Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period
from to
------------------- ---------------------
Commission file
number 0-22103
HEMLOCK FEDERAL FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 36-4126192
- ------------------------------------------ -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation Identification No.)
or organization)
5700 West 159th Street, Oak Forest , Illinois 60452
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area
code: (708) 687-9400
--------------------------------------
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such requirements for the past 90 days.
YES ____ X NO ____
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained herein, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $13.7 million.
The aggregate market value of the voting stock held by non-affiliates of
the registrant, computed by reference to the average of the bid and asked prices
of such stock on the Nasdaq Stock Market as of March 19, 1999, was $19.0
million. (The exclusion from such amount of the market value of the shares owned
by any person shall not be deemed an admission by the registrant that such
person is an affiliate of the registrant.)
As of March 22, 1999, there were issued and outstanding 1,785,974 shares of
the Issuer's Common Stock.
Transitional Small Business Disclosure Format (check one): Yes No X
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of Form 10-KSB - Annual Report to Stockholders for the fiscal
year ended December 31, 1998.
Part III of Form 10-KSB - Proxy Statement for 1999 Annual Meeting of
Stockholders.
PART I
Item 1. Business
General
Hemlock Federal Financial Corporation ("Hemlock" or the "Company") was
formed in 1997 by Hemlock Federal Bank for Savings ("Hemlock Federal" or the
"Bank") under the laws of Delaware for the purpose of becoming the savings and
loan holding company of the Bank. The Company's business consists primarily of
the business of Hemlock Federal.
Hemlock Federal is a federally chartered stock savings bank headquartered
in Oak Forest, Illinois. Hemlock Federal was originally chartered in 1904. In
1959, Hemlock Federal converted to a federal mutual charter. In 1997 Hemlock
Federal converted from a mutual to a federally chartered stock savings bank.
Hemlock Federal currently serves the financial needs of communities in its
market area through its main office located in Oak Forest, Illinois and its two
branch offices located in the village of Oak Lawn and Chicago. Its deposits are
insured up to applicable limits by the Federal Deposit Insurance Corporation
("FDIC"). At December 31, 1998, Hemlock Federal had total assets of $204.4
million, deposits of $143.1 million and equity of $27.2 million (or 13.31% of
total assets).
Hemlock Federal has been, and intends to continue to be, an independent,
community oriented, financial institution. Hemlock Federal's business involves
attracting deposits from the general public and using such deposits, together
with other funds, to originate primarily one- to four-family residential
mortgages and, to a much lesser extent, multi-family, consumer and other loans
primarily in its market area. At December 31, 1998, $87.0 million, or 84.79%, of
the Bank's total loan portfolio consisted of one- to four-family residential
mortgage loans. The Bank also invests in mortgage-backed and other securities
and other permissible investments.
The executive offices of the Bank are located at 5700 West 159th Street,
Oak Forest, Illinois 60452-3198 and its telephone number is (708) 687-9400.
Unless the context otherwise requires all references herein to the Bank or the
Company include the Company and the Bank on a consolidated basis.
Lending Activities
General. The principal lending activity of the Bank is originating for its
portfolio fixed and to a lesser extent, adjustable rate ("ARM") mortgage loans
secured by one- to four-family residences located primarily in the Bank's market
area. To a much lesser extent, Hemlock Federal also originates multi-family real
estate, consumer and other loans in its market area. At December 31, 1998, the
Bank's loans receivable, net totaled $102.0 million.
Under federal law, the aggregate amount of loans that the Bank is
permitted to make to any one borrower is generally limited to 15% of unimpaired
capital and surplus (25% if the security for such loan has a "readily
ascertainable" value or 30% for certain residential development
2
loans). At December 31, 1998, based on the above, the Bank's regulatory
loans-to-one borrower limit was approximately $3.9 million. On the same date,
the Bank had no borrowers with outstanding balances in excess of this amount. As
of December 31, 1998, the largest dollar amount outstanding or committed to be
lent to one borrower or group of related borrowers related to a multi-family
loan totaling $402,000 secured by a 12-unit apartment building located in
Bridgeview, Illinois. The second largest amount outstanding or committed to be
lent to one borrower or group of related borrowers as of December 31, 1998
related to a multi-family loan totaling $394,000 secured by a 12-unit apartment
building located in Chicago Ridge, Illinois. At December 31, 1998, this loan was
performing in accordance with its terms. As of December 31, 1998, there were no
other loans with carrying values in excess of $350,000.
All of the Bank's lending is subject to its written underwriting standards
and to loan origination procedures. Decisions on loan applications are made on
the basis of detailed applications and property valuations (consistent with the
Bank's appraisal policy). The loan applications are designed primarily to
determine the borrower's ability to repay and the more significant items on the
application are verified through use of credit reports, financial statements,
tax returns or confirmations. All loans originated by Hemlock Federal are
approved by the loan committee currently comprised of Chairman Partynski,
President Stevens, Director Bucz and Chief Lending Officer Neil Christenson and
ratified by the full Board of Directors.
The Bank requires title insurance or other evidence of title on its
mortgage loans, as well as fire and extended coverage casualty insurance in
amounts at least equal to the principal amount of the loan or the value of
improvements on the property, depending on the type of loan. The Bank also
requires flood insurance to protect the property securing its interest when the
property is located in a flood plain.
3
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio in dollar amounts and in percentages (before
deductions (or additions) for loans in process, deferred fees (premiums) and
discounts and allowances for losses) as of the dates indicated.
December 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ---------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- -------- ------ --------- -------- -------- ------- --------- -------- --------
(Dollars in Thousands)
Real Estate Loans:
One- to four-family.......... $87,041 84.79% $68,283 88.94% $48,339 89.05% $39,089 85.08% $30,792 80.45%
Multi-family................. 12,070 11.76 4,951 6.45 2,783 5.13 3,386 7.37 3,742 9.78
Commercial................... 191 .18 209 .27 573 1.06 1,101 2.40 1,566 4.09
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------
Total real estate loans.... 99,302 96.73 73,443 95.66 51,695 95.24 43,576 94.85 36,100 94.32
Consumer loans:
Deposit account.............. 129 .13 116 .15 169 .31 158 0.34 150 0.39
Automobile................... 381 .37 473 .62 301 .55 229 0.50 120 0.31
Home equity.................. 2,844 2.77 2,740 3.57 2,114 3.90 1,981 4.31 1,908 4.98
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------
Total consumer loans....... 3,354 3.27 3,329 4.34 2,584 4.76 2,368 5.15 2,178 5.68
-------- ------- ------- ------- ------- ------- ------- ------- -------
Total loans................ 102,656 100.00% 76,772 100.00% 54,279 100.00% 45,944 100.00% 38,278 100.00%
====== ====== ====== ====== ======
Less:
Loans in process............. (313) (125) --- (28) ---
Deferred fees and discounts.. 409 287 2 (84) (150)
Allowance for losses......... (775) (775) (745) (600) (469)
-------- ------- ------- ------- -------
Total loans receivable, net $101,977 $76,159 $53,536 $45,232 $37,659
======== ======= ======= ======= =======
4
The following table shows the composition of the Bank's loan portfolio by
fixed-and adjustable-rate at the dates indicated.
