Back to GetFilings.com
1
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
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from........................to........................
Commission file number...................................................0-18046
FIRST FEDERAL CAPITAL CORP
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1651288
(State or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
605 STATE STREET
LA CROSSE, WISCONSIN 54601
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (608) 784-8000
Securities registered pursuant to Section 12(b) of the Act: NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.10 PER SHARE
PREFERRED STOCK PURCHASE RIGHTS
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period as the Registrant
has been subject to such requirements), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate value of the common stock of the Registrant that was held by
non-affiliates as of February 28, 1999, was approximately $215.3 million. This
amount was based on the closing price of $13.75 per share of the Registrant's
common stock as of the same date.
The number of shares of common stock of the Registrant outstanding as of
February 28, 1999, was 18,098,472 (net of 1,843,158 shares held as treasury
stock).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III, Items 10 through 13 of this Form
10-K.
2
FORM 10-K TABLE OF CONTENTS
PART I Page
Item 1--Business.............................................................................2
Item 2--Properties..........................................................................12
Item 3--Legal Proceedings...................................................................13
Item 4--Submission of Matters to Vote of Security Holders...................................13
PART II
Item 5--Market for Registrant's Common Equity and Related Stockholder Matters...............13
Item 6--Selected Financial Data.............................................................14
Item 7--Management's Discussion and Analysis of Financial Condition and Results of
Operations..........................................................................15
Item 7A--Quantitative and Qualitative Disclosures about Market Risk.........................29
Item 8--Financial Statements and Supplementary Data.........................................32
Item 9--Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure..........................................................................59
PART III
Item 10--Directors and Executive Officers of the Registrant.................................60
Item 11--Executive Compensation.............................................................60
Item 12--Security Ownership of Certain Beneficial Owners and Management.....................60
Item 13--Certain Relationships and Related Transactions.....................................60
PART IV
Item 14--Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................60
SIGNATURES........................................................................................62
EXHIBITS..........................................................................................64
1
3
FORWARD-LOOKING STATEMENTS
The discussion in this report includes certain forward-looking
statements based on current management's expectations. Examples of factors which
could cause future results to differ from management's expectations include, but
are not limited to, the following: general economic and competitive conditions;
legislative and regulatory initiatives; monetary and fiscal policies of the
federal government; general market rates of interest; interest rates on
competing investments; interest rates on funding sources; consumer demand for
deposit and loan products and services; consumer demand for other financial
services; changes in accounting policies or guidelines; and changes in the
quality or composition of the Corporation's loan and investment portfolios.
Readers are cautioned that forward-looking statements are not guarantees of
future performance and that actual results may differ materially from
management's current expectations.
PART I
ITEM 1--BUSINESS
This section of the report contains general information about First
Federal Capital Corp (the "Corporation"), First Federal Saving Bank of La
Crosse-Madison (the "Bank"), and the Bank's wholly-owned subsidiaries (together
"the reporting group"). Included in this section is information regarding the
reporting group's markets and business environments, significant operating and
accounting policies, practices, and procedures, as well as its competitive and
regulatory environments. Information regarding the reporting group's current
financial condition and results of operations is included in Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", Part II, Item 7a, "Quantitative and Qualitative Disclosures about
Market Risk", and Part II, Item 8, "Financial Statements and Supplementary
Data". This section should be read in conjunction with those sections.
FIRST FEDERAL CAPITAL CORP
The Corporation was incorporated under the laws of the State of
Wisconsin in July 1989. In November 1989, the Corporation became the savings and
loan holding company for the Bank upon its conversion from mutual to stock form.
The Corporation currently owns all of the outstanding capital stock of the Bank,
which is the principal asset of the Corporation. The Corporation's principal
office is located at 605 State Street, La Crosse, Wisconsin, 54601, and its
telephone number is (608) 784-8000.
FIRST FEDERAL SAVINGS BANK LA CROSSE-MADISON
The Bank was founded in 1934 and is a federally-chartered,
federally-insured, savings bank headquartered in La Crosse, Wisconsin. The
Bank's primary business is attracting deposits from the general public, which
are principally used to originate single-family residential loans, as well as
commercial real estate, consumer, and education loans. The Bank also purchases
single-family residential and commercial real estate loans from time-to-time
from third-party financial institutions. The Bank is also an active seller of
residential loans in the secondary market.
The Bank's primary market areas for conducting its activities consist
of communities located in the western, south-central, and eastern portions of
Wisconsin (not including the Milwaukee metropolitan area) and the northern
portion of Illinois, as well as contiguous counties in Iowa and Minnesota. The
Bank maintains a total of 61 banking offices in its market areas. Seventeen of
these offices are located in the Madison metropolitan area, six in the La Crosse
metropolitan area, five in the city of Eau Claire, four in the city of Appleton,
and two each in the cities of Beloit, Green Bay, Hudson, and Neenah, Wisconsin.
The Bank also maintains one retail banking facility in sixteen other cities
located throughout Wisconsin, as well as three offices in Rockford, Illinois.
The Bank also has separate residential loan production offices in Janesville and
Wausau, Wisconsin, as well as commercial real estate loan production offices in
Milwaukee and Appleton, Wisconsin.
In addition to deposits, the Bank also obtains a substantial portion of
its funding through borrowings from the Federal Home Loan Bank of Chicago
("FHLB"), of which it is a member.
2
4
In addition to loans, the Bank also invests in securities issued by the
U.S. government and its agencies and in other investment securities such as
collateralized mortgage obligations ("CMOs"), mortgage-backed securities
("MBSs"), mutual funds, and corporate bonds and notes, as permitted by
applicable federal laws and regulations.
The Bank is subject to regulation and examination by the Office of
Thrift Supervision ("OTS"), its chartering authority and primary regulator, and
by the Federal Deposit Insurance Corporation ("FDIC"), which administers the
Savings Association Insurance Fund ("SAIF"), which insures the Bank's deposits
to the maximum extent permitted by law.
The Bank's principal executive offices are located at 605 State Street,
La Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000.
LENDING ACTIVITIES
GENERAL The principal categories of loans in the Bank's portfolio are
conventional residential real estate loans secured by single-family residences,
commercial real estate loans secured by multi-family residential and commercial
real estate, consumer loans, secured primarily by second mortgages on
single-family residences, and government-guaranteed education loans. The Bank
has very few mortgage loans that are insured by the Federal Housing
Administration ("FHA") or partially guaranteed by the Veterans Administration
("VA"). As of December 31, 1998, approximately 66% of the Bank's total assets
consisted of loans held for investment purposes.
In general, the Bank's origination activities have concentrated on real
estate loans secured by properties located within its primary market areas and
within a 300-mile radius of the Bank's headquarters in La Crosse. However,
single-family loans purchased by the Bank are generally secured by properties
located outside of the Bank's primary market areas.
SINGLE-FAMILY RESIDENTIAL AND CONSTRUCTION LOANS Single-family
residential loans accounted for approximately 36% of the Bank's gross loans as
of December 31, 1998. Applications for single-family residential and
construction loans are accepted by commission-based employees of the Bank at
twelve loan production offices (ten of which are located with deposit-taking
offices) and at eight deposit-taking offices of the Bank which are able to
handle such applications.
In general, the Bank retains in its portfolio only single-family
residential mortgage loans that provide for periodic adjustments of the interest
rate ("adjustable-rate mortgage loans"). These loans generally have terms of up
to 30-years and interest rates which adjust every one to two years in accordance
with an index based on the yield on certain U.S. government securities. A
portion of these loans may guarantee borrowers a fixed rate of interest for the
first three years of the loan's term. Furthermore, most of these loans have
annual interest rate change limits ranging from 1% to 2% and maximum lifetime
interest rates ranging from 11% to 16%. It is the Bank's normal practice to
discount the interest rate it charges on its adjustable-rate mortgage loans
during the first one to three years of the loan, which has the effect of
reducing a borrower's payment during such years. In addition, most of the Bank's
adjustable-rate mortgage loan agreements permit borrowers to convert their
adjustable-rate loans to fixed-rate loans under certain circumstances in
exchange for a fee. Upon conversion, the Bank generally sells such loans in the
secondary market.
Adjustable-rate mortgage loans decrease the Bank's exposure to risks
associated with changes in interest rates, but involve other risks because as
interest rates increase, borrowers' monthly payments increase, thus increasing
the potential for default. This risk has not had any adverse effect on the Bank
to date, although no assurances can be made with respect to future periods.
Although the Bank generally retains only adjustable-rate mortgage loans
in its portfolio, it continues to originate fixed-rate mortgage loans in order
to provide a full range of products to its customers. In general, such loans are
originated only under terms, conditions, and documentation standards that make
such loans eligible for sale to the Federal Home Loan Mortgage Corporation
("FHLMC"), the Federal National Mortgage Association ("FNMA"), the FHLB, and
other institutional investors. The Bank generally sells these loans at the time
they are originated. In addition, the Bank generally sells any adjustable-rate
mortgage loans that convert to fixed-rate loans
3
5
in accordance with options granted to such borrowers in the original loan
documents, as previously described. Sales of mortgage loans provide additional
funds for lending and other business purposes and have generally been under
terms that do not provide for any recourse to the Bank by the purchaser. In the
case of sales to the FHLB, however, the Bank retains a small share of the credit
risk on the underlying loans in exchange for a credit enhancement fee.
The Bank's general policy is to lend up to 80% of the appraised value
of the property securing a loan (referred to as the "loan-to-value ratio"). The
Bank occasionally will lend more than 80% of the appraised value of the
property, but will obtain private mortgage insurance on behalf of the borrower
on the portion of the principal amount of the loan that exceeds 80% of the
property's value. The Bank evaluates the collateral of its residential real
estate loans using documentation that complies with applicable regulations.
The Bank also originates loans to individuals to construct
single-family residences. Such loans accounted for approximately 2% of the
Bank's gross loans as of December 31, 1998. Construction loans may be made
without commitments to purchase the property being constructed and the borrower
may not have take-out commitments for permanent financing on hand at the time of
origination. Construction loans generally have a maturity of 6 to 12 months and
a fixed rate of interest, with payments being made monthly on an interest-only
basis. Construction loans are otherwise underwritten and approved in the same
manner as other single-family residential loans. Construction loans, however,
are generally considered to involve a higher degree of risk than conventional
residential mortgage loans. This is because the risk of loss is largely
dependent on the accuracy of the initial estimate of the property's value at
completion of construction, the estimated cost of construction, and the
borrower's ability to advance additional construction funds, if necessary.
MULTI-FAMILY RESIDENTIAL, COMMERCIAL REAL ESTATE, AND COMMERCIAL
CONSTRUCTION LOANS Multi-family residential loans and commercial real estate
loans accounted for approximately 13% and 12%, respectively, of the Bank's gross
loans as of December 31, 1998. Applications for multi-family residential and
commercial real estate loans are accepted at the Bank's main office in La
Crosse, as well as offices in Madison, Appleton, and Milwaukee. All underwriting
and approval of such loans, however, is performed at the Bank's main office in
La Crosse. It is the Bank's general policy to restrict its multi-family and
commercial real estate lending to loans secured by properties located within a
300-mile radius of La Crosse, which includes all or a portion of the states of
Nebraska, Illinois, Iowa, and Minnesota.
The Bank's emphasis in multi-family residential and commercial real
estate lending (together "commercial real estate lending") is in loans secured
by collateral classified as Type A properties, which are to comprise not less
than 80% of the Bank's commercial real estate loan portfolio. Such properties
consist of multi-family residential properties such as apartment buildings,
retail shopping establishments, office buildings, and multi-tenant industrial
buildings. Not more than 20% of the Bank's commercial real estate loan portfolio
is to include loans secured by collateral classified as Type B properties, which
consist of nursing homes, single-tenant industrial buildings, hotels and motels,
and churches. The Bank's current policy is to not make any new loans secured by
collateral classified as Type C properties, which include restaurants,
recreation facilities, and other special purpose facilities, although the Bank
has made loans secured by such properties in the past.
Applications for commercial real estate loans are generally obtained
from existing borrowers, direct contacts by loan officers, and referrals. In
general these loans have amortization periods ranging from 20 to 30 years,
mature in ten years or less, and have interest rates which are fixed for one to
five years--thereafter adjusting in accordance with a designated index that is
generally subject to a floor and a ceiling. Loan-to-value ratios on the Bank's
commercial real estate loans may be as high as 80% for loans secured by Type A
properties and 75% or lower for commercial real estate loans which are secured
by other properties. In addition, as part of the criteria for underwriting
commercial real estate loans, the Bank generally imposes on potential borrowers
a "debt coverage ratio" (the ratio of net cash from operations before payment of
debt service to debt service). This ratio ranges from 115% to 120% for loans
secured by Type A properties and 130% to 160% for loans secured by other
properties. It is also the Bank's general policy to obtain personal guarantees
of its commercial real estate loans from the principals of the borrower and,
when this cannot be obtained, to impose more stringent loan-to-value, debt
service, and other underwriting requirements. In general, mortgage loans
purchased from other financial institutions are subject to the same underwriting
standards as mortgage loans originated directly by the Bank.
4
6
From time-to-time the Bank originates loans to construct multi-family
residential and commercial real estate properties. Such loans accounted for
approximately 1% and 2%, respectively, of the Bank's gross loans as of December
31, 1998. Construction loans are generally considered to involve a higher degree
of risk than mortgage loans on completed properties. The Bank's risk of loss on
a construction loan is dependent largely upon the accuracy of the initial
estimate of the property's value at completion of construction, the estimated
cost (including interest) of construction, and the borrower's ability to advance
additional construction funds if that should become necessary. The Bank's
construction lending activities are generally limited to an area within a
150-mile radius of each of Madison, La Crosse, Appleton, and Milwaukee,
Wisconsin.
Commercial real estate lending is generally considered to involve a
higher level of risk than single-family residential lending. This is due to the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on real estate developers and managers
and on income producing properties, and the increased difficulty of evaluating
and monitoring these types of loans. Moreover, a construction loan can involve
additional risks because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost (including
interest) of the project. In addition, loans secured by properties located
outside of the Bank's immediate market area may involve a higher degree of risk.
This is because the Bank may not be as familiar with market conditions and other
relevant factors as it would be in the case of loans secured by properties
located within its market areas. The Bank does not have a material concentration
of loans outside of its immediate market area. For additional discussion, refer
to Note 3 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
The Bank has attempted to minimize the foregoing risks by, among other
things, adopting what management believes are conservative underwriting
guidelines that impose more stringent loan-to-value, debt service, and other
requirements on loans which are believed to involve higher elements of risk, by
requiring independent appraisals on all loans, by requiring personal guarantees
where appropriate, by limiting the geographic area in which the Bank will make
commercial construction loans, and by limiting the amount of certain types of
commercial real estate loans in its portfolio, as previously described.
SERVICING MORTGAGE LOANS In addition to servicing the mortgage loans in
its own portfolio, the Bank continues to service most of the single-family
mortgage loans that it sells to third-party investors. Servicing mortgage loans
includes such functions as collecting monthly principal and interest payments
from borrowers, passing such payments through to investors, maintaining escrow
accounts for real estate taxes and insurance, and making such payments on behalf
of borrowers when they are due. The Bank pays the investors an agreed-upon yield
on the loans, which is generally less than the interest agreed to be paid by the
borrowers. The difference, generally 25 basis points or more, is retained by the
Bank and recognized as servicing fee income over the lives of the loans, net of
amortization of capitalized servicing rights. The Bank also receives fees and
interest income from ancillary sources such as delinquency charges and float on
escrow and other funds. The Bank also purchases mortgage servicing rights from
third parties for which it receives an agreed-upon fee and for which it performs
substantially the same services as it performs on its own originations.
Management believes that servicing mortgage loans for third parties
provides a natural hedge against other risks inherent in the Bank's mortgage
banking operations. That is, fluctuations in gains on sales of mortgage loans
caused by changes in market interest rates will generally be offset in part by
an opposite change in loan servicing fee income. The latter is generally caused
by fluctuations in the value of servicing rights. These fluctuations are usually
the result of actual loan prepayment activity that is different from that which
was anticipated when the related servicing rights were originally recorded.
However, fluctuations in the value of mortgage servicing rights may also be
caused by mark-to-market adjustments under generally accepted accounting
principles ("GAAP"). That is, the value of servicing rights may fluctuate
because of changes in the discount rates or prepayment assumptions used to
periodically value servicing rights. For additional discussion refer to Notes 1
and 4 of the Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary Data", as
well as Part II, Item 7, "Management Discussion and Analysis of Financial
Condition and Results of Operations".
CONSUMER LOANS The Bank offers consumer loans in order to provide a
full range of financial services to its retail customers. Such loans accounted
for approximately 19% of the Bank's gross loans as of December 31, 1998.
Applications for consumer loans may be taken at all of the Bank's retail banking
offices. The majority of
5
7
such loans, however, are underwritten and approved at the Bank's headquarters in
La Crosse. Most of the Bank's consumer loan portfolio consists of second
mortgage loans, but also includes automobile loans, home equity lines of credit,
recreational vehicle and mobile home loans, deposit account secured loans, and
unsecured lines of credit or signature loans. The Bank services all of its own
consumer loans.
Consumer loans generally have shorter terms and higher rates of
interest than conventional mortgage loans, but typically involve more credit
risk than such loans because of the nature of the collateral and, in some
instances, the absence of collateral. In general, consumer loans are more
dependent upon the borrower's continuing financial stability, are more likely to
be affected by adverse personal circumstances, and are often secured by rapidly
depreciating personal property such as automobiles. However, such risks are
mitigated to some extent in the case of second mortgage loans and home-equity
lines of credit. These types of loans are secured by a second mortgage on the
borrower's residence for which the total principal balance outstanding
(including the first mortgage) does not generally exceed 100% of the property's
value. Second mortgage loans are generally fixed-rate and have terms of up to
ten years.
The Bank believes that the higher yields earned on consumer loans
compensate for the increased risk associated with such loans and that consumer
loans are important to the Bank's efforts to increase the interest rate
sensitivity and shorten the average maturity of its loan portfolio. Furthermore,
the Bank's net charge-offs on consumer loans as a percentage of gross loans has
been minimal in recent years, despite the risks inherent in consumer lending.
EDUCATION LOANS The Bank offers education loans through programs
sponsored by the federal government. As such, the federal government guarantees
most of the principal and interest on such loans. Education loans accounted for
approximately 15% of the Bank's gross loans as of December 31, 1998.
The origination of education loans is highly dependent on relationships
with the financial aid departments of post-secondary schools, rather than direct
contact with students. Furthermore, a third-party institution services the loans
for the Bank after they are originated. Education loans generally carry a
floating-rate of interest and have terms of up to fifteen years. The interest
rate received on education loans is based on a spread above the average
quarterly yield of the three-month U.S. Treasury bill.
Legislation enacted in 1998 lowered the rate paid by borrowers on
education loans originated after July 1, 1998, from the three-month U.S.
Treasury bill plus 310 basis points to the three-month U.S. Treasury bill plus
230 basis points. Management is not certain at this time what long-term impact
this legislation may have on the Bank's willingness to originate education
loans, although no changes are contemplated at this time. During the twelve
months ended December 31, 1998, 1997, and 1996, the Bank originated $37.7
million, $38.4 million, and $36.2 million in education loans, respectively.
NON-PERFORMING AND OTHER CLASSIFIED ASSETS Loans are generally placed
on non-accrual status and considered "non-performing" when, in the judgement of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
and/or non-performing status, previously accrued but unpaid interest is deducted
from interest income. In general, the Bank does not record accrued interest on
loans past due 90 days or more. Refer to Notes 1 and 3 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
When a loan is placed on non-accrual and/or non-performing status, the
Bank generally institutes foreclosure or other proceedings at that time. Real
estate property acquired by the Bank as a result of foreclosure or deed-in-lieu
of foreclosure is classified as "real estate" and is considered "non-performing"
until it is sold. Other property acquired through adverse judgement, such as
automobiles, is generally classified as an "other asset". Foreclosed real estate
and other repossessed property has not been material to the Bank in recent
years.
Federal regulations require thrift institutions to classify their
assets on a regular basis. In addition, in connection with examinations of
thrift institutions, federal examiners have authority to identify problem assets
and, if appropriate, include them in classified assets. An asset is classified
as "Substandard" if it is determined to involve a distinct possibility that the
thrift institution could sustain some loss if deficiencies associated with the
loan are not
6
8
corrected. An asset is classified, as "Doubtful" if full collection is highly
questionable or improbable. An asset is classified as "Loss" if it is considered
uncollectible, even if a partial recovery could be expected in the future. The
regulations also provide for a "Special Mention" designation, described as
assets which do not currently expose an institution to a sufficient degree of
risk to warrant adverse classification, but which possess credit deficiencies or
potential weaknesses deserving management's close attention. Assets classified
as Substandard or Doubtful require the institution to establish a general
allowance for loan losses. If an asset or portion thereof is classified as Loss,
the institution must either establish a specific allowance for loan losses in
the amount of the portion of the assets classified as loss, or charge off such
amount. Refer to Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations", for additional discussion.
ALLOWANCES FOR LOSSES ON LOANS AND REAL ESTATE The Bank's policy is to
establish allowances for estimated losses on specific loans and real estate when
it determines that losses are expected to be incurred. In addition, the Bank
maintains a general loss allowance against its loan and real estate portfolios
which is based on its own loss experience, that of the financial services
industry, and management's ongoing assessment of current economic conditions,
and the credit risk inherent in the portfolios. For additional information,
refer to Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Notes 1 and 3 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
Management of the Bank believes that the current allowances established
by the Bank are adequate to cover any potential losses in the Bank's loan and
real estate portfolios. However, future adjustments to these allowances may be
necessary and the Bank's results of operations could be adversely affected if
circumstances differ substantially from the assumptions used by management in
making its determinations in this regard.
MORTGAGE-BACKED AND RELATED SECURITIES
The Bank periodically invests in CMOs and MBSs (collectively
"mortgage-backed and related securities"). As of December 31, 1998, such
investments accounted for approximately 26% of the Bank's total assets.
Management believes CMOs represent attractive investment alternatives
relative to other investment vehicles, due to the variety of maturity and
repayment options available through such investments and due to the limited
credit risk associated with such securities. CMOs purchased by the Bank are
generally rated "AAA" by independent credit-rating agencies. In addition, such
investments are secured by credit enhancements and/or subordinated tranches or
are collateralized by U.S. government agency MBSs. The Bank generally invests
only in sequential-pay, planned amortization class ("PAC"), and targeted
amortization class ("TAC") tranches that, at the time of their purchase, are not
considered to be high-risk derivative securities, as defined in OTS regulations.
The Bank does not invest in support-, companion-, or residual-type tranches.
Furthermore, the Bank does not invest in interest-only, principal-only,
inverse-floating-rate CMO tranches, or similar complex securities.
The Bank also invests in MBSs that are guaranteed by FHLMC, FNMA, or
the Government National Mortgage Association ("GNMA"). In addition, the Bank
periodically securitizes or "swaps" mortgage loans in its own portfolio into
FHLMC or FNMA MBSs and continues to hold such securities. MBSs enhance the
quality of the Bank's assets by virtue of the guarantees that back them,
although the Bank generally foregoes the guarantee on mortgage loans that it has
swapped into MBSs (for additional discussion, refer to Note 2 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data"). In addition,
MBSs are more liquid than individual mortgage loans and receive treatment that
is more favorable when used to collateralize certain borrowings of the Bank.
The Bank classifies its mortgage-backed and related securities as
either available for sale or held for investment. For additional discussion,
refer to Part II, Item 7, "Management Discussion and Analysis of Financial
Condition and Results of Operations" and Note 1 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
7
9
INVESTMENT SECURITIES
Federally-chartered savings institutions have authority to invest in
various types of securities, including U.S. government obligations, securities
of various federal agencies, certificates of deposit issued by insured banks and
savings institutions, and federal funds. Subject to various restrictions,
federally-chartered savings institutions also may invest a portion of their
assets in commercial paper, corporate debt securities, and mutual funds whose
assets conform to the investments that a federally-chartered savings institution
is authorized to make directly. In general, investments in these types of
securities are limited to the four highest credit categories as established by
the major independent credit-rating agencies. Excluding U.S. government and
federal agency securities and mutual funds that invest exclusively in such
securities, the Bank does not invest in individual securities that exceed 10% of
its stockholder's equity.
As of December 31, 1998, the Bank held no investment securities. When
it does hold such securities, the Bank generally classifies them as available
for sale. For additional discussion, refer to Part II, Item 7, "Management
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 1 of the Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary Data".
SOURCES OF FUNDS
Deposits obtained through its retail banking offices have traditionally
been the principal source of the Bank's funds for use in lending and for other
general business purposes. The Bank also obtains funds through borrowings from
the FHLB and other sources and, to a lesser extent, from amortization, maturity,
and prepayments of outstanding loans and investments.
DEPOSIT LIABILITIES The Bank's current deposit products include regular
savings accounts, checking accounts, money market deposit accounts, individual
retirement accounts, and certificates of deposit ranging in terms from three
months to five years. Substantially all of the Bank's deposits are obtained from
individuals and businesses located in Wisconsin and the northern portion of
Illinois. As of December 31, 1998, deposit liabilities accounted for
approximately 82% of the Bank's total liabilities and equity.
In addition to serving as the Bank's primary source of funds, deposit
liabilities (especially checking accounts) are a substantial source of
non-interest income. This income is generally received in the form of overdraft
fees, periodic service charges, automated teller machine ("ATM") and debit card
fees, and other transaction charges.
The principal methods used by the Bank to attract deposit accounts
include offering a wide variety of products and services, competitive interest
rates, and convenient office locations and hours. Most of the Bank's
free-standing retail banking offices have drive-up facilities and 25 of the
Bank's retail banking facilities are located in supermarkets. The Bank also owns
79 ATM machines, all of which are located in Wisconsin and the northern portion
of Illinois. Depositors may also obtain a VISA "debit card" from the Bank, which
allows them to purchase goods and services directly from any merchant that
accepts VISA credit cards. The same debit card also provides access to the ATM
network.
From time-to-time, the Bank has also used certificates of deposit sold
through third-party brokers ("brokered deposits") as an alternative to
borrowings from the FHLB. FDIC regulations govern the acceptance of brokered
deposits by insured depository institutions such as the Bank. At December 31,
1998, the Bank had no brokered deposits outstanding.
