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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1996
Commission file number 0-28080
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UNITED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
MINNESOTA 81-0507591
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(State or other jurisdiction of (I.R.S. Employer ID No.)
incorporation or organization)
P.O. Box 2509, 601 1st Avenue North, Great Falls, Montana 59403
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(Address of principal executive offices) Zip Code)
Registrant's telephone number, including area code: (406) 761-2200
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Securities Registered Pursuant to Section 12(b) of the Act
None
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Securities Registered Pursuant to Section 12(g) of the Act
Common Stock, Par Value $1.00 per share
Traded UBMT on the NASDAQ National Market System
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such requirements for the past 90 days.
Yes [X] No [ ]
As of December 31, 1996, and as of the filing date, there were issued and
outstanding 1,223,312 shares of the Registrant's Common Stock. No preferred
shares were issued.
As of March 3, 1997, the aggregate market value of voting common stock held by
non-affiliates based on the $19.75 closing price as quoted by NASDAQ on such
date was approximately $22,165,000.
UNITED FINANCIAL CORP.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page Number
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PART I
Item 1. Business 1
Item 2. Properties 29
Item 3. Legal Proceedings 29
Item 4. Submission of Matters to a Vote of Security Holders 29
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 29
Item 6. Selected Financial Data 32
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 33
Item 8. Financial Statements and Supplementary Data 48
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 48
PART III
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners
and Management 53
Item 13. Certain Relationships and Related Transactions 53
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 54
Signatures
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PART I.
ITEM 1. BUSINESS
GENERAL - United Financial Corp. (the Holding Company), a Minnesota
corporation formed in 1996, is a savings bank holding company headquartered in
Great Falls, Montana. United Financial Corp.'s wholly owned subsidiary,
United Savings Bank, F.A. (the Bank), is a federally chartered stock savings
bank. The Bank's wholly owned subsidiary, Community Service Corporation, a
Montana corporation formed in 1974, owns and manages real estate held for
investment. The Holding Company (or Parent), the Bank, and the Bank's
subsidiary are collectively referred to as the Company. The Bank's Great
Falls, Montana headquarters serves its primary market, the Great Falls
Metropolitan area. Full service branches are located in Shelby, Glendive, and
Havre, Montana. The Bank was incorporated as a Montana chartered building and
loan association in March 1923. In 1932, the Bank was the first Montana
building and loan to be accepted for membership in the Federal Home Loan Bank
(FHLB) System. The Bank converted into a federally chartered mutual savings
and loan in 1951, a federally chartered mutual savings bank in June 1983, and
a federally chartered stock savings bank in September 1986. The Bank's
deposits are insured by the Federal Deposit Insurance Corporation (FDIC) -
Savings Association Insurance Fund (SAIF). The Bank is a member of the FHLB
of Seattle, Washington, and is subject to comprehensive supervision,
regulation, and examination by the Office of Thrift Supervision (OTS) and the
FDIC. The Bank is also subject to the regulations of the Board of Governors
of the Federal Reserve System.
The Company's principal business is attracting deposits from the general
public through its offices and, using those deposits together with other
available funds, to originate primarily loans secured by residential and
commercial real estate and consumer loans. The Company also invests in
mortgage-backed securities, U.S. Treasury obligations, other U.S. Government
agency obligations and interest-earning deposits.
The Company's financial condition and results of operations are dependent
primarily on net interest income and fee income. Net interest income is the
difference between the interest income earned on loans, mortgage-backed
securities, other investment securities, and interest-earning deposits, less
its cost of funds, consisting of interest paid on deposits and borrowed money.
The Company's financial condition and results of operations are also
significantly influenced by local and national economic conditions, changes in
market interest rates, governmental policies, tax laws and the actions of
various regulatory agencies.
MARKET AREA - The Company's primary market area includes the Great Falls,
Montana metropolitan area, as well as the areas surrounding its offices in
Shelby, Glendive and Havre, Montana. The Bank engages in a very limited
amount of lending outside the State of Montana. Great Falls, the county seat
of Cascade County, is one of the largest cities in Montana. The estimated
1996 Great Falls and Cascade County populations were approximately 58,000 and
81,000, respectively. The economy of Great Falls and the surrounding area
depends heavily on agricultural and livestock activities for which Great Falls
serves as the retail and commercial center. Two hospitals in Great Falls have
recently merged. This combined medical service serves as a regional medical
center providing open heart surgery and cancer treatment facilities. The
merger could ultimately result in the elimination of approximately 200 jobs.
Great Falls also attracts tourists due to the C.M. Russell Museum and its
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location en route to Glacier National Park, the Bob Marshall Wilderness Area
in northwestern Montana and Yellowstone National Park. Also, with its
proximity to the Canadian border, Great Falls benefits from Canadians
utilizing its retailing facilities.
Located in Great Falls is an international airport, the Montana Air
National Guard, an F-16 fighter facility and Malmstrom Air Force Base (MAFB),
consisting of a Minuteman ICBM missile wing. Implemented in mid-1994 was a
reduction at MAFB consisting of the transfer of eight KC135 tankers. Also,
the Montana Air National Guard mission was reduced in 1994 by three F-16
fighters and approximately 50 full-time guardsmen. These cut-backs left MAFB
in 1995 with its 200 Minuteman missile silo mission and a KC135 tanker group.
The Montana Air National Guard mission is now comprised of fifteen F-16
fighters, and approximately 350 full-time and 650 part-time personnel.
In 1995, the Base Closure and Realignment Commission adopted Defense
Department recommendations that resulted in the 1996 transfer of the remaining
MAFB KC135 tanker group to a Florida base. The MAFB mission now consists of
its 200 Minuteman missile silo mission, with approximately 3,900 active-duty
military personnel and their 4,700 dependents, 460 appropriated fund civilian
employees, and 820 non-appropriated fund contract civilian and private
business employees. The Base Closure and Realignment Commission also followed
Defense Department recommendations that will enhance MAFB's missile mission.
MAFB, by the end of 1998, will receive upgraded Minuteman III missiles
transferred from other Air Force bases. MAFB will not receive any additional
missile personnel due to a fully staffed missile wing now monitoring and
maintaining its existing 200 silos, some of which are empty or contain older
Minuteman IIs. There can be no assurance that future Defense Department cut-
backs will not continue to adversely influence military operations and thus
the economy in the Company's primary market area.
The economies of Shelby, Glendive and Havre, Montana, the locations of the
Company's other Bank branch offices, are also dependent to a large extent on
agricultural, livestock and railroad activities. The now merged Burlington
Northern and Sante Fe railroad is a significant employer in Shelby, Glendive
and Havre. In addition, Amtrak, which provides passenger service across
Montana to the Havre and Shelby markets, has reduced the number of days of
service. Future Amtrak curtailments of passenger service and/or reductions in
Montana freight service could have adverse economic consequences for some of
the Bank's market areas. For the past several years there has been decreased
activity in the oil and gas industry, which affects the economies of the
Shelby and Glendive areas. There can be no assurance that the economic
conditions of the Bank's market areas will not have an adverse impact on the
Company's future revenues and earnings.
COMPETITION - The Holding Company's Bank subsidiary, like other depository
institutions, is operating in a rapidly changing environment and, therefore,
faces considerable competition, both in the attraction of deposits and the
making of real estate and consumer loans. Historically, the most direct
competition for deposits has come from other savings institutions, credit
unions and commercial banks. There are approximately thirty depository
institutions, commercial banks, credit unions and savings institutions with
offices in the Bank's market areas. Nondepository financial service
organizations, primarily in the securities and insurance industries, have also
become competitors for retail savings and investment funds. The Bank's
deposit programs compete with money market mutual funds, government securities
and other investment alternatives. Since passage of the Financial
Institutions Reform, Recovery and Enforcement Act (FIRREA), the impact of
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competing brokered funds from "troubled" institutions has significantly
decreased. The Bank competes for deposits by offering a variety of deposit
accounts at interest rates based upon market conditions, convenient business
hours, quality of service and convenient branch locations.
The Bank's competition for real estate loans comes principally from
mortgage bankers, other savings institutions, commercial banks, insurance
companies and other institutional lenders. The Bank competes for loans mainly
through the interest rates and loan fees it charges on its loan programs.
Further, the Bank believes it offers a high degree of professionalism and
quality in the services it provides borrowers. The Bank's competition for
loans varies from time to time, depending upon numerous factors, including the
general availability of funds and credit, economic conditions, current
interest rate levels, volatility in the mortgage markets, and other factors
which are not readily predictable or controllable.
The FIRREA has resulted in the beginning of the consolidation of the
industry, and is reducing the distinctions between the regulatory structures
applicable to savings institutions and commercial banks. Legislation being
proposed in the United States Congress would further consolidate the
regulatory environment for most financial institutions. In many instances,
the FIRREA expressly requires that regulations of the OTS applicable to
savings institutions be comparable to regulations of the Office of Comptroller
of the Currency (OCC) applicable to national banks. Many of the specific
provisions included in the FIRREA have had little or no direct impact on the
Bank because the Bank already met or exceeded the requirements imposed
pursuant to such provisions. Passed into law in late 1991, the Federal
Deposit Insurance Corporation Improvement Act (FDICIA), significantly expanded
the scope of operating regulations and regulatory guidelines over the Bank's
operations. The current and potential long-term impact the FDICIA and future
legislation has and will have on the costs of operations and competitive
environment in which the Bank operates, however, is of major concern to the
Bank. See "Regulation" - "Bank."
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LENDING ACTIVITIES
GENERAL - One of the Company s primary sources of income is its lending
activities. The Company s interest income from loans receivable as a
percentage of total interest income for the years ending December 31, 1996,
1995 and 1994, was approximately 40.8%, 39.0% and 39.4%, respectively. The
Company s principal lending activity is the origination of residential loans
on existing real estate, including conventional residential real estate loans
(loans which are neither insured nor partially guaranteed by government
agencies) and residential real estate loans insured by the Federal Housing
Administration (FHA) or partially guaranteed by the Veterans Administration
(VA).
LOAN PORTFOLIO COMPOSITION - The following table shows the composition of
the Company's loans receivable as of the dates indicated:
(Dollars in thousands)
December 31,
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1996 1995 1994
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Real estate loans:
Single family $19,263 52.2% $19,209 60.0% $20,503 62.3%
2-4 units 1,712 4.6 1,302 4.1 1,130 3.4
5 or more units 4,497 12.2 3,986 12.4 3,931 11.9
Construction 4,620 12.5 3,373 10.5 2,455 7.5
Commercial real estate 3,077 8.4 2,517 7.9 3,193 9.7
------- ----- ------- ----- ------- -----
Total real estate loans 33,169 89.9% 30,387 94.9% 31,212 94.8%
Non-mortgage loans:
Consumer:
Home equity loans 1,132 3.1% 1,136 3.5% 1,257 3.8%
Recreational vehicle
and auto 1,239 3.3 31 .1 40 .1
Other consumer loans 104 .3 199 .6 227 .7
Commercial:
Floor plan 884 2.4
Lines of credit and other 355 1.0 282 .9 197 .6
------- ----- ------- ----- ------- -----
Total non-mortgage loans 3,714 10.1% 1,648 5.1% 1,721 5.2%
------- ----- ------- ----- ------- -----
Total loans receivable 36,883 100.0% 32,035 100.0% 32,933 100.0%
====== ====== ======
Less:
Unearned fees and discounts 4 8 11
Undisbursed loan funds 1,628 1,600 1,335
Reserve for losses 75 75 75
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Net loans receivable $35,176 $30,352 $31,512
======= ======= =======
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LOAN ACTIVITY - The table below shows the loan activity of the Company for
the years indicated.
(Dollars in thousands)
For Year Ended December 31,
-----------------------------
1996 1995 1994
Real estate loans originated: ------- ------- -------
Single family $16,780 $11,422 $14,787
2-4 units 180 596
5 or more units 289 125
Construction 7,103 5,190 7,189
Commercial real estate 1,167 45 33
Non-mortgage loans originated 5,807 1,842 1,997
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Total loans originated 31,326 19,220 24,006
Loans purchased
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Total originations and purchases 31,326 19,220 24,006
Secondary market loan sales (11,996) (8,425) (12,632)
Portfolio loan sales (3,031) (2,748) (3,679)
Loan repayments - real estate (7,643) (7,029) (10,631)
Loan repayments - non-mortgage (3,741) (1,916) (1,817)
------- ------- -------
Total sales and repayments (26,411) (20,118) (28,759)
Other net changes:
Loans in process and discounts (24) (262) (122)
Reserve for loan losses
Real estate owned transfers (67)
------- ------- -------
Total other net changes (91) (262) (122)
Net loan activity $ 4,824 $(1,160) $(4,875)
======= ======= =======
Total loans originated in 1996 were $31.3 million an increase of $12.1
million, or 63%, from the $19.2 million of loan volume generated in 1995.
This increase was primarily due to a continuing low interest rate environment,
an improved real estate economy in the Great Falls area, and the placing of
additional emphasis on the origination and retention for portfolio of multi-
family residential, commercial real estate, non-mortgage commercial, and non-
mortgage consumer loans.
RESIDENTIAL (NONCONSTRUCTION) REAL ESTATE LENDING - At December 31,
1996, approximately $25.5 million, or 69%, of the Company s $36.9 million total
loans receivable consisted of loans secured by first liens on single-family
and multi-family residential properties. At that date, nonconstruction
mortgage loans on single-family residences were approximately $19.3 million,
or 52%, of the Company s portfolio. At December 31, 1996, approximately $5.8
million, or 16%, of the Company s total loans receivable consisted of FHA-
insured and VA-guaranteed loans. During 1996, the increased emphasis on
multi-family lending resulted in an approximate $.9 million, or 17%, increase
in multi-family residential loans receivable. This increase in multi-family
lending was primarily due to two 1995 construction loans totaling $1.0 million
that received permanent financing in 1996.
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Fifty-four percent, or $16.8 million, of the Company s total loan
originations during 1996 and 59%, or $11.4 million, of total loan originations
during 1995 were secured by single-family dwellings. Of the $12.1 million
increase in total 1996 loan production, approximately $5.1 million, or 42%,
was attributable to nonconstruction residential lending.
SECONDARY MARKET LOAN ORIGINATIONS AND SALES - For the past several years,
the Company's total production of long-term (15 to 30-year maturity) fixed
rate residential loans have been originated according to prearranged
underwriting standards that result in immediate sale to the secondary market,
primarily to mortgage bankers and pension funds. While origination and sale
of these loans produces fee income, the loans are carried at their outstanding
principal balance, which is the contracted purchase price, and therefore, no
gain or loss is realized at sale. Retaining long-term, fixed-rate loan
production for portfolio in the low market interest rate cycle of the past few
years would expose the Company to declines in market values should interest
rates rise. This origination and sale policy is a component of the Company's
overall "Asset/Liability Management" program. See Part II, Item 7. -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" - "Asset/Liability Management."
Twelve million dollars, or 38%, of the Company's total $31.3 million 1996
loan production and approximately $8.4 million, or 44%, of the Company's total
$19.2 million 1995 loan production was comprised of long-term fixed-rate
mortgage loans originated for sale to the secondary market. The Company sold
long-term fixed-rate mortgage loans to the secondary market in aggregate
amounts of $11.5 million in 1996 and $8.7 million and $12.7 million during
1995 and 1994, respectively. At December 31, 1996 and 1995, the other assets
component of the Company's "Consolidated Statements of Financial Condition"
included $1.2 million and $.7 million respectively of loans contracted for
sale to the secondary market.
PORTFOLIO LOAN SALES - During 1996, 1995 and 1994 the Company sold
portfolio loans in aggregate amounts of $3.0 million, $2.7 million and $3.7
million, respectively. These long-term fixed-rate loans were refinances of
existing portfolio loans or permanent financing of completed construction
loans sold to the secondary market or to Montana State agencies. These loans
are carried at their outstanding principal balance, which was the contracted
purchase price, and therefore, no gain or loss was realized at sale.
REAL ESTATE CONSTRUCTION LOANS - In addition to first-lien mortgage loans,
the Bank also provides interim financing for construction of single-family and
multi-unit dwellings and improvement of real estate to be used for the
construction of such dwellings. Construction loans are generally made for
periods of six months, with interest paid at quarterly or six-month intervals.
Such loans may be extended for several months due to adverse weather
conditions or other justifiable delays in construction. The Bank provides
financing primarily for a small number of contractors who have demonstrated an
ability to complete projects and financial responsibility in residential
development and construction and have operated in the Bank s lending area for
a number of years. Approximately 16%, or $1.9 million, of the Company s $12.1
million dollar increase in 1996 loan originations was attributable to real
estate construction loans. The Bank originated approximately $7.1 million,
$5.2 million, and $7.2 million in primarily residential construction loans
during 1996, 1995 and 1994, respectively. As of December 31, 1996,
construction loans outstanding were approximately $4.6 million, or 13%, of the
Company s total loans receivable. Ninety-three percent of construction loans
outstanding at December 31, 1996, were residential properties. Of the $1.6
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million of undisbursed loan funds outstanding at December 31, 1996, virtually
all was attributable to construction loans.
COMMERCIAL REAL ESTATE LOANS - The Bank also engages in commercial real
estate lending. Whenever possible in making such loans, the Bank participates
in the United States Small Business Administration s program for guaranteed
commercial real estate loans. The Bank s loans on commercial real estate are
primarily first lien loans with 10 to 15-year maturities and adjustable
interest rates based on U.S. Treasury indexes for 1, 3, and 5 years. At
December 31, 1996 and 1995, commercial real estate loans receivable were
approximately 8% of total loans receivable, and totaled approximately $3.1
million and $2.5 million, respectively. Commercial real estate loans totaling
approximately $1.2 million were originated during 1996, compared to less than
$.1 million in 1995. This increase in commercial real estate loan production
was due primarily to a $.9 million commercial real estate loan for a local
medical office building. The Bank sold 90% of this $.9 million loan to its
parent company. The remaining $.3 million in commercial real estate loan
originations during 1996 represents five loans to local businesses. The
FIRREA generally limits the amount that any federal savings institution can
invest in nonresidential real estate loans, and the limitation does not have a
material impact on the Bank s commercial lending activities. The Bank is not
an agricultural lender and its portfolio does not contain agricultural loans.
NON-MORTGAGE LOANS - In addition to real estate lending, the Bank also
offers consumer and commercial non-mortgage loans. Prior to 1996, the Bank s
consumer loan portfolio included home equity, home improvement, auto, and
deposit account loans. During 1996, the Bank entered into an agreement with a
local merchant to purchase qualifying recreational vehicle (RV) loans. The
Bank requires fire, hazard and casualty insurance for loans secured by home
equity and casualty insurance for loans secured by autos and RV units. At
December 31, 1996, consumer non-mortgage loans receivable were approximately
$2.5 million, or less than 7%, of the Company s total loans receivable. The
Bank originated $2.4 million in non-mortgage consumer loans in 1996 of which
$1.4 million, or 58%, was represented by RV loans. Approximately $1.6
million, or 13% of the Company s $12.1 million increase in 1996 loan
originations was attributable to consumer non-mortgage loans. The Bank makes
and retains consumer loans in its portfolio to better match the maturities of
its assets and liabilities because the term of consumer loans is relatively
short (generally 1 to 15 years).
The Bank also offers commercial borrowers lines of credit and fixed rate
commercial loans. At December 31, 1996, the commercial non-mortgage loan
portfolio was approximately $1.2 million, or 3%, of the Company s total loans
receivable. During 1996, the Bank originated approximately $3.4 million in
commercial non-mortgage loans. Approximately 19%, or $2.3 million, of the
Company s $12.1 million increase in loan production was attributable to non-
mortgage commercial loans. In 1996, the Bank entered into a floor plan line
of credit agreement with a local merchant. This loan is secured by the
merchant s new inventory. The Bank pays the manufacturers directly for
inventory and holds the original Manufacturer s Statement of Origin and
invoice on purchases until paid for by the borrower. At December 31, 1996,
the Bank had one floor plan line of credit loan with an outstanding balance of
approximately $.9 million, or 2%, of the Company s total loans receivable.
As of December 31, 1996, the Bank had provided commercial lines of credit
loans to ten borrowers aggregating $1.1 million with a total outstanding
balance at December 31, 1996 of approximately $.3 million. The largest of
these ten loans is an approximate $.5 million secured line of credit that had
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an outstanding balance of $.2 million at December 31, 1996. The Bank also
originates a limited number of commercial loans not secured by real estate.
At December 31, 1996, the Bank had one such commercial loan outstanding, with
principal owing of less than $.1 million.
The Bank originates loans through its loan officers, other staff members
and referrals and does not utilize loan brokers or loan consultants. The
Bank's existing customer base generates many of the loans it originates.
On November 4, 1994, the four federal financial institutions regulators
issued inter-agency guidelines to explain changes made in the final rule
12CFR, part 564, published June 7, 1994, regarding the use of appraisals for
all federally related transactions. This rule continues the licensing
requirements and requires the use of licensed and/or certified appraisers for
real estate-related financial transactions where the value exceeds $250,000.
All transactions of $1,000,000 or more, nonresidential and residential over 4
units where the transaction is $250,000 or more and complex residential
transactions of $250,000 or more require a State Certified Appraiser. The
Bank requires independent appraisals and/or evaluations for all real estate
loans prior to the closing of the loan, with all appraisals conducted in
accordance with applicable OTS or FDIC regulations and the Bank's written
appraisal policy statement. At a minimum, appraisals utilized by the Bank
must be performed in accordance with generally accepted appraisal standards as
evidenced by the standards promulgated by the Appraisal Standards Board of the
Appraisal Foundation. In addition, as part of the loan approval process, the
Bank's loan officers generally conduct on-site inspections of properties
securing real estate loans which are to be held in its portfolio.
All loans made by the Bank must be approved by the Officers' Loan
Committee, which consists of certain officers of the Bank. Loans of principal
amounts in excess of $250,000 must also be approved by the Directors Loan
Committee. All members of the Board of Directors are authorized to serve on
the Directors Loan Committee.