December 31,
---------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ----------------- ----------------- -------------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
----------------- ----------------- ----------------- -------------------- -------------------
(Dollars in Thousands)
Fixed-Rate Loans:
Real estate:
One- to four-family.......... $76,331 74.36% $50,671 66.00% $43,583 80.29% $36,358 79.14% $28,654 74.86%
Multi-family................. 11,887 11.58 4,767 6.21 2,783 5.13 3,386 7.37 3,742 9.78
Commercial................... 191 .18 209 .27 573 1.06 1,101 2.40 1,566 4.09
Construction or development.. --- --- --- --- --- --- --- --- --- ---
-------- ------- ------- ------ ------- ------ ------- ------ ------- ------
Total real estate loans.... 88,409 86.12 55,647 72.48 46,939 86.48 40,845 88.91 33,962 88.73
Consumer..................... 3,354 3.27 3,329 4.34 2,584 4.76 2,368 5.15 2,178 5.68
-------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate loans..... 91,763 89.39 58,976 76.82 49,523 91.24 43,213 94.06 36,140 94.41
Adjustable-Rate Loans:
Real estate:
One-to four-family........... 10,710 10.43 17,612 22.94 4,756 8.76 2,731 5.94 2,138 5.59
Multi-family................. 183 .18 184 .24 --- --- --- --- --- ---
-------- ------- ------- ------ ------ ------ ------ ------ ------ ------
Total adjustable rate loans.. 10,893 10.61 17,796 23.18 4,756 8.76 2,731 5.94 2,138 5.59
-------- ------- ------- ------ ------ ------ ------ ------ ------ ------
Total loans................ 102,656 100.00% 76,772 100.00% 54,279 100.00% 45,944 100.00% 38,278 100.00%
======= ====== ====== ====== ======
Less:
- ----
Loans in process............. (313) (125) --- (28) ---
Deferred fees and discounts.. 409 287 2 (84) (150)
Allowance for losses......... (775) (775) (745) (600) (469)
-------- ------- ------- ------- -------
Total loans receivable, net $101,977 $76,159 $53,536 $45,232 $37,659
======== ======= ======= ======= =======
5
The following schedule illustrates the contractual maturity of the Bank's
loan portfolio at December 31, 1998. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
Real Estate
---------------------------------------
Multi-family and
Commercial Real
One- to four-family Estate Consumer Total
------------------- ------------------- -------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
------------------- ------------------- -------------------- -------------------
(Dollars in Thousands)
Due During Year(s) Ended
December 31,
1999(1)................... $ 5 7.50% $ --- ---% $ 222 10.29% $ 227 10.22%
2000 and 2001............. 901 7.94 111 8.93 1,078 8.02 2,090 8.04
2002 to 2006.............. 9,857 7.26 1,658 7.90 1,426 8.36 12,941 7.46
2007 to 2021.............. 44,889 7.08 9,789 7.63 628 8.46 55,306 7.20
2022 and following........ 31,389 7.31 703 7.80 --- --- 32,092 7.32
------- ------- ------ -------
Total................. $87,041 $12,261 $3,354 $102,656
======= ======= ====== ========
- -------------
(1) Included demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after December 31, 1999 which have
predetermined interest rates is $91.5 million while the total amount of loans
due after such dates which have floating or adjustable interest rates is $10.9
million.
6
One- to Four-Family Residential Real Estate Lending. The cornerstone of
the Bank's lending program is the origination of loans secured by mortgages on
owner-occupied one- to four- family residences. Historically, the Bank focused
its residential lending activities on fixed rate loans with 30 year terms. In
the 1980s, in order to reduce the average term to repricing of its assets, the
Bank began to stress also the origination of 15 year fixed rate loans as well as
adjustable rate loans. Substantially all of the Bank's one- to four-family
residential mortgage originations are secured by properties located in its
market area. All mortgage loans currently originated by the Bank are retained
and serviced by it, although the Bank may consider selling a portion of its
residential loan originations in the future.
The Bank currently offers fixed-rate mortgage loans with maturities from
10 to 30 years. The Bank also offers a fixed rate seven year balloon product
with a 30 year amortization schedule which is due in seven years but which,
under certain circumstances, may be converted into a fully amortizing fixed rate
loan for an additional term of up to 23 years. Interest rates and fees charged
on these fixed-rate loans are established on a regular basis according to market
conditions. As of December 31, 1998, the Bank had $8.5 million of fixed rate
loans (most of which were seven year balloon loans) with original terms of less
than 10 years, $39.6 million of fixed rate loans with original terms of 10-15
years and $28.2 million of fixed rate loans with original terms of more than 15
years. See "--Originations, Purchases and Sales and Loans and Mortgage-Backed
Securities."
The Bank also offers ARMs which carry interest rates which adjust annually
at a margin (generally 250 basis points) over the yield on the One Year Average
Monthly U.S. Treasury Constant Maturity Index ("one year CMT"). Such loans may
carry terms to maturity of up to 30 years. The ARM loans currently offered by
the Bank provide for up to 200 basis point annual interest rate change cap and a
lifetime cap generally 600 basis points over the initial rate. Initial interest
rates offered on the Bank's ARMs may be approximately 100 basis points below the
fully indexed rate, although borrowers are qualified at the fully indexed rate.
As a result, the risk of default on these loans may increase as interest rates
increase. The Bank also originates ARMs which carry interest rates which are
fixed for an initial term of up to five years and subsequently adjust annually
to a margin over the one-year CMT. The Bank's ARMs do not permit negative
amortization of principal, do not contain prepayment penalties and may be
convertible into fixed-rate loans. At December 31, 1998, one- to four-family
ARMs totaled $10.7 million or 10.43% of the Bank's total loan portfolio.
Hemlock Federal will generally lend up to 90% of the lesser of the sales
price or appraised value of the security property on owner occupied one- to
four-family loans. The loan-to-value ratio on non-owner occupied, one- to
four-family loans is generally 80% of the lesser of the sales price or appraised
value of the security property. Non-owner occupied one-to four-family loans may
pose a greater risk to the Bank than traditional owner occupied one- to
four-family loans. In underwriting one- to four-family residential real estate
loans, the Bank currently evaluates both the borrower's ability to make
principal, interest and escrow payments, the value of the property that will
secure the loan and debt to income ratios.
7
Residential loans do not currently include prepayment penalties, are
non-assumable and do not produce negative amortization. Although the Bank
currently originates mortgage loans only for its portfolio, the Bank's loans are
generally underwritten to permit their sale in the secondary market, except for
loans with loan to value ratios below 75% which are underwritten for portfolio
with a limited property evaluation rather than full appraisal.
While the Bank seeks to originate most of its one- to four-family
residential loans in amounts which are less than or equal to the applicable
Federal Home Loan Mortgage Corporation maximum (currently $240,000), the Bank
does, on an exception basis, make one-to four-family residential loans in
amounts in excess of such maximum. The Bank's delinquency experience on such
loans has been similar to its experience on its other residential loans.
The Bank's residential mortgage loans customarily include due-on-sale
clauses giving the Bank the right to declare the loan immediately due and
payable in the event that, among other things, the borrower sells or otherwise
disposes of the property subject to the mortgage and the loan is not repaid.
Multi-family and Commercial Real Estate Lending. In order to increase the
yield of its loan portfolio and to complement residential lending opportunities,
the Bank from time to time originates permanent multi-family real estate loans
secured by properties in its primary market area. The Bank made a strategic
decision in the early 1990s to eliminate its commercial real estate lending
program. At December 31, 1998, the Bank had multi-family loans totaling $12.1
million, or 11.76% of the Bank's total loan portfolio, and $191,000 in
commercial real estate loans, representing 0.18% of the total loan portfolio.
The Bank's permanent multi-family real estate loans generally carry a
maximum term of 15 years and have fixed rates. These loans are generally made in
amounts of up to 80% of the lesser of the appraised value or the purchase price
of the property. Appraisals on properties securing multi-family and commercial
real estate loans are performed by an independent appraiser designated by the
Bank at the time the loan is made. All appraisals on multi-family real estate
loans are reviewed by the Bank's loan committee. In addition, the Bank's
underwriting procedures require verification of the borrower's credit history,
income and financial statements, banking relationships, references and income
projections for the property. The Bank obtains personal guarantees on these
loans.
At December 31, 1998, the Bank's largest commercial real estate or
multi-family loan outstanding totaled $402,000 and was secured by a 12-unit
apartment building in Bridgeview, Illinois.
Multi-family and commercial real estate loans may present a higher level
of risk than loans secured by one- to four-family residences. This greater risk
is due to several factors, including the concentration of principal in a limited
number of loans and borrowers, the effects of general economic conditions on
income producing properties and the increased difficulty of evaluating and
monitoring these types of loans. While the Bank has experienced losses on
several multi-family
8
and commercial real estate loans in the past, as of December 31, 1998, there
were no multi-family loans or commercial real estate loans delinquent 90 days or
more.
Consumer Lending. Management believes that offering consumer loan products
helps to expand the Bank's customer base and to create stronger ties to its
existing customer base. In addition, because consumer loans generally have
shorter terms to maturity and carry higher rates of interest than do residential
mortgage loans, they can be valuable asset/liability management tools. The Bank
originates a variety of different types of consumer loans, including home equity
loans, automobile and deposit account loans for household and personal purposes.
Due to the tax advantages to the borrower of home equity loans, the Bank has
focused its recent consumer lending activities on home equity lending. At
December 31, 1998 consumer loans totaled $3.4 million or 3.27% of total loans
outstanding.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The Bank's consumer
loans are made at fixed interest rates, with terms of up to 10 years.
The Bank's home equity loans are written so that the total commitment
amount, when combined with the balance of the first mortgage lien, may not
exceed 85% of the appraised value of the property or $50,000. These loans are
written with fixed terms of up to 10 years and carry fixed interest rates. At
December 31, 1998, the Bank's home equity loans totaled $2.8 million, or 2.77%
of the Bank's total loan portfolio. In 1998 the Bank also began offering home
equity lines of credit to qualifying borrowers. These loans, when combined with
the balance of a first mortgage lien, may not exceed 90% if the first mortgage
lien is held by the Bank, or 80% if the first mortgage lien is held elsewhere,
or in either case $100,000. At December 31, 1998, the Bank's home equity lines
of credit totaled $522,000 outstanding, or 0.5% of the Bank's total loan
portfolio.
