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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
COMMISSION FILE NUMBER 0-19829
UMBRELLA BANCORP, INC.
------------------------
(Exact name of registrant as specified in its charter)
Maryland 36-3620612
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.}
5818 South Archer Road, Summit, Illinois 60501-1830
(Address of principal executive offices)
(708) 458-2002
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such report(s), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act) Yes No X
----- -----
The Registrant had 1,845,720 shares outstanding as of May 7, 2003.
Transitional Small Business Disclosure Format (check one): Yes No X
----- -----
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1
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2003
INDEX
PART I - FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
Item 1 Financial Statements
Unaudited Consolidated Statements of Financial Condition
as of March 31, 2003 and December 31, 2002 ........................... 3
Unaudited Consolidated Statements of Operations for the Three
Months Ended March 31, 2003 and 2002.................................. 4
Unaudited Consolidated Statements of Comprehensive Income
for the Three Months Ended March 31, 2003 and 2002 ................... 5
Unaudited Consolidated Statements of Stockholders' Equity
for the Three Months Ended March 31, 2003 and 2002.................... 6
Unaudited Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2003 and 2002.................................. 7
Notes to Unaudited Consolidated Financial Statements ................. 8
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................ 17
Item 3 Quantitative and Qualitative Disclosures about Market Risk............ 28
Item 4 Controls and Procedures............................................... 29
PART II - OTHER INFORMATION
- ---------------------------
Item 1 Legal Proceedings .................................................... 31
Item 2 Changes in Securities ................................................ 31
Item 3 Default Upon Senior Securities ....................................... 31
Item 4 Submission of Matters to a Vote of Security Holders .................. 31
Item 5 Other Information .................................................... 31
Item 6 Exhibits and Reports on Form 8-K ..................................... 31
Form 10-Q Signature Page ....................................................... 32
Certifications Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 .......................................................... 33
2
PART 1 - FINANCIAL INFORMATION
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
March 31, December 31,
ASSETS 2003 2002
------------ ------------
Cash $ 2,970 $ 2,089
Interest-earning deposits 46,421 69,811
------------ ------------
Total Cash & Cash Equivalents 49,391 71,900
Securities available-for-sale 90,030 105,613
Securities held-to-maturity - -
Loans held for sale 17,375 20,428
Loans receivable, net 80,309 96,024
Mortgage loan servicing rights, net 97 105
Investment in limited partnership 1,058 1,198
Stock in Federal Home Loan Bank of Chicago 3,029 2,947
Foreclosed real estate, net 3,956 2,361
Premises and equipment held for sale 4,993 5,401
Premises and equipment, net 11,654 13,476
Debt issuance costs, net 1,738 1,757
Accrued interest receivable 1,407 1,861
Receivable from loan servicers 869 2,480
Deferred tax assets 10,465 9,679
Prepaid expenses and other assets 7,632 8,707
------------ ------------
Total Assets $ 284,003 $ 343,937
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 230,905 $ 282,047
Borrowed money 13,375 22,305
Custodial escrow balances for loans serviced for others 6,393 7,423
Accrued interest payable 1,085 1,232
Other liabilities 1,269 5,627
Junior subordinated debt 17,123 17,123
Stockholders' Equity
Preferred stock 3 3
Preferred stock, Series A 7,986 1,921
Common stock 22 21
Additional paid-in-capital 11,073 9,284
Retained earnings - substantially restricted 419 2,620
Treasury stock - common, at cost (5,261) (5,261)
Unearned stock awards (248) (248)
Accumulated other comprehensive loss (141) (160)
------------ ------------
Total Stockholders' Equity 13,853 8,180
------------ ------------
Total Liabilities and Stockholders' Equity $ 284,003 $ 343,937
============ ============
See accompanying notes to unaudited consolidated financial statements.
3
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
For the Three Months
Ended March 31,
2003 2002
--------- ---------
Interest income:
Loans receivable $ 1,764 $ 5,077
Securities 1,115 1,205
Interest-earning deposits 392 1,603
--------- ---------
Total interest income 3,271 7,885
--------- ---------
Interest expense:
Deposits 1,930 4,919
Borrowed money 351 566
Junior subordinated debt 487 482
--------- ---------
Total interest expense 2,768 5,967
--------- ---------
Net interest income 503 1,918
Provision for loan and lease losses - 35
--------- ---------
Net interest income after provision
for loan and lease losses 503 1,883
--------- ---------
Non-interest income:
Loan servicing income (expense) (99) 73
Gain (loss) on sale of
Loans held for sale 43 (39)
Foreclosed real estate (136) (24)
Securities available-for-sale (655) (914)
Trading account securities - 508
Branch deposits 407 -
Branch facilities 33 28
Other assets 222 -
Fees and service charges 178 206
Other income (69) 16
--------- ---------
Total non-interest income (expense) (76) (146)
Non-interest expense:
Compensation and benefits 1,011 928
Occupancy and equipment 602 498
Federal deposit insurance premium 158 22
Other general and administrative fees 1,654 1,799
--------- ---------
Total non-interest expense 3,425 3,247
--------- ---------
Loss before income taxes (2,998) (1,510)
Income tax benefit 797 949
--------- ---------
Net loss $ (2,201) $ (561)
========= =========
Per Share Amounts:
Basic $ (1.25) $ (0.33)
Diluted $ (1.25) $ (0.33)
See accompanying notes to unaudited consolidated financial statements.
4
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
For the Three Months
Ended March 31,
2003 2002
--------- ---------
Net loss $ (2,201) $ (561)
Other comprehensive income
Unrealized holding gains on securities available-for-sale (624) (747)
Less reclassification adjustment for losses recognized in income (655) (914)
--------- ---------
Net unrealized gains 31 167
Tax expense (12) 63
--------- ---------
Other comprehensive income 19 104
--------- ---------
Comprehensive income (loss) $ (2,182) $ (457)
========= =========
See accompanying notes to unaudited consolidated financial statements.
5
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in Thousands)
Preferred Additional
Preferred Stock Common Paid-In Retained
Stock Series A Stock Capital Earnings
-------------------------------------------------------------------
Three months ended March 31, 2002
- ----------------------------------------
Balance at December 31, 2001 $ 3 $ - $ 21 $ 9,214 $ 15,181
Net loss - - - - (561)
Other comprehensive income, net of tax - - - - -
ESOP loan principal reduction - - - - -
Stock options exercised - - - 40 -
Cash dividends - - - - (104)
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2002 $ 3 $ - $ 21 $ 9,254 $ 14,516
========== ========== ========== ========== ==========
Three months ended March 31, 2003
- ----------------------------------------
Balance at December 31, 2002 $ 3 $ 1,921 $ 21 $ 9,284 $ 2,620
Net loss - - - - (2,201)
Other comprehensive income, net of tax - - - - -
Stock options exercised - - 1 445 -
Proceeds from capital contributions - - - 1,344 -
Issuance of Series A preferred stock - 6,065 - - -
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2003 $ 3 $ 7,986 $ 22 $ 11,073 $ 419
========== ========== ========== ========== ==========
Accumulated
Treasury Unearned Other Total
Stock ESOP Stock Comprehensive Stockholders'
Common Loan Awards Loss Equity
------------------------------------------------------------------------
Three months ended March 31, 2002
- ----------------------------------------
Balance at December 31, 2001 $ (5,121) $ (341) $ (248) $ (1,132) $ 17,577
Net loss - - - - (561)
Other comprehensive income, net of tax - - - 104 104
ESOP loan principal reduction - 17 - - 17
Stock options exercised - - - - 40
Cash dividends - - - - (104)
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2002 $ (5,121) $ (324) $ (248) $ (1,028) $ 17,073
========== ========== ========== ========== ==========
Three months ended March 31, 2003
- ----------------------------------------
Balance at December 31, 2002 $ (5,261) $ - $ (248) $ (160) $ 8,180
Net loss - - - - (2,201)
Other comprehensive income, net of tax - - - 19 19
Stock options exercised - - - - 446
Proceeds from capital contributions - - - - 1,344
Issuance of Series A preferred stock - - - - 6,065
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2003 $ (5,261) $ - $ (248) $ (141) $ 13,853
========== ========== ========== ========== ==========
See accompanying notes to unaudited consolidated financial statements.
6
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Three Months Ended
March 31,
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss $ (2,201) $ (561)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization 825 860
Accretion of discounts and deferred loan fees 19 41
Provision for loan losses - 35
(Gain) loss on sale of:
Loans held for sale (43) 39
Securities available-for-sale 655 914
Trading account securities - (508)
Foreclosed real estate 136 24
Branch facilities (33) (28)
Branch deposits (407) -
Other assets (222) -
Federal Home Loan Bank of Chicago stock dividend (82) (40)
Net change in trading account activity - 810
Loans originated and purchased for sale, net 3,096 26,047
Amortization of purchased mortgage servicing rights 148 20
Net change in debt issuance costs 19 14
Amortization of purchase price of MRP and ESOP stock - 17
Change in accrued interest receivable, prepaid expenses and other assets 731 (1,215)
Change in accrued interest payable and other liabilities (3,843) 1,066
------------ ------------
Net cash provided by (used in) operating activities (1,202) 27,535
Cash flows from investing activities:
Net (increase) decrease in loans receivable 14,917 3,245
Proceeds from maturities of and principal repayments on:
Securities available-for-sale 757 3,798
Securities held-to-maturity - 292
Proceeds from sale of (payment for):
Securities available-for-sale 114,879 40,957
Foreclosed real estate 659 155
Securities held-to-maturity - 685
Premises and equipment 1,495 -
Branch deposits, including cash and cash equivalents (8,453) -
Purchase of:
Securities available-for-sale (100,677) (19,614)
Premises and equipment (90) (230)
------------ ------------
Net cash provided by (used in) investing activities 23,487 29,288
Cash flows from financing activities:
Net change in deposits (42,689) (13,555)
Proceeds from borrowed money 10,500 98,464
Repayment of borrowed money (19,430) (100,748)
Proceeds from issuance of preferred stock, Series A 6,065 -
Proceeds from capital contributions 1,344 -
Reissuance of junior subordinated debentures - 1,065
Repurchase of junior subordinated debentures - (613)
Proceeds from exercise of stock options 446 40
Dividends paid - (104)
Net change in custodial escrow balances for loans serviced (1,030) (579)
------------ ------------
Net cash provided by (used in) financing activities (44,794) (16,030)
------------ ------------
Net increase (decrease) in cash and cash equivalents (22,509) 40,793
Cash and cash equivalents at beginning of period 71,900 37,649
------------ ------------
Cash and cash equivalents at end of period $ 49,391 $ 78,442
============ ============
Supplemental disclosures of cash flow information: Cash paid or refunded during
the period for:
Interest $ 2,915 $ 5,429
Non-cash investing activity - transfer of loans to foreclosed real estate 2,390 554
Non-cash investing activity - ending receivable from loan servicers 869 4,081
See accompanying notes to unaudited consolidated financial statements.