Under the Bank's underwriting policies, conventional, owner-occupied,
single-family residential loans can be made up to a 95% loan-to-appraised-
value (LTV) percentage. For these same loans, where the LTV exceeds 80%, the
Bank has the additional requirement of private mortgage insurance. Borrowers
generally may refinance or prepay loans at their option. The terms of the
Bank's conventional real estate loans typically include a due-on-sale clause
that provides for acceleration of indebtedness upon the sale or other
disposition of secured property. Evidence of fire, casualty and hazard
insurance with a mortgagee clause in favor of the Bank is required prior to
settlement of residential and commercial real estate loans. Title insurance
is also required on properties securing such loans to protect the Bank against
prior liens on the property or other claims against the title.
Pursuant to OTS loan policy regulations, the Bank has established lending
policies, loan portfolio diversification standards, prudent underwriting
standards, including LTV procedures for the institution's real estate loan
portfolio, and established documentation, approval and reporting requirements
so that compliance with the institution's real estate lending policies can be
monitored. The Bank's Board of Directors reviews real estate lending policies
at least once a year.
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The regulatory LTV maximums are as follows:
Loan Type Maximum LTV Ratio
Raw land 65%
Land development 75%
Construction:
Commercial, multifamily* and other
nonresidential 80%
1-4 family residential 85%
Improved property 85%
*Multifamily construction includes condominiums an cooperatives.
The guidelines stress that LTV ratios are only one of a number of credit
factors that must be considered to prudently underwrite a real estate loan.
Exceptions to the general lending policy may be made on a case-by-case basis;
however, each institution is responsible for establishing an internal process
for the review and approval of any loan that does not conform to its lending
standards and maximum LTV ratios. Such exceptions must be supported by
written justification kept in the permanent loan file. These exceptions must
also be reported to the institution's board of directors. The total of all
loans that exceed the regulatory LTV limits is limited to 100% of the
institution's total capital. The Bank has a written loan policy which
includes LTV ratios which are more conservative than the new regulatory
ratios. The guidelines have not had any material effect on the lending
posture or procedures of the Bank.
The Bank is also subject to laws and regulations that could impose
liability on lenders and owners for cleanup expenses and other costs resulting
from hazardous waste located on property securing real estate loans made by
the Bank, or on real estate that is owned by the Bank, following a
foreclosure. Recent court decisions have continued to expand the
circumstances under which lenders have been held liable for hazardous wastes.
Although the Bank's lending procedures include measures designed to limit
lender liability for hazardous waste cleanup and other related liability,
there can be no assurance that the Bank will not become subject to such
liability in the future.
Under federal law, the aggregate amount of loans that the Bank is permitted
to make to any one borrower (LTOB) cannot exceed 15% of unimpaired capital and
surplus. Amounts up to an additional 10% of unimpaired capital and surplus
may be extended for loans and extensions of credit fully secured by readily
marketable collateral, which is defined to include certain financial
instruments and bullion having a market value at least equal to the loan
amount.
The OTS has amended the loans to one borrower limitation to permit savings
associations meeting certain requirements, including capital requirements, to
extend loans to one borrower in additional amounts under certain circumstance
limited essentially to loans to develop or complete residential housing units.
At December 31, 1996, the Bank's LTOB limit was approximately $2.3 million.
The largest aggregate loans outstanding to one borrower at December 31, 1996,
was approximately $1.8 million and represented twelve loans. At December 31,
1996, the Bank was in compliance with the LTOB limitations.
Until 1981, the Bank historically made residential mortgage loans on a
long-term (generally 30 year), fixed-rate basis. In accordance with then
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applicable regulations, the Bank's single-family residential mortgage loans
provided for fixed rates of interest and for repayment of principal for up to
30 years. Since 1981, the Bank has also offered a variety of adjustable-rate
mortgage loans (ARMs), the interest rates on which vary with the movement of
the index upon which the interest rates are based. If the interest rates
change, loan payments, balances or terms may be adjusted. Thru 1994, the
Bank's primary index was the cost of funds for the Twelfth FHLB District.
Beginning February 22, 1995, the Bank's primary indexes are now the 1, 3, and
5-year constant maturity Treasury indexes. Most of the ARMs currently
originated by the Bank have loan terms of 15 to 20 years with rate adjustments
generally every 1, 3 or 5 years during the term of the loan. Generally,
interest rate adjustments on the Bank's ARMs are now limited to caps of 2% per
year and 6% for the life of the loan. At December 31, 1996, ARMs constituted
approximately $1.8 million, or 5%, of the Company's net loans receivable.
In addition to charging interest on loans, the Bank charges fees for
originating and servicing loans. These fees are for the inspection of
property, payment of invoices during construction and other miscellaneous
services. Loan origination fee income recognition is subject to Financial
Accounting Standards Board (FASB) Statement No. 91. See Part IV, Item 14. -
"Notes to Consolidated Financial Statements" - "Loan origination fees."
For those institutions with significant for-portfolio loan production, the
adoption of FASB No. 91 continues to have a major effect upon the reported
amounts of interest on loans, loan origination fees, compensation and other
employee expenses. Its application, however, has no direct effect upon actual
cash flows but, rather, affects only the timing of their recognition as income
and expense.
The average maturity of the Company's loan portfolio has decreased as
borrowers continue to make principal payments. This decrease in average
maturity is also due to the Bank's policy of selling long-term, fixed-rate
loans and retaining short-term loans in its portfolio. Additionally, with the
exception of the FHA-insured and VA-guaranteed loans it originates, the terms
of the Bank's mortgage loans contain due-on-sale clauses which generally
result in a payoff of the subject loan at the time of sale of the property
securing the loan. Although assumptions of loans containing such clauses are
generally not permitted, the Bank will permit assumption of certain
conventional loans, provided that the assuming party agrees to either a
reduction in the term of the loan being assumed or an increase in the interest
rate on the loan, or both. Because due-on-sale clauses cause acceleration of
indebtedness or may result in assumption of renegotiated loans with reduced
terms, the effect of due-on-sale clauses is a decrease in the average maturity
of the Bank's loan portfolio.
Due to changes in loan origination policies and continuing repayment of
loans and loan payoffs, the percentage of long-term, (greater than 15-year
maturity) fixed-rate loans in the Company's portfolio continues to decline.
The following table provides information regarding the maturity of all loans
included in the Company's loan portfolio as of December 31, 1996. The amounts
reflected in the following table give no effect to assumptions regarding loan
prepayments or payoffs. Loans with variable rates of interest are classified
as due when the loan principal balances are contractually due, not when the
interest rate reprices.
-10-
(Dollars in thousands)
Loan Due Dates
As of December 31, 1996
--------------------------------------------------------
1 yr >1 yr >2 yrs >3 yrs >5 yrs >10 yrs
or thru thru thru thru thru >15
Real estate first- less 2 yrs 3 yrs 5 yrs 10 yrs 15 yrs yrs Total
mortgage loans: ---- ----- ----- ----- ------- ------- ---- ------
Adjustable rate (all
property types) $ 2 $ 34 $ 6 $ 96 $ 659 $ 479 $442 $ 1,718
Fixed rate:
1-4 dwelling units 212 91 644 671 4,602 11,904 322 18,446
Other residential and
all nonresidential 322 12 814 283 3,312 2,103 6,846
Construction:
Residential 2,649 2,649
Land development 343 343
Second trust deed 2 84 479 651 244 1,460
Non-mortgage loans:
Consumer 364 54 139 455 856 607 2,475
Commercial 1,216 23 1,239
------ ---- ------ ------ ------- ------- ---- -------
$5,110 $275 $1,626 $1,984 $10,080 $15,337 $764 $35,176
====== ==== ====== ====== ======= ======= ==== =======
Total Loans Due After
December 31, 1997
-----------------
(Dollars in thousands)
Fixed interest rates $28,350
Floating or adjustable rates or balloon payments 1,716
-------
$30,066
=======
For additional information regarding loans see Part IV, Item 14. - "Notes
to Consolidated Financial Statements."
CLASSIFICATION OF ASSETS
GENERAL - When a borrower fails to make a scheduled payment on a loan and
does not cure the delinquency within 15 days, the Bank's policy is to contact
the borrower between the 15th and 45th day of delinquency to establish a
repayment schedule. If a conventional loan is not current, or a realistic
repayment schedule is not being followed by the 90th day of delinquency, the
Bank will proceed with legal action to foreclose the property after the loan
has become contractually delinquent 90 days.
The Bank, per Federal regulations, is required to review, classify and
report to its Board of Directors its assets on a regular basis and classify
them as "substandard" (distinct possibility that some loss will be sustained),
"doubtful" (high likelihood of loss), or "loss" (uncollectible). Adequate
valuation allowances are required to be established for assets classified as
substandard or doubtful in accordance with generally accepted accounting
principles. If an asset is classified as a loss, the institution must either
-11-
establish a specific valuation allowance equal to the amount classified as
loss or charge off such amount. As of December 31, 1996 and 1995, the Bank
had no asset classified as doubtful or loss, and reported $40,125 of
substandard assets. As a percent of total assets, substandard assets were
.04% and .03% at December 31, 1996 and 1995, respectively.
A savings institution is also required to set aside adequate valuation
allowances to the extent that any affiliate possesses assets which pose a risk
to the savings institution. The institution's OTS District Director has the
authority to approve, disapprove or modify any asset classification and amount
established as an allowance pursuant to such classification. In addition, a
savings institution is required to record as liabilities reserves for off-
balance-sheet items, such as letters of credit, when a loss becomes probable
or estimable. Per federal regulations, the Bank has established written
board-approved valuation and loss reserve policies as well as an Internal
Asset Review Committee. Delinquent loans are reported to the Board of
Directors monthly, and classified assets are reported to the Board of
Directors quarterly.
ASSET QUALITY and RESERVE for LOAN LOSSES
The following schedule details the amounts of the Company's nonperforming
assets consisting of nonaccrual uninsured loans, loans past due over 90 days,
restructured loans and all real estate owned - held for sale (REO/HFS) as of
the dates indicated.
(Dollars in thousands) December 31,
---------------
1996 1995
Principal Balances: ---- ----
Accruing loans past due over 90 days $18 $38
Non-accrual uninsured loans
Troubled debt restructurings
REO/HFS 40 40
---- ----
$58 $78
==== ====
As a percent of total assets .06% .07%
==== ====
Interest:
Due on non-accrual loans
Included in income None None
At December 31, 1996, 1995 and 1994, total loan loss reserves were $75,179.
Loan loss reserves as a percentage of nonperforming assets at December 31,
1996, 1995 and 1994, were 130%, 96% and 58%, respectively. Loan loss reserves
as a percentage of all uninsured loans and REO/HFS at December 31, 1996, 1995
and 1994 were approximately .25%, .32% and .33%, respectively.
Given the continuing low level of nonperforming and classified assets and
the sale of a large percentage of new loan production, no loan loss provision
expense was deemed necessary (i.e. both probable and estimable) for the years
ended December 31, 1996, and 1995. During 1996, the Bank originated
approximately $1.2 million of new recreational vehicle consumer loans. Future
loan loss provisions may be necessary for these loans.
For additional information regarding loss reserve policy see Part IV, Item
14. - "Notes to Consolidated Financial Statements" - "Reserve for possible
loan losses."
-12-
TROUBLED DEBT RESTRUCTURING - The OTS regulations provide that
institutions may, in certain instances, use FASB No. 5, "Accounting for
Contingencies," and FASB No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructuring." The Bank did not have a loan in this category
at year-end 1996 or 1995.
REAL ESTATE OWNED
The schedule below details real estate owned (REO) both held for sale and
investment by the Bank as of the dates indicated.
(Dollars in thousands)
December 31,
---------------
1996 1995
---- ----
REO held for sale $ 40 $ 40
Allowance for possible losses
REO held for investment 755 792
Accumulated depreciation (370) (341)
----- -----
385 451
$425 $491
===== =====
As a percent of total assets .41% .43%
REO HELD FOR SALE - At December 31, 1996 and 1995, the Bank had a single
REO property classified as held for sale. This $40,125 property consisted of
two Great Falls commercial lots acquired in partial satisfaction of a judgment
and held for over five years.
The Bank believes that sufficient loss allowances have been recognized in
that REO held for sale at December 31, 1996, reflects the lower of (1) fair
value minus estimated cost to sell or (2) cost. For additional information
regarding REO and REO loss reserves, see Part IV, Item 14. - "Notes to
Consolidated Financial Statements" - "Real estate owned."
REO HELD FOR INVESTMENT - This category at December 31, 1996, consisted of
two 24-unit apartment complexes located in Glendive, Montana, foreclosed by
the Bank and sold to its subsidiary, the Community Service Corporation (CSC).
The CSC purchased one apartment complex in 1985 for $480,176, and after twelve
years of depreciation, the December 31, 1996 net book value was $199,160. The
second complex was sold to the CSC in 1990 for $274,475 and after seven years
of depreciation, the December 31, 1996 net book value was $185,435. Real
estate held for investment accounted for approximately 91% of the Bank's real
estate owned at December 31, 1996. The decrease in REO held for investment
between December 31, 1996 and 1995, reflects additional depreciation and the
sale of a $33,168 book value residence to an individual in exchange for cash.
There was a $13,832 gain recognized on the sale.
For additional information regarding real estate held for sale and loss
reserve policy and reserves, see Part IV, Item 14. - "Notes to Consolidated
Financial Statements" - "Real estate owned."
-13-
SOURCES OF FUNDS
The primary sources of funds are deposits, FHLB borrowings, loan and
mortgage-backed securities repayments, proceeds from loan sales, investment
securities interest payments and maturities, and net operating revenues. The
principal uses of funds are loan originations, mortgage-backed securities and
other investment securities purchases, maturing savings certificates and
deposit withdrawals, repayment of FHLB borrowings, cash dividends, maintaining
liquidity and meeting operating expenses. See Part II, Item 7. -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" - "Liquidity and Capital Resources," and Part IV, Item 14. -
"Consolidated Statements of Cash Flows." As demonstrated by the referenced
Statements of Cash Flows, $12.6 million of net cash provided by investing
activities was utilized to repay $10.5 million of FHLB advances outstanding at
the end of 1995, and pay $1.1 million of cash dividends to shareholders.
During 1996, unlike 1995 or 1994, the Bank experienced deposits as a source,
rather than a use of funds. In addition, during 1996, the mix of investing
activities changed with increased loans originated for, and retained for
portfolio in 1996 compared to 1995 or 1994. The Bank's borrowing limit from
the FHLB is 25% of assets and there were no FHLB advances outstanding at
December 31, 1996.
DEPOSIT ACTIVITIES
Deposits are attracted from within the Bank's market area through the
offering of a broad selection of deposit instruments, including NOW accounts,
money market accounts, regular savings accounts, certificates of deposit and
retirement savings plans. Deposit account terms vary, according to the
minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. In determining the terms of its
deposit accounts, the Bank considers current market interest rates,
profitability to the Bank, matching deposit and loan products offered by its
competition and its customer preferences and concerns. The Bank reviews its
deposit mix and pricing weekly.
The principal types of deposit accounts offered by the Bank at December 31,
1996, are summarized as follows:
(Dollars in thousands) Weighted Avg.
Type Term Interest Rate Amount Percent
---- ---- ------------- ------- -------
NOW Accounts 2.86% $ 6,250 7.94%
MMDA 3.49% 2,419 3.07%
Savings Deposits 3.56% 29,918 38.02%
Time Deposits 91-Day 4.13% 297 .38%
182-Day 4.99% 7,135 9.07%
1-Year 5.29% 10,425 13.25%
1 1/2-Year 5.11% 32 .04%
2-Year 5.74% 7,831 9.95%
2 1/2-Year 5.88% 1,577 2.00%
4-Year 5.55% 12,248 15.56%
6-Year 4.79% 39 .05%
8-Year 5.99% 526 .67%
----- ------- --------
5.43% 40,110 50.97%
4.45% $78,697 100.00%
===== ======= =======
-14-
IRA/Keogh retirement account balances, of all types, at December 31, 1996
were approximately $6.0 million or 7.65% of all deposits. At December 31,
1996, there were no jumbo time deposits (minimum balance of $.1 million).
Early withdrawal from certificate deposits subjects the depositor to an
early withdrawal penalty which is currently equal to six months of simple,
nominal interest when the original maturity is longer than one year, three
months of simple, nominal interest when original maturity is 92 days to one
year, and all interest earned when original maturity is 91 days or less.
Traditionally, a relatively small number of the Bank's depositors have
resided outside Montana. Deposits are not solicited outside of Montana. At
December 31, 1996, accounts held by out-of-state depositors were approximately
$3.4 million, or 4% of total deposits.
The Bank experienced a net increase in deposits of $.4 million for the year
ended December 31, 1996, a net decrease in deposits of $10.8 million for the
year ended December 31, 1995, and a net decrease of $6.2 million for the year
ended December 31, 1994. The Bank's 1995 $10.8 million decrease in deposits
and the 1994 $6.2 million decrease in deposits was the direct result of an
improving U.S. economy and an increase in market interest rates. Depositors,
who had "parked" funds in daily savings deposits during the historical low
interest rate cycle, withdrew funds to higher rate competing alternative
investments. In addition, the Bank experienced increased competition and
higher rates offered by some competing financial institutions. During 1996,
market interest rates declined and the Bank, to stem the outflow of deposits,
adopted a more aggressive pricing policy. As a result, many daily savings
depositors elected higher rate Bank time deposits rather than withdrawal and
total deposits increased $.4 million.
Inasmuch as market demand generally dictates deposit maturities and rates,
the Bank intends to continue to offer those types of accounts that have broad
market appeal. It is the Bank's policy not to accept or place brokered
deposits. See "Regulation" - "Bank."
The following table sets forth the net change in deposits for the periods
shown. (Dollars in thousands)
For Years Ended December 31,
--------------------------------------
1996 1995 1994
No Minimum Term -------- -------- ---------
NOW Accounts $ 517 $ (111) $ 392
Money Market Demand Accounts (15) (394) (323)
-------- -------- ---------
502 (505) 69
Savings Deposits (2,543) (12,373) (5,788)
Fixed-Term
Time Deposits with initial maturities of:
6 months and under 6 56 (715)
Over 6 months to 18 months 1,943 1,994 146
Over 18 months to 30 months 887 (120) 86
Over 30 months 31 333 (604)
Jumbo Certificates* (420) (180) 600
-------- --------- --------
2,447 2,083 (487)
Net Change $ 406 ($10,795) ($6,206)
======== ========= ========
*Minimum $.1 million term 30 days to 1 year.
The following table presents, by various weighted average interest rate
categories, the amounts of the Bank's time deposits at December 31, 1996,
which mature within the periods indicated.
(Dollars in thousands)
Weighted Avg. Within Within Within
Interest Rate 1 Year 2 Years 3 Years Thereafter Total
------------- ------- ------- ------- ---------- -------
3.25 - 4.99% $ 7,432 $ 36 $ 3 $ 7,471
5.50 - 5.99% 19,583 $5,500 3,073 4,420 32,576
6.00 - 7.99% 63 63
------- ------ ------ ------ -------
Total $27,015 $5,500 $3,109 $4,486 $40,110
======= ====== ====== ====== =======
The following table presents, by various weighted average interest rate
categories, the amounts of the Bank's time deposits at December 31, 1995,
which mature within the periods indicated.
(Dollars in thousands)
Weighted Avg. Within Within Within
Interest Rate 1 Year 2 Years 3 Years Thereafter Total
------------- ------- ------- ------- ---------- -------
3.25 - 4.99% $ 916 $ 467 $ 58 $ 1,441
5.50 - 5.99% 21,287 8,304 $1,737 1,780 33,108
6.00 - 7.99% 746 455 464 1,449 3,114
------- ------ ------ ------ -------
Total $22,949 $9,226 $2,201 $3,287 $37,663
======= ====== ====== ====== =======
For additional information regarding deposits see Part IV, Item 14. -
"Notes to Consolidated Financial Statements" - "Deposits."
BORROWINGS
The FHLB of Seattle functions as the central reserve bank providing credit
for savings institutions and certain other member financial institutions. As
a member of the FHLB of Seattle, the Bank is required to own capital stock in
the FHLB of Seattle, and is authorized to apply for advances on the security
of specified collateral. Advances are made pursuant to several different
credit programs. Each credit program has its own interest rate and range of
maturities. The Bank's currently established available FHLB advance credit
line is 25% of assets. The FHLB of Seattle is required to review its credit
limitations and standards at least annually. Also see "Regulation - Bank."
Historically, the Bank has relied upon deposits, loan repayments and
investment securities cash flows as its major source of funds, and
consequently has made limited use of FHLB advances. At December 31, 1996, no
FHLB advances were outstanding. At December 31, 1995, the Bank had
outstanding $10.5 million of overnight and fixed rate FHLB advances. For
additional information regarding borrowings, see Part II, Item 7. -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Part IV, Item 14. - "Notes to Consolidated Financial
Statements" - "Federal Home Loan Bank Advances".
-16-
INVESTMENT ACTIVITIES
The Company's primary source of income is from mortgage-backed securities
and other investment securities. Interest income from these two sources as a
percentage of total interest income for the years ending December 31, 1996,
1995 and 1994 was approximately 57.1%, 57.6% and 58.4%, respectively.
Mortgage-backed securities and investment securities income has replaced
loan portfolio income as the Company's primary source of revenue for reasons
of asset liability management. See Part II, Item 7. - "Asset/Liability
Management" and Part IV, Item 14. - "Consolidated Statements of Cash Flows -
Years Ended December 31, 1996, 1995, and 1994." In addition, mortgage-backed
securities were purchased as they are "qualifying loans" for thrift tax
purposes. See Part I, Item 1. - "Taxation" and Part IV, Item 14. - "Notes to
Consolidated Financial Statements" - "Income Taxes."