The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's payment history on other debts and ability to
meet existing obligations and payments on the proposed loan. Although
creditworthiness of the applicant is of primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount. Consumer loans may entail greater credit
risk than do residential mortgage loans, particularly in the case of consumer
loans which are unsecured or are secured by rapidly depreciable assets, such as
automobiles. In such cases, any repossessed collateral for a defaulted consumer
loan may not provide an adequate source of repayment of the outstanding loan
balance as a result of the greater likelihood of damage, loss or depreciation.
In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be affected by
adverse personal circumstances. Furthermore, the application of various federal
and state laws, including bankruptcy and insolvency laws, my limit the amount
which can be recovered on such loans.
9
Originations of Loans
Real estate loans are originated by Hemlock Federal's staff through
referrals from existing customers or real estate agents. In the early 1990s, the
Bank determined to increase its one- to four-family residential loan marketing
activities and to hire several commissioned loan underwriters. As a result, the
Bank has experienced significant loan growth in recent years.
The Bank's ability to originate loans is dependent upon customer demand
for loans in its market and to a limited extent, various marketing efforts and
its ability to hire commissioned loan officers. Demand is affected by both the
local economy and the interest rate environment. See "- Market Area." Under
current policy, all loans originated by Hemlock Federal are retained in the
Bank's portfolio. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Asset/Liability Management" in the Annual
Report attached hereto as Exhibit 13.
In order to supplement loan originations, the Bank has acquired a
substantial amount of mortgage-backed and other securities which are held,
depending on the investment intent, in the "held-to-maturity" or
"available-for-sale" portfolios. See "Investment Activities - Mortgage- Backed
and Related Securities." In addition, depending on market conditions, the Bank
may also consider the purchase of residential loans from other lenders.
As a result in large part of the Bank's relatively low loans to deposits
ratios since the early 1980s, the Bank has not sold any loans in the secondary
market for many years. In view of the apparent success of the Bank's recent loan
origination efforts and the related increases in its loans to deposits ratio,
the Bank may consider the sale of a portion of its residential loan originations
in the future.
10
The following table shows the loan origination and repayment activities of
the Bank for the periods indicated.
Year Ended
December 31,
-------------------------------------
1998 1997 1996
------------- ------------ ---------
(In Thousands)
Originations by type:
Adjustable rate:
Real estate - one- to four-family...... $ 981 $ 1,852 $2,569
- multi-family......... --- 185 ---
-------- ------- ------
Total adjustable-rate............ 981 2,037 2,569
Fixed rate:
Real estate - one- to four-family...... 37,090 12,782 11,439
- multi-family......... 8,062 2,358 404
Non-real estate - consumer............. 1,838 2,158 1,308
-------- ------- ------
Total fixed-rate................. 46,990 17,298 13,151
-------- ------- ------
Total loans originated......... 47,971 19,335 15,720
Purchases;
Real estate - one- to four-family...... --- 12,607 ---
Principal repayments..................... (22,087) (9,449) (7,385)
-------- ------- ------
Total reductions................. (22,087) (9,449) (7,385)
Increase (decrease) in other items, net.. (66) 130 (31)
-------- ------- ------
Net increase..................... $ 25,818 $22,623 $8,304
======== ======= ======
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required payment
on a loan, the Bank attempts to cure the delinquency by contacting the borrower.
Generally, Bank personnel work with the delinquent borrower on a case by case
basis to solve the delinquency. Generally, a late notice is sent on all
delinquent loans followed by a phone call after the thirtieth day of
delinquency. Additional written and verbal contacts may be made with the
borrower between 30 and 60 days after the due date. If the loan is contractually
delinquent for 90 days, the Bank may institute appropriate action to foreclose
on the property. After 120 days, foreclosure procedures are initiated. If
foreclosed, the property is sold at public sale and may be purchased by the
Bank.
Real estate acquired by Hemlock Federal as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned until it is sold.
When property is acquired by foreclosure or deed in lieu of foreclosure, it is
recorded at the lower of cost or fair value less estimated selling costs. After
acquisition, all costs incurred in maintaining the property are expensed. Costs
relating to the development and improvement of the property, however, are
capitalized.
11
Delinquent Loans. The following table sets forth information concerning
delinquent mortgage and other loans at December 31, 1998. The amounts presented
represent the total remaining principal balances of the related loans, rather
than the actual payment amounts which are overdue. Percentages are exclusive of
mortgage-backed securities.
Real Estate
---------------------------------------------------
One- to four-family Commercial/Multi-Family Consumer and Other Total
------------------------ -------------------------- -------------------------- ---------------------------
Number Amount Percent Number Amount Percent Number Amount Percent Number Amount Percent
------- ------- -------- ------ --------- --------- -------- -------- -------- -------- -------- ---------
(Dollars in Thousands)
Loans delinquent for
December 31, 1998:
30-59 days............. --- $ --- ---% --- $ --- ---% --- $ --- ---% --- $ --- ---%
60-89 days............. 5 269 0.31 --- --- --- --- --- --- 5 269 0.26
90 days and over....... 3 124 0.14 --- --- --- --- --- --- 3 124 0.12
----- ----- ---- ----- ---- ------ ----- ------ ----- ---- ------ ----
Total.............. 8 $ 393 0.45% --- $ --- ---% --- $ --- ---% 8 $ 393 0.38%
===== ===== ==== ===== ====== ====== ===== ====== ===== ==== ====== ====
12
Classification of Assets. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets: Substandard,
Doubtful and Loss. Substandard assets have one or more defined weaknesses and
are characterized by the distinct possibility that the Bank will sustain some
loss if the deficiencies are not corrected. Doubtful assets have the weaknesses
of Substandard assets, with the additional characteristics that the weaknesses
make collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified Loss is considered uncollectible and of such little value that
continuance as an asset on the balance sheet of the institution is not
warranted. Assets classified as Substandard or Doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as a loss, the institution charges off such amount against
the loan loss allowance. If an institution does not agree with an examiner's
classification of an asset, it may appeal this determination to the District
Director of the OTS.
On the basis of management's review of its assets, at December 31, 1998,
the Bank had classified a total of $393,000 of its loans and other assets as
follows:
December 31,
1998
--------------
(In Thousands)
Special Mention............... $ 393
Substandard................... ---
Doubtful...................... ---
Loss.......................... ---
---------
Total.................... 393
=========
General loss allowance........ 775
=========
Specific loss allowance....... ---
=========
Charge-offs................... 21
=========
13
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Bank's loan portfolio. Foreclosed
assets include assets acquired in settlement of loans.
December 31,
------------------------------
1998 1997 1996
-------- ---------- ----------
(Dollars in Thousands)
Non-accruing loans:
One- to four-family......... $124 $256 $ ---
Multi-family................ --- --- ---
Commercial real estate...... --- --- ---
Construction or development. --- --- ---
Consumer.................... --- --- ---
------- ------- ------
Total.................. 124 256 ---
Accruing loans delinquent
more than 90 days:............ --- --- ---
One- to four-family......... --- --- ---
Multi-family................ --- --- ---
Commercial real estate...... --- --- ---
Construction or development. --- --- ---
Consumer.................... --- --- ---
------ ------ ------
Total.................. --- --- ---
Foreclosed assets:
One- to four-family......... --- --- ---
Multi-family................ --- --- ---
Commercial real estate...... --- --- ---
Construction or development. --- --- ---
Consumer.................... --- --- ---
------ ------ ------
Total.................. --- --- ---
Renegotiated loans............
Total non-performing assets... $ 124 $ 256 $ ---
===== ===== ======
Total as a percentage of
total assets.................. .06% .15% ---%
===== ===== ======
For the years ended December 31, 1998 and 1997, gross interest income
which would have been recorded had the non-accruing loans been current in
accordance with their original terms amounted to $10,493 and $19,713,
respectively. The amounts that were included in interest income on such loans
were $6,902 and $13,165 for the years ended December 31, 1998 and 1997,
respectively.
14
Management considers the Bank's non-performing and "of concern" assets in
establishing its allowance for loan losses.
The following table sets forth an analysis of the Bank's allowance for
loan losses.