7
UMBRELLA BANCORP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION AND NEW ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America ("GAAP") for interim financial information and with the instructions
to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments, including normal recurring accruals
considered necessary for fair presentation, have been included. The results of
operations for the three months ended March 31, 2003, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003.
Certain reclassifications have been made to prior period amounts in the
financial statements in order to conform to the current period presentation.
The unaudited consolidated financial statements include Umbrella Bancorp, Inc.
(the "Bancorp" or the "Company") and its wholly owned subsidiaries,
UmbrellaBank, fsb, ("UmbrellaBank" or the "Savings Bank"), Argo Redemption
Corp., Inc. ("Argo Redemption" or "ARC"), and the Savings Bank's wholly owned
subsidiary, Dolton-Riverdale Savings Service Corporation (Dolton-Riverdale).
The Bancorp, through its subsidiaries at March 31, 2003, provided a full range
of financial services primarily through its Internet banking delivery channel at
http://www.umbrellabank.com and two retail banking facilities in Cook County,
Illinois. Effective April 26, 2003 the Company operates one retail banking
facility in Cook County, Illinois.
On January 1, 2003, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations". This
statement requires that the fair value of a liability for an asset retirement
obligation be recognized in the period incurred. The adoption of this statement
did not have a material affect on the financial position and operations of the
Company.
NOTE B - REGULATORY COMPLIANCE AND BUSINESS PLAN
As previously disclosed in the Company's 2002 Annual Report to Shareholders, the
Office of Thrift Supervision (OTS) commenced risk-focused safety and soundness
examinations of the Savings Bank and the Bancorp on October 29, 2001 and
November 14, 2001, respectively. Each OTS Report of Examination ("ROE"), which
was primarily based on financial information as of September 30, 2001, was
transmitted to the Savings Bank and Bancorp, respectively, in March 2002.
The November 14, 2001 Holding Company Report of Examination ("Bancorp ROE") was
not limited to any one area, but focused on the risk factors of Transactions
with Affiliates, Funds Distribution, Financial Effect and Management Quality.
During the course of the OTS examination, the Bancorp developed and implemented
policies and procedures to address the specific regulatory violations
identified. The OTS commented in the Bancorp ROE on the Bancorp's level of
operating losses, debt service requirements and capital position. As a result of
the findings contained in the Bancorp ROE, the Bancorp was required to provide
OTS with a quarterly financial cash flow projection report and quarterly
monitoring reports. The Bancorp was also required to take actions to ensure
future regulatory compliance, and take actions sufficient to ensure safe and
sound operations. In addition, the Bancorp was placed under various operating
restrictions, including a requirement that the Bancorp file notice with the OTS
prior to adding or replacing a director or hiring a senior executive officer.
The Bancorp
8
was also restricted in making "golden parachute" payments to any institution-
affiliated party unless authorized by regulation. The Bancorp has been, and is
currently, in compliance with the requirements set forth by the OTS, as a result
of the findings contained in the Bancorp ROE.
The October 29, 2001, Report of Examination of the Savings Bank ("Savings Bank
ROE") focused on Capital Adequacy, Asset Quality, Management, Earnings,
Liquidity and Sensitivity to Market Risk. The OTS identified various regulatory
deficiencies resulting, in part, in supervisory imposed operating restrictions
on growth and lending activities, as well as restrictions on capital
distributions, contracts, "golden parachute" payments and changes in senior
executive positions. In addition, the Savings Bank was required to provide
reports to the OTS detailing corrective actions taken, identification of
policies and procedures adopted and implemented to remedy areas of criticism and
ensure future regulatory compliance. Management and the Board of Directors
responded to the Savings Bank ROE, and provided the OTS with either assurance of
compliance with the material exceptions noted in the Savings Bank ROE or the
current status of efforts to correct matters requiring on-going remediation.
Upon completion of the November 14, 2001 Bancorp ROE and October 29, 2001
Savings Bank ROE, management officials and the Boards of Directors of both the
Bancorp and the Savings Bank engaged in active discussions with the OTS to
develop a mutually agreeable business framework designed to strengthen the
regulatory foundation of the Bancorp and the Savings Bank. As a result, in the
spirit of regulatory cooperation, the Boards of Directors of both the Bancorp
and the Savings Bank, without admitting or denying that such grounds exist, or
the accuracy of the OTS findings, opinions and/or conclusions, separately agreed
to enforcement actions that became effective on August 16, 2002.
The provisions of the enforcement action between the Bancorp and OTS
established, in principal part, that the Bancorp provide the OTS with a plan for
raising additional common equity capital and restructuring outstanding debt at
the Bancorp, recognizing that economic and market conditions are outside of the
control of the Bancorp. In addition to the operating restrictions previously
placed on the Bancorp by the OTS, pursuant to the November 14, 2001 Bancorp ROE,
the agreed upon action required the Bancorp to provide the OTS with quarterly
cash flow projections for the purpose of identifying the Bancorp's sources and
uses of funds for the remainder of fiscal 2002, fiscal 2003 and fiscal 2004. The
subject enforcement action also provides that the Bancorp ensure that all
transactions with affiliates comply with applicable statutory and regulatory
regulations and that the Bancorp maintain documentation sufficient to evidence
such compliance.
The agreed upon language in the enforcement action between the Savings Bank and
the OTS provided, in principal part, for the establishment of a plan addressing
the level of the Savings Bank's fixed assets, as well as the adoption and
implementation of a capital plan for the establishment and maintenance of
acceptable capital levels. On March 24, 2003, the Savings Bank submitted to the
OTS a revised business plan which replaces the Savings Bank's previously filed
business plan, capital plan and staffing plan. The revised business plan details
the Savings Bank's overall operating strategies, in light of current economic
conditions, and the intent of the Board of Directors to reformulate and reduce
the Savings Bank's overall asset size. The agreed upon language of the
enforcement action also (without prior written approval of the OTS): prohibits
any increase in the Savings Bank's total assets during any quarter in excess of
an amount equal to net interest credited on deposit liabilities during the
quarter; and prohibits the purchase or origination of new loans other than
single-family residential mortgage loans, credit card loans and over draft lines
of credit. The Board of Directors has already taken action to alleviate many of
the issues raised by the OTS and has formalized plans, policies and procedures
concerning the Savings Bank's internal audit function, overall lending programs,
including loan administration, and refined its Allowance for Loan and Lease
Losses ("ALLL") policy and practices. In addition to the operating restrictions
previously imposed on the Savings Bank, as a result of the findings contained in
the Savings Bank ROE, the Savings Bank has developed and implemented policies
and procedures to: i) ensure compliance with its loans to one borrower
limitation; ii) address its classified assets; iii) monitor its interest rate
risk; and iv) ensure continued accurate thrift financial reports. Furthermore,
the Savings Bank has agreed not to accept, renew or roll over any brokered
deposits without the prior consent of the OTS. Beginning no later than fourth
quarter 2001, management of the
9
Savings Bank had already initiated a plan not to renew maturing brokered
deposits. Additionally, the agreed upon action provides for an independent loan
review of the Saving Bank's construction, commercial real estate, commercial,
direct lease financing and broker purchase/repurchase lending programs. Such
independent loan review is in its final stages. Of additional note, the Savings
Bank will continue to utilize its Board of Directors Joint Oversight Committee
for the purpose of reviewing and approving new lending and investment
initiatives. To date, the Savings Bank is in full material compliance with the
provisions of the agreed upon enforcement action. In addition, selected
provisions of the mutually agreed upon enforcement action have been modified, or
activities approved, by the OTS at the express request of the Savings Bank.
On May 20, 2002, the OTS and FDIC began a joint Field Visit examination in
preparation for a joint risk-focused examination of the Savings Bank. According
to the OTS/FDIC regulators, the purpose of the Field Visit was, in part, to
obtain an initial assessment of the asset quality and capital levels of the
Savings Bank to determine the effectiveness of corrective actions taken by the
Board of Directors and management since the issuance of the Savings Bank ROE,
and establish the scope for the full joint risk-focused examination of the
Savings Bank and the Bancorp, each of which commenced on July 1, 2002.
The OTS and FDIC initiated a risk-focused examination of the Savings Bank on
July 1, 2002 focusing on the examination components of capital, assets,
management, earnings, liquidity and sensitivity to interest rate risk, and
represented a continuation of the previous Field Visit. During the course of the
examination, representatives of the Savings Bank, as well as members of the
Board of Directors, met regularly and informally with representatives of both
the OTS and FDIC to address issues, provide informational updates and enhance
the existing avenues of communication that had been previously established.
During the course of the examination, on September 17, 2002, the OTS issued a
letter to the Savings Bank requiring, in part, the Savings Bank to (i) establish
position and loss limits for its available for sale investment portfolio; (ii)
reduce its borrowings under reverse repurchase agreements and margin debt to $0
and discontinue their use other than the permitted use of reverse repurchase
agreements up to $10 million for liquidity purposes; (iii) reduce its investment
in a pass through investment mutual fund to a predetermined percentage; (iv)
suspend its trading portfolio; and (v) revise its Investment Policy accordingly.
Also during the examination, the OTS and FDIC, in part, raised and discussed
with management concerns over the Savings Bank's staffing levels, overall level
of expenses, long-term earnings potential and the effect of earnings on the
Savings Bank's long-term capital position. Any issues identified by the OTS and
FDIC examiners during the course of the July 1, 2002 examination were addressed,
and appropriate action was taken by the Savings Bank, or is currently being
taken by the Savings Bank's management in consultation with the OTS. The July 1,
2002 examination of the Savings Bank culminated in a routine exit meeting with
representatives from the Savings Bank, OTS and FDIC.
Also on July 1, 2002, the OTS commenced a risk-focused examination of the
Bancorp, focusing primarily of the Bancorp's financial condition and represented
a continuation of the previous Field Visit. As with the Savings Bank
examination, members of the Bancorp's management team, as well as members of the
Board of Directors, met regularly and informally with representatives of the OTS
to address issues, provide informational updates and enhance the existing
avenues of communication previously established. During the examination, the OTS
discussed its concerns with management regarding issues including, but not
limited to, earnings, its leverage position, investment strategies, liquidity
and capital. Any issues raised by OTS during the examination were addressed
during the examination by management and continue to be of primary focus by the
Board of Directors. The July 1, 2002 examination culminated in a routine exit
meeting with representatives from the Bancorp and OTS, as well as
representatives from the FDIC.
As part of the continuing regulatory spirit of cooperation and the mutual desire
for future success, both the Bancorp and the Savings Bank are providing reports
to, and consulting with, the OTS on all matters addressed under the agreed upon
enforcement actions and issues raised during the aforementioned examinations.
