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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
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 most recently completed second fiscal quarter (June 30,
2002), was approximately $356.8 million. This amount was based on the closing
price of $22.10 per share of the Registrant's common stock as of the same date.
Indicate by check mark if the Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes [X] No [ ]
The number of shares of common stock of the Registrant outstanding as of March
3, 2003, was 19,702,712 (net of 513,221 shares held as treasury stock).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of Stockholders are
incorporated into Part III, Items 10 through 13 of this Form 10-K.
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FORM 10-K TABLE OF CONTENTS
Page
PART I
Item 1--Business.................................................................................. 2
Item 2--Properties................................................................................ 15
Item 3--Legal Proceedings......................................................................... 15
Item 4--Submission of Matters to a Vote of Security Holders....................................... 15
PART II
Item 5--Market for Registrant's Common Equity and Related Stockholder Matters..................... 16
Item 6--Selected Financial Data................................................................... 17
Item 7--Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................ 18
Item 7A--Quantitative and Qualitative Disclosures about Market Risk............................... 37
Item 8--Financial Statements and Supplementary Data............................................... 40
Item 9--Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................ 72
PART III
Item 10--Directors and Executive Officers of the Registrant....................................... 73
Item 11--Executive Compensation................................................................... 73
Item 12--Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters...................................................................... 73
Item 13--Certain Relationships and Related Transactions........................................... 73
PART IV
Item 14--Controls and Procedures.................................................................. 73
Item 15--Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 73
SIGNATURES................................................................................................ 76
CERTIFICATION............................................................................................. 78
EXHIBITS.................................................................................................. 81
1
FORWARD-LOOKING STATEMENTS
This report includes certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
include words and phrases such as "will likely result", "are expected to", "will
continue", "is anticipated", "is estimated", "is projected", "intends to", or
similar expressions. Forward-looking statements are based on management's
current 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 and business demand for deposit and
loan products and services; consumer and business 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.
Management of the Corporation does not undertake and specifically
disclaims any obligation to update any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART I
ITEM 1--BUSINESS
FIRST FEDERAL CAPITAL CORP
This section of the report contains general information about First
Federal Capital Corp (the "Corporation"), its wholly-owned subsidiary First
Federal Capital Bank (the "Bank"), and the Bank's wholly-owned subsidiaries
(collectively "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.
The Corporation's principal office is located at 605 State Street, La
Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000. The
Corporation's web page is located at www.firstfed.com. The Corporation will make
available on its website free of charge its Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
those Reports filed pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after they are filed with
the Securities and Exchange Commission.
FIRST FEDERAL CAPITAL BANK
The Bank was founded in 1934 and is a federally-chartered,
federally-insured, savings bank headquartered in La Crosse, Wisconsin. Effective
March 1, 2003, the Bank changed its name from "First Federal Savings Bank La
Crosse-Madison" to "First Federal Capital Bank". The new name will appear on all
legal documents and official communications beginning on that date. Signs,
promotional messages, letterhead, and business cards will not change, but will
continue to carry the "First Federal" name and logo. This change was made to
more appropriately reflect the Bank's expansion into many new geographic markets
in recent years, as well as its expansion into business banking in 2001.
The Bank's primary business is community banking, which includes
attracting deposits from and making loans to the general public and private
businesses, as well as governmental and non-profit entities. In addition to
deposits, the Bank obtains funds through borrowings from the Federal Home Loan
Bank of Chicago ("FHLB"), as
2
well as through other sources such as securities sold under agreements to
repurchase and purchases of federal funds. These funding sources are principally
used to originate loans, including single-family residential loans, commercial
real estate loans, business loans and lines of credit, consumer loans, and
education loans. The Bank also purchases and/or participates in loans from
third-party financial institutions and invests in mortgage-backed and related
securities. 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 southern two-thirds of Wisconsin, northern
Illinois, and south-eastern Minnesota. The Bank maintains 89 banking offices in
its market areas. Twenty 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 Appleton and Wausau areas, three each in the Beloit,
Hudson, Oshkosh, and Green Bay areas, and two each in the cities of Kenosha,
Janesville, Neenah, and Racine, Wisconsin. The Bank also maintains one banking
facility in fifteen other cities located throughout its market area in
Wisconsin. The Bank also has six offices in the Rockford, Illinois, area and
seven offices in Minnesota, including four in Rochester. Finally, the Bank has
two separate residential loan production offices in Appleton, Wisconsin.
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. The
Bank's internet site is www.firstfed.com.
ORGANIZATIONAL STRUCTURE AND SEGMENT REPORTING
In 2001, the Corporation completed a reorganization along functional
lines rather than product lines. The principal components of the Corporation's
organization now consist of a Community Banking Group, which has primary
responsibility for the sale and delivery of all the Corporation's products and
services, and a Corporate Administration and Operations Group, which has primary
responsibility for product support, data and technology management, and property
management. The Corporation also has a Commercial Real Estate Lending Division,
which is responsible for the origination and servicing of commercial real estate
loans, a Finance and Treasury Division, and a Human Resources Division. Each
group or division is led by an executive officer that reports directly to the
president of the Corporation.
Despite its reorganization along functional rather than product lines,
the Corporation continues to account for its operations along product lines. The
Corporation tracks profitability in five major areas: (i) residential lending,
(ii) commercial real estate lending, (iii) consumer lending, (iv) education
lending, and (v) investment and mortgage-related securities. 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 Corporation for
investment purposes (loans held for sale are included in the mortgage banking
profit center). This profit center also includes mortgage-backed securities
("MBSs") that are collateralized by loans that were originated by the
Corporation. Commercial real estate lending consists of the Corporation's
portfolio of multi-family and non-residential mortgage loans, as well as
functions related to the origination and servicing of such loans. Consumer
lending consists of the Corporation's second mortgage, automobile, and other
consumer installment loans, as well as functions related to the origination and
servicing of such loans. The education loan portfolio consists of loans
originated through programs sponsored by the federal government, as well as
functions related to the origination and servicing of such loans. Finally, the
Corporation's investment and mortgage-related securities portfolio is considered
a profit center for segment reporting purposes. As previously noted, however,
MBSs collateralized by loans originated by the Corporation are included in the
residential loan profit center, rather than the investment and mortgage-related
securities portfolio.
The Corporation's extensive branch network, which delivers checking,
savings, certificates of deposit and other financial products and services to
customers, is considered a support department for segment reporting purposes.
3
In October 2001, the Corporation completed the acquisition of American
Community Bankshares, Inc. ("ACB"). In addition, in April 2002 the Corporation
completed the acquisition of three bank offices in Rochester, Minnesota, from
another financial institution. These purchases included the customer loans and
deposits at those branches. In addition to offering products and services
similar to the Corporation's existing product lines, these institutions also
deliver commercial loan and deposit products and services to business customers.
This represents a new line of business for the Corporation and a new reportable
segment. The financial results of this new line of business have not been
separately reported in 2002 due to continuing efforts to develop the
departmental allocations of costs and revenues necessary to fairly present the
operating results of this line of business.
For additional discussion regarding the Corporation's reportable
segments, refer to Note 14 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's Discussion and
Analysis of Financial Condition and Results of Operations".
LENDING ACTIVITIES
GENERAL The principal categories of loans in the Corporation's
portfolio are conventional real estate loans secured by single-family
residences, commercial real estate loans secured by multi-family residential and
non-residential real estate, consumer loans secured primarily by second
mortgages on single-family residences and automobiles, government-guaranteed
education loans, and commercial loans to businesses secured by varied collateral
or consideration. Although the Corporation also originates single-family
residential loans that are insured or partially guaranteed by federal and state
agencies, the Corporation does not generally retain such loans in its
residential loan portfolio. As of December 31, 2002, approximately 69% of the
Corporation's total assets consisted of loans held for investment purposes.
RESIDENTIAL LENDING Single-family residential loans accounted for
approximately 35% of the Corporation's gross loans as of December 31, 2002.
Applications for single-family residential and construction loans are accepted
by commission-based employees of the Corporation at a number of locations (most
of which are located with deposit-taking offices) and by salaried employees at a
few other deposit-taking offices that are able to handle such applications.
In general, the Corporation 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 that 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 to five years of the loan's term. Furthermore, most of these loans
have annual interest rate change limits ranging from 1% to 2%, maximum lifetime
interest rates ranging from 11% to 14%, and minimum lifetime floor rates of
approximately 6% to 7%. It is the Corporation's practice from time-to-time to
discount the interest rate it charges on its adjustable-rate mortgage loans
during the first one to five years of the loan, which has the effect of reducing
a borrower's payment during such years. In addition, most of the Corporation's
owner-occupied 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 Corporation generally
sells such loans in the secondary market.
Adjustable-rate mortgage loans decrease the Corporation'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 Corporation to date, although no assurances can be made with respect to
future periods.
The Corporation occasionally purchases adjustable-rate single-family
residential loans from third-party financial institutions. In general, such
loans are subject to the same underwriting standards as loans originated
directly by the Corporation. However, such loans are usually secured by
properties located outside of the Corporation's primary market areas. The seller
generally retains servicing of the loans.
4
Although the Corporation generally retains only adjustable-rate
mortgage loans in its portfolio, it continues to originate and service
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
Corporation generally sells these loans at the time they are originated, but
continues to service these loans for its customers. In addition, the Corporation
generally sells any adjustable-rate mortgage loans that convert to fixed-rate
loans 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.
Sales or securitizations of mortgage loans through FHLMC and FNMA have
generally been under terms that do not provide for any recourse against the
Corporation by the investor. In the case of sales to the FHLB, however, the
Corporation retains the credit risk on the underlying loans in exchange for a
credit enhancement fee. Furthermore, the Corporation on occasion has also
retained the credit risk on certain securitizations of its own loans into MBSs
through FHLMC or FNMA.
The Corporation's general policy is to lend up to 80% of the
independently appraised value of the property securing a first mortgage loan
(referred to as the "loan-to-value ratio"). The Corporation will occasionally
lend in excess of an 80% loan-to-value ratio on a first mortgage loan, but will
generally require the borrower to obtain private mortgage insurance on the
portion of the loan that exceeds 80%. The Corporation receives commission
revenue from the independent insurance providers that sell such policies to the
Corporation's loan customers. Beginning in 2001, premium revenue on the sale of
such policies is also received through a wholly-owned, second-tier subsidiary of
the Bank. This revenue is received in exchange for the subsidiary's reinsurance
of a portion of the mortgage impairment risk. Refer to "Subsidiaries", below,
for additional discussion.
In 2001, the Corporation began to offer loan programs to qualifying
borrowers with good credit standing which will enable them to obtain a second
mortgage loan from the Corporation in conjunction with their first mortgage
loan. Under these programs, the combined principal balance of the loans will not
exceed 100% of the property's value and the Corporation will waive the
requirement for private mortgage insurance.
The Corporation also originates loans to individuals to construct
single-family residences. Such loans accounted for approximately 3% of the
Corporation's gross loans as of December 31, 2002. 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. This
risk has not had any adverse effect on the Corporation to date, although no
assurances can be made with respect to future periods.
In addition to servicing the loans in its own portfolio, the
Corporation continues to service most of the loans that it sells to third-party
investors (commonly referred to as "loans serviced for others"). Servicing
mortgage loans, whether for its own portfolio or for others, includes such
functions as collecting monthly principal and interest payments from borrowers,
maintaining escrow accounts for real estate taxes and insurance, and making such
payments on behalf of borrowers when they are due. When necessary, servicing of
mortgage loans also includes functions related to the collection of delinquent
principal and interest payments, loan foreclosure proceedings, and disposition
of foreclosed real estate.
When the Corporation services loans for others, it is compensated for
these services through the retention of a servicing fee from borrowers' monthly
payments. The Corporation pays the third-party investors an agreed-upon yield on
the loans, which is generally less than the interest agreed to be paid by the
borrowers. The difference, typically 25 basis points or more, is retained by the
Corporation and recognized as servicing fee income over the lives of the loans,
net of amortization of capitalized mortgage servicing rights. The Corporation
also receives fees and interest income from ancillary sources such as
delinquency charges and float on escrow and other funds. The
5
Corporation also purchases mortgage servicing rights from third parties for
which it retains an agreed-upon fee from borrowers' monthly payments, as
previously described. The Corporation performs substantially the same services
for these loans as it does on its own originations.
Management believes that servicing mortgage loans for third parties
provides a natural hedge against other risks inherent in the Corporation's
mortgage banking operations. That is, fluctuations in volumes of mortgage loan
originations and resulting gains on sales of such loans caused by changes in
market interest rates will generally be offset in part by an opposite change in
loan servicing fee income. 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 future prepayment assumptions used to periodically value servicing
rights. 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 a change in future prepayment assumptions
to be recorded in the period in which the change occurs. However, the offsetting
gain on the sale of the new loan, if any, cannot be recorded under GAAP until
the customer actually prepays the old loan and the new loan is sold in the
secondary market. Mortgage servicing rights are particularly susceptible to
unfavorable mark-to-market adjustments during periods of declining interest
rates during which prepayment activity typically accelerates to levels above
that which had been anticipated when the servicing rights were originally
recorded. 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's Discussion and Analysis of Financial Condition and Results of
Operations".
COMMERCIAL REAL ESTATE LENDING Multi-family residential loans and
non-residential real estate loans (together "commercial real estate loans")
accounted for approximately 24% of the Corporation's gross loans as of December
31, 2002. Applications for commercial real estate loans are accepted at the
Corporation's offices in La Crosse, Madison, Appleton, Milwaukee, and Wausau,
Wisconsin, and Rochester, Minnesota. Underwriting and approval of commercial
real estate loans, originated by commissioned loan officers located in such
offices, is performed at the Corporation's main office in La Crosse, as is the
servicing of such loans on an on-going basis. Commercial real estate loans
originated in conjunction with a business banking relationship are underwritten
and approved by authorized personnel in the local market where business banking
products and services are sold (currently La Crosse, Wausau, and Rochester).
Such loans are subject to the general policies and procedures outlined in
"Commercial Business Lending", below. It is the Corporation's general policy to
restrict its 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 Wisconsin, Nebraska, Illinois, Iowa, and Minnesota.
The Corporation's emphasis in commercial real estate lending is on
loans secured by collateral classified as Type A properties, which include
multi-family residential properties, retail shopping establishments, office
buildings, and multi-tenant industrial buildings. To a lesser extent, the
Corporation also makes loans secured by collateral classified as Type B
properties, examples of which include nursing homes, single-tenant industrial
buildings, hotels and motels, and churches. The Corporation's current policy is
to make only a limited amount of loans secured by collateral classified as Type
C properties, examples of which include restaurants, recreation facilities, and
other special purpose facilities.
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
Corporation's commercial real estate loans may be as high as 80%. In addition,
as part of the criteria for underwriting commercial real estate loans, the
Corporation 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 varies depending on the nature of the collateral, but is
always greater than 115%. It is also the Corporation's general policy to obtain
personal guarantees on its commercial real estate loans and, when such
guarantees cannot be obtained, to impose more stringent loan-to-value ratios,
debt coverage ratios, and other underwriting requirements.
6
The Corporation occasionally purchases commercial real estate loans
from third-party financial institutions. In general, such loans are subject to
the same geographic restrictions and underwriting standards as loans originated
directly by the Corporation. The Corporation, however, does not generally
service such loans after their acquisition.
From time-to-time the Corporation originates loans to construct
multi-family residential and non-residential real estate properties. Such loans
accounted for approximately 2% of the Corporation's gross loans as of December
31, 2002. Construction loans are generally considered to involve a higher degree
of risk than mortgage loans on completed properties. The Corporation'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 of construction, and the borrower's ability to advance additional
construction funds if such should become necessary.
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 of the
project. In addition, loans secured by properties located outside of the
Corporation's immediate market area may involve a higher degree of risk. This is
because the Corporation 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 Corporation does not have a material
concentration of commercial real estate loans outside of its immediate market
area.
The Corporation has attempted to minimize the foregoing risks by
adopting what management believes are conservative underwriting guidelines that
impose more stringent loan-to-value ratios, debt coverage ratios, and other
requirements on loans, which are believed to involve higher elements of risk.
The Corporation also requires independent appraisals on all loans, requires
personal guarantees where appropriate, limits the geographic area in which the
Corporation will make construction loans, and limits the types of loans in its
portfolio, as previously described.
CONSUMER LENDING The Corporation offers consumer loans in order to
provide a full range of financial services to its customers. Such loans
accounted for approximately 24% of the Corporation's gross loans as of December
31, 2002. Most of the Corporation's consumer loan portfolio consists of second
mortgage loans and home equity lines of credit, but also includes automobile
loans, recreational vehicle and mobile home loans, deposit account secured
loans, and unsecured lines of credit or signature loans. The Corporation
services all of its own consumer loans.
Applications for consumer loans are taken at most of the Corporation's
banking offices, through its internet banking channel, and over the phone at the
Corporation's headquarters in La Crosse. Applications for automobile loans are
also accepted through relationships established with a limited number of
qualifying automobile dealerships ("indirect automobile lending"). The majority
of consumer loans are underwritten, approved, and serviced on an on-going basis
at the Corporation's headquarters. In the case of indirect automobile lending,
such loans are underwritten and approved by the office that has established the
business banking relationship with the automobile dealership. As of December 31,
2002, indirect lending was only being conducted in Rochester, Minnesota.
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. In addition, various laws,
including bankruptcy and insolvency laws, may limit the amount that may be
recovered from a borrower. 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 may have terms of up to ten years.
7
The Corporation 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 Corporation's efforts to increase the
interest rate sensitivity and shorten the average maturity of its loan
portfolio. Furthermore, the Corporation's net charge-offs on consumer loans as a
percentage of gross loans have not been significant in recent years, despite the
risks inherent in consumer lending.
In conjunction with its consumer lending activities, the Corporation
offers customers credit life and disability insurance products underwritten and
administered by an independent insurance provider. The Corporation receives
commission revenue related to the sales of these products. In addition, a
wholly-owned subsidiary of the Bank receives premium revenue in exchange for the
portion of the insurance risk it has reinsured on these sales. Refer to
"Subsidiaries", below, for additional discussion.
EDUCATION LENDING The Corporation 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. A third party
services the loans for the Corporation after they are originated. Education
loans accounted for approximately 9% of the Corporation's gross loans as of
December 31, 2002.
COMMERCIAL BUSINESS LENDING As of December 31, 2002, commercial
business loans accounted for approximately 3% of the Corporation's gross loans.
These loans may take the form of lines of credit, single payment loans, or term
payment loans, and may be secured or unsecured depending on the creditworthiness
of the borrower. The Corporation operates under a commercial business lending
policy that establishes a number of tenets that guide management in making
commercial lending decisions. Among these tenets are the purpose of the loan,
the source of repayment, and an alternate source of repayment (generally in the
form of collateral or outside guarantee). Applications for commercial business
loans are accepted at the Corporation's offices in La Crosse and Wausau,
Wisconsin, as well as Rochester, Minnesota. Lending relationships with total
related borrowings of less than $1.0 million are underwritten and approved by
authorized personnel in these local markets. Lending relationships between $1.0
million and $2.5 million are approved by an intermediate commercial loan
committee. Lending relationships between $2.5 million and $5.0 million are
approved by the Corporation's senior loan committee. Finally, lending
relationships in excess of $5.0 million are approved by the Corporation's board
of directors. It is the Corporation's general policy to restrict its commercial
business lending to a market area defined as within a 150-mile radius of any
office location where business banking products and services are sold.
Commercial business loans are generally made for business expansion or
ongoing business needs. The purpose of commercial business loans can include the
purchase of equipment or the provision of operating capital for the financing of
accounts receivable and inventory. Commercial business loans are not generally
made for the purpose of acquiring real estate. Rather, such loans are typically
classified as "commercial real estate loans". However, real estate may
occasionally be accepted as incidental collateral on a loan made for another
business purpose. In general, such loans continue to be classified as
"commercial business loans".
Commercial business 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. Credit risk is controlled and monitored
through active asset quality management and the use of lending standards,
thorough review of potential borrowers, and active asset quality administration.
Active asset quality administration, including early problem loan identification
and timely resolution of problems, further ensures appropriate management of
credit risk and minimization of loan losses.
The Corporation occasionally participates in commercial business loans
originated by third-party financial institutions. In general, such loans are
subject to the same geographic restrictions and underwriting standards as loans
originated by the Corporation. The Corporation, however, does not generally
service such loans.
The Corporation believes that the higher yields earned on commercial
business loans compensate for the increased risk associated with such loans and
that commercial business loans are important to the Corporation's efforts to
increase the interest rate sensitivity and shorten the average maturity of its
loan portfolio.
NON-PERFORMING AND OTHER CLASSIFIED ASSETS Loans are generally placed
on non-accrual status and considered "non-performing" when, in the judgment of
management, the probability of collection of principal or
8
interest is deemed to be insufficient to warrant further accrual of interest.
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
Corporation does not record accrued interest on loans 90 or more days past due.
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
Corporation generally institutes foreclosure or other collection proceedings.
Real estate property acquired by the Corporation 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
judgment, such as automobiles and other depreciable assets, are generally
classified as an "other asset". The amount of foreclosed real estate and other
repossessed property has not been material to the Corporation in recent years.
Federal regulations require thrift institutions to classify their
assets on a regular basis. Accordingly, the Corporation has internal policies
and procedures in place to evaluate risk ratings on all loans. In addition, in
connection with examinations of thrift institutions, federal examiners have
authority to classify problem assets as "Substandard", "Doubtful", or "Loss". An
asset is classified as "Substandard" if it is determined to involve a distinct
possibility that the Corporation could sustain some loss if deficiencies
associated with the loan are not 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 the Corporation
to a sufficient degree of risk to warrant adverse classification, but which
possess credit deficiencies or potential weaknesses deserving management's close
attention. If an asset or portion thereof is classified as "Loss", the
Corporation must either establish a specific allowance for the portion of the
asset 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 Corporation's policy
is to establish allowances for estimated losses on specific loans and real
estate when it determines that losses are probable. In addition, the Corporation
maintains a general loss allowance against its loan and real estate portfolios
that is based on its own loss experience, management's ongoing assessment of
current economic conditions, the credit risk inherent in the portfolios, and the
experience of the financial services industry. 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 Corporation believes that the current allowances
established by the Corporation are adequate to cover probable and estimable
losses in the Corporation's loan and real estate portfolios. However, future
adjustments to these allowances may be necessary and the Corporation'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.
INVESTMENT AND MORTGAGE-RELATED SECURITIES
The Corporation periodically invests in collateralized mortgage
obligations ("CMOs") and MBSs (collectively "mortgage-backed and related
securities"). As of December 31, 2002, such investments accounted for
approximately 13% of the Corporation'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 Corporation
represent a participation interest in a pool of single-family residential
mortgage loans and 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 Corporation 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 applicable regulations. The
9
Corporation does not invest in support-, companion-, or residual-type tranches.
Furthermore, the Corporation does not invest in interest-only, principal-only,
inverse-floating-rate CMO tranches, or similar complex securities.
The Corporation also invests in MBSs that are guaranteed by FHLMC,
FNMA, or the Government National Mortgage Association ("GNMA"). In addition, the
Corporation 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 Corporation's assets by virtue of the guarantees that
back them, although the Corporation at times has relinquished such guarantee on
loans 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 Corporation.
In addition to MBSs and CMOs, federally-chartered savings institutions
such as the Bank have authority to invest in various other types of investment
securities, including U.S. and state 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 may also 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 Corporation does not invest in individual securities that exceed
10% of its stockholder's equity. As of December 31, 2002, the Corporation held
no investment securities.
The Corporation classifies its mortgage-backed and related securities
and its other investment securities as either available for sale or 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".
SOURCES OF FUNDS
DEPOSIT LIABILITIES The Corporation'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 Corporation's deposits
are obtained from individuals and businesses located in Wisconsin, northern
Illinois, and south-eastern Minnesota. As of December 31, 2002, deposit
liabilities accounted for approximately 78% of the Corporation's total
liabilities and equity.
In addition to serving as the Corporation'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 Corporation's extensive branch network
also creates opportunities for sales of non-deposit products such as
tax-deferred annuities, mutual funds, and other investment products. In exchange
for these sales, the Corporation receives commission revenue from the
third-party providers of the financial products and/or services.
The principal methods used by the Corporation to attract deposit
accounts include offering a variety of products and services, competitive
interest rates, and convenient office locations and hours. Most of the
Corporation's free-standing banking offices have drive-up facilities and 49 of
the Corporation's banking facilities are located in supermarkets. The
Corporation also owns over 114 ATM machines, most of which are located in the
Corporation's primary markets. Depositors may also obtain a debit card from the
Corporation, which allows them to purchase goods and services directly from
merchants. The same debit card also provides access to the ATM network.
From time-to-time, the Corporation 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 Corporation. At December
31, 2002, the Corporation had $5.3 million in brokered deposits outstanding.
10
FEDERAL HOME LOAN BANK ADVANCES The Corporation obtains advances from
the FHLB secured by certain of its home mortgage loans and mortgage-related
securities, as well as stock in the FHLB, a minimum amount of which the
Corporation is required to own. Such advances may be made pursuant to several
different credit programs, each with its own interest rate and range of maturity
dates. As of December 31, 2002, FHLB advances accounted for approximately 13% of
the Corporation's total liabilities and equity.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase
(commonly referred to as "reverse-repurchase agreements"). In form, these
transactions are an arrangement in which the sale of securities is accompanied
by a simultaneous agreement to repurchase the identical securities (or
substantially the same securities) at a future date. In substance, however,
these arrangements are borrowings secured by high-quality, highly-liquid
securities such as FNMA or FHLMC MBSs. Accordingly, these arrangements are
accounted for as borrowings in the Corporation's financial statements.