Per OTS regulatory requirements (including Thrift Bulletin No. 52), the
Company has established an Investment Committee and has developed
comprehensive, Board of Directors' approved, written investment policies
relating to the investment in income producing assets other than loan
originations. The Company's stated investment policy is to purchase only
held-to-maturity or available-for-sale investments and not for trading. The
Company reports monthly to its Board of Directors all investment activity,
including purchases, sales, maturities and book-vs-market-value comparisons.
The Company reports quarterly to its Board of Directors minutes of Investment
Committee meetings, recapping past activities, forecasting expected cash
flows, interest rate projections and investment strategies for the upcoming
quarter. For additional information regarding investment securities, see Part
IV, Item 14. - "Notes to Consolidated Financial Statements" - "Investments",
"Investment Securities", "Fair Value of Financial Instruments" and "Derivative
financial instruments".
Federally chartered savings institutions are authorized to invest in
various types of liquid assets, including U.S. Treasuries and securities of
various U.S. Government agencies, certificates of deposit at insured banks and
thrift institutions, bankers' acceptances, federal funds and mortgage-backed
securities. Subject to various restrictions, federally chartered savings
institutions may also invest a portion of their assets in commercial paper,
corporate debt securities and in mutual funds (the assets of which conform to
the investments that such an institution is authorized to make directly). As
of December 31, 1996, the Company had approximately $61.0 million of
investments comprised of $35.8 million, and $25.2 million of securities
classified as held-to-maturity and available-for-sale, respectively.
The following table sets forth the book value, maturities and weighted
average yields of the Company's investment portfolio at December 31, 1996.
Mortgage-backed securities due dates are maturity dates for non-REMIC
securities and expected average lives for REMIC certificates. The Kemper U.S.
Government bond mutual fund yield is based on cost.
(Dollars in thousands)
-17-
Mortgage- Kemper
U.S. Treasuries/ Backed U.S. Gov't Bond
U.S. Gov't Agencies Securities Mutual Fund Totals
----------------------------------------------------------------
Book Book Book Book
Value Yield Value Yield Value Yield Value Yield
------- ----- ------- ----- ------ ----- ------- -----
Less than 1 yr $16,006 5.40% $ 5,811 5.81% $5,182 6.36% $26,999 5.67%
After 1 yr
through 2 yrs 6,571 5.59% 885 6.36% 7,456 5.68%
After 2 yrs
through 5 yrs 6,026 6.37% 12,653 6.35% 18,679 6.36%
After 5 yrs
through 10 yrs 6,006 6.32% 6,006 6.32%
After 10 yrs 1,873 6.92% 1,873 6.92%
------- ----- ------- ----- ------ ----- ------- -----
$28,603 5.65% $27,228 6.27% $5,182 6.36% $61,013 5.99%
======= ===== ======= ===== ====== ===== ======= =====
SERVICE CORPORATION ACTIVITIES
The Holding Company has no direct subsidiaries other than the Bank. The
Bank has a wholly-owned service corporation, the Community Service
Corporation, which owns and manages real estate held for investment. At
December 31, 1996, the Bank had an investment of approximately $385,000 in its
service corporation. A federal savings institution's aggregate outstanding
investment to its service corporation cannot exceed 3% of the institution's
assets. The Bank is in compliance with the subsidiary investment limits.
EMPLOYEES
At December 31, 1996, the Company employed twenty six full-time employees
and six part-time employees. Management considers its relations with its
employees to be excellent. The Company maintains a comprehensive employee
benefit program providing, among other benefits, hospitalization and major
medical insurance, paid sick leave and retirement plans. The Company's
employees are not represented by any collective bargaining group. See Part
IV, Item 14. - "Notes to Consolidated Financial Statements" - "Retirement
plans" and "Post-retirement benefits".
REGULATION - HOLDING COMPANY
GENERAL - United Financial Corp. is a savings and loan holding company
within the meaning of Section 10 of the Home Owners Loan Act, as amended
(HOLA). As such, the Holding Company is subject to OTS examination and
supervision as well as certain reporting requirements. As a SAIF-insured
subsidiary of a savings institution holding company, the Bank is subject to
certain restrictions in dealing with the Holding Company and with other
persons from time to time affiliated with the Bank which continues to be
subject to examination and supervision by the OTS. In addition, the OTS has
enforcement authority over the Holding Company and its non-savings association
subsidiaries which also permits the OTS to restrict or prohibit activities
that are deemed to be a risk to the safety and soundness of the subsidiary
savings association. This regulation and oversight is intended primarily for
the protection of the depositors of the Bank and not for shareholders of the
Holding Company.
-18-
As a unitary savings and loan holding company, the Holding Company
generally is not subject to activity restrictions, provided the Bank satisfies
the Qualified Thrift Lender (QTL) test described below under "Regulation -
Bank" - "Qualified Thrift Lender Test". If the Holding Company acquires
control of another savings association as a separate entity, it would become a
multiple savings and loan holding company, and the activities of the Holding
Company and any of its subsidiaries (other than the Bank or any other SAIF-
insured savings association) would become subject to such restrictions unless
such other associations each qualify as a QTL or were acquired in a
supervisory acquisition.
The Holding Company must obtain approval from the OTS before acquiring
control of any other SAIF-insured association. Such acquisitions are
generally prohibited if they result in a multiple savings and loan holding
company controlling savings associations in more than one state. However,
such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings
association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more persons, may acquire
"control," as that term is defined in OTS regulations, of a federally-insured
savings institution without giving at least 60 day's written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition.
Such acquisitions of control may be disapproved if it is determined, among
other things, that (i) the acquisition would substantially lessen competition;
(ii) the financial condition of the acquiring person might jeopardize the
financial stability of the savings institution or prejudice the interest of
its depositors; or (iii) the competency, experience or integrity of the
acquiring person or the proposed management personnel indicates that it would
not be in the interest of the depositors or the public to permit the
acquisitions of control by such person.
The common stock of the Holding Company is registered as a class with the
Securities and Exchange Commission (SEC) under the Securities Exchange Act of
1934. Thus, the Holding Company is subject to the periodic reporting
requirements, proxy solicitation requirements and the insider-trading
restrictions of that Act. The periodic reports, proxy statements, and other
information filed by the Holding Company can be inspected, copied or obtained
from the Washington D.C. office of the SEC.
The Holding Company is a "registered company" under Minnesota law and is
subject certain provisions governing mergers, take-overs, business
combinations, and other similar transactions.
TRANSACTIONS WITH AFFILIATES - Section 11 of the HOLA, as amended by
FIRREA, provides that transactions between an insured subsidiary of a holding
company and an affiliate thereof will be subject to the restrictions that
apply to transactions between banks that are members of the Federal Reserve
System and their affiliates pursuant to Sections 23A and 23B of the Federal
Reserve Act. Generally, Sections 23A and 23B (i) limit the extend to which
the financial institution or its subsidiaries may engage in "covered
transactions" with an affiliate, as defined, to an amount equal to 10% of such
institution's capital and surplus and an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (ii) require that all transactions with an affiliate, whether or
not "covered transactions," be on terms substantially the same, or at least as
favorable to the institution or subsidiary as those provided to a non-
-19-
affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee or similar other types of
transactions. In addition to the restrictions that apply to member banks
pursuant to Sections 23A and 23B, three other restrictions apply to savings
associations, including those that are part of a holding company organization.
First, savings associations may not make any loan or extension of credit to an
affiliate unless that affiliate is engaged only in activities permissible for
bank holding companies. Second, savings associations may not purchase or
invest in affiliate securities except those of a subsidiary. Finally, the
Director of the OTS is granted the authority to impose more stringent
restrictions when justifiable for reasons of safety and soundness.
Extensions of credit by the Bank to its executive officers, directors and
principal shareholders are subject to Section 22(h) of the Federal Reserve
Act, which among other things, generally prohibits loans to any such
individual where the aggregate amount exceeds an amount equal to 15% of a
bank's unimpaired capital and surplus, plus an additional 10% of unimpaired
capital and surplus in case of loans that are fully secured by readily
marketable collateral. As of December 31, 1996, the Bank was in compliance
with this extension of credit regulation.
REGULATION - BANK
GENERAL - The Bank is a federally chartered stock savings bank, the
deposits of which are insured and backed by the full faith and credit of the
United States Government. As a result, the Bank is subject to broad federal
regulation and oversight applicable to all of its operations. The Bank is a
member of the FHLB of Seattle, Washington, and is also subject to certain
limited regulations by the Federal Reserve Board. The Bank is a member of the
SAIF and the deposits of the Bank are insured by the FDIC. As a result, the
FDIC has certain regulatory and examination authority over the Bank.
Some of these regulatory requirements and restrictions are discussed below
and elsewhere.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS - The OTS has extensive
authority over the operations of the Bank. Accordingly, the Bank is required
to file periodic reports with the OTS and is also subject to periodic
examinations by the OTS and the FDIC. The last regular OTS and FDIC
examinations of the Bank were completed January 1997 and April 1990,
respectively. The OTS and the FDIC have entered into an agreement that
provides for joint examinations by the FDIC with the OTS, unless compelling
reasons otherwise are warranted. Federal examiners can require the Bank to
provide higher general or specific loan loss reserves or write down assets.
During its most recent examinations, the Bank was not required to take any of
these actions.
The OTS also has extensive enforcement authority over the Bank. This
enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease and desist orders or removal orders, and
to initiate injunctive actions. Generally, these enforcement actions can be
initiated for violations of laws and regulations and for unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required. In addition, the lending and investment authority of the
Bank is prescribed by such laws and regulations.
-20-
In order to fund its operations, the OTS has established a schedule for the
assessment of fees upon all savings associations. This general assessment,
currently paid on a semiannual basis, is levied based upon the Bank's asset
size, including consolidated subsidiaries, as reported in its quarterly Thrift
Financial Report, with "troubled" institutions paying a "premium rate" on the
same asset total, and all other institutions like the Bank paying a "general
rate." The Bank paid "general rate" assessments totaling $33,162 in 1996,
$35,649 in 1995 and $37,544 in 1994.
The 1989 passage of the FIRREA provides for a major restructuring of the
federal regulatory scheme applicable to financial institutions and their
holding companies. The FIRREA abolished the Federal Home Loan Bank Board and
the Federal Savings and Loan Insurance Corporation, with many of the previous
regulatory functions transferred to the OTS. Regulatory functions relating to
deposit insurance and to conservatorships and receiverships of federally
insured financial institutions, including both savings institutions and banks,
are generally exercised by the FDIC. The FIRREA contains provisions affecting
numerous aspects of the operation and regulation of federally insured savings
institutions and empowers the OTS Director and the FDIC to promulgate
regulations implementing the provisions of FIRREA.
The 1991 passage of the FDICIA continues to have far reaching effects on
the management and operation of banks and savings associations, as well as
their relationship with federal regulators. The FDICIA provides for the
recapitalization of the Bank Insurance Fund (BIF), but does not contain
financial restructuring provisions that would allow affiliation with
securities and insurance firms or permit commercial firms to own banks, nor
does it provide for a new holding company structure, nor does it authorize
nationwide interstate banking and branching, nor does it restructure or
consolidate the bank and thrift regulatory agencies. The FDICIA authorizes a
new era of intensified regulation with explicit rules replacing the more
informal and at times flexible supervisory policies previously followed by
federal regulators. The nexus of the FDICIA is the continuation of the
reregulation of the banking and savings industry which began with the FIRREA.
The description of the FIRREA, the FDICIA and other federal legislation
rules and regulations as set forth in this form 10-K document does not purport
to be a complete recital of all laws or their impact on the Bank.
As a creditor and a financial institution, the Bank is subject to various
regulations promulgated by the Federal Reserve Board, including, without
limitation, Regulation B (Equal Credit Opportunity), Regulation D (Reserves),
Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending) and
Regulation CC (Availability of Funds). As creditors of loans secured by real
property, and as owners of real property, financial institutions, including
the Bank, may be subject to potential liability under various statutes and
regulations applicable to property owners generally, including statutes and
regulations relating to the environmental condition of the property and
bankruptcy laws.
DEPOSIT INSURANCE AND FDIC REGULATION - The Bank is a member of the SAIF
which is administered by the FDIC. Savings deposits are insured up to the
applicable limits (generally $100,000 per insured depositor) by the FDIC and
backed by the full faith and credit of the United States Government. The FDIC
is empowered to impose deposit insurance premiums, conduct examinations and
require reporting by the Bank. The FDIC may also prohibit the Bank from
engaging in any activity the FDIC determines by regulation or order to pose a
serious risk to the FDIC. The FDIC can also initiate enforcement actions
-21-
against the Bank, after giving the OTS an opportunity to take such action, and
may terminate the deposit insurance of the Bank if it determines that the Bank
has engaged or is engaging in any unsafe or unsound practice, or is in an
unsafe or unsound condition.
The FDIC has been mandated by Congress to reach a level of insurance
reserve amounting to 1.25% of bank and thrift industry deposits. In addition,
under the FDICIA, the FDIC may impose special assessments on its SAIF members
to repay amounts borrowed from the U.S. Treasury or for any other reason
deemed necessary by the FDIC. The FDICIA also is authorized by the FDIC to
implement a risk-based deposit insurance assessment system. To that end a
Risk Related Premium System now assigns each insured institution to 1 of 3
capital groups, and to 1 of 3 supervisory sub-groups. Capital groups are
assigned based upon capital ratios: "well-capitalized," "adequately-
capitalized," and "under-capitalized." Within each capital group,
institutions are further divided into sub-groups based upon their potential
"risk" to the insurance fund: "A" healthy, "B" supervisory concern, "C"
substantial supervisory concern. Under the risk-based regulations, FDIC
insurance premiums prior to 1997 ranged from a low of $.23 to a high of $.31
per $100 of deposits. See below "Regulatory Capital Requirements."
For the past several years, the Bank's risk-based insurance designation has
been the most favorable, "well-capitalized" and "A" healthy and thus the Bank
has incurred FDIC/SAIF deposit insurance premiums at the lowest available
rate, $.23 per $100 of deposits. For the past three years, the Bank has
incurred non-special assessment FDIC/SAIF deposit insurance premium expense as
follows: 1996, $170,286; 1995, $199,068; and 1994, $220,780.
Enacted into law in 1996 was legislation providing for a special assessment
against FDIC/SAIF member institutions which capitalized the SAIF insurance
reserve to the prescribed 1.25% of insured deposits level. For the Bank, this
one-time special assessment was $549,700, or 65.7 basis points per $100 of the
Bank's insured deposit base on March 31, 1995. The Company's 1996
consolidated financial statements reflect the expense and payment of this
$549,700 special assessment.
Based upon the Bank's 1996 year-end "1A" FDIC risk classification, the
Bank's FDIC/SAIF assessment rate, beginning January 1, 1997 decreased from 23
basis points to 6.48 basis points per $100 of insured deposits. Most
commercial banks, insured under the FDIC/Bank Insurance Fund (BIF) will,
beginning January 1, 1997, be assessed 1.296 basis points per $100 of insured
deposits. In addition, 1996 legislation provides for the merger of the SAIF
and BIF insurance funds on January 1, 1999, provided the bank and savings
association charters have been merged by that date.
BROKERED DEPOSITS - The Bank, due to its capital position, is empowered to,
but by policy does not accept, place or solicit brokered deposits.
REGULATORY CAPITAL REQUIREMENTS - The FIRREA established capital standards
for savings institutions, requiring the OTS to promulgate capital regulations
no less stringent than those applicable to national banks. To that end, the
OTS issued regulations resulting in three different minimum capital
requirements, a "tangible capital requirement," a "core capital or leverage
limit requirement" and a "risk-based capital requirement." For further
information on these capital requirements and the extent to which the Bank
substantially exceeds all three requirements, see Part IV, Item 14. - "Notes
to Consolidated Financial Statements" - "Regulatory Capital". The Bank, at
December 31, 1996, had no intangible assets, such as purchased mortgage
servicing rights or goodwill. -22-
For the risk-based capital component, savings institution assets are
assigned to one of the following four risk-weighted categories based upon the
degree of risk associated: (1) zero percent for cash and securities backed by
the full faith and credit of the U.S. Government and for notes and obligations
of the FSLIC and the FDIC; (2) twenty percent for high-quality, mortgage-
backed securities (typically Federal National Mortgage Association or Federal
Home Loan Mortgage Corporation), all claims on FHLBs, general obligations of
state and local governments and claims on domestic depository institutions;
(3) fifty percent for qualifying single-family, residential mortgage loans,
qualifying multi-family, residential loans and other mortgage-backed
securities backed by qualifying home mortgage loans; and (4) one-hundred
percent for all other loans and investments, including consumer loans,
commercial loans, home equity loans, non-qualifying mortgage loans,
residential construction loans, repossessed assets, real estate loans more
than ninety days delinquent, and certain equity investments.
Long proposed by the OTS, and authorized by the FIRREA, has been an
"interest-rate-risk" (IRR) component of regulatory capital. This IRR capital
component is expected to become effective in 1997. For further information
see the Part II, Item 7. - "Asset/Liability Management" - "IRR Exposure
Measurement." This IRR capital component will be expressed as the change in
net portfolio value-NPV (i.e. the present value of all expected cash flows
from assets less the present value of all expected cash flows from
liabilities) as the result of a hypothetical 200 basis points instantaneous
increase or decrease in interest rates divided by the present value of an
institution's assets. An institution with a normal level of IRR is defined by
the OTS as having a measured IRR of less than 2%. Only institutions where the
measured IRR exceeds 2% will be required to maintain an IRR capital component.
Based on its current capital position, most recent OTS calculated IRR, and
proposed exemption criteria, the Bank would not have an IRR capital
adjustment.
The FDICIA also mandates that regulations be promulgated adding other risk-
based capital requirements covering (a) concentrations of credit risk, (b)
risks from nontraditional activities and (c) the capital impact of fair value
adjustments associated with FASB Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". The Bank's significant capital
position and the extent to which it already exceeds current minimum capital
requirements leads management to believe the Bank will maintain compliance
with any new capital requirements.
The FDICIA places much greater emphasis on capital as a measure of
performance and establishes a rigid regulatory scheme based almost entirely on
capital levels. Under the FIRREA, failure to meet capital standards can
result in the use of gross restrictions, cease and desist orders, civil
monetary penalties, capital directives to enforce requirements and required
written capital plans. The FDICIA does not eliminate previous enforcement
powers, but severely limits regulators' discretion in the exercise, timing and
choice of regulatory actions. The FDICIA does so by limiting regulators'
discretion not to impose regulatory restrictions that are, in most cases,
available under current law.
The five statutory capital categories established by the FDICIA are: "well
capitalized" - institutions with capital that significantly exceeds the
required minimum level for each relevant capital measurement; "adequately
capitalized" - institutions with capital that meets the required minimum level
-23-
for each relevant capital measure; "undercapitalized" - institutions with
capital that fails to meet the required minimum level for any relevant capital
measure; "significantly undercapitalized" - institutions with capital
significantly below the required minimum level for any relevant capital
measure; and "critically undercapitalized" - institutions that fall below a
critical capital level set by the appropriate federal banking agency. The
Bank's capital position substantially exceeds the definition of "well
capitalized."
QUALIFIED THRIFT LENDER TEST - The HOLA requires savings institutions to
meet a QTL test. If the Bank maintains an appropriate level of Qualified
Thrift Investments (QTIs) (primarily residential mortgages and related
investments, including certain mortgage-related securities), it will continue
to enjoy full borrowing privileges from the FHLB of Seattle, Washington. The
required percentage of QTIs is 65% of portfolio assets (defined as all assets
minus intangible assets, property used by the institution in conducting its
business and liquid assets equal to 10% of total assets). Certain assets are
subject to a percentage limitation of 20% of portfolio assets. In addition,
savings associations may include shares of stock of the FHLBs, Federal
National Mortgage Association, and Federal Home Loan Mortgage Corporation as
qualifying QTIs. Compliance with the QTL test is determined on a monthly
basis in nine out of every 12 months. As of December 31, 1996, the Bank was
in compliance with its QTL requirement with 92% of its assets invested in
QTIs.
A savings association that does not meet a QTL test must either convert to
a bank charter or comply with the following restrictions on its operations:
(i) the savings association may not engage in any new activity or make any new
investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the savings
association shall be restricted to those of a national bank; (iii) the savings
association shall not be eligible to obtain any advances from its FHLB; and
(iv) payment of dividends by the savings association shall be subject to the
rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the savings association ceases to be a QTL, it
must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
SAFETY AND SOUNDNESS STANDARDS - Prior to the FDICIA, the phrase "unsafe or
unsound practice" was a generic term dependent upon the facts and
circumstances to be established by the appropriate banking regulatory agency.
The FDICIA now requires the federal banking regulatory agencies to prescribe
by regulation explicit standards for safety and soundness, including: (a)
operational and managerial standards; (b) asset quality, earnings and stock
valuation standards; (c) compensation standards for executive officers,
employees, directors, etc.; and (d) any other standards deemed appropriate by
the regulatory agencies. The Bank's management believes that its operations
meet or exceed current safety and soundness regulations.
CONSUMER ISSUES - The FDICIA mandates a number of pro-consumer measures,
including one entitled "The Truth in Savings Act," (TISA). The TISA contains
mandatory disclosure requirements for interest-bearing deposit accounts at
insured institutions with the goal of standardizing the types of information
presented in deposit advertisements so consumers can make meaningful
comparisons between competing claims for deposits. The Bank has implemented
ongoing TISA mandates and believes that its operations are in compliance.
-24-
The Community Reinvestment Act (CRA) requires an insured financial
institution to help meet the credit needs of its community, including low- and
moderate-income borrowers and neighborhoods, consistent with the safe and
sound operation of the institution. Regulators are authorized to evaluate and
rate the CRA activities of insured institutions. The FIRREA mandated the CRA
to require public disclosure of the regulators' evaluation and rating of each
insured depository institution. Previously, the public disclosure section of
the regulators' evaluations merely stated the institution's rating and the
agencies' conclusions on each assessment factor and discussed the facts
supporting these conclusions. The FDICIA now adds an additional requirement
that regulators disclose the data used in assessing a depository institution's
performance. During the most recent OTS compliance exam completed in November
1995, the OTS conducted CRA performance evaluations and the Bank was rated as
having had "an outstanding record of helping to meet the credit needs of its
entire local community in a manner consistent with its resources and
capabilities."