During November 2002, the Board of Directors of the Bancorp and Savings Bank
approved plans for increasing
10
capital levels at both the Bancorp and Savings Bank as well as a business plan
at the Savings Bank level which outlined the future operating strategies of the
Savings Bank to achieve the targeted capital levels along with providing the
framework for achieving profitability. The plans were delivered to the OTS for
their review and approval. To achieve the targeted capital levels and
profitability levels, the business plan of the Savings Bank highlighted the
following actions: (1) reduction of total assets to $250 million by March 31,
2003, to be achieved through the reduction of deposits by the selling of the
Savings Bank's branch deposits and operations, rate reductions and the early
redemption of brokered deposits with corresponding decreases in loans and
investments; (2) the elimination of certain lending programs; (3) a
restructuring of the Savings Bank's statement of financial condition to achieve
the desired mix of interest earning assets and interest bearing liabilities; (4)
staff and management reductions; (5) consolidation of personnel into one
facility to achieve overhead reductions and economies of scale; (6) reductions
in general and administrative expenses; and (7) capital infusions from the
Bancorp. The increase in capital levels at the Bancorp is to be achieved through
capital infusions from current principal shareholders and potential third party
investors.
On February 28, 2003, the Savings Bank withdrew its business plan previously
submitted to the OTS. On March 24, 2003, the Board of Directors submitted a
revised Savings Bank business plan to the OTS for their review and nonobjection.
The revised business plan includes significant further reductions of total
assets by December 31, 2003. To achieve the revised business plan balance sheet
reductions, the Savings Bank and the Company will continue to identify
additional assets to be held for sale. Based on the Savings Bank's initial
analysis, the fair value of assets to be held for sale exceeds the book value.
NOTE C - PREMISES AND EQUIPMENT HELD FOR SALE
As of March 31, 2003 and December 31, 2002, premises and equipment held for sale
totaled $5.0 million and $5.4 million, respectively. During June 2002, the
Savings Bank classified its investment in an office building as held for sale
and, as such, it is being carried at the lower of cost or fair value. This
building was purchased in April 2001 as a branch location for the Savings Bank.
As of March 31, 2003, the net book value of this office building was $4.6
million. During the three month period ended March 31, 2003, occupancy and
equipment expense was reduced by approximately $109,000 related to rental income
from the building and included approximately $68,000 of expenses from the
building. In addition, as of March 31, 2003 and December 31, 2002, the Savings
Bank classified $415,000 and $835,000 of land, leasehold improvements, furniture
fixtures and equipment located in its branch and corporate office locations as
held for sale. During the first quarter 2003, the Savings Bank sold $420,000 of
leasehold improvements and furniture fixtures and equipment related to the sale
of one of its branch locations as discussed more fully in Note F -- Deposits and
the consolidation the Company's corporate locations as discussed below. The
sales occurred at net book value which approximated fair market value.
On March 31, 2003, the two principal shareholders of the Company entered into an
agreement with the Company and third party owner of one of the Company's
corporate locations to assume the obligation under this lease. The transfer of
the lease obligations to the principal shareholders allowed the Company to
reverse the deferred gain and record additional paid-in capital in the amount of
$987,000 related to this corporate location as of March 31, 2003. In conjunction
with this lease assumption the two principal shareholders purchased
approximately $200,000 of leasehold improvements at this corporate location
which was funded by a loan by the Savings Bank secured by common stock of an
unrelated entity. The fair value of the leasehold improvements approximated the
net book value and the terms of the loan were consistent with the Savings Bank's
commercial secured loan terms.
The March 31, 2003 balance of land, leasehold improvements, furniture, fixtures
and equipment held for sale relate to the branch sold during April 2003 and the
further consolidation of the Company's corporate locations. The Company
currently anticipates that new tenants for its corporate locations would also
acquire the land, leasehold improvements, furniture and fixtures at these
locations. Accordingly, the Company has recorded no impairment charges for these
assets as of March 31, 2003.
11
NOTE D - PREMISES AND EQUIPMENT
As of March 31, 2003 and December 31, 2002 premises and equipment, net, totaled
$11.7 million and $13.5 million. During the first quarter 2003, the Savings Bank
entered into and closed on the sale of $1.1 million of automated teller machines
(ATMs) which were removed from the locations of a retailer who declared
bankruptcy. The ATM's were sold at net book value to the Saving Bank's joint
venture partner in its ATM network.
NOTE E - LOANS HELD FOR SALE
As of March 31, 2003, loans held for sale consisted of recently originated
one-to-four family mortgage loans totaling $550,000 and $16.8 million of
commercial and commercial real estate loans which the Company has identified as
held for sale in conjunction with the Company's business plan as described
further in Note B - Regulatory Compliance and Business Plan. Based on the bid
prices received, anticipated gains on these sales are not expected to be
significant to future operations.
As of December 31, 2002, loans held for sale totaled $20.4 million and consisted
of $2.1 million of one-to-four family mortgage loans and $17.7 million of
commercial and commercial real estate loans which the Company has identified as
held for sale in conjunction with the Company's business plan and $647,000 of
loans under the purchase repurchase program. During the third quarter of 2002,
the Company decided to cease its lending activity under the purchase repurchase
program as a result of regulatory dissatisfaction with, and criticisms of, the
program and considering the profitability of the program. The termination of the
purchase repurchase loan program was completed in January 2003. During the first
quarter the Company completed the sale of the $2.0 million of one-to-four family
mortgage loans. Based on the sales prices received the actual gains on these
sales were not significant to operations.
NOTE F - DEPOSITS
Deposits totaled $230.9 million and $282.0 million as of March 31, 2003 and
December 31, 2002, respectively. As previously disclosed in the Company's Annual
Report to Shareholders and as discussed in Note B -- Regulatory Compliance and
Business Plan, the Savings Bank is reducing deposits by selling the Savings
Bank's branch deposits and operations, rate reductions and the early redemption
of brokered deposits. The Savings Bank completed the redemption of brokered
deposits during 2002. On January 31, 2003, the Savings Bank executed a Branch
Sale Agreement to sell its branch office in Chicago, Illinois ("Madison branch")
with approximately $8.5 million in deposits on the date of sale. On January 24,
2003, the Savings Bank entered into a separate Branch Purchase and Assumption
Agreement to sell its other branch office located in Dolton, Illinois ("Dolton
branch") with approximately $20.2 million in deposits on the date of sale. Both
contracts included the sale of leasehold improvements and furniture, fixtures
and equipment at the locations along with the assumption of the building's lease
obligations. The sale of the Madison branch closed March 28, 2003 and the Dolton
branch closed April 26, 2003. During March 2003, the Savings Bank recorded a
gain on the Madison branch sale of $407,000, including recognition of the
deferred gain on the branch building sold in a prior year. The Savings Bank
recorded an additional gain of $1.1 million, including recognition of the
deferred gain on the branch building, in April 2003 when the Dolton branch sale
closed.
In connection with the sale of such branch offices, the Savings Bank filed an
application with the OTS for the redesignation of its home and branch office to
the River North area of Chicago, Illinois ("Huron"). Such application was
approved by the OTS on February 24, 2003. The Huron home office relocation as
well as the branch opening was effective April 17, 2003.
12
NOTE G - BORROWINGS AND JUNIOR SUBORDINATED DEBT
Borrowings totaled $13.4 million and $22.3 million as of March 31, 2003 and
December 31, 2002, respectively while Junior Subordinated Debt totaled $17.1
million as of March 31, 2003 and December 31, 2002.
As previously disclosed in the Company's Annual Report to Shareholders and as
discussed in Note B -- Regulatory Compliance and Business Plan, the following
transactions have taken place during the first quarter 2003.
On March 31, 2003 the Bancorp paid-off a $4.3 million note payable to a third
party with the proceeds from cash contributions from the Company's two principal
shareholders. The note payable was secured by all the common stock of the
Savings Bank. During January and February the Company paid-off a $2.0 million
note payable with the proceeds from the sale of an available-for-sale security
and capital contributions from the Company's two principal shareholders. On
February 28, 2003, the Savings Bank paid-off a $2.8 million Federal Home Loan
Bank Advance due April 20, 2003. The Savings Bank incurred a penalty of $17,600
related to this transaction. After these transactions, borrowed money totaled
$13.4 million at March 31, 2003 and consisted of the following:
Balance
March 31, 2003
Maturity (In thousands)
-------- --------------
Advance from Federal Home Loan
Bank of Chicago 11/25/06 $ 10,000
Subordinated debentures 12/08/11 3,000
Note payable Demand 295
Margin accounts Open line 80
------------
$ 13,375
Additionally, during 1998 the Company issued 11% junior subordinated debentures
aggregating $17,784,000 to Argo Capital Trust Company (Trust). The Trust issued
11% capital securities with an aggregate liquidation amount of $17,250,000 ($10
per capital security) to third-party investors. The capital securities and cash
are the sole assets of the Trust. The junior subordinated debentures are
includable as Tier I capital for regulatory capital purposes. The junior
subordinated debentures and the capital securities pay dividends and
distributions, respectively, on a quarterly basis, which are included in
interest expense.
The Trust is a statutory business trust formed under the laws of the State of
Delaware and its common stock is wholly owned by the Company. The junior
subordinated debentures will mature on November 6, 2028, at which time the
capital securities must be redeemed. The junior subordinated debentures and
capital securities can be redeemed contemporaneously, in whole or in part,
beginning November 6, 2003 at a redemption price of $10 per capital security.
The Company has provided a full and unconditional guarantee of the obligations
of the Trust under the capital securities in the event of the occurrence of an
Event of Default, as defined. Debt issuance costs totaling $1,913,000 were
capitalized related to the debenture offering and are being amortized over the
30-year life of the junior subordinated debentures.
In 2000, Argo Redemption was formed for the purpose of repurchasing a portion of
the 11% capital securities. As of March 31, 2003 and December 31, 2002 Argo
Redemption held 12,700 shares of the 11% capital securities at a cost basis of
$127,000. The 11% capital securities can be resold.
On February 27, 2003 the Company announced its intention to repurchase from time
to time in open market as well as privately negotiated transactions shares of
the Trust's 11% securities, which trade under the symbol "ATP_P" on the American
Stock Exchange. The present authorization does not impose any specific limit on
the
13
number of Trust securities which may be repurchased, and is being undertaken in
order to reduce debt and debt-like obligations as required by the capital plan
as discussed in Note B -- Regulatory Compliance and Business Plan. The
continuing payment on the Trust securities is dependent on the Company's
continuing ability to make payments on the subordinated debenture it issued to
the Trust in connection with the 1998 public offering. In the absence of prior
written approval, the Savings Bank is currently precluded from making dividend
payments to the Company under mutual agreement with the OTS. Consequently, no
assurance can be made that the Company will continue to make dividend payments
on the Trust securities. In the event that shares are repurchased and retired,
the Company will accelerate the amortization of the debt issuance costs
attributable to each security.