Securities sold under repurchase agreements are physically delivered to
the broker-dealers that arrange the transactions. The broker-dealers may sell,
loan, or otherwise dispose of such securities to other parties in the normal
course of their operations. The Corporation is exposed to risk in these types of
transactions in that changes in market prices, economic losses, or other factors
could prevent or delay the counter-parties in the transaction from returning the
securities at the maturity of the agreement. The Corporation limits its exposure
to such risk by utilizing standard industry agreements, limiting transactions to
large, reputable broker-dealers, limiting the amount that can be borrowed from
an individual broker-dealer, and limiting the duration of such agreements
(typically one to six months). There were no securities sold under agreements to
repurchase as of December 31, 2002.
FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS The Corporation has lines
of credit with three financial institutions. These lines, which amount to $60.0
million in the aggregate, permit the overnight purchase of federal funds. The
Corporation also has a standard line of credit with one of these institutions in
the amount of $35.0 million. As of December 31, 2002, there was $17.0 million
outstanding under these lines of credit.
SUBSIDIARIES
The Bank has a number of subsidiaries that engage in certain activities
that management believes are more appropriately conducted by a subsidiary of the
Bank. Following is a brief description of each subsidiary.
FIRST CAP HOLDINGS, INC. The Bank formed a wholly-owned subsidiary in
the State of Nevada in 1993. The subsidiary, First Cap 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, 2002, FCHI was managing $396
million in investments and mortgage-related securities and $306 million in
purchased single-family residential loans for the Bank. FCHI's net income was
$21.7 million, $26.4 million, and $27.7 million during the years ended December
31, 2002, 2001, and 2000, respectively. The Bank's net investment in FCHI as of
December 31, 2002, was $788 million, which was eliminated in consolidation in
accordance with GAAP.
FIRST REINSURANCE, INC. The Bank formed a wholly-owned subsidiary in
the State of Arizona in 1998. 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. 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. FRI's net income
was $153,000, $227,000, and $163,000 during the years ended December 31, 2002,
2001, and 2000, respectively. At December 31, 2002, the Bank's net investment in
FRI was $1.3 million, which was eliminated in consolidation in accordance with
GAAP.
TURTLE CREEK CORPORATION The Bank acquired Turtle Creek Corporation
("Turtle Creek") in 1995 as a result of its acquisition of another financial
institution. Turtle Creek, a Wisconsin corporation, holds a 40% limited
partnership interest in an apartment complex providing housing for
low-to-moderate income and elderly persons. Turtle Creek's aggregate investment
in this project was $51,000 at December 31, 2002. Turtle Creek had net losses of
$23,000, $18,000, and $10,000 during the years ended December 31, 2002, 2001,
and 2000, respectively. The
11
Bank's net investment in Turtle Creek as of December 31, 2002, was $70,000,
which was eliminated in consolidation in accordance with GAAP.
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. The principal asset of FEI is its
investment in FFMR, described in the next paragraph. FEI had net income of
$350,000, $113,000, and $30,000 during the years ended December 31, 2002, 2001,
and 2000, respectively. At December 31, 2002, the Bank's net investment in FEI
was $1.1 million, which was eliminated in consolidation in accordance with GAAP.
FF MORTGAGE REINSURANCE, INC. In December 2000, FEI formed FF Mortgage
Reinsurance, Inc. ("FFMR"), a Vermont corporation. FFMR was formed to reinsure
or "underwrite" a portion of the mortgage impairment insurance policies
purchased by the Bank's loan customers (refer to "Lending
Activities--Residential Lending"). FFMR assumes a second level of risk on these
policies, which is capped at a certain level. Third-party insurers assume the
first level of risk, as well as any risk above the capped amount. A third-party
management company is responsible for performing most of the administrative
functions of the subsidiary on a contract basis. FFMR had net income of $315,000
during the year ended December 31, 2002, and $42,000 in the year ended December
31, 2001, its first year of operations. FEI's net investment in FFMR as of
December 31, 2002, was $1.0 million, which was eliminated in consolidation in
accordance with GAAP.
COMPETITION
The Corporation faces significant competition in attracting deposits
through its branch network. Its most direct competition has historically come
from commercial banks, credit unions, and other savings institutions located in
its market area. In addition, the Corporation faces significant competition from
mutual fund and insurance companies, as well as primary financial markets such
as the stock and bond markets. The Corporation competes for deposits principally
by offering customers a variety of deposit products, competitive prices,
convenient branch locations and operating hours, and other services. The
Corporation does not rely upon any individual group or entity for a material
portion of its deposits.
The Corporation's competition for loans comes principally from mortgage
banking companies, other savings institutions, commercial banks, finance and
insurance companies, and credit unions. The Corporation competes for loan
originations primarily through the interest rates and loan fees it charges, the
efficiency and quality of services it provides borrowers, the variety of its
products, and on referrals from real estate brokers, builders, and business
customers.
REGULATION AND SUPERVISION
References in this section to applicable laws and regulations are brief
summaries only. All such summaries are qualified in their entirety by the
applicable laws and regulations, which you should consult to understand their
details and operation.
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 to certain OTS reporting requirements.
The Corporation is also required to file certain reports and otherwise comply
with the rules and regulations of the Securities and Exchange Commission
("SEC"). 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, continues
to meet certain regulatory requirements, which management believes it did as of
December 31, 2002.
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 to
12
certain 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 are
described in more detail in the following paragraphs.
INSURANCE OF DEPOSITS 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 for each depositor. 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 2003 will be zero, which is
the same as the Bank's 2002 rate.
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
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, 2002, 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 adjusted 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, 2002, the
Bank exceeded all minimum regulatory capital requirements as specified by the
FDIC. For additional discussion, refer to Note 12 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data."
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 its own program to classify its assets 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 OTS regulations, may lose access to FHLB advances and 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, 2002,
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
13
obligations at the beginning of each year or 5% of its outstanding advances from
the FHLB of Chicago. At December 31, 2002, the Bank had a $55.6 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 FHLBs own cost
of funds.
FEDERAL RESERVE SYSTEM Regulation D, as promulgated by the
Federal Reserve Board, requires savings institutions to maintain
non-interest-earning reserves against certain transaction deposit accounts and
other liabilities. At December 31, 2002, the Bank's minimum required reserve
level was $49.6 million and it was in compliance with the regulation.
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 12 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data." The Bank has not paid any dividends in violation of these
regulations.
COMMUNITY REINVESTMENT ACT Under the Community Reinvestment
Act of 1977, as amended (the "CRA"), and 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 2002, was "Outstanding".
TAXATION
FEDERAL TAXATION The Corporation is subject to those rules of federal
income taxation generally applicable to corporations under the Internal Revenue
Code of 1986, as amended (the "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 9 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item, 8, "Financial Statements and Supplemental
Data," for additional discussion. As of December 31, 2002, the Corporation had
no material disputes outstanding with Internal Revenue Service.
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 combined state income tax returns, whereas Wisconsin currently
requires separate returns for each entity in the consolidated group.
FCHI is incorporated in the State of Nevada, which does not currently
impose a corporate income tax. Although the earnings of FCHI are not currently
subject to taxation in the State of Wisconsin, from time-to-time the government
of the State of Wisconsin proposes legislation that would require consolidated
income tax returns for entities headquartered in the state. To date, none of
these legislative proposals have been passed into law. In addition, from
time-to-time the Wisconsin Department of Revenue ("WDR") attempts to impose
consolidated
14
income tax reporting on banking entities in the state that have investment
subsidiaries in Nevada similar to the Corporation, although the Corporation has
never been the target of such efforts by the WDR.
If legislation referred to in the previous paragraph were to ever be
passed into law, or were the WDR to be successful in imposing consolidated
income tax reporting on banking entities within the state, such efforts could
result in the earnings of FCHI 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, 2002, the
Corporation's income tax expense would have been approximately $1.7 million
higher than that which has been reported. This would have reduced diluted and
basic earnings per share by approximately $0.08 per share. At this time,
management of the Corporation is not aware of any legislative proposals that
would result in the filing of a consolidated state income tax return in the
State of Wisconsin. Furthermore, the Corporation is not aware of any successes
on the part of the WDR in imposing combined reporting on any banking entities in
the state. However, there can be no assurances that legislation will not be
introduced and passed into law in the future or that the WDR will not be
successful in imposing combined reporting on the banking industry in the state.
ITEM 2--PROPERTIES
As of December 31, 2002, the Corporation conducted its business from
its corporate offices in La Crosse, Wisconsin, 86 other banking facilities
located throughout Wisconsin, northern Illinois, and south-eastern Minnesota,
and two separate loan production offices, also located in Wisconsin. At such
date, the Corporation owned the building and/or land for 29 of its offices and
leased the building and/or the land for its remaining 60 properties, including
49 located in supermarkets. The Corporation 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".
ITEM 3--LEGAL PROCEEDINGS
The information required herein is included in Note 11 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 A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for vote during the
fourth quarter of 2002.
15
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 14, 2003, the Corporation had 19,707,112 common
shares outstanding (net of 508,821 shares of treasury stock), 1,410 stockholders
of record, 3,103 estimated beneficial stockholders, and 4,513 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 12--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".
16
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 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Total assets $3,025,624 $2,717,710 $2,352,726 $2,084,554 $1,786,504
Investment securities available for sale, at fair
value - 35,462 817 873 -
Mortgage-backed and related securities:
Available for sale, at fair value 366,075 305,980 331,237 252,165 204,109
Held for investment, at cost 30,030 134,010 77,299 103,932 102,500
Loans held for investment, net 2,100,642 1,851,316 1,772,477 1,538,595 1,177,526
Allowance for loan losses 11,658 9,962 8,028 7,624 7,624
Mortgage servicing rights, net 30,171 29,909 23,280 21,728 21,103
Intangible assets 43,818 24,946 11,490 12,463 13,485
Deposit liabilities 2,355,148 2,029,254 1,699,252 1,471,259 1,460,136
FHLB advances and other borrowings 417,613 467,447 490,846 469,580 189,778
Stockholders' equity 205,452 192,398 146,549 127,275 122,685
=====================================================================================================================
SELECTED OPERATING DATA FOR YEAR ENDED DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Interest income $ 161,250 $ 171,533 $ 161,436 $ 130,071 $ 118,668
Interest expense 79,726 108,330 101,896 75,953 71,457
- ---------------------------------------------------------------------------------------------------------------------
Net interest income 81,525 63,202 59,540 54,117 47,211
Provision for loan losses 3,468 1,763 1,009 387 293
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan
losses 78,057 61,438 58,531 53,730 46,918
- ---------------------------------------------------------------------------------------------------------------------
Gain (loss) from sale of investments and other
assets (166) 63 1,386 - 343
Other non-interest income 63,801 49,464 34,247 35,178 31,017
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest income 63,635 49,527 35,633 35,178 31,360
Non-interest expense 87,378 67,119 58,250 54,299 47,597
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense 54,313 43,847 35,914 34,609 30,681
Income tax expense 19,398 15,398 12,770 12,167 11,257
- ---------------------------------------------------------------------------------------------------------------------
Net income $ 34,916 $ 28,448 $ 23,144 $ 22,441 $ 19,424
=====================================================================================================================
SELECTED OTHER DATA AT OR FOR THE YEAR ENDED DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Return on average assets 1.23% 1.14% 1.04% 1.19% 1.19%
Return on average equity 17.56 17.19 17.01 17.63 16.59
Equity to assets at end of period 6.79 7.08 6.23 6.11 6.87
Tangible equity to tangible assets at end of period 5.42 6.22 5.77 5.54 6.16
Average interest rate spread 2.64 2.12 2.34 2.58 2.51
Average net interest margin 3.08 2.70 2.83 3.05 3.07
Ratio of allowance for loan losses to total loans
held for investment at end of period 0.55 0.54 0.45 0.50 0.65
Ratio of non-performing assets to total assets at
end of period 0.30 0.31 0.19 0.10 0.13
Ratio of non-interest income to total revenue (1) 43.84 43.93 37.44 39.40 39.91
Ratio of non-interest expense to average assets 3.08 2.70 2.62 2.88 2.91
Efficiency ratio during period (2) 59.71 58.58 60.88 59.65 60.10
Earnings per share:
Diluted earnings per share $ 1.73 $ 1.51 $ 1.25 $ 1.17 $ 0.98
Basic earnings per share 1.76 1.52 1.26 1.21 1.05
Dividends paid per share 0.51 0.47 0.42 0.34 0.27
Stock price at end of period 19.31 15.70 14.50 14.63 16.38
Book value per share at end of period 10.43 9.52 7.99 6.92 6.68
Tangible book value per share at end of period 8.20 8.29 7.36 6.24 5.95
Banking facilities at end of period 89 78 72 64 61
Full-time equivalent employees at end of period 1,213 1,033 897 831 808
=====================================================================================================================
(1) Total revenue is defined as the sum of net interest income and
non-interest income.
(2) Excludes amortization of intangible assets and gains on sales of investment
securities and other assets.
17
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis in 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".
APPLICATION OF CRITICAL ACCOUNTING POLICIES
CRITICAL JUDGMENTS AND ESTIMATES The Corporation describes all of its
significant accounting policies in Note 1, of the Corporation's Audited
Consolidated Financial Statements, included herein under Item 8. Particular
attention should be paid to two accounting areas that, in management's judgment,
require significant judgments and/or estimates on the part of management because
of the inherent uncertainties surrounding these areas and/or the subjective
nature of the areas. These areas are itemized and referenced as follows.
MORTGAGE SERVICING RIGHTS For a detailed discussion of the
judgments and estimates relating to the initial recording of and ongoing
accounting for mortgage servicing rights, refer to the appropriate section in
Note 1 of the Corporation's Audited Consolidated Financial Statements, included
herein under Item 8. Additional discussion is also available in the "Residential
Lending" section of Part I, Item 1, "Business--Lending Activities". Finally,
information on the impact mortgage servicing rights have had on the
Corporation's financial condition and results of operations for the years ending
December 31, 2002, 2001, and 2000, can be found, below, in the sections entitled
"Financial Condition--Mortgage Servicing Rights" and "Results of
Operations--Non-Interest Income--Mortgage Banking Revenue".
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE For a detailed
discussion of the judgments and estimates relating to allowances for losses on
loans and real estate, refer to the appropriate section in Note 1 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Item 8. Additional discussion is also available in the "Non-Performing and Other
Classified Assets" section and the "Allowances for Losses on Loans and Real
Estate" section of Part I, Item 1, "Business--Lending Activities". Finally,
information on the impact loss allowances have had on the Corporation's
financial condition and results of operations for the years ending December 31,
2002, 2001, and 2000, can be found, below, in the sections entitled "Financial
Condition--Non-Performing Assets" and "Results of Operations--Provisions for
Loan Losses".
NEW ACCOUNTING STANDARDS AND POLICIES During the three-year period
ended December 31, 2002, the Corporation adopted no new accounting standards or
policies that, in management's judgment, had a material impact on its financial
condition or results of operations. However, three new accounting standards were
adopted during the period that were significant to the financial services
industry as a whole. These standards are itemized in the paragraphs that follow.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133,
"ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 133") The
Corporation adopted SFAS 133 in January 2001. For further discussion, refer to
"Loans Held for Sale, Derivative Instruments, and Hedging Activities" in Note 1
of the Corporation's Audited Consolidated Financial Statements, included herein
under Item 8.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 141, "BUSINESS
COMBINATIONS" ("SFAS 141") This new standard requires the purchase method of
accounting for all mergers and acquisitions, except in very limited instances.
The Corporation adopted SFAS 141 in January 2002. This adoption did not have a
material impact on the Corporation because the acquisitions it completed in 2002
and 2001 would have been accounted for using the purchase method regardless of
SFAS 141. Refer to Note 15 of the Corporation's Audited Consolidated Financial
Statements, included herein under Item 8.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 142, "GOODWILL
AND OTHER INTANGIBLE ASSETS" ("SFAS 142") The Corporation adopted SFAS 142 in
January 2002. For further discussion, refer to "Goodwill and Intangible Assets"
in Note 1, as well as Note 6 of the Corporation's Audited Consolidated Financial
Statements, included herein under Item 8.
18
RESULTS OF OPERATIONS
OVERVIEW The Corporation's earnings for the years ended December 31,
2002, 2001, and 2000, were $34.9 million, $28.4 million, and $23.1 million,
respectively. These amounts represented returns on average assets of 1.23%,
1.14%, and 1.04%, respectively, and returns on average equity of 17.56%, 17.19%,
and 17.01%, respectively. Diluted earnings per share during these periods were
$1.73, $1.51, and $1.25, respectively.
The increase in net income from 2001 to 2002 was principally due to
increases in net interest income, mortgage banking revenue, and community
banking revenue. These developments were partially offset by increases in
non-interest expense (particularly compensation and employee benefits),
provision for loan losses, and income tax expense (the latter due to higher
pre-tax earnings).
The increase in net income from 2000 to 2001 was principally due to
increases in mortgage banking revenue, community banking revenue, and net
interest income. These developments were partially offset by increases in
non-interest expense (particularly compensation and employee benefits),
provision for loan losses, and income tax expense (the latter due to higher
pre-tax earnings).
The following paragraphs discuss the aforementioned changes in greater
detail along with other changes in the components of net income during the years
ended December 31, 2002, 2001, and 2000.
NET INTEREST INCOME Net interest income increased by $18.3 million or
almost 30% and $3.7 million or 6.2% during the years ended December 31, 2002 and
2001, respectively. The improvement in both of these periods was partly volume
related as the Corporation's average interest-earning assets grew by $301
million or 12.8% in 2002 and by $241 million or 11.5% in 2001. The principal
source of this growth occurred in the Corporation's consumer, commercial real
estate, and commercial business loan portfolios, as well as overnight
investments. Asset growth in both periods was principally funded by increases in
deposit liabilities and stockholders' equity.
Also contributing to the increase in net interest income during 2002
and 2001 were significant increases 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
110% in 2000 to 112% in 2001 and to 115% in 2002. These improvements were 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 because of increased loan prepayment
activity, which was brought about by a historically low interest rate
environment.
The Corporation's interest rate spread increased from 2.12% in 2001 to
2.64% in 2002. This improvement was primarily the result of declines earlier in
the year in the Corporation's cost of deposits, which for the year exceeded the
decline in yield on the Corporation's earning assets. Despite an overall
improvement in interest rate spread during 2002, the current interest rate
environment has had an adverse impact on the Corporation's interest rate spread
during the latter half of the year. During this time the Corporation's asset
yields declined faster than its funding costs due to high levels of refinance
activity and an increase in liquidity. Management does not expect the
Corporation's interest rate spread to improve substantially in the near term.
However, should market interest rates rise later in 2003, management believes
that asset yields may improve more quickly than increases in its cost of funds,
although there can be no assurances.
The Corporation's interest rate spread declined from 2.34% in 2000 to
2.12% in 2001. This development partially offset the improvement in net interest
income caused by the favorable developments discussed in previous paragraphs.
Beginning in 1999 and continuing into 2000, market interest rates increased
significantly, led generally by short-term interest rates. The yield curve also
flattened substantially, and was even inverted at times during 2000. Although
higher interest rates resulted in an increase in the average yield on the
Corporation's earning assets in 2000, the cost of the Corporation's
interest-bearing liabilities increased by a greater amount, which resulted in an
overall decline in the Corporation's average interest rate spread in that year.
In 2001, market interest rates reversed trend and declined dramatically,
particularly on the short end of the yield curve. However, the Corporation's
interest rate spread did not improve because only a relatively small portion of
its funding sources repriced or matured during the year.
19
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 for the years ended December 31, 2002, 2001,
and 2000.
Dollars in thousands 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
- ----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans $ 789,722 $ 49,673 6.29% $ 817,647 $ 58,799 7.19% $ 769,755 $ 56,637 7.36%
Commercial real estate loans 542,680 41,224 7.60 498,796 39,973 8.01 433,512 34,479 7.95
Consumer loans 439,491 33,476 7.62 355,504 30,530 8.59 306,650 26,202 8.54
Education loans 202,375 10,169 5.02 202,504 14,300 7.06 197,415 17,130 8.68
Commercial business loans 53,247 3,070 5.77 6,459 405 6.27 68 6 8.82
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans 2,027,515 137,611 6.79 1,880,910 144,007 7.66 1,707,400 134,454 7.87
Mortgage-backed and
related securities 399,748 18,470 4.62 378,413 24,060 6.36 360,087 24,516 6.81
Investment securities 2,865 92 3.14 6,482 209 3.15 799 40 5.03
Interest-bearing deposits
with banks 166,482 2,505 1.50 52,111 1,585 3.04 10,530 603 5.73
Other earning assets 48,455 2,571 5.31 26,281 1,672 6.36 24,359 1,822 7.48
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets 2,645,065 161,250 6.10 2,344,197 171,533 7.32 2,103,175 161,436 7.68
Non-interest-earning assets:
Office properties and equipment 33,560 28,652 25,621
Other assets 160,343 116,035 95,178
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $2,838,968 $2,488,884 $2,223,974
==================================================================================================================================
Interest-bearing liabilities:
Regular savings accounts $ 159,953 $ 1,151 0.72% $ 116,809 $ 1,529 1.31% $ 108,965 $ 1,619 1.49%
Checking accounts 118,122 475 0.41 80,221 573 0.71 75,062 571 0.76
Money market accounts 234,044 3,239 1.38 177,128 5,539 3.13 160,950 6,578 4.09
Certificates of deposit 1,346,628 52,218 3.89 1,257,943 75,944 6.04 1,082,318 64,819 5.99
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 1,858,747 57,083 3.07 1,632,101 83,585 5.12 1,427,295 73,588 5.16
FHLB advances 432,325 22,393 5.18 401,954 22,061 5.49 380,328 22,078 5.80
Other borrowings 16,254 249 1.53 51,208 2,685 5.24 101,317 6,230 6.15
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 2,307,327 79,726 3.46 2,085,263 108,330 5.20 1,908,940 101,896 5.34
Non-interest-bearing liabilities:
Non-interest-bearing deposits 300,090 209,986 160,963
Other liabilities 32,680 28,098 18,003
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 2,640,097 2,323,347 2,087,906
Stockholders' equity 198,871 165,537 136,068
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $2,838,968 $2,488,884 $2,223,974
==================================================================================================================================
Net interest income $ 81,525 $ 63,202 $ 59,540
==================================================================================================================================
Interest rate spread 2.64% 2.12% 2.34%
==================================================================================================================================
Net interest income as a
percent of average
earning assets 3.08% 2.70% 2.83%
==================================================================================================================================
Average interest-earning
assets to average
interest-bearing liabilities 114.64% 112.42% 110.18%
==================================================================================================================================
20
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.
2002 COMPARED TO 2001 2001 COMPARED TO 2000
Dollars in thousands (INCREASE(DECREASE) (INCREASE(DECREASE)
- ------------------------------------------------------------------------------------------------------------------------------
RATE/ RATE/
RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
- ------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans ($ 7,369) ($ 2,008) $ 251 ($ 9,126) ($ 1,283) $ 3,524 ($ 80) $ 2,161
Commercial real estate loans (2,088) 3,523 (178) 1,251 260 5,193 39 5,492
Consumer loans (3,452) 7,213 (815) 2,946 133 4,174 21 4,328
Education loans (4,125) (9) 3 (4,131) (3,187) 442 (83) (2,828)
Commercial business loans (33) 2,934 (236) 2,665 (2) 564 (163) 399
- ------------------------------------------------------------------------------------------------------------------------------
Total loans (17,067) 11,653 (982) (6,396) (4,079) 13,897 (266) 9,553
Mortgage-backed and related securities (6,576) 1,356 (370) (5,590) (1,621) 1,248 (83) (456)
Investment securities -- (116) (1) (117) (14) 286 (103) 169
Interest-bearing deposits with banks (800) 3,478 (1,758) 920 (283) 2,382 (1,117) 981
Other earning assets (279) 1,410 (232) 899 (273) 144 (21) (150)
- ------------------------------------------------------------------------------------------------------------------------------
Total net change in income on
interest-earning assets (24,722) 17,781 (3,342) (10,283) (6,270) 17,957 (1,591) 10,096
- ------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing deposits (31,173) 7,969 (3,298) (26,502) (1,250) 11,331 (84) 9,997
FHLB advances (1,241) 1,667 (94) 332 (1,204) 1,255 (68) (17)
Other borrowings (1,899) (1,833) 1,296 (2,436) (918) (3,081) 453 (3,544)
- ------------------------------------------------------------------------------------------------------------------------------
Total net change in expense on
interest-bearing liabilities (34,313) 7,803 (2,094) (28,604) (3,372) 9,505 301 6,434
- ------------------------------------------------------------------------------------------------------------------------------
Net change in net interest income $ 9,591 $ 9,978 ($ 1,246) $ 18,323 ($ 2,898) $ 8,452 ($ 1,892) $ 3,662
==============================================================================================================================
PROVISION FOR LOAN LOSSES Provision for loan losses was $3.5 million,
$1.8 million, and $1.0 million during the years ended December 31, 2002, 2001,
and 2000, respectively. During 2002 and 2001, the Corporation recorded
approximately $1.7 million and $672,000, respectively, in provision for loan
losses over-and-above its actual net charge-off activity. These additional
provisions were recorded to maintain the Corporation's allowance for loan losses
at a level deemed appropriate by management, and were considered proper in light
of significant growth in the Corporation's loans held for investment in recent
periods, an increased mix of higher-risk consumer loans, commercial real estate
loans, and commercial business loans, and an increase in non-performing and
classified assets. In addition, in December 2002, $550,000 in specific loss
provisions were established on three business loan relationships following
management's review of the loans. In all three cases, all or a portion of the
loans were past due and/or legal action had commenced to collect that which was
owed. Management of the Corporation deemed these loss provisions prudent after
consideration of factors such as the absence of current financial information,
deteriorating operating results, declines in the valuation of associated
collateral, and/or weakening economic conditions. Management does not expect to
incur additional losses on this group of loans at this time, although there can
be no assurances.