FEDERAL HOME LOAN BANK ADVANCES The Bank obtains advances from the FHLB
secured by certain of its home mortgage loans and mortgage-related securities,
as well as stock in the FHLB that it is required to own. Such advances may be
made pursuant to several different credit programs, each with its own interest
rate, maximum size of advance, and range of maturity dates. As of December 31,
1998, FHLB advances accounted for approximately 11% of total liabilities and
equity.
OTHER BORROWINGS The Bank has two lines of credit with two financial
institutions. These lines, which amount to $20.0 million in the aggregate,
permit the overnight purchase of fed funds. The Corporation also has a
8
10
$10.0 million line of credit with a third financial institution. The interest
rate on borrowings under this line is determined on a daily basis at 125 basis
points above the one-month London Inter-Bank Offered Rate ("LIBOR"). The Bank
has not had material amounts of other borrowings outstanding in recent years.
SUBSIDIARIES
The Bank has formed a number of subsidiaries to engage in certain
activities that are more appropriately conducted in a subsidiary of the Bank.
Following is a brief description of each subsidiary.
FIRST CAPITAL HOLDINGS, INC. In 1993 the Bank formed a wholly-owned
subsidiary in the State of Nevada. The subsidiary, First Capital Holdings, Inc.
("FCHI"), was formed to consolidate and improve the efficiency, management,
safekeeping, and operations of the Bank's investment securities portfolio and
certain other holdings. In addition, the formation of FCHI has resulted in a
lower effective income tax rate for the Bank because the State of Nevada does
not currently impose a corporate income tax. As of December 31, 1998, FCHI was
managing $305.0 million in mortgage-backed and related securities and $150.6
million in purchased single-family residential loans for the Bank. FCHI's net
income was $15.8 million, $9.8 million, and $9.5 million during the years ended
December 31, 1998, 1997, and 1996, respectively. The Bank's investment in FCHI
as of December 31, 1998, was $525.6 million, which was eliminated in
consolidation in accordance with GAAP. Refer to "Taxation" for a discussion of
proposed legislation that may affect the taxation of FCHI in the State of
Wisconsin.
FIRST REINSURANCE, INC. In December 1998 the Bank completed the
formation of a wholly-owned subsidiary in the State of Arizona. The subsidiary,
First Reinsurance, Inc. ("FRI"), was formed to reinsure or "underwrite" credit
life and disability insurance policies sold to the Bank's consumer loan
customers since October 1995. FRI assumes the first level of risk on these
policies and a third-party insurer assumes the remaining risk. The third-party
insurer is also responsible for performing most of the administrative functions
of the subsidiary on a contract basis. As a result of its assumption of risk on
policies sold since October 1995, FRI recorded an underwriting gain of $416,000
in December 1998, net of appropriate insurance reserves in accordance with GAAP.
Of this amount, all but $149,000 was eliminated in consolidation. At December
31, 1998, the Bank's investment in FRI was $509,000, which was eliminated in
consolidation in accordance with GAAP. Refer to "Taxation" for a discussion of
recent proposed legislation that may affect the taxation of FRI in the State of
Wisconsin.
FIRST ENTERPRISES, INC. The Bank's wholly-owned subsidiary, First
Enterprises, Inc. ("FEI"), was incorporated in 1971 in the State of Wisconsin.
During the period from the late-1970s to the mid-1980s, FEI was primarily
involved in the acquisition and development of hotels. Except for the
maintenance of its two remaining hotel investments, however, FEI is no longer
involved in these types of activities. FEI's investment in its remaining hotels
was $217,000 as of December 31, 1998. FEI had net income of $636,000, $49,000,
and $56,000 during the years ended December 31, 1998, 1997, and 1996,
respectively (for an explanation of the significant increase in net income in
1998, refer to Part II, Item 7, "Management Discussion and Analysis of Financial
Condition and Results of Operations"). At December 31, 1998, the Bank's
investment in FEI was $844,000, which was eliminated in consolidation in
accordance with GAAP.
TURTLE CREEK CORPORATION In 1995 the Bank acquired an additional
subsidiary, Turtle Creek Corporation ("Turtle Creek"), as a result of its
acquisition of the net assets of another financial institution. Turtle Creek, a
Wisconsin corporation, holds a 40% limited partnership interest in a fifty-unit
complex providing housing for low-to-moderate income and elderly persons in
Beloit. Turtle Creek's aggregate investment in this project was $109,000 at
December 31, 1998. Turtle Creek had a net loss of $25,000, $21,000, and $26,000
during the years ended December 31, 1998, 1997, and 1996, respectively. The
Bank's investment in Turtle Creek as of December 31, 1998, was $366,000, which
was eliminated in consolidation in accordance with GAAP.
COMPETITION
The Bank faces significant competition in attracting deposits. Its most
direct competition for deposits has historically come from commercial banks,
credit unions, and other savings institutions located in its market area. In
addition, the Bank faces significant competition from mutual fund and insurance
companies, as well as primary financial markets such as the stock and bond
markets. The Bank competes for deposits principally by offering
9
11
depositors a variety of deposit products, convenient branch locations, operating
hours, and other services. The Bank does not rely upon any individual group or
entity for a material portion of its deposits.
The Bank's competition for loans comes principally from mortgage
banking companies, other savings institutions, commercial banks, finance
companies, and credit unions. The Bank competes for loan originations primarily
through the interest rates and loan fees it charges, the efficiency and quality
of services it provides borrowers, referrals from real estate brokers and
builders, and the variety of its products. Factors that affect competition
include the general and local economic conditions, current interest rate levels,
and volatility in the secondary market for residential mortgage loans.
REGULATION OF THE CORPORATION
The Corporation is a savings and loan holding company within the
meaning of Section 10 of the Home Owners' Loan Act ("HOLA"). As such, the
Corporation is registered with and subject to OTS examination and supervision as
well as certain reporting requirements. Furthermore, the Corporation is limited
with respect to the transactions it can execute with its affiliates (including
the Bank), and its ability to acquire control of another insured financial
institution, as specified more fully in the applicable regulations. There
generally are no restrictions as to activities of a unitary savings and loan
holding company such as the Corporation as long as its sole insured subsidiary,
the Bank, complies with certain regulatory requirements, which management
believes it did as of December 31, 1998.
REGULATION OF THE BANK
The Bank, as a federally-chartered savings bank, is subject to federal
regulation and oversight by the OTS extending to all aspects of its operations.
The Bank also is subject to regulation and examination by the FDIC, which
insures the deposits of the Bank to the maximum extent permitted by law, and
requirements established by the Federal Reserve Board. The laws and regulations
governing the Bank generally have been promulgated to protect depositors and not
for the purpose of protecting stockholders of financial institutions or their
holding companies.
The investment and lending authority of a federally-chartered savings
bank is prescribed by federal laws and regulations. The Bank is also subject to
regulatory provisions affecting a wide variety of matters including, but not
limited to, branching, loans to one borrower, investment restrictions,
activities of subsidiaries, loans to "insiders", and transactions with
affiliates. Certain of the regulatory requirements applicable to the Bank and
the Corporation are more particularly described below or may be referred to
elsewhere herein.
INSURANCE OF ACCOUNTS The Bank's savings deposits are insured by SAIF,
which is administered by the FDIC, up to the maximum extent provided by law,
currently $100,000. The Bank is subject to a risk-based insurance assessment
system under which higher insurance assessment rates are charged to those thrift
institutions that are deemed to pose greater risk to the deposit insurance fund.
Under this system, insurance assessments range from 0% of deposits for the
healthiest financial institutions to 0.27% of deposits for the weakest. This
risk-based assessment schedule is identical to that for institutions insured by
the Bank Insurance Fund ("BIF"), which is also administered by the FDIC. Under
both funds, the insurance assessment paid by a particular institution will
depend on the "supervisory rating" it receives from the FDIC ("A", "B", or "C")
and on its regulatory capital level ("well capitalized", "adequately
capitalized", or "undercapitalized"). Based upon its current supervisory rating
and regulatory capital level, and assuming no change in the Bank's risk
classification or in overall premium assessment levels, the Bank anticipates
that its insurance assessment for 1998 will be zero, which is the same as the
Bank's 1997 rate.
Although the Bank's risk-based insurance assessment for 1998 is
expected to be zero, the Bank will still be required to pay 0.061% of deposits
to cover its pro rata share of the bond obligation of a government agency known
as the Finance Corporation ("FICO"). This rate is not tied to the FDIC's risk
classification; as a result, it is the same for all SAIF-insured institutions.
BIF-insured institutions, however, will only be subject to a rate of 0.0122% of
deposits.
CAPITAL STANDARDS The Bank is subject to minimum regulatory capital
requirements as specified by OTS regulations. As more fully described in such
regulations, the Bank is subject to a leverage limit of at least 3% of
10
12
total assets, a tangible capital limit of at least 1.5% of total assets, and a
risk-based capital limit of at least 8% of risk-weighted assets. As of December
31, 1998, the Bank exceeded all minimum regulatory capital requirements as
specified by the OTS.
The Bank is also subject to minimum regulatory capital requirements as
specified by FDIC regulations. As more fully described in such regulations, the
Bank must meet the following capital standards to be classified as "adequately
capitalized" under FDIC guidelines: (1) Tier 1 capital in an amount not less
than 4% of total assets, (ii) Tier 1 capital in an amount not less than 4% of
risk-weighted assets, and (iii) total capital in an amount not less than 8% of
risk-weighted assets. As of December 31, 1998, the Bank exceeded all minimum
regulatory capital requirements as specified by the FDIC. For additional
discussion refer to Note 11 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data".
LIQUIDITY REQUIREMENTS The Bank is required to maintain liquid assets
(generally defined as cash and investment-grade short-term securities, as well
as certain mortgage-related securities and obligations of the United States)
equal to at least 4% of its "liquidity base" (generally defined as short-term
deposit liabilities and other borrowings). The OTS may change this requirement
from time-to-time to any amount within the range of 4% to 10% of the liquidity
base. As of December 31, 1998, the Bank was in compliance with the minimum
requirements. For additional information refer to Part II, Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CLASSIFICATION OF ASSETS As previously described, the Bank's problem
assets are subject to classification according to one of three categories:
Substandard, Doubtful, and Loss. An institution is required to develop an
in-house program to classify its assets, including investments in subsidiaries,
on a regular basis and to set aside appropriate loss reserves on the basis of
such classification. The Bank believes that it is in compliance with the
foregoing requirements.
QUALIFIED THRIFT LENDER TEST A savings association that does not meet
the Qualified Thrift Lender Test ("QTL Test"), as set forth in the HOLA and
implementing regulations, must either convert to a bank charter or comply with
certain restrictions on its operations. Under the QTL Test, a savings
association is required to maintain a certain percentage of its assets in
qualifying investments, as defined by regulations. In general, qualifying
investments consist of housing-related assets. At December 31, 1998, the Bank's
assets invested in qualifying investments exceeded the percentage required to
qualify the Bank under the QTL Test.
FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB System,
which consists of 12 regional FHLBs, subject to supervision and regulation by
the Federal Housing Finance Board. The FHLBs provide a central credit facility
primarily for member financial institutions. The Bank, as a member of the FHLB
of Chicago, is required to purchase and hold shares of capital stock in the FHLB
of Chicago. The requirement is equal to the greater of 1% of the Bank's
aggregate unpaid residential mortgage loans, home purchase contracts, and
similar obligations at the beginning of each year or 5% of its outstanding
advances from the FHLB of Chicago. At December 31, 1998, the Bank had a $12.5
million investment in the stock of the FHLB of Chicago and was in compliance
with this requirement.
The Bank's investment in FHLB stock, its single-family mortgage loans,
and certain other assets (consisting principally of CMOs and MBSs) are used to
secure advances from the FHLB of Chicago. The interest rates charged on advances
vary with the maturity of the advance and the FHLB's own cost of funds.
FEDERAL RESERVE SYSTEM Federal Reserve Board regulations require
savings institutions to maintain non-interest-earning reserves against certain
transaction deposit accounts and other liabilities. At December 31, 1998, the
Bank's required reserves were approximately $19.9 million.
DIVIDEND RESTRICTIONS The payment of dividends by the Bank is subject
to various limitations set forth in federal regulations and as briefly described
in Note 11 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
11
13
COMMUNITY REINVESTMENT ACT Under the Community Reinvestment Act of
1977, as amended (the "CRA"), as implemented by OTS regulations, a savings
institution has a continuing and affirmative obligation, consistent with its
safe and sound operation, 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 its examination of a
savings institution, 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 by such institution. The CRA also requires all institutions
to make public disclosure of their CRA ratings. The Bank's latest CRA rating,
received in 1998, was "outstanding".
TAXATION
FEDERAL TAXATION The Bank is subject to those rules of federal income
taxation generally applicable to corporations under the Internal Revenue Code
("IRC"). The Corporation, the Bank, and the Bank's wholly-owned subsidiaries
(excluding FRI) file consolidated federal income tax returns, which has the
effect of eliminating or deferring the tax consequences of intercompany
distributions, including dividends, in the computation of consolidated taxable
income. The consolidated entity pays taxes at the federal statutory rate of 35%
of its taxable income, as defined in the IRC. Refer to Notes 1 and 8 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data" for additional
discussion. As of December 31, 1998, there were no material disputes outstanding
with Internal Revenue Service ("IRS").
STATE TAXATION The states of Wisconsin, Illinois, and Minnesota impose
a tax on their apportioned shares of the Corporation's taxable income at the
rate of 7.9%, 7.3%, and 9.8%, respectively (all state income taxes are
deductible on the Corporation's federal income tax return). These states'
definitions of taxable income are generally similar to the federal definition,
except that interest from state and municipal obligations is taxable, no
deduction is allowed for state income taxes (except for Illinois, which allows a
deduction for taxes paid to other states), and, in Wisconsin and Minnesota, net
operating losses may be carried forward but not back. Minnesota and Illinois
require the filing of consolidated state income tax returns, whereas Wisconsin
currently requires separate returns for each entity in the consolidated group.
However, refer to the next paragraph for an important legislative development
with respect to taxation in the State of Wisconsin.
FCHI and FRI, wholly-owned subsidiaries of the Bank, are subject to
taxation in the states of Nevada and Arizona, respectively. The State of Nevada
does not currently impose a corporate income tax and the State of Arizona
imposes a tax on the gross premium revenues of insurance companies rather than
taxable income. Although the taxable income of these subsidiaries is not
currently subject to taxation in the State of Wisconsin, legislation was
recently introduced in that state which would require consolidated state income
tax returns for taxable years beginning after December 31, 1999. This
legislation would result in the taxable income of FCHI, and possibly FRI, being
subject to taxation in the State of Wisconsin. If the Corporation had been
required to file a consolidated state income tax return in Wisconsin for the
year ended December 31, 1998, the Corporation's consolidated income tax expense
would have been higher by approximately $1.3 million, which would have reduced
diluted and basic earnings per share by $0.07 per share. At this time,
management of the Corporation is unable to estimate whether this legislation, as
proposed, will become law.
ITEM 2--PROPERTIES
As of December 31, 1998, the Bank conducted its business from its
corporate offices in La Crosse, Wisconsin, 58 other retail banking facilities
located throughout Wisconsin, as previously described, and two separate loan
production offices, also located in Wisconsin. At such date, the Bank owned the
building and land for 20 of its offices and leased the building and/or the land
for its remaining 41 properties, including 25 located in supermarkets. The Bank
also owns or leases certain other properties to meet various business needs. For
additional information, refer to Note 5 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
12
14
ITEM 3--LEGAL PROCEEDINGS
The information required herein is included in Note 10 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data".
ITEM 4--SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for vote during the
fourth quarter of 1998.
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation's common stock is traded on the National Association of
Securities Dealers Automated Quotation ("NASDAQ") National Market System under
the symbol FTFC. As of February 18, 1999, the Corporation had 18,093,375 common
shares outstanding (net of 1,848,255 shares of treasury stock), 1,554
stockholders of record, 3,400 estimated beneficial stockholders, and 4,954
estimated total stockholders.
Dividend and stock price information required by this item, as well as
information relating to the Corporation's stock repurchase plans, is included
under the following sections of this report:
(1) "Liquidity and Capital Resources", included herein under Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(2) "Note 11--Stockholder's Equity", included herein under Item 8,
"Financial Statements and Supplementary Data--Audited Consolidated Financial
Statements".
(3) "Quarterly Financial Information", included herein under Item 8,
"Financial Statements and Supplementary Data--Supplementary Data".
13
15
ITEM 6--SELECTED FINANCIAL DATA
The information in the following table contains selected consolidated
financial and other data. This information has been derived in part from the
Audited Consolidated Financial Statements included herein under Item 8,
"Financial Statements and Supplementary Data". Accordingly, the table should be
read in conjunction with such consolidated statements.
Dollars in thousands, except for per share amounts
- ---------------------------------------------------------------------------------------------------------------------
SELECTED BALANCE SHEET DATA AS OF DECEMBER 31 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
Total assets $1,786,504 $1,544,294 $1,515,413 $1,402,479 $1,172,886
Investment securities available for sale, at fair - 21,377 74,029 80,325 89,476
value
Mortgage-backed and related securities:
Available for sale, at fair value 204,109 47,895 61,875 84,173 -
Held for investment, at cost 102,500 124,336 147,835 171,493 269,443
Loans held for investment, net 1,177,526 1,193,893 1,106,040 932,084 723,826
Allowance for loan losses 7,624 7,638 7,888 8,186 8,074
Intangible assets 13,485 5,921 5,221 5,643 97
Deposit liabilities 1,460,136 1,146,534 1,024,093 969,423 778,641
FHLB advances and other borrowings 189,778 275,779 383,593 322,296 308,476
Stockholders' equity 122,685 109,361 95,414 98,939 77,181
- ---------------------------------------------------------------------------------------------------------------------
SELECTED OPERATING DATA FOR YEAR ENDED DECEMBER 31 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
Interest income $118,668 $114,976 $103,977 $88,858 $73,208
Interest expense 71,457 70,265 63,684 54,954 40,938
- ---------------------------------------------------------------------------------------------------------------------
Net interest income 47,211 44,711 40,293 33,904 32,270
Provision for loan losses 293 539 - - -
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 46,918 44,172 40,293 33,904 32,270
- ---------------------------------------------------------------------------------------------------------------------
Gains from sales of loans 16,929 6,374 4,331 3,545 2,945
Gains (losses) from sales of other investments 343 (725) (311) (29) 100
Other non-interest income 14,088 18,645 15,811 13,597 11,262
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest income 31,360 24,294 19,831 17,113 14,307
- ---------------------------------------------------------------------------------------------------------------------
FDIC special assessment - - 5,941 - -
Other non-interest expense 47,597 40,197 38,304 34,372 30,889
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense 47,597 40,197 44,245 34,372 30,889
- ---------------------------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary charge 30,681 28,269 15,880 16,646 15,687
Income tax expense 11,257 10,879 5,806 6,001 5,707
- ---------------------------------------------------------------------------------------------------------------------
Net income before extraordinary charge 19,424 17,390 10,074 10,645 9,980
Extraordinary charge (1) - - - - (203)
- ---------------------------------------------------------------------------------------------------------------------
Net income $19,424 $17,390 $10,074 $10,645 $9,777
- ---------------------------------------------------------------------------------------------------------------------
SELECTED OTHER DATA AT OR FOR THE YEAR ENDED
DECEMBER 31 (2) 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
Return on average assets 1.19% 1.13% 0.97% 0.87% 0.93%
Return on average equity 16.59 17.20 14.21 12.86 13.32
Average equity to average assets 7.16 6.57 6.80 6.75 6.96
Average interest rate spread 2.51 2.63 2.61 2.54 2.82
Average net interest margin 3.07 3.07 3.02 2.92 3.15
Ratio of allowance for loan losses to total loans held
for investment at end of period 0.65 0.64 0.71 0.88 1.12
Ratio of non-interest expense to average assets (3) 2.90 2.62 2.71 2.83 2.89
Earnings per share: (4)
Diluted earnings per share $0.98 $0.88 $0.68 $0.57 $0.55
Basic earnings per share 1.05 0.95 0.73 0.61 0.58
Dividends paid per share (4) 0.270 0.233 0.207 0.183 0.160
Stock price at end of period (4) 16.38 16.94 7.84 6.00 5.42
Book value per share at end of period (4) 6.68 5.95 5.19 5.02 4.47
Banking facilities at end of period 61 50 48 44 35
- ---------------------------------------------------------------------------------------------------------------------
(1) The extraordinary charge in 1994 consisted of a prepayment penalty on
certain FHLB advances, net of income tax benefit.
(2) Selected other data excludes the after-tax impact of the FDIC special
assessment as well as the impact of the extraordinary charge.
(3) Excludes the FDIC special assessment and provision for real estate losses
and recoveries.
(4) Per share data and historical stock prices have been adjusted for a
3-for-2 stock split on June 12, 1997, and a 2-for-1 stock split on June
11, 1998.
14
16
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section should be read in conjunction with Item 8, "Financial
Statements and Supplementary Data", as well as Item 7A, "Quantitative and
Qualitative Disclosures about Market Risk", and Part I, Item 1, "Business".
RESULTS OF OPERATIONS
OVERVIEW The Corporation's earnings for the years ended December 31,
1998, 1997, and 1996, were $ 19.4 million, $17.4 million, and $13.6 million,
respectively, excluding $3.5 million related to the after-tax impact of an FDIC
special assessment in 1996. These amounts, as adjusted, represented returns on
average assets of 1.19%, 1.13%, and 0.97%, respectively, and returns on average
equity of 16.59%, 17.20%, and 14.21%, respectively. Diluted earnings per share
during these periods were $0.98, $0.88, and $0.68, respectively, excluding the
after-tax effect of the FDIC special assessment in 1996 ($0.18 per share).
The improvement in earnings from 1997 to 1998 was due primarily to
increases in net interest income, retail banking fees, gain (loss) on sales of
investment securities, and other non-interest income. The latter included income
from a legal settlement, as well as an increase in fee income from certain loan
originations and conversions. Also contributing to the improvement in earnings
was a significant increase in gain on sales of loans, although this development
was offset in large part by a substantial decrease in loan servicing fees. These
favorable developments were partially offset by increases in compensation and
employee benefits, occupancy and equipment expenses, supplies, postage, and
communication expenses, and ATM and debit card transaction costs. Other
non-interest expense also increased, primarily because of increased expenses
related to the servicing of mortgage loans and the operation and disposition of
foreclosed real estate.
The improvement in earnings from 1996 to 1997 was primarily
attributable to an increase in net interest income. Also contributing, however,
were increases in retail banking fees and gain on sales of loans, as well as a
decrease in federal deposit insurance premiums. These favorable developments
were partially offset by increases in compensation and employee benefits,
advertising and marketing, and ATM and debit card transaction costs. Finally,
loss on sales of investment securities increased in 1997 as compared to the
previous year.
The following paragraphs discuss the aforementioned changes in greater
detail along with other changes in the components of earnings during the years
ended December 31, 1998, 1997, and 1996.
NET INTEREST INCOME Net interest income increased by $2.5 million or
5.6% and $4.4 million or 11.0% during the years ended December 31, 1998 and
1997, respectively. The improvement in both of these periods was primarily
volume related as the Corporation's average interest-earning assets grew by
$82.2 million or 5.6% in 1998 and by $123.7 million or 9.3% in 1997. The
principal source of growth in both periods occurred in the Corporation's
mortgage and consumer loan portfolios. Although mortgage-backed and related
securities and overnight investments also increased substantially in 1998, these
increases were caused by the securitization of adjustable-rate residential
mortgage loans into MBSs and the temporary investment of proceeds from loan
sales, respectively. Asset growth in both periods was principally funded by
increases in deposit liabilities, and to a lesser extent, by FHLB advances in
1997. Refer to "Financial Condition" for additional discussion.
Also contributing to the increase in net interest income in 1998 was an
increase in average non-interest bearing deposit liabilities, which was the
principal reason the Corporation's ratio of average interest-earning assets to
average interest-bearing liabilities improved from 109.14% in 1997 to 112.03% in
1998. The increase in non-interest-bearing liabilities was due in part to an
increase in custodial deposit accounts. The Corporation maintains borrowers'
principal and interest payments in these accounts on a temporary basis pending
their remittance to the third-party owners of the loans. Balances in these
accounts increased significantly in 1998 because of increased loan prepayment
activity, which was brought about by a declining interest rate environment.
Also contributing to the increase in net interest income in 1997 was a
slight increase in the Corporation's average interest rate spread. This increase
was caused by the investment of a higher percentage of interest-earning assets
in mortgage and consumer loans, which generally earn higher yields than the
Corporation's other earning assets, such as CMOs, MBSs, and investment
securities. This development was partially offset by an increase in 1997 in the
average cost of the Corporation's interest-bearing liabilities, due to more
competitive rate offerings on
15
17
deposit liabilities and the repayment of low cost term advances at the FHLB.
Also contributing was a 25 basis point increase in the fed funds rate in March
1997. The Corporation's overnight borrowings from the FHLB are sensitive to
changes in the fed funds rate.
The Corporation's interest rate spread decreased from 2.63% in 1997 to
2.51% in 1998, offsetting slightly the increase in net interest income in that
year caused by growth in interest-earning assets. Management attributes this
decrease to a declining interest rate environment during most of 1998, which
resulted in a relatively flat yield curve during much of the period. This type
of interest rate environment has an unfavorable impact on the Corporation's
interest rate spread because of the tendency of the Corporation's assets to
price off a longer end of the yield curve than its liabilities. If this interest
rate environment persists in the future, the Corporation may experience further
declines in its interest rate spread.
The following table sets forth information regarding the average
balances of the Corporation's assets, liabilities, and equity, as well as the
interest earned or paid and the average yield or cost of each. The information
is based on daily average balances during the years ended December 31, 1998,
1997, and 1996.