LIQUIDITY - All savings associations such as the Bank are required to
maintain an average daily balance of liquid assets equal to a certain
percentage of the sum of its average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less. The liquidity
requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations. At the
present time, the required liquid asset ratio is 5%.
Liquid assets for purposes of this ratio include specified short-term
assets (e.g., cash, certain time deposits, certain banker's acceptances and
short-term United States Government obligations), and long-term assets (e.g.,
United States Government obligations of more than one and less than five years
and state agency obligations with a minimum term of 18 months). Short-term
liquid assets currently must constitute at least 1% of the Bank's average
daily balance of net withdrawable deposit accounts and current borrowings.
Monetary penalties may be imposed upon associations for violations of
liquidity requirements.
For additional information regarding liquidity requirements, see Part II,
Item 7. -"Management's Discussion and Analysis of Financial Condition and
Results of Operations" - "Liquidity and Capital Resources."
FEDERAL HOME LOAN BANK SYSTEM - The Bank is a member of the FHLB of
Seattle, Washington which is one of several regional banks that administer the
home financing credit function for savings associations. Each FHLB serves as
a reserve or central bank for its members within its assigned areas. Each
FHLB is funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLB system. Each FHLB makes loans (advances) to its
members in accordance with the policies and the procedures established by the
FHLB board of directors. All policies and procedures are subject to the
regulation and oversight of the Federal Housing Finance Board. All advances
from the FHLB are required to be fully secured by sufficient collateral as
determined by the FHLB.
Federal law requires the FHLBs to transfer a significant amount of their
reserves and undivided profits to the government agency established to resolve
troubled thrift cases and to contribute to low and moderately priced housing
programs through direct loans or interest subsidies on advances targeted for
community investment and low and moderate income housing projects (Affordable
Housing Program). These requirements have and will continue to adversely
affect the amount of FHLB dividends. These contributions could also have an
-25-
adverse effect on the future value of FHLB stock. A loss in value of the
Bank's FHLB stock investment could result in a reduction of the Bank's
capital.
The Bank is required to purchase and maintain FHLB stock with minimum
annual requirements of the greater of: 1% of residential mortgage loans, .3%
of total assets, or 5% of FHLB advances outstanding. At December 31, 1996,
the Bank was in compliance with the minimum stock requirement with $379,000
invested in FHLB stock.
During the fiscal years 1996, 1995 and 1994, the Bank received FHLB stock
dividend income of $31,035, $23,230 and $28,639, respectively. The 1996
dividend provided the Bank with an annual return of 7.80%, the 1995 dividend
annual return was 6.59%, while the 1994 dividend was 6.84%.
FEDERAL RESERVE SYSTEM - The regulations of the Federal Reserve Board can
require savings institutions to maintain non-interest-earning reserves against
certain of their transaction accounts (primarily deposit accounts that may be
accessed by writing checks) and nonpersonal time deposits with maturities of
less than 18 months. For the calculation period including December 31, 1996
and 1995, the Bank was in compliance, but did not have a non-interest-earning
reserve requirement.
Savings associations are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require the Bank to
exhaust other reasonable alternative sources of funds, including FHLB
borrowings, before borrowing from the Federal Reserve Bank.
PROPOSED LEGISLATION - Several bills have been introduced in the United
State Congress that would, if adopted, significantly change laws and
regulations applicable to savings and loans and savings and loan holding
companies. The general tenor of this type of legislation is that the OTS will
be combined with the Office of the Comptroller of the Currency as a single
agency overseeing the operations of federal financial institutions and that
the savings institution charter will eventually be eliminated. If such
legislation were adopted, federal savings institutions would become national
banks, and savings and loan holding companies, such as the Holding Company,
would become subject to regulation and oversight by the Federal Reserve Board
as bank holding companies. The permitted activities of bank holding companies
are more limited than the activities of a savings and loan holding company.
In general, a bank holding company may engage, either directly or through one
of its subsidiaries, only in activities that the Federal Reserve Board
concludes are directly related to banking activities. Some versions of this
type of legislation provide that savings and loan holding company activities
would be "grandfathered" and not further restricted by Federal Reserve Board
regulation. If this kind of legislation were adopted, and savings and loan
holding companies became subject to regulation as bank holding companies and
no provision to grandfather savings and loan holding company activities was
included or the date on which such grandfathered activities have to be
commenced predates the date of organization of the Holding Company, some of
the operating flexibility at the holding company level that the reorganization
was intended to provide would not be available.
For more information regarding legislation see Part II, Item 7. -
"Management Discussion and Analysis of Financial Condition" - "Legislation."
-26-
The full impact that current, proposed and future legislative rules and
regulations will have on the Bank and other financial institutions are not
known at this time and cannot be predicted.
TAXATION
GENERAL - The Holding Company and its Bank subsidiary report their income
on a calendar year basis and have elected to file a consolidated federal
income tax return. Montana state statue prevents filing of a consolidated
Montana income tax return, and thus separate returns are filed by the Holding
Company and the Bank. A Tax Sharing Agreement provides that the Holding
Company and the Bank "... pay their respective federal and state taxes as
separate corporations on a stand alone basis." Generally with some
exceptions, including the Bank's reserve for bad debts discussed below, the
Holding Company, the Bank and its subsidiary are subject to federal income
taxes in the same manner as other corporations.
The following discussion of tax matters is intended solely as a summary and
does not purport to be a comprehensive description of all the tax rules
applicable to the Holding Company, the Bank or its subsidiary.
TAX BAD DEBT RESERVES - For taxable years beginning prior to January 1,
1996, savings institutions, such as the Bank, which met certain definitional
tests primarily relating to their assets and the nature of their business
("qualifying thrifts"), were permitted to establish a reserve for bad debts
and to make annual additions thereto, which additions may, within specified
formula limits, have been deducted in arriving at their taxable income. The
Bank's deduction with respect to "qualifying loans," which are generally loans
secured by certain interests in real property, including various types of
mortgage-backed securities, may have been computed using an amount based on
the Bank's actual loss experience or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted additions to the nonqualifying reserve. The Bank's deduction
with respect to nonqualifying loans was computed under the experience method,
which essentially allows a deduction based on the Bank's actual loss
experience over a period of several years. Each year the Bank selected the
most favorable way to calculate the deduction attributable to an addition to
the tax bad debt reserve.
Recently enacted federal legislation repealed the reserve method of
accounting for bad debt reserves for tax years beginning after December 31,
1995. As a result, savings associations can no longer calculate their
deduction for bad debts using the percentage-of-taxable-income method.
Instead, savings associations are required to compute their deduction based on
specific charge-offs during the taxable year or, if the savings association or
its controlled group had assets of less than $500 million, based on actual
loss experience over a period of years. This legislation also requires
savings associations to recapture into income over a six-year period their
post-1987 additions to their bad debt tax reserves, thereby generating
additional current tax liability. At December 31, 1996, the Bank's bad debt
reserve for tax purposes was approximately $3.2 million. At December 31, 1996,
there were no post-1987 reserves.
Under prior law, if the Bank failed to satisfy the qualifying thrift
definitional tests in any taxable year, it would be unable to make additions
to its bad debt reserve. Instead, the Bank would be required to deduct bad
debts as they occur and would additionally be required to recapture its bad
-27-
debt reserve deductions ratably over a multi-year period. Among other things,
the qualifying thrift definitional tests required the Bank to hold at least
60% of its assets as "qualifying assets." Qualifying assets generally include
cash, obligations of the United States or any agency or instrumentality
thereof, certain obligations of a state or political subdivision thereof,
loans secured by interests in improved residential real property or by savings
accounts, student loans and property used by the Bank in the conduct of its
banking business. Under current law, a savings association will not be
required to recapture its pre-1988 bad debt reserves if it ceases to meet the
qualifying thrift definitional tests.
CORPORATE ALTERNATIVE MINIMUM TAX - Federal tax law imposes a tax on
alternative minimum taxable income (AMTI) at a rate of 20%. The excess of the
tax bad debt reserve deduction using the percentage of taxable income method
over the deduction that would have been allowable under the experience method
is treated as a preference item for purposes of computing the AMTI. In
addition, only 90% of AMTI can be offset by net operating loss carryovers.
AMTI is increased by an amount equal to 75% of the amount by which the Bank's
adjusted current earnings exceed its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). For taxable
years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of .12% of the excess of AMTI (with certain modification)
over $2.0 million was imposed on corporations, including the Company, whether
or not an alternative minimum tax is paid.
DIVIDENDS-RECEIVED DEDUCTION AND OTHER MATTERS - The Holding Company may
exclude from its income 100% of dividends received from the Bank as a member
of the same affiliated group of corporations. The corporate dividends-
received deduction is generally 70% in the case of dividends received from
unaffiliated corporations with which the Holding Company and the Bank will not
file a consolidated tax return, except that if the Holding Company of the Bank
owns more than 20% of the stock of a corporation distributing a dividend, then
80% of any dividends received may be deducted.
There have not been any IRS audits of the Company's federal income tax
returns during the past five years.
STATE TAXATION - Under Montana tax law, savings institutions are subject to
a corporation license tax, which incorporates or is substantially similar to
applicable provisions of the Federal Code. The corporation license tax was
imposed on federal taxable income, subject to certain adjustments, at a rate
of 6.75% for 1996, 1995 and 1994.
There have not been any Montana Department of Revenue audits of the
Company's state tax returns during the past five years.
For additional information regarding federal and state income taxes, see
Part IV, Item 14. - "Notes to Consolidated Financial Statements" - "Income
Taxes".
-28-
ITEM 2. PROPERTIES
On December 31, 1996, the Company owned all of its land, buildings and
improvements having an aggregate cost of $2,520,890, less accumulated
depreciation of $1,303,631, for a net book value of $1,217,259. Office
locations:
Home Office
United Financial Corp./United Savings Bank, F.A.
601 1st Avenue North
Great Falls, MT 59401
Shelby Bank Branch Glendive Bank Branch Havre Bank Branch
201 Main Street 123 W. Bell Street 410 3rd Avenue
Shelby, MT 59474 Glendive, MT 59330 Havre, MT 59601
DATA PROCESSING EQUIPMENT - The Company's data processing is contracted
through an outside service bureau, FISERV of Milwaukee, Wisconsin. The Company
owns only the minimal equipment necessary to process transactions and
communicate with the FISERV service center.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the quarter ended December 31,
1996.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The common stock of the Registrant is traded in the over-the-counter market
and is listed with the National Association of Securities Dealers Automated
Quotation System (NASDAQ) National Market System. The trading symbol is UBMT.
As of March 3, 1997, the closing bid price per share as quoted by NASDAQ on
such date was $19.75.
STOCKHOLDERS - As of December 31, 1996, there were approximately 290
shareholders of record, and approximately 1,160 beneficial owners, for a total
estimated 1,450 shareholders.
-29-
COMMON STOCK MARKET PRICES - The Company's quarterly (high and low) stock
prices for the past two years are as follows:
UBMT Stock Price
-----------------
High Low
------ ------
1995 First quarter $17.25 $15.50
Second quarter 18.00 16.25
Third quarter 18.00 17.00
Fourth quarter 18.25 17.00
1996 First quarter $18.50 $17.50
Second quarter 18.75 17.75
Third quarter 19.25 18.00
Fourth quarter 19.75 18.50
DIVIDENDS
The Company's Board of Directors declared dividends of $.215, $.22, $.225
and $.23 for the four quarters of 1996, for a total of $.89 per share and
declared dividends of $.195, $.20, $.205 and $.21 for the four quarters of
1995, for a total of $.81 per share. On January 27, 1997, the Company's Board
of Directors declared a quarterly dividend of $.235 per share, paid February
24, 1997, to shareholders of record on February 10, 1997. The declaration and
payment of future dividends by the Board of Directors is dependent upon the
Company's net income, financial condition, economic and market conditions,
industry standards, certain regulatory and tax considerations described below
and other conditions. No assurance can be given, or should be assumed, as to
the amount, timing, or frequency of future dividend payments.
There are limited restrictions on the ability of the Holding Company to pay
dividends from its retained earnings, however, the Holding Company's dividend
policy is not expected to differ from the past dividend policy of the Bank.
The OTS utilizes a three-tiered approach to permit savings associations,
based upon their capital level and supervisory condition, to make capital
distributions which includes dividends, stock redemptions or repurchases,
cash-out mergers and other transactions charged to the Bank's capital account.
Generally, Tier 1 institutions, like the Bank, meeting their fully-phased-in
capital requirement (see "Regulation - Bank" - "Regulatory Capital
Requirements") according to the capital standards effective on January 1,
1995, may automatically make capital distributions up to 100% of net income to
date during the calendar year, "plus an amount that would reduce by one half
its surplus capital ratio as of the beginning of the calendar year." "Surplus
capital ratio" means the percentage by which an institution's capital-to-
assets ratio exceeds the ratio of its fully-phased-in capital requirements to
assets. Also, the rule is applied on a pro forma basis: that is, the
institution must still meet its fully-phased-in capital requirements after the
proposed capital distribution. Tier 2 institutions (those which meet the
current minimum capital requirement on a pro forma basis, but not meeting
capital rules applicable on January 1, 1995) can pay dividends from 25% to 75%
of net income, determined on a GAAP basis, depending on how close they are to
meeting their fully-phased-in, risk-based component of the capital standards.
Tier 3 institutions, which do not meet their current regulatory capital
requirements, may pay dividends with prior regulatory approval.
-30-
Under current federal income tax laws, any dividend distribution of
property (cash or in-kind) by a "tax-qualified" thrift will be taxable as
income to the recipient and not deductible by the issuer. Such nondeductible
distributions are deemed under the Internal Revenue Code Section 593(e) to
come from first: (a) the accumulated "earnings and profits" of the institution
amassed since the onset of federal taxation in 1952, then (b) the tax bad-debt
reserves on qualifying real property loans of the institution then (c) the
supplemental reserve for losses on loans, and (d) other capital accounts.
Any dividend by a thrift deemed to come from the tax bad debt reserves
must, under the Code, be included in taxable income (because of the required
recapture of the original tax benefit of the thrift percentage of taxable
income bad-debt method) to the extent of the lesser of the tax bad debt
reserves or the amount of the distribution grossed up for taxes attributable
to the distribution.
-31-
ITEM 6. SELECTED FINANCIAL DATA
UNITED FINANCIAL CORP.
FIVE YEAR SUMMARY OF OPERATIONS AND SELECTED FINANCIAL DATA
(Dollar amounts in thousands, except per share amounts and other data.)
December 31,
---------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
Summary of Financial Condition:
Total assets $103,837 $114,440 $112,506 $119,041 $116,598
Cash and cash equivalents 2,934 1,221 636 6,001 1,551
Investments (nonmortgage-backed
securities) 33,785 38,163 53,197 54,559 54,443
Investments (mortgage-backed
securities) 27,228 40,216 21,646 17,412 12,611
Loans receivable, net 35,176 30,352 31,512 36,388 43,211
Deposits 78,697 78,291 89,086 95,292 94,051
Federal Home Loan Bank advances 10,500
Stockholders' equity 24,416 24,688 22,548 22,655 21,589
Per share 19.96 20.18 18.43 18.52 17.65
As a percent of assets 23.51% 21.57% 20.04% 19.03% 18.52%
Year Ended December 31,
---------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
Summary of Operations:
Interest income $ 7,253 $ 7,394 $ 7,926 $ 8,253 $ 8,318
Interest expense 3,565 3,420 3,616 4,046 4,678
------- ------- ------- ------- -------
Net interest income 3,688 3,974 4,310 4,207 3,640
Provision for loan losses 27
Noninterest income 835 595 772 1,045 903
Noninterest expense 2,771 2,133 2,085 2,091 2,010
------- ------- ------- ------- -------
Income before income taxes 1,752 2,436 2,997 3,161 2,506
Income taxes 649 714 1,111 1,189 926
------- ------- ------- ------- -------
Net income $ 1,103 $ 1,722 $ 1,886 $ 1,972 $ 1,580
======= ======= ======= ======= =======
Net income per share $.90 $1.41 $1.54 $1.61 $1.29
Dividends per share $.89 $ .81 $ .73 $ .65 $ .57
Ratios:
Net income as a percent of
average assets 1.03% 1.62% 1.58% 1.64% 1.43%
Net income as a percent of
average equity 4.50% 7.21% 8.16% 8.89% 7.45%
Average equity as a percent
of average assets 23.00% 22.39% 19.41% 18.40% 19.20%
Interest rate spread 2.62% 2.91% 3.04% 2.92% 2.51%
Net yield on average interest-
earning assets 3.59% 3.83% 3.72% 3.62% 3.46%
December 31,
---------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
Other Data:
Total number of full service offices 4 4 4 4 5
Number of deposit accounts 5,998 6,145 6,429 6,736 7,135
-32-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CHANGES IN FINANCIAL CONDITION DURING 1996 - During 1996, total assets
decreased $10.6 million, or 9%, to $103.8 million, investment securities
decreased $17.4 million, or 22%, to $61.0 million, loans receivable increased
$4.8 million, or 16%, to $35.2 million, deposits increased $.4 million, or
less than 1%, to $78.7 million, FHLB advances decreased $10.5 million to none
outstanding, and stockholders' equity decreased $.3 million, or 1%, to $24.4
million.
The 1996 repayments of FHLB advances, and the net increase in loans
receivable were funded primarily by mortgage-backed securities principal
collections, matured and called investment securities, and sales of investment
securities classified as available-for-sale.
Total 1996 loan production was $31.3 million, a $12.1 million, or 63%,
increase when compared to 1995. Twelve million dollars, or 38%, of the total
1996 loan production was comprised of long-term fixed-rate mortgage loans
originated for sale to the secondary market.
The $.3 million decrease in stockholders' equity was comprised of $1.1
million of net income, less $1.1 million of cash dividends paid to
shareholders, a $.2 million increase in the unrealized loss adjustment for
available-for-sale investment securities, and a $37,000 decrease for
capitalized holding company formation costs. Stockholders' equity at December
31, 1996, was 23.5% of assets, and book value was $19.96 per share.
The following table summarizes the major components of the Company's net
income for the three years ended December 31, 1996, as well as the changes
which occurred between the periods shown.
(Dollars in thousands) Year Ended December 31,
----------------------------------------
1996 1995 1994
-------------- -------------- ------
Amount Change Amount Change Amount
------ ------ ------ ------ ------
Interest income $7,253 $(141) $7,394 $(532) $7,926
Interest expense 3,565 145 3,420 (196) 3,616
------ ------ ------ ------ ------
Net interest income 3,688 (286) 3,974 (336) 4,310
Noninterest income 835 240 595 (177) 772
Noninterest expense 2,771 638 2,133 48 2,085
------ ------ ------ ------ ------
Income before income taxes 1,752 (684) 2,436 (561) 2,997
Provision for income taxes 649 (65) 714 (397) 1,111
------ ------ ------ ------ ------
Net income $1,103 $(619) $1,722 $(164) $1,886
====== ====== ====== ====== ======
COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
GENERAL - Net income for 1996 was $1,103,000, a $619,000, or 36%, decrease
compared to 1995. The primary reasons for this decline were: (1) a $549,700
FDIC/SAIF deposit insurance special assessment, (2) a $286,000 decline in net
interest income resulting primarily from higher deposit costs and borrowing
expense, and (3) higher other expenses due to approximately $90,000 of
advertising expenditures.
-33-
Net interest margin (net interest income divided by average interest-
earning assets) declined 24 basis points to 3.59%. Net interest spread (the
difference between the average yield on interest-earning assets less the
average cost of interest-bearing liabilities) declined 29 basis points to
2.62%. The return on average assets for 1996 was 1.03% compared to 1.62% for
1995. Based on weighted average shares outstanding, 1996 net income was $.90
per share, compared to $1.41 per share for 1995.
INTEREST INCOME - Average 1996 interest-earning assets declined $1.1
million, or 1%, to $102.6 million. Average 1996 loans receivable increased
$1.0 million, or 3%, to $31.8 million, and average other interest-earning
assets declined $2.1 million, to $70.8 million. Loans receivable average
yields decreased 4 basis points to 9.29% and overall lower yields on all other
interest-earning assets resulted in a 1996 average yield for all interest-
earning assets of 7.07%, compared to 7.13% in 1995.
INTEREST EXPENSE - Average 1996 deposits decreased $2.5 million, or 3%, to
$78.5 million. The mix of average deposits changed with average lower cost
statement savings decreasing $5.2 million, or 15%, while higher cost/repricing
average time deposits increased $2.5 million, or 7%. The 1996 cost of average
time deposits increased 29 basis points to 5.43%. The 1996 average cost of
deposits rose to 4.43%, compared to 4.22% in 1995. Deposit interest expense
in 1996 therefore increased $61,000, or 2%, to $3,473,000.
Primarily due to $10.5 million dollars of FHLB advances outstanding at the
end of 1995, average 1996 borrowings were $1.6 million, a $1.5 million
increase over 1995, resulting in $92,000 of interest expense in 1996, compared
to $8,000 in 1995. The 1996 average cost of borrowings was 5.72%, compared to
5.89% in 1995. The 1996 average cost of all interest-bearing liabilities
increased to 4.45%, compared to 4.22% in 1995.
NET INTEREST INCOME - This category decreased $286,000, or 7%, to
$3,688,000 for the reasons cited above.
NONINTEREST INCOME - This category increased $240,000, or over 40%, to
$835,000. The primary reason for this increase was $150,000 in gains from
1996 sales of available-for-sale investment securities. In 1996, loan
origination fee and discount income increased $85,000, or 24%, to $443,000.
This improvement was the direct result of increased loan production. During
1996 loans originated for sale to the secondary market were $12 million,
compared to $8.4 million in 1995, and loans originated for portfolio in 1996
were $19.3 million, compared to $10.8 million in 1995.