As of December 31, 2002, 2001, and 2000, the Corporation's allowance
for loan losses was $11.7 million, $10.0 million, and $8.0 million,
respectively, or 0.55%, 0.54%, and 0.45% of loans held for investment,
respectively. The allowance for loan losses was 217%, 176%, and 256% of
non-performing loans as of the same dates, respectively. For additional
discussion, refer to "Financial Condition--Non-Performing Assets".
21
The following table summarizes the activity in the Corporation's
allowance for loan losses during each of years indicated. The purchased
allowances shown for 2001 were from the acquisition of ACB in October 2001.
Dollars in thousands 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 9,962 $8,028 $7,624 $7,624 $7,638
Provision for losses 3,468 1,763 1,009 387 293
- -------------------------------------------------------------------------------------------------------------------
Charge-offs:
Single-family mortgage loans 49 96 - - -
Consumer loans 1,759 1,057 632 408 332
Education loans 31 36 33 26 33
Commercial business loans 6 - - - -
- -------------------------------------------------------------------------------------------------------------------
Total loans charged-off 1,845 1,189 665 434 365
Recoveries 73 98 60 47 58
- -------------------------------------------------------------------------------------------------------------------
Charge-offs net of recoveries 1,772 1,091 605 387 307
Purchased allowances - 1,262 - - -
- -------------------------------------------------------------------------------------------------------------------
Balance at end of period $11,658 $9,962 $8,028 $7,624 $7,624
===================================================================================================================
Net charge-offs as a percentage of average loans outstanding 0.09% 0.06% 0.04% 0.03% 0.03%
===================================================================================================================
Ratio of allowance to total loans held for investment at end of period 0.55% 0.54% 0.45% 0.50% 0.65%
===================================================================================================================
Ratio of allowance to total non-performing loans 217% 176% 256% 724% 686%
===================================================================================================================
Note: there were no charge-offs of commercial real estate loans during the five
years ended December 31, 2002.
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 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------------------------------
Single-family mortgage loans $ 1,159 0.16% $ 140 0.02% $ 149 0.02% $ 144 0.02% $ 156 0.04%
Commercial real estate loans 5,669 1.12 7,665 1.50 7,257 1.65 7,088 2.00 7,017 2.43
Consumer loans 1,138 0.23 873 0.25 585 0.17 355 0.13 414 0.19
Commercial business loans 3,692 5.13 1,284 3.31 37 18.97 37 12.50 37 9.97
- ----------------------------------------------------------------------------------------------------------------
Total allowance for loan losses $11,658 0.55% $9,962 0.54% $8,028 0.45% $7,624 0.50% $7,624 0.65%
================================================================================================================
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.
There was no allowance for loan losses allocated to education loans as of
December 31 for any of the years presented.
Although management believes that the Corporation's present level of
allowance for loan losses is adequate, there can be no assurance that future
adjustments to the allowance will not be necessary, which could adversely affect
the Corporation's results of operations.
NON-INTEREST INCOME Non-interest income for the years ended December
31, 2002, 2001, and 2000, was $63.6 million, $49.5 million, and $35.6 million,
respectively. These amounts represented 44%, 44%, and 37% of the Corporation's
total revenue during such periods, respectively. The following paragraphs
discuss the principal components of non-interest income and the primary reasons
for their changes from 2001 to 2002 and 2000 to 2001.
22
COMMUNITY BANKING REVENUE Community banking revenue increased
by $4.6 million or 15.8% in 2002 and by $3.8 million or 15.3% in 2001. The
following table shows the Corporation's community banking revenue for the
twelve-month periods ended December 31.
Dollars in thousands 2002 2001 2000
- -------------------------------------------------------------------------------------------
Overdraft fees $16,411 $14,132 $12,644
ATM and debit card fees 9,837 7,916 6,564
Account service charges 2,205 1,863 1,730
Other fee income 1,464 1,299 1,523
- -------------------------------------------------------------------------------------------
Total deposit account revenue 29,917 25,210 22,461
- -------------------------------------------------------------------------------------------
Consumer loan insurance premiums and commissions 1,021 1,061 1,072
Other consumer loan fees 350 320 101
- -------------------------------------------------------------------------------------------
Total consumer loan revenue 1,371 1,381 1,173
- -------------------------------------------------------------------------------------------
Investment services revenue 2,310 2,420 1,537
- -------------------------------------------------------------------------------------------
Total community banking revenue $33,598 $29,011 $25,171
===========================================================================================
Overdraft fees increased by $2.3 million or 16.1% in 2002 and
by $1.5 million or 11.8% in 2001. These increases were due in part to growth of
12.1% and 12.8% in the number of checking accounts serviced by the Corporation
during 2002 and 2001, respectively. Also contributing to the growth in community
banking revenue was a $1.9 million or almost 25% increase and a $1.4 million or
over 20% increase in fees from customers' use of debit cards and ATMs in 2002
and 2001, respectively.
Consumer loan revenue declined by $10,000 or less than 1% in
2002 and increased by $208,000 or 17.7% in 2001. The Corporation's principal
sources of consumer loan revenue consist of sales of credit life and disability
insurance policies to consumer loan customers. In 2002, increased premium and
commission revenue associated with increased originations was substantially
offset by increased losses on insurance claims. The Bank's wholly-owned
reinsurance subsidiary, FRI, assumes the first level of risk on these credit
life and disability policies. Refer to Part I, Item 1, "Business--Subsidiaries"
for additional discussion.
Investment services revenue declined by $110,000 or 4.5% in
2002 and increased by $883,000 or 57% in 2001. The Corporation's principal
sources of investment services revenue consist of commissions from sales of
tax-deferred annuities, mutual funds, and other debt and equity securities.
Investment services revenue declined in 2002 in response to general declines in
market interest rates that made tax-deferred annuities less attractive to the
Corporation's customers. In addition, general declines in equity markets caused
by a declining economy and investor concerns over corporate governance issues
and geopolitical risks resulted in lower commissions from sales of mutual funds
and other equity investments. Investment services revenue increased in 2001
because of higher sales of tax-deferred annuities in that period. Also
contributing was an increase in commissions from sales of mutual funds and other
equity investments caused by an increase in the number of registered investment
representatives in the Corporation's offices.
MORTGAGE BANKING REVENUE Mortgage banking revenue increased by
$9.2 million or 50% in 2002 and by $11.0 million or over 150% in 2001. The
following table shows the Corporation's mortgage banking revenue for the periods
ended December 31.
Dollars in thousands 2002 2001 2000
- --------------------------------------------------------------------------------------------
Gross servicing fees $ 9,532 $ 8,374 $ 7,481
Mortgage servicing rights amortization (25,274) (15,971) (3,607)
Mortgage servicing rights valuation (loss) recovery (750) 67 -
- --------------------------------------------------------------------------------------------
Total loan servicing fees, net (16,492) (7,530) 3,874
- --------------------------------------------------------------------------------------------
Gain on sale of mortgage loans 42,208 24,373 2,540
Other mortgage-related income 1,758 1,421 851
- --------------------------------------------------------------------------------------------
Total mortgage banking revenue $ 27,474 $ 18,264 $ 7,265
============================================================================================
Gross servicing fees increased by $1.2 million or 13.8% in
2002 and by $893,000 or 11.9% in 2001. These increases were due primarily to
$505 million or 22.0% and a $345 million or 17.7% in growth in average loans
serviced for others in 2002 and 2001, respectively, compared to year-ago
periods. The growth in both periods was caused by a significant increase in the
origination and sale of fixed-rate mortgage loans, as described in a later
paragraph. Also contributing were increased conversions by borrowers of
adjustable-rate mortgage loans into fixed-rate loans. Upon conversion, such
loans are generally sold in the secondary market and the Corporation
23
retains the servicing. Finally, in 2001 the Corporation purchased mortgage
servicing rights ("MSRs") related to $89.4 million in mortgage loans. Such loans
consisted principally of fixed-rate, residential mortgage loans on properties
located in Iowa.
Amortization of mortgage servicing rights was $25.3 million,
$16.0 million, and $3.6 million in 2002, 2001, and 2000, respectively. With
market interest rates at historically low levels in 2001 and 2002, loan
prepayment activity increased dramatically as borrowers refinanced older,
higher-rate residential mortgage loans, into lower-rate loans. As a result of
this activity, the Corporation recorded significantly more amortization of
mortgage servicing rights in 2002 and 2001 than it did in the year-ago periods.
Management expects that interest rates will remain at
historically low levels in the near future. If this trend continues, the
Corporation will most likely continue to experience high levels of amortization
on its MSRs as a result of high levels of loan prepayment activity. Such
amortization, however, will most likely be offset by high levels of gains on
sales of mortgage loans, although there can be no assurances. It should be
noted, however, that declines in market interest rates may also expose the
Corporation to unfavorable mark-to-market adjustments against its portfolio of
MSRs--primarily because of 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.
As of December 31, 2002, the Corporation had recorded $3.4 million in
unfavorable mark-to-market adjustments against its mortgage servicing rights, of
which $750,000 was recorded through earnings in 2002. If interest rates
increase, management expects that future prepayment expectations will decline.
If such occurs, the Corporation may be required to recapture through earnings
some or all of the mark-to-market adjustment on its MSRs.
At December 31, 2002 and 2001, loans serviced for others were
$3.0 billion and $2.7 billion, respectively. As of the same dates, mortgage
servicing rights were $30.2 million and $29.9 million, respectively. For
additional discussion, relating to mortgage servicing rights, refer to Part I,
Item 1, "Business--Lending Activities", and Notes 1 and 4 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
Gains on sales of mortgage loans for the years ended December
31, 2002, 2001, and 2000, were $42.2 million, $24.4 million, and $2.5 million,
respectively. The increase in 2002 was primarily attributable to a $467 million
or 34% increase in the Corporation's mortgage loan sales in 2002. This increase
was due to a historically low interest rate environment that resulted in
increased originations of fixed-rate mortgage loans, as well as increased
conversions of adjustable-rate loans into fixed-rate loans, both of which were
generally sold in the secondary market. The increase in gains on sales of
mortgage loans in 2001 was primarily attributable to a $1.2 billion or over 820%
increase in the Corporation's mortgage loan sales in 2001. This improvement was
also caused by a lower interest rate environment relative to the previous year.
Also contributing to the increase in gains on sales of
mortgage loans in 2002 and 2001 was an increase in the average gain on
individual sales of such loans. In 2002, the average gain was 2.30% compared to
1.76% in 2001 and 1.69% in 2000. These increases were caused by a wider spread
between the mortgage rates charged to borrowers by the Corporation and the yield
demanded by investors in the secondary market. Contributing to a lesser degree
was improved management of the Corporation's mortgage loan pipeline.
In recent months, market interest rates have remained at the
historically low levels reached in the fourth quarter of 2002. Although there
can be no assurances, management expects this trend to continue in the near
future. As such, management expects the Corporation's gains on sales of mortgage
loans to remain high by historical standards albeit lower than levels obtained
in the fourth quarter of 2002. These gains, however, may be offset to some
degree by increased amortization of MSRs and/or unfavorable mark-to-market
adjustments on MSRs, as more fully described in a previous paragraph.
Other mortgage-related income was $1.8 million, $1.4 million,
and $851,000 for the years ended December 31, 2002, 2001, and 2000,
respectively. The increases in 2002 and 2001 were due in part to increases in
24
fees from customers' conversions of adjustable-rate mortgage loans into
fixed-rate mortgage loans due to the low interest rate environment, as
previously described. Also contributing were increases in fees received on loans
originated as agent for the Wisconsin State Veterans Administration and the
Wisconsin Housing and Economic Development Authority.
GAIN (LOSS) ON SALES OF INVESTMENTS AND OTHER ASSETS Gain
(loss) on sales of investments and other assets was ($166,000), $63,000, and
$1.4 million for the years ended December 31, 2002, 2001, and 2000,
respectively. The loss in 2002 was due to the sale of $35.5 million in callable
securities issued by various agencies of the U.S. government. Despite the loss
on the sale, the holding period return on these securities was comparable to a
money market yield, which was the Corporation's minimum expectation when it
purchased the securities. The gain in 2000 was caused by the sale of a piece of
real estate the Corporation acquired in the 1980s, having originally intended to
build a retail office at the location.
The recognition of gains or losses from sales of mortgage
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 NON-INTEREST INCOME Other non-interest income increased
by $540,000 or 25% in 2002 and by $378,000 or 20% in 2001. The increases in 2002
and 2001 were due in part to increases in the cash surrender value of the
Corporation's bank owned life insurance policies. Also contributing to the
increase in 2002 was the receipt of a special dividend related to the
Corporation's ownership in its primary ATM network provider.
NON-INTEREST EXPENSE Non-interest expense for the years ended December
31, 2002, 2001, and 2000, was $87.4 million, $67.1 million, and $58.3 million,
respectively. Non-interest expense as a percent of average assets during these
periods was 3.08%, 2.70%, and 2.62%, respectively. The following paragraphs
discuss the principal components of non-interest expense and the primary reasons
for their changes from 2001 to 2002 and 2000 to 2001.
COMPENSATION AND EMPLOYEE BENEFITS Compensation and employee
benefits increased by $12.8 million or over 30% in 2002 and $4.9 million or
13.9% in 2001. In general, the increase in both periods was due to normal annual
merit increases, as well as growth in the number of banking facilities operated
by the Corporation and the resulting increase in the number of employees. Since
December 31, 2000, the Corporation has increased the number of its banking
facilities from 72 to 89. In October 2001, the Corporation obtained two
locations as a result of its acquisition of ACB in Wausau, Wisconsin, and in
April 2002 the Corporation completed the purchase of three banking locations
from another financial institution in Rochester, Minnesota. Finally, in
September 2002, the Corporation acquired four banking facilities in
south-eastern Minnesota from another financial institution. As of December 31,
2002, the Corporation had 1,213 full-time equivalent employees. This compared to
1,033 and 897 as of December 31, 2001 and 2000, respectively.
Also contributing to the increase in compensation and employee
benefits in 2002 were increased costs as a result of the payment of higher
commissions to mortgage loan originators, as well as increased salaries to
employees hired to support the roll out of the Corporation's business banking
product line. The Corporation intends to expand its offering of business banking
products in up to four new markets in 2003, although there can be no assurances.
Compensation and employee benefits in both years was also impacted by an
increase in the cost of employee healthcare benefits. Such costs rose by
$547,000 or 18.0% in 2002 and by $229,000 or 8.2% in 2001.
Management recently completed a review of the Corporation's
pension plan established for the benefit of its full-time employees. As a result
of the review, an additional minimum pension obligation of approximately $1.5
million was recorded in the fourth quarter of 2002. This adjustment did not
impact the Corporation's results of operations, as the amount, net of income
taxes, was recorded as an offset to stockholders' equity as required by GAAP. As
a result of certain amendments to the pension plan and changes in assumptions
implemented in conjunction with the review, management believes that the
Corporation's pension expense will be
25
substantially higher in 2003. Pension expense for 2003 is expected to
approximate $1.6 million compared to $734,000 in 2002. Management expects to
reduce the assumption for the expected return on plan assets to 8.50% in 2003.
This compares to 9.00% in 2002.
OCCUPANCY AND EQUIPMENT Occupancy and equipment expense
increased by $2.0 million or 22.9% in 2002 and $894,000 or 11.4% in 2001. These
increases were primarily attributable to growth in the number of banking
facilities operated by the Corporation, as well as increases in the number of
full-time equivalent employees and in the number of customers served by the
Corporation.
COMMUNICATIONS, POSTAGE, AND OFFICE SUPPLIES Communications,
postage, and office supplies expense increased by $1.2 million or 21.9% in 2002
and $951,000 or 22.1% in 2001. These increases were also attributable to growth
in the number of banking facilities operated by the Corporation, 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 ATM and debit card
transaction costs increased by $763,000 or 23.5% in 2002 and $314,000 or 10.7%
in 2001. 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
in the number of ATMs operated by the Corporation. During 2002, the Corporation
increased to 114 the number of ATMs it owns and operates in its market areas, as
compared to 101 at the end of 2001.
ADVERTISING AND MARKETING Advertising and marketing costs
increased by $710,000 or over 25% in 2002 and $211,000 or 8.9% in 2001. These
increases correspond to general increases in prices for marketing-related
products and services, as well as increases in the number of communities and/or
market areas served by the Corporation.
AMORTIZATION OF INTANGIBLES Amortization of intangible assets,
which in 2002 consists primarily of deposit-based intangibles, decreased by
$387,000 or over 35% in 2002. This decrease was caused by the Corporation's
adoption of SFAS 142 in January 2002 (for more information, refer to Note 6 of
the Corporation's Audited Consolidated Financial Statements, included herein
under Part II, Item 8, "Financial Statements and Supplementary Data").
Amortization of intangible assets increased by $57,000 or 5.6% in 2001, due to
deposit-based intangibles acquired in the acquisition of ACB in October 2001.
OTHER NON-INTEREST EXPENSE Other non-interest expenses
increased by $3.2 million or more than 50% in 2002, and by $1.5 million or over
30% in 2001. The increase in 2002 was caused by a variety of factors, the most
significant of which was increased costs related to servicing of loans for FNMA
and FHLB, which increased by $1.2 million or over 115%. Under the terms of its
servicing agreements with these investors, the Corporation is required to
forward a full month's interest to the investors when certain loans are repaid,
regardless of the actual date of the loan payoff. Lower interest rates in 2002
resulted in higher prepayment and refinance activity, which increased the amount
of "loan pay-off interest" remitted to FNMA and FHLB. Also contributing to the
increase between 2002 and 2001 were merger-related costs associated with the ACB
and Rochester transactions, and the establishment of a $416,000 loss allowance
for items in the process of collection from customers. With regard to the latter
development, the provision was considered prudent by management of the
Corporation in light of increases in customer overdrafts and fraudulent
transactions. The increase in other non-interest expense in 2001 was caused by
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 and FHLB. These factors and the reasons
for their cause were substantially the same as those described for 2002.
INCOME TAX EXPENSE Income tax expense for the years ended December 31,
2002, 2001, and 2000, was $19.4 million, $15.4 million, and $12.8 million,
respectively, or 35.7%, 35.1%, and 35.6% of pretax income, respectively. The
increase in the Corporation's effective income tax rate during 2002 was due to a
higher mix of taxable earnings in the State of Wisconsin relative to the State
of Nevada, where the Corporation has established a wholly-owned investment
subsidiary and which has no corporate state income tax. The decline in the
Corporation's effective income tax rate during 2001 was due in part to the
purchase of bank owned life insurance policies. Refer to Part I, Item 1,
"Business--Subsidiaries" and "Business--Taxation", for additional discussion
relating to the Corporation's tax situation.
26
SEGMENT INFORMATION The following paragraphs contain a discussion of
the financial performance of each of the Corporation's reportable segments
(hereafter referred to as "profit centers") for the years ended December 31,
2002, 2001, and 2000. This section of the report should be read in conjunction
with Note 14 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
The following table summarizes the after-tax profits (losses) of the
Corporation's profit centers during each of the years ended December 31, 2002,
2001, and 2000.
PROFIT (LOSS) BY PROFIT CENTER 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Mortgage banking $11,679,493 $ 5,192,458 $ 3,630,010
Residential loans 7,757,952 6,953,652 8,364,834
Commercial real estate lending 9,839,007 5,344,423 4,505,490
Consumer lending 6,362,992 4,039,371 3,758,533
Education lending 2,090,320 2,978,899 3,925,613
Investment and mortgage-related securities 390,063 1,138,434 1,823,019
Other segments (587,058) (145,142) (448,015)
- -------------------------------------------------------------------------------------------------
Subtotal 37,532,766 25,502,095 25,559,484
Non-GAAP adjustments (2,617,224) 2,946,129 (2,415,608)
- -------------------------------------------------------------------------------------------------
Net income $34,915,542 $28,448,225 $23,143,876
=================================================================================================
MORTGAGE BANKING Profits from the Corporation's mortgage
banking activities were $11.7 million in 2002 compared to $5.2 million in 2001
and $3.6 million in 2000. Loan origination volumes and loan servicing fees are
the principal drivers of performance in this profit center. The Corporation's
mortgage banking operation originated $2.2 billion, $1.5 billion, and $524
million in single-family residential loans in the years ended December 31, 2002,
2001, and 2000, respectively. This improvement resulted in a similar increase in
the internal origination fees allocated to the mortgage banking profit center.
In 2002 and 2001, higher proportions of the Corporation's loan
originations were the result of increases in refinance activity. In such
environments, a substantial portion of the internal revenue allocated to the
mortgage banking profit center for loan originations is offset by an increase in
internal charges for lost servicing value. This methodology for measuring
results in the mortgage banking profit center recognizes that during periods of
high refinance activity the Corporation incurs significant costs related to the
preservation of existing mortgage customer relationships, rather than the
creation of new customer relationships. As a result, periods of high refinance
activity generally result in less earnings growth in the mortgage banking profit
center relative to growth in loan origination volumes. However, during 2002, a
substantial improvement in the average gain on sale of mortgage loans offset
increases in internal charges for lost servicing value. The improvement in
average gain was principally the result of wider spreads in the secondary market
and, to a lesser degree, improved management of the mortgage loan pipeline.
RESIDENTIAL LOANS Profits from the Corporation's residential
loan portfolio increased by $804,000 or 11.6% in 2002 compared to 2001. However,
profits decreased by $1.4 million or 16.9% in 2001 compared to 2000. The
improvement in this profit center's earnings in 2002 compared to 2001 occurred
despite a $100 million or 10.5% decline in the average assets assigned to the
profit center. The earnings of this profit center benefited in 2002 from an 84
basis point increase in its interest rate spread. This profit center is funded
by a mix of deposit liabilities and wholesale borrowings. The Corporation's
average cost of interest-bearing liabilities declined by 174 basis points
between 2002 and 2001. In contrast, the yield on the profit center's
single-family residential loans declined by only 90 basis points between the
same periods.
In 2001, the performance of this profit center was impacted by
a higher level of charge-offs of internally-capitalized origination costs
assigned to the loans in the portfolio. This development was the result of
increased prepayment activity in 2001 due to a rapidly declining interest rate
environment. Charge-offs of internally-capitalized origination costs declined by
$632,000 or 19.7% in 2002 compared to 2001 because of a reduction in the size of
the Corporation's originated residential loan portfolio. The decline in
originated residential loan balances was partially offset by purchases of
adjustable rate mortgages during 2002.
COMMERCIAL REAL ESTATE LENDING Profits from commercial real
estate lending were $9.8 million, $5.3 million, and $4.5 million for the years
ended December 31, 2002, 2001, and 2000, respectively. The
27
improvement in 2002 was principally the result of a significant increase in the
profit center's interest rate spread compared to the previous year. This profit
center is primarily funded by deposit liabilities and, to a lesser extent, by
wholesale borrowings. The Corporation's average cost of interest-bearing
liabilities declined by 174 basis points between 2002 and 2001. The yield on
commercial real estate loans, however, declined by only 41 basis points between
these years.
Also contributing to the increase in profits from commercial
real estate lending was a $46.0 million or 8.8% increase in the average assets
assigned to the profit center in 2002 compared to the previous year. Average
assets increased by $67.7 million or 14.8% in 2001 compared to 2000. During
2002, this profit center originated $110 million in commercial real estate loans
compared to $113 and $120 million in 2001 and 2000, respectively. Also
contributing to growth in this profit center were the commercial real estate
loans obtained in the ACB and Rochester banking office acquisitions.
CONSUMER LENDING Profits in the Corporation's consumer lending
profit center increased by $2.3 million or 58% and $281,000 or 7.5% in 2002 and
2001, respectively, as compared to previous years. These improvements were due
in part to a $90.8 million or 24.0% increase and $51.4 million or 15.7% increase
in the profit center's average assets during 2002 and 2001, respectively. The
profit center originated $473 million, $274 million, and $236 million in loans
during 2002, 2001, and 2000, respectively. In addition, the profit center
benefited from the acquisition of $70.7 million in loans in connection with the
purchase of seven banking offices from other financial institutions in 2002.
Similar to commercial real estate loans, this profit center is
principally funded by deposit liabilities and, to a lesser extent, by wholesale
borrowings. The Corporation's average cost of interest-bearing liabilities
declined by 174 basis points between 2002 and 2001. The yield on consumer loans,
however, declined by only 97 basis points between these same periods.
Finally, the performance of this profit center was adversely
impacted by a $608,000 or 56% increase in loan charge-off activity in the 2002.