Dollars in thousands 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
- --------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans $500,772 $38,404 7.67% $603,662 $47,927 7.94% $522,735 $41,701 7.98%
Commercial real estate loans 295,533 25,079 8.49 250,760 21,764 8.68 213,854 18,269 8.54
Consumer loans 379,686 31,986 8.42 331,226 28,251 8.53 269,951 23,816 8.82
- --------------------------------------------------------------------------------------------------------------------
Total loans 1,175,991 95,469 8.12 1,185,648 97,942 8.26 1,006,540 83,786 8.32
Mortgage-backed and
related securities 279,767 18,542 6.63 193,135 12,126 6.28 234,430 14,495 6.18
Investment securities 6,657 407 6.11 49,747 3,079 6.19 72,149 4,347 6.03
Interest-bearing deposits
with banks 63,596 3,336 5.25 10,594 576 5.44 4,756 256 5.39
Other earning assets 13,814 913 6.61 18,540 1,254 6.77 16,126 1,093 6.77
- --------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets 1,539,825 118,668 7.71 1,457,664 114,976 7.89 1,334,001 103,977 7.79
Non-interest-earning assets:
Office properties and
equipment 24,745 25,201 26,670
Real estate 1,710 735 199
Other assets 67,754 55,838 50,909
- --------------------------------------------------------------------------------------------------------------------
Total assets $1,634,034 $1,539,438 $1,411,779
- --------------------------------------------------------------------------------------------------------------------
Interest-bearing
liabilities:
Regular savings accounts $94,981 $1,843 1.94% $88,797 $1,800 2.03% $89,202 $1,775 1.99%
Checking accounts 58,126 544 0.94 52,579 524 1.00 52,297 521 1.00
Money market accounts 150,209 6,381 4.25 142,438 6,322 4.44 118,916 5,103 4.29
Certificates of deposit 843,066 50,653 6.01 710,591 42,504 5.98 654,299 39,091 5.97
- --------------------------------------------------------------------------------------------------------------------
Total deposits 1,146,382 59,422 5.18 994,405 51,150 5.14 914,714 46,490 5.08
FHLB advances 220,223 11,851 5.38 325,481 18,569 5.71 297,892 16,642 5.59
Other borrowings 7,901 185 2.34 15,650 546 3.49 15,274 552 3.61
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 1,374,506 71,457 5.20 1,335,536 70,265 5.26 1,227,880 63,684 5.19
Non-interest-bearing
liabilities:
Non-interest-bearing 126,480 92,439 78,890
deposits
Other liabilities 15,997 10,343 8,943
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 1,516,983 1,438,318 1,315,713
Stockholders' equity 117,052 101,120 96,066
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,634,034 $1,539,438 $1,411,779
- --------------------------------------------------------------------------------------------------------------------
Net interest income $47,211 $44,711 $40,293
- --------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.51% 2.63% 2.61%
- --------------------------------------------------------------------------------------------------------------------
Net interest income as a percent
of average earning assets 3.07% 3.07% 3.02%
- --------------------------------------------------------------------------------------------------------------------
Average interest-earning
assets to average interest-
bearing liabilities 112.03% 109.14% 108.64%
- --------------------------------------------------------------------------------------------------------------------
16
18
The following table sets forth the effects of changing rates and
volumes on net interest income of the Corporation for the periods indicated.
Information is provided with respect to (i) effects on net interest income
attributable to changes in volume (changes in volume multiplied by prior rate);
(ii) effects on net interest income attributable to changes in rate (changes in
rate multiplied by prior volume); (iii) changes attributable to combined effects
of rate and volume (changes in rate multiplied by changes in volume); and (iv)
the net change in interest income.
1998 COMPARED TO 1997 1997 COMPARED TO 1996
Dollars in thousands INCREASE (DECREASE) INCREASE (DECREASE)
- --------------------------------------------------------------------------------------------------------------------
RATE/ RATE/
RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
- --------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans ($1,632) ($8,169) $278 ($9,523) ($199) $ 6,457 ($31) $6,227
Commercial real estate loans (484) 3,886 (86) 3,316 292 3,153 50 3,495
Consumer loans (347) 4,133 (51) 3,734 (792) 5,406 (180) 4,434
- --------------------------------------------------------------------------------------------------------------------
Total loans (2,463) (150) 141 (2,473) (699) 15,016 (161) 14,156
Mortgage-backed and related
securities 675 5,439 302 6,416 223 (2,553) (39) (2,369)
Investment securities (37) (2,667) 33 (2,671) 119 (1,350) (37) (1,268)
Interest-bearing deposits with
banks (20) 2,882 (101) 2,761 2 315 3 320
Other earning assets (28) (320) 7 (341) (2) 163 0 161
- --------------------------------------------------------------------------------------------------------------------
Total net change in income on
interest-earning assets (1,873) 5,184 381 3,692 (357) 11,591 (235) 10,999
- --------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing deposits (190) 8,449 13 8,272 254 4,367 39 4,660
FHLB advances (1,054) (6,005) 341 (6,718) 353 1,541 33 1,927
Other borrowings (180) (270) 89 (361) (19) 14 (1) (6)
- --------------------------------------------------------------------------------------------------------------------
Total net change in expense on
interest-bearing liabilities (1,424) 2,174 442 1,192 588 5,922 71 6,581
- --------------------------------------------------------------------------------------------------------------------
Net change in net interest income ($449) $ 3,010 ($61) $ 2,500 ($945) $5,669 ($306) $4,418
- --------------------------------------------------------------------------------------------------------------------
The current interest rate environment has had a significant impact on
the ability of the Corporation to internally grow its interest-earning assets. A
low interest rate or flat yield curve environment tends to increase customer
preference for fixed-rate mortgage loans, as opposed to adjustable-rate loans.
In addition, such environment encourages borrowers to refinance their existing
adjustable-rate loans into fixed-rate loans to "lock-in" a lower long-term rate.
Given the Corporation's policy of selling these types of loans in the secondary
market, its internally originated portfolio of adjustable-rate residential
mortgage loans has declined substantially since December 31, 1997. Although some
of this decline was offset by internal growth in consumer and commercial real
estate loans, in the third and fourth quarters of 1998 the Corporation purchased
adjustable-rate residential mortgage loans from third-party originators to
maintain growth in its interest-earning assets (refer to "Financial Condition"
for additional discussion). If the current interest rate environment persists,
management believes it will continue to be a challenge for the Corporation to
internally grow its interest-earning assets.
The Corporation will continue to explore alternatives to maintain
growth in its interest-earning assets in the near term. These alternatives
include, but are not limited to, the purchase of additional adjustable-rate
residential mortgage loans from third-party originators, the purchase of
mortgage-backed and related securities, and the retention of certain fixed-rate
loans that are currently sold by the Corporation in the secondary market. It is
anticipated that such assets would be funded by growth in deposit liabilities or
increased borrowings from the FHLB. However, there are many considerations
involved in such decisions and there can be no assurances that the Corporation
will elect to adopt any of these strategies to increase its interest-earnings
assets.
PROVISION FOR LOAN LOSSES In general, provisions for loan losses
recorded during the years ended 1998, 1997, and 1996, approximated the
Corporation's actual charge-off activity during such periods, except for a
$272,000 charge-off related to education loans in 1997, as described in a
subsequent paragraph. Management of the Corporation expects the provision for
1999 to also approximate actual charge-off activity, although there can be no
assurances.
As of December 31, 1998 and December 31, 1997, the Corporation's
allowance for loan losses was $7.6 million or 0.65% and 0.64% of loans held for
investment, respectively. Although management believes that the Corporation's
present level of allowance for loan losses is adequate, there can be no
assurance that future
17
19
adjustments to the allowance will not be necessary, which could adversely affect
the Corporation's results of operations. For additional discussion, refer to
"Financial Condition--Non-Performing Assets".
The following table summarizes the activity in the Corporation's
allowance for loan losses during each of years indicated.
Dollars in thousands 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $7,638 $7,888 $8,186 $8,074 $7,828
Provision for losses 293 539 - - -
- ---------------------------------------------------------------------------------------------------------------------
Charge-offs:
Mortgage loans - 13 - - 27
Consumer loans 365 802 337 334 146
Commercial business loans - - - 135 108
- ---------------------------------------------------------------------------------------------------------------------
Total loans charged-off 365 815 337 469 281
Recoveries 58 26 39 44 49
- ---------------------------------------------------------------------------------------------------------------------
Charge-offs net of recoveries 307 789 298 425 232
Transfers - - - - 478
Purchased allowances - - - 537 -
- ---------------------------------------------------------------------------------------------------------------------
Balance at end of period $7,624 $7,638 $7,888 $8,186 $8,074
- ---------------------------------------------------------------------------------------------------------------------
Net charge-offs as a percentage of average loans outstanding 0.03% 0.07% 0.03% 0.05% 0.04%
- ---------------------------------------------------------------------------------------------------------------------
Ratio of allowance to total loans held for investment at end of period 0.65% 0.64% 0.71% 0.88% 1.12%
- ---------------------------------------------------------------------------------------------------------------------
Consumer loan charge-offs in 1997 and 1995 included $272,000 and
$125,000, respectively, related to accrued interest on education loans that was
deemed uncollectible from the United States Government. Similar charge-offs on
education loans are not anticipated in the future; however, there can be no
assurances. The purchased allowances shown for 1995 were from the acquisition of
another financial institution. The transfer shown for 1994 resulted from the
transfer of excess general loss allowances from real estate to mortgage loans.
Management considered this transfer appropriate given the significant decline in
the Corporation's problem real estate during that period.
The following table shows the Corporation's total allowance for loan
losses and the allocation to the various loan categories as of December 31 for
each of the years indicated.
Dollars in thousands 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- --------------------------------------------------------------------------------------------------------------------
Residential real estate loans $156 0.04% $148 0.03% $183 0.03% $177 0.04% $179 0.05%
Multi-family and commercial
real estate loans 7,017 2.43 7,200 2.90 7,326 3.30 7,710 3.93 7,409 4.38
Consumer loans 414 0.10 253 0.07 302 0.10 222 0.09 275 0.15
Commercial business loans 37 9.97 37 6.65 77 6.33 77 3.49 211 11.77
- --------------------------------------------------------------------------------------------------------------------
Total allowance for loan losses $7,624 0.65% $7,638 0.64% $7,888 0.71% $8,186 0.88% $8,074 1.12%
- --------------------------------------------------------------------------------------------------------------------
The amounts in the preceding table are expressed as a percentage of
gross loans outstanding for each loan category, excluding construction loans.
The total allowance is expressed as a percent of net loans held for investment.
NON-INTEREST INCOME Non-interest income for the years ended December
31, 1998, 1997, and 1996, was $31.4 million, $24.3 million, and $19.8 million,
respectively. The following paragraphs discuss the principal components of
non-interest income and the primary reasons for their changes from 1997 to 1998
and 1996 to 1997.
Retail banking fees and service charges increased by $2.4 million or
19.4% in 1998 and by $2.3 million or 22.9% in 1997. The increase in both years
was due in part to 31% growth in the number of checking accounts serviced by the
Corporation since December 31, 1996. Approximately 20% of this growth was the
result of retail banking offices opened in 1997 and 1998 (refer to "Results of
Operations--Non-Interest Expense" for additional discussion) and another 34% was
due to the acquisition of deposits from another financial institution during the
fourth quarter of 1998 (refer to "Financial Condition--Deposit Liabilities" for
additional discussion). Also contributing to the growth in retail banking fees
was a $587,000 and $332,000 or 27.1% and 18.1% increase in fees from customers'
use of ATMs in 1998 and 1997, respectively. In addition, fee income from
customers' use of debit
18
20
cards increased by $411,000 and $850,000 or approximately 40% and 525% in the
same periods, respectively. The Corporation introduced debit cards to its
checking account customers in 1996. In addition to giving customers access to
virtually any ATM network, debit cards give customers the ability to make
purchases directly from any merchant that accepts VISA credit cards. The
Corporation increased the number of ATMs it operates in 1997 and 1998 as a
result of changes in the rules governing ATM surcharges, which permitted the
Corporation to increase fee revenue from ATMs. The Corporation intends to
increase the number of ATMs it operates by approximately 13% in 1999, although
there can be no assurances.
Commissions on annuity and insurance sales decreased by $31,000 or 1.7%
in 1998 and by $253,000 or 12.3% in 1997. The Corporation's principal sources of
commission revenues are from sales of tax-deferred annuity contracts, credit
life and disability insurance policies, and mortgage loan insurance policies.
The decrease in 1998 was principally due to decreases in revenue from sales of
credit life and disability insurance policies and mortgage loan insurance
policies. The decrease in 1997 was primarily due to lower sales of tax deferred
annuities. Included in commission revenue for 1998 was a $149,000 underwriting
gain related to the Corporation's formation of FRI, a wholly-owned reinsurance
subsidiary, and its assumption of the first level of risk on credit life and
disability insurance policies sold to the Bank's consumer loan customers since
October 1995 (refer to Part I, Item 1, "Business--Subsidiaries", for additional
discussion).
Loan servicing fees were $(6.7) million, $2.4 million, and $2.2 million
in 1998, 1997, and 1996, respectively. Interest rates reached historically low
levels in 1998. As a result, actual loan prepayment activity was much higher
than that which had originally been estimated for the related mortgage servicing
rights. Because of such prepayment activity, the Corporation recorded $10.2
million in losses on its mortgage servicing rights in 1998 over-and-above that
which management considered to be "normal" periodic amortization. This compared
to only $650,000 and $624,000 in such losses in 1997 and 1996, respectively.
Excluding the effects of the aforementioned losses, but net of "normal"
periodic amortization of MSRs, loan servicing fees would have increased by
$542,000 or 18.0% and $172,000 or 6.1% in 1998 and 1997. These increases were
attributable to a $450.9 million or 32.1% increase and a $216.8 million or 18.3%
increase in mortgage loans serviced for others during such periods,
respectively. The significant growth in 1998 was due in part to the
securitization of $222.3 million of the Corporation's adjustable-rate
residential mortgage loans into MBSs. The principal balance related to these
securities was included in the amount reported as loans serviced for others even
though the securities were retained by the Corporation (refer to "Financial
Condition--Mortgage-Backed and Related Securities" for additional discussion).
The significant growth in 1997 was due in part to the Corporation's purchase of
mortgage servicing rights related to $106.9 million of mortgage loans. The
Corporation also purchased mortgage servicing rights related to $50.0 million in
mortgage loans in 1998. Such loans consisted principally of fixed-rate,
residential mortgage loans on properties located in Iowa. Also contributing to
the growth in loans serviced for others in both periods was an interest rate
environment that encouraged borrowers to convert single-family adjustable-rate
mortgage loans, which the Corporation generally retains in portfolio, to
fixed-rate mortgage loans. Upon conversion, such loans are generally sold in the
secondary market and the Corporation retains the servicing.
Subsequent to December 31, 1998, interest rates have remained at
historically low levels. If this interest rate environment persists, or if
interest rates decline further, the Corporation will most likely continue to
record large losses on its mortgage servicing rights related to faster than
anticipated prepayment activity. Such losses, however, would most likely
continue to be offset by high levels of gains on sales of mortgage loans, as
described in the following paragraph. It should be noted, however, that further
declines in interest rates may also expose the Corporation to unfavorable
mark-to-market adjustments against its portfolio of mortgage servicing
rights--primarily because of the potential for increases in market expectations
for future prepayments. Although management believes that most of the
Corporation's loans that prepay are replaced by a new loan to the same customer
or even a different customer (thus preserving the future servicing cash flow),
GAAP requires mark-to-market losses resulting from increases in market
expectations for future prepayments to be recorded in the current period.
However, the offsetting gain on the sale of the new loan, if any, cannot be
recorded until the customer actually prepays the old loan and the new loan is
sold in the secondary market. Management will continue to closely monitor the
carrying value of its mortgage servicing rights and will record mark-to-market
adjustments as appropriate. For additional discussion, refer to Notes 1 and 4 of
the Corporation's Audited Consolidated Financial Statements, included herein
under Part II, Item 8, "Financial Statements and Supplementary Data".
19
21
Gains on sales of mortgage loans for the years ended December 31, 1998,
1997, and 1996, were $16.9 million, $6.4 million, and $4.3 million,
respectively. The increases in 1998 and 1997 were primarily attributable to a
$565.9 million or approximately 175% increase and a $69.8 million or
approximately 30% increase, respectively, in the Corporation's mortgage loan
sales. These increases were due in part to declining interest rates in both
periods that resulted in increased originations of fixed-rate mortgage loans, as
well as increased conversions of adjustable-rate loans into fixed-rate, both of
which were generally sold in the secondary market. Interest rates have remained
at historically low levels in early 1999. If this situation persists, or if
interest rates decline further, the Corporation is likely to continue to
experience high levels of refinance activity, as well as increased conversions
by borrowers of their adjustable-rate loans into fixed-rate loans. Such activity
is expected to result in high levels of gains on sales of mortgage loans,
although there can be no assurances. Such gains will most likely be offset by
additional declines in the carrying value of the Corporation's mortgage
servicing rights, as described in previous paragraphs (refer also to "Lending
Activities--Servicing Mortgage Loans" in Part I, Item 1, "Business").
Also contributing to the increase in gain on sales of mortgage loans in
1997 was the Corporation's sale of $17.4 million in single-family
adjustable-rate mortgage loans; these loans were sold out of the Corporation's
"held for investment" portfolio and resulted in a $583,000 gain. In the future,
the Corporation may elect to sell modest amounts of its single-family
adjustable-rate loans in an effort to manage its liquidity position and/or its
borrowing capacity at the FHLB.
Gain (loss) on sales of investment securities for the years ended
December 31, 1998, 1997, and 1996, were $343,000, $(725,000), and $(311,000),
respectively. The losses in 1997 and 1996 were caused by the Corporation's sale
of mutual funds that invested primarily in adjustable-rate mortgage loans and
short-term government securities. The gain in 1998 was caused by the sale of
FNMA stock that had been acquired in the early 1980s.
The recognition of gains or losses from sales of loans, mortgage-backed
and related securities, and other investments is dependent on market and
economic conditions. Accordingly, there can be no assurance that the gains
reported in prior periods can be achieved in the future or that there will not
be significant inter-period variations in the results from such activities.
Furthermore, the Corporation is subject to accounting principles established by
Statement of Financial Accounting Standards No. 115 ("SFAS 115"), which limits
the Corporation's ability to sell investments classified as "held for
investment". For additional discussion refer to Note 1 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
Other income was $4.0 million, $1.9 million, and $1.3 million for the
years ended December 31, 1998, 1997, and 1996, respectively. The increase in
1998 was due in part to a $965,000 gain that was recorded on the books of FEI in
the fourth quarter (FEI is a wholly-owned subsidiary of the Bank; refer to Part
I, Item 1, "Business--Subsidiaries"). The gain related to FEI's settlement of a
lawsuit that it had brought against another financial institution. The increase
in other income in 1997 was due in part to a change in the manner in which the
Corporation accounted for certain fees and costs related to its origination of
consumer loans. Prior to 1997, such fees and costs were netted and were recorded
in other income. However, due to the increased materiality of these fees and
costs, the Corporation elected to conform its accounting for such with that
which was being done for mortgage loans. That is, loan origination fees and
certain direct costs of origination are deferred and amortized over the life of
the related loans as an adjustment of yield. Also contributing to the increases
in other income in both 1998 and 1997 were increases in fees from customers that
converted their adjustable-rate mortgage loans to fixed rate loans, as
previously described, as well as increases in fees received on loans originated
as agent for the Wisconsin State Veterans Administration ("State VA") and the
Wisconsin Housing and Economic Development Authority ("WHEDA").
NON-INTEREST EXPENSE Non-interest expense for the years ended December
31, 1998, 1997, and 1996, was $47.6 million, $40.2 million, and $38.3 million,
respectively, excluding a $5.9 million special assessment from the FDIC in 1996.
Non-interest expense as a percent of average assets during these periods was
2.90%, 2.62%, and 2.71% (excluding the special assessment discussed below). The
following paragraphs discuss the principal components of non-interest expense
and the primary reasons for their changes from 1997 to 1998 and 1996 to 1997.
20
22
Compensation and employee benefits increased by $4.8 million or 22.1%
in 1998 and $1.9 million or 9.6% in 1997. In general, the increase in both
periods was due to general growth in the number of banking facilities operated
by the Corporation, as well as normal annual merit increases. Since December 31,
1996, the Corporation has opened or acquired fourteen retail banking facilities,
eleven of which were opened or acquired in the most recent year. The Corporation
also closed one retail banking facility in 1997. In 1999 the Corporation intends
to open or acquire up to seven retail banking facilities and one loan production
facility, although there can be no assurances.
Also contributing to the increase in compensation and employee benefits
in both periods, was an increase in commissions paid in the Corporation's
Residential Lending Division, due primarily to increased originations of
mortgage loans, as previously described.
As of December 31, 1998, the Corporation had 808 full-time equivalent
employees. This compared to 690 and 641 as of December 31, 1997 and 1996,
respectively.
Occupancy and equipment expense increased by $274,000 or 4.1% in 1998
and $263,000 or 4.1% in 1997. In addition, supplies, postage, and communications
expense increased by $530,000 or 16.8% in 1998 and $319,000 or 11.3% in 1997.
These increases were primarily attributable to general growth in the number of
banking facilities operated by the Corporation, as previously described, as well
as increases in the number of full-time equivalent employees and in the number
of customers served by the Corporation.
ATM and debit card transaction costs increased by $314,000 or 15.5% in
1998 and $502,000 or 33.1% in 1997. The increase in both years was attributable
to increased use by the Corporation's customers of ATM and debit card networks,
as well as an increase the number of ATMs operated by the Corporation, as
previously described.
Federal insurance premiums increased by $94,000 or 14.8% and decreased
by $1.5 million or approximately 70% in 1997. The increase in 1998 was caused by
growth in deposit liabilities. The significant decrease in 1997 was due to the
recapitalization of the SAIF in 1996, which resulted in a substantial reduction
in the Bank's deposit insurance premiums. As a result of the recapitalization of
the SAIF, the Bank incurred a $5.9 million charge in 1996 from the FDIC which
represented its share of the recapitalization (substantially all SAIF-insured
institutions participated in the recapitalization).
Amortization of intangible assets, which consist primarily of
deposit-based intangibles and purchase accounting goodwill, increased by $86,000
or 17.3% in 1998 and $65,000 or 15.1% in 1997. The increase in 1998 was caused
by the Corporation's purchase of deposits from another financial institution in
the fourth quarter (refer to "Financial Condition--Deposit Liabilities" for
additional discussion). As a result of this purchase, as well as other possible
purchases of deposit liabilities, management expects amortization of intangible
assets to exceed $1.0 million in 1999 compared to only $582,000 and $496,000 in
1998 and 1997, respectively.
Other non-interest expenses increased by $1.3 million or approximately
40% in 1998 and decreased by $146,000 or 4.3% in 1997. The increase in 1998 was
caused by a variety of factors, the most significant of which were increased
costs related to the operation and disposition of foreclosed real estate,
increased losses on customers' deposit accounts, and increased costs related to
servicing of loans for FNMA. Under the terms of its servicing agreement with
FNMA, the Corporation is required to pay a full month's interest to FNMA when
certain loans are repaid, regardless of the actual date of the loan payoff. A
declining interest rate environment and increased prepayment activity in 1998
resulted in increased payment of "loan pay-off interest" to FNMA.
INCOME TAX EXPENSE Income tax expense for the years ended December 31,
1998, 1997, and 1996, was $11.3 million, $10.9 million, and $5.8 million,
respectively, or 36.7%, 38.5%, and 36.6% of pretax income, respectively. In 1997
the Corporation's effective tax rate was higher because a greater share of its
taxable earnings were in the State of Wisconsin as opposed to the State of
Nevada, which imposes no corporate income tax (refer to Part I, Item 1,
"Business--Subsidiaries" and "Business--Taxation", for additional discussion).
During 1998 the Corporation substantially increased its investment in FCHI, its
Nevada subsidiary, which lowered the Corporation's effective income tax rate
closer to the 1996 rate (refer to "Financial Condition--Loans Held for
Investment" and "Financial Condition--Mortgage-Backed and Related Securities"
for additional discussion).
21
23
FINANCIAL CONDITION
OVERVIEW The Corporation's total assets increased by $242.2 million or
15.7% during the twelve months ended December 31, 1998. This increase was
principally funded by a $313.6 million or approximately 25% growth in deposit
liabilities, although a portion of this growth was also used to reduce FHLB
advances and other borrowings by $86.0 million or approximately 30%. The
increase in the Corporation's total assets was ostensibly caused by a $134.7
million increase in mortgage-backed and related securities, as well as an $88.4
million increase in overnight investments. However, the increase in
mortgage-backed and related securities was due mostly to the transfer of $222.3
million in adjustable-rate residential mortgage loans from loans held for
investment to mortgage-backed and related securities, as more fully described in
a subsequent paragraph. Likewise, the increase in overnight investments was
caused by the temporary investment of proceeds from loan sales. The actual
increase in total assets is more appropriately attributed to the Corporation's
purchase of $165.1 million in adjustable-rate residential mortgage loans, as
well as continued growth in the Corporation's portfolios of commercial real
estate, consumer, and education loans.
INTEREST-BEARING DEPOSITS WITH BANKS The Corporation's interest-bearing
deposits with banks, which consist principally of overnight deposits at the
FHLB, increased substantially during the twelve months ended December 31, 1998.
This increase was caused by the temporary investment of proceeds from loan
sales, as previously described.
INVESTMENT SECURITIES The Corporation's investment securities available
for sale decreased by $21.4 million or 100% during the twelve months ended
December 31, 1998. This decrease was due to the maturity of the Corporation's
remaining investment securities during the period. Historically, the primary
purpose of this portfolio was to meet liquidity requirements imposed on the Bank
by the OTS. In 1997, however, the OTS modified its regulatory liquidity
requirements for thrift institutions. As a result of such modifications, the
Bank does not need to hold investment securities to meet the minimum regulatory
liquidity requirements. Accordingly, the Bank anticipates that it will not need
to maintain a significant portfolio of investment securities in the future,
although there can be no assurances.
The following table sets forth the composition of the Corporation's
investments available for sale as of December 31 for each of the years
indicated.