Year Ended December 31,
---------------------------
1998 1997 1996
-------- --------- --------
(Dollars in Thousands)
Balance at beginning of period.. $775 $745 $600
Charge-offs:
One- to four-family........... 21 --- 5
Multi-family.................. --- --- ---
Commercial real estate........ --- --- ---
Consumer...................... --- --- ---
------ ----- -----
21 --- 5
----- ----- ----
Recoveries:
One- to four-family........... --- --- ---
Multi-family.................. --- --- ---
Commercial real estate........ --- --- ---
Consumer...................... --- --- ---
----- ----- -----
--- --- ---
----- ----- -----
Net charge-offs................. (21) --- (5)
Additions charged to operations. 21 30 150
----- ----- -----
Balance at end of period........ $775 $775 $745
==== ==== ====
Ratio of net charge-offs
(recoveries) during the period
to average loans outstanding
during the period.............. 0.02% ---% 0.01%
Ratio of net charge-offs
(recoveries) during
the period to average
non-performing assets.......... 12.96% ---% 3.52%
===== ==== =====
15
The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:
December 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ -------------------------------- --------------------------------
Percent Percent Percent
of loans of loans of loans
Amount Loan in Each Amount Loan in Each Amount Loan in Each
of loan Amounts Category of loan Amounts Category of loan Amounts Category
loss by of Total loss by of Total loss by of Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
--------- ---------- --------- ---------- ----------- --------- ---------- ----------- ---------
(In Thousands)
One- to four-family... $174 $ 87,041 84.79% $341 $68,283 88.94% $242 $48,339 89.05%
Multi-family.......... 119 12,070 11.76 149 4,951 6.45 83 2,783 5.13
Commercial real estate 6 191 .18 11 209 .27 29 573 1.06
Consumer.............. 10 3,354 3.27 18 3,329 4.34 13 2,584 4.76
Unallocated........... 466 --- --- 256 --- --- 378 --- ---
---- -------- ------ ---- ------- ------ ---- ------- ------
Total.......... $775 $102,656 100.00% $775 $76,772 100.00% $745 $54,279 100.00%
==== ======== ====== ==== ======= ====== ==== ======= ======
The allowance for loan losses is established through a provision for loan
losses charged to earnings based on management's evaluation of the risk inherent
in its entire loan portfolio. Such evaluation, which includes a review of all
loans of which full collectibility may not be reasonably assured, considers the
market value of the underlying collateral, growth and composition of the loan
portfolio, delinquency trends, adverse situations that may affect the borrower's
ability to repay, prevailing and projected economic conditions and other factors
that warrant recognition in providing for an adequate allowance for loan losses.
In determining the general reserves under these policies, historical charge-offs
and recoveries, changes in the mix and levels of the various types of loans, net
realizable values, the current and prospective loan portfolio and current
economic conditions are considered.
While management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen economic and market
conditions could result in adjustments to the allowance for loan losses, and net
earnings could be significantly affected, if circumstances differ substantially
from the assumptions used in making the final determination.
Investment Activities
General. Hemlock Federal must maintain minimum levels of investments and
other assets that qualify as liquid assets under OTS regulations. Liquidity may
increase or decrease depending upon the availability of funds and comparative
yields on investments in relation to the return on loans. Historically, Hemlock
Federal has maintained liquid assets at levels significantly above the minimum
requirements imposed by the OTS regulations and above levels believed adequate
to meet the requirements of normal operations, including potential deposit
outflows. At December 31, 1998, Hemlock Federal's liquidity ratio for regulatory
purposes was 10.45%.
Generally, the investment policy of Hemlock Federal is to invest funds
among categories of investments and maturities based upon the Bank's
asset/liability management policies, investment quality, loan and deposit
volume, liquidity needs and performance objectives.
16
As required by SFAS 115, securities are classified into three categories:
trading, held-to-maturity and available-for-sale. Securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and are reported at fair value with unrealized gains and
losses included in trading account activities in the statement of operations.
Securities that Hemlock Federal has the positive intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized cost. All
other securities not classified as trading or held-to-maturity are classified as
available-for-sale. At December 31, 1998, Hemlock Federal had no securities
which were classified as trading and $52.5 million of mortgage-backed and
related securities and $6.1 million of other securities classified as
held-to-maturity. Available-for-sale securities are reported at fair value with
unrealized gains and losses included, on an after-tax basis, in a separate
component of retained earnings. At December 31, 1998, $28.7 million of
mortgage-backed and related securities and $1.8 million of other securities were
classified as available-for-sale.
Mortgage-Backed and Related Securities. In order to supplement its lending
activities and achieve its asset liability management goals, the Bank invests in
mortgage-backed and related securities. As of December 31, 1998, all of the
mortgage-backed and related securities owned by the Bank are issued, insured or
guaranteed either directly or indirectly by a federal agency or are rated "AAA"
by a nationally recognized credit rating agency. However, it should be noted
that, while a (direct or indirect) federal guarantee or a high credit rating may
indicate a high degree of protection against default, they do not indicate that
the securities will be protected from declines in value based on changes in
interest rates or prepayment speeds.
Consistent with its asset/liability management strategy, at December 31,
1998, $60.5 million, or 74.5% of Hemlock Federal's mortgage-backed and related
securities had adjustable or floating interest rates. In addition, as discussed
below, as of the same date, the Bank had $12.8 million of fixed rate
collateralized mortgage obligations ("CMOs") and real estate mortgage investment
conduits ("REMICs") with anticipated average lives of five years or less.
The Bank's CMOs and REMICs are securities derived by reallocating the cash
flows from mortgage-backed securities or pools of mortgage loans in order to
create multiple classes, or tranches, of securities with coupon rates and
average lives that differ from the underlying collateral as a whole. The terms
to maturity of any particular tranche is dependent upon the prepayment speed of
the underlying collateral as well as the structure of the particular CMO or
REMIC. Although a significant proportion of the Bank's CMOs and REMICs are
interests in tranches which have been structured (through the use of cash flow
priority and "support" tranches) to give somewhat more predictable cash flows,
the cash flow and hence the value of CMOs and REMICs is subject to change.
The Bank invests in CMOs and REMICs as an alternative to mortgage loans
and conventional mortgage-backed securities as part of its asset/liability
management strategy.
17
Management believes that CMOs and REMICs represent attractive investment
alternatives relative to other investments due to the wide variety of maturity
and repayment options available through such investments. In particular, the
Bank has from time to time concluded that short and intermediate duration CMOs
and REMICs (five year or less average life) often represent a better combination
of rate and duration than adjustable rate mortgage-backed securities.
The following table sets forth the composition of the Bank's
mortgage-backed securities at the dates indicated.
December 31,
-----------------------------------------------------------------------------
1998 1997 1996
-------------------------- ---------------------- ------------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----------- ------------ ---------- --------- ----------- -----------
(Dollars in Thousands)
Mortgage-backed
securities
held-to- maturity:
GNMA................. $ 19,186 24.23% $ 4,328 7.02% $ 3,058 4.81%
FNMA................. 13,607 17.18 11,977 19.42 13,916 21.89
FHLMC................ 8,007 10.11 7,773 12.61 10,094 15.88
CMOs................. 11,716 14.79 7,605 12.33 2,469 3.88
-------- ------ ------- ------ ------- -----
52,516 66.31 31,683 51.38 29,537 46.46
Mortgage-backed
securities
available-for- sale:
FNMA................. 4,118 5.20 7,777 12.61 12,821 20.17
FHLMC................ 3,434 4.34 5,347 8.67 7,742 12.17
CMOs................. 19,130 24.15 16,859 27.34 13,478 21.20
-------- ------ ------- ------ ------- ------
26,682 33.69 29,983 48.62 34,041 53.54
-------- ------ ------- ------ ------- ------
Total mortgage-backed
securities............ $ 79,198 100.00% $61,666 100.00% $63,578 100.00%
======== ====== ======= ====== ======= ======
18
The following table sets forth the contractual maturities of the Bank's
mortgage-backed securities at December 31, 1998.
December 31,
Due in 1998
------------------------------------------------------------------- --------------------
6 Months 6 Months 1 to 3 to 5 5 to 10 10 to 20 Over 20 Amortized Carrying
or Less to 1 Year 3 Years Years Years Years Years Cost Value
-------- --------- ------- ------- ------- -------- --------- ---------- --------
(In Thousands)
Federal Home Loan Mortgage Corporation.... $ --- $ --- $ 45 $ --- $ 896 $ 5,166 $ 5,218 $ 11,325 $ 11,441
Federal National Mortgage Association..... --- --- 841 --- 323 7,545 8,913 17,622 17,725
Government National Mortgage Association.. --- --- 13 --- 73 1,050 18,050 19,186 19,186
CMOs ..................................... --- --- 60 82 6,999 1,688 21,937 30,766 30,846
------ ------ ------ ----- ------ ------- -------- -------- --------
Total................................ $ --- $ --- $ 959 $ 82 $8,291 $15,449 $ 54,118 $ 78,899 $ 79,198
====== ====== ====== ===== ====== ======= ======== ======== ========
Weighted average yield.................... --- --- 7.41% 9.00% 6.43% 7.78% 6.92% 7.04% 7.01%
19
As of December 31, 1998, the Bank did not have any mortgage-backed
securities in excess of 10% of retained earnings except for FNMA, FHLMC and GNMA
issues, amounting to $17.7 million, $11.4 million and $19.2 million,
respectively.