In 2001, loan charge-off activity was up $497,000 or over 80% compared to 2000.
EDUCATION LENDING Profits from education lending were $2.1
million, $3.0 million, and $3.9 million for the years ending December 31, 2002,
2001, and 2000, respectively. These declines were due in part to decreases in
the profit center's interest rate spread during these years. Education loans
carry a floating rate of interest based on various three-month market indices.
During 2002 and 2001, the average yield on education loans declined more than
the average cost of the funding sources for the profit center, which consist
primarily of money market demand accounts.
Average assets assigned to this profit center were $212
million, $212 million, and $207 million for the years ended December 31, 2002,
2001, and 2000, respectively. This profit center has originated $43.9 million,
$33.7 million, and $33.9 million in loans for the same periods.
INVESTMENT AND MORTGAGE-RELATED SECURITIES Profits from the
Corporation's investment securities portfolio declined by $748,000 or 66% during
2002 compared to 2001. Profits also declined by $685,000 or 38% in 2001 compared
to 2000. These declines were due in part to accelerated prepayments of higher
yielding securities, as well as the buildup of overnight investments in the
profit center during 2002 and 2001. The average assets assigned to the profit
center increased by $264 million or over 80% in 2002 compared to 2001 and by
$61.1 million or 23.1% in 2001 compared to 2000. The impact of the volume
increase was partially offset by a change in investment mix toward more liquid
assets with lower interest rate spreads in 2002 compared to the previous year.
The performance of this profit center in 2002 was adversely impacted by a
$166,000 loss on the sale of certain investment securities, as described
elsewhere in this report.
OTHER SEGMENTS This profit center consists of the parent
holding company and certain of the Bank's wholly-owned subsidiaries. In
addition, in 2002 and 2001 this profit center contains the preliminary results
of the Corporation's new line of business--commercial banking. The financial
results of this profit center have not been reported separately in 2002 due to
continuing efforts to develop the departmental allocations of costs and revenues
necessary to fairly present the operating results of this line of business.
28
NON-GAAP ADJUSTMENTS Non-GAAP adjustments were ($2.6) million,
$2.9 million, and ($2.4) million for the years ended December 31, 2002, 2001,
and 2000, respectively. Non-GAAP adjustments decreased by $5.6 million in 2002
compared to the previous year due in part to an increase in residential loan
production, which increased the internally-, generated origination fees recorded
in the mortgage banking profit center. This more than offset an increase in
charge-offs of internally-generated mortgage loan servicing rights that
continued because of further declines in interest rates during 2002. Also
contributing to the decrease in non-GAAP adjustments was the fact that the
internal adjustment related to loan losses was larger than the prior year.
Non-GAAP adjustments increased by $5.4 million in 2001
compared to 2000 due primarily to the fact that a large portion of efforts of
the mortgage banking profit center in 2001 were devoted to the refinance of
existing loans rather than the origination of new loans. As such, the
Corporation recorded significantly higher levels of internal charge-offs related
to its mortgage servicing operation. In addition, the residential loan profit
center experienced a substantially higher level of charge-offs related to
internally-capitalized origination costs.
NET COST TO ACQUIRE AND MAINTAIN DEPOSIT LIABILITIES In
addition to the after-tax performance of the aforementioned profit centers,
management of the Corporation closely monitors the net cost to acquire and
maintain deposit liabilities. The Corporation's profit centers are allocated a
share of the net cost to acquire and maintain deposit liabilities according to
their proportionate use of such deposits as a funding source. As such, changes
in the net cost to acquire and maintain deposit liabilities will impact most of
the Corporation's profit centers.
The net cost to acquire and maintain deposit liabilities was
1.33%, 1.20%, and 1.15% of average deposit liabilities outstanding during the
years ended December 31, 2002, 2001, and 2000 respectively. The increase in net
cost between these periods was the result of a larger increase in the
Corporation's net costs of operating its branch network than its average deposit
liabilities. As discussed elsewhere in this report, the Corporation has incurred
significant costs in recent years to expand its branch network, as well as its
product offerings.
29
FINANCIAL CONDITION
OVERVIEW The Corporation's total assets increased by $308 million or
11.3% during the twelve months ended December 31, 2002. This increase was due in
part to the acquisition of three banking offices from another financial
institution in April and the acquisition of four supermarket banking offices
from another financial institution in September (for additional discussion,
refer to Note 15 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data"). Also contributing were increases in loans held for investment, overnight
investments, and FHLB stock. These increases were funded by increases in deposit
liabilities, as well as repayments and/or sales of mortgage-related securities
and investment securities.
INTEREST-BEARING DEPOSITS WITH BANKS Interest-bearing deposits with
banks, which consist of overnight investments at the FHLB and short-term money
market accounts, increased by $81.5 million from $98.2 million at December 31,
2001, to $180 million at December 31, 2002. The large amount of overnight
investments at December 31, 2002, was caused by the temporary investment of
proceeds from loan sales, as well as increased cash flows from repayments on
mortgage-related securities and purchased loans. These investments will be used
to pay down funding sources as they mature or will be reinvested in other
interest-earning assets.
INVESTMENT SECURITIES The Corporation's investment securities decreased
from $35.5 million at December 31, 2001, to zero at December 31, 2002. In
January 2002, the Corporation sold $35.5 million in callable securities issued
by various agencies of the U.S. government. Despite as accounting loss of
approximately $166,000 on the sale, the holding period return on these
securities was comparable to a money market yield, which was the Corporation's
minimum expectation when it purchased the securities.
MORTGAGE-BACKED AND RELATED SECURITIES The Corporation's aggregate
investment in its mortgage-backed and related securities portfolio decreased by
$43.9 million or 10.0% during the twelve months ended December 31, 2002. During
this period, principal repayments in the portfolio offset the purchase of $349
million in short- and medium-term, fixed-rate collateralized mortgage
obligations ("CMOs"), as well as $15.0 million in floating-rate CMOs. Principal
repayments on mortgage-related securities increased substantially during 2002 as
a result of a historically low interest rate environment that encouraged
borrowers to refinance higher-rate mortgage loans into lower-rate loans
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 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
- -------------------------------------------------------------------------------------------------------------------
Available for sale:
Collateralized mortgage obligations $ 321,054 $321,865 $ 221,777 $223,399 $ 120,538 $119,026
Mortgage-backed securities 41,441 44,210 81,011 82,581 207,052 212,211
- -------------------------------------------------------------------------------------------------------------------
Total available for sale 362,495 366,075 302,789 305,980 327,591 331,237
- -------------------------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations 29,130 29,290 132,755 133,666 75,532 74,708
Mortgage-backed securities 900 902 1,255 1,272 1,767 1,749
- -------------------------------------------------------------------------------------------------------------------
Total held for investment: 30,030 30,192 134,010 134,937 77,299 76,457
- -------------------------------------------------------------------------------------------------------------------
Total mortgage-backed and related
securities $ 392,525 $396,267 $ 436,799 $440,917 $ 404,890 $407,694
===================================================================================================================
Weighted-average yield 5.01% 6.06% 7.00%
===================================================================================================================
30
LOANS HELD FOR SALE The Corporation's loans held for sale declined by
$5.9 million or 10.5% during the year ended December 31, 2002. The following
table sets forth the activity in the Corporation's portfolio of loans held for
sale during each of the years indicated.
Dollars in thousands 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 56,109 $ 22,974 $ 6,346 $ 72,002 $ 45,577
Single-family mortgage loans originated for sale(1) 1,713,629 1,252,070 142,985 305,345 818,292
Loans transferred from held for investment(2) 119,631 165,583 23,743 21,283 98,718
Loans transferred to held for investment(3) - - - (43,554) -
Principal balance of loans sold (1,839,132) (1,384,518) (150,100) (348,730) (890,585)
- ---------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 50,237 $ 56,109 $ 22,974 $ 6,346 $ 72,002
=====================================================================================================================
(1) Net of monthly principal payments received from borrowers during the period
held for sale.
(2) Consists of single-family adjustable-rate mortgage loans originated for
investment that converted to fixed-rate loans. The Corporation generally
sells such loans in the secondary market.
(3) Consists of fixed-rate mortgage loans transferred to loans held for
investment at the lower of cost or market to maintain growth in the
Corporation's earning assets.
LOANS HELD FOR INVESTMENT The Corporation's loans held for investment
increased by $249 million or 13.5% during the twelve months ended December 31,
2002. Most of this increase was the result of the Corporation's purchase of $297
million in single-family residential loans from third-party financial
institutions. During 2001 and continuing into 2002, the interest rate
environment 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 low interest rates tend 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 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 in the most recent
period. Single-family residential loans purchased by the Corporation are
subjected to substantially the same underwriting process as the Corporation's
own loans. The servicing of these loans is retained by the sellers, for which
the Corporation pays a fee of approximately 38 basis points on the unpaid
principal balance. The loans are generally located throughout the U.S., with no
single state making up more than 30 to 40% of the overall principal. The loans
have adjustable-rates that reset annually at an average margin of approximately
275 basis points above the one-year U.S. Treasury bill. Most of the loans have
fixed interest rates for terms of five years before their first adjustment date.
FCHI, the Bank's wholly-owned investment subsidiary in Nevada, purchased the
loans.
Also contributing to the increase in the Corporation's loans held for
investment were the loans acquired in connection with the acquisitions described
in Note 15 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
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. However, there are many considerations involved in such decisions and
there can be no assurances that the Corporation will elect to continue any of
these strategies to increase its interest-earning assets.
31
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 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------------------------------------------------
Real estate loans:
Single-family mortgage loans $ 734,407 35% $ 669,867 36% $ 719,671 40% $ 652,883 42% $ 426,603 36%
Multi-family residential loans 254,294 12 252,312 14 236,003 13 186,591 12 148,060 13
Non-residential real estate loan 250,224 12 257,043 14 203,842 11 168,453 11 141,046 12
Construction loans (1) 97,263 5 83,537 4 77,216 4 80,563 5 63,035 5
- ----------------------------------------------------------------------------------------------------------------------------------
Total real estate loans 1,336,188 64 1,262,759 68 1,236,732 70 1,088,490 70 778,744 66
- ----------------------------------------------------------------------------------------------------------------------------------
Consumer loans:
Second mortgage and home
equity loans 345,810 16 249,501 13 253,866 14 204,806 13 175,541 15
Automobile loans 126,455 6 75,009 4 64,841 4 46,956 3 37,558 3
Other consumer loans (2) 28,615 1 29,949 2 25,262 1 14,239 1 9,006 1
- ----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 500,880 24 354,459 19 343,969 19 266,001 17 222,105 19
- ----------------------------------------------------------------------------------------------------------------------------------
Education loans 194,597 9 201,183 11 197,579 11 190,170 12 182,380 15
Commercial business loans 71,904 3 38,736 2 195 - 296 - 371 -
- ----------------------------------------------------------------------------------------------------------------------------------
Subtotal 2,103,569 100% 1,857,137 100% 1,778,475 100% 1,544,958 100% 1,183,600 100%
Unearned discounts, premiums,
and net deferred loan fees and
costs 8,731 4,141 2,029 1,260 1,549
Allowance for loan losses (11,658) (9,962) (8,028) (7,624) (7,624)
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans held for
investment $2,100,642 $1,851,316 $1,772,477 $1,538,595 $1,177,526
==================================================================================================================================
Weighted average contractual rate 6.45% 7.36% 8.00% 7.58% 7.80%
==================================================================================================================================
(1) At December 31, 2002, construction loans consisted of $63.3 million in
single-family residences, $22.7 million in non-residential real estate and
$11.3 million in multi-family residences.
(2) At December 31, 2002, other consumer loans included $19.2 million of
unsecured loans, $4.9 million of recreational and household good loans, $3.2
million of deposit account-secured loans, and $1.3 million of mobile home
loans.
32
The following table sets forth the activity in the Corporation's
portfolio of loans held for investment during each of the years indicated.
Dollars in thousands 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $1,851,316 $1,772,477 $1,538,595 $1,177,526 $1,193,893
- ---------------------------------------------------------------------------------------------------------------------
Real estate loan originations:
Single-family mortgage loans (1) 411,368 270,071 354,734 293,227 212,964
Commercial real estate loans 110,328 112,715 120,459 112,180 106,146
Decrease (increase) in loans in process (2) (16,304) 9,276 (13,546) (7,086) 1,654
- ---------------------------------------------------------------------------------------------------------------------
Total real estate loans originated 505,392 392,062 461,647 398,321 320,764
- ---------------------------------------------------------------------------------------------------------------------
Consumer loan originations:
Second mortgage and home equity loans 361,580 192,574 160,386 137,459 136,659
Automobile loans 87,770 56,081 52,967 39,635 33,729
Other consumer loans (3) 23,664 24,894 22,490 12,168 6,461
- ---------------------------------------------------------------------------------------------------------------------
Total consumer loans originated 473,014 273,549 235,843 189,262 176,849
- ---------------------------------------------------------------------------------------------------------------------
Education loan originations 43,929 33,705 33,859 29,521 37,692
Commercial business loan originations 33,803 2,278 - - -
- ---------------------------------------------------------------------------------------------------------------------
Total loans originated for investment 1,056,138 701,595 731,350 617,103 535,305
- ---------------------------------------------------------------------------------------------------------------------
Loans purchased for investment:
Single-family residential loans 296,530 178,104 13,051 97,238 165,140
Commercial real estate loans 900 - 8,625 798 -
Consumer loans - - - - 377
Commercial business loans 5,405 - - - -
- ---------------------------------------------------------------------------------------------------------------------
Total loans purchased for investment 302,835 178,104 21,676 98,036 165,517
- ---------------------------------------------------------------------------------------------------------------------
Net loans acquired (4) 115,457 114,287 - - -
Loan principal repayments (1,102,341) (742,074) (356,507) (371,999) (389,935)
Loans transferred to held for sale portfolio (5) (119,631) (165,583) (23,743) (21,283) (98,718)
Education loans sold - (1,334) (4,800) (2,165) -
Loans swapped into mortgage-backed securities - - (132,280) - (222,260)
Loans transferred from held for sale
portfolio (6) - - - 43,554 -
Other changes in loans held for investment (7) (3,131) (6,155) (1,813) (2,178) (6,276)
- ---------------------------------------------------------------------------------------------------------------------
Balance at end of period $2,100,642 $1,851,316 $1,772,477 $1,538,595 $1,177,526
=====================================================================================================================
(1) Excludes loans originated for sale and loans originated on an agency basis
for WHEDA and State VA. The latter amounted to $34.0 million, $22.6 million,
$26.3 million, $30.3 million, and $38.8 million in 2002, 2001, 2000, 1999,
and 1998, respectively.
(2) Consists of changes in loans in process on single-family, multi-family, and
non-residential real estate construction loans.
(3) Consists principally of loans secured by mobile homes, recreational and
household goods, and deposit accounts, as well as unsecured loans.
(4) Consists of $70.7 million in consumer loans, $17.1 million in single-family
residential loan, $14.2 million in commercial real estate loans, and $13.5
million in commercial business loans obtained in connection with the
acquisition of seven banking offices from other financial institutions.
(5) In 2002, consists of single-family adjustable-rate mortgage loans that
converted to fixed-rate and were sold by the Corporation in the secondary
market.
(6) Consists of fixed-rate mortgage loans transferred from loans held for sale
at the lower of cost or market to maintain growth in earning assets.
(7) Consists principally of real estate foreclosures and changes in allowance
for loan losses, discounts, premiums, and deferred fees.
FEDERAL HOME LOAN BANK STOCK The Corporation's FHLB stock increased
$27.6 million during the twelve months ended December 31, 2002. The Corporation
purchased additional shares of FHLB stock as an alternative to overnight
investments.
MORTGAGE SERVICING RIGHTS The Corporation's mortgage servicing rights,
net of valuation allowances, were $30.2 million and $29.9 million as of December
31, 2002, and 2001, respectively. These amounts were 1.02% and 1.13% of the
principal serviced for others, which amounted to $3.0 billion and $2.7 billion
at December 31, 2002 and 2001, respectively. The valuation allowance for MSR
losses was $3.4 million and $2.6 million at December 31, 2002 and 2001,
respectively.
INTANGIBLE ASSETS The Corporation's intangible assets increased by
$18.9 million or over 75% during the twelve months ended December 31, 2002. This
increase was the result of deposit-based intangibles and goodwill created in the
acquisitions of banking offices. For additional discussion, refer to Note 6 and
15 of the Corporation's Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data".
DEPOSIT LIABILITIES The Corporation's deposit liabilities increased by
$326 million or 16.1% during the twelve months ended December 31, 2002.
Management attributes much of this growth to recent volatility in other
33
financial markets, which has made traditional bank financial offerings more
attractive to consumers. Also contributing was aggressive pricing of
certificates of deposit by the Corporation in its market areas. The
Corporation's deposit liabilities were also impacted by a $34.0 million or over
30% increase in custodial deposit accounts during 2002. The Corporation
maintains borrowers' principal and interest payments in such accounts on a
temporary basis pending their remittance to the third-party owners of the loans.
Balances in these accounts increased substantially in 2002 due to significant
increases in loan prepayment activity. Also contributing to the increase in the
Corporation's deposit liabilities was the assumption of $154 million of deposit
liabilities in connection with the acquisition of seven banking offices from two
other financial institutions. For additional discussion, refer to Note 15 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data").
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 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
- -------------------------------------------------------------------------------------------------------------------
Regular savings accounts $ 159,724 0.25% $ 141,548 1.11% $ 103,662 1.49%
Interest-bearing checking accounts 138,650 0.54 101,679 0.63 80,594 0.85
Non-interest bearing checking accounts 356,357 - 285,591 - 161,602 -
Money market accounts 241,114 0.90 214,604 1.80 154,399 4.22
Variable-rate IRA accounts 4,120 0.51 4,017 1.88 2,827 3.94
Certificates of deposit 1,455,183 3.74 1,281,814 5.19 1,196,168 6.45
- ----------------------------------------------------------------------------------------------------------------
Total $2,355,148 2.45% $2,029,254 3.58% $1,699,252 5.06%
================================================================================================================
At December 31, 2002, certificates of deposit in denominations of
$100,000 or more amounted to $195 million and mature as follows: $31.8 million
within three months, $34.0 million over three through six months, $87.3 million
over six through 12 months, $18.0 million over 12 through 24 months, and $24.2
million over 24 months. At December 31, 2002, certificates of deposits issued
through third-party broker-dealers amounted to $5.3 million, all of which was
scheduled to mature within six months.
FHLB ADVANCES AND ALL OTHER BORROWINGS The Corporation's FHLB advances
and other borrowings decreased by $49.8 million or 10.7% during the year ended
December 31, 2002. During 2002, the Corporation did not incur any new borrowings
from the FHLB. Rather, $66.8 million in term advances were repaid. Other
borrowings increased by $17.0 million in 2002. These funds were principally used
to purchase treasury stock.
34
The following table presents certain information regarding the
Corporation's short-term borrowings (original maturity of less than one year) at
or for each of the years indicated.
Dollars in thousands 2002 2001 2000
- --------------------------------------------------------------------------------------------------
FHLB advances:
Average balance outstanding (1) $ 2,885 $ 35,006 $ 51,828
Maximum amount outstanding at any month-end during the period 12,500 112,080 201,273
Balance outstanding at end of period
Average interest rate during the period (2) 2.61% 4.50% 6.42%
Weighted-average interest rate at the end of period - 2.61% 6.74%
Securities sold under agreements to repurchase:
Average balance outstanding (1) - $ 36,923 $ 71,154
Maximum amount outstanding at any month-end during the period - 100,000 100,000
Balance outstanding at end of period - - 100,000
Average interest rate during the period (2) - 6.66% 6.45%
Weighted-average interest rate at the end of period - - 6.68%
Federal funds purchased:
Average balance outstanding (1) - $ 10,769 $ 15,385
Maximum amount outstanding at any month-end during the period - 20,000 20,000
Balance outstanding at end of period - - 20,000
Average interest rate during the period (2) - 5.15% 6.72%
Weighted-average interest rate at the end of period - - 6.77%
Total short-term borrowings:
Average balance outstanding (1) $ 2,885 $ 82,698 $138,367
Maximum amount outstanding at any month-end during the period 12,500 191,155 221,273
Balance outstanding at end of period - 12,500 130,545
Average interest rate during the period (2) 2.61% 5.55% 6.47%
Weighted-average interest rate at the end of period - 2.61% 6.70%
==================================================================================================
(1) Calculated using month-end balances.
(2) Calculated using month-end average interest rates.
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 judgment) amounted to $9.1 million or
0.30% of total assets at December 31, 2002, compared to $8.5 million or 0.31% at
December 31, 2001. The increase in non-performing assets in 2002 was due in part
to an overall increase in loans on non-accrual status, particularly consumer
loans. These increases, along with an $884,000 increase in real estate in
judgment and real estate acquired through foreclosure, were principally caused
by a general deterioration in overall economic conditions in 2002. With respect
to real estate in judgment and real estate acquired through foreclosure,
management does not expect to incur significant losses. However, there can be no
assurances.
The following table contains information regarding the Corporation's
non-performing assets as of December 31 for each of the years indicated.
Dollars in thousands 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Non-accrual loans:
Single-family mortgage loans $2,307 $3,078 $2,065 $ 862 $ 770
Commercial real estate loans 77 373 - - -
Consumer loans 2,605 2,040 1,069 191 341
Commercial business loans 376 164 - - -
- --------------------------------------------------------------------------------------------------------------------
Total non-accrual loans 5,365 5,655 3,134 1,053 1,111
Real estate owned and in judgment 3,731 2,847 1,222 1,091 1,264
- --------------------------------------------------------------------------------------------------------------------
Total non-performing assets $9,096 $8,502 $4,356 $2,144 $2,375
====================================================================================================================
Ratio of non-accrual loans to loans held for investment 0.26% 0.31% 0.18% 0.07% 0.09%
====================================================================================================================
Ratio of total non-performing assets to total assets 0.30% 0.31% 0.19% 0.10% 0.13%
====================================================================================================================
Ratio of total allowance for loan and real estate losses
to total non-performing assets 130% 120% 188% 365% 330%
====================================================================================================================
Note: there were no non-performing education loans as of December 31 for any of
the years presented.
In addition to non-performing assets, at December 31, 2002, management
was closely monitoring $22.6 million in assets, which it had classified as
doubtful or substandard. This compares to $10.3 million in such assets at
December 31, 2001. The increase in 2002 was due primarily to the classification
of $8.8 million in commercial
35
business loans during 2002, principally attributable to the ACB and Rochester
acquisitions. Also contributing to the increase in 2002 was the classification
of $4.5 million in commercial real estate as substandard in the fourth quarter.
Although these loans were performing in accordance with their terms, management
of the Corporation deemed their classification prudent after consideration of
factors such as declines in the valuation of associated collateral, reductions
in occupancy rates, and deteriorating economic conditions. Management does not
expect to incur a significant loss on these loans at this time, although there
can be no assurances.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation's primary sources of funds are deposits obtained
through its branch office network, borrowings from the FHLB and other sources,
amortization, maturity, and prepayment of outstanding loans and investments, and
sales of loans and other assets. During 2002, 2001, and 2000, the Corporation
used these sources of funds to fund loan commitments, purchase loans and
mortgage-related securities, and cover maturing liabilities and deposit
withdrawals. At December 31, 2002, the Corporation had $1.1 billion in time
deposits, and $171 million in FHLB advances that were scheduled to mature within
one year. In addition, the Corporation had approved loan commitments and
undisbursed commitments on construction loans outstanding as of the same date.
Management believes that the Corporation has adequate resources to fund all of
these obligations or commitments, that all of these obligations or 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 $397 million in unused borrowing capacity at
the FHLB as of December 31, 2002. The Corporation also had $78 million in unused
lines of credit with other financial institutions as of the same date.
The Corporation's stockholders' equity ratio as of December 31, 2002,
was 6.79% of total assets. The Corporation's long-term objective is to maintain
its stockholders' equity ratio at approximately 7.0%, which is consistent with
the Corporations long-term objectives for return on equity of at least 15% per
year and return on assets of at least 1% per year. The Corporation's equity
ratio is below its target range as of December 31, 2002, primarily as a result
of growth in assets during the year, as well as stock repurchases. The
Corporation expects its equity ratio to return to its target range during the
next 12 to 24 months, although there can be no assurances. The Corporation's
tangible stockholders' equity ratio was 5.42% as of December 31, 2002.
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, 2002, 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 12 of the Corporation's Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data".
The Corporation paid cash dividends of $10.1 million, $8.9 million, and
$7.7 million during the years ended December 31, 2002, 2001, and 2000,
respectively. These amounts equated to dividend payout ratios of 29.1%, 31.2%,
and 33.3% 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, which is consistent with the Corporation's long-term
earnings and asset growth rate objectives of 10% per year. However, the
Corporation's dividend policy and/or dividend payout ratio will be impacted by
considerations such as 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 12
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 28, 2003, the Corporation's Board of Directors approved a
regular quarterly dividend of $0.13 per share payable on March 13, 2003, to
shareholders of record on February 20, 2003.