DOLLARS IN THOUSANDS 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
- --------------------------------------------------------------------------------------------------------------------
Corporate obligations $ 21,045 $ 21,083 $ 41,083 $ 41,078
- -
Asset-backed securities 294 294 1,076 1,076
- -
U.S. Treasury securities 262 262
- - - -
Adjustable-rate mortgage and short-term
government mutual funds 32,436 31,613
- - - -
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total $ 21,339 $ 21,377 $ 74,857 $ 74,029
- -
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Weighted-average yield 6.34% 6.24%
-
- --------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED AND RELATED SECURITIES The Corporation's aggregate
investment in its mortgage-backed and related securities portfolios increased by
$134.4 million or approximately 80% during the twelve months ended December 31,
1998. This increase was caused by the securitization of $222.3 million of the
Corporation's adjustable-rate residential loans into MBSs during the second
quarter. These securities were classified as "available for sale" and were
transferred to FCHI, the Corporation's wholly-owned investment subsidiary in
Nevada.
The securitization of the Corporation's adjustable-rate residential
mortgage loans into MBSs improves the liquidity of the asset and increases the
Corporation's borrowing capacity by making such loans acceptable as collateral
for reverse-repurchase agreements. MBSs also receive better treatment under the
FHLB's current collateralization guidelines. The Corporation has retained the
credit risk associated with the underlying loans, which has the effect of
reducing the guarantee fee that is normally paid to the FHLMC, the issuer of the
MBSs. This fact is not expected to have any impact on the marketability of the
securities, although there can be no assurances. Furthermore, this action does
not change the credit risk profile of the Corporation's assets, as it was
exposed to the credit risk on the loans before their securitization.
22
24
The following table sets forth the composition of the Corporation's
mortgage-backed and related securities portfolios as of December 31 for each of
the years indicated.
Dollars in thousands 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
- --------------------------------------------------------------------------------------------------------------------
Available for sale:
Collateralized mortgage obligations $ 33,871 $ 33,787 $ 48,953 $ 47,895 $64,890 $ 61,875
Mortgage-backed securities 165,872 170,322 - - - -
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total available for sale 199,743 204,109 48,953 47,895 64,890 61,875
- --------------------------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations 97,251 97,608 115,847 115,057 136,184 133,584
Mortgage-backed securities 5,249 5,300 8,489 8,557 11,651 11,633
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total held for investment: 102,500 102,908 124,336 123,614 147,835 145,217
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total mortgage-backed and related
securities $302,243 $ 307,017 $ 173,289 $ 171,509 $212,725 $207,092
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Weighted-average yield 6.95% 6.29% 6.30%
- --------------------------------------------------------------------------------------------------------------------
LOANS HELD FOR SALE The Corporation's loans held for sale increased by
$26.4 million or approximately 60% during the year ended December 31, 1998. This
increase was due to a declining interest rate environment during most of 1998
that increased consumer demand for fixed-rate mortgage loans and resulted in
increased conversions of adjustable-rate loans into fixed-rate loans, as
previously described. Both of these categories of loans are classified as "held
for sale" until the date of sale, which typically occurs within 30 to 60 days of
origination and/or conversion.
LOANS HELD FOR INVESTMENT The Corporation's loans held for investment
decreased by $16.4 million or 1.4% during the twelve months ended December 31,
1998. This decrease was caused by the aforementioned securitization of
adjustable-rate residential mortgage loans into MBSs, although the impact of
this transaction was offset somewhat by the Corporation's purchase in 1998 of
$165.1 million in adjustable-rate mortgage loans originated by third-party
financial institutions. These loans were purchased to maintain growth in the
Corporation's level of earning assets. A low interest rate environment in 1998
had a significant impact on the ability of the Corporation to maintain its
internally originated portfolio of loans held for investment. This situation
developed because a low interest rate environment tends to increase customer
preference for fixed-rate mortgage loans, as opposed to adjustable-rate loans.
In addition, a low interest rate environment encourages borrowers to refinance
their existing adjustable-rate residential mortgage loans into fixed-rate loans
to "lock-in" a lower long-term rate. Given the Corporation's policy of selling
these types of loans in the secondary market, its internally originated
portfolio of adjustable-rate residential loans declined significantly in 1998.
Although some of this decline was offset by internal growth in commercial real
estate, consumer, and education loans, the Corporation purchased adjustable-rate
mortgage loans from two third-party financial institutions in an effort to
maintain growth in its level of earning assets during 1998. These loans were
subjected to substantially the same underwriting process as the Corporation's
own loans. The loans are located throughout the U.S., with no single state
making up a significant portion of the overall principal. The loans have
adjustable-rates that reset annually at an average margin of approximately 250
basis points above the one-year U.S. Treasury bill. Most of the loans have fixed
interest rates for terms of three to seven years before their first adjustment
date. The loans were purchased by FCHI, the Corporation's wholly-owned
investment subsidiary in Nevada.
The Corporation will continue to explore alternatives to maintain
growth in its interest-earning assets in the near term. These alternatives
include, but are not limited to, the purchase of additional adjustable-rate
residential mortgage loans from third-party financial institutions, the purchase
of mortgage-backed and related securities, and the retention of certain
fixed-rate loans that are currently sold by the Corporation in the secondary
market. It is anticipated that such assets would be funded by growth in deposit
liabilities or increased borrowings from the FHLB. However, there are many
considerations involved in such decisions and there can be no assurances that
the Corporation will elect to adopt any of these strategies to increase its
interest-earnings assets.
23
25
The following table sets forth the composition of the Corporation's
portfolio of loans held for investment as of December 31 for each of the years
indicated.
Dollars In thousands
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- --------------------------------------------------------------------------------------------------------------------
Real estate loans:
Single-family residential $ 426,603 36% $ 537,722 45% $ 543,109 49% $ 462,760 49% $ 343,904 47%
Multi-family residential 148,060 13 140,589 12 127,334 11 119,955 13 102,356 14
Commercial real estate
loans 141,046 12 107,315 9 94,401 8 76,242 8 66,848 9
Construction (1) 63,035 5 51,319 4 46,641 4 31,364 3 29,847 4
- --------------------------------------------------------------------------------------------------------------------
Total real estate loans 778,744 66 836,945 70 811,485 73 690,321 73 542,955 74
- --------------------------------------------------------------------------------------------------------------------
Consumer loans:
Second mortgage and home
equity loans 175,541 15 163,231 14 119,645 11 83,993 9 53,931 7
Education loans 182,380 15 159,893 13 134,094 12 108,003 11 84,604 12
Automobile loans 37,558 3 31,182 3 36,831 3 39,653 4 39,822 5
Other consumer loans (2) 9,006 1 9,149 1 10,724 1 16,238 2 10,613 1
- --------------------------------------------------------------------------------------------------------------------
Total consumer loans 404,485 34 363,455 30 301,294 27 247,887 26 188,970 26
- --------------------------------------------------------------------------------------------------------------------
Other loans:
Small Business
Administration loans 345 - 377 - 1,006 - 1,237 - 1,381 -
Commercial business loans 26 - 179 - 211 - 968 - 411 -
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total other loans 371 - 556 - 1,217 - 2,205 - 1,792 -
- --------------------------------------------------------------------------------------------------------------------
Subtotal 1,183,600 100% 1,200,957 100% 1,113,996 100% 940,413 100% 733,717 100%
Unearned discounts,
premiums, and net
deferred loan fees/costs 1,549 574 (68) (143) (1,817)
Allowance for loan losses (7,624) (7,638) (7,888) (8,186) (8,074)
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total loans held for
investment $ 1,177,526 $ 1,193,893 $ 1,106,040 $ 932,084 $ 723,826
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Weighted-average 7.75% 8.20% 8.16% 8.24% 7.83%
contractual rate
- --------------------------------------------------------------------------------------------------------------------
(1) At December 31, 1998, construction loans consisted of $31.0 million in
single-family residences, $13.8 million in multi-family residences, and
$18.2 million in commercial real estate.
(2) At December 31, 1998, other consumer loans included $0.5 million of mobile
home loans, $1.5 million of recreational and household good loans, $5.4
million of unsecured loans, and $1.6 million of deposit account-secured
loans.
24
26
The following table sets forth the activity in the Corporation's
portfolio of loans held for investment during each of the years ended December
31:
Dollars in thousands 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $1,193,893 $1,106,040 $ 932,084 $ 723,826 $ 572,066
- ---------------------------------------------------------------------------------------------------------------------
Single-family residential (1) 212,964 243,694 247,362 147,827 175,493
Multi-family and commercial real estate 106,146 71,554 65,384 21,477 28,207
- ---------------------------------------------------------------------------------------------------------------------
Total real estate loans originated 319,110 315,248 312,746 169,304 203,700
- ---------------------------------------------------------------------------------------------------------------------
Consumer loan originations:
Second mortgage and home equity loans 136,659 120,809 89,115 65,397 47,256
Education loans 37,692 38,422 36,176 31,347 30,135
Automobile loans 33,729 23,923 29,377 23,489 36,861
Other consumer loans 6,461 7,004 8,675 9,701 7,775
- ---------------------------------------------------------------------------------------------------------------------
Total consumer loans originated 214,541 190,158 163,343 129,934 122,027
- ---------------------------------------------------------------------------------------------------------------------
Decrease (increase) in loans in process (2) 1,654 (13,081) (3,277) (1,836) (6,123)
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
Total loans originated for investment 535,305 492,325 472,812 297,402 319,604
- ---------------------------------------------------------------------------------------------------------------------
Loans purchased for investment:
Single-family residential loans 165,140 - - - -
Consumer loans 377 - - 22 -
Multi-family and commercial real estate
loans - 6,373 9,692 1,946 233
- ---------------------------------------------------------------------------------------------------------------------
Total loans purchased for investment 165,517 6,373 9,692 1,968 233
- ---------------------------------------------------------------------------------------------------------------------
Loans swapped into mortgage-backed securities (222,260) - - - -
Loans acquired through merger - - - 107,788 -
Loans transferred to held for sale portfolio
(3) (98,718) (92,573) (15,659) (12,448) (6,265)
Loan principal repayments (389,935) (317,291) (292,199) (186,024) (161,385)
Other changes in loans held for investment
(4) (6,276) (981) (690) (428) (427)
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
Balance at end of period $1,177,526 $1,193,893 $1,106,040 $ 932,084 $ 723,826
- ---------------------------------------------------------------------------------------------------------------------
(1) Excludes loans originated for sale of $818.3 million, $258.8 million, $237.6
million, $180.3 million, and $132.4 million in 1998, 1997, 1996, 1995, and
1994, respectively. Also excludes loans originated on an agency basis for
WHEDA and State VA of $38.8 million, $23.1 million, $20.9 million, $27.9
million, and $22.8 million in 1998, 1997, 1996, 1995, and 1994,
respectively.
(2) Consists principally of changes in loans in process on single-family,
multi-family, and commercial real estate construction loans.
(3) Consists of single-family adjustable-rate mortgage loans that converted to
fixed-rate and were sold by the Corporation in the secondary market.
(4) Consists principally of real estate foreclosures and changes in allowance
for loan losses, discounts, premiums, and deferred fees.
DEPOSIT LIABILITIES The Corporation's deposit liabilities increased by
$313.6 million or approximately 25% during the twelve months ended December 31,
1998. This growth was due in part to a number of popular CD products offered to
customers during the year, as well as a $51.4 million increase in non-interest
bearing checking accounts. In addition to the Corporation's competitive CD
products, management attributes the growth in its deposit liabilities to the
combined effects of its expansion efforts in recent years, its convenient
banking locations, and the strong local economies in its market areas.
In the fourth quarter of 1998, the Corporation completed the purchase
of three retail banking offices in Rockford, Illinois, from another financial
institution. In connection with this purchase, the Corporation acquired $76.9
million in deposits and paid a premium of $8.0 million. The intangible assets
created by this transaction will be amortized straight-line over fifteen years.
25
27
The following table sets forth the composition of the Corporation's
deposit liabilities as of December 31 for each of the years indicated.
Dollars in thousands 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
- --------------------------------------------------------------------------------------------------------------------
Regular savings accounts $ 103,467 1.98% $ 87,605 1.98% $ 85,675 1.98%
Interest-bearing checking accounts 83,260 0.86 54,994 0.99 53,907 1.00
Non-interest bearing checking accounts 144,731 - 93,323 - 75,341 -
Money market accounts 166,801 4.03 143,116 4.36 134,977 4.35
Variable-rate IRA accounts 3,215 4.11 2,956 4.41 3,345 4.43
Certificates of deposit 958,662 5.83 764,540 6.04 670,848 6.01
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total $1,460,136 4.49% $1,146,534 4.79% $1,024,093 4.74%
- --------------------------------------------------------------------------------------------------------------------
At December 31, 1998, certificates of deposit in denominations of
$100,000 or more amounted to $90.7 million and mature as follows: $37.8 million
within three months, $6.5 million over three through six months, $28.9 million
over six through 12 months, $15.7 million over 12 through 24 months, and $1.8
million over 24 months. At December 31, 1998, the Bank had no brokered deposits
outstanding.
FHLB ADVANCES AND OTHER BORROWINGS The Corporation's FHLB advances and
other borrowings decreased by $86.0 million or approximately 30% during the year
ended December 31, 1998. This decrease was funded by growth in deposit
liabilities, as previously described.
The following table presents certain information regarding the
Corporation's short-term FHLB advances and other borrowings (original maturity
of less than one year) at or for the years ended December 31, 1998, 1997, and
1996.
Dollars in thousands
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
FHLB advances:
Average balance outstanding (1) $ 89,832 $ 244,609 $ 90,016
Maximum amount outstanding at any month-end during the period 211,300 300,985 181,602
Balance outstanding at end of period 3,000 211,300 181,602
Average interest rate during the period (2) 5.65% 5.39% 5.55%
Weighted-average interest rate at the end of period 5.76% 5.73% 5.53%
Other borrowings: (3)
Average balance outstanding (1) $769 $ 3,846 $ 2,308
Maximum amount outstanding at any month-end during the period 10,000 10,000 5,000
Balance outstanding at end of period - 10,000 5,000
Average interest rate during the period (2) 4.81% 5.95% 5.98%
Weighted-average interest rate at the end of period - 4.81% 5.64%
Total short-term borrowings:
Average balance outstanding (1) $ 90,601 $248,455 $ 92,324
Maximum amount outstanding at any month-end during the period 221,300 305,985 186,602
Balance outstanding at end of period 3,000 221,300 186,602
Average interest rate during the period (2) 5.64% 5.40% 5.56%
Weighted-average interest rate at the end of period 5.76% 5.69% 5.53%
- --------------------------------------------------------------------------------------------------------------------
(1) Calculated using month-end balances.
(2) Calculated using month-end weighted average interest rates.
(3) Consists primarily of an overnight line of credit with another financial
institution.
NON-PERFORMING ASSETS The Corporation's non-performing assets
(consisting of non-accrual loans, real estate acquired through foreclosure or
deed-in-lieu thereof, and real estate in judgement) amounted to $2.4 million or
0.13% of total assets at December 31, 1998, compared to $4.9 million or 0.32% at
December 31, 1997.
26
28
The following table contains information regarding the Corporation's
non-performing assets during the five year period ended December 31, 1998.
Dollars in thousands 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Non-accrual loans:
Single-family residential $ 770 $ 738 $1,003 $ 547 $ 428
Multi-family and commercial real estate - 3,000 - 104 -
- --------------------------------------------------------------------------------------------------------------------
Total real estate loans 770 3,738 1,003 651 428
Consumer loans 341 672 973 605 313
Commercial business loans - - - - 129
- --------------------------------------------------------------------------------------------------------------------
Total non-accrual loans 1,111 4,410 1,976 1,256 870
Real estate owned and in judgement 1,264 492 460 193 265
- --------------------------------------------------------------------------------------------------------------------
Total non-performing assets $2,375 $4,902 $2,436 $1,449 $1,135
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Ratio of non-accrual loans to total net loans receivable 0.09% 0.37% 0.18% 0.13% 0.12%
- --------------------------------------------------------------------------------------------------------------------
Ratio of total non-performing assets to total assets 0.13% 0.32% 0.16% 0.10% 0.10%
- --------------------------------------------------------------------------------------------------------------------
Ratio of total allowance for loan and real estate losses
to total non-performing assets 330% 159% 331% 577% 727%
- --------------------------------------------------------------------------------------------------------------------
The $2.5 million or approximately 50% decrease in non-performing assets
during the year ended December 31, 1998, was principally due to a change in the
status of a $3.0 million loan on an apartment complex located in Indiana. In
1998 the Corporation took a deed-in-lieu of foreclosure on the loan and sold the
property to another party. The Corporation financed the sale of the property at
normal rate and terms, except that the loan was interest-only for a period of
two years. The Corporation also committed an additional $2.0 million to the loan
for purposes of refurbishing the property. The new borrower was also required to
contribute $1.1 million towards the refurbishing. The Corporation incurred a
$203,000 loss on the sale of the property, which was included in other
non-interest expense.
In addition to non-performing assets, at December 31, 1998, management
was closely monitoring $6.4 million in assets which it had classified as
doubtful, substandard, or special mention, but which were performing in
accordance with their terms. This compares to $7.2 million in such assets at
December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation's primary sources of funds are deposits obtained
through its retail branch offices, borrowings from the FHLB and other sources,
amortization, maturity, and prepayment of outstanding loans and investments, and
sales of loans and other assets. During 1998, 1997, and 1996, the Corporation
used these sources of funds to fund loan commitments, purchase investment
mortgage-related securities, and cover maturing liabilities and deposit
withdrawals. At December 31, 1998, the Corporation had approved real estate loan
commitments of $24.0 million outstanding, undisbursed commitments on
construction loans of $34.7 million, and mortgage loan sale commitments of $92.3
million outstanding. In addition, the Corporation had $713.3 million in time
deposits and $10.7 million in FHLB term advances that were scheduled to mature
within one year. Management believes that the Corporation has adequate resources
to fund all of these commitments, that all of these commitments will be funded
by the required date, and that the Corporation can adjust the rates it offers on
certificates of deposit to retain such deposits in changing interest rate
environments. Under FHLB lending and collateralization guidelines, the
Corporation had approximately $370 million in unused borrowing capacity at the
FHLB as of December 31, 1998.
The Corporation's stockholders' equity ratio as of December 31, 1998,
was 6.87% of total assets. The Corporation's objective is to maintain its
stockholders' equity ratio in a range of approximately 6.5% to 7.0%, which is
consistent with return on asset and return on equity goals of at least 1% and
15%, respectively. The Bank is also required to maintain specified amounts of
capital pursuant to regulations promulgated by the OTS and the FDIC. The Bank's
objective is to maintain its regulatory capital in an amount sufficient to be
classified in the highest regulatory capital category (i.e., as a "well
capitalized" institution). At December 31, 1998, the Bank's regulatory capital
exceeded all regulatory minimum requirements, as well as the amount required to
be classified as a "well capitalized" institution. For additional discussion,
refer to Note 11 of the Corporation's Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
27
29
The Corporation paid cash dividends of $5.0 million, $4.3 million, and
$3.9 million during the years ended December 31, 1998, 1997, and 1996,
respectively. These amounts equated to dividend payout ratios of 25.7%, 24.6%,
and 38.5% of the net income in such periods, respectively. It is the
Corporation's objective to maintain its dividend payout ratio in a range of 25%
to 35% of net income. However, the Corporation's dividend policy and/or dividend
payout ratio will be impacted by considerations which include, but are not
limited to, the level of stockholders' equity in relation to the Corporation's
stated goal, as previously described, regulatory capital requirements for the
Bank, as previously described, and certain dividend restrictions in effect for
the Bank (for additional discussion refer to Note 11 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data"). Furthermore, unanticipated or
non-recurring fluctuations in earnings may impact the Corporation's ability to
pay dividends and/or maintain a given dividend payout ratio.
On January 26, 1999, the Corporation's Board of Directors approved a
regular quarterly dividend of $0.07 per share payable on March 11, 1999, to
shareholders of record on February 18, 1999.
During 1998, the Corporation repurchased 447,000 shares of common stock
at a cost of $7.4 million under its 1996 and 1997 stock repurchase plans (the
"1996 Plan" and "1997 Plan", respectively). As of December 31, 1998, no shares
remained to be purchased under the 1996 Plan and 519,152 shares remained under
the 1997 Plan. On January 26, 1999, the Corporation's Board of Directors
extended the 1997 Plan for an additional twelve months. On February 11, 1999,
however, the Corporation completed the purchase of the remaining shares under
the 1997 Plan. For additional discussion, refer to Note 11 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
During 1998, the Corporation reissued 426,775 shares of common stock
out of its inventory of treasury stock with a cost basis of $5.5 million. In
general, these shares were issued upon the exercise of stock options by, or the
issuance of restricted stock to, employees and directors of the Corporation.
YEAR 2000 COMPLIANCE
Potential software and hardware failures arising from calculations that
use the year 2000 represent a significant risk exposure to the Corporation. If
not corrected, software and hardware failures caused by the year 2000 could
result in a major system failure and/or miscalculations, which could result in a
material loss to the Corporation--the probability or amount of which cannot be
estimated at this time. Accordingly, management has implemented an on-going
program designed to ensure that the Corporation's information systems will not
be adversely impacted by the year 2000.
The Corporation's program to resolve the year 2000 issue involves the
following four phases: assessment, remediation, testing, and implementation. The
Corporation has completed the assessment phase and has found that the year 2000
issue affects all of its significant information systems. With respect to
remediation, the Corporation estimates that it was 95% complete as of December
31, 1998, and expects to be substantially complete by March 31, 1999. For all
practical purposes, the testing and implementation of most software programs
occurs simultaneously. The Corporation estimates that these phases were 75%
complete as of December 31, 1998, and that it will be substantially complete by
March 31, 1999. These estimates include systems purchased from and maintained by
third-party software and hardware vendors.
The Corporation's information systems interface directly with those of
certain third-party transaction processors, to include the Federal Reserve Bank
of Minneapolis. With respect to the year 2000 issue, the Corporation's
information systems are highly dependent on the state of readiness of these
third-party transaction processors, as well as the communication systems over
which the data is exchanged. The Corporation expects to complete the testing and
implementation phases that relate to interface programs with third-party
transaction processors by March 31, 1999. The Corporation is unable, however, to
provide any assurances with respect to year 2000 readiness on the part of public
providers of communication services and other utilities.
The Corporation is in the process of developing contingency plans to
deal with communication and other utility failures that may occur as a result of
the year 2000 issue. It is also developing plans to temporarily accumulate data
related to customer transactions should its own information systems or those of
third parties fail. A
28
30
portion of such contingency plans may include the manual processing of certain
types of customer transactions. In addition, it may include plans to temporarily
honor certain obligations of reputable third parties, such as recurring deposits
from the federal government, that could be disrupted by the year 2000 and which
could have a significant impact on the Corporation's customers if not honored.
However, there can be no assurances that the Corporation will honor the
obligations of third parties. The Corporation estimates that its contingency
plan will be completed by March 31, 1999.
The Corporation is using in-house personnel to identify and correct
year 2000 issues, as well as cooperation with third-party software and hardware
vendors. As of December 31, 1998, the Corporation estimates that it has spent
approximately $290,000 in direct, incremental costs related to the year 2000
issue. This amount includes additional compensation costs to retain essential
personnel, hire additional personnel, and purchase new software--it does not
include opportunity costs. The Corporation is unable to estimate additional
future costs of the year 2000 issue at this time, but does not believe such will
be material to its financial condition or results of operations.
Although management does not believe that the arrival of the year 2000
will pose significant operational problems to the Corporation, there can be no
assurances that it will be successful in preventing failures caused by this
issue. There can also be no assurances that such failures will not result in a
material loss to the Corporation. Such losses may include loss of customer
goodwill, waivers of customer transaction fees and interest, errors in honoring
obligations of third parties, fraudulent transactions, or other sources of loss
not know at this time. As previously mentioned, the Corporation is unable to
estimate the probability or the amount of future loss at this time, if any.
ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation manages the exposure of its operations to changes in
interest rates ("interest rate risk" or "market risk") by monitoring its ratios
of interest-earning assets to interest-bearing liabilities within one- and
three-year maturities and/or repricing dates (i.e., its one- and three-year
"funding gaps"). Management has sought to control the Corporation's funding
gaps, thereby limiting the affects of changes in interest rates on its future
earnings, by selling substantially all of its long-term, fixed-rate,
single-family mortgage loan production, investing in adjustable-rate
single-family mortgage loans, investing in consumer and education loans, which
generally have shorter terms to maturity and/or floating rates of interest, and
investing in multi-family residential and commercial real estate loans, which
also tend to have shorter terms to maturity and/or floating rates of interest.
The Corporation also invests from time-to-time in short- and medium-term
fixed-rate CMOs and MBSs. As a result of this strategy, the Corporation's
exposure to interest rate risk is significantly impacted by its funding of the
aforementioned asset groups with deposit liabilities and FHLB advances that tend
to have average terms to maturity of less than one year or carry floating rates
of interest.
In general, it is management's goal to maintain the Corporation's
one-year funding gap in a range between 0% and -25% and its three-year funding
gap in a range between +5% and -5%. Management believes this strategy takes
advantage of the fact that market yield curves tend to be upward sloping, which
increases the spread between the Corporation's earning assets and
interest-bearing liabilities. Furthermore, management of the Corporation does
not believe that this strategy exposes the Corporation to unacceptable levels of
interest rate risk as evidenced by the fact that the Corporation's three-year
funding gap is generally maintained in a narrow band around zero, which implies
that the Corporation is exposed to little interest rate risk over a three-year
horizon. In addition, it should be noted that for purposes of its funding gap
analysis, the Corporation classifies its interest-bearing checking, savings, and
money market deposits in the shortest category, due to their potential to
reprice. However, it is the Corporation's experience that these deposits do not
reprice as quickly or to the same extent as other financial instruments,
especially in a rising rate environment.
29
31
The following table summarizes the Corporation's funding gap as of
December 31, 1998.