NONINTEREST EXPENSE - This category increased $638,000, or 30%, to
$2,771,000. The primary reason for this increase was the 1996 $549,700
FDIC/SAIF deposit insurance premium previously discussed. The after tax impact
of this special assessment was a $338,300, or a 28 cent per share reduction in
1996 net income. In 1996, a $16,000 loss on the sale of real estate owned was
incurred. Other expenses increased $103,000, or 25%, to $522,000 due
primarily to higher advertising expense for a media marketing campaign.
PROVISION FOR INCOME TAXES - Income before taxes in 1996 was $1,752,000, a
$684,000, or 28%, reduction from 1995. Total 1996 income taxes were $649,000,
a $65,000, or 9%, decrease compared to 1995. This disproportionate decrease
in 1996 taxes, compared to the pre-tax earnings decrease, was due primarily to
the 1995 federal statutory bad debt deduction. This 1995 bad debt deduction
reduced 1995 federal income taxes by approximately $152,000. For 1996 and
1995, the Company incurred the 6.75% marginal Montana corporate license tax.
-34-
PROVISION FOR LOSSES ON LOANS AND ASSET QUALITY - Non-performing assets
consisting of non-accrual uninsured loans, accruing loans past due over 90
days, restructured loans, and all real estate owned held for sale (REO/HFS)
were approximately $58,000 at December 31, 1996, and $78,000 at December 31,
1995, representing .06%, and .07% of total assets, respectively. At December
31, 1996 and 1995, total loss reserves were $75,000. Loss reserves as a
percentage of nonperforming assets at December 31, 1996 and 1995, were 130%
and 96%, respectively. Loss reserves as a percentage of uninsured loans and
REO/HFS at December 31, 1996 and 1995, were .25% and .32%, respectively.
Federal regulations require the Bank to classify its assets as substandard
(distinct possibility that some loss will be sustained), doubtful (high
likelihood of loss), and loss (uncollectible). At December 31, 1996 and 1995,
the Bank's substandard assets were approximately $40,000. At the end of 1996
and 1995, no asset was classified as doubtful or loss.
Given the continuing low level of nonperforming and classified assets and
the sale of a large percentage of new loan production, no loan loss provision
expense was deemed necessary (i.e. both probable and estimable) for the years
ended December 31, 1996 and 1995. During 1996, loans receivable increased
approximately $1.2 million as a result of new recreational vehicle consumer
loans. Future loan loss provisions may be necessary for these loans.
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994
GENERAL - Net income for 1995 was $1,722,000, a decrease of $164,000, or 9%
less than 1994. Net income for 1995 was the third best year surpassed only by
1994's second best year, $1,886,000. During 1995, continuing increases in
market interest rates had two major unfavorable results: (1) higher deposit
costs and a net deposit outflow (funded by a decrease in average higher
yielding interest-earning assets), and (2) less loan production resulting in
lower loan origination fees and discount income.
Net interest margin (net interest income divided by average interest-
earning assets) increased 11 basis points to 3.83%. Net interest spread (the
difference between the average yield on interest-earning assets less the
average cost of interest-bearing liabilities) decreased 13 basis points to
2.91%. The 1995 return on average assets was 1.62% compared to 1.58% for
1994. Based on weighted average shares outstanding, 1995 net income was $1.41
per share, compared to $1.54 per share for 1994.
INTEREST INCOME - Average 1995 interest-earning assets declined $11.9
million, or 10%, due to the funding of deposit withdrawals. Average 1995
loans receivable decreased $2.5 million and average investment securities
decreased $9.9 million. While loans receivable average yields decreased 5
basis points to 9.33%, overall higher market interest rates for other
interest-earning assets resulted in a 1995 average yield for all interest-
earning assets of 7.13%, compared to 6.85% in 1994.
INTEREST EXPENSE - Average 1995 deposits decreased $14.0 million, or 15%,
compared with 1994, while due to higher interest rates and time deposits
repricing, deposit interest expense declined only $204,000, or 6%. The 1995
average cost of deposits was 4.22%, compared to 3.81% in 1994. Due to $10.5
million of FHLB advances at year-end, average 1995 borrowings were only
$137,000, resulting in $8,000 of interest expense in 1995, compared to none in
1994. The 1995 average cost of borrowings was 5.89%. The average 1995 cost
of all interest-bearing liabilities was 4.22%.
-35-
NET INTEREST INCOME - Despite the net $196,000 decrease in interest
expense, the even greater $532,000 decrease in interest income resulted in a
$336,000, or 8%, reduction in net interest income.
NONINTEREST INCOME - This category decreased $177,000, or 23%, to
$595,000, and was the second primary reason for the decline in 1995's
earnings. Due to both higher market interest rates and increased competition
for loans, 1995 loan production declined 20% to $19.2 million, resulting in
loan origination fee and discount income declining $171,000, or 32%. In
addition, due primarily to lower average balances, 1995 FHLB stock dividend
income was $5,000 lower, offset by a $5,000 net gain from the sale of
investment securities.
NONINTEREST EXPENSE - This category increased $48,000, or 2%, to
$2,133,000, and was the net result of a $48,000, or 4%, increase in salaries
and employee benefits, a $17,000, or 7%, increase in net occupancy and
equipment expense (due to a Great Falls office remodel and a data center
conversion), offset by a $22,000, or 10%, reduction in FDIC/SAIF deposit
insurance due to a lower deposit base.
PROVISION FOR INCOME TAXES - Income before taxes was $2,436,000, a
$561,000, or 19%, reduction from 1994. Total 1995 income taxes were $714,000,
a $397,000, or 36%, decrease compared to 1994. This disproportionate decrease
in 1995 taxes, compared to the decrease in pre-tax earnings, was due primarily
to the Bank utilizing the federal statutory bad debt deduction to lower the
34% marginal federal corporate tax rate in 1995, compared to no bad debt
deduction in 1994. The Bank's 1995 bad debt deduction reduced federal taxes
by approximately $152,000. For both 1995 and 1994, the marginal Montana
corporate license tax was 6.75%.
REGULATORY DEVELOPMENTS
As required by the FIRREA, the OTS requires that the Bank maintain minimum
levels of capital under three separate standards (see Part IV, Item 14. -
"Notes to Consolidated Financial Statements" - "Regulatory Capital"). At
December 31, 1996, the Bank's stockholders' equity was $15.3 million resulting
in a capital ratio of approximately 16.2%. The Bank, as demonstrated by the
referenced footnote, is in substantial compliance with, and far exceeds, each
of the three minimum regulatory capital requirements. The balance of the
Bank's operations are in compliance with the many other FIRREA provisions,
none of which materially restrict the Bank's present operational plans.
However, FIRREA compliance has resulted in higher deposit insurance premiums,
increased regulatory compliance expense and reduced FHLB stock dividends.
The regulatory focus on capital as the primary measurement of an
institution's strength was reemphasized by the FDICIA. The FDICIA introduced a
capital framework resulting in the classification of an institution as "well
capitalized," "adequately capitalized," "under capitalized," "significantly
under capitalized," and "critically under capitalized." Other FDICIA
provisions address individual capital components for the risk from changes in
interest rates, concentrations of credit, nontraditional activities, and the
capital impact of fair value adjustments associated with the Financial
Accounting Standards Board Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." FDICIA provisions also provide
for prompt corrective supervisory action, as well as mandatory and
discretionary supervisory actions for those institutions failing to meet
minimum thresholds. FDICIA provisions significantly expand the scope of
-36-
operating regulations and widen the application of regulatory guidelines over
the operations of federally insured financial institutions. The Bank's FDICIA
capital rating exceeds "well capitalized" and its operations are in compliance
with FDICIA provisions, none of which materially restrict the Bank's present
operational plans. However, FDICIA compliance has increased the Bank's
regulatory burden and increased regulatory compliance expense.
LEGISLATION
Over the past year, regulatory and legislative changes have continued to
have a dramatic effect on the Bank and all other federally regulated
depository institutions. Regulatory agencies have become more aggressive in
their oversight role and have been implementing a "get-tough" approach to
compliance examinations and fair lending law interpretation and enforcement.
The current Administration is focusing on consumer compliance issues, in
particular fair lending, while Congress continues to focus on areas that pose
potential safety and soundness problems. It is doubtful that the complexity
of the laws, regulations and guidelines facing the Bank, and all other
federally regulated depository institutions, will materially abate in the near
future. Their impact on the Bank has become clear. The Bank will continue to
be burdened with regulatory compliance issues that add to the Bank's costs of
operations, while at the same time providing a distinct competitive advantage
to nonregulated competitors.
Enacted into law in 1996 was legislation providing for a special assessment
against FDIC/SAIF member institutions which capitalized the SAIF insurance
reserve to the prescribed 1.25% of insured deposits level. For the Bank, this
one-time special assessment was $549,700, or 65.7 basis points per $100 of the
Bank's insured deposit base on March 31, 1995. The Company's 1996
consolidated financial statements reflect the expense and payment of this
$549,700 special assessment.
Based upon the Bank's 1996 year-end "1A" FDIC risk classification, the
Bank's FDIC/SAIF assessment rate, beginning January 1, 1997, will decrease
from 23 basis points to 6.48 basis points per $100 of insured deposits. Most
commercial banks, insured under the FDIC/Bank Insurance Fund (BIF) will,
beginning January 1, 1997, be assessed 1.296 basis points per $100 of insured
deposits. In addition, 1996 legislation provides for the merger of the SAIF
and BIF insurance funds on January 1, 1999, provided the bank and savings
association charters have been merged by that date. The U.S. Treasury
Department is required to present its common insurance fund recommendations to
Congress by March 31, 1997.
What ultimate impact this new legislation, and other potential changes in
federal law regarding interstate banking and branching, Glass-Stegall Act
revisions, the potential merger of federal regulatory agencies, the continued
consolidation of the banking industry, increasing competition from non-
regulated competitors, and other regulatory changes will have on the Bank's
operations cannot be predicted at this time.
ASSET/LIABILITY MANAGEMENT
The Bank's earnings depend to a large extent on the level of its "net
interest income." Net interest income depends upon the difference (referred
to as "interest rate spread") between the yield on the Bank's loan and
investment portfolios and interest-earning cash balances ("interest-earning
assets"), and the rates paid on its deposits and borrowings ("interest-bearing
-37-
liabilities"). Net interest income is further affected by the relative
amounts of the Bank's interest-earning assets and interest-bearing
liabilities. When interest-earning assets approximate or exceed interest-
bearing liabilities, any positive interest rate spread will generate net
interest income. When the amount of interest-earning assets is less than the
amount of interest-bearing liabilities, the net yield on interest-earning
assets is less than the interest rate spread. Should this difference in
amounts become too great, the Bank could incur a net interest expense despite
a positive spread.
One of the primary objectives of the Bank's management over the past
several years has been to restructure the Bank's balance sheet to reduce its
vulnerability to changes in interest rates (Interest Rate Risk). Savings
institutions historically have suffered from a mismatch in the term to
maturity of their assets and liabilities, with mortgage loan assets tending to
be of a much longer term than deposits, the primary liabilities of savings
institutions. In periods of rising interest rates, this mismatch can render
savings institutions vulnerable to increases in costs of funds (deposits and
borrowings) that can outstrip increases in returns on longer-term fixed rate
loans and investments, resulting in a decrease in positive interest rate
spread and lower earnings.
Several strategies have been employed by the Bank to minimize the mismatch
of asset and liability maturities. For the past several years, the Bank has
maintained the policy of selling all newly-originated long-term (15 to 30-year
maturity) fixed-rate mortgage loans to the secondary market. These loans are
sold at their outstanding principal balance, which is the prearranged contract
purchase price, and therefore, no gain or loss is realized at sale. The Bank
promotes the origination and retention of loans providing for periodic
interest rate adjustments, shorter terms to maturity or balloon provisions.
The Bank also emphasizes investment in adjustable rate or shorter-term
mortgage-backed securities and other interest-earning investments. Liquidity
not utilized for retained loan production has resulted, over the past several
years, in an increase in the relative percentage to total assets of shorter-
term investments versus longer-term loans. In the very low market interest
rate and flat yield curve environment of the past few years, no real
opportunity existed to extend loan portfolio or investment maturity purchases
for a higher yield. Longer term (15 to 30-year) fixed-rate mortgage loan
retention, or greater than 7-year to maturity investment purchases would have
provided only a marginal increase in interest income while exposing the Bank
to significant declines in market values if interest rates rose substantially.
During 1996, the Bank decided to retain selected portfolio loans for higher
earnings by engaging in increased multi-family and commercial estate lending,
as well as increased non-mortgage commercial and consumer lending. Multi-
family, all commercial real estate lending and commercial and consumer non-
mortgage lending is generally shorter-term in nature than single family
residential lending and, although typically fixed rate, bears higher interest
rates.
While the Bank believes that its ongoing asset/liability management
strategies have reduced exposure to interest rate risk, future earnings and
stockholders' equity will continue to be influenced by changes in levels of
market interest rates, competition, and other economic factors beyond the
control of the Bank's management. Management believes that its conservative
short-term maturity and adjustable rate investment and loan portfolio
policies, enable the Bank to minimize portfolio market value declines, and
maintain earnings, while providing the liquidity to reprice assets to offset
higher market interest rates and increased deposit costs.
-38-
INTEREST RATE RISK EXPOSURE- IRR exposure seeks to establish a methodology
to measure the potential for the reduction of earnings and stockholders'
equity resulting from both lower net interest income (NII) and lower net
portfolio value (NPV) caused by changes in market interest rates. The
earnings of most financial institutions are exposed to IRR because typically a
larger dollar amount of liabilities (primarily deposits) reprice faster than
do loans, investments, or other interest-earning assets. Therefore, when
interest rates rise, the cost of deposits reprice and often do so more rapidly
than the yield on interest-earning assets, thereby reducing NII. Typically, a
financial institution's interest-earning assets are of a longer duration or
term than its interest-bearing liabilities, and therefore net portfolio value,
i.e. the present value of all expected cash flows from assets less the present
value of all expected cash flows from liabilities will decline as interest
rates rise. NPV thus provides a leading indicator of future potential changes
in both NII and stockholders' equity.
Given that IRR, is the most important component of the Bank's earnings, and
given OTS mandates (including Thrift Bulletin No. 13), the Bank has
established a formal written Board of Director's approved IRR policy. The
Bank has also established an Asset/Liability Management Committee and an
Investment Committee which meets at least quarterly to review and report in
writing to the Bank's Board of Directors management's efforts to minimize IRR.
IRR EXPOSURE MEASUREMENT - The most effective method of measuring IRR is
via asset/liability computer simulation. Inputting comprehensive detailed raw
data concerning assets and liabilities, along with a variety of assumptions,
forecasts, and pricing changes, simulation compares the effects of a variety
of interest rate environments on an institution's NII and NPV. While the Bank
has the option of buying, and producing its own asset/liability program, the
problems with such computer models are four fold: (1) high cost, (2) rapid
obsolescence as requirements and data change over time, (3) extremely labor
intensive, and (4) most importantly, the product derived is only as good as
the time available to devote to the assumptions and forecasts inputted. The
Bank's management has determined that the cost versus benefit to be derived
from an in-house model is not worth the manpower and software costs involved.
Also given the Bank's asset size, (less than $500 million) the Bank falls
under an OTS exemption that allows utilization of an asset/liability computer
simulation program prepared and distributed by the OTS. The OTS Thrift
Financial Report includes Schedule CMR which provides detailed information
about the balances, interest rates, repricing, and maturity characteristics of
the Bank's financial instruments. By utilizing the Bank's provided Schedule
CMR data, the OTS runs computer simulations ("Net Portfolio Value Model")
utilizing OTS assumptions. Received quarterly is an Interest Rate Risk
Exposure Report detailing the Bank's interest rate sensitivity under various
instantaneous changes in interest rates. This OTS computer simulation report
displays first the present value of the Bank's total assets and net portfolio
value with no change in rates, then displays the changes expected to occur
with four instantaneous 100 basis point increases and four instantaneous 100
basis point decreases in interest rates.
-39-
The Bank's Board of Directors, per OTS requirements, has established the
following maximum precentage changes, or policy limits for NPV:
% Change
Net Portfolio Value
-------------------
Instantaneous Basis Point Change In Rates NPV
+400 -40%
+300 -30%
+200 -20%
+100 -10%
0 0
-100 -10%
-200 -20%
-300 -30%
-400 -40%
The following table demonstrates the Bank's December 31, 1996 NPV:
$ Amount, $ Change, and % Change for the four instantaneous increases and the
four instantaneous decreases in interest rates:
(Dollars in thousands)
Net Portfolio Value - NPV
--------------------------------------------------------------
Change in Rates $ Amount $ Change % Change
--------------- -------- -------- --------
+400 bp 16,353 -1,981 -11%
+300 bp 17,009 -1,326 -7%
+200 bp 17,639 -695 -4%
+100 bp 18,128 -206 -1%
0 18,334
-100 bp 18,217 -118 -1%
-200 bp 18,140 -194 -1%
-300 bp 18,523 188 +1%
-400 bp 19,153 819 +4%
The following table demonstrates the Bank's December 31, 1996 Present Value
(PV) of total assets, NPV Ratio, and Basis Point Change for the four
instantaneous increases and the four instantaneous decreases in interest
rates:
(Dollars in thousands)
Change in Rates $ PV of Total Assets NPV Ratio Basis Point Change
--------------- -------------------- --------- ------------------
+400 bp 93,890 17.42% -140 bp
+300 bp 94,920 17.92% -90 bp
+200 bp 95,932 18.39% -43 bp
+100 bp 96,814 18.72% -9 bp
0 97,423 18.82%
-100 bp 97,721 18.64% -18 bp
-200 bp 98,080 18.49% -32 bp
-300 bp 98,916 18.73% -9 bp
-400 bp 100,012 19.15% +33 bp
The OTS has also established an IRR Capital Component. For further
information see "Regulation - Regulatory Capital Requirements."
-40-
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
AVERAGE BALANCE SHEETS - The following table sets forth for each of the
three years indicated information regarding the Company's: (1) average balance
sheets, and (2) an analysis of net interest earnings as follows: (i) for each
category of interest-earning asset and interest-bearing liability, the average
amount outstanding during the year and interest earned and paid, (ii) the
average yield for each category of interest-earning asset, and average cost
for each category of interest-bearing liability, (iii) the average yield for
all interest-earning assets and the average cost for all interest-bearing
liabilities, (iv) the net yield for interest-earning assets, and (v) other
information regarding return on average assets, return on average equity,
equity to average assets ratio, and dividend payout ratio.
-41-
UNITED FINANCIAL CORP.
AVERAGE BALANCE SHEET For the Year Ended December 31, 1996
(Dollars in thousands) -------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS --------- --------- ----------
Loans receivable $ 31,821 $2,956 9.29%
Mortgage-backed securities 32,524 2,017 6.20%
Investments-other 35,389 2,128 6.01%
Interest-earning deposits 2,907 152 5.22%
--------- ------ -----
Total interest-earning assets 102,641 $7,253 7.07%
====== =====
Non-earning assets 4,017
---------
Total assets $106,658
=========
LIABILITIES & STOCKHOLDERS' EQUITY
Deposits $ 78,451 3,473 4.43%
FHLB advances 1,608 92 5.72%
--------- ------ -----
Total interest-bearing liabilities $ 80,059 $3,565 4.45%
========= ====== =====
Stockholders' equity 24,977
Unrealized loss on securities
available-for-sale (442)
---------
Total stockholders' equity $ 24,535
=========
Net interest-earning assets $ 22,582
Net interest income $3,688
======
Net interest spread (1) 2.62%
=====
Net interest margin (2) 3.59%
Net income $1,103
======
Return on average assets (3) 1.03%
Return on average equity (4) 4.50%
Equity to average assets ratio (5) 23.00%
Dividend payout ratio (6) 99%
Interest-earning assets to
interest-bearing liabilities ratio 1.28
Income per share $ .90
Dividends paid per share $ .89
(1) Average yield interest-earning assets minus average rate interest-bearing
liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
-42-
UNITED FINANCIAL CORP.
AVERAGE BALANCE SHEET For the Year Ended December 31, 1995
(Dollars in thousands) -------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS --------- --------- ----------
Loans receivable $ 30,870 $2,880 9.33%
Mortgage-backed securities 20,183 1,262 6.25%
Investments-other 48,388 3,000 6.20%
Interest-earning deposits 4,319 252 5.83%
--------- ------ -----
Total interest-earning assets 103,760 $7,394 7.13%
====== =====
Non-earning assets 2,839
---------
Total assets $106,599
=========
LIABILITIES & STOCKHOLDERS' EQUITY
Deposits $ 80,928 3,412 4.22%
FHLB advances 137 8 5.89%
--------- ------ -----
Total interest-bearing liabilities $ 81,065 $3,420 4.22%
========= ====== =====
Stockholders' equity $ 24,551
Unrealized loss on securities
available-for-sale (687)
---------
Total stockholders' equity $ 23,864
=========
Net interest-earning assets $ 22,695
Net interest income $3,974
======
Net interest spread (1) 2.91%
=====
Net interest margin (2) 3.83%
Net income $1,722
======
Return on average assets (3) 1.62%
Return on average equity (4) 7.21%
Equity to average assets ratio (5) 22.39%
Dividend payout ratio (6) 57%
Interest-earning assets to
interest-bearing liabilities ratio 1.28
Income per share $1.41
Dividends paid per share $ .81
(1) Average yield interest-earning assets minus average rate interest-bearing
liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
-43-
UNITED FINANCIAL CORP.