During 2002, the Corporation repurchased 713,144 shares of its common
stock under its 2000 stock repurchase plan (the "2000 Plan") at a cost of $13.8
million. As of December 31, 2002, 191,116 shares remain to be
36
purchased under the 2000 plan. In April 2002, the Corporation's Board of
Directors extended the 2000 Plan for another twelve months and adopted another
stock repurchase plan (the "2002 Plan") that authorizes the repurchase of up to
1,001,678 shares or approximately 5% of the Corporation's outstanding common
stock. The 2002 Plan has a twelve-month term and authorizes the Corporation to
repurchase shares from time-to-time in open-market transactions as, in the
opinion of management, market conditions warrant. The repurchased shares will be
held as treasury stock and will be available for general corporate purposes. For
additional discussion, refer to Note 12 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
During 2002, the Corporation reissued 201,647 shares of common stock
out of its inventory of treasury stock with a cost basis of approximately $3.6
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.
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
"gaps"). Management has sought to control the Corporation's one- and three-year
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, education, and commercial
business loans, which generally have shorter terms to maturity and/or floating
rates of interest, and investing in 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 adjustable-rate and 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 long-term goal to maintain the
Corporation's one-year gap in a range of +/- 30% and its three-year gap in a
range of +/- 10%, although typically the Corporations' one- and three-year gaps
will be negative. 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 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 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. In addition, the Corporation classifies certain FHLB advances that
are redeemable prior to maturity (at the option of the FHLB) according to their
redemption dates, which are earlier than their maturity dates.
37
The following table summarizes the Corporation's gap as of December 31,
2002.
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 $ 144,351 $ 55,129 $ 53,869 $ 15,706 $ 5,393 $ 274,448
Adjustable 254,979 239,302 414,362 199,199 1,842 1,109,684
Consumer and education loans 373,330 68,396 153,603 62,414 35,127 692,870
Commercial business loans 31,990 15,296 21,477 2,659 16 71,438
Mortgage-backed and related securities 307,925 68,392 12,787 54 25 389,183
Other earning assets 235,389 - - - - 235,389
- -------------------------------------------------------------------------------------------------------------------------
Total $1,347,964 $ 446,515 $ 656,098 $ 280,032 $ 42,403 $ 2,773,012
=========================================================================================================================
Interest-bearing liabilities:
Deposits liabilities:
Regular savings and checking accounts $ 298,367 - - - - $ 298,367
Money market deposit accounts 241,121 - - - - 241,121
Variable-rate IRA accounts 4,120 - - - - 4,120
Time deposits 438,007 $ 653,509 $ 278,906 $ 84,761 - 1,455,183
FHLB advances and other borrowings 272,594 70,004 50,015 25,000 - 417,613
- -------------------------------------------------------------------------------------------------------------------------
Total $1,254,209 $ 723,513 $ 328,921 $ 109,761 - $ 2,416,404
=========================================================================================================================
Excess (deficiency) of earning assets
over interest-bearing liabilities $ 93,755 $ (276,998) $ 327,177 $ 170,271 $ 42,403
=========================================================================================================================
Cumulative excess (deficiency) of
earning assets over interest-bearing
liabilities $ 93,755 $ (183,243) $ 143,934 $ 314,205 $ 356,608
=========================================================================================================================
Cumulative excess (deficiency) of earning
assets over interest-bearing
liabilities as a percent of total
assets 3.10% -6.06% 4.76% 10.38% 11.79%
=========================================================================================================================
Cumulative earning assets as a percentage
of interest-bearing liabilities 107.48% 90.73% 106.24% 113.00% 114.76%
=========================================================================================================================
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 8.93% as of December 31, 2002, which
compares to 5.79% and -3.25% as of December 31, 2001 and 2000, respectively.
The Corporation's one-year gap was -6.06% at December 31, 2002,
compared to -11.63% and -20.65% at December 31, 2001 and 2000, respectively. The
decline in the Corporation's negative one-year gap in 2002 and 2001 was
primarily attributable to an increase in overnight and short-term investments, a
shortening of the weighted-average lives all of the Corporation's
mortgage-related assets due to declining interest rates, and in 2001, an
increase in time deposits and FHLB advances maturing beyond one year.
Certain shortcomings are inherent in using 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. This is especially true for assets
such as mortgage loans that have embedded prepayment options and liabilities
that have early redemption features. Also, 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 due to
changes in borrowers' preferences.
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 same period. Alternatively, material and prolonged decreases in interest
rates may benefit the Corporation's operations.
38
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 MBSs and other commitments of a similar
nature 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 match substantially all of its pipeline
with forward sales. These forward sales generally require delivery within 30 to
60 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 Corporation is required by the OTS to estimate the sensitivity of
its net portfolio value of equity ("NPV") to immediate and sustained changes in
interest rates and to measure such sensitivity on at least a quarterly basis.
NPV 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 Corporation
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 13 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 Corporation generally relies on
estimates of value provided by the OTS. The same is true for certain other
assets such as deposit-based intangibles.
The following table summarizes as of December 31, 2002 and 2001, the
sensitivity of the Corporation's NPV 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 NPV
-------------
Change in Interest Rates 12/31/02 12/31/01
- ------------------------ -------- --------
200 basis point increase $217.4 $229.1
Base scenario 217.6 236.1
100 basis point decline 209.3 225.6
Certain shortcomings are inherent in using NPV 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 Corporation'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 Corporation's
assets, liabilities, and off-balance sheet items are or will be equal to those
presented in the NPV analysis.
39
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2002 and 2001
ASSETS 2002 2001
- -------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 84,482,722 $ 70,756,705
Interest-bearing deposits with banks 179,755,367 98,233,160
Investment securities available for sale, at fair value - 35,461,500
Mortgage-backed and related securities:
Available for sale, at fair value 366,075,106 305,979,912
Held for investment, at cost (fair value of $30,192,176
and $134,937,344, respectively) 30,029,690 134,010,248
Loans held for sale 50,237,199 56,109,442
Loans held for investment, net 2,100,641,557 1,851,316,436
Federal Home Loan Bank stock 55,634,400 28,063,300
Accrued interest receivable, net 17,522,581 19,016,429
Office properties and equipment 35,647,335 30,653,310
Mortgage servicing rights, net 30,171,341 29,908,769
Intangible assets 43,818,386 24,946,280
Other assets 31,608,545 33,254,152
- -------------------------------------------------------------------------------------------------------------------
Total assets $3,025,624,228 $2,717,709,643
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------
Deposit liabilities $2,355,148,292 $2,029,254,047
Federal Home Loan Bank advances 400,600,000 467,415,000
Other borrowings 17,012,682 32,311
Advance payments by borrowers for taxes and insurance 11,906,038 1,640,142
Accrued interest payable 3,119,227 4,063,741
Other liabilities 32,385,986 22,906,699
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 2,820,172,225 2,525,311,940
- -------------------------------------------------------------------------------------------------------------------
Preferred stock, $0.10 par value (5,000,000 shares authorized, none outstanding) - -
Common stock, $0.10 par value (100,000,000 shares authorized, 20,215,933 and
20,200,829 shares issued, respectively) 2,021,593 2,020,083
Additional paid-in capital 46,577,431 46,607,845
Retained earnings 165,628,148 141,717,089
Treasury stock, at cost (511,497 and 0 shares, respectively) (10,178,374) -
Unearned restricted stock (32,083) (87,083)
Accumulated non-owner adjustments to equity, net 1,435,289 2,139,769
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 205,452,003 192,397,703
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $3,025,624,228 $2,717,709,643
===================================================================================================================
Refer to accompanying Notes to Consolidated Financial Statements.
40
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2002, 2001, and 2000
2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Interest on loans $137,611,379 $144,007,080 $134,454,432
Interest on mortgage-backed and related securities 18,470,156 24,060,467 24,516,300
Interest and dividends on investments 5,168,808 3,465,094 2,465,456
- -------------------------------------------------------------------------------------------------------------
Total interest income 161,250,343 171,532,641 161,436,188
- -------------------------------------------------------------------------------------------------------------
Interest on deposit liabilities 57,082,939 83,584,616 73,587,725
Interest on FHLB advances and other borrowings 22,642,672 24,745,757 28,308,198
- -------------------------------------------------------------------------------------------------------------
Total interest expense 79,725,611 108,330,373 101,895,922
- -------------------------------------------------------------------------------------------------------------
Net interest income 81,524,732 63,202,268 59,540,266
Provision for loan losses 3,468,063 1,763,391 1,008,780
- -------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 78,056,669 61,438,877 58,531,486
- -------------------------------------------------------------------------------------------------------------
Community banking revenue 33,598,092 29,010,521 25,170,767
Mortgage banking revenue 27,474,147 18,264,355 7,265,026
Gain (loss) on sale of investments and other assets (166,264) 63,190 1,385,591
Other income 2,729,075 2,189,240 1,811,167
- -------------------------------------------------------------------------------------------------------------
Total non-interest income 63,635,051 49,527,306 35,632,550
- -------------------------------------------------------------------------------------------------------------
Compensation and employee benefits 52,985,416 40,152,644 35,246,002
Occupancy and equipment 10,717,300 8,721,140 7,827,333
Communications, postage, and office supplies 6,407,854 5,256,205 4,304,790
ATM and debit card transaction costs 4,005,468 3,241,996 2,927,597
Advertising and marketing 3,298,384 2,588,745 2,377,953
Amortization of intangibles 698,411 1,084,974 1,027,761
Other expenses 9,265,480 6,073,769 4,538,896
- -------------------------------------------------------------------------------------------------------------
Total non-interest expense 87,378,312 67,119,473 58,250,331
- -------------------------------------------------------------------------------------------------------------
Income before income taxes 54,313,408 43,846,710 35,913,705
Income tax expense 19,397,866 15,398,485 12,769,829
- -------------------------------------------------------------------------------------------------------------
Net income $ 34,915,542 $ 28,448,225 $ 23,143,876
=============================================================================================================
PER SHARE INFORMATION 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.73 $ 1.51 $ 1.25
Basic earnings per share 1.76 1.52 1.26
Dividends paid per share 0.51 0.47 0.42
=============================================================================================================
Refer to accompanying Notes to Audited Consolidated Financial Statements.
41
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2002, 2001, and 2000
COMMON
STOCK AND ACCUMULATED
ADDITIONAL UNEARNED NON-OWNER
PAID-IN RETAINED TREASURY RESTRICTED ADJUSTMENTS
CAPITAL EARNINGS STOCK STOCK TO EQUITY TOTAL
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 $ 36,534,227 $ 106,929,097 ($ 14,388,670) ($ 591,183) ($ 1,208,245) $127,275,226
Net income 23,143,876 23,143,876
Securities valuation adjustment,
net of income taxes 3,571,132 3,571,132
------------
Net income and non-owner
adjustments to equity 26,715,008
------------
Dividends paid (7,699,035) (7,699,035)
Exercise of stock options (417,520) 809,879 392,359
Restricted stock award 4,688 160,312 (165,000) -
Purchase of treasury stock (1,708,663) (1,708,663)
Amortization of restricted stock 960,500 614,100 1,574,600
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 36,534,227 122,921,606 (15,127,142) (142,083) 2,362,887 146,549,495
Net income 28,448,225 28,448,225
Securities valuation adjustment,
net of income taxes (214,539) (214,539)
Reclassification adjustment for
gain on securities included
in income, net of income taxes (8,579) (8,579)
------------
Net income and non-owner
adjustments to equity 28,225,107
------------
Common stock issued for
acquisition 12,085,017 16,518,776 28,603,793
Dividends paid (8,866,148) (8,866,148)
Exercise of stock options 8,684 (1,508,794) 1,821,742 321,632
Purchase of treasury stock (3,213,376) (3,213,376)
Amortization of restricted stock 722,200 55,000 777,200
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 48,627,928 141,717,089 - (87,083) 2,139,769 192,397,703
Net income 34,915,542 34,915,542
Securities valuation adjustment,
net of income taxes 79,296 79,296
Reclassification adjustment for
loss on securities included
in income, net of income taxes 108,072 108,072
Additional minimum pension liability,
net of income taxes (891,848) (891,848)
------------
Net income and non-owner
adjustments to equity 34,211,062
------------
Dividends paid (10,145,762) (10,145,762)
Exercise of stock options (28,904) (1,746,936) 3,591,732 1,815,892
Purchase of treasury stock (13,770,106) (13,770,106)
Amortization of restricted stock 888,214 55,000 943,214
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $ 48,599,024 $ 165,628,148 ($ 10,178,374) ($ 32,083) $ 1,435,289 $205,452,003
==================================================================================================================================
Refer to accompanying Notes to Audited Consolidated Financial Statements.
42
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001, and 2000
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 34,915,542 $ 28,448,225 $ 23,143,876
Adjustments to reconcile net income to net cash provided (used) by
operations:
Provision for loan and real estate losses 3,415,158 1,807,782 1,069,996
Increase (decrease) in mortgage servicing rights valuation allowance 750,000 (66,643) -
Net loan costs deferred (3,932,341) (2,740,892) (1,349,652)
Amortization of mortgage servicing rights 25,273,796 15,970,764 3,606,592
Other amortization 6,887,848 2,891,259 2,578,123
Depreciation 3,319,594 2,586,951 2,573,353
Gains on sales of mortgage loans (42,208,187) (24,372,880) (2,539,739)
Loss (gain) on sales of investments and other assets 166,264 (63,190) (1,385,591)
Decrease (increase) in accrued interest receivable 1,901,575 1,610,828 (4,280,167)
Increase (decrease) in accrued interest payable (1,465,034) (1,449,262) 1,531,595
Increase in current and deferred income taxes 1,473,902 3,990,480 351,772
Other accruals and prepaids, net (2,094,992) 435,401 (663,059)
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operations before loan originations and sales 28,403,125 29,048,823 24,637,099
Loans originated for sale (1,713,628,833) (1,252,070,158) (142,985,217)
Sales of loans originated for sale or transferred from held for
investment 1,858,340,739 1,390,901,215 150,876,533
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operations 173,115,031 167,879,880 32,528,415
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Decrease (increase) in interest-bearing deposits with banks (81,522,207) (75,614,559) 4,735,769
Purchases of investment securities - (35,553,880) -
Maturities of investment securities - 100,000 100,000
Sales of investment securities 35,098,150 21,823,808 -
Purchases of mortgage-backed and related securities available for sale (363,914,125) (167,327,646) -
Principal repayments on mortgage-backed and related securities
available for sale 302,304,690 193,046,784 58,228,257
Sales of mortgage-backed and related securities available for sale - 7,408,541 -
Purchases of mortgage-backed and related securities held for
investment - (100,780,023) -
Principal repayments on mortgage-backed and related securities held
for investment 102,986,604 43,826,047 26,567,249
Loans originated for investment (1,056,138,397) (701,594,833) (731,349,977)
Loans purchased for investment (302,834,697) (178,103,908) (21,675,836)
Loan principal repayments 1,102,340,559 742,073,665 356,507,215
Sales of education loans - 1,384,322 4,996,708
Increase in Federal Home Loan Bank stock (27,571,100) (1,671,500) (3,056,800)
Additions to office properties and equipment (7,524,801) (6,388,322) (4,931,478)
Purchase of net assets of other financial institutions (7,914,840) (25,623,980) -
Purchase of bank-owned life insurance - (15,000,000) -
Other, net 1,746,398 (11,529,079) 1,377,132
- -----------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (302,943,766) (309,524,563) (308,501,761)
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in deposit liabilities 172,343,825 202,008,108 227,992,689
Purchased deposit liabilities 25,290,037 - -
Long-term advances from Federal Home Loan Bank - 162,500,000 185,000,000
Repayment of long-term Federal Home Loan Bank advances (54,315,000) (53,245,000) (95,400,000)
Decrease in short-term Federal Home Loan Bank borrowings (12,500,000) (23,045,000) (165,728,000)
Increase (decrease) in securities sold under agreements to repurchase - (100,000,000) 100,000,000
Decrease in federal funds purchased - (20,000,000) -
Increase (decrease) in other borrowings 16,980,371 (2,609,059) (2,605,331)
Increase (decrease) in advance payments by borrowers for taxes and
insurance 10,236,607 529,901 (4,384,104)
Common stock issued for acquisition - 28,603,793 -
Purchase of treasury stock (13,770,106) (3,213,376) (1,708,663)
Dividends paid (10,145,762) (8,866,148) (7,699,035)
Other, net 9,434,780 4,292,350 385,588
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 143,554,752 186,955,569 235,853,144
- -----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and due from banks 13,726,017 45,310,886 (40,120,202)
Cash and due from banks at beginning of period 70,756,705 25,445,819 65,566,021
- -----------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $ 84,482,722 $ 70,756,705 $ 25,445,819
=============================================================================================================================
Supplemental disclosures of cash flow information:
Interest and dividends received on loans and investments $ 163,151,918 $ 173,143,469 $ 157,156,021
Interest paid on deposits and borrowings 81,190,645 109,779,635 100,364,327
Income taxes paid 18,534,887 11,408,441 12,559,751
Income taxes refunded 616,089 1,454 141,693
Transfer of loans from held for investment to held for sale 119,630,789 165,583,373 23,743,254
Mortgage-backed securities swaps - - 132,280,050
=============================================================================================================================
Refer to accompanying Notes to Audited Consolidated Financial Statements.
43
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, south-eastern Minnesota, and northern
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, MORTGAGE-BACKED AND RELATED SECURITIES, AND
STOCK HELD FOR REGULATORY PURPOSES Investment securities and 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. Stock of the FHLB is primarily 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, DERIVATIVE INSTRUMENTS, AND HEDGING ACTIVITIES In
January 2001, the Corporation adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). This standard established new rules for the
recognition and measurement of derivatives and hedging activities and required
all derivatives to be recorded in the Statement of Financial Condition at fair
value. The adoption of this standard did not have a material impact on the
Corporation's financial condition or results of operations.
The Corporation does not use derivative instruments such as futures,
swaps, caps, floors, options, interest- or principal-only strips, or similar
financial instruments to manage its operations. However, the Corporation does
use forward sales of MBSs and other commitments of a similar nature to manage
exposure to market risk in its "pipeline" of single-family residential loans
intended for sale. Forward sales are derivative instruments and are subject to
the rules established by SFAS 133. In addition, commitments to extend credit
that relate to loans the Corporation intends to sell ("interest rate
commitments") are also considered to be derivative instruments under
44
SFAS 133. The Corporation's policy is to offset substantially all of its
exposure to market risk in its pipeline of loans intended for sale against
forward sales.
Single-family residential loans held for sale that are matched against
a forward sale are accounted for using the "fair value hedge method".
Accordingly, the loans and the forward sales are valued on a quarterly basis and
net unrealized gains or losses are recorded in the current period's earnings.
Loans held for sale that are not matched against forward sales are carried at
the lower of aggregate cost or market. Net unrealized losses on these loans, if
any, are recorded in the current period's earnings. In general, the Corporation
does not maintain a material amount of loans held for sale that are not matched
against forward sales. Net unrealized gains or losses associated with the
Corporation's pipeline of single-family loans intended for sale are included in
gain on sale of mortgage loans, which is a component of mortgage banking
revenue.
Interest rate commitments on loans the Corporation intends to sell,
forward sales matched against such commitments, and forward sales that are not
matched against a loan or interest rate commitment are valued on a quarterly
basis. Net unrealized gains or losses associated with such derivative
instruments are recorded in the current period's earnings.
Net unrealized gains or losses associated with the Corporation's
pipeline are included in gain on sale of mortgage loans, which is a component of
mortgage banking revenue. Net unrealized gains and/or loses on the Corporation's
pipeline were not material during any of the periods presented in the
Corporation's Statements of Operations.
SECURITIZATIONS AND SALES OF MORTGAGE LOANS The Corporation sells
substantially all of the fixed-rate single-family mortgage loans it originates,
including adjustable-rate loans that convert to fixed-rate loans. These sales
are accomplished through cash sales to FHLMC, FNMA, FHLB, and other third-party
investors, as well as through securitizations with FHLMC and FNMA. In general,
MBSs received from FHMLC or FNMA in exchange for fixed-rate mortgage loans are
sold immediately in the securities market. The gain or loss associated with
sales of single-family mortgage loans is recorded as a component of mortgage
banking revenue.
Originations and sales of single-family mortgage loans will vary
significantly from period to period depending on customer preferences for
fixed-rate mortgage loans, customer refinance activity, and/or customer
conversions of adjustable-rate loans into fixed-rate loans. Accordingly, the
gain or loss associated with sales of single-family mortgage loans may vary
substantially from period to period. In general, however, fluctuations in gains
or losses on sales of single-family mortgage loans are offset to some degree by
opposite changes in the amortization of mortgage servicing rights, which is also
recorded as a component of mortgage banking revenue (refer to "Mortgage
Servicing Rights", below).
From time-to-time the Corporation also exchanges adjustable-rate
mortgage loans held for investment for FHLMC or FNMA MBSs backed by the same
loans. The resulting MBSs are classified in the Corporation's Statement of
Financial Condition as "mortgage-backed and related securities available for
sale". The Corporation continues to service the loans underlying these
securities after they are exchanged.
Sales or securitizations of mortgage loans through FHLMC and FNMA are
generally done under terms that do not provide for any recourse to the
Corporation by the investor. However, in the case of sales to the FHLB, the
Corporation retains the credit risk on the underlying loans in exchange for a
credit enhancement fee. Furthermore, the Corporation sometimes retains an
exposure to credit risk on loans it securitizes into MBSs through FHLMC or FNMA.
In these instances, the Corporation records a recourse liability to provide for
potential credit losses. Because the loans involved in these transactions are
similar to those in the Corporation's loans held for investment, the review of
the adequacy of the recourse liability is similar to the review of the adequacy
of the allowance for loan losses (refer to "Allowance for Loan Losses", below).
MORTGAGE SERVICING RIGHTS The Corporation continues to service most
single-family mortgage loans it sells to third parties. 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. When necessary, servicing mortgage loans also includes
functions related to the collection of delinquent principal and interest
payments, loan foreclosure proceedings, and disposition of foreclosed real
estate. The Corporation generally earns a servicing fee of 25 basis points or
more on the outstanding loan balance for performing these services as well as
fees and interest income
45
from ancillary sources such as delinquency charges and float. Servicing fee
income is recorded as a component of mortgage banking revenue, net of the
amortization and charges described in the following paragraphs.
The Corporation records originated mortgage servicing rights ("OMSR")
as a component of gain on sale of mortgage loans when the obligation to service
such loans has been retained by the Corporation. The initial value recorded for
OMSR is based on the relative values of the servicing rights and the underlying
loans without the servicing rights. This value approximates the present value of
the servicing fee 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 in proportion to estimated gross servicing revenues, net of estimated
costs of servicing, adjusted for expected prepayments. In addition to this
periodic amortization, the carrying value of OMSR associated with loans that
actually prepay is also charged against servicing fee income as amortization. As
a result of the latter charges, there may be considerable variation in
amortization of OMSR from period to period depending on actual customer
prepayment activity. In general, however, variations in the amortization of
OMSRs will offset to some degree opposite changes in gains or losses on sales of
single-family mortgage loans, as previously described (refer to "Securitizations
and Sales of Mortgage Loans", above).
From time-to-time the Corporation also purchases mortgage servicing
rights ("PMSR") from third-parties. Similar to originated servicing, the
Corporation generally earns a fee of 25 basis points or more for performing
duties similar to those described for its own originations. PMSR is recorded at
cost and is amortized in a manner similar to that described for OMSR. The
Corporation purchases or originates mortgage servicing rights on single-family
residential mortgage loans only.
The carrying value of OMSR and PMSR as recorded in the Corporation's
Consolidated Statement of Financial Condition (collectively "mortgage servicing
rights" or "MSRs") is subject to impairment because of changes in loan
prepayment expectations and in market discount rates used to value the future
cash flows associated with such assets. In valuing MSRs, the Corporation
stratifies the loans by investor and by the type of remittance program sponsored
by the investor, if applicable. If, based on a periodic evaluation, the
estimated fair value of the MSRs related to a particular stratum is determined
to be less than its carrying value, a valuation allowance is recorded against
such stratum and against the Corporation's loan servicing fee income, which is
included as a component of mortgage banking revenue. A valuation allowance is
not recorded if the estimated fair value of a stratum exceeds its carrying
value. Because of this inconsistent treatment, the Corporation may be required
to maintain a valuation allowance against MSRs even though the estimated fair
value of the Corporation's total MSR portfolio exceeds its carrying value in
total. In addition, the Corporation may be required to maintain a valuation
allowance even though it is unlikely to actually incur an economic loss in
future periods because valuation allowances resulting from increases in
prepayment expectations are likely to be offset by additional OMSR gains in
future periods. The valuation allowance is calculated using the current
outstanding principal balance of the related loans, long-term prepayment
assumptions as provided by independent sources, a market-based discount rate,
and other management assumptions related to future costs to service the loans,
as well as ancillary sources of income.
ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is composed of
specific and general valuation allowances. The Corporation establishes specific
valuation allowances on loans it considers to be impaired and if loss is
considered probable. A loan is considered impaired when the carrying amount of
the loan exceeds the present value of the expected future cash flows, discounted
at the loan's original effective interest rate, or the fair value of the
underlying collateral. A specific valuation allowance is established for an
amount equal to the impairment. General valuation allowances are based on an
evaluation of the various risk components that are inherent in the credit
portfolio. The risk components that are evaluated include past loan loss
experience; the level of non-performing and classified assets; current economic
conditions; volume, growth, and composition of the loan portfolio; adverse
situations that may affect borrowers' ability to repay; the estimated value of
any underlying collateral; peer group comparisons; regulatory guidance; and
other relevant factors.