NOTE H - EARNINGS (LOSS) PER SHARE
The following table sets forth the components of basic and diluted earnings
(loss) per share. Basic and diluted loss per share are the same for 2003 and
2002, as diluted loss per share would be anti-dilutive.
Three Months Ended
-------------------------
March 31,
-------------------------
2003 2002
---------- ----------
Dollar and shares in
thousands,
except per share data
Numerator
Net loss $ (2,201) $ (561)
========== ==========
Denominator
Basic loss per share -
weighted average shares outstanding 1,759 1,709
Effect of dilutive stock options outstanding
- -
---------- ----------
Diluted loss per share -
weighted average shares outstanding
1,759 1,709
========== ==========
Basic loss per share $ (1.25) $ (0.33)
========== ==========
Diluted loss per share $ (1.25) $ (0.33)
========== ==========
NOTE I - CAPITAL TRANSACTIONS
On March 31, 2003, the Bancorp made a $1.5 million cash contribution to the
Savings Bank in order to increase the Savings Bank's capital ratios.
For the period January 1, 2003 to March 31, 2003, the Company received from
three of its principal shareholders cash totaling $7,547,000 for 6,065 shares of
Series A Preferred Stock ($6,065,000), 118,134 shares of common stock ($446,000)
related to the exercise of stock options, and $1,036,000 for available-for-sale
securities at the higher of fair market value or amortized cost.
For the period January 1, 2003 to March 31, 2003 the Company recorded in
additional paid-in-capital $987,000
14
related to the assumption of the Company's lease obligation on one of its
corporate locations by the Company's two principal shareholders and $357,000
related to the purchase of available-for-sale securities by the Company's two
principal shareholders at an amount which exceeded fair value.
For the period April 1, 2003 to May 15, 2003 the Company received from several
Directors and a shareholder cash totaling $200,000 for 18,000 shares of Series A
Preferred Stock ($180,000) and 4,000 shares of common stock ($20,000) related to
the exercise of stock options.
NOTE J - REGULATORY CAPITAL REQUIREMENTS
Pursuant to the Financial Institutions Reform, Recovery and Enforcement Act of
1989 ("FIRREA"), savings institutions must meet three separate minimum capital
requirements. There are no similar minimum capital requirements for thrift
holding companies. The following tables summarize, as of March 31, 2003 and
December 31, 2002, the Savings Bank's actual capital amounts and ratios.
As of March 31, 2003 and December 31, 2002, the Savings Bank was well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Savings Bank must maintain total
risk-based, Tier I risk-based, Tier I leverage, and tangible capital ratios as
set forth in the following table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
March 31, 2003 Amount Ratio Amount Ratio Amount Ratio
============== ------ ------ ------ ----- ------ -----
(Dollars in Thousands)
Total Capital
(to Risk Weighted Assets)
Savings Bank $23,989 16.33% $11,750 8.00% $14,688 10.00%
Tier I Capital
(to Risk Weighted Assets)
Savings Bank $19,266 13.12% $ 5,875 4.00% $ 8,812 6.00%
Tier I Capital
(to Adjusted Assets)
Savings Bank $19,266 7.10% $10,856 4.00% $13,570 5.00%
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
================= ------ ------ ------ ----- ------ -----
(Dollars in Thousands)
Total Capital
(to Risk Weighted Assets)
Savings Bank $24,226 13.61% $14,245 8.00% $17,806 10.00%
Tier I Capital
(to Risk Weighted Assets)
Savings Bank $19,047 10.70% $ 7,122 4.00% $10,684 6.00%
Tier I Capital
(to Adjusted Assets)
Savings Bank $19,047 5.76% $13,227 4.00% $16,533 5.00%
15
NOTE K - COMMITMENTS AND CONTINGENCIES
At March 31, 2003, the Savings Bank had funding commitments totaling $8.5
million. These commitments include $5.8 million for unused lines of credit,
$878,000 for the unfunded portion of construction loans, and $1.8 million for
commitments to originate loans. Commitments to fund loans and lines of credit
have credit risk essentially the same as that involved in extending loans to
customers and are subject to the Savings Bank's normal credit policies.
On March 31, 2003 the Savings Bank funded early its Community Reinvestment Act
(CRA) investment commitments to the Chicago Equity Fund and Community Investment
Corporation of $1.2 million and $216,000, respectively. These commitments were
originally to be funded over nine and five years, respectively. The Savings Bank
has an investment commitment of $51,000 to be funded over two years for
investment in the Kedzie Limited Partnership.
NOTE L - STOCK COMPENSATION
The Company applies APB Opinion No. 25 in accounting for the stock option plans
and, accordingly, compensation cost based on the fair value at grant date has
not been recognized for its stock options in the consolidated financial
statements. Had the Company determined compensation cost based on the fair value
at the grant date for its stock options under SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net loss would have been reduced to the
pro forma amounts indicated below:
2003 2002
---- ----
Net loss
As reported $ (2,201) $ (561)
Pro forma (2,210) (570)
Loss per share
Basic loss per share as reported $ (1.25) $ (.33)
Pro forma basic loss per share (1.26) (.33)
Diluted loss per share as reported $ (1.25) $ (.33)
Pro forma diluted loss per share (1.26) (.33)
16
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995 and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors that could have a material adverse affect on the
operations and future prospects of the Company and its subsidiary include, but
are not limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or securities portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area, the Company's implementation of new technologies, the
Company's ability to develop and maintain secure and reliable electronic
systems, accounting principles, policies and guidelines, and limitations imposed
on the Savings Bank's operations as a result of the agreed upon enforcement
action described in the "Regulatory Compliance" section of "Management's
Discussion and Analysis of Financial Condition and Results of Operations." These
risks and uncertainties should be considered in evaluating forward-looking
statements, and undue reliance should not be placed on such statements. Further
information concerning the Company and its business, including additional
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission
including the Company's Form 10-K for the year ended December 31, 2002.
OVERVIEW
Umbrella Bancorp, Inc. ("Umbrella Bancorp" or "Company") is a unitary savings
and loan holding company and is registered as such with the Office of Thrift
Supervision ("OTS"), Federal Deposit Insurance Corporation ("FDIC") and the
Securities and Exchange Commission ("SEC"). The Company's business activities
currently consist of ownership of UmbrellaBank, fsb, ("UmbrellaBank" or "Savings
Bank"), and investments in other equity and debt securities. The Company is a
Federal Housing Authority ("FHA") approved originator and servicer and an
approved Federal National Mortgage Association ("Fannie Mae") servicer.
In October of 1998, the Company formed Argo Capital Trust Co. ("Argo Capital
Trust"), a statutory business trust formed under the laws of the State of
Delaware. In November 1998, the Company and Argo Capital Trust offered 11%
Capital Securities with a liquidation amount of $10.00 per security. The
proceeds from the offering were $17,250,000. Argo Capital Trust used the gross
proceeds from the sale of the Capital Securities to purchase Junior Subordinated
Debentures of the Company. The Junior Subordinated Debentures carry an interest
rate of 11% paid quarterly in arrears and are scheduled to mature, subject to
the Company's right to prepay the debentures under certain circumstances, on
November 6, 2028.
On June 24, 2000, the Company incorporated a wholly owned subsidiary, Argo
Redemption Corporation, an Illinois corporation ("ARC"). ARC was chartered to
effectuate, from time to time, purchases of the Company's outstanding Capital
Securities by tender, in the open market or by private agreement. Acquisitions
through the over-the-counter dealer market are anticipated to comprise the
majority of purchase activity. As of March 31, 2003, ARC held 12,700 shares of
Argo Capital Trust Preferred securities with a cost basis of $127,000.
On February 27, 2003 the Company announced its intention to repurchase from time
to time in open market as well as privately negotiated transactions shares of
the Trust's 11% securities, which trade under the symbol
17
"ATP_P" on the American Stock Exchange. The present authorization does not
impose any specific limit on the number of Trust securities which may be
purchased, and is being undertaken in order to reduce debt and debt-like
obligations as required by the capital plan as discussed following in the
"Regulatory Compliance" and "Business Plan" sections. The continuing payment on
the Trust securities is dependent on the Company's continuing ability to make
payments on the subordinated debenture it issued to the Trust in connection with
the 1998 public offering. In the absence of prior written approval, the Savings
Bank is currently precluded from making dividend payments to the Company under
mutual agreement with the OTS. Consequently, no assurance can be made that the
Company will continue to make dividend payments on the Trust securities.
UmbrellaBank is a federally chartered savings institution. The Savings Bank
operates under the authority of the OTS, its deposits are insured by the FDIC,
and it is a member of the Federal Home Loan Bank ("FHLB") System. UmbrellaBank's
primary business is the solicitation of savings deposits from the general
public, and the purchase or origination of loans secured by one-to-four-family
residential and commercial real estate, together with investments in a portfolio
of mortgage mutual funds, mortgage backed securities, municipal bonds and other
agency securities. UmbrellaBank's retail banking operations have been conducted
from two traditional branch facilities, as well through an Internet banking
channel operating under the name umbrellabank.com. Effective April 26, 2003 the
Savings Bank had one branch facility. At March 31, 2003, umbrellabank.com
deposits totaled $208.2 million and represented 90.1% of total Saving Bank
deposits of $230.9 million.
Additionally, UmbrellaBank, with its joint venture partner, operates a network
of approximately 1,500 ATM machines in 18 states. The Savings Bank generates
interest and fee income from a network of regionally deployed ATMs. Deployment
activities have been concentrated primarily in the Midwest and Mid-Atlantic
regions of the country, with limited expansion in the southeastern United States
and west of the Mississippi. Revenues are derived from interchange and surcharge
fees, together with income from related leasing and interest on currency used in
operations.
During 2003 and in conjunction with its business plan, the Savings Bank intends
to originate, purchase and sell fixed-rate and adjustable-rate mortgage loans
secured by one-to-four family residences. To a lesser extent, the Savings Bank
plans to originate real estate secured commercial loans (subject to regulatory
approval), home equity loans, and other consumer loans, including consumer
credit card facilities through the umbrellabank.com Internet channel.
The Savings Bank's results of operations are dependent primarily on net interest
income, which is the difference between the interest earned on its loan and
security portfolios, and the interest paid on deposits and borrowed funds. The
Savings Bank's operating results are also affected by provisions for loan
losses, loan servicing fees, customer service charges and fees, fees from ATM
operations, gains (losses) on the sale of securities, loans and other assets and
other income. Operating expenses of the Savings Bank include employee
compensation and benefits, equipment and occupancy costs, outsourced servicing
expenses, federal deposit insurance premiums, professional fees and other
general and administrative expenses. The Savings Bank's results of operations
are further affected by economic and competitive conditions, particularly
changes in market interest rates. Results are also affected by monetary and
fiscal policies of federal agencies and actions of regulatory authorities.