MORE THAN MORE THAN MORE THAN
6 MONTHS 6 MONTHS 1 YEAR TO 3 YEARS TO OVER
Dollars in thousands OR LESS TO 1 YEAR 3 YEARS 5 YEARS 5 YEARS TOTAL
- --------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Mortgage loans:
Fixed $114,874 $ 35,649 $ 35,396 $ 12,169 $ 15,205 $ 213,293
Adjustable 129,285 123,039 215,764 126,133 43,356 637,577
Consumer loans 77,637 225,457 81,464 15,308 3,756 403,622
Mortgage-backed and related securities 66,602 78,103 124,686 18,151 16,208 303,750
Investment securities and other
earning assets 96,450 - - - 12,586 109,036
- --------------------------------------------------------------------------------------------------------------------
Total $484,848 $462,248 $457,310 $171,761 $ 91,111 $1,667,278
- --------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits liabilities:
Regular savings and checking accounts $186,467 - - - - $ 186,467
Money market deposit accounts 167,061 - - - - 167,061
Variable-rate IRA accounts 3,215 - - - - 3,215
Time deposits 480,912 $231,062 $241,387 $ 5,278 $ 23 958,662
FHLB advances and other borrowings 85,868 2,803 67,660 33,433 14 189,778
- --------------------------------------------------------------------------------------------------------------------
Total $923,523 $233,865 $309,047 $ 38,711 $ 37 $1,505,183
- --------------------------------------------------------------------------------------------------------------------
Excess (deficiency) of earning assets
over interest-bearing liabilities ($438,675) $228,383 $148,263 $133,050 $ 91,074
- --------------------------------------------------------------------------------------------------------------------
Cumulative excess (deficiency) of
earning assets over interest-bearing
liabilities ($438,675) ($210,292) ($ 62,029) $ 71,021 $162,095
- --------------------------------------------------------------------------------------------------------------------
Cumulative excess (deficiency) of
earning assets over interest-bearing
liabilities as a percent of total
assets -24.55% -11.77% -3.47% 3.98% 9.07%
- --------------------------------------------------------------------------------------------------------------------
Cumulative earning assets as a
percentage of interest-bearing
liabilities 52.50% 81.83% 95.77% 104.72% 110.77%
- --------------------------------------------------------------------------------------------------------------------
Note: If redeemable FHLB advances, interest-bearing checking, and regular
savings deposits were deemed to reprice after one year, the Corporation's
one-year funding gap would have been 2.86% as of December 31, 1998, which
compares to -4.77% and -14.12% as of December 31, 1997 and 1996, respectively.
The Corporation's one-year funding gap was -11.77% at December 31,
1998, compared to -14.00% and -23.32% at December 31, 1997 and 1996,
respectively. The Corporation's one-year funding gap improved slightly in 1998
principally because an increase in liabilities expected to mature or reprice
within one year was matched by a similar increase in assets expected to mature
or reprice within the same time frame. This resulted in little change in the
Corporation's one-year cumulative deficiency of earning assets over
interest-bearing liabilities, in dollar terms. However, because the
Corporation's total assets grew by $242.2 million or 15.7%, as previously
described, the one-year cumulative deficiency as a percent of total assets
improved from -14.00% to -11.77%.
Certain shortcomings are inherent in using funding gap to quantify
exposure to interest rate risk. For example, although certain assets and
liabilities may have similar maturities or repricings in the table, they may
react differently to actual changes in market interest rates. The interest rates
on certain types of assets and liabilities may fluctuate in advance of changes
in market interest rates, while interest rates on other types may lag behind
changes in market rates. This is especially true in circumstances where
management has a certain amount of control over interest rates, as it does in
the case of deposit liabilities. Additionally, certain assets such as
adjustable-rate mortgage loans have features that restrict changes in interest
rates on a short-term basis and over the life of the asset. Furthermore, the
proportion of adjustable-rate loans in the Corporation's portfolio may change as
interest rates change. For example, if current market interest rates remain at
or below current levels the proportion of adjustable-rates loans in the
Corporation's portfolio may decline for reasons described elsewhere in this
report. Finally, as interest rates change, the rates at which loans actually
prepay will differ from those rates assumed by management in the table.
Although management believes that its asset/liability management
strategies reduce the potential effects of changes in interest rates on the
Corporation's operations, material and prolonged increases in interest rates may
adversely affect the Corporation's operations because the Corporation's
interest-bearing liabilities which mature or reprice within one year are greater
than the Corporation's interest-earning assets which mature or reprice within
the
30
32
same period. Alternatively, material and prolonged decreases in interest rates
may benefit the Corporation's operations.
The Corporation does not use derivative financial instruments such as
futures, swaps, caps, floors, options, interest- or principal-only strips, or
similar financial instruments to manage its interest rate risk. However, the
Corporation does use forward sales of mortgage-backed securities to manage
exposure to market risk in its "pipeline" of single-family residential loans
intended for sale. This pipeline consists of mortgage loans that are held for
sale as of the balance sheet date as well as commitments to originate mortgage
loans that are intended for sale, but are not closed as of the balance sheet
date. Loans held for sale are generally matched against forward sales that
require delivery within 30 to 60 days of the balance sheet date. The
Corporation's policy is to cover its commitments to originate loans intended for
sale with forward sales that have a value of 40% to 130% of the value of such
commitments, depending on management's expectations for near-term changes in
interest rates and anticipated cancellations by borrowers. These forward sales
generally require delivery within 60 to 90 days. Given these policies, as well
as the short-term nature of the Corporation's pipeline and its related forward
sales, management believes these financial instruments pose little market risk
to the Corporation.
The Bank is required by the OTS to estimate the sensitivity of its
market value of portfolio equity ("MVPE") to immediate and sustained changes in
interest rates and to measure such sensitivity on at least a quarterly basis.
MVPE is defined as the estimated net present value of an institution's existing
assets, liabilities, and off-balance sheet instruments at a given level of
market interest rates. Computation of the estimated net present value of assets,
liabilities, and off-balance sheet instruments requires management to make
numerous assumptions with respect to such items. These assumptions include, but
are not limited to, appropriate discount rates, loan prepayment rates, deposit
decay rates, etc., for each interest rate scenario. In general, the Bank has
used substantially the same assumptions for computing the net present value of
financial assets and liabilities in the base scenario as it uses in preparing
the fair value disclosures required under GAAP (refer to Notes 1 and 12 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data"). Computations of
net present values for other interest rate scenarios follow the same basic
approach except that discount rates, loan prepayment rates, and other
assumptions are adjusted accordingly. The net present values of non-financial
assets and liabilities are generally estimated to be equal to their carrying
values under all interest rate scenarios as permitted by OTS regulations. With
respect to off-balance sheet items, the Bank generally relies on estimates of
value provided by the OTS. The same is true for certain other financial assets
such as mortgage servicing rights and deposit-based intangibles.
The following table summarizes as of December 31, 1998 and 1997, the
sensitivity of the Bank's MVPE and net interest income to immediate and
sustained changes in interest rates, as shown (parallel shifts in the term
structure of interest rates are assumed as permitted by OTS regulations; dollars
are presented in millions).
Estimated MVPE
---------------------
Change in interest rates 12/31/98 12/31/97
------------------------ -------- --------
200 basis point increase $132.9 $137.5
Base scenario 142.7 137.3
200 basis point decline 159.5 133.6
Certain shortcomings are inherent in using MVPE to quantify exposure to
market risk. For example, actual and future values of assets, liabilities, and
off-balance sheet items will differ from those determined by the model for a
variety of reasons to include, but not limited to, differences in actual market
discount rates, differences in actual loan prepayment activity, and differences
in deposit customers' responses to changes in interest rates and the resulting
impact on the Bank's offering rates. Furthermore, the analysis does not
contemplate future shifts in asset or liability mix or any actions management
may take in response to changes in interest rates. As a result of these
shortcomings, it is unlikely that actual or future values of the Bank's assets,
liabilities, and off-balance sheet items are or will be equal to those presented
in the MVPE analysis. Furthermore, it should be noted that although the
estimated changes in the Bank's MVPE as shown above are within limits
established by the Bank's Board of Directors, management and the Board of
Directors do not place a significant amount of emphasis on MVPE when evaluating
exposure to interest rate risk. Management's primary tool for managing exposure
to interest rate risk is the Corporation's funding gap, as previously described.
31
33
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1998 and 1997
ASSETS 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 43,642,705 $ 29,939,484
Interest-bearing deposits with banks 96,549,775 7,113,756
Investment securities available for sale, at fair value - 21,376,678
Mortgage-backed and related securities:
Available for sale, at fair value 204,108,879 47,895,297
Held for investment, at cost (fair value of $102,908,423 and $123,613,629,
respectively) 102,500,238 124,335,969
Loans held for sale 72,002,437 45,576,945
Loans held for investment, net 1,177,525,727 1,193,893,087
Federal Home Loan Bank stock 12,485,500 13,811,300
Accrued interest receivable, net 13,888,538 11,547,757
Office properties and equipment 25,082,582 24,243,132
Mortgage servicing rights, net 21,103,459 16,290,903
Intangible assets 13,485,366 5,921,443
Other assets 4,128,510 2,348,647
- -------------------------------------------------------------------------------------------------------------------
Total assets $1,786,503,716 $1,544,294,398
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------
Deposit liabilities $1,460,135,660 $1,146,533,896
Federal Home Loan Bank advances and other borrowings 189,777,984 275,778,770
Advance payments by borrowers for taxes and insurance 1,762,190 3,872,764
Accrued interest payable 1,947,823 2,030,153
Other liabilities 10,195,412 6,717,469
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 1,663,819,069 1,434,933,052
- -------------------------------------------------------------------------------------------------------------------
Preferred stock, $.10 par value, 5,000,000 shares authorized, none outstanding - -
Common stock, $.10 par value, 20,000,000 shares authorized, 19,941,630 shares
issued and outstanding, including 1,580,795 and 1,560,570 shares of treasury
stock, respectively 1,994,163 997,082
Additional paid-in capital 34,540,065 35,537,146
Retained earnings 97,291,806 84,548,291
Treasury stock, at cost (12,722,834) (10,845,168)
Unearned restricted stock (1,256,266) (211,006)
Non-owner adjustments to equity, net 2,837,713 (664,999)
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 122,684,647 109,361,346
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,786,503,716 $1,544,294,398
- -------------------------------------------------------------------------------------------------------------------
Refer to accompanying Notes to Audited Consolidated Financial Statements.
32
34
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Interest on loans $ 95,469,420 $ 97,941,595 $ 83,786,180
Interest on mortgage-backed and related securities 18,542,233 12,125,868 14,494,999
Interest and dividends on investments 4,656,215 4,908,793 5,695,818
- -------------------------------------------------------------------------------------------------------------------
Total interest income 118,667,868 114,976,256 103,976,997
- -------------------------------------------------------------------------------------------------------------------
Interest on deposit liabilities 59,421,641 51,149,724 46,490,086
Interest on FHLB advances and other borrowings 12,035,553 19,115,333 17,193,577
- -------------------------------------------------------------------------------------------------------------------
Total interest expense 71,457,194 70,265,057 63,683,663
- -------------------------------------------------------------------------------------------------------------------
Net interest income 47,210,674 44,711,199 40,293,334
Provision for loan losses 293,112 538,957 -
- -------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 46,917,562 44,172,242 40,293,334
- -------------------------------------------------------------------------------------------------------------------
Retail banking fees and service charges 15,025,325 12,583,927 10,237,623
Commissions on annuity and insurance sales 1,780,045 1,810,667 2,063,520
Loan servicing fees, net (6,673,635) 2,367,828 2,221,690
Gain on sales of loans 16,928,546 6,373,747 4,330,550
Gain (loss) on sales of investment securities 342,803 (725,142) (311,151)
Other income 3,956,985 1,882,658 1,288,940
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income 31,360,070 24,293,685 19,831,172
- -------------------------------------------------------------------------------------------------------------------
Compensation and employee benefits 26,659,541 21,827,232 19,913,513
Occupancy and equipment 6,949,198 6,675,597 6,412,307
Supplies, postage, and communications 3,675,696 3,145,803 2,826,979
ATM and debit card transaction costs 2,335,872 2,022,031 1,519,743
Advertising and marketing 2,157,076 2,173,031 1,710,140
Federal deposit insurance premiums 731,691 637,353 2,124,036
FDIC special assessment - - 5,941,000
Amortization of intangible assets 582,159 496,180 431,263
Other expenses 4,505,290 3,219,825 3,365,746
- -------------------------------------------------------------------------------------------------------------------
Total non-interest expense 47,596,523 40,197,052 44,244,727
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 30,681,109 28,268,875 15,879,779
Income tax expense 11,256,975 10,878,512 5,805,862
- -------------------------------------------------------------------------------------------------------------------
Net income $ 19,424,134 $ 17,390,363 $ 10,073,917
- -------------------------------------------------------------------------------------------------------------------
PER SHARE INFORMATION 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.98 $ 0.88 $ 0.50
Basic earnings per share 1.05 0.95 0.54
Dividends paid per share 0.270 0.233 0.207
- -------------------------------------------------------------------------------------------------------------------
Refer to accompanying Notes to Audited Consolidated Financial Statements.
33
35
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 19,424,134 $ 17,390,363 $ 10,073,917
Adjustments to reconcile net income to net cash provided
(used) by operations:
Provision for loan and real estate losses 548,573 458,070 (10,240)
(recoveries), net
Net loan fees (costs) deferred (1,162,077) (835,277) 73,827
Depreciation and amortization 16,886,960 6,363,677 5,950,546
Gains on sales of loans, and other investments (17,271,349) (5,648,605) (4,019,400)
Increase in accrued interest receivable (2,340,781) (60,330) (1,354,216)
Decrease in accrued interest payable (82,330) (402,643) (199,862)
Increase in current and deferred income taxes 2,093,042 1,554,525 1,819,263
Other accruals and prepaids, net (407,797) (202,660) (414,056)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by operations before loan 17,688,375 18,617,120 11,919,779
originations and sales
Loans originated for sale (818,292,296) (258,817,745) (237,592,344)
Sales of loans originated for sale 791,718,170 252,349,050 240,578,067
- -------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operations (8,885,751) 12,148,425 14,905,502
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Decrease (increase) in interest-bearing deposits with (89,436,019) (4,656,855) 1,594,387
banks
Purchases of investment securities - - (34,828,051)
Sales of investment securities 351,483 31,710,769 11,019,370
Maturities of investment securities 21,318,517 20,785,762 29,482,069
Purchases of mortgage-backed and related securities held
for
investment (20,355,825) - -
Principal repayments on mortgage-backed and related
securities
held for investment 42,177,481 23,369,489 23,315,115
Principal repayments on mortgage-backed and related
securities
available for sale 69,972,407 15,934,333 20,855,233
Loans originated for investment (535,305,071) (492,325,180) (472,812,233)
Loans purchased for investment (165,517,368) (6,372,996) (9,692,282)
Loan principal repayments 389,935,430 317,290,692 292,198,986
Sales of loans originated for investment 101,632,748 75,122,123 17,124,014
Sales of real estate 5,593,229 1,380,170 242,993
Purchases of office properties and equipment (3,671,180) (2,595,908) (1,954,572)
Purchases of mortgage servicing rights (454,774) (1,374,069) -
Other, net (6,982,877) 6,108,616 (330,466)
- -------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (190,741,819) (15,623,054) (123,785,437)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposit liabilities 236,668,976 122,441,009 54,670,368
Deposits purchased 76,932,788 - -
Long-term advances from Federal Home Loan Bank 150,660,000 25,000,000 132,000,000
Repayment of long-term Federal Home Loan Bank advances (18,305,000) (165,507,000) (114,905,000)
Net increase (decrease) in short-term Federal Home Loan
Bank
borrowings (208,300,000) 29,698,000 38,207,000
Increase (decrease) in other borrowings (10,055,786) 2,994,787 5,995,202
Increase (decrease) in advance payments by borrowers for
taxes
and insurance (2,110,574) (39,442) 171,688
Purchase of treasury stock (7,356,875) (2,868,938) (9,674,875)
Dividends paid (5,001,135) (4,283,617) (3,874,954)
Other, net 198,397 1,335,060 560,276
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 213,330,791 8,769,859 103,139,705
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and due from banks 13,703,221 5,295,230 (5,740,230)
Cash and due from banks at beginning of period 29,939,484 24,644,254 30,384,484
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $ 43,642,705 $ 29,939,484 $ 24,644,254
- -------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Interest and dividends received on loans and investments $ 116,327,087 $ 114,915,926 $ 102,622,781
Interest paid on deposits and borrowings 71,539,524 70,667,700 63,883,525
Income taxes paid 10,010,000 9,689,000 4,540,490
Income taxes refunded 1,273,063 339,171 543,978
Mortgage-backed securities swaps 222,259,814 - -
- -------------------------------------------------------------------------------------------------------------------
Refer to accompanying Notes to Audited Consolidated Financial Statements.
34
36
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1998, 1997, and 1996
Common
Stock and
Additional Unearned Non-Owner
Paid-In Retained Treasury Restricted Adjustments
Capital Earnings Stock Stock to Equity Total
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 $ 35,854,026 $ 66,370,129 ($858,750) ($817,250) ($1,609,161) $ 98,938,994
-------------
Net income 10,073,917 10,073,917
Securities valuation
adjustment,
net of income taxes (1,026,613) (1,026,613)
Reclassification adjustment
for
loss on securities
included in
income, net of income taxes 185,010 185,010
-------------
Net income and non-owner
adjustments to equity 9,232,314
-------------
Exercise of stock options 390,021 390,021
Dividends paid (3,874,954) (3,874,954)
Purchase of treasury stock (9,674,875) (9,674,875)
Amortization of restricted 402,858 402,858
stock
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 36,244,047 72,569,092 (10,533,625) (414,392) (2,450,764) 95,414,358
-------------
Net income 17,390,363 17,390,363
Securities valuation
adjustment,
net of income taxes 1,354,595 1,354,595
Reclassification adjustment
for
loss on securities
included in
income, net of income taxes 431,169 431,169
-------------
Net income and non-owner
adjustments to equity 19,176,127
-------------
Exercise of stock options 290,181 (1,127,547) 2,557,395 1,720,029
Dividends paid (4,283,617) (4,283,617)
Purchase of treasury stock (2,868,938) (2,868,938)
Amortization of restricted 203,386 203,386
stock
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 36,534,228 84,548,291 (10,845,168) (211,006) (664,999) 109,361,346
-------------
Net income 19,424,134 19,424,134
Securities valuation
adjustment,
net of income taxes 3,706,543 3,706,543
Reclassification adjustment
for
gain on securities
included in
income, net of income taxes (203,831) (203,831)
-------------
Net income and non-owner
adjustments to equity 22,926,846
-------------
Exercise of stock options (2,443,580) 4,509,897 2,066,317
Dividends paid (5,001,135) (5,001,135)
Restricted stock award 764,096 969,312 (1,733,408)
-
Purchase of treasury stock (7,356,875) (7,356,875)
Amortization of restricted 688,148 688,148
stock
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $ 36,534,228 $ 97,291,806 ($12,722,834) ($1,256,266) $ 2,837,713 $ 122,684,647
- -------------------------------------------------------------------------------------------------------------------
Refer to accompanying Notes to Audited Consolidated Financial Statements.
35
37
Notes to Audited Consolidated Financial Statements
NOTE 1--Summary of Significant Accounting Policies
BUSINESS The Corporation provides a wide range of financial services to
individuals and businesses in Wisconsin and the northern portion of Illinois
through its wholly-owned subsidiary bank. The Corporation is subject to
competition from other financial institutions and markets. The Corporation, the
Bank, and the Bank's subsidiaries are also subject to the regulations of certain
governmental agencies and undergo periodic examinations by those regulatory
authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION The accounting and reporting
policies of the Corporation, the Bank, and the Bank's subsidiaries conform to
GAAP and to general practices within the financial services industry. In
preparing the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet and revenues and expenses for the period. Actual
results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements
include the accounts and balances of the Corporation, the Bank, and the Bank's
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
INVESTMENT SECURITIES, INCLUDING MORTGAGE-BACKED AND RELATED
SECURITIES, AND STOCK HELD FOR REGULATORY PURPOSES Investment securities,
including mortgage-backed and related securities, are classified in one of two
categories and accounted for as follows: (1) securities that the Corporation has
the positive intent and ability to hold to maturity are classified as "held for
investment" and reported at amortized cost; (2) securities not classified as
"held for investment" are classified as "available for sale" and reported at
fair value, with unrealized gains and losses excluded from earnings and reported
as non-owner adjustments to equity, net of estimated income taxes. Management
determines the appropriate classification for its securities at the time of
purchase. The specific identification method is used to determine the cost of
securities sold. The Corporation does not maintain a trading account for
investment securities or mortgage-backed and related securities.
The Corporation occasionally enters into purchases of securities and/or
whole-loans under agreements to resell ("repurchase agreements"). The amounts
advanced under these agreements represent short-term loans and are reflected as
a receivable in the Corporation's Consolidated Statement of Financial Condition.
Stock of the FHLB is owned due to regulatory requirements and is
carried at cost.
INTEREST ON LOANS Interest income is accrued on loan balances
outstanding. Accrued interest on impaired loans is reversed when management
determines that the collection of interest or principal is considered unlikely.
In general, this occurs when a loan is 90 days past due. Interest income is
subsequently recognized only to the extent cash payments are received. Loans are
restored to accrual status when the obligation is brought current and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt.
DISCOUNTS, PREMIUMS, AND DEFERRED LOAN FEES AND COSTS Discounts and
premiums on loans are amortized over the life of the related loans using a
method that approximates the level-yield method. Loan origination fees and
certain direct loan origination costs are deferred and amortized over the life
of the related loans as an adjustment of yield. Such fees and costs are
amortized using a method that approximates the level-yield method.
LOANS HELD FOR SALE Loans originated and held for sale are carried at
the lower of aggregate cost or market. Net unrealized losses are recognized
through a valuation allowance and a charge to income.
MORTGAGE SERVICING RIGHTS Servicing mortgage loans includes such
functions as collecting monthly payments of principal and interest from
borrowers, passing such payments through to third-party investors, maintaining
escrow accounts for taxes and insurance, and making such payments when they are
due. The Corporation generally earns a fee of 25 basis points or more on the
outstanding loan balance for performing these services as well as fees and
interest income from ancillary sources such as delinquency charges and float.
36
38
The Corporation records originated mortgage servicing rights ("OMSR")
as a component of gain on the sale of mortgage loans. The value recorded for
OMSR approximates the present value of the servicing fee (typically 25 basis
points or more) adjusted for expected future costs to service the loans, as well
as income and fees expected to be received from ancillary sources, as previously
described. The carrying value of OMSR is amortized against service fee income
over the estimated lives of the loans using the income-forecast method. The
Corporation also purchases mortgage servicing rights ("PMSR") from
third-parties. PMSR is recorded at cost and is also amortized over the estimated
lives of the loans using the income-forecast method.
The value of OMSR and PMSR (collectively "mortgage servicing rights" or
"MSRs") is subject to impairment as a result of changes in loan prepayment
expectations and in market discount rates used to value the future cash flows
associated with such assets. If, based on periodic evaluations, the estimated
present value of MSRs is determined to be less than carrying value, a valuation
adjustment is recorded against such assets and against the Corporation's loan
servicing fee income in the period of the prepayment. The valuation adjustment
is calculated using the current outstanding principal balance of the related
loans, a long-term prepayment assumption as determined by management, and a
discount rate that the Corporation has experienced in recent bids on MSRs in the
secondary market.
The Corporation purchases or originates MSRs on single-family
residential mortgage loans only. In valuing the MSRs recorded on such loans, the
Corporation stratifies the loans by type of loan (e.g., fixed-rate versus
adjustable-rate, non-government-guaranteed loans versus government-guaranteed
loans), year of original funding, contractual interest rate, and original term
to maturity.
REAL ESTATE Real estate acquired through foreclosure or deed in lieu of
foreclosure and real estate subject to redemption are recorded at the lower of
cost or estimated fair market value. Costs relating to the development and
improvement of the property are capitalized. Income and expenses incurred in
connection with holding and operating the property are included in the
Corporation's Consolidated Statements of Operations.
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE A periodic review of
loans and real estate is made to determine whether the estimated fair value of
the related assets is equal to or in excess of the related carrying amounts. In
making such determination, consideration is given to estimated sales prices,
refurbishing costs, selling costs, and market discount rates. Where loss is
indicated, a specific allowance for loss is established. In addition, the
Corporation maintains a general loss allowance against its loan and real estate
portfolios which is based on its own loss experience, that of the financial
services industry, and management's ongoing assessment of current economic
conditions, and the credit risk inherent in the portfolios.
OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are
recorded at cost less accumulated depreciation which is provided over the
estimated useful lives (five to forty years) of the respective assets on a
straight-line basis. The cost of leasehold improvements is being amortized on
the straight-line basis over the lesser of the term of the respective lease or
the estimated economic life. When properties are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the
respective accounts and the resulting gain or loss is recorded in income.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase
("reverse-repurchase agreements"). Reverse-repurchase agreements are treated as
financing, and the obligations to repurchase securities sold are reflected as a
liability in the Corporation's Consolidated Statement of Financial Condition.
The securities underlying the agreements remain in the asset accounts.
INCOME TAXES The Corporation, the Bank, and all but one of the Bank's
subsidiaries file a consolidated federal income tax return and separate or
consolidated state income tax returns, depending on the state. Provision is made
in the income tax expense accounts for deferred taxes applicable to income and
expense items reported in different periods for financial statement purposes
than for income tax purposes.
PENSION COSTS AND OTHER POSTRETIREMENT BENEFITS The Corporation's net
periodic pension cost consists of the expected cost of benefits earned by
employees during the current period and an interest cost on the projected
37
39
benefit obligation, reduced by the earnings on assets held by the retirement
plan, by amortization of transitional assets over a period of 15 years
(beginning in 1987), and by amortization of any actuarial gains and losses over
the estimated future service period of existing plan participants. The projected
unit credit actuarial cost method is used to determine expected pension costs.
The Corporation's funding policy is to contribute amounts deductible for federal
income tax purposes.
The Corporation's cost of postretirement benefits, which consists of
medical reimbursements for retirees, is recognized during the years that the
employees render the necessary service, adjusted for interest costs on the
projected benefit obligation and for the amortization of a transitional
obligation over 20 years (beginning in 1993). The projected unit credit
actuarial cost method is used to determine expected postretirement benefit
costs. The Corporation's postretirement benefit plan is not currently funded.