The allowance is increased by provisions charged to earnings and
reduced by charge-offs, net of recoveries. The Corporation's Board of Directors
reviews the adequacy of the allowance for loan losses on a quarterly basis. The
allowance reflects management's best estimate of the amount necessary to provide
for the impairment of loans, as well as other credit risks of the Corporation.
The allowance is based on a risk model developed and implemented by management
and approved by the Corporation's Board of Directors.
46
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, less estimated costs to sell. 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.
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.
GOODWILL AND INTANGIBLE ASSETS From time-to-time the Corporation has
acquired all or a portion of the assets and liabilities of other financial
institutions and has paid or received amounts for such assets and liabilities
that are not equal to their identifiable fair value. Prior to 2002, a portion of
the resulting difference (deposit-based intangible) was amortized to earnings
over the estimated remaining lives of the deposit liabilities acquired in these
transactions. The remaining amount (goodwill) was amortized over 20 years. On
January 1, 2002, the Corporation adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under
SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to annual impairment tests in accordance with
the new statements. Other identifiable intangible assets continue to be
amortized over their useful lives, which include deposit-based intangibles.
In October 2002, the FASB issued Statement of Accounting Standards No.
147, "Acquisitions of Certain Financial Institutions" ("SFAS 147"). Although the
Corporation adopted this statement, such had no impact on its financial
condition or results of operations.
IMPAIRMENT OF LONG-LIVED ASSETS In January 2002, Statement of
Accounting Standards No. 144, "Accounting for the Impairment of Long-Lived
Assets and Long-Lived Assets to be Disposed of" ("SFAS 144") became effective.
Although the Corporation has adopted this standard, such had no impact on its
financial condition or results of operations.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase with
third-party broker-dealers (commonly referred to as "reverse-repurchase
agreements"). These arrangements are treated as a 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.
Securities sold under reverse repurchase agreements are physically
delivered to the broker-dealers that arranged the transactions. The
broker-dealers may have sold, loaned, or otherwise disposed of such securities
to other parties in the normal course of their operations. The Corporation is
exposed to risk in these types of transactions in that changes in market prices,
economic losses, or other factors could prevent or delay the counter-party in
the transaction from returning the securities at the maturity of the agreement.
The Corporation limits its exposure to such risk by utilizing standard industry
agreements, limiting counter-parties to large, reputable broker-dealers,
limiting the amount that can be borrowed from an individual counter-party, and
limiting the duration of such agreements (typically one to six months).
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. Income taxes are
accounted for using the "asset and liability" method. Under this method, a
deferred tax asset or liability is determined based on the enacted tax rates
that will be in effect when the differences between the financial statement
carrying amounts and tax bases of existing assets and liabilities are expected
to be reported in the Corporation's income tax returns. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date of the change. A valuation allowance is provided for
any deferred tax asset for which it
47
is more likely than not that the asset will not be realized. Changes in
valuation allowances are recorded as a component of income.
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
benefit obligation, reduced by the earnings on assets held by the retirement
plan, 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 the fair value of financial instruments disclosed elsewhere in
this report.
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 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 OR FOR INVESTMENT The estimated fair
values of loans held for sale or for investment are 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 the end of the period,
adjusted for management's estimate of differences in liquidity, credit risk,
remaining term to maturity, etc.
The estimated fair value of loans held for sale also includes
an adjustment for the estimated fair value of unfunded interest rate commitments
on loans the Corporation intends to sell, as well as forward commitments to sell
loans. The methods used to value these commitments are described under
"Off-Balance Sheet Financial Instruments", below.
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.
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.
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 their face amount. 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.
48
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.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE, FEDERAL FUNDS
PURCHASED, AND OTHER BORROWINGS These funding sources consist principally of
short-term or variable rate borrowings. As such, the Corporation has estimated
the fair value of these funding sources to approximate carrying value.
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.
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, forward 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.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Indebtedness of Others" (FIN 45). The Corporation does not engage in
the types of transactions covered by FIN 45 to any material degree. Accordingly,
FIN 45 has and will not have a material impact on the Corporation's financial
condition or results of operations.
The fair values of commitments to extend credit are determined
using discounted cash flow techniques, similar to that which is used for loans
held for sale or for investment, as previously described.
The fair values of forward commitments to sell loans are based
on average quoted market prices obtained from independent pricing sources. 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-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 initial contingent award, adjusted retroactively for
any changes in the value of the stock between the initial award date and the
final measurement date. Such value is amortized as expense over the measurement
period of the award.
As permitted by GAAP, the Corporation has not adopted 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 elsewhere in this report on a pro forma basis.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure" ("SFAS 148"). The Corporation is not required to adopt this
statement and does not currently have any intentions of adopting it.
49
EARNINGS PER SHARE Basic and diluted earnings per share data are based
on the weighted-average number of common shares outstanding during each period.
Diluted earnings per share is further adjusted for potential common shares that
were dilutive and outstanding during the period. Potential common shares
generally consist of stock options outstanding under the incentive plans
described elsewhere in this report. The dilutive effect of potential common
shares is computed using the treasury stock method. All stock 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, 2002,
2001, and 2000, is as follows:
2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
DILUTED BASIC DILUTED BASIC DILUTED BASIC
- --------------------------------------------------------------------------------------------------------------------
Net income $34,915,542 $34,915,542 $28,448,225 $28,448,225 $23,143,876 $23,143,876
====================================================================================================================
Average common shares issued, net
of actual treasury shares 19,892,179 19,892,179 18,682,407 18,682,407 18,318,197 18,318,197
Potential common shares issued
under stock options (treasury
stock method) 271,658 - 188,582 - 153,888 -
- --------------------------------------------------------------------------------------------------------------------
Average common shares and
potential common shares 20,163,837 19,892,179 18,870,989 18,682,407 18,472,085 18,318,197
====================================================================================================================
Earnings per share $ 1.73 $ 1.76 $ 1.51 $ 1.52 $ 1.25 $ 1.26
====================================================================================================================
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 Corporation 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 $49.6 million at December 31, 2002.
RECLASSIFICATION Certain 2001 and 2000 balances have been reclassified
to conform with the 2002 presentation.
50
NOTE 2--INVESTMENT SECURITIES AND MORTGAGE-BACKED AND RELATED SECURITIES
Investment securities and mortgage-backed and related securities at
December 31, 2002 and 2001, are summarized as follows:
2002
- -------------------------------------------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------
Available for sale:
Collateralized mortgage obligations $321,054,160 $1,109,312 ($298,506) $321,864,966
Mortgage-backed securities 41,440,735 2,769,405 - 44,210,140
- -------------------------------------------------------------------------------------------------
Total available for sale 362,494,895 3,878,717 (298,506) 366,075,106
- -------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations 29,129,314 188,596 (27,917) 29,289,994
Mortgage-backed securities 900,376 12,952 (11,146) 902,182
- -------------------------------------------------------------------------------------------------
Total held for investment 30,029,690 201,548 (39,063) 30,192,176
- -------------------------------------------------------------------------------------------------
Total investment securities and
mortgage-related securities $392,524,585 $4,080,265 ($337,569) $396,267,282
=================================================================================================
2001
- -------------------------------------------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------
Available for sale:
Investment securities $ 35,360,585 $ 100,915 - $ 35,461,500
Collateralized mortgage obligations 221,777,458 1,919,852 ($298,471) 223,398,839
Mortgage-backed securities 81,011,417 1,593,939 (24,283) 82,581,073
- -------------------------------------------------------------------------------------------------
Total available for sale 338,149,460 3,614,706 (322,754) 341,441,412
- -------------------------------------------------------------------------------------------------
Held for investment:
Collateralized mortgage obligations 132,755,022 1,058,523 (147,711) 133,665,834
Mortgage-backed securities 1,255,226 30,378 (14,094) 1,271,510
- -------------------------------------------------------------------------------------------------
Total held for investment 134,010,248 1,088,901 (161,805) 134,937,344
- -------------------------------------------------------------------------------------------------
Total investment securities and
mortgage-related securities $ 472,159,708 $ 4,703,607 ($484,559) $476,378,756
=================================================================================================
Accrued interest on investment securities was zero and $437,022 at
December 31, 2002 and 2001, respectively. Accrued interest receivable on
mortgage-backed and related securities was $2,085,348 and $2,688,617 at December
31, 2002 and 2001, respectively.
MBSs consist of FHLMC and FNMA securities. As of December 31, 2002, the
Corporation had retained the credit risk on $25.7 million in FHLMC MBSs. CMOs
consist of securities backed by the aforementioned agency-backed securities or
by whole-loans. As of December 31, 2002, approximately 79% of the Corporation's
CMO portfolio consisted of securities backed by whole loans--all of which were
rated triple-A or its equivalent by the major credit-rating agencies.
Approximately 35% 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.
Realized losses on sales of investment securities were $166,264 in
2002. Realized gains on sales of investment securities were $13,199 in 2001.
There were no realized gains or losses on sales of investment securities in
2000. There were no realized gains or losses on sales of mortgage-backed and
related securities during 2002, 2001, and 2000.
51
NOTE 3--LOANS HELD FOR INVESTMENT
Loans held for investment at December 31 are summarized as follows:
2002 2001
- -----------------------------------------------------------------------
First mortgage loans:
Single-family real estate $ 734,407,400 $ 669,866,752
Multi-family real estate 254,294,478 252,311,829
Non-residential real estate 250,223,910 257,042,756
Construction 97,263,177 83,536,806
Consumer loans:
Second mortgage and home equity 345,810,380 249,500,788
Automobile 126,454,963 75,009,273
Other consumer 28,613,347 29,949,607
Education loans 194,597,010 201,183,233
Commercial business loans 71,904,398 38,735,556
- -----------------------------------------------------------------------
Subtotal 2,103,569,063 1,857,136,600
Unearned discount, premiums, and net
deferred loan fees and costs 8,730,580 4,141,413
Allowance for loan losses (11,658,086) (9,961,577)
- -----------------------------------------------------------------------
Total $2,100,641,557 $1,851,316,436
=======================================================================
Accrued interest receivable on loans was $15,305,012 and $15,764,703 at
December 31, 2002 and 2001, respectively.
Loans serviced for investors were $3.0 billion, $2.7 billion, and $2.1
billion at December 31, 2002, 2001, and 2000, respectively. These loans are not
reflected in the Corporation's Consolidated Statements of Financial Condition.
At December 31, 2002, the Corporation had retained the credit risk related to
$2.0 billion in single-family residential loans sold to the FHLB in exchange for
a monthly credit enhancement fee.
At December 31, 2002 and 2001, loans on non-accrual status were $5.4
million and $5.7 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,
Minnesota, and Illinois, as well as contiguous counties in Iowa, 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 originated or
purchased outside of the Corporation's primary market area were $307 million and
$237 million at December 31, 2002 and 2001, respectively.
With respect to multi-family and non-residential 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 all or a
portion of the states of Wisconsin, Nebraska, Illinois, Iowa, and Minnesota,
although in the past the Corporation originated multi-family and non-residential
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. Multi-family and non-residential real
estate loans originated or purchased outside of the Corporation's market area
were $19.9 million and $22.6 million, at December 31, 2002 and 2001,
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.
Furthermore, in the case of second mortgages and home equity loans, the
Corporation does not generally allow the sum of the first and second mortgage
amounts to exceed 100% of the appraised value of the property securing the loan.
Education loans are substantially guaranteed by the U.S. government.
52
With respect to commercial business loans, it is the Corporation's
policy that such loans be supported primarily by the borrower's ability to repay
the loan and/or alternative sources of repayment (generally in the form of
collateral or outside guarantee), and secondarily by the value of the collateral
securing the loan, if any. Applications for commercial business loans are
accepted at the Corporation's offices in La Crosse and Wausau, Wisconsin, as
well as Rochester, Minnesota. It is the Corporation's general policy to restrict
its commercial business lending to a market area defined as within a 150-mile
radius of any office location where business banking products and services are
sold.
A summary of the activity in the allowance for loan losses is as
follows:
2002 2001 2000
- -----------------------------------------------------------------------------------
Balance at beginning of period
Provision charged to expense $ 9,961,577 $ 8,027,526 $7,623,526
3,468,063 1,763,391 1,008,780
- -----------------------------------------------------------------------------------
Loans charged-off (1,844,943) (1,189,383) (664,765)
Recoveries 73,389 98,026 59,985
- -----------------------------------------------------------------------------------
Charge-offs, net (1,771,554) (1,091,357) (604,780)
Purchased allowances - 1,262,017 -
- -----------------------------------------------------------------------------------
Balance at end of period $11,658,086 $ 9,961,577 $8,027,526
===================================================================================
NOTE 4--MORTGAGE SERVICING RIGHTS
A summary of the activity in mortgage servicing rights is as follows:
- ------------------------------------------------------------------------------------------------------------
PURCHASED ORIGINATED VALUATION
MSR MSR ALLOWANCE TOTAL
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 $ 2,228,624 $ 22,166,000 ($2,666,643) $ 21,727,981
Purchased servicing 1,865,307 1,865,307
Originated servicing 3,293,776 3,293,776
Amortization charged to earnings (437,834) (3,168,758) (3,606,592)
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 3,656,097 22,291,018 (2,666,643) 23,280,472
Purchased servicing 1,100,197 1,100,197
Originated servicing 20,183,936 20,183,936
Originated servicing obtained through acquisition 1,248,285 1,248,285
Amortization charged to earnings (1,669,661) (14,301,103) (15,970,764)
Valuation adjustments charged to earnings 66,643 66,643
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 3,086,633 29,422,136 (2,600,000) 29,908,769
Originated servicing 26,286,368 26,286,368
Amortization charged to earnings (1,754,025) (23,519,771) (25,273,796)
Valuation adjustments charged to earnings (750,000) (750,000)
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $ 1,332,608 $ 32,188,733 ($3,350,000) $ 30,171,341
============================================================================================================
As more fully described in Note 1, originated servicing is recorded as
a component of gain on sale of mortgage loans, which is included as a component
of mortgage banking revenue. In addition, amortization and valuation adjustments
charged to earnings are recorded as an offset to servicing fee income, which is
also recorded as a component of mortgage banking revenue.
As noted in the table, above, amortization of MSRs varies considerably
from period to period. The amortization of MSRs is significantly influenced by
the interest rate environment and the impact such has on borrower behavior and
the broader market's expectations for future loan prepayment activity. If the
interest rate environment at December 31, 2002, remains unchanged for the next
five years and/or the market's expectations for future loan prepayment activity
does not change over the same period, management estimates amortization of MSRs
will be $15.6 million, $8.9 million, $4.6 million, $2.2 million, and $1.1
million during the years 2003 to 2007, respectively. Management cautions the
reader that the only thing known for certain with respect to this estimate is
that it is a virtual certainty that it will not transpire because it is a
virtual certainty that interest rates will fluctuate, borrower behavior will
change, and market expectations for future prepayments will vary. The reader is
also cautioned that the disclosure does not include an estimate of amortization
for MSRs originated or purchased after December 31, 2002. As a result of these
shortcomings, management cautions the reader that this disclosure may be of very
limited value.
53
NOTE 5--OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment at December 31 are summarized as
follows:
2002 2001
- -----------------------------------------------------------------------------
Office buildings and improvements $22,699,575 $19,842,841
Furniture and equipment 26,338,144 22,398,647
Leasehold improvements 8,235,992 7,152,627
Land and improvements 4,616,028 4,429,865
Property acquired for expansion 712,330 332,864
Construction in progress 2,262,012 2,963,335
- -----------------------------------------------------------------------------
Subtotal 64,864,081 57,120,179
Less allowances for depreciation and amortization 29,216,746 26,466,869
- -----------------------------------------------------------------------------
Total $35,647,335 $30,653,310
=============================================================================
The Corporation rents office space and land under operating leases at
certain of its locations. These leases have terms expiring between 2003 and 2034
and provide for renewals subject to escalation clauses. Rental expense was
$2,655,420, $2,217,502, and $1,862,905 for the years ended December 31, 2002,
2001, and 2000, respectively.
NOTE 6--INTANGIBLE ASSETS
The Corporation adopted SFAS 142 on January 1, 2002. Under SFAS 142,
goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. Other identifiable
intangible assets continue to be amortized over their useful lives, which
include deposit-based intangibles. If SFAS 142 had been in effect during the
twelve months ended December 31, 2001 and 2000, the Corporation's net income in
such periods would have been higher by approximately $662,000 in each period, or
$0.03 and $0.04 per diluted share, respectively.
The following table provides a summary of the Corporation's goodwill
and other intangible assets as of December 31:
2002 2001
- ------------------------------------------------------------------------------
Goodwill:
Deductible for tax purposes $22,939,311 $ 6,276,631
Not deductible for tax purposes 15,607,127 15,607,127
Deposit-based intangibles:
Deductible for tax purposes 2,876,753 217,174
Not deductible for tax purposes 1,465,617 1,828,517
Other intangibles, deductible for tax purposes 929,578 1,016,830
- ------------------------------------------------------------------------------
Total $43,818,386 $ 24,946,280
==============================================================================
As of December 31, 2002, the weighted-average remaining amortization
period for deposit-based intangibles deductible for tax purposes was
approximately 12 years. It was 14 years for non-deductible deposit-based
intangibles. Amortization for all deposit-based intangibles is expected to be
$666,000 in 2003, $591,000 in 2004, $503,000 in 2005, $441,000 in 2006, and
$390,000 in 2007. As of December 31, 2002, the weighted-average remaining
amortization period for other intangibles was approximately 9 years.
Amortization for other intangibles is expected to be approximately $124,000 per
year in the years 2003 through 2007.
As described in Note 14, the Corporation disregards the impact of
goodwill and other intangible assets in evaluating the performance of its
reportable segments. Consequently, no effort has been made to allocate such
assets to the Corporation's reportable segments. As described in Note 14, the
Corporation accounts for its operations along product lines. However, management
of the Corporation believes it is more appropriate in the banking industry for
goodwill and other intangible assets to continue to be associated with the
specific customer base or market from which such assets arose, as opposed to
particular product lines. Accordingly, the Corporation maintains its accounting
records for goodwill and other intangible assets by market, rather than by
product line. Management of the Corporation believes this approach to be
appropriate, because its annual impairment evaluation for goodwill and other
intangible assets begins with an analysis of its customer, loan, and deposit
bases in a particular market, as well as the wealth of public information that
is available in the banking industry on the value of
54
such franchises. The following table summarizes the Corporation's goodwill and
other intangible assets by market as of December 31:
2002 2001
- ----------------------------------------------------------------------------------------------------------------
DEPOSIT-BASED DEPOSIT-BASED
MARKET GOODWILL INTANGIBLES OTHER GOODWILL INTANGIBLES OTHER
- ----------------------------------------------------------------------------------------------------------------
Wausau, Wisconsin $12,513,602 $ 1,465,617 - $12,513,602 $ 1,828,517 -
Rochester, Minnesota 16,662,680 2,692,857 - - - -
Rockford, Illinois 6,276,630 - - 6,276,630 - -
Beloit/Janesville, Wisconsin 3,093,526 20,327 - 3,093,526 30,503 -
All other markets - 163,569 929,578 - 186,671 1,016,830
- ----------------------------------------------------------------------------------------------------------------
Total $38,546,438 $ 4,342,370 $929,578 $21,883,758 $ 2,045,691 $1,016,830
================================================================================================================
Management has evaluated the Corporation's intangible assets in
accordance with SFAS 142 and has determined that such assets are not impaired at
this time.
NOTE 7--DEPOSIT LIABILITIES
Deposit liabilities at December 31 are summarized as follows:
2002 2001
- -----------------------------------------------------------------------
Checking accounts:
Non-interest-bearing $ 356,357,052 $ 285,591,265
Interest-bearing 138,650,072 101,679,255
Money market accounts 241,113,975 214,604,134
Regular savings accounts 159,723,965 141,547,813
Variable-rate IRA accounts 4,120,419 4,017,132
- -----------------------------------------------------------------------
Total demand deposits 899,965,483 747,439,599
- -----------------------------------------------------------------------
Time deposits maturing within...
Three months 220,091,094 500,198,795
Four to six months 217,916,156 200,025,611
Seven to twelve months 653,508,965 189,677,794
Thirteen to twenty-four months 157,528,782 217,244,381
Twenty-five to thirty-six months 121,376,825 146,742,749
Thirty-seven to forty-eight months 14,508,390 24,149,896
Forty-nine to sixty months 70,252,597 3,775,222
- -----------------------------------------------------------------------
Total time deposits 1,455,182,809 1,281,814,448
- -----------------------------------------------------------------------
Total $2,355,148,292 $2,029,254,047
=======================================================================
Accrued interest payable on deposit liabilities was $1,295,729 and
$2,029,395 at December 31, 2002 and 2001, respectively. Time deposits include
$195 million and $152 million of certificates in denomination of $100,000 or
more at December 31, 2002 and 2001, respectively. Time deposits also include
$5.3 million and $22.3 million in deposits obtained through third-party brokers
at December 31, 2002 and 2001, respectively.
Included in non-interest-bearing checking accounts at December 31, 2002
and 2001, were $139 million and $105 million, respectively, which represented
amounts held in custody for third-party investors in loans serviced by
Corporation.
Interest expense on deposit liabilities for the year ended December 31
is summarized as follows:
2002 2001 2000
- -----------------------------------------------------------------------------------
Checking accounts $ 475,103 $ 573,484 $ 571,473
Money market savings accounts 3,239,148 5,538,599 6,577,913
Regular savings 1,150,568 1,528,534 1,619,063
Time deposits 52,218,120 75,943,999 64,819,276
- -----------------------------------------------------------------------------------
Total $57,082,939 $83,584,616 $73,587,725
===================================================================================
55
NOTE 8--FEDERAL HOME LOAN BANK ADVANCES AND ALL OTHER BORROWINGS
FHLB advances and all other borrowings at December 31 are summarized as
follows:
2002 2001
- --------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED
BALANCE AVERAGE RATE BALANCE AVERAGE RATE
- --------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances maturing in...
2002 - - $ 66,815,000 3.75%
2003 $170,600,000 5.32% 170,600,000 5.32
2004 125,000,000 5.09 125,000,000 5.09
2005 77,500,000 5.58 77,500,000 5.58
2008 27,500,000 4.96 27,500,000 4.96
- --------------------------------------------------------------------------------------------------------------
Total FHLB advances 400,600,000 5.27 467,415,000 5.05
Other borrowings 17,012,682 2.47 32,311 9.00
- --------------------------------------------------------------------------------------------------------------
Total $417,612,682 5.16% $467,447,311 5.05%
==============================================================================================================
Accrued interest payable on FHLB advances and all other borrowings was
$1,823,680 and $2,034,345 at December 31, 2002 and 2001, respectively.
The Corporation's borrowings at the FHLB are limited to the lesser of
35% of total assets or 60% of the book value of certain mortgage. Interest on
the Corporation's open line of credit with the FHLB is paid monthly at
approximately 25 basis points above the federal funds rate. As of December 31,
2002 and 2001, there were no borrowings outstanding under this line of credit.
As of December 31, 2002, $76.3 million, $75.0 million, $52.5 million, and $27.5
million of the advances maturing in the years 2003, 2004, 2005, and 2008,
respectively, consist of borrowings that are redeemable quarterly at the option
of the FHLB.
The Corporation has unsecured lines of credit with three financial
institutions. These lines, which amount to $60.0 million in the aggregate,
permit the overnight purchase of federal funds. There were no amounts
outstanding under these lines as of December 31, 2002. The Corporation also has
an unsecured line of credit with one of these institutions in the amount of
$35.0 million. As of December 31, 2002, there was $17.0 million outstanding
under this unsecured line of credit.