During 2002 and continuing into 2003, the implementation of certain initiatives
under the business plan have had and are anticipated to continue to have a
significant effect on the total assets and lending, investing and retail
operations of the Savings Bank and the Company. During 2002, total assets of the
Savings Bank decreased $186.6 million from $521.8 million to $335.2 at December
31, 2001 and 2002, respectively. Consolidated assets of the Company decreased
$192.7 million from $536.6 million to $343.9 million at December 31, 2001 and
2002, respectively. During the first quarter of 2003, total assets of the
Savings Bank decreased $58.4 million from $335.2 million to $276.8 million at
December 31, 2002 and March 31, 2003, respectively. Consolidated assets of the
Company decreased $59.9 million from $343.9 million to $284.0 million at
December 31, 2002 and March 31, 2003, respectively.
18
REGULATORY COMPLIANCE
As previously disclosed in the Company's 2002 Annual Report to Shareholders, the
OTS commenced risk-focused safety and soundness examinations of the Savings Bank
and the Bancorp on October 29, 2001 and November 14, 2001, respectively. Each
OTS Report of Examination ("ROE"), which was primarily based on financial
information as of September 30, 2001, was transmitted to the Savings Bank and
Bancorp, respectively, in March 2002.
The November 14, 2001 Holding Company Report of Examination ("Bancorp ROE") was
not limited to any one area, but focused on the risk factors of Transactions
with Affiliates, Funds Distribution, Financial Effect and Management Quality.
During the course of the OTS examination, the Bancorp addressed the specific
regulatory violations identified, and developed and implemented policies and
procedures to ensure future regulatory compliance. The OTS commented in the
Bancorp ROE on the Bancorp's level of operating losses, debt service
requirements and capital position. As a result of the findings contained in the
Bancorp ROE, the Bancorp was required to provide OTS with a quarterly financial
cash flow projection report and quarterly monitoring reports. The Bancorp was
also required to take actions to ensure future regulatory compliance, and take
actions sufficient to ensure safe and sound operations. In addition, the Bancorp
was placed under various operating restrictions, including a requirement that
the Bancorp file notice with the OTS prior to adding or replacing a director or
hiring a senior executive officer. The Bancorp was also restricted in making
"golden parachute" payments to any institution-affiliated party unless
authorized by regulation. The Bancorp has been, and is currently in compliance
with the requirements set forth by the OTS, as a result of the findings
contained in the Bancorp ROE.
The October 29, 2001, Report of Examination of the Savings Bank ("Savings Bank
ROE") focused on Capital Adequacy, Asset Quality, Management, Earnings,
Liquidity and Sensitivity to Market Risk. The OTS identified various regulatory
deficiencies resulting, in part, in supervisory imposed operating restrictions
on growth and lending activities, as well as restrictions on capital
distributions, contracts, "golden parachute" payments and changes in senior
executive positions. In addition, the Savings Bank was required to provide
reports to the OTS detailing corrective actions taken, identification of
policies and procedures adopted and implemented to remedy areas of criticism and
ensure future regulatory compliance. Management and the Board of Directors
responded to the Savings Bank ROE, and provided OTS with either assurance of
compliance with the material exceptions noted in the Savings Bank ROE or the
current status of efforts to correct matters requiring on-going remediation.
Upon completion of the November 14, 2001 Bancorp ROE and October 29, 2001
Savings Bank ROE, management officials and the Boards of Directors of both the
Bancorp and the Savings Bank engaged in active discussions with the OTS to
develop a mutually agreeable business framework designed to strengthen the
regulatory foundation of the Bancorp and the Savings Bank. As a result, in the
spirit of regulatory cooperation, the Boards of Directors of both the Bancorp
and the Savings Bank, without admitting or denying that such grounds exist, or
the accuracy of the OTS findings, opinions and/or conclusions, separately agreed
to enforcement actions that became effective on August 16, 2002.
The provisions of the enforcement action between the Bancorp and OTS
established, in principal part, that the Bancorp provide the OTS with a plan for
raising additional common equity capital and restructuring outstanding debt at
the Bancorp, recognizing that economic and market conditions are outside of the
control of the Bancorp. In addition to the operating restrictions previously
placed on the Bancorp by the OTS, pursuant to the November 14, 2001 Bancorp ROE,
the agreed upon action required the Bancorp to provide the OTS with quarterly
cash flow projections for the purpose of identifying the Bancorp's sources and
uses of funds for the remainder of fiscal 2002, fiscal 2003 and fiscal 2004. The
subject enforcement action also provides that the Bancorp ensure that all
transactions with affiliates comply with applicable statutory and regulatory
requirements and that the Bancorp maintain documentation sufficient to evidence
such compliance. To date, the Bancorp is in full material compliance with the
provisions of the agreed upon enforcement action.
19
The agreed upon language in the enforcement action between the Savings Bank and
the OTS provided, in principal part, for the establishment of a plan addressing
the level of the Savings Bank's fixed assets, as well as the adoption and
implementation of a capital plan for the establishment and maintenance of
acceptable capital levels. On March 24, 2003, the Savings Bank submitted to the
OTS a revised business plan which replaces the Savings Bank's previously filed
business plan, capital plan and staffing plan. The revised business plan details
the Savings Bank's overall operating strategies, in light of current economic
conditions, and the intent of the Board of Directors to reformulate and reduce
the Savings Bank's overall asset size. The agreed upon language of the
enforcement action also (without prior written approval of the OTS): prohibits
any increase in the Savings Bank's total assets during any quarter in excess of
an amount equal to net interest credited on deposit liabilities during the
quarter; and prohibits the purchase or origination of new loans other than
single-family residential mortgage loans, credit card loans and over draft lines
of credit. The Board of Directors has already taken action to alleviate many of
the issues raised by the OTS and has formalized plans, policies and procedures
concerning the Savings Bank's internal audit function, overall lending programs,
including loan administration, and refined its Allowance for Loan and Lease
Losses ("ALLL") policy and practices. In addition to the operating restrictions
previously imposed on the Savings Bank, as a result of the findings contained in
the Savings Bank ROE, the Savings Bank has developed and implemented policies
and procedures to: (i) ensure compliance with its loans to one borrower
limitation; (ii) address its classified assets; (iii) monitor its interest rate
risk; and (iv) ensure continued accurate thrift financial reports. Furthermore,
the Savings Bank has agreed not to accept, renew or roll over any brokered
deposits without the prior consent of the OTS. Beginning no later than fourth
quarter 2001, management of the Savings Bank had already initiated a plan not to
renew maturing brokered deposits. Additionally, the agreed upon action provides
for an independent loan review of the Saving Bank's construction, commercial
real estate, commercial, direct lease financing and broker purchase/repurchase
lending programs. Such independent loan review is in its final stages. Of
additional note, the Savings Bank will continue to utilize its Board of
Directors Joint Oversight Committee for the purpose of reviewing and approving
new lending and investment initiatives. To date, the Savings Bank is in full
material compliance with the provisions of the agreed upon enforcement action.
In addition, selected provisions of the mutually agreed upon enforcement action
have been modified, or activities approved, by the OTS at the express request of
the Savings Bank.
On May 20, 2002, the OTS and FDIC began a joint Field Visit examination in
preparation for a joint risk-focused examination of the Savings Bank. According
to the OTS/FDIC regulators, the purpose of the Field Visit was, in part, to
obtain an initial assessment of the asset quality and capital levels of the
Savings Bank to determine the effectiveness of corrective actions taken by the
Board of Directors and management since the issuance of the Savings Bank ROE,
and establish the scope for the full joint risk-focused examination of the
Savings Bank and the Bancorp, each of which commenced on July 1, 2002.
The OTS and FDIC initiated a risk-focused examination of the Savings Bank on
July 1, 2002 focusing on the examination components of capital, assets,
management, earnings, liquidity and sensitivity to interest rate risk, and
represented a continuation of the previous Field Visit. During the course of the
examination, representatives of the Savings Bank, as well as members of the
Board of Directors, met regularly and informally with representatives of both
the OTS and FDIC to address issues, provide informational updates and enhance
the existing avenues of communication that had been previously established.
During the course of the examination, on September 17, 2002, the OTS issued a
letter to the Savings Bank requiring, in part, the Savings Bank to i) establish
position and loss limits for its available-for-sale investment portfolio; ii)
reduce its borrowings under reverse repurchase agreements and margin debt to $0
and discontinue their use other than the permitted use of reverse repurchase
agreements up to $10 million for liquidity purposes; iii) reduce its investment
in a pass through investment mutual fund to a predetermined percentage; iv)
suspend its trading portfolio; and v) revise its Investment Policy accordingly.
Also during the examination, the OTS and FDIC, in part, raised and discussed
with management concerns over the Savings Bank's staffing levels, overall level
of expenses, long-term earnings potential and the effect of earnings on the
Savings Bank's long-term capital position. Any issues identified by the OTS and
FDIC examiners during the course of the July 1, 2002 examination were addressed,
and appropriate action was taken by
20
the Savings Bank, or is currently being taken by the Savings Bank's management
in consultation with the OTS. The July 1, 2002 examination of the Savings Bank
culminated in a routine exit meeting with representatives from the Savings Bank,
OTS and FDIC.
Also on July 1, 2002, the OTS commenced a risk-focused examination of the
Bancorp, focusing primarily of the Bancorp's financial condition and represented
a continuation of the previous Field Visit. As with the Savings Bank
examination, members of the Bancorp's management team, as well as members of the
Board of Directors, met regularly and informally with representatives of the OTS
to address issues, provide informational updates and enhance the existing
avenues of communication previously established. During the examination, the OTS
discussed its concerns with management regarding issues including, but not
limited to, earnings, its leverage position, investment strategies, liquidity
and capital. Any issues raised by OTS during the examination were addressed
during the examination by management and continue to be of primary focus by the
Board of Directors. The July 1, 2002 examination culminated in a routine exit
meeting with representatives from the Bancorp and OTS, as well as
representatives from the FDIC.
As part of the continuing regulatory spirit of cooperation and the mutual desire
for future success, both the Bancorp and the Savings Bank are providing reports
to, and consulting with, the OTS on all matters addressed under the agreed upon
enforcement actions and issues raised during the aforementioned examinations.