The market values of a portion of the Bank's mortgage-backed securities
held-to-maturity have been from time to time lower than their carrying values.
However, for financial reporting purposes, such declines in value are considered
to be temporary in nature since they have been due to changes in interest rates
rather than credit concerns.
The following table shows mortgage-backed securities purchase, sale and
repayment activities of the Bank for the periods indicated.
Year Ended December 31,
--------------------------------------
1998 1997 1996
----------- ------------ -----------
(In Thousands)
Purchases:
Adjustable-rate..................... $ --- $ 3,561 $11,960
Fixed-rate.......................... 25,680 --- ---
CMOs................................ 25,698 14,179 10,075
--------- ------- -------
Total purchases.............. 51,378 17,740 22,035
Sales:
Adjustable-rate..................... --- --- 979
Fixed-rate.......................... --- --- ---
CMOs................................ 1,911 --- 3,754
--------- ------- -------
Total sales................. 1,911 --- 4,733
Principal repayments................ (32,017) (19,865) (22,112)
Discount/premium net change......... 333 (91) (230)
Fair value net change............... (251) 304 (108)
--------- ------- -------
Net increase (decrease)...... $ 17,532 $(1,912) $(5,148)
========= ======= =======
The Bank continues to maintain a substantial portion of its assets in
mortgage-backed securities, although in recent years the percentage of such
securities to total assets has decreased. Since pass-through mortgage-backed
securities generally carry a yield approximately 50 to 100 basis points below
that of the corresponding type of residential loan (due to the implied federal
agency guarantee fee and the retention of a servicing spread by the loan
servicer), and the Bank's CMOs and REMICs also carry lower yields (due to the
implied federal agency guarantee and because such securities tend to have
shorter actual durations than 30 year loans), in the event that the proportion
of the Bank's assets consisting of mortgage-backed and related securities
increases, the Bank's asset yields could be somewhat adversely affected. The
Bank will evaluate mortgage-backed and related securities purchases in the
future based on its asset/liability objectives, market conditions and
alternative investment opportunities.
20
Securities. Federally chartered savings institutions have the authority to
invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers' acceptances,
repurchase agreements and federal funds. Subject to various restrictions,
federally chartered savings institutions may also invest their assets in
commercial paper, investment grade corporate debt securities and mutual funds
whose assets conform to the investments that a federally chartered savings
institution is otherwise authorized to make directly.
In order to complement its lending and mortgage-backed securities
investment activities and to increase its holding of short and medium term
assets, the Bank invests in liquidity investments and in high-quality
investments, such as U.S. Treasury and agency obligations. At December 31, 1998,
the Bank's securities portfolio totaled $7.9 million. At December 31, 1998, the
Bank did not own any securities of a single issuer which exceeded 10% of the
Bank's retained earnings, other than federal agency obligations.
The following table sets forth the composition of the Bank's securities
and other earning assets at the dates indicated.
December 31,
----------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
---------------------- ---------------------- ----------------------
(Dollars in Thousands)
Securities held-to-maturity:
Federal agency obligations........... $ 6,101 77.12% $14,735 80.29% $ --- ---%
Securities available-for sale:
Federal agency obligations........... 1,810 22.88 3,617 19.71 7,827 100.00
------- ------ ------- ------ ------- ------
Total securities................ $ 7,911 100.00% $18,352 100.00% $ 7,827 100.00%
======= ====== ======= ====== ======= ======
Average remaining life of securities: 3 years 4 years 1 year
Other earning assets:
Interest-earning deposits with banks. $ 3,107 47.42% $12,169 85.34% $15,639 90.45%
FHLB stock........................... 1,850 28.24 987 6.92 901 5.21
FHLMC stock.......................... 1,595 24.34 1,103 7.74 751 4.34
------- ------ ------- ------ ------- ------
Total.......................... $ 6,552 100.00% $14,259 100.00% $17,291 100.00%
======= ====== ======= ====== ======= ======
21
The composition and maturities of the securities portfolio, excluding FHLB
stock, are indicated in the following table.
December 31, 1998
-------------------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over
1 Year Years Years 10 years Total Securities
------------ ----------- ----------- ----------- ---------------------------
Book Value Book Value Book Value Book Value Book Value Carrying Value
------------ ----------- ----------- ----------- ----------- --------------
(Dollars in Thousands)
Federal agency obligations... $ 2,475 $ 3,164 $ 2,266 $ --- $ 7,905 $ 7,911
-------- -------- -------- ------ -------- ---------
Weighted average yield....... 4.38% 6.24% 6.64% ---% 5.82% 5.81%
======== ======== ======== ====== ======== =========
Sources of Funds
General. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and funds provided from
operations.
Deposits. Hemlock Federal offers deposit accounts having a wide range of
interest rates and terms. The Bank's deposits consist of passbook, NOW, money
market and various certificate accounts. The Bank relies primarily on
competitive pricing and customer service to attract and retain these deposits.
The Bank's customers may access their accounts through any of the Bank's four
offices and three automated teller machines. In addition, the Bank's customers
may access their accounts through CIRRUS, a nationwide ATM network. The Bank
only solicits deposits in its market area and does not currently use brokers to
obtain deposits.
The variety of deposit accounts offered by the Bank has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As a result, as customers have become more interest rate
conscious, the Bank has become more susceptible to short-term fluctuations in
deposit flows.
The Bank manages the pricing of its deposits in keeping with its
asset/liability management, profitability and growth objectives. While the Bank
experienced deposit growth of 9.31% in 1998, management believes this growth was
due primarily to the consolidation of competition within its market area, and is
therefore not sustainable. However, with the opening of a fourth full service
branch office in Lemont, Illinois in December, 1998, management believes that
deposit growth for the Bank will be greater than that experienced in the years
1997 and 1996.
Management believes that the "core" portion of the Bank's regular savings,
NOW and money market accounts can have a lower cost and be more resistant to
interest rate changes than certificate accounts. These accounts increased
$972,000 million since December 31, 1993. The Bank intends to utilize customer
service and marketing initiatives in an effort to maintain the volume of such
deposits. However, there can be no assurance as to whether the Bank will be able
to maintain or increase its core deposits in the future.
22
The following table sets forth the savings flows at the Bank during the
periods indicated.
Year Ended
December 31,
---------------------------------------
1998 1997 1996
----------- ---------- ------------
(Dollars In Thousands)
Opening balance............... $ 130,958 $ 131,243 $ 130,741
Deposits...................... 241,772 271,622 207,748
Withdrawals................... (235,112) (277,503) (212,752)
Interest credited............. 5,531 5,596 5,506
----------- ---------- ----------
Ending balance................ $143,149 $ 130,958 $ 131,243
=========== ========== ==========
Net increase (decrease)....... $ 12,191 $ (285) $ 502
----------- ========== ==========
Percent increase (decrease)... 9.31% (0.22)% 0.38%
==== ===== ====
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank as of the dates
indicated.
December 31,
------------------------------------------------------------------
1998 1997 1996
-------------------- --------------------- ---------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
--------- --------- --------- ---------- --------- ----------
(Dollars in Thousands)
Transactions and Savings Deposits
Passbook Accounts 2.94%......... $ 47,799 33.39% $44,891 34.28% $ 47,174 35.94%
NOW Accounts 2.02%.............. 16,901 11.81 14,950 11.41 13,711 10.45
Money Market Accounts 3.20%..... 6,596 4.61 5,091 3.89 5,463 4.16
-------- ------ ------- ------ -------- ------
Total Non-Certificates.......... 71,296 49.81 64,932 49.58 66,348 50.55
Certificates:
0.00 - 3.99%.................... 48 0.03 --- --- --- ---
4.00 - 5.99%.................... 66,193 46.24 57,588 43.98 56,735 43.23
6.00 - 7.99%.................... 5,612 3.92 8,438 6.44 8,160 6.22
-------- ------ -------- ------ -------- ------
Total Certificates.............. 71,853 50.19 66,026 50.42 64,895 49.45
-------- ------ -------- ------ -------- ------
Total Deposits.................. $143,149 100.00% $130,958 100.00% $131,243 100.00%
======== ====== ======== ====== ======== ======
23
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of December 31,
1998.