AVERAGE BALANCE SHEET For the Year Ended December 31, 1994
(Dollars in thousands) -------------------------------------
Average Interest Average
Balance Earned/Pd Yield/Cost
ASSETS --------- --------- ----------
Loans receivable $ 33,326 $3,125 9.38%
Mortgage-backed securities 20,438 1,179 5.77%
Investments-other 57,986 3,451 5.95%
Interest-earning deposits 3,897 171 4.39%
--------- ------ -----
Total interest-earning assets 115,647 $7,926 6.85%
====== =====
Non-earning assets 3,440
---------
Total assets $119,087
=========
LIABILITIES & STOCKHOLDERS' EQUITY
Deposits $ 94,966 3,616 3.81%
FHLB advances
--------- ------ -----
Total interest-bearing liabilities $ 94,966 $3,616 3.81%
========= ====== =====
Stockholders' equity $ 23,759
Unrealized loss on securities
available-for-sale (641)
---------
Total stockholders' equity $ 23,118
=========
Net interest-earning assets $ 20,681
Net interest income $4,310
======
Net interest spread (1) 3.04%
=====
Net interest margin (2) 3.72%
Net income $1,886
======
Return on average assets (3) 1.58%
Return on average equity (4) 8.16%
Equity to average assets ratio (5) 19.41%
Dividend payout ratio (6) 47%
Interest-earning assets to
interest-bearing liabilities ratio 1.22
Income per share $1.54
Dividends paid per share $ .73
(1) Average yield interest-earning assets minus average rate interest-bearing
liabilities
(2) Net interest income divided by average interest-earning assets
(3) Net income divided by average total assets
(4) Net income divided by average equity
(5) Average equity divided by average total assets
(6) Dividends paid per share divided by net income per share
-44-
The following table sets forth the Company's weighted average yield on
interest-earning assets and cost of interest-bearing liabilities at December
31st for each of the three years indicated:
At December 31,
--------------------------------
1996 1995 1994
Year-end yield: ----- ----- -----
Loans receivable 9.18% 9.16% 9.16%
Mortgage-backed securities 6.27 5.77 5.89
Investments 5.76 6.00 6.18
Interest-earning deposits 6.41 4.75 5.81
----- ----- -----
Interest-earning assets 7.14% 6.79% 6.98%
Year-end cost:
Deposits 4.45% 4.44% 3.94%
FHLB advances N/A 5.78 N/A
----- ----- -----
Interest-bearing liabilities 4.45% 4.60% 3.94%
Interest rate spread 2.69% 2.19% 3.04%
===== ===== =====
The following table sets forth information regarding changes in interest
income and interest expense for the Company for the years indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to (1) changes in volume (changes in
volume multiplied by previous rate), (2) changes in rates (changes in rate
multiplied by previous volume) and (3) change in rate/volume (change in rate
multiplied by the change in volume):
-45-
UNITED FINANCIAL CORP.
RATE VOLUME ANALYSIS Years Ended December 31,
(Dollars in thousands) ---------------------------------
1996 v. 1995
------------
Increase (decrease) due to:
Rate/
Volume Rate Volume Total
Interest income: ------ ------ ------ ------
Loans receivable $ 90 $ (9) $ (5) $ 76
Mortgage-backed securities 771 (10) (6) 755
Investments (806) (91) 25 (872)
Interest-earning deposits (82) (26) 8 (100)
------ ----- ----- ------
Total interest income (27) (136) 22 (141)
Interest expense:
Deposits (40) 92 9 61
FHLB advances 87 (3) 84
------ ------ ----- ------
Total interest expense 47 92 6 145
------ ------ ----- ------
Net interest income $ (74) $(228) $ 16 $(286)
====== ====== ===== ======
1995 v. 1994
Interest income: ------------
Loans receivable $(230) $ (16) $ 1 $(245)
Mortgage-backed securities (15) 99 (1) 83
Investments (510) 114 (54) (450)
Interest-earning deposits 18 56 6 80
------ ------ ----- ------
Total interest income (737) 253 (48) (532)
Interest expense:
Deposits (534) 387 (57) (204)
FHLB advances 8 8
------ ------ ----- ------
Total interest expense (534) 387 (49) (196)
------ ------ ----- ------
Net interest income $(203) $(134) $ 1 $(336)
====== ====== ===== ======
1994 v. 1993
Interest income: ------------
Loans receivable $(667) $ (43) $ 7 $(703)
Mortgage-backed securities 333 (130) (43) 160
Investments 439 (115) (41) 283
Interest-earning deposits (112) 86 (41) (67)
------ ------ ------ ------
Total interest income (7) (202) (118) (327)
Interest expense:
Deposits (61) (375) 6 (430)
FHLB advances
------ ------ ------ ------
Total interest expense (61) (375) 6 (430)
------ ------ ------ ------
Net interest income $ 54 $ 173 $(124) $ 103
====== ====== ====== ======
-46-
LIQUIDITY AND CAPITAL RESOURCES
Federal regulations require the Bank to maintain a daily average balance of
liquid assets equal to a percentage, currently 5%, of net withdrawable
deposits and other borrowings payable in one year or less. As of December 31,
1996 and December 31, 1995, the Bank's liquidity ratios were 28.9% and 46.0%,
respectively. The same regulations also require the Bank to maintain a short-
term liquid assets ratio equal to at least 1% of its average daily balance of
net withdrawable deposits and borrowings payable in one year or less. As of
December 31, 1996 and 1995, the Bank's short-term liquid asset ratios were
17.1% and 22.5%, respectively. During the fiscal years 1996 and 1995, the
Bank consistently maintained both ratios far in excess of regulatory
requirements. The Bank's liquidity investments for regulatory purposes were
approximately $23.4 million at December 31, 1996, and consisted primarily of
cash, interest-earning bank accounts, FHLB certificates of deposit, U.S.
Treasuries and U.S. Government agencies with maturities of five years or less.
The primary sources of funds are deposits, FHLB borrowings, loan and
mortgage-backed securities repayments, proceeds from loan sales, investment
securities interest payments and maturities, and net operating revenues. The
principal uses of funds are loan originations, mortgage-backed securities and
other investment securities purchases, maturing savings certificates and
deposit withdrawals, repayment of FHLB borrowings, cash dividends, maintaining
liquidity and meeting operating expenses. As demonstrated by the 1996
Statements of Cash Flows, $12.6 million of net cash provided by investing
activities was utilized to repay $10.5 million of FHLB advances outstanding at
the end of 1995, and pay $1.1 million of cash dividends to shareholders.
During 1996, unlike 1995 or 1994, the Company experienced deposits as a
source, rather than a use of funds. In addition, during 1996, the mix of
investing activities changed with increased loans originated for, and retained
for portfolio in 1996 compared to 1995 or 1994.
The Bank can borrow from the FHLB in an amount not to exceed 25% of assets.
The Company currently has no material commitments for loan fundings or other
expenditures.
At December 31, 1996, the Company's stockholders' equity was approximately
$24.4 million, or over 23.5% of assets. Additionally, the Bank's regulatory
capital is over $12.1 million more than the highest of three regulatory
capital standards required by federal regulations. The Company's current
level of capital and liquidity provides it with the opportunity to manage its
balance sheet with a great deal of flexibility while still complying with
regulatory requirements. This operating advantage has provided management
with the ability to restructure its balance sheet over the past several years.
As a result, the Bank has become more profitable and has better matched its
assets and liabilities to react to and take advantage of changes in market
conditions. Management believes that the present facilities and equipment
required to conduct its business are more than adequate for the foreseeable
future.
EFFECT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms
of historic dollars, without considering changes in the relative purchasing
power of money over time due to inflation. Unlike industrial companies,
-47-
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, interest rates have a more significant
impact on a financial institution's performance than the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The management of United Financial Corp. has prepared and is responsible
for the consolidated financial statements of the Company. These statements
have been prepared in accordance with generally accepted accounting principles
applied on a consistent basis. See part IV, Item 14. - "Financial Statement
Schedules."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the directors
of the Company. The information includes as of March 1, 1997, the shares of
the Company's Common Stock beneficially owned by each director, and by all
directors and executive officers as a group. Where beneficial ownership is
less than one percent (*), the percentage is not reflected in the table.
Except as otherwise noted, each beneficial owner listed has sole investment
and voting power with respect to the common stock indicated.
Number of
Shares of
Term of Common Stock
Director Office Beneficially Percent
Director/Age Since Expires Position Owned of Class
- ------------ -------- ------- --------- ------------ --------
Bruce K. Weldele 1983 1999 Chairman, 30,000(1) 2.5%
Age 51 President,
CEO and
Director
Dean J. Mart 1988 1999 Senior Vice 5,000 *
Age 55 President -
Loan Admin.
Director
J. William Bloemendaal 1976 1998 Director 28,760(2)(3) 2.4%
Age 67
Elliott L. Dybdal 1980 1998 Director 18,750(3) 1.5%
Age 65
William L. Madison 1996 1999 Director 100(3) *
Age 41
Rudy Tramelli 1971 1997 Director 100(3) *
Age 68
Larry D. Williams 1991 1997 Director 150(3) *
Age 54
-48-
All directors and executive
officers as a group (11 persons) 101,030 8.3%
(1) Includes 5,000 shares held by Bruce K. Weldele in an Individual Retirement
Account.
(2) Includes 4,000 shares held by Dr. Bloemendaal in an Individual Retirement
Account and 10,000 shares held by Great Falls Orthopaedic Associates
Profit Sharing and Pension Plans of which Dr. Bloemendaal is trustee.
(3) Voting and investment power is shared with spouse with whom shares are
held jointly.
DIRECTORS - Bruce K. Weldele has held the position of President and
Chairman of the Board of Directors of United Financial Corp. since its
inception. Mr. Weldele joined the Bank in 1983 as Executive Vice President.
He has served as the Bank's President and Chief Executive Officer since
October 1983. Mr. Weldele was first elected to the Bank's Board of Directors
in July 1983. Since January 1984, he has served as Chairman of the Board.
Dean J. Mart has held the position of Senior Vice President of United
Financial Corp. since its inception. Mr. Mart joined the Bank in July 1984 as
Senior Vice President. Since that time, he has been responsible for loan
administration. Before joining the Company, he was employed for over 20 years
by Norwest Bank Great Falls, N.A., and served during a period of that time as
Vice President - Commercial Loan Officer.
Dr. J. William Bloemendaal is a full-time physician specializing in
orthopaedic surgery. He has practiced medicine since 1961 and has been
associated since 1975 with Great Falls Orthopaedic Associates, a five-person
group actively practicing orthopaedic surgery. Dr. Bloemendaal currently
serves as President of Great Falls Orthopaedic Associates.
Elliott L. Dybdal has been employed by Talcott Building Company in Great Falls
for over 34 years, serving for the last 21 years as its President and Chief
Executive Officer. He also serves as a director of Talcott Building Company.
William L Madison has served as President/Owner of Johnson Madison Lumber Co.,
Inc., a retail building materials business, since 1984.
Rudy Tramelli is self-employed and engages in real estate management and
development. He has been actively employed in these business activities for
over 32 years.
Larry D. Williams is the Superintendent of the Great Falls Public Schools.
Before his appointment as Superintendent in July 1989, Mr. Williams served for
five years as the director of personnel for the Bozeman, Montana Public
Schools. His 28-year career in education has included 8 years as a classroom
instructor of music at the elementary, secondary and collegiate level and 20
years in a variety of administrative positions.
EXECUTIVE OFFICERS - The following table sets forth information with
respect to the executive officers of the Company and the Bank who are not
directors of the Company or the Bank. All executive officers have held their
positions since the inception of United Financial Corp. They are elected
annually by the Board of Directors and serve at the discretion of the Board of
Directors.
-49-
Name Age Position Held
- ---- --- -------------
Charles J. Hallingstad 46 Vice President - Marketing and Human
Resources
Loyall Kissee 55 Vice President - Branch and Savings
Administration, Secretary and Branch
Manager
G. Brent Marvosh 49 Vice President - Finance/Treasurer
Michael J. McCleary 48 Vice President - Operations
Mr. Hallingstad joined the Bank in 1972 and has served in various capacities
since that time. In January 1981 he was named Vice President in charge of
Marketing. Since January 1984, he has served as Vice President in charge of
Marketing and Human Resources.
Mr. Kissee joined the Bank in 1974 and has held various positions since that
time. In March 1980 he was elected Vice President in charge of Branch and
Savings Administration. In 1981, Mr. Kissee was elected Secretary of the Bank
and has served in that capacity since that time. Since February 1986, he has
served as branch Manager of the Bank's branch office in Havre.
Mr. Marvosh, a Certified Public Accountant, joined the Bank in October 1980
and has served the Bank in various capacities since that time. Commencing
January 1983, he served as Assistant Controller and in November 1983 was
elected Treasurer/Controller. In October 1985, he was elected Vice President
of Finance in addition to his position as Treasurer.
Mr. McCleary joined the Bank in 1977 and has acted in several different
capacities since that time. In January 1981, he became Assistant Vice
President having responsibilities as Treasurer/Controller until January 1983
when he became Assistant Vice President in charge of Operations. In October
1985, he was elected Vice President in charge of Operations.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT - The Company
has adopted procedures to assist its directors and executive officers with
Section 16(a) of the Securities Exchange Act of 1934, which includes assisting
the officer or director in preparing forms for filing. Based on the review of
such forms, United Financial Corp. believes that all of its executive officers
and directors complied with all filing requirements applicable to them.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows the cash compensation paid by the Company for
services rendered during the past three (3) years ended December 31, 1996, to
its President and Chief Executive Officer. No other executive officer
received total cash compensation during the period exceeding $100,000.
-50-
Name and Principal Positions: Bruce K. Weldele, Chairman of the Board,
President and Chief Executive Officer and Director
Long Term Compensation
Annual Compensation ----------------------------
- -------------------------------- Restricted Options LTIP All Other
Year Salary(1) Bonus Other Stock(2) SARs(2) Payouts Comp.(3)
- ---- --------- ----- ----- ----------- ------- ------- ---------
1996 $155,100 -0- -0- - - - $1,900
1995 150,000 -0- -0- - - - 3,080
1994 144,000 -0- -0- - - - 3,080
(1) Includes earnings reductions contributions made by Bruce K. Weldele to the
Company's 401(k) Plan (or that of the Bank prior to the formation of the
Company).
(2) Neither the Company nor the Bank maintains any plan pursuant to which it
has granted or issued options, SARs, restricted stock, or other stock based
compensation to executives.
(3) Represents the Company's or the Bank's contributions on behalf of Bruce K.
Weldele to the 401(k) Thrift Retirement Plan.
EXECUTIVE OFFICER SEVERANCE AGREEMENTS - During fiscal year in 1993, the
Board of Directors approved change of control severance agreements for each of
the executive officers of the Company and the Bank. The agreements provide
for severance compensation for each of the executive officers in the event any
company or person acquires control of the Bank, as determined in accordance
with applicable federal regulations. Pursuant to his agreement, upon change
of control, Mr. Weldele would be entitled to lump-sum compensation equal to
two times his annual base salary plus any target bonuses, and 24 months of
continued welfare and employee benefits. The agreements with all other
executive officers provide for payment upon a change of control of lump-sum
compensation equal to the annual base salary, plus any target bonuses, and 12
months of continued welfare and employee benefits.
BOARD OF DIRECTORS REPORT ON EXECUTIVE COMPENSATION - The Board of
Directors had furnished the following report on executive compensation:
All directors not employed by the Company annually review salary
recommendations made by the Chief Executive Officer which cover all officers
(other than the Chief Executive Officer). The specific recommendations
reflect the job responsibilities assigned to each officer, the manner in which
those duties have been performed, and the prevailing market conditions
relative to each position.
Compensation of the Chief Executive Officer for 1996 was reviewed by the
directors and increased at approximately the inflation rate.
PENSION PLAN - The Company has a noncontributory defined benefit pension
plan (the Pension Plan) which is administered by the Financial Institutions
Retirement Fund (the Fund). The Fund is a nonprofit, tax-qualified pension
plan and trust through which Federal Home Loan Banks, savings and loan
associations and similar institutions may cooperate in providing for the
retirement of their employees.
-51-
After becoming eligible for membership in the Pension Plan, employees who
complete 1,000 hours of service each calendar year will be enrolled as active
members and will be entitled to accrue retirement benefits under the Pension
Plan. The monthly pension amount to be received by an employee under the
Pension Plan upon retirement is based on an employee's benefit service and
salary. Benefit service includes the period of employment as an active member
in the Pension Plan in addition to any previous employment prior to the date
the Company joined the Fund and for which it has purchased credit. Salary for
purposes of the Company's contribution to the Pension Plan includes an
employee's basic annual salary rate as of each January 1, exclusive of any
special payments.
Whether an employee has a vested right to receive retirement benefits under
the Pension Plan depends upon the employee's age and years of vesting service.
Vesting service includes the period of time beginning from the first day of
the month in which an employee was hired and the last day of the month in
which the employee terminates his or her employment. Vesting service
specifically excludes service performed after an employee has attained the age
of 65 and does not include any period of employment that precedes the earliest
date that the Company provided the employee with credit under any pension
plan. An active member employee who has performed 5 years of vesting service,
is fully vested and is entitled to receive 100% of his retirement benefits
under the Pension Plan upon attaining the age of 65, whether or not such
employee has terminated employment with the Company prior to attaining the age
of 65. Any employee who has completed fewer than 5 years of vesting service
will not be eligible to receive retirement benefits if such employee
terminates service with the Company prior to becoming fully vested.
Retirement benefits under the Pension Plan will be paid when an employee
entitled to such benefits attains the normal retirement age of 65. In certain
circumstances, some individuals may be entitled to receive early retirement
benefits upon attaining the age of 45, although such benefits will be reduced
on the basis of an early retirement factor that is applied to the full amount
the employee would be entitled to receive at the normal retirement age of 65.
The following table sets forth, in straight life annuity amounts, the
estimated benefits payable upon retirement to active member participants in
the Pension Plan. The estimated annual benefits set forth in the table do not
reflect, however, refunds of contributions that members made and elected to
receive while the Company participated on a contributory basis. Salary is
calculated on the basis of the employee's average salary in the five highest
consecutive years of compensation; provided, however, if an employee has fewer
than five years of service at the time of his retirement, salary is based on
the employee's previous year's salary and, assuming salaries increase at 5%
per annum, the estimated pension benefits are approximately 15% lower than
those reflected in the table based on the 5-year highest salary average.
-52-
Years of Service
-----------------------------------------------
Salary 15 20 25 30 35
-------- ------- ------- ------- ------- -------
$ 30,000 $10,125 $13,500 $16,875 $20,250 $23,625
40,000 13,500 18,000 22,500 27,000 31,500
50,000 16,875 22,500 28,125 33,750 39,375
60,000 20,250 27,000 33,750 40,500 47,250
70,000 23,625 31,500 39,375 47,250 55,125
80,000 27,000 36,000 45,000 54,000 63,000
90,000 30,375 40,500 50,625 60,750 70,875
100,000 33,750 45,000 56,250 67,500 78,750
110,000 37,125 49,500 61,875 74,250 86,625
120,000 40,500 54,000 67,500 81,000 94,500
130,000 43,875 58,500 73,125 87,750 102,375
During the fiscal year ended December 31, 1996, no funds were paid or
distributed pursuant to the Pension Plan to Mr. Weldele, the most highly
compensated executive officer named above. At December 31, 1996, Mr. Weldele
had twelve years of credited service under the Pension Plan and his defined
compensation for purposes of the Pension Plan as of December 31, 1996, was
$127,800.
SECTION 401(k) PLAN - The Company has an employees' savings plan under
Section 401(k) of the Internal Revenue Code (the Code). The Company allows
eligible employees to contribute up to 15% of their monthly wages. Subject to
Code limitation, the Company matches an amount equal to 50% of the employee's
contribution, up to 6% of total wages. Participants are at all times fully
vested in their contributions and are immediately vested in the Company's
contributions.
For further information, see Part IV, Item 14. - "Notes to Consolidated
Financial Statements" - "Retirement Plans."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Except as set forth below, no person is known to the Company to own
beneficially more than 5% of the outstanding shares of the Company's common
stock.
Name and Address Amount and Nature of Percent
of Beneficial Owner Beneficial Ownership of Class
------------------- -------------------- --------
Eighteen Seventy Financial Inc. 120,000 9.8%(1)
Two Manhattanville Road
Purchase, NY 10577
(1) As reported by Schedule 13D dated August 30, 1996, filed by Eighteen
Seventy Financial Inc. and its parent corporation, Eighteen Seventy
Corporation.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
United Financial Corp. (the parent) is a holding company for the Bank. The
Bank is a federally chartered savings bank. The Company makes mortgage and
consumer loans to its directors, officers and employees in accordance with
-53-
regulations promulgated by the OTS and other applicable statutes and
regulations. These loans are currently made in the ordinary course of
business on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
nonaffiliated persons and, in the judgment of management, do not involve more
than the normal risk of collectibility or present other unfavorable features.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8K
List of Documents filed by Company as part of this Report.
(a) (1) Financial Statements:
The following financial statements of Company for the year ended
December 31, 1996 are included herein as follows:
Page Number
-----------
Independent Auditors' Report F-1
Consolidated Statements of Financial Condition, F-2
December 31, 1996 and 1995
Consolidated Statements of Income - Years Ended F-3
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows - Years Ended F-4
December 31, 1996, 1995 and 1994
Consolidated Statements of Changes in Stockholders' Equity F-5
- Years Ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements F-6
Statement of Financial Condition, Parent Only - F-21
December 31, 1996
Statement of Income, Parent Only - F-22
Year Ended December 31, 1996
Statement of Cash Flows, Parent Only - F-22
Year Ended December 31, 1996
(2) Financial Statement Schedules:
Financial statement schedules have been omitted because they are
inapplicable or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
-54-
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of United Financial Corp.:
We have audited the accompanying consolidated statements of financial
condition of United Financial Corp. and subsidiaries as of December 31, 1996
and 1995, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1996. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of United
Financial Corp. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996 in conformity with generally
accepted accounting principles.
As discussed in the notes to the consolidated financial statements, the
Company changed its method of accounting for investments in debt and equity
securities in 1994 to adopt the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities".