BUSINESS PLAN
During November 2002, the Board of Directors of the Bancorp and Savings Bank
approved plans for increasing capital levels at both the Bancorp and Savings
Bank as well as a business plan at the Savings Bank level which outlined the
future operating strategies of the Savings Bank to achieve the targeted capital
levels along with providing the framework for achieving profitability. The plans
were delivered to the OTS for their review and approval. To achieve the targeted
capital levels and profitability levels the business plan of the Savings Bank
highlighted the following actions; (1) reduction of total assets to $250 million
by March 31, 2003, to be achieved through the reduction of deposits by the
selling of the Savings Bank's branch deposits and operations, rate reductions
and the early redemption of brokered deposits with corresponding decreases in
loans and investments; (2) the elimination of certain lending programs; (3) a
restructuring of the Savings Bank's statement of financial condition to achieve
the desired mix of interest earning assets and interest bearing liabilities; (4)
staff and management reductions; (5) consolidation of personnel into one
facility to achieve overhead reductions and economies of scale; (6) reductions
in general and administrative expenses; and (7) capital infusions from the
Bancorp. The increase in capital levels at the Bancorp is to be achieved through
capital infusions from current principal shareholders and potential third party
investors.
On February 28, 2003, the Savings Bank withdrew its business plan previously
submitted to the OTS. On March 24, 2003 the Board of Directors submitted a
revised Savings Bank business plan to the OTS for their review and nonobjection.
The revised business plan includes significant further reductions of total
assets by December 31, 2003. To achieve the revised business plan balance sheet
reductions, the Savings Bank and the Company will continue to identify
additional assets to be held for sale. Based on the Savings Bank's initial
analysis, the fair value of assets to be held for sale exceeds the book value.
FINANCIAL CONDITION
Total assets decreased by $59.9 million to $284.0 million at March 31, 2003,
from $343.9 million at December 31, 2002. Proceeds from the sale of securities
available-for-sale and principal repayments on loans receivable as well as
proceeds from loan sales were used to fund the $51.1 million decrease in
deposits, consisting of $8.5 million related to the sale of the Madison branch
and a decline in other deposit accounts as the Company executes its business
plan as discussed previously. Borrowed money also decreased by $8.9 million at
March 31, 2003, as compared to December 31, 2002, which was funded by the
proceeds of available for sale securities and
21
contributions from the Company's two principal shareholders.
Interest-earning deposits decreased $23.4 million during the three months ended
March 31, 2003 to $46.4 million due to a $10.3 million decrease in ATM cash and
a $13.1 million decrease in other interest earning deposits. Interest-earning
deposits at March 31, 2003 includes $16.9 million of ATM cash, on which the
Savings Bank earns a return of 200 basis points over the overnight FHLB rate,
and $29.5 million of other interest earning deposits with an annualized yield of
1.55% at March 31, 2003.
Securities available-for-sale decreased by $15.6 million to $90.0 million at
March 31, 2003 from $105.6 million at December 31, 2002, as the Company utilized
the proceeds of sales of such securities to fund deposit and debt reductions
discussed below.
Loans held for sale decreased $3.0 million to $17.4 million at March 31, 2003
from $20.4 million at December 31, 2002. The decrease is primarily due to the
bulk sale of $2.0 million of one-to-four-family mortgage loans and pay-downs of
approximately $900,000 related to commercial and commercial real estate loans
previously identified as held for sale. As of March 31, 2003, loans held for
sale consisted of recently originated one-to-four family mortgage loans totaling
$550,000 and $16.8 million of commercial and commercial real estate loans which
the Company has identified as held for sale in conjunction with the Company's
business plan as described previously in Business Plan section. Based on the bid
prices received, anticipated gains on these sales are not expected to be
significant to future operations. As discussed in Note E -- Loans Held for Sale,
the termination of the purchase repurchase loan program was completed in January
2003 with the final pay-off of the $647,000 of loans outstanding under the
purchase repurchase program as of December 31, 2002.
Net loans receivable decreased by $15.7 million to $80.3 million at March 31,
2003, from $96.0 million at December 31, 2002, as the funds received from loan
repayments were utilized to fund the deposit and debt reductions discussed
below.
As of March 31, 2003 and December 31, 2002, premises and equipment held for sale
totaled $5.0 million and $5.4 million, respectively. During June 2002, the
Savings Bank classified its investment in an office building as held for sale
and, as such, it is being carried at the lower of cost or fair value. This
building was purchased in April 2001 as a branch location for the Savings Bank.
As of March 31, 2003, the net book value of this office building was $4.6
million. During the three month period ended March 31, 2003, occupancy and
equipment expense was reduced by approximately $109,000 related to rental income
from the building and included approximately $68,000 of expenses from the
building. In addition, as of March 31, 2003 and December 31, 2002, the Savings
Bank classified $415,000 and $835,000 of land, leasehold improvements, furniture
fixtures and equipment located in its branch and corporate office locations as
held for sale. During the first quarter 2003, the Savings Bank sold $420,000 of
leasehold improvements and furniture fixtures and equipment related to the sale
of one of its branch locations as discussed more fully following and the
consolidation the Company's corporate locations as discussed below. The sales
occurred at net book value.
On March 31, 2003, the two principal shareholders of the Company entered into an
agreement with the Company and third party owner of one of the Company's
corporate locations to assume the obligation under this lease. The transfer of
the lease obligations to the principal shareholders allowed the Company to
reverse the deferred gain and record additional paid-in capital in the amount of
$987,000 related to this corporate location as of March 31, 2003. In conjunction
with this lease assumption the two principal shareholders purchased
approximately $200,000 of leasehold improvements at this corporate location
which was funded by a loan from the Savings Bank secured by common stock of an
unrelated entity. The fair value of the leasehold improvements approximated the
net book value and the terms of the loan were consistent with the Savings Bank's
commercial secured loan terms.
The March 31, 2003 balance of land, leasehold improvements, furniture, fixtures
and equipment held for sale relate to the branch sold during April 2003 and the
further consolidation of the Company's corporate locations.
22
The Company currently anticipates that new tenants for its corporate locations
would also acquire the land, leasehold improvements, furniture and fixtures at
these locations. Accordingly, the Company has recorded no impairment charges for
these assets as of March 31, 2003.
Premises and equipment decreased by $1.8 million to $11.7 million at March 31,
2003 from $13.5 million at December 31, 2002. During the first quarter 2003, the
Savings Bank entered into and closed on the sale of $1.1 million of ATMs which
were removed from the locations of a retailer who declared bankruptcy. The ATM's
were sold at net book value to the Saving Bank's joint venture partner in its
ATM network. Net depreciation expense reflected in the statement of operations
is $294,000, which reflects gross depreciation of $825,000 less $531,000
reimbursed to the Company through its ATM partnership activities.
As of March 31, 2003 and December 31, 2002 deferred tax assets totaled $10.5
million and $9.7 million, respectively. Included in these balances are $85,000
and $95,000 related to securities available-for-sale at March 31, 2003 and
December 31, 2002, respectively. The remaining deferred tax asset primarily
consists of the tax effects of bad debt deductions, partnership interests,
Federal Home Loan Bank stock dividends, the remaining deferred gain on a prior
sale of a branch facility, and federal and state net operating loss
carry-forwards. Based on management's projections of future taxable income, no
valuation allowance is recorded against the deferred tax asset.
Prepaid expenses and other assets decreased by $1.1 million to $7.6 million at
March 31, 2003 from $8.7 million at December 31, 2002. This decrease was
primarily the result of the receipt in January 2003 of $800,000 related to the
settlement of certain investment transactions and a general decrease in accounts
receivable as the Company received or settled disputed amounts with vendors
during the first quarter 2003. Included in prepaid expenses and other assets at
March 31, 2003 and December 31, 2002 is $2.7 million related to tax refunds due
from the Internal Revenue Service and Illinois Department of Revenue for
previously filed tax returns and amounts previously paid on prior tax returns
that were claimed when the December 31, 2001 tax returns were filed and will be
claimed when the December 31, 2002 tax returns are filed.
Deposits decreased $51.1 million to $230.9 million at March 31, 2003, from
$282.0 million at December 31, 2002. As previously disclosed in the Company's
Annual Report to Shareholders and as discussed in the previous Business Plan
section the Savings Bank is reducing deposits by selling the Savings Bank's
branch deposits and operations, rate reductions and the early redemption of
brokered deposits. The Savings Bank completed the redemption of brokered
deposits during 2002. On January 31, 2003, the Savings Bank executed a Branch
Sale Agreement to sell its branch office in Chicago, Illinois ("Madison branch")
with approximately $8.5 million in deposits on the date of sale. On January 24,
2003, the Savings Bank entered into a separate Branch Purchase and Assumption
Agreement to sell its other branch office located in Dolton, Illinois ("Dolton
branch") with approximately $20.2 million in deposits on the date of sale. Both
contracts included the sale of leasehold improvements and furniture, fixtures
and equipment at the locations along with the assumption of the building's lease
obligations. The sale of the Madison branch closed March 28, 2003 and the Dolton
branch closed April 26, 2003. During March 2003, the Savings Bank recorded a
gain on the Madison branch sale of $407,000, including recognition of the
deferred gain on the branch building sold in a prior year. The Savings Bank
recorded an additional gain of $1.1 million, including recognition of the
deferred gain on the branch building, in April 2003 when the Dolton branch sale
closed.
In connection with the sale of such branch offices, the Savings Bank filed an
application with the OTS for the redesignation of its home and branch office to
the River North area of Chicago, Illinois ("Huron"). Such application was
approved by the OTS on February 24, 2003. The Huron home office relocation as
well as the branch opening was effective April 17, 2003.
Borrowings decreased by $8.9 million to $13.4 million at March 31, 2003, from
$22.3 million at December 31, 2002. As previously disclosed in the Company's
Annual Report to Shareholders and in conjunction with the
23
Company's business plan the following transactions have taken place during the
first quarter 2003. On March 31, 2003 the Bancorp paid-off a $4.3 million note
payable to a third party with the proceeds from cash contributions from the
Company's two principal shareholders. The note payable was secured by all the
common stock of the Savings Bank. During January and February the Company
paid-off a $2.0 million note payable with the proceeds from the sale of an
available-for-sale security and capital contributions from the Company's two
principal shareholders. On February 28, 2003, the Savings Bank paid-off a $2.8
million Federal Home Loan Bank Advance due April 20, 2003. The Savings Bank
incurred a penalty of $17,600 related to this transaction.
Other liabilities decreased $4.3 million to $1.3 million at March 31, 2003 from
$5.6 million at December 31, 2002. The decrease is primarily attributable to 1)
the Savings Bank funding early its Community Reinvestment Act (CRA) investment
commitments to the Chicago Equity Fund and Community Investment Corporation of
$1.2 million and $216,000, respectively; 2) a $852,000 decrease in deferred gain
on prior facility sales due to the assumption of the Madison branch lease by the
purchaser of the Madison branch and the assumption by the Company's two
principal shareholders of one of the Company's corporate locations lease; 3) a
$100,000 decrease in real estate taxes payable due to the transactions described
in 2) above and 4) a $1.7 million decrease in accounts payable principally
related to the $1.4 million included in accounts payable at December 31, 2002
related to remittances received on loans sold during December 2002 which were
remitted to the purchaser of the loans in 2003 and the Company's concerted
effort to reduce liabilities at March 31, 2003 in accordance with the business
plan.