Maturity
--------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
----------- --------- ---------- ----------- -----------
(In Thousands)
Certificates of deposit less
than $100,000................. $ 87 $ 14,140 $ 29,097 $ 22,607 $ 65,931
Certificates of deposit of
$100,000 or more.............. --- 1,122 3,110 1,690 5,922
------- --------- ---------- ---------- ---------
Total certificates of deposit.. $ 87 $ 15,262 $ 32,207 $ 24,297 $ 71,853
======= ======== ========= ========== =========
Borrowings. Hemlock Federal's other available sources of funds include
advances from the FHLB of Chicago and other borrowings. As a member of the FHLB
of Chicago, the Bank is required to own capital stock in the FHLB of Chicago and
is authorized to apply for advances from the FHLB of Chicago. Each FHLB credit
program has its own interest rate, which may be fixed or variable, and range of
maturities. The FHLB of Chicago may prescribe the acceptable uses for these
advances, as well as limitations on the size of the advances and repayment
provisions.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances for the periods indicated. The Bank had no other
outstanding borrowings during the periods shown
Year Ended
December 31,
------------------------------
1998 1997 1996
---------- ---------- --------
(Dollars In Thousands)
Maximum Balance:
FHLB Advances............... $ 37,000 $ 11,000 $ 1,500
Average Balance:
FHLB Advances............... $ 24,923 $ 3,462 $ 1,500
24
The following table sets forth certain information as to the Bank's FHLB
advances at the dates indicated.
December 31,
-----------------------------------
1998 1997 1996
---------- --------- -------
(Dollars in Thousands)
FHLB advances............................ $ 31,000 $ 11,000 $ 1,500
Weighted average interest rate
during the period of FHLB advances....... 5.42% 5.86% 9.72%
Weighted average interest rate
at end of period of FHLB advances........ 4.91% 5.86% 9.72%
Subsidiary and Other Activities
As a federally chartered savings bank, Hemlock Federal is permitted by OTS
regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries, and may invest an additional 1% of its assets
in service corporations where such additional funds are used for inner-city or
community development purposes. In addition to investments in service
corporations, federal institutions are permitted to invest an unlimited amount
in operating subsidiaries engaged solely in activities which a federal savings
association may engage in directly. At December 31, 1998, Hemlock Federal did
not have any subsidiaries.
25
REGULATION
General
Hemlock Federal is a federally chartered savings bank, the deposits of
which are federally insured and backed by the full faith and credit of the
United States Government. Accordingly, Hemlock Federal is subject to broad
federal regulation and oversight extending to all its operations. Hemlock
Federal is a member of the FHLB of Chicago and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of Hemlock Federal, the
Holding Company also is subject to federal regulation and oversight. The purpose
of the regulation of the Holding Company and other holding companies is to
protect subsidiary savings associations. Hemlock Federal is a member of the
Savings Association Insurance Fund ("SAIF"), which together with the Bank
Insurance Fund (the "BIF") are the two deposit insurance funds administered by
the FDIC, and the deposits of Hemlock Federal are insured by the FDIC. As a
result, the FDIC has certain regulatory and examination authority over Hemlock
Federal.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
Federal Regulation of Savings Associations
The OTS has extensive authority over the operations of savings
associations. As part of this authority, Hemlock Federal is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. The last regular OTS and FDIC examinations of Hemlock Federal were
as of September 1997 and February 1995, respectively. Under agency scheduling
guidelines, it is likely that another examination will be initiated in the near
future. When these examinations are conducted by the OTS and the FDIC, the
examiners may require Hemlock Federal to provide for higher general or specific
loan loss reserves. All savings associations are subject to a semi-annual
assessment, based upon the savings association's total assets, to fund the
operations of the OTS. Hemlock Federal's OTS assessment for the fiscal year
ended December 31, 1998 was $51,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including Hemlock Federal and the
Holding Company. This enforcement authority includes, among other things, the
ability to assess civil money penalties, to issue cease-and-desist or removal
orders and to initiate injunctive actions. In general, these enforcement actions
may be initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
In addition, the investment, lending and branching authority of Hemlock
Federal is prescribed by federal laws and it is prohibited from engaging in any
activities not permitted by such laws. For instance, no savings institution may
invest in non-investment grade corporate debt
26
securities. In addition, the permissible level of investment by federal
associations in loans secured by non-residential real property may not exceed
400% of total capital, except with approval of the OTS. Federal savings
associations are also generally authorized to branch nationwide. Hemlock Federal
is in compliance with the noted restrictions.
Hemlock Federal's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At December 31, 1998, Hemlock Federal's lending
limit under this restriction was $3.9 million. Hemlock Federal is in compliance
with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution which fails to comply with these
standards must submit a compliance plan. A failure to submit a plan or to comply
with an approved plan will subject the institution to further enforcement
action.
Insurance of Accounts and Regulation by the FDIC
Hemlock Federal is a member of the SAIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of
27
1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC
must seek to restore the reserve ratio to that designated reserve level, or such
higher reserve ratio as established by the FDIC. The FDIC may also impose
special assessments on SAIF members to repay amounts borrowed from the United
States Treasury or for any other reason deemed necessary by the FDIC.
For the first six months of 1995, the assessment schedule for BIF members
and SAIF members ranged from .23% to .31% of deposits. As is the case with the
SAIF, the FDIC is authorized to adjust the insurance premium rates for banks
that are insured by the BIF of the FDIC in order to maintain the reserve ratio
of the BIF at 1.25% of BIF insured deposits. As a result of the BIF reaching its
statutory reserve ratio the FDIC revised the premium schedule for BIF insured
institutions to provide a range of .04% to .31% of deposits. The revisions
became effective in the third quarter of 1995. In addition, the BIF rates were
further revised, effective January 1996, to provide a range of 0% to .27%. The
SAIF rates, however, were not adjusted. At the time the FDIC revised the BIF
premium schedule, it noted that, absent legislative action (as discussed below),
the SAIF would not attain its designated reserve ratio until the year 2002. As a
result, SAIF insured members would continue to be generally subject to higher
deposit insurance premiums than BIF insured institutions until, all things being
equal, the SAIF attains its required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provided for a one-time assessment to be imposed on all deposits
assessed at the SAIF rates, as of March 31, 1995, in order to recapitalize the
SAIF. It also provides for the merger of the BIF and the SAIF on January 1, 1999
if no savings associations then exist. The special assessment rate has been
established at .657% of deposits by the FDIC and the resulting assessment of
$840,000 was paid in November 1996. This special assessment significantly
increased noninterest expense and adversely affected the Bank's results of
operations for the year ended December 31, 1996. As a result of the special
assessment, the Bank's deposit insurance premiums were reduced to $71,000 based
upon its current risk classification and the new assessment schedule for SAIF
insured institutions. These premiums are subject to change in future periods.
Regulatory Capital Requirements
Federally insured savings associations, such as Hemlock Federal, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual Hemlock Federal stock and related income.
28
In addition, all intangible assets, other than a limited amount of purchased
mortgage servicing rights, must be deducted from tangible capital for
calculating compliance with the requirement. At December 31, 1998, Hemlock
Federal did not have any intangible assets recorded as assets on its financial
statements.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. All subsidiaries of Hemlock Federal are includable
subsidiaries.
At December 31, 1998, Hemlock Federal had tangible capital of $22.7
million, or 11.24% of adjusted total assets, which is approximately $19.5
million above the minimum requirement of 1.5% of adjusted total assets in effect
on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio. At December 31, 1998,
Hemlock Federal had no intangibles which were subject to these tests.
At December 31, 1998, Hemlock Federal had core capital equal to $22.7
million, or 11.24% of adjusted total assets, which is $14.6 million above the
minimum leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At December 31, 1998, Hemlock
Federal had $775,000 of general loss reserves and no capital instruments that
qualify as supplementary capital, which was less than 1.25% of risk-weighted
assets.
Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. Hemlock Federal had no
such exclusions from capital and assets at December 31, 1998.
29
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For example,
the OTS has assigned a risk weight of 50% for prudently underwritten permanent
one- to four-family first lien mortgage loans not more than 90 days delinquent
and having a loan to value ratio of not more than 80% at origination unless
insured to such ratio by an insurer approved by the FNMA or FHLMC.