FAIR VALUES OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS The following methods and assumptions were used by the Corporation
in estimating fair value disclosures for financial instruments (refer to Note 12
for actual fair value amounts):
CASH AND DUE FROM BANKS AND INTEREST-BEARING DEPOSITS WITH
BANKS The face amounts presented in the Corporation's Consolidated Statements of
Financial Condition for cash and interest-bearing deposits approximates fair
value for such assets.
INVESTMENT SECURITIES AND MORTGAGE-BACKED AND RELATED
SECURITIES Fair values for this group of financial instruments are based on
average quoted market prices obtained from one or more independent pricing
sources. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
LOANS HELD FOR SALE The fair value of loans held for sale is
estimated by matching such loans against outstanding commitments to sell such
loans. The method used for unmatched commitments is discussed under "Off-Balance
Sheet Financial Instruments", below.
LOANS HELD FOR INVESTMENT The estimated fair value of loans
held for investment is determined using discounted cash flow techniques.
Scheduled principal and interest payments are adjusted for estimated future
prepayments as provided by third-party market sources or as estimated by
management using historical prepayment experience. Discount rates used in the
fair value computations are generally based on interest rates offered by the
Corporation on similar loans as of December 31, 1998 and 1997, adjusted for
management's estimate of differences in liquidity, credit risk, remaining term
to maturity, etc.
FEDERAL HOME LOAN BANK STOCK FHLB stock held in excess of
minimum requirements can be returned to the FHLB for face value. Accordingly,
the fair value of all FHLB stock is estimated to be equal to the face amount
presented in the Corporation's Consolidated Statements of Financial Condition.
DEPOSIT LIABILITIES The fair values of demand deposit accounts
(i.e., interest-bearing and non-interest-bearing checking accounts and money
market and regular savings accounts) are equal to the face amount presented in
Note 6. The fair value of fixed-rate time deposits is estimated using a
discounted cash flow calculation that applies interest rates offered by the
Corporation as of the measurement date to a schedule of aggregate contractual
maturities of such deposits as of the same dates.
FEDERAL HOME LOAN BANK ADVANCES The fair value of FHLB
advances is estimated using a discounted cash flow calculation that applies
interest rates quoted by the FHLB as of the measurement date to a schedule of
aggregate contractual maturities of such liabilities as of the same date. The
fair value of FHLB advances excludes the effect of any prepayment penalties that
may be incurred if the Corporation were to prepay any of its term advances.
OTHER BORROWINGS Other borrowings consist of short-term
borrowings from third-party financial institutions and borrowings under
long-term contracts. Other borrowings are not material to the Corporation either
individually or in the aggregate. As such, the Corporation has estimated the
fair value of such borrowings to approximate carrying value.
38
40
ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE The fair
value of advance payments by borrowers for taxes and insurance is equal to the
face amount presented in the Corporation's Consolidated Statement of Financial
Condition.
ACCRUED INTEREST RECEIVABLE AND PAYABLE The fair value of
accrued interest is equal to the face amount presented in the Corporation's
Consolidated Statement of Financial Condition.
MORTGAGE SERVICING RIGHTS The fair value of MSRs is estimated
using a discounted cash flow calculation that applies discount rates considered
reasonable by management to a schedule of both contractual and estimated cash
flows. Such cash flows are adjusted for loan prepayment rates deemed appropriate
by management.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS. The Corporation has
become a party to financial instruments with off-balance-sheet risk in the
normal course of its business in order to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit, standby
letters of credit, lines of credit, commitments to sell loans, and financial
guarantees.
Off-balance-sheet financial instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the statement of financial condition. In the event of
non-performance by the other party to a financial instrument, the Corporation's
exposure to credit loss is represented by the contractual amount of the
instrument. The Corporation uses the same credit policies in granting
commitments, letters and lines of credit, and financial guarantees as it does
for on-balance-sheet financial instruments.
The fair values of commitments to extend credit and unmatched
commitments to sell loans, both which are generally short-term in nature, are
estimated to be equal to their respective face values.
Home equity lines of credit carry floating market rates of
interest. Accordingly, the fair value of outstanding home equity lines of credit
is estimated to be equal to the face value of such commitments.
Other than credit enhancements on loans sold to the FHLB, the
Corporation does not issue material amounts of financial guarantees or stand-by
letters of credit. Management believes that the Corporation's exposure to loss
on such instruments is insignificant, including its credit enhancements with the
FHLB. Accordingly, management believes the fair value of such financial
instruments approximates zero.
STOCK SPLITS Earnings per share and dividends paid per share, as
presented in the Corporation's Consolidated Statements of Operations, have been
adjusted to recognize a two-for-one stock split on June 11, 1998, and a
three-for-two stock split on June 12, 1997. Common shares issued and
outstanding, as presented in the Corporation's Consolidated Statements of
Financial Condition, have also been adjusted for such stock splits.
STOCK-BASED COMPENSATION The Corporation records expense relative to
stock-based compensation using the "intrinsic value method". Since the intrinsic
value of the Corporation's stock options is generally "zero" at the time of the
award, no expense is recorded. With respect to restricted stock awards, the
intrinsic value is generally equal to the fair value of the Corporation's common
stock on the date of the award. Such value is amortized as expense over the
vesting period of the award.
As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), the Corporation has not
adopt the "fair value method" of expense recognition for stock-based
compensation awards. Rather, the effects of the fair value method on the
Corporation's earnings have been disclosed on a pro forma basis, as permitted by
SFAS 123. Refer to Note 9 for the appropriate disclosures.
EARNINGS PER SHARE Earnings per share data are based on the
weighted-average number of common shares outstanding during each period,
including any restricted shares. Diluted earnings per share is adjusted for
common stock equivalents outstanding at the end of each period. Common stock
equivalents are computed using the treasury stock method and consist of stock
options outstanding under the stock incentive plans described in Note 9. All
stock
39
41
options are assumed to be 100% vested for purposes of the earnings per share
computations. The computation of earnings per share for the years ended
December 31, 1998, 1997, and 1996, is as follows:
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Basic Diluted Basic Diluted Basic Diluted
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Net income $19,424,134 $19,424,134 $17,390,363 $17,390,363 $10,073,917 $10,073,917
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Average common shares issued,
net
of actual treasury shares 18,479,178 18,479,178 18,321,902 18,321,902 18,784,716 18,784,716
Common stock equivalents based
on
the treasury stock method - 1,384,968 - 1,368,810 - 1,340,451
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Average common shares and
common stock equivalents 18,479,178 19,864,146 18,321,902 19,690,712 18,784,716 20,125,167
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Earnings per share $ 1.05 $ 0.98 $ 0.95 $ 0.88 $ 0.54 $ 0.50
- --------------------------------------------------------------------------------------------------------------------
PENDING ACCOUNTING CHANGE In 1998 the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and for Hedging Activities" ("SFAS 133").
This standard establishes new rules for the recognition and measurement of
derivatives and hedging activities. It requires all derivatives to be recorded
on the balance sheet at fair value, although the timing of recognition in
earnings will depend on the classification of the hedge according to criteria
established by SFAS 133. Changes in the fair value of derivatives that do not
meet these criteria are required to be included in earnings in the period of the
change. The new standard is effective for years beginning after June 15, 1999,
although earlier adoption is permitted. The Corporation does not intend to adopt
SFAS 133 until January 1, 2000.
The Corporation does not use derivative financial instruments such as
futures, swaps, caps, floors, options, interest- or principle-only strips, or
similar financial instruments to manage its operations. However, the Corporation
does use forward sales of mortgage-backed securities to manage exposure to
market risk in its "pipeline" of single-family residential loans intended for
sale. Forward sales are derivative securities and are subject to the rules
established by SFAS 133. The Corporation has not completed the complex analysis
necessary to determine the impact SFAS 133 will have on its statements of
financial condition or operations. However, such impact is not expected to be
material, although there can be no assurances.
CASH AND CASH EQUIVALENTS For purposes of the Corporation's
Consolidated Statements of Cash Flows, cash and cash equivalents consists solely
of cash on hand and non-interest-bearing deposits in banks ("cash and due from
banks"). The Bank is required to maintain a certain amount of cash on hand and
non-interest-bearing account balances at the Federal Reserve Bank of Minneapolis
to meet specific reserve requirements. These requirements approximated $19.9
million at December 31, 1998.
RECLASSIFICATION Certain 1997 and 1996 balances have been
reclassified to conform with the 1998 presentation.
40
42
NOTE 2--MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed and related securities at December 31, 1998 and 1997,
are summarized as follows:
1998
- --------------------------------------------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
Available for sale:
- --------------------------------------------------------------------------------------------------------------------
Collateralized mortgage obligations $ 33,870,813 $ 9,230 ($ 93,319) $ 33,786,724
Mortgage-backed securities 165,872,355 4,568,826 (119,026) 170,322,155
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total available for sale 199,743,168 4,578,056 (212,345) 204,108,879
- --------------------------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations $ 97,250,994 422,662 (65,366) 97,608,290
Mortgage-backed securities 5,249,244 59,792 (8,903) 5,300,133
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total held for investment 102,500,238 482,454 (74,269) 102,908,423
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total mortgage-backed and related securities $ 302,243,406 $ 5,060,510 ($286,614) $ 307,017,302
- --------------------------------------------------------------------------------------------------------------------
1997
- --------------------------------------------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Available for sale:
Collateralized mortgage obligations $ 48,953,197 $ 14,498 ($1,072,398) $ 47,895,297
- --------------------------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations 115,847,369 73,583 (863,972) 115,056,980
Mortgage-backed securities 8,488,600 115,668 (47,619) 8,556,649
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total held for investment 124,335,969 189,251 (911,591) 123,613,629
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Total mortgage-backed and related securities $ 173,289,166 $ 203,749 ($1,983,989) $ 171,508,926
- --------------------------------------------------------------------------------------------------------------------
Accrued interest receivable on mortgage-backed and related
securities was $2,719,588 and $961,052 at December 31, 1998 and 1997,
respectively.
Mortgage-backed securities consist of FHLMC, FNMA, and GNMA securities.
The Corporation has retained the credit risk on $165.9 million in FHLMC MBSs as
of December 31, 1998.
Collateralized mortgage obligations consist of securities backed by the
aforementioned agency-backed securities or by whole-loans. As of December 31,
1998, approximately 79% of the Corporation's CMO portfolio consisted of
securities backed by whole loans--all of which were generally rated triple-A or
its equivalent by the major credit-rating agencies. Approximately 24% of the
Corporation's whole-loan CMOs consisted of loans on properties located in the
state of California. No other geographical location had a material
concentration.
There were no realized gains or losses on sales of mortgage-backed and
related securities during 1998, 1997, or 1996.
43
NOTE 3--LOANS HELD FOR INVESTMENT
Loans held for investment at December 31 are summarized as follows:
1998 1997
- --------------------------------------------------------------------------------------------------------------------
First mortgage loans:
Single-family $426,602,634 $537,722,070
Multi-family 148,059,630 140,589,481
Commercial 141,046,301 107,315,226
Construction 63,035,445 51,318,856
Education loans 182,379,556 159,893,040
Second mortgage and home equity loans 175,541,150 163,231,165
Consumer loans 46,564,021 40,330,804
Commercial business loans 371,336 556,270
- --------------------------------------------------------------------------------------------------------------------
Subtotal 1,183,600,073 1,200,956,912
Unearned discount, premiums, and net deferred loan fees and costs 1,549,180 573,702
Allowance for loan losses (7,623,526) (7,637,527)
- -------------------------------------------------------------------------------------------------------------------
Total $1,177,525,727 $1,193,893,087
===================================================================================================================
Accrued interest receivable on loans held for investment was
$11,134,804 and $10,232,335 at December 31, 1998 and 1997, respectively.
Loans serviced for investors were $1.9 billion, $1.4 billion, and $1.2
billion at December 31, 1998, 1997, and 1996, respectively. These loans are not
reflected in the Corporation's Consolidated Statements of Financial Condition.
At December 31, 1998, the Corporation had retained a small portion of the credit
risk related to $235.6 million in single-family residential loans sold to the
FHLB in exchange for a monthly credit enhancement fee.
At December 31, 1998 and 1997, loans on non-accrual status were $1.1
million and $4.4 million, respectively. The Corporation has no loans
contractually past due ninety or more days for which interest is being accrued.
With respect to single-family mortgage loans, it is the Corporation's
general policy to restrict lending to its primary market areas in Wisconsin as
well as contiguous counties in Iowa and Minnesota, though from time-to-time the
Corporation will purchase single-family loans originated outside of its primary
market area. It is also the Corporation's general policy to limit an individual
single-family mortgage loan to 80% of the appraised value of the property
securing the loan. The Corporation will occasionally lend more than 80% of the
appraised value of the property, but generally will require the borrower to
obtain private mortgage insurance on the portion of the loan amount that exceeds
80% of the collateral. Single-family mortgage loans purchased outside of the
Corporation's market area were $157.4 million at December 31, 1998, compared to
an insignificant amount at December 31, 1997.
With respect to multi-family and commercial real estate loans, it is
the Corporation's policy to restrict its lending area to loans secured by
property located within a 300-mile radius of La Crosse, to include the states of
Nebraska, Illinois, Iowa, and Minnesota, although in the past the Corporation
originated multi-family and commercial real estate loans outside of this area.
It is also the Corporation's general policy to limit loans on multi-family
residential complexes, retail shopping centers, office buildings, and
multi-tenant industrial buildings to 80% of the appraised value of the property
securing the loan. Loans on other types of commercial properties, such as
nursing homes, hotels/motels, churches, and single-tenant industrial buildings
are limited to 75% or less of the appraised value of the property securing the
loan. In addition, it is the Corporation's policy that no more than 20% of its
multi-family and commercial real estate loans consist of this second category of
loans. Multi-family and commercial real estate loans originated or purchased
outside of the Corporation's market area were $22.3 million and $27.3 million,
at December 31, 1998 and 1997, respectively.
With respect to consumer loans, it is the Corporation's policy that
such loans be supported primarily by the borrower's ability to repay the loan
and secondarily by the value of the collateral securing the loan, if any.
Education loans are guaranteed by the U.S. government.
42
44
A summary of the activity in the allowance for loan losses is as
follows:
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $7,637,527 $7,888,323 $8,186,077
Provision charged to expense
293,112 538,957 -
- ------------------------------------------------------------------------------------------------------------------
Loans charged-off (365,511) (816,217) (336,989)
Recoveries 58,398 26,464 39,235
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Charge-offs, net (307,113) (789,753) (297,754)
- ------------------------------------------------------------------------------------------------------------------
Balance at end of period $7,623,526 $7,637,527 $7,888,323
==================================================================================================================
NOTE 4--MORTGAGE SERVICING RIGHTS
A summary of the activity in mortgage servicing rights is as follows:
PURCHASED ORIGINATED ALLOWANCE FOR
MSR MSR LOSS TOTAL
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 $4,193,965 $6,506,371 ($407,732) $10,292,604
Originated servicing 3,726,336 3,726,336
Amortization charged to earnings (485,880) (1,021,960) (1,507,840)
Valuation adjustments charged to earnings (623,898) (623,898)
Charge-offs (157,346) (463,284) 620,630 -
- ------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 3,550,739 8,747,463 (411,000) 11,887,202
Purchased servicing 1,374,069 1,374,069
Originated servicing 5,543,993 5,543,993
Amortization charged to earnings (503,540) (1,360,821) (1,864,361)
Valuation adjustments charged to earnings (650,000) (650,000)
Charge-offs (164,749) (341,850) 506,599 -
- ------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 4,256,519 12,588,785 (554,401) 16,290,903
Purchased servicing 454,774 454,774
Originated servicing 17,587,381 17,587,381
Amortization charged to earnings (527,655) (2,468,568) (2,996,223)
Valuation adjustments charged to earnings (10,233,376) (10,233,376)
Charge-offs (864,565) (3,800,276) 4,664,841 -
- ------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $3,319,073 $23,907,322 ($6,122,936) $21,103,459
- ------------------------------------------------------------------------------------------------------------------
NOTE 5--OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment at December 31 are summarized as
follows:
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Office buildings and improvements $18,594,097 $18,679,458
Furniture and equipment 17,402,874 15,407,247
Leasehold improvements 4,814,633 4,170,200
Land and improvements 4,245,353 4,265,028
Property acquired for expansion 358,470 358,470
Construction in progress 786,064 237,706
- ------------------------------------------------------------------------------------------------------------------
Subtotal 46,201,491 43,118,109
- ------------------------------------------------------------------------------------------------------------------
Less allowances for depreciation and amortization 21,118,909 18,874,977
- ------------------------------------------------------------------------------------------------------------------
Total $25,082,582 $24,243,132
- ------------------------------------------------------------------------------------------------------------------
Depreciation expense was $2,472,324, $2,533,147, and $2,599,431 for the
years ended December 31, 1998, 1997, and 1996, respectively.
The Corporation rents office space and land under operating leases at
certain of its locations. These leases have terms expiring between 1999 and 2006
and provide for renewals subject to escalation clauses. Rental expense was
$1,455,439, $1,168,705, and $988,483 for the years ended December 31, 1998,
1997, and 1996, respectively.
43
45
NOTE 6--DEPOSIT LIABILITIES
Deposit liabilities at December 31 are summarized as follows:
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Checking accounts:
Non-interest-bearing $144,730,597 $93,322,644
Interest-bearing 83,260,201 54,993,534
Money market savings:
Great Rate accounts 111,245,052 98,457,235
Insured Market Fund accounts 21,732,447 17,238,632
Market Rate accounts 33,823,677 27,420,923
Regular savings accounts 103,466,501 87,605,203
Variable-rate IRA accounts 3,215,403 2,955,620
Time deposits maturing within...
Three months 394,201,833 102,853,066
Four to six months 85,907,182 45,787,447
Seven to twelve months 233,229,535 213,706,514
Thirteen to twenty-four months 213,708,882 367,717,799
Twenty-five to thirty-six months 26,026,189 27,576,115
Thirty-seven to forty-eight months 2,753,897 4,635,486
Forty-nine to sixty months 2,834,264 2,263,677
- ------------------------------------------------------------------------------------------------------------------
Total time deposits 958,661,783 764,540,105
- ------------------------------------------------------------------------------------------------------------------
Total $1,460,135,660 $1,146,533,896
- ------------------------------------------------------------------------------------------------------------------
Time deposits include $90.7 million and $63.6 million of certificates
in denominations of $100,000 or more at December 31, 1998 and 1997,
respectively. Accrued interest payable on deposit liabilities was $1,107,214 and
$781,597 at December 31, 1998 and 1997, respectively.
Included in non-interest-bearing checking accounts at December 31, 1998
and 1997, were $35.2 million and $17.3 million, respectively, which represented
amounts held in custody for third-party investors in loans serviced by the
Corporation.
Interest expense on deposit liabilities for the year ended December 31
is summarized as follows:
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Checking accounts $543,825 $524,432 $521,038
Money market savings accounts 6,381,467 6,321,899 5,103,182
Regular savings 1,842,854 1,799,864 1,774,934
Time deposits 50,653,495 42,503,529 39,090,932
- ------------------------------------------------------------------------------------------------------------------
Total $59,421,641 $51,149,724 $46,490,086
- ------------------------------------------------------------------------------------------------------------------
44
46
NOTE 7--FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Federal Home Loan Bank advances and other borrowings at December 31 are
summarized as follows:
1998 1997
- ------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED
BALANCE AVERAGE RATE BALANCE AVERAGE RATE
- ------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances maturing in...
1998 $198,305,000 5.69%
- -
1999 $10,715,000 6.02% 6,715,000 6.16
2000 33,400,000 5.60 26,400,000 5.56
2001 34,245,000 5.09
2002 1,415,000 5.92
2003 32,000,000 5.19
2008 75,000,000 4.78
- -
Open line of credit 31,300,000 5.84
- -
- -----------------------------------------------------------------------------------------------------------------
Total FHLB advances 186,775,000 5.14 262,720,000 5.71
Other borrowings 3,002,984 6.41 13,058,770 5.94
- -----------------------------------------------------------------------------------------------------------------
Total $189,777,984 5.16% $275,778,770 5.72%
- -----------------------------------------------------------------------------------------------------------------
The Corporation's borrowings at the FHLB of Chicago are limited to 35%
of total assets or 60% of the book value of certain mortgage loans plus 75% of
the market value of certain mortgage-backed and related securities, whichever is
less. Interest on the open line of credit is paid monthly at 0.45% above the
FHLB's daily investment deposit rate or approximately 25 basis points above the
federal funds rate. Advances that mature in the years 2000 and 2008 include
$25.0 million and $50.0 million, respectively, that are redeemable quarterly at
the option of the FHLB. Advances that mature in 2008 also include $25.0 million
that is redeemable quarterly at the option of the FHLB beginning in 2001.
The Corporation has two lines of credit with two financial
institutions. These lines, which amount to $20.0 million in the aggregate,
permit the overnight purchase of fed funds; there were no amounts outstanding
under these lines as of December 31, 1998. The Corporation also has a $10.0
million line of credit with a third financial institution under which $3.0
million was outstanding as of December 31, 1998. The interest rate on borrowings
under this line is determined on a daily basis at 125 basis points above the
one-month London Inter-Bank Offered Rate ("LIBOR"). The Corporation has pledged
all issued and outstanding capital stock of the Bank as collateral for this line
of credit.
Accrued interest payable on FHLB advances and other borrowings was
$841,012 and $1,248,781 at December 31, 1998 and 1997, respectively.
NOTE 8--INCOME TAXES
Federal and state income tax expense for the years ended December 31 is
summarized as follows:
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Current:
Federal $10,920,797 $9,795,713 $5,007,142
State 720,178 979,799 77,720
- ------------------------------------------------------------------------------------------------------------------
Total current 11,640,975 10,775,512 5,084,862
- ------------------------------------------------------------------------------------------------------------------
Deferred:
Federal (307,000) (104,000) 582,000
State (77,000) 207,000 139,000
- ------------------------------------------------------------------------------------------------------------------
Total deferred (384,000) 103,000 721,000
- ------------------------------------------------------------------------------------------------------------------
Total $11,256,975 $10,878,512 $5,805,862
- ------------------------------------------------------------------------------------------------------------------
45
47
The significant components of the Corporation's deferred tax expense
for the years ended December 31 are summarized as follows:
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Mortgage servicing rights $1,003,793 $901,452 $818,705
Office properties and equipment depreciation 679,244 (828,725) (56,321)
Asset valuation allowances (249,578) (657,090) (311,288)
Deferred loan fees (189,160) 380,707 288,351
Provision for loan and real estate losses, net (150,979) 107,907 128,248
Deferred compensation (610,536) 2,473 (147,559)
FHLB stock dividends (362,877) - -
Other (503,907) 196,276 864
- ------------------------------------------------------------------------------------------------------------------
Total deferred ($384,000) $103,000 $721,000
==================================================================================================================
The income tax provision differs from the provision computed at the
federal statutory corporate tax rate for the years ended December 31 as follows:
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Income taxes at federal statutory of 35% $10,738,388 $9,894,106 $5,557,922
State income taxes net of federal income tax benefit 418,066 771,420 140,868
Other 100,521 212,986 107,072
- ------------------------------------------------------------------------------------------------------------------
Income tax provision $11,256,975 $10,878,512 $5,805,862
==================================================================================================================
The significant components of the Corporation's deferred tax assets and
liabilities as of December 31, are summarized as follows:
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Loan and real estate loss allowances $2,660,621 $2,509,642
Deferred compensation 1,612,207 1,001,671
Asset valuation allowances 913,753 664,175
State tax loss carryforwards 270,658 397,394
Office properties and equipment depreciation - 384,033
Securities valuation allowance - 354,870
Other 523,696 78,056
- ------------------------------------------------------------------------------------------------------------------
Total deferred tax assets 5,980,935 5,389,841
Valuation allowance (298,785) (326,959)
- ------------------------------------------------------------------------------------------------------------------
Adjusted deferred tax assets 5,682,150 5,062,882
- ------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Mortgage servicing rights 3,485,422 2,481,629
Securities valuation allowance 1,527,999 -
Office properties and equipment depreciation 295,211 -
Deferred loan fees 361,674 550,833
FHLB stock dividends 262,937 625,814
Purchase acquisition adjustments 242,247 329,151
Federal tax effect of state deferred taxes, net 113,751 161,714
Investment in unconsolidated partnerships 81,182 82,234
Other 200,444 221,355
- ------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities 6,570,867 4,452,730
- ------------------------------------------------------------------------------------------------------------------
Net deferred tax assets (liabilities) ($888,717) $610,152
==================================================================================================================
The Bank qualifies under provisions of the IRC that prior to 1996
permitted it to deduct from taxable income an allowance for bad debts that
generally exceeded losses charged to income for financial reporting purposes.
Accordingly, no provision for income taxes has been made for $21.1 million of
retained income at December 31, 1998. If in the future the Bank no longer
qualifies as a bank for tax purposes, income taxes may be imposed at the
then-applicable rates. If income taxes had been provided, the deferred tax
liability would have been approximately $8.5 million.
46
48
NOTE 9--EMPLOYEE BENEFIT PLANS
PENSION PLAN The Corporation has established a pension plan for the
benefit of full-time employees that have at least one year of service and have
attained the age of 20. Benefits under the plan are based on the employee's
years of service and compensation during the years immediately preceding
retirement. The following table summarizes the components of pension benefit
obligation and plan assets, the funded status of the plan, the amount recognized
in the Corporation's consolidated financial statements, and the weighted-average
assumptions for the years ended December 31, 1998 and 1997.