Billings, Montana
January 17, 1997 KPMG Peat Marwick LLP
F-1
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share and per share data)
December 31,
--------------------
1996 1995
ASSETS --------- ---------
Cash and cash equivalents:
Cash and amounts due from banks $ 921 $ 805
Interest-earning deposits with banks 2,013 416
--------- ---------
2,934 1,221
Investments:
Securities held-to-maturity 35,828 43,117
Securities available-for-sale 25,185 35,261
--------- ---------
61,013 78,378
Loans receivable, net 35,176 30,352
Premises and equipment, net 1,407 1,494
Real estate owned 425 491
Accrued interest receivable 817 916
Federal Home Loan Bank stock, at cost 379 476
Other assets 1,686 1,112
--------- ---------
$103,837 $114,440
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
NOW and money market demand accounts $ 8,669 $ 8,167
Savings deposits 29,918 32,461
Time deposits 40,110 37,663
--------- ---------
78,697 78,291
Federal Home Loan Bank advances 10,500
Accrued interest payable 66 68
Advance payments by borrowers for
taxes and insurance 211 224
Income taxes payable 36 19
Deferred income taxes 223 241
Other liabilities 188 409
--------- ---------
79,421 89,752
Stockholders' equity:
Preferred stock, $1.00 par value
(2,000,000 shares authorized; none outstanding)
Common stock, $1.00 par value
(8,000,000 shares authorized;
1,223,312 outstanding) 1,223 1,223
Paid-in capital 7,626 7,663
Retained earnings-partially restricted 16,060 16,046
Unrealized loss on securities
available-for-sale (493) (244)
--------- ---------
24,416 24,688
--------- ---------
Commitments and contingencies
$103,837 $114,440
========= =========
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
Year Ended December 31,
----------------------------
1996 1995 1994
------- ------- -------
Interest Income:
Loans $2,956 $2,880 $3,125
Mortgage-backed securities 2,017 1,262 1,179
Investment securities 2,128 3,000 3,451
Interest-earning deposits 152 252 171
------- ------- -------
7,253 7,394 7,926
Interest Expense:
Deposits 3,473 3,412 3,616
Federal Home Loan Bank advances 92 8
------- ------- -------
3,565 3,420 3,616
------- ------- -------
Net interest income 3,688 3,974 4,310
Provision for losses on loans
------- ------- -------
Net interest income after
provision for losses on loans 3,688 3,974 4,310
Noninterest Income:
Fees and discounts 444 358 529
FHLB stock dividends 31 23 29
Investment securities sales, net gain 150 6
Other income 210 208 214
------- ------- -------
835 595 772
Noninterest Expense:
Salaries and employee benefits 1,172 1,174 1,126
Net occupancy and equipment expense 248 250 233
Data processing expense 93 91 91
FDIC/SAIF deposit insurance premium 170 199 221
FDIC/SAIF deposit insurance special assessment 550
Other expenses 538 419 414
------- ------- -------
2,771 2,133 2,085
------- ------- -------
Income before income taxes 1,752 2,436 2,997
Provision for income tax expense (benefit):
Current 667 759 1,126
Deferred (18) (45) (15)
------- ------- -------
649 714 1,111
------- ------- -------
Net income $1,103 $1,722 $1,886
======= ======= =======
Net income per share $.90 $1.41 $1.54
See Notes to Consolidated Financial Statements
F-3
UNITED FINANCIAL CORP. Year Ended December 31,
CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------
(Dollars in thousands) 1996 1995 1994
-------- -------- ------
Operating Activities:
Net income $ 1,103 $ 1,722 $ 1,886
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization of bank
premises and equipment 114 118 85
Depreciation of real estate held for investment 37 38 40
Investment securities net accretion (208) (54) (21)
Sales of available-for-sale securities, net gain (150) (6)
Loans originated for the secondary market (11,996) (8,426) (12,704)
Proceeds from secondary market loan sales 11,482 8,725 12,727
Federal Home Loan Bank stock dividends (30) (23) (29)
Net change in income taxes payable 17 13 (77)
Net change in deferred income taxes (18) (45) (15)
Net change in accrued interest receivable 98 91 (74)
Net change in accrued interest payable (2) 26 6
Net change in other assets 114 (138) (8)
Net change in other liabilities (222) 139 (93)
-------- ------- --------
Net cash provided by operating activities 339 2,180 1,723
-------- ------- --------
Investing Activities:
Purchases of held-to-maturity securities (25,047)(25,092) (17,560)
Proceeds from matured and called
held-to-maturity securities 7,000 3,195 14,060
Mortgage-backed securities principal collections 25,559 4,707 3,736
Purchases of available-for-sale securities (6,908) (7,824)
Proceeds from matured and called
available-for-sale securities 12,556 3,294 2,500
Proceeds from sales of available-for-sale securities 4,141 12,797
Loans originated for portfolio (19,330)(10,794) (11,302)
Loan principal collections 11,384 8,945 12,448
Proceeds from sales of portfolio loans 3,031 2,748 3,679
All other changes in loans, net 92 262 122
Purchases of premises and equipment (28) (301) (16)
Net decrease in real estate owned 29 35 64
Federal Home Loan Bank stock net redemptions (purchases) 128 (62) 147
-------- ------- --------
Net cash provided (used) by investing activities 12,607 (266) 54
-------- ------- --------
Financing Activities:
Net increase (decrease) in deposits 406 (10,795) (6,206)
Net change in Federal Home Loan Bank advances (10,500) 10,500
Net decrease in advance escrow payments by borrowers (13) (42) (44)
Holding company formation costs (37)
Cash dividends paid (1,089) (991) (893)
-------- ------- --------
Net cash used by financing activities (11,233) (1,328) (7,143)
-------- ------- --------
Increase (Decrease) in cash and cash equivalents 1,713 586 (5,366)
Cash and cash equivalents at beginning of year 1,221 635 6,001
------- -------- --------
Cash and cash equivalents at end of year $ 2,934 $ 1,221 $ 635
======= ======== ========
F-4
Supplemental Cash Flow Disclosure:
Cash payments for interest $ 3,566 $ 3,394 $ 3,610
Cash payments for income taxes $ 513 $ 915 $ 1,197
See Notes to Consolidated Financial Statements
UNITED FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Three Years Ended December 31, 1996
----------------------------------------------
Unrealized
holding
gains
Common Paid-In Retained (losses)
Stock Capital Earnings net Total
------- ------- -------- -------- -------
Balance - December 31, 1993 $1,223 $7,663 $14,322 $ (553) $22,655
Effect of change in accounting
for investment securities
January 1, 1994 619 619
Net income 1,886 1,886
Cash dividends paid
($.73 per share) (893) (893)
Increase in unrealized loss on
investment securities
available-for-sale (1,718) (1,718)
------ ------- -------- ------- --------
Balance - December 31, 1994 1,223 7,663 15,315 (1,652) 22,549
Net income 1,722 1,722
Cash dividends paid
($.81 per share) (991) (991)
Decrease in unrealized loss
on investment securities
available-for-sale 1,408 1,408
------ ------- -------- ------- --------
Balance - December 31, 1995 1,223 7,663 16,046 (244) 24,688
Net income 1,103 1,103
Cash dividends paid
($.89 per share) (1,089) (1,089)
Holding company formation costs (37) (37)
Increase in unrealized loss
on investment securities
available-for-sale (249) (249)
------ ------- -------- ------- --------
Balance - December 31, 1996 $1,223 $7,626 $16,060 $(493) $24,416
====== ======= ======== ======= ========
See Notes to Consolidated Financial Statements
F-5
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 1996
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The accompanying consolidated financial statements
include the accounts of United Financial Corp. (the Company) a savings bank
holding company, and its wholly-owned subsidiary, United Savings Bank, F.A.
(the Bank). The consolidated financial statements also include the Community
Service Corporation, a wholly-owned subsidiary of the Bank. All significant
intercompany balances and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported and disclosed amounts of assets and liabilities as of
the date of the balance sheet and income and expenses for the period. Actual
results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the reserve for possible loan
losses and the valuation of real estate acquired in connection with
foreclosures or in satisfaction of loans. In connection with the
determination of the reserves for losses on loans and real estate owned,
management obtains independent appraisals for significant properties.
Management believes that the reserves for losses on loans and real estate
owned are adequate. While management uses available information to recognize
losses on loans and real estate owned, future additions to the reserves may be
necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's reserves for losses on loans and real estate
owned. Such agencies may require the Bank to recognize additions to the
reserves based on their judgments about information available to them at the
time of their examination.
INVESTMENTS - Investments are required to be classified into three
categories and accounted for as follows:
1) Debt securities that the Company has the positive intent and ability to
hold to maturity are classified as held-to-maturity and reported at
amortized cost.
2) Debt and equity securities, if bought and held principally for the
purpose of selling them in the near term, are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings.
3) Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale and
reported at fair value, with net unrealized gains and losses excluded from
earnings and reported (net of tax effect) as a separate component of
stockholders' equity.
At December 31, 1996 and 1995, the net unrealized gains and losses for all
available-for-sale securities were losses of $834,590 and $412,405, for which
the net unrealized tax benefit (a component of other assets) was $341,336 and
$168,055, respectively. The stockholders' equity unrealized loss adjustment,
F-6
net of the tax effect, at December 31, 1996 and 1995, was $493,254 and
$244,350, respectively.
The Company's investment portfolio contains both debt and equity
securities. The Kemper U.S. Government bond fund is the Company's only equity
investment, while the Company's debt investments include U.S. Treasuries, U.S.
Government agencies (including FHLB certificates of deposit) and mortgage-
backed securities. Nonmortgage-backed investment securities are classified as
either held-to-maturity or available-for-sale. Mortgage-backed investment
securities represent participating interests in pools of first-mortgage loans
originated and serviced by issuers of the securities. Mortgage-backed
securities are classified as held-to-maturity and are recorded at cost in the
underlying pool of mortgage loans at the time of purchase, adjusted for any
premium or discount. Investment discount is accreted or, in the case of
premium, is amortized into income, using a method that approximates the level
yield method, over the remaining term to maturity, adjusted for prepayments as
received. The Company, by policy, does not purchase any investment for trading
purposes. The cost of any investment, if sold, is determined by specific
identification. Declines in the fair value of available-for-sale or held-to-
maturity securities below carrying value that are other than temporary are
charged to expense as realized losses and the related carrying value reduced
to fair value.
SECONDARY MARKET LOAN SALES - For the past several years, the Company's
total production of long-term, fixed-rate loans has been originated according
to prearranged purchaser underwriting standards that result in immediate sale
to the secondary market, primarily to mortgage bankers and pension funds.
These loans are carried at their outstanding principal balance, which is the
contracted purchase price, and therefore, no gain or loss is realized at sale.
At December 31, 1996 and 1995, the other assets component of the Company's
Consolidated Statements of Financial Condition included $1,238,647 and
$724,476, respectively, of loan production contracted for sale to the
secondary market.
LOAN ORIGINATION FEES - Statement of Financial Accounting Standards No. 91
provides for the deferral of loan origination fees and direct loan origination
costs with those amounts recognized over the lives of the related loans as an
adjustment of the loan's yield using a method which approximates the level-
yield method. The Bank has elected to record such fees on a cash basis.
Management has evaluated the effect of this method on the consolidated
earnings and financial condition and concluded such effect to not be
materially different than recognition of fees as an adjustment of yield.
LOANS RECEIVABLE - Loans receivable are stated at unpaid principal
balances, less the reserve for loan losses, discounts, unearned income and
loans in process. Loans are placed on non-accrual status when collection of
interest is considered doubtful (generally loans past due 90 days or more).
All loan interest previously accrued is provided an allowance by a charge to
interest income, and income is subsequently recognized only to the extent that
cash payments are received.
RESERVE FOR POSSIBLE LOAN LOSSES - The reserve for possible loan losses is
established through a provision for losses on loans which is charged to
expense. Loan losses are charged against the reserve when management believes
that the collectability of principal is unlikely. The reserve balance is an
amount management believes will be adequate to absorb losses inherent in
existing loans and commitments to extend credit, based on evaluations of
collectability and prior loss experience. The evaluations consider such
F-7
factors as changes in the nature and volume of the portfolio, overall
portfolio quality, loan concentrations, specific problem loans, commitments,
and current and anticipated economic conditions that may affect the borrowers'
ability to pay.
The Company provides a reserve for losses on specific loans which are
deemed to be impaired. Groups of small balance homogeneous loans (generally
consumer loans) are evaluated for impairment collectively. A loan is
considered impaired when, based upon current information and events, it is
probable that the Company will be unable to collect, on a timely basis, all
principal and interest according to the contractual terms of the loan's
original agreement. When a specific loan is determined to be impaired, the
reserve for possible loan losses is increased through a charge to expense for
the amount of the impairment. The amount of the impairment is measured using
cash flows discounted at the loan's effective interest rate, except when it is
determined that the sole source of repayment for the loan is the operation or
liquidation of the underlying collateral. In such cases, the current value of
the collateral, reduced by anticipated selling costs will be used in place of
discounted cash flows. The Company recognizes interest income on impaired
loans only to the extent that cash payments are received.
The reserve for possible loan losses as determined above, includes the
reserve for impaired loans. The Company's existing policies for evaluating
the adequacy of the reserve for loan losses and policies for discontinuing the
accrual of interest on loans are used to establish the basis for determining
whether a loan is impaired. At December 31, 1996 and 1995, no loans were
classified as non-accrual or impaired.
REAL ESTATE OWNED - Real estate owned represents real estate assets
acquired through foreclosure or deed in lieu, and is comprised of properties
both held for sale and held for investment, i.e., the production of income.
Foreclosed assets held for sale are carried at the lower of (1) fair value
minus estimated cost to sell, or (2) cost. Fair value is determined as the
amount that could be reasonably expected in a current sale (other than a
forced or liquidation sale) between a willing buyer and a willing seller.
Management conducts an evaluation of each asset after foreclosure, and
periodically thereafter. If the fair value of the asset minus the estimated
cost to sell is less than the cost of the property, this deficiency is
recognized as a valuation allowance and is charged to expense. Foreclosed
assets held for the production of income are properties sold at their carrying
value to the Bank's subsidiary, the Community Service Corporation, in exchange
for loans and cash. The subsidiary carries these assets at their cost, less
depreciation, which is computed using the straight-line method over the
estimated useful lives of the assets. For both types of real estate owned,
costs, if any, related to development and improvement are capitalized, whereas
costs related to the holding of the assets are expensed.
PREMISES AND EQUIPMENT - Premises and equipment are recorded at cost.
Depreciation and amortization are computed on the straight-line method over
the estimated useful lives of the assets which range from 10 to 40 years for
buildings and improvements and 3 to 10 years for furniture and equipment.
FEDERAL HOME LOAN BANK STOCK - Federal law requires a member institution of
the Federal Home Loan Bank (FHLB) System to hold common stock of its district
FHLB according to predetermined formulas.
INCOME TAXES - The Company and its subsidiaries have elected to file a
consolidated federal income tax return. State statue prevents filing of a
F-8
consolidated Montana income tax return, and thus separate returns are filed by
the parent Company and the Bank. Deferred tax assets and liabilities are
recognized for the estimated future consequences attributable to differences
between the financial statement amounts of assets and liabilities and their
respective tax bases. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in tax expense in the period that includes
the enactment date.
RETIREMENT PLANS - The Bank contributes to the Savings Associations
Retirement Fund (a multi-employer defined benefit plan) which covers
substantially all employees. The Bank funds actuarially determined pension
costs as accrued. Consulting actuaries to the plan have indicated that the
Fund continues to maintain the ERISA full funding limitation. Accordingly,
normal plan costs of $111,971, $102,779 and $95,816, were offset from full
funding for the plan years ending June 30, 1996, 1995 and 1994, respectively.
Actual recorded pension expense, representing fiduciary insurance and
administrative costs only, was $2,697, $2,709 and $2,577, for the years ending
December 31, 1996, 1995 and 1994, respectively.
The Bank has an employees' savings plan under Section 401(k) of the
Internal Revenue Code (the Code). The Bank allows eligible employees to
contribute up to 15% of their monthly wages. Subject to Code limitations, the
Bank matches an amount equal to 50% of the employee's contribution, up to 6%
of total wages. Participants are at all times fully vested in their
contributions and are immediately vested in the Bank's contributions. The
Bank's 401(k) contributions and administrative costs were $23,345, $25,583 and
$25,577 respectively in 1996, 1995 and 1994.
NET INCOME PER SHARE - Net income per share data is based upon the weighted
average number of shares outstanding.
CASH EQUIVALENTS - For purposes of the statements of cash flows, the
Company considers all cash, daily interest and non-interest-bearing deposits
with banks as cash equivalents.
DERIVATIVE FINANCIAL INSTRUMENTS - The Company has not entered into any
swaps, options, or futures contracts. Included in U.S. Government agencies
are investments in structured notes which have contractual step-up interest
rates and call features.
IMPAIRMENT AND DISPOSAL OF LONG-LIVED ASSETS - FASB Statement No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed Of," requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or circumstances
indicate that the carrying amount of an asset may not be recoverable. An
impairment loss is recognized if the sum of the expected future cash flows is
less than the carrying amount of the asset. Statement No. 121 was adopted
January 1, 1996, and did not have a material impact on the Company's
consolidated financial position or results of operations.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES - In June 1996, the FASB issued Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." Statement No. 125 provides guidance on accounting for transfers
and servicing of financial assets, recognition and measurement of servicing
assets and liabilities, financial assets subject to prepayment, secured
borrowings and collateral, and extinguishment of liabilities.
F-9
Statement No. 125 generally requires the recognition as separate assets the
rights to service mortgage loans for others, whether the servicing rights are
acquired through purchases or loan originations. Statement No. 125 also
specifies that financial assets subject to prepayment, including loans that
can be contractually prepaid or otherwise settled in such a way that the
holder would not recover substantially all of its recorded investment, be
measured like debt securities available-for-sale under Statement No. 115, as
amended by Statement No. 125. Statement No. 125 is effective for fiscal years
beginning after December 31, 1996, and is not expected to have a material
impact on the Company's consolidated financial position or results of
operations.
INVESTMENT SECURITIES - A comparison of the amortized cost and estimated
fair value of investment securities at the dates indicated is as follows:
(Dollars in thousands)
December 31, 1996
------------------------------------------
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Fair
Gains Losses Value
------------------------------------------
Held-to-Maturity:
U.S. Government agencies $ 2,600 $ 9 $ 2,609
FHLB certificates of deposit 6,000 6,000
------- ---- ------ -------
U.S. Government agencies and other 8,600 9 8,609
------- ---- ------ -------
GNMA fixed and adjustable rate 2,092 31 $ (1) 2,122
FNMA and FHLMC adjustable rate 5,787 28 (79) 5,736
FNMA and FHLMC 7 yr and FHLMC
5 yr balloons 14,965 143 (3) 15,105
FNMA and FHLMC REMIC certificates 4,384 (13) 4,371
------- ---- ------ -------
Mortgage-backed securities 27,228 202 (96) 27,334
------- ---- ------ -------
$35,828 $211 $ (96) $35,943
======= ==== ====== =======
Available-for-Sale:
U.S. Treasuries and U.S.
Government agencies $20,024 $ 94 $(115) $20,003
Kemper U.S. Government bond
mutual fund 5,996 (814) 5,182
------- ---- ------ -------
$26,020 $ 94 $(929) $25,185
======= ==== ====== =======
F-10
December 31, 1995
------------------------------------------
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Fair
Gains Losses Value
------------------------------------------
Held-to-Maturity:
U.S. Treasuries and U.S.
Government agencies $ 2,901 $ 1 $ (1) $ 2,901
GNMA fixed and adjustable rate 2,339 35 (1) 2,373
FNMA and FHLMC adjustable rate 5,952 35 (31) 5,956
FNMA 7 year and FHLMC 5 year balloons 5,196 79 5,275
FNMA and FHLMC REMIC certificates 26,729 8 (43) 26,694
------- ---- ------ -------
Mortgage-backed securities 40,216 157 (75) 40,298
------- ---- ------ -------
$43,117 $158 $ (76) $43,199
======= ==== ====== =======
Available-for-Sale:
U.S. Treasuries and U.S.
Government agencies $29,678 $395 $(234) $29,839
Kemper U.S. Government bond
mutual fund 5,996 (574) 5,422
------- ---- ------ -------
$35,674 $395 $(808) $35,261
======= ==== ====== =======
A comparison of the amortized cost and estimated fair values of held-to-
maturity and available-for-sale investment securities by contractual
maturities at December 31, 1996 is shown below. Expected maturities may
differ from contractual maturities as some securities have call or prepayment
options.
(Dollars in thousands)
December 31, 1996
------------------------------
Amortized Estimated
Cost Fair Value
--------- ----------
Held-to-Maturity:
Due in 1 year or less $ 6,000 $ 6,000
Due after 1 year through 5 years 2,600 2,609
Mortgage-backed securities 27,228 27,334
------- -------
$35,828 $35,943
======= =======
Available-for-Sale:
Due in 1 year or less $10,027 $10,006
Due after 1 year through 2 years 6,003 5,971
Due after 2 years through 5 years 3,994 4,026
Kemper U.S. Government bond mutual fund 5,996 5,182
------- -------
$26,020 $25,185
======= =======
F-11
Gross proceeds from sales of investment securities available-for-sale for
the year ended December 31, 1996, were $4,141,328 resulting in gross gains of
$150,235. Gross proceeds from sales of investment securities available-for-
sale for the year ended December 31, 1995, were $12,796,898 resulting in gross
gains of $154,608 and gross losses of $149,305. There were no sales of
investment securities in 1994.
