tax effects of such
adjustments are included as a component of net deferred taxes with a
corresponding offset to goodwill. Additionally, United's unrealized loss on
securities available-for-sale and retained earnings are eliminated.
Accordingly, for financial reporting purposes, the Merger will be reported as
if Heritage was recapitalized at the Effective Date with 475,000 common shares
outstanding and United thereafter acquired through the issuance of 1,223,312
shares of United common stock to United shareholders. The total purchase price
consideration of United is calculated based on an average of the market price of
United shares immediately prior to and after the announcement of the Merger
($20.25) times the number of shares deemed issued to United shareholders plus
direct acquisition costs. The difference between the purchase price so
determined and the fair value of identifiable tangible and intangible net assets
of United at the Effective Date is recorded as goodwill.
Any transactions conducted in the ordinary course of business between
Heritage and United are immaterial and, accordingly, have not been eliminated.
Heritage Bank and United Bank will be merged in the future. The impact of such
merger is not expected to be material. Heritage also expects to achieve certain
operating cost savings as a result of the Merger, however, no pro forma
adjustment has been included in the unaudited pro forma combined financial
information for operating cost savings.
NOTE B: PURCHASE PRICE. Total pro forma acquisition consideration is calculated
as follows (in thousands):
Fair value of United common stock deemed issued $24,766
Less common stock issuance costs (126)
-------
Total purchase price consideration of stock issued 24,640
Direct acquisition costs 179
-------
Total acquisition consideration $24,819
=======
NOTE C: ALLOCATION OF PURCHASE PRICE. The actual revaluation of United's net
assets acquired is subject to the completion of studies and evaluations by
management and
(Continued)
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
HERITAGE AND UNITED FINANCIAL
will be based on the estimated fair value of the net assets acquired at the
Effective Date. Accordingly, the actual allocation of the purchase price is not
yet finalized and the portion of the purchase price allocated to fair value
adjustments, identifiable intangibles and goodwill is therefore subject to
change.
Subject to the foregoing, the purchase price has been allocated as estimated
below (in thousands):
United's historical net assets at December 31, 1997 $24,649
Estimated fair value adjustments at February 3, 1998:
Investment securities 183
Loans receivable 678
Premises, equipment and real estate owned 849
Deposits 47
Accrued expenses (1,487)
-------
Total adjustments 270
Estimated income tax effects at 38.5% (104)
-------
Net fair value adjustments 166
-------
Estimated fair value of net assets 24,815
Goodwill as if Merger was effective December 31, 1997 4
-------
Pro forma purchase price consideration $24,819
=======
NOTE D: PRO FORMA ADJUSTMENTS. For the unaudited pro forma statements of income,
the pro forma adjustments are based on the allocated purchase price of the net
assets acquired based on the fair value estimates at February 3, 1998 described
above applied as if the Merger had occurred on January 1, 1997.
United - The fair values at the Effective Date will be determined and the
related amortization will be calculated as follows:
Investment securities and loans will be adjusted to fair value based on
current interest rates at the Effective Date and the fair value adjustments
will be amortized to interest income over the average estimated life of the
underlying securities or loans, currently estimated to be three years and
nine years, respectively.
Premises and equipment will be adjusted to fair value based on current
market value valuations and the fair value adjustment will be depreciated
on a straight line basis over the remaining estimated economic life of the
related assets, currently estimated at 20 years.
The adjustments to accrued expenses include estimated severance costs under
existing United employment agreements, an anticipated data processing
termination expense and United's direct Merger related expenses.
For purposes of calculating pro forma adjustments, straight line
amortization has been used as any differences between the interest method
and the straight line method should not be significant. Goodwill resulting
from the Merger is expected to be amortized over 10 years.
Heritage - At the Effective Date, Heritage paid off all outstanding
long-term debt through a corresponding contribution of capital. Heritage
stockholders' equity, outstanding indebtedness and interest expense related
to this indebtedness has been eliminated based on the historical amount
incurred for the pro forma periods presented.
(Continued)
EXHIBIT INDEX
Exhibit
Number Description
- ------- ----------------------------------------------------------
2.1 United Savings Bank, F.A. Agreement and Plan of Reorganization, dated
as of February 26, 1996.
2.2 Agreement and Plan of Merger (the "Merger Agreement") dated August
25, 1997 by and between United Financial and Heritage (incorporated
by reference to Exhibit B of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997)
2.3 Amendment No. 1 to the Merger Agreement by and between United
Financial and Heritage, effective as of August 25, 1997 (incorporated
by reference to Exhibit 2.2 of the Company's Current Report on Form
8-K dated February 18, 1998)
3.1 Articles of Incorporation of United Financial Corp., as amended.
3.2 Bylaws of United Financial Corp., as amended.
10.1 Change of Control Severance Agreement
10.2 Schedule to Exhibit 10.1: Change of Control Severance Agreement
10.3 Form of Right of First Refusal Agreement granted by certain
shareholders owning 263,200 shares of the Company in favor of John
Morrison (incorporated by reference to Exhibit B to Schedule 13D for
John and Susan Morrison, filed on February 17, 1998)
21.1 Subsidiaries of the Company
27.1 Financial Data Schedule