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Reconciliation of projected benefit obligation:
Benefit obligation at beginning of year 7,002,102 $5,692,032
Service costs 487,251 317,232
Interest costs 569,673 458,386
Actuarial loss 1,530,203 835,874
Benefit payments (227,608) (301,422)
- ------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year $9,361,621 $7,002,102
- ------------------------------------------------------------------------------------------------------------------
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year: $7,125,080 $6,218,479
Actual return on plan assets 1,070,911 1,208,023
Benefit payments (227,608) (301,422)
- ------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $7,968,383 $7,125,080
- ------------------------------------------------------------------------------------------------------------------
Funded status:
Funding shortfall (excess) at end of year $1,393,238 ($122,978)
Unrecognized transition asset 110,927 206,379
Unrecognized prior service cost 145,526 921,055
Unrecognized net loss (1,231,807) (868,634)
- ------------------------------------------------------------------------------------------------------------------
Accrued pension expense $417,884 $135,822
- ------------------------------------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Service costs $487,251 $317,232
Interest costs 569,673 458,386
Expected return on plan assets (631,412) (551,400)
Amortization of transition asset (95,452) (95,452)
Amortization of prior service costs (59,608) (121,219)
Recognized actuarial loss 11,610 24,731
- ------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $282,062 $32,278
- ------------------------------------------------------------------------------------------------------------------
Weighted-average assumptions:
Discount rate 6.50% 7.00%
Expected return on plan assets 9.00% 9.00%
Rate of compensation increase 5.50% 5.50%
- ------------------------------------------------------------------------------------------------------------------
47
49
POSTRETIREMENT EMPLOYEE BENEFITS The Corporation provides certain
health care insurance benefits to retired employees. Substantially all of the
employees of the Corporation may become eligible for these benefits if they
reach normal retirement age while working for the Corporation. The following
table summarizes the components of postretirement benefit obligation and funded
states, as well as the amounts recognized in the Corporation's consolidated
financial statements for the years ended December 31, 1998 and 1997.
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Reconciliation of projected benefit obligation:
Benefit obligation at beginning of year $1,610,192 $1,097,792
Service costs 61,949 53,899
Interest costs 127,047 108,130
Actuarial loss 260,418 413,315
Benefit payments (39,630) (62,944)
- ------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year $2,019,976 $1,610,192
- ------------------------------------------------------------------------------------------------------------------
Funded status:
Funding shortfall at end of year $2,019,976 $1,610,192
Unrecognized transition asset (479,219) (513,449)
Unrecognized net loss (490,949) (242,843)
- ------------------------------------------------------------------------------------------------------------------
Accrued post-retirement benefit expense $1,049,808 $853,900
- ------------------------------------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Service costs $61,949 $53,899
Interest costs 127,047 108,130
Amortization of transition obligation 34,230 34,230
Recognized actuarial loss 12,312 629
- ------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $235,538 $196,888
- ------------------------------------------------------------------------------------------------------------------
The weighted-average annual assumed rate of increase in the per capita
cost of covered benefits for 1998 is 10.1% and is assumed to decrease gradually
to 5.5% in 2004 and thereafter. The discount rate used to determine the
actuarial present value of the projected postretirement benefit obligation was
6.5%, 7.0%, and 7.5% for 1998 and 1996, respectively.
The assumed rate of increase in the per capita cost of covered benefits
has an effect on the amounts reported in the Corporation's consolidated
financial statements. For example, a one percentage point increase in the
assumed trend rate would increase the accumulated postretirement benefit
obligation as of December 31, 1998, by approximately $564,000 and the aggregate
service and interest cost components of postretirement benefit expense for 1998
by approximately $71,000.
SAVINGS PLANS The Corporation maintains a 401(k) savings plan for the
benefit of substantially all of its employees. Employees may contribute up to a
certain percentage of their compensation to the plan and the Corporation will
match their contributions within certain limits. In addition, the employee may
also receive discretionary profit sharing contributions from the Corporation.
The Corporation provided matching and discretionary contributions of
approximately $286,000, $248,000, and $181,000 during the years ended December
31, 1998, 1997, and 1996, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN The Corporation makes annual
discretionary contributions to an Employee Stock Ownership Program ("ESOP") for
the benefit of substantially all of its employees. All contributions are
recorded as compensation expense on the books of the Corporation at the time
they are made. The Corporation recorded approximately $286,000, $246,000, and
$217,000 in ESOP-related compensation expense during the years ended December
31, 1998, 1997, and 1996, respectively.
SUPPLEMENTAL PENSION PLAN The Corporation makes annual contributions to
a supplemental pension plan for certain key members of management. All
contributions are recorded as compensation expense on the books of the
Corporation at the time they are made. The Corporation recorded approximately
$203,000, $197,000, and $146,000 during the years ended December 31, 1998, 1997,
and 1996, respectively.
STOCK INCENTIVE PLANS During 1989, 1992, and 1997, the Corporation
adopted stock incentive plans designed to attract and retain qualified personnel
in key management positions. In addition, during 1995 the Corporation assumed
the stock incentive plan of a financial institution that was acquired by the
Corporation. These
48
50
plans provide for the grant of stock options, restricted stock, and stock
appreciation rights. In general, stock options granted under these plans
are exercisable at a price equal to the fair value of the stock on the date of
the grant. Furthermore, the options are subject to three- to five-year graded
vesting requirements and a maximum exercise period of ten years. These plans
authorize the issuance of approximately 4.4 million shares in the aggregate, of
which 1.3 million shares were unallocated as of December 31, 1998. Activity in
these stock incentive plans for each of the three years ended December 31, 1998,
1997, and 1996, is summarized in the following paragraphs.
Stock options outstanding at the beginning of each of the three
preceding years were 1,674,056, 1,879,508, and 1,937,230, respectively. These
options had weighted-average exercise prices of $3.07, $2.86, and $2.81,
respectively. Stock options granted during these years were 309,000, 7,500, and
18,000, respectively, at weighted-average exercise prices of $14.77, $8.50, and
$6.80, respectively. Stock options exercised during these years were 297,521,
211,170, and 60,466, respectively, at weighted-average exercise prices of $1.92,
$1.34, and $2.04, respectively. Stock options outstanding at the end of each of
the three preceding years were 1,685,535, 1,674,056, and 1,879,508,
respectively. These options had weighted-average exercise prices of $5.42,
$3.07, and $2.86, respectively. Of these options, 1,430,234, 1,527,488, and
1,528,824, respectively, were fully-vested and exercisable at weighted-average
exercise prices of $3.81, $2.84, and $2.45, respectively. As of December 31,
1998, the exercise prices of options outstanding on that date ranged from $1.31
to $15.63 and had a weighted-average remaining life of 5.0 years. Within this
range, 952,335 options had a weighted-average exercise price of $2.40 and a
weighted-average remaining life of 3.0 years; 424,200 options had a
weighted-average exercise price of $5.38 and a weighted-average remaining life
of 6.5 years; and 309,000 shares had a weighted-average exercise price of $14.77
and a weighted average remaining life of 9.0 years. Expirations and forfeitures
of stock options during the three years ended December 31, 1998, 1997, and 1996,
were not material.
During the year ended December 31, 1998, 112,002 shares of restricted
stock were granted under the aforementioned plans at a weighted-average fair
value of $15.48. No shares of restricted stock were granted in 1997 and 1996.
During 1989 and 1992, the Corporation also adopted stock incentive
plans designed to attract and retain qualified non-employee directors for the
Corporation and its subsidiaries. Under both plans each director receives
options to purchase 8,800 shares upon election or re-election to the Board of
Directors. The stock options are exercisable at a price at least equal to the
fair value of the stock on the date of grant and are fully-vested on the date of
the grant. These plans have authorized the issuance of 672,942 shares in the
aggregate, of which 224,146 shares were unallocated as of December 31, 1998.
Activity in these stock incentive plans for each of the three years ended
December 31, 1998, 1997, and 1996 is summarized in the following paragraph.
Stock options outstanding at the beginning of each of the three
preceding years were 227,766, 254,565, and 240,058, respectively. These options
had weighted-average exercise prices of $3.89, $3.34, and $2.81, respectively.
Stock options granted during these years were 26,400, 26,400, and 35,196,
respectively at weighted-average exercise prices of $17.59, $8.96, and $7.05,
respectively. Stock options exercised during these years were 35,200, 53,290,
and 20,598, respectively, at weighted-average exercise prices of $1.31, $3.80,
and $3.47, respectively. Finally, stock options outstanding at the end of
December 31, 1998, were 218,966. These options had a weighted-average exercise
price of $5.95, a range of exercise prices from $1.31 to $17.59, and a
weighted-average remaining life of 5.0 years. Within this range, 122,166 had a
weighted-average exercise price of $2.67 and a weighted-average remaining life
of 2.8 years; 70,400 options had a weighted-average exercise price of $7.27 and
a weighted-average remaining life of 7.2 years; and 26,400 shares had a
weighted-average exercise price of $17.59 and a weighted average remaining life
of 9.3 years. There were no expirations or forfeitures of stock options during
these years.
As described in Note 1, the Corporation has elected to provide pro
forma disclosure of the effects of its stock incentive plans. If the Corporation
had accounted for its stock incentive plans using the fair value method, the
Corporation's pro forma net income would have been $18,428,000, $17,195,000, and
$9,700,000 during the years ended December 31, 1998, 1997, and 1996,
respectively. Pro forma diluted earnings per share would have been $0.93, $0.88,
and $0.49 and pro forma basic earnings per share would have been $1.00, $0.94,
and $0.51 during the same periods, respectively.
The weighted-average fair value of the options granted in 1998, 1997,
and 1996, were $5.25, $2.66, and $2.09, respectively. The fair values of these
options were estimated as of the dates they were granted using a Black-
49
51
Scholes option pricing model. Weighted-average assumptions for 1998 were as
follows: 5.0% risk-free interest rate, 2.0% dividend yield, 30% volatility, and
a seven-year expected life. Weighted-average assumptions for periods prior to
1998 were as follows: 6.5% risk-free interest rate, 2.6% dividend yield, 30%
volatility, and a seven-year expected life.
NOTE 10--COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS The Corporation and its subsidiaries are engaged in
various routine legal proceedings occurring in the ordinary course of business
which in the aggregate are believed by management to be immaterial to the
consolidated financial condition of the Corporation.
OTHER COMMITMENTS AND CONTINGENCIES At December 31, 1998, the
Corporation had commitments to originate mortgage loans at market terms
aggregating approximately $24.0 million which expire on various dates in 1998.
At December 31, 1998, the Corporation also had commitments to fund $34.7 million
in additional proceeds on construction loans. As of the same date the
Corporation had approximately $5.9 million in commitments outstanding under
standby letters of credit and financial guarantees, as well as $8.9 million in
commitments outstanding under unused home equity lines of credit. Furthermore,
the Corporation had commitments to sell approximately $92.3 million in mortgage
loans to FHLMC, FNMA, and the FHLB at various dates in 1999.
At December 31, 1998, the Corporation had retained a small portion of
the credit risk related to $235.6 million in single-family residential loans
sold to the FHLB in exchange for a monthly credit enhancement fee.
NOTE 11--STOCKHOLDERS' EQUITY
PREFERRED STOCK The Corporation is authorized to issue up to 5,000,000
shares of preferred stock, $.10 par value per share, although no such stock was
outstanding at December 31, 1998. The Board of Directors of the Corporation is
authorized to establish the voting powers, designations, preferences, or other
special rights of such shares and the qualifications, limitations, and
restrictions thereof. The preferred stock may be issued in distinctly designated
series, may be convertible to common stock, and may rank prior to the common
stock in dividend rights, liquidation preferences, or both.
SHAREHOLDERS' RIGHTS PLAN The Corporation's Board of Directors adopted
a shareholders' rights plan (the "Rights Plan") in 1995. Under the terms of the
Rights Plan, the Board of Directors declared a dividend of one preferred share
purchase right on each outstanding share of common stock of the Corporation.
However, the rights can only be exercised if a person or group acquires 20% or
more of the common stock or announces a tender or exchange offer that would
result in a 20% or greater position in the stock. Initially, each right will
entitle shareholders to buy one one-hundredth share of the Corporation's
preferred stock at a price of $50.00, subject to adjustment. Under certain
circumstances, including the acquisition of beneficial ownership of 25% or more
of the Corporation's common stock, holders of the Corporation's common stock,
other than the acquirer, will be entitled to exercise the rights to purchase
common stock from the Corporation having a value equal to two times the exercise
price of the right. If the Corporation is acquired in a merger, share exchange,
or other business combination in which the Corporation is not the survivor,
after a person or group's acquisition of beneficial ownership of 20% or more of
the common stock, rights holders will be entitled to purchase the acquirer's
shares at a similar discount. Issuance of the rights has no dilutive effect,
will not affect reported earnings per share, is not taxable to the Corporation
or its shareholders, and will not change the way in which the Corporation's
shares are traded. The rights expire ten years for the adoption of the Rights
Plan.
STOCK REPURCHASE PLANS AND TREASURY STOCK In 1997 and 1996 the
Corporation's Board of Directors authorized the repurchase of up to 919,052 and
984,000 shares of the Corporation's outstanding common stock, respectively.
Under the plans, repurchases may be made from time-to-time in the open market
during the ensuing twelve months as conditions permit (both plans were extended
for an additional twelve months in January 1998 and the 1997 Plan was extended
for additional twelve months in January 1999). Repurchased shares are held as
treasury stock and are available for general corporate purposes.
50
52
During 1998, 1997, and 1996, the Corporation repurchased 447,000,
264,000, and 1,394,400 shares under the 1997 and 1996 Plans, as well as a prior
plan, which is no longer active. These shares were repurchased at an average
cost of $16.46, $10.87, and $6.94 per share during 1998, 1997, and 1996,
respectively. As of December 31, 1998, 519,152 shares remained to be purchased
under the 1997 Plan and no shares remained under the 1996 Plan. On February 11,
1999, the Corporation completed the purchase of the remaining shares under the
1997 Plan.
During 1998 and 1997, the Corporation reissued 426,775 and 240,330
shares of common stock out of treasury stock, respectively. These shares had an
average cost basis of $12.84 and $10.64 per share, respectively. In general,
these shares were issued upon the exercise of stock options by, or the issuance
of restricted stock to, employees and directors of the Corporation. The
Corporation uses the "last-in/first-out" method to determine the cost basis of
shares removed from treasury stock.
DIVIDEND RESTRICTIONS The ability of the Corporation to pay dividends
will depend primarily upon the receipt of dividends from the Bank. The Bank may
not declare or pay a cash dividend without regulatory approval if such dividend
would cause its net capital to be reduced below either the amount required for
the liquidation account or the current risk-based capital requirements imposed
by the OTS. The Bank is a "Tier 1" association under current OTS regulations. As
such, the Bank's dividend payments are limited to 100% of its net income during
the year plus an amount that would reduce by one-half its excess risk-based
regulatory capital as of the beginning of the year, or 75% of its net income
during the most recent four-quarter period, whichever is greater.
REGULATORY CAPITAL REQUIREMENTS Financial institutions such as the Bank
are subject to minimum regulatory capital requirements as specified in federal
banking law and supporting regulations. Failure of a financial institution to
meet such requirements may subject the institution to certain mandatory--and
possibly discretionary--actions on the part of its regulators (referred to as
"prompt corrective actions"). Such actions, if undertaken, could severely
restrict the activities of the institution. During each of the years ended
December 31, 1998 and 1997, the Bank's regulatory capital was sufficient for it
to be classified as "adequately capitalized" under the prompt corrective action
provisions of the federal banking law and supporting regulations. Accordingly,
the Bank is not subject to prompt corrective actions by its regulators.
The following table summarizes the Bank's current regulatory capital in
both percentage and dollar terms as of December 31, 1998 and 1997. It also
summarizes the minimum capital levels that must be maintained by the Bank for it
to be classified as "adequately capitalized" and "well capitalized" under the
prompt corrective action provisions of federal banking law and supporting
regulations.
MINIMUM REQUIREMENTS
TO BE CLASSIFIED AS...
-----------------------------------
ADEQUATELY WELL
DECEMBER 31, 1998 CAPITALIZED CAPITALIZED ACTUAL
- -------------------------------------------------------------------------------------------------------------------
Tier 1 leverage ratio 4.0% 5.0% 5.58%
Tier 1 risk-based capital ratio 4.0% 6.0% 10.03%
Total risk-based capital ratio 8.0% 10.0% 10.76%
Tier 1 leverage ratio capital $70,797,000 $88,497,000 $98,745,000
Tier 1 risk-based capital 39,365,000 59,047,000 98,745,000
Total risk-based capital 78,730,000 98,412,000 105,928,000
- ------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
- ------------------------------------------------------------------------------------------------------------------
Tier 1 leverage ratio 4.0% 5.0% 6.39%
Tier 1 risk-based capital ratio 4.0% 6.0% 11.45%
Total risk-based capital ratio 8.0% 10.0% 12.23%
Tier 1 leverage ratio capital $61,625,000 $77,031,000 $98,430,000
Tier 1 risk-based capital 34,394,000 51,591,000 98,430,000
Total risk-based capital 68,788,000 85,985,000 105,193,000
- ------------------------------------------------------------------------------------------------------------------
51
53
NOTE 12--FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of financial instruments as of December 31 are as follows:
1998 1997
- ---------------------------------------------------------------------------------------------------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
- ---------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and due from banks $43,642,705 $43,642,705 $29,939,484 $29,939,484
Interest-bearing deposits with banks 96,549,775 96,549,775 7,113,756 7,113,756
Investment securities available for sale 21,376,678 21,376,678
- -
Mortgage-backed and related securities:
Available for sale 204,108,879 204,108,879 47,895,297 47,895,297
Held for investment 102,500,238 102,908,423 124,335,969 123,613,629
Loans held for sale 72,002,437 73,600,000 45,576,945 46,600,000
Loans held for investment, gross 1,183,600,073 1,190,000,000 1,200,956,912 1,211,000,000
Federal Home Loan Bank stock 12,485,500 12,485,500 13,811,300 13,811,300
Accrued interest receivable 13,888,538 13,888,538 11,547,757 11,547,757
Mortgage servicing rights 21,103,459 21,103,459 16,290,903 16,290,903
Financial liabilities:
Deposit liabilities $1,460,135,660 $1,466,000,000 $1,146,533,896 $1,149,000,000
Federal Home Loan Bank advances and other borrowings 189,777,984 190,000,000 275,778,770 276,000,000
Advance payments by borrowers for taxes and insurance 1,762,190 1,762,190 3,872,764 3,872,764
Accrued interest payable 1,947,823 1,947,823 2,030,153 2,030,153
- --------------------------------------------------------------------------------------------------------------------
Refer to Note 1 for the methods and assumptions used by the Corporation
in estimating the fair value of financial instruments. The carrying value shown
for loans held for investment excludes the impact of the Corporation's allowance
for loan losses.
NOTE 13--SEGMENT INFORMATION
DIVISIONS AND PROFIT CENTERS The Bank has six operating divisions: (i)
executive, (ii) finance and administration, (iii) human resources, (iv)
residential lending, (v) commercial real estate lending, and (vi) retail
banking. Each division is headed by an executive officer that reports directly
to the president of the Bank. The last three divisions contain the Bank's profit
centers for segment reporting purposes. These divisions are primarily involved
in the delivery of financial products and services to the Bank's deposit and
loan customers. The remaining divisions consist principally of support
departments.
Residential lending is divided into two profit centers for segment
reporting purposes: (i) a mortgage banking profit center that is responsible for
loan origination, sales of loans in the secondary market, and servicing of
residential loans, and (ii) a residential loan portfolio that consists of loans
held by the Bank for investment purposes (loans held for sale are included in
the mortgage banking profit center). Commercial real estate lending is a single
profit center for segment reporting purposes. It consists of the Bank's
portfolio of multi-family and commercial mortgage loans, as well as functions
related to the origination and servicing of such loans. Retail banking is
divided into two profit centers for segment reporting purposes: (i) a consumer
lending portfolio, which consists of the Bank's second mortgage, automobile, and
other consumer installment loans, as well as functions related to the
origination and servicing of such loans and (ii) an education loan portfolio,
which also includes functions related to the origination and servicing of the
loans. The Bank's retail branch network, which delivers checking, savings, and
other deposit-related products and services to customers, is also part of retail
banking, but is considered a support department for segment reporting purposes,
as more fully described in a subsequent paragraph. Finally, the Bank's
investment and mortgage-related securities portfolio is considered a profit
center for segment reporting purposes. Personnel in finance and administration
manage this portfolio.
MEASUREMENT OF SEGMENT PROFIT (LOSS) Management evaluates the after-tax
performance of the Bank's profit centers as if each center were a separate
entity--each with its own earning assets, actual and/or allocated non-earning
assets, and allocated funding resources. Each profit center has its own interest
income, non-interest income, and non-interest expense as captured by the Bank's
accounting systems. Interest expense is allocated to each profit center
according to its use of the Bank's funding sources, which consist primarily of
deposit liabilities, FHLB
52
54
advances, and equity. In general, all funding sources are allocated
proportionately to each profit center. However, in certain instances specific
liabilities may be matched against specific assets of profit centers.
The net cost of operating the Bank's support departments is allocated
to the Bank's profit centers and to the retail banking network using a variety
of methods deemed appropriate by management. In general, these net costs are
included in the non-interest expense of each profit center, to include the
retail banking network. In addition, certain allocations of revenues and
expenses are made between profit centers when they perform services for each
other.
The Bank's retail branch network is considered a support department
center for segment reporting purposes. Retail banking fees and revenues are
deducted from the non-interest expense of operating the network (to include an
allocation of net costs from the Bank's other support departments) to arrive at
net cost for the branch network. This net cost is then allocated to each profit
center based on its use of deposit liabilities to fund its operations. This
amount is reported as "net cost to acquire and maintain deposit liabilities" and
is included as an adjustment to the net interest income of each profit center.
For segment reporting purposes, management makes certain non-GAAP
adjustments and reclassifications to the earnings, assets, and equity of the
Bank that, in management's judgement, more fairly reflect the performance and/or
financial condition of certain of the Bank's profit centers. Following is a
description of the more significant adjustments:
INTEREST INCOME AND EXPENSE Interest income is credited to the
mortgage banking profit center for implied earnings on non-interest-bearing
liabilities such as custodial and escrow accounts. The offsetting interest
expense is charged to each profit center according to their use of these funding
sources, as previously described. Fee income from customers that make their
monthly loan payments late ("late charges") is reclassified from interest income
to non-interest income in the mortgage banking profit center.
LOAN ORIGINATION FEES AND COSTS In accordance with GAAP,
origination fees earned on residential loans held for investment are deferred
and amortized over the expected life of the loans, as are the direct costs to
originate the loans. In general, these deferrals and their subsequent
amortization are disregarded for segment reporting purposes. As a result, the
mortgage banking cost center receives revenue for loans that it originates for
the portfolio of residential loans held for investment, as well as a full charge
for the costs to originate the loans. These fees and costs are in addition to
the fees it receives and the costs it incurs on loans originated for sale in the
secondary market, which are included in current earnings under GAAP.
MORTGAGE SERVICING RIGHTS In accordance with GAAP, mortgage
servicing rights are not recorded on residential loans held for investment.
However, for segment reporting purposes, the mortgage banking profit center
receives an income allocation for the origination of such loans, which
represents the estimated value of the mortgage servicing rights. This allocation
is in addition to the gain from mortgage servicing rights that is recorded on
loans sold in the secondary market, as permitted under GAAP. The amortization of
the mortgage servicing rights created by this allocation is charged-back to the
mortgage banking profit center over the estimated life of the loans.
LOAN SERVICING FEES In accordance with GAAP, loan servicing
fee income is not recorded on loans held for investment. However, for segment
reporting purposes, the mortgage banking profit center receives an income
allocation for the services it performs for the Bank's residential, commercial
real estate, and consumer loan portfolios. This allocation is in addition to the
service fee income that the profit center receives on loans serviced for
third-parties, as recorded in the Bank's Consolidated Statement of Operations.
The aforementioned loan portfolios are charged with the offsetting servicing
cost.
PROVISION FOR LOAN AND REAL ESTATE LOSSES For segment
reporting purposes, the Bank disregards provisions for loan and real estate
losses recorded under GAAP. Rather, actual charge-off (recovery) activity is
charged (credited) to each profit center in the period it occurs.
INTANGIBLE ASSETS The amortization of goodwill and certain
other intangible assets is disregarded for segment reporting purposes.
53
55
INCOME TAXES in general, a standard income tax rate of
approximately 41% is used for segment reporting purposes. However, the income
tax benefit associated with assets held in Nevada by FCHI, the Bank's
wholly-owned investment subsidiary, is allocated to the profit centers that own
such assets. This results in a lower effective income tax rate, or even a
negative rate, for such profit centers. During the years ended December 31, 1997
and 1996, the investment and mortgage-related securities profit center was the
only segment that held assets in Nevada. During the year ended December 31,
1998, this segment, as well as the residential loan portfolio, held assets in
Nevada.
NON-GAAP ADJUSTMENTS TO ASSETS AND EQUITY Allowances for
losses on loans and real estate and security valuation allowances are added to
and/or excluded from assets of the profit centers. In addition, an estimated
value for mortgage servicing rights not recorded under GAAP is estimated and
added to the assets of the mortgage banking profit center. For each of these
adjustments, a corresponding amount is added to or excluded from equity prior to
the proportionate allocation of equity to the profit centers, as previously
described. The amount added to or excluded from equity is net of the estimated
income tax effect.
SEGMENT PROFIT (LOSS) STATEMENTS AND OTHER INFORMATION The following
tables contain profit (loss) statements for each of the Bank's reportable
segments for the years ended December 31, 1998, 1997, and 1996 (1997 is
presented on both pages to facilitate its comparison with 1998 and 1996). In
addition to the after-tax performance of profit centers, management of the Bank
closely monitors the net cost to acquire and maintain deposit liabilities (as
defined elsewhere in this footnote). The net cost to acquire and maintain
deposit liabilities was 1.32%, 1.35%, and 1.52% of average deposit liabilities
outstanding during the years ended December 31, 1998, 1997, and 1996,
respectively.