ACCRUED INTEREST RECEIVABLE - Accrued interest receivable at the dates
indicated consisted of the following:
(Dollars in thousands)
December 31,
----------------
1996 1995
---- ----
Accrued interest receivable on:
Interest-earning deposits $ 15 $ 30
Mortgage-backed securities 142 193
Other investment securities 371 438
Loans receivable 289 255
---- ----
$817 $916
==== ====
LOANS RECEIVABLE - Loans receivable at the dates indicated consisted of the
following:
December 31,
--------------------
1996 1995
------- -------
Conventional real estate loans:
1-4 family residential units $15,445 $13,540
5 or more family residential units 4,497 3,986
Construction 4,620 3,373
Commercial and other 3,077 2,517
FHA insured or VA guaranteed loans 5,530 6,970
Home equity loans 1,132 1,136
Loans to depositors, savings secured 92 175
Recreational vehicle and auto loans 1,239 31
Other non-mortgage loans 1,251 307
------- -------
36,883 32,035
Less:
Discounts on loans 4 8
Reserve for possible loan losses 75 75
Loans in process 1,628 1,600
------- -------
$35,176 $30,352
======= =======
Real estate loans serviced for others totaled $4,380,889, $3,719,442 and
$2,101,509 at December 31, 1996, 1995 and 1994, respectively. These loans are
not included in the consolidated financial statements.
There were no nonaccrual loan principal balances for which interest income
had not been recognized at December 31, 1996, 1995 and 1994.
F-12
The average yield on loans was 9.29%, 9.33% and 9.38% for the years ended
December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, 1995
and 1994, the average yield on loans was 9.18%, 9.16% and 9.16%, respectively.
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and involve,
to varying degrees, elements of credit risk.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses
the same credit policies in making commitment and conditional obligations as
it does for on-balance-sheet instruments.
Financial instruments outstanding at December 31, 1996, whose contract
amounts represent credit risk are fixed-rate commitments to extend credit
totaling approximately $462,000.
At December 31, 1996 and 1995, the Company had adjustable rate loans in its
portfolio of approximately $1,765,000 and $2,290,000, respectively.
A summary of changes in the reserve for possible loan losses for the years
indicated is as follows:
(Dollars in thousands)
Year Ended December 31,
--------------------------
1996 1995 1994
---- ---- ----
Balance at beginning of period $75 $75 $75
Provision charged to operating expense
Losses charged off
--- --- ---
$75 $75 $75
=== === ===
REAL ESTATE OWNED - Real estate owned at the dates indicated consisted of
the following:
(Dollars in thousands)
December 31,
------------
1996 1995
---- ----
Real estate held for investment $755 $792
Accumulated depreciation (370) (341)
----- -----
385 451
Real estate held for sale 40 40
----- -----
$425 $491
===== =====
During 1996, the Bank sold real estate held for sale with a $245,924 book
value to an individual in exchange for a $184,000 loan and cash. There was a
$15,924 loss recognized on the sale. During 1996, the Bank's subsidiary sold
real estate held for investment with a $33,168 book value to an individual in
exchange for cash. There was a $13,832 gain recognized on the sale.
F-13
During 1995, the Bank's subsidiary sold real estate held for investment
with a $34,799 book value to an individual in exchange for cash. There was a
$6,669 gain recognized on the sale.
A summary of changes in the allowance for possible losses on the disposition
of real estate owned for the years indicated is as follows:
(Dollars in thousands)
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Balance at beginning of period $60
Provision charged to operating expense
Losses charged off (60)
---- ---- ----
==== ==== ====
PREMISES AND EQUIPMENT - Premises and equipment at the dates indicated are
summarized as follows:
(Dollars in thousands)
December 31,
--------------------
1996 1995
------ -------
Land $ 264 $ 264
Buildings and improvements 2,257 2,257
Furniture and equipment 341 396
------- -------
2,862 2,917
Accumulated depreciation (1,455) (1,423)
------- -------
$1,407 $1,494
======= =======
DEPOSITS - Deposits at the dates indicated are comprised of the following:
(Dollars in thousands)
December 31, 1996 December 31, 1995
------------------------------- -----------------
Weighted Avg.
Interest Rate Amount Percent Amount Percent
------------- ------- ------- ------- -------
NOW accounts 2.86% $ 6,250 7.9% $ 5,733 7.3%
Money market demand accounts 3.49% 2,419 3.1% 2,434 3.1%
----- ------- ------ ------- ------
3.03% 8,669 11.0% 8,167 10.4%
Savings deposits 3.56% 29,918 38.0% 32,461 41.5%
Time deposits 3.25 - 4.99% 7,471 9.5% 1,441 1.8%
5.00 - 5.99% 32,576 41.4% 33,108 42.3%
6.00 - 7.99% 63 .1% 3,114 4.0%
----- ------- ------ ------- ------
5.43% 40,110 51.0% 37,663 48.1%
----- ------- ------ ------- ------
4.45% $78,697 100.0% $78,291 100.0%
===== ======= ====== ======= ======
F-14
There were no jumbo time deposits (minimum $.1 million) at December 31,
1996. There were approximately $.4 million of jumbo time deposits at December
31, 1995.
Maturities of time deposits are as follows:
(Dollars in thousands)
December 31,
-----------------------
1996 1995
------- -------
Due date:
Within one year $27,015 $22,949
Within two years 5,500 9,226
Within three years 3,109 2,201
Thereafter 4,486 3,287
------- -------
$40,110 $37,663
======= =======
Interest expense on deposits consisted of the following:
Year Ended December 31,
-----------------------------------
1996 1995 1994
Interest on deposits: ------ ------ ------
NOW and money market demand accounts $ 257 $ 243 $ 252
Savings deposits 1,078 1,277 1,823
Time deposits 2,147 1,898 1,548
Less withdrawal penalties (9) (6) (7)
------- ------- -------
$3,473 $3,412 $3,616
======= ======= =======
The average cost of deposits was 4.43%, 4.22% and 3.81% for the years ended
December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, 1995
and 1994, the cost of deposits was 4.45%, 4.44% and 3.94%, respectively.
FEDERAL HOME LOAN BANK ADVANCES - There were no FHLB advances outstanding
at December 31, 1996, and $10.5 million of FHLB advances were outstanding at
December 31, 1995. The weighted average interest rate on FHLB advances
outstanding at December 31, 1995 was 5.78%. FHLB advances are secured by
pledges of FHLB stock, funds on deposit, and by a blanket assignment of the
Bank's unpledged, qualifying mortgage loans, mortgage-backed securities, and
other investment securities.
F-15
INCOME TAXES - A summary of the current and deferred components of income
tax expense (benefit) are as follows:
(Dollars in thousands)
Year Ended December 31,
-------------------------------
1996 1995 1994
------ ------ -------
Current - Federal $549 $595 $ 921
- State 118 164 205
----- ----- -------
667 759 1,126
----- ----- -------
Deferred - Federal (15) (44) (13)
- State (3) (1) (2)
----- ----- -------
(18) (45) (15)
----- ----- -------
Provision for income taxes $649 $714 $1,111
===== ===== =======
The Company's income taxes differ from those computed at the federal
statutory corporate tax rate of 34% for 1996, 1995 and 1994 as follows:
Year Ended December 31,
-------------------------------
1996 1995 1994
------ ------ -------
Tax provision at statutory rate $596 $828 $1,019
Tax-exempt interest and dividends (23) (29) (42)
State tax, net of federal income tax benefit 76 108 134
Tax reserve for loan losses due to an
increase in base year reserves (194)
Other 1
---- ----- -------
Provision for income taxes $649 $714 $1,111
==== ===== =======
F-16
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at the dates
indicated are as follows:
(Dollars in thousands) December 31,
-----------------
1996 1995
---- ----
Deferred tax assets:
Loans, due to the reserve for possible loan
losses deferred for financial purposes $ 29 $ 29
Vacation/termination benefits not recognized
for tax purposes until paid 27 25
Other deferred tax assets 13
---- ----
69 54
---- ----
Deferred tax liabilities:
Premises and equipment, principally due to
differences in depreciation 211 198
Federal Home Loan Bank stock, principally due
to dividends not recognized for tax purposes 68 88
Other deferred tax liabilities 13 9
---- ----
292 295
---- ----
Net deferred tax liability $223 $241
==== ====
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the existence of, or generation of, taxable income in
the periods which those temporary differences are deductible. Management
considers the scheduled reversal of deferred tax liabilities, taxes paid in
carryback years, projected future taxable income, and tax planning strategies
in making this assessment. Based upon the level of historical taxable income
and projections for future taxable income over the periods which the deferred
tax assets are deductible, at December 31, 1996 and 1995, management believes
it is more likely than not that the Company and the Bank will realize the
benefits of those deductible differences.
Retained earnings, at December 31, 1996, includes approximately $3,200,000
for which no provision for federal income tax has been made. This amount
represents the base year tax bad debt reserve which is essentially an
allocation of earnings to pre-1988 bad debt deductions for income tax purposes
only. This amount is treated as a permanent difference and deferred taxes are
not recognized unless it appears that this amount will be reduced and thereby
result in taxable income in the foreseeable future. Under current tax
regulations, management does not foresee any changes in its business or
operations which would result in a recapture of its federal bad debt reserve
into taxable income.
For taxable years beginning prior to January 1, 1996, savings institutions
such as the Bank were allowed, if certain conditions were met, a special bad
debt deduction for income tax purposes under Section 593 of the Internal
Revenue Code. The deduction was based on actual loss experience over a period
of years or a percentage of taxable income before such deduction. The Bank,
beginning with the 1988 tax year, had not utilized the percentage of taxable
income bad debt deduction. F-17
Recently enacted federal legislation repeals the Section 593 percentage of
taxable income method of computing tax deductions for bad debt reserves for
tax years beginning after December 31, 1995. As a result, savings
associations are no longer able to calculate their deduction for bad debts
using the percentage-of-taxable-income method. Instead, savings associations
with assets of less than $500 million compute their deduction based on actual
loss experience over a period of years. This legislation also requires
savings associations to recapture into income over a six-year period their bad
debt tax reserves in excess of their 1987 "base year" reserve level thereby
generating additional tax liability. At December 31, 1996, the Bank's bad
debt tax reserves were approximately the same as its base year reserves,
therefore no recapture is required.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company is required to disclose
the fair value of financial instruments, whether recognized or not recognized
in the statement of financial condition. A financial instrument is defined as
cash, evidence of an ownership interest in an entity, or a contract that both
imposes a contractual obligation on one entity to deliver cash or another
financial instrument to a second entity.
Quoted market prices are used for fair value when available, but do not
exist for some of the Company's financial instruments, primarily loans and
time deposits. The fair value of these instruments has been derived from the
Office of Thrift Supervision Net Portfolio Value Model (OTS Model). This OTS
Model primarily employs the static discounted cash flow method which estimates
the fair value of loans and time deposits by discounting the cash flows the
instruments are expected to generate by the yields currently available to
investors on instruments of comparable risk and duration. Therefore, to
calculate present value, the OTS Model makes assumptions about the size and
timing of expected cash flows and appropriate discount rates. Different
assumptions could materially change these instruments' estimated value.
The following assumptions and methods are used by the Company in estimating
fair value:
Financial Assets - The fair value approximates book value for cash and cash
equivalents as they represent over-night funds. For all investment securities,
the fair value is based upon quoted market prices. The fair value of loans
receivable was obtained from the OTS Model. The fair value of accrued
interest receivable approximates book value as the Company expects contractual
receipt in the short-term. The fair value of FHLB stock approximates
redemption value. Secondary market loan sales receivable approximates book
value as each loan is contracted for immediate sale.
Financial Liabilities - The fair value of NOW and money market demand
accounts and non-term savings deposits approximates book value as these
deposits are payable on demand. The fair value of time deposits was obtained
from the OTS Model. The fair value of FHLB advances and accrued interest
payable approximates book value due to contractual payment in the short-term.
Off-Balance Sheet - Commitments made to extend credit represent commitments
for loan originations, the majority of which are contracted for immediate
sale, and therefore no fair value adjustment is necessary.
Limitations - Fair value estimates are made at a specific point in time,
based on relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that could
result from offering for sale at one time the Company's entire holdings of a
F-18
particular instrument. Because no market exists for a significant portion of
the Company's financial instruments, fair value estimates are based on
judgments regarding comparable market interest rates, future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing on-and-off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not
considered financial instruments. In addition, the tax effect of the
difference between the fair value and carrying value of financial instruments
can have a significant effect on fair value estimates and have not been
considered in the estimates presented herein.
The approximate book value and estimated fair value of the Company's financial
instruments at the dates indicated are as follows:
(Dollars in thousands)
December 31,
-----------------------------------
1996 1995
---------------- ----------------
Book Fair Book Fair
Value Value Value Value
------- ------- ------- -------
Financial Assets:
Cash and cash equivalents $ 2,934 $ 2,934 $ 1,221 $ 1,221
Securities held-to-maturity 35,828 35,943 43,117 43,199
Securities available-for-sale 25,185 25,185 35,261 35,261
Loans receivable 35,176 35,700 30,352 31,200
Accrued interest receivable 817 817 915 915
Federal Home Loan Bank stock 379 379 476 476
Secondary market loan sales receivable 1,239 1,239 724 724
Financial Liabilities:
NOW and money market demand accounts 8,669 8,669 8,167 8,167
Savings deposits 29,918 29,918 32,461 32,461
Time deposits 40,110 40,000 37,662 37,700
Federal Home Loan Bank advances 10,500 10,500
Accrued interest payable 66 66 67 67
Off-Balance Sheet:
Commitments to extend credit 462 462 1,328 1,328
MATERIAL CONTRACTS - Beginning in 1993, and renewed each year since, the
Bank's Board of Directors provided change of control severance agreements to
its President and each of its five Vice Presidents. The agreements provide
for severance compensation in the event any company or person acquires control
of the Bank, as determined in accordance with applicable federal regulations.
Pursuant to his agreement upon a change of control, the Bank's President would
be entitled to lump-sum compensation equal to two times his annual base salary
plus any target bonuses, and 24 months of continued welfare and employee
benefits. The agreements with the Bank's five Vice Presidents provide for
payment, upon a change of control, of lump-sum compensation equal to their
annual base salary, plus any target bonuses, and 12 months of continued
welfare and employee benefits. F-19
REGULATORY CAPITAL - The Bank is required to meet three FIRREA-enacted
capital requirements: a tangible capital requirement (stockholders' equity
adjusted for the effects of intangibles, investments and advances to
"nonincludable" subsidiaries and other factors) equal to not less than 1.5% of
tangible assets (as defined in the regulations), a core capital requirement,
comprised of tangible capital adjusted for supervisory goodwill and other
defined factors equal to not less than 3% of tangible assets, and a risk-based
capital requirement equal to at least 8% of all risk-weighted assets. For
risk-weighting, selected assets are given a risk assignment of 0% to 100%.
The Bank's total risk-weighted assets at December 31, 1996, were approximately
$35.8 million.
The following table demonstrates as of December 31, 1996, the extent to
which the Bank exceeds in dollars and in percent, the three FIRREA minimum
capital requirements:
(Dollars in thousands)
Regulatory Capital
--------------------------------
Actual Requirement Excess
------- ----------- -------
Tangible capital:
$ Amount $14,974 $1,417 $13,557
% of tangible assets 15.9% 1.5% 14.4%
Core capital:
$ Amount $14,974 $2,834 $12,140
% of tangible assets 15.9% 3.0% 12.9%
Risk-based capital:
$ Amount $15,009 $2,862 $12,147
% of risk-weighted assets 42.0% 8.0% 34.0%
Stockholders' equity as shown on the Company's consolidated financial
statements differs from tangible, core and risk-based regulatory capital at
December 31, 1996, as follows:
(Dollars in thousands)
Consolidated stockholders' equity $24,416
Parent holding company stockholders' equity (9,100)
--------
Bank stockholders' equity 15,316
Non-includable investments and notes of Bank subsidiary (386)
Unrealized loss on debt investment securities available-for-sale 44
--------
Tangible and core Bank capital 14,974
Reserve for possible loan losses 75
Other assets required to be deducted (40)
--------
Risk-based capital $15,009
========
The OTS is responsible for insuring that capital standards reflect interest
rate risk (IRR), defined as the potential for the reduction of earnings and
stockholders' equity resulting from changes in market interest rates. The OTS
has delayed implementation of a proposed capital deduction for savings
institutions with a greater than normal level of IRR as calculated by the OTS
Model. Due to its current capital position, the most recent OTS calculated
IRR and proposed exemption criteria, the Bank is not expected to have an IRR
capital adjustment.
F-20
Failure to comply with applicable regulatory capital requirements can
result in capital directives from the director of the OTS, restrictions on
growth, and other limitations on a savings association's operations.
LITIGATION - The Company is not involved in any pending material legal
proceedings.
REORGANIZATION - During the year ended December 31, 1996, the Board of
Directors of the Bank approved a plan of reorganization whereby the Bank
became a wholly-owned subsidiary of United Financial Corp. The plan was
approved by stockholders and federal regulators and each common share of
United Savings Bank, F.A. was exchanged for one share of United Financial
Corp. The reorganization was a business combination between entities under
common control and accounted for similar to a pooling-of-interests.
UNITED FINANCIAL CORP. (Parent Only)
STATEMENT OF FINANCIAL CONDITION
(Dollars in thousands)
December 31, 1996
-----------------
ASSETS
Cash and cash equivalents - interest-earning
deposits with banks $ 593
--------
Investments:
Securities held-to-maturity 1,600
Securities available-for-sale 5,998
--------
7,598
Loans receivable 802
Accrued interest receivable 138
Investment in subsidiary 15,316
--------
$24,447
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Income taxes payable $ 31
--------
Stockholders' equity:
Common stock 1,223
Paid-in capital 7,626
Retained earnings-partially restricted 16,060
Unrealized loss on securities available-for-sale (493)
--------
24,416
--------
$24,447
========
F-21
UNITED FINANCIAL CORP. (Parent Only)
STATEMENT OF INCOME
(Dollars in thousands)
Year Ended December 31, 1996
Income ----------------------------
Interest Income:
Loans $ 13
Investment securities 290
Interest-earning deposits 41
--------
344
Gain on sale of investment security 18
Dividends from subsidiary 556
--------
918
Expenses 11
--------
Income before income taxes and equity in
undistributed income of subsidiary 907
Provision for current income tax expense 133
--------
Income before equity in undistributed
income of subsidiary 774
Equity in undistributed income of subsidiary 329
--------
Net income $ 1,103
========
F-22
UNITED FINANCIAL CORP. (Parent Only)
STATEMENT OF CASH FLOWS
(Dollars in thousands) Year Ended December 31, 1996
----------------------------
Operating Activities
Net income $1,103
Adjustments to reconcile net cash provided
by operating activities:
Investment securities discount accretion (20)
Gain on sale of available-for-sale security (18)
Net change in accrued interest receivable (138)
Net change in income taxes payable 10
Equity in undistributed income of subsidiary (329)
-------
Net cash provided by operating activities 608
-------
Investing Activities
Purchases of held-to-maturity securities (2,600)
Proceeds from matured held-to-maturity security 1,000
Purchases of available-for-sale securities (6,908)
Proceeds from sale of available-for-sale security 1,002
Purchase of mortgage loan participation from subsidiary (810)
Loan principal collections 8
-------
Net cash used by investing activities (8,308)
-------
Financing Activities
Initial capitalization from subsidiary 8,886
Holding company formation costs (37)
Cash dividends paid (556)
-------
Net cash provided by financing activities 8,293
-------
Increase in cash and cash equivalents 593
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year $ 593
=======
Cash payments for income taxes $ 123
F-23
(3) EXHIBITS.
3.1 Charter of the Company incorporated by reference to Exhibit 3.1
of the Company's Form 10-K for the year ended December 31, 1986,
dated March 23, 1987.
3.2 Bylaws of the Company incorporated by reference to Exhibit 3.2
of the Company's Form 10-K for the year ended December 31, 1986,
dated March 23, 1987.
4 Instruments defining the rights of stockholders incorporated
by reference to Exhibit 4(i) to the Company's Registration
Statement on Form 10, dated August 11, 1986.
10.1 Material Contracts - Change of Control Severance Agreement
incorporated by reference to Exhibit 10.1 of the Company's Form
10-K for the year ended December 31, 1993.
10.2 Schedule to Exhibit 10: Change of Control Severance Agreement
incorporated by reference to Exhibit 10.2 of the Company's Form
10-K for the year ended December 31, 1993.
22.1 Subsidiaries of the Company.
(b) Reports on Form 8-K filed during the quarter ended December 31,
1996
None
EXHIBIT INDEX
Exhibit Number Description
- -------------- ------------
22.1 Subsidiaries of the Company.
EXHIBIT 22.1
SUBSIDIARIES OF THE COMPANY
State of
Percentage of Incorporation
Parent Subsidiary Ownership or Organization
- ---------------------- -------------- ------------- ---------------
United Financial Corp. United Savings 100% Minnesota
Bank, F.A.
SIGNATURES
Pursuant to the requirements of section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized:
UNITED FINANCIAL CORP.
Date: March 24, 1997 By: /s/Bruce K. Weldele
--------------------------- ---------------------------------
Bruce K. Weldele
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By: /s/Bruce K. Weldele By: /s/G. Brent Marvosh
------------------------------ ---------------------------------
Bruce K. Weldele G. Brent Marvosh, CPA
Chairman of the Board, Vice President, Finance/Treasurer
President and (Principal Finance and
Chief Executive Officer Accounting Officer)
Date: March 24, 1997 Date: March 24, 1997
---------------------------- -------------------------------
By: /s/ Loyall Kissee By: /s/William L. Madison
------------------------------ --------------------------------
Loyall Kissee William L. Madison
Vice President and Secretary Director
Date: March 24, 1997 Date: March 24, 1997
---------------------------- ------------------------------
By: /s/Dr. J. William Bloemendaal By: /s/Dean J. Mart
------------------------------ --------------------------------
Dr. J. William Bloemendaal Dean J. Mart
Director Senior Vice President/Director
Date: March 24, 1997 Date: March 24, 1997
---------------------------- ------------------------------
By: /s/Elliott L. Dybdal By: /s/ Rudy Tramelli
------------------------------ --------------------------------
Elliott L. Dybdal Rudy Tramelli
Director Director
Date: March 24, 1997 Date: March 24, 1997
---------------------------- ------------------------------
By: not in attendance
------------------------------
Larry D. Williams
Director