OTS regulations also require that every savings association with more than
normal interest rate risk exposure to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings association, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The rule will not become effective until the OTS
evaluates the process by which savings associations may appeal an interest rate
risk deduction determination. It is uncertain as to when this evaluation may be
completed. Any savings association with less than $300 million in assets and a
total capital ratio in excess of 12% is exempt from this requirement unless the
OTS determines otherwise.
On December 31, 1998, Hemlock Federal had total capital of $23.4 million
(including $22.7 million in core capital and $775,000 in qualifying
supplementary capital) and risk-weighted assets of $78.2 million; or total
capital of 30% of risk-weighted assets. This amount was $17.2 million above the
8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a 4% core capital ratio, a 4% Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its
30
activities in addition to those applicable to significantly undercapitalized
associations. In addition, the OTS must appoint a receiver (or conservator with
the concurrence of the FDIC) for a savings association, with certain limited
exceptions, within 90 days after it becomes critically undercapitalized. Any
undercapitalized association is also subject to the general enforcement
authority of the OTS and the FDIC, including the appointment of a conservator or
a receiver.
The OTS is also generally authorized to reclassify an association into a
lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on Hemlock
Federal may have a substantial adverse effect on Hemlock Federal's operations
and profitability. Company shareholders do not have preemptive rights, and
therefore, if the Company is directed by the OTS or the FDIC to issue additional
shares of Common Stock, such issuance may result in the dilution in the
percentage of ownership of the Company.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions on savings associations with
respect to their ability to make distributions of capital, which include
dividends, stock redemptions or repurchases, cash-out mergers and other
transactions charged to the capital account. OTS regulations also prohibit a
savings association from declaring or paying any dividends or from repurchasing
any of its stock if, as a result, the regulatory capital of the association
would be reduced below the amount required to be maintained for the liquidation
account established in connection with its mutual to stock conversion.
Generally, savings associations, such as Hemlock Federal, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of their net income for the most recent four quarter
period. However, an association deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
Hemlock Federal may pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. Savings
associations that do not, or would not meet their current minimum capital
requirements following a proposed capital distribution, however, must obtain OTS
approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns. See "Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association that is a
subsidiary of a holding company
31
may make a capital distribution without notice to the OTS (unless it is a
subsidiary of a holding company) provided that it has a CAMEL 1 or 2 rating, is
not of supervisory concern, and would remain adequately capitalized (as defined
in the OTS prompt corrective action regulations) following the proposed
distribution. Savings associations that would remain adequately capitalized
following the proposed distribution but do not meet the other noted requirements
must notify the OTS 30 days prior to declaring a capital distribution. The OTS
stated it will generally regard as permissible that amount of capital
distributions that do not exceed 50% of the institution's excess regulatory
capital plus net income to date during the calendar year. A savings association
may not make a capital distribution without prior approval of the OTS and the
FDIC if it is undercapitalized before, or as a result of, such a distribution.
As under the current rule, the OTS may object to a capital distribution if it
would constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
Liquidity
All savings associations, including Hemlock Federal, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what Hemlock Federal
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources." This liquid asset ratio requirement may vary from time to time
(between 4% and 10%) depending upon economic conditions and savings flows of all
savings associations. At the present time, the minimum liquid asset ratio is 5%.
In addition, short-term liquid assets (e.g., cash, certain time deposits,
certain bankers acceptances and short-term United States Treasury obligations)
currently must constitute at least 1% of the association's average daily balance
of net withdrawable deposit accounts and current borrowings. Penalties may be
imposed upon associations for violations of either liquid asset ratio
requirement. At December 31, 1998, Hemlock Federal was in compliance with both
requirements, with an overall liquid asset ratio of 10.45% and a short-term
liquid assets ratio of 10.19%.
Accounting
An OTS policy statement applicable to all savings associations clarifies
and re-emphasizes that the investment activities of a savings association must
be in compliance with approved and documented investment policies and
strategies, and must be accounted for in accordance with GAAP. Under the policy
statement, management must support its classification of and accounting for
loans and securities (i.e., whether investment, sale or trading) with
appropriate documentation. Hemlock Federal is in compliance with these amended
rules.
OTS accounting regulations, which may be made more stringent than GAAP
require that transactions be reported in a manner that best reflects their
underlying economic substance and inherent risk and that financial reports must
incorporate any other accounting regulations or orders prescribed by the OTS.
32
Qualified Thrift Lender Test
All savings associations, including Hemlock Federal, are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. As an
alternative, the savings association may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under
either such test such assets primarily consist of residential housing related
loans and investments. At December 31, 1998, Hemlock Federal met the test and
has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "- Holding Company Regulation."
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of Hemlock
Federal, to assess the institution's record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
applications, such as a merger or the establishment of a branch, by Hemlock
Federal. An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
The federal banking agencies, including the OTS, have recently revised the
CRA regulations and the methodology for determining an institution's compliance
with the CRA. Due to the heightened attention being given to the CRA in the past
few years, Hemlock Federal may be required to devote additional funds for
investment and lending in its local community. Hemlock Federal was examined for
CRA compliance in March 1997 and received a rating of satisfactory.
33
Transactions with Affiliates
Generally, transactions between a savings association or its subsidiaries
and its affiliates are required to be on terms as favorable to the association
as transactions with non-affiliates. In addition, certain of these transactions,
such as loans to an affiliate, are restricted to a percentage of the
association's capital. Affiliates of Hemlock Federal include the Holding Company
and any company which is under common control with Hemlock Federal. In addition,
a savings association may not lend to any affiliate engaged in activities not
permissible for a bank holding company or acquire the securities of most
affiliates. Hemlock Federal's subsidiaries are not deemed affiliates; however,
the OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case-by-case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation
The Company is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, the Company is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. In addition, the OTS has enforcement authority over the Company and its
non-savings association subsidiaries which also permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to the subsidiary
savings association.
As a unitary savings and loan holding company, the Company generally is
not subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than Hemlock Federal or any other SAIF-insured savings
association) would become subject to such restrictions unless such other
associations each qualify as a QTL and were acquired in a supervisory
acquisition.
If Hemlock Federal fails the QTL test, the Company must obtain the
approval of the OTS prior to continuing after such failure, directly or through
its other subsidiaries, any business activity other than those approved for
multiple savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure the Company must register as, and will become
subject to, the restrictions applicable to bank holding companies. The
activities authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "- Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control of
any other SAIF-insured association. Such acquisitions are generally prohibited
if they result in a multiple savings and loan holding company controlling
savings associations in more than one state.
34
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal Securities Law
The stock of the Company is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to
the information, proxy solicitation, insider trading restrictions and other
requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW and Super NOW checking accounts). At December
31, 1998, Hemlock Federal was in compliance with these reserve requirements. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements that may be imposed
by the OTS. See "-Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
Hemlock Federal is a member of the FHLB of Chicago, which is one of 12
regional FHLBs, that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures, established
by the board of directors of the FHLB, which are subject to the oversight of the
Federal Housing Finance Board. All advances from the FHLB are required to be
fully secured by sufficient collateral as determined by the FHLB. In addition,
all long-term advances are required to provide funds for residential home
financing.
As a member, Hemlock Federal is required to purchase and maintain stock in
the FHLB of Chicago. At December 31, 1998, Hemlock Federal had $1.9 million in
FHLB stock, which was in compliance with this requirement. In past years,
Hemlock Federal has received substantial
35
dividends on its FHLB stock. Over the past five calendar years such dividends
have averaged 5.63% and were 4.59% for calendar year 1998.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of Hemlock Federal's FHLB stock may result in a corresponding
reduction in Hemlock Federal's capital.
For the year ended December 31, 1998, dividends paid by the FHLB of
Chicago to Hemlock Federal totaled $76,000, which constitute a $12,000 increase
from the amount of dividends received in calendar year 1997. The $76,000
dividend received for the year ended December 31, 1998, reflects an annualized
rate of 4.59%.
Federal and State Taxation
Savings associations, such as Hemlock Federal, are permitted to establish
reserves using an experience method for bad debts and to make annual additions
thereto which may, within specified formula limits, be taken as a deduction in
computing taxable income for federal income tax purposes. Under the experience
method, the bad debt reserve deduction is an amount determined under a formula
based generally upon the bad debts actually sustained by the savings association
over a period of years.
In August 1996, legislation was enacted that repeals the reserve method of
accounting (including the percentage of taxable income method) used by many
thrifts, including the Bank, to calculate their bad debt reserve for federal
income tax purposes. As a result, thrifts must recapture that portion of the
reserve that exceeds the amount that could have been taken under the specific
charge-off method for post-1987 tax years. The legislation also requires thrifts
to account for bad debts for federal income tax purposes on the same basis as
commercial banks for tax years beginning after December 31, 1995. The recapture
will occur over a six-year period, the commencement of which will be delayed
until the first taxable year beginning after December 31, 1997, provided the
institution meets certain residential lending requirements. The management of
the Company does not believe that the legislation will have a material impact on
the Company or the Bank.