Stockholders' equity increased $5.7 million to $13.9 million at March 31, 2003
from $8.2 million at December 31, 2002 primarily as a result of 1) the Company
receiving from three of its principal shareholders cash totaling $6,511,000 for
6,065 shares of Series A Preferred Stock ($6,065,000) and 118,134 shares of
common stock ($446,000) related to the exercise of stock options; 2) the
recording of $987,000 in additional paid-in-capital related to the assumption of
the Company's lease obligation on one of its corporate locations by the
Company's two principal shareholders; and 3) the recording of $357,000 in
additional paid-in-capital related to the purchase of available-for-sale
securities by the Company's two principal shareholders at an amount which
exceeded fair value. These increases to stockholders' equity were partially
offset by the recording of a net loss of $2,201,000 for the three months ended
March 31, 2003.
For the period April 1, 2003 to May 15, 2003 the Company received from several
Directors and a shareholder cash totaling $200,000 for 18,000 shares of Series A
Preferred Stock ($180,000) and 4,000 shares of common stock ($20,000) related to
the exercise of stock options.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits, proceeds from principal and
interest payments on the loan and securities available-for-sale portfolios,
custodial deposit accounts related to loans serviced for others, borrowed money;
FHLB advances; and loan and security sales. The most liquid assets are cash and
short-term investments. The levels of these assets are dependent on operating,
financing, and investing activities during any given period. Cash and
interest-earning deposits totaled $49.4 million at March 31, 2003. The Company
has adequate alternative funding sources if short-term liquidity needs arise.
Legislation repealed the OTS minimum liquidity ratio requirements. OTS
regulations now require the Savings Bank to maintain sufficient liquidity to
ensure the Savings Bank's safe and sound operation.
Liquidity management for the Savings Bank is both a daily and long-term function
of the Savings Bank's senior management. Management meets regularly to monitor
interest rates, current and projected commitments to originate/purchase/sell
loans and the likelihood of funding such commitments, monitor deposit flows and
projected cash flows. Excess funds are generally invested in short-term
investments. Cash flow projections are updated regularly to assure necessary
liquidity.
24
At March 31, 2003, the Savings Bank's capital exceeded all capital requirements
of the OTS. The Savings Bank's Tier I capital to adjusted assets, Tier I capital
to risk-weighted assets, and risk-based capital ratios were 7.10%, 13.12%, and
16.33%, respectively.
On March 31, 2003 the Bancorp paid-off a $4.3 million note payable to a third
party with the proceeds from cash contributions from the Company's two principal
shareholders. The note payable was secured by all the common stock of the
Savings Bank. During January and February the Company paid-off a $2.0 million
note payable with the proceeds from the sale of an available-for-sale security
and capital contributions from the Company's two principal shareholders. On
February 28, 2003, the Savings Bank paid-off a $2.8 million Federal Home Loan
Bank Advance due April 20, 2003. The Savings Bank incurred a penalty of $17,600
related to this transaction.
On March 31, 2003, the Bancorp made a $1.5 million cash contribution the Savings
Bank in order to increase the Savings Bank's capital ratios.
For the period January 1, 2003 to March 31, 2003, the Company received from
three of its principal shareholders cash totaling $7,547,000 for 6,065 shares of
Series A Preferred Stock ($6,065,000), 118,134 shares of common stock ($446,000)
related to the exercise of stock options, and $1,036,000 for available-for-sale
securities at the higher of fair market value or amortized cost.
For the period April 1, 2003 to May 15, 2003 the Company received from several
Directors and a shareholder cash totaling $200,000 for 18,000 shares of Series A
Preferred Stock ($180,000) and 4,000 shares of common stock ($20,000) related to
the exercise of stock options.
At March 31, 2003 the Savings Bank had funding commitments totaling $8.5
million. These commitments include $5.8 million for unused lines of credit,
$878,000 for the unfunded portion of construction loans, and $1.8 million for
commitments to originate loans. Commitments to fund loans and lines of credit
have credit risk essentially the same as that involved in extending loans to
customers and are subject to the Savings Bank's normal credit policies.
On March 31, 2003 the Savings Bank funded early its CRA investment commitments
to the Chicago Equity Fund and Community Investment Corporation of $1.2 million
and $216,000, respectively. These commitments were originally to be funded over
nine and five years, respectively. The Savings Bank has an investment commitment
of $51,000 to be funded over two years for investment in the Kedzie Limited
Partnership.
ASSET QUALITY
The Bancorp and the Savings Bank regularly review assets to determine proper
valuation. The allowance for loan losses is maintained at a level determined to
be adequate by management to absorb probable incurred credit losses.
Determination of an appropriate level of allowance for loan losses necessarily
involves a high degree of judgment. Primary considerations in this evaluation
are prior loan loss experience, the character and mix of the loan portfolio,
adverse situations which may affect a borrower's ability to repay, size of the
loan portfolio, peer group information, business and economic conditions and
management's estimate of probable incurred losses. While management uses all
available information, including the monitoring of the economic conditions in
the geographic regions in which the loan portfolio is located, future additions
to the allowance may be necessary based on estimates that are susceptible to
significant revision as a result of changes in economic conditions and other
factors. Additionally, various regulatory agencies, as an integral part of their
examination process, periodically review UmbrellaBank's allowance for loan
losses. Such agencies may require UmbrellaBank to recognize additions to the
allowance based on their judgment of information available to them at the time
of their examination.
25
The Company's consolidated allowance for loan losses at March 31, 2003 was $3.5
million as compared to $4.1 million at December 31, 2002. The allowance for loan
losses as a percentage of consolidated nonperforming loans was 25.5% and 19.9%
at March 31, 2003 and December 31, 2002, respectively. The decline in the
allowance for loan loss is primarily related to charge-offs during the first
quarter 2003.
At March 31, 2003, the Savings Bank had fifty (50) properties, totaling $4.0
million classified as foreclosed real estate, as compared to fifty (52)
properties totaling $2.4 million at December 31, 2002. As of March 31, 2003,
thirteen (13) of the properties totaling $1.3 million were related to the
Savings Bank's purchase of a distressed loan portfolio during 2002. The
portfolio was purchased at a substantial discount with one portion of the exit
strategy being converting the properties to foreclosed real estate and realizing
a return on the ultimate sale. Based on this strategy it is likely that the
Savings Bank's investment in foreclosed real estate will increase in future. The
underlying properties at March 31, 2003 consisted primarily of single-family
residences and included one significant undeveloped land parcel. The foreclosed
real estate has been written down to estimated fair value at March 31, 2003.
The Savings Bank's total amount of loans receivable ninety (90) days or more
past due at March 31, 2003, was $13.2 million or 13.11% of gross loans
receivable compared to $19.9 million or 16.65% of gross loans receivable at
December 31, 2002. The $6.7 million decrease was due to the pay-off of certain
commercial loans previously delinquent, the transfer of loans to foreclosed real
estate and a general improvement in previously delinquent one-to-four family
mortgages. Loans ninety (90) days or more past due are primarily secured by
one-to-four family residences and, for commercial loans, single and multi-family
unit residential property and commercial business assets. During 2003,
management anticipates the nonaccrual loans will be sold or transferred to
foreclosed real estate for their ultimate disposition.
Total non-performing assets, including discounted loans receivable, were $17.2
million or 6.1% of total assets compared to $22.3 million or 6.5% of total
assets at December 31, 2002.
Along with other financial institutions, management shares a concern for the
outlook of the economy during the remainder of 2003. A slow down in economic
activity beginning in 2002 severely impacted several major industries, as well
as the economy as a whole. Even though there are numerous indications of
emerging strength, it is not certain that this strength is sustainable. In
addition, consumer confidence may be negatively impacted by the recent
volatility in equity prices. These events could still adversely affect cash
flows for both commercial and individual borrowers, as a result of which, the
Savings Bank could experience increases in problem assets, delinquencies and
losses on loans.
RESULTS OF OPERATIONS - COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS
ENDED MARCH 31, 2003 AND 2002.
GENERAL
Net loss for the three months ended March 31, 2003 was $2.2 million or ($1.25)
per diluted share as compared to net loss of $561,000 or ($.33) per diluted
share for the corresponding period in 2002. The $1.6 million increase in net
loss was primarily related to the $1.4 million decline in net interest income
and a $520,000 reduced tax benefit due to the accounting for certain
transactions. Both items are discussed below.
INTEREST INCOME
Interest income for the three months ended March 31, 2003 totaled $3.3 million,
as compared to $7.9 million for the comparable 2002 period. The $4.6 million
decrease was primarily the result of a 149 basis point decrease in the tax
equivalent yield on earning assets to 4.91% from 6.40%. Earning asset yields
have declined as a result of re-pricing Prime rate based loans with each change
in the Prime lending rate, as well as a result of the Company's
26
affirmative actions to reduce the amount of assets of the Savings Bank and
Bancorp. In addition, the increase in nonperforming assets during the first
quarter 2003 as compared to the first quarter 2002 had a negative impact on
interest income. The average yield on earning assets was 4.85% at the Savings
Bank and 13.34% at the Bancorp, with a consolidated Company average yield of
4.91% for the three months ended March 31, 2003.
INTEREST EXPENSE
Interest expense for the three months ended March 31, 2002, totaled $2.8 million
as compared to $6.0 million for the comparable 2002 period. The $3.2 million
decrease was primarily the result of a 82 basis point decline in the average
cost of interest-bearing liabilities to 3.79% for the three months ended March
31, 2003 as compared to 4.61% for the same period last year as well as a $213.6
million decrease in deposit accounts as of March 31, 2003 as compared to March
31, 2002. The average cost of interest-bearing liabilities was 3.24% at the
Savings Bank and 10.57% at the Bancorp, with a consolidated Company average cost
of 3.79% for the three months ended March 31, 2003.
Interest-bearing liabilities include $17.1 million of 11.0% junior subordinated
debt, which the Bancorp issued in November, 1998. Interest-bearing liabilities
also include $3.0 million of subordinated debentures issued by the Savings Bank
in November 2001 with an annualized cost of 5.78% for the three months ended
March 31, 2003.