NOTE 9--INCOME TAXES
Federal and state income tax expense for the years ended December 31 is
summarized as follows:
2002 2001 2000
- --------------------------------------------------------------
Current:
Federal $16,147,140 $12,819,735 $12,689,599
State 197,726 128,750 104,230
- --------------------------------------------------------------
Total current 16,344,866 12,948,485 12,793,829
- --------------------------------------------------------------
Deferred:
Federal 1,901,000 2,427,000 (24,000)
State 1,152,000 23,000 -
- --------------------------------------------------------------
Total deferred 3,053,000 2,450,000 (24,000)
- --------------------------------------------------------------
Total $19,397,866 $15,398,485 $12,769,829
==============================================================
56
The significant components of the Corporation's deferred tax expense
for the years ended December 31 are summarized as follows:
2002 2001 2000
- -----------------------------------------------------------------------------------------
Mortgage servicing rights $1,570,734 $3,523,085 $ 200,744
Office properties and equipment depreciation 209,218 118,544 (17,036)
Asset valuation allowances 143,102 (76,492) (43,871)
Deferred loan fees 146,949 68,944 540,898
Provision for loan and real estate losses, net (866,930) (442,792) (183,455)
Deferred compensation (197,379) (669,402) (789,847)
FHLB stock dividends 1,105,635 719,313 783,665
Purchase acquisition adjustments 621,889 (402,148) (46,712)
Other 319,782 (389,052) (468,386)
- -----------------------------------------------------------------------------------------
Total deferred $3,053,000 $2,450,000 $ (24,000)
=========================================================================================
The income tax provision differs from the provision computed at the
federal statutory corporate tax rate for the years ended December 31 as follows:
2002 2001 2000
- --------------------------------------------------------------------------------------------
Income taxes at federal statutory of 35% $19,009,693 $15,346,348 $12,569,797
State income tax net of federal income tax effect 877,322 98,637 67,749
Other (489,149) (46,500) 132,283
- --------------------------------------------------------------------------------------------
Income tax provision $19,397,866 $15,398,485 $12,769,829
============================================================================================
The significant components of the Corporation's deferred tax assets and
liabilities as of December 31, are summarized as follows:
2002 2001
- -----------------------------------------------------------------------------
Deferred tax assets:
Loan and real estate loss allowances $ 4,946,152 $ 4,072,692
Deferred compensation 3,597,615 3,394,793
Asset valuation allowances 241,338 383,825
State tax loss carryforwards, net 1,829,918 2,157,092
Additional minimum pension liability 594,566 -
Other 107,661 262,766
- -----------------------------------------------------------------------------
Total deferred tax assets 11,317,250 10,271,168
Valuation allowance (458,920) (670,868)
- -----------------------------------------------------------------------------
Adjusted deferred tax assets 10,858,330 9,600,300
- ----------------------------------------------------------------------------
Deferred tax liabilities:
Mortgage servicing rights 10,942,816 9,357,079
Securities valuation allowance 1,253,074 1,152,183
Office properties and equipment depreciation 671,206 461,249
Deferred loan fees 1,260,021 1,111,289
FHLB stock dividends 2,910,578 1,802,054
Purchase acquisition adjustments 1,303,485 680,505
Investment in unconsolidated partnerships 62,722 100,749
Other 453,728 366,250
- -----------------------------------------------------------------------------
Total deferred tax liabilities 18,857,630 15,031,358
- -----------------------------------------------------------------------------
Net deferred tax liabilities ($ 7,999,300) ($ 5,431,058)
=============================================================================
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, 2002. 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 tax liability
would have been approximately $8.5 million. At December 31, 2002, the
Corporation had $29.1 million in state net operating loss carryforwards for tax
purposes that expire between 2004 and 2017.
57
NOTE 10--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, 2002 and 2001.
2002 2001
- ----------------------------------------------------------------------------------
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $12,337,045 $10,491,473
Service costs 852,988 681,215
Interest costs 910,252 791,813
Plan amendment (37,305) 50,395
Actuarial loss 1,587,379 602,524
Benefit payments (344,131) (280,375)
- ----------------------------------------------------------------------------------
Benefit obligation at end of year $15,306,228 $12,337,045
==================================================================================
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year: $10,038,249 $10,986,168
Actual return on plan assets (1,216,526) (667,544)
Employer contributions 437,811 -
Benefit payments (344,131) (280,375)
- ----------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 8,915,403 $10,038,249
==================================================================================
Funded status:
Funding shortfall at end of year $ 6,390,825 $ 2,298,796
Additional minimum pension liability 1,486,414 -
Unrecognized prior service cost 7,475 (7,656)
Unrecognized net loss (5,233,056) (1,422,223)
- ----------------------------------------------------------------------------------
Accrued pension expense $ 2,651,658 $868,917
==================================================================================
Components of net periodic benefit cost:
Service costs $ 852,988 $ 681,215
Interest costs 910,252 791,813
Expected return on plan assets (1,006,928) (974,261)
Amortization of prior service costs (22,174) (22,174)
- ----------------------------------------------------------------------------------
Net periodic benefit cost $ 734,138 $ 476,593
==================================================================================
Weighted-average assumptions:
Discount rate 6.75% 7.25%
Expected return on plan assets 9.00% 9.00%
Rate of compensation increase 5.50% 5.50%
==================================================================================
Beginning in 2003, the expected return on plan assets will be reduced
to 8.5%. The additional minimum pension liability of $1,486,414 in 2002 was
recorded through accumulated non-owner adjustments to equity, net of estimated
income taxes of $594,566.
58
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
status, as well as the amounts recognized in the Corporation's consolidated
financial statements for the years ended December 31, 2002 and 2001.
2002 2001
- --------------------------------------------------------------------------------------------------------------------
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $3,013,756 $2,191,915
Service costs 106,399 123,921
Interest costs 202,940 205,598
Actuarial (gain) loss (83,163) 589,450
Benefit payments (81,229) (97,128)
- --------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year $3,158,703 $3,013,756
====================================================================================================================
Funded status:
Funding shortfall at end of year $3,158,703 $3,013,756
Unrecognized transition asset (342,299) (376,529)
Unrecognized net loss (820,449) (923,068)
- --------------------------------------------------------------------------------------------------------------------
Accrued post-retirement benefit expense $1,995,955 $1,714,159
====================================================================================================================
Components of net periodic benefit cost:
Service costs $ 106,399 $ 123,921
Interest costs 202,940 205,598
Amortization of transition obligation 34,230 34,230
Recognized actuarial loss 19,456 28,556
- --------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 363,025 $ 392,305
====================================================================================================================
Weighted-average assumptions:
Discount rate 6.75% 7.25%
Rate of compensation increase 5.50% 5.50%
====================================================================================================================
The assumed rate of increase in the per capita cost of covered benefits
was approximately 6.5% for 2002, declining to approximately 5.5% in 2004 and
thereafter. This assumption has a significant 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, 2002, by
approximately $252,000 and the aggregate service and interest cost components of
postretirement benefit expense for 2002 by approximately $29,000. A one
percentage point decline would decrease these amounts by approximately $222,000,
and $25,000, respectively.
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 $968,000, $790,000, and $551,000 during the years ended December
31, 2002, 2001, and 2000, 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 $657,000, $482,000, and
$373,000 in ESOP-related compensation expense during the years ended December
31, 2002, 2001, and 2000, respectively.
SUPPLEMENTAL PENSION PLAN The Corporation makes annual contributions to
a supplemental pension plan for certain 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 $347,000, $285,000, and
$238,000 in such expense during the years ended December 31, 2002, 2001, and
2000, respectively.
STOCK INCENTIVE PLANS The Corporation has adopted a stock incentive
plan designed to attract and retain qualified personnel in key management
positions. The plan provides for the grant of stock options, restricted stock,
and stock appreciation rights. In general, stock options granted under the plan
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
59
vesting requirements and a maximum exercise period of ten years. The plan
currently authorizes the issuance of approximately 4.5 million shares, of which
614,000 shares were unallocated as of December 31, 2002. Activity in these stock
incentive plans for each of the three years ended December 31, 2002, 2001, and
2000, is summarized as follows:
2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
- ----------------------------------------------------------------------------------------------------------------------------
Stock options outstanding at beginning of period 996,802 $ 12.39 741,770 $ 10.24 734,060 $ 9.34
Stock options granted 68,582 19.59 380,550 14.17 95,000 11.00
Stock options exercised (153,596) 6.89 (107,638) 3.61 (84,290) 3.10
Stock options forfeited (10,500) 15.36 (17,880) 13.80 (3,000) 14.75
- ----------------------------------------------------------------------------------------------------------------------------
Stock options outstanding at end of period 901,288 $ 13.84 996,802 $ 12.39 741,770 $ 10.24
============================================================================================================================
Fully-vested options outstanding at end of period 565,915 $ 13.18 498,420 $ 11.03 569,770 $ 9.59
============================================================================================================================
The following table presents the stock options outstanding as of
December 31, 2002, by range of exercise prices:
WEIGHTED AVG WEIGHTED AVG
STOCK OPTIONS REMAINING EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE
- -----------------------------------------------------------------------------------------------------------------------
$ 0.00 - $5.00 1,234 1.3 years $ 3.58
5.01 - 10.00 57,000 2.6 years 5.54
10.01 - 15.00 753,972 6.9 years 13.92
15.01 - 20.00 46,250 9.0 years 16.91
20.01 - 25.00 42,832 9.3 years 20.55
- -----------------------------------------------------------------------------------------------------------------------
Total Options Outstanding 901,288 6.8 years $ 13.84
=======================================================================================================================
During the years ended December 31, 2002, 2001, and 2000, 46,000,
68,000, and 15,000 shares of restricted stock were granted at weighted-average
fair values of $18.88, $14.50 and $11.00, respectively.
The Corporation has also adopted a stock incentive plan designed to
attract and retain qualified non-employee directors for the Corporation and its
subsidiaries. Under the plan each director receives options to purchase 8,800
shares upon election or re-election to the Board of Directors. In general, 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 1,071,000 shares, of which 380,000 shares
were unallocated as of December 31, 2002. Activity in these stock incentive
plans for each of the three years ended December 31, 2002, 2001, and 2000 is
summarized as follows:
2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
- ----------------------------------------------------------------------------------------------------------------------------
Stock options outstanding at beginning of period 156,396 $ 11.67 138,796 $ 10.42 131,996 $ 9.09
Stock options granted 17,600 19.33 26,400 14.79 26,400 11.75
Stock options exercised (37,400) 13.46 (8,800) 1.36 (19,600) 3.25
- ----------------------------------------------------------------------------------------------------------------------------
Stock options outstanding at end of period 136,596 $ 12.17 156,396 $ 11.67 138,796 $ 10.42
============================================================================================================================
The following table presents the stock options outstanding as of
December 31, 2002, by range of exercise prices:
WEIGHTED AVG WEIGHTED AVG
STOCK OPTIONS REMAINING EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE
- -----------------------------------------------------------------------------------------------------------------------
$ 0.00 - $5.00 17,596 0.8 years $ 4.77
5.01 - 10.00 31,000 3.9 years 8.11
10.01 - 15.00 61,600 7.7 years 13.50
15.01 - 20.00 26,400 7.9 years 18.75
- -----------------------------------------------------------------------------------------------------------------------
Total Options Outstanding 136,596 6.0 years $ 12.17
=======================================================================================================================
60
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 $34.1 million, $27.5 million,
and $22.7 million during the years ended December 31, 2002, 2001, and 2000,
respectively. Pro forma diluted earnings per share would have been $1.69, $1.46,
and $1.23 and pro forma basic earnings per share would have been $1.71, $1.47,
and $1.24 during the same periods, respectively.
The weighted-average fair value of the options granted in 2002, 2001,
and 2000, were $5.86, $4.26, and $3.91, respectively. The fair values of these
options were estimated as of the dates they were granted using a Black-Scholes
option-pricing model. Weighted-average assumptions for 2002 were 3.4% risk-free
interest rate, 2.7% dividend yield, 30% volatility, and a seven-year expected
life. Weighted-average assumptions for 2001 were 4.6% risk-free interest rate,
3.2% dividend yield, 30% volatility, and a seven-year expected life.
Weighted-average assumptions for 2000 were 6.0% risk-free interest rate, 3.0%
dividend yield, 35% volatility, and a seven-year expected life.
NOTE 11--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, 2002, the
Corporation had commitments to originate mortgage loans at market terms
aggregating approximately $179 million, which expire on various dates in 2003.
At December 31, 2002, the Corporation also had commitments to fund $63.0 million
in additional proceeds on construction loans. As of the same date the
Corporation had approximately $6.4 million in commitments outstanding under
standby letters of credit and financial guarantees, $61.9 million in commitments
outstanding under unused home equity lines of credit, and $2.0 million and $17.5
million under commercial real estate lines and commercial business lines of
credit, respectively. Furthermore, the Corporation had commitments to sell
approximately $195 million in mortgage loans to FHLMC, FNMA, and the FHLB at
various dates in 2003.
At December 31, 2002, the Corporation had retained the credit risk
related to $2.0 billion in single-family residential loans sold to the FHLB in
exchange for a monthly credit enhancement fee.
NOTE 12--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, 2002. 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 has
adopted a shareholders' rights plan (the "Rights Plan"). 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
61
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 in 2005.
STOCK REPURCHASE PLANS AND TREASURY STOCK In 2002, 2000, and 1999 the
Corporation's Board of Directors authorized the repurchase of up to 1,001,678,
913,554, and 905,248 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, in the opinion of management,
market conditions warrant. The 1999 Plan was extended for an additional twelve
months in April 2000 and again in April 2001; and the 2000 Plan was extended for
an additional twelve months in April 2001 and again in April 2002. Repurchased
shares are held as treasury stock and are available for general corporate
purposes.
During 2002, 2001, and 2000, the Corporation repurchased 713,144,
228,800, and 143,904 shares under the 2002, 2000, and 1999 Plans at an average
cost of $19.31, $14.04, and $11.87 per share, respectively. As of December 31,
no shares remained under the 1999 Plans, and 1,001,678 shares and 191,116 shares
remained to be purchased under the 2002 and 2000 Plans, respectively.
During 2002, 2001, and 2000 the Corporation reissued 201,647,
1,825,132, and 85,807 shares of common stock out of treasury stock,
respectively. These shares had an average cost basis of $17.81, $10.05, and
$11.31 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. In addition, during 2001, 1,685,126 of these
shares, plus 250,178 previously unissued shares, were issued in connection with
the acquisition of ACB.
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 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, 2002 and 2001, the Bank's regulatory capital was sufficient 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.
62
The following table summarizes the Bank's current regulatory capital in
both percentage and dollar terms as of December 31, 2002 and 2001. 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. As indicated in the table, the Bank is "well capitalized" for
regulatory capital purposes.
MINIMUM REQUIREMENTS
TO BE CLASSIFIED AS...
----------------------
ADEQUATELY WELL
DECEMBER 31, 2002 CAPITALIZED CAPITALIZED ACTUAL
- -------------------------------------------------------------------------------------------------------------------
Tier 1 leverage ratio 4.0% 5.0% 5.63%
Tier 1 risk-based capital ratio 4.0% 6.0% 10.22%
Total risk-based capital ratio 8.0% 10.0% 10.88%
Tier 1 leverage ratio capital $119,667,000 $149,584,000 $168,476,000
Tier 1 risk-based capital 65,908,000 98,862,000 168,476,000
Total risk-based capital 131,816,000 164,770,000 179,254,000
===================================================================================================================
DECEMBER 31, 2001
- -------------------------------------------------------------------------------------------------------------------
Tier 1 leverage ratio 4.0% 5.0% 5.97%
Tier 1 risk-based capital ratio 4.0% 6.0% 10.69%
Total risk-based capital ratio 8.0% 10.0% 11.33%
Tier 1 leverage ratio capital $108,232,000 $135,290,000 $161,526,000
Tier 1 risk-based capital 60,457,000 90,685,000 161,526,000
Total risk-based capital 120,914,000 151,142,000 171,172,000
===================================================================================================================
NOTE 13--FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of financial instruments as of December 31 are as follows:
2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
- --------------------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and due from banks $ 84,482,722 $ 84,482,722 $ 70,756,705 $ 70,756,705
Interest-bearing deposits with banks 179,755,367 179,755,367 98,233,160 98,233,160
Investment securities available for sale - - 35,461,500 35,461,500
Mortgage-backed and related securities:
Available for sale 366,075,106 366,075,106 305,979,912 305,979,912
Held for investment 30,029,690 30,192,176 134,010,248 134,937,344
Loans held for sale 50,237,199 50,300,000 56,109,442 56,109,442
Loans held for investment, gross 2,112,299,643 2,134,400,000 1,861,278,013 1,877,400,000
Federal Home Loan Bank stock 55,634,400 55,634,400 28,063,300 28,063,300
Accrued interest receivable 17,522,581 17,522,581 19,016,429 19,016,429
Mortgage servicing rights 30,171,341 31,500,000 29,908,769 34,600,000
Financial liabilities:
Deposit liabilities $2,355,148,292 $2,381,500,000 $2,029,254,047 $2,044,600,000
Federal Home Loan Bank advances and all other
borrowings 417,612,682 439,400,000 467,447,311 484,500,000
Advance payments by borrowers for taxes and insurance 11,906,038 11,906,038 1,640,142 1,640,142
Accrued interest payable 3,119,227 3,119,227 4,063,741 4,063,741
================================================================================================================================
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 14--SEGMENT INFORMATION
ORGANIZATIONAL STRUCTURE In 2001, the Corporation completed a
reorganization along functional lines rather than product lines. The principal
components of the Corporation's organization now consist of a Community Banking
Group, which has primary responsibility for the sale and delivery of all the
Corporation's products and
63
services, and a Corporate Administration and Operations Group, which has primary
responsibility for product support, data and technology management, and property
management. The Corporation also has a Commercial Real Estate Lending Division,
which is responsible for the origination and servicing of commercial real estate
loans, a Finance and Treasury Division, and a Human Resources Division. Each
group or division is led by an executive officer that reports directly to the
President of the Corporation.
Despite its reorganization along functional rather than product lines,
the Corporation continues to account for its operations along product lines. The
Corporation tracks profitability in five major areas: (i) residential lending,
(ii) commercial real estate lending, (iii) consumer lending, (iv) education
lending, and (v) investment and mortgage-related securities. 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 Corporation for
investment purposes (loans held for sale are included in the mortgage banking
profit center). This profit center also includes MBSs that are collateralized by
loans that were originated by the Corporation. Commercial real estate lending
consists of the Corporation's portfolio of multi-family and non-residential
mortgage loans, as well as functions related to the origination and servicing of
such loans. Consumer lending consists of the Corporation's second mortgage,
automobile, and other consumer installment loans, as well as functions related
to the origination and servicing of such loans. The education loan portfolio
consists of loans originated through programs sponsored by the federal
government, as well as functions related to the origination and servicing of
such loans. Finally, the Corporation's investment and mortgage-related
securities portfolio is considered a profit center for segment reporting
purposes. However, MBSs collateralized by loans originated by the Corporation
are included in the residential loan profit center, rather than the investment
and mortgage-related securities portfolio.
The Corporation's extensive branch network, which delivers checking,
savings, certificates of deposit and other financial products and services to
customers, is considered a support department for segment reporting purposes, as
more fully described in a subsequent paragraph.
In October 2001, the Corporation completed the acquisition of ACB. In
April 2002, the Bank completed the acquisition of three bank offices in
Rochester, Minnesota, from another financial institution. These purchases
included the customer loans and deposits at those branches. In addition to
offering products and services similar to the Corporation's existing product
lines, these institutions also deliver commercial loan and deposit products and
services to business customers. This represents a new line of business for the
Corporation and a new reportable segment. The financial results of this new line
of business have not been separately reported in 2002 due to continuing efforts
to develop the departmental allocations of costs and revenues necessary to
fairly present the operating results of this line of business.
MEASUREMENT OF SEGMENT PROFIT (LOSS) Management evaluates the after-tax
performance of the Corporation'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 Corporation's accounting systems. Interest expense is allocated to each
profit center according to its use of the Corporation's funding sources, which
consist primarily of deposit liabilities, FHLB 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 Corporation's support departments is
allocated to the Corporation's profit centers and to the 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
branch network. In addition, certain allocations of revenues and expenses are
made between profit centers when they perform services for each other. Such
amounts, however, are not generally material in nature.
The Corporation's 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 Corporation's other support departments) to
arrive at the net cost for the banking network. This net cost is then allocated
to each profit center based on its use of deposit liabilities to fund its
64
operations. This amount is reported as the "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 results of operations and financial
condition of the Corporation that, in management's judgment, more fairly reflect
the performance and/or financial condition of certain of the Corporation'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. Income from bank
owned life insurance is reclassified from non-interest income to interest income
in the investment and mortgage-related security 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 profit 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 Corporation'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 Corporation'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 Corporation 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 other
intangible assets is disregarded for segment reporting purposes.
INCOME TAXES In general, a standard income tax rate of
approximately 40% 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.
NON-GAAP ADJUSTMENTS TO FINANCIAL CONDITION 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
65
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 Corporation's reportable
segments for the years ended December 31, 2002, 2001, and 2000 (2001 is
presented on both pages to facilitate its comparison with 2002 and 2000). In
addition to the after-tax performance of profit centers, management of the
Corporation 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 1.33%, 1.20%, and 1.15% of average deposit
liabilities outstanding during the years ended December 31, 2002, 2001, and
2000, respectively.
66
COMMERCIAL INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION & MORTGAGE
YEAR ENDED DECEMBER 31, 2002 BANKING LOANS LENDING LENDING LENDING SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------------
Interest income $ 2,368,108 $ 50,578,320 $ 40,980,844 $ 32,759,292 $ 10,168,607 $ 20,680,787
Interest expense 2,374,432 27,039,946 17,000,886 13,860,620 3,320,310 16,598,524
Net cost to acquire and maintain
deposit liabilities 758,172 7,341,730 5,980,527 4,926,204 2,228,580 5,240,318
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (764,496) 16,196,644 17,999,431 13,972,468 4,619,718 (1,158,054)
Net loan charge-offs (recoveries) - 19,734 - 1,702,923 31,096 -
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (764,496) 16,176,910 17,999,431 12,269,545 4,588,622 (1,158,054)
Non-interest income 45,648,631 - 28,464 1,746,340 1,892 (166,264)
Non-interest expense 25,241,523 4,619,974 1,480,542 3,314,528 1,074,992 136,264
- -----------------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 19,642,612 11,556,936 16,547,353 10,701,357 3,515,522 (1,460,583)
Income tax expense (benefit) 7,963,119 3,798,984 6,708,346 4,338,365 1,425,202 (1,850,645)
- -----------------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 11,679,493 $ 7,757,952 $ 9,839,007 $ 6,362,992 $ 2,090,320 $ 390,063
===================================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -----------------------------------------------------------------------------------------------------------------------------------
Average assets $ 81,376 $ 858,609 $ 571,050 $ 469,212 $ 212,248 $ 590,294
===================================================================================================================================
Total assets at end of period $ 97,585 $ 853,869 $ 541,398 $ 530,398 $ 204,634 $ 674,796
===================================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2001 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- -------------------------------------------------------------------------------------------------------
Interest income $ 3,757,135 - ($ 42,753) (1) $ 161,250,343
Interest expense 1,527,630 - (1,996,738) (1) 79,725,611
Net cost to acquire and maintain
deposit liabilities 773,478 (27,249,008) -
- -------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs 1,456,028 27,249,008 1,953,985 81,524,732
Net loan charge-offs (recoveries) 6,270 1,708,038 (2) 3,468,063
- -------------------------------------------------------------------------------------------------------
Net interest income (expense) 1,449,758 27,249,008 245,947 78,056,669
Non-interest income 536,506 31,631,274 (15,791,792) (3) 63,635,051
Non-interest expense 2,734,783 58,880,282 (10,104,575) (3) 87,378,312
- -------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (748,519) - (5,441,270) 54,313,408
Income tax expense (benefit) (161,461) (2,824,046) 19,397,866
- -------------------------------------------------------------------------------------------------------
Segment profit (loss) ($ 587,058) - ($ 2,617,224) $ 34,915,542
=======================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------
Average assets $ 63,714 - ($ 7,535) (4) $ 2,838,968
=======================================================================================================
Total assets at end of period $ 130,533 ($ 7,589) (4) $ 3,025,624
=======================================================================================================
COMMERCIAL INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION & MORTGAGE
YEAR ENDED DECEMBER 31, 2001 BANKING LOANS LENDING LENDING LENDING SECURITIES
- -------------------------------------------------------------------------------------------------------------------------------
Interest income $ 3,257,387 $ 65,810,100 $ 39,962,209 $ 30,359,780 $ 14,300,051 17,106,976
Interest expense 3,823,851 44,705,517 24,188,333 17,475,196 6,153,219 14,274,353
Net cost to acquire and maintain
deposit liabilities 503,629 6,336,321 5,495,949 3,981,966 2,241,482 2,450,646
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,070,093) 14,768,262 10,277,927 8,902,618 5,905,350 381,977
Net loan charge-offs (recoveries) - (7,563) - 1,094,829 36,463 -
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,070,093) 14,775,825 10,277,927 7,807,789 5,868,887 381,977
Non-interest income 26,888,068 - 38,548 1,689,466 52,590 -
Non-interest expense 17,085,283 5,405,384 1,328,210 2,703,827 911,555 101,294
- -------------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 8,732,692 9,370,441 8,988,265 6,793,428 5,009,922 280,683
Income tax expense (benefit) 3,540,234 2,416,789 3,643,842 2,754,056 2,031,023 (857,751)
- -------------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 5,192,458 $ 6,953,652 $ 5,344,423 $ 4,039,371 $ 2,978,899 $ 1,138,434
===============================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------------------------------
Average assets $ 85,394 $ 958,964 $ 525,031 $ 378,437 $ 212,454 $ 325,935
===============================================================================================================================
Total assets at end of period $ 101,776 $ 859,077 $ 574,208 $ 384,275 $ 211,642 $ 550,770
===============================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2001 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- ------------------------------------------------------------------------------------------------------
Interest income $ 408,163 $ 327,975 (1) $ 171,532,641
Interest expense 249,806 (2,539,902) (1) 108,330,373
Net cost to acquire and maintain
deposit liabilities 81,359 (21,091,352) -
- ------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs 76,998 21,091,352 2,867,877 63,202,268
Net loan charge-offs (recoveries) - 639,662 (2) 1,763,391
- ------------------------------------------------------------------------------------------------------
Net interest income (expense) 76,998 21,091,352 2,228,215 61,438,877
Non-interest income 285,599 26,748,850 (6,175,815) (3) 49,527,306
Non-interest expense 512,254 47,840,202 (8,768,536) (3) 67,119,473
- ------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (149,657) - 4,820,936 43,846,710
Income tax expense (benefit) (4,515) 1,874,807 15,398,485
- ------------------------------------------------------------------------------------------------------
Segment profit (loss) ($ 145,142) - $ 2,946,129 $ 28,448,225
======================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- ------------------------------------------------------------------------------------------------------
Average assets $ 7,569 - ($ 4,899) (4) $ 2,488,884
======================================================================================================
Total assets at end of period $ 42,944 ($ 6,982) (4) $ 2,717,710
======================================================================================================
(1) Consists principally of interest income and expense adjustments related to
late charges, implied earnings on custodial and escrow accounts, and
earnings on bank owned life insurance.