In addition to the regular income tax, corporations, including savings
associations such as Hemlock Federal, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income. The Bank does not expect to be
subject to the alternative minimum tax.
36
To the extent earnings appropriated to a savings association's bad debt
reserves exceed the allowable amount of such reserves computed under the
experience method ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of December 31, 1998, Hemlock Federal's Excess for tax purposes
totaled approximately $3.1 million.
The Company and Hemlock Federal file separate federal and state income tax
returns on a calendar basis, using the accrual method of accounting.
The Company and Hemlock Federal have not been audited by the IRS with
respect to federal income tax returns in the past five years. With respect to
years examined by the IRS, either all deficiencies have been satisfied or
sufficient reserves have been established to satisfy asserted deficiencies. In
the opinion of management, any examination of still open returns (including
returns of subsidiaries and predecessors of, or entities merged into, the
Company) would not result in a deficiency which could have a material adverse
effect on the financial condition of the Company and its subsidiaries.
Illinois Taxation. For Illinois income tax purposes, the Company and
Hemlock Federal are taxed at an effective rate equal to 7.18% of Illinois
taxable income. For these purposes, "Illinois Taxable Income" generally means
federal taxable income, subject to certain adjustments (including the addition
of interest income on state and municipal obligations and the exclusion of
interest income on United States Treasury obligations).
Delaware Taxation. As a Delaware holding company, the Company is exempted
from Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. The Company is also subject to
an annual franchise tax imposed by the State of Delaware.
Competition
Hemlock Federal faces strong competition both in originating real estate
loans and in attracting deposits. Competition in originating loans comes
primarily from commercial banks, credit unions, mortgage bankers and other
savings institutions, which also make loans secured by real estate located in
the Bank's market area. Hemlock Federal competes for loans principally on the
basis of the interest rates and loan fees it charges, the types of loans it
originates and the quality of services it provides to borrowers.
Competition for those deposits is principally from commercial banks,
credit unions, mutual funds, securities firms and other savings institutions
located in the same communities. The ability of the Bank to attract and retain
deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk,
convenient locations and other factors. The Bank competes for these deposits by
offering competitive rates, convenient business hours and a customer-oriented
staff.
37
Executive Officers Of the Registrant Who Are Not Directors
The following information as to the business experience during the last
five years is supplied with respect to executive officers of the Bank who do not
serve on the Company's or the Bank's Board of Directors.
Jean M. Thornton. Ms. Thornton, age 38, is currently serving as
Vice-President, Controller/Treasurer. She has worked at the Bank since 1991 as
Chief Accountant, and as Treasurer since 1995.
Employees
At December 31, 1998, the Bank had a total of 73 employees including 19
part-time employees. None of the Bank's employees are represented by any
collective bargaining agreement. Management considers its employee relations to
be good.
Item 2. Properties
The following table sets forth information concerning the main office and
each branch office of the Bank at December 31, 1998. At December 31, 1998, the
Bank's premises had an aggregate net book value of approximately $2.86 million.
Year Owned or Net Book Value at
Location Acquired Leased December 31, 1998
- ------------------------------- ---------- -------------- -------------------
(In Thousands)
Main Office:
5700 West 159th Street 1974 Owned $511
Oak Forest, Illinois 60452
Full Service Branches:
8855 South Ridgeland Ave. 1975 Leased(1) 168
Oak Lawn, Illinois 60453
4646 South Damen Avenue 1990 Leased ---
Chicago, Illinois 60609
15730 West 127th Street 1998 Owned(2) 2,185
Lemont, Illinois 60439
(1) The land on which the Oak Lawn branch is built is leased. Under the terms of
the lease, upon the expiration of the lease in 2005, title to the building
housing the branch which is currently held by the Bank, will pass to the
landlord.
(2) Construction of the building was completed in December, 1998.
The Bank believes that its current facilities are adequate to meet the
present and foreseeable future needs of the Bank and the Company.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data processing
and computer equipment utilized by the Bank at December 31, 1998 was
approximately $191,546.
38
Item 3. Legal Proceedings
From time to time, Hemlock Federal is involved as plaintiff or defendant
in various legal proceedings arising in the normal course of its business. While
the ultimate outcome of these various legal proceedings cannot be predicted with
certainty, it is the opinion of management that the resolution of these legal
actions should not have a material effect on the Company's and Hemlock Federal's
financial position or results of operations.
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,
1998.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Page 48 of the Annual Report is herein incorporated by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 5 through 19 of the Annual Report is herein incorporated by
reference.
Item 7. Financial Statements
(a) Financial Statements
The following information appearing in the Company's Annual Report to
Stockholders for the year ended December 31, 1998, is incorporated by reference
in this Annual Report on Form 10-KSB as Exhibit 13.
Annual Report Section Pages in Annual Report
Common Stock and Related Information 48
Selected Financial and Other Data 3
Management's Discussion and Analysis 5
of Financial Condition and Results
of Operations
Report of Independent Auditors 20
Consolidated Statements of Financial Condition 21
as of December 31, 1998 and 1997
39
Consolidated Statements of Income 22
for Years Ended December 31, 1998,
1997 and 1996
Consolidated Statements of Changes in 23
Stockholders' Equity for Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows 25
for Years Ended December 31, 1998,
1997 and 1996
Notes to Consolidated Financial 27
Statements
With the exception of the aforementioned information, the Corporation's
Annual Report to Stockholders for the year ended December 31, 1998 is not deemed
filed as part of this Annual Report on Form 10-K.
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months prior
to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
40
PART III
Item 9. Directors, Executive Officers Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act
Information concerning Directors of the Registrant is incorporated herein
by reference from the Company's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held in 1999, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in 1999, a copy of which will be filed not later than
120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and
Management
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held in 1999, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is
incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held in 1999, a copy of which will be filed
not later than 120 days after the
close of the fiscal year.
41
PART IV
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
Reference to
Regulation Prior filing or
S-K Exhibit Exhibit Number
Number Document Attached Hereto
2 Plan of acquisition, reorganization, arrangement, None
liquidation or succession
3(i) Articles of Incorporation *
3(ii) By-Laws *
4 Instruments defining the rights of security holders, *
including debentures
9 Voting Trust Agreement None
10 Material contracts:
(i) Stock Option and Incentive Plan *
(ii) Recognition and Retention Plan *
(iii) Employment Agreement with Executive Officers *
11 Statement re: computation of per share earnings None
13 Annual Report 13
16 Letter re: change in certifying accountants None
21 Subsidiaries of Registrant 21
22 Published report regarding matters submitted to vote None
of security holders
23 Consent of Experts and Counsel Not required
24 Power of attorney Not required
27 Financial Data Schedule 27
28 Information from reports furnished to state insurance None
regulatory authorities
99 Additional Exhibits None
- ----------------
* Filed as exhibit to the Company's Form S-1 registration statement filed
on December 27, 1996 (File No. 333-18895) pursuant to Section 5 of the
Securities Act of 1933. All of such previously filed documents are hereby
incorporated herein by reference in accordance with Item 601 of
Regulation S-B.
The Company did not file any reports on Form 8-K during the quarter
ended December
31, 1998.
42
SIGNATURES
Pursuant to the requirements of Section 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.
HEMLOCK FEDERAL
FINANCIAL CORPORATION
By: /s/ Maureen G. Partynski
------------------------------------
Maureen G. Partynski, Chairman of
the Board and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
/s/ Michael R. Stevens /s/ Kenneth J. Bazarnik
- ---------------------------------- ----------------------------------
Michael R. Stevens, President, Kenneth J. Bazarnik, Director
Chief Financial and Accounting
Officer and Director
Date: March 30, 1999 Date: March 30, 1999
/s/ Rosanne Pastorek-Belczak /s/ Charles Gjondla
- ---------------------------------- ----------------------------------
Rosanne Pastorek-Belczak, Charles Gjondla, Director
Vice-President/ Secretary
and Director
Date: March 30, 1999 Date: March 30, 1999
/s/ Frank A. Bucz /s/ G. Gerald Schiera
- ---------------------------------- ----------------------------------
Frank A. Bucz, Auditor/ G. Gerald Schiera, Director
Consultant and Director
Date: March 30, 1999 Date: March 30, 1999
Exhibit Index
Exhibit
No. Document
13 Annual Report
21 Subsidiaries of Registrant
27 Financial Data Schedule