NET INTEREST INCOME
Net interest income for the three months ended March 31, 2003 totaled $503,000
as compared to $1.9 million for the comparable 2002 period. The $1.4 million
decrease was primarily due to a 67 basis point decrease in the net interest
spread to 1.12% as compared to 1.79%. The net interest spread has decreased as
earning asset yields have declined as a result of re-pricing Prime rate based
loans with each change in the Prime lending rate, as well as a result of the
Company's affirmative actions to reduce the amount of assets of the Savings Bank
and Bancorp. In addition, the increase in nonperforming assets during the first
quarter 2003 as compared to the first quarter 2002 had a negative impact on net
interest spread. The net interest spread was 1.61% at the Savings Bank and 2.77%
at the Bancorp, with a consolidated Company net interest spread of 1.12%.
PROVISION FOR LOAN AND LEASE LOSSES
The Company did not record a provision for loan and lease losses during the
three months ended March 31, 2003 as compared to $35,000 during the comparable
period in 2002. As discussed in the Company's 2002 Annual Report to
Shareholders, subsequent to March 31, 2002 the Company recorded a provision for
loan and lease losses of $9.8 million and net charge-offs of $8.6 million. As
disclosed previously in the Asset Quality section the Company's allowance for
loan and lease losses at March 31, 2003 was $3.5 million or 25.5% of
nonperforming loans. Based on the level of allowance for loan losses as compared
to nonperforming loans the Company did not deem any provision for loan and lease
losses necessary in the first quarter 2003.
NON-INTEREST INCOME
Non-interest income (expense) decreased by $70,000 to ($76,000) of expense for
the three months ended March 31, 2003, as compared to expense of ($146,000) for
the three months ended March 31, 2002. The decline in expense was principally
the result of a $407,000 gain on sale of the Madison branch operations; a
$225,000 gain on a sale of an investment by the Savings Bank subsidiary; a
$43,000 gain on sale of loans and a $259,000 decrease in loss on the sale of
available-for-sale securities. These items were offset by a $112,000 increase in
the loss on sale of REO assets; a $508,000 decline in trading account profits
due to the elimination of trading account activities as discussed in the
Regulatory Compliance section; a $172,000 decline in loan servicing income
mainly due to the amortization of purchased mortgage servicing rights.
27
NON-INTEREST EXPENSE
Non-interest expense increased by $200,000 to $3.4 million for the three months
ended March 31, 2003 from $3.2 million for the same period last year. The
overall increase in operating expenses was primarily the result a $136,000
increase in federal deposit insurance premiums; a $102,000 increase in costs
related to the sale of the Madison and Dolton branches, as well as the
administrative relocation to Huron (moving, repairs and maintenance, and network
communication); a $69,000 increase in other general insurance premiums; a
$85,000 increase in data processing de-conversion fees and contract fees due to
branch sales; a $46,000 increase in legal fees resulting from the Bancorp ROE
and Savings Bank ROE discussed in the preceding Regulatory Compliance section.
These items were partially offset by a $67,000 reduction in deposit, loan and
internet support service fees due to reduction of deposit levels and new loan
originations; a net $53,000 favorable ATM over/short adjustments; a $40,000
reduction in consulting fees and a $84,000 reduction in brokered commissions and
promotion / publicity expenses.
INCOME TAX EXPENSE
The Company recorded a tax benefit of $797,000 for the three months ended March
31, 2003 compared to a tax benefit of $949,000 for the same period last year.
The 2003 benefit is based on a tax rate of approximately 39% calculated on the
pre-tax loss of $3.0 million, plus tax benefits derived from tax-exempt
municipal securities and tax-exempt charter school loans, plus utilization of
affordable housing tax credits. In addition, the Company's tax benefit, as well
as its deferred tax asset, was reduced by $520,000 related to the lease
assumption and purchase of available-for-sale security transactions between the
Company and its two principal shareholders as previously discussed.
Management's analysis of the deferred tax asset at March 31, 2003 is discussed
in the preceding Financial Condition section.
ACCOUNTING DEVELOPMENTS
On January 1, 2003, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations". This
statement requires that the fair value of a liability for an asset retirement
obligation be recognized in the period incurred. The adoption of this statement
did not have a material affect on the financial position and operations of the
Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As part of its normal operations, the Savings Bank is subject to interest-rate
risk on the interest-sensitive assets it invests in and the interest-sensitive
liabilities it borrows. The Investment Committee, which includes members of
senior management and directors, monitors and determines the strategy of
managing the rate and sensitivity repricing characteristics of the individual
asset and liability portfolios the Savings Bank maintains. The overall goal is
to manage this interest rate risk to most efficiently utilize the Savings Bank's
capital, as well as to maintain an acceptable level of change to its net
portfolio value ("NPV") and net interest income. The Savings Bank's strategy is
to minimize the impact of sudden and sustained changes in interest rates on NPV
and its net interest margin.
Interest rate risk exposure is measured using interest rate sensitivity analysis
to determine the Savings Bank's change in NPV in the event of hypothetical
changes in interest rates, as well as interest rate sensitivity gap analysis,
which monitors the repricing characteristics of the Savings Bank's
interest-earning assets and interest-bearing liabilities. The Board of Directors
has established limits to changes in NPV and net interest income across a range
of hypothetical interest rate changes. If estimated changes to NPV and net
interest income are not within these limits, the Board may direct management to
adjust its asset/liability mix to bring its interest rate risk within
28
Board limits.
In an effort to reduce its interest rate risk, the Savings Bank has focused on
strategies limiting the average maturity of its assets by emphasizing the
origination of adjustable-rate mortgage loans. The Savings Bank, from time to
time, also invests in long-term, fixed-rate mortgages provided it is compensated
with an acceptable spread. None of these strategies are prohibited or otherwise
restricted by the Savings Bank ROE discussed previously.
Interest rate sensitivity analysis is used to measure the Savings Bank's
interest rate risk by calculating the estimated change in the NPV of its cash
flows from interest sensitive assets and liabilities, as well as certain
off-balance-sheet items, in the event of a series of sudden and sustained
changes in interest rates ranging from 100 to 300 basis points. Management
assumes that a 200 basis point movement up or down is considered reasonable and
plausible for purposes of managing its interest-rate risk on a day-to-day basis.
NPV is the market value of portfolio equity and is computed as the difference
between the market value of assets and the market value of liabilities, adjusted
for the value of off-balance-sheet items. The following table presents the
Saving Bank's projected change in NPV for the various rate shocks as of December
31, 2002 which is the most recent available.
Estimated Increase
(Decrease) in NPV
Change in Estimated -----------------
Interest Rate NPV Amount Percent
------------- --- ------ -------
(Dollars in thousands)
300 basis point rise $ 24,780 $ (4,282) (15)%
200 basis point rise 26,252 (2,810) (10)
100 basis point rise 27,794 (1,268) (4)
Base scenario 29,062 --- ---
100 basis point decline 30,188 1,126 4
Due to the level of interest rates at December 31, 2002, the Company is not able
to model an additional 200 or 300 basis point decrease in rates.
The NPV is calculated by the Savings Bank using guidelines established by the
OTS related to interest rates, loan prepayment rates, deposit decay rates, and
market values of certain assets under the various interest rate scenarios. These
assumptions should not be relied upon as indicative of actual results due to the
inherent shortcomings of the NPV analysis. These shortcomings include: (i) the
possibility that actual market conditions could vary from the assumptions used
in the computation of NPV; (ii) certain assets, including adjustable-rate loans,
have features which affect the potential repricing of such instruments, which
may vary from the assumptions used; and (iii) the likelihood that as interest
rates are changing, the Investment Committee would likely be changing strategies
to limit the indicated changes in NPV as part of its management process. In
addition, as the Company executes its business plan to reduce assets and
liabilities and restructure its balance sheet the Company could experience
significant changes in NPV at various points in time during 2003 and the
Investment Committee would likely be changing strategies to address these
changes.
The Savings Bank does not use derivative instruments to control interest rate
risk. In addition, interest rate risk is the most significant market risk
affecting the Savings Bank. Other types of market risk, such as foreign currency
exchange risk and commodity price risk, do not arise in the normal course of the
Company's business activities and operations.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to the
Securities Exchange Act of 1934 ("Exchange Act") Rule 13a-
29
14. Based upon that evaluation, the Company's Chief Executive Officer along with
the Company's Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's periodic SEC filings. There have been
no significant changes in the Company's internal controls or in other factors
which could have a significant adverse effect on these controls subsequent to
the date the Company carried out its evaluation.
Management's responsibility related to establishing and maintaining effective
disclosure controls and procedures includes maintaining effective internal
controls over financial reporting that are designed to produce reliable
financial statements in accordance with accounting policies generally accepted
in the United States of America and produce reports submitted under the Exchange
Act which are in accordance with the SEC's rules and forms. In designing and
evaluating the disclosure controls and procedures, management recognized that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
30
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Bancorp and the Savings Bank are not engaged in any legal proceedings of a
material nature at the present time.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
Exhibit 99.1 Certificate of Chief Executive Officer
Exhibit 99.2 Certificate of Chief Financial Officer
The following exhibits are incorporated herein by reference:
(3) The Certificate of Incorporation and By-Laws.
3.1 Amended Certificate of Incorporation of Umbrella
Bancorp, Inc.*
3.2 By-Laws of Umbrella Bancorp, Inc.*
4.0 Stock Certificate of Umbrella Bancorp, Inc.*
11.0 Statement Regarding Computation of Earnings Per Share
(See Note D)
B. Reports of Form 8-K
A report on Form 8-K was filed on February 3, 2003 relating to
the Company's announcement of loan sales and its entering into
sale agreements related to its two retail branches.
A report on Form 8-K was filed on February 27, 2003 relating
to the Company's intention to repurchase Trust Preferred
securities of its subsidiary trust.
* Incorporated herein by reference into this document from the
Exhibits to Form S-1, Registration Statement, and filed on
January 28, 1992, any amendments thereto, Registration No.
33-45222.
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SIGNATURES
Pursuant to the requirement of the Securities and Exchange Act of 1934, the
Registrant had duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UMBRELLA BANCORP, INC.
Date: May 16, 2003 /S/ John G. Yedinak
------------------------- ------------------------------------------
John G. Yedinak, Chairman, President and
Chief Executive Officer
Date: May 16, 2003 /S/ Frank J. Shinnick
------------------------- ------------------------------------------
Frank J. Shinnick, Chief Financial Officer
32
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John G. Yedinak, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Umbrella Bancorp, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in the quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flow of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or 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
33
6. The registrant's other certifying officer and I have indicated in this
quarterly 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: May 16, 2003 /S/ John G. Yedinak
---------------------- ------------------------------------------
John G. Yedinak, Chairman, President and
Chief Executive Officer
34
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Frank J. Shinnick, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Umbrella Bancorp, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in the quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flow of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or 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
35
6. The registrant's other certifying officer and I have indicated in this
quarterly 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: May 16, 2003 /S/ Frank J. Shinnick
---------------------- ------------------------------------------
Frank J. Shinnick, Chief Financial
Officer
36