54
56
LOANS HELD FOR INVESTMENT
--------------------------------------------------- INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE COMMERCIAL & MORTGAGE
YEAR ENDED DECEMBER 31, 1998 BANKING RESIDENTIAL REAL ESTATE CONSUMER EDUCATION SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Interest income $ 4,503,290 $ 33,496,128 $ 25,066,823 $ 18,321,380 $ 13,501,027 $ 23,198,449
Interest expense 4,617,955 20,614,365 14,031,760 10,076,044 7,316,551 17,605,864
Net cost to acquire and
maintain deposit
liabilities 547,379 4,332,138 3,635,592 2,612,673 2,077,845 3,118,890
- -------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (662,044) 8,549,625 7,399,471 5,632,663 4,106,631 2,473,695
Net loan charge-offs
(recoveries) -- 17,082 203,379 274,597 32,515 --
- -------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (662,044) 8,532,543 7,196,092 5,358,066 4,074,116 2,473,695
Non-interest income 22,060,254 -- 55,367 1,036,406 95,122 --
Non-interest expense 13,141,292 1,877,465 1,415,221 1,793,030 818,311 177,015
- -------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 8,256,918 6,655,078 5,836,238 4,601,442 3,350,927 2,296,680
Income tax expense (benefit) 3,347,355 2,530,646 2,366,011 1,865,425 1,358,466 (45,191)
- -------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 4,909,563 $ 4,124,432 $ 3,470,227 $ 2,736,017 $ 1,992,461 $ 2,341,871
=========================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------------------------
Average assets $ 98,039 $ 460,016 $ 310,633 $ 223,066 $ 177,403 $ 374,527
=========================================================================================================================
Total assets at end of period $ 90,536 $ 499,930 $ 342,434 $ 238,889 $ 192,224 $ 426,793
=========================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 1998 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Interest income -- -- $ 580,771 (1) $ 118,667,868
Interest expense $ 75,070 -- (2,880,415)(1) 71,457,194
Net cost to acquire and
maintain deposit
liabilities 8,242 (16,332,759) -- --
- ----------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (83,312) 16,332,759 3,461,186 47,210,674
Net loan charge-offs
(recoveries) -- -- (234,461) 293,112
- ----------------------------------------------------------------------------------------------
Net interest income (expense) (83,312) 16,332,759 3,695,647 46,917,562
Non-interest income 1,432,728 15,254,216 (8,574,023) 31,360,070
Non-interest expense 326,783 31,586,975 (3,539,569) 47,596,523
- ----------------------------------------------------------------------------------------------
Profit (loss) before taxes 1,022,633 -- (1,338,807) 30,681,109
Income tax expense (benefit) 698,577 -- (864,314) 11,256,975
- ----------------------------------------------------------------------------------------------
Segment profit (loss) $ 324,056 ($474,493) $19,424,134
==============================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ----------------------------------------------------------------------------------------------
Average assets $ 704 -- ($10,354)(4) $ 1,634,034
==============================================================================================
Total assets at end of period $ 1,241 -- ($ 5,543)(4) $ 1,786,504
==============================================================================================
LOANS HELD FOR INVESTMENT
--------------------------------------------------- INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE COMMERCIAL & MORTGAGE
YEAR ENDED DECEMBER 31, 1997 BANKING RESIDENTIAL REAL ESTATE CONSUMER EDUCATION SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Interest income $ 1,521,194 $ 46,009,725 $21,746,184 $16,552,232 $11,676,426 $17,034,661
Interest expense 2,393,024 28,685,579 11,808,145 8,905,641 6,430,163 13,631,493
Net cost to acquire and
maintain deposit
liabilities 398,387 4,703,759 3,152,711 2,381,416 1,831,784 1,856,314
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,270,217) 12,620,387 6,785,328 5,265,175 3,414,479 1,546,854
Net loan charge-offs (recoveries) -- (59,742) (15,303) 511,964 18,869 --
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,270,217) 12,680,129 6,800,631 4,753,211 3,395,610 1,546,854
Non-interest income 16,393,361 452,243 52,531 1,037,696 12,765 (725,142)
Non-interest expense 9,471,294 2,671,899 982,650 1,513,641 782,369 156,692
- ---------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 5,651,850 10,460,473 5,870,512 4,277,266 2,626,006 665,020
Income tax expense (benefit) 2,291,260 4,240,676 2,379,905 1,734,003 1,064,583 (337,107)
- ---------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 3,360,590 $ 6,219,797 $ 3,490,607 $ 2,543,263 $ 1,561,423 $ 1,002,127
===========================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ---------------------------------------------------------------------------------------------------------------------------
Average assets $ 51,239 $ 607,651 $ 261,025 $ 196,881 $ 151,441 $ 282,797
===========================================================================================================================
Total assets at end of period $ 68,541 $ 598,619 $ 280,604 $ 215,218 $ 167,507 $ 223,665
===========================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 1998 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Interest income -- -- 435,834(1) $ 114,976,256
Interest expense $ 270,017 -- (1,859,005) 70,265,057
Net cost to acquire and
maintain deposit
liabilities 9,250 (14,333,621) -- --
- ----------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (279,267) 14,333,621 2,294,839 44,711,199
Net loan charge-offs
(recoveries) -- -- 83,169 538,957
- ----------------------------------------------------------------------------------------------
Net interest income (expense) (279,267) 14,333,621 2,211,670 44,172,242
Non-interest income (8,835) 12,071,266 (4,992,200) 24,293,685
Non-interest expense 379,362 26,404,887 (2,165,742) 40,197,052
- ----------------------------------------------------------------------------------------------
Profit (loss) before taxes (667,464) -- (614,788) 28,268,875
Income tax expense (benefit) (214,727) -- (280,081) 10,878,512
- ----------------------------------------------------------------------------------------------
Segment profit (loss) ($452,737) -- ($ 334,707) $ 17,390,363
==============================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ----------------------------------------------------------------------------------------------
Average assets $ 612 -- ($ 12,208)(4) $ 1,539,438
==============================================================================================
Total assets at end of period $ 571 -- ($ 10,431)(4) $ 1,544,294
==============================================================================================
(1) Consists principally of interest income and expense adjustments related to
late charges and implied earnings on custodial and escrow accounts.
(2) In general, the Corporation records actual loan and real estate charge-off
(recovery) activity against each profit center for segment reporting
purposes.
(3) Consists principally of non-GAAP adjustments related to loan origination
fees and costs, mortgage servicing rights, and loan servicing fees. The
offsets for the adjustments described in (1), above, are also include in
non-interest income.
(4) Consists of allowances for loss on loans and real estate and security
valuation allowances that are disregarded for segment reporting purposes.
Also includes mortgage servicing rights that are not recorded under GAAP,
but are recorded for segment reporting purposes.
55
57
LOANS HELD FOR INVESTMENT
--------------------------------------------------- INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE COMMERCIAL & MORTGAGE
YEAR ENDED DECEMBER 31, 1997 BANKING RESIDENTIAL REAL ESTATE CONSUMER EDUCATION SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
Interest income $ 1,521,194 $ 46,009,725 $21,746,184 $16,552,232 $11,676,426 $17,034,661
Interest expense 2,393,024 28,685,579 11,808,145 8,905,641 6,430,163 13,631,493
Net cost to acquire and
maintain deposit
liabilities 398,387 4,703,759 3,152,711 2,381,416 1,831,784 1,856,314
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,270,217) 12,620,387 6,785,328 5,265,175 3,414,479 1,546,854
Net loan charge-offs
(recoveries) -- (59,742) (15,303) 511,964 18,869 --
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,270,217) 12,680,129 6,800,631 4,753,211 3,395,610 1,546,854
Non-interest income 16,393,361 452,243 52,531 1,037,696 12,765 (725,142)
Non-interest expense 9,471,294 2,671,899 982,650 1,513,641 782,369 156,692
- ---------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 5,651,850 10,460,473 5,870,512 4,277,266 2,626,006 665,020
Income tax expense (benefit) 2,291,260 4,240,676 2,379,905 1,734,003 1,064,583 (337,107)
- ---------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 3,360,590 $ 6,219,797 $ 3,490,607 $ 2,543,263 $ 1,561,423 $ 1,002,127
===========================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ---------------------------------------------------------------------------------------------------------------------------
Average assets $ 51,239 $ 607,651 $ 261,025 $ 196,881 $ 151,441 $ 282,797
===========================================================================================================================
Total assets at end of period $ 68,541 $ 598,619 $ 280,604 $ 215,218 $ 167,507 $ 223,665
===========================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 1997 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
Interest income -- -- $435,834(1) $114,976,256
Interest expense $270,017 -- (1,859,005)(1) 70,265,057
Net cost to acquire and
maintain deposit
liabilities 9,250 (14,333,621) -- --
- -------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (279,267) 14,333,621 2,294,839 44,711,199
Net loan charge-offs
(recoveries) -- -- 83,169(2) 538,957
- -------------------------------------------------------------------------------------------------------
Net interest income (expense) (279,267) 14,333,621 2,211,670 44,172,242
Non-interest income (8,835) 12,071,266 (4,992,200)(3) 24,293,685
Non-interest expense 379,362 26,404,887 (2,165,742)(3) 40,197,052
- -------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (667,464) -- (614,788) 28,268,875
Income tax expense (benefit) (214,727) -- (280,081) 10,878,512
- -------------------------------------------------------------------------------------------------------
Segment profit (loss) ($452,737) -- ($334,707) $17,390,363
=======================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------
Average assets $612 -- ($12,208)(4) $1,539,438
=======================================================================================================
Total assets at end of period $571 -- ($10,431)(4) $1,544,294
=======================================================================================================
LOANS HELD FOR INVESTMENT
--------------------------------------------------- INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE COMMERCIAL & MORTGAGE
YEAR ENDED DECEMBER 31, 1996 BANKING RESIDENTIAL REAL ESTATE CONSUMER EDUCATION SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
Interest income $ 1,352,606 $ 39,998,430 $18,252,099 $13,632,264 $ 9,631,434 $20,190,817
Interest expense 2,201,321 24,569,269 9,799,341 7,149,947 5,158,411 16,166,190
Net cost to acquire and
maintain deposit
liabilities 425,758 5,213,286 2,905,860 2,176,843 1,677,133 2,381,663
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,274,473) 10,215,875 5,546,898 4,305,474 2,795,890 1,642,964
Net loan charge-offs
(recoveries) -- (10,240) -- 289,061 8,693 --
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,274,473) 10,226,115 5,546,898 4,016,413 2,787,197 1,642,964
Non-interest income 15,611,604 -- 73,386 672,597 13,172 (311,151)
Non-interest expense 9,206,267 2,389,900 876,791 1,775,187 898,857 180,534
- ---------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 5,130,864 7,836,215 4,743,493 2,913,823 1,901,512 1,151,279
Income tax expense (benefit) 2,080,052 3,176,801 1,923,012 1,181,264 770,873 (228,627)
- ---------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 3,050,812 $ 4,659,414 $ 2,820,481 $ 1,732,559 $ 1,130,639 $ 1,379,906
===========================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ---------------------------------------------------------------------------------------------------------------------------
Average assets $ 47,689 $ 535,226 $ 218,295 $ 160,494 $ 123,652 $ 340,611
===========================================================================================================================
Total assets at end of period Segment information not available
===========================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 1997 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- -------------------------------------------------------------------------------------------------------
Interest income -- -- $919,347(1) $103,976,997
Interest expense $312,685 -- (1,673,501)(1) 63,683,663
Net cost to acquire and
maintain deposit
liabilities 26,204 (14,806,747) -- --
- -------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (338,889) 14,806,747 2,592,848 40,293,334
Net loan charge-offs
(recoveries) -- -- (287,514)(2) --
- -------------------------------------------------------------------------------------------------------
Net interest income (expense) (338,889) 14,806,747 2,880,362 40,293,334
Non-interest income 44,007 10,200,669 (6,473,112)(3) 19,831,172
Non-interest expense 286,790 25,007,416 3,622,985(3) 44,244,727
- -------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (581,672) -- (7,215,735) 15,879,779
Income tax expense (benefit) (182,420) -- (2,915,093) 5,805,862
- -------------------------------------------------------------------------------------------------------
Segment profit (loss) ($399,252) -- ($4,300,642) $10,073,917
=======================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------
Average assets $1,932 -- ($16,120)(4) $1,411,779
=======================================================================================================
Total assets at end of period $1,515,413
=======================================================================================================
(1) Consists principally of interest income and expense adjustments related to
late charges and implied earnings on custodial and escrow accounts.
(2) In general, the Corporation records actual loan and real estate charge-off
(recovery) activity against each profit center for segment reporting
purposes.
(3) Consists principally of non-GAAP adjustments related to loan origination
fees and costs, mortgage servicing rights, and loan servicing fees. 1996
also includes the FDIC special assessment ($5.9 million). The offsets for
the adjustments described in (1), above, are also include in non-interest
income.
(4) Consists of allowances for loss on loans and real estate and security
valuation allowances that are disregarded for segment reporting purposes.
Also includes mortgage servicing rights that are not recorded under GAAP,
but are recorded for segment reporting purposes.
56
58
NOTE 14--PARENT COMPANY ONLY FINANCIAL INFORMATION
DECEMBER 31
- -------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF FINANCIAL CONDITION: 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Cash in bank $3,047,526 $405,267
Interest-bearing deposits with subsidiary bank -- 2,757,648
Investment in subsidiary 122,446,917 108,994,270
Other assets 155,314 236,485
- -------------------------------------------------------------------------------------------------------------------
Total assets $125,649,757 $112,393,670
===================================================================================================================
Other borrowings $2,950,000 $3,000,000
Other liabilities 15,110 32,324
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 2,965,110 3,032,324
- -------------------------------------------------------------------------------------------------------------------
Common stock 1,994,163 997,082
Additional paid-in capital 34,540,065 35,537,146
Retained earnings 97,291,806 84,548,291
Treasury stock, at cost (12,722,834) (10,845,168)
Unearned restricted stock (1,256,266) (211,006)
Non-owner adjustments to equity, net 2,837,713 (664,999)
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 122,684,647 109,361,346
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $125,649,757 $112,393,670
===================================================================================================================
YEAR ENDED DECEMBER 31
- -------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS: 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Other income $78,434 $67,605 $133,581
Other expense 522,190 743,276 693,068
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Loss before income taxes and equity in earnings of subsidiary (443,756) (675,671) (559,487)
Income tax benefit 155,314 236,485 195,820
- -------------------------------------------------------------------------------------------------------------------
Loss before equity in earnings of subsidiary (288,442) (439,186) (363,667)
Equity in earnings of subsidiary 19,712,576 17,829,549 10,437,584
- -------------------------------------------------------------------------------------------------------------------
Net income $19,424,134 $17,390,363 $10,073,917
===================================================================================================================
YEAR ENDED DECEMBER 31
- -------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS: 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Net income $19,424,134 $17,390,363 $10,073,917
Equity in earnings of subsidiary (19,712,576) (17,829,549) (10,437,584)
Other accruals and prepaids (17,214) (70,781) (76,583)
- -------------------------------------------------------------------------------------------------------------------
Net cash used by operations (305,656) (509,967) (440,250)
- -------------------------------------------------------------------------------------------------------------------
Decrease (increase) in interest-bearing deposits with
subsidiary bank 2,757,648 (341,769) 4,449,181
Dividends received from subsidiary 11,500,000 9,500,000 8,000,000
Other, net 81,171 -- (3,200)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 14,338,819 9,158,231 12,445,981
- -------------------------------------------------------------------------------------------------------------------
Proceeds from sale of common stock 328,958 484,179 194,225
Increase (decrease) in other borrowings (50,000) (2,000,000) 1,000,000
Dividends paid to shareholders (5,001,135) (4,283,617) (3,874,954)
Purchase of treasury stock (7,356,875) (2,868,938) (9,674,875)
Other, net 688,148 203,386 238,637
- -------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (11,390,904) (8,464,990) (12,116,967)
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash in bank 2,642,259 183,274 (111,236)
Cash at beginning of period 405,267 221,993 333,229
- -------------------------------------------------------------------------------------------------------------------
Cash in bank at end of period $3,047,526 $405,267 $221,993
===================================================================================================================
57
59
REPORT OF MANAGEMENT
The management of First Federal Capital Corp has prepared the
accompanying financial statements and is responsible for their integrity and
objectivity. The statements, which include amounts that are based on
management's best estimates and judgements, have been prepared in conformity
with generally accepted accounting principles and are free of material
misstatement. Management also prepared the other information in the annual
report on Form 10-K and is responsible for its accuracy and consistency with the
financial statements.
The Corporation maintains a system of internal control over financial
reporting, which is designed to provide reasonable assurance to the
Corporation's management and Board of Directors regarding the preparation of
reliable published annual and interim financial statements. The system contains
self-monitoring mechanisms, and actions are taken to correct deficiencies as
they are identified. However, even an effective internal control system, no
matter how well designed, has inherent limitations--including the possibility of
circumvention or overriding of controls--and therefore can provide only
reasonable assurance with respect to financial statement preparation. Further,
because of changes in conditions, internal control system effectiveness may vary
over time.
The Corporation assessed its internal control system as of December 31,
1998, in relation to criteria for effective internal control over the
preparation of its published annual and interim financial statements described
in "Internal Control--Integrated Framework" issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this assessment,
the Corporation believes that, as of December 31, 1998, its system of internal
control over the preparation of its published annual and interim financial
statements met those criteria.
/s/Thomas W. Schini /s/Jack C. Rusch /s/Michael W. Dosland
Thomas W. Schini Jack C. Rusch Michael W. Dosland
Chairman of the Board and Executive Vice President and Vice President and Controller
Chief Executive Officer Chief Financial Officer
REPORT OF INDEPENDENT AUDITORS
We have audited the accompanying consolidated statements of financial
condition of First Federal Capital Corp as of December 31, 1998 and 1997, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those statements require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of First
Federal Capital Corp at December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Milwaukee, Wisconsin
January 22, 1999
58
60
SUPPLEMENTARY DATA
Quarterly Financial Information (Unaudited)
DEC. SEPT. JUNE MARCH DEC. SEPT. JUNE MARCH
Dollars in thousands, except for per share 1998 1998 1998 1998 1997 1997 1997 1997
amounts
- -------------------------------------------------------------------------------------------------------------------
Interest on loans $24,598 $21,837 $23,252 $25,783 $25,349 $25,138 $24,153 $23,302
Interest on mortgage-backed and related 5,745 6,334 3,846 2,617 2,817 2,965 3,128 3,215
securities
Interest and dividends on investments 1,018 819 1,587 1,232 889 1,245 1,335 1,440
- -------------------------------------------------------------------------------------------------------------------
Total interest income 31,361 28,990 28,685 29,632 29,055 29,347 28,617 27,956
- -------------------------------------------------------------------------------------------------------------------
Interest on deposits 15,965 15,215 14,473 13,769 13,718 13,076 12,377 11,978
Interest on borrowings 3,128 2,224 2,734 3,950 3,924 4,929 5,090 5,172
- -------------------------------------------------------------------------------------------------------------------
Total interest expense 19,093 17,439 17,207 17,718 17,643 18,005 17,467 17,150
- -------------------------------------------------------------------------------------------------------------------
Net interest income 12,269 11,551 11,478 11,914 11,413 11,342 11,150 10,806
Provision for loan losses 88 63 89 53 164 123 132 121
- -------------------------------------------------------------------------------------------------------------------
Net interest income after provision 12,181 11,488 11,389 11,861 11,249 11,220 11,019 10,685
- -------------------------------------------------------------------------------------------------------------------
Gain on sale of loans 5,849 3,499 3,761 3,820 2,155 2,438 992 789
Gain (loss) on sale of investments 343 - - - - (628) (43) (55)
Other non-interest income 2,987 4,375 3,731 2,996 4,859 4,691 4,676 4,364
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income 9,179 7,874 7,492 6,816 7,014 6,501 5,625 5,153
- -------------------------------------------------------------------------------------------------------------------
Total non-interest expense 13,386 11,961 11,347 10,902 10,603 10,134 9,747 9,712
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 7,974 7,400 7,534 7,775 7,660 7,587 6,897 6,125
Income tax expense 2,818 2,628 2,836 2,976 2,927 2,896 2,688 2,367
- -------------------------------------------------------------------------------------------------------------------
Net Income $5,155 $4,772 $4,698 $4,799 $4,733 $4,691 $4,209 $3,758
===================================================================================================================
Diluted earnings per share $0.26 $0.24 $0.24 $0.24 $0.24 $0.24 $0.21 $0.19
===================================================================================================================
Dividends paid per share $0.070 $0.070 $0.070 $0.060 $0.060 $0.060 $0.060 $0.053
===================================================================================================================
Stock price at end of period $16.38 $14.50 $17.94 $16.50 $16.94 $14.50 $12.25 $9.34
===================================================================================================================
High stock price during period $16.50 $18.38 $18.25 $16.94 $17.00 $14.50 $12.25 $9.84
===================================================================================================================
Low stock price during period $12.00 $13.00 $15.72 $14.25 $12.50 $11.50 $8.42 $7.84
===================================================================================================================
Note: per share data and historical stock prices have been adjusted for a
3-for-2 stock split on June 12, 1997, and a 2-for-1 stock split on June 11,
1998.
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
59
61
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from the
sections entitled "Matters to be Voted on at the Annual Meeting--Matter 1.
Election of Directors" and "Executive Officers Who Are Not Directors" in the
definitive proxy statement of the Corporation dated March 19, 1999.
ITEM 11--EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the
section entitled "Compensation of Executive Officers and Directors" in the
definitive proxy statement of the Corporation dated March 19, 1999.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required herein is incorporated by reference from the
section entitled "Beneficial Ownership of Common Stock by Certain Beneficial
Owners and Management" in the definitive proxy statement of the Corporation
dated March 19, 1999.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference from the
section entitled "Indebtedness of Management and Certain Transactions" in the
definitive proxy statement of the Corporation dated March 19, 1999.
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
(1) The following financial statements are included herein under Part II, Item
8, "Financial Statements and Supplementary Data":
Consolidated Statements of Condition at December 31, 1998 and 1997
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 1998
Consolidated Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 1998
Notes to Audited Consolidated Financial Statements
Report of Management
Report of Independent Auditors
(2) All financial statement schedules required under this item are omitted
because the required information is either not applicable or the required
information is included in the Audited Consolidated Financial Statements or in
the notes thereto.
60
62
(3) Exhibit Index.
No. Exhibit Description
3.1 Articles of Incorporation (1)
3.2 Bylaws, as amended (9)
4.1 Specimen stock certificate (1)
4.2 Rights Agreement, dated as of January 24, 1995 (1)
10.1 1989 Stock Incentive Plan (1)
10.2 1989 Directors' Stock Option Plan, as amended (2)
10.3 1992 Stock Incentive Plan (3)
10.4 1992 Stock Option and Incentive Plan (3)
10.5 Rock Financial Corp. 1992 Stock Option and Incentive Plan (4)
10.6 1997 Stock Option and Incentive Plan (9)
10.7 Employee Stock Ownership Plan (1)
10.8 Employment agreements between the Bank and the following executive
officers:
a) Thomas W. Schini (5)
b) Bradford R. Price (1)
c) Jack C. Rusch (1)
d) Joseph M. Konradt (7)
e) Milne J. Duncan (1)
f) Robert P. Abell (1)
g) Jeffrey J. Johnson (6)
10.9 Employment agreement between the Bank and John T. Bennett (6)
10.10 First Federal of La Crosse Directors' Deferred Compensation Plan (1)
10.11 First Federal of La Crosse Annual Incentive Bonus Plan (1)
10.12 First Federal of La Crosse Incentive Bonus Plan for Group Life Insurance
(1)
10.13 First Federal of Madison Deferred Compensation Plan for Directors (1)
11.1 Computation of Earnings Per Share--Reference is made to Note 1 of the
Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary
Data"
13.1 1998 President's Message (8)
21.1 Subsidiaries of the Registrant--Reference is made to Part I, Item 1,
"Business--Subsidiaries"
23.1 Consent of Ernst & Young LLP (7)
27.1 Financial Data Schedule (7)
99.1 1998 Proxy Statement (7)
(1) Incorporated herein by reference to exhibits filed with the Corporation's
Form S-1 Registration Statement declared effective by the SEC on September
8, 1989 (Registration No. 33-98298-01).
(2) Incorporated herein by reference to exhibits filed with the Corporation's
Annual Report on Form 10-K for the year ended December 31, 1989, filed with
the SEC on March 30, 1990.
(3) Incorporated herein by reference to the Corporation's definitive proxy
statement dated March 11, 1992.
(4) Incorporated herein by reference to exhibits filed with the Corporation's
Post-Effective Amendment No. 1 on Form S-8 to Form S-4 Registration
Statement filed with the SEC on December 26, 1995 (Registration No.
33-98298-01)
(5) Incorporated herein by reference to the exhibits filed with the
Corporation's Annual Report on Form 10-K for the year ended December 31,
1994, filed with the SEC on March 30, 1995.
(6) Incorporated herein by reference to exhibits filed with the Corporation's
Form S-4 Registration Statement declared effective by the SEC on October
18, 1995 (Registration No. 33-98298-01).
(7) Filed herewith.
(8) Filed in paper format pursuant to Rule 101(b) of Regulation S-T.
(9) Incorporated herein by reference to the exhibits filed with the
Corporation's Annual Report on Form 10-K for the year ended December 31,
1997, filed with the SEC on March 20, 1998.
(b) The Corporation filed no reports on Form 8-K during the fourth quarter of
1998.
(c) Refer to item (a)(3) above for all exhibits filed herewith.
(d) Refer to items (a)(1) and (2) above for financial statements required under
this item.
61
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL CAPITAL CORP
February 28, 1999 By: /s/Thomas W. Schini
Thomas W. Schini
President, Chairman of
the Board, and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Thomas W. Schini February 28, 1999
Thomas W. Schini
President, Chairman of the
Board and Chief Executive Officer
(principal executive officer)
/s/ Dale A. Nordeen February 28, 1999
Dale A. Nordeen
Vice Chairman of the Board
/s/ Marjorie A. Davenport February 28, 1999
Marjorie A. Davenport
Director
/s/ Henry C. Funk February 28, 1999
Henry C. Funk
Director
/s/ John F. Leinfelder February 28, 1999
John F. Leinfelder
Director
/s/ Richard T. Lommen February 28, 1999
Richard T. Lommen
Director
/s/ Patrick J. Luby February 28, 1999
Patrick J. Luby
Director
62
64
/s/ David C. Mebane February 28, 1999
David C. Mebane
Director
/s/ Phillip J. Quillin February 28, 1999
Phillip J. Quillin
Director
/s/ Don P. Rundle February 28, 1999
Don P. Rundle
Director
/s/ Jack C. Rusch February 28, 1999
Jack C. Rusch
Executive Vice President and
Chief Financial Officer
(principal financial officer)
/s/ Michael W. Dosland February 28, 1999
Michael W. Dosland
Vice president and Controller
(principal accounting officer)
63