(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 included 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.
67
COMMERCIAL INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION & MORTGAGE
YEAR ENDED DECEMBER 31, 2001 BANKING LOANS LENDING LENDING LENDING SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------
Interest income $ 3,257,387 $ 65,810,100 $ 39,962,209 $ 30,359,780 $ 14,300,051 $ 17,106,976
Interest expense 3,823,851 44,705,517 24,188,333 17,475,196 6,153,219 14,274,353
Net cost to acquire and maintain
deposit liabilities 503,629 6,336,321 5,495,949 3,981,966 2,241,482 2,450,646
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,070,093) 14,768,262 10,277,927 8,902,618 5,905,350 381,977
Net loan charge-offs (recoveries) - (7,563) - 1,094,829 36,463 -
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,070,093) 14,775,825 10,277,927 7,807,789 5,868,887 381,977
Non-interest income 26,888,068 - 38,548 1,689,466 52,590 -
Non-interest expense 17,085,283 5,405,384 1,328,210 2,703,827 911,555 101,294
- -----------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 8,732,692 9,370,441 8,988,265 6,793,428 5,009,922 280,683
Income tax expense (benefit) 3,540,234 2,416,789 3,643,842 2,754,056 2,031,023 (857,751)
- -----------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 5,192,458 $ 6,953,652 $ 5,344,423 $ 4,039,371 $ 2,978,899 $ 1,138,434
=============================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -----------------------------------------------------------------------------------------------------------------------------
Average assets $ 85,394 $ 958,964 $ 525,031 $ 378,437 $ 212,454 $ 325,935
=============================================================================================================================
Total assets at end of period $ 101,776 $ 859,077 $ 574,208 $ 384,275 $ 211,642 $ 550,770
=============================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2001 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- --------------------------------------------------------------------------------------------------------
Interest income $ 408,163 $ 327,975 (1) $ 171,532,641
Interest expense 249,806 (2,539,902) (1) 108,330,373
Net cost to acquire and maintain
deposit liabilities 81,359 (21,091,352) -
- --------------------------------------------------------------------------------------------------------
Net interest income (expense) 76,998 21,091,352 2,867,877 63,202,268
before charge-offs
Net loan charge-offs (recoveries) - 639,662 (2) 1,763,391
- --------------------------------------------------------------------------------------------------------
Net interest income (expense) 76,998 21,091,352 2,228,215 61,438,877
Non-interest income 285,599 26,748,850 (6,175,815) (3) 49,527,306
Non-interest expense 512,254 47,840,202 (8,768,536) (3) 67,119,473
- --------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (149,657) - 4,820,936 43,846,710
Income tax expense (benefit) (4,515) 1,874,807 15,398,485
- --------------------------------------------------------------------------------------------------------
Segment profit (loss) $ (145,142) - $ 2,946,129 $ 28,448,225
========================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- --------------------------------------------------------------------------------------------------------
Average assets $ 7,569 - $ (4,899) (4) $ 2,488,884
========================================================================================================
Total assets at end of period $ 42,944 - $ (6,982) (4) $ 2,717,710
========================================================================================================
COMMERCIAL INVESTMENT
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION & MORTGAGE
YEAR ENDED DECEMBER 31, 2001 BANKING LOANS LENDING LENDING LENDING SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------
Interest income $ 640,642 $ 65,906,572 $ 34,471,809 $ 26,081,871 $ 17,129,748 $ 16,552,193
Interest expense 2,092,805 45,748,126 20,929,687 14,991,089 7,730,662 12,878,675
Net cost to acquire and maintain
deposit liabilities 384,125 5,062,463 4,771,977 3,421,079 2,173,040 1,854,402
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (1,836,288) 15,095,983 8,770,145 7,669,703 7,226,046 1,819,116
Net loan charge-offs (recoveries) - 52,920 - 598,249 32,827 -
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) (1,836,288) 15,043,063 8,770,145 7,071,454 7,193,219 1,819,116
Non-interest income 19,735,764 - 52,984 1,614,005 215,988 -
Non-interest expense 11,794,513 2,972,485 1,245,783 2,364,348 807,099 97,366
- -----------------------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes 6,104,963 12,070,578 7,577,346 6,321,111 6,602,108 1,721,750
Income tax expense (benefit) 2,474,953 3,705,744 3,071,856 2,562,578 2,676,495 (101,269)
- -----------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) $ 3,630,010 $ 8,364,834 $ 4,505,490 $ 3,758,533 $ 3,925,613 $ 1,823,019
=============================================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -----------------------------------------------------------------------------------------------------------------------------
Average assets $ 44,031 $ 934,451 $ 457,302 $ 327,067 $ 207,454 $ 264,815
=============================================================================================================================
Total assets at end of period $ 45,873 $ 1,015,190 $ 488,638 $ 362,561 $ 205,246 $ 240,259
=============================================================================================================================
SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2001 SEGMENTS ALLOCATIONS ADJUSTMENTS CONSOLIDATED
- -------------------------------------------------------------------------------------------------------------
Interest income - $ 653,353 (1) $ 161,436,188
Interest expense $ 363,991 (2,839,113) (1) 101,895,922
Net cost to acquire and maintain
deposit liabilities 3,346 (17,670,432) -
- -------------------------------------------------------------------------------------------------------------
Net interest income (expense)
before charge-offs (367,337) 17,670,432 3,492,466 59,540,265
Net loan charge-offs (recoveries) - 324,784 (2) 1,008,780
- -------------------------------------------------------------------------------------------------------------
Net interest income (expense) (367,337) 17,670,432 3,167,682 58,531,486
Non-interest income (4,546) 22,953,049 (8,934,693) (3) 35,632,550
Non-interest expense 294,315 40,623,481 (1,949,058) (3) 58,250,331
- -------------------------------------------------------------------------------------------------------------
Profit (loss) before taxes (666,198) - (3,817,953) 35,913,705
Income tax expense (benefit) (218,183) (1,402,345) 12,769,829
- -------------------------------------------------------------------------------------------------------------
Segment profit (loss) ($ 448,015) - ($ 2,415,608) $ 23,143,876
=============================================================================================================
BALANCE SHEET INFORMATION
Dollars in thousands
- -------------------------------------------------------------------------------------------------------------
Average assets $ 320 - ($ 11,466) (4) $ 2,223,974
=============================================================================================================
Total assets at end of period $ 633 - ($ 5,674) (4) $ 2,352,726
=============================================================================================================
(1) Consists principally of interest income and expense adjustments related to
late charges, implied earnings on custodial and escrow accounts, and
earnings on bank owned life insurance.
(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 included 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.
68
NOTE 15--ACQUISITION OF BANKING OFFICES
In April 2002, the Bank completed the acquisition of three bank offices
in Rochester, Minnesota, from another financial institution for $29.2 million in
cash. This acquisition represented the Bank's first expansion into the State of
Minnesota and gave it a substantial market share in the metropolitan community
of Rochester. The transaction was accounted for using the purchase method of
accounting in accordance with Statement of Financial Accounting Standards No.
141, "Business Combinations" ("SFAS 141"). The amount of goodwill recorded in
connection with the transaction was $16.7 million, which represented the
difference between the estimated fair value of the identifiable tangible and
intangible assets acquired and the estimated fair value of the liabilities
assumed. This goodwill is expected to be deductible for tax purposes. The Bank
also recorded a deposit-based intangible of $2.1 million in connection with the
transaction, which is tax-deductible and will be amortized using an accelerated
method, in accordance with Statement of Accounting Standards No. 142 "Goodwill
and Other Intangible Assets" ("SFAS 142"). Goodwill will not be amortized, which
is in accordance with SFAS 142. As described in Note 6, the Corporation does not
allocate goodwill and other intangibles by reportable segment.
Following is a summary of the assets acquired and liabilities assumed
in the Rochester transaction. The table excludes cash and cash equivalents
acquired of $629,000.
ASSETS ACQUIRED AND LIABILITIES ASSUMED AMOUNT
- --------------------------------------------------------------------------------------------
Loans held for investment $114,644,811
Accrued interest receivable 403,577
Office properties and equipment 129,788
Intangible assets 18,739,080
Other assets 2,736,102
- --------------------------------------------------------------------------------------------
Total assets 136,653,358
- ---------------------------------------------------------------------------------------------
Deposit liabilities 128,260,383
Accrued interest payable 438,552
Advance payments by borrowers for taxes and insurance 29,289
Other liabilities 10,294
- --------------------------------------------------------------------------------------------
Total liabilities 128,738,518
- --------------------------------------------------------------------------------------------
Net assets (liabilities) acquired or assumed $ 7,914,840
============================================================================================
In September 2002, the Bank completed the acquisition of four
supermarket banking offices in the Minnesota cities of Rochester, Albert Lea,
Austin, and Mankato from another financial institution for $796,000 in cash.
This acquisition expanded the Bank's presence in south-eastern Minnesota and
complimented its previous acquisition in Rochester. The transaction was
accounted for using the purchase method of accounting in accordance with SFAS
141. The Bank recorded a deposit-based intangible of $796,000 in connection with
the transaction, which is tax-deductible and will be amortized using an
accelerated method, in accordance with SFAS 142. No goodwill was recorded in
this transaction. As described in Note 6, the Corporation does not allocate
goodwill and other intangibles by reportable segment.
Following is a summary of the assets acquired and liabilities assumed
in the transaction. The table excludes cash and cash equivalents acquired of
$463,000.
ASSETS ACQUIRED AND LIABILITIES ASSUMED AMOUNT
- ----------------------------------------------------------------------------------------------
Loans held for investment $ 811,704
Accrued interest receivable 4,150
Office properties and equipment 94,223
Intangible assets 796, 437
Other assets 13,764
- ----------------------------------------------------------------------------------------------
Total assets 1,720,278
- ----------------------------------------------------------------------------------------------
Deposit liabilities 25,290,037
Accrued interest payable 81,968
- ----------------------------------------------------------------------------------------------
Total liabilities 25,372,005
- ----------------------------------------------------------------------------------------------
Net assets (liabilities) acquired or assumed ($ 23,651,727)
==============================================================================================
69
NOTE 16--PARENT COMPANY ONLY FINANCIAL INFORMATION
DECEMBER 31
- ------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF FINANCIAL CONDITION: 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
Cash in bank $ 27,870 $ 17,125
Interest-bearing deposits with subsidiary bank 3,519,050 573,433
Investment in subsidiary 218,696,628 191,725,269
Other assets 197,768 100,642
- ------------------------------------------------------------------------------------------------------------------------
Total assets $ 222,441,316 $192,416,469
========================================================================================================================
Other borrowings $ 16,989,313 -
Other liabilities - $18,766
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 16,989,313 18,766
- ------------------------------------------------------------------------------------------------------------------------
Common stock 2,021,593 2,020,083
Additional paid-in capital 46,577,431 46,607,845
Retained earnings 165,628,148 141,717,089
Treasury stock, at cost (10,178,374) -
Unearned restricted stock (32,083) (87,083)
Non-owner adjustments to equity, net 1,435,289 2,139,769
- ------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 205,452,003 192,397,703
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 222,441,316 $192,416,469
========================================================================================================================
YEAR ENDED DECEMBER 31
- ------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS: 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Other income $ 5,738 $ 38,989 $ 40,539
Other expense 623,876 379,623 750,067
- ------------------------------------------------------------------------------------------------------------------------
Loss before income taxes and equity in earnings of subsidiary (618,138) (340,634) (709,528)
Income tax benefit 216,348 119,222 248,335
- ------------------------------------------------------------------------------------------------------------------------
Loss before equity in earnings of subsidiary (401,790) (221,412) (461,193)
Equity in earnings of subsidiary 35,317,332 28,669,637 23,605,069
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 34,915,542 $ 28,448,225 $ 23,143,876
========================================================================================================================
YEAR ENDED DECEMBER 31
- ------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS: 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 34,915,542 $ 28,448,225 $ 23,143,876
Equity in earnings of subsidiary (35,317,332) (28,669,637) (23,605,069)
Change in income taxes and other accruals and prepaid (115,892) 113,110 19,661
- ------------------------------------------------------------------------------------------------------------------------
Net cash used by operations (517,682) (108,302) (441,532)
- ------------------------------------------------------------------------------------------------------------------------
Decrease (increase) in interest-bearing deposits with subsidiary bank (2,945,617) 3,782,086 (3,117,730)
Dividends received from subsidiary 15,750,000 9,900,000 14,600,000
Capital contributions to subsidiary (7,500,000) - -
Purchase of net assets of other financial institutions - (28,603,959) -
- ------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities 5,304,383 (14,921,873) 11,482,270
- ------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in other borrowings 16,989,313 (2,601,542) (2,598,458)
Dividends paid to shareholders (10,145,762) (8,866,148) (7,699,035)
Purchases of treasury stock (13,770,106) (3,213,376) (1,708,663)
Common stock issued for acquisition - 28,603,793 -
Other, net 2,150,599 1,071,630 1,005,913
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (4,775,956) 14,994,357 (11,000,243)
- ------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash in bank 10,745 (35,818) 40,495
Cash at beginning of period 17,125 52,943 12,448
- ------------------------------------------------------------------------------------------------------------------------
Cash in bank at end of period $ 27,870 $ 17,125 $ 52,943
========================================================================================================================
70
REPORT OF INDEPENDENT AUDITORS
We have audited the accompanying consolidated statements of financial condition
of First Federal Capital Corp as of December 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Federal
Capital Corp at December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.
As discussed in Note 1, in 2002 First Federal Capital Corp changed its
methodology for accounting for goodwill.
/s/ ERNST & YOUNG LLP
Milwaukee, Wisconsin
January 23, 2003
71
SUPPLEMENTARY DATA
Quarterly Financial Information (Unaudited)
DEC. SEPT. JUNE MARCH
Dollars in thousands, except for per share amounts 2002 2002 2002 2002
- ---------------------------------------------------------------------------------------------------
Interest on loans $35,252 $35,205 $34,098 $33,057
Interest on mortgage-backed and related securities 2,789 4,559 5,707 5,415
Interest and dividends on investments 1,681 1,319 1,208 961
- ---------------------------------------------------------------------------------------------------
Total interest income 39,723 41,082 41,013 39,433
- ---------------------------------------------------------------------------------------------------
Interest on deposits 14,090 14,191 13,789 15,014
Interest on FHLB advances and other borrowings 5,495 5,652 5,706 5,789
- ---------------------------------------------------------------------------------------------------
Total interest expense 19,585 19,843 19,495 20,803
- ---------------------------------------------------------------------------------------------------
Net interest income 20,138 21,240 21,518 18,630
Provision for loan losses 1,334 716 771 647
- ---------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 18,804 20,524 20,747 17,982
- ---------------------------------------------------------------------------------------------------
Gain (loss) on sale of investments and other assets - - - (166)
Other non-interest income 21,027 16,717 12,977 13,080
- ---------------------------------------------------------------------------------------------------
Total non-interest income 21,027 16,717 12,977 12,913
Total non-interest expense 24,097 22,892 21,257 19,133
- ---------------------------------------------------------------------------------------------------
Income before income taxes 15,734 14,349 12,467 11,763
Income tax expense 5,731 5,293 4,278 4,095
- ---------------------------------------------------------------------------------------------------
Net Income $10,003 $ 9,056 $ 8,189 $ 7,667
===================================================================================================
Diluted earnings per share $ 0.50 $ 0.45 $ 0.40 $ 0.38
===================================================================================================
Dividends paid per share $ 0.13 $ 0.13 $ 0.13 $ 0.12
===================================================================================================
Stock price at end of period $ 19.31 $ 19.43 $ 22.10 $ 18.85
===================================================================================================
High stock price during period $ 19.50 $ 21.60 $ 22.47 $ 18.85
===================================================================================================
Low stock price during period $ 16.88 $ 17.55 $ 18.50 $ 14.68
===================================================================================================
DEC. SEPT. JUNE MARCH
Dollars in thousands, except for per share amounts 2001 2001 2001 2001
- ---------------------------------------------------------------------------------------------------
Interest on loans $35,912 $36,474 $35,741 $35,880
Interest on mortgage-backed and related securities 6,163 5,290 6,005 6,602
Interest and dividends on investments 1,248 628 851 738
- ---------------------------------------------------------------------------------------------------
Total interest income 43,323 42,391 42,597 43,221
- ---------------------------------------------------------------------------------------------------
Interest on deposits 20,087 20,911 21,147 21,440
Interest on FHLB advances and other borrowings 5,955 5,699 5,874 7,219
- ---------------------------------------------------------------------------------------------------
Total interest expense 26,042 26,609 27,021 28,659
- ---------------------------------------------------------------------------------------------------
Net interest income 17,282 15,782 15,577 14,562
Provision for loan losses 578 355 437 394
- ---------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 16,704 15,427 15,140 14,167
- ---------------------------------------------------------------------------------------------------
Gain (loss) on sale of investments and other assets (25) 38 50 -
Other non-interest income 16,052 11,291 11,432 10,690
- ---------------------------------------------------------------------------------------------------
Total non-interest income 16,026 11,329 11,482 10,690
Total non-interest expense 18,199 16,439 16,767 15,714
- ---------------------------------------------------------------------------------------------------
Income before income taxes 14,531 10,316 9,855 9,144
Income tax expense 5,071 3,593 3,487 3,247
- ---------------------------------------------------------------------------------------------------
Net Income $ 9,460 $ 6,724 $ 6,367 $ 5,897
===================================================================================================
Diluted earnings per share $ 0.49 $ 0.36 $ 0.34 $ 0.32
===================================================================================================
Dividends paid per share $ 0.12 $ 0.12 $ 0.12 $ 0.11
===================================================================================================
Stock price at end of period $ 15.70 $ 14.90 $ 16.20 $ 14.00
===================================================================================================
High stock price during period $ 15.75 $ 16.35 $ 16.20 $ 16.63
===================================================================================================
Low stock price during period $ 14.27 $ 14.10 $ 13.16 $ 12.75
===================================================================================================
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
72
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
Proxy Statement of the Corporation dated March 19, 2003.
ITEM 11--EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the
section entitled "Compensation of Executive Officers and Directors" in the Proxy
Statement of the Corporation dated March 19, 2003.
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 Proxy Statement of the Corporation dated March 19,
2003.
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
Proxy Statement of the Corporation dated March 19, 2003.
PART IV
ITEM 14--CONTROLS AND PROCEDURES
An evaluation of the Corporation's disclosure controls and procedures
(as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934 (the "Act") was carried out under the supervision and with the
participation of the Corporation's Chief Executive Officer, Chief Financial
Officer and several other members of the Corporation's senior management within
the 90-day period preceding the filing date of this quarterly report. The
Corporation's Chief Executive Officer and Chief Financial Officer concluded that
the Corporation's disclosure controls and procedures as currently in effect are
effective in ensuring that the information required to be disclosed by the
Corporation in the reports it files or submits under the Act is (i) accumulated
and communicated to the Corporation's management (including the Chief Executive
Officer and Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. In the quarter ended December 31, 2002, the Corporation
did not make any significant changes in, nor take any corrective actions
regarding, its internal controls or other factors that could significantly
affect these controls.
ITEM 15--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, 2002 and 2001
73
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 2002
Consolidated Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 2002
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2002
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.
EDGAR VERSION
(3) Exhibit Index.
No. Exhibit Description
- --- -------------------
3.1 Articles of Incorporation, as amended (7)
3.2 Bylaws, as amended (6)
4.1 Specimen stock certificate (1)
4.2 Rights Agreement, dated as of January 24, 1995 (5)
10.1 1989 Stock Incentive Plan (1)
10.2 1989 Directors' Stock Option Plan, as amended (2)
10.3 1992 Directors' Stock Option Plan, as amended (7)
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 (6)
10.7 Employee Stock Ownership Plan (8)
10.8 Employment agreements, as amended, between the Corporation and the Bank and the following
executive officers:
a) Jack C. Rusch (8)
b) Thomas W. Schini (7)
c) Bradford R. Price (8)
d) Robert P. Abell (8)
e) Michael W. Dosland (8)
f) Milne J. Duncan (8)
g) Joseph M. Konradt (8) (Mr. Konradt resigned from the Corporation February 4, 2003. Mr. Konradt's
employment agreements have been superceded by a resignation agreement included herein as Exhibit
10.13)
10.9 First Federal of La Crosse Directors' Deferred Compensation Plan (1)
10.10 First Federal of La Crosse Annual Incentive Bonus Plan (1)
10.11 First Federal of La Crosse Incentive Bonus Plan for Group Life Insurance (1)
10.12 First Federal of Madison Deferred Compensation Plan for Directors (1)
10.13 Resignation Agreement with Joseph M. Konradt (9)
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 2003 President's Message (10)
21.1 Subsidiaries of the Registrant--Reference is made to Part I, Item 1, "Business--Subsidiaries"
74
23.1 Consent of Ernst & Young LLP (9)
99.1 2003 Proxy Statement (9)
99.2 Section 906 Certification (9)
(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.
(3) Incorporated herein by reference to the Corporation's 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 (Registration No. 33-98298-01).
(5) Incorporated herein by reference to the Corporation's Registration
Statement on Form 8-A.
(6) 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.
(7) Incorporated herein by reference to the exhibits filed with the
Corporation's Annual Report on Form 10-K for the year ended December
31, 2000.
(8) Incorporated herein by reference to the exhibits filed with the
Corporation's Annual Report on Form 10-K for the year ended December
31, 2001.
(9) Filed herewith.
(10) Filed in paper format pursuant to Rule 101(b) of Regulation S-T.
(b) No reports on form 8-K were filed with the SEC by the Corporation during
the fourth quarter of 2002.
(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.
75
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 20, 2003 By: /s/ Jack C. Rusch
Jack C. Rusch
President 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 20, 2003
Thomas W. Schini
Chairman of the Board
/s/ Jack C. Rusch February 20, 2003
Jack C. Rusch
President, Chief Executive Officer, and
Director (principal executive officer)
/s/ Marjorie A. Davenport February 20, 2003
Marjorie A. Davenport
Director
/s/ John F. Leinfelder February 20, 2003
John F. Leinfelder
Director
/s/ Richard T. Lommen February 20, 2003
Richard T. Lommen
Director
/s/ Patrick J. Luby February 20, 2003
Patrick J. Luby
Director
/s/ David C. Mebane February 20, 2003
David C. Mebane
Director
/s/ Phillip J. Quillin February 20, 2003
Phillip J. Quillin
Director
76
/s/ Edwin J. Zagzebski February 20, 2003
Edwin J. Zagzebski
Director
/s/ Michael W. Dosland February 20, 2003
Michael W. Dosland
Senior Vice President and
Chief Financial Officer
(principal financial officer)
/s/ Kenneth C. Osowski February 20 2003
Kenneth C. Osowski
Vice President and Controller
(principal accounting officer)
77
CERTIFICATION
I, Jack C. Rusch, certify that:
1. I have reviewed this annual report on Form 10-K of First
Federal Capital Corp.,
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and
procedures to ensure that material
information relating to the registrant,
including its consolidated subsidiaries, is
made known to us by others within those
entities, particularly during the period in
which this annual report is being prepared;
b) evaluated the effectiveness of the
registrant's disclosure controls and
procedures as of a date within 90 days prior
to the filing date of this annual report
(the "Evaluation Date"); and
c) presented in this annual report our
conclusions about the effectiveness of the
disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design
or operation of internal controls which
could adversely affect the registrant's
ability to record, process, summarize and
report financial data and have identified
for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that
involves management or other employees who
have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: February 20, 2003 /s/ Jack C. Rusch
Jack C. Rusch
President and Chief Executive Officer
(duly authorized officer)
78
CERTIFICATION
I, Michael W. Dosland, certify that:
1. I have reviewed this annual report on Form 10-K of First
Federal Capital Corp.,
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and
procedures to ensure that material
information relating to the registrant,
including its consolidated subsidiaries, is
made known to us by others within those
entities, particularly during the period in
which this annual report is being prepared;
b. evaluated the effectiveness of the
registrant's disclosure controls and
procedures as of a date within 90 days prior
to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our
conclusions about the effectiveness of the
disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a. all significant deficiencies in the design
or operation of internal controls which
could adversely affect the registrant's
ability to record, process, summarize and
report financial data and have identified
for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that
involves management or other employees who
have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: February 20, 2003 /s/ Michael W. Dosland
Michael W. Dosland
Senior Vice President and
Chief Financial Officer
79
CERTIFICATION
I, Kenneth C. Osowski, certify that:
1. I have reviewed this annual report on Form 10-K of First
Federal Capital Corp.,
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and
procedures to ensure that material
information relating to the registrant,
including its consolidated subsidiaries, is
made known to us by others within those
entities, particularly during the period in
which this annual report is being prepared;
b. evaluated the effectiveness of the
registrant's disclosure controls and
procedures as of a date within 90 days prior
to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our
conclusions about the effectiveness of the
disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a. all significant deficiencies in the design
or operation of internal controls which
could adversely affect the registrant's
ability to record, process, summarize and
report financial data and have identified
for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that
involves management or other employees who
have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: February 20, 2003 /s/ Kenneth C. Osowski
Kenneth C. Osowski
Vice President and Controller
80